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 x No ¨

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

The number of shares of the Registrant’s Common Stock, $.001 par value, outstanding at April 30, 2005 was 33,244,002

The unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and include the accounts of NeoMagic Corporation and its wholly owned subsidiaries (collectively “NeoMagic” or the “Company”). Certain information and 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 April 30, 2005, and the operating results and cash flows for the three months ended April 30, 2005 and 2004. 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, 2005, included in the Company’s Form 10-K filed with the Securities and Exchange Commission.

The results of operations for the three months ended April 30, 2005 are not necessarily indicative of the results that may be expected for the year ending January 31, 2006.

The first fiscal quarters of 2006 and 2005 ended on May 1, 2005 and May 2, 2004, respectively. The Company’s quarters generally have 13 weeks. The first quarter of fiscal 2005 had 14 weeks. The Company’s fiscal years generally have 52 weeks. Fiscal 2005 had 53 weeks. For ease of presentation, the accompanying financial statements have been shown as ending on the last day of the calendar month of April.

At April 30, 2005, the Company had several stock-based employee compensation plans, including stock option plans and an employee stock purchase plan. The Company accounts for these plans under the intrinsic value method. The following table illustrates the effect on net loss and loss per share as if the Company had applied the fair value recognition method:

In the three months ended April 30, 2005 and 2004, respectively, the fair value of each option grant was estimated on the date of the grant using the Black-Scholes option-pricing model using a dividend yield of 0% and the following additional weighted-average assumptions:

The following data shows 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 April 30, 2005 and 2004, respectively, basic earnings per share equals diluted earnings per share due to the net loss for the quarter. During the three months ended April 30, 2005 and 2004, the Company excluded from the computation of basic and diluted loss per share options to purchase 11,536,019 and 3,342,485 shares of common stock, respectively, because the effect would be anti-dilutive.

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.

Unrealized gains or losses on the Company’s available-for-sale securities are included in comprehensive loss and reported separately in stockholders’ equity.

Net comprehensive loss includes the Company’s net loss, as well as accumulated other comprehensive loss on available for sale securities. Net comprehensive loss for the three months ended April 30, 2005 and 2004, respectively, is as follows (in thousands):

Total accumulated other comprehensive loss was $4,000 and $14,000 at April 30, 2005 and January 31, 2005, respectively. Accumulated other comprehensive loss consists entirely of unrealized losses on available for sale securities.

In fiscal 2003, the Company entered into capital leases for software licenses used in the design of semiconductors. In March 2004 and October 2004, the Company entered into new capital lease agreements adding additional software and extending the terms of two of the Company’s existing leases. In the first quarter of fiscal 2006, the Company amended the payment schedule for one of its capital leases, which reduced fiscal 2006 payments by $150,000, increased fiscal 2007 payments by $100,000 and increased fiscal 2008 payments by $50,000. 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:

Future minimum payments under the capital leases consist of the following, as of April 30, 2005:

On August 20, 2004, the Company issued 5,000 shares of Mandatorily Redeemable Series B Convertible Preferred Stock (the “Series B Preferred Stock”), Series A Warrants for the purchase of 1,608,696 shares of common stock at $1.64 per share, and Series B Warrants for the purchase of 1,000,000 shares of common stock at $1.60 per share for an aggregate cash purchase price of $5,000,000. After deducting certain transaction costs of $65,000, net cash proceeds received by the Company were $4,935,000. In addition, the Company incurred out-of-pocket expenses of approximately $392 thousand related to the financing. The Series B Preferred Stock is convertible at the option of the investor into 4,347,826 shares of the Company’s Common Stock at a conversion price of $1.15 per share, and is subject to certain anti-dilution provisions. The Series B Preferred Stock is redeemable by the Company for a mandatory payment of $5 million three years from the issue date of August 20, 2004 if the conversion option has not been exercised. The Series B Preferred Stock has liquidation preferences over the

Company’s Common Stock and has no voting rights. Furthermore, as long as the preferred stock remains outstanding, provisions of the Preferred Stock limit our ability to issue any security with greater or equal seniority to the Preferred Stock. In addition, there are restrictions on dividend payments as long as the Series B Convertible Preferred Stock remains outstanding. The Series A Warrants to purchase common stock are exercisable for five years from the date of issuance. The Series B Warrants to purchase common stock were exercisable until 90 days after the date that the registration statement relating to the common shares underlying the securities issued in this transaction was declared effective by the Securities and Exchange Commission. On September 24, 2004, this registration statement was declared effective. The Series B Warrants expired unexercised on December 26, 2004.

In accordance with SFAS 150, the Company classified the estimated fair value of the Mandatorily Redeemable Series B Convertible Preferred Stock as a liability. The Company estimated the fair values of the Series B Preferred Stock and the Series A and B Warrants and allocated the net proceeds of $4,935,000 based on relative fair values in accordance with EITF 00-27 and calculated the intrinsic value of the conversion option embedded within the convertible preferred stock using the effective conversion price of $1.15 per common share. The intrinsic value of the beneficial conversion option calculated was $1,203,000 and the fair value allocated to the Series A and Series B warrants was $1,153,000. The fair value allocated to the warrants and the intrinsic value of the beneficial conversion option were recorded as credits to additional paid in capital in stockholders’ equity on the consolidated balance sheets with an offsetting amount of $2,356,000 treated as a reduction in the $5 million liability recorded for the Mandatorily Redeemable Series B Convertible Preferred Stock. The net-recorded liability of $2,644,000 for the Mandatorily Redeemable Series B Convertible Preferred Stock is accreting to the redemption value of $5 million through charges to interest expense over the three-year period until mandatory redemption. The Company accreted interest expense of $197,000 during the first quarter of fiscal 2006. The Company accreted interest expense of $327,000 for the months of September 2004 through January 2005 in fiscal 2005. The net-recorded liability is $3,168,000 as of April 30, 2005.

The Company’s out-of-pocket expenses of approximately $392,000 related to the financing were recorded as deferred financing costs on the consolidated balance sheets with $131,000 recorded in current assets. The Company recorded amortization of the deferred financing of $33,000 as interest expense during the first quarter of fiscal 2006.

On April 6, 2005 NeoMagic completed the sale of selected patents to Faust Communications, LLC, a private company, for net proceeds of approximately $3.5 million. The gross proceeds in the transaction were approximately $4.5 million. Expenses include a commission payment to the Consortium for Technology Licensing, Ltd. of approximately $1.0 million. The patents sold relate to products no longer sold by NeoMagic and not to products that NeoMagic currently sells or plans to sell. NeoMagic retains a worldwide, non-exclusive license under the patents sold.

The sale does not include several of NeoMagic’s important patents covering embedded DRAM technology or any of the unique array processing technology used in NeoMagic’s MiMagic 6 product. During the patent sale negotiations, NeoMagic was represented by The Consortium for Technology Licensing, Ltd., of Nissequogue, New York, a company whose CEO served on the board of NeoMagic until December 2004. On March 28, 2005 NeoMagic entered into an amended and restated Patent Licensing Agreement with the Consortium for Technology Licensing, Ltd. governing the relationship between the two parties.

Income tax expense was $49 thousand and $7 thousand for the three months ended April 30, 2005 and 2004, respectively. We recorded a tax provision of $49 thousand on a pre-tax loss of $1.6 million in the three months ended April 30, 2005 that consisted of foreign income taxes and an increase of $44 thousand for accrued interest on tax liabilities. In the three months ended April 30, 2004, taxes consisted of foreign income taxes.

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

The Company generally sells products with a limited warranty of product quality and a limited indemnification of customers against intellectual property infringement claims related to the Company’s products. The Company accrues for known warranty and indemnification issues if a loss is probable and can be reasonably estimated, and accrues for estimated but unidentified issues based on historical activity. The accrual and the related expense for known issues were not significant as of and for the first quarter of fiscal 2006 and 2005. Due to product testing, the short time between product shipment and the detection and correction of product failures, and a low historical rate of payments on indemnification claims, the accrual based on historical activity and the related expense were not significant at April 30, 2005 and January 31, 2005.

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” SFAS No. 123R requires employee stock options and rights to purchase shares under stock participation plans to be accounted for under the fair value method, and eliminates the ability to account for these instruments under the intrinsic value method prescribed by APB Opinion No. 25, as allowed under the original provisions of SFAS No. 123. SFAS No. 123R requires the use of an option pricing model for estimating fair value, which is amortized to expense over the service periods. The requirements of SFAS No. 123R are effective for the first fiscal year beginning after June 15, 2005. SFAS No. 123R allows for either prospective recognition of compensation expense or retrospective recognition, which may be back to the original issuance of SFAS No. 123. The Company is currently evaluating the impact of adoption of SFAS No. 123R.

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

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

NeoMagic designs, develops and markets high-performance, power-efficient Applications Processors that enable multimedia features and applications in mobile phones and other handheld devices. In the past, we provided semiconductor solutions, called multimedia accelerators, to top notebook computer manufacturers. In April 2000, we began to exit the multimedia accelerator market. However, the majority of our historical net sales through the end of fiscal year 2002 continued to come from these multimedia accelerator products. We do not expect to have revenue related to these products in the future. We are now focused solely on the Applications Processor market.

NeoMagic has established relationships with third-party manufacturing partners to produce semiconductor products for us. Pursuant to these relationships, we design the overall product, including the logic and analog circuitry, and the manufacturing partners manufacture the wafers, perform testing and package the products. We are focused on leveraging our 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 our continued development of solutions that facilitate the mobilization of multimedia applications.

In November of 2003, we introduced a new technology architecture, called Associative Processor Array (APA). The APA architecture uses a massively parallel approach to processing information, which means that APA operates on multimedia data in parallel, without increasing clock rates. Existing competitive solutions use a sequential processing flow that operates on each individual data element in sequence, relying on ever-faster clock rates to improve performance. These faster clock rates burn power, thus reducing battery life. With its ability to handle large amounts of data simultaneously and at lower clock rates, the APA platform is able to process multimedia data such as video, still pictures and audio with low power consumption. We anticipate but we cannot assure you that the MiMagic 6, the first of our chips to use APA, will begin production shipments during the fourth quarter of calendar year 2005.

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 first fiscal quarters of 2006 and 2005 ended on May 1, 2005 and May 2, 2004, respectively. The Company’s quarters generally have 13 weeks. The first quarter of fiscal 2005 had 14 weeks. The Company’s fiscal years generally have 52 weeks. Fiscal 2005 had 53 weeks. For ease of presentation, the accompanying financial statements have been shown as ending on the last day of the calendar month of April.

NeoMagic’s discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us 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, we evaluate our estimates, including those related to intangible assets and long-lived assets, revenue recognition, inventories and income taxes. We base our estimates on historical experience and on various other assumptions that we believe 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.

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

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

We recognize revenue from non-distributor product sales when the products are shipped to customers, title has transferred, and no obligations remain. Thus, we require the following: (i) execution of a written customer order, (ii) shipment of the product, (iii) fee is fixed or determinable, and (iv) collectibility of the proceeds is probable. Our shipment terms are FOB shipping point.

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

At the end of each accounting period, we make a determination of certain factors including sales returns and allowances, which could affect the amount of revenue recorded for the period. Sales returns

provisions include considerations for known but unprocessed sales returns and estimation for unknown returns based on historical experiences. Actual sales returns may vary significantly from historical experience and could have a material effect on our operating results.

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

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Based on the uncertainty of future pre-tax income, we have fully reserved our deferred tax assets. In the event we determine that we would be able to realize some or all of our deferred tax assets in the future, an adjustment to the deferred tax assets would increase income in the period when such determination was made.

We have also provided accruals for certain tax liabilities based on our estimate of whether, and the extent to which, additional taxes will be due. If payment of these amounts ultimately proves to be unnecessary, or less than currently assessed, the resulting reversal of such accruals would result in tax benefits being recorded in the period when the accruals are no longer deemed necessary. Conversely, if our estimate of tax liabilities is more than the amount ultimately assessed, further charges would result.

Net sales were $299 thousand for the three months ended April 30, 2005, compared to $651 thousand for the three months ended April 30, 2004. Net sales decreased due to a $464 thousand decrease in shipments of our MiMagic 3 applications processor partially offset by a $75 thousand increase in shipments of our MiMagic 5 applications processor.

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 78% and 84% of net sales in the three months ended April 30, 2005 and 2004, respectively. We expect that export sales will continue to represent a significant portion of net sales. All sales transactions were denominated in United States dollars. The following is a summary of the Company’s net sales by major geographic area:

Gross loss was $33 thousand and $64 thousand for the three months ended April 30, 2005 and 2004, respectively. The improvement in gross loss is primarily due to a decrease in amortization expense relating to core technology and licensed intellectual property of $183 thousand for the three months ended April 30, 2005 compared to the three months ended April 30, 2004. The core technology became fully amortized in the fourth quarter of fiscal 2005 and we recorded an impairment charge for the balance of licensed intellectual property in the fourth quarter of fiscal 2005. The lower amortization was partially offset by the lower sales and the write-off of excess MiMagic 5 inventory of approximately $95 thousand. In addition, the gross loss for the three months ended April 30, 2005 was favorably impacted by the release of reserves of $24 thousand as a result of the sales of previously reserved inventory. The gross loss for the three months ended April 30, 2004 was favorably impacted by releases of reserves in the amount of $35 thousand as a result of the sales of previously reserved inventory in the first quarter of fiscal 2005.

Research and development expenses include compensation and associated costs relating to development personnel, amortization of intangible assets and prototyping costs, which are comprised of photomask costs and pre-production wafer costs. Research and development expenses were $3.1 million and $4.9 million for the three months ended April 30, 2005 and 2004, respectively. These expenses include amortization of deferred compensation of $71 thousand and $65 thousand for the three months ended April 30, 2005 and 2004, respectively. Research and development expenses decreased in the first quarter of fiscal 2006 compared to the first quarter of fiscal 2005 primarily due to lower labor costs of $0.8 million due to decreased headcount. In addition, decreased amortization of intellectual property of $0.2 million, lower outside consultant costs of $0.1 million, lower travel costs of $0.1 million, lower software license and maintenance costs of $0.1 million, and lower allocation costs of $0.2 million due to lower allocated IT depreciation and other allocated costs contributed to the decrease in research in development expenses in the first quarter of fiscal 2006 compared to the first quarter of fiscal 2005.

Sales, general and administrative expenses were $1.8 million and $2.1 million for the three months ended April 30, 2005 and 2004, respectively. These expenses include amortization of deferred compensation of $29 thousand and $49 thousand for the three months ended April 30, 2005 and 2004, respectively. Sales, general and administrative expenses primarily decreased in the first quarter of fiscal 2006 due to decreased labor costs of $0.2 million due to decreased headcount. Increased audit fees of $0.1 million were offset by overall cost reduction efforts.

The Company earns interest on its cash and short-term investments. Interest and other income was $0.1 million and $0.1 million for the three months ended April 30, 2005 and 2004, respectively. Lower average cash and short-term investment balances was offset by increased interest rates.

Interest expense was $288 thousand and $24 thousand for the three months ended April 30, 2005 and 2004, respectively. The increase in the first quarter of fiscal 2006 from the first quarter of fiscal 2005 is primarily due to accreted interest expense of $197 thousand in the first quarter of fiscal 2006 related to our Mandatorily Redeemable Series B Convertible Preferred Stock issued in August 2004. In addition, we recorded $33 thousand of interest expense in the first quarter of fiscal 2006 due to amortization of deferred financing costs related to our Mandatorily Redeemable Series B preferred stock.

The Company’s cash, cash equivalents and short-term investments decreased $0.9 million in the three months ended April 30, 2005 to $24.1 million from $25.0 million at January 31, 2005. The operating loss for the first quarter of fiscal 2006 was partially offset by a gain of $3.5 million on the sale of certain patents as described in Note 8 of the Condensed Consolidated Financial Statements.

We believe our current cash, cash equivalents and short-term investments will satisfy our projected cash requirements through at least the next twelve months. However, we expect we will need to raise additional capital to fund future operating activities beyond the next 12 months. Beyond fiscal 2006, the adequacy of our resources will depend largely on our ability to complete additional financing and our success in re-establishing profitable operations and positive operating cash flows. If we experience a

material shortfall versus our plan for fiscal 2006, we expect to take all appropriate actions to ensure the continuing operation of our business and to mitigate any negative impact on our cash position. We believe we can take actions to achieve further reductions in our operating expenses, if necessary. We also believe that we can take actions to generate cash by selling or licensing intellectual property, seeking funding from strategic partners, and seeking further equity or debt financing from financial sources. There can be no assurance that additional financing will be available on acceptable terms or at all. Furthermore, as long as the Preferred Stock remains outstanding, provisions of the Preferred Stock limit our ability to issue any security with greater or equal seniority to the Preferred Stock.

Cash and cash equivalents used in operating activities for the three months ended April 30, 2005 was $4.0 million, compared to $6.3 million of net cash used in operating activities for the three months ended April 30, 2004. The cash used in operating activities for the three months ended April 30, 2005 was primarily due to the net loss of $1.6 million and the $3.5 million gain on the sale of patents partially offset by non-cash depreciation of $0.4 million and non-cash accretion of $0.2 million. The cash used in operating activities for the three months ended April 30, 2004 stems primarily from a net loss of $7.0 million, increases in inventory of $0.6 million and other current assets of $0.2 million, as well as a decreases in accounts payable of $0.2 million, partially offset by non-cash depreciation and amortization of $1.0 million and deferred compensation amortization charges of $0.1 million, a decrease in accounts receivable of $0.2 million and an increase in the liability for compensation and related benefits of $0.2 million.

Net cash provided by investing activities for the three months ended April 30, 2005 was $11.2 million, compared to $0.8 million of net cash provided by investing activities for the three months ended April 30, 2004. Net cash provided by investing activities in the first quarter of fiscal 2006 related primarily to net maturities of short-term investments of $7.7 million and proceeds from the sale of patents of $3.5 million. Net cash provided by investing activities in the first quarter of fiscal 2005 related primarily to net maturities of short-term investments of $0.8 million.

Net cash used in financing activities was $ 0.4 million for the three months ended April 30, 2005, compared to $ 0.5 million of net cash provided by financing activities for the three months ended April 30, 2004. The net cash used in financing activities for the three months ended April 30, 2005 is due to payments on capital lease obligations of $0.4 million. The net cash provided by financing activities for the three months ended April 30, 2004 was due to net proceeds from the issuance of common stock of $0.7 million partially offset by payments on capital lease obligations of $0.2 million.

Our lease for our headquarters in Santa Clara, California expires in April 2010. We lease offices in Israel and India under operating leases that expire in September 2005 for Israel and in December 2006 for India. On February 1, 2005, we entered into a sublease agreement to sub-lease 10,000 square feet in our Santa Clara facility for a two year period starting on March 15, 2005 for $12,000 per month.

We lease software licenses under capital leases. Refer to Note 6, Obligations under Capital Leases, in the consolidated financial statements for additional information.

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

The following summarizes the Company’s contractual obligations at April 30, 2005, and the effect such obligations are expected to have on our liquidity and cash flow (in thousands).

We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of April 30, 2005, we are not involved in SPE transactions.

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” SFAS No. 123R requires employee stock options and rights to purchase shares under stock participation plans to be accounted for under the fair value method, and eliminates the ability to account for these instruments under the intrinsic value method prescribed by APB Opinion No. 25, as allowed under the original provisions of SFAS No. 123. SFAS No. 123R requires the use of an option pricing model for estimating fair value, which is amortized to expense over the service periods. The requirements of SFAS No. 123R are effective for the first fiscal year beginning after June 15, 2005. SFAS No. 123R allows for either prospective recognition of compensation expense or retrospective recognition, which may be back to the original issuance of SFAS No. 123. We are currently evaluating the impact of adoption of SFAS No. 123R.

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

We have been incurring substantial losses and consuming cash in operations as we invest heavily in new product development in advance of achieving significant customer sales. This is expected to continue during the fiscal year ending January 31, 2006. Our ability to achieve cash flow breakeven is likely to depend on the success of our MiMagic 5 and MiMagic 6 products. However, even if the MiMagic 5, MiMagic 6, and subsequent products achieve widespread customer acceptance, the length of customer design-in cycles would preclude substantial product shipments in the fiscal year ending January 31, 2006. Accordingly, even if these new products are successful, we are likely to incur significant additional losses and consume cash in operations during the fiscal year ending January 31, 2006.

Given the long cycle times required to achieve design wins, convert customer design wins into production orders, and for customers to achieve volume shipments of their products, we are likely to require additional working capital to fund our business. We believe that our existing capital resources will be sufficient to meet our capital requirements through at least the next 12 months. However, we expect we will need to raise additional capital to fund future operating activities beyond the next 12 months. Our 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. Our ability to raise capital and the terms of any financing will depend, in part, on our ability to establish customer engagements and generate sales. As discussed below, revenue performance is difficult to

forecast. There can be no assurance that additional equity or debt financing, if required, will be available on acceptable terms or at all. Furthermore, as long as the preferred stock remains outstanding, provisions of the Preferred Stock limit our ability to issue any security with greater or equal seniority to the Preferred Stock.

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

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

Our future success depends in part on the continued service of our key engineering, sales, marketing, manufacturing, finance and executive personnel, and our ability to identify, hire and retain additional personnel. There is strong competition for qualified personnel in the semiconductor industry, and there can be no assurance that we will be able to continue to attract and retain qualified personnel necessary for the development of our business. We have experienced the loss of personnel though headcount reductions and attrition. We have recently lost some of our executive management. For example, Prakash Agarwal, one of our co-founders who was our President, Chief Executive Officer and a Director since our founding, resigned from all these positions on April 19, 2005. Our new President and Chief Executive Officer, Doug Young, has been with us only since February 2004. We cannot assure you that the resignation of Mr. Agarwal and the appointment of Mr. Young will not have a material adverse effect on our business, financial condition and results of operations. All our executive officers are employees at will. We have no employment contracts and do not maintain key person insurance on any of our personnel. If we are not able to maintain key personnel, if our headcount is not appropriate for our future direction, or if we fail to recruit key personnel critical to our future direction in a timely manner, this may have a material adverse effect on our business, financial condition and results of operations. In addition, our future success will depend in part on our ability to identify and retain qualified individuals to serve on our board of directors. We believe that maintaining a board of directors comprised of qualified members is critical given the current status of our business and operations. Moreover, Nasdaq Stock Market rules require three outside board members to serve on our audit committee. Any inability on our part to identify and retain qualified board members could have a material adverse effect on our business or could lead to the delisting of our securities from the Nasdaq Stock Market.

Four customers accounted for 28%, 16%, 14% and 13%, respectively, of net sales in the three months ended April 30, 2005. Three customers accounted for 29%, 28% and 22%, respectively, of net sales in the three months ended April 30, 2004. We expect that a small number of customers will account for a substantial portion of our net sales for the foreseeable future. Furthermore, the majority of our sales were historically made, and are expected to continue to be made, on the basis of purchase orders rather than pursuant to long-term purchase agreements. As a result, our business, financial condition and results of operations could be materially adversely affected by the decision of a single customer to cease using our products, or by a decline in the number of handheld devices sold by a single customer.

Our products are designed to afford the mobile phone and handheld device 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 our products, the market demand for our products may be negatively impacted.

The market for Applications Processors is intensely competitive and is characterized by rapid technological change, evolving industry standards and declining average selling prices. We believe that the principal factors of competition in this market are video and 3D graphics performance, price, features, power consumption, size and customer support. Our ability to compete successfully in the Applications Processor market depends on a number of factors including, success in designing and subcontracting the manufacture of new products that implement new technologies, product quality and reliability, price, ramp of production of our products, customer demand and acceptance of more sophisticated multimedia functionality on mobile phones and other handheld devices, end-user acceptance of our customers’ products, market acceptance of competitors’ products and general economic conditions. Our ability to compete will also depend on our ability to identify and ensure compliance with evolving industry standards and market trends.

We compete with both domestic and international companies, some of which have substantially greater financial and other resources than us with which to pursue engineering, manufacturing, marketing and distribution of their products. Our principal competitors include Texas Instruments, Renesas, ST Microelectronics and Broadcom as well as a number of vertically integrated electronics firms that are developing their own solutions. We may also face increased competition from new entrants into the market including companies currently at developmental stages. We believe we have significant intellectual properties and historically demonstrated expertise in SOC technology. However, our inability to introduce timely new products for our market, to support these products in customer programs, or to manufacture these products could have a material adverse effect on our business, financial condition and operating results.

Some of our current and potential competitors operate their own manufacturing facilities. Since we do not operate our own manufacturing facility and may from time-to-time make binding commitments to purchase products (no binding purchase orders were outstanding as of April 30, 2005), we may not be able to reduce our costs and cycle time or adjust our production to meet changing demand as rapidly as companies that operate their own facilities, which could have a material adverse effect on our results of operations.

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

Our ability to compete in the future will also depend on our ability to identify and ensure compliance with evolving industry standards and market trends. Unanticipated changes in market trends and industry standards could render our products incompatible with products developed by major hardware manufacturers and software developers. As a result, we could be required to invest significant time and resources to redesign our 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 we will be able to redesign our products or obtain the necessary third-party licenses within the appropriate window of market demand. If our products are not in compliance with prevailing market trends and industry standards for a significant period of time, we could miss crucial OEM (Original Equipment Manufacturer) and ODM (Original Design Manufacturer) design cycles, which could result in a material adverse effect on our business, financial condition and results of operations.

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

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

We 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 our products competitively and introduce new 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 manufacturing partners to effectively manufacture new products, quality of new products, differentiation of new products from those of our competitors and market acceptance of our products and the products of our customers. There can be no

assurance that the products we expect to introduce will incorporate the features and functionality demanded by mobile phone and handheld device manufacturers and consumers, will be successfully developed, or will be introduced within the appropriate window of market demand. There can be no assurance that customers who utilize our semiconductor products will achieve the levels of market success with their own products that they may project to us.

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

Our products require wafers manufactured with state-of-the-art fabrication equipment and techniques. We currently utilize several foundries for wafer fabrication. We expect that, for the foreseeable future, some of our products will be manufactured by a single source. Since, in our experience, the lead time needed to establish a 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 our manufacturing partners, the failure of our manufacturing partners to dedicate adequate resources to the production of our products, or the financial instability of our manufacturing partners would have a material adverse effect on our business, financial condition and results of operations. Furthermore, in the event that the transition to the next generation of manufacturing technologies by our manufacturing partner is unsuccessful, our business, financial condition and results of operations would be materially and adversely affected.

There are many other risks associated with our 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 us; and potential misappropriation of our intellectual property. We are dependent on our manufacturing partners to produce wafers with acceptable quality and manufacturing yields, to deliver those wafers on a timely basis to our third party assembly subcontractors and to allocate a portion of their manufacturing capacity sufficient to meet our needs. Although our products are designed using the process design rules of the particular manufacturer, there can be no assurance that our 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 our manufacturing partners will continue to devote adequate resources to the production of our products or continue to advance the process design technologies on which the manufacturing of our products are based.

Our products are assembled and tested by third-party subcontractors. We do 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 our reliance on third-party subcontractors to assemble and test our products, we 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 our products. Due to the amount of time normally required to qualify assembly and test subcontractors, product shipments could be delayed significantly if we were required to find alternative subcontractors. Any problems associated with the delivery, quality or cost of the assembly and test of our products could have a material adverse effect on our business, financial condition and results of operations.

We have wafer supply relationships with several foundries to support our product efforts. Normally, we place binding purchase orders two to three months prior to wafer shipment. We had no binding orders for wafers outstanding as of April 30, 2005. We order wafers for deliveries in advance and with the additional time to assemble and test wafers, we can have orders for finished goods that will not be available for up to four months into the future. If we do not have sufficient demand for our products and cannot cancel our current and future commitments without material impact, we may experience excess inventory, which will result in a write-off affecting gross margin and results of operations. If we cancel a purchase order, we must pay cancellation penalties based on the status of work in process or the proximity of the cancellation to the delivery date. We must place purchase orders for wafers before we receive purchase orders from our own customers. This limits our ability to react to fluctuations in demand for our products, which can be unexpected and dramatic, and from time-to-time will cause us 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 customers, semiconductor companies from time-to-time take charges for excess inventory. We did in fact incur such charges in fiscal 2005 of $0.4 million. Significant write-offs of excess inventory have had and could continue to have a material adverse effect on our financial condition and results of operations. Conversely, failure to order sufficient wafers would cause us to miss revenue opportunities and, if significant, could impact sales by our customers, which could adversely affect our customer relationships and thereby materially adversely affect our 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. We often purchase wafers, not die, and pay an agreed upon price for wafers meeting certain acceptance criteria. Accordingly, we bear the risk of the yield of good die from wafers purchased meeting the acceptance criteria.

Semiconductor manufacturing yields are a function of both product design, which is developed largely by us, and process technology, which is typically proprietary to the manufacturer. Historically, we have 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 and communication between the manufacturer and us. This risk is compounded by the offshore location of our manufacturers, increasing the effort and time required identifying, communicating and resolving manufacturing yield problems. As our relationships with new manufacturing partners develop, yields could be adversely affected due to difficulties associated with adapting our 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 our per unit product cost and could force us to allocate our available product supply among our customers, potentially adversely impacting customer relationships as well as revenues and gross margins. There can be no assurance that our manufacturers will achieve or maintain acceptable manufacturing yields in the future.

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

We rely in part on patents to protect our intellectual property. As of April 30, 2005, we had 21 patents. In April 2005, we sold 58 patents to Faust Communications, LLC for net proceeds of $3.5 million. The patents sold related to products we no longer sell and not to products that we currently sell or plan to sell. We retain a worldwide, non-exclusive license under the patents sold. The sale did not include several of our important patents covering embedded DRAM technology or any of the unique array processing technology used in our MiMagic 6 product. The remaining 21 issued patents are scheduled to expire no later than January 2022. Additionally, we have several patent applications pending. There can be no assurance that our pending patent applications, or any future applications will be approved. Further, there can be no assurance that any issued patents will provide us 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 our ability to do business. In addition, there can be no assurance that others will not independently develop similar products, duplicate our products or design around any patents that may be issued to us.

We also rely on a combination of mask work protection, trademarks, copyrights, trade secret laws, employee and third-party nondisclosure agreements and licensing arrangements to protect our 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 our trade secrets or intellectual property, disclose such intellectual property or trade secrets, or that we can meaningfully protect our intellectual property. A failure by us to meaningfully protect our intellectual property could have a material adverse effect on our business, financial condition and results of operations.

Any patent litigation, whether or not determined in our favor or settled by us, would at a minimum be costly and could divert the efforts and attention of our management and technical personnel from productive tasks, which could have a material adverse effect on our 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 customers or end users of our 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 our business, financial condition and results of operations. In the event of any adverse ruling in any such matter, we 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 in our ability to market our products, or delays and costs associated with redesigning our products or payments of license fees to third parties, or any failure by us to develop or license a substitute technology on commercially reasonable terms could have a material adverse effect on our business, financial condition and results of operations.

Export sales have been a critical part of our 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 manufacturers that sell to United States-based OEMs) accounted for 78% and 84% of our net sales for the three months ended April 30, 2005 and 2004, respectively. We expect that net sales derived from international sales will continue to represent a significant portion of our total net sales. Letters of credit issued by customers have supported a portion of our international sales. To date, our international sales have been denominated in United States dollars. Increases in the value of the U.S. dollar relative to the local currency of our customers could make our 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 our wafers. In addition, many of the assembly and test services used by us are procured from international sources. Wafers are priced in U.S. dollars under our purchase orders with our manufacturing suppliers.

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

A Lack of Effective Internal Control Over Financial Reporting Could Result in an Inability to Accurately Report Our Financial Results

Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed. In connection with our management’s evaluation of our internal control over financial reporting as of January 31, 2005, management identified a control deficiency that constituted a material weakness. As more fully described in Item 9A of our Annual Report on Form 10-K, as of January 31, 2005, our management concluded that we did not maintain effective controls over the process of evaluating impairment of long-lived assets. This control deficiency resulted in a material adjustment recorded by us to the financial statements in the fourth quarter of fiscal 2005. As a result of the material weaknesses identified, our management concluded that our internal control over financial reporting was not effective as of January 31, 2005. We remediated this material weakness in the first quarter of fiscal 2006. At April 30, 2005 we did not have any intangible assets.

A failure to implement and maintain effective internal control over financial reporting could result in a material misstatement of our financial statements or otherwise cause us to fail to meet our financial reporting obligations. This, in turn, could result in a loss of investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.

Generally accepted accounting principles in the United States are subject to interpretation by the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants, the Securities and Exchange Commission (SEC) and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change. For example, we currently are not required to record stock-based compensation charges if an employee’s stock option exercise price is equal to or exceeds the deemed fair value of our common stock at the date of grant. However, several companies have recently elected to change their accounting policies and begun to record the fair value of stock options as an expense. The FASB published a pronouncement in December 2004 that would require us to record expense for the fair value of stock options granted. The effective date of the proposed standard is for fiscal years beginning after June 15, 2005 and will be applicable starting in our fiscal year 2007. Our future operating expenses may be adversely affected in connection with the issuance of stock options.

The market price of our 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 our Common Stock could be subject to significant fluctuations in response to various factors, including quarter-to-quarter variations in our anticipated or actual operating results, announcements of new products, technological innovations or setbacks by us or our competitors, general conditions in the semiconductor industry, unanticipated shifts in the markets for mobile phones and other handheld devices or changes in industry standards, losses of key customers, litigation commencement or developments, the impact of our financing activities, including dilution to shareholders, changes in or the failure by us to meet estimates of our performance by securities analysts, market conditions for high technology stocks in general, and other events or factors. In future quarters, our operating results may be below the expectations of public market analysts or investors.

On February 28, 2005, we received a notice from the Nasdaq Stock Market that we were no longer in compliance with the requirements for continued inclusion of our common stock on the Nasdaq National Market pursuant to the Nasdaq’s Marketplace Rule 4450(a)(5) (the “Rule”) because our common stock had closed below $1.00 per share for 30 consecutive business days. We were given 180 calendar days, or until August 29, 2005, to regain compliance with the Rule. To regain compliance with the Rule, the closing bid price of our common stock must be $1.00 per share or more for a minimum of 10 consecutive business days prior to August 29, 2005. If we are unable to regain compliance with the Rule by August 29, 2005, we will receive a delisting notification from Nasdaq. Upon receipt of the delisting notification, we may appeal the delisting to a Listings Qualifications Panel of Nasdaq or we may apply to transfer our securities to The Nasdaq SmallCap Market if, at such time, we satisfy the requirements for initial inclusion on such market as set forth in Marketplace Rule 4310(c), other than the minimum bid price

requirement of $1.00 per share. If our application to transfer to the Nasdaq SmallCap Market is approved, we will have until February 23, 2006 to demonstrate compliance with the continued listing requirements of the Nasdaq SmallCap Market. We have asked in the proxy statement for our 2005 annual meeting of stockholders that the stockholders approve giving the board the authorization to file an amendment to our certificate of incorporation that would effect a reverse stock split at the ratio of between one-for-five and one-for-ten, inclusive. Even if granted authorization to effect a reverse stock split, the board may choose not to effect such a split.

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. In addition, there are other continued listing requirements, such as a minimum stockholders equity requirement. If the Company fails to comply with other listing requirements, it may receive future correspondence from the Nasdaq and may risk potential delisting. There is no guarantee that an active trading market for our common stock will be maintained on the Nasdaq National Market. You may not be able to sell your shares quickly, at the market price or at all if trading in our stock is not active.

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

The terrorist attacks in September 2001 in the United States had a material adverse effect on the economy. Any similar future events may disrupt NeoMagic’s operations or those of our customers and suppliers. In addition, any similar future events could have an adverse impact on the U.S. and world economy, in general, and consumer confidence and spending in particular, which could harm NeoMagic’s sales. Any similar future events could increase volatility in the U.S. and world financial markets, which could harm NeoMagic’s stock price and may limit the capital resources available to us and our customers or suppliers. This could have a significant impact on NeoMagic’s operating results, revenues and costs and may result in increased volatility in the market price of our common stock.

The Company’s cash, cash equivalents and short-term investments are exposed to financial market risk due to fluctuations in interest rates, which may affect our interest income. As of April 30, 2005, the Company’s cash, cash equivalents and short-term investments earned interest at an average rate of 2.1%. 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 April 30, 2005, with consistent cash balances, interest income would be adversely affected by approximately $13,000 per quarter. The Company does not use its investment portfolio for trading or other speculative purposes.

Currently all of the Company’s sales and substantially all 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.

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

As of January 31, 2005, the end of our last fiscal year, we identified a material weakness related to our process of evaluating long-lived assets for impairment, including insufficient controls over the review and documentation of key assumptions used in preparing forecasted cash flows used to support our impairment analyses. We have addressed this material weakness and have instituted a process for the evaluation of long-lived assets that adequately documents the assumptions used in preparing forecasted cash flows and increased the level of review performed with respect to the reasonableness of certain key assumptions used in the underlying forecast supporting the impairment analysis. At April 30, 2005 we did not have any intangible assets.

During the first quarter of fiscal 2006, there have been no changes in the Company’s internal control over financial reporting, other than addressing the material weakness identified in the fourth quarter of fiscal 2005 as discussed above, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The company’s management, including the CEO and CFO, does not expect that our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

court for further proceedings. In November 2002, the lower court heard oral arguments on cross-motions for summary judgment on the matter. In May 2003, the lower court ruled in favor of Trident. In December 2003 the Company filed an appeal in the United States Court of Appeals, for the Federal Circuit. In August 2004 the Federal Circuit rejected the appeal and affirmed the lower court’s decision of no infringement by the Trident products. While the Company believes it has valid defenses against Trident’s counter claim filed in 1999, there can be no assurance as to whether Trident will or will not proceed with the counter-suit.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

NEOMAGIC CORPORATION

(Registrant)

/s/ Scott Sullinger

SCOTT SULLINGER

V.P. Finance and Chief Financial Officer

( Authorized Officer and Principal Financial Officer)

June 10, 2005

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


DELAWARE		77-0344424
[ State or other jurisdiction of incorporation or organization]		[I.R.S. Employer Identification No.]

3250 Jay Street Santa Clara, California		95054
[Address of principal executive offices]		[Zip Code]


		PAGE
PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION

Item 1.	Unaudited Condensed Consolidated Financial Statements:

	Condensed Consolidated Statements of Operations Three months ended April 30, 2005 and 2004	3

	Condensed Consolidated Balance Sheets April 30, 2005 and January 31, 2005	4

	Condensed Consolidated Statements of Cash Flows Three months ended April 30, 2005 and 2004	5

	Notes to Unaudited Condensed Consolidated Financial Statements	6-10

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11-26

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	26

Item 4.	Disclosure Controls and Procedures	27

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	27-28

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	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	28

Signatures		29

Exhibit Index		30-31

Certifications


	Three Months Ended
(In thousands, except per share data)	April 30, 2005			April 30, 2004
Net sales	$	299		$	651

Cost of sales (1)		332			715

Gross loss		(33	)		(64	)

Operating expenses:
Research and development (2)		3,083			4,868
Sales, general and administrative (3)		1,790			2,140
Gain on sale of patents		(3,481	)		—

Total operating expenses		1,392			7,008

Loss from operations		(1,425	)		(7,072	)

Other income (expense), net:
Interest income and other		117			103
Interest expense		(288	)		(24	)

Loss before income taxes		(1,596	)		(6,993	)

Income tax provision		49			7

Net loss	$	(1,645	)	$	(7,000	)

Basic and diluted net loss per share	$	(.05	)	$	(.22	)

Weighted average common shares outstanding for basic and diluted net loss per share		33,235			32,077


(In thousands)	April 30, 2005			January 31, 2005(1)
ASSETS
Current assets:
Cash and cash equivalents	$	15,677		$	8,944
Short-term investments		8,381			16,082
Accounts receivable, net		55			12
Inventory		228			376
Prepaid and other current assets		874			792

Total current assets		25,215			26,206

Property, plant and equipment, net		3,425			3,835
Long term prepaid assets		372			458
Other assets		215			215

Total assets	$	29,227		$	30,714

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,004		$	1,084
Compensation and related benefits		1,299			1,017
Income taxes payable		3,895			3,851
Current portion of capital lease obligations		1,167			1,602
Other accruals		212			225

Total current liabilities		7,577			7,779

Capital lease obligations		2,044			2,004
Mandatorily redeemable Series B convertible preferred stock Authorized and issued shares – 5,000		3,168			2,971
Other long-term liabilities		12			—
Commitments and contingencies

Stockholders’ equity:
Common stock		33			33
Additional paid-in-capital		95,386			95,606
Deferred compensation		(959	)		(1,280	)
Accumulated other comprehensive loss		(4	)		(14	)
Accumulated deficit		(78,030	)		(76,385	)

Total stockholders’ equity		16,426			17,960

Total liabilities and stockholders’ equity	$	29,227		$	30,714


	Three Months Ended April 30,
(In thousands)	2005			2004
Operating activities:
Net loss	$	(1,645	)	$	(7,000	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation		434			576
Amortization and accretion		197			423
Amortization of deferred compensation		97			118
Gain on sale of patents		(3,481	)		—
Changes in operating assets and liabilities:
Accounts receivable		(43	)		239
Inventory		148			(564	)
Other current assets		(82	)		(198	)
Long term prepaid and other assets		86			(34	)
Accounts payable		(80	)		(166	)
Compensation and related benefits		282			249
Income taxes payable		44			—
Other accruals		(1	)		62

Net cash used in operating activities		(4,044	)		(6,295	)

Investing activities:
Purchases of property, plant, equipment and intangibles		(24	)		(32	)
Proceeds from sale of patents		3,481			—
Purchases of short-term investments		(10,097	)		(7,695	)
Maturities of short-term investments		17,808			8,532

Net cash provided by investing activities		11,168			805

Financing activities:
Payments on capital lease obligations		(395	)		(217	)
Net proceeds from issuance of common stock		4			675

Net cash provided by (used in) financing activities		(391	)		458

Net increase (decrease) in cash and cash equivalents		6,733			(5,032	)
Cash and cash equivalents at beginning of period		8,944			12,342

Cash and cash equivalents at end of period	$	15,677		$	7,310

Supplemental schedules of cash flow information:
Cash paid during the period for:
Interest	$	71		$	35
Taxes	$	5		$	6

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Three months ended April 30, (in thousands, except per share amounts)	2005			2004
Net loss, as reported	$	(1,645	)	$	(7,000	)
Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects		97			118
Less: Total stock-based compensation expense determined under the fair value method for all awards, net of related tax effects		(857	)		(1,262	)

Pro forma net loss		(2,405	)		(8,144	)

Reported basic and diluted loss per share	$	(0.05	)	$	(0.22	)

Pro forma basic and diluted loss per share	$	(0.07	)	$	(0.25	)


	Option Plans				Stock Purchase Plan
Three months ended April 30,	2005		2004		2005		2004
Risk-free interest rates	4.0	%	3.57	%	3.32	%	1.31	%
Volatility	.77		.71		.85		.77
Expected life of option in years	5.0		4.93		.50		1.43


Inventory consists of: (in thousands)	April 30, 2005		January 31, 2005
Raw materials	$	141	$	115
Work in process		31		52
Finished goods		56		209

Total	$	228	$	376


(in thousands)	April 30, 2005			January 31, 2005
Software under capital lease	$	4,243		$	4,243
Accumulated amortization		(1,174	)		(821	)

Net software under capital lease	$	3,069		$	3,422


Fiscal year ending January 31, (in thousands)
2006	$	1,341
2007		1,748
2008		423

Total minimum lease payments		3,512
Less: amount representing interest		(301	)

Present value of net minimum lease payments		3,211
Less: current portion		(1,167	)

Long-term portion	$	2,044


	2006		2007		2008		2009		2010		Thereafter		Total
CONTRACTUAL OBLIGATIONS
Operating leases	$	737	$	934	$	1,028	$	1,073	$	1,100	$	277	$	5,149
Capital leases		1,341		1,748		423				—		—		3,512

Total contractual cash obligations	$	2,078	$	2,682	$	1,451	$	1,073	$	1,100	$	277	$	8,661


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

		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

	(a)	Exhibits

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


Number		Description
3.1	(1)	Amended and Restated Certificate of Incorporation.

3.2	(1)	Bylaws.

4.1	(10)	Preferred Stock Rights Agreement dated December 19, 2002, between the Company and EquiServe Trust Company, N.A.

4.2	(13)	Amendment to Rights Agreement, dated as of August 20, 2004, between the Company and EquiServe Trust Company, N.A.

4.3	(12)	Series A Warrant to Satellite Strategic Finance Associates, LLC, dated August 20, 2004.

4.4	(12)	Series B Warrant to Satellite Strategic Finance Associates, LLC, dated August 20, 2004.

4.5	(12)	Registration Rights Agreement dated August 19, 2004 by and between the Company and Satellite Strategic Finance Associates, LLC.

4.6	(9)	Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock.

4.7	(12)	Certificate of Designations, Preferences and Rights of the Series B Convertible Preferred Stock dated August 20, 2004

10.1	(1)	Form of Indemnification Agreement entered into by the Company with each of its directors and executive officers.

10.2	(2)	Lease Agreement, dated as of October 9, 1997, between the Company and A&P Family Investments, as landlord for the leased premises located at 3250 Jay Street.

10.3	(1)	Amended and Restated 1993 Stock Plan and related agreements.

10.4	(2)	Amendment No. 1, dated as of October 15, 1997, between the Company and A&P Family Investments, as landlord for the leased premises located at 3260 Jay Street.

10.5	(1)	Lease Agreement, dated as of February 5, 1996, between the Company and A&P Family Investments, as landlord.

10.6	(1)	1997 Employee Stock Purchase Plan, with exhibit.

10.7	(4)	1998 Nonstatutory Stock Option Plan.

10.8	(4)	Wafer Supply Agreement, dated as of March 15, 1999, between NeoMagic International Corporation and Siemens Aktiengesellschaft Semiconductor Group, now Infineon Technologies AG.

10.9	(5)	General Amendment to the Wafer Supply Agreement with Product Sourcing Agreement, dated January 9, 2001, between NeoMagic International Corporation and Infineon Technologies AG.

10.10	(6)	Employment Offer Letter dated May 10, 2000, between the Company and Sanjay Adkar.

10.11	(6)	Employee Loan Agreement dated May 10, 2000, between the Company and Sanjay Adkar.

10.12	(6)	Security Agreement dated September 1, 2001, between the Company and Stephen Lanza.

10.13	(6)	Promissory Note dated September 1, 2001, between the Company and Stephen Lanza.

10.14	(7)	Full and Final Release dated September 9, 2002, from the Wafer Supply Agreement and the Product Sourcing Agreement between NeoMagic International Corporation and Infineon Technologies AG.

10.15	(8)	Amendment No. 1, dated as of February 26, 2002, between the Company and A&P Family Investments, as landlord for the leased premises located at 3250 Jay Street.

10.16	(8)	Amendment No. 2, dated as of April 7, 2000, between the Company and A&P Family Investments, as landlord for the leased premises located at 3260 Jay Street.



10.17	(8)	Amendment No. 3, dated as of February 26, 2002, between the Company and A&P Family Investments, as landlord for the leased premises located at 3260 Jay Street.

10.18	(11)	Amendment No. 4, dated as of January 31, 2003, between the Company and A&P Family Investments, as landlord for the leased premises located at 3260 Jay Street.

10.19	(12)	Securities Purchase Agreement dated August 19, 2004 by and between the company and Satellite Strategic Finance Associates, LLC.

10.20		Amended and Restated Patent Licensing Agreement dated March 28, 2005 by and between the Company and The Consortium for Technology Licensing, Ltd.

10.21		Patent Purchase Agreement dated April 6, 2005 by and between the Company and Faust Communications, LLC

31.1		Certification of the Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated December 10, 2003.

31.2		Certification of the Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated December 10, 2003.

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

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