q112form10q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
FORM 10-Q
[x]
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended May 1, 2011
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OR
[_]
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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Commission file number: 0-23985
NVIDIA CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
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94-3177549
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(State or Other Jurisdiction of
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(I.R.S. Employer
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Incorporation or Organization)
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Identification No.)
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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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
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
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Accelerated filer o
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Non-accelerated filer o (Do not check if a smaller reporting company)
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Smaller reporting company o
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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 common stock, $0.001 par value, outstanding as of May 23, 2011, was 600,288,389.
NVIDIA CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MAY 1, 2011
TABLE OF CONTENTS
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Page
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3
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24
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33
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34
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34
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49
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50
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51
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PART I. FINANCIAL INFORMATION
NVIDIA CORPORATION AND SUBSIDIARIES
(In thousands, except per share data)
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Sales, general and administrative
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Other income (expense), net
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Income before income tax expense
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Basic net income per share
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Shares used in basic per share computation
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Diluted net income per share
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Shares used in diluted per share computation
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See accompanying Notes to Condensed Consolidated Financial Statements.
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May 1,
2011
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January 30,
2011
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ASSETS
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Current assets:
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Cash and cash equivalents
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Prepaid expenses and other
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Property and equipment, net
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Deposits and other assets
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LIABILITIES AND STOCKHOLDERS’ EQUITY
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Accrued liabilities and other
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Total current liabilities
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Other long-term liabilities
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Capital lease obligations, long-term
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Commitments and contingencies - see Note 12
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Additional paid-in capital
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Accumulated other comprehensive income
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Total stockholders' equity
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Total liabilities and stockholders' equity
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See accompanying Notes to Condensed Consolidated Financial Statements.
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Three Months Ended
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May 1,
2011
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May 2,
2010
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Cash flows from operating activities:
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Adjustments to reconcile net income to net cash provided by operating activities:
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Depreciation and amortization
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Stock-based compensation expense
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Excess tax benefits from stock-based compensation
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Changes in operating assets and liabilities:
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Prepaid expenses and other current assets
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Deposits and other assets
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Accrued liabilities and other long-term liabilities
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Net cash provided by (used in) operating activities
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Cash flows from investing activities:
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Purchases of marketable securities
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Proceeds from sales and maturities of marketable securities
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Purchases of property and equipment and intangible assets
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Net cash used in investing activities
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Cash flows from financing activities:
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Proceeds from issuance of common stock under employee stock plans
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Payments under capital lease obligations
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Excess tax benefits from stock-based compensation
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Net cash provided by financing activities
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Change in cash and cash equivalents
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Cash and cash equivalents at beginning of period
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Cash and cash equivalents at end of period
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Supplemental disclosures of cash flow information:
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Cash paid for income taxes, net
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Cash paid for interest on capital lease obligations
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Other non-cash activities:
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Assets acquired by assuming related liabilities
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Change in unrealized gains from marketable securities
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See accompanying Notes to Condensed Consolidated Financial Statements.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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, or U.S. GAAP, 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 fiscal year ended January 30, 2011.
Fiscal Year
We operate on a 52 or 53-week year, ending on the last Sunday in January. Fiscal year 2012 and fiscal year 2011 are both 52-week years. The first quarter of fiscal years 2012 and 2011 are both 13-week quarters.
Principles of Consolidation
Our condensed 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.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP, 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, cash equivalents and marketable securities, accounts receivable, inventories, income taxes, goodwill, stock-based compensation, warranty liabilities, litigation, investigation and settlement costs and other contingencies. These estimates are based on historical facts and various other assumptions that we believe are reasonable.
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 or 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 or 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, as the level of returns cannot be reasonably estimated.
Our customer programs primarily involve rebates, which are designed to serve as sales incentives to resellers of our products in various target markets. We accrue for 100% of the potential rebates and do not apply a breakage factor. We recognize a liability for these rebates at the later of the date at which we record the related revenue or the date at which we offer the rebate. 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.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Our customer programs also include marketing development funds, or MDFs. We account for MDFs as either a reduction of revenue or an operating expense, depending on the nature of the program. MDFs represent monies paid to retailers, system builders, original equipment manufacturers, or OEMs, 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 NVIDIA 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 over the period that services are performed. For all license and service arrangements, 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.
Royalty revenue is recognized related to the distribution or sale of products that use our technologies under license agreements with third parties. We recognize royalty revenue upon receipt of a confirmation of earned royalties and when collectability is reasonably assured from the applicable licensee.
Inventories
Inventory cost is computed on an adjusted standard basis, which approximates actual cost on an average or first-in, first-out basis. Inventory costs consist primarily of the cost of semiconductors purchased from subcontractors, including wafer fabrication, assembly, testing and packaging, manufacturing support costs, including labor and overhead associated with such purchases, final test yield fallout, inventory provisions and shipping costs. We write down our inventory to the lower of cost or estimated market value. Obsolete or unmarketable inventory is completely written off based upon assumptions about future demand, future product purchase commitments, estimated manufacturing yield levels and market conditions. If actual market conditions are less favorable than those projected by management, or if our future product purchase commitments to our suppliers exceed our forecasted future demand for such products, additional future inventory write-downs may be required that could adversely affect our operating results. Inventory reserves once established are not reversed until the related inventory has been sold or scrapped. If actual market conditions are more favorable than expected and we sell products that we have previously written down, our reported gross margin would be favorably impacted.
Adoption of New and Recently Issued Accounting Pronouncements
During the three months ended May 1, 2011, there was no recent issuance of accounting pronouncements as compared to those described in our Annual Report on Form 10-K for the fiscal year ended January 30, 2011 that are of significance, or have potential material significance, to us.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Note 2 - Stock-Based Compensation
We measure stock-based compensation expense at the grant date of the related equity awards, based on the fair value of the awards, and recognize the expense using the straight-line attribution method over the requisite employee service period adjusted for estimated forfeitures. We estimate the fair value of employee stock options on the date of grant using a binomial model and we use the closing trading price of our common stock on the date of grant as the fair value of awards of restricted stock units, or RSUs. We calculate the fair value of our employee stock purchase plan using the Black-Scholes model.
Our consolidated statements of operations include stock-based compensation expense, net of amounts capitalized as inventory, as follows:
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Three Months Ended
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May 1,
2011
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May 2,
2010
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Sales, general and administrative
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During the three months ended May 1, 2011, we granted approximately 2.9 million stock options, with an estimated total grant-date fair value of $26.6 million and a per option weighted average grant-date fair value of $9.24. During the three months ended May 1, 2011, we granted approximately 3.3 million RSUs, with an estimated total grant-date fair value of $59.6 million and a per RSU weighted average grant-date fair value of $18.18.
During the three months ended May 2, 2010, we granted approximately 2.4 million stock options, with an estimated total grant-date fair value of $17.6 million and a per option weighted average grant-date fair value of $7.47. During the three months ended May 2, 2010, we granted approximately 2.7 million RSUs, with an estimated total grant-date fair value of $48.5 million and a per RSU weighted average grant-date fair value of $17.94.
Of the estimated total grant-date fair value, we estimated that the stock-based compensation expense related to the equity awards that are not expected to vest was $15.4 million and $12.2 million, for the three months ended May 1, 2011 and May 2, 2010 respectively. As of May 1, 2011 and May 2, 2010, the aggregate amount of unearned stock-based compensation expense related to our equity awards was $194.3 million and $159.2 million, respectively, adjusted for estimated forfeitures. As of May 1, 2011 and May 2, 2010, we expect to recognize the unearned stock-based compensation expense related to stock options over an estimated weighted average amortization period of 2.2 years and 1.8 years, respectively. As of May 1, 2011 and May 2, 2010, we expect to recognize the unearned stock-based compensation expense related to RSUs over an estimated weighted average amortization period of 2.7 years and 2.4 years, respectively.
Valuation Assumptions
We utilize a binomial model for calculating the estimated fair value of new stock-based compensation awards granted under our equity incentive plans. We have determined that the use of implied volatility is expected to be reflective of market conditions and, therefore, can be expected to be a reasonable indicator of our expected volatility. We also segregate options into groups of 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 reasonable estimate of the fair value of our employee stock options. For our employee stock purchase plan we continue to use the Black-Scholes model.
We estimate forfeitures at the time of grant and revise the estimates of forfeiture, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
The fair value of stock options granted under our equity incentive plans and shares issued under our employee stock purchase plan have been estimated at the date of grant with the following assumptions:
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Three Months Ended
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May 1,
2011
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May 2,
2010
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Stock Options
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(Using a binomial model)
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Three Months Ended
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May 1,
2011
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May 2,
2010
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Employee Stock Purchase Plan
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(Using a Black-Scholes model)
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Equity Award Activity
The following summarizes the stock option and RSU activity under our equity incentive plans:
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Options Outstanding
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Weighted Average Exercise Price
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Stock Options
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(In thousands)
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(Per share)
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Balances, January 30, 2011
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RSUs
Outstanding
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Weighted Average Grant-Date Fair Value
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Restricted Stock Units
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(In thousands)
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(Per share)
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Balances, January 30, 2011
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NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Note 3- Patent Cross License Agreement
On January 10, 2011, we entered into a six-year patent cross licensing agreement, or the License Agreement, with Intel Corporation. Under the License Agreement, Intel has granted to NVIDIA and its qualified subsidiaries, and NVIDIA has granted to Intel and Intel’s qualified subsidiaries, a non-exclusive, non-transferable, worldwide license, without the right to sublicense to all patents that are either owned or controlled by the parties at any time that have a first filing date on or before March 31, 2017, to make, have made (subject to certain limitations), use, sell, offer to sell, import and otherwise dispose of certain semiconductor- and electronic-related products anywhere in the world. NVIDIA’s rights to Intel’s patents have certain specified limitations, including but not limited to, NVIDIA was not granted a license to: (1) certain microprocessors, defined in the License Agreement as “Intel Processors” or “Intel Compatible Processors;” (2) certain chipsets that connect to Intel Processors; or (3) certain flash memory products. In connection with the License Agreement, NVIDIA and Intel mutually agreed to settle all outstanding legal disputes. Under the License Agreement, Intel will pay NVIDIA an aggregate amount of $1.5 billion, payable in annual installments, as follows: a $300 million payment on each of January 18, 2011, January 13, 2012 and January 15, 2013 and a $200 million payment on each of January 15, 2014, 2015 and 2016.
Accounting for the Agreement
The License Agreement between NVIDIA and Intel includes multiple elements. As a result, we determined each element of the License Agreement, their fair value and when they should be recognized. We allocated the total consideration, comprising of the cash payments from Intel and the estimated fair value of the license we received from Intel, to the legal settlement and the license to Intel based on the estimated relative fair value of these elements as follows:
The elements of the License Agreement are accounted for as follows:
1.
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Legal settlement: In connection with the License Agreement, both parties agreed to settle all outstanding legal disputes. The fair value allocated to the settlement of $57.0 million was recorded in the fourth quarter of fiscal year 2011, as a benefit to operating expense.
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2.
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License to Intel: We will recognize $1,583.0 million in total, or $66.0 million per quarter, as revenue over the term of the agreement of six years, the period over which Intel will have access to newly filed NVIDIA patents. Consideration received in advance of the performance period has been classified as deferred revenue. In the first quarter of fiscal year 2012, we recognized $22.0 million of revenue as our performance obligation under the agreement commencing on April 2011.
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3.
|
License from Intel: We recognized $140.0 million as an intangible asset upon execution of the agreement in the fourth quarter of fiscal year 2011. Amortization expense of $5.0 million per quarter will be charged to cost of sales over the seven year estimated useful life of the technology beginning in April 2011. In the first quarter of fiscal year 2012, we recognized amortization expense of $1.7 million.
|
Fair Value Determination
In determining the estimated fair value of the elements of the License Agreement, we assumed the highest and best use of each element from a market participant perspective. The inputs and assumptions used in our valuation included projected revenue, royalty rates, discount rates, useful lives and income tax rates, among others. The development of a number of these inputs and assumptions in the model required a significant amount of management judgment and is based upon a number of factors, including the selection of industry comparables, royalty rates, market growth rates and other relevant factors. Changes in any number of these assumptions may have had a substantial impact on the estimated fair value of each element. These inputs and assumptions represent management’s best estimate at the time of the transaction.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Note 4 – Net Income Per Share
The following is a reconciliation of the numerator and denominators of the basic and diluted net loss per share computations for the periods presented:
|
|
Three Months Ended
|
|
|
|
May 1, 2011
|
|
|
May 2, 2010
|
|
|
|
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
$ |
135,219 |
|
|
$ |
137,594 |
|
|
|
|
|
|
|
|
|
|
Denominator for basic net income per share, weighted average shares
|
|
|
594,802 |
|
|
|
567,183 |
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Equity awards outstanding
|
|
|
18,672 |
|
|
|
23,814 |
|
Denominator for diluted net income per share, weighted average shares
|
|
|
613,474 |
|
|
|
590,997 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per share
|
|
$ |
0.23 |
|
|
$ |
0.24 |
|
Diluted net income per share
|
|
$ |
0.22 |
|
|
$ |
0.23 |
|
Diluted net income per share for the three months ended May 1, 2011 does not include the effect of anti-dilutive common equivalent shares from 10.4 million stock options and RSUs Diluted net income per share for the three months ended May 2, 2010 does not include the effect of anti-dilutive common equivalent shares from 14.7 million stock options and RSUs.
Note 5 – Income Taxes
We recognized income tax expense of $21.3 million and $13.1 million for the three months ended May 1, 2011 and May 2, 2010, respectively. Income tax expense as a percentage of income before taxes, or our effective tax rate, was 13.6% and 8.7% for the three months ended May 1, 2011 and May 2, 2010, respectively. The difference in our effective tax rate of 13.6% and 8.7% was primarily related to discrete tax benefits attributable to the expiration of statues of limitations in certain non-U.S. jurisdictions not previously recognized that were greater in the first quarter of fiscal year 2011 over the first quarter of fiscal year 2012.
Our effective tax rate on income before tax for the first three months of fiscal year 2012 of 13.6% was lower than the United States federal statutory rate of 35% due primarily to income earned in jurisdictions where the tax rate is lower than the United States federal statutory tax. Further, our annual projected effective tax rate as of the first three months of fiscal year 2012 of 16.7% differs from our effective tax rate for the first three months fiscal year 2012 of 13.6% due to favorable discrete events that occurred in the first quarter of fiscal year 2012 primarily attributable to the expiration of statutes of limitations in certain non-U.S. jurisdictions for which we had not previously recognized related tax benefits.
Our effective tax rate on income before tax for the first three months of fiscal year 2011 of 8.7% was lower than the United States federal statutory tax rate of 35% primarily due to income earned in jurisdictions where the tax rate is lower than the United States federal statutory tax rate and favorable discrete events that occurred in the first three months of fiscal year 2011 primarily attributable to the expiration of statutes of limitations in certain non-U.S. jurisdictions for which we had not previously recognized related tax benefits.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Note 6 - Marketable Securities
All of our cash equivalents and marketable securities are classified as “available-for-sale” securities. These securities are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income, a component of stockholders’ equity, net of tax.
We performed an impairment review of our investment portfolio as of May 1, 2011. Based on our quarterly impairment review and having considered the guidance in the relevant accounting literature, we did not record any other than temporary impairment charges during the first three months of fiscal year 2012. We concluded that our investments were appropriately valued and that no additional other than temporary impairment charges were necessary on our portfolio of available for sale investments as of May 1, 2011. The following is a summary of cash equivalents and marketable securities at May 1, 2011 and January 30, 2011:
|
|
May 1, 2011
|
|
|
|
Amortized
Cost
|
|
|
Unrealized
Gain
|
|
|
Unrealized
Loss
|
|
|
Estimated
Fair Value
|
|
|
|
|
|
Debt securities of United States government agencies
|
|
$ |
586,435 |
|
|
$ |
1,074 |
|
|
$ |
(125 |
) |
|
$ |
587,384 |
|
Corporate debt securities
|
|
|
954,909 |
|
|
|
3,585 |
|
|
|
(43 |
) |
|
|
958,451 |
|
Mortgage backed securities issued by United States government-sponsored enterprises
|
|
|
151,034 |
|
|
|
4,625 |
|
|
|
(60 |
) |
|
|
155,599 |
|
|
|
|
283,564 |
|
|
|
- |
|
|
|
- |
|
|
|
283,564 |
|
Debt securities issued by United States Treasury
|
|
|
565,930 |
|
|
|
2,534 |
|
|
|
(8 |
) |
|
|
568,456 |
|
|
|
$ |
2,541,872 |
|
|
$ |
11,818 |
|
|
$ |
(236 |
) |
|
$ |
2,553,454 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
510,546 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,042,908 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2,553,454 |
|
|
|
January 30, 2011
|
|
|
|
Amortized
Cost
|
|
|
Unrealized
Gain
|
|
|
Unrealized
Loss
|
|
|
Estimated
Fair Value
|
|
|
|
|
|
Debt securities of United States government agencies
|
|
$ |
531,789 |
|
|
$ |
1,034 |
|
|
$ |
(226 |
) |
|
$ |
532,597 |
|
Corporate debt securities
|
|
|
925,226 |
|
|
|
3,354 |
|
|
|
(208 |
) |
|
|
928,372 |
|
Mortgage backed securities issued by United States government-sponsored enterprises
|
|
|
140,844 |
|
|
|
4,599 |
|
|
|
(21 |
) |
|
|
145,422 |
|
|
|
|
132,586 |
|
|
|
- |
|
|
|
- |
|
|
|
132,586 |
|
Debt securities issued by United States Treasury
|
|
|
435,091 |
|
|
|
1,939 |
|
|
|
(18 |
) |
|
|
437,012 |
|
|
|
$ |
2,165,536 |
|
|
$ |
10,926 |
|
|
$ |
(473 |
) |
|
$ |
2,175,989 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
350,787 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,825,202 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2,175,989 |
|
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
The amortized cost and estimated fair value of cash equivalents and marketable securities which are primarily debt instruments are classified as available-for-sale at May 1, 2011 and January 30, 2011 and are shown below by contractual maturity.
|
|
May 1, 2011
|
|
|
January 30, 2011
|
|
|
|
Amortized
Cost
|
|
|
Estimated
Fair Value
|
|
|
Amortized
Cost
|
|
|
Estimated
Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,504,472 |
|
|
$ |
1,507,268 |
|
|
$ |
1,176,046 |
|
|
$ |
1,178,733 |
|
|
|
|
955,123 |
|
|
|
961,438 |
|
|
|
899,993 |
|
|
|
904,926 |
|
Mortgage-backed securities issued by government-sponsored enterprises not due at a single maturity date
|
|
|
82,277 |
|
|
|
84,748 |
|
|
|
89,497 |
|
|
|
92,330 |
|
|
|
$ |
2,541,872 |
|
|
$ |
2,553,454 |
|
|
$ |
2,165,536 |
|
|
$ |
2,175,989 |
|
Net realized gains for the three months ended May 1, 2011 and May 2, 2010 were not significant.
Note 7 – Fair Value of Cash Equivalents and Marketable Securities
We measure our cash equivalents and marketable securities at fair value. The fair values of our financial assets and liabilities are determined using quoted market prices of identical assets or quoted market prices of similar assets from active markets. Our Level 1 assets consist of our money market fund deposits. We classify securities within Level 1 assets when the fair value is obtained from real time quotes for transactions in active exchange markets involving identical assets. Our available-for- sale securities are classified as having Level 2 inputs. Our Level 2 assets are valued utilizing a market approach where the market prices of similar assets are provided by a variety of independent industry standard data providers to our investment custodian. There were no significant transfers between Levels 1 and 2 assets for the three months ended May 1, 2011.
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
|
|
|
May 1, 2011
|
|
(Level 1)
|
|
(Level 2)
|
|
|
(In thousands)
|
Debt securities issued by United States government agencies (1)
|
|
$ |
587,384 |
|
|
$ |
- |
|
|
$ |
587,384 |
|
Debt securities issued by United States Treasury (2)
|
|
|
568,456 |
|
|
|
- |
|
|
|
568,456 |
|
Corporate debt securities (3)
|
|
|
958,451 |
|
|
|
- |
|
|
|
958,451 |
|
Mortgage-backed securities issued by government-sponsored entities (4)
|
|
|
155,599 |
|
|
|
- |
|
|
|
155,599 |
|
|
|
|
283,564 |
|
|
|
283,564 |
|
|
|
- |
|
Total cash equivalents and marketable securities
|
|
$ |
2,553,454 |
|
|
$ |
283,564 |
|
|
$ |
2,269,890 |
|
(1)
|
Includes $67.3 million in Cash Equivalents and $520.1 million in Marketable Securities on the Condensed Consolidated Balance Sheet.
|
(2)
|
Includes $103.4 million in Cash Equivalents and $465.1 million in Marketable Securities on the Condensed Consolidated Balance Sheet.
|
(3)
|
Includes $56.4 million in Cash Equivalents and $902.1 million in Marketable Securities on the Condensed Consolidated Balance Sheet.
|
(4)
|
Included in Marketable Securities on the Condensed Consolidated Balance Sheet.
|
(5)
|
Included in Cash Equivalents on the Condensed Consolidated Balance Sheet.
|
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Note 8 - 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.
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, the Trustee appointed by the Bankruptcy Court to represent 3dfx’s bankruptcy estate served his complaint on NVIDIA. The Trustee’s complaint asserted claims for, among other things, successor liability and fraudulent transfer and sought additional payments from us. In early November 2005, 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. 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 reached in November 2005 never progressed through the confirmation process and the Trustee’s case still remains pending appeal. As such, we have not reversed the accrual of $30.6 million - $5.6 million as a charge to settlement costs and $25.0 million as additional purchase price for 3dfx – that we recorded during the three months ended October 30, 2005, pending resolution of the appeal of the Trustee’s case.
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 the Condensed Consolidated Financial Statements for further information regarding this litigation.
|
|
Fair Market Value
|
|
Straight-Line Amortization Period
|
|
|
(In thousands)
|
|
(Years)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Note 9 - Intangible Assets
The components of our amortizable intangible assets are as follows:
|
May 1, 2011
|
|
January 30, 2011
|
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net Carrying
Amount
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net Carrying
Amount
|
|
|
(In thousands)
|
|
|
|
$ |
321,350 |
|
|
$ |
(69,646 |
) |
|
$ |
251,704 |
|
|
$ |
320,477 |
|
|
$ |
(62,791 |
) |
|
$ |
257,686 |
|
Acquired intellectual property
|
|
|
76,264 |
|
|
|
(63,951 |
) |
|
|
12,313 |
|
|
|
76,264 |
|
|
|
(61,175 |
) |
|
|
15,089 |
|
|
|
|
31,278 |
|
|
|
(16,534 |
) |
|
|
14,744 |
|
|
|
31,278 |
|
|
|
(15,308 |
) |
|
|
15,970 |
|
|
|
$ |
428,892 |
|
|
$ |
(150,131 |
) |
|
$ |
278,761 |
|
|
$ |
428,019 |
|
|
$ |
(139,274 |
) |
|
$ |
288,745 |
|
Amortization expense associated with intangible assets for the three months ended May 1, 2011 and May 2, 2010 was $10.9 million and $7.1 million, respectively. Future amortization expense related to the net carrying amount of intangible assets at May 1, 2011 is estimated to be $39.8 million for the remainder of fiscal year 2012, $46.3 million in fiscal year 2013, $41.9 million in fiscal year 2014, $41.8 million in fiscal year 2015, $39.6 million in fiscal year 2016 and a total of $69.4 million in fiscal year 2017 and fiscal years subsequent to fiscal 2017.
Note 10 - Balance Sheet Components
Certain balance sheet components are as follows:
|
|
May 1,
2011
|
|
|
January 30,
2011
|
|
Inventories:
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At May 1, 2011, we had outstanding inventory purchase obligations totaling approximately $491.0 million.
|
|
May 1,
2011
|
|
|
January 30,
2011
|
|
Prepaid Expenses and Other:
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total prepaid expenses and other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
|
|
May 1,
2011
|
|
|
January 30,
2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued customer programs (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued payroll and related expenses
|
|
|
|
|
|
|
|
|
Accrued legal settlement (3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxes payable, short- term
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total accrued liabilities and other
|
|
|
|
|
|
|
|
|
(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.
|
|
May 1,
2011
|
|
|
January 30,
2011
|
|
|
|
(In thousands)
|
|
Other Long-Term Liabilities:
|
|
|
|
|
|
|
Deferred income tax liability
|
|
|
|
|
|
|
|
|
Income taxes payable, long term
|
|
|
|
|
|
|
|
|
Asset retirement obligation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other long-term liabilities
|
|
|
|
|
|
|
|
|
Total other long-term liabilities
|
|
|
|
|
|
|
|
|
Note 11 - Guarantees
U.S. GAAP 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, U.S. GAAP 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 the second quarter of fiscal year 2011, we recorded an additional charge to cover the estimated remaining customer warranty, repair, return, replacement and other costs arising from a weak die/packaging material set in certain versions of our previous generation media and communications processor, or MCP, and graphics processing unit, or GPU, products used in notebook configurations. The net charge amounted to $193.9 million, of which $181.2 million was charged against cost of revenue. The extra remediation costs are primarily due to additional platforms from late failing systems that we had not previously considered to be at risk. Included in the charge are the estimated costs of implementing a settlement reached during the second quarter of fiscal year 2011 with the plaintiffs of a putative consumer class action lawsuit related to this same matter and another related estimated consumer class action settlement. As a result of this settlement, the other estimated settlement, and offsetting insurance reimbursements, we recorded a net charge of $12.7 million to sales, general and administrative expense during the second quarter of fiscal year 2011. Together with the $282.0 million net charge we had previously recorded for related estimated costs, this brings the total cumulative net charge to $475.9 million, of which $466.4 million has been charged against cost of revenue and the remainder has been charged to sales, general and administrative.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited
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 products are failing in the field at higher than normal rates. Testing suggests a weak material set of die/package combination, system thermal management designs, and customer use patterns are contributing factors for these failures. 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 products in their notebook system designs. We intend to fully support our customers in their repair and replacement of these impacted products that fail, and their other efforts to mitigate the consequences of these failures. The weak die/packaging material combination is not used in any of our products that are currently in production.
In September, October and November 2008, several putative securities class action lawsuits were filed against us, asserting various claims related to the impacted MCP and GPU products. Please refer to Note 12 of these Notes to the Condensed Consolidated Financial Statements for further information regarding this litigation and the settlement.
Accrual for product warranty liabilities
Cost of revenue includes the estimated cost of product warranties. Under limited circumstances, we may offer an extended limited warranty to customers for certain products. Additionally, we accrue for known warranty and indemnification issues if a loss is probable and can be reasonably estimated. The estimated product warranty liabilities for the three months ended May 1, 2011 and May 2, 2010 are as follows:
|
|
Three Months Ended
|
|
|
|
|
May 1,
2011
|
|
May 2,
2010
|
|
|
|
|
(In thousands) |
|
Balance at beginning of period (1)
|
|
$ |
107,896 |
|
|
$ |
92,655 |
|
|
|
|
1,406 |
|
|
|
1,170 |
|
|
|
|
(28,578 |
) |
|
|
(46,262 |
) |
|
|
$ |
80,724 |
|
|
$ |
47,563 |
|
(1) Includes $103,662 for the three months ended May 1, 2011 and $88,065 for the three months ended May 2, 2010 for incremental repair and replacement costs from a weak die/packaging material set.
(2) Includes $23,432 for the three months ended May 1, 2011 and $36,928 for the three months ended May 2, 2010, respectively, in cash payments.
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. U.S. GAAP 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, disclosures about the guarantees that an entity has issued, including a tabular reconciliation of the changes of the entity’s product warranty liabilities are also required.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited
Note 12 - Commitments and Contingencies
3dfx
On December 15, 2000, NVIDIA and one of our indirect subsidiaries entered into an Asset Purchase Agreement, or APA, to purchase certain graphics chip assets from 3dfx. The transaction closed on April 18, 2001. That acquisition, and 3dfx’s October 2002 bankruptcy filing, led to four lawsuits against NVIDIA: two brought by 3dfx’s former landlords, one by 3dfx’s bankruptcy trustee and the fourth by a committee of 3dfx’s equity security holders in the bankruptcy estate. The two landlord cases have been settled with payments from the landlords to NVIDIA, and the equity security holders lawsuit was dismissed with prejudice and no appeal was filed. Accordingly, only the bankruptcy trustee suit remains outstanding as more fully explained below.
In March 2003, the Trustee appointed by the Bankruptcy Court to represent 3dfx’s bankruptcy estate served a complaint on NVIDIA asserting claims for, among other things, successor liability and fraudulent transfer and seeking additional payments from us. The Trustee’s fraudulent transfer theory alleged that NVIDIA had failed to pay reasonably equivalent value for 3dfx’s assets, and sought recovery of the difference between the $70 million paid and the alleged fair value, which the Trustee estimated to exceed $50 million. The Trustee’s successor liability theory alleged NVIDIA was effectively 3dfx’s legal successor and therefore was responsible for all of 3dfx’s unpaid liabilities.
On October 13, 2005, the Bankruptcy Court heard the Trustee’s motion for summary adjudication, and on December 23, 2005, denied that motion in all material respects and held that NVIDIA may not dispute that the value of the 3dfx transaction was less than $108 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 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. 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, 2006, the Bankruptcy Court scheduled a trial for one portion of the Trustee’s case against NVIDIA. On January 2, 2007, NVIDIA terminated 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. The parties completed post-trial briefing 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 and evidence and concluded that “the creditors of 3dfx were not injured by the Transaction.” This decision did not entirely dispose of the Trustee’s action, however, as the Trustee’s claims for successor liability and intentional fraudulent conveyance were still pending. On June 19, 2008, NVIDIA filed a motion for summary judgment to convert the Memorandum Decision After Trial to a final judgment. That motion was granted in its entirety and judgment was entered in NVIDIA’s favor on September 11, 2008. The Trustee filed a Notice of Appeal from that judgment on September 22, 2008, and on September 25, 2008, NVIDIA exercised its election to have the appeal heard by the United States District Court.
The District Court’s hearing on the Trustee’s appeal was held on June 10, 2009. On December 20, 2010, the District Court issued an Order affirming the Bankruptcy Court’s entry of summary judgment in NVIDIA’s favor. On January 19, 2011, the Trustee filed a Notice of Appeal to the United States Court of Appeals for the Ninth Circuit.
While the conditional settlement reached in November 2005 never progressed through the confirmation process, the Trustee’s case still remains pending on appeal. Accordingly, we have not reversed the accrual of $30.6 million – $5.6 million as a charge to settlement costs and $25.0 million as additional purchase price for 3dfx – that we recorded during the three months ended October 30, 2005, pending resolution of the appeal of the Trustee’s case.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Rambus Inc.
On July 10, 2008, Rambus Inc. filed suit against NVIDIA, 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. Rambus has since dropped two patents from its lawsuit in the Northern District of California. The two cases have been consolidated into a single proceeding in the San Francisco division of the Northern District of California. On April 13, 2009, the Court issued an order staying motion practice and allowing only certain document discovery to proceed. On February 11, 2011, the Court lifted the stay and ordered that discovery on other issues could proceed. A case management conference is currently scheduled for June 24, 2011.
On November 6, 2008, Rambus filed a complaint alleging a violation of 19 U.S.C. Section 1337 based on a claim of patent infringement of nine Rambus patents against NVIDIA and 14 other respondents with the U.S. International Trade Commission, or ITC. Rambus has subsequently withdrawn four of the nine patents at issue. The complaint sought an exclusion order barring the importation of products that allegedly infringe the now five Rambus patents. The ITC instituted the investigation and a hearing was held on October 13-20, 2009. The Administrative Law Judge issued an Initial Determination on January 22, 2010, which found the asserted claims of two patents in one patent family infringed but invalid, and the asserted claims of three patents in a separate patent family, valid, infringed and enforceable. This decision was reviewed by the ITC. The ITC issued a Final Decision on July 26, 2010. In its Final Decision, the ITC found that NVIDIA infringed three related patents and issued a limited exclusion order prohibiting import of certain NVIDIA products. NVIDIA is appealing certain aspects of the ruling that were unfavorable to NVIDIA. Rambus is also appealing certain aspects of the ruling that were unfavorable to Rambus.
On May 13, 2011, the Federal Circuit issued two opinions in related cases that address issues material to the disputes between Rambus and certain other parties in the ITC. Those opinions may positively affect NVIDIA’s defenses in all of the cases brought against NVIDIA by Rambus. In those opinions, the Federal Circuit held Rambus destroyed documents when it had a legal duty to preserve them and that, if done in bad faith, Rambus is to bear the “heavy burden” to prove that NVIDIA suffered no prejudice in its ability to defend the cases brought against it by Rambus. In the ITC’s Final Decision, despite finding Rambus acted in bad faith, the ITC incorrectly placed the burden on NVIDIA to prove actual prejudice.
NVIDIA also sought reexamination of the patents asserted in the ITC, as well as other patents, in the United States Patent and Trademark Office, or USPTO. Proceedings are underway with respect to all challenged patents. With respect to the claims asserted in the ITC, the USPTO has issued a preliminary ruling invalidating many of the claims. The USPTO has issued "Right to Appeal Notices" for the three patents found by the administrative law judge to be valid, enforceable and infringed. In the Right to Appeal Notices, the USPTO Examiner has cancelled all asserted claims of one of the patents and allowed the asserted claims on the other two patents. Rambus and NVIDIA both sought review of the USPTO Examiner's adverse findings. The Board of Patent Appeals and Interferences (BPAI) recently heard oral argument on two of the patents that are subject to reexamination. We expect rulings from the BPAI on these patents this summer.
Rambus has also been subject to an investigation in the European Union. NVIDIA was not a party to that investigation, but has sought to intervene in the appeal of the investigation. As a result of Rambus’ commitments to resolve that investigation, for a period of five years from the date of the resolution, Rambus must now provide a license to memory controller manufacturers, sellers and/or companies that integrate memory controllers into other products. The license terms are set forth in a license made available on Rambus’ website, or the Required Rambus License. On August 12, 2010, we entered into the Required Rambus License. Pursuant to the agreement, Rambus charges a royalty of (i) one percent of the net sales price per unit for certain memory controllers and (ii) two percent of the net sales price per unit for certain other memory controllers, provided that the maximum average net sales price per unit for these royalty bearing products shall be deemed not to exceed a maximum of $20. The agreement has a term until December 9, 2014. However, NVIDIA may terminate the agreement on or after August 12, 2011 with thirty days prior written notice to Rambus.
On December 1, 2010, Rambus filed a lawsuit against NVIDIA and several other companies alleging six claims for patent infringement. This lawsuit is pending in the Northern District of California and seeks damages, enhanced damages and injunctive relief. On the same day, Rambus filed a complaint with the ITC alleging that NVIDIA and several other companies violated 19 U.S.C. Section 1337 based on a claim of patent infringement of three Rambus patents. Rambus seeks exclusion of certain NVIDIA products from importation into the United States. The Northern District of California has stayed the case pending resolution of the ITC investigation. The asserted patents are related to each other, and the three patents in the ITC complaint are also at issue in the lawsuit pending in the Northern District of California. Many of the patents at issue in these lawsuits are also being challenged in Rambus’ other disputes with NVIDIA.
NVIDIA intends to pursue its offensive and defensive cases vigorously in all actions.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Product Defect Litigation and Securities Cases
Product Defect Litigation
In September, October and November 2008, several putative consumer class action lawsuits were filed against us, asserting various claims arising from a weak die/packaging material set in certain versions of our previous generation products used in notebook configurations. Most of the lawsuits were filed in Federal Court in the Northern District of California, but three were filed in state court in California, in Federal Court in New York, and in Federal Court in Texas. Those three actions have since been removed or transferred to the United States District Court for the Northern District of California, San Jose Division, where all of the actions now are currently pending. The various lawsuits are titled Nakash v. NVIDIA Corp., Feinstein v. NVIDIA Corp., Inicom Networks, Inc. v. NVIDIA Corp. and Dell, Inc. and Hewlett Packard, Olivos v. NVIDIA Corp., Dell, Inc. and Hewlett Packard, Sielicki v. NVIDIA Corp. and Dell, Inc., Cormier v. NVIDIA Corp., National Business Officers Association, Inc. v. NVIDIA Corp., and West v. NVIDIA Corp. The First Amended Complaint was filed on October 27, 2008, which no longer asserted claims against Dell, Inc. The various complaints assert claims for, among other things, breach of warranty, violations of the Consumer Legal Remedies Act, Business & Professions Code sections 17200 and 17500 and other consumer protection statutes under the laws of various jurisdictions, unjust enrichment, and strict liability.
The District Court has entered orders deeming all of the above cases related under the relevant local rules. On December 11, 2008, NVIDIA filed a motion to consolidate all of the aforementioned consumer class action cases. On February 26, 2009, the District Court consolidated the cases, as well as two other cases pending against Hewlett Packard, under the caption “The NVIDIA GPU Litigation” and ordered the plaintiffs to file lead counsel motions by March 2, 2009. On March 2, 2009, several of the parties filed motions for appointment of lead counsel and briefs addressing certain related issues. On April 10, 2009, the District Court appointed Milberg LLP lead counsel. On May 6, 2009, the plaintiffs filed an Amended Consolidated Complaint, alleging claims for violations of California Business and Professions Code Section 17200, Breach of Implied Warranty under California Civil Code Section 1792, Breach of the Implied Warranty of Merchantability under the laws of 27 other states, Breach of Warranty under the Magnuson-Moss Warranty Act, Unjust Enrichment, violations of the New Jersey Consumer Fraud Act, Strict Liability and Negligence, and violation of California’s Consumer Legal Remedies Act.
On August 19, 2009, we filed a motion to dismiss the Amended Consolidated Complaint, and the Court heard arguments on that motion on October 19, 2009. On November 19, 2009, the Court issued an order dismissing with prejudice plaintiffs causes of action for Breach of the Implied Warranty under the laws of 27 other states and unjust enrichment, dismissing with leave to amend plaintiffs’ causes of action for Breach of Implied Warranty under California Civil Code Section 1792 and Breach of Warranty under the Magnuson-Moss Warranty Act, and denying NVIDIA’s motion to dismiss as to the other causes of action. The Court gave plaintiffs until December 14, 2009 to file an amended complaint. On December 14, 2009, plaintiffs filed a Second Amended Consolidated Complaint, asserting claims for violations of California Business and Professions Code Section 17200, Breach of Implied Warranty under California Civil Code Section 1792, Breach of Warranty under the Magnuson-Moss Warranty Act, violations of the New Jersey Consumer Fraud Act, Strict Liability and Negligence, and violation of California’s Consumer Legal Remedies Act. The Second Amended Complaint seeks unspecified damages. On January 19, 2010, we filed a motion to dismiss the Breach of Implied Warranty under California Civil Code Section 1792, Breach of Warranty under the Magnuson-Moss Warranty Act, and California’s Consumer Legal Remedies Act claims in the Second Amended Consolidated Complaint. In addition, on April 1, 2010, Plaintiffs filed a motion to certify a class consisting of all people who purchased computers containing certain of our MCP and GPU products. On May 3, 2010, we filed an opposition to Plaintiffs’ motion for class certification. A hearing on both motions was held on June 14, 2010. On July 16, 2010, the parties filed a stipulation with the District Court advising that, following mediation they had reached a settlement in principle in The NVIDIA GPU Litigation. The settlement in principle was subject to certain approvals, including final approval by the court. As a result of the settlement in principle, and the other estimated settlement, and offsetting insurance reimbursements, NVIDIA recorded a net charge of $12.7 million to sales, general and administrative expense during the second quarter of fiscal year 2011. In addition, a portion of the $181.2 million of additional charges we recorded against cost of revenue related to the weak die/packaging set during the second quarter of fiscal year 2011, relates to estimated additional repair and replacement costs related to the implementation of these settlements. On August 12, 2010, the parties executed a Stipulation and Agreement of Settlement and Release. On September 15, 2010, the Court issued an order granting preliminary approval of the settlement and providing for notice to the potential class members. The Final Approval Hearing was held on December 20, 2010, and on that same day the Court approved the settlement and entered Final Judgment over several objections. In January 2011, several objectors filed Notices of Appeal of the Final Judgment to the United States Court of Appeals for the Ninth Circuit.
On February 28, 2011, a group of purported class members filed a motion with the District Court purporting to seek enforcement of the settlement. The Motion claimed that NVIDIA was not properly complying with its obligations under the settlement in connection with the remedies provided to purchasers of Hewlett-Packard computers included in the settlement. On March 4, 2011, NVIDIA and Class Counsel at Milberg LLP filed oppositions to the Motion. The Court held a hearing on March 28, 2011, and denied the Motion on May 2, 2011.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Securities Cases
In September 2008, three putative securities class actions, or the Actions, were filed in the United States District Court for the Northern District of California arising out of our announcements on July 2, 2008, that we would take a charge against cost of revenue to cover anticipated costs and expenses arising from a weak die/packaging material set in certain versions of our previous generation MCP and GPU products and that we were revising financial guidance for our second quarter of fiscal year 2009. The Actions purport to be brought on behalf of purchasers of NVIDIA stock and assert claims for violations of Sections 10(b) and 20(a) of the Exchange Act. On October 30, 2008, the Actions were consolidated under the caption In re NVIDIA Corporation Securities Litigation, Civil Action No. 08-CV-04260-JW (HRL). Lead Plaintiffs and Lead Plaintiffs’ Counsel were appointed on December 23, 2008. On February 6, 2009, co-Lead Plaintiff filed a Writ of Mandamus with the Ninth Circuit Court of Appeals challenging the designation of co-Lead Plaintiffs’ Counsel. On February 19, 2009, co-Lead Plaintiff filed with the District Court, a motion to stay the District Court proceedings pending resolution of the Writ of Mandamus by the Ninth Circuit. On February 24, 2009, Judge Ware granted the stay. On November 5, 2009, the Court of Appeals issued an opinion reversing the District Court’s appointment of one of the lead plaintiffs’ counsel, and remanding the matter for further proceedings. On December 8, 2009, the District Court appointed Milberg LLP and Kahn Swick & Foti, LLC as co-lead counsel.
On January 22, 2010, Plaintiffs filed a Consolidated Amended Class Action Complaint for Violations of the Federal Securities Laws, asserting claims for violations of Section 10(b), Rule 10b-5, and Section 20(a) of the Exchange Act. The consolidated complaint sought unspecified compensatory damages. We filed a motion to dismiss the consolidated complaint in March 2010 and a hearing was held on June 24, 2010 before Judge Seeborg. On October 19, 2010, Judge Seeborg granted our motion to dismiss with leave to amend. On December 2, 2010, co-Lead Plaintiffs filed a Second Consolidated Amended Complaint. We moved to dismiss on February 14, 2011, and a hearing on the motion is currently scheduled for July 28, 2011.
Accounting for loss contingencies
While there can be no assurance of favorable outcomes, we believe the claims made by other parties in the above ongoing matters are without merit and we intend to vigorously defend the actions. With the exception of the 3dfx and product defect litigation cases, we have not recorded any accrual for contingent liabilities associated with the legal proceedings described above based on our belief that liabilities, while possible, are not probable. Further, any possible range of loss in these matters cannot be reasonably estimated at this time. We are engaged in other legal actions not described above arising in the ordinary course of its business and, while there can be no assurance of favorable outcomes, we believe that the ultimate outcome of these actions will not have a material adverse effect on our operating results, liquidity or financial position.
Note 13 - Stockholders’ Equity
Stock Repurchase Program
Our Board of Directors has authorized us, subject to certain specifications, to repurchase shares of our common stock up to an aggregate maximum amount of $2.7 billion through May 2013. 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 Rule 10b-18 of the Securities Exchange Act, subject to market conditions, applicable legal requirements, and other factors. The program does not obligate NVIDIA 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.
We did not enter into any structured share repurchase transactions or otherwise purchase any shares of our common stock during the three months ended May 1, 2011. Through May 1, 2011, we have repurchased an aggregate of 90.9 million shares under our stock repurchase program for a total cost of $1.46 billion. As of May 1, 2011, we are authorized, subject to certain specifications, to repurchase shares of our common stock up to $1.24 billion through May 2013.
Convertible Preferred Stock
As of May 1, 2011 and January 30, 2011, there were no shares of preferred stock outstanding.
Common Stock
We are authorized to issue up to 2,000,000,000 shares of our common stock at $0.001 per share par value.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Note 14 – Comprehensive Income
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income components include unrealized gains or losses on available-for-sale securities, net of tax. The components of comprehensive income, net of tax, were as follows:
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2011
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May 2,
2010
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(In thousands)
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Net change in unrealized gains (losses) on available-for-sale securities, net of tax
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Reclassification adjustments for net realized losses on available-for-sale securities included in net loss, net of tax
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Total comprehensive income
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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.
Our GPU business is comprised primarily of our GeForce discrete and chipset products which support desktop and notebook personal computers, or PCs, plus memory products. Our GPU business is also comprised of license revenue in connection with the License Agreement with Intel. Our professional solutions business, or PSB, is comprised of our Quadro professional workstation products and other professional graphics products, including our NVIDIA Tesla high-performance computing products. Our CPB is comprised of our Tegra mobile products that support smartphones, tablets, personal media players, or PMPs, internet television, in-car instrumentation, navigation and entertainment, and other similar devices. CPB also includes license, royalty, other revenue and associated costs related to video game consoles and other digital consumer electronics devices.
The “All Other” category includes non-recurring charges and benefits that we do not allocate to our operating segments as these expenses and credits are not included in the segment operating performance measures evaluated by our CODM. There were no non-recurring charges or benefits for the three months ended May 1, 2011.
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 as a whole.
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
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GPU
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PSB
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CPB
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All Other
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Consolidated
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(In thousands)
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Three Months Ended May 1, 2011:
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Depreciation and amortization expense
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Three Months Ended May 2, 2010:
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Depreciation and amortization expense
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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:
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Three Months Ended
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May 1,
2011
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May 2,
2010
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(In thousands)
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Revenue:
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Revenue from significant customers, those representing 10% or more of total revenue, aggregated approximately 11% of our total revenue from one customer and 28% of our total revenue from two customers for the three months ended May 1, 2011 and May 2, 2010, respectively.
Accounts receivable from significant customers, those representing 10% or more of total accounts receivable, aggregated approximately 12% of our accounts receivable balance from one customer at May 1, 2011 and approximately 11% of our accounts receivable balance from one customer at January 30, 2011.
Note 16- Subsequent Event
On May 9, 2011, we announced our intention to acquire Icera Inc., an innovator of baseband processors for 3G and 4G cellular phones and tablets. Icera’s high speed wireless-modem products have been approved by more than 50 carriers across the globe. We believe that by combining our products and technologies, including the Tegra processor, we could enhance our position as a player in the growing mobile market. The acquisition, for $367 million in cash, has been approved by both companies' boards of directors and is expected to be completed, subject to customary closing conditions, approximately 30 days from the announcement date. Also in connection with our agreement to acquire Icera, we have committed to establishing a retention program in the amount of approximately $68.0 million to be paid out to Icera employees over a period of four years.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “goal,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential” and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail under the heading “Risk Factors.” Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.
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, the NVIDIA logo, CUDA, GeForce, Quadro, Tegra, and Tesla are trademarks and/or registered trademarks of NVIDIA Corporation in the United States and other countries. Other company and product names may be trademarks of the respective companies with which they are associated.
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 30, 2011 and “Item 1A. Risk Factors” of this Quarterly Report on Form 10-Q and 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 invented the graphics processing unit, or GPU, in 1999. Since then, we have strived to set new standards in visual computing with interactive graphics available on devices ranging from tablets and smart phones to notebooks and workstations. Our expertise in programmable GPUs and computer-systems technology has led to breakthroughs in parallel processing which make supercomputing less expensive and widely accessible. We are strategically investing in three major areas – visual computing, high performance computing and mobile computing. We serve the visual computing market with our consumer GeForce graphics products and professional Quadro graphics products; the high performance computing market with our Tesla computing solutions products; and the mobile computing market with our Tegra system-on-chip products.
We have three primary financial reporting segments – GPU, Professional Solutions Business, or PSB and Consumer Products Business, or CPB. Our GPU business is comprised primarily of our GeForce discrete and chipset products which support desktop and notebook personal computers, or PCs, plus memory products. Our GPU business is also comprised of license revenue in connection with the License Agreement with Intel Corporation. Our PSB is comprised of our Quadro professional workstation products and other professional graphics products, including our NVIDIA Tesla high-performance computing products. Our CPB is comprised of our Tegra mobile products that support smartphones, tablets, personal media players, or PMPs, internet television, in-car instrumentation, navigation and entertainment, and other similar 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, or OEMs, original design manufacturers, or ODMs, 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.
Recent Developments, Future Objectives and Challenges
GPU Business
During the first quarter of fiscal year 2012, we launched the GeForce GTX 590, one of the fastest and quietest graphics card available in the marketplace today. This product is more than two times quieter than the closest competitive product under full graphics load. GTX 590 is powered by dual Fermi GPUs on a single card and targets the enthusiast market.
During the first quarter of fiscal year 2012, we also launched the GeForce GTX 550 Ti, an entry-level gaming GPU for next generation Intel systems. GTX 550 Ti delivers faster performance for DX11 games compared with its closest competitive product. The GTX 550 Ti is up to 50 percent faster in today's newest DX11 tessellated games, and 38 percent faster in previous-generation DX9 and DX10 games.
Professional Solutions Business
During the first quarter of fiscal year 2012, we announced the new Quadro 400, a new professional graphics solution designed for applications such as Autodesk AutoCAD and other leading CAD/CAM applications. The Quadro 400 GPU offers power efficiency, consuming less than 35 watts, and its low-profile footprint means it offers the flexibility to fit into any workstation, including small form-factor systems. We also announced the new CUDA® 4.0 Toolkit. The new release provides unified virtual addressing, GPU-to-GPU communication and enhanced C++ template libraries which enable more developers to take advantage of GPU computing. We believe this, along with other ongoing initiatives in our Tesla high-performance computing business, will lead to continued growth in the PSB.
Consumer Products Business
During the first quarter of fiscal year 2012, we launched along with our partners, the first wave of Android smartphones and tablets. Among them are the Motorola Atrix 4G and LG Optimus 2X smartphones; as well as tablets like the Acer ICONIA Tab A500, Asus Eee Pad Transformer, Dell Streak, LG Optimus Pad and G-Slate, and Motorola Xoom. In addition, Samsung and Sony announced that their Galaxy Tab 10.1 and Sony S1 and S2 projects, respectively, will be using our Tegra™ 2 mobile super chip.
Icera Acquisition
On May 9, 2011, we announced our intention to acquire Icera Inc., an innovator of baseband processors for 3G and 4G cellular phones and tablets. Icera’s high speed wireless-modem products have been approved by more than 50 carriers across the globe. We believe that by combining our products and technologies, including the Tegra processor, we could enhance our position as a player in the growing mobile market. The acquisition, for $367 million in cash, has been approved by both companies' boards of directors and is expected to be completed, subject to customary closing conditions, approximately 30 days from the announcement date.
Product Defect
During the second quarter of fiscal year 2011, we recorded an additional charge to cover the estimated remaining customer warranty, repair, return, replacement and other costs arising from a weak die/packaging material set in certain versions of our previous generation MCP and GPU products used in notebook configurations. The net charge amounted to $193.9 million, of which $181.2 million was charged against cost of revenue. The extra remediation costs are primarily due to additional platforms from late failing systems that we had not previously considered to be at risk. Included in the charge are the estimated costs of implementing a settlement reached during the second quarter of fiscal year 2011 with the plaintiffs of a putative consumer class action lawsuit related to this same matter and another related estimated consumer class action settlement. As a result of this settlement, the other estimated settlement, and offsetting insurance reimbursements, we recorded a net charge of $12.7 million to sales, general and administrative expense during the second quarter of fiscal year 2011. Together with the $282.0 million net charge we had previously recorded for related estimated costs, this brings the total cumulative net charge to $475.9 million, of which $466.4 million has been charged against cost of revenue.
We intend to fully support our customers in their repair and replacement of these impacted products that fail, and their other efforts to mitigate the consequences of these failures. 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 products.
In September, October and November 2008, several putative securities class action lawsuits were filed against us, asserting various claims related to the impacted MCP and GPU products. Please refer to Note 12 of the Notes to the Condensed Consolidated Financial Statements for further information regarding this litigation and the settlement.
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 three operating segments to our CODM: the GPU business is comprised primarily of our GeForce discrete and chipset products which support desktop and notebook PCs, plus memory products. Our GPU business is also comprised of license revenue in connection with the License Agreement with Intel; 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; and our CPB which is comprised of our Tegra mobile products that support smartphones, tablets, personal media players, or PMPs, internet television, in-car instrumentation, navigation and entertainment, and other similar devices. CPB also includes license, royalty, other revenue and associated costs related to video game consoles and other digital consumer electronics devices.
The “All Other” category includes non-recurring charges and benefits that we do not allocate to our other operating segments as these expenses and credits are not included in the segment operating performance measures evaluated by our CODM. There were no non-recurring charges or benefits for the first three months of fiscal years 2012 and 2011. Please refer to Note 15 of the Notes to the Condensed Consolidated Financial Statements for further disclosure regarding segment information.
Results of Operations
The following table sets forth, for the periods indicated, certain items in our condensed consolidated statements of operations expressed as a percentage of revenue.
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Three Months Ended
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May 1,
2011
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May 2,
2010
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Sales, general and administrative
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Interest and other income, net
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Income before income tax expense
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Three months ended May 1, 2011 and May 2, 2010
Revenue
Revenue was $962.0 million for our first quarter of fiscal year 2012, compared to $1.00 billion for our first quarter of fiscal year 2011, which represents a decrease of approximately 4%. We expect revenue to increase 4 to 6 percent during the second quarter of fiscal year 2012 as compared to the first quarter of fiscal year 2012. A discussion of our revenue results for each of our operating segments is as follows:
GPU Business. GPU business revenue decreased by approximately 18% to $637.6 million in the first quarter of fiscal year 2012, compared to $780.9 million for the first quarter of fiscal year 2011. The decline was primarily the result of a decrease in sales of our MCP chipset products as these products approach their end of life. Our notebook GPU revenue also declined in the first quarter of fiscal year 2012 as compared to 2011, related to the higher unit volume of our products that shipped with notebooks based on Intel’s Calpella platform in the first quarter of fiscal year 2011 as compared with the unit volume of our products that shipped in the first quarter of fiscal year 2012 with notebooks based on Intel’s Sandy Bridge platform. Revenue from sales of our desktop GPU products increased slightly in the first quarter of fiscal year 2012, primarily as a result of higher average sales prices. Our market share, in both the discrete desktop GPU and notebook GPU markets, measured in unit volume on a calendar quarter basis, declined during the most recent quarter when compared to a year ago according to the May 2011 PC Graphics Report from Mercury Research.
PSB. PSB revenue increased by approximately 6% to $201.8 million in the first quarter of fiscal year 2012, compared to $189.7 million for the first quarter of fiscal year 2011. This increase was driven by growth in both our Quadro and Tesla brands with the launch of products containing our new Fermi architecture.
CPB. CPB revenue increased by 293% to $122.6 million in the first quarter of fiscal year 2012, compared to $31.2 million for the first quarter of fiscal year 2011. We achieved record revenue due to a significantly higher unit shipment volume of Tegra products, primarily Tegra 2- based products, as our partners launched several Android smartphones and tablets.
Concentration of Revenue
Revenue from sales to customers outside of the United States and other Americas accounted for 81% and 85% of total revenue for the first quarter of fiscal years 2012 and 2011, respectively. Revenue by geographic region is allocated to individual countries based on the location to which the products are initially billed even if the revenue is attributable to end customers in a different location.
Revenue from significant customers, those representing 10% or more of total revenue, aggregated approximately 11% of our total revenue from one customer and 28% of our total revenue from two customers, for the first quarter of fiscal years 2012 and 2011 respectively.
Gross Profit and Gross Margin
Gross profit consists of total revenue, net of allowances, less cost of revenue. Cost of revenue consists primarily of the cost of semiconductors purchased from subcontractors, including wafer fabrication, assembly, testing and packaging, manufacturing support costs, including labor and overhead associated with such purchases, final test yield fallout, inventory and warranty provisions and shipping costs. Cost of revenue also includes development costs for license, service arrangements and stock-based compensation related to personnel associated with manufacturing.
Gross margin is the percentage of gross profit to revenue. Our gross margin can vary in any period depending on the mix of types of products sold. Our gross margin is significantly impacted by the mix of products we sell. Product mix is often difficult to estimate with accuracy. Therefore, if we experience product transition challenges, if we achieve significant revenue growth in our lower margin product lines, or if we are unable to earn as much revenue as we expect from higher margin product lines, our gross margin may be negatively impacted.
Our overall gross margin was 50.4% and 45.6% for the first quarter of fiscal year 2012 and 2011, respectively. The improvement in gross margin for the first quarter of fiscal year 2012 when compared to the first quarter of fiscal year 2011 was attributable to a richer product mix and the continuing positive impact of improved yields of our 40nm products as well as other manufacturing cost reductions. Additionally, our gross margin was favorably impacted by sales of products that were previously written off or written down and sales of such items improved gross margin by approximately 2.7% and 1.2% in the first quarter of fiscal years 2012 and 2011, respectively. Offsetting these releases are provisions for new inventory reserves. The net effect to gross margin from new inventory reserves and sales of items previously written down was a 1.4% favorable impact in the first quarter of fiscal year 2012 and 2.2% unfavorable impact in the first quarter of fiscal year 2011.
We intend to focus on improving our gross margin by delivering cost effective product architectures, enhancing business processes and delivering profitable growth. We expect gross margin to be between 50.5% and 51.5% during the second quarter of fiscal year 2012.
A discussion of our gross margin results for each of our operating segments is as follows:
GPU Business. The gross margin of our GPU business increased during the first quarter of fiscal year 2012 as compared to the first quarter of fiscal year 2011. The increase was primarily due to strong average selling price, ASP, growth in our desktop and notebook products. Gross margin also improved as a result of favorable product mix, better yields of our 40nm products as well as other manufacturing cost reductions. Additionally, the net impact of new inventory reserves and releases resulting from sales of products that were previously written off or written down had a favorable effect on gross margin for this business in the first quarter of fiscal year 2012, and had a negative impact on gross margin in the first quarter of fiscal year 2011.
PSB. The gross margin of our PSB decreased during the first quarter of fiscal year 2012 as compared to the first quarter of fiscal year 2011. The decrease was primarily due to a less favorable mix of products sold.
CPB. The gross margin of our CPB decreased during the first quarter of fiscal year 2012 as compared to the first quarter of fiscal year 2011, reflecting the evolution within the quarter from a business with revenue based primarily on license and royalty revenue to a business based primarily on Tegra product revenue.
Operating Expenses
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Three Months Ended
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May 1,
2011
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May 2,
2010
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$
Change
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%
Change
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(In millions)
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Research and development expenses
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$ |
231.5 |
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$ |
218.1 |
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$ |
13.4 |
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6.1 |
% |
Sales, general and administrative expenses
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98.1 |
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90.9 |
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7.2 |
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7.9 |
% |
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$ |
329.6 |
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$ |
309.0 |
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$ |
20.6 |
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6.7 |
% |
Research and development as a percentage of net revenue
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24.1 |
% |
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21.8 |
% |
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Sales, general and administrative as a percentage of net revenue
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10.2 |
% |
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9.1 |
% |
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Research and Development
Research and development expenses were $231.5 million and $218.1 million during the first quarter of fiscal year 2012 and 2011, respectively, an increase of $13.4 million, or 6.1%. Compensation and benefits increased by $11.6 million and stock based compensation increased by $3.9 million, primarily related to growth in headcount. These increases were offset by a decrease of $3.8 million in product and technology development expenses.
Sales, General and Administrative
Sales, general and administrative expenses were $98.1 million and $90.9 million during the first quarter of fiscal years 2012 and 2011, respectively, a decrease of $7.2 million, or 7.9%. Compensation and benefits increased by $6.2 million and stock based compensation increased by $1.9 million, primarily related to growth in headcount. These increases were offset by a decrease in outside professional fees by $4.2 million due to reduced litigation activities.
We expect operating expenses to be approximately $332 million to $336 million in the second quarter of fiscal year 2012.
Interest Income
Interest income consists of interest earned on cash, cash equivalents and marketable securities. Interest income was $5.3 million and $5.6 million in the first quarter of fiscal years 2012 and 2011, respectively, a decrease of $0.3 million. These decreases were primarily due to lower interest rates in the first quarter of fiscal year 2012 when compared to the first quarter of fiscal year 2011.
Other Income (Expense), net
Other income (expense) primarily consists of realized gains and losses on the sale of marketable securities and foreign currency translation. Other (expense), net of other income was ($3.7) million in the first quarter of fiscal year 2012 compared to ($2.2) million in the first quarter of fiscal year 2011. The increase of $1.5 million was primarily driven by an increase in foreign currency losses in the first quarter of fiscal year 2012.
Income Taxes
We recognized income tax expense of $21.3 million and $13.1 million for the three months ended May 1, 2011 and May 2, 2010, respectively. Income tax expense as a percentage of income before taxes, or our effective tax rate, was 13.6% and 8.7% for the three months ended May 1, 2011 and May 2, 2010, respectively. The difference in our effective tax rate of 13.6% and 8.7% was primarily related to discrete tax benefits attributable to the expiration of statues of limitations in certain non-U.S. jurisdictions not previously recognized that were greater in the first quarter of fiscal year 2011 over the first quarter of fiscal year 2012.
Our effective tax rate on income before tax for the first three months of fiscal year 2012 of 13.6% was lower than the United States federal statutory rate of 35% due primarily to income earned in jurisdictions where the tax rate is lower than the United States federal statutory tax. Further, our annual projected effective tax rate as of the first three months of fiscal year 2012 of 16.7% differs from our effective tax rate for the first three months fiscal year 2012 of 13.6% due to favorable discrete events that occurred in the first quarter of fiscal year 2012 primarily attributable to the expiration of statutes of limitations in certain non-U.S. jurisdictions for which we had not previously recognized related tax benefits.
Our effective tax rate on income before tax for the first three months of fiscal year 2011 of 8.7% was lower than the United States federal statutory tax rate of 35% primarily due to income earned in jurisdictions where the tax rate is lower than the United States federal statutory tax rate and favorable discrete events that occurred in the first three months of fiscal year 2011 primarily attributable to the expiration of statutes of limitations in certain non-U.S. jurisdictions for which we had not previously recognized related tax benefits.
We expect our effective tax rate in the second quarter of fiscal year 2012 to be approximately 14% to 16%, depending primarily on any discrete tax events that may occur in such quarter.
Please refer to Note 5 of the Notes to Condensed Consolidated Financial Statements for further information regarding the components of our income tax expense.
Liquidity and Capital Resources
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As of
May 1,
2011
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As of
January 30,
2011
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(In millions)
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Cash and cash equivalents
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Cash, cash equivalents, and marketable securities
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Three Months Ended
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May 1,
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May 2,
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2011
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2010
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(In millions)
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Net cash provided by (used in) operating activities
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Net cash used in investing activities
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Net cash provided by financing activities
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As of May 1, 2011, we had $2.73 billion in cash, cash equivalents and marketable securities, an increase of $235.9 million from $2.49 billion at the end of fiscal year 2011. Our portfolio of cash equivalents and marketable securities is managed by several financial institutions. Our investment policy requires the purchase of top-tier investment grade securities, the diversification of asset type and includes certain limits on our portfolio duration.
Operating activities
Operating activities provided cash of $172.2 million and used cash of $5.4 million during the first three months of fiscal years 2012 and 2011, respectively. The increase in cash provided by operating activities in the first three months of fiscal year 2012 was primarily due to favorable changes in working capital driven by a decrease in accounts receivable due to improved sales linearity and stronger collections.
Investing activities
Investing activities consisted primarily of purchases and sales of marketable securities and purchases of property and equipment, which include leasehold improvements for our facilities and intangible assets. Investing activities used cash of $252.5 million and $57.3 million during the first three months of fiscal years 2012 and 2011, respectively. The increase in investing activities was primarily as a result of increased capital expenditure related to purchases of new research and development equipment, testing equipment, technology licenses, software and intangible assets to support our increased investment in product development.
We expect to spend approximately $125 million to $175 million for capital expenditures during the remainder of fiscal year 2012, primarily for leasehold improvements, software licenses, emulation equipment, computers and engineering workstations. In addition, we plan to use cash in connection with the acquisition of new businesses or assets.
Financing activities
Financing activities provided cash of $98.6 million and $62.8 million during the first three months of fiscal years 2012 and 2011, respectively. Net cash provided by financing activities in the first three months of fiscal year 2012 was primarily due to an increase of proceeds from issuance of common stock under our employee stock plans during the first three months of fiscal year 2012.
Liquidity
Our primary source of liquidity is cash generated by our operations. Our investment portfolio consisted of cash and cash equivalents, commercial paper, mortgage-backed securities issued by government-sponsored enterprises, equity securities, money market funds and debt securities of corporations, municipalities and the United States government and its agencies. These investments are denominated in United States dollars. As of May 1, 2011, we did not have any investments in auction-rate preferred securities.
All of our cash equivalents and marketable securities are treated as “available-for-sale”. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate debt securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or if the decline in fair value of our publicly traded debt or equity investments is judged to be other-than-temporary. We may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. However, because any debt securities we hold are classified as “available-for-sale,” no gains or losses are realized in our statement of operations due to changes in interest rates unless such securities are sold prior to maturity or unless declines in market values are determined to be other-than-temporary. These securities are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income, a component of stockholders’ equity, net of tax.
As of May 1, 2011 and January 30, 2011, we had $2.73 billion and $2.49 billion, respectively, in cash, cash equivalents and marketable securities. Our investment policy requires the purchase of top-tier investment grade securities and the diversification of asset types and includes certain limits on our portfolio duration, as specified in our investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issue, issuer or type of instrument. As of May 1, 2011, we were in compliance with our investment policy. As of May 1, 2011, our investments in government agencies and government sponsored enterprises represented approximately 51% of our total investment portfolio, while the financial sector accounted for approximately 30% of our total investment portfolio. All of our investments are with A/A2 or better rated securities.
We performed an impairment review of our investment portfolio as of May 1, 2011. Based on our quarterly impairment review, we concluded that our investments were appropriately valued and did not record any impairment during three months ended May 1, 2011.
Net realized gains for the three months ended May 1, 2011 were $0.1 million. As of May 1, 2011, we had a net unrealized gain of $11.6 million, which was comprised of gross unrealized gains of $11.8 million, offset by gross unrealized losses of $0.2 million. As of January 30, 2011, we had a net unrealized gain of $10.5 million, which was comprised of gross unrealized gains of $11.0 million, offset by $0.5 million of gross unrealized losses.
Our accounts receivable are highly concentrated and make us vulnerable to adverse changes in our customers’ businesses, and to downturns in the industry and the worldwide economy. One customer accounted for approximately 12% of our accounts receivable balance at May 1, 2011. While we strive to limit our exposure to uncollectible accounts receivable using a combination of credit insurance and letters of credit, difficulties in collecting accounts receivable could materially and adversely affect our financial condition and results of operations. These difficulties are heightened during periods when economic conditions worsen. We continue to work directly with more foreign customers and it may be difficult to collect accounts receivable from them. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance consists of an amount identified for specific customers and an amount based on overall estimated exposure. If the financial condition of our customers were to deteriorate, resulting in an impairment in their ability to make payments, additional allowances may be required, we may be required to defer revenue recognition on sales to affected customers, and we may be required to pay higher credit insurance premiums, any of which could adversely affect our operating results. In the future, we may have to record additional reserves or write-offs and/or defer revenue on certain sales transactions which could negatively impact our financial results.
Our cash balances are held in numerous locations throughout the world, including substantial amounts held outside of the United States. As of May 1, 2011, we had cash, cash equivalents and marketable securities of $773.2 million held within the United States and $1.95 billion held outside of the United States. Most of the amounts held outside the United States may be repatriated to the United States but, under current law, would be subject to U.S. federal income taxes, less applicable foreign tax credits. Further, repatriation of some foreign balances may be restricted by local laws. As of January 30, 2011, we have not provided for U.S. federal and state income taxes on approximately $904.3 million of undistributed earnings of non-United States subsidiaries, as such earnings are considered indefinitely reinvested outside the United States. Although we have no current need to do so, if we repatriate foreign earnings for cash requirements in the United States, we would incur U.S. federal and state income tax, less applicable foreign tax credits, and reduced by the current amount of our U.S. federal and state net operating loss and tax credit carryforwards. Further, in addition to the $773.2 million of cash, cash equivalents and marketable securities held within the United States and available to fund our U.S. operations and any other U.S. cash needs, we have access to external sources of financing if cash is needed in the United States other than by repatriation of foreign earnings where U.S. income tax may otherwise be due. Accordingly, we do not reasonably expect any material effect on our business, as a whole, or to our financial flexibility with respect to our current cash balances held outside of the United States.
Stock Repurchase Program
Our Board of Directors has authorized us, subject to certain specifications, to repurchase shares of our common stock up to an aggregate maximum amount of $2.7 billion through May 2013. 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 Rule 10b-18 of the Securities Exchange Act of 1934, as amended, subject to market conditions, applicable legal requirements, and other factors. The program does not obligate NVIDIA 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. We did not enter into any structured share repurchase transactions or otherwise purchase any shares of our common stock during the three months ended May 1, 2011. Through May 1, 2011, we have repurchased an aggregate of 90.9 million shares under our stock repurchase program for a total cost of $1.46 billion. As of May 1, 2011, we are authorized, subject to certain specifications, to repurchase shares of our common stock up to $1.24 billion through May 2013.
Operating Capital and Capital Expenditure Requirements
We believe that our existing cash balances and anticipated cash flows from operations will be sufficient to meet our operating, acquisition and capital requirements for at least the next twelve months. However, there is no assurance that we will not need to raise additional equity or debt financing within this time frame. Additional financing may not be available on favorable terms or at all and may be dilutive to our then-current stockholders. We also may require additional capital for other purposes not presently contemplated. If we are unable to obtain sufficient capital, we could be required to curtail capital equipment purchases or research and development expenditures, which could harm our business. Factors that could affect our cash used or generated from operations and, as a result, our need to seek additional borrowings or capital include:
· decreased demand and market acceptance for our products and/or our customers’ products;
· inability to successfully develop and produce in volume production our next-generation products;
· competitive pressures resulting in lower than expected average selling prices; and
· new product announcements or product introductions by our competitors.
We expect to spend approximately $125 million to $175 million for capital expenditures during the remainder of fiscal year 2012. In addition, we may continue to use cash in connection with the acquisition of new businesses or assets.
For additional factors see “Item 1A. Risk Factors - Risks Related to Our Business, Industry and Partners - Our revenue may fluctuate while our operating expenses are relatively fixed, which makes our results difficult to predict and could cause our results to fall short of expectations.”
Icera Acquisition
On May 9, 2011, we announced our intention to acquire Icera Inc., an innovator of baseband processors for 3G and 4G cellular phones and tablets. Icera’s high speed wireless-modem products have been approved by more than 50 carriers across the globe. We believe that by combining our products and technologies, including the Tegra processor, we could enhance our position as a player in the growing mobile market. The acquisition, for $367 million in cash, has been approved by both companies' boards of directors and is expected to be completed, subject to customary closing conditions, approximately 30 days from the announcement date. Also in connection with our agreement to acquire Icera, we have committed to establishing a retention program in the amount of approximately $68.0 million to be paid out to Icera employees over a period of four years.
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 the second quarter of fiscal year 2011, we recorded an additional charge to cover the estimated remaining customer warranty, repair, return, replacement and other costs arising from a weak die/packaging material set in certain versions of our previous generation media and communications processor, or MCP, and graphics processing unit, or GPU, products used in notebook configurations. The net charge amounted to $193.9 million, of which $181.2 million was charged against cost of revenue. The extra remediation costs are primarily due to additional platforms from late failing systems that we had not previously considered to be at risk. Included in the charge are the estimated costs of implementing a settlement reached during the second quarter of fiscal year 2011 with the plaintiffs of a putative consumer class action lawsuit related to this same matter and another related estimated consumer class action settlement. As a result of this settlement, the other estimated settlement, and offsetting insurance reimbursements, we recorded a net charge of $12.7 million to sales, general and administrative expense during the second quarter of fiscal year 2011. Together with the $282.0 million net charge we had previously recorded for related estimated costs, this brings the total cumulative net charge to $475.9 million, of which $466.4 million has been charged against cost of revenue and the remainder has been charged to sales, general and administrative.
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 products are failing in the field at higher than normal rates. Testing suggests a weak material set of die/package combination, system thermal management designs, and customer use patterns are contributing factors for these failures. 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 products in their notebook system designs. We intend to fully support our customers in their repair and replacement of these impacted products that fail, and their other efforts to mitigate the consequences of these failures. The weak die/packaging material combination is not used in any of our products that are currently in production.
In September, October and November 2008, several putative securities class action lawsuits were filed against us, asserting various claims related to the impacted MCP and GPU products. Please refer to Note 12 of the Notes to the Condensed Consolidated Financial Statements for further information regarding this litigation and the settlement.
Contractual Obligations
At May 1, 2011, we had outstanding inventory purchase obligations totaling approximately $491.0 million. Also in connection with our agreement to acquire Icera, we have committed to establishing a retention program in the amount of approximately $68.0 million to be paid out to Icera employees over a period of four years. There were no other material changes in our contractual obligations from those disclosed in our Annual Report on Form 10-K for the fiscal year ended January 30, 2011.
Please see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” in our Annual Report on Form 10-K for a description of our contractual obligations.
Off-Balance Sheet Arrangements
As of May 1, 2011, we had no material off-balance sheet arrangements as defined in Regulation S-K 303(a)(4)(ii).
Adoption of New and Recently Issued Accounting Pronouncements
Please see Note 1 of the Notes to Condensed Consolidated Financial Statements for a discussion of adoption of new and recently issued accounting pronouncements.
Investment and Interest Rate Risk
As of May 1, 2011 and January 30, 2011, we had $2.73 billion and $2.49 billion, respectively, in cash, cash equivalents and marketable securities. We invest in a variety of financial instruments, consisting principally of cash and cash equivalents, commercial paper, mortgage-backed securities issued by government-sponsored enterprises, equity securities, money market funds and debt securities of corporations, municipalities and the United States government and its agencies. As of May 1, 2011, we did not have any investments in auction-rate preferred securities. All of our investments are denominated in United States dollars.
All of the cash equivalents and marketable securities are treated as “available-for-sale.” Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or if the decline in fair value of our publicly traded debt or equity investments is judged to be other-than-temporary. We may suffer losses in principal if we are forced to sell securities that decline in securities market value due to changes in interest rates. However, because any debt securities we hold are classified as “available-for-sale,” no gains or losses are realized in our Condensed Consolidated Statements of Operations due to changes in interest rates unless such securities are sold prior to maturity or unless declines in value are determined to be other-than-temporary. 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.
As of May 1, 2011, we performed a sensitivity analysis on our floating and fixed rate investments. According to our analysis, parallel shifts in the yield curve of both plus or minus 0.5% would result in changes in fair market values for these investments of approximately $11.7 million.
The financial turmoil that affected the banking system and financial markets and increased the possibility that financial institutions might consolidate or go out of business resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and extreme volatility in fixed income, credit, currency and equity markets. There could be a number of follow-on effects from the credit crisis on our business, including insolvency of key suppliers resulting in product delays; inability of customers, including channel partners, to obtain credit to finance purchases of our products and/or customer, including channel partner, insolvencies; and failure of financial institutions, which may negatively impact our treasury operations. Other income and expense could also vary materially from expectations depending on gains or losses realized on the sale or exchange of financial instruments; impairment charges related to debt securities as well as equity and other investments; interest rates; and cash, cash equivalent and marketable securities balances. Volatility in the financial markets and economic uncertainty increases the risk that the actual amounts realized in the future on our financial instruments could differ significantly from the fair values currently assigned to them. As of May 1, 2011, our investments in government agencies and government sponsored enterprises represented approximately 51% of our total investment portfolio, while the financial sector accounted for approximately 30% of our total investment portfolio. Of the financial sector investments, over half are guaranteed by the U.S. government. All of our investments are with A/A2 or better rated securities. If the fair value of our investments in these sectors was to decline by 2%-5%, fair market values for these investments would decline by approximately $42-$104 million.
Exchange Rate Risk
We consider our direct exposure to foreign exchange rate fluctuations to be minimal. Gains or losses from foreign currency remeasurement are included in “Other income (expense), net” in our Condensed Consolidated Financial Statements and to date have not been significant. The impact of foreign currency transaction loss included in determining net income for the first three months of fiscal years 2012 and 2011 was $(2.2) million and $0.7 million, respectively. Currently, revenue and arrangements with third-party manufacturers provide for pricing and payment in United States dollars, and, therefore, are not subject to exchange rate fluctuations. Increases in the value of the United States’ dollar relative to other currencies would make our products more expensive, which could negatively impact our ability to compete. Conversely, decreases in the value of the United States’ dollar relative to other currencies could result in our suppliers raising their prices in order to continue doing business with us. Fluctuations in currency exchange rates could harm our business in the future.
We may enter into certain transactions such as forward contracts which are designed to reduce the future potential impact resulting from changes in foreign currency exchange rates. There were no forward exchange contracts outstanding at May 1, 2011.
Controls and Procedures
Disclosure Controls and Procedures
Based on their evaluation as of May 1, 2011, our management, including our Chief Executive Officer and Chief Financial Officer, has concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) were effective to provide reasonable assurance.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal controls over financial reporting during our fiscal quarter ended May 1, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls, will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within NVIDIA have been detected.
Please see Part I, Item 1, Note 12 of the Notes to Condensed Consolidated Financial Statements for a discussion of our legal proceedings.
In evaluating NVIDIA and our business, the following factors should be considered in addition to the other information in this Quarterly Report on Form 10-Q. Before you buy our common stock, you should know that making such an investment involves some risks including, but not limited to, the risks described below. Additionally, any one of the following risks could seriously harm our business, financial condition and results of operations, which could cause our stock price to decline. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.
Risks Related to Our Business, Industry and Partners
Our business results could be adversely affected if the identification and development of new products is delayed or unsuccessful.
In order to maintain or improve our financial results, we will need to continue to identify and develop new products and enhancements to our existing products in a timely and cost-effective manner. The process of developing new products and services and enhancing existing products and services is highly complex, costly and uncertain, and any failure by us to anticipate customers’ changing needs and emerging technology trends could significantly harm our market. We must make long-term investments and commit significant resources before knowing whether our predictions will accurately reflect customer demand for our new products and technologies. It is possible that our development efforts will not be successful and that our new technologies will not result in meaningful revenues. Even if we introduce new and enhanced products to the market, we may not be able to achieve market acceptance of them in a timely manner.
Our ability to successfully develop and deliver new products will depend on various factors, including our ability to:
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Effectively identify and capitalize upon opportunities in new markets;
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Timely complete and introduce new products and technologies;
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Transition our semiconductor products to increasingly smaller line width geometries; and
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Obtain sufficient foundry capacity and packaging materials.
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We occasionally have experienced delays in completing the development and introduction of new products and product enhancements, and we could experience delays in the future. In addition, in the past, we have been unable to successfully manage product transitions from older to newer products resulting in obsolete inventory. Our failure to successfully develop and introduce new products and technologies or identify new uses for existing or future products, could result in rapidly declining average selling prices, reduced demand for our products or loss of market share any of which could harm our competitive position and cause our revenue, gross margin and overall financial results to suffer.
If we are unable to achieve market acceptance and design wins for our products and technologies, our results of operations and competitive position will be harmed.
The success of our business depends to a significant extent on our ability to achieve market acceptance of our new products and enhancements to our existing products and identify and enter new markets. The market for our product and technologies has been characterized by unpredictable and sometimes rapid shifts in the popularity of products, often caused by the publication of competitive industry benchmark results, changes in pricing of dynamic random-access memory devices and other changes in the total system cost of add-in boards, as well as by severe price competition and by frequent new technology and product introductions. Broad market acceptance is difficult to achieve and such market acceptance, if achieved, is difficult to sustain due to intense competition and frequent new technology and product introductions. If we do not successfully achieve or maintain market acceptance for our products and enhancements or identify and enter new markets, our ability to compete and maintain or increase revenues will suffer.
Additionally, there can be no assurance that the industry will continue to demand new products with improved standards, features or performance. If our customers, original equipment manufacturers, or OEMs, original design manufacturers, or ODMs, add-in-card and motherboard manufacturers, system builders and consumer electronics companies, do not continue to design products that require more advanced or efficient processors and/or the market does not continue to demand new products with increased performance, features, functionality or standards, sales of our products could decline and the markets for our products could shrink. Decreased sales of our products for these markets could negatively impact our revenue and our financial results.
We believe achieving design wins, which entails having our existing and future products chosen for hardware components or subassemblies designed by OEMs, or ODMs, add-in board and motherboard manufacturers is an integral part of our future success. Our OEM, ODM, and add-in board and motherboard manufacturers’ customers typically introduce new system configurations as often as twice per year, typically based on spring and fall design cycles or in connection with trade shows. Accordingly, when our customers are making their design decisions, our existing products must have competitive performance levels or we must timely introduce new products in order to be included in our customers’ new system configurations. This requires that we:
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anticipate the features and functionality that customers and consumers will demand;
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incorporate those features and functionalities into products that meet the exacting design requirements of our customers;
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price our products competitively; and
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introduce products to the market within our customers’ limited design cycles
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If OEMs, ODMs, and add-in board and motherboard manufacturers do not include our products in their systems, they will typically not use our products in their systems until at least the next design configuration. Therefore, we endeavor to develop close relationships with our OEMs and ODMs, in an attempt to better anticipate and address customer needs in new products so that we will achieve design wins.
Our ability to achieve design wins also depends in part on our ability to identify and be compliant with evolving industry standards. Unanticipated changes in industry standards could render our products incompatible with products developed by major hardware manufacturers and software developers. If our products are not in compliance with prevailing industry standards, we may not be designed into our customers’ product designs. However, to be compliant with changes to industry standards, we may have to invest significant time and resources to redesign our products which could negatively impact our gross margin or operating results. If we are unable to achieve new design wins for existing or new customers, we may lose market share and our operating results would be negatively impacted.
If we are unable to compete in the markets for our products, our financial results will be adversely impacted.
The market for our products, specifically the GPU and mobile and consumer markets are extremely competitive, and we expect competition to intensify as current competitors expand their product offerings, industry standards continue to evolve and others realize the market potential of mobile and consumer products and services. Our current competitors include the following, some of which have greater financial, technical and management resources than us:
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suppliers of GPUs, including chipsets, that incorporate 3D graphics functionality as part of their existing solutions, such as Advanced Micro Devices Inc., or AMD, Intel Corporation, or Intel, Matrox Electronics Systems Ltd., Silicon Integrated Systems, or SIS, and VIA Technologies, Inc.; and
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suppliers of system-on-a-chip products that support tablets, netbooks, PNDs, PMPs, PDAs, cellular phones, handheld devices or embedded devices such as AMD, Broadcom Corporation, Freescale Semiconductor, Inc., Fujitsu Limited, Imagination Technologies Ltd., Intel, Marvell Technology Group Ltd., NEC Corporation, Qualcomm Incorporated, Renesas Technology Corp., Samsung Electronics Co., Ltd., Seiko Epson Corporation, STMicroelectronics, Texas Instruments Incorporated, and Toshiba America Electronic Components, Inc.
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We expect competition to increase from both existing competitors and new market entrants with products that may be less costly than ours, or may provide better performance or additional features not provided by our products. In addition, it is possible that new competitors or alliances among competitors could emerge and acquire significant market share. Furthermore, competitors with greater financial resources may be able to offer lower prices than us, or they may offer additional products, services or other incentives that we may not be able to match. In addition, many of our competitors operate and maintain their own fabrication facilities and have longer operating histories, greater name recognition, larger customer bases, and greater sales, marketing and distribution resources than we do.
Our ability to compete will depend on, among other factors, our ability to:
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continue to keep pace with technological developments;
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develop and introduce new products, services, technologies and enhancements on a timely basis;
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become a preferred partner for operating system platforms, such as Android and Windows Mobile;
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transition our semiconductor products to increasingly smaller line width geometries;
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obtain sufficient foundry capacity and packaging materials; and
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succeed in significant foreign markets, such as China and India.
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If we are unable to compete in our current or new markets, demand for our products could decrease which could cause our revenue to decline and our financial results to suffer.
We expect substantial competition from both Intel’s and AMD’s strategy of selling platform solutions, such as the success Intel achieved with its Centrino platform solution. AMD is also shipping a platform solution. Additionally, Intel and AMD have each announced its intention to integrate a central processing unit, or CPU, and a GPU on the same chip, as evidenced by AMD’s announcement of its Fusion processor project and Intel’s introduction of Sandy Bridge products. If AMD and Intel continue to pursue platform solutions, we may not be able to successfully compete and our business would be negatively impacted.
If new consumer products and technologies which incorporate our products do not achieve market acceptance, our business could be negatively impacted.
The success of our business also depends on market acceptance of new consumer products and technologies, such as smartphones, smartbooks, tablets and other similar consumer electronics devices, which contain our products. As markets for these new consumer products emerge, we may encounter new sources of competition as well as customers who have different requirements than those in the PC business. If market acceptance of such products and technologies is not attained, our ability to compete and maintain or increase revenues will be adversely affected.
Our ability to be successful in emerging consumer product markets depends in part on our ability to cultivate new industry relationships in these market segments. As the number and variety of Internet-connected devices increase, we will need to improve the functionality of our products to succeed in these new markets, which may require significant time and resources on our part to design our products which could negatively impact our business.
We sell our products to a small number of customers and our business could suffer if we lose any of these customers.
We receive a significant amount of our revenue from a limited number of customers. Aggregate sales to customers in excess of 10% of total revenue for the first quarters of fiscal year 2012 and 2011 were 11% from one customer and 28% of our total revenue from two customers, respectively. Sales to our largest customers have fluctuated significantly from period to period primarily due to the timing and number of design wins with each customer, as well as the continued diversification of our customer base as we expand into new markets, and will likely continue to fluctuate dramatically in the future. Our operating results in the foreseeable future will continue to depend on sales to a relatively small number of customers, as well as the ability of these customers to sell products that incorporate our products. In the future, these customers may decide not to purchase our products at all, purchase fewer products than they did in the past, or alter their purchasing patterns in some other way, particularly because:
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substantially all of our sales are made on a purchase order basis, which permits our customers to cancel, change or delay product purchase commitments with little or no notice to us and without penalty;
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our customers may develop their own solutions;
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our customers may purchase products from our competitors; or
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our customers may discontinue sales or lose market share in the markets for which they purchase our products.
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The loss of any of our large customers or a significant reduction in sales we make to them would likely harm our financial condition and results of operations.
If we fail to appropriately scale our operations in response to changes in demand for our existing products or to the demand for new products requested by our customers, our business and profitability could be materially and adversely affected.
To achieve our business objectives, it may be necessary from time to time for us to expand or contract our operations. In the future, we may not be able to scale our workforce and operations in a sufficiently timely manner to respond effectively to changes in demand for our existing products or to the demand for new products requested by our customers. In that event, we may be unable to meet competitive challenges or exploit potential market opportunities, and our current or future business could be materially and adversely affected. Conversely, if we expand our operations and workforce too rapidly in anticipation of increased demand for our products, and such demand does not materialize at the pace at which we expected, the rate of increase in our costs and operating expenses may exceed the rate of increase in our revenue, which would adversely affect our results of operations. In addition, if such demand does not materialize at the pace which we expect, we may be required to scale down our business through expense and headcount reductions as well as facility consolidations or closures that could result in restructuring charges that would materially and adversely affect our results of operations. Because many of our expenses are fixed in the short-term or are incurred in advance of anticipated sales, we may not be able to decrease our expenses in a timely manner to offset any decrease in customer demand. If customer demand does not increase as anticipated, our profitability could be adversely affected due to our higher expense levels.
Our past growth has placed, and any future long-term growth is expected to continue to place, a significant strain on our management personnel, systems and resources. To implement our current business and product plans, we will need to continue to expand, train, manage and motivate our workforce. All of these endeavors require substantial management effort. If we are unable to effectively manage our expanding operations, we may be unable to scale our business quickly enough to meet competitive challenges or exploit potential market opportunities, or conversely, we may scale our business too quickly and the rate of increase in our costs and expenses may exceed the rate of increase in our revenue, either of which would materially and adversely affect our results of operations.
We depend on foundries to manufacture our products and these third parties may not be able to satisfy our manufacturing requirements, which would harm our business.
We do not manufacture the silicon wafers used for our products and do not own or operate a wafer fabrication facility. Instead, we are dependent on industry-leading foundries, such as Taiwan Semiconductor Manufacturing Company Limited, or TSMC, to manufacture our semiconductor wafers using their fabrication equipment and techniques. A substantial portion of our wafers are supplied by TSMC. The foundries, which have limited capacity, also manufacture products for other semiconductor companies, including some of our competitors. Since we do not have long-term commitment contracts with any of these foundries, they do not have an obligation to provide us with any minimum quantity of product at any time except as may be provided in a specific purchase order. Most of our products are only manufactured by one foundry at a time. In times of high demand, the foundries could choose to prioritize their capacity for other companies, reduce or eliminate deliveries to us, or increase the prices that they charge us. If we are unable to meet customer demand due to reduced or eliminated deliveries or have to increase the prices of our products, we could lose sales to customers, which would negatively impact our revenue and our reputation.
Because the lead-time needed to establish a strategic relationship with a new manufacturing partner and achieve initial production could be over a year, we do not have an alternative source of supply for our products. In addition, the time and effort to qualify a new foundry would result in additional expense, diversion of resources, and could result in lost sales, any of which would negatively impact our financial results. We believe that long-term market acceptance for our products will depend on reliable relationships with the third-party manufacturers we use to ensure adequate product supply and competitive pricing to respond to customer demand.
If our third-party foundries are not able to transition to new manufacturing process technologies or develop, obtain or successfully implement high quality, leading-edge process technologies our operating results and gross margin could be adversely affected.
We use the most advanced manufacturing process technology appropriate for our products that is available from our third-party foundries. As a result, we continuously evaluate the benefits of migrating our products to smaller geometry process technologies in order to improve performance and reduce costs. We believe this strategy will help us remain competitive. Our current product families are manufactured using 0.15 micron, 0.14 micron, 0.13 micron, 0.11 micron, 90 nanometer, 65 nanometer, 55 nanometer and 40 nanometer process technologies. Manufacturing process technologies are subject to rapid change and require significant expenditures for research and development, which could negatively impact our operating expenses and gross margin.
We have experienced difficulty in migrating to new manufacturing processes in the past and, consequently, have suffered reduced yields, delays in product deliveries and increased expense levels. We may face similar difficulties, delays and expenses as we continue to transition our new products to smaller geometry processes. Moreover, we are dependent on our third-party manufacturers to invest sufficient funds in new manufacturing processes in order to have ample capacity for all of their customers and to develop the processes in a timely manner. Our product cycles may also depend on our third-party manufacturers migrating to smaller geometry processes successfully and in time for us to meet our customer demands. Some of our competitors own their manufacturing facilities and may be able to move to a new state of the art manufacturing process more quickly or more successfully than our manufacturing partners. If our suppliers fall behind our competitors in manufacturing processes, the development and customer demand for our products and the use of our products could be negatively impacted. If we are forced to use larger geometric processes in manufacturing a product than our competition, our gross margin may be reduced. The inability by us or our third-party manufacturers to effectively and efficiently transition to new manufacturing process technologies may adversely affect our operating results and our gross margin.
We cannot be certain that our third-party foundries will be able to develop, obtain or successfully implement high quality, leading-edge process technologies needed to manufacturer our products profitably or on a timely basis or that our competitors (including those that own their own manufacturing facilities) will not develop such high quality, leading-edge process technologies earlier. If our third party-foundries experience manufacturing inefficiencies, we may fail to achieve acceptable yields or experience product delivery delays. If our third-party foundries fall behind our competitors (including those that own their own manufacturing facilities), the development and customer demand for our products and the use of our products could be negatively impacted. Additionally, we cannot be certain that our third-party foundries will manufacture our products at a price that is competitive to what our competitors pay. If our third-party foundries do not charge us a competitive price, our operating results and gross margin will be negatively impacted.
Failure to achieve expected manufacturing yields for our products could negatively impact our financial results and damage our reputation.
Manufacturing yields for our products are a function of product design, which is developed largely by us, and process technology, which typically is proprietary to the manufacturer. Low yields may result from either product design or process technology failure. We do not know a yield problem exists until our design is manufactured. When a yield issue is identified, the product is analyzed and tested to determine the cause. As a result, yield problems may not be identified until well into the production process. Resolution of yield problems requires cooperation by, and communication between, us and the manufacturer. Because of our potentially limited access to wafer foundry capacity, decreases in manufacturing yields could result in an increase in our costs and force us to allocate our available product supply among our customers. Lower than expected yields could potentially harm customer relationships, our reputation and our financial results.
Global economic conditions may adversely affect our business and financial results.
Our operations and performance depend significantly on worldwide economic conditions. Uncertainty about current global economic conditions poses a continuing risk to our business as consumers and businesses have postponed spending in response to tighter credit, negative financial news and/or declines in income or asset values, which have reduced the demand for our products.
Other factors that could depress demand for our products in the future include conditions in the residential real estate and mortgage markets, expectations for inflation, labor and healthcare costs, access to credit, consumer confidence, and other macroeconomic factors affecting consumer and business spending behavior. These and other economic factors have reduced demand for our products in the past and could further harm our business, financial condition and operating results.
Our business is cyclical in nature and has experienced severe downturns that have harmed, and may in the future harm our business and financial results.
Our business is directly affected by market conditions in the highly cyclical semiconductor industry. The semiconductor industry has been adversely affected by many factors, including the global downturn, ongoing efforts by our customers to reduce their spending, diminished product demand, increased inventory levels, lower average selling prices, uncertainty regarding long-term growth rates and underlying financial health and increased competition. These factors, could, among other things, limit our ability to maintain or increase our sales or recognize revenue and in turn adversely affect our business, operating results and financial condition. If our actions to reduce our operating expenses to sufficiently offset these factors when they occur are unsuccessful, our operating results will suffer.
Our failure to estimate customer demand properly could adversely affect our financial results.
We manufacture our products based on forecasts of customer demand in order to have shorter shipment lead times and quicker delivery schedules for our customers. As a result, we may build inventories for anticipated periods of growth which do not occur or may build inventory anticipating demand for a product that does not materialize. In forecasting demand, we make multiple assumptions any of which may prove to be incorrect. Situations that may result in excess or obsolete inventory include:
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changes in business and economic conditions, including downturns in the semiconductor industry and/or overall economy;
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changes in consumer confidence caused by changes in market conditions, including changes in the credit market, expectations for inflation, and energy prices;
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if there were a sudden and significant decrease in demand for our products;
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if there were a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements;
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if we fail to estimate customer demand properly for our older products as our newer products are introduced; or
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if our competition were to take unexpected competitive pricing actions.
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Any inability to sell products to which we have devoted resources could harm our business. In addition, cancellation or deferral of customer purchase orders could result in our holding excess inventory, which could adversely affect our gross margin and restrict our ability to fund operations. Additionally, because we often sell a substantial portion of our products in the last month of each quarter, we may not be able to reduce our inventory purchase commitments in a timely manner in response to customer cancellations or deferrals. We could be subject to excess or obsolete inventories and be required to take corresponding inventory write-downs and/or a reduction in average selling prices if growth slows or does not materialize, or if we incorrectly forecast product demand, which could negatively impact our financial results.
Conversely, if we underestimate our customers’ demand for our products, our third party manufacturing partners may not have adequate lead-time or capacity to increase production for us meaning that we may not be able to obtain sufficient inventory to fill our customers’ orders on a timely basis. Even if we are able to increase production levels to meet customer demand, we may not be able to do so in a cost effective or timely manner. Inability to fulfill our customers’ orders on a timely basis, or at all, could damage our customer relationships, result in lost revenue, cause a loss in market share, impact our customer relationships or damage our reputation, any of which could adversely impact our business.
Because our gross margin for any period depends on a number of factors, our failure to forecast changes in any of these factors could adversely affect our gross margin.
We are focused on improving our gross margin. Our gross margin for any period depends on a number of factors, including:
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the mix of our products sold;
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average selling prices;
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introduction of new products;
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unexpected pricing actions by our competitors;
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the cost of product components; and
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the yield of wafers produced by the foundries that manufacture our products.
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If we do not correctly forecast the impact of any of the relevant factors on our business, there may not be any actions we can take or we may not be able to take any possible actions in time to counteract any negative impact on our gross margin. In addition, if we are unable to meet our gross margin target for any period or the target set by analysts, the trading price of our common stock may decline.
Our revenue may fluctuate while our operating expenses are relatively fixed, which makes our results difficult to predict and could cause our results to fall short of expectations.
Demand for many of our revenue components fluctuates and is difficult to predict, and our operating expenses are relatively fixed and largely independent of revenue. Therefore, it is difficult for us to accurately forecast revenue and profits or losses in any particular period. Our operating expenses, which are comprised of research and development expenses and sales, general and administrative expenses represented 34.3% and 30.9% of our total revenue for the first quarter of fiscal years 2012 and 2011 respectively. Since we often recognize a substantial portion of our revenue in the last month of each quarter, we may not be able to adjust our operating expenses in a timely manner in response to any unanticipated revenue shortfalls in any quarter. Further, some of our operating expenses, like stock-based compensation expense, can only be adjusted over a longer period of time and cannot be reduced during a quarter. If we are unable to reduce operating expenses quickly in response to any revenue shortfalls, our financial results will be negatively impacted.
Any one or more of the risks discussed in this Quarterly Report on Form 10-Q or other factors could prevent us from achieving our expected future revenue or net income. Accordingly, we believe that period-to-period comparisons of our results of operations should not be relied upon as an indication of future performance. Similarly, the results of any quarterly or full fiscal year period are not necessarily indicative of results to be expected for a subsequent quarter or a full fiscal year. As a result, it is possible that in some quarters our operating results could be below the expectations of securities analysts or investors, which could cause the trading price of our common stock to decline. We believe that our quarterly and annual results of operations may continue to be affected by a variety of factors that could harm our revenue, gross profit and results of operations.
Any difficulties in collecting accounts receivable, including from foreign customers, could harm our operating results and financial condition.
Our accounts receivable are highly concentrated and make us vulnerable to adverse changes in our customers’ businesses, and to downturns in the industry and the worldwide economy. We recorded approximately 12% of our accounts receivable balance from one customer at May 1, 2011.
Difficulties in collecting accounts receivable could materially and adversely affect our financial condition and results of operations. These difficulties are heightened during periods when economic conditions worsen. We continue to work directly with more foreign customers and it may be difficult to collect accounts receivable from them. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance consists of an amount identified for specific customers and an amount based on overall estimated exposure. If the financial condition of our customers were to deteriorate, resulting in an impairment in their ability to make payments, additional allowances may be required, we may be required to defer revenue recognition on sales to affected customers, and we may be required to pay higher credit insurance premiums, any of which could adversely affect our operating results. In the future, we may have to record additional reserves or write-offs and/or defer revenue on certain sales transactions which could negatively impact our financial results.
We obtain credit insurance over the purchasing credit extended to certain customers. As a result of the tightening of the credit markets, we may not be able to acquire credit insurance on the credit we extend to these customers or in amounts that we deem sufficient. While we have procedures to monitor and limit exposure to credit risk on our accounts receivable, there can be no assurance such procedures will effectively limit our credit risk or avoid losses, which could harm our financial condition or operating results.
We may not be able to attract and retain qualified employees which could negatively impact our business.
Our future success and ability to compete is substantially dependent on our ability to identify, hire, train and retain highly qualified key personnel. The market for key employees in the technology industry can be competitive. None of our key employees is bound by an employment agreement, meaning our relationships with all of our key employees are at will. The loss of the services of any of our other key employees without an adequate replacement or our inability to hire new employees as needed could delay our product development efforts, harm our ability to sell our products or otherwise negatively impact our business.
In addition, we rely on stock-based awards as a means for recruiting, motivating and retaining highly skilled talent. If the value of such stock awards does not appreciate as measured by the performance of the price of our common stock or if our share-based compensation otherwise ceases to be viewed as a valuable benefit, our ability to attract, retain, and motivate employees could be weakened, which could harm our results of operations.
We are dependent on third parties for assembly, testing and packaging of our products, which reduce our control over the delivery schedule, product quantity or product quality.
Our products are assembled, tested and packaged by independent subcontractors, such as Advanced Semiconductor Engineering, Inc., Amkor Technology, JSI Logistics, Ltd., King Yuan Electronics Co., Siliconware Precision Industries Co. Ltd., and ChipPAC. As a result, we do not directly control our product delivery schedules, product quantity, or product quality. All of these subcontractors assemble, test and package products for other companies, including some of our competitors. Since we do not have long-term agreements with our subcontractors, when demand for subcontractors to assemble, test or package products is high, our subcontractors may decide to prioritize the orders of other customers over our orders. Since the time required to qualify a different subcontractor to assemble, test or package our products can be lengthy, if we have to find a replacement subcontractor we could experience significant delays in shipments of our products, product shortages, a decrease in the quality of our products, or an increase in product cost. Any product shortages or quality assurance problems could increase the costs of manufacture, assembly or testing of our products, which could cause our gross margin and revenue to decline.
We rely on third-party vendors to supply software development tools to us for the development of our new products and we may be unable to obtain the tools necessary to develop or enhance new or existing products.
We rely on third-party software development tools to assist us in the design, simulation and verification of new products or product enhancements. To bring new products or product enhancements to market in a timely manner, or at all, we need software development tools that are sophisticated enough or technologically advanced enough to complete our design, simulations and verifications. In the past, we have experienced delays in the introduction of products as a result of the inability of then available software development tools to fully simulate the complex features and functionalities of our products. In the future, the design requirements necessary to meet consumer demands for more features and greater functionality from our products may exceed the capabilities of available software development tools. Unavailability of software development tools may result in our missing design cycles or losing design wins, either of which could result in a loss of market share or negatively impact our operating results.
Because of the importance of software development tools to the development and enhancement of our products, a critical component of our product development efforts is our partnerships with leaders in the computer-aided design industry, including Cadence Design Systems, Inc. and Synopsys, Inc. We have invested significant resources to develop relationships with these industry leaders and have often assisted them in the definition of their new products. We believe that forming these relationships and utilizing next-generation development tools to design, simulate and verify our products will help us remain at the forefront of the 3D graphics, communications and networking segments and develop products that utilize leading-edge technology on a rapid basis. If these relationships are not successful, we may be unable to develop new products or product enhancements in a timely manner, which could result in a loss of market share, a decrease in revenue or negatively impact our operating results.
We are dependent on the personal computer market and its rate of growth in the future may have a negative impact on our business.
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 personal computer, or 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. 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.
If our products contain significant defects our financial results could be negatively impacted, our reputation could be damaged and we could lose market share.
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 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 our customers’ costs to repair or replace products in the field. A product recall or a significant number of product returns could be expensive, damage our reputation, could result in the shifting of business to our competitors and could result in litigation against us. Costs associated with correcting defects, errors, bugs or other issues could be significant and could materially harm our financial results. During fiscal years 2011, 2010 and 2009, we recorded net warranty charges of $466.4 million against cost of revenue to cover anticipated customer warranty, repair, return, replacement and other costs arising from a weak die/packaging material set used in certain versions of our previous generation MCP and GPU products shipped after July 2008 and used in notebook configurations. Please see the risk entitled “We are subject to litigation arising from alleged defects in our previous generation MCP and GPU products, which if determined adversely to us, could harm our business” for further information regarding this product defect.
We may have to invest more resources in research and development than anticipated, which could increase our operating expenses and negatively impact our operating results.
If new competitors, technological advances by existing competitors, our entry into new markets, or other competitive factors require us to invest significantly greater resources than anticipated in our research and development efforts, our operating expenses would increase. Our engineering and technical resources included 4,437 full-time employees as of May 1, 2011 and 3,971 employees as of May 2, 2010, respectively. Research and development expenditures were $231.5 million and $218.1 million for the first quarter of fiscal years 2012 and 2011, respectively. Research and development expenses included stock-based compensation expense of $18.6 million and $14.6 million for the first quarter of fiscal years 2012 and 2011, respectively. If we are required to invest significantly greater resources than anticipated in research and development efforts without a corresponding increase in revenue, our operating results could decline. Research and development expenses are likely to fluctuate from time to time to the extent we make periodic incremental investments in research and development and these investments may be independent of our level of revenue which could negatively impact our financial results. In order to remain competitive, we anticipate that we will continue to devote substantial resources to research and development, and we expect these expenses to increase in absolute dollars in the foreseeable future due to the increased complexity and the greater number of products under development.
We are subject to risks associated with international operations which may harm our business.
We conduct our business worldwide. Our semiconductor wafers are manufactured, assembled, tested and packaged by third-parties located outside of the United States and other Americas. We generated 81% and 85% of our revenue for the first quarter of fiscal years 2012 and 2011, respectively, from sales to customers outside the United States and other Americas. As of May 1, 2011, we have offices in 15 countries outside of the United States. The manufacture, assembly, test and packaging of our products outside of the United States, operation of offices outside of the United States, and sales to customers internationally subjects us to a number of risks, including:
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international economic and political conditions, such as political tensions between countries in which we do business;
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unexpected changes in, or impositions of, legislative or regulatory requirements;
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complying with a variety of foreign laws;
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differing legal standards with respect to protection of intellectual property and employment practices;
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cultural differences in the conduct of business;
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inadequate local infrastructure that could result in business disruptions;
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exporting or importing issues related to export or import restrictions, tariffs, quotas and other trade barriers and restrictions;
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financial risks such as longer payment cycles, difficulty in collecting accounts receivable and fluctuations in currency exchange rates;
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imposition of additional taxes and penalties; and
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other factors beyond our control such as terrorism, civil unrest, war and diseases such as severe acute respiratory syndrome and the Avian flu.
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If sales to any of our customers outside of the United States and other Americas are delayed or cancelled because of any of the above factors, our revenue may be negatively impacted.
Our international operations in Australia, China, Finland, France, Germany, Hong Kong, India, Japan, Korea, Russia, Singapore, Sweden, Switzerland, Taiwan, and the United Kingdom are subject to many of the above listed risks. Difficulties with our international operations, including finding appropriate staffing and office space, may divert management’s attention and other resources any of which could negatively impact our operating results.
The economic conditions in our primary overseas markets, particularly in Asia, may negatively impact the demand for our products abroad. All of our international sales to date have been denominated in United States dollars. Accordingly, an increase in the value of the United States dollar relative to foreign currencies could make our products less competitive in international markets or require us to assume the risk of denominating certain sales in foreign currencies. We anticipate that these factors will impact our business to a greater degree as we further expand our international business activities.
Conditions outside the control of our independent subcontractors and manufacturers may impact their business operations and thereby adversely interrupt our manufacturing and sales processes.
The economic, market, social, and political situations in countries where certain independent subcontractors and manufacturers are located are unpredictable, can be volatile, and can have a significant impact on our business because we may be unable to obtain or distribute product in a timely manner. Market and political conditions, including currency fluctuation, terrorism, political strife, war, labor disruption, and other factors, including climate change, natural or man-made disasters, adverse changes in tax laws, tariff, import or export quotas, power and water shortages, or interruption in air transportation, in areas where our independent subcontractors and manufacturers are located could also have a severe negative impact on our operating capabilities. For example, because we rely heavily on TSMC to produce a significant portion of our silicon wafers, earthquakes, typhoons or other natural disasters in Taiwan and Asia could limit our wafer supply and thereby harm our business, financial condition, and operational results.
We may not be able to realize the potential financial or strategic benefits of business acquisitions or strategic investments, which could hurt our ability to grow our business, develop new products or sell our products.
We have acquired and invested in other businesses that offered products, services and technologies that we believe will help expand or enhance our existing products and business. Most recently, we announced our intention to acquire Icera Inc., an innovator of baseband processors for 3G and 4G cellular phones and tablets, which is expected to be completed, subject to customary closing conditions, in approximately 30 days from the announcement date. However, there can be no assurance the Icera acquisition will be completed as proposed, or at all. We may enter into future acquisitions of, or investments in, businesses, in order to complement or expand our current businesses or enter into a new business market. Negotiations associated with an acquisition or strategic investment could divert management’s attention and other company resources. Any of the following risks associated with past or future acquisitions or investments could impair our ability to grow our business, develop new products, our ability to sell our products, and ultimately could have a negative impact on our growth or our financial results: