===============================================================================
UNITED STATES
SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
--------------------------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the period ended July 31, 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 August 31, 1999 there were 24,492,032 shares of the Registrant's
Common Stock outstanding.
===============================================================================
<PAGE>
3DFX INTERACTIVE, INC.
Form 10-Q
INDEX
Cover Page
Index
PART I. Financial Information
Item 1. Financial statements
Condensed Consolidated Balance Sheets -- July 31, 1999 and
December 31, 1998
Condensed Statements of Operations -- Three Months and Six Months Ended
July 31, 1999 and June 30, 1998
Condensed Consolidated Statements of Cash Flows -- Six Months Ended
July 31, 1999 and June 30, 1998
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 4. Submission of Matters to a Vote of Security Holders
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)
(unaudited)
<TABLE>
<CAPTION>
July 31, December 31,
1999 1998
------------ ------------
<S> <C> <C>
Assets:
Cash and cash equivalents ........................ $69,779 $92,922
Short-term investments ........................... 25,388 3,058
Accounts receivable, net ......................... 67,537 36,335
Inventory ........................................ 54,650 23,991
Other current assets ............................. 18,843 12,089
------------ ------------
Total current assets ..................... 236,197 168,395
Property and equipment, net....................... 42,097 15,629
Intangibles....................................... 17,534 --
Goodwill.......................................... 30,469 --
Other assets...................................... 3,563 97
------------ ------------
$329,860 $184,121
============ ============
Liabilities and Shareholders' Equity:
Short-term debt .................................. $13,500 $ --
Accounts payable ................................. 60,489 41,104
Accrued liabilities .............................. 20,196 16,031
Current portion of capitalized lease obligations . 720 389
------------ ------------
Total current liabilities ................ 94,905 57,524
------------ ------------
Other long term liabilities 2,131 284
------------ ------------
Shareholders' equity:
Common stock ..................................... 250,055 126,569
Warrants ......................................... 242 242
Deferred compensation ............................ (414) (697)
(Accumulated deficit) retained earnings .......... (17,059) 199
------------ ------------
Total shareholders' equity ............... 232,824 126,313
------------ ------------
$329,860 $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>
Three Months Ended Six Months Ended
------------------- -------------------
July 31, June 30, July 31, June 30,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues................................ $104,836 $58,643 $145,280 $108,651
Cost of revenues........................ 76,308 30,443 102,498 56,173
--------- --------- --------- ---------
Gross profit.......................... 28,528 28,200 42,782 52,478
--------- --------- --------- ---------
Operating expenses:
Research and development.............. 16,577 8,308 28,333 14,134
Selling, general and administrative... 19,006 8,041 25,626 17,679
In-process research and development... 4,302 -- 4,302 --
Goodwill and intangibles amortization. 2,974 -- 2,974 --
--------- --------- --------- ---------
Total operating expenses.............. 42,859 16,349 61,235 31,813
--------- --------- --------- ---------
Income (loss) from operations........... (14,331) 11,851 (18,453) 20,665
Interest and other income, net.......... 685 1,052 1,596 1,566
--------- --------- --------- ---------
Income (loss) before income taxes....... (13,646) 12,903 (16,857) 22,231
(Benefit) provision for income taxes.... (2,047) 3,871 (3,074) 5,737
--------- --------- --------- ---------
Net income (loss)....................... ($11,599) $9,032 ($13,783) $16,494
========= ========= ========= =========
Net income (loss) per share:
Basic................................. ($0.50) $0.59 ($0.71) $1.16
========= ========= ========= =========
Diluted............................... ($0.50) $0.54 ($0.71) $1.04
========= ========= ========= =========
Shares used in net income (loss) per
share calculations:
Basic................................. 23,296 15,238 19,533 14,212
--------- --------- --------- ---------
Diluted............................... 23,296 16,763 19,533 15,909
--------- --------- --------- ---------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
3DFX INTERACTIVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
-------------------
July 31, June 30,
1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income .................................. ($13,783) $16,494
Adjustments to reconcile net loss to net
cash provided by (used in) operating
activities:
Depreciation .................................... 5,289 2,201
Amortization .................................... 2,974 --
Write-off of acquired in-process research and
development................................... 4,302 --
Stock compensation............................... 242 242
Increase in allowance for doubtful
accounts....................................... 2,653 1,333
Changes in assets and liabilities:
Accounts receivable............................ 8,710 (27,860)
Inventory...................................... (2,191) (24,056)
Other assets................................... (2,239) 300
Accounts payable............................... (3,379) 33,164
Accrued liabilities............................ (8,381) 7,576
--------- ---------
Net cash (used in) provided by operating
activities................................... (5,803) 9,394
--------- ---------
Cash flows from investing activities:
Maturities of short-term investments, net........... 3,685 (2,017)
Purchases of property and equipment................. (19,391) (5,841)
Merger with STB Systems, Inc........................ (7,226) --
--------- ---------
Net cash used in investing activities............ (22,932) (7,858)
--------- ---------
Cash flows from financing activities:
Proceeds from secondary public offering, net........ -- 54,752
Proceeds from issuance (repurchase) of Common
Stock, net...................................... (2,520) 1,142
Principal payments of capitalized lease
obligations, net................................. (417) (542)
Payments on line of credit, net..................... (2,143) (582)
--------- ---------
Net cash (used in) provided by financing
activitiies.................................. (5,080) 54,770
--------- ---------
Net increase (decrease) in cash and
cash equivalents.................................... (33,815) 56,306
Cash and cash equivalents at beginning
of period........................................... 103,594 28,937
--------- ---------
Cash and cash equivalents at end of period............ $69,779 $85,243
========= =========
</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 2D media processors, subsystems
and API software for the interactive electronic entertainment 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. The results of operations for the
quarter or six months ended July 31, 1999 are not necessarily indicative
of the results to be expected for the full year.
One customer represented 18% and one customer represented 15% of the
Company's revenues during the second quarter and first half of 2000,
respectively. Two customers represented 42% and 22% and three customers
represented 43%, 18% and 13% of the Company's revenue during the second
quarter and first half of 1998, respectively.
Note 2 - Merger Agreement:
In December 1998, the Company entered into an Agreement and Plan of
Reorganization (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 is
the surviving corporation of the Merger and became a wholly owned
subsidiary of 3Dfx. The merger is accounted for under the purchase
method of 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.
The purchase price of $133.2 million includes $116.1 million of
stock issued at fair value (fair value being determined as the
average price of the 3Dfx stock for a period three days before and
after the announcement of the merger), $9.9 million in STB stock option
costs (being determined under both the Black Sholes formula and in
accordance with the Merger Agreement) and $7.2 million in estimated
expenses of the transaction. The purchase price was allocated
as follows: $85.6 million to the estimated fair value of STB net
tangible assets purchased (as of May 13, 1999), $(7.6) million to
establish deferred tax liabilities associated with the certain
intangibles acquired, $4.3 million to purchased in-process research
and development, $11.4 million to purchased existing technology, $4.4
million to trademarks, $2.3 million to workforce-in-place, $1.0 million
to executive covenants and $31.8 million to goodwill. The allocation of
the purchase price to intangibles was based upon an independent, third
party appraisal and management's estimates.
The intangible assets and goodwill acquired have estimated useful lives
and estimated first year amortization, as follows:
<TABLE>
<CAPTION>
Calculated
Estimated First Year
Amount Useful Life Amortization
------------- ------------- -----------
<S> <C> <C> <C>
Purchased existing technology:
1.5 year life.............. $6,475,000 1.5 years $4,317,000
3 year life................ 4,966,000 3 years 1,655,000
Trademarks......................... 4,406,000 5 years 881,000
Workforce-in-place................. 2,250,000 5 years 450,000
Executive covenants................ 1,000,000 5 years 200,000
Goodwill........................... 31,880,000 5 years 6,376,000
</TABLE>
The value assigned to purchased in-process research and
development ("IPR&D") was determined by identifying research projects
in areas for which technological feasibility had not been established.
These include projects for Voodoo3 as well as other specialized
technologies totaling $4.3 million. The value was determined by
estimating the expected cash flows from the projects once commercially
viable, discounting the net cash flows back to their present value and
then applying a percentage of completion to the calculated value as
defined below.
Net Cash Flows. The net cash flows from the identified projects
are based on our estimates of revenues, cost of sales, research and
development costs, selling, general and administrative costs, royalty
costs and income taxes from those projects. These estimates are based
on the assumptions mentioned below. The research and development costs
included in the model reflect costs to sustain projects, but exclude
costs to bring in-process projects to technological feasibility.
The estimated revenues are based on management projections of
each in-process project and the business projections were compared and
found to be in line with industry analysts' forecasts of growth in
substantially all of the relevant markets. Estimated total revenues
from the IPR&D product areas are expected to peak in the year ending
December 31, 1999 and decline from 2000 into 2001 as other new products
are expected to become available. These projections are based on our
estimates of market size and growth, expected trends in technology and
the nature and expected timing of new project introductions by our
competitors and us.
Projected gross margins approximate STB's recent historical
performance and are in line with comparable industry margins. The
estimated selling, general and administrative costs are consistent with
STB's historical cost structure, which is in line with industry
averages at approximately 10% of revenues. Research and development
costs are consistent with STB's historical cost structure.
Royalty rate. The Company applied a royalty charge of 25% of
operating income for each in-process project to attribute value for
dependency on predecessor core technologies.
Discount rate. Discounting the net cash flows back to their
present value is based on the industry weighted average cost of capital
("WACC"). The industry WACC is approximately 14%. The discount rate
used in discounting the net cash flows from IPR&D is 20%, a 600 basis
point increase from the industry WACC. This discount rate is higher
than the industry WACC due to inherent uncertainties surrounding the
successful development of the IPR&D, market acceptance of the
technology, the useful life of such technology and the uncertainty of
technological advances which could potentially impact the estimates
described above.
Percentage of completion. The percentage of completion for each
project was determined using costs incurred to date on each project as
compared to the remaining research and development to be completed to
bring each project technological feasibility. The percentage of
completion varied by individual project ranging from 50% to 91%.
If the projects discussed above are not successfully developed,
the sales and profitability of the combined company may be adversely
affected in future periods.
Pro forma results of operations for the combined company as if the
transaction had consummated at the beginning of the earliest period
presented and carried forward into 1999 are as follows:
Six Months Ended Year Ended
July 31, December 31,
1999 1998
--------- ---------
Revenues ...........................$226,068 $467,441
--------- ---------
Net income (loss) ..................($31,558) $9,110
--------- ---------
Basic net loss per share ........... ($1.62) $0.40
========= =========
Diluted net loss per share ......... ($1.62) $0.37
========= =========
On a combined basis, there were no material transactions between the
Company and STB during the periods presented except for sales of
product by the Company to STB which have been eliminated.
Note 3 - Public Offering:
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 4 - 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. 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>
Three Months Ended Six Months Ended
------------------- -------------------
July 31, June 30, July 31, June 30,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net income (loss) available to common
shareholders (numerator)............ ($11,599) $9,032 ($13,783) $16,494
Weighted average common shares
outstanding (denominator for basic
computation)....................... 23,296 15,238 19,533 14,212
Effect of dilutive securities --
common stock equivalents............ -- 1,525 -- 1,697
--------- --------- --------- ---------
Weighted average shares outstanding
(denominator for diluted computation) 23,296 16,763 19,533 15,909
========= ========= ========= =========
Basic net income (loss) per share..... ($0.50) $0.59 ($0.71) $1.16
========= ========= ========= =========
Diluted net income (loss) per share.. ($0.50) $0.54 ($0.71) $1.04
========= ========= ========= =========
</TABLE>
During the three and six months ended July 31, 1999, weighted
average options under the treasury stock method to purchase
approximately 2,084,000 and 3,025,000 shares, respectively, were
outstanding but not included in the computation because they were
antidilutive.
Note 5 - Income Taxes:
The Company recorded for the three months and the six months ended
July 31, 1999 an effective tax rate of 15% and 18%, respectively. The
Company recorded for the three months and the six months ended June 30,
1998 an effective tax rate of 30% and 26%, respectively. The Company's
effective tax rate in fiscal 2000 differed from the statutory rate due to
the impact of non-deductible expenses including intangible amortization
and in-process research and development. The effective tax rate in
fiscal 1998 is different from the statutory rate due to the utilization
of federal and state net operating loss carryforwards and tax credits.
Note 6 - 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 the three months and the six
months ended July 31, 1999 and the three months and the six months ended
June 30, 1998 was not materially different from net income.
Note 7 - Short-term Debt:
As a result of the merger with STB, the Company has a $40 million
revolving credit facility ("Revolving Credit Facility") with a bank.
The Revolving Credit Facility bears interest at LIBOR plus 175 basis
points (5.369% at July 31, 1999). At July 31, 1999, the Company had
$13.5 million outstanding under the Revolving Credit Facility.
Availability under the Revolving Credit Facility is subject to
limitation determined by the Company's borrowing base, which is
calculated based on eligible accounts receivable, as defined in the
Revolving Credit Facility Agreement
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 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 third and twelfth paragraph under "Results of
Operations" regarding factors affecting gross profit; the sentences in
the fourth and fifth and thirteenth and fourteenth paragraphs under
"Results of Operations" regarding future research and development
and selling, general and administrative costs, respectively; 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 derives
revenue from the sale of 3D and 3D/2D media processors and graphics
boards 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 media
processors in 1997 and 1998. In March 1999, the Company began shipment
of its Voodoo3 product family of enhanced and more fully-featured, single
chip 3D/2D media processors. The Voodoo3 product family broadens the
Company's products to include board-level products.
The Company's sales have historically been concentrated
among a limited number of customers. Revenues derived from
sales to Ingram Micro accounted for approximately 18% of revenues
for the quarter ended July 31, 1999. Revenues derived from sales to STB
prior to the May 13, 1999 effective date of the merger accounted for
15% of revenues for the six months ended July 31, 1999. Revenues derived
from sales to Diamond Multimedia Systems, Inc. ("Diamond") and Creative
Technology, Ltd. ("Creative") accounted for approximately 42% and 22%,
respectively, of revenues for the quarter ended June 30, 1998. Revenues
derived from sales to Diamond, Creative and Elitetron Electronic Co.,
Ltd. accounted for approximately 43%, 18% and 13%, respectively, of
revenues for the first half of fiscal 1998. 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 revenue in 1998. Diamond and Creative Labs
compete directly with STB and new products being sold and developed by
3Dfx are and 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. 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 an example, in the quarter ended July 31, 1999, revenue fell
short of original expectations due to the STB Merger which had not
consummated until mid-May as opposed to the end of April as planned
preventing the inclusion of Voodoo3 board sales for the first thirrteen
days of May in the Company's quarterly revenues as well as the Company's
decision to reduce prices earlier than planned.
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 4 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).
In December 1998, the Company entered into an Agreement and Plan of
Reorganization (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 is
the surviving corporation of the Merger and became a wholly owned
subsidiary of 3Dfx. The merger is accounted for under the purchase
method of 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.
The purchase price of $133.2 million includes $116.1 million of
stock issued at fair value (fair value being determined as the
average price of the 3Dfx stock for a period three days before and
after the announcement of the merger), $9.9 million in STB stock option
costs (being determined under both the Black Sholes formula and in
accordance with the Merger Agreement) and $7.2 million in estimated
expenses of the transaction. The purchase price was allocated
as follows: $85.6 million to the estimated fair value of STB net
tangible assets purchased (as of May 13, 1999), $(7.6) million to
establish deferred tax liabilities associated with the certain
intangibles acquired, $4.3 million to purchased in-process research
and development, $11.4 million to purchased existing technology, $4.4
million to trademarks, $2.3 million to workforce-in-place, $1.0 million
to executive covenants and $31.8 million to goodwill. The allocation of
the purchase price to intangibles was based upon an independent, third
party appraisal and management's estimates.
The intangible assets and goodwill acquired have estimated useful lives
and estimated first year amortization, as follows:
<TABLE>
<CAPTION>
Calculated
Estimated First Year
Amount Useful Life Amortization
------------- ------------- -----------
<S> <C> <C> <C>
Purchased existing technology:
1.5 year life.............. $6,475,000 1.5 years $4,317,000
3 year life................ 4,966,000 3 years 1,655,000
Trademarks......................... 4,406,000 5 years 881,000
Workforce-in-place................. 2,250,000 5 years 450,000
Executive covenants................ 1,000,000 5 years 200,000
Goodwill........................... 31,880,000 5 years 6,376,000
</TABLE>
The value assigned to purchased in-process research and
development ("IPR&D") was determined by identifying research projects
in areas for which technological feasibility had not been established.
These include projects for Voodoo3 as well as other specialized
technologies totaling $4.3 million. The value was determined by
estimating the expected cash flows from the projects once commercially
viable, discounting the net cash flows back to their present value and
then applying a percentage of completion to the calculated value as
defined below.
Net Cash Flows. The net cash flows from the identified projects
are based on our estimates of revenues, cost of sales, research and
development costs, selling, general and administrative costs, royalty
costs and income taxes from those projects. These estimates are based
on the assumptions mentioned below. The research and development costs
included in the model reflect costs to sustain projects, but exclude
costs to bring in-process projects to technological feasibility.
The estimated revenues are based on management projections of
each in-process project and the business projections were compared and
found to be in line with industry analysts' forecasts of growth in
substantially all of the relevant markets. Estimated total revenues
from the IPR&D product areas are expected to peak in the year ending
December 31, 1999 and decline from 2000 into 2001 as other new products
are expected to become available. These projections are based on our
estimates of market size and growth, expected trends in technology and
the nature and expected timing of new project introductions by our
competitors and us.
Projected gross margins approximate STB's recent historical
performance and are in line with comparable industry margins. The
estimated selling, general and administrative costs are consistent with
STB's historical cost structure, which is in line with industry
averages at approximately 10% of revenues. Research and development
costs are consistent with STB's historical cost structure.
Royalty rate. The Company applied a royalty charge of 25% of
operating income for each in-process project to attribute value for
dependency on predecessor core technologies.
Discount rate. Discounting the net cash flows back to their
present value is based on the industry weighted average cost of capital
("WACC"). The industry WACC is approximately 14%. The discount rate
used in discounting the net cash flows from IPR&D is 20%, a 600 basis
point increase from the industry WACC. This discount rate is higher
than the industry WACC due to inherent uncertainties surrounding the
successful development of the IPR&D, market acceptance of the
technology, the useful life of such technology and the uncertainty of
technological advances which could potentially impact the estimates
described above.
Percentage of completion. The percentage of completion for each
project was determined using costs incurred to date on each project as
compared to the remaining research and development to be completed to
bring each project technological feasibility. The percentage of
completion varied by individual project ranging from 50% to 91%.
If the projects discussed above are not successfully developed,
the sales and profitability of the combined company may be adversely
affected in future periods.
Results of Operations
The results of operations for the three and six month periods presented
include the effect of the merger with STB from the date of consummation,
May 13, 1999 which is discussed in Note 2 to the Unaudited Consolidated
Condensed Financial Statements contained herein.
Three Months Ended July 31, 1999 and June 30, 1998
Revenues. Revenues are recognized upon product shipment. The
Company's total revenues were $104.8 million in the three months ended
July 31, 1999, and $58.6 million in the three months ended June 30,
1998. The increase was primarily attributable to revenues of $98.0
million generated from board-level sales incorporating Voodoo3
technology by STB following the May 13, 1999 effective date of the merger.
Revenues in the three months ended July 31, 1999 were principally
attributable to sales of the Company's Voodoo3 and Banshee products.
In the quarter ended July 31, 1999, revenue fell short of original
expectations due to the STB Merger which had not consummated
until mid-May as opposed to the end of April as planned preventing
the inclusion of Voodoo3 board sales for the first thirteen days of
days of May in the Company's quarterly revenues as well as the Company's
decision to reduce prices earlier than planned. Substantially
all of the revenues in the three months ended June 30, 1998
were derived from sale of the Company's Voodoo2 and Voodoo Graphics
chipsets. 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. See "Overview".
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. Gross
profit as a percentage of revenues was 28% and 48% in the three months
ended July 31, 1999 and June 30, 1998, respectively. The decrease can
primarily be attributed to the gross profit generated from sales of
board-level products which have lower margins as compared with the margins
on chip only products. In addition, the decrease in gross profit as a
percentage of revenues resulted from lower margins associated with the
Voodoo3 and Voodoo Banshee products sold in the three months ended July
31, 1999 as compared with the margins of Voodoo2 and Voodoo Graphics
sold in the three months ended June 30, 1998. 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 and production 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 100% from $8.3 million in the three
months ended June 30, 1998 to $16.6 million in the three months ended
July 31, 1999. Included in the quarter ended July 31, 1999 is $3.3
million in research and development expenses attributable to the
operations of STB following the May 13, 1999 effective date of the
merger. Excluding the effect of STB, research and development expenses
increased 69% in the three months ended July 31, 1999 as compared to
three months ended June 30,1998. This increase reflects an increase in
personnel costs, common cost allocations and 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 increased 138% from $8.0 million in the three
months ended June 30, 1998 to $19.0 million in the three months ended
July 31, 1999. The increase is primarily attributable to the inclusion
of $10.3 million in expenses relating to the operations of STB following
the May 13, 1999 effective date of the merger. Excluding the effect of
STB, selling, general and administrative expenses increased 10% in the
quarter ended July 31, 1999 compared to the quarter ended June 30, 1998.
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.
In-process Research and Development. The Company recorded a non-
recurring charge of $4.3 million related to in-process research and
development purchased as part of the merger with STB on May 13, 1999.
The amount of this charge was determined through valuation techniques
generally used by appraisers in the high-technology industry and was
immediately expensed because technological feasibility of the underlying
technology had not yet been established and no alternative use had been
identified. This amount was expensed as a non-recurring charge upon
consummation of the merger. See "Overview".
Goodwill and Intangibles Amortization. In connection with the
STB merger, the Company recorded assets representing goodwill of
approximately $31.8 million and intangibles of approximately $19.1
million. These amounts will be amortized ratably over the amortization
periods of the applicable assets. For the three months ended July 31,
1999, the Company recorded $2.9 million in related amortization.
Interest and Other Income (Expense), Net. Interest and other income
(expense),net decreased from $1.0 million in the three months ended
June 30, 1998 to $685,000 in the three months ended July 31, 1999.
The decrease is primarily related to decreased earnings from lower
invested cash balances and interest expense on the outstanding
equipment line of credit and capital lease balances.
Provision (Benefit)For Income Taxes. The Company recorded an income
tax benefit of $2.0 million for the three months ended July 31, 1999, at
an effective tax rate equal to 15% of pretax income. The Company recorded
a provision for income taxes of $3.9 million for the three months ended
June 30, 1998, an effective tax rate of 30%. The Company's
effective tax rate in fiscal 2000 differed from the statutory rate due to
the impact of non-deductible expenses including intangible amortization
and in-process research and development. The Company's effective tax rate
in fiscal 1998 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.
Six Months Ended July 31, 1999 and June 30, 1998
Revenues The Company's total revenues were $145.3 million in the six
months ended July 31, 1999, and $108.7 million in the six months ended
June 30, 1998. The increase includes revenues of $98.0 million
generated from sales of board-level sales incorporating Voodoo3
technology by STB following the May 13, effective date of the merger.
Revenues in the six months ended July 31, 1999 were principally
attributable to sales of the Company's Voodoo3 and Banshee products.
Substantially all of the revenues in the six months ended June 30, 1998
were derived from sale of the Company's Voodoo2 and Voodoo Graphics chipsets.
Gross Profit. Gross profit as a percentage of revenues was 29% and
48% in the six months ended July 31, 1999 and June 30, 1998,
respectively. The decrease can be primarily attributed to the gross
profit generated from the sales of board-level products which have lower
margins as compared with the margins on chip only products. In
addition, the decrease in gross profit as a percentage of revenues
resulted from lower margins associated with the Voodoo3 and Voodoo
Banshee products sold in the six months ended July 31, 1999 as compared
with the margins of Voodoo2 and Voodoo Graphics products sold in the six
months ended June 30, 1998. 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 increased
100% from $14.1 million in the six months ended June 30, 1998 to $28.3
million in the six months ended July 31, 1999. Included in the six
months ended July 31, 1999 is $3.3 million in research and development
expenses attributable to the operations of STB following the May 13,
1999 effective date of the merger. Excluding the effect of STB,
research and development expenses increased 77% in the six months ended
July 31, 1999 as compared to the six months ended June 30, 1998. This
increase reflects an increase in personnel costs, common cost
allocations and 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 increased 45% from $17.7 million in the six
months ended June 30, 1998 to $25.6 million in the six months ended July
31, 1999. The increase is primarily attributable to the inclusion of
$10.3 million in expenses relating to the operations of STB following
the May 13, 1999 effective date of the merger. Excluding the effect of
STB, selling, general and administrative expenses remained relatively
flat for the six months ending July 31, 1999 as compared to the six
months ending June 30,1998. 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 (Expense), Net. Interest and other income
(expense), net remained flat at $1.6 million in the six months ended
June 30, 1998 to $1.6 million in the six months ended July 31, 1999.
Provision (Benefit) For Income Taxes. The Company recorded an income tax
benefit of $3.1 million for the six months ended July 31, 1999, an
effective tax rate of 18%. The Company's effective tax rate in fiscal
2000 differed from the statutory rate due to the impact of non-deductible
expenses including intangible amortization and in-process research
and development. The Company recorded a provision for income
taxes of $5.7 million for the six months ended June 30, 1998, an
effective tax rate of 26%. The Company's effective tax rate in fiscal
1998 differs from the federal statutory rate due to utilization of net
operating loss carryforwards and other tax credits.
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 calendar 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. 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 calendar 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 calendar 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 calendar 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
As of July 31, 1999, the Company had working capital of $141.2
million including cash, cash equivalents and short-term investments of
$95.2 million. Net cash used in operating activities in the first six
months of fiscal 2000 was due primarily to a net loss of $13.8 million,
and decreases of $8.4 million in accruals, $3.4 million in accounts
payable and $2.2 million prepaids and other assets offset by a decrease
of $8.7 million in accounts receivable, adjustments of depreciation of
$5.3 million and amortization of $2.9 million, and the in-process
research and development write-off of $4.3 million. Net cash
provided by operating activities in the first half of fiscal 1998 was
due primarily to net income of $16.5 million, and increases of $33.2
million and $7.6 million in accounts payable and accrued liabilities,
respectively, partially offset by a $24.0 million and $27.9 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 $22.9 million
and $7.9 million in the six months ended July 31, 1999 and June 30,
1998, respectively, and was due in each period to the purchase of
investments and to the purchase of property and equipment, except for,
in the six months ended July 31, 1999, which includes $7.2 million used
in the merger of STB. The Company does not have any significant capital
spending or purchase commitments other than normal purchase commitments
and commitments under leases. As of July 31, 1999, the Company had
capital equipment of $64.8 million less accumulated depreciation of
$22.8 million to support its research and development, operations and
administrative activities. 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 used in financing activities for the six months ended July
31, 1999 of $5.1 million was due to the repurchase of common stock of
$2.5 million and payments on line of credit and capital lease
obligations. Net cash provided by financing activities was
approximately $54.7 million in the first half of fiscal 1998 due
primarily to proceeds from the secondary 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.
Lose 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 that 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 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. Additionally, the Company had net losses of $11.6 million
and $13.8 million in the three and six months ended July 31, 1999.
Although the Company had net income of $21.7 million in 1998, 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.
Prior to the merger with STB, certain of 3Dfx's principal competitors
offered a single vendor solution, because they maintain their own
semiconductor foundries and may therefore benefit from certain capacity,
cost and technical advantages. While the merger with STB enhances the
Company'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 that 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. 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 Ingram Micro accounted for approximately 18% of
the quarter ended July 31, 1999. Revenues derived from sales to
STB prior to the effective date of the Merger accounted for 15% of the
revenues for the six months ended July 31, 1999. Revenues derived from
sales to Diamond and Creative accounted for approximately 42% and 22%,
respectively, of revenues for the three months ended June 30,
1998. Revenues derived from sales to Diamond (and its subsidiaries),
Creative (and its subsidiaries) and Elitetron accounted for
approximately 43%, 18% and 13% of revenues in the first half of 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 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 and tested by
two third party subcontractors on a purchase order basis rather than
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. the Company 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 the Company 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 primarily sold to major original equipment
manufacturers, or OEMs, and, to a lesser degree, to commercial
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.
PART II - Other Information
ITEM 1: Legal Proceedings
On June 10, 1999 3Dfx Interactive, Inc. (the "Company) filed a lawsuit
against Creative Technology, Ltd. and Creative Labs, Inc. ("Defendants")
alleging breach of contract and copyright infringement. Defendants
filed their answer and counter-claim on July 29, 1999, alleging breach
of contract, Lanham Act violations, False Advertising, and Unfair
Business Practices under California Business and Professions Code
Sections 17200. Defendants seek unspecified monetary damages and
injunctive relief. The Company intends to pursue its claims against
Defendants and to defend all counterclaims vigorously.
ITEM 4: Submission of Matters to a Vote of Security Holders
1. The Registrant held a Special Meeting of Shareholders on April 30,
1999, which was adjourned to May 13, 1999 prior to the taking of a vote
on any matter. The following is a brief description of the each matter
voted upon at the May 13, 1999 adjournment of such Special Meeting and a
statement of the number of votes cast for, against or withheld and the
number of abstentions and broker non-votes with respect to each matter.
a) The shareholders approved and adopted the Agreement and Plan
of Reorganization, dated as of December 13, 1998, among the Registrant,
Voodoo Merger Sub, a wholly-owned subsidiary of the Registrant, and STB
Systems, Inc., approved the merger of the Registrant and STB Systems,
Inc., and approved the issuance of shares of the Registrant's common
stock necessary to complete the merger:
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN BROKER NON-VOTES
- ----------------- ---------- ------------- --------------
<C> <C> <C> <C>
8,745,051 94,542 29,054 --
</TABLE>
b) The shareholders approved an amendment to the Registrant's Bylaws
to increase the size of the Board of Directors to nine members:
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN BROKER NON-VOTES
- ----------------- ---------- ------------- --------------
<C> <C> <C> <C>
8,156,574 648,551 63,522 --
</TABLE>
c) The shareholders ratified and approved an increase in the number
of shares reserved for issuance under Registrant's 1995 Employee Stock
Plan by 2,000,000 to a total of 6,375,000:
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN BROKER NON-VOTES
- ----------------- ---------- ------------- --------------
<C> <C> <C> <C>
8,528,332 280,887 59,428 --
</TABLE>
<PAGE>
2. The Registrant's 1999 Annual Meeting of Shareholders was held on
July 28, 1999. The following is a brief description of the each matter
voted upon at the meeting and a statement of the number of votes cast
for, against or withheld and the number of abstentions and broker non-
votes with respect to each matter.
a) The shareholders elected the following directors to serve
for the ensuing year and until their successors are elected:
<TABLE>
<CAPTION>
Director Votes For Votes Withheld
- ----------------- ------------ -------------
<S> <C> <C>
L. Gregory Ballard 18,801,507 451,975
Gordon A. Campbell 18,807,654 445,828
James L. Hopkins 18,805,104 448,378
Alex Leupp 18,817,997 435,485
William Ogle 18,806,019 447,463
Scott D. Sellers 18,805,698 447,784
Anthony Sun 18,820,187 433,295
James Whims 18,806,914 446,568
Philip M. Young 18,818,652 434,830
</TABLE>
b) The shareholders ratified the appointment of
PricewaterhouseCoopers LLP independent public accountants of the
Registrant for the fiscal year ending January 31, 2000.
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN BROKER NON-VOT
- ----------------- ------------ ------------- --------------
<C> <C> <C> <C>
19,188,284 39,086 26,112 --
</TABLE>
<PAGE>
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 relating to
the acquisition by the Registrant of STB Systems, Inc., which
acquisition was consummated on May 13, 1999, and on July 27, 1999 the
Registrant filed on Form 8-K/A an amendment to such report for the
purpose of filing pro forma financial statements relating to such
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: September 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 six months ended July 31, 1999 and June 30, 1998
(in thousands)
(unaudited)
<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 six months
ended July 31, 1999...... $3,666 $2,653 $5,549 $0 $11,868
For the six months
ended June 30, 1998...... $1,763 $77 $ -- $200 $1,640
Inventory Reserve:
For the six months
ended July 31, 1999...... $7,828 $ -- $16,230 $ 1,230 $22,828
For the six months
ended June 30, 1998...... $661 $6,064 $ -- $ -- $6,725
</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 CONDE
CONSOLIDATED BALANCE SHEETS, CONDENSED CONSOLIDATED STATEMENTS OF OPERAT
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-31-2000
<PERIOD-START> FEB-01-1999
<PERIOD-END> JUL-31-1999
<CASH> 69,779
<SECURITIES> 25,388
<RECEIVABLES> 79,405
<ALLOWANCES> 11,868
<INVENTORY> 54,650
<CURRENT-ASSETS> 236,197
<PP&E> 64,925
<DEPRECIATION> 22,828
<TOTAL-ASSETS> 329,860
<CURRENT-LIABILITIES> 94,905
<BONDS> 0
0
0
<COMMON> 250,055
<OTHER-SE> (17,231)
<TOTAL-LIABILITY-AND-EQUITY> 329,860
<SALES> 145,280
<TOTAL-REVENUES> 145,280
<CGS> 102,498
<TOTAL-COSTS> 102,498
<OTHER-EXPENSES> 61,235
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (16,857)
<INCOME-TAX> (3,074)
<INCOME-CONTINUING> (13,783)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,783)
<EPS-BASIC> (0.71)
<EPS-DILUTED> (0.71)
</TABLE>
