NEOMAGIC CORP - 10-Q Quarterly Report

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 ý No o

The number of shares of the Registrant's Common Stock, $.001 par value, outstanding at November 30, 2002 was 29,947,125

		PAGE
PART I. CONSOLIDATED CONDENSED FINANCIAL INFORMATION
Item 1.	Unaudited Consolidated Condensed Financial Statements:
	Consolidated Condensed Statements of Operations Three and Nine months ended October 31, 2002 and 2001	3
	Consolidated Condensed Balance Sheets October 31, 2002 and January 31, 2002	4
	Consolidated Condensed Statements of Cash Flows Nine months ended October 31, 2002 and 2001	5
	Notes to Unaudited Consolidated Condensed Financial Statements	6-12
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	12-27
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27
Item 4.	Controls and Procedures	27
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	28
Item 2.	Changes in Securities	28
Item 3.	Defaults Upon Senior Securities	28
Item 4.	Submission of Matters to a Vote of Security Holders	28
Item 5.	Other Information	28
Item 6.	Exhibits and Reports on Form 8-K	28
	Signatures	29
	Certifications	30-31

NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

NEOMAGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

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 Note disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company, the financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position at October 31, 2002, the operating results for the three and nine months ended October 31, 2002 and 2001, and the cash flows for the nine months ended October 31, 2002 and 2001. 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, 2002, included in the Company's most recent Form 10-K filed with the Securities and Exchange Commission.

The results of operations for the three and nine months ended October 31, 2002 are not necessarily indicative of the results that may be expected for the year ending January 31, 2003.

The third fiscal quarters of 2003 and 2002 ended on October 27, 2002 and October 28, 2001, respectively. For ease of presentation, the accompanying financial statements have been shown as ending on the last day of the calendar month of October.

In July 2002, the Financial Accounting Standards Board approved Statement of Financial Accounting Standards No. 146 (SFAS 146) "Accounting for Costs Associated with Exit or Disposal Activities." SFAS 146 addresses the financial accounting and reporting for obligations associated with an exit activity, including restructuring, or with a disposal of long-lived assets. Exit activities include, but are not limited to, eliminating or reducing product lines, terminating employees and contracts and relocating plant facilities or personnel. SFAS 146 specifies that a company will record a liability for a cost associated with an exit or disposal activity only when that liability is incurred and can be measured at fair value. Therefore, commitment to an exit plan or a plan of disposal expresses only management's intended future actions and, therefore, does not meet the requirement for recognizing a liability and the related expense. SFAS 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. The Company does not anticipate that the adoption of SFAS 146 will have a material effect on its financial position or results of operations.

In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144 (SFAS 144), "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and the accounting and reporting provisions of APB No. 30, "Reporting the Results of Operations for a Disposal of a Segment of a Business." The Company adopted SFAS 144 on February 1, 2002. In accordance with SFAS 144, the Company assesses the recoverability of its long-lived assets by comparing projected undiscounted net cash flows associated with those assets against their respective carrying amounts to determine whether impairment exists. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. See Note 9 "Intangible Assets" for the effect of adopting the provisions and the results of impairment assessments.

NeoMagic adopted Statement of Financial Accounting Standards No. 141 (SFAS 141) "Business Combinations", and Statement of Financial Accounting Standards No. 142 (SFAS 142) "Goodwill and Other Intangible Assets," in the first quarter of fiscal 2003. See Note 3 "Cumulative Effect of Accounting Change" for the effect of adopting the provisions and the results of transitional impairment tests.

On February 1, 2002, NeoMagic adopted Statement of Accounting Standards No. 142 (SFAS 142), "Goodwill and Other Intangibles Assets, which required companies to discontinue the amortization of goodwill and certain intangible assets with an indefinite useful life. Instead, goodwill and intangible assets deemed to have an indefinite useful life must be reviewed for impairment using a two step method upon adoption of SFAS 142 and annually thereafter, or more frequently when indicators of impairment exist.

Upon adoption of the standard, the Company tested goodwill for impairment using the two-step process prescribed in SFAS 142. The Company completed the first of the two required transitional impairment tests of goodwill and indefinite lived intangible assets as of February 1, 2002 during the second quarter of fiscal 2003. The Company determined that there were indicators of impairment, as the carrying value of the reporting unit exceeded fair value derived from the market capitalization model. The second step of the transitional impairment test, which is to determine the amount of impairment, was completed in the third quarter of fiscal 2003 by comparing the implied values of the goodwill to the fair values of net tangible assets and identifiable intangibles. Based on the results of the second transitional impairment test, the Company recorded a non-cash accounting change adjustment of $4.2 million, reflecting a reduction in the carrying value of its goodwill, as a cumulative effect of an accounting change in the accompanying consolidated condensed statements of operations.

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

For the three months ended October 31, 2002 and October 31, 2001 and for the nine months ended October 31, 2002 and October 31, 2001, respectively, basic earnings per share equals diluted earnings per share due to the net loss for those periods.

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, the Company received $11.7 million in a lump-sum cash payment. An additional $2.3 million was 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 that was transferred to the Buyer. In addition, the Company accrued approximately $0.6 million in transaction costs and approximately $2.3 million in retention packages for the affected employees during the first quarter of fiscal 2001. During the second quarter of fiscal 2001, the Company incurred additional costs of $0.3 million. During the third quarter of fiscal 2001, the Company received a $1.5 million cash payment which was previously contingent on the Company's performance of certain obligations related to the transfer of licenses with third parties to the Buyer. As a result, the Company recorded a pre-tax gain of approximately $6.5 million on the sale, which is recorded in Income, net of expenses, from the sale of DVD assets on the Consolidated Condensed Statements of Operations for the year ended January 31, 2001. In the first quarter of fiscal 2003, the Company received a $1.6 million cash payment previously contingent on the transfer of licenses with third parties to the Buyer, which is recorded as a gain in the Consolidated Condensed Statements of Operations for the nine months ended October 31, 2002.

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

Inventory consists of:		October 31, 2002		January 31, 2002
		(in thousands)
Raw materials		$	175	$	—
Work in process			99		—
Finished goods			452		78

	Total	$	726	$	78

Total accumulated other comprehensive loss was $10 thousand at October 31, 2002 compared to other comprehensive income of $19 thousand at January 31, 2002. Accumulated other comprehensive income consists entirely of unrealized gains and losses on available for sale securities.

Effective February 1, 2002, NeoMagic adopted SFAS 142, which was issued by the Financial Accounting Standards Board in July 2001. Under this standard, the Company ceased amortizing goodwill effective February 1, 2002. The Company completed the transitional tests for goodwill impairment using the two-step process prescribed in SFAS 142. See Note 3 "Cumulative Effect of Accounting Change" for the effects of adopting the provisions and the results of transitional impairment tests. In addition, on adoption of SFAS 142, the Company reclassified certain intangibles with net book value $383 thousand, consisting of assembled workforce and acquisition costs, which are no longer defined as an acquired intangible under SFAS 142, to goodwill. Accordingly, there was no

amortization of assembled workforce and acquisition costs recognized during the nine months ended October 31, 2002.

The following table presents a reconciliation of previously reported net loss and net loss per share to the amounts adjusted to exclude goodwill and acquired workforce amortization (in thousands, except per share data):

The following table provides a summary of the carrying amount of intangible assets that will continue to be amortized and excludes amounts originally allocated to an intangible asset representing the value of the assembled workforce:

Amortization expense for other intangible assets was $450 thousand and $1,452 thousand for the three and nine months ended October 31, 2002, respectively. The estimated annual amortization expense for other intangible assets is $423 thousand for the remaining quarter of fiscal 2003, $1,823 thousand for the fiscal year ended January 31, 2004, $1,603 thousand for the fiscal year ended January 31, 2005, and $939 thousand for the fiscal year ended January 31, 2006.

The Company wrote off licensed intangible properties with a net book value of $531 thousand relating to licensed intellectual property that was no longer used by the Company in the first quarter of fiscal 2003.

During the third quarter of fiscal 2003, the Company determined that certain intangible assets purchased as part of the LinkUp Systems Corporation acquisition completed in December 2001 were impaired and recorded a total impairment charge of $873 thousand during the period. Of the total impairment charge, $367 thousand related to impairment of certain acquired intangibles that were capitalized relating to developed technology. The impairment was caused by a decline in the related sales forecasts of products associated with the intangibles. The impairment charge relating to developed technology is included in the cost of sales section of the consolidated statements of operations. In addition, the Company also recorded a $506 thousand impairment charge with respect to intangibles relating to customer relationships. Several key customers with whom the Company was engaged have abandoned their related product plans, which led to the impairment. The impairment charge relating to customer relationships is included in the operating expenses section of the consolidated statements of operations.

In January 2001, the Company extended its wafer supply agreement with Infineon Technologies AG of Germany ("Infineon") through fiscal 2004 to ensure future wafer supply for the Company's new product efforts. The terms of the agreement provided that NeoMagic would make use of Infineon's 0.20 micron and 0.17 micron embedded DRAM (eDRAM) process technologies. The agreement also provided for access to additional capacity and to more advanced process technologies to be developed by Infineon. NeoMagic provided $15 million in guarantees towards its wafer purchases over the term of the agreement. The amount of guarantee is included as restricted cash on the balance sheet at January 31, 2002. At the end of fiscal year 2002, due to uncertainties over Infineon's continued eDRAM product development, the Company decided not to use Infineon's eDRAM technology for its future production. Discussions commenced between NeoMagic and Infineon on restructuring the wafer supply agreement with the intent to release NeoMagic from the related guarantee. During the nine-month period ended October 31, 2002, the Company has recorded $3.6 million in charges, which reflects the value of the final settlement. These amounts are shown on the Consolidated Condensed Statements of Operations as a special charge for the nine months ended October 31, 2002. As a result of the settlement, $15.0 million of restricted cash was released and reclassified to cash and cash equivalents on the Consolidated Condensed Balance Sheet.

In October 2002, the Company entered into a capital lease to finance software licenses used in the design of semiconductors. Obligations under capital leases represent the present value of future payments under the lease agreements. Property, plant and equipment includes the following amounts for leases that have been capitalized:

October 31,	2002		2001
	(in thousands)
Net property, plant and equipment under capital lease	$	1,589	$	—

Future minimum payments under the capital leases consist of the following at October 31, 2002:

Fiscal year ending January 31,
(in thousands)
2003	$	262
2004		843
2005		843
2006		422

Total minimum lease payments		2,370
Amount representing interest		269

Present value of net minimum lease payments		2,101
Less current portion		744

Long-term portion	$	1,357

The consolidated statements of operations of NeoMagic presented throughout this report include the operating results of LinkUp Systems from the date of acquisition, December 18, 2001. The following pro forma information for the nine months ended October 31, 2001 is presented as if the acquisition of LinkUp was consummated at the beginning of fiscal 2002. This unaudited pro forma data does not purport to represent the Company's actual results of operations had the LinkUp acquisition occurred at the beginning of fiscal 2002 and should not serve as a forecast of the Company's operating results for any future periods.

The pro forma information for October 31, 2001 is based on historical results of operations of NeoMagic for the nine month period ended October 31, 2001 and historical results of LinkUp from January 1, 2001 to October 31, 2001 (in thousands, except per share data).

	Three Months Ended October 31, 2001		Nine Months Ended October 31, 2001
Pro forma net sales	$	536		$	1,711
Pro forma net loss	$	(8,524	)	$	(26,277	)
Pro forma basic and diluted net loss per share	$	(0.31	)	$	(0.95	)

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 90% and 73% of net sales in the three months ended October 31, 2002 and 2001, respectively. Export sales accounted for 89% and 92% of net sales in the nine months ended October 31, 2002 and 2001, respectively. All sales transactions were denominated in United States dollars.

Four customers accounted for 46%, 15%, 14%, and 10% of net sales for the three months ended October 31, 2002. One customer accounted for 87% of net sales for the three months ended October 31, 2001. Four customers accounted for 21%, 20%, 20%, and 20% of net sales for the nine months ended October 31, 2002. Four customers accounted for 41%, 23%, 17% and 11% of net sales for the nine months ended October 31, 2001.

In some cases in Japan and Asia, NeoMagic sells its products through distributors. In these cases, "customers" are the distributors, not the original equipment manufacturer that actually uses the

NeoMagic chip in its device. For instance, Sony Japan uses the NeoMagic NMC 1121 (companion chip) in two of its CLIE PDAs. However, the revenue is recognized as revenue from Macnica, NeoMagic's Japanese distributor. This revenue accounts for 46% of NeoMagic's revenue in the third quarter. In short, revenue from products that are sold to OEMs outside of the United States is added together according to the distributor who sold the product. Each distributor is then considered a "customer" and this total is assigned to that customer/distributor.

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

This filing contains forward-looking statements within the meaning of the Securities Act of 1933. Examples of such forward-looking statements include statements about our current expectations for future product sales and revenue growth, our cash position, market developments and visibility, as well as statements about the introduction of new members of the MiMagic product family and the development of new technology. These statements reflect our current expectations. However, actual events and results could vary significantly based on a variety of factors including but not limited to customer acceptance of new NeoMagic products, the market acceptance of handheld system products developed and marketed by customers that use the Company's products, the Company's ability to execute product and technology development plans on schedule, and the Company's ability to access advanced manufacturing technologies in sufficient capacity without significant cash pre-payments or investment. Additional risks that could affect the Company's future operating results are more fully described below in "Factors that May Affect Future Results" and in our prior filings with the United States Securities and Exchange Commission (SEC), which are available online at http://www.sec.gov. NeoMagic may, from time to time, make additional written or oral forward-looking statements, including statements contained in filings with the SEC and reports to shareholders. NeoMagic does not undertake the obligation to update any forward-looking statements that may be made by or on behalf of the company.

NeoMagic develops, manufactures and sells applications processors to enable new generations of handheld systems, offering low power, small form-factor, and high performance multimedia features and performance. Previously, the Company provided semiconductor solutions for the Notebook PC Multimedia Accelerator marketplace. In April 2000, the Company announced its intention to exit this market and is now focused solely on developing, manufacturing and selling applications processors and companion chips for the Handheld Systems market. The Company is now generating revenues from this new product effort. Throughout the year, the Company expects to see customers introducing new handheld systems that use the Company's chips, primarily in Japan, Europe, and the Far East. The Company also expects to launch additional new members of its MiMagic™ family of applications processors as fiscal 2003 and fiscal 2004 progress.

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

The Company's fiscal year end is January 31. Any references herein to a fiscal year refer to the year ended January 31 of such year. The third fiscal quarters of 2003 and 2002 ended on October 27,

2002 and October 28, 2001, respectively. For ease of presentation, the accompanying financial statements have been shown as ending on the last day of the calendar month of October.

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

The Company believes the following critical accounting policies involve more significant judgments and estimates in the preparation of the Company's consolidated financial statements:

NeoMagic has significant tangible and intangible assets on its balance sheet, including other purchased intangibles related to acquisitions.

As a result of adopting SFAS 142, "Goodwill and Other Intangible Assets," on February 1, 2002, the Company discontinued the amortization of goodwill. Instead, goodwill was reviewed for impairment upon adoption of SFAS 142 and again in the third quarter of fiscal 2002 because indicators of impairment were present. Refer to Note 3 of the consolidated condensed financial statements for a discussion of the impact of adopting and applying SFAS 142.

Intangibles assets are carried and reported at acquisition cost, net of accumulated amortization subsequent to acquisition. The acquisition cost is amortized over estimated useful lives, which range from 2 to 3 years. Intangible assets are reviewed for impairment whenever events or circumstances indicate impairment might exist, or at least annually, in accordance with SFAS 144, "Accounting for the impairment of Disposal of Long-Lived Assets." Projected undiscounted net cash flows expected to be derived from the use of those assets are compared to the respective net carrying amounts to determine whether impairment exists. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. The determination of the net carrying value of goodwill and intangible assets and the extent to which, in any, there is impairment are dependent on significant estimates and judgments on the Company's part, including the useful life over which the intangible assets are to be amortized, and the estimates of the value of future cash flows, which are based upon further estimates of future revenue, expenses and operating margins. Refer to Note 9 of the consolidated condensed financial statements for a discussion of the impact of adopting and applying SFAS 144.

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

introduce product enhancements and new products, and improve our manufacturing processes, demand for our existing products in inventory may decrease. In the first quarter of fiscal 2001, consistent with this policy, we recorded a charge of $7.0 million for excess and obsolete write-downs related to restructuring the business. In the future, we may find that similar assessments may warrant another write-down or write-off of inventory.

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

With respect to products shipped to distributors, the Company generally defers recognition of product revenue until the distributors sell its products to their customers. On occasion, however, the Company will sell products with "End of Life" status to its distributors under special arrangements without any price protection or return privileges for which the Company recognizes revenue upon transfer of title, typically upon shipment.

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

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

Net sales were $655 thousand and $1.5 million for the three months and nine months ended October 31, 2002, respectively, compared to $83 thousand and $351 thousand for the three months and nine months ended October 31, 2001. Net sales increased due to the Company's shipments of its new applications processors and companion integrated circuits for the Handheld Systems market in the three months and nine months ended October 31, 2002. Sales for the nine months ended October 2001 were of the Company's legacy notebook products.

In some cases in Japan and Asia, NeoMagic sells its products through distributors. In these cases, "customers" are the distributors, not the original equipment manufacturer that actually uses the NeoMagic chip in its device. For instance, Sony Japan uses the NeoMagic NMC 1121 (companion chip) in two of its CLIE PDAs. However, the revenue is recognized as revenue from Macnica, NeoMagic's Japanese distributor. This revenue accounts for 46% of NeoMagic's revenue in the third quarter. In short, revenue from products that are sold to OEMs outside of the United States is added together according to the distributor who sold the product. Each distributor is then considered a "customer" and this total is assigned to that customer/distributor.

Gross margin (loss) was $(492) thousand and $82 thousand for the three months ended October 31, 2002 and 2001, respectively. Gross margin (loss) was $(941) thousand and $343 thousand in the nine months ended October 31, 2002 and 2001, respectively. The negative gross margins in the three and nine month periods ended October 31, 2002 are due to under absorption of manufacturing overhead resulting from low production levels and amortization and impairment charges of acquired intangible assets. The Company's sales in the three and nine month periods ended October 31, 2001 were of its fully reserved legacy notebook products.

Research and development expenses include compensation and associated costs relating to development personnel, operating system costs and prototyping costs, which are comprised of pre-production photomask costs, pre-production wafer costs, and amortization of intangibles relating to development stage products. Research and development expenses were $5.7 million and $6.0 million for the three months ended October 31, 2002 and 2001, respectively. Research and development expenses were $18.1 million and $19.3 million for the nine months ended October 31, 2002 and 2001, respectively. These expenses include amortization of deferred compensation of $0.1 million and $0.5 million for the three months ended October 31, 2002 and 2001, respectively and $0.9 million and $1.5 million for the nine months ended October 31, 2002 and 2001, respectively. The decreases of $0.4 million and $1.2 million in total research and development expenses for the three months and nine months ended October 31, 2002 are primarily related to lower consulting costs offset somewhat by increased amortization of acquired and licensed intangibles relating to products which are in the research and development stage. Included in the research and development expenses for the nine months ended October 31, 2002, was a charge of $0.5 million to write off certain Licensed Intellectual Property. The Company has made, and intends to continue to make, significant investments in research and development as it focuses on developing products for the Handheld Systems market.

Sales, general and administrative expenses were $2.1 million and $1.9 million for the three months ended October 31, 2002 and 2001, respectively. Sales, general and administrative expenses were $7.8 million and $5.8 million for the nine months ended October 31, 2002 and 2001, respectively. These expenses include amortization of deferred compensation of $0.1 million and $0.1 million for the three months ended October 31, 2002 and 2001, respectively and $0.9 million and $0.4 million for the nine months ended October 31, 2002 and 2001, respectively. Sales, general and administrative expenses increased in absolute dollars due primarily to increased sales expenses related to the Company's new

product efforts for the Handheld Systems market as well as increased amortization of deferred compensation resulting from the acquisition of LinkUp Systems in December 2001.

NeoMagic adopted Statement of Financial Accounting Standards No. 144 (SFAS 144), "Accounting for the Impairment or Disposal of Long-Lived Assets," in the first quarter of fiscal 2003. In accordance with SFAS 144, the Company assesses the recoverability of its long-lived assets by comparing projected undiscounted net cash flows associated with those assets against their respective carrying amounts to determine whether impairment exists. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. During the third quarter of fiscal 2003, the Company determined that certain intangible assets purchased as part of the LinkUp Systems Corporation acquisition completed in December 2001 were impaired and recorded a total impairment charge of $873 thousand during the period. Of the total impairment charge, $367 thousand related to impairment of certain acquired intangibles that were capitalized relating to developed technology. The impairment was caused by a decline in the related sales forecasts of products associated with the intangibles. The impairment charge relating to developed technology is included in the cost of sales section of the consolidated statements of operations. In addition, the Company also recorded a $506 thousand impairment charge with respect to intangibles relating to customer relationships. Several key customers with whom the Company was engaged have abandoned their related product plans, which led to the impairment. The impairment charge relating to customer relationships is included in the operating expenses section of the consolidated statements of operations.

retention packages for the affected employees during the first quarter of fiscal 2001. During the second quarter of fiscal 2001, the Company incurred additional costs of $0.3 million. During the third quarter of fiscal 2001, the Company received a $1.5 million cash payment which was previously contingent on the Company's performance of certain obligations related to the transfer of licenses with third parties to the Buyer. As a result, the Company recorded a pre-tax gain of approximately $6.5 million on the sale, which is recorded in Income, net of expenses, from the sale of DVD assets on the Consolidated Condensed Statements of Operations for the year ended January 31, 2001. In the first quarter of fiscal 2003, the Company received a $1.6 million cash payment previously contingent on the transfer of licenses with third parties to the Buyer, which is recorded as a gain in the Consolidated Condensed Statements of Operations for the nine months ended October 31, 2002.

The Company earns interest on its cash equivalents, short-term investments, and restricted cash. Interest and other income was $0.3 million and $0.8 million for the three months ended October 31, 2002 and 2001, respectively. Interest and other income was $1.6 million and $3.0 million for the nine months ended October 31, 2002 and 2001, respectively. The decrease in interest and other income is primarily due to significantly lower interest rates.

Interest expense was $0 for both the three months ended October 31, 2002 and 2001. Interest expense was $0 and $11,000 for the nine months ended October 31, 2002 and 2001, respectively.

The Company recorded a $6.3 million tax benefit in the second quarter of fiscal 2003, primarily related to changes in the federal tax law. The Job Creation and Worker Assistance Act of 2002 was enacted on March 9, 2002 and contained provisions extending the net loss carry-back period from two to five years. This change allowed the Company to utilize net operating losses incurred in fiscal 2002 to recover taxes paid in prior periods. The $6.3 million benefit represents additional refunds that the Company claimed on the 2002 net operating loss carry-back due to the change in tax law.

The Company completed the transitional impairment testing of goodwill using the two-step process prescribed in SFAS 142 during the third quarter of fiscal 2003. As a result, the Company recorded a $4.2 million non-cash charge to reduce the carrying value of its goodwill to zero, which is shown as a cumulative effect of a change in accounting principle in the third quarter of fiscal 2003.

The Company's cash, cash equivalents and short-term investments increased $2.4 million in the nine months ended October 31, 2002 to $74.3 million from $71.9 million at January 31, 2002.

Cash and cash equivalents provided by operating activities for the nine months ended October 31, 2002 was $1.0 million, compared to $28.5 million of net cash used in operating activities for the nine months ended October 31, 2001. The cash provided by operating activities stems primarily from non-cash charges for depreciation expense, deferred compensation amortization, and goodwill and other acquired intangible asset impairment charges, a decrease in restricted cash, income tax receivable and other current assets, and increases in accounts payable and compensation and related benefits partially offset by a net loss of $25.5 million, increases in accounts receivable, inventory and other assets and decreases in income taxes payable and other accruals.

Net cash provided by investing activities for the nine months ended October 31, 2002, was $4.4 million, compared to $4.0 million of net cash provided by investing activities for the nine months ended October 31, 2001. Net cash provided by investing activities for the nine months ended October 31, 2002 related primarily to net proceeds from the maturities of short-term investments of $3.5 million and proceeds from the sale of DVD assets of $1.6 million, partially offset by purchases of property, plant and equipment of $0.7 million.

Net cash provided by financing activities was $0.5 million for the nine months ended October 31, 2002, compared to $0.6 million of net cash provided by financing activities for the nine months ended October 31, 2001. The net cash provided by financing activities primarily represents proceeds from the issuance of common stock.

At October 31, 2002, the Company's principal sources of liquidity included cash, cash equivalents and short-term investments of $74.3 million. The Company believes that it will not generate cash from operations during the next twelve months. The Company 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. After this period, capital requirements will depend on many factors, including general economic conditions, 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. To the extent that existing cash, cash equivalents and short-term investment balances and any cash from operations are insufficient to fund the Company's future activities, the Company may need to raise additional equity or debt financing in the future. There can be no assurance that additional equity or debt financing, if required, will be available on acceptable terms or at all.

The Company leases software licenses under capital leases. Refer to note 9 of the consolidated condensed financial statements for additional information.

The Company has a PrimeXsys wireless platform license agreement with ARM Ltd. for intellectual property that requires payments of $425 thousand and $850 thousand in February 2003 and May 2003, respectively.

The Company leases offices in Santa Clara, California, India and Israel under operating leases that expire at various times through April 2010. Future minimum lease payments under non-cancelable operating leases as of October 31, 2002 are as follows:

Fiscal year ending January 31:
(in thousands)
2003*	$	534
2004*		1,185
2005		1,057
2006		1,083
2007		1,095
Thereafter		3,497

Total minimum lease payments	$	8,451

The Company has been incurring substantial losses as it invests heavily in new product development in advance of achieving significant customer sales. This is expected to continue in fiscal year 2004. The Company's ability to achieve cash flow breakeven is likely to depend on the success of its MiMagic 5, which has recently been released, and the success of other products and technology still in development and scheduled for release in the second half of fiscal year 2004. However, even if the MiMagic 5 and subsequent products achieve widespread customer acceptance, the length of customer design-in cycles would preclude significant product shipments in fiscal year 2004. Accordingly, even if these new products are successful, the Company will incur significant additional losses in fiscal year 2004.

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

The Company is now focused on providing high-performance semiconductor solutions for sale to original equipment manufacturers of handheld systems. New product planning is primarily focused on application processors for handheld systems, and multimedia technologies for integration into such processors, such as MPEG-4 video compression, image processing, graphics, and audio technologies. The Company's future business, financial condition and results of operations will depend to a significant extent on its ability to develop new products that address these market opportunities. As a result, the Company believes that significant expenditures for research and development will continue to be required in the future.

The markets for handheld systems are emerging opportunities, 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 to create or acquire intellectual property, the ability of strategic manufacturing partners to effectively design and implement the manufacture of new products, quality of new products, differentiation of new products from those of the Company's competitors and market acceptance of the Company's and its customers' products. There can be no assurance that the products the Company expects to introduce will incorporate the features and functionality demanded by system manufacturers and consumers, will

be successfully developed, or will be introduced within the appropriate window of market demand, nor can there be assurance that customers who utilize the Company's semiconductor products will achieve the levels of market success with their own system products that they may project to the Company.

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

The Company has exited the Notebook PC market and is generating revenues from its handheld system products. Until the Company achieves substantial growth in revenue, it will continue to incur substantial losses. There is no assurance as to how quickly revenues will grow.

The Company'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 ability of the Company to increase its customer base and its sales, 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. In particular, the Company's new product development efforts and customer engagements in System-on-Chip integration and supporting multimedia technologies such as MPEG-4 streaming video 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. Furthermore, the majority of the Company's sales were historically made, and are expected to continue to be made, on the basis of purchase orders rather than pursuant to long-term purchase agreements, which increases the difficulty of forecasting sales. The Company may be unable to adjust spending sufficiently in a timely manner to compensate for any unexpected sales shortfall, which could materially adversely affect quarterly operating results. Accordingly, the Company believes that period-to-period comparisons of its operating results should not be relied upon as an indication of future performance. In addition, the results of any quarterly period are not indicative of results to be expected for a full fiscal year. In future quarters, the Company's operating results may be below the expectations of public market analysts or investors.

In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 requires us to perform impairment analysis on our long-lived assets, other than goodwill, to be held and used whenever events or changes in circumstances indicate the carrying amount may not be recoverable. An impairment loss will be recognized if the carrying amount of a long-lived asset exceeds its fair value. SFAS 144 retains the fundamental provisions of SFAS 121 related to (i) the recognition and measurement of the impairment of long-lived assets to be held and used, and (ii) the measurement of long-lived assets to be disposed of by sale. As SFAS 144 excludes goodwill, certain long-lived assets may be subject to impairment charges sooner than they would have been recorded under SFAS 121, which SFAS 144 replaces. During the third quarter of fiscal 2003, we recorded an impairment charge of $873 thousand related to our long-lived assets as a result of our SFAS 144 analysis. If economic conditions in our industry continue to deteriorate and adversely affect

our business, we could be required to record additional impairment charges related to our long-lived assets, which could have a material adverse effect on our results of operations and financial condition. Refer to Note 2, "Recent Accounting Pronouncements," of Notes to Consolidated Condensed Financial Statements for further discussion.

Our financial results could be affected by potential changes in the accounting rules governing the recognition of stock-based compensation expense. We measure compensation expense for our employee stock plans under the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." In addition, we provide pro forma disclosures of our operating results in our Notes to Consolidated Financial Statements as if the fair value method of accounting had been applied in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation." Had we accounted for our compensation expense under the fair value method of accounting prescribed by SFAS 123, the charge would have been significant, totaling $6.7 million, $6.3 million and $7.5 million during fiscal 2002, 2001 and 2000, respectively. Currently, the U. S. Congress, the Securities and Exchange Commission and the Financial Accounting Standards Board are considering changes to accounting rules concerning the recognition of stock option compensation expense. If one or more of these proposals are implemented, we and other companies may be required to measure compensation expense using the fair value method, which would adversely affect our results of operations by reducing our income or increasing our losses by an amount equal to such stock option charges.

The Company's sales were historically concentrated within a limited customer base in the notebook PC market. The Company has now exited the notebook PC market and is generating revenues from products for the Handheld Systems market. Four customers accounted for 46%, 15%, 14%, and 10% of net sales for the three months ended October 31, 2002. One customer accounted for 87% of net sales for the three months ended October 31, 2001. Four customers accounted for 21%, 20%, 20%, and 20% of net sales for the nine months ended October 31, 2002. Four customers accounted for 41%, 23%, 17% and 11% of net sales for the nine months ended October 31, 2001. The Company expects to have commitments from only a limited number of customers during fiscal 2003. The Company expects that a small number of customers will account for a substantial portion of its net sales for the foreseeable future. As a result, the Company's business, financial condition and results of operations could be materially adversely affected by the decision of a single customer to cease using the Company's products, or by a decline in the number of handheld systems sold by a single customer.

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

The market for semiconductor solutions for handheld systems, in which the Company is now focused, is intensely competitive and is characterized by rapid technological change, evolving industry standards and declining average selling prices. NeoMagic believes that the principal factors of competition in this market are performance, price, features, power consumption, size and software support. The ability of the Company to compete successfully in this new rapidly evolving Handheld Systems market depends on a number of factors including, success in designing and subcontracting the manufacture of new products that implement new technologies, product quality and reliability, price,

the efficiency of production, ramp up of production of the Company's products for particular system manufacturers, end-user acceptance of the system manufacturers' products, market acceptance of competitors' products, NeoMagic's ability to provide appropriate applications software support, and general economic conditions.

NeoMagic competes with major domestic and international companies, some of which have substantially greater financial and other resources than the Company with which to pursue engineering, manufacturing, marketing and distribution of their products. The Company's principal competitors include Intel's StrongARM and XScale product lines, Texas Instruments' OMAP product line, and a number of vertically integrated electronics firms who are developing their own solutions. NeoMagic may also face increased competition from new entrants into the Handheld Systems Semiconductor market including companies currently at developmental stages. Certain of the Company's competitors may offer products with more functionality and or higher processor speeds at the expense of battery life and power consumption than the Company's product offerings.

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

Some of the Company's current and potential competitors may secure preferential pricing due to volume agreements that may not be available to the Company which could result in an adverse effect on the Company's business, financial condition and results of operations.

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

The Company's ability to compete in the future will also depend on its ability to identify and ensure compliance with evolving industry standards and market trends. Unanticipated changes in market trends and industry standards could render the Company's products incompatible with products developed by major hardware manufacturers and software developers. As a result, the Company could be required to invest significant time and resources to redesign its products or obtain license rights to technologies owned by third parties in order to ensure compliance with relevant industry standards and market trends. There can be no assurance that the Company will be able to redesign its products or obtain the necessary third-party licenses within the appropriate window of market demand. If the Company's products are not in compliance with prevailing market trends and industry standards for a significant period of time, the Company could miss crucial OEM design cycles, which could result in a material adverse effect on the Company's business, financial condition and results of operations.

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

of manufacturing technologies by the Company's manufacturing partner is unsuccessful, the Company's business, financial condition and results of operations would be materially and adversely affected.

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

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

The Company has wafer supply relationships with several foundries to support the Company's product efforts. Normally, 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. The Company orders wafers for deliveries in advance and with the additional time to assemble and test wafers, the Company can have orders for finished goods that will not be available for up to 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 before it receives purchase orders from its own customers. This limits the Company's ability to react to fluctuations in demand for its products, which can be unexpected and dramatic, and from time-to-time will cause the Company to have an excess or shortage of wafers for a particular product. As a result of the long lead-time for manufacturing wafers and the increase in "just in time" ordering by manufacturers, semiconductor companies such as the Company from time-to-time must take charges for excess inventory. The Company did in fact incur such charges in fiscal 2001 of $9.2 million. Significant write-offs of excess inventory have had and could continue to have a material adverse effect on the Company's financial condition and results 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.

The fabrication of semiconductors is an extremely complex process, which typically includes hundreds of process steps. Minute levels of contaminants in the manufacturing environment, defects in masks used to print circuits on a wafer, utilization of equipment with variations and numerous other factors can cause a substantial percentage of wafers to be rejected or a significant number of die on each wafer to be nonfunctional. Many of these problems are difficult to diagnose and time consuming or expensive to remedy. As a result, semiconductor companies often experience problems in achieving acceptable wafer manufacturing yields, which are represented by the number of good die as a proportion of the total number of die on any particular wafer. The Company often purchases wafers, not die, and pays an agreed upon price for wafers meeting certain acceptance criteria. Accordingly, the Company bears the risk of the yield of good die from wafers purchased meeting the acceptance criteria. The Company experienced such yield problems in fiscal 2000, which materially adversely affected the Company's net sales, gross margins and results of operations in fiscal 2000 and 2001.

Semiconductor manufacturing yields are a function of both product design, which is developed largely by the Company, and process technology, which is typically proprietary to the manufacturer. Historically, the Company has experienced lower yields on new products. Since low yields may result from either design or process technology failures, yield problems may not be effectively determined or resolved until an actual product exists that can be analyzed and tested to identify process sensitivities relating to the design rules that are used. As a result, yield problems may not be identified until well into the production process, and resolution of yield problems would require cooperation by and communication between the Company and the manufacturer. This risk is compounded by the offshore location of the Company's manufacturers, increasing the effort and time required identifying, communicating and resolving manufacturing yield problems. As the Company's relationships with new manufacturing partners develop, yields could be adversely affected due to difficulties associated with 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.

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

The Company relies in part on patents to protect its intellectual property. As of October 31, 2002, the Company has been issued 62 patents, each covering certain aspects of the design and architecture of the Company's products. Additionally, the Company has numerous patent applications pending. There can be no assurance that the Company's pending patent applications, or any future applications will be approved. Further, there can be no assurance that any issued patents will provide the Company with significant intellectual property protection, competitive advantages, or will not be challenged by third parties, or that the patents of others will not have an adverse effect on the Company's ability to do business. In addition, there can be no assurance that others will not independently develop similar products, duplicate the Company's products or design around any patents that may be issued to the Company.

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

Company's trade 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 seeking damages and an injunction 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. The Court ruled that there was no infringement by Trident. The Company filed an appeal in the United States Court of Appeals for the Federal Circuit. On April 17, 2002, the United States Court of Appeals for the Federal Circuit affirmed the lower court's judgment of non-infringement on one patent and vacated the courts judgment of non-infringement of another patent, thereby remanding it to the lower court for further proceedings. In November 2002, the lower court heard oral arguments on cross-motions for summary judgment on the matter, and we are currently awaiting its ruling. 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.

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.

Export sales have been a critical part of the Company's business. Sales to customers located outside the United States (including sales to the foreign operations of customers with headquarters in the United States and foreign system manufacturers that sell to United States-based OEMs) accounted for 90% and 73% of the Company's net sales for the three months ended October 31, 2002 and 2001, respectively. Export sales accounted for 89% and 92% of net sales in the nine months ended October 31, 2002 and 2001, respectively. The Company expects that net sales derived from international sales will continue to represent a significant portion of its total net 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 have produced, and are expected to continue to produce for the foreseeable future, all of the Company's wafers. In addition, many of the assembly and test services

used by the Company are procured from international sources. Under the Company's purchase orders with manufacturing suppliers, the wafers are priced in U.S. dollars.

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

The Company requires substantial working capital to fund its business, particularly to finance inventories and accounts receivable and for capital expenditures. The Company believes that its existing capital resources will be sufficient to meet the Company's capital requirements through the next 12 months, although the Company could be required, or could elect, to seek to raise additional capital during such period. The Company's future capital requirements will depend on many factors, including the rate of net sales growth, timing and extent of spending to support research and development programs in new and existing areas of technology, expansion of sales and marketing support activities, and timing and customer acceptance of new products. The Company may raise additional equity or debt financing in the future. There can be no assurance that additional equity or debt financing, if required, will be available on acceptable terms or at all.

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 has experienced the loss of certain key personnel and also reduced personnel in its restructuring. If the Company's headcount is not appropriate for its future direction and the Company fails to recruit key personnel critical to its future direction in a timely manner, it may have a material adverse effect on the Company's business, financial condition and results of operations.

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

Since the Company's decline in 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.

There may not be an active, liquid trading market for our common stock. For several weeks in October 2002, our common stock traded below the $1 minimum bid price requirement of the Nasdaq National Market. If we fail to comply with the continued listing requirements of the NASDAQ National Market, including the minimum bid price per share requirement, we may be delisted from trading on such market, and thereafter trading in our common stock, if any, would be conducted through the Nasdaq Small Cap Market, the over-the-counter market or on the Electronic Bulletin Board of the National Association of Securities Dealers, Inc. There is no guarantee that an active trading market for our common stock will be maintained on the NASDAQ National Market. You may not be able to sell your shares quickly, at the market price or at all if trading in our stock is not active.

The Company's cash equivalents, short-term investments, and restricted cash are exposed to financial market risk due to fluctuations in interest rates, which may affect our interest income. As of October 31, 2002, the Company's cash equivalents, short-term investments, and restricted cash earned interest at an average rate of 1.6%. Due to the short-term nature of the Company's investment portfolio, operating results or cash flows are vulnerable to sudden changes in market interest rates. Assuming a decline of 10% in the market interest rates at October 31, 2002, with consistent cash balances, interest income would be adversely affected by approximately $30,000 per quarter. The Company does not use its investment portfolio for trading or other speculative purposes.

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

Regulations under the Securities Exchange Act of 1934 require public companies to maintain "disclosure controls and procedures," which are defined to mean a company's controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms. Our chief executive officer and chief financial officer, based on their evaluation of our disclosure controls and procedures within 90 days before the filing date of this report, concluded that our disclosure controls and procedures were effective for this purpose.

There were no significant changes in our internal controls or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation.

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 seeking damages and an injunction 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 for damages against the Company alleging an attempted monopolization in violation of antitrust laws, arising from NeoMagic's filing of the patent infringement action against Trident. The Court ruled that there was no infringement by Trident. The Company filed an appeal in the United States Court of Appeals for the Federal Circuit. On April 17, 2002, the United States Court of Appeals for the Federal Circuit affirmed the lower court's judgment of non-infringement on one patent and vacated the court's judgment of non-infringement of another patent, thereby remanding it to the lower court for further proceedings. In November 2002, the lower court heard oral arguments on cross-motions for summary judgment on the matter, and we are currently awaiting its ruling. 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.

On September 10, 2002, the Company issued 1,667,000 shares of unregistered common stock and paid $1.5 million in cash to Infineon Technologies AG of Germany ("Infineon") to release the Company from its wafer supply agreement with Infineon. Such shares were issued in reliance upon an exemption from registration pursuant to Section 4 (2) of the Securities Act of 1933.

Our audit committee has considered whether any reasonably anticipated non-audit services to be rendered by Ernst & Young LLP during the course of fiscal 2003 are compatible with maintaining Ernst & Young LLP's independence as auditors of our fiscal 2003 consolidated financial statements, and have approved the anticipated non-audit services, maintaining they would not impair Ernst & Young's independence. The audit committee has approved the following non-audit services to be performed by Ernst & Young LLP: quarterly review of the unaudited condensed consolidated financial statements as of April 30, July 31, and October 31, 2002; and state and local tax, as well as regulatory, compliance services.

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

The Company did not file any reports on Form 8-K during the three months ended October 31, 2002.

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.

I, Prakash Agarwal, Chief Executive Officer of NeoMagic Corporation, certify that:

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

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

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

5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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

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

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended October 31, 2002
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

DELAWARE [State or other jurisdiction of incorporation or organization]		77-0344424 [I.R.S. Employer Identification No.]
3250 Jay Street Santa Clara, California [Address of principal executive offices]		95054 [Zip Code]
(408) 988-7020 Registrant's telephone number, including area code

			Three Months Ended						Nine Months Ended
			October 31, 2002			October 31, 2001			October 31, 2002			October 31, 2001
Net sales			$	655		$	83		$	1,511		$	351
Cost of product sales				780			1			2,085			8
Impairment of certain acquired intangible assets				367			—			367			—

Total				1,147			1			2,452			8

Gross margin (loss)				(492	)		82			(941	)		343
Operating expenses:
	Research and development(1)			5,662			6,041			18,131			19,344
	Sales, general and administrative(2)			2,127			1,857			7,836			5,805
	Impairment of certain acquired intangible assets			506			—			506			—
	Special Charges			—			—			3,600			—

		Total operating expenses		8,295			7,898			30,073			25,149

Loss from operations				(8,787	)		(7,816	)		(31,014	)		(24,806	)
Other income (expense), net:
	Income, net of expenses, from the sale of DVD assets			—			—			1,580			—
	Interest income and other income			277			843			1,557			2,987
	Interest expense			—			—			—			(11	)

Loss before income tax benefit and cumulative effect of change in accounting principle				(8,510	)		(6,973	)		(27,877	)		(21,830	)
Income tax benefit				—			(188	)		(6,339	)		(770	)

Loss before cumulative effect of change in accounting principle				(8,510	)		(6,785	)		(21,538	)		(21,060	)
Cumulative effect of change in accounting principle				(4,175	)		—			(4,175	)		—

Net loss			$	(12,685	)	$	(6,785	)	$	(25,713	)	$	(21,060	)

Basic and diluted net loss per share			$	(0.44	)	$	(0.26	)	$	(0.90	)	$	(0.81	)
Weighted average common shares outstanding for basic and diluted				29,157			26,263			28,453			26,032

			October 31, 2002			January 31, 2002(1)
			(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents		$	44,912		$	38,996
	Short-term investments			29,363			32,914
	Accounts receivable, net			435			125
	Inventory			726			78
	Income tax receivable			8			3,303
	Other current assets			1,612			3,005

		Total current assets		77,056			78,421
Property, plant and equipment, net				4,329			3,734
Restricted cash				—			15,000
Employee notes receivable				1,300			1,300
Goodwill				—			3,792
Intangibles, net				4,789			5,705
Other assets				474			357

		Total assets	$	87,948		$	108,309

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable		$	2,169		$	2,147
	Accrued compensation and related benefits			1,447			1,253
	Income taxes payable			3,522			3,934
	Deferred rent			284			582
	Deferred gain on the sale of DVD assets			—			1,580
	Other accrued liabilities			1,598			607
	Current portion of capital lease obligations			744			—

		Total current liabilities		9,764			10,103
Capital lease obligations				1,357			—
Stockholders' equity:
	Common stock			30			28
	Additional paid-in-capital			88,979			86,436
	Deferred compensation			(186	)		(2,004	)
	Accumulated other comprehensive income			(10	)		19
	Retained earnings			(11,986	)		13,727

		Total stockholders' equity		76,827			98,206

		Total liabilities and stockholders' equity	$	87,948		$	108,309

			Nine Months Ended
			October 31, 2002			October 31, 2001
Operating activities:
Net loss			$	(25,713	)	$	(21,060	)
Adjustments to reconcile net loss to net cash used for operating activities:
	Depreciation and amortization			2,206			2,801
	Loss on disposal of property, plant and equipment			2			77
	Loss on restructuring of wafer purchase agreement			3,600			—
	Income, net of expenses, from the sale of DVD assets			(1,580	)		—
	Amortization of deferred compensation			1,771			1,885
	Impairment of acquired intangible assets and goodwill			5,048			—
	Changes in operating assets and liabilities:
		Accounts receivable		(310	)		190
		Inventory		(648	)		—
		Income tax receivable		3,295			896
		Other current assets		1,393			737
		Restricted cash		15,000			(15,000	)
		Other assets		(457	)		1,232
		Accounts payable		22			(1,571	)
		Compensation and related benefits		194			(645	)
		Income taxes payable		(412	)		2,581
		Other accruals		(2,387	)		(628	)

Net cash provided by (used for) operating activities				1,024			(28,505	)

Investing activities:
	Net proceeds from the sale of DVD assets			1,580			—
	Proceeds from sale of property, plant, and equipment			—			1
	Purchases of property, plant and equipment			(702	)		(893	)
	Purchases of short-term investments			(41,191	)		(44,707	)
	Maturities of short-term investments			44,713			49,620

Net cash provided by investing activities				4,400			4,021

Financing activities:
	Repayment on note receivable from stockholders			—			40
	Net proceeds from issuance of common stock			492			573

Net cash provided by financing activities				492			613

Net increase (decrease) in cash and cash equivalents				5,916			(23,871	)
Cash and cash equivalents at beginning of period				38,996			72,852

Cash and cash equivalents at end of period			$	44,912		$	48,981

Supplemental schedules of cash flow information:
Cash paid (received) during the period for:
	Interest		$	—		$	11
	Taxes		$	(9,568	)	$	(5,700	)
Supplemental disclosure of non-cash financing activities:
	Issuance of common stock in connection with restructuring of wafer purchasing agreement Interest		$	2,100		$	—

October 31, 2002	Cost		Accumulated Amortization			Net
Licensed intellectual property	$	3,159	$	(11	)	$	3,148
Core technology		1,800		(500	)		1,300
Developed technology		550		(333	)		217
Patents		1,697		(1,573	)		124

	$	7,206	$	(2,417	)	$	4,789

January 31, 2002	Cost		Accumulated Amortization			Net
Licensed intellectual property	$	1,811	$	(327	)	$	1,484
Core technology		1,800		(49	)		1,751
Developed technology		900		(38	)		862
Customer relationships		700		(19	)		681
Patents		1,690	$	(1,256	)		434
Assembled workforce		1,179		(885	)		294
Acquisition costs		354		(265	)		89
Other		114		(4	)		110

	$	8,548	$	(2,843	)	$	5,705

		NEOMAGIC CORPORATION (Registrant)


		/s/ Stephen T. Lanza STEPHEN T. LANZA Chief Financial Officer (Principal Financial and Accounting Officer) December 11, 2002



Date: December 11, 2002		/s/ PRAKASH AGARWAL Prakash Agarwal Chief Executive Officer



Date: December 11, 2002		/s/ STEPHEN T. LANZA Stephen T. Lanza Chief Financial Officer

Number		Description
3.1	(1)	Amended and Restated Certificate of Incorporation
3.2	(1)	Bylaws
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		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		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		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.
21.1	(6)	NeoMagic Subsidiaries.
99.1		Certification by Prakash Agarwal and Stephen T. Lanza pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.