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NVIDIA 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Q206 FORM 10Q

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
 
FORM 10-Q
 
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the quarterly period ended July 31, 2005
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 

Commission file number: 0-23985

NVIDIA CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
94-3177549
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)

2701 San Tomas Expressway
Santa Clara, California 95050
(408) 486-2000
(Address, including Zip Code, of Registrant's Principal Executive Offices
and Registrant's Telephone Number, including Area Code)

----------------

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [_]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [_] No [X]

The number of shares of the registrant's common stock outstanding as of August 12, 2005 was 168,692,071 shares.

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

 






NVIDIA CORPORATION
FORM 10-Q
TABLE OF CONTENTS

   
Page
 
PART I: FINANCIAL INFORMATION
 
 
Item 1.
 
Financial Statements (Unaudited)
 
 
 
Condensed Consolidated Balance Sheets as of July 31, 2005 and January 30, 2005
 
1
 
 
Condensed Consolidated Statements of Income for the three and six months ended July 31, 2005 and July 25, 2004
 
2
 
 
Condensed Consolidated Statements of Cash Flows for the six months ended July 31, 2005 and July 25, 2004
 
3
 
 
Notes to Condensed Consolidated Financial Statements
 
4
     
 
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
15
     
 
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
 
25
     
 
Item 4.
 
Controls and Procedures
 
40
     
 
PART II: OTHER INFORMATION
 
 
Item 1.
 
Legal Proceedings
 
41
     
 
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
41
     
 
Item 3.
 
Defaults Upon Senior Securities
 
41
     
 
Item 4.
 
Submission of Matters to a Vote of Security Holders
 
41
     
 
Item 5.
 
Other Information
 
42
     
 
Item 6.
 
Exhibits
 
42
     
 
Signature
 
 
43
 





PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS (Unaudited)

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

   
July 31,
 
January 30,
 
   
2005
 
2005
 
ASSETS
         
Current assets:
         
Cash and cash equivalents
 
$
242,170
 
$
208,512
 
Marketable securities
   
475,376
   
461,533
 
Accounts receivable, net
   
355,393
   
296,279
 
Inventories
   
300,955
   
315,518
 
Prepaid expenses and other current assets
   
24,756
   
19,819
 
Deferred income taxes
   
3,265
   
3,265
 
Total current assets
   
1,401,915
   
1,304,926
 
               
Property and equipment, net
   
178,951
   
178,955
 
Deposits and other assets
   
15,977
   
9,034
 
Goodwill
   
108,107
   
108,107
 
Intangible assets, net
   
23,268
   
27,514
 
   
$
1,728,218
 
$
1,628,536
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
             
               
Current liabilities:
             
Accounts payable
 
$
221,047
 
$
238,223
 
Accrued liabilities
   
204,451
   
182,077
 
Current portion of capital lease obligations
   
-
   
856
 
Total current liabilities
   
425,498
   
421,156
 
               
Deferred income tax liabilities
   
20,754
   
20,754
 
Long-term liabilities
   
6,733
   
8,358
 
               
Stockholders’ equity:
             
Common stock
   
174
   
169
 
Additional paid-in capital
   
691,914
   
636,618
 
Deferred compensation
   
(2,290
)
 
(2,926
)
Treasury stock
   
(122,142
)
 
(24,644
)
Accumulated other comprehensive loss, net
   
(4,218
)
 
(3,463
)
Retained earnings
   
711,795
   
572,514
 
Total stockholders' equity
   
1,275,233
   
1,178,268
 
   
$
1,728,218
 
$
1,628,536
 
               
               

See accompanying notes to condensed consolidated financial statements.


1


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

   
Three Months Ended
 
Six Months Ended
 
   
July 31,
 
July 25,
 
July 31,
 
July 25,
 
   
2005
 
2004
 
2005
 
2004
 
                   
Revenue
 
$
574,812
 
$
456,061
 
$
1,158,658
 
$
927,966
 
Cost of revenue
   
357,278
   
315,968
   
730,971
   
639,037
 
Gross profit
   
217,534
   
140,093
   
427,687
   
288,929
 
Operating expenses:
                         
Research and development
   
85,814
   
85,420
   
171,727
   
163,170
 
Sales, general and administrative
   
51,683
   
50,874
   
99,741
   
98,080
 
Total operating expenses
   
137,497
   
136,294
   
271,468
   
261,250
 
Operating income
   
80,037
   
3,799
   
156,219
   
27,679
 
Interest income
   
4,867
   
2,688
   
8,762
   
5,539
 
Interest expense
   
(2
)
 
(46
)
 
(12
)
 
(122
)
Other income (expense), net
   
354
   
(42
)
 
842
   
(10
)
Income before income tax expense
   
85,256
   
6,399
   
165,811
   
33,086
 
Income tax expense
   
10,419
   
1,280
   
26,530
   
6,618
 
Net income
 
$
74,837
 
$
5,119
 
$
139,281
 
$
26,468
 
Basic net income per share
 
$
0.44
 
$
0.03
 
$
0.83
 
$
0.16
 
Diluted net income per share
 
$
0.41
 
$
0.03
 
$
0.77
 
$
0.15
 
Shares used in basic per share computation
   
168,943
   
166,252
   
168,795
   
165,711
 
Shares used in diluted per share computation
   
180,790
   
177,419
   
180,612
   
177,999
 

See accompanying notes to condensed consolidated financial statements.

2


NVIDIA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
   
Six Months Ended
 
   
July 31,
 
July 25,
 
   
2005
 
2004
 
Cash flows from operating activities:
             
Net income
 
$
139,281
 
$
26,468
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Depreciation and amortization
   
49,667
   
47,486
 
Stock-based compensation
   
562
   
747
 
Bad debt expense
   
(477
)
 
(202
)
Other
   
85
   
-
 
Changes in operating assets and liabilities:
             
Accounts receivable
   
(48,637
)
 
(59,834
)
Inventories
   
14,563
   
(32,747
)
Prepaid expenses and other current assets
   
(4,937
)
 
(1,789
)
Deposits and other assets
   
(6,943
)
 
(546
)
Accounts payable
   
(17,176
)
 
37,859
 
Accrued liabilities
   
10,938
   
15,153
 
Net cash provided by operating activities
   
136,926
   
32,595
 
Cash flows from investing activities:
             
Purchases of marketable securities
   
(133,214
)
 
(170,132
)
Sales and maturities of marketable securities
   
115,614
   
121,967
 
Purchases of property, equipment and intangible assets
   
(42,689
)
 
(35,227
)
Net cash used in investing activities
   
(60,289
)
 
(83,392
)
Cash flows from financing activities:
             
Common stock issued under employee stock plans
   
55,895
   
19,787
 
Stock repurchases
   
(98,509
)
 
-
 
Principal payments on capital leases
   
(856
)
 
(2,833
)
Retirement of common stock
   
491
   
-
 
Net cash (used in) provided by financing activities
   
(42,979
)
 
16,954
 
Change in cash and cash equivalents
   
33,658
   
(33,843
)
Cash and cash equivalents at beginning of period
   
208,512
   
214,422
 
Cash and cash equivalents at end of period
 
$
242,170
 
$
180,579
 
               
Supplemental disclosures of cash flow information:
             
Cash paid for interest
 
$
12
 
$
122
 
Net payment (refund) of income taxes
 
$
1,838
 
$
(258
)
               
Non cash activities:
             
Acquisition of business - goodwill adjustment
 
$
-
 
$
343
 
Application of customer advance to accounts receivable
 
$
10,000
 
$
10,271
 
Deferred stock compensation
 
$
74
 
$
251
 
Unrealized losses from marketable securities
 
$
944
 
$
5,041
 
               

See accompanying notes to condensed consolidated financial statements.

3


NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1 - Summary of Significant Accounting Policies

Basis of presentation

The accompanying unaudited condensed consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Securities and Exchange Commission, or SEC, Regulation S-X. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, except as otherwise noted, considered necessary for a fair statement of results of operations and financial position have been included. The results for the interim periods presented are not necessarily indicative of the results expected for any future period. The following information should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended January 30, 2005. 

Fiscal year

We operate on a 52 or 53-week year, ending on the Sunday nearest January 31. Fiscal year 2006 is a 52-week year, compared to fiscal year 2005 which was a 53-week year. The second quarters of fiscal year 2006 and fiscal year 2005 were both 13-week quarters.

Reclassifications

Certain prior fiscal year balances were reclassified to conform to the current fiscal year presentation.

Use of Estimates

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

Stock-Based Compensation 

We use the intrinsic value method, as prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, to account for our stock-based employee compensation plans. As such, compensation expense is recorded if on the date of grant the current fair value per share of the underlying stock exceeds the exercise price per share. Compensation cost for our stock-based compensation plans as determined consistent with Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, would have decreased net income in the periods presented to the pro forma amounts indicated below:

4


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



   
Three Months Ended
 
Six Months Ended
 
   
July 31,
 
July 25,
 
July 31,
 
July 25,
 
   
2005
 
2004
 
2005
 
2004
 
   
(In thousands, except per share data)
 
                   
Net income, as reported
 
$
74,837
 
$
5,119
 
$
139,281
 
$
26,468
 
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects
   
244
   
291
   
472
   
597
 
Deduct: Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
   
(22,034
)
 
(21,699
)
 
(38,880
)
 
(42,420
)
Pro forma net income (loss)
 
$
53,047
 
$
(16,289
)
$
100,873
 
$
(15,355
)
Basic net income per share - as reported
 
$
0.44
 
$
0.03
 
$
0.83
 
$
0.16
 
Basic net income (loss) per share - pro forma
 
$
0.31
 
$
(0.10
)
$
0.60
 
$
(0.09
)
Diluted net income per share - as reported
 
$
0.41
 
$
0.03
 
$
0.77
 
$
0.15
 
Diluted net income (loss) per share - pro forma
 
$
0.29
 
$
(0.10
)
$
0.56
 
$
(0.09
)

During the first quarter of fiscal 2006, we transitioned from a Black-Scholes model to a binomial model for calculating the estimated fair value of new stock-based compensation awards granted under our stock option plans.  As a result of recent regulatory guidance, including SEC Staff Accounting Bulletin No. 107, or SAB No. 107, and in anticipation of the impending effective date of Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standards No. 123(R), or SFAS No. 123(R), Share-Based Payment, we reevaluated the assumptions we use to estimate the value of employee stock options and shares issued under our employee stock purchase plan, beginning with stock options granted and shares issued under our employee stock purchase plan in our first quarter of fiscal 2006.  Our management determined that the use of implied volatility is expected to be more reflective of market conditions and, therefore, can reasonably be expected to be a better indicator of expected volatility than historical volatility. Additionally, in the first quarter of fiscal 2006, we began segregating options into groups for employees with relatively homogeneous exercise behavior in order to make full use of the capabilities of the binomial valuation model.  As such, the expected term is based on detailed historical data about employees' exercise behavior, vesting schedules, and death and disability probabilities.  Our management believes the resulting binomial calculation provides a more refined estimate of the fair value of our employee stock options. For our employee stock purchase plan, our management decided to continue to use the Black-Scholes model to calculate the estimated fair value. 
 
For the purpose of the pro forma calculation, the fair value of stock options granted under our stock option plans and the fair value of shares issued under our employee stock purchase plan have been estimated with the following assumptions:

 
Stock Options
 
Employee Stock Purchase Plan
               
 
Three Months Ended
 
Three Months Ended
 
July 31,
 
July 25,
 
July 31,
 
July 25,
 
2005
 
2004
 
2005
 
2004
 
(Using a binomial model)
 
(Using the Black-Scholes model)
 
(Using the Black-Scholes model)
 
(Using the Black-Scholes model)
Expected life (in years)
3.6 - 5.1
 
4.0
 
0.5 - 2.0
 
1.5
Risk free interest rate
4.1%
 
3.4%
 
1.1% - 2.1%
 
1.9%
Volatility
40% - 46%
 
80%
 
41%
 
80%
Dividend yield
--
 
--
 
--
 
--
 


5


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

 
Stock Options
 
Employee Stock Purchase Plan
               
 
Six Months Ended
 
Six Months Ended
 
July 31,
 
July 25,
 
July 31,
 
July 25,
 
2005
 
2004
 
2005
 
2004
 
(Using a binomial model)
 
(Using the Black-Scholes model)
 
(Using the Black-Scholes model)
 
(Using the Black-Scholes model)
Expected life (in years)
3.6 - 5.1
 
4.0
 
0.5 - 2.0
 
1.5
Risk free interest rate
4.0%
 
2.9%
 
1.1% - 2.1%
 
1.9%
Volatility
37% - 48%
 
80%
 
41%
 
80%
Dividend yield
--
 
--
 
--
 
--

Note 2 - Recently Issued Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123(R), which requires the measurement and recognition of compensation expense for all stock-based compensation payments. In April 2005, the SEC delayed the effective date of SFAS No. 123(R), which is now effective for annual periods that begin after June 15, 2005. In March 2005, the SEC issued SAB No. 107, which includes interpretive guidance for the initial implementation of SFAS 123(R). SFAS No. 123(R) allows for either prospective recognition of compensation expense or retrospective recognition. We are currently evaluating which expense recognition method we will apply upon adoption of SFAS No. 123(R). We will implement the provisions of SFAS No. 123(R) beginning in fiscal 2007. Once adopted, the standard will have an adverse impact on our operating results.
    
In June 2005, the FASB issued SFAS No. 154, or SFAS No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. We will adopt SFAS 154 during the first quarter of fiscal 2007. We do not expect the adoption of SFAS No. 154 to have a material impact on our consolidated financial position, results of operations or cash flows.

Note 3 - Net Income Per Share

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

   
Three Months Ended
 
Six Months Ended
 
   
July 31,
 
July 25,
 
July 31,
 
July 25,
 
   
2005
 
2004
 
2005
 
2004
 
   
(In thousands, except per share data)
 
Numerator:
                 
Numerator for basic and diluted net income per share
 
$
74,837
 
$
5,119
 
$
139,281
 
$
26,468
 
Denominator:
                         
Denominator for basic net income per share, weighted average shares
   
168,943
   
166,252
   
168,795
   
165,711
 
Effect of dilutive securities:
                         
Stock options outstanding
   
11,847
   
11,167
   
11,817
   
12,288
 
Denominator for diluted net income per share, weighted average shares
   
180,790
   
177,419
   
180,612
   
177,999
 
Net income per share:
                         
Basic net income per share
 
$
0.44
 
$
0.03
 
$
0.83
 
$
0.16
 
Diluted net income per share
 
$
0.41
 
$
0.03
 
$
0.77
 
$
0.15
 
 
6

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

Diluted net income per share for the three and six months ended July 31, 2005 does not include the effect of 4.1 million and 11.3 million anti-dilutive common equivalent shares, respectively. The weighted-average exercise price of stock options excluded from the computation of diluted net income per share was $34.76 and $29.32 for the three and six months ended July 31, 2005, respectively. Diluted net income per share for the three and six months ended July 25, 2004 does not include the effect of 14.0 million and 13.2 million anti-dilutive common equivalent shares, respectively. The weighted-average exercise price of stock options excluded from the computation of diluted net income per share was $27.93 and $28.37 for the three and six months ended July 25, 2004, respectively.

Note 4 - Guarantees

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

We record a reduction to revenue for estimated product returns at the time revenue is recognized primarily based on historical return rates. The reductions to revenue for estimated product returns for the three and six months ended July 31, 2005 and July 25, 2004 are as follows:


Description
 
Balance at Beginning of Period
 
Additions (1)
 
Deductions (2)
 
Balance at End of Period
 
   
(In thousands)
 
Three months ended July 31, 2005
                         
Allowance for sales returns
 
$
10,805
 
$
8,213
 
$
(8,331
)
$
10,687
 
Three months ended July 25, 2004
                         
Allowance for sales returns
 
$
8,066
 
$
6,532
 
$
(3,559
)
$
11,039
 
Six months ended July 31, 2005
                         
Allowance for sales returns
 
$
11,687
 
$
14,144
 
$
(15,144
)
$
10,687
 
Six months ended July 25, 2004
                         
Allowance for sales returns
 
$
9,421
 
$
10,609
 
$
(8,991
)
$
11,039
 
                           

(1) Allowances for sales returns are charged as a reduction to revenue.

(2) Represents amounts written off against the allowance for sales returns.

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 our agreements do not have a maximum stated liability. However, historically costs related to these indemnification provisions have not been significant.  As such, we have not recorded any liability in our condensed consolidated financial statements for such indemnifications.

7


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

Note 5 - Comprehensive Income

Comprehensive income consists of net income and other comprehensive income or loss. Other comprehensive income or loss components include unrealized gains or losses on available-for-sale securities, net of tax. The components of comprehensive income, net of tax, were as follows:


   
Three Months Ended
 
Six Months Ended
 
   
July 31,
 
July 25,
 
July 31,
 
July 25,
 
   
2005
 
2004
 
2005
 
2004
 
   
(In thousands)
 
                   
Net income
 
$
74,837
 
$
5,119
 
$
139,281
 
$
26,468
 
Net change in unrealized losses on available-for-sale securities
   
(526
)
 
(1,807
)
 
(1,245
)
 
(5,078
)
Tax effect of unrealized losses on available-for-sale securities
   
105
   
705
   
249
   
2,024
 
Reclassification adjustments for net realized losses on available-for-sale securities included in net income
   
138
   
91
   
301
   
36
 
Tax effect of reclassification adjustments for net realized losses on available-for-sale securities included in net income
   
(27
)
 
(18
)
 
(60
)
 
(7
)
Total comprehensive income
 
$
74,527
 
$
4,090
 
$
138,526
 
$
23,443
 


Note 6 - 3dfx Asset Purchase

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. The 3dfx asset purchase was accounted for under the purchase method of accounting and closed on April 18, 2001. Under the terms of the Asset Purchase Agreement, the cash consideration due at the closing was $70.0 million, less $15.0 million that was loaned to 3dfx pursuant to a Credit Agreement dated December 15, 2000. The Asset Purchase Agreement also provided, subject to the other provisions thereof, that if 3dfx properly certified that all its debts and other liabilities had been provided for, then we would have been obligated to pay 3dfx two million shares of NVIDIA common stock. If 3dfx could not make such a certification, but instead properly certified that its debts and liabilities could be satisfied for less than $25.0 million, then 3dfx could have elected to receive a cash payment equal to the amount of such debts and liabilities and a reduced number of shares of our common stock, with such reduction calculated by dividing the cash payment by $25.00 per share. If 3dfx could not certify that all of its debts and liabilities had been provided for, or could not be satisfied, for less than $25.0 million, we would not be obligated under the agreement to pay any additional consideration for the assets. We are currently party to litigation relating to certain aspects of the asset purchase and 3dfx’s subsequent bankruptcy in October 2002. Please see Note 11 for further information regarding this litigation.

8


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

The 3dfx asset purchase price of $70.0 million and direct transaction costs of $4.2 million were allocated based on fair values presented below.

   
 
Fair Market Value
 
Straight-Line Amortization Period
 
   
(In thousands)
 
(Years)
 
           
Property and equipment
 
$
2,433
   
1-2
 
Trademarks
   
11,310
   
5
 
Goodwill
   
60,418
   
--
 
Total
 
$
74,161
       

The final allocation of the purchase price of the 3dfx assets is contingent upon the amount of and circumstances surrounding additional consideration, if any, that we may pay related to the 3dfx asset purchase.

Note 7 - Goodwill and Intangible Assets

We are currently amortizing our intangible assets with finite lives over periods ranging from 3 to 5 years. The components of our amortizable intangible assets are as follows:
 
   
July 31, 2005
 
January 30, 2005
 
   
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Amount
 
Accumulated
Amortization
 
Net Carrying Amount
 
   
(In thousands)
 
                           
Technology licenses
 
$
21,586
 
$
(11,607
)
$
9,979
 
$
17,236
 
$
(9,841
)
$
7,395
 
Patents
   
23,380
   
(17,699
)
 
5,681
   
23,260
   
(15,400
)
 
7,860
 
Acquired intellectual property
   
27,086
   
(21,859
)
 
5,227
   
27,086
   
(18,578
)
 
8,508
 
Trademarks
   
11,310
   
(9,676
)
 
1,634
   
11,310
   
(8,544
)
 
2,766
 
Other
   
1,494
   
(747
)
 
747
   
1,494
   
(509
)
 
985
 
Total intangible assets
 
$
84,856
 
$
(61,588
)
$
23,268
 
$
80,386
 
$
(52,872
)
$
27,514
 

Amortization expense associated with intangible assets for the three and six months ended July 31, 2005 was $4.4 million and $8.7 million, respectively. Amortization expense associated with intangible assets for the three and six months ended July 25, 2004 was $5.3 million and $10.3 million, respectively. Amortization expense for the net carrying amount of intangible assets at July 31, 2005 is estimated to be $8.3 million for the remainder of fiscal 2006, $10.4 million in fiscal 2007, $4.1 million in fiscal 2008, and $0.5 million fiscal 2009 and thereafter.

As of July 31, 2005 and January 30, 2005, the carrying amount of goodwill is as follows:

   
(In thousands)
 
       
3dfx
 
$
50,326
 
MediaQ
   
52,913
 
Other
   
4,868
 
Total goodwill
 
$
108,107
 

9


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

Note 8 - Marketable Securities

We account for our investment instruments in accordance with Statement of Financial Accounting Standards No. 115, or SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. All of our cash equivalents and marketable securities are treated as “available-for-sale” under SFAS No. 115. Cash equivalents consist of financial instruments which are readily convertible into cash and have original maturities of three months or less at the time of acquisition. Marketable securities consist primarily of highly liquid investments with a maturity of greater than three months when purchased and some equity investments. We classify our marketable securities at the date of acquisition in the available-for-sale category as our intention is to convert them into cash for operations. These securities are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income (loss), a component of stockholders’ equity, net of tax. Realized gains and losses on the sale of marketable securities are determined using the specific-identification method. Net realized losses for the three and six months ended July 31, 2005 were $0.1 million and $0.3 million, respectively. Net realized losses for the three and six months ended July 25, 2004 were $0.1 million and nil, respectively.

Note 9 - Balance Sheet Components
 
Certain balance sheet components are as follows:

   
July 31,
 
January 30,
 
Inventories:
 
2005
 
2005
 
   
(In thousands)
 
       
Raw materials
 
$
22,848
 
$
23,225
 
Work in-process
   
113,980
   
130,211
 
Finished goods
   
164,127
   
162,082
 
Total inventories
 
$
300,955
 
$
315,518
 

The significant decrease in work-in-process primarily relates to the ramping of our GeForce 6 series products in the fourth quarter of fiscal 2005.

At July 31, 2005, we had outstanding inventory purchase obligations totaling approximately $267 million.

   
July 31,
 
January 30,
 
Property and Equipment:
 
2005
 
2005
 
   
(In thousands)
 
       
Software
 
$
142,228
 
$
125,310
 
Test equipment
   
88,842
   
86,883
 
Computer equipment
   
96,475
   
82,428
 
Leasehold improvements
   
81,991
   
79,160
 
Construction in process
   
3,138
   
3,264
 
Office furniture and equipment
   
20,554
   
18,777
 
     
433,228
   
395,822
 
Accumulated depreciation and amortization
   
(254,277
)
 
(216,867
)
Property and equipment, net
 
$
178,951
 
$
178,955
 

10


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

   
July 31,
 
January 30,
 
 
 
2005
 
2005
 
   
(In thousands)
 
Accrued Liabilities:
     
Accrued customer programs
 
$
77,932
 
$
83,013
 
Deferred revenue
   
5,584
   
11,500
 
Customer advances
   
10,235
   
1,457
 
Taxes payable
   
53,395
   
28,826
 
Accrued payroll and related expenses
   
35,996
   
37,016
 
Deferred rent
   
11,413
   
10,844
 
Other
   
9,896
   
9,421
 
Total accrued liabilities
 
$
204,451
 
$
182,077
 
 
   
July 31,
 
January 30,
 
   
2005
 
2005
 
Long-term Liabilities:
 
(In thousands)
 
Asset retirement obligation
 
$
4,483
 
$
4,483
 
Technology licenses
   
2,250
   
3,875
 
Total long-term liabilities
 
$
6,733
 
$
8,358
 

Note 10 - Segment Information
 
Our chief operating decision maker, or CODM, our Chief Executive Officer, reviews financial information presented on an operating segment basis for purposes of making operating decisions and assessing financial performance. During the first quarter of fiscal 2006, we reorganized our operating segments to bring all major product groups in line with our strategy to position ourselves as a leader in graphics and digital media processing solutions for digital devices. We now report financial information for four product-line operating segments to our CODM: the GPU Business, which is composed of products that support desktop PCs, notebook PCs and professional workstations; the MCP Business, which is composed of NVIDIA nForce products; the WMP Business, which supports handheld personal digital assistants, cellular phones and other handheld devices; and the Consumer Electronics Business, which is composed of revenue from our contractual arrangements with Sony Computer Entertainment, or SCE, for the development of their next-generation PlayStation3, revenue from sales of our Xbox-related products, revenue from our license agreement with Microsoft relating to the successor product to their initial Xbox gaming console, the Xbox360, and related devices, and digital media processor products. In addition to these operating segments, we have the “All Other” category that includes human resources, legal, finance, general administration and corporate marketing expenses, which total $27.7 million for the second quarter of fiscal 2006, $26.0 million for the second quarter of fiscal 2005, $51.6 million for the first half of fiscal 2006, and $50.8 million for the first half of fiscal 2005, that we do not allocate to our other operating segments. “All Other” also includes the results of operations of other miscellaneous operating segments that are neither individually reportable, nor aggregated with another operating segment. Revenue in the “All Other” category is primarily derived from sales of memory.  All prior period amounts have been restated to reflect our new reporting structure.
 
Our CODM does not review any information regarding property and equipment 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.


11


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

 
   
GPU
 
MCP
 
WMP
 
CE
 
All Other
 
Consolidated
 
   
(In thousands)
 
Three Months Ended July 31, 2005:
                         
Revenue
 
$
385,826
 
$
75,872
 
$
2,135
 
$
81,543
 
$
29,436
 
$
574,812
 
Depreciation expense
 
$
8,219
 
$
3,080
 
$
2,882
 
$
337
 
$
8,062
 
$
22,580
 
Operating income (loss)
 
$
72,737
 
$
5,340
 
$
(10,115
)
$
40,787
 
$
(28,712
)
$
80,037
 
Three Months Ended July 25, 2004:
                                     
Revenue
 
$
288,507
 
$
33,208
 
$
5,201
 
$
86,722
 
$
42,423
 
$
456,061
 
Depreciation expense
 
$
8,226
 
$
3,463
 
$
2,749
 
$
205
 
$
8,389
 
$
23,032
 
Operating income (loss)
 
$
17,296
 
$
(15,769
)
$
(9,258
)
$
32,872
 
$
(21,342
)
$
3,799
 
                                       
Six Months Ended July 31, 2005:
                                     
Revenue
 
$
795,752
 
$
147,677
 
$
9,897
 
$
139,621
 
$
65,711
 
$
1,158,658
 
Depreciation expense
 
$
16,279
 
$
6,190
 
$
6,040
 
$
697
 
$
15,702
 
$
44,908
 
Operating income (loss)
 
$
150,868
 
$
12,263
 
$
(25,975
)
$
69,727
 
$
(50,664
)
$
156,219
 
Six Months Ended July 25, 2004:
                                     
Revenue
 
$
663,776
 
$
68,121
 
$
10,860
 
$
110,511
 
$
74,698
 
$
927,966
 
Depreciation expense
 
$
16,273
 
$
6,739
 
$
5,263
 
$
390
 
$
16,806
 
$
45,471
 
Operating income (loss)
 
$
79,273
 
$
(29,605
)
$
(16,051
)
$
40,895
 
$
(46,833
)
$
27,679
 

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 table summarizes information pertaining to our operations in different geographic regions:

   
Three Months Ended
 
Six Months Ended
 
   
July 31,
 
July 25,
 
July 31,
 
July 25,
 
   
2005
 
2004
 
2005
 
2004
 
   
(In thousands)
 
Revenue:
                 
United States
 
$
133,406
 
$
148,750
 
$
231,211
 
$
209,565
 
Other Americas
   
6,043
   
2,288
   
6,965
   
3,546
 
China
   
110,407
   
46,896
   
179,150
   
152,640
 
Taiwan
   
241,582
   
161,849
   
539,281
   
399,657
 
Other Asia Pacific
   
44,809
   
38,946
   
99,640
   
79,281
 
Europe
   
38,565
   
57,332
   
102,411
   
83,277
 
Total revenue
 
$
574,812
 
$
456,061
 
$
1,158,658
 
$
927,966
 

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

 
Three Months Ended
Six Months Ended
 
July 31,
July 25,
July 31,
July 25,
 
2005
2004
2005
2004
Revenue:
       
Customer A
10%
12%
14%
22%
Customer B
7%
4%
7%
11%
Customer C
13%
20%
10%
13%
Customer D
8%
12%
11%
8%

12


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

Note 11 - Litigation

3dfx

On December 15, 2000, NVIDIA Corporation and one of our indirect subsidiaries entered into an agreement to purchase certain graphics chip assets from 3dfx. The 3dfx asset purchase closed on April 18, 2001. In May 2002, we were served with a complaint filed by the landlord of 3dfx’s San Jose, California commercial real estate lease. In October 2002, 3dfx filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the Northern District of California. In December 2002, we were served with a complaint filed by the landlord of 3dfx’s Austin, Texas commercial real estate lease. The landlords’ complaints both assert claims for, among other things, interference with contract, successor liability and fraudulent transfer. The landlords’ are seeking to recover, among other things, amounts owed on their leases in the aggregate amount of approximately $10 million. In March 2003, we were served with a complaint filed by the Trustee appointed by the Bankruptcy Court to represent the interests of the 3dfx bankruptcy estate. The Trustee’s complaint asserts claims for, among other things, successor liability and fraudulent transfer. The Trustee’s complaint seeks additional payments from us, the amount of which has not been quantified. The landlords’ actions were removed to the Bankruptcy Court from the Superior Court of California and consolidated with the Trustee’s action for purposes of discovery. Upon motion by NVIDIA, the District Court withdrew the reference to the Bankruptcy Court of the two actions filed by the landlords. These actions are now before the District Court and should be tried there. The District Court declined, at this time, to withdraw the reference as to the Trustee’s case. Discovery in all actions is currently proceeding and no trial dates have been set in either the District Court or the Bankruptcy Court. We believe the claims asserted against us are without merit and we will continue to defend ourselves vigorously.

Opti Incorporated

On October 19, 2004, Opti Incorporated, or Opti, filed a complaint for patent infringement against NVIDIA in the United States District Court for the Eastern District of Texas. Opti asserts that unspecified NVIDIA chipsets infringe five U.S. patents held by Opti. Opti seeks unspecified damages for our alleged conduct, attorneys fees and triple damages for alleged willful infringement by NVIDIA. NVIDIA filed a response to this complaint in December 2004. After a case management conference in July 2005, discovery has just begun and a trial date has now been set for July 2006. We believe the claims asserted against us are without merit and we will continue to defend ourselves vigorously.

American Video Graphics

In August 2004, a Texas limited partnership named American Video Graphics, LP, or AVG, filed three separate complaints for patent infringement against various corporate defendants, not including NVIDIA, in the United States District Court for the Eastern District of Texas. AVG initially asserted that each of the approximately thirty defendants sells products that infringe one or more of seven separate patents that AVG claims relate generally to graphics processing functionality. Each of the three lawsuits target a different group of defendants; one case involves approximately twenty of the leading personal computer manufacturers, the PC Makers Case, one case involves the three leading video game console makers, the Game Console Case, and one case involves approximately ten of the leading video game publishers, the Game Publishers Case. In November 2004, NVIDIA sought and was granted permission to intervene in two of the three pending AVG lawsuits, the PC Makers Case and the Game Console Case. Our complaint in intervention alleges both that the patents in suit are invalid and that, to the extent AVG’s claims target NVIDIA products, the asserted patents are not infringed. Two other leading suppliers of graphics processing products, Intel Corporation, or Intel, and ATI Technologies, Inc., or ATI, have also intervened in the cases, ATI in both the PC Makers and Game Console Case, and Intel in the PC Makers Case.



13


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

After some consensual reconfigurations proposed by the various parties, in January 2005, the district court judge entered docket control and discovery orders in the three lawsuits. Plaintiff has recently dismissed one patent from the PC Makers case such that the case now involves three separate patents and is currently scheduled for trial beginning in September 2006. The Game Console Case involves a single patent and is currently scheduled for trial beginning in December 2006. We believe that, to the extent AVG’s infringement allegations target functionality that may be performed by NVIDIA products, those claims are without merit, and we will continue to defend ourselves and our products vigorously.

We are subject to other legal proceedings, but we do not believe that the ultimate outcome of any of these proceedings will have a material adverse effect on our financial position or overall trends in results of operations. However, if an unfavorable ruling were to occur in any specific period, there exists the possibility of a material adverse impact on the results of operations of that period.

Note 12 - Stock Repurchase Program

On August 9, 2004 we announced that our Board of Directors, or the Board, had authorized a stock repurchase program to repurchase shares of our common stock, subject to certain specifications, up to an aggregate maximum amount of $300.0 million. During the second quarter of fiscal 2006, we repurchased 1.8 million shares of our common stock for $50.0 million. As part of our share repurchase program, we may from time-to-time 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 an incremental number of shares of our common stock, within a minimum and a maximum, at the end of the term of the agreement. We entered into two such transactions during the second quarter of fiscal 2006 which, in the aggregate, required up-front payments totaling $25.0 million. Under these agreements, we repurchased 0.9 million shares of our common stock, which we recorded on the trade date of the transactions. Through the end of the second quarter of fiscal 2006, we have repurchased 5.8 million shares under our stock repurchase program for a total cost of approximately $123.1 million.

Note 13 - Change in Accounting Estimate

We compute income taxes for interim reporting purposes using estimates of our effective annual income tax rate for the entire fiscal year. During the second quarter of fiscal 2006, we revised our estimated effective income tax rate for fiscal year 2006 to 16% from the 20% rate that we had used in the first quarter of fiscal 2006. The change in the rate was primarily a result of changes in our geographic mix of income subject to tax. As a result of the change, the effective income tax rate for the second quarter of fiscal 2006 was 12.2%. The effect of the change in the estimated annual effective income tax rate for fiscal 2006 was to increase net income by $6.6 million for both the three months and six months ended July 31, 2005. The effect of the change in estimate on earnings per share was $0.04 for basic earnings per share and $0.03 for diluted earnings per share for the three months ended July 31, 2005. The effect of the change in estimate on basic and diluted earnings per share was $0.04 for the six months ended July 31, 2005.

Note 14 - Income Taxes

The American Jobs Creation Act of 2004 was signed into law on October 22, 2004. This act provides a special one-time dividends received deduction on the repatriation of certain foreign earnings to a United States taxpayer. We are currently in the process of evaluating whether or not, and to what extent, if any, this provision may benefit NVIDIA. We expect to complete such evaluation before the end of our fiscal year 2006. The range of possible amounts that we are considering for repatriation under this provision is between zero and $500 million. The range of income tax expense we would recognize if we repatriate earnings in this range is expected to be between zero and $27 million.


14


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are subject to the “safe harbor” created by those sections. When used in this report, the words “expects,” “believes,” “intends,” “anticipates,” “estimates,” “plans,” and similar expressions are intended to identify forward-looking statements. These forward-looking statements relate to future periods and include, but are not limited to, the features, benefits, capabilities, performance, production and availability of our technology and products, the length of product cycles, our gross margin, sources of revenue and anticipated revenue, including anticipated revenue derived from our relationship with SEC and our license with Microsoft,  revenue mix, increases in and reasons for our expenditures, planned capital expenditures, products under development, our cash flow and cash balances, our liquidity, uses of cash, investments of our cash and marketable securities, our tax rate, repatriation of foreign earnings, our quarterly and annual results of operations, our inventories, product life cycles, average selling prices, our strategies as to our GPU, MCP, WMP and Consumer Electronics Businesses, growth of our businesses, our fastest growing business, factors contributing to the growth of our businesses, the ramp of our WMP products, the adoption of PCI Express, additional platform innovations, focus of our competitors on platform solutions, importance of stock option grants to our business, expensing of stock options, use of the binomial model for calculating the fair value of stock compensation awards, our critical accounting policies, our relationship with and the development of a GPU for SCE, the impact of recent accounting pronouncements, expectations regarding our competition and our competitive position, our intellectual property, the importance of our strategic relationships, customer demand, our reliance on a limited number of customers, expansion of our technologies and products, including by investment or acquisition, our internal control over financial reporting, our ability to attract customers, our ability to attract and retain qualified personnel, our foreign currency risk strategy, compliance with the RoHS Directive and other environmental laws and regulations. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, the risks discussed below as well as unanticipated decreases in average selling prices of a particular product, our inability to decrease inventory purchase commitments in a meaningful timeframe, our inability to compete in new markets, the write-down of the value of inventory, entry of new competitors in our established markets, reduction in demand for or market acceptance of our products or our customers’ products, defects in our products, the impact of competitive pricing pressure, new product announcements or introductions by our competitors, disruptions in our relationships with Taiwan Semiconductor Manufacturing Company, or TSMC, International Business Machines Corporation, or IBM, United Microelectronics Corporation, or UMC, Chartered Semiconductor Manufacturing, or Chartered, and other key suppliers, fluctuations in general economic conditions, failure to achieve design wins, the seasonality of the PC and our other product segments, international and political conditions, the concentration of sales of our products to a limited number of customers, unforeseen reductions in demand for our products, our ability to safeguard our intellectual property, delays in the development of new products, delays in volume production of our products, developments in and expenses related to litigation and the matters set forth under the caption “Business Risks.” These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
 
In this report, all references to “NVIDIA,” “we,” “us,” or “our,” mean NVIDIA Corporation and our subsidiaries.
 
NVIDIA, GeForce, MXM, SLI, GoForce, NVIDIA Quadro and NVIDIA nForce are our trademarks or registered trademarks in the United States and other countries. We also refer to trademarks of other corporations and organizations in this document.
 
Overview
 
Our Company
 
NVIDIA Corporation is a worldwide leader in graphics and digital media processors. Our products enhance the end-user experience on consumer and professional computing devices. NVIDIA graphics processing units, or GPUs, media and communications processors, or MCPs, and wireless media processors, or WMPs, have broad market reach and are incorporated into a variety of platforms, including consumer and enterprise personal computers, or PCs, notebooks, workstations, personal digital assistants, or PDAs, cellular phones, and video game consoles. We were incorporated in California in April 1993 and reincorporated in Delaware in April 1998. Our headquarter facilities are in Santa Clara, California.
 
15


Fiscal 2006 Developments, Future Objectives and Challenges
 
GPU Business
 
In February 2005, we announced the GeForce Go 6600, a mobile GPU designed specifically to deliver advanced multimedia functionality without sacrificing portability.  Also in February 2005, we introduced the GeForce Go 6800 Ultra mobile GPU - our fastest mobile GPU to date.  
 
In March 2005, we introduced two new GeForce 6 GPUs: a 512MB version of the GeForce 6800 Ultra GPU designed for the enthusiast segment, and a new lower-cost AGP version of the GeForce 6200 GPU, designed to bring Microsoft DirectX 9.0 Shader Model 3.0 technology to the mainstream segment.  These two GPUs utilize the NVIDIA ForceWare software suite and Unified Driver Architecture to incorporate software optimizations that take full advantage of our newest features. 
 
In June 2005, we launched and simultaneously shipped our second generation Shader Model 3.0 GPU, the GeForce 7800 GTX, which is designed to address the high-end enthusiast desktop PC segment. In August 2005, we launched and shipped our second GeForce 7 GPU, the GeForce 7800 GT, which is designed to address the high-end performance desktop PC segment.

In July 2005, we introduced two new NVIDIA Quadro GPUs, the NVIDIA Quadro FX 4500 and the NVIDIA Quadro FX 3450, which are designed for the high-end and mainstream professional segments, respectively. Both products support our Scalable Link Interface, or SLI, technology.

The combination of our GeForce 7 and GeForce 6 series of GPUs and our SLI technology has created a new class of gaming and workstation class PCs.  SLI technology takes advantage of the increased bandwidth of the PCI Express bus architecture to allow two NVIDIA-based graphics cards to operate in a single PC or workstation.  In June 2005, we made our SLI technology available to users in the mainstream segment with our GeForce 6600.
 
MCP Business
 
In April 2005, we announced the availability of our NVIDIA nForce4 SLI Intel Edition MCP for Intel platforms.  This new line of core-logic solutions incorporates a host of new and innovative NVIDIA features that have never before been available on the Intel platform and extends the NVIDIA nForce brand into new segments.  In addition, during the first quarter of fiscal 2006, NVIDIA nForce Professional MCP shipped in its first enterprise server platform. 

In August 2005, we announced that the NVIDIA nForce4 SLI X16 Intel Edition technology is now featured in the new Dell Dimension XPS 600 desktop PC.
 
Our NVIDIA nForce product line has achieved record revenue for three consecutive quarters.  We believe that Advanced Micro Devices’, or AMD’s, transition to K8, our extension into new segments, and our entry into the Intel market will make our MCP Business one of our fastest growing businesses. Furthermore, we believe that our ability to simultaneously innovate using our GPU, MCP, and software knowledge base will allow us to make additional platform innovations in the future.  We are now beginning production of a new NVIDIA nForce MCP with an integrated GPU and expect this to be an important new growth driver for both our desktop and mobile businesses.
 
WMP Business
 
Our strategy in the WMP Business is to lead innovation and capitalize on the emergence of the mobile phone as a versatile consumer lifestyle device.  Our initial focus was on 3G cellular phones.  As a result, our current WMP Business has been heavily concentrated at one original equipment manufacturer, or OEM, and its products have not achieved the anticipated level of commercial success.  However, we expect that we will ramp up production of WMP products related to a number of new design wins with existing and new customers for the holiday season, many of which are scheduled to go into production during the third quarter of fiscal 2006.

16

Consumer Electronics Business
 
In April 2005, we finalized our definitive agreement with Sony Computer Entertainment, or SCE, to jointly develop a custom GPU incorporating our next-generation GeForce GPU and SCE’s system solutions in SCE’s next generation PlayStation3.  Our collaboration with SCE includes license fees and royalties for the next generation PlayStation3 and all derivatives, including next generation digital consumer electronics devices.  In addition, we are licensing software development tools for creating shaders and advanced graphics capabilities to SCE.  In fiscal 2006, we expect to recognize revenue of approximately $40 million from development, software, and license fees associated with this collaboration.  Depending on the ultimate success of this next generation platform, we expect to generate, starting in fiscal 2007, revenue ranging from $50 million to $100 million annually from license fees and royalties over the next five years with the possibility of additional royalties for several years thereafter.
 
During our fiscal 2004, Microsoft Corporation announced that it had entered into an agreement with one of our competitors to develop technology for future Xbox products and services.  During the first quarter of fiscal 2006, Microsoft indicated that it would not order any more Xbox-related products from us after our second fiscal quarter. As a result, the second quarter of fiscal 2006 was the last quarter during which we will recognize revenue from the sale of our Xbox-related products to Microsoft. However, as a result of our license agreement with Microsoft relating to the successor product to their initial Xbox gaming console, the Xbox360, and related devices, we recognized an incremental amount of related license revenue from Microsoft during the second quarter of fiscal 2006, and expect to do so in future periods.

Gross Margin Improvement

We continue to remain intensely focused on improving our gross margin. During the second quarter of fiscal 2006, our gross margin was 37.8%, which represented an increase of 180 basis points from our gross margin of 36.0% for the first quarter of fiscal 2006 and an increase of 710 basis points from our gross margin of 30.7% for the second quarter of fiscal 2005. We expect our gross margin to be approximately 37% to 38% during the third quarter of fiscal 2006.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, cost of revenue, expenses and related disclosure of contingencies. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, accounts receivable, inventories, long-lived assets, goodwill, income taxes and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

There were no material changes in our critical accounting policies and estimates during the first quarter of fiscal 2006 from those disclosed in our Annual Report on Form 10-K for the year ended January 30, 2005. Please see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended January 30, 2005 for a discussion of our critical accounting policies and estimates.

17


Results of Operations

The following table sets forth, for the periods indicated, certain items in our condensed consolidated income statements expressed as a percentage of revenue.

   
Three Months Ended
 
Six Months Ended
 
   
July 31,
 
July 25,
 
July 31,
 
July 25,
 
   
2005
 
2004
 
2005
 
2004
 
                   
                   
Revenue
   
   100.0%
 
 
  100.0%
 
 
  100.0%
 
 
  100.0%
 
Cost of revenue
   
62.2
 
 
69.3
 
 
63.1
 
 
68.9
 
Gross profit
   
37.8
 
 
30.7
 
 
36.9
 
 
31.1
 
Operating expenses:
                         
Research and development
   
14.9
 
 
18.7
 
 
14.8
 
 
17.6
 
Sales, general and administrative
   
9.0
 
 
11.2
 
 
8.6
 
 
10.5
 
Total operating expenses
   
23.9
 
 
29.9
 
 
23.4
 
 
28.1
 
Operating income
   
13.9
 
 
0.8
 
 
13.5
 
 
3.0
 
Interest and other income, net
   
0.9
 
 
0.6
 
 
0.8
 
 
0.6
 
Income before income tax expense
   
14.8
 
 
1.4
 
 
14.3
 
 
3.6
 
Income tax expense
   
1.8
 
 
0.3
 
 
2.3
 
 
0.7
 
Net income
   
  13.0%
 
 
  1.1%
 
 
  12.0%
 
 
  2.9%
 

Three and Six Months Ended July 31, 2005 and July 25, 2004

Revenue  
 
During the first quarter of fiscal 2006, we reorganized our operating segments to bring all major product groups in line with our strategy to position ourselves as a leader in graphics and digital media processing solutions for digital devices. We now report financial information for four product-line operating segments to our chief operating decision maker, or CODM, our Chief Executive Officer: the GPU Business, which is composed of products that support desktop PCs, notebook PCs and professional workstations; the MCP Business, which is composed of NVIDIA nForce products; the WMP Business, which supports handheld personal digital assistants, cellular phones and other handheld devices; and the Consumer Electronics Business, which is composed of revenue from our contractual arrangements with SCE for the development of their next-generation PlayStation3, revenue from sales of our Xbox-related products, revenue from our license agreement with Microsoft relating to the successor product to their initial Xbox gaming console, the Xbox360, and related devices, and digital media processor products.  Please refer to Note 10 of the Notes to Condensed Consolidated Financial Statements for further information.
 
Revenue was $574.8 million for the second quarter of fiscal 2006 and $456.1 million for the second quarter of fiscal 2005, which represented an increase of 26%.    Revenue was $1.16 billion for the first half of fiscal 2006 and $928.0 million for the first half of fiscal 2005, which represented an increase of 25%. A discussion of our revenue results for each of our operating segments is as follows:
 
GPU Business
 
GPU Business revenue was $385.8 million for the second quarter of fiscal 2006 and $288.5 million for the second quarter of fiscal 2005, which represented an increase of 34%.  The revenue increase was primarily the result of increased sales of our desktop products and NVIDIA Quadro workstation products. Desktop revenue increased due to a significant increase in high-end unit sales volume and increased average selling prices that were offset by a decrease in sales of mainstream desktop products. Workstation revenue increased due to an increase in average selling prices as a result of the increased mix of GeForce 6-based products during the second quarter of fiscal 2006. Offsetting these increases was a slight decrease in mobile revenue due to sales volume decreases that were offset by an increase in average selling prices. 

GPU Business revenue increased by 20% to $795.8 million for the first half of fiscal 2006 compared to $663.8 million for the first half of fiscal 2005. The increase was the result of sales of our GeForce 6 and GeForce 7 families of desktop GPUs that serve the high-end segment. Sales of our NVIDIA Quadro workstation products continued to improve, resulting primarily from an increase in average selling prices.
 
18

MCP Business
 
MCP Business revenue was $75.9 million for the second quarter of fiscal 2006 and $33.2 million for the second quarter of fiscal 2005, which represented an increase of 128%.  MCP Business revenue increased by 117% to $147.7 million for the first half of fiscal 2006 compared to $68.1 million for the first half of fiscal 2005. The overall increase in MCP Business revenue is primarily due to increased sales of NVIDIA nForce4 products, which we began selling during the fourth quarter of fiscal 2005 and, to a lesser degree, to increased sales of NVIDIA nForce3 products, offset by decreased sales of NVIDIA nForce2 products.

 WMP Business
 
WMP Business revenue was $2.1 million for the second quarter of fiscal 2006 and $5.2 million for the second quarter of fiscal 2005, which represented a decrease of 59%.  WMP Business revenue decreased by 9% to $9.9 million for the first half of fiscal 2006 compared to $10.9 million for the first half of fiscal 2005. The overall decrease in WMP Business revenue is due to unit sales volume decreases, offset by an increase in average selling prices. Our current WMP Business has been heavily concentrated at one original equipment manufacturer, or OEM, and its products have not achieved the anticipated level of commercial success.  However, we expect that we will ramp up production of WMP products related to a number of new design wins with existing and new customers for the holiday season.

Consumer Electronics Business
 
Consumer Electronics Business revenue was $81.5 million for the second quarter of fiscal 2006 and $86.7 million for the second quarter of fiscal 2005, which represented a decrease of 6%.  During the second quarter of fiscal 2006, we recognized revenue from our contractual arrangements with SCE for the development of its next-generation PlayStation3.  No such revenue was recognized during the second quarter of fiscal 2005 as our definitive agreement with SCE was not executed until the first quarter of fiscal 2006. Offsetting the SCE revenue was a decrease in sales of Xbox-related products to Microsoft in the second quarter of fiscal 2006 due to unit sales volume decreases.  During our fiscal 2004, Microsoft Corporation announced that it had entered into an agreement with one of our competitors to develop technology for future Xbox products and services.  During the first quarter of fiscal 2006, Microsoft indicated that it would not order any more Xbox-related products from us after our second fiscal quarter. As a result, the second quarter of fiscal 2006 was the last quarter during which we will recognize revenue from the sale of our Xbox-related products to Microsoft. However, as a result of our license agreement with Microsoft relating to the successor product to their initial Xbox gaming console, the Xbox360, and related devices, we recognized an incremental amount of related license revenue from Microsoft during the second quarter of fiscal 2006, and expect to do so in future periods.

Consumer Electronics Business revenue increased by 26% to $139.6 million for the first half of fiscal 2006 compared to $110.5 million for the first half of fiscal 2005. During the first half of fiscal 2006, we recognized revenue from our contractual arrangements with SCE for the development of its next-generation PlayStation3. No such revenue was recognized during the first half of fiscal 2005 as our definitive agreement with SCE was not executed until the first quarter of fiscal 2006. In addition, revenue from sales of Xbox-related products to Microsoft during the first half of fiscal 2006 was greater than the first half of fiscal 2005 due to unit sales volume increases.
 
Consolidated Revenue
 
Revenue from sales to customers outside of the United States and other Americas accounted for 76% and 67% of revenue for the second quarter of fiscal 2006 and 2005, respectively. Revenue from sales to customers outside of the United States and other Americas accounted for 79% and 77% of revenue for the first half of fiscal 2006 and 2005, 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.  The decrease in the percentage of revenue from sales to customers outside of the United States and other Americas is primarily due to increased sales of Xbox-related products, which are billed to Microsoft in the United States.
 
Sales to Microsoft accounted for approximately 13% of revenue for the second quarter of fiscal 2006 and 10% of revenue for the first half of fiscal 2006. Our other three largest customers accounted for approximately 25% of revenue for the second quarter of fiscal 2006 and 32% of revenue for the first half of fiscal 2006. Sales to Microsoft accounted for approximately 20% of revenue for the second quarter of fiscal 2005 and 13% of revenue for the first half of fiscal 2005. Our other three largest customers accounted for approximately 28% of revenue for the second quarter of fiscal 2005 and 41% of revenue for the first half of fiscal 2005. 

19

Gross Profit

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 provisions and shipping costs.  Cost of revenue also includes development costs for license and service arrangements. Gross margin is the ratio 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 was 37.8% and 30.7% for the second quarter of fiscal 2006 and the second quarter of fiscal 2005, respectively. Our gross margin was 36.9% and 31.1% for the first half of fiscal 2006 and the first half of fiscal 2005, respectively. A discussion of our gross profit results for each of our operating segments is as follows:
 
GPU Business
 
The gross margin of our GPU Business increased during the second quarter of fiscal 2006 as compared to the second quarter of 2005 as well as during the first half of fiscal 2006 as compared to the first half of fiscal 2005 primarily due to the initial sales of our GeForce 7 series GPUs and increased sales of our GeForce 6 series GPUs, which collectively now account for more than 75% of our GPU Business revenue.  In addition, revenue from our NVIDIA Quadro workstation products, which typically provide the highest gross margins of any of our products, increased as a percentage of our total GPU Business revenue.

MCP Business
 
The gross margin of our MCP Business increased during the second quarter of fiscal 2006 as compared to the second quarter of fiscal 2005 as well as during the first half of fiscal 2006 as compared to the first half of fiscal 2005 primarily due to the increase in revenue from sales of our NVIDIA nForce3 and NVIDIA nForce4 products.  Also, our NVIDIA nForce3 and NVIDIA nForce4 products have experienced higher gross margins than our previous generations of NVIDIA nForce products, such as the NVIDIA nForce2. 

 WMP Business
 
The gross margin of our WMP Business increased during the second quarter of fiscal 2006 as compared to the second quarter of fiscal 2005 primarily due to an increase in average selling prices.  Our WMP Business has been heavily concentrated at one OEM.  The gross margin of our WMP Business decreased during the first half of fiscal 2006 as compared to the first half of fiscal 2005 due to the write-off in the first half of fiscal 2006 of certain handheld products that we believe exceeds the demand of that OEM. 

Consumer Electronics Business
 
The gross margin of our Consumer Electronics Business increased during the second quarter of fiscal 2006 as compared to the second quarter of fiscal 2005 as well as during the first half of fiscal 2006 as compared to the first half of fiscal 2005 primarily due to the reduction of die costs for Xbox-related products. The reduction in die costs began during the fourth quarter of fiscal 2005 as the result of our utilization of a different foundry for the manufacturing of the semiconductor wafers used for Xbox-related products.
 
Consolidated Gross Margin
 
The improvement in our gross margin reflects our continuing focus on delivering cost effective product architectures, enhancing business processes and driving profitable growth.  We expect our gross margin to be approximately 37% to 38% during the third quarter of fiscal 2006.

20


Operating Expenses
 
Research and Development

   
Three Months Ended
         
Six Months Ended
         
   
July 31,
 
July 25,
   
%
 
July 31,
 
July 25,
   $  
%
 
   
2005
 
2004
 
Change
 
Change
 
2005
 
2004
 
Change
 
Change
 
   
(in millions)
 
Research and Development:
                                 
Salaries and related benefits
 
$
50.1
 
$
43.3
 
$
6.8
   
16%
 
$
98.9
 
$
84.2
 
$
14.7
   
17%
 
Computer software and lab equipment
   
11.5
   
10.4
   
1.1
   
10%
 
 
22.4
   
20.6
   
1.8
   
9%
 
New product development
   
8.5
   
8.1
   
0.4
   
5%
 
 
15.3
   
12.7
   
2.6
   
20%
 
Facility expense
   
8.3
   
8.1
   
0.2
   
2%
 
 
16.1
   
15.5
   
0.6
   
4%
 
Depreciation and amortization
   
14.3
   
14.2
   
0.1
   
1%
 
 
28.6
   
27.7
   
0.9
   
3%
 
License and development project costs
   
(9.6
)
 
-
   
(9.6
)
 
-
   
(14.3
)
 
-
   
(14.3
)
 
-
 
Other
   
2.7
   
1.3
   
1.4
   
108%
 
 
4.7
   
2.5
   
2.2
   
88%
 
Total
 
$
85.8
 
$
85.4
 
$
0.4
   
0.5%
 
$
171.7
 
$
163.2
 
$
8.5
   
5%
 
Research and development as a percentage of net revenue
   
14.9
%
 
18.7
%
             
14.8
%
 
17.6
%
           
 
Research and development expenses were $85.8 million and $85.4 million in the second quarter of fiscal 2006 and fiscal 2005, respectively, an increase of $0.4 million, or 0.5%. This increase was primarily due to a $6.8 million increase in salaries and benefits related to 200 additional personnel and a $1.1 million increase in computer software and lab equipment. These increases were offset by an increase of $9.6 million in license and development project costs, primarily related to development costs related to our collaboration with SCE that are classified as cost of revenue in our condensed consolidated income statement and other engineering costs that were capitalized on our condensed consolidated balance sheet and will be expensed on a percentage of completion basis under a development contract. Neither of these development projects were in effect during the second quarter of fiscal 2005.
 
Research and development expenses were $171.7 million and $163.2 million for the first half of fiscal 2006 and fiscal 2005, respectively, an increase of $8.5 million, or 5%. This increase was primarily due to a $14.7 million increase in salaries and benefits related to 200 additional personnel, a $2.6 million increase in new product development costs related to an overall increase in product tape-outs and prototype materials, and a $1.8 million increase in computer software and lab equipment. These increases were offset by an increase of $14.3 million in license and development project costs, primarily related to development costs related to our collaboration with SCE that are classified as cost of revenue in our condensed consolidated income statement and other engineering costs that were capitalized on our condensed consolidated balance sheet and will be expensed on a percentage of completion basis under a development contract. Neither of these development projects were in effect during the first half of fiscal 2005.
 
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.

21


Sales, General and Administrative

   
Three Months Ended
         
Six Months Ended
         
   
July 31,
 
July 25,
   $  
%
 
July 31,
 
July 25,
   $  
%
 
   
2005
 
2004
 
Change
 
Change
 
2005
 
2004
 
Change
 
Change
 
   
(in millions)
 
Sales, General and Administrative:
                                                 
Salaries and related benefits
 
$
28.0
 
$
22.7
 
$
5.3
   
23%
 
$
54.2
 
$
45.3
 
$
8.9
   
20%
 
Advertising and promotions
   
6.9
   
13.1
   
(6.2
)
 
(47%)
 
 
13.8
   
23.8
   
(10.0
)
 
(42%)
 
Legal and accounting fees
   
4.6
   
1.6
   
3.0
   
195%
 
 
8.6
   
4.1
   
4.5
   
110%
 
Facility expense
   
3.0
   
2.2
   
0.8
   
38%
 
 
6.1
   
4.5
   
1.6
   
35%
 
Depreciation and amortization
   
8.3
   
8.9
   
(0.6
)
 
(7%)
 
 
16.3
   
17.8
   
(1.5
)
 
(8%)
 
Other
   
0.9
   
2.4
   
(1.5
)
 
(63%)
 
 
0.7
   
2.6
   
(1.9
)
 
(73%)
 
Total
 
$
51.7
 
$
50.9
 
$
0.8
   
2%
 
$
99.7
 
$
98.1
 
$
1.6
   
2%
 
Sales, general and administrative as a percentage of net revenue
   
9.0
%
 
11.2
%
             
8.6
%
 
10.5
%
           

Sales, general and administrative expenses were $51.7 million and $50.9 million in the second quarter of fiscal 2006 and fiscal 2005, respectively, an increase of $0.8 million, or 2%. This increase was primarily due to a $5.3 million increase related to 77 additional personnel, a $3.0 million increase in legal expenses primarily due to certain insurance reimbursements that were received during the second quarter of fiscal 2005, and an $0.8 million increase in facilities expense due to the expansion of our international sites. These increases were offset by a $6.2 million decrease in advertising and promotions, primarily associated with a reduction in certain marketing programs, trade show expenses and advertising during the second quarter of fiscal 2006 compared to the second quarter of fiscal 2005.

Sales, general and administrative expenses were $99.7 million and $98.1 million for the first half of fiscal 2006 and fiscal 2005, respectively, an increase of $1.6 million, or 2%. This increase was primarily due to an $8.9 million increase related to 77 additional personnel, a $4.5 million increase in legal expenses primarily due to certain insurance reimbursements that were received during the first half of fiscal 2005, and a $1.6 million increase in facilities expense due primarily to the expansion of our international sites. These increases were offset by a $10.0 million decrease in advertising and promotions, primarily associated with a reduction in certain marketing programs, trade show expenses and advertising during the first half of fiscal 2006 compared to the first half of fiscal 2005. In addition, deprecation and amortization decreased $1.5 million primarily due to the end of life of some intangible assets that occurred during the fourth quarter of fiscal 2005.

We expect sales, general and administrative expenses to continue to increase in absolute dollars as we continue to support our operations and global business expansion efforts, expand our sales, launch our new products, and protect our business interests.

Interest Income and Interest Expense

Interest income consists of interest earned on cash, cash equivalents and marketable securities. Interest income was $4.9 million and $2.7 million in the second quarter of fiscal 2006 and fiscal 2005, respectively, an increase of $2.2 million. Interest income was $8.8 million and $5.5 million for the first half of fiscal 2006 and fiscal 2005, respectively, an increase of $3.3 million. These increases were primarily the result of higher average balances of cash, cash equivalents, and marketable securities and higher yields during the first half of fiscal 2006 when compared to the first half of fiscal 2005.

Interest expense consists primarily of interest incurred as a result of capital lease obligations.

22


Income Taxes

We recognized income tax expense of $10.4 million and $1.3 million in the second quarter of fiscal 2006 and fiscal 2005, respectively. Income tax expense as a percentage of income before taxes, or our annual effective tax rate, was 12.2% for the second quarter of fiscal 2006 and 20% for the second quarter of fiscal 2005. We recognized income tax expense of $26.5 million and $6.6 million for the first half of fiscal 2006 and fiscal 2005, respectively. Our annual effective tax rate was 16% for the first half of fiscal 2006 and 20% for the first half of fiscal 2005. During the second quarter of fiscal 2006, we reduced our effective tax rate to 16% for the year from the 20% effective tax rate used in the first quarter of fiscal 2006, primarily as a result of changes in our geographic mix of income subject to tax. Our annual effective tax rate is lower than the United States Federal Statutory rate of 35% due primarily to income earned in lower tax jurisdictions and research and development tax credits.

The American Jobs Creation Act of 2004 was signed into law on October 22, 2004. This act provides a special one-time dividends received deduction on the repatriation of certain foreign earnings to a United States taxpayer. We are currently in the process of evaluating whether or not, and to what extent, if any, this provision may benefit NVIDIA. We expect to complete such evaluation before the end of our fiscal year 2006. The range of possible amounts that we are considering for repatriation under this provision is between zero and $500 million. The range of income tax expense we would recognize if we repatriate earnings in this range is expected to be between zero and $27 million.

Liquidity and Capital Resources
 
As of July 31, 2005, we had $717.5 million in cash, cash equivalents and marketable securities, an i