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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549  FORM 10-Q
 (MARK ONE) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
 FOR THE TRANSITION PERIOD FROMTO COMMISSION FILE NUMBER: 000-31089 VIRAGE LOGIC CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE
    
    77-0416232(STATE OR OTHER JURISDICTION OF
    
    (I.R.S. EMPLOYERINCORPORATION OR ORGANIZATION)
    
    IDENTIFICATION NO.)
  VIRAGE LOGIC CORPORATION
47100 BAYSIDE PARKWAY
FREMONT, CALIFORNIA 94538
(510) 360-8000
(ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF PRINCIPAL EXECUTIVE OFFICE) 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
þ No o Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). Yes þ No o As of February 7, 2005,
there were 22,030,998 shares of the Registrants ordinary shares outstanding.




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VIRAGE LOGIC CORPORATION FORM 10-Q INDEX PAGEPart I.  Financial InformationItem 1.
    
    Financial Statements
    
    
    3Unaudited Condensed Consolidated Balance Sheets  December 31, 2004 and September 30, 2004
    
    
    3Unaudited Condensed Consolidated Statements of Operations  Three Months Ended December 31, 2004 and December 31, 2003
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows  Three Months Ended December 31, 2004, and December 31, 2003
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risks
    
    
    31Item 4.
    
    Controls and Procedures
    
    
    31Part II.  Other Information
    
    
    33Item 1.
    
    Legal Proceedings
    
    
    33Item 2.
    
    Changes in Securities and Use of Proceeds
    
    
    33Item 3.
    
    Defaults upon Senior Securities
    
    
    33Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    33Item 5.
    
    Other Information
    
    
    33Item 6.
    
    Exhibits
    
    
    33Signatures
    
    
    
    
    34Exhibit Index
    
    
    
    
    35EXHIBIT 10.20EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS VIRAGE LOGIC
CORPORATION 
 UNAUDITED CONDENSED
CONSOLIDATED BALANCE SHEETS
 (In thousands, except
share and per share amounts)
 December 31,
    
    
    September 30,2004
    
    
    2004ASSETS:Current assets:Cash and cash
equivalents
    
    $
    28,863
    
    
    $
    28,746Short-term investments
    
    
    27,703
    
    
    
    27,144Accounts receivable, net of allowance for
doubtful account of $938 and $648,
respectively
    
    
    16,974
    
    
    
    17,756Costs in excess of related billings on
uncompleted contracts
    
    
    825
    
    
    
    670Prepaid expenses and other current
assets
    
    
    4,607
    
    
    
    4,079Taxes receivable
    
    
    1,304
    
    
    
    1,302Total current assets
    
    
    80,276
    
    
    
    79,697Property, equipment and leasehold improvements,
net
    
    
    3,900
    
    
    
    4,090Goodwill
    
    
    9,782
    
    
    
    9,782Other intangible assets, net
    
    
    2,665
    
    
    
    2,762Deferred tax assets
    
    
    5,225
    
    
    
    5,225Long-term investments
    
    
    9,991
    
    
    
    7,222Other long-term assets
    
    
    1,276
    
    
    
    410Total assets
    
    $
    113,115
    
    
    $
    109,188LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    875
    
    
    $
    506Accrued expenses
    
    
    6,031

    
    
    
    5,019Deferred revenue
    
    
    5,706
    
    
    
    7,548Income taxes payable
    
    
    3,644
    
    
    
    3,569Total current liabilities
    
    
    16,256
    
    
    
    16,642Deferred tax liabilities
    
    
    1,035
    
    
    
    1,035Total liabilities
    
    
    17,291
    
    
    
    17,677Stockholders equity:Common stock, $.001 par value; Authorized
shares  150,000,000; issued and outstanding
shares  21,945,550 and 21,580,437 at December
31, 2004 and September 30, 2004,
respectively
    
    
    22
    
    
    
    22Additional paid-in capital
    
    
    114,970
    
    
    
    112,457Accumulated other comprehensive income
(loss)
    
    
    33
    
    
    
    (28
    )Accumulated deficit
    
    
    (19,201
    )
    
    
    (20,940
    )Total stockholders equity
    
    
    95,824
    
    
    
    91,511Total liabilities and stockholders equity
    
    $
    113,115
    
    
    $
    109,188
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements 3




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VIRAGE LOGIC
CORPORATION 
 UNAUDITED CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands, except
share and per share amounts)
 Three Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003Revenue:License
    
    $
    13,062
    
    
    $
    9,474Royalties
    
    
    2,797
    
    
    
    1,386Total revenues
    
    
    15,859
    
    
    
    10,860Cost and expenses:Cost of revenue, excluding amortization of deferred
stock compensation of $0 and $11,
respectively
    
    
    3,037
    
    
    
    2,436Research and development, excluding amortization of
deferred stock compensation of $0 and $19,
respectively
    
    
    4,773
    
    
    
    4,413Sales and marketing, excluding amortization of deferred
stock compensation of $0 and $14,
respectively
    
    
    3,813
    
    
    
    3,248General and administrative, excluding amortization of
deferred stock compensation of $0 and $6,
respectively
    
    
    1,934
    
    
    
    1,445Stock-based compensation
    
    
    
    
    
    
    50Total cost and expenses
    
    
    13,557
    
    
    
    11,592Operating income (loss)
    
    
    2,302
    
    
    
    (732
    )Interest income and other expenses, net
    
    
    294
    
    
    
    168Income (loss) before income taxes
    
    
    2,596
    
    
    
    (564
    )Income tax provision (benefit)
    
    
    857
    
    
    
    (205
    )Net income (loss)
    
    $
    1,739
    
    
    $
    (359
    )Net income (loss) per share:Basic
    
    $
    0.08
    
    
    $
    (0.02
    )Diluted
    
    $
    0.08
    
    
    $
    (0.02
    )Weighted average shares used in computing per share amounts:Basic
    
    
    21,781
    
    
    
    21,181Diluted
    
    
    22,697
    
    
    
    21,181
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements 4




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VIRAGE LOGIC
CORPORATION 
 UNAUDITED CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In
thousands)
 Three Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)
    
    $
    1,739
    
    
    $
    (359
    )Adjustment to reconcile net income (loss) to net cash provided
by operating activities:Provision for doubtful accounts
    
    
    200
    
    
    
    (90
    )Depreciation and amortization
    
    
    608
    
    
    
    888Amortization of intangible assets
    
    
    97
    
    
    
    97Amortization of deferred stock compensation
    
    
    
    
    
    
    50Changes in operating assets and liabilities:Accounts receivable
    
    
    582
    
    
    
    (2,735
    )Costs in excess of related billings on uncompleted contracts
    
    
    (155
    )
    
    
    (96
    )Prepaid expenses and other assets
    
    
    (1,393
    )
    
    
    120Taxes receivable
    
    
    (2
    )
    
    
    (120
    )Accounts payable and accrued liabilities
    
    
    1,381
    
    
    
    326Deferred revenue
    
    
    (1,842
    )
    
    
    3,104Income tax payable
    
    
    75
    
    
    
    (309
    )Net cash provided by operating activities
    
    
    1,290
    
    
    
    876CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property and equipment
    
    
    (426
    )
    
    
    (157
    )Purchase of investments
    
    
    (17,762
    )
    
    
    (939
    )Proceeds from maturities of investments
    
    
    14,393
    
    
    
    10,000Net cash provided by (used in) investing activities
    
    
    (3,795
    )
    
    
    8,904CASH FLOWS FROM FINANCING ACTIVITIES:Net proceeds from issuance of common stock
    
    
    2,513
    
    
    
    333Net cash provided by financing activities
    
    
    2,513
    
    
    
    333Effect of exchange rates on cash
    
    
    109
    
    
    
    Net increase in cash and cash equivalents
    
    
    117
    
    
    
    10,113Cash and cash equivalents at beginning of period
    
    
    28,746
    
    
    
    38,930Cash and cash equivalents at end of period
    
    $
    28,863
    
    
    $
    49,043
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements 5




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VIRAGE LOGIC
CORPORATION 
 NOTES TO UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Description of Business Virage Logic Corporation (the Company) was incorporated in California in November 1995 and
subsequently reincorporated in Delaware in July 2000. The Company provides semiconductor
intellectual property (IP) platforms based on memory, logic, and I/Os (input/output interface
components) that are silicon-proven and production ready. These various forms of IP are utilized by
the Companys customers to design and manufacture System-on-Chip (SoC) integrated circuits that
power todays consumer, communications and networking, handheld and portable, computer and
graphics, and automotive applications. Basis of Presentation and Principles of Consolidation The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America for
interim financial information, and in accordance with the instructions to Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes required by accounting
principles generally accepted in United States of America for complete financial statements, and
should be read in conjunction with the Companys audited consolidated financial statements as of,
and for the fiscal year ended September 30, 2004 contained in the Companys 2004 Annual Report on
Form 10-K. In the opinion of the management, the unaudited interim financial statements reflect
all adjustments (consisting only of normal, recurring adjustments) necessary for a fair
presentation of the financial position, results of operations and cash flows for the periods
indicated. Operating results for the three months ended December 31, 2004 are not necessarily
indicative of the results that may be expected for any other interim period or for the fiscal year
ending September 30, 2005. The accompanying unaudited condensed consolidated financial statements include the accounts of
Virage Logic Corporation and its wholly-owned subsidiaries and operations located in the Republic
of Armenia, Germany, India, Israel, Japan and the United Kingdom. All intercompany balances and
transactions have been eliminated upon consolidation. Foreign Currency Translation The financial position and results of operations of the Companys certain foreign operations are
measured using a currency other than the U.S. dollars as their functional currency. Accordingly,
for these operations all assets and liabilities are translated into U.S. dollars at the current
exchange rates as of the respective balance sheet date. Revenue and expense items are translated
using the weighted average exchange rate prevailing during the period. Cumulative gains and losses
from the translation of these operations financial statements are reported as a separate component
of stockholders equity. Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates. Revenue Recognition The Companys revenue recognition policy is based on the American Institute of Certified Public
Accountants Statement of Position 97-2, Software Revenue Recognition as amended by Statement of
Position 98-4 and Statement of Position 98-9. Additionally, revenue is recognized on some of our
products, according to Statement of Position 81-1, Accounting for Performance of Construction-Type
and Certain Production-Type Contracts. Revenues from perpetual licenses for the semiconductor IP products are generally recognized when
persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is
fixed or determinable, and collectability is reasonably assured. If any of these criteria are not
met, revenue recognition is deferred until such 6




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VIRAGE LOGIC CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS time as all criteria are met. Revenues from term-based licenses are recognized ratably over the
term of the license, which is generally twelve months in duration, provided the criteria mentioned
above are met. License of custom memory compilers and logic libraries may involve customization to the
functionality of the software, therefore revenues from such licenses are recognized in accordance
with Statement of Position 81-1 over the period that services are performed. Revenue derived from
library development services are recognized using a percentage-of-completion method, and revenues
from technical consulting services are recognized as the services are performed. For all license
and service agreements accounted for using the percentage-of-completion method, the Company
determines progress-to-completion based on labor hours incurred. The Company believes that it is
able to reasonably and reliably estimate the costs to complete projects accounted for using the
percentage-of-completion method based on historical experience of similar project requirements.
Alternatively, if the Company cannot reasonably and reliably estimate the costs to complete a
project, the completed contract method of accounting is used, such that costs are deferred until
the project is completed at which time revenues and related costs are recognized. A provision for
estimated losses on any projects is made in the period in which the loss becomes probable and can
be reasonably estimated. Costs incurred in advance of billings are recorded as costs in excess of
related billings on uncompleted contracts. If customer acceptance is required for completion of
specified milestones, the related revenue is deferred until the acceptance criteria are met. For agreements that include multiple elements, the Company recognizes revenues attributable to
delivered or completed elements covered by such agreements when such elements are completed or
delivered. The amount of such revenues is determined by deducting the aggregate fair value of the
undelivered or uncompleted elements, which the Company determines by each such elements
vendor-specific objective evidence of fair value, from the total revenues recognizable under such
agreement. Vendor-specific objective evidence of fair value of each element of an arrangement is
based upon the normal pricing for such licensed product and service when sold separately, and for
maintenance, it is determined based on the stated renewal rate in
each contract as long as it is substantive. Revenues are
recognized once the Company delivers the element identified as having vendor-specific objective
evidence or once the provision of the services is completed. Maintenance revenues are recognized
ratably over the contractual term of the maintenance period, which is generally twelve months. The Company assesses whether the fee associated with each transaction is fixed or determinable and
collection is reasonably assured and evaluates the payment terms. If a portion of the fee is due
beyond normal payment terms, the Company recognizes the revenues on the payment due date, if
collection is reasonably assured. The Company assesses collectibility based on a number of
factors, including past transaction history and the overall credit-worthiness of the customer. If
collection is not reasonably assured, revenue is deferred and recognized at the time collection
becomes reasonably assured, which is generally upon receipt of cash. Amounts invoiced to customers in excess of recognized revenues are recorded as deferred revenues.
The timing and amounts invoiced to customers can vary significantly depending on specific contract
terms and can therefore have a significant impact on deferred revenues in any given period. Royalty revenues are generally determined and recognized one quarter in arrears, when a production
volume report is received from the customer or foundry, and are calculated based on actual
production volumes of wafers containing chips utilizing our semiconductor IP technologies based on
a rate per-chip or rate per-wafer depending on the terms of the respective license agreement. Stock-based compensation The Company accounts for stock-based compensation arrangements in accordance with the provision of
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25),
and related interpretations in accounting for its employee stock options and complies with the
disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123), as amended by Statement of Financial Accounting Standards
No. 148, Accounting for Stock-based Compensation Transition and Disclosure, an Amendment of FASB
123 (SFAS No. 148). Under APB 25, when the exercise price of the Companys employee stock options
equals the market price of the underlying stock on the date of grant, no compensation expense is
recognized. 7




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VIRAGE LOGIC CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The following table illustrates the effect on net income (loss) and net income (loss) per share if
the Company had accounted for its stock options and stock purchase plans under the fair value
method of accounting under SFAS No. 123 (in thousands, except per share data): Three Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003Net income (loss) as reported
    
    $
    1,739
    
    
    $
    (359
    )Add: Stock-based compensation expense included in
reported net income (loss) above, net of taxes
    
    
    
    
    
    
    33Less: Fair value of stock-based compensation expense for
all awards, net of taxes
    
    
    (484
    )
    
    
    (694
    )Proforma net income (loss)
    
    $
    1,255
    
    
    $
    (1,020
    )Basic net income (loss) per share:As reported
    
    $
    0.08
    
    
    $
    (0.02
    )Proforma
    
    $
    0.06
    
    
    $
    (0.05
    )Diluted net income (loss) per share:As reported
    
    $
    0.08
    
    
    $
    (0.02
    )Proforma
    
    $
    0.06
    
    
    $
    (0.05
    )Weighted average shares used in computing per share amounts:Basic
    
    
    21,781
    
    
    
    21,181Diluted
    
    
    22,697
    
    
    
    21,181
 The table below illustrates the underlying weighted-average assumptions in determining the fair
value of the options granted: Three Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003Volatility
    
    
    78.9
    %
    
    
    100.0
    %Risk-free interest rate
    
    
    3.3
    %
    
    
    2.4
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected option lives
    
    6.5 years
    
    4  5 years
 The SFAS No. 123 adjusted impact of options on the net income (loss) for the three months ended
December 31, 2004 and 2003 are not representative of the effects on net income (loss) for future
periods. NOTE 2  NET INCOME (LOSS) PER SHARE Basic and diluted net income (loss) per share is presented in conformity with Statement of
Financial Accounting Standards No. 128, Earnings Per Share (SFAS No. 128). Accordingly, basic and
diluted net income (loss) per share have been computed using the weighted average number of shares
of common stock outstanding during the period, less weighted average shares outstanding that are
subject to repurchase by the Company. 8




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VIRAGE LOGIC CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The following table presents the computation of basic and diluted net loss per share applicable to
common stockholders (in thousands, except per share data): Three Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003Basic
earnings (loss) per share:Net income (loss)
    
    $
    1,739
    
    
    $
    (359
    )Shares used in computation:Weighted average common shares outstanding
    
    
    21,956
    
    
    
    21,257Less: Weighted average number of common shares subject to
repurchase
    
    
    (175
    )
    
    
    (76
    )Shares used in computing basic net income (loss) per share
    
    
    21,781
    
    
    
    21,181Add:Weighted average share equivalents from stock options
    
    
    916
    
    
    
    Shares used in computing diluted net income (loss) per share
    
    
    22,697
    
    
    
    21,181Basic net income (loss) per share
    
    $
    0.08
    
    
    $
    (0.02
    )Diluted net income (loss) per share
    
    $
    0.08
    
    
    $
    (0.02
    )
 For the computation of net loss per share for the three months ended December 31, 2003, the Company
excluded all outstanding warrants, stock options and shares subject to repurchase as the inclusion
of these securities would have been anti-dilutive. Options and warrants totaling approximately
753,000 shares, and shares subject to repurchase totaling 61,000 shares, have been excluded from
the calculation of net loss per share for the quarter ended December 31, 2003. For the computation of net income per share for the three months ended December 31, 2004, the
Company excluded approximately 728,000 shares of outstanding stock options as the exercise prices
of those options were greater than the weighted average market price of the Companys stock during
the period. NOTE 3  COMPREHENSIVE INCOME (LOSS) Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS No.
130) established standards for the reporting and display of comprehensive income (loss).
Comprehensive income includes unrealized gains and losses on investments and accumulated other
comprehensive income is included as a component of stockholders equity. Total comprehensive income for the three-month periods ended December 31, 2004 and 2003,
respectively, is as follows: Three Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003Net income (loss)
    
    $
    1,739
    
    
    $
    (359
    )Foreign currency translation adjustments
    
    
    101
    
    
    
    Changes in unrealized (gain) loss on investments, net
    
    
    (40
    )
    
    
    (3
    )Comprehensive income (loss)
    
    $
    1,800
    
    
    $
    (362
    )
 9




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VIRAGE LOGIC CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 4  SEGMENT INFORMATION The Company operates only in one segment, the sale of semiconductor IP platforms based on memory,
logic, and I/Os and the sale of the individual platform components. The Chief Executive Officer has been identified as the Chief Operating Decision Maker (CODM)
because he has final authority over resource allocation decisions and performance assessment. The
CODM does not receive discrete financial information about the IP
platform or the individual platform components. Revenues by geographic region are based on the region in which the customers are located. Total revenues by geography are as follows: Three Months EndedDecember 31,
    
    
    December 31,Total Revenue by Geography
    
    2004
    
    
    2003(in thousands)United States
    
    $
    4,728
    
    
    $
    3,493Canada
    
    
    466
    
    
    
    629Japan
    
    
    1,738
    
    
    
    1,269Taiwan
    
    
    3,003
    
    
    
    1,472Europe, Middle East and Africa (EMEA)
    
    
    3,057
    
    
    
    1,926Other Asia (China, Malaysia, Korea and Singapore)
    
    
    2,867
    
    
    
    2,071Total
    
    $
    15,859
    
    
    
    10,860
 Total license revenues by geometry are as follows: Three Months EndedDecember 31,
    
    
    December 31,Total License Revenue by Geometry
    
    2004
    
    
    20030.18 Micron Technology
    
    
    12
    %
    
    
    10
    %0.13 Micron Technology
    
    
    51
    
    
    
    5790 Nanometer Technology
    
    
    25
    
    
    
    22Other
    
    
    12
    
    
    
    11Total
    
    
    100
    %
    
    
    100
    %
 The Company has only one product line, and as such disclosure by product groupings is not
applicable. Long-lived assets are located primarily in the United States, with the exception of a building in
Armenia, which is owned by the Company. The Armenian building and leasehold improvements are valued
at cost less accumulated depreciation and amortization, and amounted to approximately $1.7 million
as of December 31, 2004. NOTE 5  RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standard Board (FASB) issued Statement of Financial
Accounting Standards No. 123R, Share-Based Payments (SFAS No. 123R), revising SFAS No. 123. The
revision supersedes APB 25 and its related implementation guidance. SFAS No. 123R eliminates the
alternative use of the intrinsic value method permitted under APB No. 25 and requires
publicly-traded companies to measure the cost of equity-based awards granted to employees based on
the grant-date fair value of the award. SFAS No. 123R also provides that the costs should be
recognized over the period during which the employees services are rendered (generally the vesting
period). No compensation cost is recognized for equity instruments for which employees do not
render the requisite services. SFAS No. 123R is effective for fiscal periods beginning after June
15, 2005. The impact on the Companys financial statements of adopting the new standard is
illustrated in Note 1. 10




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VIRAGE LOGIC CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS In April 2004, the EITF issued Statement No. 03-06 Participating Securities and the Two  Class
Method Under FASB Statement No. 128, Earnings Per Share (EITF 03-06). EITF 03-06 addresses a
number of questions regarding the computation of earnings per share by companies that have issued
securities other than common stock that contractually entitle the holder to participate in
dividends and earnings of the company when, and if, it declares dividends on its common stock. The
issue also provides further guidance in applying the two-class method of calculating earnings per
share, clarifying what constitutes a participating security and how to apply the two-class method
of computing earnings per share once it is determined that a security is participating, including
how to allocate undistributed earnings to such a security. EITF 03-06 became effective during the
quarter ended June 30, 2004, the adoption of which did not have an impact on the calculation of
earnings per share of the Company. NOTE 6  COMMITMENTS AND CONTINGENCIES Indemnifications. The Company enters into standard license agreements in its ordinary course of
business. Pursuant to these agreements, the Company agrees to indemnify its customers for losses
suffered or incurred by them as a result of any patent, copyright, or other intellectual property
infringement claim by any third party with respect to the Companys products. These agreements
generally have perpetual terms. The maximum amount of indemnification the Company could be required
to make under these agreements is generally limited to the license fees received by the Company.
The Company estimates the fair value of its indemnification obligation as insignificant, based upon
its history of litigation concerning product and patent infringement claims. Accordingly, the
Company has no liabilities recorded for indemnification under these agreements as of December 31,
2004. Warranties. The Company offers its customers a warranty that its software products will
substantially conform to their functional specifications. To date, there have been no payments or
material costs incurred related to fulfilling these warranty obligations. Accordingly, the Company has no liabilities recorded for these warranties as of December 31, 2004.
The Company assesses the need for a warranty reserve on a quarterly basis and there can be no
guarantee that a warranty reserve will not become necessary in the future. 11




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Statements made in this section, Managements Discussion and Analysis of Financial Condition and
Results of Operations, other than statements of historical fact, are forward-looking statements
that involve risks and uncertainties. These statements relate to products, customers, business
prospects, technologies, trends and effects of acquisitions. In some cases, forward-looking
statements can be identified by terminology such as may, will, should, expect,
anticipate, intend, plan, believe, estimate, potential, or continue, the negative of
these terms or other comparable terminology. Forward-looking statements are subject to a number of
known and unknown risks and uncertainties which might cause actual results to differ materially
from those expressed or implied by such statements. These risks include our ability to forecast our
business, including our revenue, income and order flow outlook, our ability to execute on our
strategy of being a provider of semiconductor IP platforms, our ability to continue to develop new
products and maintain and develop new relationships with third-party foundries, integrated device
manufacturers, and fabless semiconductor companies, our ability to overcome the challenges
associated with establishing licensing relationships with semiconductor companies, our ability to
obtain royalty revenues from customers in addition to license fees, our ability to receive accurate
information necessary for calculation of royalty revenues and to collect royalty revenues from
customers, business and economic conditions generally and in the semiconductor industry in
particular, pace of adoption of new technologies by our customers and increases or fluctuations in
the demand for their products, competition in the market for semiconductor IP platforms, and other
risks and uncertainties including those set forth below under Risk Factors. These forward-looking
statements speak only as of the date hereof, we expressly disclaim any obligation or undertaking to
release publicly any updates or revisions to any forward-looking statements contained herein. The
following information should be read in conjunction with the Managements Discussion and Analysis
of Financial Condition and Results of Operations section of the Companys Form 10-K for the fiscal
year ended September 30, 2004 filed with the Securities and Exchange Commission. Overview Business Environment We provide semiconductor intellectual property (semiconductor IP) platforms based on memory, logic
and I/Os (input/output interface components) that are silicon proven and production ready. These
various forms of IP are utilized by our customers to design and manufacture system-on-a-chip (SoC)
integrated circuits that power todays consumer, communications and networking, handheld and
portable, computer and graphics, and automotive applications. Our customers include fabless semiconductor companies, integrated device manufacturers (IDMs) and
foundries. As semiconductor companies face increasing pressures to bring products to market faster
and semiconductors have shorter product cycles, we focus on providing our customers a broad product
offering as a means to satisfy a larger portion of our customers semiconductor IP needs, while
positioning ourselves to offer advanced products as the semiconductor industry migrates to lower
geometries. The timing of customer purchases of our products is typically related to new design starts by
fabless companies and migration to new manufacturing processes by IDMs and foundries. Because of
the high costs involved in new design starts and migration to new manufacturing processes, our
customers decisions regarding these matters are heavily dependent on their long-term business
outlook. As a result, our business, and specifically our license revenues, is more likely to grow
at times of positive outlook for the semiconductor industry. While we saw signs of moderate
recovery in the semiconductor industry during fiscal 2004, we believe that our customers remain
cautious in their long-term business outlook. We saw an increase in design starts in 0.13 micron and 90 nanometer process nodes during fiscal
2004, and this continued in the first quarter of fiscal 2005. Furthermore, the capabilities offered
by our STAR Memory System to improve yield and time-to-market and help reduce our customers
overall costs became more important in these lower geometries, and continues to contribute to
increasing license revenues. In the first quarter of fiscal 2005, we derived approximately 76% of license revenue from the more
advanced processes, 0.13 micron and 90nm technologies, and approximately 24% from the older process
nodes, 12




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predominantly 0.18 and 0.25 micron technologies. The Company expects the 0.13 micron and 90nm
technologies to drive revenue growth in the foreseeable future while license revenues from the
older process nodes decline. The Companys royalty revenue to date has been largely from production
on the older process nodes and we expect future growth in royalty revenues to be driven by the
advanced processes, 0.13 micron and 90nm technologies, in addition to continued production on the
0.18 micron technology. We sell our product early in the design process, and there are delays of 18 to 36 months between
the sale of our products and the time we expect to receive royalty revenues. These delays are due
to the length of time required for our customers to implement our semiconductor IP into their
design, and to manufacture, market and sell a product incorporating our products. As a result, we
expect our royalty revenues to increase in periods in which manufacturing volumes of semiconductors
are growing as was the case during fiscal 2004 and when comparing the first quarters of fiscal 2004
and 2005. Future growth of our royalty revenue is dependent on our ability to increase the number
of designs incorporating our products and on such designs achieving substantial manufacturing
volumes. Sources of Revenues Our revenues are derived principally from licenses of our semiconductor IP products, which include:  
    embedded memory, logic and I/O elements;
    standard and custom memory compilers;
    memory test processor and fuse box components for embedded test and repair of defective memory cells. We also derive revenues from royalties, custom design services, maintenance services and library
development related to the license of logic components. Our revenues are reported in two separate
categories: license revenues and royalty revenues. License revenues are derived from license fees,
maintenance fees, and fees for custom design services. Royalty revenues are derived from fees paid
by a customer or a third-party foundry based on production volumes of wafers containing chips
utilizing our semiconductor IP technologies. The license of our semiconductor IP typically covers a range of embedded memory, logic and I/O
products. Licenses of our semiconductor IP products can be either perpetual or term-based. In
addition, maintenance can be purchased for both types of licenses. We derive our royalty revenues from third-party foundries that manufacture chips incorporating our
Area, Speed and Power (ASAP) memory products for our fabless customers, and from integrated device
manufacturers and fabless customers that utilize our STAR Memory System , NetCAM and NOVeA
technologies. Royalty payments are in addition to the license fees we collect from our customers,
and are calculated based on production volumes of wafers containing chips utilizing our
semiconductor IP technologies based on a rate per-chip or rate per-wafer depending on the terms of
the respective license agreement. Royalty revenues are generally determined and recognized one
quarter in arrears, when a production volume report is received from the customer or foundry. Currently, license fees represent the majority of our revenues. Royalty revenues for the three
months ended December 31, 2004 and 2003 were $2.8 million and $1.4 million, respectively. We have been dependent on a limited number of customers for a substantial portion of our annual
revenues, although that dependence continues to decrease. Our customers comprising the top 10
customer group have changed from time to time. For the three months ended December 31, 2004 and
2003, no single customer accounted for more than 10% of our revenue. Sales to customers located outside of North America accounted for approximately 67% and 62% for the
three months ended December 31, 2004 and 2003, respectively. Substantially all of our direct sales
representatives and field application engineers are located in North America and Europe and service
those regions. In Japan and the rest of Asia, we sell both indirectly through distributors and
directly through our sales representatives. All revenues to date have been denominated in U.S.
dollars. 13




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Critical Accounting Policies The preparation of financial statements in accordance with generally accepted accounting principles
in the United States requires that we make estimates and judgments, which affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities. We continually evaluate our estimates, including those related to
percentage-of-completion, allowance for doubtful accounts, investments, intangible assets, income
taxes, and contingencies such as litigation. We base our estimates on historical experience and
other assumptions that we believe are reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions. We have identified the following as critical accounting policies to our company:  
    revenue recognition
    valuation of accounts receivable
    valuation of long-lived assets and investments
    valuation of purchased intangibles, including goodwill
    accounting for stock options
    income taxes. Revenue Recognition Our revenue recognition policy is based on the American Institute of Certified Public Accountants
Statement of Position 97-2, Software Revenue Recognition as amended by Statement of Position 98-4
and Statement of Position 98-9. Additionally, revenue is recognized on some of our products,
according to Statement of Position 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts. Revenues from perpetual licenses for our semiconductor IP products are generally recognized when
persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is
fixed or determinable, and collectability is reasonably assured. If any of these criteria are not
met, we defer recognizing the revenue until such time as all criteria are met. Revenues from
term-based licenses, which are generally twelve months in duration, are recognized ratably over the
term of the license, provided the criteria mentioned above are met. License of custom memory compilers and logic libraries may involve customization to the
functionality of the software, therefore revenues from such licenses are recognized in accordance
with Statement of Position 81-1 over the period that we perform the services. Revenue derived from
library development services are recognized using a percentage-of-completion method. For all
license and service agreements accounted for using the percentage-of-completion method, we
determine progress-to-completion based on labor hours incurred. We believe that we are able to
reasonably and reliably estimate the costs to complete projects accounted for using the
percentage-of-completion method based on historical experience of similar project requirements.
Alternatively, if we cannot reasonably and reliably estimate the costs to complete a project, the
completed contract method of accounting is used, such that costs are deferred until the project is
completed at which time revenues and related costs are recognized. A provision for estimated losses
on engagements is made in the period in which the loss becomes probable and can be reasonably
estimated. Costs incurred in advance of billings are recorded as costs in excess of related
billings on uncompleted contracts. If customer acceptance is required for completion of specified
milestones, the related revenue is deferred until the acceptance criteria are met. For agreements that include multiple elements, we recognize revenues attributable to delivered or
completed elements covered by such agreements when such elements are completed or delivered. The
amount of such revenues is determined by deducting the aggregate fair value of the undelivered or
uncompleted elements, which we determine by each such elements vendor-specific objective evidence
of fair value, from the total revenues recognizable under such agreement. Vendor-specific objective
evidence of fair value of each element of an arrangement is based upon the normal pricing for such
licensed product and service when sold separately, and for 14




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maintenance, it is determined based on the stated renewal rate in each contract. Revenues are
recognized once we deliver the element identified as having vendor-specific objective evidence or
once the provision of the services is completed. Maintenance revenues are recognized ratably over
the contractual term of the maintenance period, which is generally twelve months. We assess whether the fee associated with each transaction is fixed or determinable and collection
is reasonably assured and evaluate the payment terms. If a portion of the fee is due beyond normal
payment terms, we recognize the revenues on the payment due date, if collection is reasonably
assured. We assess collectibility based on a number of factors, including past transaction history
and the overall credit-worthiness of the customer. If collection is not reasonably assured,
revenue is deferred and recognized at the time collection becomes reasonably assured, which is
generally upon receipt of cash. Amounts invoiced to our customers in excess of recognized revenues are recorded as deferred
revenues. The timing and amounts invoiced to customers can vary significantly depending on specific
contract terms and can therefore have a significant impact on deferred revenues in any given
period. Royalty revenues are generally determined and recognized one quarter in arrears, when a production
volume report is received from the customer or foundry, and are calculated based on actual
production volumes of wafers containing chips utilizing our semiconductor IP technologies based on
a rate per-chip or rate per-wafer depending on the terms of the respective license agreement. While we believe our estimates used in calculating percentage-of-completion for certain agreements
involving customization are reasonable, the use of different assumptions could materially affect
the timing of our revenue recognition. Valuation of Accounts Receivable We perform ongoing credit evaluations of our customers and adjust customers credit limits based
upon their payment history and current credit worthiness, as determined by our review of their
then-current credit information. We monitor collections and payments from our customers and
maintain an allowance for estimated credit losses based upon our historical experience and any
specific customer collection risks that we have identified. While such credit losses have
historically been within our expectations and the allowance we have established, we cannot
guarantee that we will continue to experience the same credit loss rates that we have in the past.
Since our accounts receivable are concentrated in a relatively small number of customers, a
significant change in the liquidity or financial position of any one of these customers could have
a material adverse impact on the quality of our accounts receivables and our future operating
results. Valuation of Long-Lived Assets and Investments We periodically review the carrying value of our long-lived assets and investments for continued
realizability. This review is based upon our projections of anticipated future cash flows from such
assets and investments. While we believe that our estimates of future cash flows are reasonable,
the use of different assumptions regarding the amount and timing of such cash flows based upon
different outlooks on the general economic condition and the state of the semiconductor industry
could materially affect our evaluations. This could result in an impairment charge and have a
materially adverse impact on our future operating results. Valuation of Purchased Intangibles, Including Goodwill We periodically evaluate purchased intangibles, including goodwill, for impairment. An assessment
of goodwill is subjective by nature, and significant management judgment is required to forecast
future operating results, projected cash flows and current period market capitalization levels. If
our estimates or related assumptions change in the future, these changes in conditions could
require material write-downs of net intangible assets, including impairment charges for goodwill.
The valuation of intangible assets was based on managements estimates. Such estimates included
cash flow projections, discount rates and estimated life of technology, which management believes
are reasonable under the circumstances. Use of other estimates or assumptions may have resulted in
a different valuation for such intangible assets acquired leading to changes in recorded asset
values. Intangible assets with finite useful lives are amortized over the estimated life of each
asset. As of December 31, 2004, management believes no 15




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impairment of intangible assets has occurred. The carrying value of purchased intangibles,
including goodwill, is $12.4 million at December 31, 2004. If the asset is deemed impaired, the
maximum amount of impairment would be the full carrying value of the asset. Accounting for Stock-Based Compensation We account for stock-based compensation under Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25) and Financial Accounting Standards Board (FASB)
Interpretation No. 44, Certain Transactions Involving Stock Compensation (FIN 44), and comply
with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation (SFAS No.
123), as amended by Statement of Financial Accounting Standards No. 148, Accounting for
Stock-based Compensation Transition and Disclosure, an Amendment of FASB 123 (SFAS No. 148). In
accordance with APB 25, we do not recognize compensation expense for options granted to employees
as all employee options are granted with an exercise price equal to the fair market value of the
underlying stock at the grant date. In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R,
Share-Based Payments (SFAS No. 123R), revising SFAS No. 123. SFAS No. 123R supersedes APB 25 and
its related implementation guidance. SFAS No. 123R eliminates the alternative use of the intrinsic
value method permitted under APB No. 25 and requires publicly-traded companies to measure the cost
of equity-based awards granted to employees based on the grant-date fair value of the award. SFAS
No. 123R also provides that the costs should be recognized over the period during which the
employees services are rendered (generally the vesting period). No compensation cost is
recognized for equity instruments for which employees do not render the requisite services. FAS
123R is effective for fiscal periods beginning after June 15, 2005. The adoption of SAFS No. 123R
will reduce our profitability. The impact on the Companys financial statements for the quarter
ended December 31, 2004 and 2003 of adopting this new standard is illustrated in Note 1 to our
unaudited condensed consolidated financial statements included in this quarterly report. We account for stock options or warrants granted to non-employees, excluding non-employee
directors, under SFAS No. 123 and EITF Issue No. 96-18, Accounting for Equity Instruments with
Variable Terms that are Issued for Consideration Other Than Employee Services under SFAS 123. We
record the expense of such services based upon the estimated fair value of the equity instrument
using the Black-Scholes pricing model. Assumptions used to value the equity instruments are
consistent with equity instruments issued to employees. We charge the value of the equity
instrument to earnings over the term of the service agreement. At the time all non-employee options
and warrants were valued, the instruments were immediately exercisable and there were no ongoing
obligations from the holders. We did not grant stock options to any non-employees during the three
months ended December 31, 2004 and 2003. We make estimates and assumptions for the inputs, such as interest rate, weighted average expected
option life and volatility, used in the fair value calculation. Current regulatory activity
indicates that stock options granted to both employees and non-employees will need to be valued at
their fair value and included in operating expenses in the near future. At such time as the
regulation takes effect, material differences in amounts of expense may result if different
estimates and assumptions are required or if a different valuation model were to be implemented. Income taxes We record the estimated future tax effects of temporary differences between the tax bases of assets
and liabilities and amounts reported in the accompanying consolidated balance sheets. These
differences resulted in deferred tax assets of $5.2 million and deferred tax liabilities of $1.0
million at December 31, 2004. The carrying value of the Companys net deferred tax assets assumes
that we will be able to generate sufficient future taxable income in certain tax jurisdictions,
based on estimates and assumptions. Management periodically evaluates the recoverability of the
deferred tax assets and recognizes the tax benefit only as reassessment demonstrates they are
realizable. At such time it is determined that it is more likely than not that the deferred tax
assets are not realizable, the valuation allowance is adjusted. This assessment is based on
projections of future taxable income, which is impacted in future periods by income before taxes
and stock option exercises. The actual taxable income realized in the future and other factors
determine how much benefit the Company ultimately realizes from the deferred tax assets. In the event that actual results differ from the estimates or adjustments are made to the estimates
used in determining the valuation allowance, an additional valuation allowance may be required,
which could materially impact the Companys financial position and results of operations. 16




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RESULTS OF OPERATIONS  THREE MONTHS ENDED DECEMBER 31, 2004 AND 2003 Three Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003Revenue:License
    
    
    82.4
    %
    
    
    87.2
    %Royalties
    
    
    17.6
    
    
    
    12.8Total revenues
    
    
    100.0
    
    
    
    100.0Cost and expenses:Cost of revenues
    
    
    19.2
    
    
    
    22.4Research and development
    
    
    30.1
    
    
    
    40.6Sales and marketing
    
    
    24.0
    
    
    
    29.9General and administrative
    
    
    12.2
    
    
    
    13.3Stock-based compensation
    
    
    0.0
    
    
    
    0.5Total cost and expenses
    
    
    85.5
    
    
    
    106.7Operating income (loss)
    
    
    14.5
    
    
    
    (6.7
    )Interest income and other expense, net
    
    
    1.9
    
    
    
    1.5Income tax provision (benefit)
    
    
    5.4
    
    
    
    (1.9
    )Net income (loss)
    
    
    11.0
    %
    
    
    (3.3
    )%
 Revenues Revenues for the three-month period ended December 31, 2004 totaled $15.9 million, representing an
increase of 46% from $10.9 million for the three months ended December 31, 2003. The increase is
attributed to the overall growth of $3.6 million in license revenue globally, combined with growth
of $1.4 million in royalty revenue. For the three months ended December 31, 2004 and 2003, total license revenues by geometry are as
follows: Three Months EndedDecember 31,
    
    
    December 31,Total License Revenues by Geometry
    
    2004
    
    
    20030.18 micron technology
    
    
    12
    %
    
    
    10
    %0.13 micron technology
    
    
    51
    
    
    
    5790 nanometer technology
    
    
    25
    
    
    
    22Other
    
    
    12
    
    
    
    11Total
    
    
    100
    %
    
    
    100
    %
 License revenue for the three-month period ended December 31, 2004 was $13.1 million, representing
a $3.6 million, or 37.9% increase as compared to $9.5 million for the three-month period ended
December 31, 2003. The increase in license revenue is primarily attributed to a number of
significant licensing agreements we entered into in each of the North America, Europe and Asia
regions. While we experienced overall revenue growth in absolute dollar terms, we also anticipate changes in
our product mix as we continue to invest and introduce more advanced technology. Revenue
associated with the 0.13 micron technology as a percentage of total license revenue decreased to
approximately 51% during the quarter ended December 31, 2004, from approximately 57% in the same
period in fiscal 2004. The decrease in the 0.13 micron technology as a percentage of total license
revenue reflects continued new business for the 0.18 micron technology as well as the introduction
of our 65-nanometer technology. At the same time, revenue associated with the 90-nanometer
technology continues to grow, both in absolute dollars and as a percentage of license revenue. 17




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Royalties increased by $1.4 million, or 101.8% from $1.4 million in the three months ended December
31, 2003 to $2.8 million for the three months ended December 31, 2004. The increase was primarily
attributed to the growth in royalties associated with the 0.18 micron and 0.13 micron technology
processes. For the three months ended December 31, 2004 and 2003, total revenues by geography are as follows: Three Months EndedDecember 31,
    
    
    December 31,Total Revenues by Geography
    
    2004
    
    
    2003(in thousands)United States
    
    $
    4,728
    
    
    $
    3,493Canada
    
    
    466
    
    
    
    629Japan
    
    
    1,738
    
    
    
    1,269Taiwan
    
    
    3,003
    
    
    
    1,472Europe, Middle East and Africa (EMEA)
    
    
    3,057
    
    
    
    1,926Other Asia (China, Malaysia, Korea and Singapore)
    
    
    2,867
    
    
    
    2,071Total
    
    $
    15,859
    
    
    $
    10,860
 We experienced revenue growth across all regions, except Canada, with the most significant
increases in sales to customers in the United States, Taiwan and Europe. The increase in sales in
the United States is primarily due to new license agreements with certain existing customers using
our STAR Memory System and SRAM product family. The increase in sales in the Europe and Asia
regions are primarily a result of an increased level of royalties from our foundry customers
stemming from higher manufacturing volumes, combined with new license agreements we negotiated
during the quarter. Cost of Revenues Cost of revenues consists primarily of personnel expenses and the allocation of facilities costs,
and depreciation expenses of acquired software and capital equipment. Cost of revenue for the
three months ended December 31, 2004 totaled $3.0 million, representing an increase of 24.7% over
$2.4 million for the three months ended December 31, 2003. The increase is mainly attributed to 30
additional headcounts in the design and engineering teams necessary to support the growth in
license revenue, as well as higher amortization expenses associated with purchased software
maintenance and support contracts. We believe that cost of revenues will continue to fluctuate in
the future, both in absolute dollars and as a percentage of revenues, based on the mix of
customized products sold by us, and the level of license revenues. Cost of revenues for the three
months ended December 31, 2003 excludes $11,000 of amortization of deferred stock-based
compensation. Research and Development Expenses Research and development expense (R&D expense) primarily includes personnel expense, software
license and maintenance fees, as well as capital equipment depreciation expenses. R&D expense for
the three months ended December 31, 2004 was $4.8 million, an increase of $0.4 million, or 8.2%,
from $4.4 million for the three months ended December 31, 2003. The increase is primarily due to
30 additional headcounts in the design and engineering teams, combined with higher amortization
expenses associated with purchased software maintenance and support contracts to support our design
and engineering teams. R&D expense as a percentage of total revenue for the three months ended
December 31, 2004 decreased to 30.1% from 40.6% for the same period in 2003. The decrease is mainly
attributed to the revenue growth we experienced. Regardless of this recent decrease, we anticipate
that R&D expense will increase, both in absolute dollars and as a percentage of total revenues, as
we continue to expand our product offerings and to invest in technologies for future delivery.
Research and development expense for the three months ended December 31, 2003 excludes $19,000 of
amortization of deferred stock-based compensation. Sales and Marketing Expenses Sales and marketing expense consists mainly of personnel expenses, commissions, advertising and
promotion-related costs. Sales and marketing expense for the three months ended December 31, 2004
totaled $3.8 million, representing an increase of $0.6 million, or 17.4%, over the three months
ended December 31, 2003. The increase in 18




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sales expense is mainly attributed to 5 additional headcounts and an increase of approximately
$250,000 in commissions related to increased revenue, combined with the increased level of expenses
associated with advertising, marketing communication and public relation. Sales and marketing
expense as a percentage of revenue was approximately 24% for the three months ended December 31,
2004, compared to 29.9% for the three months ended December 31, 2003. The decrease in sales and
marketing expense as a percentage of revenue is mainly attributed to the continued growth of
overall revenues. Sales and marketing expense for the three months ended December 31, 2003
excludes $14,000 of amortization of deferred stock-based compensation. General and Administrative Expenses General and administrative expense (G&A expense) consists primarily of personnel, corporate
governance and other costs associated with the management of our business. G&A expense for the
three months ended December 31, 2004 totaled approximately $1.9 million, representing an increase
of approximately $0.5 million, or 33.8%, over the three months ended December 31, 2003. G&A
expense as a percentage of total revenue was 12.2% for the three months ended December 31, 2004,
compared to 13.3% for the same period in 2003. The absolute dollar increase in G&A expense is
mainly attributed to the following: 1) higher personnel and related costs associated with 13
additional headcounts; 2) approximately $200,000 higher professional fees incurred to support
compliance with regulations under the Sarbanes-Oxley Act, and 3) a charge of approximately $200,000
related to the provision for doubtful accounts. We currently anticipate that our G&A expense in
absolute dollar will continue to increase as we broaden our internal infrastructure with additional
headcount in key positions and incremental professional services to support the expansion of our
business and the compliance with regulations under the Sarbanes-Oxley Act. G&A expense for the
three months ended December 31, 2003 excludes $6,000 of amortization of deferred stock-based
compensation. Stock-Based Compensation Expenses We recorded $50,000 of amortization of deferred stock-based compensation for the three months ended
December 31, 2003. The deferred stock-based compensation costs associated with the granting of
employee stock options and restricted stock were fully amortized in the third quarter of fiscal
year 2004. Interest Income and Other Expenses Interest income for the three months ended December 31, 2004 was $320,000 compared to $162,000 for
the same period in 2003. The increase in interest income was primarily due to the increased
interest rate environment applicable to our treasury investment portfolio of marketable securities
held as available-for-sale. Income Taxes Provision For the three months ended December 31, 2004, we recorded an income tax provision of $857,000,
representing an effective tax rate of 33% on the pre-tax net income of $2.6 million. For the same
period in 2003, we recorded a tax benefit of approximately $205,000, yielding an effective tax rate
of approximately 36% on our pre-tax net loss of approximately $564,000. LIQUIDITY AND CAPITAL RESOURCES At December 31, 2004, our cash and cash equivalents totaled approximately $28.9 million, as
compared to $28.7 million at September 30, 2004. At December 31, 2004 our short-term and long-term
marketable investments totaled approximately $37.7 million as compared to $34.4 million at
September 30, 2004. Net cash provided by operating activities was approximately $1.3 million for the three months ended
December 31, 2004. Net cash provided by operating activities during the quarter primarily resulted
from net income of $1.7 million for the period, adjusted for non-cash charges associated with
provision for doubtful accounts, depreciation and amortization, combined with a decrease of $0.6
million in net accounts receivable attributed to our continued efforts in collections, an increase
of $1.4 million in accounts payable and accrued expenses resulting from the higher volume of
invoices processed as well as increased payroll accrual, offset by an increase of $1.4 million in
prepaid expenses and other assets resulting from additional software maintenance contracts acquired
to support the need of 19




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our growing engineering team, and a decrease of $1.8 million in deferred revenue, which represented
billings in the quarter preceding the performance of services, which were subsequently performed in
the first quarter of fiscal 2005, and which has been recognized as revenue during the current
quarter. Net cash provided by operating activities for the three months ended December 31, 2003 totaled
approximately $0.9 million. Net cash provided by operating activities for the quarter primarily
resulted from a net loss of approximately $0.4 million, adjusted for non-cash depreciation and
amortization charges, and a $2.7 million increase in accounts receivable associated with a contract
for which the percentage-of-completion accounting method was used. Net cash used in investing activities totaled approximately $3.8 million for the three months ended
December 31, 2004. The use of cash for the quarter resulted from a net use of cash of
approximately $3.4 million associated with the net purchase of marketable investments as well as
cash used to purchase property and equipment totaling approximately $0.4 million. Net cash provided by investing activities totaled approximately $8.9 million for the three months
ended December 31, 2003. Cash provided by investing activities for the quarter primarily resulted
from a net $9.1 million of investment maturities. Net cash provided by financing activities totaled approximately $2.5 million and $0.3 million for
the three months ended December 31, 2004 and 2003, respectively, and is attributed to the proceeds
from exercises of employee stock options during the respective quarters. Our future capital requirement will depend on many factors, including the rate of sales growth,
market acceptance of our existing and new technologies, the amount and timing of research and
development expenditures, the timing of the introduction of new technologies, expansion of sales
and marketing efforts, potential acquisitions, and levels of working capital, primarily accounts
receivable. There can be no assurance that additional equity or debt financing, if required, will
be available on satisfactory terms. We believe that our current capital resources and cash
generated from operations will be sufficient to meet our needs for at least the next twelve months,
although we may seek to raise additional capital during that period and there can be no assurance
that we will not require additional financing beyond this time frame. CONTRACTUAL OBLIGATIONS AND COMMITMENTS Information regarding our long-term operating lease payments and other commitments is provided in
Item 7 Managements Discussion and Analysis of Results of Operations and Financial Condition of
our Annual Report on our Form 10-K for the fiscal year ended September 30, 2004. There have been
no material changes in contractual obligations since September 30, 2004. 20




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RISK FACTORS Risks Related to Our Business Inability or delayed execution on our strategy to be a leading provider of
semiconductor IP platforms could adversely affect our revenues and
profitability. From inception to May 2002, primarily all of our revenues resulted from licenses to our embedded
memory products. After our acquisition of In-Chip Systems, Inc. in May 2002, we were able to expand
our product offering to also include logic products. In 2003, we added I/Os to our product offering
to enable us to offer what we define as a semiconductor IP platform. If our strategy to be a
provider of semiconductor IP platforms is not broadly accepted by potential customers or acceptance
is delayed for whatever reason, our revenues and profitability could be adversely affected. In
addition, our profitability could also be adversely affected due to investment of resources towards
the development and/or acquisition of logic and I/O products and lower than anticipated revenues
from the sale of such products. Factors that could prevent us from gaining market acceptance of our
semiconductor IP platform include:  
    Difficulty convincing customers of our memory products to purchase other products from us;
    Competition resulting in minority market share;
    Inability to migrate technologies to manufacturing processes at new foundries due to less design experience;
    Limited experience in sales and marketing of the platform strategy and limited knowledge of the market; and
    Difficulties and delays in expanding our logic and I/O product offerings. Our quarterly operating results may fluctuate significantly and any failure to
meet financial expectations for any fiscal quarter may cause our stock price to
decline. Our quarterly operating results are likely to fluctuate in the future from quarter to quarter and
on an annual basis due to a variety of factors, many of which are outside of Virage Logics
control. Factors that could cause our revenues and operating results to vary from quarter to
quarter include:  
    large orders unevenly spaced over time and timing of our sales cycle;
    establishment or loss of strategic relationships with third-party semiconductor foundries;
    pace of adoption of new technologies by customers;
    timing of new technologies and technology enhancements by us and our competitors;
    fluctuations in the demand for products that incorporate our IP;
    constrained or deferred spending decisions by customers;
    inability to collect trade receivables;
    the timing and completion of milestones under customer agreements;
    the impact of competition on license revenues or royalty rates;
    the cyclical nature of the semiconductor industry and the general economic environment;
    difficulties in forecasting royalty revenues because of factors out of our control, such
as the timing of manufacturing of semiconductors subject to royalty obligations, the
number of such semiconductors actually manufactured and the timing and results of audits
of royalty reports received from our customers; 21




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
    changes in development schedules, research and development expenditure levels and product
support by us and our customers;
    recording a significant portion of our quarterly revenues in the last month of a quarter.
This is the result of closing more product orders, and therefore, a higher percentage of
product shipments, in the last month of a quarter than in the first months of a quarter.
Some customers believe they can enhance their bargaining power by waiting until the end
of the quarter to finalize negotiations; and
    costs associated with merger and acquisition plans that are not pursued. As a result, we believe that period-to-period comparisons of our results of operations are not
necessarily meaningful and you should not rely on these comparisons as indications of future
performance. These factors, together with the fact that our expenses are primarily fixed and
independent of revenues in any particular period, make it difficult for us to accurately predict
our revenues and operating results and may cause them to be below market analysts expectations in
some future quarters, which could cause the market price of our stock to decline significantly, as
happened in connection with our operating results for the first and second quarters of fiscal 2003. If we are unable to continue establishing relationships on favorable
contractual terms with semiconductor companies to license our IP, our business
will be harmed. We currently rely on license fees from the sale of perpetual and term licenses to generate a large
portion of our revenues. These licenses produce large amounts of revenue in the periods in which
the license fees are recognized, but are not necessarily indicative of a commensurate level of
revenue from the same customers in future periods. In addition, our agreements with our customers
do not obligate them to license new or future generations of our IP. As a result, the growth of our
business depends significantly on our ability to expand our business with existing customers and
attract new customers. We face numerous challenges in entering into license agreements with semiconductor companies on
terms beneficial to our business, including:  
    the lengthy and expensive process of building a relationship with a potential licensee;
    competition with the customers internal design teams and other providers of
semiconductor IP, as our customers may evaluate these alternatives for each design;
and
    the need to persuade potential licensees to rely on us for critical technology. These factors may make it difficult for us to maintain our current relationships or establish new
relationships with additional licensees. Further, there are a finite number of fabless
semiconductor companies and integrated device manufacturers to which we can license our IP. If we
are unable to establish and maintain these relationships, we will be unable to generate license
fees, and our revenues will decrease. If we are unable to maintain existing relationships and/or develop new
relationships with third-party semiconductor manufacturers, or foundries, we
will be unable to verify our technologies on their processes and license our IP
to them or their customers. Our ability to verify our technologies for new manufacturing processes depends on entering into
development agreements with third-party foundries to provide us with access to these processes. In
addition, we rely on third-party foundries to manufacture our silicon test chips, to provide
referrals to their customer base and to define the focus of our research and development
activities. We currently have agreements with Taiwan Semiconductor
Manufacturing Company (TSMC), United Microelectronics Corporation (UMC), Chartered Semiconductor
Manufacturing (Chartered), Tower Semiconductor (Tower), Silterra Malaysia (Silterra), Semiconductor
Manufacturing International Corporation (SMIC) and DongbuAnam Semiconductor. If we are unable to
maintain our existing relationships with these foundries or enter into new agreements with other
foundries, we will be unable to verify our technologies for their manufacturing processes and our
ability to develop products for emerging 22




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technologies will be hampered. We would then be unable to
license our IP to fabless semiconductor companies that use these foundries to manufacture their
silicon chips, which is a significant source of our revenues. If we are unsuccessful in increasing our royalty revenues, our revenues and
profitability may not be as large as we anticipate. We have historically generated revenues almost entirely from license fees. We have agreements with
certain third-party semiconductor foundries to pay us royalties on their sales of silicon chips
they manufacture for our fabless customers. Beginning with our STAR Memory System, CAM technologies
and more recently with the introduction of our NOVeA technology, in addition to collecting
royalties from third-party semiconductor foundries, we intend to increase our royalty base by
collecting royalties directly from our integrated device manufacturer and fabless customers.
However, we may not be successful in convincing all customers to agree to pay us royalties. For the
quarters ended December 31, 2004 and 2003, we recorded royalty revenues of approximately $2.8
million and $1.4 million, respectively. The continued growth of our revenues depends in part on
increasing our royalty revenues, but we may not be successful in increasing our royalty revenues as
expected and we face difficulties in forecasting our royalty revenues because of many factors
beyond our control, such as fluctuating sales volumes of products that incorporate our IP,
commercial acceptance of these products, short or unpredictable product life cycles for some
customer products containing our IP, potential slow down for manufacturing of certain newer process
technology, foundry rate adjustments, the cyclical nature of the semiconductor industry that
affects the number of designs and may result in lower manufacturing volumes in certain periods as a
result of inventory build-up, accuracy of revenue reports and difficulties in the royalty
collection process. In addition, occasionally we have completed agreements whereby significant
upfront license fees are reduced or limited in exchange for higher royalty rates, which should
result in future royalty revenues, but these royalty arrangements may not provide us with the
anticipated benefits as sales of products incorporating our IP may not offset lower license fees. It is difficult for us to verify royalty amounts owed to us under our licensing
arrangements, and this may cause us to lose revenues or inaccurately report
revenues. The standard terms of our license agreements require our licensees to document the manufacture and
sale of products that incorporate our technology and report this data to us on a quarterly basis.
While standard license terms give us the right to audit the books and records of our licensees to
verify this information, audits can be expensive, time consuming and potentially detrimental to our
ongoing business relationship with our licensees. Our failure to audit our licensees books and
records may result in us receiving more or less royalty revenue than we are entitled to under the
terms of our license agreements. The results of such audits could also result in an increase, as a
result of a licensees underpayment, or decrease, as a result of a licensees overpayment, to
royalty revenues. Such adjustments are recorded in the period they are determined. Any adverse
material adjustments resulting from royalty audits may cause our revenues and operating results to
be below market expectations, which could cause our stock price to decline. The royalty audit may
also trigger disagreements over contract terms with our licensees and such disagreements could
hamper customer relations, divert the efforts and attention of our management from normal
operations and impact our business operations. Products that do not meet customer specifications or contain defects that harm
our customers could damage our reputation and cause us to lose customers and
revenue. The complexity and ongoing development of our products could lead to design or manufacturing
problems. Our semiconductor IP products may fail to meet our customers technical requirements, or
may contain defects, which may cause our customers to fail to complete the design and manufacturing
of their products in a timely manner. Any of these problems may harm our customers businesses. If
any of our products fail to meet specifications or have reliability or quality problems, our
reputation could be damaged significantly and customers might be reluctant to buy our products,
which could result in a decline in net revenue, an increase in product returns and the loss of
existing customers or failure to attract new customers. These problems may adversely affect
customer relationships, as well as our business, financial condition and results of operations. Our international operations may be adversely affected by instability in the countries in which we operate. We currently have subsidiaries or branches in Armenia, India, the United Kingdom, Israel, Germany
and Japan. In addition, a significant portion of our IP is being developed in development centers
located in the Republic of 23




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Armenia and India. Israel continues to face an increased level of
violence and terror, India is experiencing rising costs and Armenia, only independent since 1991,
has suffered significant political and economic instability. Accordingly, continued and heightened
unrest in areas of the world in which we operate may adversely affect our business in a number of
ways, including the following:  
    changes in the political or economic conditions in Armenia and India
and the surrounding region, such as fluctuations in exchange rates,
changes in laws protecting IP, the imposition of currency transfer
restrictions or limitations, or the adoption of burdensome trade or
tax policies, procedures, rules, regulations or tariffs, could
adversely affect our ability to develop new products, to take
advantage of the cost savings associated with operations in Armenia
and India, and to otherwise conduct business effectively in Armenia
and India;
    our ability to continue conducting business in Israel and other
countries in the normal course may be adversely affected by increased
risk of social and political instability and our employees working and
visiting in Israel may be affected by terrorist attacks;
    our Israeli customers demand for our products may be adversely
affected because of negative economic consequences associated with
reduced levels of safety and security in Israel. Problems associated with international business operations could affect our ability to license our IP. Sales to customers located outside North America accounted for 62%, 52% and 44% of our revenues for
fiscal years ended September 30, 2004, 2003, and 2002, respectively. For the three months ended
December 31, 2004 and 2003, sales to customers located outside North America accounted for 67% and
62% of our revenues, respectively. We anticipate that sales to customers located outside North
America will increase and will continue to represent a significant portion of our total revenues in
future periods. In addition, most of our customers that do not own their own fabrication plants
rely on third-party foundries located outside of North America. Accordingly, our operations and
revenues are subject to a number of risks associated with doing business in international markets,
including the following:  
    managing foreign distributors and sales partners and sharing revenues with such third parties;
    staffing and managing foreign branch offices and subsidiaries;
    political and economic instability;
    international conflicts or other crises, such as the outbreak of Severe Acute Respiratory
Syndrome, or SARS;
    greater difficulty in collecting account receivables resulting in longer collection periods;
    foreign currency exchange fluctuations;
    changes in tax laws and tariffs;
    compliance with, and unexpected changes in, a wide variety of foreign laws and regulatory
environments with which we are not familiar;
    timing and availability of export licenses;
    inadequate protection of IP rights in some countries; and
    obtaining governmental approvals for certain technologies. If these risks actually materialize, our international operations may be adversely affected and
sales to international customers, as well as those domestic customers that use foreign fabrication
plants, may decrease. 24




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We have a long and unpredictable sales cycle, which can result in uncertainty
and delays in generating additional revenues. Historically, because of the complexity of our products, it can take a significant amount of time
and effort to explain the benefits of our products and to negotiate a sale. For example, it
generally takes at least three to nine months after our first contact with a prospective customer
before we start licensing our IP to that customer. In addition, purchase of our products is usually
made in connection with new design starts, the timing of which are out of our control. Accordingly,
we may be unable to predict accurately the timing of any significant future sales of our products.
We may also spend substantial time and management attention on potential license agreements that
are not consummated, thereby foregoing other opportunities. We rely on a small number of customers for a substantial portion of our
revenues and our accounts receivables are concentrated among a small number of
customers. We have been dependent on a limited number of customers for a substantial portion of our annual
revenues in each fiscal year, although the customers comprising this group have changed from time
to time. No single customer generated more than 10% of our revenues for the quarters ended December
31, 2004 and 2003. Since fiscal year 2001, our five largest customers have represented between
25-45% of our revenues. The license agreements we enter into with our customers do not obligate
them to license future generations of our IP and, as a result, we cannot predict if and when they
will purchase additional products from us. As a result of this customer concentration, we could
experience a dramatic reduction in our revenues if we lose one or more of our significant customers
and are unable to replace them. In addition, since our accounts receivable are concentrated in a
relatively small number of customers, a significant change in the liquidity, financial position, or
issues regarding timing of payments of any one of these customers could have a material adverse
impact on the collectability of our accounts receivable, historical revenues recorded and our
future operating results. We may have difficulty sustaining profitability and may experience additional losses in the future. Although we recorded net income of $1.7 million for the quarter ended December 31, 2004, and $1.9
million for fiscal year 2004, we suffered five consecutive quarters of net losses in fiscal 2003
and the first quarter of 2004. The losses recorded in these periods were due principally to fewer
project design starts by fabless semiconductor customers on the 0.13 micron technology and the
slow-down in industry adoption of the 90-nanometer process technology. In order to maintain and
improve our profitability, we will need to continue to generate new sales while controlling our
costs. As we plan on continuing the growth of our business while implementing cost control
measures, we may not be able to successfully generate enough revenues to remain profitable with
this growth. Any failure to increase our revenues and control costs as we pursue our planned growth
would harm our profitability and would likely negatively affect the market price of our stock. In
addition, if we incurred losses for a sustained period we may be prevented from being able to fully
utilize our deferred tax asset which will result in the need for a valuation allowance to be
recorded. We may be unable to deliver our customized memory, logic and I/O products in
the time-frame demanded by our customers, which could damage our reputation and
future sales. A portion of our contracts require us to provide customized products to our customers within a
specified delivery timetable. While we have experienced delays in delivering products to our
customers, we believe the durations of these delays were sufficiently short in length so as to not
materially damage our relationship with our customers. Furthermore, these delays did not result in
a material impact on our operations. However, any failure to meet significant customer milestones
could damage our reputation in our industry and harm our ability to attract new customers. We may be unable to attract and retain key personnel who are critical to the success of our business. We believe our future success depends on our ability to attract and retain engineers and other
highly skilled personnel and senior managers. In addition, in order to grow our business we must
increase our sales force, both domestic and international, with qualified employees. Hiring
qualified technical, sales and management personnel is difficult due to a limited number of
qualified professionals and competition in our industry for these types of employees. We have in
the past experienced delays and difficulties in recruiting and retaining qualified technical and
sales personnel and believe that at times our employees are recruited aggressively by our
competitors and start-up companies. Our employees are at will and may leave our employment at any
time, and under certain 25




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circumstances, start-up companies can offer more attractive stock option
packages than we offer. As a result, we may experience significant employee turnover. Failure to
attract and retain personnel, particularly sales and technical personnel would make it difficult
for us to develop and market our technologies. In addition, our business and operations are substantially dependent on the performance of our key
personnel, including Adam A. Kablanian, our President and Chief Executive Officer, and Alexander
Shubat, our Vice President of Research and Development and Chief Technical Officer. We do not have
formal employment agreements with Mr. Kablanian or Dr. Shubat and do not maintain key person life
insurance policies on their lives. If Mr. Kablanian or Dr. Shubat were to leave or become unable to
perform services for our company, our business could be severely harmed. We may need additional capital that may not be available to us and, if raised,
may dilute our stockholders ownership interest in us. We may need to raise additional funds to develop or enhance our technologies, to fund expansion, to
respond to competitive pressures or to acquire complementary products, businesses or technologies.
Additional financing may not be available on terms that are acceptable to us. If we raise
additional funds through the issuance of equity or convertible debt securities, the percentage
ownership of our stockholders would be reduced and these securities might have rights, preferences
and privileges senior to those of our current stockholders. If adequate funds are not available on
acceptable terms, our ability to fund our expansion, take advantage of unanticipated opportunities,
develop or enhance our products or services, or otherwise respond to competitive pressures would be
significantly limited. If we are unable to effectively manage our growth, our business may be harmed. Our future success depends on our ability to successfully manage our growth. Our ability to manage
our business successfully in a rapidly evolving market requires an effective planning and
management process. Our customers rely heavily on our technological expertise in designing and
testing our products. Relationships with new customers may require significant engineering
resources. As a result, any increase in the demand for our products will increase the strain on our
personnel, particularly our engineers. Our historical growth, international expansion, and our strategy of being a provider of
semiconductor IP platforms, have placed, and are expected to continue to place, a significant
strain on our managerial and financial resources as well as our financial and management controls,
reporting systems and procedures. Although some new controls, systems and procedures have been
implemented, our future growth, if any, will depend on our ability to continue to implement and
improve operational, financial and management information and control systems on a timely basis,
together with maintaining effective cost controls. Our inability to manage any future growth
effectively would be harmful to our revenues and profitability. Any acquisitions we make may not provide us the expected benefits and could
disrupt our business and harm our financial condition. We acquired In-Chip Systems, Inc. in May 2002, and we may continue to acquire businesses or
technologies that we believe are a strategic fit with our business. The In-Chip acquisition as well
as other future acquisitions may result in unforeseen operating difficulties and expenditures and
may absorb significant management attention that would otherwise be available for ongoing
development of our business. In addition, the integration of acquisition targets may prove to be
more difficult than expected, and we may be unsuccessful in maintaining and developing relations
with the employees, customers and business partners of In-Chip and other acquisition targets. Since
we will not be able to accurately predict these difficulties and expenditures, it is possible that
these costs may outweigh the value
we realize from a future acquisition. Future acquisitions could result in issuances of equity
securities that would reduce our stockholders ownership interest, the incurrence of debt,
contingent liabilities, deferred stock based compensation or expenses related to the valuation of
goodwill or other intangible assets and the incurrence of large, immediate write-offs. 26




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Risks Related to Our Industry If demand for products incorporating complex semiconductors and semiconductor
IP platforms does not increase, our business may be harmed. Our business and the adoption and continued use of our IP by semiconductor companies depends on
continued demand for products requiring complex semiconductors, embedded memories and logic
elements, such as cellular and digital phones, pagers, PDAs, digital cameras, DVD players, switches
and modems. The demand for such products is uncertain and difficult to predict, and it depends on
factors beyond our control such as the competition faced by each customer, market acceptance of
products that incorporate our IP and the financial and other resources of each customer. A
reduction in the demand for products incorporating complex semiconductors and semiconductor IP or a
decline in the general economic environment which results in the cutback of research and
development budgets or capital expenditures would likely result in a reduction in demand for our
products and could harm our business. In addition, with increasing complexity in each successive
generation of semiconductors, we face the risk that the rate of adoption of smaller technology
processes may slow. In addition, the semiconductor industry is highly cyclical and has fluctuated between significant
economic downturns characterized by diminished demand, erosion of average selling prices and
production overcapacity, as well as periods of increased demand and production capacity
constraints. Until recently, the semiconductor industry has experienced a downturn during a
significant economic slowdown, resulting in lower levels of technology expenditures by the ultimate
users of technology products. As a result of such fluctuations in the semiconductor industry and
the general economic slowdown, we may face a reduced number of design starts, tightening of
customers operating budgets, extensions of the approval process for new orders and projects and
consolidation among our customers, all of which may harm the demand for our products and may cause
us to experience substantial period-to-period fluctuations in our operating results. Further, the
markets for third-party semiconductor IP have emerged only in recent years. Because of the recent
emergence of these markets, it is difficult to forecast whether these markets will continue to
develop or grow at a rate sufficient to support our business. The market for semiconductor IP platforms is highly competitive, and we may
lose market share to larger competitors with greater resources and to companies
that develop their semiconductor IP platforms using internal design teams. We face competition from both existing suppliers of third-party semiconductor IP as well as new
suppliers that may enter the market. We also compete with the internal design teams of large,
integrated device manufacturers. Many of these internal design teams have substantial programming
and design resources and are part of larger organizations with substantial financial and marketing
resources. These internal teams may develop technologies that compete directly with our
technologies or may actively seek to license their own technologies to third parties, which could
negatively affect our revenue and operating results. Many of our existing competitors have longer operating histories, greater brand recognition and
larger customer bases, as well as greater financial and marketing resources, than we do. This may
allow them to respond more quickly than we can to new or emerging technologies and changes in
customer requirements. It may also allow them to devote greater resources than we can to the
development and promotion of their products. In addition, the intense competition in the market for
semiconductor IP could result in pricing pressures, reduced license revenues, reduced margins or
lost market share, any of which could harm our operating results and cause our stock price to
decline. The technology used in the semiconductor industry is rapidly changing and if we
are unable to develop new technologies and adapt our existing IP to new
processes, we will be unable to attract or retain customers. The semiconductor industry has been characterized by an increasingly rapid rate of development of
new technologies and manufacturing processes, rapid changes in customer requirements, frequent
product introductions and ongoing demands for greater speed and functionality. Our future success
depends on our ability to develop new technologies and introduce new products to the marketplace in
a timely manner, and to adapt our existing IP to satisfy the requirements of new processes and our
customers. If our development efforts are not successful or are significantly delayed, or if the
enhancements or new generations of our products do not achieve market acceptance, we may be unable
to attract or retain customers and our operating results could be harmed. 27




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Our ability to continue developing technical innovations involves several risks, including:  
    our ability to anticipate and respond in a timely manner to changes in
the requirements of semiconductor companies;
    the emergence of new semiconductor manufacturing processes and our
ability to enter into strategic relationships with third-party
semiconductor foundries to develop and test technologies for these new
processes and provide customer referrals;
    the significant research and development investment that we may be
required to make before market acceptance, if any, of a particular
technology;
    the possibility that the industry may not accept a new technology or
may delay use of a new technology after we have invested a significant
amount of resources to develop it; and
    new technologies introduced by our competitors. If we are unable to adequately address these risks, our IP will become obsolete and we will be
unable to sell our products. Further, as new technologies or manufacturing processes are announced,
customers may defer licensing our IP until those new technologies become available or our IP has
been adopted for that manufacturing process. In addition, research and development requires a
significant expense and resource commitment. Since we have a limited operating history, we are
unable to predict our future resource requirements. As a result, we may not have the financial and
other resources necessary to develop the technologies demanded in the future and may be unable to
attract or retain customers. General economic conditions and future terrorist attacks may reduce our revenues and harm our business. As our business has grown, we have become increasingly subject to the risks arising from adverse
changes in domestic and global economic conditions. As a result of the recent economic slowdown in
the United States and in other parts of the world, many industries are still delaying or reducing
technology purchases and investments and similarly, our customers may delay payment for our
products causing our accounts receivable to increase. In addition, continued unrest in Israel and
the Middle East may negatively impact the investments that our worldwide customers make in these
geographic regions. The impact of this slowdown on us is difficult to predict, but if businesses or
consumers defer or cancel purchases of new products that contain complex semiconductors, purchases
by fabless semiconductor companies and integrated device manufacturers and production levels by
semiconductor manufacturers could decline, causing our revenues to be adversely affected, which
would have an adverse effect on our results of operations and could have an adverse effect on our
financial condition. Risk Related to Our Intellectual Property Rights If we are not able to protect our IP adequately, we will have less proprietary
technology to license, which will reduce our revenues and profits. Our patents, copyrights, trademarks, trade secrets and other IP are critical to our success. We
rely on a combination of patent, trademark, copyright, mask work and trade secret laws to protect
our proprietary rights. We cannot be sure that the U.S. Patent and Trademark Office will issue
patents or trademark registrations for any of our pending applications. Further, any patents or
trademark rights that we hold or may hold in the future may be challenged, invalidated or
circumvented or may not be of sufficient scope or strength to provide meaningful protection or any
commercial advantage to us. We have not attempted to secure patent protection in foreign countries,
and the laws of some foreign countries may not adequately protect our IP as well as the laws of the
United States. Also, the portion of our IP developed outside of the United States may not receive
the same copyright protection that it would receive if it was developed in the United States. As we
increase our international presence, we expect that it will become more difficult to monitor the
development of competing technologies that may infringe on our rights as well as unauthorized use
of our technologies. We use licensing agreements, confidentiality agreements and employee nondisclosure and assignment
agreements to limit access to and distribution of our proprietary information and to obtain
ownership of technology prepared on a 28




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work-for-hire basis. We cannot be sure that we have taken
adequate steps to protect our IP rights and deter misappropriation of these rights or that we will
be able to detect unauthorized uses and take immediate or effective steps to enforce our rights.
Since we also rely on unpatented trade secrets to protect some of our proprietary technology, we
cannot be certain that others will not independently develop or otherwise acquire the same or
substantially equivalent technologies or otherwise gain access to our proprietary technology or
disclose that technology. We also cannot be sure that we can ultimately protect our rights to our
unpatented proprietary technology. In addition, third parties might obtain patent rights to such
unpatented trade secrets, which they could use to assert infringement claims against us. Third parties may claim we are infringing or assisting others to infringe their
IP rights, and we could suffer significant litigation or licensing expenses or
be prevented from licensing our technology. While we do not believe that our technology or the conduct of our business infringes the valid IP
rights of third parties, we may be unaware of IP rights of others that may cover some of our
technology. As a result, third parties may claim we or our customers are infringing their IP
rights. Our license agreements typically require us to indemnify our customers for infringement
actions related to our technology. Any litigation regarding patents or other IP could be costly and time-consuming, and divert our
management and key personnel from our business operations. The complexity of the technology
involved makes any outcome uncertain. If we do not prevail in any infringement action, we may be
required to pay significant damages and may be prevented from developing some of our technology or
from licensing some of our IP for certain manufacturing processes unless we enter into a royalty or
license agreement. In addition, if challenging a claim is not feasible, we might be required to
enter into royalty or license agreements in order to settle a claim and continue to license or
develop our IP, which may result in significant expenditures. We may not be able to obtain such
agreements on terms acceptable to us or at all, and thus, may be prevented from licensing or
developing our technology. Risks Related to Our Stock Our stock price may be volatile and could decline substantially. The market price of our common stock has fluctuated significantly in the past, will likely continue
to fluctuate in the future and may decline. Fluctuations or a decline in our stock price may occur
regardless of our performance. Among the factors that could affect our stock price, in addition to
our performance, are:  
    variations between our operating results and the published expectations of securities analysts;
    changes in financial estimates or investment recommendations by securities analysts following
our business;
    announcements by us or our competitors of significant contracts, new products or services,
acquisitions, or other significant transactions;
    sale of our common stock or other securities in the future;
    the inclusion or exclusion of our stock in various indices or investment categories,
especially as compared to the investment profiles of our stockholders at a given time;
    changes in economic and capital market conditions;
    changes in business regulatory conditions; and
    the trading volume of our common stock. Compliance with Internal Control Attestation Effective internal controls are necessary for us to provide reliable financial reports and
effectively prevent fraud. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we will be
required, beginning with the current fiscal year to include in our annual report our assessment of
the effectiveness of our internal control over financial 29




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reporting and our audited financial statements as of the end of fiscal 2005. Furthermore, our independent registered public accounting
firm will be required to attest to whether our assessment of the effectiveness of our internal
control over financial reporting is fairly stated in all material respects and separately report on
whether it believes we maintained, in all material respects, effective internal control over
financial reporting as of September 30, 2005. We have not yet completed our assessment of the
effectiveness of our internal controls. If we fail to timely complete this assessment, or if our
independent registered public accounting firm cannot attest to our assessment, we could be subject
to regulatory sanctions and a loss of public confidence in our internal controls. In addition, any
failure to implement required new or improved controls, or difficulties encountered in their
implementation, could harm our operating results or cause us to fail to timely meet our regulatory
reporting obligations. Any of these failures could have a negative effect on the trading price of
our stock. Recording compensation expense in connection with stock option grants may cause our profitability
to be reduced significantly. The Financial Accounting Standards Board (FASB) has recently issued an accounting standard, SFAS
123(R), that will require the fair value of all equity-based awards granted to employees be
recognized in the income statement as compensation expense starting in fiscal period that begins
after June 15, 2005. The various methods for determining the fair value of stock options are based
on, among other things, the volatility of the underlying stock. Our stock price has historically
been volatile. Therefore, the adoption of an accounting standard requiring companies to expense
stock options could negatively affect our profitability and may adversely affect our stock price.
Such adoption could also limit our ability to continue to use stock options as an incentive and
retention tool, which could, in turn, hurt our ability to recruit employees and retain existing
employees. Changes to accounting standards and rules could either delay our recognition of
revenues or reduce the amount of revenues that we may recognize at a specific
time, and thus defer or reduce our profitability. These effects on our reported
results could cause our stock price to be lower than it otherwise might have
been. We adopted the American Institute of Certified Public Accountants Statement of Position, or SOP,
97-2, Software Revenue Recognition, as of October 1, 1998. In December 1998, the American
Institute of Certified Public Accountants issued SOP 98-9, Modification of SOP 97-2, Software
Revenue Recognition, with Respect to Certain Transactions. We implemented these provisions as of
October 1, 1999. In December 1999, the Securities and Exchange Commission issued SEC Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements which summarizes certain
of the SECs views in applying generally accepted accounting principles to revenue recognition in
financial statements. Additional accounting guidance or pronouncements in the future could affect
the timing of our revenue recognition in the future, which could cause our operating results to
fail to meet the expectations of investors and securities analysts. In addition, changes to
accounting policies that affect other aspects of our business may adversely affect our reported
financial results. Our certificate of incorporation and bylaws as well as Delaware law contain
provisions that could discourage transactions resulting in a change in control,
which may negatively affect the market price of our common stock. Our certificate of incorporation, our bylaws and Delaware law contain provisions that might enable
our management to discourage, delay or prevent change in control. In addition, these provisions
could limit the price that investors would be willing to pay in the future for shares of our common
stock. These provisions include:  
    our board of directors is authorized, without prior stockholder approval, to create and issue preferred
stock, commonly referred to as blank check preferred stock, with rights senior to those of common
stock;
    our board of directors is staggered into 3 classes, only one of which is elected at each annual meeting;
    stockholder action by written consent is prohibited;
    nominations for election to our board of directors and the submission of matters to be acted upon by
stockholders at a meeting are subject to advance notice requirements;
    certain provisions in our bylaws and certificate may only be amended with the approval of stockholders
holding 80% of our outstanding voting stock; 30




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
    the ability of our stockholders to call special meetings of stockholders is prohibited; and
    our board of directors is expressly authorized to make, alter or repeal our bylaws. We are also subject to Section 203 of the Delaware General Corporation Law, which provides, subject
to enumerated exceptions, that if a person acquires 15% or more of our outstanding voting stock,
the person is an interested stockholder and may not engage in any business combination with us
for a period of three years from the time the person acquired 15% or more of our outstanding voting
stock. Compliance with changing regulation of corporate governance and public
disclosure may result in additional expenses. Changing laws, regulations and standards relating to corporate governance and public disclosure,
including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ National Market rules, are
creating uncertainty for companies such as ours. These new or changed laws, regulations and
standards are subject to varying interpretations in many cases due to their lack of specificity,
and as a result, their application in practice may evolve over time as new guidance is provided by
regulatory and governing bodies, which could result in continuing uncertainty regarding compliance
matters and higher costs necessitated by ongoing revisions to disclosure and governance practices.
We are committed to maintaining high standards of corporate governance and public disclosure. As a
result, we intend to invest resources to comply with evolving laws, regulations and standards, and
this investment may result in increased general and administrative expenses and a diversion of
management time and attention from revenue-generating activities to compliance activities. If our
efforts to comply with new or changed laws, regulations and standards differ from the activities
intended by regulatory or governing bodies due to ambiguities related to practice, our reputation
may be harmed. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS Our core business, the sale of semiconductor IP for the design and manufacture of system-on-a-chip
integrated circuits, has limited exposure to financial market risks, including changes in foreign
currency exchange rates and interest rates. A significant portion of our customers are located in
Asia, Canada and Europe. However, to date, our exposure to foreign currency exchange fluctuations
has been minimal because all of our license agreements provide for payment in U.S. dollars. Our international business is subject to risks typical of an international business, including, but
not limited to differing economic conditions, changes in political climate, differing tax
structures, other regulations and restrictions and foreign exchange rate volatility. Our foreign
subsidiaries incur most of their expenses in the local currency. To date the expenses denominated
in foreign currencies have not been material, therefore, we do not anticipate our future results to
be materially adversely impacted by changes in these factors. We maintain an investment portfolio of various issuers, types and maturities. These securities are
generally classified as available-for-sale and, consequently, are recorded on the balance sheet at
fair value with unrealized gains or losses reported as a separate component of stockholders
equity. Our investments primarily consist of short-term money market mutual funds, United States
government obligations and mortgage-backed securities and commercial paper. Our investments balance
of $27.7 million at December 31, 2004 consists of instruments with original maturities of less than
one year. Due to the short-term nature of these investments, we do not believe our investment
balance is materially exposed to interest rate risk. We also hold approximately $7.6 million in
U.S. government obligations with maturities up to two years. 
 ITEM 4. CONTROLS AND PROCEDURES An evaluation was performed under the supervision and with the participation of our management,
including the President and Chief Executive Officer along with the Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and procedures as of the end
of the period covered by this quarterly report. Based on that evaluation, the Companys management,
including the President and Chief Executive Officer along 31




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with the Chief Financial Officer, concluded that the Companys disclosure controls and procedures were effective. Except as noted
below, there have been no significant changes in the Companys internal controls during the period
covered by this quarterly report or in other factors that have materially affected or could
materially affect internal controls. We intend to review and evaluate the design and effectiveness
of our disclosure controls and procedures on an ongoing basis and to improve our controls and
procedures over time and to correct any deficiencies that we may discover in the future. Our goal
is to ensure that our senior management has timely access to all material financial and
non-financial information concerning our business. While we believe the present design of our
disclosure controls and procedures is effective to achieve our goal, future events affecting our
business may cause us to significantly modify our disclosure controls and procedures. Effective October 2004, the Company changed the enterprise resource planning (ERP) system that it
uses in its daily operations. It converted its database and operational processing systems to the
Softrax Operations and Financial Suite. In addition to providing the same information that the
previous system provided, the Company believes that the new ERP system will improve its operational
efficiency, automate its information process and expand its software revenue recognition, deferred
revenue tracking and backlog tracking capabilities. Additionally, the new ERP system should allow
the Company to retain control and integrity of its information systems as it grows in the future.
Although the transition has proceeded to date without material adverse effects, the possibility
exists that the migration to the new ERP information system could adversely affect the Companys
internal controls over financial reporting, the disclosure controls and procedures or the
operations in future periods. The process of implementing a new information system could adversely
impact the Companys ability to do the following in a timely manner: accept and process customer
orders, ship products, invoice and collect receivables, place purchase orders and pay invoices, and
all other business transactions. There were no other significant changes in the Companys internal
controls or, to the knowledge of management of the Company, in other factors that could materially
affect internal controls over financial reporting that occurred during the Companys first quarter
of fiscal 2005. 32




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PART II  OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS None. 
 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS None. 
 ITEM 5. OTHER INFORMATION None. 
 ITEM 6. EXHIBITS Exhibit
No.
    
    Exhibits10.20
    
    
    Virage Logic Corporation FY 2005 Bonus Plan31.1
    
    
    Certification Pursuant to Rule 15d-14 of the Securities and
Exchange Act as amended, as Pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2
    
    
    Certification Pursuant to Rule 15d-14 of the Securities and
Exchange Act as amended, as Pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1
    
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 33




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: February 9, 2005
    
    VIRAGE LOGIC CORPORATION/s/ Adam KablanianADAM A. KABLANIANPresident and Chief Executive Officer/s/ Michael E. SeifertMICHAEL E. SEIFERTVice President, Finance and Chief Financial Officer(Principal Financial and Accounting Officer)
 34




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EXHIBIT INDEX 10.20
    
    
    Virage Logic Corporation FY 2005 Bonus Plan31.1
    
    
    Certification Pursuant to Rule 15d-14 of the Securities and Exchange
Act as amended, as Pursuant to Section 302 of the Sarbanes-Oxley Act f 200231.2
    
    
    Certification Pursuant to Rule 15d-14 of the Securities and Exchange
Act as amended, as Pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 35