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NVIDIA 10-Q 2008

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
q309form10q.htm
 

 
  
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________

FORM 10-Q

(Mark One)

[x]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended October 26, 2008

OR

[_]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____ to ______

Commission file number: 0-23985


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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:
 
Large accelerated filer x    
Accelerated filer o 
Non-accelerated filer    o  (Do not check if a smaller reporting company) 
Smaller reporting company o       
                                                                                                                                                          
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No x
 
       The number of shares of registrant's common stock, $0.001 par value, outstanding as of November 25, 2008 was 537,063,084.
 
 

 

 


 
NVIDIA CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED OCTOBER 26, 2008
 
 
TABLE OF CONTENTS

     
Page
 
 
     
 
 
   
3
 
 
 
   
3
 
 
 
   
4
 
 
 
   
5
 
 
 
   
6
 
 
 
   
28
 
 
 
   
43
 
 
 
   
44
 
 
       
 
 
   
44
 
 
 
   
45
 
 
 
   
60
 
 
 
   
61
 
 
 
   
61
 
 
 
   
61
 
 
 
   
62
 
 
     
63
 

 



 
 
 
 

 





CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share data)
 
 

   
Three Months Ended
   
Nine Months Ended
 
   
October 26,
2008
   
October 28,
2007
   
October 26,
2008
   
October 28,
2007
 
                                 
Revenue   
 897,655
   
1,115,597
    $
2,943,719
    $
 2,895,130
 
         Cost of revenue
   
529,812
     
600,044
     
1,911,116
     
1,575,447
 
Gross profit
   
367,843
     
515,553
     
1,032,603
     
1,319,683
 
Operating expenses
                               
         Research and development
   
212,360
     
179,529
     
644,100
     
495,802
 
         Sales, general and administrative
   
90,349
     
88,183
     
275,782
     
250,034
 
         Restructuring charges
   
8,338
     
-
     
8,338
     
-
 
Total operating expenses
   
311,047
     
267,712
     
928,220
     
745,836
 
Income from operations
   
56,796
     
247,841
     
104,383
     
573,847
 
         Interest income
   
9,447
     
17,416
     
35,851
     
46,250
 
         Other income (expense), net
   
(5,240
)
   
1,542
     
(12,813
)
   
1,342
 
Income before income tax expense
   
61,003
     
266,799
     
127,421
     
621,439
 
         Income tax expense (benefit)
   
(745
)
   
31,138
     
9,797
     
80,787
 
Net income
 
$
61,748
   
$
235,661
   
$
117,624
   
$
540,652
 
                                 
Basic net income per share
 
$
0.11
   
$
0.42
   
$
0.21
   
$
0.99
 
Weighted average shares used in basic per share computation
   
543,807
     
554,966
     
551,623
     
547,796
 
                                 
Diluted net income per share
 
$
0.11
   
$
0.38
   
$
0.20
   
$
0.89
 
Weighted average shares used in diluted per share computation
   
564,536
     
612,985
     
590,490
     
605,733
 

See accompanying Notes to Condensed Consolidated Financial Statements




 
 
 
 
3

 



CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands)

   
October 26,
2008
   
January 27,
2008
 
ASSETS
           
Current assets:
           
     Cash and cash equivalents
 
$
461,253
   
$
726,969
 
     Marketable securities
   
843,635
     
1,082,509
 
     Accounts receivable, net
   
607,834
     
666,494
 
     Inventories
   
523,988
     
358,521
 
     Prepaid expenses and other
   
43,389
     
54,336
 
            Total current assets
   
2,480,099
     
2,888,829
 
Property and equipment, net
   
609,674
     
359,808
 
Goodwill
   
366,286
     
354,057
 
Intangible assets, net
   
155,646
     
106,926
 
Deposits and other assets
   
37,193
     
38,051
 
           Total assets
 
$
3,648,898
   
$
3,747,671
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
     Accounts payable
 
$
387,252
   
$
492,099
 
     Accrued liabilities
   
617,213
     
475,062
 
            Total current liabilities
   
1,004,465
     
967,161
 
Other long-term liabilities
   
157,358
     
162,598
 
Commitments and contingencies - see Note 13
               
Stockholders’ equity:
               
      Preferred stock
   
-
     
-
 
      Common stock
   
629
     
619
 
      Additional paid-in capital
   
1,841,850
     
1,654,681
 
      Treasury stock, at cost
   
(1,463,268
)
   
(1,039,632
)
      Accumulated other comprehensive income (loss)
   
(3,970
)
   
8,034
 
      Retained earnings
   
2,111,834
     
1,994,210
 
            Total stockholders' equity
   
2,487,075
     
2,617,912
 
                      Total liabilities and stockholders' equity
 
$
3,648,898
   
$
3,747,671
 
                 
 
See accompanying Notes to Condensed Consolidated Financial Statements.
 


 

 
 
 
 
4

 



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
 
 
Nine Months Ended
 
   
October 26,
2008
   
October 28,
2007
 
Cash flows from operating activities:
           
Net income
$
117,624
   
$
540,652
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
     Depreciation and amortization
 
136,968
     
96,256
 
     Stock-based compensation expense related to employees
 
120,873
     
98,868
 
     Payments under patent licensing arrangement
 
         (21,502
)
   
(49,634
)
     Impairment charge on investments
 
9,891
     
-
 
     Deferred income taxes
 
1,568
     
67,279
 
     Other
 
1,899
     
618
 
Changes in operating assets and liabilities, net of effects of acquisitions:
             
     Accounts receivable
 
59,276
     
(32,943
)
     Inventories
 
(165,154
)
   
48,590
 
     Prepaid expenses and other current assets
 
11,205
     
(4,327
)
     Deposits and other assets
 
(2,030
)
   
3,193
 
     Accounts payable
 
(114,292
)
   
175,096
 
     Accrued liabilities and other long-term liabilities
 
112,879
     
74,077
 
                 Net cash provided by operating activities
 
269,205
     
1,017,725
 
Cash flows from investing activities:
             
     Proceeds from sales and maturities of marketable securities
 
1,131,147
     
521,712
 
     Purchases of marketable securities
 
(917,987
)
   
(739,706
)
     Purchases of property and equipment and intangible assets
 
(364,695
)
   
(117,406
)
     Acquisition of businesses, net of cash and cash equivalents
 
(27,948
)
   
-
 
     Other
 
1,468
     
-
 
                  Net cash used in investing activities
 
(178,015
)
   
(335,400
)
Cash flows from financing activities:
             
     Payments for stock repurchases
 
(423,636
)
   
(374,427
)
     Proceeds from issuance of common stock under employee stock plans
 
66,730
     
204,390
 
                  Net cash used in financing activities
 
(356,906
)
   
(170,037
)
Change in cash and cash equivalents
 
(265,716
)
   
512,288
 
Cash and cash equivalents at beginning of period
 
726,969
     
544,414
 
Cash and cash equivalents at end of period
$
461,253
   
$
1,056,702
 
               
Supplemental disclosures of cash flow information:
             
     Cash paid for income taxes, net
$
6,679
   
$
4,299
 
Other non-cash activities:
             
     Assets acquired by assuming related liabilities
$
33,330
   
$
16,348
 
     Change in unrealized gains (losses) from marketable securities
$
(14,886
 
$
2,571
 

See accompanying Notes to Condensed Consolidated Financial Statements.
 


 
 
5

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



 
Note 1 - Summary of Significant Accounting Policies

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

Fiscal year
 
We operate on a 52 or 53-week year, ending on the last Sunday in January. Each quarter in fiscal years 2009 and 2008 was a 13-week quarter.

Reclassifications
 
Certain prior fiscal year balances have been reclassified to conform to the current fiscal year presentation.
 
Principles of Consolidation
 
Our consolidated financial statements include the accounts of NVIDIA Corporation and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.
 
Product Warranties
 
We generally offer limited warranty that ranges from one to three years for products in order to repair or replace products for any manufacturing defects or hardware component failures. Cost of revenue includes the estimated cost of product warranties that are calculated at the point of revenue recognition.

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


 
 
6

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

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

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

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




 
 
 
 
7

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

On January 28, 2008, we adopted Statement of Financial Accounting Standards No. 157, or SFAS No. 157, Fair Value Measurements for all financial assets and liabilities. SFAS No. 157 applies to all financial assets and financial liabilities recognized or disclosed at fair value in the financial statements. SFAS No. 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of SFAS No. 157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements.  The adoption of SFAS No. 157 for financial assets and liabilities did not have a significant impact on our consolidated financial statements, and the resulting fair values calculated under SFAS No. 157 after adoption were not significantly different than the fair values that would have been calculated under previous guidance. Please refer to Note 17 of these Notes to these Condensed Consolidated Financial Statements for further details on our fair value measurements.

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

In October 2008, the FASB issued Staff Position No. FAS 157-3, or FSP No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. FSP No. 157-3 clarifies the application of SFAS No. 157 in a market that is not active, and addresses application issues such as the use of internal assumptions when relevant observable data does not exist, the use of observable market information when the market is not active, and the use of market quotes when assessing the relevance of observable and unobservable data. FSP No. 157-3 is effective for all periods presented in accordance with SFAS No. 157. The adoption of FSP No. 157-3 did not have a significant impact on our consolidated financial statements, and the resulting fair values calculated under SFAS No. 157 after adoption were not significantly different than the fair values that would have been calculated under previous guidance.

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

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

Recently Issued Accounting Pronouncements

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

In April 2008, the FASB issued FASB Staff Position No. FAS No.142-3, or FSP No. 142-3, Determination of Useful Life of Intangible Assets. FSP No. 142-3 amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under Statement of Financial Accounting Standards No. 142, or SFAS No. 142, Goodwill and Other Intangible Assets. FSP No. 142-3 also requires expanded disclosure regarding the determination of intangible asset useful lives. FSP No. 142-3 is effective for fiscal years beginning after December 15, 2008. Earlier adoption is not permitted. We are currently evaluating the potential impact the adoption of FSP No. 142-3 will have on our consolidated financial position, results of operations and cash flows.

 
 
 
 
 
8

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

 
Note 2 - Stock-Based Compensation

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

   
Three Months Ended
   
Nine Months Ended
 
   
October 26,
2008
   
October 28,
2007
   
October 26,
2008
   
October 28,
2007
 
     
(In thousands)
 
Cost of revenue
 
$
3,558
   
$
2,566
   
$
10,027
   
$
8,077
 
Research and development
 
$
22,740
   
$
18,650
   
$
71,500
   
$
57,471
 
Sales, general and administrative
 
$
12,086
   
$
10,787
   
$
39,346
   
$
33,320
 

During the three and nine months ended October 26, 2008, we granted approximately 7.7 million and 17.4 million stock options, respectively, with an estimated total grant-date fair value of $45.7 million and $141.1 million, respectively, and a per option weighted average grant-date fair value of $5.93 and $8.13, respectively. Of the estimated total grant-date fair value, we estimated that the stock-based compensation expense related to the awards that are not expected to vest was $7.5 million and $23.3 million for the three and nine months ended October 26, 2008, respectively.

During the three and nine months ended October 28, 2007, we granted approximately 7.3 million and 15.9 million stock options, respectively, with an estimated total grant-date fair value of $117.8 million and $187.6 million, respectively, and a per option weighted average grant-date fair value of $16.03 and $11.79, respectively. Of the estimated total grant-date fair value, we estimated that the stock-based compensation expense related to the awards that are not expected to vest was $22.7 million and $36.2 million for the three and nine months ended October 28, 2007, respectively.

As of October 26, 2008 and October 28, 2007, the aggregate amount of unearned stock-based compensation expense related to our stock options was $226.8 million and $244.7 million, respectively, adjusted for estimated forfeitures.  We will recognize the unearned stock-based compensation expense related to stock options over an estimated weighted average amortization period of 1.9 years and 2.2 years, respectively.

Valuation Assumptions

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

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

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



 
 
 
 
9

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

   
Three Months Ended
   
Nine Months Ended
 
   
October 26,
2008
   
October 28,
2007
   
October 26,
2008
   
October 28,
2007
 
     
(Using a binomial model)
 
Expected life (in years)
   
3.6 -5.8
     
3.8 - 5.8
     
3.6 - 5.8
     
3.8 - 5.8
 
Risk free interest rate
   
2.7% - 3.4
%
   
4.1% - 4.7
%
   
2.6% - 3.7
%
   
4.1% - 5.0
%
Volatility
   
61% - 105
%
   
45% - 54
%
   
52% - 105
%
   
37% - 54
%
Dividend Yield
   
-
     
-
     
-
     
-
 
 

Employee Stock Purchase Plan

   
Three Months Ended
   
Nine Months Ended
 
   
October 26,
2008
   
October 28,
2007
   
October 26,
2008
   
October 28,
2007
 
     
(Using a Black-Scholes model)
 
Expected life (in years)
   
0.5 - 2.0
     
0.5 - 2.0
     
0.5 - 2.0
     
0.5 - 2.0
 
Risk free interest rate
   
2.0% - 2.4
%
   
4.1% - 4.5
%
   
1.6% - 2.4
%
   
4.1% - 5.0
%
Volatility
   
62%
     
54
%
   
62% - 68
%
   
47% - 54
%
Dividend Yield
   
-
     
-
     
-
     
-
 

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

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

The following summarizes the transactions under our equity incentive plans:
 
 
Options Available for Grant
   
Options
Outstanding
   
Weighted Average Exercise Price Per Share
 
Balances, January 27, 2008
 
44,044,004
     
90,581,073
   
$
13.18
 
Granted
 
(17,358,152
)
   
17,358,152
   
$
14.64
 
Exercised
 
-
     
(6,019,139
)
 
$
4.68
 
Cancelled
 
2,413,243
     
(2,413,243
)
 
$
22.00
 
Balances, October 26, 2008
 
29,099,095
     
99,506,843
   
$
13.73
 
 
 

 
 
 
 
10

 
 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
 
Note 3 – Restructuring Charges

On September 18, 2008, we announced a workforce reduction to allow for continued investment in strategic growth areas, which was completed in the third quarter of fiscal year 2009. As a result, we eliminated approximately 360 positions worldwide, or about 6.5% of our global workforce.  During the third quarter of fiscal year 2009, expenses associated with the workforce reduction, which were comprised primarily of severance and benefits payments to these employees, totaled $8.3 million.

       The following table provides a summary of the restructuring activities and related liabilities recorded in accrued liabilities in our Condensed Consolidated Balance Sheet:

   
October 26,
2008
 
Accrued Restructuring Charges : 
 
(In thousands)
 
Balance at January 27, 2008
  $ -  
Charges
    8,338  
Cash payments
    (7,241 )
Non-cash charges
    (330 )
Balance at October 26, 2008
  $ 767  

  The remaining accrual of $0.8 million as of October 26, 2008 relates to severance and benefits payments, which are expected to be paid during the fourth quarter of fiscal year 2009.

Note 4 – Income Taxes

We recognized income tax expense (benefit) of ($0.7) million and $31.1 million for the three months ended October 26, 2008 and October 28, 2007, respectively, and $9.8 million and $80.8 million for the nine months ended October 26, 2008 and October 28, 2007, respectively. Income tax expense (benefit) as a percentage of income before taxes, or our effective tax rate, was (1.2%) and 11.7% for the three months ended October 26, 2008 and October 28, 2007, respectively, and 7.7% and 13.0% for the nine months ended October 26, 2008 and October 28, 2007, respectively.  Our effective tax rate is lower than the United States federal statutory tax rate of 35.0% due primarily to income earned in lower tax jurisdictions and the U.S. tax benefit of the federal research tax credits available in the respective periods.

Our effective tax rate of 7.7% for the first nine months of fiscal year 2009 was lower than our effective tax rate of 13.0% for the first nine months of fiscal year 2008 due primarily to a favorable impact from the expiration of statutes of limitations in certain non-U.S. jurisdictions and due to the reinstatement of the U.S. federal research tax credit under the Emergency Economic Stabilization Act of 2008, which was signed into law on October 3, 2008 and was retroactive to January 1, 2008.

During the second quarter of fiscal year 2009, the Internal Revenue Service closed its review of our U.S. federal income tax returns for fiscal year 2004 through 2006 with no material changes to our income tax returns as filed.  However, due to net operating losses generated in those and other tax years, we remain subject to future examination of our U.S. federal income tax returns beginning in fiscal year 2002 through fiscal year 2008.  For the nine months ended October 26, 2008, there have been no other material changes to our tax years that remain subject to examination by major tax jurisdictions.  Additionally, there have been no material changes to our unrecognized tax benefits and any related interest or penalties from our fiscal year ended January 27, 2008.

While we believe that we have adequately provided for all uncertain tax positions, amounts asserted by tax authorities could be greater or less than our accrued position. Accordingly, our provisions on federal, state and foreign tax-related matters to be recorded in the future may change as revised estimates are made or the underlying matters are settled or otherwise resolved with the respective tax authorities. As of October 26, 2008, we do not believe that our estimates, as otherwise provided for, on such tax positions will significantly increase or decrease within the next twelve months.
 

 
 
 
 
11

 
 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
Note 5 – 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
   
Nine Months Ended
 
   
October 26,
2008
   
October 28,
2007
   
October 26,
2008
   
October 28,
2007
 
   
(In thousands, except per share data)
 
Numerator:
                       
        Net income
 
$
61,748
   
$
235,661
   
$
117,624
   
$
540,652
 
Denominator:
                               
        Denominator for basic net income per share, weighted average shares
   
543,807
     
554,966
     
551,623
     
547,796
 
Effect of dilutive securities:
                               
        Stock options outstanding
   
20,729
     
58,019
     
38,867
     
57,937
 
Denominator for diluted net income per share, weighted average shares
   
564,536
     
612,985
     
590,490
     
605,733
 
        Net income per share:
                               
Basic net income per share
 
$
0.11
   
$
0.42
   
$
0.21
   
$
0.99
 
Diluted net income per share
 
$
0.11
   
$
0.38
   
$
0.20
   
$
0.89
 

Diluted net income per share for the three and nine months ended October 26, 2008 does not include the effect of anti-dilutive common equivalent shares from stock options outstanding of 58.8 million and 45.2 million, respectively.  Diluted net income per share for the three and nine months ended October 28, 2007 does not include the effect of anti-dilutive common equivalent shares from stock options outstanding of 8.5 million and 11.5 million, respectively.
 
Note 6 - 3dfx
 
      During fiscal year 2002, we completed the purchase of certain assets from 3dfx Interactive, Inc., or 3dfx, for an aggregate purchase price of approximately $74.2 million. On December 15, 2000, NVIDIA Corporation and one of our indirect subsidiaries entered into an Asset Purchase Agreement, or the APA, to purchase certain graphics chip assets from 3dfx. Under the terms of the APA, the cash consideration due at the closing was $70.0 million, less $15.0 million that was loaned to 3dfx pursuant to a Credit Agreement dated December 15, 2000. The APA also provided, subject to the other provisions thereof, that if 3dfx properly certified that all its debts and other liabilities had been provided for, then we would have been obligated to pay 3dfx one million shares, which due to subsequent stock splits now totals six million shares, of NVIDIA common stock. If 3dfx could not make such a certification, but instead properly certified that its debts and liabilities could be satisfied for less than $25.0 million, then 3dfx could have elected to receive a cash payment equal to the amount of such debts and liabilities and a reduced number of shares of our common stock, with such reduction calculated by dividing the cash payment by $25.00 per share. If 3dfx could not certify that all of its debts and liabilities had been provided for, or could not be satisfied, for less than $25.0 million, we would not be obligated under the APA to pay any additional consideration for the assets.  On April 18, 2001, NVIDIA paid the cash consideration, and 3dfx effected the conveyance of the assets NVIDIA had purchased.

  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 asserts claims for, among other things, successor liability and fraudulent transfer and seeks additional payments from us.  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.

 
 
 
 
12

 
 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
 
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 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 13 of these Notes to Condensed Consolidated Financial Statements for further information regarding this litigation. 
 
   
Fair Market
Value
   
Straight-Line Amortization Period
 
   
(In thousands)
   
(Years)
 
Property and equipment
 
$
2,433
     
1-2
 
Trademarks
   
11,310
     
5
 
Goodwill
   
85,418
     
--
 
 Total
 
$
99,161
         
 
Note 7 – Business Combinations

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

On November 30, 2007, we completed our acquisition of Mental Images, Inc., or Mental Images, an industry leader in photorealistic rendering technology. The aggregate purchase price consisted of total consideration of approximately $88.3 million. The total consideration also includes approximately $7.8 million which reflects an initial investment we made in Mental Images in prior periods and $5.6 million primarily towards guaranteed payments subsequent to completion of our acquisition. 

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

 

 
13

 
 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
 
As of October 26, 2008, the estimated fair values of the purchase price allocated to assets we acquired and liabilities we assumed on the respective acquisition dates were as follows:  

   
Mental Images
   
Ageia
 
Fair Market Values
 
(In thousands)
 
Cash and cash equivalents
 
$
988
   
$
1,744
 
Marketable securities
   
     
28
 
Accounts receivable
   
1,462
     
911
 
Prepaid and other current assets
   
214
     
3,825
 
Property and equipment
   
1,212
     
169
 
In-process research and development
   
4,000
     
-
 
Goodwill
   
58,768
     
16,547
 
Intangible assets:
               
    Existing technology
   
14,400
     
13,450
 
    Customer relationships
   
6,500
     
170
 
    Patents
   
5,000
     
-
 
    Trademark
   
1,200
     
900
 
Total assets acquired
   
93,744
     
37,744
 
Current liabilities
   
(1,579
)
   
(6,994
)
Acquisition related costs
   
(1,303
)
   
(1,030
)
Long-term liabilities
   
(2,542
)
   
-
 
Total liabilities assumed
   
(5,424
)
   
(8,024
)
Purchase price allocation
 
$
88,320
   
$
29,720
 
 
 
     
Mental Images
   
Ageia
 
   
(Straight-line depreciation/amortization period)
Property and equipment
   
2 -5 years
   
1-2 years
 
Intangible assets:
             
Existing technology
   
4-5 years
   
4 years
 
Customer relationships
   
4-5 years
   
5 years
 
Patents
   
5 years
   
-
 
Trademark
   
5 years
   
5 years
 

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

 
14

 
 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
Note 8 - 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.  Any unrealized losses which are considered to be other-than-temporary impairments are recorded in the other income (expense) section of our consolidated statements of income.  Realized gains (losses) on the sale of marketable securities are determined using the specific-identification method and recorded in the other income (expense) section of our consolidated statements of income.  

We performed an impairment review of our investment portfolio as of October 26, 2008. Currently, we have the intent and ability to hold our investments with impairment indicators until maturity. Based on our quarterly impairment review and having considered the guidance in Statement of Financial Accounting Standards Staff Position No. 115-1, or FSP No. 115-1, A Guide to the Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities, we recorded other than temporary impairment charges of $8.8 million for the three months ended October 26, 2008. These charges include $5.6 million related to what we believe is an other than temporary impairment of our investment in the money market funds held by the Reserve International Liquidity Fund, Ltd., or International Reserve Fund.  Please refer to Note 17 of these Notes to the Condensed Consolidated Financial Statements for further details. We concluded that our investments were appropriately valued and that, except for the $8.8 million impairment charges recognized in the quarter, no other than temporary impairment charges were necessary on our portfolio of available for sale investments as of October 26, 2008.

Net realized gains for the three and nine months ended October 26, 2008 were $0.9 million and $2.1 million, respectively. Net realized gains for the three and nine months ended October 28, 2007 were not significant.  As of October 26, 2008, we had a net unrealized loss of $4.1 million, which was comprised of gross unrealized losses of $7.0 million, offset by $2.9 million of gross unrealized gains.  As of January 27, 2008, we had a net unrealized gain of $10.7 million, which was comprised of gross unrealized gains of $11.1 million, offset by $0.4 million of gross unrealized losses.   
 
Note 9 - Goodwill
 
The carrying amount of goodwill is as follows:
 
   
October 26,
2008
   
January 27,
2008
 
   
(In thousands)
 
PortalPlayer
 
 $
104,473
   
$
104,473
 
3dfx
   
75,326
     
75,326
 
Mental Images
   
58,768
     
63,086
 
MediaQ
   
35,167
     
35,167
 
ULi
   
31,115
     
31,115
 
Hybrid Graphics
   
27,906
     
27,906
 
Ageia
   
16,547
     
-
 
Other
   
16,984
     
16,984
 
 Total goodwill
 
$
366,286
   
$
354,057
 
 
During the nine months ended October 26, 2008, goodwill increased by $12.2 million, primarily due to our acquisition of Ageia on February 10, 2008.  This increase in goodwill was offset by a decrease of $4.3 million for Mental Images related to the reassessment of estimates made during the preliminary purchase price allocation.
 

 
15

 
 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
 
Note 10 - Amortizable Intangible Assets
 
We currently amortize our intangible assets with definitive lives over periods ranging from one to ten years using a method that reflects the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up or, if that pattern can not be reliably determined, using a straight-line amortization method. The components of our amortizable intangible assets are as follows:

   
October 26, 2008
   
January 27, 2008
 
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net Carrying
Amount
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net Carrying
Amount
 
                                                                                                               (In thousands)
 
Technology licenses
 
$
130,359
   
$
(31,304
)
 
$
99,055
   
$
94,970
   
$
(32,630
)
 
$
62,340
 
Acquired intellectual property
   
75,280
     
(30,538
)
   
44,742
     
77,900
     
(41,030
)
   
36,870
 
Patents
   
18,588
     
(6,739
)
   
11,849
     
35,348
     
(27,632
)
   
7,716
 
Other
   
-
     
-
     
-
     
1,494
     
(1,494
)
   
-
 
Total intangible assets
 
$
224,227
   
$
(68,581
)
 
$
155,646
   
$
209,712
   
$
(102,786
)
 
$
106,926
 
 
The increase in the net carrying amount of technology licenses as of October 26, 2008 when compared to January 27, 2008, is primarily related to approximately $21.5 million of net cash outflows under a confidential patent licensing arrangement entered into during fiscal year 2007 and $25.0 million towards the purchase of a non-exclusive license related to advanced power management and other computing technologies that we entered into during the third quarter of fiscal 2009.  These increases were offset by amortization for the nine months ended October 26, 2008. Additionally, the increase in the net carrying value of acquired intellectual property is primarily related to the intangible assets that resulted from our acquisition of Ageia during the first quarter of fiscal year 2009, offset by amortization for the nine months ended October 26, 2008. Please refer to Note 7 of these Notes to Condensed Consolidated Financial Statements for further information. During the nine months ended October 26, 2008, the increase in the gross carrying amount of the intangible assets was offset by the write-off of fully amortized intangible assets that are no longer in use.

Amortization expense associated with intangible assets for the three and nine months ended October 26, 2008 was $8.7 million and $23.7 million, respectively.  Amortization expense associated with intangible assets for the three and nine months ended October 28, 2007 was $5.7 million and $18.2 million, respectively.  Future amortization expense related to the net carrying amount of intangible assets at October 26, 2008 is estimated to be $8.8 million for the remainder of fiscal year 2009, $31.3 million in fiscal 2010, $27.1 million in fiscal 2011, $24.5 million in fiscal 2012, $18.6 million in fiscal 2013, $14.1 million in fiscal 2014 and $31.2 million in fiscal years subsequent of fiscal 2014.
 
Note 11 - Balance Sheet Components
 
Certain balance sheet components are as follows:
 
   
October 26,
2008
   
January 27,
2008
 
Inventories: 
 
(In thousands)
 
Raw materials
 
$
30,559
   
$
31,299
 
Work in-process
   
161,534
     
107,835
 
Finished goods
   
331,895
     
219,387
 
 Total inventories
 
$
523,988
   
$
358,521
 
 
The increase in inventories at October 26, 2008 when compared to January 27, 2008 was due primarily to increases in our newer GPU and MCP products. At October 26, 2008, we had outstanding inventory purchase obligations totaling approximately $446 million.
 
 
16

 
 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
 
   
October 26,
2008
   
January 27,
2008
 
Estimated
Useful Life
   
(In thousands)
 
(Years)
Property and Equipment:
             
Test equipment
 
$
232,290
   
$
186,774
 
3
Land
   
213,929
     
38,442
 
(A)
Software and licenses
   
191,027
     
246,725
 
3 - 5
Computer equipment
   
130,174
     
137,642
 
3
Leasehold improvements
   
121,733
     
103,353
 
(B)
Office furniture and equipment
   
32,319
     
28,220
 
5
Building
   
29,216
     
4,104
 
25
Construction in process
   
13,997
     
8,258
 
(C)
     
964,685
     
753,518
   
Accumulated depreciation and amortization
   
(355,011
)
   
(393,710
)
 
 Total property and equipment, net
 
$
609,674
   
$
359,808
   

(A) Land is a non-depreciable asset.
(B) Leasehold improvements are amortized based on the lesser of either the asset’s estimated useful life or the remaining lease term.
(C) Construction in process represents assets that are not in service as of the balance sheet date.

The increase in property and equipment, net, at October 26, 2008 compared to January 27, 2008, includes the purchase of a property that is comprised of approximately 25 acres of land and ten commercial buildings in Santa Clara, California, which we purchased for approximately $150 million.  During the nine months ended October 26, 2008, we also wrote-off approximately $151.0 million of fully depreciated property and equipment that was no longer in use, including $74.6 million of software and licenses.
 
   
October 26,
2008
   
January 27,
2008
 
Accrued Liabilities:
 
(In thousands)
 
Accrued customer programs (1)
 
$
256,989
   
$
271,869
 
Warranty accrual (2)
   
181,687
     
5,707
 
Accrued payroll and related expenses
   
76,666
     
122,284
 
Accrued legal settlement (3)
   
30,600
     
30,600
 
Accrued costs related to purchase of property
   
28,146
     
-
 
Deferred rent
   
12,065
     
11,982
 
Deferred revenue
   
4,031
     
5,856
 
Accrued restructuring (4)
   
767
     
-
 
Other
   
26,262
     
26,764
 
 Total accrued liabilities
 
$
617,213
   
$
475,062
 

(1) Please refer to Note 1 of these Notes to Condensed Consolidated Financial Statements for discussion regarding the nature of accrued customer programs and their accounting treatment related to our revenue recognition policies and estimates.
(2) Please refer to Note 12 of these Notes to Condensed Consolidated Financial Statements for discussion regarding the warranty accrual.
(3) Please refer to Note 13 of these Notes to Condensed Consolidated Financial Statements for discussion regarding the 3dfx litigation.
(4) Please refer to Note 3 of these Notes to Condensed Consolidated Financial Statements for discussion regarding the Restructuring Charges.
  
 
 
 
 
17

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

   
October 26,
2008
   
January 27,
2008
 
Other Long-term Liabilities: 
 
(In thousands)
 
Deferred income tax liability
 
$
85,007
   
$
86,900
 
Income taxes payable, long-term
   
48,627
     
44,235
 
Asset retirement obligation
   
6,661
     
6,470
 
Other long-term liabilities
   
17,063
     
24,993
 
 Total other long-term liabilities
 
$
157,358
   
$
162,598
 

Note 12 - Guarantees
 
FASB Interpretation No. 45, or FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a tabular reconciliation of the changes of the entity’s product warranty liabilities.

Product Defect

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

In July 2008, we recorded a $196.0 million charge against cost of revenue to cover anticipated customer warranty, repair, return, replacement and other associated costs arising from a weak die/packaging material set in certain versions of our previous generation media and communications processor, or MCP, and GPU products used in notebook systems. All of our newly manufactured products and all of our products that are currently shipping in volume have a different material set that we believe is more robust.
 
The previous generation MCP and GPU products that are impacted were included in a number of notebook products that were shipped and sold in significant quantities. Certain notebook configurations of these MCP and GPU products are failing in the field at higher than normal rates. While we have not been able to determine a root cause for these failures, testing suggests a weak material set of die/package combination, system thermal management designs, and customer use patterns are contributing factors. We have worked with our customers to develop and have made available for download a software driver to cause the system fan to begin operation at the powering up of the system and reduce the thermal stress on these chips. We have also recommended to our customers that they consider changing the thermal management of the MCP and GPU products in their notebook system designs. We intend to fully support our customers in their repair and replacement of these impacted MCP and GPU products that fail, and their other efforts to mitigate the consequences of these failures.

We continue to engage in discussions with our supply chain regarding reimbursement to us for some or all of the costs we have incurred and may incur in the future relating to the weak material set. We also continue to seek to access our insurance coverage. However, there can be no assurance that we will recover any such reimbursement. We continue to not see any abnormal failure rates in any systems using NVIDIA products other than certain notebook configurations. However, we are continuing to test and otherwise investigate other products. There can be no assurance that we will not discover defects in other MCP or GPU products.
 
        In September, October and November 2008, several putative class action lawsuits were filed against us, asserting various claims related to the impacted MCP and GPU products.  Please refer to Note 13 of these Notes to Condensed Consolidated Financial Statements for further information regarding this litigation.
 

 
 
 
 
18

 
 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
Accrual for estimated product returns and product warranty liabilities

We record a reduction to revenue for estimated product returns at the time revenue is recognized primarily based on historical return rates. Cost of revenue includes the estimated cost of product warranties that are calculated at the point of revenue recognition. Under limited circumstances, we may offer an extended limited warranty to customers for certain products. The estimated product returns and estimated product warranty liabilities for the three and nine months ended October 26, 2008 and October 28, 2007 are as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
October 26,
2008
   
October 28,
2007
   
October 26,
2008
 
October 28,
2007
 
   
(In thousands)
 
Balance at beginning of period
 
$
205,091
   
$
20,694
   
$
24,432
   
$
17,958
 
Additions (1),(4)
   
6,550
     
7,362
     
219,842
     
20,810
 
Deductions (2),(5)
   
(12,129
)
   
(5,546
)
   
(44,762
)
   
(16,258
)
Balance at end of period (3)
 
$
199,512
   
$
22,510
   
$
199,512
   
$
22,510
 
 
(1) Includes $ 6,550 and $ 22,588 for the three and nine months ended October 26, 2008, respectively, and $6,584 and $19,611 for the three and nine months ended October 28, 2007, respectively, towards allowances for sales returns estimated at the time revenue is recognized primarily based on historical return rates and is charged as a reduction to revenue.

(2) Includes $6,685 and $23,489 for the three and nine months ended October 26, 2008, respectively, and $5,546 and $16,258 for the three and nine months ended October 28, 2007, respectively, written off against the allowance for sales returns.

(3) Includes $17,825 and $17,830 at October 26, 2008 and October 28, 2007, respectively, relating to allowance for sales returns.

(4) Includes $195,954 for the nine months ended October 26, 2008 for incremental repair and replacement costs from a weak die/packaging material set.

(5) Includes $4,660 and $20,490 for the three and nine months ended October 26, 2008 in deductions towards warranty accrual associated with incremental repair and replacement costs from a weak die/packaging material set.
         
In connection with certain agreements that we have executed in the past, we have at times provided indemnities to cover the indemnified party for matters such as tax, product and employee liabilities. We have also on occasion included intellectual property indemnification provisions in our technology related agreements with third parties. Maximum potential future payments cannot be estimated because many of these agreements do not have a maximum stated liability. As such, we have not recorded any liability in our Condensed Consolidated Financial Statements for such indemnifications.
 
Note 13 - Commitments and Contingencies
    
         3dfx
 
On December 15, 2000, NVIDIA Corporation and one of our indirect subsidiaries entered into an Asset Purchase Agreement, or APA, to purchase certain graphics chip assets from 3dfx.  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.
 
Landlord Lawsuits.
 
In May 2002, we were served with a California state court complaint filed by the landlord of 3dfx’s San Jose, California commercial real estate lease, Carlyle Fortran Trust, or Carlyle. In December 2002, we were served with a California state court complaint filed by the landlord of 3dfx’s Austin, Texas commercial real estate lease, CarrAmerica Realty Corporation, or CarrAmerica. The landlords both asserted claims for, among other things, interference with contract, successor liability and fraudulent transfer. The landlords sought to recover damages in the aggregate amount of approximately $15 million, representing amounts then owed on the 3dfx leases.  The cases were later removed to the United States Bankruptcy Court for the Northern District of California when 3dfx filed its bankruptcy petition and consolidated for pretrial purposes with an action brought by the bankruptcy trustee.

 
 
 
 
19

 
 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
In 2005, the U.S. District Court for the Northern District of California withdrew the reference to the Bankruptcy Court for the landlords’ actions, and on November 10, 2005, granted our motion to dismiss both landlords’ complaints.  The landlords filed amended complaints in early February 2006, and NVIDIA again filed motions to dismiss those claims. On September 29, 2006, the District Court dismissed the CarrAmerica action in its entirety and without leave to amend.  On December 15, 2006, the District Court also dismissed the Carlyle action in its entirety.  Both landlords filed timely notices of appeal from those orders.  
 
On July 17, 2008, the United States Court of Appeals for the Ninth Circuit held oral argument on the landlords' appeals.  On November 25, 2008, the Court of Appeals issued its opinion affirming the dismissal of Carlyle’s complaint in its entirety.  The Court of Appeals also affirmed the dismissal of most of CarrAmerica’s complaint, but reversed the District Court’s dismissal of CarrAmerica’s claims for interference with contractual relations and fraud.  The Court of Appeals has not yet issued its mandate.  After the mandate issues, CarrAmerica’s case will be remanded back to the District Court for further proceedings. We continue to believe that there is no merit to Carr’s remaining claims. 
 
Trustee Lawsuit.
 
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 asserts claims for, among other things, successor liability and fraudulent transfer and seeks 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 was therefore responsible for all of 3dfx's unpaid liabilities.  This action was consolidated for pretrial purposes with the landlord cases, as noted above.
 
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 Equity Committee Lawsuit.
 
On December 8, 2005, the Trustee filed a Form 8-K on behalf of 3dfx, disclosing the terms of the conditional settlement agreement between NVIDIA and the Creditor’s Committee. Thereafter, certain 3dfx shareholders filed a petition with the Bankruptcy Court to appoint an official committee to represent the claimed interests of 3dfx shareholders. The court granted that petition and appointed an Equity Securities Holders’ Committee, or the Equity Committee. The Equity Committee thereafter sought and obtained an order granting it standing to bring suit against NVIDIA, for the benefit of the bankruptcy estate, to compel NVIDIA to pay the Stock Consideration then unpaid from the APA, and filed its own competing plan of reorganization/liquidation. The Equity Committee’s plan assumes that 3dfx can raise additional equity capital that would be used to retire all of 3dfx’s debts, and thus to trigger NVIDIA's obligation to pay six million shares of Stock Consideration specified in the APA. NVIDIA contends, among other things, that such a commitment is not sufficient and that its obligation to pay the stock consideration had long before been extinguished. On May 1, 2006, the Equity Committee filed its lawsuit for declaratory relief to compel NVIDIA to pay the Stock Consideration. In addition, the Equity Committee filed a motion seeking Bankruptcy Court approval of investor protections for Harbinger Capital Partners Master Fund I, Ltd., an equity investment fund that conditionally agreed to pay no more than $51.5 million for preferred stock in 3dfx. The hearing on that motion was held on January 18, 2007, and the Bankruptcy Court approved the proposed protections.
 
 
 
 
 
20

 
 
 
NVIDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
 
After losing an earlier motion to dismiss, the Equity Committee again amended its complaint, and NVIDIA moved to dismiss that amended complaint as well. On December 21, 2006, the Bankruptcy Court granted the motion as to one of the Equity Committee’s claims, and denied it as to the others. However, the Bankruptcy Court also ruled that NVIDIA would only be required to answer the first three causes of action by which the Equity Committee seeks determinations that (1) the APA was not terminated before 3dfx filed for bankruptcy protection, (2) the 3dfx bankruptcy estate still holds some rights in the APA, and (3) the APA is capable of being assumed by the bankruptcy estate.
 
Because of the trial of the Trustee's fraudulent transfer claims against NVIDIA, the Equity Committee's lawsuit did not progress substantially in 2007.  On July 31, 2008, the Equity Committee filed a motion for summary judgment on its first three causes of action.  On September 15, 2008, NVIDIA filed a cross-motion for summary judgment.  On October 24, 2008, the Court held a hearing on the parties’ cross-motions for summary judgment, and the matter now awaits that court’s decision.
 
Proceedings, SEC inquiry and lawsuits related to our historical stock option granting practices