NVIDIA Corporation
NVIDIA CORP (Form: 10-Q, Received: 08/21/2008 08:58:25)


 
  
UNITED STATES
SECURITIES AND 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 quarterly period ended July 27, 2008

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: 0-23985

LOGO
 
 

NVIDIA CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
94-3177549
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)

2701 San Tomas Expressway
Santa Clara, California 95050
(408) 486-2000
(Address, including zip code, and telephone number,
including area code, of principal executive offices)

N/A
(Former name, former address and former fiscal year if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:
 
Large accelerated filer x     
Accelerated filer o  
Non-accelerated filer    o   (Do not check if a smaller reporting company) 
Smaller reporting company o        
                                                                                                                                                          
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No x
 
       The number of shares of registrant's common stock, $0.001 par value, outstanding as of August 15, 2008 was 556,581,921.
 
 


 
NVIDIA CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JULY 27, 2008


TABLE OF CONTENTS

     
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2

 
 
 


PART I. FINANCIAL INFORMATION

ITEM 1 .  FINANCIAL STATEMENTS (UNAUDITED)

NVIDIA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands, except per share data)
 
 

   
Three Months Ended
   
Six Months Ended
 
   
July 27,
2008
 
 
July 29,
2007
   
July 27,
2008
   
July 29,
2007
 
                                 
Revenue
 
$
892,676
   
$
935,253
     $
2,046,064
     $
1,779,533
 
         Cost of revenue
   
742,759
     
511,261
     
1,381,304
     
975,403
 
Gross profit
   
149,917
     
423,992
     
664,760
     
804,130
 
Operating expenses
                               
         Research and development
   
212,910
     
157,952
     
431,740
     
316,273
 
         Sales, general and administrative
   
92,399
     
81,280
     
185,433
     
161,851
 
Total operating expenses
   
305,309
     
239,232
     
617,173
     
478,124
 
Income (loss) from operations
   
(155,392
)
   
184,760
     
47,587
     
326,006
 
         Interest income
   
12,081
     
15,625
     
26,404
     
28,833
 
         Other income (expense), net
   
(3,289
)
   
466
     
(7,573
)
   
(199
)
Income (loss) before income tax expense
   
(146,600
)
   
200,851
     
66,418
     
354,640
 
Income tax expense (benefit)
   
(25,671
)
   
28,119
     
10,542
     
49,649
 
Net income (loss)
 
$
(120,929
)
 
$
172,732
     $
55,876
     $
304,991
 
                                 
Basic net income (loss) per share
 
$
(0.22
)
 
$
0.32
     $
0.10
   
$
0.56
 
Shares used in basic per share computation (1)
   
555,417
     
547,305
     
555,531
     
544,275
 
                                 
Diluted net income (loss) per share
 
$
(0.22
)
 
$
0.29
     $
0.09
   
$
0.51
 
Shares used in diluted per share computation (1)
   
555,417
     
603,830
     
592,181
     
600,957
 

(1)  
Reflects a three-for-two stock split effective on September 10, 2007.

See accompanying Notes to Condensed Consolidated Financial Statements



 
 
 
3

 
 
 


NVIDIA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands)

   
July 27,
2008
   
January 27,
2008
 
ASSETS
           
Current assets:
           
     Cash and cash equivalents
 
$
719,143
   
$
726,969
 
     Marketable securities
   
938,087
     
1,082,509
 
     Accounts receivable, net
   
679,416
     
666,494
 
     Inventories
   
432,279
     
358,521
 
     Prepaid expenses and other
   
45,294
     
54,336
 
 Total current assets
   
2,814,219
     
2,888,829
 
Property and equipment, net
   
599,478
     
359,808
 
Goodwill
   
365,800
     
354,057
 
Intangible assets, net
   
145,148
     
106,926
 
Deposits and other assets
   
35,404
     
38,051
 
           Total assets
 
$
3,960,049
   
$
3,747,671
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
     Accounts payable
 
$
438,892
   
$
492,099
 
     Accrued liabilities
   
696,124
     
475,062
 
 Total current liabilities
   
1,135,016
     
967,161
 
Other long-term liabilities
   
162,118
     
162,598
 
Commitments and contingencies - see Note 12
               
Stockholders’ equity:
               
      Preferred stock
   
-
     
-
 
      Common stock
   
625
     
619
 
      Additional paid-in capital
   
1,776,698
     
1,654,681
 
      Treasury stock, at cost
   
(1,163,528
)
   
(1,039,632
)
     Accumulated other comprehensive income (loss)
   
(966
)
   
8,034
 
     Retained earnings
   
2,050,086
     
1,994,210
 
 Total stockholders' equity
   
2,662,915
     
2,617,912
 
                     Total liabilities and stockholders' equity
 
$
3,960,049
   
$
3,747,671
 
                 
 
See accompanying Notes to Condensed Consolidated Financial Statements.
 


 
 
 
 
4

 
 
 


NVIDIA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
 
   
Six Months Ended
 
     
July 27,
2008
   
July 29,
2007
 
Cash flows from operating activities:
             
Net income
 
$
55,876
   
$
304,991
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
     Depreciation and amortization
   
87,664
     
63,226
 
     Stock-based compensation expense related to employees
   
81,423
     
66,865
 
     Payments under patent licensing arrangement
   
(26,680
)
   
(20,723
)
     Deferred income taxes
   
5,547
     
39,277
 
     Other
   
3,145
     
185
 
Changes in operating assets and liabilities, net of effects of acquisitions:
               
     Accounts receivable
   
(12,373
)
   
10,950
 
     Inventories
   
(73,139
)
   
78,489
 
     Prepaid expenses and other current assets
   
9,136
     
(842
)
     Deposits and other assets
   
(491
)
   
2,437
 
     Accounts payable
   
(87,730
)
   
50,685
 
     Accrued liabilities and other long-term liabilities
   
183,824
     
21,337
 
 Net cash provided by operating activities
   
226,202
     
616,877
 
Cash flows from investing activities:
               
      Proceeds from sales and maturities of marketable securities
   
810,508
     
374,661
 
      Purchases of marketable securities
   
(678,704
)
   
(455,909
)
      Purchases of property and equipment and intangible assets
   
(255,687
)
   
(46,980
)
      Acquisition of businesses, net of cash and cash equivalents
   
(27,948
)
   
-
 
      Proceeds from sale of investment in non-affiliates
   
3,218
     
-
 
      Purchases of investment in non-affiliates
   
(1,500
)
   
-
 
 Net cash used in investing activities
   
(150,113
)
   
(128,228
)
Cash flows from financing activities:
               
      Payments for stock repurchases
   
(123,896
)
   
(249,386
)
      Proceeds from issuance of common stock under employee stock plans
   
39,981
     
131,068
 
 Net cash used in financing activities
   
(83,915
)
   
(118,318
)
Change in cash and cash equivalents
   
(7,826
)
   
370,331
 
Cash and cash equivalents at beginning of period
   
726,969
     
544,414
 
Cash and cash equivalents at end of period
 
$
719,143
   
$
914,745
 
                 
Supplemental disclosures of cash flow information:
               
      Cash paid for income taxes, net
 
$
4,459
   
$
3,505
 
Other non-cash activities:
               
      Assets acquired by assuming related liabilities
 
$
68,408
   
  $
-
 
      Unrealized losses from marketable securities
 
 $
11,252
   
$
564
 

See accompanying Notes to Condensed Consolidated Financial Statements.
 

 
5

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 

 
Note 1 - Summary of Significant Accounting Policies

Basis of presentation
 
The accompanying unaudited condensed consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Securities and Exchange Commission, or SEC, Regulation S-X. In the opinion of management, all adjustments, consisting only of normal recurring adjustments except as otherwise noted, considered necessary for a fair statement of results of operations and financial position have been included. The results for the interim periods presented are not necessarily indicative of the results expected for any future period. The following information should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended January 27, 2008.  

Fiscal year
 
We operate on a 52 or 53-week year, ending on the last Sunday in January. The first and second quarters in fiscal years 2009 and 2008 were all 13-week quarters.

Stock Split

In August 2007, our Board of Directors, or the Board, approved a three-for-two stock split of our outstanding shares of common stock on Monday, August 20, 2007 to be effected in the form of a stock dividend. The stock split was effective on Monday, September 10, 2007 and entitled each stockholder of record on August 20, 2007 to receive one additional share for every two outstanding shares of common stock held and cash in lieu of fractional shares. All share and per-share numbers contained herein have been retroactively adjusted to reflect this stock split.
 
Reclassifications
 
Certain prior fiscal year balances have been reclassified to conform to the current fiscal year presentation.
 
Principles of Consolidation
 
Our consolidated financial statements include the accounts of NVIDIA Corporation and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.
 
Product Warranties
 
We generally offer limited warranty that ranges from one to three years for products in order to repair or replace products for any manufacturing defects or hardware component failures. Cost of revenue includes the estimated cost of product warranties that are calculated at the point of revenue recognition.

Use of Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, accounts receivable, inventories, warranties, income taxes, goodwill, stock-based compensation and contingencies. These estimates are based on historical facts and various other assumptions that we believe are reasonable.  
 
 

 
6

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
 
Revenue Recognition
 
Product Revenue  
 
We recognize revenue from product sales when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed and determinable, and collection is reasonably assured. For most sales, we use a binding purchase order and in certain cases we use a contractual agreement as evidence of an arrangement. We consider delivery to occur upon shipment provided title and risk of loss have passed to the customer based on the shipping terms. At the point of sale, we assess whether the arrangement fee is fixed and determinable and whether collection is reasonably assured. If we determine that collection of a fee is not reasonably assured, we defer the fee and recognize revenue at the time collection becomes reasonably assured, which is generally upon receipt of payment.
 
Our policy on sales to certain distributors, with rights of return, is to defer recognition of revenue and related cost of revenue until the distributors resell the product.

We record estimated reductions to revenue for customer programs at the time revenue is recognized. Our customer programs primarily involve rebates, which are designed to serve as sales incentives to purchasers of our products.  We account for rebates in accordance with Emerging Issues Task Force Issue 01-9, or EITF 01-09, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products) and, as such, we accrue for 100% of the potential rebates and do not apply a breakage factor. Rebates typically expire six months from the date of the original sale, unless we reasonably believe that the customer intends to claim the rebate. Unclaimed rebates are reversed to revenue upon expiration of the rebate.
 
Our customer programs also include marketing development funds, or MDFs. We account for MDFs as either a reduction of revenue or an operating expense in accordance with EITF 01-09. MDFs represent monies paid to retailers, system builders, original equipment manufacturers, distributors and add-in card partners that are earmarked for market segment development and expansion and typically are designed to support our partners’ activities while also promoting our products. Depending on market conditions, we may take actions to increase amounts offered under customer programs, possibly resulting in an incremental reduction of revenue at the time such programs are offered.
 
We also record a reduction to revenue by establishing a sales return allowance for estimated product returns at the time revenue is recognized, based primarily on historical return rates. However, if product returns for a particular fiscal period exceed historical return rates we may determine that additional sales return allowances are required to properly reflect our estimated exposure for product returns.

License and Development Revenue  
 
For license arrangements that require significant customization of our intellectual property components, we generally recognize this license revenue using the percentage-of-completion method of accounting over the period that services are performed. For all license and service arrangements accounted for under the percentage-of-completion method, we determine progress to completion based on actual direct labor hours incurred to date as a percentage of the estimated total direct labor hours required to complete the project. We periodically evaluate the actual status of each project to ensure that the estimates to complete each contract remain accurate. A provision for estimated losses on contracts is made in the period in which the loss becomes probable and can be reasonably estimated. Costs incurred in advance of revenue recognized are recorded as deferred costs on uncompleted contracts. If the amount billed exceeds the amount of revenue recognized, the excess amount is recorded as deferred revenue. Revenue recognized in any period is dependent on our progress toward completion of projects in progress. Significant management judgment and discretion are used to estimate total direct labor hours. Any changes in or deviations from these estimates could have a material effect on the amount of revenue we recognize in any period.



 
 
 
7

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
 
Adoption of New Accounting Pronouncements

On January 28, 2008, we adopted Statement of Financial Accounting Standards No. 157, or SFAS No. 157, Fair Value Measurements . SFAS No. 157 for all financial assets and financial liabilities recognized or disclosed at fair value in the financial statements. SFAS No. 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of SFAS No. 157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements.  The adoption of SFAS No. 157 for financial assets and liabilities did not have a significant impact on our consolidated financial statements, and the resulting fair values calculated under SFAS No. 157 after adoption were not significantly different than the fair values that would have been calculated under previous guidance. Please refer to Note 16 of these Notes to the Condensed Consolidated Financial Statements for further details on our fair value measurements.

Additionally, in February 2008, the Financial Accounting Standards Board, or FASB, issued FASB Staff Position No. FAS 157-2, or FSP No. 157-2, Effective Date of FASB Statement No. 157, to partially defer FASB Statement No. 157, Fair Value Measurements .  FSP No. 157-2 defers the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. We do not believe the adoption of FSP No. 157-2 will have a material impact on our consolidated financial position, results of operations and cash flows.

On January 28, 2008, we adopted Statement of Financial Accounting Standards No. 159, or SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits companies to choose to measure certain financial instruments and certain other items at fair value using an instrument-by-instrument election. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. Under SFAS No. 159, we did not elect the fair value option for any of our assets and liabilities. The adoption of SFAS No. 159 did not have an impact on our consolidated financial statements.

In June 2007, the FASB ratified Emerging Issues Task Force Issue No. 07-3, or EITF 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities . EITF 07-3 requires non-refundable advance payments for goods and services to be used in future research and development activities to be recorded as an asset and the payments to be expensed when the research and development activities are performed. We adopted the provisions of EITF 07-3 beginning with our fiscal quarter ended April 27, 2008. The adoption of EITF 07-3 did not have any impact on our consolidated financial position, results of operations and cash flows.

Recently Issued Accounting Pronouncements

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), or SFAS No. 141(R), Business Combinations . Under SFAS No. 141(R), an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. In addition, acquired in-process research and development, or IPR&D, is capitalized as an intangible asset and amortized over its estimated useful life.  We are required to adopt the provisions of SFAS No. 141(R) beginning with our fiscal quarter ending April 26, 2009.  The adoption of SFAS No. 141(R) is expected to change our accounting treatment for business combinations on a prospective basis beginning in the period it is adopted.
 

 
 
 
8

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 


Note 2 - Stock-Based Compensation

Effective January 30, 2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123(R), or SFAS No. 123(R) ,   Share-based Payment, which establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation expense is measured at grant date, based on the fair value of the awards, and is recognized as expense over the requisite employee service period. We elected to adopt the modified prospective application method beginning January 30, 2006 as provided by SFAS No. 123(R). We recognize stock-based compensation expense using the straight-line attribution method. We estimate the value of employee stock options on the date of grant using a binomial model.
 
Our condensed consolidated statements of operations include stock-based compensation expense, net of amounts capitalized as inventory, as follows:

   
Three Months Ended
   
Six Months Ended
 
   
July 27,  
 2008
   
July 29,
2007
   
July 27,
2008
   
July 29,
2007
 
Cost of revenue
 
$
3,333
   
$
2,702
   
$
6,469
   
$
5,511
 
Research and development
 
$
24,226
   
$
16,421
   
$
48,760
   
$
38,821
 
Sales, general and administrative
 
$
12,806
   
$
10,337
   
$
27,260
   
$
22,533
 

During the three and six months ended July 27, 2008, we granted approximately 0.9 million and 9.7 million stock options, respectively, with an estimated total grant-date fair value of $8.4 million and $95.4 million, respectively, and a per option weighted average grant-date fair value of $9.07 and $9.88, respectively. Of the estimated total grant-date fair value, we estimated that the stock-based compensation expense related to the awards that are not expected to vest was $1.4 million and $15.7 million for the three and six months ended July 27, 2008, respectively.

During the three and six months ended July 29, 2007, we granted approximately 1.4 million and 8.6 million stock options, respectively, with an estimated total grant-date fair value of $13.7 million and $69.8 million, respectively, and a per option weighted average grant-date fair value of $10.35 and $8.15, respectively. Of the estimated total grant-date fair value, we estimated that the stock-based compensation expense related to the awards that are not expected to vest was $2.6 million and $13.5 million for the three and six months ended July 29, 2007, respectively.

As of July 27, 2008 and July 29, 2007, the aggregate amount of unearned stock-based compensation expense related to our stock options was $223.9 million and $175.0 million, respectively, adjusted for estimated forfeitures.  We will recognize the unearned stock-based compensation expense related to stock options over an estimated weighted average amortization period of 1.8 years and 2.0 years, respectively.

Valuation Assumptions

We determined that the use of implied volatility is expected to be more reflective of market conditions and, therefore, can reasonably be expected to be a better indicator of our expected volatility than historical volatility. We also segregated options into groups for employees with relatively homogeneous exercise behavior in order to calculate the best estimate of fair value using the binomial valuation model.  As such, the expected term assumption used in calculating the estimated fair value of our stock-based compensation awards using the binomial model is based on detailed historical data about employees' exercise behavior, vesting schedules, and death and disability probabilities.  Our management believes the resulting binomial calculation provides a more refined estimate of the fair value of our employee stock options. For our employee stock purchase plan we continue to use the Black-Scholes model.

SFAS No. 123(R) also requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience. If factors change and we employ different assumptions in the application of SFAS No. 123(R) in future periods, the compensation expense that we record under SFAS No. 123(R) may differ significantly from what we have recorded in the current period.


 
 
 
9

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 

The fair value of stock options granted during the first half of fiscal years 2009 and 2008, respectively, under our stock option plans and shares issued under our employee stock purchase plan have been estimated at the date of grant with the following assumptions:

Stock Options

   
Three Months Ended
   
Six Months Ended
 
   
July 27,
2008
   
July 29,
2007
   
July 27,
2008
   
July 29,
2007
 
     
(Using a binomial model)
 
Expected life (in years)
   
3.7 -5.0
     
3.8 - 5.2
     
3.6-5.7
     
3.8 - 5.8
 
Risk free interest rate
   
2.9% - 3.7
%
   
5.0
%
   
2.6% - 3.7
%
   
4.6% - 5.0
%
Volatility
   
52% - 63
%
   
37% - 40
%
   
52% - 68
%
   
37% - 45
%
Dividend Yield
   
-
     
-
     
-
     
-
 

Employee Stock Purchase Plan

   
Three Months Ended
   
Six Months Ended
 
   
July 27,
2008
   
July 29,
2007
   
July 27,
2008
   
July 29,
2007
 
     
(Using a Black-Scholes model)
 
Expected life (in years)
   
-
     
-
     
0.5 - 2.0
     
0.5 - 2.0
 
Risk free interest rate
   
-
     
-
     
1.6% - 1.8
%
   
3.5% - 5.2
%
Volatility
   
-
     
-
     
68
%
   
38% - 47
%
Dividend Yield
   
-
     
-
     
-
     
-
 
 
There were no grants made under the Employee Stock Purchase Plan during the three months ended July 27, 2008 and July 29, 2007.

Equity Incentive Plans
 
We consider equity compensation to be long-term compensation and an integral component of our efforts to attract and retain exceptional executives, senior management and world-class employees. We believe that properly structured equity compensation aligns the long-term interests of stockholders and employees by creating a strong, direct link between employee compensation and stock appreciation, as stock options are only valuable to our employees if the value of our common stock increases after the date of grant.

The description of the key features of the Nvidia Corporation 2007 Equity Incentive Plan, or the 2007 Plan, PortalPlayer, Inc. 1999 Stock Option Plan, or 1999 Plan, and 1998 Employee Stock Purchase Plan, may be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended January 27, 2008.

The following summarizes the transactions under our equity incentive plans:
 
   
Options Available for Grant
   
Options
Outstanding
   
Weighted Average Exercise Price Per Share
 
Balances, January 27, 2008
   
44,044,004
     
90,581,073
   
$
13.18
 
Granted
   
(9,656,565
)
   
9,656,565
   
$
18.30
 
Exercised
   
-
     
(4,494,733
)
 
$
4.81
 
Cancelled
   
1,035,615
     
(1,035,615
)
 
$
22.25
 
Balances, July 27, 2008
   
35,423,054
     
94,707,290
   
$
14.00
 
 
 

 
 
 
10

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 


Note 3 – Income Taxes

We recognized income tax expense (benefit) of ($25.7) million and $28.1 million for the three months ended July 27, 2008 and July 29, 2007, respectively, and $10.5 million and $49.6 million for the six months ended July 27, 2008 and July 29, 2007, respectively. Income tax expense (benefit) as a percentage of income before taxes, or our effective tax rate, was (17.5%) and 14.0% for the three months ended July 27, 2008 and July 29, 2007, respectively, and 15.9% and 14.0% for the six months ended July 27, 2008 and July 29, 2007, respectively.  Our effective tax rate is lower than the United States Federal Statutory rate of 35.0% due primarily to income earned in lower tax jurisdictions and U.S. tax benefit of the federal research tax credits available in the respective periods.

Our effective tax rates for the first half of fiscal year 2009 increased to 15.9% from 14.0% during the first half of fiscal year 2008 primarily due to the expiration of the federal research tax credit in fiscal year 2009.  In addition, during the three months ended July 27, 2008, we increased our estimate of the annual effective tax rate for fiscal year 2009 from 17.0% to 22.8%. The increase in our effective income tax rate was a result of the impact of non-deductible tax items to our annual effective tax rate caused by the change in our outlook for the financial results of fiscal year 2009.  This increase in our estimated annual effective tax rate was offset in the second quarter primarily by a favorable impact from the expiration of statues of limitations in certain non-U.S jurisdictions, resulting in an effective tax rate for the first half of fiscal year 2009 of 15.9%.

During the three months ended July 27, 2008, the Internal Revenue Service closed its review of our U.S. federal income tax returns for fiscal year 2004 through 2006 with no material changes to our income tax returns as filed.  However, due to net operating losses generated in those and other tax years, we remain subject to future examination of our U.S. federal income tax returns beginning in fiscal year 2002 through fiscal year 2008.  For the six months ended July 27, 2008, there have been no other material changes to our tax years that remain subject to examination by major tax jurisdictions.  Additionally, there have been no material changes to our unrecognized tax benefits and any related interest or penalties from our fiscal year ended January 27, 2008.

While we believe that we have adequately provided for all uncertain tax positions, amounts asserted by tax authorities could be greater or less than our accrued position. Accordingly, our provisions on federal, state and foreign tax-related matters to be recorded in the future may change as revised estimates are made or the underlying matters are settled or otherwise resolved with the respective tax authorities. As of July 27, 2008, we do not believe that our estimates, as otherwise provided for, on such tax positions will significantly increase or decrease within the next twelve months.


 
 
 
11

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 

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 period. Diluted net income (loss) per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period, using the treasury stock method. Under the treasury stock method, the effect of stock options outstanding is not included in the computation of diluted net income per share for periods when their effect is anti-dilutive. The following is a reconciliation of the numerators and denominators of the basic and diluted net income (loss) per share computations for the periods presented: 

   
Three Months Ended
   
Six Months Ended
 
   
July 27,
2008
   
July 29,
2007
   
July 27,
2008
   
July 29,
2007
 
   
(In thousands, except per share data)
 
Numerator:
                       
Net income (loss)
 
$
(120,929
)
 
$
172,732
   
$
55,876
   
$
304,991
 
Denominator:
                               
Denominator for basic net income per share, weighted average shares
   
555,417
     
547,305
     
555,531
     
544,275
 
Effect of dilutive securities:
                               
Stock options outstanding
   
-
     
56,525
     
36,650
     
56,682
 
Denominator for diluted net income (loss) per share, weighted average shares
   
555,417
     
603,830
     
592,181
     
600,957
 
Net income per share:
                               
Basic net income (loss) per share
 
$
(0.22
)
 
$
0.32
   
$
0.10
   
$
0.56
 
Diluted net income (loss) per share
 
$
(0.22
)
 
$
0.29
   
$
0.09
   
$
0.51
 

Diluted net income (loss) per share for the three and six months ended July 27, 2008 does not include the effect of anti-dilutive common equivalent shares from stock options outstanding of 61.6 million and 33.1 million, respectively.  Diluted net income per share for three and six months ended July 29, 2007 does not include the effect of anti-dilutive common equivalent shares from stock options outstanding of 5.1 million and 16.8 million, respectively.

Note 5 - Marketable Securities
 
We account for our investment instruments in accordance with Statement of Financial Accounting Standards No. 115, or SFAS No. 115,  Accounting for Certain Investments in Debt and Equity Securities, or SFAS No. 115. All of our cash equivalents and marketable securities are treated as “available-for-sale” under SFAS No. 115. Cash equivalents consist of financial instruments which are readily convertible into cash and have original maturities of three months or less at the time of acquisition. Marketable securities consist primarily of highly liquid investments with a maturity of greater than three months when purchased and some equity investments. We classify our marketable securities at the date of acquisition in the available-for-sale category as our intention is to convert them into cash for operations. These securities are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income (loss), a component of stockholders’ equity, net of tax.  Any unrealized losses which are considered to be other-than-temporary impairments are recorded in the other expense section of our consolidated statements of operations.  Realized gain (loss) on the sale of marketable securities is determined using the specific-identification method. Net realized gain (loss) for the three and six months ended July 27, 2008 was ($0.1) million and $1.2 million, respectively.  Net realized gains for the three and six months ended July 29, 2007 were not significant. The unrealized gain (loss) as of July 27, 2008 and July 29, 2007 was ($0.5) million and $1.8 million, respectively.  Please refer to Note 16 of these Notes to the Condensed Consolidated Financial Statements for further details on our fair value measurements.


 
 
 
12

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 

Note 6 - 3dfx

During fiscal year 2002, we completed the purchase of certain assets from 3dfx Interactive, Inc., or 3dfx, for an aggregate purchase price of approximately $74.2 million. On December 15, 2000, NVIDIA Corporation and one of our indirect subsidiaries entered into an Asset Purchase Agreement, or the APA, which closed on April 18, 2001, to purchase certain graphics chip assets from 3dfx. Under the terms of the APA, the cash consideration due at the closing was $70.0 million, less $15.0 million that was loaned to 3dfx pursuant to a Credit Agreement dated December 15, 2000. The APA also provided, subject to the other provisions thereof, that if 3dfx properly certified that all its debts and other liabilities had been provided for, then we would have been obligated to pay 3dfx one million shares, which due to subsequent stock splits now totals six million shares, of NVIDIA common stock. If 3dfx could not make such a certification, but instead properly certified that its debts and liabilities could be satisfied for less than $25.0 million, then 3dfx could have elected to receive a cash payment equal to the amount of such debts and liabilities and a reduced number of shares of our common stock, with such reduction calculated by dividing the cash payment by $25.00 per share. If 3dfx could not certify that all of its debts and liabilities had been provided for, or could not be satisfied, for less than $25.0 million, we would not be obligated under the APA to pay any additional consideration for the assets.
 
In October 2002, 3dfx filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the Northern District of California. In March 2003, we were served with a complaint filed by the Trustee appointed by the Bankruptcy Court to represent 3dfx’s bankruptcy estate. The Trustee’s complaint asserts claims for, among other things, successor liability and fraudulent transfer and seeks additional payments from us. On October 13, 2005, the Bankruptcy Court held a hearing on the Trustee’s motion for summary adjudication. On December 23, 2005, the Bankruptcy Court denied the Trustee’s Motion for Summary Adjudication in all material respects and held that NVIDIA may not dispute that the value of the 3dfx transaction was less than $108.0 million. The Bankruptcy Court denied the Trustee’s request to find that the value of the 3dfx assets conveyed to NVIDIA was at least $108.0 million. In early November 2005, after several months of mediation, NVIDIA and the Official Committee of Unsecured Creditors, or the Creditors’ Committee, agreed to a Plan of Liquidation of 3dfx, which included a conditional settlement of the Trustee’s claims against NVIDIA. This conditional settlement was subject to a confirmation process through a vote of creditors and the review and approval of the Bankruptcy Court after notice and hearing. The conditional settlement called for a payment by NVIDIA of approximately $30.6 million to the 3dfx estate. Under the settlement, $5.6 million related to various administrative expenses and Trustee fees, and $25.0 million related to the satisfaction of debts and liabilities owed to the general unsecured creditors of 3dfx. Accordingly, during the three month period ended October 30, 2005, we recorded $5.6 million as a charge to settlement costs and $25.0 million as additional purchase price for 3dfx.  The Trustee advised that he intended to object to the settlement. However, the conditional settlement never progressed substantially through the confirmation process.
 
On December 21, 2005, the Bankruptcy Court determined that it would schedule trial of one portion of the Trustee’s case against NVIDIA. On January 2, 2007, NVIDIA exercised its right to terminate the settlement agreement on grounds that the Bankruptcy Court had failed to proceed toward confirmation of the Creditors’ Committee’s plan. A non-jury trial began on March 21, 2007 on valuation issues in the Trustee's constructive fraudulent transfer claims against NVIDIA. Specifically, the Bankruptcy Court tried four questions: (1) what did 3dfx transfer to NVIDIA in the APA?; (2) of what was transferred, what qualifies as "property" subject to the Bankruptcy Court's avoidance powers under the Uniform Fraudulent Transfer Act and relevant bankruptcy code provisions?; (3) what is the fair market value of the "property" identified in answer to question (2)?; and (4) was the $70 million that NVIDIA paid "reasonably equivalent" to the fair market value of that property? At the conclusion of the evidence, the Bankruptcy Court asked the parties to submit post-trial briefing. That briefing was completed on May 25, 2007.  On April 30, 2008, the Bankruptcy Court issued its Memorandum Decision After Trial, in which it provided a detailed summary of the trial proceedings and the parties' contentions with respect to each of the questions to be tried.  The Bankruptcy Court concluded that "the creditors of 3dfx were not injured by the Transaction."  This decision does not entirely dispose of the Trustee's action, however; still pending are the Trustee's claims for successor liability and intentional fraudulent conveyance.  On May 12, 2008, the Trustee filed a motion for leave to pursue an interlocutory appeal, but thereafter withdrew the motion.  NVIDIA has filed a motion for summary judgment on all causes of action in order to convert the Memorandum Decision After Trial to a final judgment.  That motion is scheduled to be heard on August 28, 2008.

       The 3dfx asset purchase price of $95.0 million and $4.2 million of direct transaction costs were allocated based on fair values presented below. The final allocation of the purchase price of the 3dfx assets is contingent upon the outcome of all of the 3dfx litigation. Please refer to Note 12 of these Notes to Condensed Consolidated Financial Statements for further information regarding this litigation. 

   
Fair Market Value
   
Straight-Line Amortization Period
 
   
(In thousands)
   
(Years)
 
Property and equipment
 
$
2,433
     
1-2
 
Trademarks
   
11,310
     
5
 
Goodwill
   
85,418
     
--
 
 Total
 
$
99,161
         


 
 
 
13

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
Note 7 – Business Combinations

On February 10, 2008, we acquired Ageia Technologies, Inc., or Ageia, an industry leader in gaming physics technology. The combination of the graphics processing unit, or GPU, and physics engine brands is expected to enhance the visual experience of the gaming world. The aggregate purchase price consisted of total consideration of approximately $29.7 million.

On November 30, 2007, we completed our acquisition of Mental Images, Inc., or Mental Images, an industry leader in photorealistic rendering technology. Mental Images’ Mental Ray product is considered by many to be the most pervasive ray tracing renderer in the industry. The aggregate purchase price consisted of total consideration of approximately $88.3 million. The total consideration also includes approximately $7.8 million which reflects an initial investment we made in Mental Images in prior periods and $5.6 million primarily towards guaranteed payments subsequent to completion of our acquisition. 

We allocated the purchase price of each of these acquisitions to tangible assets, liabilities and identifiable intangible assets acquired, as well as IPR&D, if identified, based on their estimated fair values. The excess of purchase price over the aggregate fair values was recorded as goodwill. The fair value assigned to identifiable intangible assets acquired was based on estimates and assumptions made by management. Purchased intangibles are amortized on a straight-line basis over their respective useful lives. The allocation of the purchase price for the Mental Images and Ageia acquisitions have been prepared on a preliminary basis and reasonable changes are expected as additional information becomes available.  

As of July 27, 2008, the estimated fair values of the purchase price allocated to assets we acquired and liabilities we assumed on the respective acquisition dates were as follows:  
   
Mental
Images
   
Ageia
 
Fair Market Values
 
(In thousands)
 
Cash and cash equivalents
 
$
988
   
$
1,744
 
Marketable securities
   
     
28
 
Accounts receivable
   
1,462
     
911
 
Prepaid and other current assets
   
214
     
3,825
 
Property and equipment
   
1,212
     
166
 
In-process research and development
   
4,000
     
-
 
Goodwill
   
58,271
     
16,558
 
Intangible assets:
               
    Existing technology
   
14,400
     
13,450
 
    Customer relationships
   
6,500
     
170
 
    Patents
   
5,000
     
-
 
    Trademark
   
1,200
     
900
 
Total assets acquired
   
93,247
     
37,752
 
Current liabilities
   
(1,177
)
   
(6,994
)
Acquisition related costs
   
(1,208
)
   
(1,038
)
Long-term liabilities
   
(2,542
)
   
-
 
Total liabilities assumed
   
(4,927
)
   
(8,032
)
Purchase price allocation
 
$
88,320
   
$
29,720
 

     
Mental Images
   
Ageia
 
   
(Straight-line depreciation/amortization period)
Property and equipment
   
2 -5 years
   
1-2 years
 
Intangible assets:
             
Existing technology
   
4-5 years
   
4 years
 
Customer relationships
   
4-5 years
   
5 years
 
Patents
   
5 years
   
-
 
Trademark
   
5 years
   
5 years
 

The amount of the IPR&D represents the value assigned to research and development projects of Mental Images that had commenced but had not yet reached technological feasibility at the time of the acquisition and for which we had no alternative future use. In accordance with Statement of Financial Accounting Standards No. 2, or SFAS No. 2, Accounting for Research and Development Costs , as clarified by FASB issued Interpretation No. 4, or FIN 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method an interpretation of FASB Statement No. 2 , amounts assigned to IPR&D meeting the above-stated criteria were charged to research and development expenses as part of the allocation of the purchase price.
 
The pro forma results of operations for these acquisitions have not been presented because the effects of the acquisitions, individually or in the aggregate, were not material to our results.
 
 
 
 
14

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
Note 8 - Goodwill
 
The carrying amount of goodwill is as follows:
 
   
July 27,
2008
   
January 27,
2008
 
   
(In thousands)
 
PortalPlayer
 
 $
104,473
   
$
104,473
 
3dfx
   
75,326
     
75,326
 
Mental Images
   
58,271
     
63,086
 
MediaQ
   
35,167
     
35,167
 
ULi
   
31,115
     
31,115
 
Hybrid Graphics
   
27,906
     
27,906
 
Ageia
   
16,558
     
-
 
Other
   
16,984
     
16,984
 
 Total goodwill
 
$
365,800
   
$
354,057
 
 
During the six months ended July 27, 2008, goodwill increased by $17.0 million due to our acquisition of Ageia on February 10, 2008.  This increase in goodwill was offset by a decrease of $4.8 million for Mental Images related to the reassessment of estimates made during the preliminary purchase price allocation.
 
Note 9 - Amortizable Intangible Assets
 
We are currently amortizing our intangible assets with definitive lives over periods ranging from one to seven years, primarily on a straight-line basis. The components of our amortizable intangible assets are as follows:

   
July 27, 2008
   
January 27, 2008
 
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net Carrying
Amount
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net Carrying
Amount
 
                                                           (In thousands)
 
Technology licenses
  $ 112,263     $ (28,128 )   $ 84,135     $ 94,970     $ (32,630 )   $ 62,340  
Acquired intellectual property
    75,880       (26,242 )     49,638       77,900       (41,030 )     36,870  
Patents
    17,183       (5,808 )     11,375       35,348       (27,632 )     7,716  
Other
    -       -       -       1,494       (1,494 )     -  
Total intangible assets
  $ 205,326     $ (60,178 )   $ 145,148     $ 209,712     $ (102,786 )   $ 106,926  
 
The increase in the net carrying amount of technology licenses as of July 27, 2008 when compared to January 27, 2008, is primarily related to approximately $26.7 million of net cash outflows under a confidential patent licensing arrangement entered into during fiscal year 2007, offset by amortization for the six months ended July 27, 2008. Additionally, the increase in the net carrying value of acquired intellectual property is primarily related to the intangible assets that resulted from our acquisition of Ageia during the first quarter of fiscal year 2009, offset by amortization for the six months ended July 27, 2008. Please refer to Note 7 of these Notes to Condensed Consolidated Financial Statements for further information. The decrease in the gross carrying amounts of the intangible assets as of July 27, 2008 when compared to January 27, 2008 is primarily due to the write-off of fully amortized intangible assets.

Amortization expense associated with intangible assets for the three and six months ended July 27, 2008 was $7.5 million and $15.0 million, respectively.  Amortization expense associated with intangible assets for the three and six months ended July 29, 2007 was $5.6 million and $12.6 million, respectively.  Future amortization expense related to the net carrying amount of intangible assets at July 27, 2008 is estimated to be $18.7 million for the remainder of fiscal year 2009, $28.5 million in fiscal 2010, $23.7 million in fiscal 2011, $22.0 million in fiscal 2012, $17.4 million in fiscal 2013, $13.3 million in fiscal 2014 and $21.5 million in fiscal years subsequent of fiscal 2014.

 
 
 
15

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
Note 10 - Balance Sheet Components
 
Certain balance sheet components are as follows:
 
   
July 27,
2008
   
January 27,
2008
 
Inventories:  
 
(In thousands)
 
Raw materials
 
$
27,549
   
$
31,299
 
Work in-process
   
176,099
     
107,835
 
Finished goods
   
228,631
     
219,387
 
 Total inventories
 
$
432,279
   
$
358,521
 
 
At July 27, 2008, we had outstanding inventory purchase obligations totaling approximately $615.6 million.

   
July 27,
2008
   
January 27,
2008
   
Estimated
Useful Life
   
(In thousands)
   
(Years)
Property and Equipment:
               
Test equipment
 
$
225,546
   
$
186,774
   
3
Land
   
208,908
     
38,442
   
(A)
Software and licenses
   
190,145
     
246,725
   
3 - 5
Computer equipment
   
138,588
     
137,642
   
3
Leasehold improvements
   
118,335
     
103,353
   
(B )
Office furniture and equipment
   
31,675
     
28,220
   
5
Building
   
29,199
     
4,104
   
25
Construction in process
   
9,990
     
8,258
   
(C )
     
952,386
     
753,518
     
Accumulated depreciation and amortization
   
(352,908
)
   
(393,710
)
 
 
 Total property and equipment, net
 
$
599,478
   
$
359,808
     

During the six months ended July 27, 2008, we wrote-off  $113.1 million of fully depreciated property and equipment, including $68.8 million of software and licenses.

(A) Land is a non-depreciable asset.
(B) Leasehold improvements are amortized based on the lesser of either the asset’s estimated useful life or the remaining lease term.
(C) Construction in process represents assets that are not in service as of the balance sheet date.
 
   
July 27,
2008
   
January 27,
2008
 
Accrued Liabilities:
 
(In thousands)
 
Accrued customer programs (1)
 
$
297,545
   
$
271,869
 
Warranty accrual (2)
   
187,131
     
5,707
 
Accrued payroll and related expenses
   
91,276
     
122,284
 
Accrued costs related to purchase of property
   
37,948
     
-
 
Accrued legal settlement (3)
   
30,600
     
30,600
 
Deferred rent
   
12,273
     
11,982
 
Deferred revenue
   
10,823
     
5,856
 
Taxes payable
   
7,317
     
7,766
 
Other
   
21,211
     
18,998
 
 Total accrued liabilities
 
$
696,124
   
$
475,062
 

(1) Please refer to Note 1 of these Notes to Condensed Consolidated Financial Statements for discussion regarding the nature of accrued customer programs and their accounting treatment related to our revenue recognition policies and estimates.
(2) Please refer to Note 11 of these Notes to Condensed Consolidated Financial Statements for discussion regarding the warranty accrual.
(3) Please refer to Note 12 of these Notes to Condensed Consolidated Financial Statements for discussion regarding the 3dfx litigation.
 
 
 
 
16

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
 
   
July 27,
2008
   
January 27,
2008
 
Other Long-term Liabilities:  
 
(In thousands)
 
Deferred income tax liability
 
$
88,956
   
$
86,900
 
Income taxes payable, long term
   
47,886
     
44,235
 
Asset retirement obligation
   
6,597
     
6,470
 
Other long-term liabilities
   
18,679
     
24,993
 
 Total other long-term liabilities
 
$
162,118
   
$
162,598
 


Note 11 - Guarantees
 
FASB Interpretation No. 45, or FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a tabular reconciliation of the changes of the entity’s product warranty liabilities.

Product Defect

Our products are complex and may contain defects or experience failures due to any number of issues in design, fabrication, packaging, materials and/or use within a system. If any of our products or technologies contains a defect, compatibility issue or other error, we may have to invest additional research and development efforts to find and correct the issue.  Such efforts could divert our management’s and engineers’ attention from the development of new products and technologies and could increase our operating costs and reduce our gross margin. In addition, an error or defect in new products or releases or related software drivers after commencement of commercial shipments could result in failure to achieve market acceptance or loss of design wins. Also, we may be required to reimburse customers, including for customers’ costs to repair or replace the products in the field, which could cause our revenue to decline. A product recall or a significant number of product returns could be expensive, damage our reputation and could result in the shifting of business to our competitors. Costs associated with correcting defects, errors, bugs or other issues could be significant and could materially harm our financial results.

During our fiscal quarter ended July 27, 2008, we recorded a $196.0 million charge against cost of revenue to cover anticipated customer warranty, repair, return, replacement and other associated costs arising from a weak die/packaging material set in certain versions of our previous generation MCP and GPU products used in notebook systems. All of our newly manufactured products and all of our products that are currently shipping in volume have a different material set that we believe is more robust.

The previous generation MCP and GPU products that are impacted were included in a number of notebook products that were shipped and sold in significant quantities. Certain notebook configurations of these MCP and GPU products are failing in the field at higher than normal rates. While we have not been able to determine a root cause for these failures, testing suggests a weak material set of die/package combination, system thermal management designs, and customer use patterns are contributing factors. We have worked with our customers to develop and have made available for download a software driver to cause the system fan to begin operation at the powering up of the system and reduce the thermal stress on these chips. We have also recommended to our customers that they consider changing the thermal management of the MCP and GPU products in their notebook system designs. We intend to fully support our customers in their repair and replacement of these impacted MCP and GPU products that fail, and their other efforts to mitigate the consequences of these failures.

We continue to engage in discussions with our supply chain regarding reimbursement to us for some or all of the costs we have incurred and may incur in the future relating to the weak material set. We also continue to seek to access our insurance coverage. However, there can be no assurance that we will recover any such reimbursement. We continue to not see any abnormal failure rates in any systems using NVIDIA products other than certain notebook configurations. However, we are continuing to test and otherwise investigate other products. There can be no assurance that we will not discover defects in other MCP or GPU products.



 
 
 
17

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 

Accrual for estimated product returns and product warranty liabilities

We record a reduction to revenue for estimated product returns at the time revenue is recognized primarily based on historical return rates. Cost of revenue includes the estimated cost of product warranties that are calculated at the point of revenue recognition. Under limited circumstances, we may offer an extended limited warranty to customers for certain products. The estimated product returns and estimated product warranty liabilities for the three and six months ended July 27, 2008 and July 29, 2007 are as follows:

   
Three Months Ended
   
Six Months Ended
 
   
July 27,
2008
   
July 29,
2007
   
July 27,
2008
 
July 29,
2007
 
   
(In thousands)
 
Balance at beginning of period
 
$
25,100
   
$
19,063
   
$
24,432
   
$
17,958
 
Additions (1),(4)
   
203,743
     
8,468
     
213,293
     
13,448
 
Deductions (2),(5)
   
(23,752
)
   
(6,837
)
   
(32,634
)
   
(10,712
)
Balance at end of period (3)
 
$
205,091
   
$
20,694
   
$
205,091
   
$
20,694
 
 
(1) Includes $7,173 and $16,039 for the three and six months ended July 27, 2008, respectively and $8,281 and $13,027 for the three and six months ended July 29, 2007, respectively, towards allowances for sales returns estimated at the time revenue is recognized primarily based on historical return rates and is charged as a reduction to revenue.

(2) Includes $7,922 and $16,804 for the three and six months ended July 27, 2008, respectively and $6,837 and $10,712 for the three and six months ended July 29, 2007, respectively, written off against the allowance for sales returns.

(3) Includes $17,960 and $16,792 at July 27, 2008 and July 29, 2007, respectively, relating to allowance for sales returns.

(4) Includes $195,954 for the three and six months ended July 27, 2008 for incremental repair and replacement costs from a weak die/packaging material set.

(5) Includes $15,830 for the three and six months ended July 27, 2008 in deductions towards warranty accrual associated with incremental repair and replacement costs from a weak die/packaging material set.
         
In connection with certain agreements that we have executed in the past, we have at times provided indemnities to cover the indemnified party for matters such as tax, product and employee liabilities. We have also on occasion included intellectual property indemnification provisions in our technology related agreements with third parties. Maximum potential future payments cannot be estimated because many of these agreements do not have a maximum stated liability. As such, we have not recorded any liability in our Condensed Consolidated Financial Statements for such indemnifications.
 


 
 
 
18

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 


Note 12 - Commitments and Contingencies

       3dfx
 
  On December 15, 2000, NVIDIA Corporation and one of our indirect subsidiaries entered into an Asset Purchase Agreement, or APA, to purchase certain graphics chip assets from 3dfx which closed on April 18, 2001.

  In May 2002, we were served with a California state court complaint filed by the landlord of 3dfx’s San Jose, California commercial real estate lease, Carlyle Fortran Trust, or Carlyle. In December 2002, we were served with a California state court complaint filed by the landlord of 3dfx’s Austin, Texas commercial real estate lease, CarrAmerica Realty Corporation. The landlords’ complaints both asserted claims for, among other things, interference with contract, successor liability and fraudulent transfer. The landlords’ sought to recover money damages, including amounts owed on their leases with 3dfx in the aggregate amount of approximately $15 million. In October 2002, 3dfx filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the Northern District of California. In January 2003, the landlords’ actions were removed to the United States Bankruptcy Court for the Northern District of California and consolidated, for purposes of discovery, with a complaint filed against NVIDIA by the Trustee in the 3dfx bankruptcy case. Upon motion by NVIDIA in 2005, the District Court withdrew the reference to the Bankruptcy Court for the landlords’ actions, which were removed to the United States District Court for the Northern District of California. The Trustee’s lawsuit remained in the Bankruptcy Court.  On November 10, 2005, the District Court granted our motion to dismiss the landlords’ respective amended complaints and allowed the landlords until February 4, 2006 to amend their complaints. The landlords re-filed claims against NVIDIA in early February 2006, and NVIDIA again filed motions requesting the District Court to dismiss those claims. On September 29, 2006, the District Court dismissed the CarrAmerica action in its entirety and without leave to amend. The District Court found, among other things, that CarrAmerica lacked standing to bring the lawsuit and that standing rests exclusively with the bankruptcy Trustee. On October 27, 2006, CarrAmerica filed a notice of appeal from that order. On December 15, 2006, the District Court also dismissed the Carlyle action in its entirety, finding that Carlyle also lacked standing to pursue its claims, and that certain claims were substantively unmeritorious.  Carlyle filed a notice of appeal from that order on January 9, 2007.  Both landlords’ appeals are pending before the United States Court of Appeals for the Ninth Circuit, and briefing on both appeals has been consolidated. NVIDIA has filed motions to recover its litigation costs and attorneys fees against both Carlyle and CarrAmerica. The District Court has postponed consideration of those motions until after the appeals are resolved.  On July 17, 2008, the Ninth Circuit held oral argument on the landlords' appeals, and the matter now awaits that court's decision.

  In March 2003, we were served with a complaint filed by the Trustee appointed by the Bankruptcy Court to represent 3dfx’s bankruptcy estate. The Trustee’s complaint asserts claims for, among other things, successor liability and fraudulent transfer and seeks additional payments from us. On October 13, 2005, the Bankruptcy Court held a hearing on the Trustee’s motion for summary adjudication. On December 23, 2005, the Bankruptcy Court denied the Trustee’s Motion for Summary Adjudication in all material respects and held that NVIDIA may not dispute that the value of the 3dfx transaction was less than $108.0 million. The Bankruptcy Court denied the Trustee’s request to find that the value of the 3dfx assets conveyed to NVIDIA was at least $108.0 million. In early November 2005, after several months of mediation, NVIDIA and the Official Committee of Unsecured Creditors, or the Creditors’ Committee, agreed to a Plan of Liquidation of 3dfx, which included a conditional settlement of the Trustee’s claims against us. This conditional settlement was subject to a confirmation process through a vote of creditors and the review and approval of the Bankruptcy Court after notice and hearing. The conditional settlement called for a payment by NVIDIA of approximately $30.6 million to the 3dfx estate. Under the settlement, $5.6 million related to various administrative expenses and Trustee fees, and $25.0 million related to the satisfaction of debts and liabilities owed to the general unsecured creditors of 3dfx. Accordingly, during the three month period ended October 30, 2005, we recorded $5.6 million as a charge to settlement costs and $25.0 million as additional purchase price for 3dfx.  The Trustee advised that he intended to object to the settlement. The conditional settlement never progressed substantially through the confirmation process.

  On December 21, 2005, the Bankruptcy Court determined that it would schedule trial of one portion of the Trustee’s case against NVIDIA. On January 2, 2007, NVIDIA exercised its right to terminate the settlement agreement on grounds that the Bankruptcy Court had failed to proceed toward confirmation of the Creditors’ Committee’s plan. A non-jury trial began on March 21, 2007 on valuation issues in the Trustee's constructive fraudulent transfer claims against NVIDIA. Specifically, the Bankruptcy Court tried four questions: (1) what did 3dfx transfer to NVIDIA in the APA?; (2) of what was transferred, what qualifies as "property" subject to the Bankruptcy Court's avoidance powers under the Uniform Fraudulent Transfer Act and relevant bankruptcy code provisions?; (3) what is the fair market value of the "property" identified in answer to question (2)?; and (4) was the $70 million that NVIDIA paid "reasonably equivalent" to the fair market value of that property? At the conclusion of the evidence, the Bankruptcy Court asked the parties to submit post-trial briefing. That briefing was completed on May 25, 2007.  On April 30, 2008, the Bankruptcy Court issued its Memorandum Decision After Trial, in which it provided a detailed summary of the trial proceedings and the parties' contentions with respect to each of the questions to be tried.  The Bankruptcy Court concluded that "the creditors of 3dfx were not injured by the Transaction."  This decision does not entirely dispose of the Trustee's action, however; still pending are the Trustee's claims for successor liability and intentional fraudulent conveyance.  On May 12, 2008, the Trustee filed a motion for leave to pursue an interlocutory appeal, but thereafter withdrew the motion.  NVIDIA has filed a motion for summary judgment on all causes of action in order to convert the Memorandum Decision After Trial to a final judgment.  That motion is scheduled to be heard on August 28, 2008.
 
 
 
 
19

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
  
        On December 8, 2005, the Trustee filed a Form 8-K on behalf of 3dfx, in which the Trustee disclosed the terms of the conditional settlement agreement between NVIDIA and the Creditor’s Committee. Thereafter, certain shareholders of 3dfx filed a petition with the Bankruptcy Court to appoint an official committee to represent the claimed interests of 3dfx shareholders. That petition was granted and an Equity Holders’ Committee was appointed. Since that appointment, the Equity Holders’ Committee has filed a competing plan of reorganization/liquidation. The Equity Holders’ Committee’s plan assumes that 3dfx can raise additional equity capital that would be used to retire all of 3dfx’s debts. The Equity Holders’ Committee contends that the commitment by an investor to pay in equity capital is sufficient to trigger NVIDIA's obligations under the APA to pay the stock consideration.  NVIDIA contends, among other things, that such a commitment is not sufficient and that its obligation to pay the stock consideration has been extinguished. By virtue of stock splits since the execution of the APA, the stock consideration would now total six million shares of NVIDIA common stock. The Equity Holders’ Committee filed a motion with the Bankruptcy Court seeking an order giving it standing to bring a lawsuit to obtain the stock consideration. Over our objection, the Bankruptcy Court granted that motion on May 1, 2006 and the Equity Holders’ Committee filed its Complaint for Declaratory Relief against NVIDIA that same day. NVIDIA moved to dismiss the Complaint for Declaratory Relief, and the Bankruptcy Court granted that motion with leave to amend. The Equity Committee thereafter amended its complaint, and NVIDIA moved to dismiss that amended complaint as well. At a hearing on December 21, 2006, the Bankruptcy Court granted the motion as to one of the Equity Holders’ Committee’s claims, and denied it as to the others.

However, the Bankruptcy Court also ruled that NVIDIA would only be required to answer the first three causes of action by which the Equity Holders’ Committee seeks a determination that the APA was not terminated before 3dfx filed for bankruptcy protection, that the 3dfx bankruptcy estate still holds some rights in the APA, and that the APA is capable of being assumed by the bankruptcy estate.  Because of the trial of the Trustee's fraudulent transfer claims against NVIDIA, the Equity Committee's lawsuit did not progress substantially in 2007.  On July 31, 2008, the Equity Holders' Committee filed a motion for summary judgment on its first three causes of action.  A hearing is scheduled on that motion for October 24, 2008.  The next status conference is scheduled for August 28, 2008.  In addition, the Equity Holders ' Committee filed a motion seeking Bankruptcy Court approval of investor protections for Harbinger Capital Partners Master Fund I, Ltd., an equity investment firm that has conditionally agreed to pay no more than $51.5 million for preferred stock in 3dfx. The hearing on that motion was held on January 18, 2007, and the Bankruptcy Court approved the proposed protections.

Proceedings, SEC inquiry and lawsuits related to our historical stock option granting practices

In June 2006, the Audit Committee of the Board of NVIDIA, or the Audit Committee, began a review of our stock option practices based on the results of an internal review voluntarily undertaken by management. The Audit Committee, with the assistance of outside legal counsel, completed its review on November 13, 2006 when the Audit Committee reported its findings to our full Board. The review covered option grants to all employees, directors and consultants for all grant dates during the period from our initial public offering in January 1999 through June 2006. Based on the findings of the Audit Committee and our internal review, we identified a number of occasions on which we used an incorrect measurement date for financial accounting and reporting purposes.

We voluntarily contacted the SEC regarding the Audit Committee’s review.  In late August 2006, the SEC initiated an inquiry related to our historical stock option grant practices. In October 2006, we met with the SEC and provided it with a review of the status of the Audit Committee’s review. In November 2006, we voluntarily provided the SEC with additional documents. We continued to cooperate with the SEC throughout its inquiry.  On October 26, 2007, the SEC formally notified us that the SEC's investigation concerning our historical stock option granting practices had been terminated and that no enforcement action was recommended.

Concurrently with our internal review and the SEC’s inquiry, since September 29, 2006, ten derivative cases have been filed in state and federal courts asserting claims concerning errors related to our historical stock option granting practices and associated accounting for stock-based compensation expense. These complaints have been filed in various courts, including the California Superior Court, Santa Clara County, the United States District Court for the Northern District of California, and the Court of Chancery of the State of Delaware in and for New Castle County. The California Superior Court cases have been consolidated and plaintiffs filed a consolidated complaint on April 23, 2007. Plaintiffs in the Delaware action filed an Amended Shareholder Derivative Complaint on February 12, 2008. Plaintiffs in the federal action submitted a Second Amended Consolidated Verified Shareholders Derivative Complaint on March 18, 2008. All of the cases purport to be brought derivatively on behalf of NVIDIA against members of our Board and several of our current and former officers and directors. Plaintiffs in these actions allege claims for, among other things, breach of fiduciary duty, unjust enrichment, insider selling, abuse of control, gross mismanagement, waste, and constructive fraud. The Northern District of California action also alleges violations of federal provisions, including Sections 10(b) and 14(a) of the Securities Exchange Act of 1934. The plaintiffs seek to recover for NVIDIA, among other things, damages in an unspecified amount, rescission, punitive damages, treble damages for insider selling, and fees and costs. Plaintiffs also seek an accounting, a constructive trust and other equitable relief. We intend to take all appropriate action in response to these complaints. Between May 14, 2007 and May 17, 2007, we filed several motions to dismiss or to stay the federal, Delaware and Santa Clara actions. The Delaware motions were superseded when the Delaware plaintiffs filed the Amended Shareholder Derivative Complaint on February 28, 2008. The federal motions were superseded when the federal plaintiffs submitted the Second Amended Consolidated Verified Shareholders Derivative Complaint on March 18, 2008. We have not yet responded to either of these Complaints.  The Santa Clara motion to stay was denied without prejudice and the parties are currently engaged in discovery-related proceedings.

On August 5, 2007, our Board authorized the formation of a Special Litigation Committee to investigate, evaluate, and make a determination as to how NVIDIA should proceed with respect to the claims and allegations asserted in the underlying derivative cases brought on behalf of NVIDIA. The Special Litigation Committee has made substantial progress in completing its work, but has not yet issued a report.
 
 
 
20

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 

 
Department of Justice Subpoena and Investigation, and Civil Cases

On November 29, 2006, we received a subpoena from the San Francisco Office of the Antitrust Division of the United States Department of Justice, or DOJ, in connection with the DOJ's investigation into potential antitrust violations related to GPUs and cards. No specific allegations have been made against us. We are cooperating with the DOJ in its investigation.

As of May 13, 2008, 55 civil complaints have been filed against us. The majority of the complaints were filed in the Northern District of California, several were filed in the Central District of California, and other cases were filed in several other Federal district courts.  On April 18, 2007, the Judicial Panel on Multidistrict Litigation transferred the actions currently pending outside of the Northern District of California to the Northern District of California for coordination of pretrial proceedings before the Honorable William H. Alsup.  By agreement of the parties, Judge Alsup will retain jurisdiction over the consolidated cases through trial or other resolution.

In the consolidated proceedings, two groups of plaintiffs (one putatively representing all direct purchasers of GPUs and the other putatively representing all indirect purchasers) filed consolidated, amended class-action complaints. These complaints purport to assert federal antitrust claims based on alleged price fixing, market allocation, and other alleged anti-competitive agreements between us and ATI Technologies, ULC., or ATI, and Advanced Micro Devices, Inc., or AMD, as a result of its acquisition of ATI.  The indirect purchasers’ consolidated amended complaint also asserts a variety of state law antitrust, unfair competition and consumer protection claims on the same allegations, as well as a common law claim for unjust enrichment.

Plaintiffs filed their first consolidated complaints on June 14, 2007.  On July 16, 2007, we moved to dismiss those complaints.  The motions to dismiss were heard by Judge Alsup on September 20, 2007.  The Court subsequently granted and denied the motions in part, and gave the plaintiffs leave to move to amend the complaints.  On November 7, 2007, the Court granted plaintiffs’ motion to file amended complaints, ordered defendants to answer the complaints, lifted a previously entered stay on discovery, and set a trial date for January 12, 2009.  Discovery is underway and Plaintiffs filed motions for class certification on April 24, 2008.  We filed oppositions to the motions on May 20, 2008.  On July 18, 2008, the Court ruled on Plaintiffs’ class certification motions.  The Court denied class certification for the proposed class of indirect purchasers.  The Court granted in part class certification for the direct purchasers but limited the direct purchaser class to individual purchasers that acquired graphics processing cards products directly from NVIDIA or ATI from their websites between December 4, 2002 and November 7, 2007.  The Court excluded from the direct purchaser class business entities that purchased graphics products from NVIDIA or ATI for resale.  The case will continue on behalf of the class of direct purchasers certified by the Court as well as for the several individual indirect purchasers suing on their own behalf.  The Court also instructed the parties to give written notice of the class certification order to all non-certified direct purchasers, who will then have thirty days from the notice to move to intervene in this action.  The Court's ruling on class certification is subject to interim appeal at the discretion of the United States Court of Appeals for the Ninth Circuit.  We believe the allegations in the complaints are without merit and intend to vigorously defend the cases.
 
Rambus Corporation

On July 10, 2008, Rambus Corporation, or Rambus, filed suit against NVIDIA Corporation, asserting patent infringement of 17 patents claimed to be owned by Rambus.  Rambus seeks damages, enhanced damages and injunctive relief.  The lawsuit was filed in the Northern District of California in San Jose, California.  On July 11, 2008, NVIDIA filed suit against Rambus in the Middle District of North Carolina asserting numerous claims, including antitrust and other claims.  NVIDIA seeks damages, enhanced damages and injunctive relief.  NVIDIA intends to pursue its offensive and defensive cases vigorously.


 
 
 
21

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 

Note 13 - Stockholders’ Equity
 
Stock Repurchase Program

During fiscal year 2005, we announced that our Board had authorized a stock repurchase program to repurchase shares of our common stock, subject to certain specifications, up to an aggregate maximum amount of $300 million.  During fiscal year 2007, the Board further approved an increase of $400 million to the original stock repurchase program. In fiscal year 2008, we announced a stock repurchase program under which we may purchase up to an additional $1.0 billion of our common stock over a three year period through May 2010. On August 12, 2008, we announced that our Board further authorized an additional increase of $1.0 billion to the stock repurchase program. As a result of these increases, we have an ongoing authorization from the Board, subject to certain specifications, to repurchase shares of our common stock up to an aggregate maximum amount of $2.7 billion through May 2010. 
 
The repurchases will be made from time to time in the open market, in privately negotiated transactions, or in structured stock repurchase programs, and may be made in one or more larger repurchases, in compliance with the Securities Exchange Act of 1934, or the Exchange Act, Rule 10b-18, subject to market conditions, applicable legal requirements, and other factors. The program does not obligate us to acquire any particular amount of common stock and the program may be suspended at any time at our discretion. As part of our share repurchase program, we have entered into, and we may continue to enter into, structured share repurchase transactions with financial institutions. These agreements generally require that we make an up-front payment in exchange for the right to receive a fixed number of shares of our common stock upon execution of the agreement, and a potential incremental number of shares of our common stock, within a pre-determined range, at the end of the term of the agreement.

Through July 27, 2008, we had repurchased 68.0 million shares under our stock repurchase program for a total cost of $1.16 billion. During the three months ended July 27, 2008, we did not enter into any structured share repurchase transactions.

        Convertible Preferred Stock
 
As of July 27, 2008 and January 27, 2008, there were no shares of preferred stock outstanding.

Common Stock
 
At the Annual Meeting of Stockholders held on June 19, 2008, the stockholders approved an increase in our authorized number of shares of common stock to 2,000,000,000. The par value of common stock remains unchanged at $0.001 per share.


 
 
 
22

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 

Note 14 - Comprehensive Income (Loss)

Comprehensive income (loss) consists of net income (loss) and other comprehensive income or loss. Other comprehensive income or loss components include unrealized gains or losses on available-for-sale securities, net of tax. The components of comprehensive income (loss), net of tax, were as follows:
  
   
Three Months Ended
   
Six Months Ended
 
   
July 27,
2008
   
July 29,
2007
   
July 27,
2008
 
July 29,
2007
 
   
(In thousands)
 
Net income (loss)
 
$
(120,929
)
 
$
172,732
   
$
55,876
   
$
304,991
 
Net change in unrealized gains (losses) on available-for-sale securities, net of tax
   
(2,545
)
   
320
     
(8,176
)
   
241
 
Reclassification adjustments for net realized gains (losses) on available-for-sale securities included in net income (loss), net of tax
   
30
     
(18
)
   
(824
)
   
(90
)
Total comprehensive income (loss)
 
$
(123,444
)
 
$
173,034
   
$
46,876
   
$
305,142
 

Note 15 - Segment Information

Our Chief Executive Officer, who is considered to be our chief operating decision maker, or CODM, reviews financial information presented on an operating segment basis for purposes of making operating decisions and assessing financial performance.

We report financial information for four operating segments to our CODM: the GPU business, which is comprised primarily of our GeForce products that support desktop and notebook PCs, plus memory products; the professional solutions business, or PSB, which is comprised of our NVIDIA Quadro professional workstation products and other professional graphics products, including our NVIDIA Tesla high-performance computing products; the MCP business which is comprised of NVIDIA nForce core logic and motherboard GPU products; and our consumer products business, or CPB, which is comprised of our GoForce and APX mobile brands and products that support handheld personal media players, or PMPs, personal digital assistants, or PDAs, cellular phones and other handheld devices.  CPB also includes license, royalty, other revenue and associated costs related to video game consoles and other digital consumer electronics devices.

       In addition to these operating segments, we have the “All Other” category that includes human resources, legal, finance, general administration and corporate marketing expenses, which total $80.8 million and $62.9 million for second quarter of fiscal years 2009 and 2008, respectively, and total $156.9 million and $130.8 million for the first half of fiscal years 2009 and 2008, respectively, that we do not allocate to our other operating segments as these expenses are not included in the segment operating performance measures evaluated by our CODM. “All Other” also includes the results of operations of other miscellaneous reporting segments that are neither individually reportable, nor aggregated with another operating segment. Revenue in the “All Other” category is primarily derived from sales of components.

Our CODM does not review any information regarding total assets on an operating segment basis. Operating segments do not record intersegment revenue, and, accordingly, there is none to be reported. The accounting policies for segment reporting are the same as for NVIDIA Corporation as a whole. 

 
 
 
23

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 

 
   
GPU
   
PSB
   
MCP
   
CPB
   
All Other
   
Consolidated
   
   
(In thousands)
 
Three Months Ended July 27, 2008:
                                   
Revenue
 
$
503,489
   
$
179,653
   
$
166,781
   
$
34,625
   
$
8,128
   
$
892,676
 
Depreciation and amortization expense
 
$
13,826
   
$
5,241
   
$
7,756
   
$
4,600
   
$
14,440
   
$
45,863
 
Operating income (loss)
 
$
(41,595
)
 
$
83,686
   
$
(107,072
)
 
$
(6,359
)
 
$
(84,052
)
 
$
(155,392
)
Three Months Ended July 29, 2007:
                                   
Revenue
 
$
579,034
   
$
127,321
   
$
161,058
   
$
62,182
   
$
5,658
   
$
935,253
 
Depreciation and amortization expense
 
$
8,932
   
$
1,960
   
$
6,844
   
$
5,004
   
$
9,710
   
$
32,450
 
Operating income (loss)
 
$
167,828
   
$
66,363
   
$
12,401
   
$
2,767
   
$
(64,599
)
 
$
184,760
 
Six Months Ended July 27, 2008:
                                               
Revenue
 
$
1,204,978
   
$
383,080
   
$
361,874
   
$
77,090
   
$
19,042
   
$
2,046,064
 
Depreciation and amortization expense
 
$
26,540
   
$
9,866
   
$
15,426
   
$
9,518
   
$
26,081
   
$
87,431
 
Operating income (loss)
 
$
127,452
   
$
194,014
   
$
(103,492
)
 
$
(10,209
)
 
$
(160,178
)
 
$
47,587
 
Six Months Ended July 29, 2007:
                                               
Revenue
 
$
1,062,529
   
$
268,194
   
$
309,808
   
$
129,408
   
$
9,594
   
$
1,779,533
 
Depreciation and amortization expense
 
$
17,217
   
$
4,147
   
$
13,437
   
$
11,099
   
$
18,872
   
$
64,772
 
Operating income (loss)
 
$
292,245
   
$
135,670
   
$
20,240
   
$
12,935
   
$
(135,084
)
 
$
326,006
 

Revenue by geographic region is allocated to individual countries based on the location to which the products are initially billed even if our customers’ revenue is attributable to end customers that are located in a different location. The following tables summarize information pertaining to our revenue from customers based on invoicing address in different geographic regions:

   
Three Months Ended
   
Six Months Ended
 
   
July 27,
2008
   
July 29,
2007
   
July 27,
2008
   
July 29,
2007
 
   
(In thousands)
 
Revenue:
                       
Taiwan
 
$
272,078
   
$
316,974
   
$
663,706
   
$
589,957
 
China
   
269,266
     
297,458
     
636,692
     
535,743
 
Other Asia Pacific
   
171,000
     
138,830
     
338,854
     
248,616
 
Europe
   
81,519
     
89,318
     
213,473
     
170,868
 
United States
   
77,464
     
72,524
     
171,295
     
174,390
 
Other Americas
   
21,349
     
20,149
     
22,044
     
59,959
 
Total revenue
 
$
892,676
   
$
935,253
   
$
2,046,064
   
$
1,779,533
 

Revenue from significant customers, those representing approximately 10% or more of total revenue for the respective periods, is summarized as follows:

   
Three Months Ended
   
Six Months Ended
 
   
July 27,
2008
   
July 29,
2007
   
July 27,
2008
   
July 29,
2007
 
Revenue:
                       
Customer A
   
13
%
   
5
%
   
11
%
   
5
%
Customer B
   
9
%
   
12
%
   
10
%
   
11
%


 
 
 
24

 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 

Accounts receivable from significant customers, those representing approximately 10% or more of total trade accounts receivable for the respective periods, is summarized as follows:
 
   
July 27,
2008
   
January 27,
2008
 
Accounts Receivable:
             
Customer A
   
11
%
 
12
%

Note 16 – Fair Value of Cash Equivalents and Marketable Securities

We measure our cash equivalents and marketable securities at fair value. Our financial assets and liabilities are determined using market prices from both active markets, or Level 1, and less active markets, or Level 2. Level 1 valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 valuations are obtained from readily-available pricing sources for identical instruments in less active markets. All of our cash equivalents and marketable securities valuations are classified as Level 1 or Level 2 because we value those using quoted market prices or alternative pricing sources and models utilizing market observable inputs.

As of July 27, 2008, we did not have any assets or liabilities without observable market values, or Level 3 assets, that would require a high level of judgment to determine fair value.

Financial assets and liabilities measured at fair value are summarized below:

         
Fair value measurement at reporting date using
 
         
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
 
   
July 27, 2008
   
(Level 1)
   
(Level 2)
 
   
(In thousands)
 
Asset-backed Securities (1)
 
$
68,811
   
$
-
   
$
68,811
 
Commercial paper (2)
   
397,504
     
-
     
397,504
 
Corporate debt securities (3)
   
280,061
     
-
     
280,061
 
Debt securities issued by United States Treasury (1)
   
55,977
     
-
     
55,977
 
Other Debt securities issued by U.S. Government agencies (4)
   
434,899
     
-
     
434,899
 
Mortgage-backed securities issued by Government-sponsored entities (1)
   
124,120
     
-
     
124,120
 
Money market funds (5)
   
125,991
     
125,991
     
-
 
Equity securities (1)
   
1,358
     
-
     
1,358
 
Total assets
 
$
1,488,721
   
$
125,991
   
$
1,362,730
 


(1)             Included in Marketable securities on the Condensed Consolidated Balance Sheet.
(2)             Includes $377,412 in Cash and cash equivalents and $20,092 in Marketable securities on the Condensed Consolidated Balance Sheet.
(3)             Includes $4,318 in Cash and cash equivalents and $275,743 in Marketable securities on the Condensed Consolidated Balance Sheet.
(4)             Includes $42,915 in Cash and cash equivalents and $391,984 in Marketable securities on the Condensed Consolidated Balance Sheet.
(5)             Included in Cash and cash equivalents on the Condensed Consolidated Balance Sheet.


 
 
 
25

 
 
 

ITEM 2 . MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements:

   When used in this Quarterly Report on Form 10-Q, the words “believes,” “plans,” “estimates,” “anticipates,” “expects,” “intends,” “allows,” “can,” “will” and similar expressions are intended to identify forward-looking statements. These statements relate to future periods and include, but are not limited to, statements as to: the features, benefits, capabilities, performance, impact and production of our products and technologies; product, manufacturing, design or software defects and the impact of such defects; defects in materials used to manufacture a product; causes of product defects; our reliance on third parties to manufacture, assemble and test our products; reliance on a limited number of customers and suppliers; new products or markets; design wins; our market position; our competition, sources of competition and our competitive position; our strategic relationships; average selling prices; seasonality; customer demand; growth; our international operations; our ability to attract and retain qualified personnel; our inventory; acquisitions and investments; stock options; the impact of stock-based compensation expense; our financial results; our tax positions; mix and sources of revenue; capital and operating expenditures; our cash;  liquidity; our investment portfolio and marketable securities; our exchange rate risk; our stock repurchase program; our internal control over financial reporting; our disclosure controls and procedures; recent accounting pronouncements; our intellectual property; compliance with environmental laws and regulations; ongoing and potential litigation; and the Department of Justice subpoena and investigation.  Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected.  These risks and uncertainties include, but are not limited to, the risks discussed below as well as difficulties associated with: fluctuations in general economic conditions in the United States and worldwide; difficulties in entering new markets; slower than expected development of a new market; conducting international operations; slower than anticipated growth; forecasting customer demand; product, manufacturing, software and design defects; defects in product design or materials used to manufacture a product; supply constraints; the impact of competitive pricing pressures; unanticipated decreases in average selling prices; increased sales of lower margin products; international and political conditions; changes in international laws; fluctuations in the global credit market; fixed operating expenses; our inventory levels; fluctuations in investments and the securities market; changes in customers’ purchasing behaviors; the concentration of sales of our products to a limited number of customers; decreases in demand for our products; delays in the development of new products by us or our partners; delays in volume production of our products; developments in and expenses related to litigation or regulatory actions; our inability to realize the benefits of acquisitions; and the matters set forth under Part II, Item 1A. - Risk Factors. These forward-looking statements speak only as of the date hereof. Except as required by law, we expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
 
          All references to “NVIDIA,” “we,” “us,” “our” or the “Company” mean NVIDIA Corporation and its subsidiaries, except where it is made clear that the term means only the parent company.
 
NVIDIA, GeForce, SLI, Hybrid SLI, GoForce, Quadro, NVIDIA Quadro, NVIDIA nForce, Tesla, Tegra, CUDA, NVIDIA APX, PhysX, Ageia, Mental Images, and the NVIDIA logo are our trademarks and/or registered trademarks in the United States and other countries that are used in this document. We may also refer to trademarks of other corporations and organizations in this document.
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Item 6. Selected Financial Data” of our Annual Report on Form 10-K for the fiscal year ended January 27, 2008 and Part II, “Item 1A. Risk Factors”, of our Condensed Consolidated Financial Statements and related Notes thereto, as well as other cautionary statements and risks described elsewhere in this Quarterly Report on Form 10-Q, before deciding to purchase, hold or sell shares of our common stock.

Overview

Our Company
 
NVIDIA Corporation is the worldwide leader in visual computing technologies and the inventor of the graphic processing unit, or the GPU. Our products are designed to generate realistic, interactive graphics on consumer and professional computing devices. We serve the entertainment and consumer market with our GeForce products, the professional design and visualization market with our Quadro products, and the high-performance computing market with our Tesla products. We have four major product-line operating segments: the GPU Business, the professional solutions business, or PSB, the media and communications processor, or MCP, business, and the consumer products business, or CPB. 

Our GPU business is comprised primarily of our GeForce products that support desktop and notebook personal computers, or PCs, plus memory products. Our PSB is comprised of our NVIDIA Quadro professional workstation products and other professional graphics products, including our NVIDIA Tesla high-performance computing products. Our MCP business is comprised of NVIDIA nForce core logic and motherboard GPU, or mGPU products. Our CPB is comprised of our GoForce and APX mobile brands and products that support handheld personal media players, or PMPs, personal digital assistants, or PDAs, cellular phones and other handheld devices. CPB also includes license, royalty, other revenue and associated costs related to video game consoles and other digital consumer electronics devices.  Original equipment manufacturers, original design manufacturers, add-in-card manufacturers, system builders and consumer electronics companies worldwide utilize our processors as a core component of their entertainment, business and professional solutions.

We were incorporated in California in April 1993 and reincorporated in Delaware in April 1998. Our headquarter facilities are in Santa Clara, California. Our Internet address is www.nvidia.com . The contents of our website are not a part of this Form 10-Q.
26

 
Recent Developments, Future Objectives and Challenges

GPU Business

During the first half of fiscal year 2009, we launched several new GPUs in the GeForce family. The product launches included the GeForce 9600 GT, which provides more than double the performance of our previous GeForce 8600 GTS; the GeForce 9800 GX2, which provides a new dual GPU board featuring Quad SLI technology; and the GeForce 9800 GTX, which is a flexible GPU that supports both two-way and three-way Scalable Link Interface, or SLI, technology.  Additionally, we also launched the GeForce 8800 GT, which is the first after-market consumer graphics card for the Mac Pro and is sold directly by us.

On February 10, 2008, we completed our acquisition of Ageia Technologies, Inc., or Ageia, an industry leader in gaming physics technology. Ageia's PhysX software is widely adopted in several PhysX-based games that are shipping or in development on Sony Playstation 3, Microsoft Xbox 360, Nintendo Wii, and gaming PCs. We believe that the combination of the GPU and physics engine brands will result in an enhanced visual experience for the gaming world.

During the second quarter of fiscal year 2009, we launched the GeForce GTX 280 and 260 GPUs.  These products represent the second-generation of our unified architecture. Based on a comparison between the GeForce GTX 280 and the GeForce 8800 Ultra in a variety of benchmarks and resolutions, the GeForce GTX 280 and 260 GPUs deliver 50 percent more gaming performance over our previous GeForce 8800 Ultra GPU. We also launched the GeForce 9800 GTX+, GeForce 9800 GT, and GeForce 9500 GT GPUs that provide support for our PhysX physics engine and CUDA parallel processing across a wide range of price segments.

Professional Solutions Business
 
During the first half of fiscal year 2009, we launched the Quadro FX 3600M Professional, which is among the highest performing notebook GPUs.

In the second quarter of fiscal year 2009, we launched the Tesla C1060 computing processor and the S1070 computing system, which is among the first teraflop processors and has a 1U system with up to four teraflops of performance.

MCP Business
 
During the first half of fiscal year 2009, we shipped Hybrid SLI DX10 mGPUs – the GeForce 8000 GPU series.  The GeForce 8000 GPU series includes GeForce Boost Hybrid SLI technology, which is designed to double performance when paired with a GeForce 8 series desktop GPU.  Additionally, we also launched the NVIDIA nForce 790i Ultra SLI MCP, which is one of the industry’s highly rated overclockable platform for Intel processors.

During the second quarter of fiscal year 2009, we launched the GeForce 9M series of notebook GPUs that enables improved performance in notebooks with Hybrid SLI technology and PhysX technology. We also launched SLI for Intel Broomfield CPU platforms.  When paired with the nForce 200 SLI MCP, Intel’s Bloomfield CPU and Tylersburg core logic chipset will deliver NVIDIA three-way SLI technology with up to a 2.8 times performance boost over traditional single graphics card platforms.

Consumer Products Business

During the first half of fiscal year 2009, we launched the NVIDIA APX 2500 application processor.  The APX 2500 is a computer-on-a-chip designed to meet the growing multimedia demands of today's mobile phone and entertainment user.  We believe that the mobile application processor is an area where we can add a significant amount of value and we also believe it represents a revenue growth opportunity.

During the second quarter of fiscal year 2009, we launched the Tegra 600 and 650 that represent a single-chip heterogeneous computer architecture designed for low-power mobile computing devices.
 
27

 
Product Defect

Our products are complex and may contain defects or experience failures due to any number of issues in design, fabrication, packaging, materials and/or use within a system. If any of our products or technologies contains a defect, compatibility issue or other error, we may have to invest additional research and development efforts to find and correct the issue.  Such efforts could divert our management’s and engineers’ attention from the development of new products and technologies and could increase our operating costs and reduce our gross margin. In addition, an error or defect in new products or releases or related software drivers after commencement of commercial shipments could result in failure to achieve market acceptance or loss of design wins. Also, we may be required to reimburse customers, including for customers’ costs to repair or replace the products in the field, which could cause our revenue to decline. A product recall or a significant number of product returns could be expensive, damage our reputation and could result in the shifting of business to our competitors. Costs associated with correcting defects, errors, bugs or other issues could be significant and could materially harm our financial results.

During our fiscal quarter ended July 27, 2008, we recorded a $196.0 million charge against cost of revenue to cover anticipated customer warranty, repair, return, replacement and other associated costs arising from a weak die/packaging material set in certain versions of our previous generation MCP and GPU products used in notebook systems. All of our newly manufactured products and all of our products that are currently shipping in volume have a different material set that we believe is more robust.

The previous generation MCP and GPU products that are impacted were included in a number of notebook products that were shipped and sold in significant quantities. Certain notebook configurations of these MCP and GPU products are failing in the field at higher than normal rates. While we have not been able to determine a root cause for these failures, testing suggests a weak material set of die/package combination, system thermal management designs, and customer use patterns are contributing factors. We have worked with our customers to develop and have made available for download a software driver to cause the system fan to begin operation at the powering up of the system and reduce the thermal stress on these chips. We have also recommended to our customers that they consider changing the thermal management of the MCP and GPU products in their notebook system designs. We intend to fully support our customers in their repair and replacement of these impacted MCP and GPU products that fail, and their other efforts to mitigate the consequences of these failures.

We continue to engage in discussions with our supply chain regarding reimbursement to us for some or all of the costs we have incurred and may incur in the future relating to the weak material set. We also continue to seek to access our insurance coverage. However, there can be no assurance that we will recover any such reimbursement. We continue to not see any abnormal failure rates in any systems using NVIDIA products other than certain notebook configurations. However, we are continuing to test and otherwise investigate other products. There can be no assurance that we will not discover defects in other MCP or GPU products.

Dependence on PC Market

We derive and expect to continue to derive the majority of our revenue from the sale or license of products for use in the desktop PC and notebook PC markets, including professional workstations. A reduction in sales of PCs, or a reduction in the growth rate of PC sales, may reduce demand for our products. These changes in demand could be large and sudden. During the second quarter of fiscal year 2009, sales of our desktop GPU products decreased by approximately 25% compared to the second quarter of fiscal year 2008.  These decreases were primarily due to the Standalone Desktop GPU market segment decline as reported in the latest PC Graphics 2008 Report from Mercury Research.   Since PC manufacturers often build inventories during periods of anticipated growth, they may be left with excess inventories if growth slows or if they incorrectly forecast product transitions. In these cases, PC manufacturers may abruptly suspend substantially all purchases of additional inventory from suppliers like us until their excess inventory has been absorbed, which would have a negative impact on our financial results.

Seasonality

Our industry is largely focused on the consumer products market.  Due to seasonality in this market, we typically expect to see stronger revenue performance in the second half of the calendar year related to back-to-school and holiday seasons.


28

 
Financial Information by Business Segment and Geographic Data

Our Chief Executive Officer, who is considered to be our chief operating decision maker, or CODM, reviews financial information presented on an operating segment basis for purposes of making operating decisions and assessing financial performance.

We report financial information for four operating segments to our CODM: the GPU business, which is comprised primarily of our GeForce products that support desktop and notebook personal computers, or PCs, plus memory products; the PSB, which is comprised of our NVIDIA Quadro professional workstation products and other professional graphics products, including our NVIDIA Tesla high-performance computing products; the MCP business which is comprised of NVIDIA nForce core logic and mGPU products; and our CPB, which is comprised of our GoForce and APX mobile brands and products that support handheld PMPs, PDAs, cellular phones and other handheld devices.  CPB also includes license, royalty, other revenue and associated costs related to video game consoles and other digital consumer electronics devices.

       In addition to these operating segments, we have the “All Other” category that includes human resources, legal, finance, general administration and corporate marketing expenses, which total $80.8 million and $62.9 million for second quarter of fiscal years 2009 and 2008, respectively, and total $156.9 million and $130.8 million for the first half of fiscal years 2009 and 2008, respectively, that we do not allocate to our other operating segments as these expenses are not included in the segment operating performance measures evaluated by our CODM. “All Other” also includes the results of operations of other miscellaneous reporting segments that are neither individually reportable, nor aggregated with another operating segment. Revenue in the “All Other” category is primarily derived from sales of components. 
 
Results of Operations

The following table sets forth, for the periods indicated, certain items in our consolidated statements of operations expressed as a percentage of revenue.
 
   
Three Months Ended
   
Six Months Ended
 
   
July 27,
2008
   
July 29,
2007
   
July 27,
2008
   
July 29,
2007
 
Revenue
   
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Cost of revenue
   
83.2
   
54.7
   
67.5
   
54.8
 
Gross profit
   
16.8
   
45.3
   
32.5
   
45.2
 
Operating expenses:
                         
Research and development
   
23.9
   
16.9
   
21.1
   
17.8
 
Sales, general and administrative
   
10.4
   
8.7
   
9.1
   
9.1
 
Total operating expenses
   
34.3
   
25.6
   
30.2
   
26.9
 
Operating income (loss)
   
(17.5
)
 
19.7
   
2.3
   
18.3
 
Interest and other income, net
 
  
1.0
   
1.7
   
0.9
   
1.6
 
Income (loss) before income tax expense (benefit)
   
(16.5
)
 
21.4