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UNITED STATES
SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q/A
--------------------------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the period ended April 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the transition period from _______ to _______
COMMISSION FILE NUMBER: 0-22651
3DFX INTERACTIVE, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 77-0390421
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
4435 Fortran Drive
San Jose, California 95134
(Address of principal executive offices)
Telephone Number (408) 935-4400
(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 [ ]
As of May 31, 1999 there were 24,421,305 shares of the Registrant's
Common Stock outstanding.
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<PAGE>
3DFX INTERACTIVE, INC.
Form 10-Q/A
INDEX
Cover Page
Index
PART I. Financial Information
Item 1. Financial statements
Condensed Consolidated Balance Sheets -- April 30, 1999 and
December 31, 1998
Condensed Statements of Operations -- Three Months Ended
April 30, 1999 and March 31, 1998 and One Month Ended January 31, 1999
Condensed Consolidated Statements of Cash Flows -- Three Months Ended
April 30, 1999 and March 31, 1998 and One Month Ended January 31, 1999
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
PART II. Other Information
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
Signatures
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
3DFX INTERACTIVE, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands)
<TABLE>
<CAPTION>
(unaudited)
April 30, December 31,
1999 1998
------------ ------------
<S> <C> <C>
Assets:
Cash and cash equivalents ........................ $55,556 $92,922
Short-term investments ........................... 23,192 3,058
Accounts receivable, net ......................... 33,482 36,335
Inventory ........................................ 18,306 23,991
Other current assets ............................. 13,396 12,089
------------ ------------
Total current assets ..................... 143,932 168,395
Property and equipment, net....................... 21,572 15,629
Other assets...................................... 3,284 97
------------ ------------
$168,788 $184,121
============ ============
Liabilities and Shareholders' Equity:
Accounts payable ................................. $35,113 $41,104
Accrued liabilities .............................. 10,670 16,031
Current portion of capitalized lease obligations . 216 389
------------ ------------
Total current liabilities ................ 45,999 57,524
------------ ------------
Capitalized lease obligations, less current portion. 449 284
------------ ------------
Shareholders' equity:
Common stock ..................................... 128,093 126,569
Warrants ......................................... 242 242
Deferred compensation ............................ (535) (697)
(Accumulated deficit) retained earnings .......... (5,460) 199
------------ ------------
Total shareholders' equity ............... 122,340 126,313
------------ ------------
$168,788 $184,121
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
3DFX INTERACTIVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
One
Three Months Ended Month
------------------- Ended
April 30, March 31, January 31,
1999 1998 1999
--------- --------- -----------
<S> <C> <C> <C>
Revenues................................ $40,444 $50,008 $17,048
Cost of revenues........................ 26,190 25,730 14,527
--------- --------- -----------
Gross profit.......................... 14,254 24,278 2,521
--------- --------- -----------
Operating expenses:
Research and development.............. 11,756 5,826 3,340
Selling, general and administrative... 6,620 9,638 4,614
--------- --------- -----------
Total operating expenses.............. 18,376 15,464 7,954
--------- --------- -----------
Income (loss) from operations........... (4,122) 8,814 (5,433)
Interest and other income, net.......... 911 514 322
--------- --------- -----------
Income (loss) before income taxes....... (3,211) 9,328 (5,111)
(Benefit) provision for income taxes.... (1,027) 1,866 (1,636)
--------- --------- -----------
Net income (loss)....................... ($2,184) $7,462 ($3,475)
========= ========= ===========
Net income (loss) per share:
Basic................................. ($0.14) $0.57 ($0.22)
========= ========= ===========
Diluted............................... ($0.14) $0.50 ($0.22)
========= ========= ===========
Shares used in net income (loss) per
share calculations:
Basic................................. 15,768 13,091 15,641
--------- --------- -----------
Diluted............................... 15,768 14,924 15,641
--------- --------- -----------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
3DFX INTERACTIVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
One
Three Months Ended Month
------------------- Ended
April 30, March 31, January 31,
1999 1998 1999
--------- --------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income ........................... ($2,184) $7,462 ($3,475)
Adjustments to reconcile net loss to net
cash provided by (used in) operating
activities:
Depreciation ............................. 1,821 894 675
Stock compensation........................ 121 121 40
Increase in allowance for doubtful
accounts................................ (409) 1,456 4,449
Changes in assets and liabilities:
Accounts receivable..................... (5,528) (25,775) 4,341
Inventory............................... (323) (11,790) 6,008
Other assets............................ (4,821) 653 459
Accounts payable........................ 5,206 21,832 (11,195)
Accrued liabilities..................... (4,460) 10,533 (869)
--------- --------- -----------
Net cash provided by (used in) operating
activities............................ (10,577) 5,386 433
--------- --------- -----------
Cash flows from investing activities:
Purchases of short-term investments.......... (1,917) (24,367) (18,222)
Purchases of property and equipment.......... (6,980) (1,580) (1,459)
--------- --------- -----------
Net cash used in investing activities..... (8,897) (25,947) (19,681)
--------- --------- -----------
Cash flows from financing activities:
Proceeds from secondary public offering, net. -- 54,830 --
Proceeds from issuance of Common Stock, net.. 1,496 139 32
Principal payments of capitalized lease
obligations, net.......................... (148) (304) (24)
Payments on drawdown on line of credit, net.. -- (291) --
--------- --------- -----------
Net cash provided by financing activities. 1,348 54,374 8
--------- --------- -----------
Net increase (decrease) in cash and
cash equivalents............................. (18,126) 33,813 (19,240)
Cash and cash equivalents at beginning
of period.................................... 73,682 28,937 92,922
--------- --------- -----------
Cash and cash equivalents at end of period..... $55,556 $62,750 $73,682
========= ========= ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
3DFX INTERACTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - The Company and Its Significant Accounting Policies:
3Dfx Interactive Inc. (the "Company" or "3Dfx") was incorporated in
California on August 24, 1994. The Company is engaged in the design,
development, marketing and support of 3D and 3D/2D media processors,
subsystems and API software for the interactive personal computer market.
The unaudited condensed consolidated financial statements included
herein have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain
information or footnote disclosure normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of the Company, the accompanying unaudited
condensed consolidated financial statements contain all adjustments,
consisting only of normal recurring adjustments, necessary to present
fairly the financial information included therein. While the Company
believes that the disclosures are adequate to make the information not
misleading, it is suggested that these financial statements be read in
conjunction with the audited financial statements and accompanying notes
included in the Company's Annual Report on Form 10-K, as amended, for the
fiscal year ended December 31, 1998 as filed with the Securities and
Exchange Commission. On March 29, 1999, the Board of Directors determined
that it would be in the best interests of the Company and its shareholders
to change its fiscal year from a December Fiscal Year to a year beginning
on February 1 and ending on January 31 ("January Fiscal Year"), beginning
on February 1, 1999. Accordingly, the Company has separately presented the
results of operations and cash flows for the one month period ended
January 31,1999. The results of operations for the one month period ended
January 31, 1999 or the quarter ended April 30, 1999 are not necessarily
indicative of the results to be expected for the full year.
Three customers represented 51%, 18%, and 12% and three customers
represented 41%, 22% and 13% of the Company's revenue during the three
months ended April 30, 1999 and March 31, 1998, respectively. Two
customers represented 36% and 25% of the Company's revenue during the one
month ended January 31, 1999.
Note 2 - Public Offerings:
In March 1998, the Company completed a public offering of 2,900,000
shares of common stock at a price of $23.75 per share. Of the 2,900,000
shares offered, 2,028,140 were sold by the Company and 871,860 were sold
by selling shareholders. The Company received cash of approximately $45.5
million, net of underwriting discounts and commissions and other offering
costs. The Company did not receive any of the proceeds from the sale of
shares by the selling shareholders. On March 23, 1998, the Company's
underwriters exercised an option to purchase an additional 435,000 shares
of common stock at a price of $23.75 per share to cover over-allotments.
In connection with the exercise of such option, the Company received cash
of approximately $9.3 million, net of underwriting discounts and
commissions and other offering costs.
Note 3 - Net Income (Loss) per Share:
Basic net income (loss) per share is computed using the weighted average
number of common shares outstanding during the periods. Diluted net income
(loss) per share is computed using the weighted average number of common
and potentially dilutive common shares during the periods, except those
that are antidilutive. A reconciliation of the numerators and denominators
of the basic and diluted per share computations as follows (in thousands,
except per share data):
<TABLE>
<CAPTION>
One
Three Months Ended Month
------------------- Ended
April 30, March 31, January 31,
1999 1998 1999
--------- --------- -----------
<S> <C> <C> <C>
Net income (loss) available to common
shareholders (numerator).............. ($2,184) $7,462 ($3,475)
Weighted average common shares
outstanding (denominator for basic
computation).......................... 15,768 13,091 15,641
Effect of dilutive securities --
common stock equivalents.............. -- 1,833 --
--------- --------- -----------
Weighted average shares outstanding
(denominator for diluted computation). 15,768 14,924 15,641
========= ========= ===========
Basic earnings (loss) per share......... ($0.14) $0.57 ($0.22)
========= ========= ===========
Diluted earnings (loss) per share....... ($0.14) $0.50 ($0.22)
========= ========= ===========
</TABLE>
During the quarter ended April 30, 1999 and the one month ended January
31, 1999, options to purchase approximately 116,250 and 94,542 shares,
respectively were outstanding but not included in the computation because
they were antidilutive.
Note 4 - Income Taxes:
The Company recorded for the three months ended April 30, 1999 and March
31, 1998 an effective tax rate of 32% and 20%, respectively. The Company
recorded for the one month ended January 31, 1999 an effective tax rate of
32%. The effective tax rate is different from the statutory rate due to
the utilization of federal and state net operating loss carryforwards and
tax credits.
Note 5 - Comprehensive Income:
In January 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" (SFAS 130) which
establishes standards for reporting and displaying comprehensive income
and its components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. Such items may include foreign
currency translation adjustments, unrealized gains/losses from investing
and hedging activities, and other transactions. Comprehensive income for
each of the three months ended April 30, 1999 and March 31, 1998 and the
one month ended January 31, 1999 was equal to net income.
Note 6 - Merger Agreement:
In December 1998, the Company entered into a Merger Agreement
(the"Merger Agreement") with STB Systems Inc., a Texas corporation
("STB"). The Merger Agreement provided for the merger of a newly formed,
wholly owned subsidiary of 3Dfx with and into STB. STB will be the
surviving
corporation of the Merger and will become a wholly owned subsidiary of
3Dfx. The merger will be accounted for under purchase accounting. The
merger was approved by the shareholders of both STB and 3Dfx on May 5,
1999 and May 12, 1999, respectively. The merger was consummated on May
13, 1999.
Pro forma results of operations for the combined company as if the
transaction consummated at the beginning of the earliest period presented
are as follows:
Three Months Ended Year Ended
April 30, December 31,
1999 1998
--------- ---------
Revenues .......................... $111,893 $467,411
--------- ---------
Net (loss) income.................. ($6,991) $13,604
---------
Basic net (loss) income per share .. ($0.29) $0.60
========= =========
Diluted net (loss) income per share . ($0.29) $0.55
========= =========
<PAGE>
3DFX INTERACTIVE, INC.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. These statements
include the sentence in the first paragraph under "Overview" regarding
anticipated revenue growth; the sentence in the second paragraph under
"Overview" regarding expected customer concentration; the sentence in the
third paragraph under "Overview" regarding availability of raw materials;
the sentences in the second paragraph under "Results of Operations"
regarding factors affecting gross margin; the sentences in the third and
fourth paragraphs under "Results of Operations" regarding future research
and development and selling, general and administrative costs,
respectively; the statements below under "Year 2000 Compliance"; the
sentence in the third paragraph under "Liquidity and Capital
Resources" regarding capital expenditures; the statements in the
sixth paragraph under "Liquidity and Capital Resources" regarding future
liquidity and capital requirements and the statements below under "Factors
Affecting Future Operating Results". These forward-looking statements are
based on current expectations and entail various risks and uncertainties
that could cause actual results to differ materially from those projected
in the forward-looking statements. Such risks and uncertainties are set
forth below under "Factors Affecting Future Operating Results".
Overview
The Company was founded in August 1994 to design, develop, market and
support 3D media processors, subsystems and API software for the
interactive electronic entertainment market. The Company had no operations
during the period from inception (August 24, 1994) through December 31,
1994. The Company was considered a development stage enterprise and was
primarily engaged in product development and product testing until its
first commercial product shipments in the third quarter of 1996. The
Company has incurred net losses in every quarter since inception until the
fourth quarter of fiscal 1997 and each quarter in fiscal 1998. The Company
incurred net losses of approximately $1.7 million and $14.8 million in
1996 and 1997, respectively. The Company generated net income of $21.7
million in 1998 and had retained earnings of $199,000 at December 31,
1998. The Company incurred net losses of $3.5 million and $2.2
million for the one month ended January 31, 1999 and the quarter ended
April 30, 1999, respectively. These net losses incurred were attributable
to the lack of substantial revenue and continuing significant costs
incurred in the research, development and testing of the Company's
products. Although the Company has experienced revenue growth in recent
periods, historical growth rates will not be sustained and are not
indicative of future operating results. There can be no assurance that
significant revenues or profitability will be sustained or increased on
a quarterly or annual basis in the future.
The Company derives revenue from the sale of 3D and 3D/2D media
processors designed for use in PCs and coin-op arcade systems. The Company
began commercial shipments of its first 3D graphics product, the Voodoo
Graphics chipset, in September 1996 and introduced subsequent 3D and 3D/2D
media processors in 1997 and 1998. In March 1999, the Company began
shipment of its Voodoo3 product family. Voodoo3 is an enhanced and more
fully-featured single chip 3D/2D media processor. As a result of the
Company's limited operating history, it has only a limited number of
customers. Revenues derived from sales to STB Systems, Inc. ("STB"),
Creative Technology, Ltd. ("Creative") including its subsidiaries,
and Elitetron Electronic Co., Ltd ("Elitetron") accounted for
approximately 51%, 18%, and 12%, respectively, of revenues for the
quarter ended April 30, 1999. Revenues derived from sales to
Diamond Multimedia Systems, Inc. ("Diamond"), Elitetron and Creative
accounted for approximately 41%, 22% and 13%, respectively, of
revenues for the first quarter of fiscal 1998. Revenues derived
from sales to Creative and Elitetron accounted for approximately
36% and 25%, respectively, of revenues for the one month ended January 31,
1999. The Company expects that a small number of customers will continue
to account for a substantial portion of its total revenues for the
foreseeable future. The loss of any one of these customers could have a
material impact on the Company's results of operations, cash flows, or
financial position. In addition, sales to these customers can fluctuate
and could have a material impact on the Company's revenues and
profitability on a quarterly basis. The announcement and consummation of
the merger between 3Dfx and STB has caused some of 3Dfx's customers to end
or curtail their relationships with the combined company. If the loss of
these customers of 3Dfx is not replaced by sales from the combined
company, the business of the combined company will be greatly harmed. For
example, two of 3Dfx's largest customers, Creative Labs and Diamond,
compete directly with STB. In dollars, these customers together accounted
for approximately $117.5 million of 3Dfx's total revenues in 1998.
New products being developed by 3Dfx will primarily be sold directly
to OEM and retail customers rather than through Diamond and Creative
Labs. As a result, sales to Diamond and Creative Labs following the merger
have been reduced significantly from prior levels and these customers will
no longer continue to be significant customers of the combined company.
To date, neither Diamond nor Creative Labs has communicated to 3Dfx
that it will terminate the customer relationship for any products
incorporated into their product lines. Because the combined company will
be a chip and board manufacturer that will compete with board
manufacturers, 3Dfx has told existing customers 'that are board
manufacturers, like Diamond and Creative, that new 3Dfx graphics chips
will not be offered for sale to them. If the loss of business from current
3Dfx customers cannot be replaced through the combined company's
own add-in-board level products, or if any other major customer of 3Dfx
terminates its relationship with the combined company, the business of
the combined company could be materially harmed.
As part of its manufacturing strategy, the Company leverages the
expertise of third party suppliers in the areas of wafer fabrication,
assembly, quality control and assurance, reliability and testing. This
strategy allows the Company to devote its resources to research and
development and sales and marketing activities while avoiding the
significant costs and risks associated with owning and operating a wafer
fabrication facility and related operations. The Company does not
manufacture the semiconductor wafers used for its products and does not
own or operate a wafer fabrication facility. All of the Company's wafers
are currently manufactured by Taiwan Semiconductor Manufacturing
Corporation ("TSMC") in Taiwan. The Company obtains manufacturing
services from TSMC on a purchase order basis. The Company provides TSMC
with a rolling six month forecast of its supply needs and TSMC builds to
the Company's orders. The Company purchases wafers and die from TSMC. Once
production yield for a particular product stabilizes, the Company pays an
agreed price for wafers meeting certain acceptance criteria pursuant to a
"good die" only pricing structure for that particular product. Until
production yield for a particular product stabilizes, however, the Company
must pay an agreed price for wafers regardless of yield. Such wafer and
die purchases constitute a substantial portion of cost of products
revenues once products are sold. TSMC is responsible for procurement of
raw materials used in the production of the Company's products. The
Company believes that raw materials required are readily available. The
Company's products are packaged by two third party subcontractors,
Advanced Semiconductor Engineering Group ("ASE") and Caesar Technology,
Inc. All of the Company's products are tested by ASE. Such assembly and
testing is conducted on a purchase order basis rather than under a long-
term agreement. All purchases of wafers and assembly and test services
are denominated in U.S. dollars.
In connection with the grant of stock options to employees since
inception (August 1994) through the effective date of the Company's IPO,
the Company recorded aggregate deferred compensation of approximately $1.9
million, representing the difference between the deemed fair value of the
Common Stock for accounting purposes and the option exercise price at the
date of grant. This amount is presented as a reduction of shareholders'
equity and is amortized ratably over the vesting period of the applicable
options. This amortization resulted in charges to operations of $484,000
(of which $194,000 and $290,000 were recorded in research and development
expenses and selling, general and administrative expenses, respectively)
in each of the years ended December 31, 1998 and 1997, and $196,000 (of
which $50,000 and $146,000 were recorded in research and development
expenses and selling, general and administrative expenses, respectively in
the year ended December 31, 1996, and will result in charges over the next
5 quarters aggregating approximately $121,000 per quarter (of which
$48,000 and $73,000 will be recorded in research and development expenses
and selling, general and administrative expenses, respectively).
Results of Operations
Three Months Ended April 30, 1999 and March 31 1998
Revenues. Revenues are recognized upon product shipment. The Company's
total revenues were $40.4 million in the three months ended April 30,
1999, and $50.0 million in the three months ended March 31, 1998. Revenues
in the three months ended April 30, 1999 were principally attributable to
sales of the Company's Voodoo3, Voodoo2 and Banshee chips. Substantially
all of the revenues in the three months ended March 31, 1998 were derived
from sale of the Company's Voodoo2 and Voodoo Graphics chipsets. The
decline in sales can be attributed to the announcement of the merger with
STB which caused some of the Company's customers to end or curtail their
relationship with the Company. See "Overview". As a result of the
merger, some of the Company's significant customers will not do business
with the combined company because these customers were competitors of STB
and will therefore be competitors of the combined company.
Gross Profit. Gross profit consists of total revenues less cost of
revenues. Cost of revenues consists primarily of costs associated with the
purchase of components and the procurement of semiconductors from the
Company's contract manufacturers, labor and overhead associated with such
procurement and warehousing, shipping and warranty costs. Cost of revenues
increased 2% from $25.7 million in the three months ended March 31,1998 to
$26.2 million in the three months ended April 30, 1999. Gross profit as a
percentage of revenues was 49% and 35% in the three months ended March 31,
1998 and April 30, 1999, respectively. The increase in cost of revenues
resulted from lower margins associated with the Voodoo3 and Voodoo Banshee
products as compared with the margins of Voodoo2 and Voodoo Graphics and
the decrease in revenues in the three months ended April 30, 1999 as
compared with the three months ended March 31, 1998. Given the Company's
limited operating history and limited history of product shipments, the
Company believes that an analysis of gross profit as a percentage of total
revenues is not meaningful. The Company's future gross profit will be
affected by the overall level of sales; the mix of products sold in a
period; manufacturing yields; and the Company's ability to reduce product
procurement costs.
Research and Development. Research and development expenses consist
primarily of compensation and other expenses related to research and
development personnel, occupancy costs of research and development
facilities, depreciation of capital equipment used in product development
and engineering costs paid to the Company's foundries in connection with
manufacturing start-up of new products. Research and development expenses
increased 102% from $5.8 million in the three months ended March 31, 1998
to $11.8 million in the three months ended April 30, 1999. The increase
reflects an increase in personnel costs, common cost allocations and non-
recurring engineering costs resulting from the development of Voodoo3 and
other future products. The Company expects to continue to make substantial
investments in research and development and anticipates that research and
development expenses will increase in absolute dollars in future periods,
although such expenses as a percentage of total revenues will fluctuate.
Selling, General and Administrative. Selling, general and
administrative expenses include compensation and benefits for sales,
marketing, finance and administration personnel, commissions paid to
independent sales representatives, tradeshow, advertising and other
promotional expenses and facilities expenses. Selling, general and
administrative expenses decreased 31% from $9.6 million in the three
months ended March 31, 1998 to $6.6 million in the three months ended
April 30, 1999. The decrease resulted primarily from shared advertising
programs with STB in connection with the launch of Voodoo3, offset by
the increase in personnel. The shared advertising campaign resulted in
a $4 million reduction in advertising in the three months ended April 30,
1999. The Company expects that selling, general and administrative
expenses will increase in absolute dollars in future periods, although
such expenses as a percentage of total revenues will fluctuate.
Interest and Other Income, Net. Interest and other income, net
increased from $514,000 in the three months ended March 31, 1998 to
$911,000 in the three months ended April 30, 1999. The increase is
primarily related to increased earnings from higher investment cash
balances, partially offset by interest expense on the outstanding
equipment line of credit and capital lease balances.
Provision For Income Taxes. The Company recorded an income tax benefit
of $1.0 million for the three months ended April 30, 1999, an effective
tax rate of 32%. The Company recorded a provision for income taxes of $1.9
million for the three months ended March 31, 1998, an effective tax rate
of 20%. The Company's effective tax rate differs from the federal
statutory rate due to utilization of net operating loss carryforwards and
other tax credits.
Provision for income taxes was $7.7 million in 1998. 3Dfx recorded no
provision for income taxes in 1997 as it incurred losses during such
period. At December 31, 1998, 3Dfx had net operating loss carryforwards
for federal and state income tax purposes of approximately $10.7 million
and $9.7 million, respectively, which expire beginning in 2011 and 2001,
respectively. Under the Tax Reform Act of 1986, the amount of and the
benefit from net operating losses that can be carried forward may be
impaired in certain circumstances. Events which may cause changes in
3Dfx's tax carryovers include, but are not limited to, a cumulative
ownership change of more than 50% over a three year period. The completion
of 3Dfx's initial public offering in June 1997 resulted in an annual
limitation of 3Dfx's ability to utilize net operating losses incurred
prior to that date. The annual limitation is approximately $5.4 million.
Year 2000 Compliance
Like many other companies, the Year 2000 computer issue creates
risks for the Company. If internal systems do not correctly recognize and
process date information beyond the Year 1999, there could be an adverse
impact on the Company's operations. There are two other related issues
which could also lead to incorrect calculations or failures: (1) some
systems' programming assigns special meaning to certain dates, such as
9/9/99, and (2) the Year 2000 is a leap year. As used in this section,
"Year 2000 capable" means that when used properly and in conformity with
the product information provided by the company, and when used with Year
2000 capable computer systems, the product will accurately store, display,
process, provide, and/or receive data from, into, and between the
twentieth and twenty-first centuries, including leap year calculations,
provided that all other technology used in combination with the Company's
product properly exchanges date data with the Company's product.
Internal Systems. To address these Year 2000 issues with its
internal systems, the Company has initiated a program that is designed to
deal with the Company's internal management information systems and its
embedded systems (e.g. phones, and security systems). The program includes
both assessment and remediation proceeding in parallel and the Company
currently plans to have changes to those management and critical systems
completed and tested by the third quarter of 1999. These activities are
intended to encompass all major categories of systems used by the Company,
including sales and financial systems and embedded systems. The program
has completed its assessment phase, which identified a number of systems
that had date dependencies. None of the systems are considered by the
Company to be mission critical. Approximately 95% of the date dependencies
have already been remediated. In almost all cases the fixes involved
updating software or firmware. The unremediated date dependencies involve
desktop workstations, and are expected to be fully remediated by the third
quarter of 1999.
Products. The Company has examined all versions of its products and
has determined that its products do not have any date dependencies that
could give rise to Year 2000 capability problems. The Company plans to
evaluate new products as they are developed. Because its products have no
date dependencies, the Company does not believe it is legally responsible
for costs incurred by customers related to ensuring their Year 2000
capability.
Suppliers. The Company is also working with key suppliers of
products and services to determine whether their operations and products
are Year 2000 capable and to monitor their progress toward Year 2000
capability. The Company identified three vendors that could materially
impact the Company's business if they experienced significant Year 2000
problems. These include the Company's supplier of wafer foundry services
and the Company's two suppliers of chip packages. The Company has obtained
verbal assurances from each of these suppliers of services that they
comply with industry standards for Year 2000 readiness. The Company is in
the process of determining whether its three providers of
telecommunications services are Year 2000 compliant. This assessment is
expected to be completed by the third quarter of fiscal year 1999.
Costs. The Company is incurring various costs to provide customer
support and customer satisfaction services regarding Year 2000 issues and
it is anticipated that these expenditures will continue through 1999 and
thereafter. The costs incurred to date related to the Company's Year 2000
assessment and remediation programs have not been material. The cost which
will be incurred by the Company regarding the implementation of Year 2000
compliant internal information systems, answering and responding to
customer requests related to Year 2000 issues, including both incremental
spending and redeployed resources, is currently not expected to exceed
$300,000. The total cost estimate does not include potential costs related
to any customer or other claims or the cost of internal software and
hardware replaced in the normal course of business. In some instances, the
installation schedule of new software and hardware in the normal course of
business is being accelerated to also afford a solution to Year 2000
capability issues. The total cost estimate is based on the current
assessment of the projects and is subject to change as the project
progress. Based on currently available information, management does not
believe that the Year 2000 matters discussed above related to internal
information technology or embedded systems of key suppliers' systems or
products sold to customers will have a material impact on the Company's
financial condition or overall trends in results of operations. However,
the Company cannot guarantee that the year 2000 situation will not
negatively impact the Company. In addition, the failure to ensure Year
2000 capability by a supplier or another third party could have a material
adverse effect on the Company. The Company's Year 2000 compliance programs
have been conducted internally, without the use independent verification
or validation processes. These assessment and compliance programs have not
caused the deferral by the Company of other information technology
projects.
The Company's most reasonably likely worst case Year 2000 scenario
is that the Company experiences product procurement delays due to Year
2000 problems. These would arise because the Company's three major
suppliers described above are located outside of the United States. The
Company has not assessed, and may not be able to assess, what Year 2000
problems may occur with the public infrastructure, including
transportation and export systems, of these countries. Such problems may
result in delays in the Company's procuring products, which the Company
estimates may be approximately 4 weeks. The Company is in the process of
developing a contingency plan to address this scenario. This plan will
include the maintenance of a 3 to 6 week safety supply of product. The
Company expects this contingency plan to be in place by the fourth quarter
of fiscal 1999.
The Company has begun internal discussions concerning contingency
planning to address potential problem areas with internal systems and with
suppliers and other third parties. It is expected that assessment,
remediation and contingency planning activities will be ongoing throughout
1999 with the goal of appropriately resolving all material internal
systems and third party issues.
Liquidity and Capital Resources
Net cash used in operating activities in the first three months of
fiscal 2000 was due primarily to a net loss of $2.2 million, and
increases of $5.5 million in accounts receivable and $4.8 million in
prepaids and other assets, partially offset by a $1.8 million
depreciation adjustment. Net cash provided by operating activities in the
first quarter of fiscal 1998 was due primarily to net income of $7.5
million, and increases of $21.8 million and $10.5 million in accounts
payable and accrued liabilities, respectively, partially offset by a $25.8
million and $11.8 million increase in inventory and accounts receivable,
respectively, due to the increase in manufacturing to meet customer demand
associated with the generation of revenues.
Net cash used in investing activities was approximately $8.9 million and
$25.9 million in the three months ended April 30, 1999 and March 31, 1998,
respectively, and was due in each period to the purchase of investments
and to the purchase of property and equipment. The Company does not have
any significant capital spending or purchase commitments other than normal
purchase commitments and commitments under leases. As of April 30, 1998,
the Company had capital equipment of $32.5 million less accumulated
depreciation of $11.0 million to support its research and development,
operations and administrative activities. The Company has financed
approximately $2.6 million of its capital equipment from capital lease
obligations through April 30, 1999. The Company expects capital
expenditures to increase over the next several years as it expands
facilities and acquires equipment to support the planned expansion of its
operations.
Net cash provided by financing activities was approximately $1.3 million
and $54.4 million in the first three months of fiscal 2000 and fiscal
1998, respectively, due primarily to exercise of options in the the three
months ended April 30, 1999 and proceeds from the public offering in March
1998.
The Company's future liquidity and capital requirements will depend upon
numerous factors, including the costs and timing of expansion of research
and product development efforts and the success of these development
efforts, the costs and timing of expansion of sales and marketing
activities, the extent to which the Company's existing and new products
gain market acceptance, competing technological and market developments,
the costs involved in maintaining and enforcing patent claims and other
intellectual property rights, and available borrowings under line of
credit arrangements and other factors. The Company believes that the
proceeds from its March 1998 public offering, the Company's current cash
balances and cash generated from operations and from available or future
debt financing will be sufficient to meet the Company's operating and
capital requirements through at least December 1999. However, there can be
no assurance that the Company will not require additional financing within
this time frame. The Company's forecast of the period of time through
which its financial resources will be adequate to support its operations
is a forward- looking statement that involves risks and uncertainties, and
actual results could vary. The factors described earlier in this paragraph
will impact the Company's future capital requirements and the adequacy of
its available funds. The Company may be required to raise additional funds
through public or private financing, strategic relationships or other
arrangements. There can be no assurance that such additional funding, if
needed, will be available on terms attractive to the Company, or at all.
Furthermore, any additional equity financing may be dilutive to
shareholders, and debt financing, if available, may involve restrictive
covenants. Strategic arrangements, if necessary to raise additional funds,
may require the Company to relinquish its rights to certain of its
technologies or products. The failure of the Company to raise capital when
needed could have a material adverse effect on the Company's business,
financial condition and results of operations.
Factors Affecting Operating Results
Risks related to the Merger with STB Systems, Inc. The merger of STB
Systems, Inc. with and into a wholly-owned subsidiary of the Company
resulted in STB becoming a wholly-owned subsidiary of the Company
effective May 13, 1999. As a result of the broad scope of 3Dfx's and
STB's operations and the geographic distance separating their bases of
operation, it will be difficult to quickly integrate the products,
technologies, research and development activities, administration, sales
and marketing and other operations of the two companies. The
difficulties, costs and delays involved in integrating the companies,
which may be substantial, may include:
o Distracting management and other key personnel, particularly senior
engineers involved in product development and product definition, from
the business of the Company.
o Perceived and potential adverse changes in business focus or product
offerings, especially the focus on retail consumers versus original
equipment manufacturers, or OEMs.
o Potential incompatibility of business cultures.
o Costs and delays in implementing common systems and procedures,
particularly in integrating different information systems.
o Possible negative effects on customer service resulting from the
differing focus on the retail consumer and the OEMs.
o Inability to retain and integrate key management, technical, sales and
customer support personnel.
o Potential conflicts in direct sales channels and valued added
resellers.
The failure to successfully integrate 3Dfx and STB in a timely manner
could result in a failure of the Company to realize any of the anticipated
benefits of the merger and could materially harm the business of the
Company.
Loss of Customers or Suppliers because of STB Merger; Limited Sources for
Chips and Boards. The merger caused some of 3Dfx's customers to end or
curtail their relationships with the Company because the Company's
products are now both graphics chips and graphics boards. Thus, the
Company competes with companies that were previously 3Dfx's customers,
graphics board manufacturers. Moreover, the Company has told former
customers who are graphics board manufacturers that new generations of
the Company's graphics chips will not be offered for sale to them.
Similarly, the merger has disrupted STB's relationships with its
suppliers, some of whom were competitors of 3Dfx. The loss of STB
suppliers may cause the Company to lose customers that want the Company's
products to contain components from those suppliers. The loss of customers
of 3Dfx could cause a decline in sales for the Company unless new sales by
the combined company have an offsetting effect.
For example, two of 3Dfx's largest customers, Creative and Diamond,
were direct competitors of STB. During 1998, sales to Diamond (and its
subsidiaries) represented approximately 32% of 3Dfx's total revenue and
sales to Creative (and its subsidiaries) represented approximately 26% of
3Dfx's total revenue. New products being developed by the Company will
primarily be sold directly to OEM and retail customers rather than through
Diamond and Creative. As a result, sales to Diamond and Creative Labs
following the announcement of the merger have been reduced significantly
from prior levels and these customers are no longer significant customers
of the Company. Similarly, nVidia, which was a major supplier of STB and
which was a direct competitor of 3Dfx, has terminated its relationship with
the Company. Although the Company has continued to sell to its customers
its current products that use nVidia graphics chips, it does not expect to
use nVidia's graphic chips on any new products. Unless the Company can
persuade STB's customers that are purchasing products using nVidia
graphics chips to purchase new products based on 3Dfx graphics chips,
STB's revenue contribution to the Company will be reduced significantly.
As a result of the merger, STB will become significantly dependent
on 3Dfx's graphics chip design and development capabilities and 3Dfx will
become more dependent on STB's graphics boards and manufacturing
capabilities. This will occur because both companies will be more
restricted in their ability to select products produced by either STB's or
3Dfx's competitors. If either 3Dfx's graphics chips or STB's graphics
boards fail to meet the requirements of either company's customers, the
Company's relationship with those customers could be hurt. This could
negatively affect the Company's financial performance. In addition, STB
will be highly dependent on 3Dfx's ability to provide graphics chips on a
timely basis meeting the rigid scheduling requirements of OEMs. If 3Dfx's
graphics chips could not be provided on a timely basis, STB may not be
able to readily find suitable alternative graphics chips, which could
result in the loss of business and customers as well as unused
manufacturing capacity.
The Quarterly Operating Results of the Company May Fluctuate. The
Company's quarterly and annual results of operations have varied
significantly in the past and are likely to continue to vary in the
future. These variations are the result of a number of factors, many of
which are beyond the Company's control. These factors include:
o The ability to successfully develop, introduce and market new or
enhanced products;
o The ability to introduce and market products in accordance with
customer design requirements and design cycles;
o Changes in the relative volume of sales of various products with
different margins;
o Changes in demand for the Company's products and its customers'
products;
o Gains or losses of significant customers or strategic relationships;
o The volume and timing of customer orders;
o The availability, pricing and timeliness of delivery of components for
the Company's products;
o The timing of new product announcements or introductions by
competitors;
o Product obsolescence, the management of product transitions;
o Production delays; and
o Decreases in the average selling prices of products.
Any one or more of the factors listed above or other factors could
cause the Company to fail to achieve its revenue and profitability
expectations. Most of the Company's operating expenses are relatively
fixed in the short term. The Company may be unable to rapidly adjust
spending to compensate for any unexpected sales shortfall, which could
materially harm quarterly operating results. As a result of the above
factors, the Company believes that investors should not rely on period-to-
period comparisons of results of operations as an indication of future
performance. The results of any one quarter are not indicative of results
to be expected for a full fiscal year.
The Company Has a Limited Operating History. The Company has been
shipping products only since the third quarter of 1996. This limited
operating history makes the assessment of the Company's future operating
results difficult. Additionally, the Company incurred net losses of
approximately $1.7 million in 1997 and $14.8 million in 1996. These net
losses were attributable to the lack of substantial sales and to
continuing significant costs incurred in product research, development and
testing. Although the Company had net income of $21.7 million in 1998,
and net revenues of $50.0 million and $40.4 million in the three months
ended March 31, 1998 and April 30, 1999, respectively, historical growth
rates may not be sustained. Additionally, significant revenues or
profitability may not be sustained or increased on a quarterly or annual
basis in the future.
The Company Faces Intense Competition. The markets in which the Company
compete are intensely competitive and are likely to become more
competitive in the future. Existing competitors and new market entrants
may introduce products that are less costly or provide better performance
or features than the Company's products. The Company does not compete on
the basis of price alone. The Company believes that the principal
competitive factors for 3D graphics products are:
o Product performance and quality;
o Conformity to industry standard application programming interfaces, or
APIs;
o Access to customers and distribution channels;
o Price;
o Product support; and
o Ability to bring new products to the market in a timely way.
Many of the Company's current and potential competitors have
substantially greater financial, technical, manufacturing, marketing,
distribution and other resources than the Company. These competitors may
also have greater name recognition and market presence, longer operating
histories, lower cost structures and larger customer bases than the
Company. As a result, such competitors may be able to adapt more quickly
to new or emerging technologies and changes in customer requirements.
Certain of 3Dfx's principal competitors offer a single vendor solution.
Some maintain their own semiconductor foundries and may therefore benefit
from certain capacity, cost and technical advantages. While the merger
with STB enhances theCompany's ability to compete with these
competitors, the Company faces significant risks in achieving the
benefits of the merger with STB and to the extent those benefits are not
realized, these competitors continue to pose a threat to the Company.
The Company seeks to use strategic relationships to augment its
capabilities. However, the benefits of these relationships may not be
realized or sufficient to overcome the established positions of the
Company's largest competitors as suppliers to the PC OEM and retail
markets. Regardless of the relative qualities of the Company's products,
the market power, product breadth and customer relationships of its larger
competitors can be expected to provide such competitors with substantial
competitive advantages.
The Company has traditionally competed primarily against companies
that typically have operated in the PC 2D graphics market and now
offer 3D capability as an enhancement to their 2D solutions or companies
that have recently entered the market with an integrated 3D/2D solution
but which have not traditionally manufactured 2D solutions or have not
been involved in the market previously. These competitors include 3Dlabs,
Inc., Ltd., ATI Technologies, Inc., nVidia Corporation, Micron Technology,
Inc., S3 Incorporated and Trident Microsystems. The Company also competes
with Videologic Group Plc, which has partnered with NEC to focus
exclusively on developing a 3D solution for the interactive electronic
entertainment market. Additionally, Intel has recently entered the 3D
graphics market, targeting its efforts at the mainstream PC market. The
Company also faces potential competition from companies that have focused
on the high-end of the 3D market and the production of 3D systems targeted
for the professional engineering market and who are now developing lower
cost versions of their 3D technology to bring workstation-like 3D graphics
to mainstream applications. These competitors include 3Dlabs, Integraph
Corporation, Real 3D, an operating unit of Lockheed Martin Corp., and
Silicon Graphics, Inc.
In addition, as a result of the acquisition of STB, The Company now
competes with graphics board manufacturers, suppliers who sell graphics
chips directly to OEMs, OEMs who internally produce graphics chips or
integrate graphics chips on the main computer processing board of their
personal computers, commonly known as the motherboard, and from the makers
of other personal computer components and software that are increasingly
providing graphics processing capabilities.
The Company Depends on the PC Market. For 1996, 1997 and 1998, 82%, 93%
and 100% of the Company's revenues were derived from graphics chips sold
for use in PCs. For the three months ended March 31, 1998 and April 30,
1999, 100% of the Company's revenues were derived from graphics
chips sold for use in PCs. The Company expects to continue to derive
almost all of its revenues from the sales of products for use in PCs,
although as a result of the STB merger, the Company expects to sell
graphics boards as well as graphics chips. The PC and graphics chip and
board industries are cyclical and have been characterized by:
o Rapid technological change;
o Evolving industry standards;
o Cyclical market patterns;
o Frequent new product introductions and short product life cycles;
o Significant price competition and price erosion;
o Fluctuating inventory levels;
o Alternating periods of over-capacity and capacity constraints;
o Variations in manufacturing costs and yields; and
o Significant expenditures for capital equipment and product development.
The PC and graphics chip and board markets have also grown
substantially in recent years. However, such growth may not continue. A
decline in PC or semiconductor sales or in the growth rate of such sales
would likely reduce demand for the Company's products. Moreover, such
changes in demand could be large and sudden. Since PC manufacturers often
build inventories during periods of anticipated growth, they may be left
with excess inventories if growth slows or if they have incorrectly
forecasted product transitions. In such cases, the manufacturers may
abruptly stop purchasing additional inventory from suppliers such as the
Company until the excess inventory has been used. Such suspension of
purchases or any reduction in demand for PCs generally, or for particular
products that incorporate the Company's products, would materially harm
the Company's business.
In addition, the PC and graphics chip and board industries have in
the past experienced significant economic downturns at various times,
characterized by lower product demand and accelerated reduction of product
prices. The Company may experience substantial period-to-period
fluctuations in results of operations due to general semiconductor
industry conditions.
Dependence on the Retail Distribution Channel. The Company's products
have historically been distributed in the retail distribution channel. To
access the retail channel, the Company has depended on graphics board
manufacturers whose products are sold to consumers. The Company developed
its strong presence in the retail market through its own marketing
efforts, as well as through the significant marketing efforts of a number
of customers, including Diamond and Creative Labs. As a result of the STB
merger, the Company has lost some of its largest customers, who were
direct competitors of STB, and will become primarily dependent on STB to
support the retail sales channel. Historically, STB has targeted low
levels of retail sales volume and has directed most of its sales and
marketing resources to the OEM sales channel. As a result, there may be
substantial risks associated with the Company's dependence on near-term
revenues from the retail channel as the Company transitions to direct
sales in the retail channel.
The Company Faces the Challenge of Growth. The Company has experienced
rapid growth and may continue to experience such growth. Growth has
placed, and is expected to continue to place, a significant strain on the
Company's managerial, operational and financial resources, including their
sales, customer support, research and development, and finance and
administrative operations. Although some new controls, systems and
procedures have been implemented, the Company's future growth, if any,
will depend on its ability to continue to implement and improve
operational, financial and management information and control systems on a
timely basis, together with maintaining effective cost controls, and any
failure to do so could inhibit growth and harm the company.
The Company Depends on New Product Development. The markets for which the
Company's products are designed are intensely competitive and are
characterized by short product life cycles, rapidly changing technology,
evolving industry standards and declining average selling prices. The
Company's businesses will depend to a significant extent on its ability to
successfully develop new products. As a result, the Company believes that
significant expenditures for research and development will continue to be
required in the future. To succeed in this environment the Company must
anticipate the features and functionality that customers will demand. The
Company must then incorporate those features and functionality into
products that meet the design requirements of the PC market and the timing
requirements of retail selling seasons. The success of the Company's new
product introductions will depend on several factors, including:
o Proper new product definition;
o Timely completion and introduction of new product designs;
o The ability of subcontractors and component manufacturers to
effectively design and implement the manufacture of new products;
o Quality of new products;
o Product performance as compared to competitors' products;
o Market acceptance of the Company's and its customers' products;
o Competitive pricing of products; and
o Introduction of new products to the market within the limited time
window for OEM design cycles and retail selling seasons.
As the markets for the Company's products continue to develop and
competition increases, the Company anticipates that product life cycles
will shorten and average selling prices will decline. In particular,
average selling prices and, in some cases, gross margins for the Company's
products will decline as products mature. Thus, the Company will need to
introduce new products to maintain average selling prices and gross
margins. To do this, the Company must successfully identify new product
opportunities and develop and bring new products to market in a timely
manner. The Company has in the past experienced delays in completing
development and introduction of new products. The failure of the Company
to successfully develop and introduce new products and achieve market
acceptance for such products would materially harm the Company's business.
The Company's Products Have Short Product Life Cycles; The Company Must
Successfully Manage Product Transitions. The Company's products have short
product life cycles. A failure by the Company to successfully introduce
new products within a given product cycle could materially harm its
business for that cycle and possibly for subsequent cycles. Any such
failure could also damage the Company's brand name, reputation and
relationships with its customers and cause longer term harm to its
business.
The PC market frequently undergoes transitions in which products
rapidly incorporate new features and performance standards on an industry-
wide basis. The Company's products must be able to support the new
features and performance levels being required by PC manufacturers at the
beginning of such a transition. Otherwise, the Company would likely lose
business as well as the opportunity to compete for new design contracts
until the next product transition. Failing to develop products with
required features and performance levels or a delay as short as a few
months in bringing a new product to market could significantly reduce the
Company's revenues for a substantial period.
The success of the Company depends upon continued market acceptance
of its existing products, and its ability to continually develop and
introduce new products and features and product enhancements to meet
changing customer requirements. Each new product cycle presents new
opportunities for competitors of the Company to gain market share.
There are long lead times for certain components used in the
Company's products. Therefore, the Company may not be able to quickly
reduce its production or inventory levels in response to unexpected
shortfalls in sales or, conversely, to increase production in response to
unexpected demand. The Company's existing products may not continue to be
accepted by its markets and the Company may not be successful in enhancing
its existing products or identifying, developing, manufacturing or
marketing new products. Delays in developing new products or product
enhancements or the failure of such products or product enhancements to
gain market acceptance would materially harm the Company's businesses.
The Company Has Significant Customer Concentration. The Company's sales
are highly concentrated among a limited number of customers. Revenues
derived from sales to STB, Creative (including its subsidiaries) and
Elitetron accounted for approximately 51%, 18%, and 12% of revenues for
the quarter ended April 30, 1999. Revenues derived from sales to Diamond,
Elitetron and Creative accounted for approximately 41%, 22% and 13%,
respectively, of revenues for the three months ended March 31, 1998.
Revenues derived from sales to Diamond (and its subsidiaries), Creative
(and its subsidiaries) and Elitetron accounted for approximately 32%, 26%
and 16% of revenues in 1998. The Company expects that a small number of
customers will continue to account for a substantial portion of its
revenues for the foreseeable future.
All of the Company's sales were made pursuant to purchase orders.
This lack of long-term commitments, together with the customer
concentration noted above, pose a significant risk. If a single customer
of the Company cancels an order or ceases to be a customer, the Company's
business and financial condition could be materially harmed. As a result
of the merger with STB, the Company has lost several of its current
customers. See "Overview" above for a fuller discussion of the effect of
the merger on the Company's customer base.
The Company Has Significant Product Concentration. The Company's revenues
are dependent on the markets for 3D/2D and 3D media processors and
graphics boards for PCs and on the Company's ability to compete in those
markets. Since the Company has no other significant revenue-generating
products, the Company's business would be materially harmed if it were
unsuccessful in selling these products.
The Company Depends on Independent Manufacturers and Other Third Parties.
The Company's graphics chip products require wafers manufactured with
state-of-the-art fabrication equipment and techniques. The Company does
not manufacture the semiconductor wafers used for its graphics chip
products and does not own or operate a wafer fabrication facility. Taiwan
Semiconductor Manufacturing Company, or TSMC, currently manufactures all
of the Company's wafers in Taiwan. The Company obtains manufacturing
services from TSMC on a purchase order basis. The Company depends on TSMC
to:
o Produce wafers of acceptable quality and with acceptable manufacturing
yields;
o Deliver those wafers to the Company and its independent assembly and
testing subcontractors on a timely basis; and
o Allocate to the Company a portion of their manufacturing capacity
sufficient to meet the Company's needs.
The Company expects to continue to be dependent upon TSMC in the
future. The Company has no readily available alternative source of supply
and it could take several months to establish a strategic relationship
with a new manufacturing partner. Therefore, a manufacturing disruption
experienced by TSMC would impact the production of the Company's graphics
chip products for a substantial period of time. Additionally, TSMC
fabricates wafers for other companies and could choose to prioritize
capacity for other uses or reduce or eliminate deliveries to the Company
on short notice. Any disruption in the Company's access to TSMC's
production capacity would materially harm the Company 's business.
There are many other risks associated with the Company's dependence
upon third party manufacturers, including:
o Reduced control over delivery schedules, quality assurance,
manufacturing yields and cost;
o The potential lack of adequate capacity during periods of excess
demand;
o Limited warranties on wafers supplied to the Company; and
o Potential misappropriation of the Company 's intellectual property.
The Company's graphics chip products are packaged by two third
party subcontractors and tested by one third party subscontractor on a
purchase order basis rather that under a long-term agreement. As a
result of its reliance on these subcontractors to assemble and test its
graphic chips products, the Company cannot directly control product
delivery schedules. This could lead to product shortages or quality
assurance problems that could increase the costs of manufacturing
or assembly of the Company's graphics chip products. A
significant amount of time is required to qualify assembly and test
subcontractors. Therefore, product shipments could be delayed
significantly if the Company is required to find alternative
subcontractors. And problems associated with the delivery, quality or cost
of the assembly and testing of the Company's products could materially
harm the Company's business.
Semiconductor Manufacturers Experience Manufacturing Yield Problems. The
fabrication of semiconductors is a complex and precise process that often
experiences problems that are difficult to diagnose and time consuming or
expensive to solve. As a result, semiconductor companies often experience
problems in achieving acceptable wafer manufacturing yields. These yields
reflect the number of good die as a proportion of the total number of die
on any particular wafer. Once production yields for a product stabilize,
the Company pays an agreed price for wafers meeting certain acceptance
criteria pursuant to a "good die" only pricing structure for that product.
Until production yields for a product stabilize, however, the Company must
pay an agreed price for wafers regardless of yield. Accordingly, in this
latter circumstance, the Company bears the risk of final yield of good
die. Poor yields would materially harm the Company's business.
Semiconductor manufacturing yields are a function of both product
design, which is developed largely by the Company, and process technology,
which is typically proprietary to the manufacturer. Low yields may result
from either design or process technology failure. Thus, yield problems may
not be 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. At that point,
resolution of yield problems would require cooperation by and
communication between the Company and the manufacturer. The offshore
location of the Company's manufacturer compounds this risk because it
increases the effort and time required to identify, communicate and
resolve manufacturing yield problems. As the Company's relationships with
TSMC and any additional manufacturing partners develop, yields could be
harmed from difficulties in adapting the Company's technology and product
design to the proprietary process technology and design rules of each
manufacturer.
The Company's manufacturers may not achieve or maintain acceptable
manufacturing yields in the future. Because of the Company's potentially
limited access to wafer fabrication capacity from its manufacturers, any
decrease in manufacturing yields could result in an increase in the
Company's per unit costs and force the Company to allocate its available
product supply among its customers. Such an allocation could potentially
adversely impact customer relationships as well as revenues and gross
profit. Any inability of the Company to achieve planned yields from its
manufacturers could materially harm the Company 's business. The Company
also faces the risk of product recalls resulting from design or
manufacturing defects which are not discovered during the manufacturing
and testing process. In the event of a significant number of product
returns due to a defect or recall, the Company's revenues and gross profit
could be materially harmed.
The Company Faces Risks Relating to Intellectual Property. The Company
relies primarily on a combination of patent, mask work protection,
trademarks, copyrights, trade secret laws, employee and third-party
nondisclosure agreements and licensing arrangements to protect its
intellectual property. If these efforts are not sufficient to protect the
Company's intellectual property, the Company's business may be harmed.
Many foreign jurisdictions offer less protection of intellectual property
rights than the United States. Therefore, the protection provided to the
Company's proprietary technology by the laws of foreign jurisdictions may
not be sufficient to protect its technology.
The semiconductor industry is characterized by vigorous protection
and pursuit of intellectual property rights or positions and it is common
in the PC industry for companies to assert intellectual property
infringement claims against other companies. Therefore, the Company's
products may become the target of infringement claims. If that were to
occur, the Company may be required to spend significant time and money to
defend its products, redesign its products or develop or license a
substitute technology. Any of these events could materially harm the
Company's business. Litigation by or against the Company could result in
significant expense to the Company and could divert the efforts of the
Company's technical and management personnel, regardless of the outcome of
such litigation.
The Company's International Operations Are Subject to Certain Risks. The
Company relies on foreign third-party manufacturing, assembly and testing
operations that are located in Asia. In addition, the Company has
significant export sales. These international operations subject the
Company to a number of risks associated with conducting business outside
of the United States. These risks include:
o Unexpected changes in legislative or regulatory requirements;
o Delays resulting from difficulty in obtaining export licenses for
certain technology;
o Tariffs, quotas and other trade barriers and restrictions;
o Longer accounts receivable payment cycles;
o Difficulties in collecting payment;
o Potentially adverse tax consequences, including repatriation of
earnings;
o Burdens of complying with a variety of foreign laws;
o Unfavorable intellectual property laws;
o Political instability; and
o Foreign currency fluctuations.
Any of these factors could materially harm the international
operations and sales of the Company, and consequently, its business.
Recently, the financial markets in Asia have experienced significant
turmoil, which could harm the Company's international sales or operations.
Currently, all of the Company's product sales and its arrangements with
its foundry and assembly and test vendors provide for pricing and payment
in U.S. dollars. To date, the Company has not engaged in any currency
hedging activities, although the Company may do so in the future. An
increase in the value of the U.S. dollar relative to foreign currencies
could make the Company's products more expensive and potentially less
competitive in foreign markets.
The Company's Stock Price May Be Volatile; Securities Class Action
Litigation. The trading price of the Company's Common Stock has in the
past fluctuated and could in the future fluctuate significantly. The
fluctuations have been or could be in response to numerous factors,
including:
o Quarterly variations in results of operations;
o Announcements of technological innovations or new products by the
Company, its customers or competitors;
o Changes in securities analysts' recommendations;
o Earnings estimates for the Company; and
o General fluctuations in the stock market.
The Company's revenues and results of operations may be below the
expectations of public market securities analysts or investors. This could
result in a sharp decline in the market price of the Company's Common
Stock. In addition, stock markets have from time to time experienced
extreme price and volume fluctuations. The market prices for high
technology companies have been particularly affected by these market
fluctuations and such effects have often been unrelated to the operating
performance of such companies. These broad market fluctuations may cause a
decline in the market price of the Company's common stock. In addition,
the Company issued to shareholders of STB an aggregate of approximately
8,267,000 shares of the Company's Common Stock, almost all of which became
freely tradable upon consummation of the merger. As a result, substantial
sales of the Company's Common Stock could occur, which could adversely
affect or cause substantial fluctuations in the market price of the
Company's Common Stock.
In the past, following periods of volatility in the market price of
a company's stock, securities class action litigation has been brought
against the issuing company. It is possible that similar litigation could
be brought against the Company. Such litigation could result in
substantial costs and would likely divert management's attention and
resources. Any adverse determination in such litigation could also subject
the Company to significant liabilities. A securities class action lawsuit
of this type was filed on October 9, 1998 in Dallas County, Texas against
STB and certain of its officers and directors, along with the underwriters
who participated in STB's public offering on March 20, 1998. The lawsuit
alleges that the registration statement for STB's secondary public
offering contained false and misleading statements of material facts and
omitted to state material facts, alleging that the registration statement
failed to disclose certain alleged STB product defects, alleged
difficulties with some of STB's major customers and STB's allegedly
deteriorating financial performance. The lawsuit seeks recission and/or
unspecified damages. STB denies the allegations in the lawsuit and intends
to vigorously defend the lawsuit. In the event the plaintiffs in the
lawsuit prevail in connection with any of their claims, then, depending
upon the magnitude of damages and expenses incurred by STB and the extent
to which such damages and expenses are covered by insurance, the lawsuit
could have a negative effect on the financial condition and results of the
Company.
Risks Associated with Year 2000 Compliance. The Company uses a
significant number of computer software programs and operating systems in
its internal operations. These include applications used in financial
business systems and various administration functions, and also software
programs in their products. If these software applications are unable to
appropriately interpret dates occurring in the upcoming calendar year
2000, some level of modification or replacement of such software may be
necessary. The Company believes that all of its existing products are Year
2000 compliant and has conducted or is conducting Year 2000 compliance
testing. Despite such belief, the Company's products may not be Year 2000
compliant. If the Company's products fail to perform, including failures
due to the onset of calendar year 2000, its business would likely be
materially harmed.
The Company is currently evaluating its information technology for
Year 2000 compliance. This evaluation includes reviewing what actions are
required to make all internally used software systems Year 2000 compliant
as well as actions necessary to make the Company less vulnerable to Year
2000 compliance problems associated with third parties' systems. Such
measures may not solve all of the Company's Year 2000 problems. Any Year
2000 problems could materially harm the Company's business. In addition,
the Company's customers and suppliers may not be year 2000 compliant,
which could materially harm the Company's business. See "Year 2000
Compliance" above.
The Company Depends on Third Party Developers and Publishers. The Company
believes that the availability of numerous high quality, commercially
successful software entertainment titles and applications significantly
affects sales of its graphics chips and boards. The Company depends on
third party software developers and publishers to create, produce and
market software titles that will operate with its products. Only a
limited number of software developers are capable of creating high quality
entertainment software. Competition for these resources is intense and is
expected to increase. Therefore, a sufficient number of high quality,
commercially successful software titles compatible with the Company's
products may not be developed. In addition, the development and marketing
of game titles that do not fully demonstrate the technical capabilities of
the Company's products could create the impression that the Company's
technology offers only marginal performance improvements, if any, over
competing products.
The Company's success will be substantially affected by the adoption
by software developers of Glide, its proprietary, low-level 3D API.
Although the Company's products support game titles developed for most
industry standard APIs, the Company believes that Glide currently allows
developers to fully exploit the technical capabilities of the Company's
products. Glide competes with APIs developed or expected to be developed
by other companies having significantly greater financial resources,
marketing power, name recognition and experience than the Company. For
example, certain industry standard APIs, such as Microsoft's D3D and SGI's
OpenGL, have a much larger installed customer base and a much larger base
of existing software titles. Developers may face additional costs to port
games developed on other standard APIs to Glide for play on the Company's
architecture. There can be no assurance that Glide will be adopted by a
sufficient number of software developers or that developers who have used
Glide in the past will continue to do so in the future.
Risks related to Environmental Regulation. The production and manufacture
of certain of the Company's products requires the use of toxic and other
hazardous substances. If the Company does not comply with all local,
state, federal and foreign governmental regulations relating to the
storage, use and disposal of these substances, substantial monetary fines
could be levied against the Company or the production of the Company's
products could be suspended, resulting in product delivery delays,
cancelled product orders, decreased revenue and negative financial
results.
Dependence on Third-Party Certification. The Company submits most of its
graphics board products for compatibility and performance testing to the
Microsoft Windows Hardware Quality Lab because OEM customers typically
require such products to have this certification prior to making volume
purchases. This certification typically requires up to several weeks to
complete and entitles the Company to claim that a particular product is
"Designed for Microsoft Windows." The Company may not receive this
certification for future products in a timely fashion, which could result
in product shipment delays and lost sales.
Dependence on Single Manufacturing Facility for Graphics Boards. In
connection with the acquisition of STB, the Company also acquired STB's
sole manufacturing facility, which is located in Juarez, Mexico. Since
the Company is dependent on this single manufacturing facility for the
manufacture of graphics board products, any disruption of manufacturing
operations at this facility would have far reaching negative consequences.
A disruption could result from various factors, including difficulties in
attracting and retaining qualified manufacturing employees, difficulties
associated with the use of new, reconfigured or upgraded manufacturing
equipment, labor disputes, human error, governmental or political risks or
a natural disaster such as an earthquake, tornado, fire or flood.
In comparison to those of its competitors that do not maintain their
own manufacturing facilities, the Company incurs higher relative fixed
overhead and labor costs as a result of operating its own manufacturing
facility. Any failure to generate the level of product revenues needed to
absorb these overhead and labor costs would negatively affect the
Company's financial results.
Risks related to Changes in Product Mix. The Company offers three broad
categories of products: (i) graphics boards and other multimedia
subsystems that are sold to major original equipment manufacturers,
or OEMs, and, to retail customers, (ii) specialized technology products
that are primarily sold to resellers, the workstation groups of OEMs
and corporate customers in certain industries and (iii) graphics
chips sold for inclusion in other companies products.
As a result of the varying gross profit margins associated with
its products and sales channels, shifts in the mix of products sold or in
the sales channels into which such products are sold could significantly
harm the Company's gross profits and gross profit margins. For example, a
decrease in sales of graphics boards and other multimedia subsystems to
the commercial market or in sales of specialized technology products could
result in a disproportionately greater decrease in the Company's gross
profit margin. This is because these sales currently have higher gross
profit margins than sales of graphics boards and other multimedia
subsystem products to the Company's OEM customers. On the other hand, any
decrease in the volume of graphics boards and other multimedia subsystems
sold to the Company's OEM customers would significantly reduce total net
sales and negatively impact the Company's financial results.
<PAGE>
PART II - Other Information
ITEM 1: Legal Proceedings
On September 21, 1998, the Company filed suit against nVidia Corporation
("nVidia") in Northern California District Federal Court. The complaint
alleges patent infringement relating to nVidia's use of multi-texturing
technology in its RIVA TNT product. Discovery in the case is presently
under way.
ITEM 6: Exhibits
(a) Exhibits
27.1 Financial Data Schedule
(b) Financial Statements Schedule
Schedule II - Valuation and Qualifying Accounts
Reports on Form 8-K
On May 21, 1999, the Registrant filed a report on Form 8-K with
respect to Item 8, Change in Fiscal Year. The Registrant is currently
operating on a fiscal year ending December 31 ("December Fiscal Year").
On March 29, 1999, the Board of Directors of the Registrant determined
that it would be in the best interests of the Registrant and its
Shareholders to change its fiscal year from a December Fiscal Year
to a year beginning on February 1 and ending on January 31 ("January
Fiscal Year"), beginning on February 1, 1999. In connection with this
change in fiscal year, the Registrant will file with the Securities and
Exchange Commission a quarterly report on Form 10-Q covering the first
fiscal quarter of the January Fiscal Year, which report shall also
include information on the transition period from January 1, 1999
(the day after the fiscal year ended December 31, 1998) to January
31, 1999.
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.
Dated: June 14, 1999
3DFX INTERACTIVE, INC.
(Registrant)
/s/ L. GREGORY BALLARD
--------------------------------------
L. Gregory Ballard
Chief Executive Officer
(Principal Executive Officer)
/s/ DAVID ZACARIAS
--------------------------------------
David Zacarias
Vice President, Administration
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
<PAGE>
FINANCIAL STATEMENTS SCHEDULE
3DFX INTERACTIVE, INC.
Valuation and Qualifying Accounts
For the quarters ended April 30, 1999 and March 31, 1998
(in thousands)
<TABLE>
<CAPTION>
Additions
---------------------
Charged to Charged
Beginning Costs and to Other Ending
Balance Expenses Accounts Deductions Balance
- ---------------------------- --------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Allowance for Doubtful
Accounts:
For the three months
ended April 30, 1999...... $6,729 $392 $ -- $802 $6,319
For the three months
ended Match 31, 1998...... $308 $1,455 $ -- $ -- $1,763
Inventory Reserve:
For the three months
ended April 30, 1999...... $7,828 $ -- $ -- $ -- $7,828
For the three months
ended Match 31, 1998...... $661 $534 $ -- $ -- $1,195
</TABLE>
<PAGE>
INDEX TO EXHIBITS
EXHIBITS
---------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED
CONSOLIDATED BALANCE SHEETS, CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-31-2000
<PERIOD-START> FEB-01-1999
<PERIOD-END> APR-30-1999
<CASH> 55,556
<SECURITIES> 23,192
<RECEIVABLES> 39,801
<ALLOWANCES> 6,319
<INVENTORY> 18,306
<CURRENT-ASSETS> 143,932
<PP&E> 32,581
<DEPRECIATION> 11,009
<TOTAL-ASSETS> 168,788
<CURRENT-LIABILITIES> 45,999
<BONDS> 0
0
0
<COMMON> 128,093
<OTHER-SE> (5,753)
<TOTAL-LIABILITY-AND-EQUITY> 168,788
<SALES> 40,444
<TOTAL-REVENUES> 40,444
<CGS> 26,190
<TOTAL-COSTS> 26,190
<OTHER-EXPENSES> 18,376
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (3,211)
<INCOME-TAX> (1,027)
<INCOME-CONTINUING> (2,184)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,184)
<EPS-BASIC> (0.14)
<EPS-DILUTED> (0.14)
</TABLE>
