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NeoMagic 10-Q 2009 UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D. C. 20549
Form
10-Q
(Mark
One)
For the
quarterly period ended November 1, 2009
OR
For the
transition period from
to
Commission
file number 000-22009
NEOMAGIC
CORPORATION
(Exact
Name of Registrant as Specified in Its Charter)
(408)
428-9725
Registrant’s
Telephone Number, Including Area Code
Indicate
by check mark whether the Registrant (1) has filed all reports required to
be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90
days. Yes x No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of “accelerated filer,” “large accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large
Accelerated Filer ¨ Accelerated
Filer ¨ Non-
Accelerated Filer ¨ Smaller
Reporting Company x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨ No x
The
number of shares of the Registrant’s Common Stock, $.001 par value, outstanding
at November 1, 2009 was 38,051,394.
NEOMAGIC
CORPORATION
FORM
10-Q
INDEX
Part I.
FINANCIAL INFORMATION
NEOMAGIC
CORPORATION
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(In
thousands, except per share data)
(Unaudited)
The
accompanying notes are an integral part of these unaudited Condensed Financial
Statements.
3
NEOMAGIC
CORPORATION
CONDENSED
CONSOLIDATED BALANCE SHEETS
(In
thousands except per share data)
The
accompanying notes are an integral part of these unaudited Condensed Financial
Statements.
4
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In
thousands)
The
accompanying notes are an integral part of these unaudited Condensed Financial
Statements.
5
NEOMAGIC
CORPORATION
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The
accompanying unaudited interim 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 accounting principles generally accepted in the
United States of America, 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 November 1, 2009, the operating
results for the three and nine months ended November 1, 2009 and October 26,
2008 and the cash flows for the nine months ended November 1, 2009 and October
26, 2008. 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 25, 2009, included in the Company’s Form 10-K filed with the
Securities and Exchange Commission.
The
Company believes its current cash and cash equivalents and investments will not
satisfy its projected cash requirements through the next twelve months and there
exists substantial doubt about the Company’s ability to continue as a going
concern. If the Company experiences a material shortfall versus its plan for
fiscal 2010, it will endeavor to take all appropriate actions to
continue operation of its business and to mitigate any negative impact on its
cash position. The Company believes that it 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.
We cannot assure you that additional financing will be available on acceptable
terms or at all. Beyond its third quarter of fiscal 2010, the adequacy of the
Company’s resources will depend largely on its ability to complete additional
financing and its success in re-establishing profitable operations and positive
operating cash flows.
In
September 24, 2008, the Company ceased efforts to raise additional capital. As a
result, NeoMagic proceeded with efforts to substantially reduce its operating
activities and reduce its on-going expenditures by terminating employment for
substantially all of its operational and engineering employees. Additionally, in
September 2008, the remaining independent members of the Company’s board of
directors resigned as directors of NeoMagic Corporation, and in January 2009,
our Chief Financial Officer, resigned his position with the
Company.
In
February 2009, the Board of Directors discontinued its business operations in
Israel and India. In accordance with the guidance provided by ASC 810-10
(formerly ARB 51) and beginning with the third fiscal quarter of fiscal year
2010, the Company will no longer consolidate the financial statements of our
previous subsidiaries in Israel and India.
On
October 16, 2009, the Company closed a private equity financing. The
financing provided that the Company will use the proceeds from the
sale of the Securities for general corporate purposes, including general and
administrative expenses and payment of outstanding liabilities, and not to
redeem or repurchase the Company's Securities. The Company sold and issued the
Shares and the Class A and Class B Warrants for an aggregate offering price of
$752 thousand. After deducting offering costs, net cash proceeds received by the
Company were $734 thousand. The Company has concluded that the
Employee Investors did not receive value in excess of the amounts invested, and
consequently has not recorded a compensation expense related to the
transaction. The Company intends to secure an independent valuation
to support this conclusion. (See Note 8 – Equity
Financing).
During
its third fiscal quarter, the Company appointed three new members to its Board
of Directors. As of the end of its third fiscal quarter, the Company
had not replaced its Chief Financial Officer. Subsequent to its third
fiscal quarter ended November 1, 2009, the Company retained an Acting Chief
Financial Officer.
The
Company’s operations consist primarily of supporting its existing customers,
developing new products, and administration of the corporation.
Management will focus on new product sales and will continue to look for funding
from strategic partners and will seek further equity or debt financing from
financial sources and other opportunities.
6
The
results of operations for the three and nine months ended November 1, 2009 are
not necessarily indicative of the results that may be expected for the year
ending January 31, 2010.
The third
fiscal quarters of 2010 and 2009 ended on November 1, 2009 and October 26, 2008,
respectively. The Company’s quarters generally have 13 weeks. The third quarters
of fiscal 2010 and 2009 each had 13 weeks. The Company’s fiscal years generally
have 52 weeks. Fiscal 2010 will have 53 weeks and fiscal 2009 had 52
weeks.
Subsequent
Events
We
evaluated subsequent events through December 15, 2009, the date this Quarterly
Report on Form 10-Q was filed with the Securities and Exchange Commission
(SEC).
At November 1, 2009, the
Company had several stock-based employee compensation plans, including stock
option plans and employee stock purchase plans. Stock options may be issued to
directors, officers, employees and consultants (“Service Providers”) under the
Company’s 2003 Stock Plan, the Amended 1998 Non-Statutory Stock Option Plan, and
1993 Stock Option Plan. The stock options generally vest over a four-year
period, have a maturity of ten years from the issuance date, and have an
exercise price equal to the closing price on the NASDAQ of the common stock on
the date of grant. Generally, unvested options are forfeited 30 to 90 days from
the date a Service Provider ceases to be a Service Provider, or in the case of
death or disability, the post-exercise period may extend for a period of up to
12 months. To cover the exercise of vested options, the Company issues new
shares from its authorized but unissued share pool. At November 1, 2009,
approximately 1,941,288, 148,921, and 2,800 shares of the
Company’s registered common stock were reserved for issuance under the 2003
Stock Option Plan, Amended 1998 Stock Option Plan, and 1993 Stock Option Plan,
respectively.
In accordance with the
2003 Stock Plan (the “2003 Plan”), the Board of Directors may grant nonstatutory
stock options and stock purchase rights to employees, consultants and directors.
Incentive stock options may be granted only to employees. The 2003 Plan
terminates in 2013. The Board of Directors determines vesting provisions for
stock purchase rights and options granted under the 2003 Plan. Stock options
expire no later than ten years from the date of grant. Generally stock options
vest over a period of four years when granted to new employees. In the event of
voluntary or involuntary termination of employment with the Company for any
reason, with or without cause, all unvested options are forfeited and all vested
options must be exercised within a 90-day period, or as set forth in the option
agreement, or they are forfeited. Certain of the options and stock purchase
rights are exercisable immediately upon grant. However, under the terms of the
2003 Plan, common shares issued on exercise of options before vesting are
subject to repurchase by the Company. As of November 1, 2009, no shares of
common stock were subject to this repurchase provision. Other options granted
under the 2003 Plan are exercisable during their term in accordance with the
vesting schedules set forth in the option agreement. As of November 1, 2009,
there were 578,408 options issued and outstanding under the 2003 Plan. The
number of shares reserved under the 2003 Plan is subject to an automatic
increase for unexercised forfeited shares
subject to options issued under the 1993 Plan. As of November 1,
2009, the number of options outstanding under the 1993 Plan was
2,800.
Under the
1998 Nonstatutory Stock Option Plan (the “1998 Plan”), the Board of Directors
may grant nonstatutory stock options to employees, consultants and officers. The
1998 Plan terminated automatically in June 2008. No additional
options may be granted under the 1998 Plan. As of November 1, 2009
there were 148,921 options issued and outstanding under the 1998
Plan.
On
December 22, 2005, the Company entered into an amendment to the 1998 Plan
to permit holders of certain stock options to voluntarily make irrevocable
advance elections to reduce the exercise period for such stock options. These
advance elections could qualify certain stock options for exemptions from the
potentially unfavorable tax effects imposed by Section 409A of the Internal
Revenue Code, and the proposed regulations issued thereunder (collectively,
“Section 409A”). Specifically, the 1998 Plan was amended to authorize and
provide the framework necessary for the implementation of a short-term deferral
exercise election; that is, certain eligible stock option holders were permitted
to elect to exercise stock options that vest in a given calendar year by no
later than March 15th of the following year. If an option holder made this
election, the stock option agreement underlying the eligible stock options
subject to the election was automatically amended to the extent necessary to
implement the election.
7
Under the
1993 Stock Plan (the “1993 Plan”), the Board of Directors may grant incentive
stock options to employees and nonstatutory stock options and stock purchase
rights to employees, consultants and directors. The 1993 Plan terminated as to
future grants in September 2003. The Board of Directors determined vesting
provisions for stock purchase rights and options granted under the 1993 Plan.
Stock options expire no later than ten years from the date of grant. Generally
stock options vest over a period of four years when granted to new employees. In
the event of voluntary or involuntary termination of employment with the Company
for any reason, with or without cause, all unvested options are forfeited and
all vested options must be exercised within a 90-day period, or as set forth in
the option agreement, or they are forfeited. Certain of the options and stock
purchase rights are exercisable immediately upon grant. However, common shares
issued on exercise of options before vesting are subject to repurchase by the
Company. As of November 1, 2009, no shares of common stock were subject
to
this
repurchase provision. Other options granted under the 1993 Plan are exercisable
during their term in accordance with the vesting schedules set forth in the
option agreement. Unexercised forfeited shares are transferable to the 2003 Plan
as provided within the 2003 Plan.
The 2006
Employee Stock Purchase Plan (“ESPP”) permits eligible employees to purchase
common stock through payroll deductions of up to 10% of the employee’s
compensation. The price of common stock to be purchased under ESPP is 85% of the
lower of the fair market value of the common stock at the beginning of the
offering period or at the end of the relevant purchase period. To cover the
exercise of vested options, the Company issues new shares from its authorized
but unissued share pool. At November 1, 2009, approximately 151,699 shares were
available for future purchase under the 2006 Employee Stock Purchase
Plan.
Adoption
of ASC 718 (Formerly SFAS No. 123(R))
Effective
January 30, 2006, the Company adopted ASC 718, “Share-Based Payment”,
(formerly SFAS No. 123 (revised 2004)), which requires the
Company to measure the cost of employee services received in exchange for all
equity awards granted under its stock option plans and employee stock purchase
plans based on the fair market value of the award as of the grant date. The
Company has adopted ASC 718 using the modified prospective application method of
adoption that requires the Company to record compensation cost related to
unvested stock awards as of January 30, 2006 by recognizing the unamortized
grant date fair value of these awards over the remaining service periods of
those awards with no change in historical reported earnings. Awards granted
after January 30, 2006 are valued at fair value in accordance with
provisions of ASC 718 and recognized on a ratable basis over the service periods
of each award. The Company began using estimated forfeiture rates in the first
quarter of 2007 based on its historical experience.
Stock
Compensation Expense
The
following table shows total stock-based compensation expense included in the
accompanying Consolidated Condensed Financial Statements for the three and nine
months ended November 1, 2009 and October 26, 2008.
For the
nine months ended November 1, 2009 and October 26, 2008, the total compensation
cost related to unvested stock-based awards granted to employees under the stock
option plans but not yet recognized was approximately $368 thousand and $3.7
million, respectively, after estimated forfeitures. The cost will be recognized
on a straight-line basis over an estimated weighted average period of
approximately 1.72 years and 2.57 years for the nine months ended November 1,
2009 and October 26, 2008, respectively, for stock options and will be adjusted
if necessary in subsequent periods if actual forfeitures differ from those
estimates.
There was
no outstanding compensation cost related to options to purchase common shares
under the ESPP for the nine months ended November 1, 2009 as the ESPP was
suspended in July 2008. For the nine months ended October 26, 2008,
there was no unrecognized compensation cost related to options to purchase
common shares under the ESPP.
8
There
were no net cash proceeds from the sales of common stock under employee stock
purchase and stock option plans for the three and nine months ended November 1,
2009. Net cash proceeds from the sales of common stock under employee
stock option and stock purchase plans was $70 thousand for the three and nine
months ended October 26, 2008. No income tax benefit was realized from the sales
of common stock under employee stock purchase and stock option plans during the
three and nine months ended November 1, 2009 and October 26, 2008. In accordance
with ASC 718, the Company presents excess tax benefits from the exercise of
stock options, if any, as financing cash flows rather than operating cash
flows.
Determining
Fair Value
Valuation
and amortization method – The Company estimates the fair value using a
Black-Scholes option pricing formula and a single option award approach. This
fair value is then amortized ratably over the requisite service periods of the
awards, which is generally the vesting period.
Expected
term – The Company’s expected term represents the period that the Company’s
stock-based awards are expected to be outstanding. The expected term for options
granted is based upon historical review. The Company believes that this method
meets the requirements for ASC 718. There were no options granted for the three
and nine months ended November 1, 2009.
Expected
Volatility – The Company’s expected volatility for options granted is computed
based on the Company’s historical stock price volatility. The Company believes
historical volatility to be the best estimate of future volatility and noted no
unusual events that might indicate that historical volatility would not be
representative of future volatility.
Risk-Free
Interest Rate – The risk-free interest rate used in the Black-Scholes option
valuation method is based on the implied yield currently available on U.S.
Treasury zero-coupon issues with a remaining term equal to the expected term of
the option.
Expected
Dividend – The dividend yield reflects that the Company has never paid any cash
dividends and has no intention to pay dividends in the foreseeable
future.
Estimated
Forfeiture – The estimated forfeiture rate was based on an analysis of the
Company’s historical forfeiture rates. The estimated average forfeiture rate for
the three and nine months ended November 1, 2009 was 93.8% and 93.8%,
respectively. The estimated average forfeiture rate for the three and
nine months ended October 26, 2008 was 76.08% and 55.28%
respectively.
In the
three months ended November 1, 2009 and October 26, 2008, respectively, the fair
value of each option grant was estimated on the date of grant using the
Black-Scholes option valuation model and the ratable attribution approach using
a dividend yield of 0% and the following weighted average
assumptions: For the three and nine months ended November 1, 2009,
there were no stock options granted or ESPP shares issued.
9
Stock
Options and Awards Activities
The
following is a summary of the Company’s stock option activity under the stock
option plans as of November 1, 2009 and related information:
The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value, based on the Company’s closing stock price of $0.16 per share
at October 30, 2009, the last market day of our fiscal quarter ended November 1,
2009, which would have been received by option holders had all option holders
exercised their options that were in-the-money as of that date. There were no
in-the-money options exercisable as of November 1, 2009 and October 26,
2008.
The
exercise prices for options outstanding and exercisable as of November 1, 2009
and their weighted average remaining contractual lives were as
follows:
10
The
following data shows the amounts used in computing income (loss) per share and
the effect on the weighted-average number of shares of diluted potential common
stock.
For the
three and nine months ended November 1, 2009 and October 26, 2008,
respectively, basic net income (loss) per share equals diluted net income per
share since all options and warrants outstanding have an exercise price greater
than the fair market value of our common stock as of those dates. During the
three months ended November 1, 2009 and October 26, 2008, the Company
excluded from the computation of basic and diluted income (loss) per share
options and warrants to purchase 48,100,918 and 4,740,102 shares of common
stock, respectively, because the effect would be anti-dilutive. During the nine
months ended November 1, 2009 and October 26, 2008, the Company excluded from
the computation of basic and diluted income (loss) per share options and
warrants to purchase 48,141,487 and 5,098,946 shares of common stock,
respectively, because the effect would be anti-dilutive.
All
highly liquid investments purchased with an original maturity of 90 days or less
are considered cash equivalents. Investments with an original maturity of
greater than 90 days, but less than one year, are classified as short-term
investments.
Investments
in debt securities are classified as held-to-maturity when the Company has the
positive intent and ability to hold the securities to maturity. Held-to-maturity
securities are stated at amortized cost with corresponding premiums or discounts
amortized to interest income over the life of the investment. Securities not
classified as held-to-maturity are classified as available-for-sale and are
reported at fair market value. Unrealized gains or losses on available-for-sale
securities are included, net of tax, in stockholders’ equity until their
disposition. Realized gains and losses and declines in value judged to be other
than temporary on available-for-sale securities are included in interest income
and other. The cost of securities sold is based on the specific identification
method.
11
All cash
equivalents and short-term investments are classified as available-for-sale and
are recorded at fair market value. All available-for-sale securities have
maturity dates of less than one year from the balance sheet dates. For all
classifications of securities, cost approximates fair market value as of
November 1, 2009 and January 25, 2009, and consists of the following (in
thousands):
Fair
Value of Financial Instruments
On
January 28, 2008, the Company adopted ASC 820 (formerly SFAS
157, “Fair Value Measurements”), which defines fair value,
establishes a framework for using fair value to measure assets and liabilities,
and expands disclosures about fair value measurements. ASC 820 applies whenever
other statements require or permit assets or liabilities to be measured at fair
value. ASC 820 is effective for the Company beginning January 28, 2008,
except for non-financial assets and liabilities that are recognized or disclosed
at fair value in the financial statements on a nonrecurring basis, for which
application has been deferred for one year.
The
Company utilizes the market approach to measure fair value for its financial
assets and liabilities. The market approach uses prices and other relevant
information generated by market transactions involving identical or comparable
assets or liabilities.
ASC 820
includes a fair value hierarchy that is intended to increase consistency and
comparability in fair value measurements and related disclosures. The fair value
hierarchy is based on inputs to valuation techniques that are used to measure
fair value that are either observable or unobservable. Observable inputs reflect
assumptions market participants would use in pricing an asset or liability based
on market data obtained from independent sources while unobservable inputs
reflect a reporting entity’s pricing based upon their own market assumptions.
The fair value hierarchy consists of the following three
levels:
12
The
following table summarizes the Company’s financial assets measured at fair value
on a recurring basis as of November 1, 2009 and the basis for that measurement
(in thousands):
The
Company’s financial assets and liabilities are valued using market prices on
both active markets (Level 1) and less active markets (Level 2). Level 1
instrument valuations are obtained from real-time quotes for transactions in
active exchange markets involving identical assets. As of November 1, 2009, the
Company did not have any assets with valuations obtained from readily-available
pricing sources for comparable instruments (Level 2 assets) or those without
observable market values that would require a high level of judgment to
determine fair value (Level 3 assets).
ASC 820
also became effective the first quarter of fiscal 2009. This option was not
chosen, so marketable securities continue to be accounted for as
available-for-sale securities under ASC 320 (formerly SFAS 115 “Accounting for
Certain Investments in Debt and Equity Securities”).
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 income (loss) includes the Company’s net income (loss), as well as
accumulated other comprehensive income (loss) on available-for-sale securities.
Net comprehensive loss for the three and nine months ended November 1, 2009 and
October 26, 2008, respectively, is as follows (in thousands):
Total
accumulated other comprehensive income (loss) was $0 at November 1, 2009 and
January 25, 2009.
13
In
January 2007, the Company entered into a new capital lease to replace an
expiring lease for software licenses used in the design of its semiconductor
products. Obligations under capital leases represent the present value of future
payments under the lease agreements.
The
capital leases were fully amortized as of January 25, 2009, due to the
restructuring activities in fiscal 2009 and the discontinuation of semiconductor
development efforts utilizing the capitalized software.
In
January 2009, the Company settled in full its outstanding obligation under
capital leases of $420 thousand for a cash payment of $25
thousand.
On October 12,
2009, the Company entered into a Stock Purchase Agreement with Attiva Capital
Partners, Ltd.; Bluestone Financial Ltd., and Mediastone LLC, ( collectively,
the "Investors"), pursuant
to which the Company sold to the Investors an aggregate of 20,000,000
shares of restricted unregistered Common Stock at $0.03 per share, for a total
consideration of $600,000. In connection with the purchase, the
Company has also issued to such Investors (i) Class A Warrants entitling them to
purchase an aggregate of 20,000,000 shares of the Company's Common Stock at an
exercise price of $0.06 per share; and (ii) Class B Warrants entitling them to
purchase an aggregate of 20,000,000 shares of the Common Stock at an exercise
price of $0.09 per share. The closing date of the sale was October 16,
2009.
These Warrants, which are exercisable
during the 2 year period following the Closing Date, were initially subject to
an earlier termination of the exercise period by the Company, upon 30 days'
notice to the Investors, if the quoted bid price of the Common Stock in the
"pink sheets" (or on a nationally recognized exchange or other trading system on
which the Common Stock may hereafter be listed) was greater than 200%
(the “Trigger Percentage”) of the respective Warrant's exercise price for a
period of 15 consecutive trading days.
Following the end of our third fiscal
quarter, on November 17, 2009, the quoted bid price of the Common Stock had been
greater than $.12 for more than 15 consecutive trading days and, accordingly,
the Company became entitled to shorten the exercise period for the Class A
Warrants to 30 days. However, pursuant to a request from the
Investors, on November 23, 2009, the Company's Board of Directors determined
that it was in the best interests of the Company's shareholders not
to and the Board approved an Amendment of the Class A and B Warrants
which increased the Trigger Percentage from 200% to 300%. As a result, the
Company cannot accelerate the Exercise Period for the Class A or Class B
Warrants until the 15 trading day bid price has been $0.18 or $0.27,
respectively. All other provisions of the Warrants remain in full force and
effect.
In
addition, as of October 12, 2009, the Company concurrently entered into a Stock
Purchase Agreement with its Chief Executive Officer, Chief Operating Officer and
three other employees (the “Employee Investors”), pursuant to which the Employee
Investors paid $152,414 to the Company on the Closing Date of October 16, 2009,
to purchase an aggregate of 5,080,480 shares of the Company's restricted
unregistered Common Stock at $0.03 per share. In connection with such purchase,
the Company issued to such Employee Investors an aggregate of 2,540,240 Class A
Warrants exercisable at $0.06 per share and 2,540,240 Class B Warrants,
exercisable at $0.09 per share. All of these two year Warrants are identical in
form to the Class A and Class B warrants being issued to the Investors, except
that the expiration date for these warrants is not subject to any
acceleration. The closing date of the sale was October 16,
2009.
The
Company has concluded that the Employee Investors did not receive value in
excess of the amounts invested, and consequently has not recorded a compensation
expense related to the transaction. The Company intends to secure an
independent valuation to support this conclusion.
The Stock Purchase Agreements provided
that the Company will use the proceeds from the sale of the Securities for
general corporate purposes, including general and administrative expenses and
payment of outstanding liabilities, and not to redeem or repurchase the
Company's Securities. The Company sold and issued the Shares and the Class A and
Class B Warrants for an aggregate offering price of $752 thousand. After
deducting offering costs, net cash proceeds received by the Company were $734
thousand.
14
The Class
A Warrants and Class B Warrants provide for adjustments to the exercise price
and number of shares for which the Class A Warrants and Class B Warrants may be
exercised in certain circumstances, including stock splits, stock dividends,
certain distributions, reclassifications. Class A Warrants and Class
B Warrants are each subject to a minimum price of $0.06 per
share.
The
proceeds were allocated between the Shares and the Warrants based on their
respective fair values. The Warrants were classified as equity in accordance
with ASC 815-40 (formerly EITF No. 00-19, “Accounting for Derivative Financial
Instruments Indexed to and Potentially Settled in a Company’s Own Stock”). As
both the Shares and the Class A and Class B Warrants are equity instruments, the
proceeds from the issuance were allocated on the relative fair value method;
however, the Company is aggregating them for financial reporting purposes. This
financing transaction is shown on the Statement of Stockholders’ Equity as
proceeds from issuance of common stock with detachable warrants for the
quarter-ended November 1, 2009.
On
December 6, 2006, NeoMagic closed the sale and issuance of
(i) 2,500,000 shares of its Common Stock, $.001 par value (the “2006
Shares”), and (ii) warrants to purchase 1,250,000 shares of Common Stock at
an exercise price of $5.20 per share (the “2006 Warrants”). The Company sold and
issued the 2006 Shares and the 2006 Warrants for an aggregate offering price,
before deducting any expenses, of $11,450,000. After deducting offering costs,
net cash proceeds received by the Company were approximately $10.5 million. The
issuance and sale of the 2006 Shares and the 2006 Warrants was registered under
a shelf Registration Statement on Form S-3, which was declared effective on
October 31, 2006 (the “Primary S-3”).
The 2006
Warrants provide that each holder of a 2006 Warrant may exercise its 2006
Warrant for shares of Common Stock at an exercise price of $5.20 per share, but
no 2006 Warrant was exercisable for cash until one year after its initial
issuance. The 2006 Warrants, however, became net exercisable on June 6,
2007. The 2006 Warrants provide for adjustments to the exercise price per share
and number of shares for which the 2006 Warrants may be exercised in certain
circumstances, including stock splits, stock dividends, certain distributions,
reclassifications and, subject to a minimum price of $4.58 per share, dilutive
issuances (i.e., price based anti-dilution adjustments).
The 2006
Warrants were initially classified as a liability in accordance with ASC 815-40.
Although the 2006 Warrants as originally issued provided that shares of common
stock may be issued upon a cash exercise under a private placement exemption if
the Primary S-3 is not effective, the staff of the SEC advised the Company that
the Company would be obligated to physically settle the contract only by
delivering registered shares. Under ASC 815-40, if the Company must settle the
contract by delivering registered shares, it is assumed that the Company will be
required to net-cash settle the contract. As a result, the 2006 Warrants were
initially required to be classified as a liability. The fair value of the 2006
Warrants was estimated to be $5.7 million at the date of issue using the
Black-Scholes option pricing model with the following assumptions: risk-free
interest rate of 4.53%; no dividend yield; an expected life of 5 years; and a
volatility factor of 94.9%. The Company is required to revalue the cash
exercisable 2006 Warrants at the end of each reporting period with the change in
value reported in the statement of operations as a “gain or loss from the change
in fair value on revaluation of warrant liability” in the period in which the
change occurred. In fiscal 2008 and fiscal 2007, the Company recognized a gain
on the change in fair value on revaluation of warrant liability of $0.8 million
and $1.8 million, respectively. Since the warrants were initially classified as
a liability, the proceeds allocated to equity were the gross proceeds of
$11,450,000 less the fair value of the warrants of $5,688,000 and less the
offering costs allocated to the warrants of $273,000. The total offering costs
of $974,000 were allocated between the 2006 Warrants and the common stock based
on their respective fair values. Offering costs of $273,000 were allocated to
the 2006 Warrants and reported as interest expense in the statement of
operations for fiscal 2007.
15
In
July 2007, the Company offered holders of 2006 Warrants, the ability to amend
their outstanding warrants. The amended 2006 Warrants are only exercisable on a
net share settlement basis and are no longer cash exercisable. Since holders of
amended 2006 warrants cannot make or execute a cash exercise, the Company will
not be required to register the shares issued upon exercise of such amended
warrants under any circumstances. Accordingly, as of July 27, 2007, the
amended 2006 Warrants were no longer required to be classified as a liability
under ASC 815-40 and were reclassified as equity. The Company completed its
warrant exchange offer on July 27, 2007. At that time, 96% of all
outstanding 2006 Warrants were amended, representing 1,200,000 shares of the
1,250,000 shares subject to warrants that had been available for amendment. One
investor holding a warrant to purchase 50,000 shares chose not to participate.
The 2006 Warrants were revalued on July 27, 2007, the date the warrant
exchange offer was completed, and the Company recognized a loss on the change in
fair value on revaluation of warrant liability of $248,000. The fair value of
the 2006 Warrants was estimated to be $3.1 million. The $3.0 million value of
the amended 2006 Warrants was reclassified to equity as of July 27, 2007
and the $0.1 million value of the 2006 Warrants that were not amended remained
on the Company’s balance sheet as a liability of $7 thousand as of November 1,
2009 and $85 as of January 25, 2009.
The
Company maintained a full valuation allowance on its net deferred tax assets as
of November 1, 2009. The valuation allowance was determined in accordance with
the provisions of ASC 740 (formerly SFAS No. 109, “Accounting for Income
Taxes”), which requires an assessment of both positive and negative evidence
when determining whether it is more likely than not that deferred tax assets are
recoverable; such assessment is required on a jurisdiction by jurisdiction
basis. The Company intends to maintain a full valuation allowance on the U.S.
deferred tax assets until sufficient positive evidence exists to support
reversal of the valuation allowance.
In June
2006, the Financial Accounting Standards Board (FASB) issued ASC740, (formerly
FIN 48 “Accounting for Uncertainty in Income Taxes”). ASC 740 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financials. This interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. ASC 740 also
provides guidance on derecognition of tax benefits, classification on the
balance sheet, interest and penalties, accounting in interim periods,
disclosure, and transition. The Company adopted ASC 740 effective
January 29, 2007.
The
Company has unrecognized tax benefits of approximately $2.3 million as of
January 27, 2008, of which $0.6 million if recognized would result in a
reduction of the Company’s effective tax rate. The Company recorded a decrease
of its unrecognized tax benefits of approximately $0 and $296 thousand as of
November 1, 2009 and October 26, 2008, respectively.
Over the
next twelve months, the Company’s existing tax positions may continue to
generate an increase in unrecognized tax benefits subject to management’s
periodic reviews of the Company’s uncertain tax positions. However, the Company
does not expect the changes in unrecognized tax benefits of its tax positions,
if any, will result in recognition of an uncertain tax
liability.
The
Company is subject to audit by the IRS for all years since fiscal 2003, and to
audit by the California Franchise Tax Board for all years since fiscal
2001.
16
Commitments
In May
1996, the Company moved its principal headquarters to a facility in Santa Clara,
California, under a non-cancelable operating lease that expired in April 2003.
In January 1998, the Company entered into a second non-cancelable
operating lease for an adjacent building, which became its new corporate
headquarters. This lease had a co-terminus provision with the original lease
that expired in April 2003. In March 2002, the Company extended the term for
45,000 square feet under this lease for another seven years with a termination
date of April 2010. In January 2009, the Company defaulted on its lease and
vacated the premises. Subsequent to our fiscal year ended January 25,
2009, we received were sued by our Landlord. In July 2009, the
Company finalized negotiations with the landlord to settle the outstanding debt
for $35,000 through three payments, with the last payment scheduled for August
28, 2009. During the quartered ended November 1, 2009, the Company
paid its obligation to the landlord.
In
January 2009, the Company moved its principal headquarters to a facility in San
Jose, California, under a non-cancelable operating lease that expires in January
2010. The Company’s subsidiaries had leased offices in Israel and India under
operating leases that expired in September 2008 and December 2008, respectively.
During the quarter ended January 25, 2009, the offices in Israel and India were
vacated. In accordance with the guidance provided by ASC 810-10 (formerly ARB
51) and beginning with the third fiscal quarter of fiscal year 2010, the Company
will no longer consolidate the financial statements of our previously
consolidated subsidiaries in Israel and India. As of November 1, 2009, future
minimum lease payments under the Company’s operating leases are as
follows:
Design
tool software licenses
We had
commitments under time-based subscription licenses for design tool software of
$285,000 as of the beginning of our third fiscal quarter 2010. We
have received notice from our vendor that we are in default of the license
agreement and they are seeking the acceleration of an additional $285,000, which
would have been payable in October 2009. In October 2009, the Company
finalized negotiations with its design tool software vendor to settle the
outstanding debt for $75,000. Subsequent to the quarter ended
November 1, 2009, the Company paid this obligation to the vendor in
full.
Other
Commitments
We had commitments under various
purchase orders and other accounts payable liabilities with various vendors of
approximately $245,000, for which the Company negotiated settlements of the
outstanding debt for $43,000 in cash and 200,000 shares of the Company’s common
stock that bear a restrictive legend and are unregistered. As of
November 1, 2009, the Company had fulfilled its obligations to the
vendors.
We had compensation commitments to
former employees and, under Employment Agreements, with three former officers of
the Company for $608 thousand. During its fiscal third quarter 2010, we paid in
full all amounts due to to former non-officer employees and settled
the claims of former officers for cash of $122,000 and the issuance
of 200,000 restricted unregistered shares of the Company’s common
stock. As of November 1, 2009, the Company had paid $20,000 of the
cash settlement with the remainder to be paid monthly over an eighteen month
period. The Company also had a compensation commitment of $422
thousand with its current employees. This debt was settled for cash
payments of $210 thousand during the Company’s third quarter ended November 1,
2009.
17
The
Company generally sells its products with a limited warranty and a limited
indemnification of customers against intellectual property infringement claims.
The Company accrues for known warranty and indemnification issues if a loss is
probable and can be reasonably estimated, and accrues for estimated incurred but
unidentified claims based on historical activity. The accrual and the related
expense for known claims was not significant as of and for the three and nine
month periods ended November 1, 2009 and October 26, 2008, 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.
As
detailed in Contingencies (see Note 11), we had commitments under time-based
subscription licenses for design tool software of $285,000 as of August 2,
2009. We have received notice from our vendor that we are in default
of the license agreement and they are seeking the acceleration of an additional
$285,000, which would be payable in October 2009. In October 2009,
the Company finalized negotiations with its design tool software vendor to
settle the outstanding debt for $75,000. Subsequent to the quarter
ended November 1, 2009, the Company paid its obligation to the
vendor.
We had commitments under various
purchase orders and other accounts payable liabilities with various vendors of
approximately $245,000, which the Company negotiated settlements of the
outstanding debt for $43,000 in cash and 200,000 shares of the Company’s common
stock that bear a restrictive legend and are unregistered. As of
November 1, 2009, the Company had paid its obligations to the
vendors. Had the Company paid its obligation in full prior to quarter
ended November 1, 2009, on a pro forma basis, the Company would have recorded, a
gain on debt forgiveness for these obligations of $2.9 million and $3.0 million
for the three and nine months ended November 1, 2009, respectively.
On a pro forma basis, the Company would have recorded a net income of $2.9
million and $2.1 million for the three and nine months ended November 1, 2009,
and earnings per share of $0.17 and $0.15 for the three and nine months ended
November 1, 2009, respectively.
Subsequent to the quarter ended
November 1, 2009, the quoted bid price of the Company’s common stock was greater
than $.12 for more than 15 consecutive trading days as of as of November 17,
2009. Under the terms of the October 2009 Equity Financing, the Company became
entitled to shorten the Exercise Period for the Investor’s Class A Warrants to
30 days. However, pursuant to a request from the Investors, on
November 23, 2009, the Company's Board of Directors determined that it was in
the best interests of the Company's shareholders not to shorten the Exercise
Period and the Board approved an Amendment of the Class A and B Warrants which
increased the Trigger Percentage from 200% to 300%. As a result, the Company
cannot accelerate the Exercise Period for the Class A or Class B Warrants until
the 15 trading day bid price has been $0.18 or $0.27, respectively. All other
provisions of the Warrants remain in full force and effect.
Also, subsequent to the quarter ended
November 1, 2009, the Company retained James D. Pardee, a partner at FLG
Partners, LLC, a Silicon Valley chief financial officer service and board
advisory consultancy firm, to serve at our Acting Chief Financial
Officer.
In April 2009, the FASB issued guidance
on determining fair value when the volume and level of activity for an asset or
liability has significantly decreased, and in identifying transactions that are
not orderly. Based on the guidance, if an entity determines that the level of
activity for an asset or liability has significantly decreased and that a
transaction is not orderly, further analysis of transactions or quoted prices is
needed, and a significant adjustment to the transaction or quoted prices may be
necessary to estimate fair value. The guidance was effective on a prospective
basis for interim and annual periods ending after June 15, 2009. The adoption of
this guidance had no material impact on the Company's financial results and
positions.
In April 2009, the FASB issued
additional requirements regarding interim disclosures about the fair value of
financial instruments which were previously only disclosed on an annual basis.
Entities are now required to disclose the fair value of financial instruments
which are not recorded at fair value in the financial statements in both their
interim and annual financial statements. The new requirements were effective for
interim and annual periods ending after June 15, 2009 on a prospective basis.
There was no impact on the Company's financial results as this relates only to
additional disclosures.
18
In May
2009, the FASB issued updated guidance ASC 855, “Subsequent
Events”, (formerly
SFAS No. 165) , which establish general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued. ASC 855 is for interim or annual
periods that ended after June 15, 2009, and were effective for the Company
beginning with the second quarter of 2010. The adoption of ASC 855 did not have
a material effect on the Company’s financial statements.
In
June 2009, the FASB issued ASC 810, (formerly SFAS No. 167, Amendments to FASB
Interpretation No. 46(R)), which is effective for us beginning February 1, 2010.
This Statement amends FIN 46(R), Consolidation of Variable Interest
Entities an interpretation of ARB No. 51, to require revised evaluations of
whether entities represent variable interest entities, ongoing assessments of
control over such entities, and additional disclosures for variable interests.
We do not believe the adoption of this pronouncement will have a material impact
on our financial statements.
As of September 2009, the Company
adopted Financial Accounting Standards Board (“FASB”) Accounting Standards
Codification (“ASC” or the “Codification”) 105 (formerly FASB Statement No.
168 “FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles”). This standard establishes only two levels of U.S.
generally accepted accounting principles (“GAAP”), authoritative and
non-authoritative. The Codification became the single source of authoritative,
nongovernmental GAAP, except for rules and interpretive releases of the
SEC, which are sources of authoritative GAAP for SEC registrants. All other
non-grandfathered, non-SEC accounting literature not included in the
Codification became non-authoritative. ASC 105 does not change previously issued
GAAP, but reorganizes GAAP into Topics. In circumstances where
previous standards require a revision, the FASB will issue an Accounting
Standards Update (“ASU”) on the Topic. Our adoption of ASC 105 did
not have any impact on the Company’s financial statements.
Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the American Institute of Certified Public Accountants
(“AICPA”) and the SEC did not or are not believed by management to have a
material impact on the Company’s present or future consolidated financial
statements.
19
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. 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 devices developed and marketed by customers that use our
products, our ability to execute product and technology development plans on
schedule, and our ability to access advanced manufacturing technologies in
sufficient capacity without significant cash pre-payments or investment.
Examples of forward-looking statements include statements about our expected
revenues, our competitive advantage in our markets, the potential market for our
products, our expected production timelines, our customer base and our need for
additional financing beyond the next 12 months. Forward-looking statements are
subject to risk and uncertainties that could cause actual results to differ
materially from those projected. These forward-looking statements speak only as
of the date hereof. We expressly disclaim any obligation or undertaking to
release publicly any updates or revisions to any forward-looking statements
contained herein, to reflect any changes in our expectations with regard thereto
or any changes in events, conditions or circumstances on which any such
statement is based.
Overview
NeoMagic
Corporation was incorporated in California in May 1993 and subsequently
reincorporated in Delaware in February 1997.
Due to
the deteriorating financial markets during fiscal year 2009 and the Company’s
inability to raise additional cash, in September 2008, the Board of Directors
and Management of NeoMagic decided to significantly reduce our operations and
cost structure. The Company has reduced in-house development of new
silicon and is currently focusing on completed device designs which may or may
not use our current inventory of chips. Using some of the proceeds
from the October 2009 equity financing, the Company has begun development of new
products.
NeoMagic designs and delivers consumer
electronic device solutions with semiconductors and software for video,
television, imaging, graphics, and audio. We provide low cost,
innovative multimedia chip technology for tomorrow's entertainment and
communication needs. We continue to deliver semiconductor
chips (primarily from our MiMagic 3 product line), software and device designs.
Our solutions offer low power consumption, small form-factor and high
performance processing. As part of our complete system solution, we deliver a
suite of middleware and sample applications for imaging, video and audio
functionality, and we provide multiple operating system ports with customized
drivers for our products. Our product portfolio includes semiconductor solutions
known as Applications Processors. Our Applications Processors are sold under the
“MiMagic” brand name with a focus on enabling high performance multimedia within
a low power consumption environment.
In the past, we provided graphics
processor semiconductors to top notebook computer manufacturers. In April 2000,
we began to exit the graphics processor market. However, the majority of our
historical net sales through the end of fiscal 2002 continued to come from these
products. We do not expect to have revenue related to these products in the
future. We believe that we were one of the first companies to adopt large
amounts of on-chip memory for commercial applications. Many industry sources
consider our graphics processors to be the semiconductor industry’s first
commercially successful embedded DRAM products. Currently, embedded DRAM
technology is used broadly in many applications. On February 15, 2008, we
completed the sale of selected patents, which included our embedded DRAM
patents, and a patent application to Faust Communications Holdings, LLC for
$12.5 million, providing net proceeds of $9.5 million after agency commissions.
We have retained a worldwide, non-exclusive, royalty-free license to use the
technology covered by these patents and patent application for all of our
current and future products.
The third
fiscal quarters of 2010 and 2009 ended on November 1, 2009 and October 26, 2008,
respectively. The Company’s quarters generally have 13 weeks. The second quarter
of fiscal 2010 had 13 weeks and the first quarter of fiscal 2009 had 13 weeks.
The Company’s fiscal years generally have 52 weeks. Fiscal 2010 will have 53
weeks and fiscal 2009 had 52 weeks.
20
Critical
Accounting Policies and Estimates
Our
condensed consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America.
The preparation of such statements requires us to make estimates and assumptions
that affect the reported amounts of revenues and expenses during the reporting
period and the reported amounts of assets and liabilities as of the date of the
financial statements. Our estimates are based on historical experience and other
assumptions that we consider to be appropriate in the circumstances. However,
actual future results may vary materially from our estimates.
We
believe that the following accounting policies are “critical” as defined by the
SEC, in that they are both highly important to the portrayal of our financial
condition and results, and require difficult management judgments and
assumptions about matters that are inherently uncertain:
There
have been no significant changes to these policies from the disclosures noted in
our Annual Report on Form 10-K for the fiscal year ended January 25,
2009.
21
Results
of Operations
Revenue
Net revenue was $348 thousand
for the three months ended November 1, 2009, compared to $500 thousand for the
three months ended October 26, 2008, and consisted entirely of net product
revenue in both quarters. Net product revenue decreased in the third
fiscal quarter of 2010 relative to the third fiscal quarter of 2009 due to a
$152 thousand decrease in shipments of our MiMagic 3 applications
processor. The decreased shipments of our MiMagic 3 application
processor were primarily due to decreased shipments to our international
customer. Net revenue was $1.2 million for the nine months ended November
1, 2009, compared to $1.5 million for the nine months ended October 26, 2008.
There was no licensing revenue during any of the periods
reported. Net product revenue decreased during the nine months ended
November 1, 2009 relative to the nine months ended October 26, 2008 primarily
due to an approximately $245 thousand decrease in shipments of our MiMagic 3
applications processor, and due to an approximately $55 thousand decrease in
shipments of our MiMagic 6+ applications processor. The overall decrease in
shipments of our MiMagic 3 applications processor during the three
quarters of fiscal 2010 relative to the same period in fiscal 2009 was driven by
decreased product orders. The decrease in shipments of our MiMagic 6+
applications processor during the three quarters of fiscal 2010 relative to the
same period in fiscal 2009 was driven by lack of demand.
Product
sales to customers located outside the United States (including sales to the
foreign operations of customers with headquarters in the United States, and
foreign system manufacturers that sell to United States-based OEMs) accounted
for 100% and 100% of product revenue in the three months ended November 1, 2009
and October 26, 2008, respectively. During the nine months ended November 1,
2009 and October 26, 2008, product sales to customers located outside the United
States accounted for 100% and 99% of product revenue,
respectively. During the first nine months of fiscal 2010 and fiscal
2009, 100% and 88%, respectively, of our revenue resulted from the sale of our
MiMagic 3 application processor. We expect that export sales will continue to
represent the majority of our product revenue.
Our
customer base can shift significantly from period to period as some customer
programs end and new programs do not always emerge to replace them. In addition,
new customers are often added from period to period. All sales transactions were
denominated in United States dollars.
Gross
Profit (loss)
Gross profit was $174
thousand for the three months ended November 1, 2009 compared to a gross loss of
$968 thousand for the three months ended October 26, 2008. The increase in gross
profit is primarily due to a reduction in cost of our MM3 application processor
for the three months ended November 1, 2009, compared to the three months ended
October 26, 2008, which included charges of $1.2 million for the write-down of
MiMagic 6+ and MiMagic 8 inventories to anticipated market value where ending
on-hand quantities exceeded the foreseeable customer requirements due to shifts
in market demand. Gross profit was $672 thousand for the nine
months ended November 1, 2009 compared to a gross loss of $3.1 million for the
nine months ended October 26, 2008. The increase in gross profit for the first
nine months of fiscal 2010 as compared to the same period in fiscal 2009 was
driven by the reasons stated above.
Research
and Development Expenses
Our
in-house Research and Development has been reduced and is used in combination
with external contractors. Research and development expenses are
primarily directed to development for the wireless IP camera, picture frame, and
handheld devices markets. Research and development expenses include compensation
and associated costs relating to development personnel, outside engineering
consulting, amortization of intangible assets and prototyping costs, which are
comprised of photomask costs and other pre-production costs. Research and
development expenses were approximately $131 thousand and $1.4 million for the
three months ended November 1, 2009 and October 26, 2008, respectively. Research
and development expenses decreased in the third quarter of fiscal 2010 compared
to the third quarter of fiscal 2009 primarily due to decreased labor costs. For
the nine months ended November 1, 2009 and October 26, 2008, research and
development expenses were ($366) thousand and $7.6 million, respectively.
Research and development expenses decreased in the first nine months of fiscal
2010 compared to the first nine months of fiscal 2009 primarily due to decreased
labor costs and patent related activity including cancellation of a patent
transfer.
22
Sales,
General and Administrative Expenses
Sales,
general and administrative expenses were $269 thousand and $1.2 million for the
three months ended November 1, 2009 and October 26, 2008, respectively. Sales,
general and administrative expenses decreased primarily due to
decreased labor costs, legal and audit fees, and operational
expenses. For the nine months ended November 1, 2009 and October 26,
2008, sales, general and administrative expenses were $2.3 million and $4.5
million, respectively. The decrease in sales, general and administrative
expenses was driven by lower compensation costs, legal and audit fees, and by
lower facilities costs.
In the
first quarter of fiscal 2009, we completed the sale of 18 non-essential patents,
which included our embedded DRAM patents, and a patent application to Faust
Communications Holdings, LLC for $12.5 million, providing net proceeds of $9.5
million after agency commissions. We have retained a worldwide, non-exclusive,
royalty-free license to use the technology covered by these patents and patent
application for all of our current and future products. The patents sold in the
first quarter of fiscal 2009 do not relate to products NeoMagic currently sells
or plans to sell. There were no patent sales in the first nine months of fiscal
2010.
Restructuring
Expenses
In
September 2008, the Company extended a corporate restructuring plan (the “Plan”)
initiated in July 2008 and approved by the Board of Directors in response to
continuing economic uncertainties with the intent to improve its operating cost
structure. As part of the Plan, the Company scaled back its product development
efforts, reduced its workforce through a lay-off, and, terminating substantially
all of its operational and engineering employees, and closing subsidiaries in
Israel and India. These restructuring activities have resulted in charges
related to severance and benefit arrangements for terminated employees, contract
termination and other exit-related costs, and asset impairment charges related
to accelerated amortization of semiconductor design automation software tools
and other property and equipment assets. Related to these activities, the
Company incurred total restructuring charges of $1.5 million and $1.6 million,
in the three and nine months ended October 26, 2008. Of these charges, $0.7
million and $0.9 million, in the three and nine months ended October 26,
2008, resulted in cash expenditures. In the three and nine months ended November
1, 2009, the Company recorded ($282) thousand and ($349) thousand in
restructuring charges for compensation expense of the compensation settlements
of our former officers. This credit amount resulted from the reduction in
liabilities for compensation settlements with our former employees. The
restructuring charges are reported in the condensed consolidated statements of
operations under operating expenses, “Restructuring expense”.
Stock
Compensation
Stock
compensation expense was $84 thousand and $166 thousand for the three months
ended November 1, 2009 and October 26, 2008, respectively. For the first nine
months of fiscal 2010 and fiscal 2009, stock compensation expense was $267
thousand and $1.1 million, respectively. Stock compensation expense recorded in
cost of revenues, research and development expenses and selling, general and
administrative expenses for the three and nine months ended November 1, 2009 and
October 26, 2008, is the amortization of the fair value of share-based payments
made to employees and members of our board of directors in the form of stock
options and purchases under the employee stock purchase plan as we adopted the
provision of ASC 718 (formerly SFAS No. 123 (R)) on the first day of
fiscal 2007 (See Note 2). The fair value of stock options granted and rights
granted to purchase our common stock under the employee stock purchase plan is
recognized as expense over the employee requisite service period.
Interest
Income and Other
The
Company earns interest on its cash and short-term investments. There
was minimal interest and other income for the three and nine months ended
November 1, 2009. For the three and nine months ended October 26,
2008, the Company earned interest and other income of $69 thousand and $170
thousand, respectively. The decrease is due to lower average cash and short-term
investment balances and decreased interest rates.
23
Interest
Expense
The
Company incurred minimal interest expense for the three and nine months ended
November 1, 2009. Interest expense for the three and nine months
ended October 26, 2008 was $7 thousand and $26 thousand,
respectively. The interest expense represents interest on capital
lease obligations. The decreased interest expense was due to
decreased due to declining capital lease balances.
Loss
on Marketable Equity Securities
In
January 2006, the Company made a $200 thousand minority equity investment in
Neonode, Inc. (“Neonode”), a then privately held mobile telephone company. In
August 2007, effective upon the merger of Neonode with a subsidiary of SBE, Inc.
(“SBE”), SBE changed its name to Neonode, Inc. and its common stock was publicly
traded on the Nasdaq Stock Exchange (“NEON”). Currently, NEON is traded on the
bulletin board “pink sheets.” Upon the merger of SBE and Neonode, the Company’s
investment converted into approximately 127,000 shares of Neonode common stock.
The investment was classified as an available for sale security and had a fair
value on January 27, 2008 of $471 thousand. Management considered the
impairment to be other than temporary and has recorded an impairment loss of
$191 thousand in Other income (expense), net in the Statement of Operations
during its third quarter 2009. In November 2008, the security was sold for a net
value of $9 thousand.
Change
in Fair Value of Warrant Liability
The
Company recorded a loss of $7 thousand for the quarter ended November 1,
2009 for the change in fair value on revaluation of its warrant liability
associated with its warrants issued on December 6, 2006 (the “2006
Warrants”). The Company recorded a gain of $4 thousand for the
quarter ended October 26, 2008, for the change in fair value on revaluation of
its warrant liability associated with its 2006 Warrants. For the first nine
months of fiscal 2010 and fiscal 2009, the Company recorded a loss of $7
and a gain of $38 thousand, respectively. The Company is required to
revalue certain of the 2006 Warrants at the end of each reporting period and
reflect in the statement of operations a gain or loss for the change in fair
value of the warrant liability in the period in which the change occurred. We
calculate the fair value of the warrants outstanding using the Black-Scholes
model (see Note 9). Following the warrant exchange in the second quarter of
fiscal 2008, the number of 2006 Warrants subject to quarterly re-evaluation has
decreased from warrants to purchase 1,250,000 shares to a warrant to purchase
50,000 shares, which significantly decreased the magnitude of the revaluation
for the first six months of fiscal 2009.
Gain
on Debt Forgiveness
The Company recorded a gain on debt
forgiveness for the three and nine months ended November 1, 2009 of
$2.4 million and $2.5 million, respectively. Subsequent to November 1, 2009, the
Company completed negotiations with additional creditors to settle other
liabilities that were outstanding as of its quarter ended November 1,
2009.
Income
Taxes
The
Company did not incur an income tax expense in the three and nine months ended
November 1, 2009. The Company did not record a provision for domestic
income taxes in the nine months of fiscal 2010, as we anticipate utilizing net
operating losses. Income tax expense was $4 thousand for the three months ended
October 26, 2008 and for the first nine months of fiscal 2009 income tax expense
was $27 thousand. We recorded tax provisions of $4 thousand, notwithstanding
incurring losses before income taxes of $5.0 million and $7.3 million, in the
three and nine months ended October 26, 2008, respectively, primarily due to
foreign income taxes. We did not record a provision for domestic income taxes
for the first nine months of fiscal 2009, as we anticipated an operating loss
for the fiscal year.
Liquidity
and Capital Resources
The
Company’s cash, cash equivalents and short-term investments increased by $171
thousand in the nine months ended November 1, 2009 to $354 thousand from $183
thousand at January 25, 2009.
24
The
Company does not believe its current cash and cash equivalents and investments
will satisfy its projected cash requirements through the next twelve months and
there exists substantial doubt about the Company’s ability to continue as a
going concern. If the Company experiences a material shortfall versus its plan
for fiscal 2010, it expects to take all appropriate actions to ensure the
continuing operation of its business and to mitigate any negative impact on its
cash position. The Company believes that it 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.
We cannot assure you that additional financing will be available on acceptable
terms or at all. Beyond its third quarter fiscal 2010, the adequacy of the
Company’s resources will depend largely on its ability to complete additional
financing and its success in re-establishing profitable operations and positive
operating cash flows.
Cash and cash equivalents used in
operating activities was $563 thousand for the nine months ended November 1,
2009 and $10.6 million for the nine months ended October 26, 2008. The net cash
used in operating activities for the nine months ended November 1, 2009, was
primarily due to a
reduction in operating income for a non-cash gain on debt forgiveness of $2.5
million, a decrease in compensation and related benefits liability of $298
thousand, a decrease in patent related expense of $270 thousand, and an
increase in accounts receivable of $94 thousand, off-set by a
non-cash stock-based compensation expense of $267 thousand, an increase in
accounts payable of $322 thousand, and an increase in other accruals
of $281 thousand. The net cash used in
operating activities for the nine months ended October 26, 2008 was
primarily due to net losses of $7.3 million reduced by the non-operating
gain on the sale of patents of $9.5 million, which were partially offset by
non-cash charges for inventory write-downs of $3.4 million, stock-based
compensation expenses of $1.1 million and depreciation expenses of $0.8 million.
Reductions in working capital assets and liabilities generated $0.7 million of
cash inflows from operating activities, comprised principally of a decrease in
accounts receivable of $0.4 million, a decrease in other current assets of $0.4
million, an increase in compensation and related benefits accruals of $0.1
million, partially offset by a reduction in income taxes payable of $0.3
million.
There was
minimal cash provided by investing activities for the nine months ended November
1, 2009. The net cash provided by investing activities for the nine months ended
October 26, 2008 was primarily due to the net proceeds from the sale of patents
of $9.5 million and the maturities of short-term investments of $3.5 million,
partially offset by net purchases of short-term investments of $3.0
million.
Net cash
provided by financing activities was $0.7 million and net cash used in financing
activities was $0.2 million for the nine months ended November 1, 2009 and
October 26, 2008, respectively. The net cash provided by financing activities
for the nine months ended November 1, 2009, was due to net proceeds from the
issuance of common stock. The net cash used in financing activities
for the nine months ended October 26, 2008 was due to payments on capital lease
obligations of $0.2 million partially offset by net proceeds from the issuance
of common stock of $0.1 million.
In
January 2009, the Company defaulted on its lease and vacated the
premises. Subsequent to our fiscal year ended January 25, 2009, we
received were sued by our Landlord. In July 2009, the Company
finalized negotiations with the landlord to settle the outstanding debt for
$35,000 through three payments, with the last payment scheduled for August 28,
2009. During the quartered ended November 1, 2009, the Company paid
its obligation to the landlord.
We lease
certain software licenses under capital leases. In January 2009, the Company
settled in full its outstanding obligation under capital leases of $420 thousand
for a cash payment of $25 thousand.
Contractual
Obligations
The
following summarizes the Company’s contractual obligations at November 1, 2009,
and the effect such obligations are expected to have on our liquidity and cash
flow (in thousands).
25
Off-Balance
Sheet Arrangements
As of
November 1, 2009, we had no off-balance sheet arrangements as defined in
Item 303(a) (4) of Regulation S-K.
Recent
Accounting Pronouncements
Please
refer to Note 14 of Notes to our condensed consolidated financial statements
included in Item 1 of Part I for a discussion of the expected impact of
recently issued accounting standards.
Not
Applicable.
Evaluation
of Disclosure Controls and Procedures
We
maintain disclosure controls and procedures (as defined in Rule 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”))
designed to ensure that information we are required to disclose in reports that
we file or submit under the Exchange Act is accumulated and communicated to our
management, including our principal executive and principal financial officers,
as appropriate to allow timely decisions regarding required disclosure, and that
such information is recorded, processed, summarized and reported within the time
periods specified in the SEC rules and forms. Our Chief Executive Officer, who
is our (Acting) Chief Financial Officer, evaluates the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Exchange Act) as of the end of the period covered by this Quarterly
Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer, who
is also our (Acting) Chief Financial Officer, has concluded that our disclosure
controls and procedures were effective as of November 1,
2009.
Changes
in Internal Controls Over Financial Reporting
During
our third fiscal quarter 2010, three new members were appointed to our board of
directors. Our external audit committee consists of two independent
members. During the third quarter of fiscal 2009, the management of the Company
executed a significant reduction of force. The remaining independent directors
of the Company resigned as directors the Company in September 2008,
and our Chief Financial Officer then resigned his position in January 2009.
Because of the reduction in force, the resignation of all independent directors
and the resignation of the CFO, control procedures which are normally in place
with separate individuals have necessarily been combined across a significantly
reduced staff. While we believe that internal controls are intact and
carefully monitored, the combination of staff functions does expose the Company
to risk associated with internal controls. During its third fiscal quarter, the
Company appointed three new members to its Board of
Directors. Subsequent to its third fiscal quarter ended November 1,
2009, the Company retained an Acting Chief Financial Officer.
Inherent
Limitations on Effectiveness of Controls
The
effectiveness of any system of internal control over financial reporting is
subject to inherent limitations, including the risk of exercise of judgment in
designing, implementing, operating, and evaluating the controls and procedures,
and the inability to eliminate the risk of misconduct completely. Accordingly,
any system of internal control over financial reporting can only provide
reasonable, not absolute, assurances. In addition, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate. We intend to
continue to monitor and upgrade our internal controls as necessary or
appropriate for our business, but we cannot assure that such improvements will
be sufficient to provide us with effective internal control over financial
reporting.
26
Part
II. Other Information
The
factors discussed below are cautionary statements that identify important risk
factors that could cause actual results to differ materially from those
anticipated in the forward-looking statements in this Quarterly Report on Form
10-Q. If any of the following risks actually occurs, our business, financial
condition and results of operations would suffer. In this case, the trading
price of our common stock could decline and investors might lose all or part of
their investment in our common stock.
We
Need Additional Capital and We Have Substantially Reduced our Operating
Activities
At
November 1, 2009, we had $354 thousand in cash and cash equivalents and $127
thousand in accounts receivable. We believe that this level of cash, cash
equivalents and accounts receivable is not sufficient to maintain continuing
operations at current levels. The adequacy of our resources will depend largely
on our ability to achieve positive operating cash flows principally through
reductions in expenditures. These uncertainties raise substantial doubt about
our ability to continue as a going concern.
We are
not generating sufficient cash from the sale of our products to support our
operations and have been incurring significant losses. We have been funding our
operations primarily with the cash proceeds of the sale of our MM3 application
processor. During our third fiscal quarter ended November 1, 2009, we completed
a private equity financing with a net proceed of $734 thousand. The
Company will use the proceeds from the sale of the Securities for general
corporate purposes, including general and administrative expenses and payment of
outstanding liabilities, and not to redeem or repurchase the Company's
Securities. We expect to incur additional operating losses and may have negative
operating cash flows through the end of our fourth fiscal quarter in January
2010 and beyond. Unless we are able to increase sales and raise additional
capital, we will not have sufficient cash to support our operations. We have
taken steps to restructure our operations and reduce our monthly operational
cash expenditures. In February 2009, the Company’s subsidiaries
discontinued business operations in Israel and India. In accordance with the
guidance provided by ASC 810-10 and beginning with the third fiscal quarter of
fiscal year 2010, we will no longer consolidate the financial statements of our
previous subsidiaries in Israel and India.
There is
no assurance that we will be successful in reducing our operating expenses,
generating sufficient cash flows from operations or obtaining sufficient funding
from any source on acceptable terms, if at all. If we are unable to generate
sufficient cash flows from our operations, we may not be able to continue
operations as proposed, requiring us to modify our business plan, curtail
various aspects of our operations or cease operations. In such event, investors
may lose a portion or all of their investment. The report of our independent
registered public accounting firm, in respect of our 2009 fiscal year, included
an explanatory going concern paragraph regarding substantial doubt as to our
ability to continue as a going concern, which indicates an absence of obvious or
reasonably assured sources of future funding that will be required by us to
maintain ongoing operations.
We
Have a Limited Customer Base
In the
first nine months of fiscal 2010, one customer accounted for 100% of our product
revenue. In each of the last two fiscal years, three customers have accounted
for over two-thirds of our product revenue. In fiscal 2009, one customer
accounted for 86% of product revenue. In fiscal 2008, the top three customers
accounted for 50%, 20%, and 14%, respectively, of product
revenue. There was no licensing revenue in fiscal 2010 to date, nor
in 2009 and 2008. We expect that a small number of customers will continue to
account for a substantial portion of our product revenue for the foreseeable
future. Furthermore, the majority of our sales were 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.
27
We
May Lose Our Customer Base
Our
products are designed to afford handheld device manufacturer significant
advantages with respect to product performance, power consumption and product
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.
We
Have Been Delisted from The Nasdaq Stock Market
In
October 2008, due to our inability to comply with the minimum
shareholders’ equity, market value of listed securities and net income
requirements set forth in Rule 4310(c)(3), our common
stock was delisted from The Nasdaq Capital Market. Trading in our
common stock is now conducted on the Bulletin Board “pink sheets”. There is no
guarantee that there will be an active trading market for our common stock. You
may not be able to sell your shares of our stock quickly, at the market price or
at all, if trading in our stock is not active.
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 do not provide reliable financial reports or prevent fraud, we will be
subject to potential liability and may have to incur expenses to defend the
Company against governmental proceedings or private litigation and/or to pay
fines or damages. Such proceedings would also require significant management
time and would distract management from focusing on the business. Failing to
provide reliable financial reports would also cause loss of reputation in the
investor community and would likely result in a decrease in our stock
price.
During
our third fiscal quarter 2010, three new members were appointed to our board of
directors. Our external audit committee consists of two independent
members. In January 9, 2009, the Company’s Chief Financial Officer
resigned and no replacement was named as of November 1, 2009. In addition, the
Company has significantly reduced its financial accounting staff which could
decrease the effectiveness of its internal control over financial
reporting. Subsequent to the quarter ended November 1, 2009, the
Company retained the services of James D. Pardee, a partner at FLG Partners,
LLC, a Silicon Valley chief financial officer services and board advisory
consultancy firm, to serve at our Acting Chief Financial
Officer.
Our
Revenues Are Difficult To Predict
For a
variety of reasons, our revenues are difficult to predict and may vary
significantly from quarter to quarter. Our ability to achieve design wins
depends on a number of factors, many of which are outside of 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. Our customer base can shift
significantly from period to period as existing customer programs end and new
programs do not always replace ending programs. All of these factors make it
difficult to predict our revenues from period to period.
The
difficulty in forecasting revenues increases the difficulty in anticipating our
inventory requirements. This difficulty increases the likelihood that we may
overproduce particular parts, resulting in inventory write-downs, or
under-produce 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 revenue performance does not match
investor expectations.
28
We
May Encounter Inventory Excess or Shortage
To have
product inventory to meet potential customer purchase orders, we place purchase
orders for semiconductor wafers from our manufacturer in advance of having firm
purchase orders from our customers. 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 an inventory write-down 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 2009 of $3.4 million. Significant write-downs for
excess inventory did occur in fiscal 2009, which had 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.
We
Face Intense Competition in Our Markets
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 audio/video performance, price, features, power consumption, product
size and customer support, as well as, company stability. 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 and 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. Our
small size and perceived instability are negative factors in competing for
business.
We
compete with both domestic and foreign 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. We may
also face increased competition from new entrants into the market, including
companies currently in the development stage. We believe we have significant
expertise in SOC technology. However, if we cannot timely introduce new products
for our markets, support these products in customer programs, or manufacture
these products, such inabilities 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, 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. In addition, if
production levels increase the value of binding purchase orders may increase
significantly.
Uncertainty
Regarding Future Licensing Revenue and Gain on Sale of
Patents
Patents
sold in prior fiscal years related to products we no longer sell and not to
products that we currently sell or plan to sell. We retained a worldwide,
non-exclusive license under the patents sold. The sales did not include our
important patents covering the unique array processing technology used in our
MiMagic products. We cannot assure you that we will be able to generate any
future licensing revenue or gains on sales of patents from our remaining 15
patents as November 1, 2009, or from any future patents that we will own or have
the right to license.
29
We
Depend on Qualified Personnel
Our
future success depends in part on the continued service of our personnel, and
our ability to identify, contract or hire and retain additional personnel to
serve potential customers in our targeted markets. There is strong competition
for qualified personnel in the semiconductor industry, and we cannot assure you
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 both through headcount reductions and attrition. In the past two years
we have lost some of our executive management, including our Vice
President, Worldwide Sales, Vice President of Marketing, Vice President of
Operations, and Chief Financial Officer. As of November 1, 2009 our Chief
Executive Officer, has been filling the position of Acting Chief Financial
Officer. Subsequent to the quarter ended November 1, 2009, the Company retained
the services of James D. Pardee, a partner at FLG Partners, LLC, a Silicon
Valley chief financial officer services and board advisory consultancy firm, to
serve at our Acting Chief Financial Officer.
All our
executive officers are employees “at will”. We have employment contracts with
Douglas R. Young, our chief executive officer, and Syed Zaidi, our chief
operating officer, and until his departure in January 2009 with our chief
financial officer. Until their departure in September 2008, we had employment
contracts with our vice president of operations, and our vice president of
marketing. The employment contracts allow us to terminate their employment at
any time but require us to make severance payments depending upon the
circumstances surrounding termination of employment. We do not maintain key
person insurance on any of our personnel. If we are not able to retain 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, SEC and
Nasdaq Capital Market rules require that three independent board members serve
on our audit committee. As of November 1, 2009, we have two independent board
members that 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 and we have been delisted from the Nasdaq Capital Market. Our stock
currently is trading on the Bulletin Board “pink sheet”.
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 to comply with relevant industry standards
and market trends. We cannot assure you 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 and ODM design cycles, which could result in a material adverse
effect on our business, financial condition and results of
operations.
Our
products require wafers manufactured with state-of-the-art fabrication equipment
and techniques. We currently use one third-party foundry for wafer fabrication.
We expect that, for the foreseeable future, all of our products will be
manufactured at Taiwan Semiconductor Manufacturing Corporation on a
purchase-order-by-purchase-order basis. 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, we may have no readily available
alternative source of supply for specific products. In addition to time
constraints, switching foundries would require a diversion of engineering
manpower and financial resources to redesign our products so that the new
foundry could manufacture them. We cannot assure you that we can redesign our
products to be manufactured by a new foundry in a timely manner, nor can we
assure you that we will not infringe on the intellectual property of our current
wafer manufacturer when we redesign our products for a new foundry. A
manufacturing disruption experienced by our manufacturing partner, the failure
of our
30
manufacturing
partner to dedicate adequate resources to the production of our products, or the
financial instability of our manufacturing partner would have a material adverse
effect on our business, financial condition and results of operations.
Furthermore, if 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.
We have
many other risks due to our dependence on a third-party manufacturer, 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 partner 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, we cannot assure you that our manufacturing partner 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, we cannot
assure you that our manufacturing partner will continue to devote adequate
resources to produce our products or continue to advance the process design
technologies on which the manufacturing of our products are
based.
We
Rely on Third-Party Subcontractors to Assemble and Test Our
Products
Our
products are assembled and tested by third-party subcontractors. We expect that,
for the foreseeable future, the vast majority of our products will be packaged
and assembled on a purchase-order-by-purchase-order basis. We do not have
long-term agreements with any of these subcontractors. Such assembly and testing
is conducted on a purchase order basis. Because we rely 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.
Our
Manufacturing Yields May Fluctuate
Fabricating
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, variation in
equipment used 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 typically 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 to identify, communicate and resolve
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. We cannot assure you that our manufacturers will
achieve or maintain acceptable manufacturing yields in the future.
31
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 November 1, 2009,
we had been issued and held 15 patents. These issued patents are scheduled to
expire between 2014 and 2025. In February 2008 we sold 18 patents and one patent
application to Faust Communications, LLC for net proceeds of $9.5 million. The
patents sold related to products we no longer sell and not to products that we
currently sell or plan to sell. We retained a worldwide, non-exclusive license
under the patents sold. The sales did not include our important patents covering
the unique array processing technology used in our MiMagic products.
Additionally, we have several patent applications pending. We cannot assure you
that our pending patent applications, or any future applications, will be
approved. Further, we cannot assure you 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, we cannot
assure you 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, we
cannot assure you that others will not independently develop substantially
equivalent intellectual property or otherwise gain access to our trade secrets
or intellectual property or disclose such intellectual property or trade
secrets, or that we can meaningfully protect our intellectual property. Our
failure to meaningfully protect our intellectual property could have a material
adverse effect on our business, financial condition and results of
operations.
As a
general matter, the semiconductor industry has experienced substantial
litigation regarding patent and other intellectual property rights. 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.
We cannot assure you 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. If any
adverse ruling in any such matter occurs, we could be required to pay
substantial damages, which could include treble damages, to cease the
manufacturing, use and sale of infringing products, to discontinue the use of
certain processes, or to obtain a license under the intellectual property rights
of the third party claiming infringement. We cannot assure you, 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.
We
Depend on Foreign Sales and Suppliers
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 100% and 96% of our product
revenue for the nine months ended November 1, 2009 and October 26, 2008,
respectively.
We expect
that product revenue derived from foreign sales will continue to represent a
significant portion of our total product revenue. To date, our
foreign 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.
Foreign
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 we use are procured from foreign sources. Wafers are priced in
U.S. dollars under our purchase orders with our manufacturing
suppliers.
32
Foreign
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. We cannot assure you that one or more of these risks will
not have a material adverse effect on our business, financial condition and
results of operations.
Our
Financial Results Could Be Affected by Changes in Accounting
Principles
Generally
accepted accounting principles in the United States are subject to issuance and
interpretation by the Financial Accounting Standards Board, or FASB, the
American Institute of Certified Public Accountants, the 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.
Our
Stock Price May Be Volatile
The market price of our
Common Stock, like that of other semiconductor companies, has been and is likely
to continue to be, highly volatile. For example, during the quarter ended
November 1, 2009, the highest closing sale price per share was $0.19 and the
lowest was less than $0.03 per share. During the quarter ended October 26, 2008,
the highest closing sale price per share was $0.41 and the lowest was
$0.01 per share. 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 sales of our
common stock, 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 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.
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The
following Exhibits are filed as part of, or incorporated by reference into, this
Report:
34
35
36
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
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