<PAGE>   1
                                    FORM 10-Q


                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

 (Mark One)

  [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

  For the quarterly period ended June 27, 1997

                                       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   _______

================================================================================
                               ACCELGRAPHICS, INC.

             (Exact name of registrant as specified in its charter)

DELAWARE                                             77-0450627
--------                                             ----------
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)

1873 BARBER LANE, MILPITAS, CALIFORNIA 95035
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (408) 546-2100
                                                    --------------


================================================================================

         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
            ---       ---

           The number of shares outstanding of the registrant's common
                      stock at July 22, 1997 was 8,335,585.


         * The Registrant has been subject to such filing requirements since
           April 10, 1997, the effective date of the Registration Statement of
           Form 8-A.




                                     Page 1
<PAGE>   2
                               ACCELGRAPHICS, INC.

                               INDEX TO FORM 10-Q

<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                          <C>
PART I. FINANCIAL INFORMATION:

ITEM 1. Condensed Consolidated Financial Statements (Unaudited)

        Condensed Consolidated Balance Sheet as of June 30, 1997
        and December 31, 1996                                                 3

        Condensed Consolidated Statement of Operations for the three
        and six months ended June 30, 1997 and 1996                           4

        Condensed Consolidated Statement of Cash Flows for the six
        months ended June 30, 1997 and 1996                                   5

        Notes to Condensed Consolidated Financial Statements                  6

ITEM 2. Management's Discussion and Analysis of
         Financial Condition And Results of Operations                        8


PART II - OTHER INFORMATION

ITEM 6.  Exhibits                                                            22

Signature(s)                                                                 22
</TABLE>


                                     Page 2
<PAGE>   3
PART I. FINANCIAL INFORMATION:

ITEM 1. Condensed Consolidated Financial Statements (Unaudited)

                               ACCELGRAPHICS, INC.
                      CONDENSED CONSOLIDATED BALANCE SHEET
                    (in thousands, except per share amounts)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                  June 30,      December 31,
                                                                    1997            1996
                                                                  --------      ------------
<S>                                                               <C>             <C>     
ASSETS
Current assets:
  Cash and cash equivalents                                       $ 16,401        $  2,979
  Short-term investments                                             6,026            --
  Accounts receivable, net                                           5,966           4,392
  Inventories                                                        1,449             507
  Prepaid expenses                                                     341              49
                                                                  --------        --------
    Total current assets                                            30,183           7,927
Property and equipment, net                                            699             512
Long-term investment                                                   996            --
                                                                  --------        --------
    Total assets                                                  $ 31,878        $  8,439
                                                                  ========        ========
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
  Current portion of capital lease obligation                     $     56        $     16
  Accounts payable                                                   4,221           1,466
  Accrued liabilities                                                1,664           1,123
  Customer advances                                                   --               292
                                                                  --------        --------
         Total current liabilities                                   5,941           2,897
                                                                  --------        --------
Capital lease obligation, net of current portion                       135              34
Long-term debt                                                         179            --
Subordinated convertible note payable to related party                --             1,748
                                                                  --------        --------
                                                                       314           1,782
                                                                  --------        --------
Mandatorily redeemable convertible preferred stock                    --             8,930
                                                                  --------        --------
Stockholders' equity:
  Preferred Stock, $0.001 par value, 2,000 and 10,000
    shares authorized                                                 --              --
  Common Stock, $0.001 par value, 50,000 shares authorized;
     8,364 and 1,253 shares issued and outstanding                       8               1
  Additional paid-in capital                                        30,077             785
  Notes receivable from stockholders                                   (69)            (89)
  Deferred stock compensation                                         (281)           (396)
  Cumulative translation adjustment                                     (5)             (5)
  Accumulated deficit                                               (4,107)         (5,466)
                                                                  --------        --------
          Total stockholders' equity (deficit)                      25,623          (5,170)
                                                                  --------        --------
                                                                  $ 31,878        $  8,439
                                                                  ========        ========
</TABLE>

     See accompanying Notes to Condensed Consolidated Financial Statements.



                                     Page 3
<PAGE>   4
                               ACCELGRAPHICS, INC.
                 CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
                    (in thousands, except per share amounts)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                             Three Months Ended        Six Months Ended
                                                  June 30,                  June 30,
                                              1997         1996         1997         1996
                                            --------     --------     --------     --------
<S>                                         <C>          <C>          <C>          <C>     
Revenues                                    $  9,974     $  3,067     $ 21,806     $  5,438
Cost of revenues                               6,683        2,015       14,267        3,485
                                            --------     --------     --------     --------
  Gross profit                                 3,291        1,052        7,539        1,953
                                            --------     --------     --------     --------
Operating expenses:
  Research and development                     1,145          586        2,200        1,054
  Sales and marketing                          1,230          817        2,741        1,506
  General and administrative                     462          238          937          514
                                            --------     --------     --------     --------
     Total operating expenses                  2,837        1,641        5,878        3,074
                                            --------     --------     --------     --------
Income (loss) from operations                    454         (589)       1,661       (1,121)
Interest and other income (expense), net         227           (6)         224          (34)
                                            --------     --------     --------     --------
Income (loss) before provision
   for income taxes                              681         (595)       1,885       (1,155)

  Provision for income taxes                    (156)        --           (526)        --
                                            --------     --------     --------     --------
Net income (loss)                           $    525     $   (595)    $  1,359     $ (1,155)
                                            ========     ========     ========     ========
Net income loss) per share                  $   0.06     $  (0.10)    $   0.18     $  (0.19)
                                            ========     ========     ========     ========
Shares used to compute net income (loss)
  per share                                    8,792        6,245        7,745        6,226
                                            ========     ========     ========     ========
</TABLE>


     See accompanying Notes to Condensed Consolidated Financial Statements.


                                     Page 4
<PAGE>   5
                               ACCELGRAPHICS, INC.
                 CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
                                 (in thousands)
                                   (Unaudited)

                                
                                

<TABLE>
<CAPTION>
                                                                Six Months Ended
                                                                    June 30,
                                                               1997         1996
                                                             --------     --------
<S>                                                          <C>          <C>      
Cash flows from operating activities:
Net income (loss)                                            $  1,359     $ (1,155)
Adjustments to reconcile net income (loss) to
  net cash provided by operating activities:
    Depreciation and amortization                                 162          106
    Loss on disposal of asset                                      28         --
    Stock compensation expense and other                          115           42
Changes in assets and liabilities:
  Accounts receivable                                          (1,574)        (308)
  Inventories                                                    (942)        (629)
  Prepaid expenses                                               (292)          13
  Accounts payable                                              2,755          430
  Accrued liabilities                                             541            6
  Customer advances                                              (292)         (56)
                                                             --------     --------
Net cash provided by (used in) operating activities             1,860       (1,551)
                                                             --------     --------
Cash flows from investing activities:
  Acquisition of property and equipment                          (224)        (123)
  Purchase of investments                                      (7,022)        --
                                                             --------     --------
Net cash used in investing activities                          (7,246)        (123)
                                                             --------     --------
Cash flows from financing activities:
  Repayment of Subordinated convertible note payable           (1,748)        --
  Repayment of capital lease obligation                           (12)        --
  Proceeds from repayment of stockholders notes                    20         --
  Proceeds from issuance of common stock                       20,369            3
  Proceeds from issuance of preferred stock                      --          3,185
  Borrowing under term loan                                       179         --
                                                             --------     --------
Net cash provided by financing activities                      18,808        3,188
                                                             --------     --------
Effect of exchange rates on cash                                 --             (2)
                                                             --------     --------
Net increase in cash and cash equivalents                      13,422        1,512
Cash and cash equivalents at beginning of period                2,979        1,373
                                                             --------     --------
Cash and cash equivalents at end of period                     16,401        2,885
                                                             ========     ========
Supplemental Disclosure of cash flow information:
    Income taxes paid during the period                      $     47     $   --
                                                             ========     ========
    Interest paid during the period                          $    182     $     33
                                                             ========     ========
Supplemental disclosure of non-cash financing activities:
    Issuance of capital lease obligations for
         acquisition of property and equipment               $    154     $   --
                                                             ========     ========
</TABLE>

     See accompanying Notes to Condensed Consolidated Financial Statements.


                                     Page 5
<PAGE>   6
                               ACCELGRAPHICS, INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

NOTE 1.  BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared by the Company in accordance with generally accepted accounting
principles for interim financial information and pursuant to rules and
regulations of the Securities and Exchange Commission. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation have been included. These financial
statements should be read in conjunction with the Company's consolidated
financial statements and notes thereto for the year ended December 31, 1996,
which are contained in the Company's Registration Statement on Form SB-2.

The Company operates under a 52-53 week fiscal year with thirteen week quarters
that end on the Friday closest to calendar quarter end. For convenience of
presentation, financial information has been shown as ending on the last date of
the calendar quarter.

Operating results for the quarter ended June 30, 1997 may not necessarily be
indicative of the results to be expected for any other interim period or for the
full year.

NOTE 2.  INVENTORIES
Inventories are stated at the lower of cost (determined on a first-in, first-out
basis) or market. Inventories consisted of (in thousands):

<TABLE>
<CAPTION>
                    June 30, 1997    December 31, 1996
                    -------------    -----------------
<S>                    <C>               <C>   
Raw materials          $  540            $  144
Work in process           863                41
Finished goods             46               322
                       ------            ------
                       $1,449            $  507
                       ======            ======
</TABLE>

NOTE 3. NET INCOME (LOSS) PER SHARE
Net income (loss) per share is computed using the weighted-average number of
common and common equivalent shares outstanding during the periods. Common
equivalent shares consist of mandatorily redeemable convertible preferred stock
(using the if-converted method) and stock options and warrants (using the
treasury stock method). Common equivalent shares are excluded from the
computation if their effect is antidilutive, except that, pursuant to the rules
of the Securities and Exchange Commission, all series of mandatorily redeemable
convertible preferred stock and common equivalent shares (using the treasury
stock method and the public offering price) issued during the 12 month period
prior to the Company's initial public offering have been included in the
computation as if they were outstanding for all periods presented.

In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share." This statement is
effective for the Company's fiscal year ending December 31, 1997. The statement
redefines earnings per share under generally accepted accounting principles.
Under the new standard, primary earnings per share is replaced by basic earnings
per share and fully diluted earnings per share is replaced by diluted earnings
per share. If the Company had adopted this statement for the three and six month
periods ended June 30, 1997 and 1996, the Company's net income (loss) per share
would have been as follows:

<TABLE>
<CAPTION>
                                                 Three Months Ended      Six Months Ended
                                                     June 30,                 June 30,
                                                   1997       1996        1997       1996
                                                 --------   --------    --------   --------
<S>                                               <C>        <C>         <C>        <C>     
Basic net income (loss) per share                 $  0.07    $  (0.10)   $  0.19    $ (0.19)
Diluted net income (loss) per share               $  0.06    $  (0.10)   $  0.18    $ (0.18)
</TABLE>



                                     Page 6
<PAGE>   7
NOTE 4.  COMMON STOCK

The Company completed its initial public offering of Common Stock on April 16,
1997 in an underwriting led by Cowen & Company, Robertson Stephens & Company LLC
and SoundView Financial Group, Inc. The offering consisted of 2,145,000 shares
issued by the Company and 455,000 shares sold by existing shareholders, as well
as the underwriters' over-allotment option of 390,000 shares issued by the
Company and resulted in net proceeds to the Company of approximately $20.3
million. In conjunction with the offering, all shares of mandatorily redeemable
convertible preferred stock were automatically converted into 4,509,000 shares
of common stock. In April 1997, the Company repaid the $1,748,000 subordinated
convertible note payable to related party.

In March 1997, the Board of Directors adopted the 1997 Employee Stock Purchase
Plan (the "Purchase Plan") and the 1997 Directors' Stock Option Plan (the
"Directors' Plan") and authorized the reservation of 400,000 shares of Common
Stock for issuance under the Purchase Plan and 200,000 shares of Common Stock
for issuance under the Directors' Plan. Shares may be purchased under the
Purchase Plan at 85% of the lesser of the fair market value of the Common Stock
on the grant or purchase date. In addition, the Board of Directors also approved
an increase of 1,300,000 in the number of shares authorized for issuance under
the 1995 Stock Plan.

In March 1997, the Company reincorporated in the State of Delaware. The par
value of the Company's Common Stock is $0.001.


                                     Page 7
<PAGE>   8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

The following information should be read in conjunction with the Consolidated
Financial Statements and the notes thereto and in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations in the
Company's registration statement on Form SB-2 as amended. This quarterly report
on Form 10-Q, and in particular Management's Discussion and Analysis of
Financial Condition and Results of Operations, contains forward-looking
statements regarding future events or the future performance of the Company that
involve certain risks and uncertainties including those discussed in "Risk
Factors" below. In this report, the words "anticipates," "believes", "expects",
"future" and similar expressions identify forward-looking statements. Actual
events or the actual future results of the Company may differ materially from
any forward looking statements due to such risks and uncertainties. The Company
assumes no obligation to update these forward-looking statements to reflect
actual results or changes in factors or assumptions affecting such
forward-looking assumptions. Readers are cautioned not to place undue reliance
on these forward-looking statements, which reflect management's analysis only as
of the date hereof. The Company undertakes no obligation to publicly release the
results of any revision to these forward-looking statements, which may be made
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.

OVERVIEW

         AccelGraphics, Inc. designs, develops and markets high-performance,
cost-effective, 3-dimensional ("3D") graphics subsystems, software accelerators
and application utility software products for the professional Windows NT and
Windows 95 markets. The Company commenced operations in late 1994.

         The Company's graphic subsystems include the AccelECLIPSE, AccelPRO MX,
AccelPRO TX and AccelSTAR products, while the Company's application utility
software include the AccelVIEW and Flying Carpet products.

         The Company has increased its research and development, sales and
marketing and administrative capabilities since its inception and may continue
to expand such capabilities in the future. Any increase in the Company's
operating expenses caused by this potential expansion could have a material
adverse effect on the Company's operating results if revenues do not increase at
an equal or greater rate. Also, the Company's expenses for these and other
activities are based in significant part on its expectations regarding future
revenues and are fixed to a large extent in the short term. Accordingly, the
Company may be unable to adjust spending in a timely manner to compensate for
any unexpected revenue shortfall, which would have a material adverse effect on
the Company's business, financial condition and results of operations.

         The Company has a limited operating history upon which an evaluation of
the Company and its prospects can be based. The Company's prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in the early stages of development, particularly
companies in new and rapidly evolving markets. To address these risks, the
Company must, among other things, respond to competitive developments, attract,
retain and motivate qualified persons, continue to upgrade its technologies and
commercialize its products. There can be no assurance that the Company will be
successful in addressing these and other risks.

         Although the Company has experienced significant revenue growth since
its inception, the Company does not believe that such growth rates are
sustainable. Past revenue growth rates may not be indicative of future revenue
growth, if any, or future operating results. The Company first attained
quarterly profitability in the fourth quarter of 1996. There can be no assurance
that the Company will sustain profitability on a quarterly basis or will achieve
profitability on an annual basis. The Company's limited operating history makes
the prediction of future operating results difficult, if not impossible.



                                     Page 8
<PAGE>   9
Results of Operations

         The following table sets forth certain consolidated statement of
operations data as a percentage of revenues for the periods indicated:

<TABLE>
<CAPTION>
                                                      Three Months Ended          Six Months Ended
                                                            June 30,                   June 30,
                                                      1997          1996          1997          1996
                                                     ------        ------        ------        ------
<S>                                                   <C>           <C>           <C>           <C>   
Revenues                                              100.0%        100.0%        100.0%        100.0%
Cost of revenues                                       67.0          65.7          65.4          64.1
                                                     ------        ------        ------        ------
  Gross profit                                         33.0          34.3          34.6          35.9
                                                     ------        ------        ------        ------
Operating expenses:
  Research and development                             11.5          19.1          10.1          19.4
  Sales and marketing                                  12.3          26.6          12.6          27.7
  General and administrative                            4.6           7.8           4.3           9.5
                                                     ------        ------        ------        ------
     Total operating expenses                          28.4          53.5          27.0          56.5
                                                     ------        ------        ------        ------
Income (loss) from operations                           4.6         (19.2)          7.6         (20.6)
Interest and other income (expense), net                2.3          (0.2)          1.0          (0.6)
                                                     ------        ------        ------        ------
Income (loss) before provision for income taxes         6.9         (19.4)          8.6         (21.2)
  Provision for income taxes                           (1.6)         --            (2.4)         --
                                                     ------        ------        ------        ------
Net income (loss)                                       5.3%        (19.4)%         6.2%        (21.2)%
                                                     ======        ======        ======        ======
</TABLE>

Revenues

         Revenues increased by 225% to $10.0 million during the second quarter
of 1997 from $3.1 million during the second quarter of 1996 and by 301% to $21.8
million for the first six months of 1997 from $5.4 million for the first six
months of 1996. The increases in revenues during the second quarter of 1997 and
the first six months of 1997 were primarily due to unit sales of the AccelPRO TX
and the AccelECLIPSE product lines. Revenue for the first six months of 1996 was
primarily comprised of sales of the Company's AG300/500 product line.
Revenues from software products have to-date been immaterial.

         The Company's customers include original equipment manufacturers
("OEMs"), distributors, value added resellers ("VARs") and end users. Revenues
from product sales are generally recognized upon product shipment, less an
allowance for estimated future returns and exchanges. Provisions for the costs
of technical support services for the Company's hardware products and estimated
future warranty claims are recorded as a cost of revenues upon recognition of
related revenues.

         International revenues increased by 240% to $3.7 million during the
second quarter of 1997 from $1.1 million during the second quarter of 1996,
representing 37.0% and 35.4%, respectively, of revenues, and by 521% to $9.6
million for the first six months of 1997 from $1.5 million for the first six
months of 1996, representing 44.1% and 28.4%, respectively, of revenues. The
increase in international revenues is primarily a result of increased sales of
the Company's products to its OEM customers in Europe and Asia Pacific. Revenues
from the Company's international customers are generally denominated in United
States dollars. Although the effects of currency fluctuations have been
insignificant to date, there can be no assurance that such fluctuations will not
be significant in the future.

         Revenues from Hewlett-Packard Company ("HP") and Digital Equipment
Corporation ("Digital") accounted for 45.0% and 20.8%, respectively, of revenues
during the second quarter of 1997. Revenues from HP and Digital accounted for
1.7% and 44.6%, respectively, of revenues during the second quarter of 1996. The
loss of any major customer, or the delay in or reduction of orders 


                                     Page 9
<PAGE>   10
from such customers could have a material adverse effect on the Company's
business, financial condition and results of operations.

Gross Profit

         Gross profit increased by 213% to $3.3 million during the second
quarter of 1997 from $1.1 million during the second quarter of 1996,
representing 33.0% and 34.3%, respectively, of revenues and increased by 286% to
$7.5 million during the first six months of 1997 from $2.0 million during the
first six months of 1996, representing 34.6% and 35.9%, respectively, of
revenues. The absolute dollar increase in gross profit resulted from increased
revenues, while the decrease in gross profit as a percentage of revenues was
primarily due to increased sales to OEMs, which generally yield lower gross
margins. The Company expects that gross margins will decrease over time as a
result of competitive pricing pressures and changes in sales channel and product
mix.

         The Company's gross margin is affected by many factors, including the
sales channel mix, sales to OEMs which generally yield lower gross margins, the
mix of products sold, competitive pricing pressures, introductions of new
products and the availability, reliability and cost of components and products
from the Company's subcontractors and suppliers. In addition, the Company orders
products in advance of planned shipments and, due to rapid technological changes
or other factors such as customers curtailing or changing timing or mix of
orders, there is a risk that the Company will forecast incorrectly and produce
excess or insufficient inventories of particular products. The Company's
customers' ability to reschedule or cancel orders without significant penalty
could adversely affect the Company's operating results, as the Company may be
unable to adjust its purchases from its subcontractors and suppliers to match
such customers' changes and cancellations.

Operating Expenses

         Research and Development. Research and development expenses increased
by 95% to $1.1 million during the second quarter of 1997 from $590,000 during
the second quarter of 1996, representing 11.5% and 19.1%, respectively, of
revenues, and increased by 109% to $2.2 million during the first six months of
1997 from $1.1 million during the first six months of 1996, representing 10.1%
and 19.4%, respectively, of revenues. Research and development expenses consist
primarily of personnel costs and other personnel-related expenses, including the
services of outside consultants. The increase in research and development costs
is primarily due to increased personnel and related costs to support new product
development activities. The Company anticipates that research and development
expenses may continue to increase in absolute dollars as the Company continues
to add research and development personnel and support for new product
development activities.

         Sales and Marketing. Sales and marketing expenses increased by 51% to
$1.2 million during the second quarter of 1997 from $820,000 during the second
quarter of 1996, representing 12.3% and 26.6%, respectively, of revenues, and
increased by 82% to $2.7 million during the first six months of 1997 from $1.5
million during the first six months of 1996, representing 12.6% and 27.7%,
respectively, of revenues. Sales and marketing expenses consist primarily of
salaries, commissions, marketing expenses and technical support for the sales
organization. The absolute dollar increase in sales and marketing expenses was
due primarily to the expansion of the Company's sales efforts in the United
States, Europe and Asia Pacific, as well as increased marketing and public
relations activities related to the introductions of new product lines. The
Company anticipates that sales and marketing expenses may increase in absolute
dollars as the Company expands its sales force and marketing activities.

         General and Administrative. General and administrative expenses
increased by 94% to $460,000 during the second quarter of 1997 from $240,000
during the second quarter of 1996, representing 4.6% and 7.8%, respectively, of
revenues, and increased by 82% to $940,000 during the first six months of 1997
from $510,000 during the first six months of 1996, representing 4.3% and 9.5%,
respectively, of revenues. Increased general and administrative expenses were
due primarily to increased staffing and other costs incurred to support the
Company's growth. The Company anticipates that general and administrative
expenses will increase in absolute 



                                    Page 10
<PAGE>   11
dollars, and may also increase as a percentage of revenues, to support the
Company's growth and as a result of costs associated with operating as a public
company.

Interest and other income (expense), net

         Interest and other income (expense), net consists primarily of interest
income earned on the Company's cash, cash equivalents and investments, and other
items including interest on capital lease obligations and long-term debt.
Interest and other income (expense), net was $227,000 in the second quarter of
1997 and resulted primarily from interest income on the proceeds of the initial
public offering, which was completed in April 1997, less interest expense of
$10,000 on the Company's subordinated convertible note payable. Interest
expense, net in the second quarter of 1996 was $6,000 and included $40,000 of
interest expense on the subordinated convertible note payable to a related
party. The note payable was repaid in April 1997.

Provision for Income Taxes

         The provision for income taxes for the first six months of 1997
reflects the estimated annualized effective tax rate of 25% applied to income
before provision for income taxes, and includes consideration of the Company's
anticipated taxable income, tax rates and changes in its valuation allowance.
The Company recorded no provision for income taxes during the first six months
of 1996 as it incurred losses.

LIQUIDITY AND CAPITAL RESOURCES

         Cash and cash equivalents increased by $13.4 million during the first
six months of 1997. Cash flows from operating activities generated $1.9 million
in cash, primarily due to net income of $1.4 million as well as increases in
accounts payable of $2.8 million and income taxes payable of $480,000, offset in
part by increases in accounts receivable of $1.6 million and inventory of
$940,000.

         Net cash used in investing activities was approximately $7.2 million
due to the purchase of $220,000 of property and equipment and purchase of $7.0
million of investments.

         Net cash provided by financing activities was $18.8 million, primarily
due to net proceeds from the Company's initial public offering of $20.3 million,
offset by $1.7 million used to repay a note payable.

         At June 30, 1997, the Company had $16.4 million of cash and cash
equivalents and $7 million of available for sale investments. The Company has
available borrowing facilities of $4.0 million with a bank of which $180,000 is
outstanding. The borrowings bear interest at rates between 8.75% and 9.0%, are
secured by all of the Company's assets and require that the Company maintain
certain financial ratios and levels of tangible net worth and profitability and
also restricts the Company's ability to pay cash dividends. The $3 million line
of credit portion of the borrowing facilities expires in October 1997. The
Company expects that it will be able to renew this line of credit.

         The Company believes that existing cash, cash equivalents and
investments, its available borrowings and lines of credit will be sufficient to
finance its working capital and capital expenditure requirements for at least
the next 12 months. Thereafter, the Company may require additional funds to
support its working capital requirements or for other purposes and may seek to
raise such additional funds through bank borrowings and public or private sales
of its securities, including equity and debt securities. The Company's future
capital requirements will depend on numerous factors, including, without
limitation, management of working capital, the success of marketing, sales and
distribution efforts, market acceptance of the Company's products, the progress
of its research and development programs, the costs involved in defending and
enforcing intellectual property rights, competition, competing technological and
market developments, and the effectiveness of product commercialization
activities and arrangements. There can be no assurance that additional funds, if
required, will be available to the Company on favorable terms or at all.


                                    Page 11
<PAGE>   12
RISK FACTORS

         In addition to other information in this Form 10-Q, the following are
important factors that should be considered carefully in evaluating the Company
and its business.

LIMITED HISTORY OF PROFITABILITY AND UNCERTAINTY OF FUTURE FINANCIAL RESULTS

         The Company has incurred a net operating loss in each year since
commencing operations in late 1994. As a result, the Company had an accumulated
deficit as of June 30, 1997 of approximately $4.1 million. The Company has only
three quarters of profitability, which may not be indicative of future operating
results, and the Company does not believe that its current annual revenue growth
rates are sustainable. To date, the Company has earned substantially all of its
revenues from sales of its graphics subsystem product lines. There can be no
assurance that the Company will ever achieve profitability on an annual basis in
the future or that it can sustain profitability on a quarterly basis. The
Company is in its third year of operations and is subject to the risks inherent
in the operation of a new business, such as the difficulties and delays often
encountered in the development and production of new, complex technologies.
There can be no assurance that the Company will be able to address these risks.

         The Company expects to expand its research and development, sales and
marketing and administrative capabilities. The anticipated increase in the
Company's operating expenses caused by this expansion could have a material
adverse effect on the Company's operating results if revenues do not increase at
an equal or greater rate. Also, the Company's expenses for these and other
activities are based in significant part on its expectations regarding future
revenues and are fixed to a large extent in the short term. Accordingly, the
Company may be unable to adjust spending in a timely manner to compensate for
any unexpected revenue shortfall, which would have a material adverse effect on
the Company's business, financial condition and results of operations.


SIGNIFICANT VARIABILITY IN QUARTERLY RESULTS

         The Company's quarterly operating results have varied significantly in
the past and are likely to vary significantly in the future. The Company's
quarterly results are affected by a wide variety of factors including the gain
or loss of significant customers, size and timing of individual orders, timely
introduction and market acceptance of new products offered by the Company and
its competitors, availability, reliability and cost of components, the Company's
success in negotiating original equipment manufacturer ("OEM") and other
customer agreements, customer order deferrals in anticipation of new products,
technological changes in operating systems or applications, variations in
manufacturing quality or capacities, changes in the pricing policies of the
Company or its competitors, changes in demand for 3-dimensional ("3D") graphics
functionality, changes in the mix of revenues from products having differing
gross margins, changes in sales channel mix, changes in average sales prices,
warranty expenses, fluctuations in the Company's expense levels, the Company's
success at expanding its direct sales force and indirect distribution channels,
risks related to international operations, extraordinary events such as
litigation or acquisitions and general industry and economic conditions, as well
as other factors. Any of the above risks could have a material adverse effect on
the Company's business, financial condition and results of operations.

         Quarterly revenues and operating results depend primarily on the
volume, timing and shipment of orders during the quarter, which are difficult to
forecast because customers generally place their orders on an as-needed basis
and, accordingly, the Company has historically operated with a relatively small
backlog. The Company's third party distribution channels provide the Company
with limited information regarding the quantity of the Company's products in the
sales channel. This reduces the Company's ability to predict fluctuations in
revenues resulting from a surplus or a shortage in its distribution channel and
could contribute to volatility in the Company's results of operations and cash
flows. A surplus of inventory in the distribution channel could unexpectedly
cause a reduction in product shipments and revenues. Moreover, a
disproportionate percentage of the Company's revenues in any quarter may be
generated in the last month of a quarter. As a result, a shortfall in revenues
in any quarter as compared to expectations may not be identifiable until near
the end of the quarter. The Company 



                                    Page 12
<PAGE>   13
may experience relatively weak demand in third quarters due to historically weak
summer sales in Europe.

         The Company's gross margins are impacted by the sales channel mix, mix
of products sold, increased competition and related decreases in unit average
selling prices, introduction of new products, availability, reliability and cost
of components from the Company's subcontractors and suppliers, and general
economic conditions. Currently, the Company is focusing on increasing its sales
to OEMs, which have historically yielded lower margins than other channels.
Individual product lines generally provide higher margins at the beginning of
the life cycle and lower margins as the product line matures. In addition, the
Company's markets are characterized by rapidly changing technology and declining
average selling prices. Accordingly, the Company's gross margins may decline
from the levels experienced to date, which would have an adverse effect on the
Company's business, financial condition and results of operations.

         A significant portion of the Company's operating expenses are
relatively fixed in the short term and planned expenditures are based on revenue
forecasts. As a result, if revenues are below levels needed to offset these
operating expenses, the Company's business, financial condition and results of
operations may be disproportionately affected because only a portion of the
Company's expenses vary with revenue. The Company generally must plan
production, order components and undertake its development, sales and marketing
activities several months in advance of shipping product and recognizing
revenues. Accordingly, any shortfall in revenues in a given quarter may impact
the Company's operating results and cash balances in a magnified way due to the
Company's inability to adjust expenses or inventory during the quarter to match
the level of revenues for the quarter. In addition, in the event the Company's
customers desire to purchase products in excess of forecasted amounts, the
Company may not have sufficient inventory or access to sufficient manufacturing
capacity to meet such demands. Although the Company has experienced growth in
revenues in recent quarters, there can be no assurance that the Company will
sustain such revenue growth or be profitable on an operating basis in any future
period. For the foregoing reasons, the Company believes that period-to-period
comparisons of its results are not necessarily meaningful and should not be
relied upon as indications of future performance. Further, when the Company
announced that its revenues and net income were below the expectations of market
analysts for the second quarter of 1997, the Company's stock price suffered a
significant decline. Accordingly, it is likely that in some future quarter the
Company's revenues or operating results will be below the expectations of public
market analysts and investors. In such event, the price of the Common Stock
could be materially adversely affected.

COMPETITION

         The market for 3D graphics accelerators is extremely competitive and
subject to rapid change. The Company expects competition to increase in the
future from existing competitors and from new market entrants with products that
may be less costly than the Company's products or provide better performance or
additional features not currently provided by the Company. The Company competes
with the following three major groups: professional 3D graphics board companies
(including Intergraph Corporation and Dynamic Pictures, Inc.), RISC/UNIX
workstation companies (including Sun Microsystems, Inc. ("Sun") and Silicon
Graphics, Inc. ("SGI")) and traditional volume personal computer ("PC") board
suppliers (including ELSA GmbH, Diamond Multimedia Systems, Inc., Matrox
Electronic Systems Ltd. and STB Systems, Inc.). A variety of potential actions
by any of the Company's competitors could have a material adverse effect on the
Company's business, financial condition and results of operations. Such actions
may include reduction of product prices, increased promotion, announcement or
accelerated introduction of new or enhanced products, product giveaways, product
bundling or other competitive actions.

Many of the companies that currently compete with the Company or that may
compete with the Company have longer operating histories and significantly
greater financial, technical, sales, marketing and other resources, as well as
greater name recognition and larger customer bases, than the Company. As a
result, these competitors may be able to respond more quickly and effectively to
new or emerging technologies and changes in customer requirements or to devote
greater resources to the development, promotion, sale and support of their
products than the Company. Some of these companies also purchase their
components from the Company's suppliers. Consequently, the Company expects to
continue to experience increased competition, which could 



                                    Page 13
<PAGE>   14
result in significant price reductions, loss of market share and lack of
acceptance of new products, any of which could have a material adverse effect on
the Company's business, financial condition and results of operations. There can
be no assurance that the Company will be able to compete against current or
future competitors successfully or that competitive pressures faced by the
Company will not have a material adverse effect upon its business, financial
condition and results of operations.

SHORT PRODUCT LIFE CYCLES

         The market for the Company's products is characterized by frequent new
product introductions and rapid product obsolescence. The life cycles of the
Company's products are difficult to estimate. Generally, life cycles of personal
computer 3D graphics subsystems are relatively short, approximately six to
fifteen months. The Company must constantly monitor industry trends and select
new technologies and features for its products, as well as monitor the timing of
introduction of new products. Moreover, short product life cycles, coupled with
single-source supply of components used in the Company's products, may prevent
the Company from being able, in a timely manner, to reduce its procurement
commitments, production or inventory levels in response to obsolescence,
unexpected shortfalls in orders, revenues or declines in prices or, conversely,
to increase production in response to unexpected increases in demand. Failure to
respond to the market adequately could have a material adverse effect on the
Company's business, financial condition and results of operations. The timing of
the end of a product's life cycle is difficult to predict and is typically
characterized by steep declines in unit sales, pricing and margins. As new
products are planned and introduced, the Company may not be able to control the
inventory levels of older products and phase out production, potentially
resulting in excess inventory and the expenses associated therewith. The Company
could experience unexpected reductions in revenues from older generation
products as customers anticipate new products. To the extent the Company is
unsuccessful in managing product transitions, its business, financial condition
and results of operations would be adversely affected.

RELIANCE ON THIRD PARTY DISTRIBUTION AND MAJOR OEMS

         The Company relies on OEMs, value added resellers ("VARs") and a
network of distributors for both domestic and international revenues. In
particular, revenues from Hewlett-Packard Company ("HP") and Digital Equipment
Corporation ("Digital") accounted for 45.0% and 20.8%, respectively, of revenues
during the second quarter of 1997. Revenues from HP and Digital accounted for
1.7% and 44.6%, respectively, of revenues during the second quarter of 1996. The
Company believes that its future success may depend upon its ability to broaden
its customer base. There can be no assurance that a major customer will not
reduce, delay or eliminate its purchases from the Company, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. In connection with the terms of the OEM Agreement with
HP, HP has a non-exclusive manufacturing license pursuant to which it is granted
the right to manufacture or have manufactured the Company's products in the
event of the Company's bankruptcy, receivership or failure to supply HP with
specified quantities of products due to a cause not associated with the
negligence of either party for the term of the agreement or until the Company is
out of bankruptcy or receivership. In connection with the terms of the OEM
Agreement with Digital, Digital has a non-exclusive manufacturing license
pursuant to which it is granted the right to manufacture the Company's products
in the event that the Company is unable to supply Digital with specified
quantities of products, until the Company demonstrates its ability and readiness
to assume its obligations. In the event the Company were required to grant such
nonexclusive manufacturing rights to Digital, HP or any other OEM that
subsequently may obtain such rights, such grant could have the effect of
decreasing the value of the Company's ownership rights with respect to such
products and/or decrease the Company's revenues, either of which could have an
adverse effect on the Company's business, financial condition or results of
operations. The Company's customer agreements are short term and automatically
renew each year and generally may be canceled for convenience upon written
notice by either party. Generally, there are no minimum purchase requirements
for the Company's OEMs, VARs and distributors. Some of the Company's OEMs, VARs
and distributors offer competitive products manufactured internally or by third
parties. There can be no assurance that the Company's OEMs, VARs and
distributors will give a priority to the marketing of the Company's products as
compared to competing products or alternative solutions or that such OEMs, VARs
and distributors 



                                    Page 14
<PAGE>   15
will continue to offer the Company's products. Moreover, there can be no
assurance that the Company will continue to sell substantial quantities of its
products to these OEMs, VARs and distributors, or that upon any termination of
the Company's relationships with any of these OEMs, VARs or distributors, the
Company would be able to obtain suitable alternate distributions channels. The
loss of one or more of the Company's OEMs, VARs or distributors could have a
material adverse effect on the Company's business, financial condition and
results of operations. Additionally, the Company's southern and northern
European distributor maintains a credit limit with the Company for the purchase
of a certain amount of the Company's products. In the event that the demand for
the Company's products exceeds this credit limit, the Company may be unable to
increase the credit limit and supply this distributor with additional quantities
of products. Accordingly, the Company may experience significant backlog and
delays in the supply of additional products to this distributor, which could
have a material adverse effect on the Company's business, financial condition
and results of operations.

         Although the Company seeks information from end users who purchase the
Company's products from OEMs, VARs and distributors, the Company generally does
not sell directly to end users and cannot directly observe their experience with
the Company's products. The Company also does not have direct control over the
marketing and support efforts of its OEMs, VARs and distributors. This may
result in the inability of the Company to identify potential opportunities with
these customers and may cause a potential delay by the Company in the
recognition and correction of any problems with such OEM, VAR or distributor
sales or support organizations. Failure of the Company to respond to customer
preferences or experience with its products or the failure of OEMs, VARs or
distributors to market and support the Company's products successfully, could
have a material adverse effect on the Company's business, financial condition
and results of operations.

INTERNATIONAL REVENUES

         The Company's international revenues accounted for approximately 44% of
the Company's revenues in the first six months of 1997, consisting primarily of
sales to international OEM and distributors in Europe and Asia Pacific.
International revenues accounted for approximately 31% and 22% of the Company's
1996 and 1995 revenues, respectively, and primarily consisted of sales to third
party distributors based in the United Kingdom and Germany. However, the Company
believes that products sold to its European distributors are resold throughout
Europe. The Company expects that international revenues will continue to account
for a significant portion of its total revenues in future periods. International
revenues are subject to certain inherent risks, including unexpected changes in
regulatory requirements and tariffs, government controls, political instability,
longer payment cycles, difficulties in collecting accounts receivable,
difficulties in staffing and managing foreign operations and potentially adverse
tax consequences. The Company's inability to obtain foreign regulatory approvals
on a timely basis could have a material adverse effect on the Company's
business, financial condition and results of operations. Fluctuations in
currency exchange rates could cause the Company's products to become relatively
more expensive to end users in a particular country, leading to a reduction in
sales in that country. The impact of future exchange rate fluctuations cannot be
predicted adequately. To date, the Company has not found it appropriate to hedge
the risks associated with fluctuations in exchange rates, as substantially all
of the Company's foreign sales have been denominated in U.S. dollars. However,
if future transactions are denominated in foreign currencies, the Company may
undertake to hedge transactions. There can be no assurance that any hedging
techniques implemented by the Company would be successful or that the Company's
results of operations would not be materially adversely affected by exchange
rate fluctuations. In general, certain seasonal factors and patterns impact the
level of business activities at different times in different regions of the
world. For example, sales in Europe are adversely affected in the third quarter
of each year as many customers and end users reduce their business activities
during the summer months. These seasonal factors and currency fluctuation risks
could have a material adverse effect on the Company's business, financial
condition and results of operations. Further, because the Company operates in
different countries, the Company's management must address differences in
regulatory environments and cultures. Failure to address these differences
successfully could be disruptive to the Company's operations and could have a
material adverse effect on the Company's business, financial condition and
results of operations.



                                    Page 15
<PAGE>   16
RAPID TECHNOLOGICAL CHANGE

         The computer industry in general, and the markets for the Company's
products in particular, are characterized by ongoing technological developments,
evolving industry standards and rapid changes in customer requirements. Customer
preferences can change rapidly and new technology can quickly render existing
products obsolete. In order to keep pace with this rapidly changing market
environment, the Company must continually develop and incorporate into its
products technological advances and new features desired by customers at
competitive prices. There can be no assurance that the Company will be
successful in developing and marketing, on a timely basis or at all, competitive
products, product enhancements and new products that respond to technological
changes or changes in customer requirements and industry standards, or that the
Company's enhanced or new products will adequately address the changing needs of
the marketplace. Additionally, application programming interfaces ("APIs") have
evolved and changed over time. Although OpenGL has developed into a leading
industry standard API for professional 3D graphics development, it is likely
that industry standards will continue to evolve to meet rapidly changing
customer requirements. There can be no assurance that the Company will be
successful in developing and marketing product enhancements or new products that
respond to these evolving standards. In addition, Intel has introduced the
Accelerated Graphics Port (AGP) bus structure, an alternative to the existing
PCI bus structure, which is expected to be adopted beginning in the third
quarter of 1997 through the first quarter of 1998. Failure by the Company to
respond effectively to changes in the 3D graphics market, to develop or acquire
new technology or to successfully conform to industry standards would have a
material adverse effect on the business, financial condition and results of
operations of the Company. Operating systems and independent software vendor
("ISV") applications are updated from time to time. The Company must constantly
monitor these changes and upgrade its products to remain compatible with any
upgrades in operating systems and ISV applications. There can be no assurance
that the Company will be successful in developing new versions or enhancements
to its products or that the Company will not experience delays in the upgrade of
its products. In the event that there are delays in the completion of any
upgrade to its products, the Company's business, financial condition and results
of operations would be materially adversely affected. In addition, the Company
strives to achieve compatibility between the Company's products and 3D graphics
applications the Company believes are or will become popular and widely adopted.
The Company invests substantial resources in development efforts aimed at
achieving such compatibility. Any failure by the Company to anticipate or
respond adequately to changes in applications could result in a loss of
competitiveness and could adversely affect the Company's business, financial
condition and results of operations.

DIFFICULTIES IN MANAGING GROWTH

         The Company has experienced significant growth in its business over the
past two years which has placed demands on the Company's operational and
financial personnel and systems, outside manufacturing capacity, research and
development, technical support and other resources. The Company is expanding its
sales and marketing organizations, developing its distribution channels to
penetrate different and broader markets, funding additional research and
development and increasing its support organization to accommodate its growing
customer base. With continued growth, the Company may find it necessary to
enhance existing and implement new financial and management information systems
and controls and train its personnel to effectively operate such systems. Any
delay in the implementation of or any disruptions in the transition to such new
and enhanced systems and controls and personnel training could adversely affect
the Company's ability to accurately forecast sales demand and adjust third party
manufacturing to such demand, adjust purchasing levels, accurately record and
control inventory levels and record and report financial and management
information on a timely and accurate basis. Inaccuracy in demand forecasts in
the environment in which the Company operates can quickly result in either
insufficient or excess inventory and disproportional overhead expenses. Certain
of the Company's officers have recently joined the Company and the Company
anticipates further increases in the number of employees. The Company plans to
expand the geographic scope of its customer base and operations. Failure to
manage these changes and to expand effectively any of these areas would have a
material adverse effect on the Company's business, financial condition and
results of operations.

DEPENDENCE ON SUBCONTRACTORS AND SOLE-SOURCE SUPPLIERS



                                    Page 16
<PAGE>   17
         The Company relies on subcontractors to manufacture, subassemble, test
and ship the Company's products. The Company relies on sole-source suppliers for
certain critical components, such as 3Dlabs, Inc. ("3Dlabs") for its graphics
acceleration chips, Mitsubishi Electric Corporation ("Mitsubishi") for its
graphics acceleration chips and 3DRAM chips and Nan Ya PCB Service Co. ("Nan
Ya") for its printed circuit boards. In addition, there is a limited
availability of certain application specific integrated circuit chipsets that
provide VRAM and DRAM memory. The Company procures its components and products
through purchase orders and does not have specific requirement agreements with
any of its subcontractors or suppliers. Each of the Company's subcontractors and
suppliers can cease supplying the services, products or components at any time
with no penalty. In the event it becomes necessary for the Company to replace a
key subcontractor or supplier, the Company could incur significant manufacturing
set-up costs and delays while new sources are located and alternate components
are integrated into the design of the Company's products. There can be no
assurance that the Company will be able to maintain its current subcontractor
and supplier relationships or that the Company will be able to find suitable
replacement subcontractors and suppliers, if necessary. Although the Company
maintains ongoing efforts to obtain required quantities of products, component
shortages may exist from time to time, and there can be no assurance that the
Company's current subcontractors and suppliers will continue to provide
sufficient quantities of suitable quality product components at acceptable
prices. The Company's emphasis on maintaining low inventory may accentuate the
effects of any shortages that may result from sole source products or
subcontractors. The inability of the Company to obtain product components at
their historical cost levels would directly affect the cost of the Company's
products. Also, product components may contain undetected errors or "bugs" when
first supplied to the Company that, despite testing by the Company, are
discovered only after the Company's product has been installed and used by
customers. There can be no assurance that errors will not be found in the
Company's products due to errors in the product components, or that any such
errors will not impair the market acceptance of these products or require
significant product recalls. Problems encountered by customers and product
recalls could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Company's
ability to respond to greater than anticipated market demand may be constrained
by availability of services, products or components. The loss of subcontractors
or suppliers or the failure of subcontractors or suppliers to meet the Company's
price, quality, quantity and delivery requirements would have a material adverse
effect on the Company's business, financial condition and results of operations.

DEPENDENCE ON KEY PERSONNEL; NEED TO ATTRACT AND RETAIN HIGHLY SKILLED PERSONNEL

         The success of the Company depends to a large extent upon its ability
to continue to attract and retain highly skilled personnel. Competition for
employees in the high technology sector in general, and in the graphics industry
in particular, is intense, and there can be no assurance that the Company will
be able to attract and retain sufficient numbers of qualified employees. The
Company has recently experienced a significant expansion in the overall level of
its business and the scope of its operations, including research and
development, marketing, sales, technical support and administration. It may
become increasingly difficult to hire, train and assimilate the new employees
needed given the market conditions. If the Company is unable to continue to
attract and retain sufficient numbers of qualified employees, it may be required
to rely on more expensive consultants. The Company has not entered into
employment agreements with any of its key personnel. Additionally, the Company
has not required its key personnel to enter into noncompetition agreements with
the Company. The Company's inability to retain, attract and assimilate certain
members of the executive management team or key employees would have a material
adverse effect on the Company's business, financial condition and results of
operations.

DEPENDENCE ON ISV RELATIONSHIPS

         The Company's business strategy includes developing strategic
relationships with major ISVs that serve the 3D graphics market, including
Autodesk, Inc. ("Autodesk") and Autodesk's Kinetix division ("Kinetix"),
Computer Associates International, Inc., Electronic Data Systems Corporation's
("EDS") Unigraphics division, Matra Datavision S.A., Microsoft Corporation's
("Microsoft") Softimage, Parametric Technology Corporation ("PTC"), Ricoh
Corporation, 



                                    Page 17
<PAGE>   18
Structural Dynamics Research Corporation ("SDRC") and Visible Decisions, Inc.
The Company has devoted substantial engineering and management resources to
developing relationships with its ISV partners. If any of the Company's current
or future ISV partners were to cease supporting the Company's products, such
action could have a material adverse effect on the Company's business, financial
condition and results of operations. Further, there can be no assurance that the
Company will be able to successfully sustain its relationships or enter into new
relationships with major ISVs on terms acceptable to the Company or at all.

UNCERTAINTY REGARDING DEVELOPMENT OF 3D GRAPHICS MARKET

         The 3D graphics market on NT workstations has recently begun to develop
and is rapidly evolving. The Company's future financial performance will depend
in large part on the continued growth of this market and the demand for 3D
graphics for professional 3D applications. The failure of the 3D graphics market
to achieve anticipated growth levels or a substantial change in 3D graphics
customer preferences would have a material adverse effect on the Company's
business, financial condition and results of operations. Additionally, demand
for the Company's products is also dependent upon the widespread development of
3D graphics applications by ISVs, the success of the Company's customers in
effectively developing a market for the Company's products and the willingness
of end users to pay for enhanced 3D capabilities on NT workstations. The
Company's products currently are designed for use on NT and/or Windows 95
workstations. In the event that end users, and particularly businesses, delay
their adoption of or fail to adopt NT or Windows 95, the market for the
Company's products would be diminished and the Company's business, financial
condition and results of operations could be materially adversely affected.

RISK OF MIGRATION TO THE MOTHERBOARD

         The Company's 3D graphics subsystems function with Personal
Workstations to provide additional 3D and 2-dimensional ("2D") graphics
performance and functionality. As technology becomes more widely utilized, it
may become economically feasible to incorporate certain 3D graphics capabilities
onto PC motherboards or into microprocessors. The Company recognizes that
migration could occur with respect to the functionality provided by the
Company's current products. The Company's success is largely dependent on its
ability to continue to develop products which incorporate higher performance
technologies and additional functionality which system manufacturers have not
yet fully incorporated into PC motherboards or microprocessors. While the
Company believes that a market will continue to exist for add-in subsystems that
provide additional performance and advanced functionality and that offer
flexibility in systems configuration, there can be no assurance that the
incorporation of certain 3D and 2D capabilities onto PC motherboards or
microprocessors will not adversely affect the market for the Company's products
and consequently, the Company's business, financial and results of operations
could be materially adversely affected.

LIMITED HISTORY OF PRODUCT DEVELOPMENT

         The Company's products are complex, are based on relatively new
technology and have a limited history of reliability. The Company generally
provides a three-year warranty for its products. In general, the Company's
return policy permits return within five days after receipt of products that do
not meet product specifications. Companies engaged in the development and
production of new, complex technologies and products often encounter
difficulties in performance and reliability and delays in product introduction
and volume shipments. Additionally, products as complex as those offered by the
Company may contain undetected errors or "bugs" when introduced that, despite
testing by the Company, are discovered only after a product has been installed
and used by customers. There can be no assurance that the Company will be
successful in resolving any problems with the Company's existing or future
products. Failure by the Company to resolve manufacturing or operational
problems with any existing product or any new product in a timely manner would
have a material adverse effect on the Company's business, financial condition
and results of operations.

         The success of the Company will likely depend on its ability to develop
and market new products that provide superior performance at competitive prices.
Any quality, reliability or performance problems with such products, regardless
of materiality, or any other actual or 



                                    Page 18
<PAGE>   19
perceived problems with the Company's products, could have a material adverse
effect on market acceptance of such products and the Company's reputation. There
can be no assurance that such problems or perceived problems will not arise or
that, even in the absence of such problems, the Company's products will receive
market acceptance. A failure of the Company's products to receive market
acceptance for any reason would have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, the
announcement by the Company of new products and technologies could cause
customers to defer purchases of the Company's existing products, which would
have a material adverse effect on the Company's business, financial condition
and results of operations.

SOFTWARE DEFECTS

         The Company's software products, and its hardware products
incorporating any software, are extremely complex as a result of such factors as
advanced functionality, the diverse operating environments in which they may be
deployed, the need for interoperability and the multiple versions of such
products that must be supported for diverse operating platforms, languages and
standards. These products may contain undetected errors or failures when first
introduced or as new versions are released. The Company generally provides a
three-year warranty for its products. In general, the Company's return policy
permits return within five days after receipt of products that do not meet
product specifications. There can be no assurance that, despite testing by the
Company and by current and potential customers, errors will not be found in new
products after commencement of commercial shipments, resulting in loss of or
delay in market acceptance. Such loss or delay would likely have a material
adverse effect on the Company's business, financial condition and results of
operations. Additionally, new versions or upgrades to operating systems and ISV
applications may require upgrades to the Company's software products to maintain
compatibility with these new versions or upgrades. There can be no assurance
that the Company will be successful in developing new versions or enhancements
to its software or that the Company will not experience delays in the upgrade of
its software products. In the event the Company experiences delays or is unable
to maintain compatibility with operating systems and ISV applications, the
Company's business, financial condition and results of operations would be
materially adversely affected.

RISKS ASSOCIATED WITH INTELLECTUAL PROPERTY

         Although the Company has three patent applications filed in the United
States, these claims are not related to the Company's current product lines.
Instead, the Company relies exclusively on trade secret and copyright protection
for its proprietary technology. Despite the Company's precautions, it may be
possible for a third party to copy or otherwise obtain and use the Company's
technologies without authorization or to develop competing technologies
independently. Furthermore, the laws of certain countries in which the Company
does business, including countries in which the Company does a significant
amount of business, such as the United Kingdom and Germany, may not protect the
Company's software and intellectual property rights to the same extent as the
laws of the United States. There can be no assurance that the Company's means of
protecting its proprietary rights will be adequate or that the Company's
competitors will not independently develop similar technology. If unauthorized
copying or misuse of the Company's products were to occur to any substantial
degree, or if a competitor of the Company were to effectively duplicate the
Company's proprietary technology, the Company's business, financial condition
and results of operations would be materially adversely affected. Furthermore,
while the Company requires employees and consultants to enter into
confidentiality agreements, there can be no assurance that proprietary
information will not be disclosed, that others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to the Company's trade secrets or disclose such technology, or that
the Company can meaningfully protect its trade secrets. Certain technology used
by the Company's products is licensed from third parties, generally on a
non-exclusive basis. The termination of any such license, or the failure of any
third party licensor to adequately maintain or update its product, could result
in delay in the Company's ability to ship its products while it seeks to
implement technology offered by alternative sources, if any. Any required
replacement licenses could prove to be either unavailable or costly.

         Although the Company has not received notices from third parties
alleging infringement claims that the Company believes would have a material
adverse effect on the Company's business, 



                                    Page 19
<PAGE>   20
there can be no assurance that third parties will not claim that the Company's
current or future products or manufacturing processes infringe the proprietary
rights of others. Any such claim, with or without merit, could result in costly
litigation or might require the Company to enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to the Company, or at all, which could have a
material adverse effect upon the Company's business, financial condition and
results of operations.

FUTURE CAPITAL REQUIREMENTS

         The Company's future capital requirements will depend upon many
factors, including the development of new products, the success of the Company's
research and development efforts, the expansion of the Company's sales and
marketing efforts and the status of competitive products. The Company believes
that existing cash, cash equivalents and investments, its available borrowings
and lines of credit will be sufficient to finance its working capital and
capital expenditure requirements for at least the next 12 months. There can be
no assurance, however, that the Company will not require additional financing
during such time. Further, there can be no assurance that any additional
financing will be available to the Company on acceptable terms, if at all. If
additional funds are raised by issuing equity securities, further dilution to
the existing stockholders could result. The inability to obtain acceptable
financing would have a material adverse effect on the Company's business,
financial condition and results of operations.

CONCENTRATION OF STOCK OWNERSHIP

         As of June 30, 1997, the Company's directors and officers and their
affiliates beneficially own approximately 50% of the outstanding Common Stock.
As a result, these stockholders will be able to exercise significant influence
over all matters requiring stockholder approval, including the election of
directors and approval of significant corporate transactions. Such concentration
of ownership may have the effect of delaying or preventing a change in control
of the Company.

POSSIBLE VOLATILITY OF STOCK PRICE

         The price of the Company's common stock has to-date experienced extreme
price fluctuations. Factors such as quarterly variations in actual or
anticipated operating results, changes in earnings estimates by analysts, market
conditions in the industry, announcements by competitors, regulatory actions and
general economic conditions may have a significant effect on the market price of
the Common Stock. Following fluctuations in the market price of a corporation's
securities, securities class action litigation has often resulted. There can be
no assurance that such litigation will not occur in the future with respect to
the Company. Such litigation could result in substantial costs and a diversion
of management's attention and resources, which could have a material adverse
effect on the Company's business, financial condition and results of operations.

SHARES ELIGIBLE FOR FUTURE SALE

         As of July 25, 1997, the Company had 8,330,711 shares of Common Stock
outstanding. As of July 25, 1997, the Company had 2,990,000 shares of Common
Stock eligible for sale in the public market. An additional 5,691,740 shares of
Common Stock (including approximately 353,811 shares issuable upon exercise of
vested options) will be eligible for sale beginning on October 8, 1997, unless
earlier released, in whole or in part, by Cowen & Company. Certain stockholders
holding 4,174,458 shares of Common Stock (assuming exercise of outstanding
warrants for 30,000 shares of Common Stock) are entitled to registration rights
with respect to their shares of Common Stock. If such stockholders, by
exercising their demand registration rights, cause a significant number of
securities to be registered and sold in the public market, such sales could have
an adverse effect on the market price of the Company's Common Stock. Sales of
significant amounts of such shares in the public market after October 8, 1997,
or the prospect of such sales, could adversely affect the market price of the
Common Stock. Such sales also might make it more difficult for the Company to
sell equity securities or equity-related securities in the future at a time and
price that the Company deems appropriate.



                                    Page 20
<PAGE>   21
BLANK CHECK PREFERRED STOCK; ANTI-TAKEOVER PROVISIONS

         The Company's Board of Directors has the authority to issue up to
2,000,000 shares of Preferred Stock and to determine the price, rights,
preferences and privileges of those shares without any further vote or action by
the stockholders. The rights of the holders of Common Stock will be subject to,
and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. The issuance of Preferred Stock may have
the effect of delaying, deterring or preventing a change of control of the
Company without further action by the stockholders and may adversely affect the
voting and other rights of the holders of Common Stock. The Company has no
current plans to issue shares of Preferred Stock. The Company's Certificate of
Incorporation and Bylaws provide for, among other things, the prospective
elimination of cumulative voting with respect to the election of directors, the
elimination of actions to be taken by written consent of the Company's
stockholders and certain procedures such as advance notice procedures with
regard to the nomination, other than by or at the direction of the Board of
Directors, of candidates for election as directors. In addition, the Company's
charter documents provide that the Company's Board of Directors be divided into
three classes, each of which serves for a three-year term. The foregoing
provisions could have the effect of making it more difficult for a third party
to effect a change in the control of the Board of Directors. In addition, these
provisions could have the effect of making it more difficult for a third party
to acquire, or of discouraging a third party from attempting to acquire, or of
making the Company less attractive to a potential acquiror of a majority of the
outstanding voting stock of the Company, and may complicate or discourage a
takeover of the Company. The foregoing provisions may also result in the
Company's stockholders receiving less consideration for their shares than might
otherwise be available in the event of a takeover attempt of the Company.


                                    Page 21
<PAGE>   22
PART II.   OTHER INFORMATION

ITEM 6.    EXHIBITS

11.1 Statement Regarding Computation of Net Income (Loss) Per Share

27.1 Financial Data Schedule


SIGNATURES

         Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.


                                           ACCELGRAPHICS, INC.



Date:   August 7, 1997                    /s/ Nancy E. Bush
                                           ------------------------------------
                                           Nancy E. Bush
                                           Vice President and Chief 
                                           Financial Officer


                                    Page 22
<PAGE>   23
                                INDEX TO EXHIBITS



Exhibit  Description
-------  -----------

11.1     Statement Regarding Computation of Net Income (Loss) Per Share

27.1     Financial Data Schedule


                                    Page 23