3dfx takes a hit after reporting loss

3dfx stock dropped about 27 percent today, and some financial analysts reevaluated it, including Arnab Chanda at BancBoston.

Chanda downgraded the stock from "buy" to "attractive," according to Bloomberg. Michael Kim with Webush Morgan Securities downgraded 3dfx to "hold" from "strong buy."

A little over a year ago the 3D computer title belonged to 3dfx, which boasted a legion of ultra-loyal gaming customers. However, at the time, the firm was in the process of shifting to a strategy to play in all segments of the graphics market, not just the high-performance PC segment. Part of shift involved buying board maker STB.

"The reason Wall Street didn't react kindly is because they don't like surprises, and we surprised them with what the second-quarter number was," said Jim Hawkins, vice president of 3dfx's Finance and Strategic Planning.

"I don't think we could have changed that given when we found out the information that affected the second-quarter numbers," Hawkins said.

That information had to do with the price protection 3dfx offers its dealers. When a manufacturer cuts prices, dealers can request compensation for product they bought at higher cost.

Because 3dfx cut prices early into its third fiscal quarter, but dealers held inventory shipped the previous quarter, auditors recommended an earlier accounting of the price protection.

3dfx has between six to eight weeks of inventory on dealers' shelves, "which is not unusually high for us," said Hawkins.

3dfx also took a hit due to the acquisition of graphics rival, STB. That merger is not going as smoothly as expected and will likely drag on 3dfx profits for at least another quarter, said analysts.

"The merger kept them from including STB sales in the quarter, but 3dfx still incurred costs associated with the merger," said Peter Glaskowsky, analyst with MicroDesign Resources.

3dfx had planned on closing the acquisition by April 30, but because of a delay getting approval from STB shareholders, the company could not account for about 13 days of STB sales.

"If you add the lost revenue to the reported top-line revenue and take into effect the price protection, you come pretty close to the reported $120 million top-line revenue we were looking for," said Hawkins.

Instead, 3dfx reported $104.8 million in revenue for the quarter ended July 31, nearly double the $59.8 million a year earlier. But the company lost $11.6 million, a major decline from the $9 million profit it posted a year ago.

"They're selling a lot more chips, but the costs of the STB merger more than made up for any money they were making from chips," said Glaskowsky.

3dfx closed at 10.5, down 3.87, or a decline of 26.96.

"Wall Street and [PC manufacturers that use the chips] are just totally unforgiving," said Jon Peddie, president of Jon Peddie Associates. "It's a cutthroat business, and nobody is your friend. It's, 'what have you done for me lately,' and lately is measured in microseconds."

Going forward, 3dfx is likely to recover in one or two quarters, said analysts, but only if it executes correctly on the merger. At issue is keeping STB's business thriving. STB supplies graphics cards directly to some PC manufacturers, including Compaq Computer and Gateway, a sales area 3dfx has little experience in.

PC manufacturers "have no time to be compassionate," said Peddie. "They've got to get to market on time and with comparable product. 3dfx can't afford to be late in the time window the [PC manufacturers] want."