10-Q 1 d00805e10vq.txt FORM 10-Q 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 Period Ended July 31, 2002. [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition Period from __________ to __________. Commission file number 0-22651 ---------- 3DFX INTERACTIVE, INC. (Exact name of registrant as specified in its charter) ---------- CALIFORNIA 77-0390421 ---------- ---------- (State or Other Jurisdiction of (IRS Employer Identification No.) Incorporation or Organization) P.O. BOX 60486 PALO ALTO, CALIFORNIA 94306 ---------- (Address of Principal Executive Office) (Zip Code) TELEPHONE NUMBER (650) 326-7995 ---------- (Registrant's telephone number, including area code) ---------- (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 periods 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, No Par Value -- 39,774,364 shares as of October 25, 2002 -------------------------------------------------------------------------------- 3dfx Interactive, Inc. Index

i PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS 3dfx INTERACTIVE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF NET LIABILITIES IN LIQUIDATION (In thousands) (Unaudited)

The accompanying notes are an integral part of these financial statements. 1 3DFX INTERACTIVE, INC. CONSOLIDATED STATEMENTS OF CHANGES IN NET LIABILITIES IN LIQUIDATION (In thousands) (Unaudited)

The accompanying notes are an integral part of these financial statements. 2 3DFX INTERACTIVE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF DISCONTINUED OPERATIONS (In thousands, except per share data) (Unaudited)

The accompanying notes are an integral part of these financial statements. 3 3DFX INTERACTIVE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS OF DISCONTINUED OPERATIONS (In thousands) (Unaudited)

The accompanying notes are an integral part of these financial statements. 4 3DFX INTERACTIVE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1 - The Company and its Significant Accounting Policies: 3dfx 3dfx Interactive, Inc. ("3dfx" or "the Company") was incorporated in California on August 24, 1994. 3dfx developed high performance, cost-effective graphics chips, graphics boards, software and related technology that enable an interactive and realistic 3D experience across multiple hardware platforms. 3dfx has subsidiaries in the United States and Mexico. The unaudited condensed consolidated financial statements as of July 31, 2002 and for the three and six months ended include the financial statements of 3dfx and its wholly owned subsidiaries. All significant intercompany transactions and accounts have been eliminated. The unaudited condensed consolidated financial statements included herein have been prepared by 3dfx pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information or footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of 3dfx, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial information included therein. While 3dfx believes that the disclosures are adequate to make the information not misleading, it is suggested that these financial statements be read in conjunction with the audited financial statements and accompanying notes included in 3dfx's Annual Report on Form 10-K for the fiscal year ended January 31, 2002 as filed with the Securities and Exchange Commission. As described below, on March 27, 2001, 3dfx's shareholders approved proposals to liquidate, wind-up and dissolve 3dfx pursuant to a plan of dissolution. 3dfx is proceeding to wind-up its affairs and dissolve. Accordingly, all activities of 3dfx as of and since March 27, 2001 are presented under the liquidation basis of accounting. Under the liquidation basis of accounting, assets are stated at their estimated net realizable values and liabilities are stated at their anticipated settlement amount, if reasonably estimable. See "Activities While in Liquidation" below. See also Note 6. NVIDIA ASSET SALE TERMS In the fall of 2000, 3dfx began experiencing financial difficulties due in part to substantially reduced demand in the retail channel for its products. This reduced demand is attributable to a number of factors, including, in part, its failure to introduce products in a timely manner and from disappointing customer response to its existing products, as well as reduced demand in the retail channel in general and the add-in graphics segment in particular. In addition, 3dfx's high research and development costs and substantial debt burden, together with the loss of several large customers due to 3dfx's May 1999 acquisition of STB Systems, Inc. and its inability to refinance its debt on commercially reasonable terms, aggravated its financial difficulties. After extensive exploration and evaluation of various strategic alternatives, the 3dfx board of directors concluded that the liquidation, winding up and dissolution of 3dfx provided the best protection to 3dfx's creditors and was in the best interests of its shareholders. On December 15, 2000, 3dfx entered into an asset purchase agreement with Nvidia Corporation ("Nvidia") and a subsidiary of Nvidia ("Nvidia Sub") under which Nvidia Sub would acquire certain of 3dfx's assets, including its core graphics processor assets. Under the terms of the asset purchase agreement, Nvidia agreed to pay 3dfx $70.0 million in cash and 2,000,000 shares (on a post-split basis) of registered 5 Nvidia common stock, subject to the satisfaction of certain conditions specified in the asset purchase agreement as described below. Upon signing the asset purchase agreement, Nvidia loaned to 3dfx $15.0 million in cash for working capital. The asset sale to Nvidia Sub was approved by 3dfx shareholders on March 27, 2001, and on April 18, 2001 substantially all of 3dfx's assets were sold to Nvidia Sub. Upon closing, 3dfx received $55.0 million in cash, which amount was net of repayment of the $15.0 million cash loan 3dfx received upon signing the asset purchase agreement. In addition, under the terms of the asset purchase agreement, 3dfx and Nvidia Sub caused the pending patent litigation between the parties to be dismissed with prejudice. Under the terms of the asset purchase agreement, 3dfx may receive part or all of a one-time post-closing cash payment of up to $25.0 million upon its request if it is not in breach of the asset purchase agreement, it has expended all or substantially all of the $70.0 million cash consideration in payment of its liabilities and determines in good faith that (i) the remaining portion of the cash consideration previously received by it is not sufficient to pay its remaining liabilities, and (ii) such remaining liabilities could and would be satisfied if 3dfx received the post-closing cash payment and applied it to the payment of such liabilities, and if Nvidia Sub does not determine in good faith that the requested amount would not permit 3dfx to pay in full its remaining liabilities. In the event that 3dfx were to receive the post-closing cash payment, the 2,000,000 shares of Nvidia common stock comprising the remaining consideration otherwise payable to 3dfx under the asset purchase agreement will be reduced by the number of shares equal to the quotient determined by dividing the amount of the post-closing cash payment by $25. 3dfx's net liabilities in liquidation at July 31, 2002 were $35.2 million. The 2,000,000 shares of Nvidia common stock will only become deliverable to 3dfx upon satisfaction of certain conditions specified in the asset purchase agreement, including the completion of the winding up of the business of 3dfx pursuant to 3dfx's plan of dissolution, and 3dfx's certification that (i) all liabilities of 3dfx and its subsidiaries have been paid in full or otherwise provided for and (ii) 3dfx has or will be validly dissolved. As a result of the contingencies described above (including 3dfx's net liabilities in liquidation, which at July 31, 2002 were $35.2 million), the contingent receivable and related tax provision on the gain have not been recorded in the accompanying consolidated statement of net liabilities in liquidation as of July 31, 2002. The ultimate total of the value of Nvidia stock received by 3dfx, if any, is dependent on the number and market value of shares received given the conditions described above. SERIES B PREFERRED STOCK FINANCING On June 13, 2002, 3dfx entered into a Series B Preferred Stock Purchase Agreement with SF Capital Partners Ltd. whereby SF Capital had agreed to invest between $25 and $35 million in 3dfx in exchange for shares of 3dfx's Series B Preferred Stock (the "Series B Financing"). The amount of the investment was to be based on the sum at closing of 3dfx's fixed and determinable liabilities, maximum reasonably known undeterminable liabilities and anticipated expenses reasonably necessary to complete the liquidation, winding-up and dissolution of 3dfx. The agreement with SF Capital provided that once the amount of all of 3dfx's liabilities is determined, or if some liabilities are not determinable then the maximum amount of all undetermined liabilities shall be reasonably known to 3dfx and SF Capital, and subject to the satisfaction of certain other specified conditions, then SF Capital will place the purchase price for the shares of Series B Preferred Stock into escrow pending closing. The purchase price will be released to 3dfx from escrow, and the closing of the Series B Financing will occur, upon the satisfaction of conditions that 3dfx and SF Capital specify in the escrow agreement. The number of shares of Series B Preferred Stock of 3dfx issuable to SF Capital at closing will be equal to the quotient derived by dividing (x) the sum of the investment amount and a specified percent of the investment amount by (y) the average closing price of Nvidia common stock for the five trading days preceding the closing. The "specified percentage of the investment amount" referred to in the preceding formula ranges from 25% to 40%, and varies based on the price of Nvidia common stock preceding the closing (the higher 6 the price of Nvidia common stock, the higher the specified percentage of the investment amount"). The Series B Preferred Stock will not be entitled to dividends, subject to redemption or conversion, and will have no voting rights, but it will have priority for payment upon the liquidation, winding-up or dissolution of 3dfx. If 3dfx is in the process of liquidating, dissolving or winding up, immediately upon its receipt of 500,000 or more shares of Nvidia common stock, 3dfx shall distribute to the holders of the Series B Preferred Stock, at 3dfx's election, either (i) $90 cash per share of Series B Preferred Stock or (ii) one share of Nvidia stock per share of Series B Preferred Stock (the "Liquidation Preference"). In the meantime, the prior written consent of the holders of not less than a majority of the outstanding shares of Series B Preferred Stock is required for 3dfx to make any dividends, distributions or redemptions on any other securities, or for 3dfx to issue any debt or equity securities, or for 3dfx to enter into any merger, sale of shares of capital stock having voting power with respect to 35% or more of its outstanding capital stock, or any transaction in which all or substantially all of the assets of 3dfx are sold. The holders of Series B Preferred Stock will have certain other rights designed to protect their investment in 3dfx. The stock purchase agreement with SF Capital is terminable if the funding amount exceeds the $35 million level or falls under the $25 million level, if the Nvidia closing price is equal to or less than $26, if the transaction fails to close within one year, if 3dfx is in material default of the agreement or if the Nvidia common stock is delisted from the Nasdaq National Market. As of October 28, 2002, Nvidia's closing common stock price was $11.16 per share. As a result, it is unlikely that the Series B Financing will be successfully closed. LIQUIDATION, WINDING UP AND DISSOLUTION On December 15, 2000, the board of directors of 3dfx also approved a plan of dissolution and on March 27, 2001 this plan of dissolution was approved by 3dfx's shareholders. On March 30, 2001, 3dfx filed a certificate of election to liquidate, wind up and dissolve with the California Secretary of State's office. 3dfx is proceeding to wind up its affairs and is no longer operating or generating revenues in the normal course of business. Accordingly, all of the activities of 3dfx have been presented on a liquidation basis of accounting. See also Note 6. At this time, 3dfx cannot determine if there will be any assets remaining after paying for, or providing for the payment of, 3dfx's liquidation expenses and all of its and its subsidiaries' debts and liabilities, as well as the distribution of the Liquidation Preference to the holders of the Series B Preferred Stock (if any). 3dfx expects to continue to incur certain administrative and other costs associated with its bankruptcy proceeding and the winding up its affairs. The amount of unknown or contingent liabilities cannot be quantified and could decrease or eliminate any remaining assets available for distribution to 3dfx's common shareholders. Further, if 3dfx or its subsidiaries are subject to any contingent liabilities, this could require that it establish reserves that could delay any distribution to 3dfx common shareholders. Because of the uncertainties as to the source of any 3dfx funds, the settlement amount of 3dfx's and its subsidiaries' debts and liabilities (including tax liabilities), as well as the volatility in the market price of Nvidia's stock, 3dfx cannot at this time determine the timing or amount of distributions that may be made to its common shareholders, if any. Only if there are assets remaining after the payment of all debts and liabilities, and the distribution of the Liquidation Preference (if any), will 3dfx common shareholders receive a distribution of those assets. 3dfx has substantially reduced its costs in order to conserve its resources. These cost-cutting measures included the termination of virtually all employees, reduction in leased space and other efforts to reduce non-essential expenses. During the fiscal year 2002, 3dfx also continued to liquidate its remaining assets, negotiate with third parties for resolutions of various litigation matters that would be agreeable to all parties involved, and to reach settlements with its vendors in 7 reduction of its accounts payable, as well as seeking to reach mutually satisfactory settlements with the lessors of its facilities and equipment leases. 3dfx provided manufacturing services to third parties to help cover the overhead associated with its Juarez, Mexico manufacturing facility until its lease of that facility was terminated in April 2002. The sales and costs of sales related to these operations are recorded as other income and expense on the condensed consolidated statement of discontinued operations for the period from February 1, 2001 to March 26, 2001 and as selling, general, and administrative expense for the six months ended July 31, 2002 and for the period from March 27, 2001 to July 31, 2001. ACTIVITIES WHILE IN LIQUIDATION During the six months ended July 31, 2002, 3dfx continued to negotiate with third parties for resolutions of various litigation matters that would be agreeable to all parties involved, and to reach settlements with its vendors in reduction of its accounts payable, as well as seeking to reach mutually satisfactory settlements with the lessors to its facilities and various equipment leases. Any remaining inventory and other assets held for sale have been written down to their net realizable value, which equals zero. As 3dfx is in liquidation, these remaining assets may be sold. 3dfx believes that any gains on such sales that may be realized will be immaterial. At July 31, 2002, 3dfx was still in negotiations to settle certain remaining leases under which it has contractual obligations. However, at July 31, 2002, 3dfx had total future lease obligations of $4.8 million and lease termination costs of $4.0 million in the current year, all of which has been accrued for as estimated costs during the period of liquidation in 3dfx's statement of net liabilities in liquidation. During the six months ended July 31, 2002, 3dfx incurred selling, general and administrative costs of $927,000, which were comprised of personnel expenses, legal and other professional fees, current period facilities expense, lease payments and lease termination expense. 3dfx also received other income of $93,000 relating primarily to an income tax refund receivable which was collected. Changes in net liabilities for the period from March 27, 2001 to July 31, 2001 were a result of selling, general and administrative expenses of $9.8 million, which is comprised of operating expenses, accrued expenses and lease termination expense, partially offset by the forgiveness of liabilities, a decrease in the deferred tax asset of $35.0 million and the net gain on sale of assets to Nvidia Sub of $2.3 million, which was comprised of the following: (a) a gain on the sale of inventory and other assets held for sale to Nvidia Sub of $14.3 million, which was comprised of the purchase by Nvidia Sub of certain inventory, fixed assets and intangible assets with net book values of $55.7 million offset by proceeds of $70.0 million and (b) losses of $12.0 million on sale of and impairment of inventory and other assets held for sale. At July 31, 2002, 3dfx had net liabilities in liquidation of $35.2 million. In light of the amount of 3dfx's liabilities, as well as contingencies relating to unknown or contingent liabilities and Nvidia's delivery of the shares of Nvidia common stock provided for in the Nvidia asset purchase agreement, there can be no assurance that 3dfx will have any assets available for distribution to its common shareholders. 8 Note 2 - Balance Sheet Components (in thousands): Estimated Costs During Period of Liquidation:

Note 3 - Net Loss Per Share: Basic net loss per share is computed using the weighted average number of common shares outstanding during the periods. Diluted net loss per share is computed using the weighted average number of common and potentially dilutive common shares during the periods presented. Diluted loss per share was the same as basic loss per share for the period from February 1, 2001 to March 26, 2001, and options to purchase approximately 3,276,380 shares of common stock were outstanding but not included in the calculation because they were anti-dilutive. No per share data is presented on or after March 27, 2001, as such information is not meaningful. Note 4 - Comprehensive Loss: Total comprehensive loss for the period February 1, 2001 to March 26, 2001 was $3.4 million, comprised of $700,000 from an unrealized loss on investment in 3Dlabs and net loss from discontinued operations of $2.7 million. Note 5 - Commitments and Contingencies: LEASES 3dfx leases, under noncancelable operating leases, certain of its facilities and equipment. There were no capital leases outstanding as of July 31, 2002. During fiscal 2002, the Company terminated several of its operating leases. At July 31, 2002, 3dfx was still in negotiations to settle certain remaining leases under which it has contractual obligations. However, at July 31, 2002, 3dfx had total future lease obligations of $8.8 million, all of which has been accrued. The remaining operating lease agreements existing at July 31, 2002, expire at various dates through 2007. CONTINGENCIES 3dfx was a party to the following legal proceedings involving certain collection matters against 3dfx, as previously reported in 3dfx's Annual Report on Form 10-K for the year ended January 31, 2002. The status of each proceeding is indicated in the table and, as indicated, 3dfx was successful in reaching terms agreeable to each of the indicated parties. In light of 3dfx's filing on October 15, 9 2002 of a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code, attempts to enforce any of the judgments is subject to an automatic stay.

3dfx is currently involved in litigation filed against it in the Superior Court of the State of California for the County of Santa Clara on February 11, 2002 by Carlyle Fortran Trust, 3dfx's landlord for its former headquarters in San Jose, California. The landlord filed for breach of lease in a tenant in possession action based on 3dfx's failure to pay rental amounts that are delinquent. On June 11, 2002, the court ruled in 3dfx's favor on a Summary Judgment motion filed by the landlord. The case was set for trial on October 21, 2002 to determine the relevant factual and legal issues, but did not occur in light of 3dfx's bankruptcy petition filing. On May 10, 2002 Carlyle Fortran Trust filed a second lawsuit in the Superior Court of the State of California for the County of Santa Clara against Nvidia and 3dfx, alleging an action for intentional interference with contract, fraudulent transfer, declaratory relief and unfair business practices. In September 2002 Carlyle Fortran Trust added certain of the directors and officers of Nvidia and 3dfx as defendants in this lawsuit. 3dfx is a party to litigation filed February 23, 2001 by Worldcom, Inc. in Dallas County on an open account for telephone services. The amount of damages stated in the petition was $1,389,000 plus interest and attorney's fees. The parties engaged in nonbinding mediation on June 24, 2002, but no resolution was achieved. Initial discovery has been conducted. Trial is currently set for January 6, 2003, although 10 3dfx's bankruptcy filing may affect this trial date. 3dfx disputes Worldcom's claims and intends to vigorously defend itself in this matter. Finally, a default judgment was entered in favor of CarrAmerica, 3dfx's lessor for its offices in Austin, Texas, on May 20, 2002 resulting from a lawsuit filed April 18, 2002 in the 261st Judicial District Court of Travis County, Texas. The judgment is now final. As the Nvidia asset purchase agreement requires that 3dfx wind up and dissolve, on July 15, 2002 3dfx filed a petition with the Superior Court of the State of California for the County of Santa Clara requesting that the Court take jurisdiction over 3dfx's winding up proceeding as allowed by the California corporate law. Two of 3dfx's creditors challenged this request. The Court formally denied 3dfx's request on September 6, 2002. 3dfx is also a party to various other lawsuits. Although the amount of any liability that could arise with respect to these other proceedings cannot be predicted accurately, 3dfx believes that any liability that might result from these other claims will not have a material adverse effect on its financial position. Note 6 - Subsequent Event: On October 15, 2002 3dfx filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the Northern District of California under Case No. 02-55795 and an order for relief was entered by the Bankruptcy Court. As a result of the Chapter 11 filing, claims against 3dfx are subject to an automatic stay, and no party may take action to realize its pre-petition claims, except pursuant to an order of the Bankruptcy Court. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF DISCONTINUED OPERATIONS This report 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. Any statements contained in this document, including without limitation statements to the effect that 3dfx or its management "believes," "expects," "anticipates," "plans," "may," "will," "projects," "continues," or "estimates," or statements concerning "potential," or "opportunity" or other variations thereof or comparable terminology or the negative thereof, that are not statements of historical fact should be considered forward-looking statements. These forward-looking statements are based on current expectations and entail various risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Some of such risks and uncertainties are set forth below under "Risk Factors." OVERVIEW 3dfx developed high performance, cost-effective graphics chips, graphics boards, software and related technology that enabled an interactive and realistic 3D experience across multiple hardware platforms, but is now in the process of winding up its business. As discussed below, on March 27, 2001, 3dfx's shareholders approved proposals to liquidate, wind up and dissolve 3dfx pursuant to a plan of dissolution and to sell certain of its assets to Nvidia US Investment Company ("Nvidia Sub"), a wholly owned subsidiary of Nvidia Corporation ("Nvidia"). 3dfx is continuing to wind up its affairs and dissolve. Accordingly, all activities of 3dfx subsequent to March 27, 2001 are presented on a liquidation basis in the accompanying consolidated financial statements. Additionally, on October 15, 2002, 3dfx voluntarily filed a petition with the United States Bankruptcy Court for the Northern District of California under Chapter 11 of the United States Bankruptcy Code. 11 NVIDIA ASSET SALE TERMS In the fall of 2000, 3dfx began experiencing financial difficulties due in part to substantially reduced demand in the retail channel for its products. This reduced demand is attributable to a number of factors, including, in part, its failure to introduce products in a timely manner and from disappointing customer response to its existing products, as well as reduced demand in the retail channel in general and the add-in graphics segment in particular. In addition, 3dfx's high research and development costs and substantial debt burden, together with the loss of several large customers due to 3dfx's May 1999 acquisition of STB Systems, Inc. and its inability to refinance its debt on commercially reasonable terms, aggravated its financial difficulties. After extensive exploration and evaluation of various strategic alternatives, the 3dfx board of directors concluded that the liquidation, winding up and dissolution of 3dfx provided the best protection to 3dfx's creditors and was in the best interests of its shareholders. On December 15, 2000, 3dfx entered into an asset purchase agreement with Nvidia and Nvidia Sub under which Nvidia Sub would acquire certain of 3dfx's assets, including its core graphics processor assets. Under the terms of the asset purchase agreement, Nvidia Sub agreed to pay 3dfx $70.0 million in cash and 2,000,000 shares of registered Nvidia common stock (after giving effect to a recent Nvidia stock split), subject to the satisfaction of certain conditions specified in the asset purchase agreement as described below. Upon signing the asset purchase agreement, Nvidia Sub loaned to 3dfx $15.0 million in cash for working capital. The asset sale to Nvidia Sub was approved by 3dfx shareholders on March 27, 2001, and on April 18, 2001 substantially all of 3dfx's assets were sold to Nvidia Sub. Upon closing, 3dfx received $55.0 million in cash, which amount was net of repayment of the $15.0 million cash loan 3dfx received upon signing the asset purchase agreement. In addition, under the terms of the asset purchase agreement, 3dfx and Nvidia Sub caused the pending patent litigation between the parties to be dismissed with prejudice. Under the terms of the asset purchase agreement, 3dfx may receive part or all of a one-time post-closing cash payment of up to $25.0 million upon its request if it is not in breach of the asset purchase agreement, it has expended all or substantially all of the $70.0 million cash consideration in payment of its liabilities and determines in good faith that (i) the remaining portion of the cash consideration previously received by it is not sufficient to pay its remaining liabilities, and (ii) such remaining liabilities could and would be satisfied if 3dfx received the post-closing cash payment and applied it to the payment of such liabilities, and if Nvidia Sub does not determine in good faith that the requested amount would not permit 3dfx to pay in full its remaining liabilities. In the event that 3dfx were to receive the post-closing cash payment, the 2,000,000 shares of Nvidia common stock comprising the remaining consideration otherwise payable to 3dfx under the asset purchase agreement will be reduced by the number of shares equal to the quotient determined by dividing the amount of the post-closing cash payment by $25. 3dfx's net liabilities in liquidation at July 31, 2002, were $35.2 million. The 2,000,000 shares of Nvidia common stock will only become deliverable to 3dfx upon satisfaction of certain conditions specified in the asset purchase agreement, including the completion of the winding up of the business of 3dfx pursuant to 3dfx's plan of dissolution, and 3dfx's certification that (i) all liabilities of 3dfx and its subsidiaries have been paid in full or otherwise provided for and (ii) 3dfx has or will be validly dissolved. The ultimate total value of the Nvidia stock received by 3dfx, if any, is dependent on the number and market value of shares received given the conditions described above. SERIES B PREFERRED STOCK FINANCING On June 13, 2002, 3dfx entered into a Series B Preferred Stock Purchase Agreement with SF Capital Partners Ltd. whereby SF Capital agreed to invest between $25 and $35 million in 3dfx in exchange for shares of 3dfx's Series B Preferred Stock (the "Series B Financing"). The amount of the investment will be based on the sum at 12 closing of 3dfx's fixed and determinable liabilities, maximum reasonably known undeterminable liabilities and anticipated expenses reasonably necessary to complete the liquidation, winding-up and dissolution of 3dfx. The agreement with SF Capital provides that once the amount of all of 3dfx's liabilities is determined, or if some liabilities are not determinable then the maximum amount of all undetermined liabilities shall be reasonably known to 3dfx and SF Capital, and subject to the satisfaction of certain other specified conditions, then SF Capital will place the purchase price for the shares of Series B Preferred Stock into escrow pending closing. The purchase price will be released to 3dfx from escrow, and the closing of the Series B Financing will occur, upon the satisfaction of conditions that 3dfx and SF Capital specify in the escrow agreement. The number of shares of Series B Preferred Stock of 3dfx issuable to SF Capital at closing will be equal to the quotient derived by dividing (x) the sum of the investment amount and a specified percent of the investment amount by (y) the average closing price of Nvidia common stock for the five trading days preceding the closing. The "specified percentage of the investment amount" referred to in the preceding formula ranges from 25% to 40%, and varies based on the price of Nvidia common stock preceding the closing (the higher the price of Nvidia common stock, the higher the "specified percentage of the investment amount"). The Series B Preferred Stock will not be entitled to dividends, subject to redemption or conversion, and will have no voting rights, but it will have priority for payment upon the liquidation, winding-up or dissolution of 3dfx. If 3dfx is in the process of liquidating, dissolving or winding up, immediately upon its receipt of 500,000 or more shares of Nvidia common stock, 3dfx shall distribute to the holders of the Series B Preferred Stock, at 3dfx's election, either (i) $90 cash per share of Series B Preferred Stock or (ii) one share of Nvidia stock per share of Series B Preferred Stock (the "Liquidation Preference"). In the meantime, the prior written consent of the holders of not less than a majority of the outstanding shares of Series B Preferred Stock is required for 3dfx to make any dividends, distributions or redemptions on any other securities, or for 3dfx to issue any debt or equity securities, or for 3dfx to enter into any merger, sale of shares of capital stock having voting power with respect to 35% or more of its outstanding capital stock, or any transaction in which all or substantially all of the assets of 3dfx are sold. The holders of Series B Preferred Stock will have certain other rights designed to protect their investment in 3dfx. The stock purchase agreement with SF Capital is terminable if the funding amount exceeds the $35 million level or falls under the $25 million level, if the Nvidia closing price is equal to or less than $26, if the transaction fails to close within one year, if 3dfx is in material default of the agreement or if the Nvidia common stock is delisted from the Nasdaq National Market. As of October 28, 2002, Nvidia's closing common stock price was $11.16 per share. As a result, it is unlikely that the Series B Financing will be successfully closed. BANKRUPTCY FILING As the Nvidia asset purchase agreement requires that 3dfx wind up and dissolve, on July 15, 2002 3dfx filed a petition with the Superior Court of the State of California for the County of Santa Clara requesting that the Court take jurisdiction over 3dfx's winding up proceeding as allowed by the California corporate law. Two of 3dfx's creditors challenged this request. The Court formally denied 3dfx's request on September 6, 2002. Given the foregoing developments, and in light of 3dfx's significant debts and liabilities, dwindling cash resources and the fact that 3dfx was not yet in a position to either obtain the remaining consideration provided for under the Nvidia asset purchase agreement or to close the Series B Financing, on October 15, 2002 3dfx voluntarily filed a petition with the United States Bankruptcy Court for the Northern District of California under Chapter 11 of the United States Bankruptcy Code. As a result of the Chapter 11 filing, claims against 3dfx are subject to an automatic stay, and no party may take action to realize its pre-petition claims, except pursuant to an order of the Bankruptcy Court. 3dfx sought bankruptcy protection because it believes that the bankruptcy process provides the best means of enabling it to repay its creditors, as well the best means of providing an opportunity for 3dfx to make a 13 distribution to its common shareholders. In addition, under Section 502(b)(6) of the United States Bankruptcy Code, 3dfx is entitled to seek the rejection of its two unexpired leases. The Bankruptcy Code places a limit on the amount of a claim that a lessor to a rejected lease can assert, which limit is the greater of (i) one year's rent under the lease or (ii) 15% of the remaining lease rentals up to an amount equal to the total that would be due over three years. 3dfx calculates that the application of the foregoing limit would result in the elimination of approximately $5.1 million from its currently calculated net liabilities in liquidation. There can be no assurance that 3dfx will be successful in its efforts to have the leases rejected. LIQUIDATION, WINDING UP AND DISSOLUTION On December 15, 2000, the board of directors of 3dfx approved a plan of dissolution and on March 27, 2001 this plan of dissolution was approved by 3dfx's shareholders. On March 30, 2001, 3dfx filed a certificate of election to liquidate, wind up and dissolve with the California Secretary of State's office. 3dfx is proceeding to wind up its affairs and is no longer operating or generating revenues in the normal course of business. At this time, 3dfx cannot determine if there will be any assets remaining after paying for, or providing for the payment of, 3dfx's liquidation expenses and all of its and its subsidiaries' debts and liabilities, as well as the distribution of the Liquidation Preference to the holders of the Series B Preferred Stock (if any). 3dfx expects to continue to incur certain administrative and other costs associated with its bankruptcy proceeding and the winding up its affairs. The amount of unknown or contingent liabilities cannot be quantified and could decrease or eliminate any remaining assets available for distribution to 3dfx's common shareholders. Further, if 3dfx or its subsidiaries are subject to any contingent liabilities, this could require that it establish reserves that could delay any distribution to 3dfx common shareholders. Because of the uncertainties as to the source of any 3dfx funds, the settlement amount of 3dfx's and its subsidiaries' debts and liabilities (including tax liabilities), as well as the volatility in the market price of Nvidia's stock, 3dfx cannot at this time determine the timing or amount of distributions that may be made to its common shareholders, if any. Only if there are assets remaining after the payment of all debts and liabilities, and the distribution of the Liquidation Preference (if any), will 3dfx common shareholders receive a distribution of those assets. 3dfx has substantially reduced its costs in order to conserve its resources. These cost-cutting measures included the termination of virtually all employees, reduction in leased space and other efforts to reduce non-essential expenses. During fiscal 2002, 3dfx also continued to liquidate its remaining assets, negotiate with third parties for resolutions of various litigation matters that would be agreeable to all parties involved, and to reach settlements with its vendors in reduction of its accounts payable, as well as seeking to reach mutually satisfactory settlements with the lessors of its facilities and equipment leases. 3dfx provided manufacturing services to third parties to help cover the overhead associated with its Juarez, Mexico manufacturing facility until its lease of that facility was terminated in April 2002. The sales and costs of sales related to these operations are recorded as other income and expense on the condensed consolidated statement of discontinued operations for the period from February 1, 2001 to March 26, 2001, and as selling, general, and administrative expense for the six months ended July 31, 2002 and for the period from March 27, 2001 to July 31, 2001. ACTIVITIES WHILE IN LIQUIDATION During the six months ended July 31, 2002, 3dfx continued to negotiate with third parties for resolutions of various litigation matters that would be agreeable to all parties involved, and to reach settlements with its vendors in reduction of its accounts payable, as well as seeking to reach mutually satisfactory settlements with the lessors to its facilities and various equipment leases. Any remaining inventory 14 and other assets held for sale have been written down to their net realizable value, which equals zero. As 3dfx is in liquidation, these remaining assets may be sold. 3dfx believes that any gains on such sales that may be realized will be immaterial. At July 31, 2002, 3dfx was still in negotiations to settle certain remaining leases under which it has contractual obligations. However, at July 31, 2002, 3dfx had total future lease obligations of $4.8 million and lease termination costs of $4.0 million in the current year, all of which has been accrued for as estimated costs during the period of liquidation in 3dfx's statement of net liabilities in liquidation. At July 31, 2002, 3dfx had net liabilities in liquidation of $35.2 million. In light of the amount of 3dfx's net liabilities, as well as significant contingencies relating to unknown or contingent liabilities and substantial uncertainty as to 3dfx's receipt of any of the remaining consideration provided for in the Nvidia asset purchase agreement or the closing of the Series B Financing, there can be no assurance that 3dfx will have any assets available for distribution to its common shareholders. STATEMENT OF CHANGES IN NET LIABILITIES IN LIQUIDATION During the six months ended July 31, 2002, 3dfx incurred selling, general and administrative costs of $927,000, which were comprised of personnel expenses, legal and other professional fees, current period facilities expense, lease payments and lease termination expense. Changes in net liabilities for the period from March 27, 2001 to July 31, 2001 were a result of selling, general and administrative expenses of $9.8 million, which is comprised of operating expenses, accrued expenses and lease termination expense, partially offset by the forgiveness of liabilities, a decrease in the deferred tax asset of $35.0 million and the net gain on sale of assets to Nvidia Sub of $2.3 million, which was comprised of the following: (a) a gain on the sale of inventory and other assets held for sale to Nvidia Sub of $14.3 million, which was comprised of the purchase by Nvidia Sub of certain inventory, fixed assets and intangible assets with net book values of $55.7 million offset by proceeds of $70.0 million and (b) losses of $12.0 million on sale of and impairment of inventory and other assets held for sale. 3dfx's receipt of the shares of Nvidia common stock provided for in the Nvidia asset purchase agreement has not been recorded in the accompanying consolidated statement of net liabilities in liquidation, because obtaining the cash necessary to pay 3dfx's liabilities is a condition to 3dfx being entitled to receive the shares of Nvidia stock. RESULTS OF DISCONTINUED OPERATIONS For the period from February 1, 2001 to March 26, 2001 Revenues. 3dfx did not have any revenues for the period from February 1, 2001 to March 26, 2001. Selling, General and Administrative. Selling, general and administrative expenses include compensation and benefits for sales, marketing, finance and administration personnel, commissions paid to independent sales representatives, tradeshow, advertising and other promotional expenses and facilities expenses. Selling, general and administrative expenses were $7.8 million for the period from February 1, 2001 to March 26, 2001. Other Income (Expense), Net. Other income (expense), net was $182,000 for the period from February 1, 2001 to March 26, 2001. LIQUIDITY AND CAPITAL RESOURCES 15 As of July 31, 2002, 3dfx had cash and cash equivalents of $80,000. On April 18, 2001, 3dfx completed the sale of substantially all of its assets to Nvidia Sub and at the closing received cash in the net amount of $55 million pursuant to an asset purchase agreement. After establishing a reserve for the winding up of its affairs, 3dfx used the remaining proceeds received from the asset sale to Nvidia Sub to pay a significant portion of its and its subsidiaries' known and determinable debts and liabilities. As described above, 3dfx must satisfy a number of conditions provided for in the Nvidia asset purchase agreement in order to qualify for payment of the remaining consideration provided for in that agreement. 3dfx has not yet satisfied those conditions, and there can be no assurance that 3dfx will be able to satisfy the conditions to its receipt of the remaining consideration provided for in the Nvidia asset purchase agreement. On June 13, 2002, 3dfx entered into a Series B Preferred Stock Purchase Agreement with SF Capital Partners Ltd. whereby SF Capital has agreed to invest between $25 and $35 million in 3dfx in exchange for shares of 3dfx's Series B Preferred Stock (the Series B Financing). The closing of the Series B Financing is subject to a number of conditions, and the stock purchase agreement can be terminated under a number of circumstances including if the Nvidia closing price is equal to or less than $26. Nvidia's stock price is currently less than $26. 3dfx made arrangements to obtain the Series B Financing in order to provide the cash funding necessary to pay its liabilities and otherwise satisfy the requirements to the delivery of the Nvidia stock to 3dfx under the Nvidia asset purchase agreement. As Nvidia's closing stock price was $11.16 per share on October 28, 2002, it is unlikely that the Series B Financing will be successfully closed. In light of 3dfx's significant debts and liabilities and the denial of 3dfx's petition requesting that a California court assume jurisdiction over its winding up, and given 3dfx's dwindling cash resources and the fact that it was not yet in a position to either obtain the remaining consideration provided for under the Nvidia asset purchase agreement or close the Series B Financing, on October 15, 2002 3dfx voluntarily filed a petition with the United States Bankruptcy Court for the Northern District of California under Chapter 11 of the United States Bankruptcy Code. 3dfx's principal anticipated liquidity needs involve personnel and professional expenses associated with its bankruptcy proceeding. 3dfx is seeking to address each of these liquidity needs with its remaining cash resources. At July 31, 2002, 3dfx had net liabilities in liquidation of $35.2 million. In light of the amount of 3dfx's net liabilities, as well as significant contingencies relating to unknown or contingent liabilities, and substantial uncertainty as to 3dfx's receipt of any of the remaining consideration provided for in the Nvidia asset purchase agreement or the closing of the Series B Financing, there can be no assurance that 3dfx will have any assets available for distribution to its common shareholders. RISK FACTORS This Report contains certain forward-looking statements within the meaning of the federal securities laws. 3dfx's actual results and the timing of certain events could differ greatly from those anticipated in these forward-looking statements as a result of known and unknown factors, including the risks faced by 3dfx described below. The risks and uncertainties described below are not the only ones facing 3dfx. Additional risks and uncertainties not presently known by 3dfx or that 3dfx does not currently believe are important may also harm 3dfx's business operations. If any of the following risks actually occur, 3dfx's business, financial conditions or results of operations could be seriously harmed. The following factors and other information in this Report should be considered carefully in evaluating 3dfx and an investment in 3dfx's common stock. 3DFX CANNOT DETERMINE AT THIS TIME THE AMOUNT OF DISTRIBUTIONS TO ITS COMMON SHAREHOLDERS, OR WHETHER ANY DISTRIBUTIONS WILL BE MADE, BECAUSE THERE ARE A VARIETY 16 OF FACTORS, SOME OF WHICH ARE OUTSIDE OF 3DFX'S CONTROL, THAT COULD AFFECT THE ABILITY OF 3DFX TO MAKE DISTRIBUTIONS TO ITS COMMON SHAREHOLDERS. 3dfx cannot determine at this time the amount of or whether there will be any distributions to its common shareholders because that determination depends on a variety of factors, including, but not limited to, whether and when 3dfx will receive the remaining consideration provided for in the Nvidia asset purchase agreement, whether and when the Series B Financing will close, what the value is of 3dfx's remaining assets, the amount of 3dfx's and its subsidiaries' known and unknown debts and liabilities (including the resolution of pending litigation and other contingent liabilities), and other matters. Examples of uncertainties that could reduce the value or eliminate distributions to 3dfx common shareholders include the following: o Whether and when 3dfx will satisfy the conditions to the delivery of the remaining consideration provided for in the Nvidia asset purchase agreement. o Whether and when the Series B Financing will close, which is subject to a number of conditions, including (i) the Nvidia stock price being greater than $26 per share (Nvidia's closing stock price on October 28, 2002 was $11.16 per share) and (ii) the funding amount necessary to satisfy all of 3dfx's debts and liabilities being less than $35 million. o The uncertainties relating to 3dfx's bankruptcy proceedings. o The volatility in the market price of Nvidia stock. o Delays in completing 3dfx's bankruptcy proceedings and the ultimate dissolution of 3dfx could result in additional expenses and result in no distributions to 3dfx common shareholders. o The amount of 3dfx's and its subsidiaries' debts and liabilities and the estimate of the costs and expenses of 3dfx's bankruptcy proceedings and dissolution, including any tax liabilities. o If liabilities of 3dfx or its subsidiaries that are unknown or contingent later arise or become fixed in amounts that are greater than anticipated. o If the resolution of claims disputed by 3dfx results in greater than anticipated liabilities or expenses. For the foregoing reasons, there can be no assurance that there will be any distribution to common shareholders. AS A RESULT OF 3DFX'S BANKRUPTCY FILING, ITS COMMON SHAREHOLDERS MAY NOT REALIZE ANY VALUE FOR THEIR SHARES. On October 15, 2002, 3dfx filed a voluntary petition for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. Currently, neither 3dfx nor its creditors have proposed a plan of reorganization and there can be no assurance that the Bankruptcy Court will confirm any plan of reorganization that 3dfx or its creditors may propose. As provided by the Bankruptcy Code, 3dfx initially has the exclusive right to propose a plan of reorganization for 120 days following the filing of its Chapter 11 petition. If 3dfx fails to file a plan of reorganization during such period or any extension thereof as approved by the Bankruptcy Court, or if such plan is not accepted by the requisite number of creditors entitled to vote on the plan, other parties in interest in the bankruptcy proceeding may be permitted to 17 propose their own plan or plans of reorganization. The failure to have a plan of reorganization approved by the Bankruptcy Court could result in a liquidation of 3dfx's remaining assets, consisting predominantly of its cash and cash equivalents. During the bankruptcy proceeding, 3dfx will incur significant costs including, but not limited to, personnel and professional fees and other cash demands typical in bankruptcy proceedings. These costs, which are being expensed as incurred, are expected to significantly decrease 3dfx's remaining cash resources and otherwise decrease any assets that may ultimately be available for distribution to 3dfx's common shareholders. Further, 3dfx may incur unanticipated expenses and liabilities associated with the bankruptcy. In addition, 3dfx has not yet proposed its plan of reorganization, and it is uncertain at this time what will be the effect of the plan on its creditors and shareholders. 3dfx does not know if the plan will enable it to pay in whole or in part the claims of its creditors, nor whether there will assets sufficient to make a distribution to shareholders. Due to the existence of contingent claims, 3dfx may not be able to make a full distribution for some time, even if a distribution is made at all. 3dfx may be unable to develop, prosecute, confirm and consummate a plan of reorganization, and may incur unanticipated expenses of and liabilities associated with litigation and bankruptcy. 3DFX MAY NOT BE ABLE TO SATISFY ITS DEBT OBLIGATIONS AND UNLESS AND UNTIL IT CAN DO SO, IT WILL NOT BE ABLE TO MAKE A DISTRIBUTION TO ITS COMMON SHAREHOLDERS. 3dfx may not be able to obtain payment of the remaining consideration provided for under the Nvidia asset purchase agreement or to close the Series B Financing, in which event it would have no apparent source of funds with which to satisfy all of its known and unknown debts and liabilities. Unless and until 3dfx can satisfy all of its debts and liabilities, it will not be able to make a distribution to its common shareholders. Further, even if 3dfx can pay all of its debts and liabilities, it is not likely that 3dfx will be able to make a distribution of any significance to its common shareholders and there can be no assurance as to the likely timing of any such distribution. 3DFX IS UNABLE TO SPECIFY THE TYPE OF ASSETS THAT MAY BE DISTRIBUTED TO 3DFX'S COMMON SHAREHOLDERS, IF ANY DISTRIBUTION IS MADE. In the event 3dfx is able to satisfy all of its debts and liabilities and to make a distribution of remaining assets to its common stockholders, there can be no assurance as to the type of assets that may be distributed. To the extent that 3dfx receives shares of Nvidia common stock, 3dfx may distribute the shares of Nvidia common stock received by it upon its dissolution directly to its common shareholders, or it may sell these shares in the open market or contribute the shares to a liquidating trust for the benefit of 3dfx's common shareholders. Further, 3dfx may elect to directly distribute shares of Nvidia common stock to some of its common shareholders, while distributing an equivalent per share value in cash to others who would otherwise be entitled to receive a fractional amount or small number of shares of Nvidia common stock. At this time, 3dfx is unable to provide specifics about the type of assets that 3dfx's common shareholders may receive or what the value of those assets might be at the time of distribution, if any distribution is made. 18 3DFX's COMMON STOCK WAS RECENTLY REMOVED FROM THE OTCBB AND IS NOW QUOTED IN THE OTC PINK SHEETS. Trading in 3dfx's common stock was quoted on the National Association of Securities Dealers' OTC Bulletin Board ("OTCBB") until October 2002. At that time, quotations for trading in 3dfx's common stock commenced in the OTC "pink sheets" due to 3dfx's inability to file current reports with the SEC. As a consequence, it is expected that 3dfx shareholders will find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, 3dfx common stock. ONCE 3DFX IS DISSOLVED OR ALL OF ITS ASSETS ARE TRANSFERRED TO A LIQUIDATING TRUST, IT WILL CLOSE ITS STOCK TRANSFER BOOKS AND NO TRANSFER OF 3DFX'S COMMON STOCK WILL BE RECORDED. Once 3dfx is dissolved or all of its assets are transferred to a liquidating trust, it will close its stock transfer books and no transfer of 3dfx's common stock will be recorded. Thereafter, certificates representing 3dfx common stock will not be assignable or transferable on 3dfx's books except by will, intestate succession or operation of law. The equity interests of all of 3dfx's shareholders will be fixed on the basis of their respective stock holdings at the close of business on the final record date for the distribution of all remaining assets of 3dfx, and after the final record date, any distributions made by 3dfx will be made solely to the common shareholders of record on such date, except as may be necessary to reflect subsequent transfers recorded on 3dfx's books as a result of any assignments by will, intestate succession or operation of law. For any other trades after the final record date, the seller and purchaser of 3dfx's stock will need to negotiate and rely on contractual obligations between themselves with respect to the right to a liquidating distribution arising from ownership of 3dfx's common stock. 3DFX WILL CONTINUE TO INCUR THE EXPENSE OF COMPLYING WITH REPORTING REQUIREMENTS UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). 3dfx is obligated to comply with applicable reporting requirements of the Exchange Act, even though compliance with such reporting requirements is economically burdensome. The Exchange Act provides for an exemption which allows an issuer to terminate its reporting obligations under the Exchange Act under certain circumstances. However, 3dfx is unable to terminate its reporting obligations at this time. 3dfx cannot predict if, or when, it will meet the requirements for the exemption. In the meantime, 3dfx intends to soon file a request with the Securities and Exchange Commission (SEC) requesting that the SEC approve a "no-action position" that would permit 3dfx to file bankruptcy court reports with the SEC in lieu of the periodic reports required under the Securities Exchange Act of 1934. There can be no assurance that the SEC will approve a "no-action position," but if it does so then 3dfx's SEC reporting expenses will be reduced. The expenses for the preparation and filing of reports with the SEC will in any case reduce 3dfx's limited cash resources. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 3dfx's cash equivalents are exposed to financial market risks due to fluctuations and interest rates, which may affect interest income. Due to the short term nature of 3dfx's investment portfolio, 3dfx would not expect operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates. 3dfx does not use its investment portfolio for trading or other speculative purposes. 19 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 3dfx was a party to the following legal proceedings involving certain collection matters against 3dfx, as previously reported in 3dfx's Annual Report on Form 10-K for the year ended January 31, 2002. The status of each proceeding is indicated in the table and, as indicated, 3dfx was successful in reaching terms agreeable to each of the indicated parties. In light of 3dfx's filing on October 15, 2002 of a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code, attempts to enforce any of the judgments is subject to an automatic stay.

3DFX INTERACTIVE INC 10-Q