StockTalk:
TMF Interview With 3Dfx Interactive CEO Greg Ballard
With Yi-Hsin Chang (TMF Puck)

September 17, 1998

Part 1 of 3

On September 14, 3Dfx Interactive <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TDFX)") else Response.Write("(Nasdaq: TDFX)") end if %> warned that third quarter sales have been lower than expected due to a seasonal slowdown in its retail distribution channel. The 3D media processor chip developer forecasted it will lose "several million dollars" in pre-tax operating earnings for the quarter, but it expects to be profitable overall thanks to a recent litigation settlement with gamemaker Sega.

TMF: One of the reasons we're talking today is because of the third quarter earnings warning you issued on Monday. What do you think went wrong this quarter, were you caught off guard, and what are you doing to address the problem?

Ballard: The fact of the matter is something did go wrong, but in the total scheme of things it is probably as good a bad outcome as is possible. What happened was we probably ended up selling too much product in the second quarter, and the result of that is that the inventory levels in the channel were simply too great for all of it to have sold through by the end of the third quarter.

Now, typically in this business where we're so retail-based, you find a seasonal slowdown in the June, July, and August time frame, and we were no exception to the slowdown, but it did not slow down more than we expected. As a matter of fact, many retailers told us the seasonal slowdown was not even as great as expected. But because the inventory levels were higher than they probably should have been, the end result was that our customers -- the board customers -- didn't need to replenish their inventory by buying from us in the volume that we had originally predicted. So we ended up with a shortfall in the third quarter but no real long-term negative impact on our business.

We still expect 3Dfx to be the leading seller in the fourth quarter -- it was in the third quarter, so we expect it to continue that in the fourth quarter. The introduction of the Banshee, which is our integrated 2D/3D part, especially in the LAM business is coming in actually ahead of our expectations. So we're expecting, despite our challenge in the third quarter, to recover quite nicely in the fourth quarter, and right now 1999 is looking better than ever.

"So we're expecting, despite our challenge in the third quarter, to recover quite nicely in the fourth quarter, and right now 1999 is looking better than ever."

TMF: I was looking at your 10-Q from a year ago and 10-K from last year. There wasn't any mention of a "seasonal slowdown" of any sort. Is this something you're discovering as you're maturing? Is this something that you'll have to address from now on?

Ballard: That's actually a very good observation. Last year there was not a seasonal slowdown because, in a sense, the 3D market was exploding for the first time. The business sort of exploded, and it masked, if you will, the natural seasonality that I think most hardware companies in the consumer business have seen in the past. Certainly, Sony PlayStation and Nintendo and other consoles in the past have always seen a seasonal slowdown. In that sense, we're not much different than them. We have the same dynamic with the consumer at retail, which is that during the summer they're out at picnics and on the beach and not so much sitting at their computer playing games. So as the leaves start to fall, people's attention turns back to the fun that they can have inside as opposed to outside.

TMF: In your press release, you mentioned that you began production shipments on your newest product, Voodoo Banshee, in mid-August. Could you elaborate on that and also tell us when you expect to start incurring revenues from this product?

Ballard: Well, we'll get revenue in the third quarter. One of the issues that I'd like to talk about a little bit is our credibility in terms of what we have delivered in the marketplace in terms of products. So far, we have never disappointed people in terms of the delivery of our products, the time of our products, or the performance of those products.

In December of last year we announced that Banshee was going to sample in the first quarter of this year and would be in volume production in the third quarter. We absolutely nailed that in both instances. We sampled in the first quarter, and we in fact are doing production volume in this quarter. And our production volume is actually measured in the hundreds of thousands of units, so it's not a technical achievement of that objective. We actually are doing exactly what we said we would, so you'll see revenue in the third quarter from Banshee. That revenue will increase substantially in the fourth quarter as we really start to roll it out.

TMF: How many OEMs [original equipment manufacturers] have signed on for Voodoo Banshee, and if you can't tell us the names of those companies, can you describe if they are in the high-end business, in the low-end business, etc.?

Ballard: I can't name them, and actually I probably shouldn't give you the numbers because the numbers change on a daily basis. As a matter of fact, even yesterday I was told of two new OEMs who have entered into our radar screen that weren't there certainly last week, so we have a lot of momentum right now with the OEMs. How many we actually end up landing at the end of the day is still total guesswork because, until they actually ship the computers, at any point you can lose that design win. Having said that, we do have a major OEM design win and a couple of very prestigious design wins, all of which add up to substantial volume in the fourth quarter that is OEM-based.

So what is the nature of the design wins? Typically, as you would expect right now, our principle inroads have been with companies that consider themselves more consumer-oriented rather than business-oriented because that is our appeal. We have the brand image, we have the strong relationships with the content providers, and we have the performance leader. So while we do think we have a major appeal into the commercial market, right now our leading entrees are in the consumer market.

TMF: As far as the numbers, what can you say -- is there less than 10?

"So far, we have never disappointed people in terms of the delivery of our products, the time of our products, or the performance of those products."

Ballard: I'd say definitely less than 10, but that's not surprising. I'll tell you what our original ambition was and then measure it against that. I have publicly stated that we wanted to have two to three OEM design wins in the fourth quarter. The reason I had relatively modest ambitions was that this is our first foray into that business. We have been, as we've readily acknowledged, principally a retail company. The movement into the OEM business requires a different infrastructure, it requires a different set of technologies, and it requires a different mindset, if you will, and I did not want to make that change too abruptly.

I wanted to make sure that we could adequately service -- in fact, overservice -- any customer that we brought on as an OEM customer. So in the last six months we have been building the infrastructure, bringing in the people, bringing in the tools necessary to provide that level of support, and we've done that. In fact, I will say that the number of OEM design wins that we have will likely be more than we originally anticipated, but certainly still less than 10.

Let me just clarify. If we're talking about board companies, then I would modify the statement to tell you that we have a large number of board design wins, and those will be announced over the course of the next couple of weeks. So we have no shortage of board companies. That has not been an issue for us, nor will it be going forward. We have the best board companies that you can imagine supporting Banshee. The issue for us and one certainly that Wall Street has raised is how well we would do in getting design wins with the system OEMs? Again, I would say we're ahead of our own expectations in that regard and about where I want to be right now.

TMF: That's what you mean by the two to three system OEMs?

Ballard: Yeah, originally we said we wanted to be at two to three. But I'll tell you, though, at the end of the day I think we'll be ahead of that, slightly. It's hard to say exactly where we're going to end up. Like I said, literally every day we have a new opportunity that's presenting itself. One of the reasons why that's the case and it's worth emphasizing is that right now Banshee is the most -- I'm going to assert this and if I unfairly malign our competitors, I certainly don't mean to -- but I think the perception right now is that Banshee is the most stable of the parts in the marketplace, the most flexible in the sense that it has both an 8-meg and a 16-meg capability, and the performance leader.

You couple that with the fact that it's cheaper than several of the other competitor parts of the market, and that's potentially an extremely, extremely powerful position for the product right now with the OEMs. Therefore, as we come into the final decision-making process for a number of these guys, people who maybe weren't even considering us a month ago have started to change their view and are starting to focus on Banshee as an alternative.

Part 2

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