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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q (Mark One) [X]
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the period ending June 30, 2004
 OR [  ]
    
    Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
 Commission file number 000-31089 VIRAGE LOGIC CORPORATION  Delaware
(State or other jurisdiction of
incorporation or organization)
    
    77-0416232
(IRS Employer Identification No.)
 47100 Bayside Parkway
Fremont, California 94538
(Address of principal executive offices) (510) 360-8000
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [  ] Indicate by a check whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). Yes [X] No [  ] As of July 31, 2004 there were 21,482,331 shares of the Registrants Common
Stock outstanding.




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##### Table of Contents



VIRAGE LOGIC CORPORATION FORM 10-Q INDEX  
 PagePART I - Financial InformationITEM 1 - Financial StatementsUnaudited Condensed Consolidated Balance Sheets as of June 30, 2004 and September 30, 2003
    
    
    3Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2004 and 2003
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2004 and 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 Risk
    
    
    35ITEM 4  Controls and Procedures
    
    
    36PART II - Other InformationITEM 1  Legal Proceedings
    
    
    37ITEM 2  Changes in Securities and Use of Proceeds
    
    
    37ITEM 3  Defaults upon Senior Securities
    
    
    37ITEM 4  Submission of Matters to a Vote of Security Holders
    
    
    37ITEM 5  Other Information
    
    
    37ITEM 6  Exhibits and Reports on Form 8-K
    
    
    37Signatures
    
    
    38EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 2




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VIRAGE LOGIC CORPORATION 
   June 30,
    
    September 30,2004
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    42,961
    
    
    $
    38,930Short-term investments
    
    
    9,610
    
    
    
    16,085Accounts receivable, net of allowance of $605 in 2004
and $738 in 2003
    
    
    13,718
    
    
    
    10,499Costs in excess of related billings on uncompleted
contracts
    
    
    743
    
    
    
    619Prepaid expenses and other
    
    
    3,829
    
    
    
    3,820Taxes receivable
    
    
    1,911
    
    
    
    Total current assets
    
    
    72,772
    
    
    
    69,953Long-term investments
    
    
    10,600
    
    
    
    4,095Property, leasehold improvements and equipment, net
    
    
    4,535
    
    
    
    6,250Goodwill, net
    
    
    9,782
    
    
    
    9,782Other intangible assets, net
    
    
    2,858
    
    
    
    3,148Deferred tax assets
    
    
    2,942
    
    
    
    2,942Other long-term assets
    
    
    399
    
    
    
    392Total assets
    
    $
    103,888
    
    
    $
    96,562LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    937
    
    
    $
    807Accrued expenses
    
    
    5,208
    
    
    
    3,771Deferred revenue
    
    
    5,904
    
    
    
    2,613Income taxes payable
    
    
    1,390
    
    
    
    309Total current liabilities
    
    
    13,439
    
    
    
    7,500Deferred tax liabilities
    
    
    1,189
    
    
    
    1,189Merger-related liability
    
    
    
    
    
    
    500Total liabilities
    
    
    14,628
    
    
    
    9,189Stockholders equity:Common stock, $.001 par value:Authorized shares  150,000 at June 30, 2004
and September 30, 2003,Issued and outstanding shares  21,473 and 21,200 at
June 30, 2004 and September 30, 2003, respectively
    
    
    21
    
    
    
    21Additional paid-in capital
    
    
    111,746
    
    
    
    110,330Accumulated other comprehensive income
    
    
    (58
    )
    
    
    2Deferred stock-based compensation
    
    
    
    
    
    
    (130
    )Accumulated deficit
    
    
    (22,449
    )
    
    
    (22,850
    )Total stockholders equity
    
    
    89,260
    
    
    
    87,373Total liabilities and stockholders equity
    
    $
    103,888
    
    
    $
    96,562
 See accompanying notes to unaudited condensed consolidated financial statements. 3




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VIRAGE LOGIC CORPORATION 
   Three Months Ended
    
    Nine Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenue:License
    
    $
    11,933
    
    
    $
    8,467
    
    
    $
    32,619
    
    
    $
    28,563Royalties
    
    
    1,919
    
    
    
    1,097
    
    
    
    5,070
    
    
    
    2,191Total revenues
    
    
    13,852
    
    
    
    9,564
    
    
    
    37,689
    
    
    
    30,754Cost and expenses:Cost of revenues (exclusive of amortization of
deferred stock compensation of $7, $27,
$29 and $245, respectively)
    
    
    2,872
    
    
    
    2,224
    
    
    
    8,175
    
    
    
    7,114Research and development (exclusive of
amortization of deferred stock compensation
of $12, $56, $49 and $479, respectively)
    
    
    4,645
    
    
    
    4,678
    
    
    
    13,697
    
    
    
    14,328Sales and marketing (exclusive of
amortization of deferred stock compensation
of $9, $40, $37 and $306, respectively)
    
    
    3,869
    
    
    
    3,344
    
    
    
    10,831
    
    
    
    9,357General and administrative (exclusive of
amortization of deferred stock compensation
of $4, $14, $16 and $123, respectively)
    
    
    1,759
    
    
    
    1,135
    
    
    
    4,840
    
    
    
    3,629Stock-based compensation
    
    
    32
    
    
    
    137
    
    
    
    131
    
    
    
    1,153Total cost and expenses
    
    
    13,177
    
    
    
    11,518
    
    
    
    37,674
    
    
    
    35,581Operating income (loss)
    
    
    675
    
    
    
    (1,954
    )
    
    
    15
    
    
    
    (4,827
    )Interest income and other expense, net
    
    
    164
    
    
    
    145
    
    
    
    468
    
    
    
    533Income (loss) before taxes
    
    
    839
    
    
    
    (1,809
    )
    
    
    483
    
    
    
    (4,294
    )Income tax provision (benefit)
    
    
    268
    
    
    
    (596
    )
    
    
    82
    
    
    
    (1,131
    )Net income (loss)
    
    $
    571
    
    
    $
    (1,213
    )
    
    $
    401
    
    
    $
    (3,163
    )Basic net income (loss) per share
    
    $
    0.03
    
    
    $
    (0.06
    )
    
    $
    0.02
    
    
    $
    (0.15
    )Diluted net income (loss) per share
    
    $
    0.03
    
    
    $
    (0.06
    )
    
    $
    0.02
    
    
    $
    (0.15
    )Shares used in computing per share amounts:Basic
    
    
    21,479
    
    
    
    20,822
    
    
    
    21,346
    
    
    
    20,742Diluted
    
    
    21,874
    
    
    
    20,822
    
    
    
    21,996
    
    
    
    20,742
 See accompanying notes to unaudited condensed consolidated financial statements. 4




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VIRAGE LOGIC CORPORATION 
   Nine Months EndedJune 30,2004
    
    2003Operating activitiesNet income (loss)
    
    $
    401
    
    
    $
    (3,163
    )Adjustments to reconcile net income (loss) to net cash
provided by operating activities:Provision for doubtful accounts
    
    
    30
    
    
    
    29Depreciation and amortization
    
    
    2,457
    
    
    
    2,607Amortization of intangible assets
    
    
    290
    
    
    
    289Amortization of stock-based compensation
    
    
    131
    
    
    
    1,153Changes in operating assets and liabilities:Accounts receivable
    
    
    (3,249
    )
    
    
    3,278Costs in excess of related billings on uncompleted contracts
    
    
    (124
    )
    
    
    209Prepaid expenses and other
    
    
    (9
    )
    
    
    (592
    )Taxes receivable
    
    
    (1,911
    )
    
    
    (925
    )Other assets
    
    
    (7
    )
    
    
    23Accounts payable
    
    
    130
    
    
    
    (230
    )Accrued expenses
    
    
    1,437
    
    
    
    (141
    )Deferred revenue
    
    
    3,291
    
    
    
    (386
    )Income taxes payable
    
    
    1,081
    
    
    
    (2,049
    )Net cash provided by operating activities
    
    
    3,948
    
    
    
    102Investing activitiesPurchase of property and equipment
    
    
    (742
    )
    
    
    (3,319
    )Purchase of investments
    
    
    (17,267
    )
    
    
    (24,016
    )Proceeds from maturities of investments
    
    
    17,177
    
    
    
    32,945Payment of merger-related liability
    
    
    (500
    )
    
    
    (500
    )Net cash provided by (used in) investing activities
    
    
    (1,332
    )
    
    
    5,110Financing activitiesNet proceeds from issuance of stock
    
    
    1,415
    
    
    
    846Payments on capital lease obligations
    
    
    
    
    
    
    (81
    )Net cash provided by financing activities
    
    
    1,415
    
    
    
    765Net increase in cash and cash equivalents
    
    
    4,031
    
    
    
    5,977Cash and cash equivalents at beginning of period
    
    
    38,930
    
    
    
    35,422Cash and cash equivalents at end of the period
    
    $
    42,961
    
    
    $
    41,399
 See accompanying notes to unaudited condensed consolidated financial statements. 5




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VIRAGE LOGIC CORPORATION 
   Note 1. Organization and Summary of Significant Policies 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 are used in a variety of electronic products including
high-speed communications, computer and consumer products, such as cellular and
digital phones, pagers, PDAs, digital cameras, DVD players, switches and
modems. Principles of Consolidation The accompanying condensed consolidated financial statements include the
accounts of Virage Logic Corporation and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation. 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. Unaudited Interim Financial Statements The accompanying condensed consolidated financial statements as of June
30, 2004, and for the three and nine months ended June 30, 2004 and 2003, are
unaudited. The unaudited condensed consolidated financial statements have been
prepared on the same basis as the annual consolidated financial statements and,
in the opinion of management, reflect all adjustments, which include only
normal recurring adjustments, necessary to present fairly our financial
position, as of June 30, 2004 our results of operations for the three and nine
months ended June 30, 2004 and 2003, and cash flows for the nine months ended
June 30, 2004 and 2003, respectively. These condensed consolidated financial
statements and related notes should be read in conjunction with our audited
consolidated financial statements and related notes included in our 2003 Annual
Report on Form 10-K as filed with the Securities and Exchange Commission. Our
balance sheet as of September 30, 2003, was derived from audited financial
statements but does not include all disclosures required for annual reporting.
Our results for the three and nine months ended June 30, 2004 are not
necessarily indicative of the expected results for any other interim period or
for the year ending September 30, 2004. 6




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Revenue Recognition Our revenue recognition policy follows specific and detailed guidelines
and 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, Statement of Position 98-9 and Statement of
Position 81-1. 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, there are no significant remaining
obligations on our part, 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, logic libraries and I/Os may involve
customization to the functionality of the software, therefore revenues from
such licenses are recognized over the period that we perform the services.
Generally our contracts are established as fixed fee arrangements. Revenue
derived from custom products 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 and estimates of efforts required to complete each
project. These estimates are based on the amount of work we require, and we
believe we are able to reasonably and reliably estimate the costs to complete
projects accounted for using the percentage-of-completion method. However, use
of different assumptions under the percentage-of-completion method could affect
our revenues and the timing of recognizing certain revenues. Alternatively,
for customers transactions for which we can not 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 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 in-process contracts. If customer
acceptance is required for completion of specified milestones, the related
revenue is deferred until the acceptance criteria is 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 maintenance, it is determined
based on the stated renewal rate in each contract. Maintenance revenues are
recognized ratably over the contractual term of the maintenance period, which
is generally one year. 7




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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. From time to time, we may exercise our audit rights under our
contracts with customers to audit our licensees royalty records. The results
of such royalty audits could result in an increase, as a result of a licensees
underpayment, or decrease, as a result of a licensees overpayment, to royalty
revenues. Such adjustments are recorded in the period they are determined. 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 Opinion No. 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 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 148). Under APB Opinion No. 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. 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 123
(in thousands, except per share data): Three Months Ended
    
    Nine Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    571
    
    
    $
    (1,213
    )
    
    $
    401
    
    
    $
    (3,163
    )Add: Stock-based compensation
expense included in reported
net income(loss), net of tax
    
    
    21
    
    
    
    90
    
    
    
    86
    
    
    
    761Deduct: Total stock-based
compensation expense
determined under fair value
based method for all awards,
net of tax
    
    
    (1,472
    )
    
    
    (1,582
    )
    
    
    (4,254
    )
    
    
    (5,024
    )Proforma net loss
    
    
    (880
    )
    
    
    (2,705
    )
    
    
    (3,767
    )
    
    
    (7,426
    )Shares used in computing Pro
forma per share amounts:Basic
    
    
    21,479
    
    
    
    20,822
    
    
    
    21,346
    
    
    
    20,742Diluted
    
    
    21,479
    
    
    
    20,822
    
    
    
    21,346
    
    
    
    20,742Net loss per
share  Pro formaBasic and diluted
    
    $
    (0.04
    )
    
    $
    (0.13
    )
    
    $
    (0.18
    )
    
    $
    (0.36
    )
 8




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The SFAS 123 adjusted impact of options on the net income (loss) for the
three and nine months ended June 30, 2004 and 2003 is 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 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. 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 Ended
    
    Nine Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    571
    
    
    $
    (1,213
    )
    
    $
    401
    
    
    $
    (3,163
    )Weighted average shares of common stock
outstanding
    
    
    21,482
    
    
    
    20,992
    
    
    
    21,381
    
    
    
    20,976Less weighted average shares subject to
repurchase
    
    
    (3
    )
    
    
    (170
    )
    
    
    (35
    )
    
    
    (234
    )Shares used in computing basic net
income (loss) per share
    
    
    21,479
    
    
    
    20,822
    
    
    
    21,346
    
    
    
    20,742Items net of treasury stock buyback:Employee stock options
    
    
    395
    
    
    
    
    
    
    
    640
    
    
    
    Employee stock purchase plan
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    Shares used in computing diluted net
income per share
    
    
    21,874
    
    
    
    20,822
    
    
    
    21,996
    
    
    
    20,742Net income (loss) per share:Basic
    
    $
    0.03
    
    
    $
    (0.06
    )
    
    $
    0.02
    
    
    $
    (0.15
    )Diluted
    
    $
    0.03
    
    
    $
    (0.06
    )
    
    $
    0.02
    
    
    $
    (0.15
    )
 Potentially dilutive shares are excluded from the calculation of diluted
net loss per share because they are antidilutive. For the three months ended
June 30, 2004 and 2003, potential common shares that were excluded from the net
income (loss) per share computations as their effect would be antidilutive were
3.7 million and 5.1 million, and for the nine months ended June 30, 2004 and
2003 were 5.6 million and 5.1 million. Shares subject to repurchase total
approximately 0 and 135,000 for the three and nine months ended June 30, 2004
and 2003, respectively. Note 3. Comprehensive Income (Loss) Statement of Financial Accounting Standards No. 130, Reporting
Comprehensive Income (SFAS 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. 9




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Total comprehensive income (loss) is as follows (in thousands): Three Months Ended
    
    Nine Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    571
    
    
    $
    (1,213
    )
    
    $
    401
    
    
    $
    (3,163
    )Change in net unrealized gains and
losses on investments, net of tax
    
    
    (50
    )
    
    
    5
    
    
    
    (51
    )
    
    
    10Total comprehensive income (loss)
    
    $
    521
    
    
    $
    (1,208
    )
    
    $
    350
    
    
    $
    (3,153
    )
 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 individual components. Revenues by geographic region are based on the region in which the customers
are located. Total revenues by geography and license revenues by geometry are as follows (in thousands): Three Months Ended
    
    Nine Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Total revenues by geography:United States
    
    $
    6,019
    
    
    $
    4,341
    
    
    $
    13,049
    
    
    $
    13,414Canada
    
    
    711
    
    
    
    232
    
    
    
    1,812
    
    
    
    1,122Japan
    
    
    892
    
    
    
    921
    
    
    
    3,597
    
    
    
    3,614Taiwan
    
    
    1,392
    
    
    
    1,130
    
    
    
    4,681
    
    
    
    4,548Europe, Middle
East, Africa
(EMEA)
    
    
    2,916
    
    
    
    1,636
    
    
    
    8,803
    
    
    
    5,512Other
    
    
    1,922
    
    
    
    1,304
    
    
    
    5,747
    
    
    
    2,544Total
    
    $
    13,852
    
    
    $
    9,564
    
    
    $
    37,689
    
    
    $
    30,754License revenues by geometry:0.18 micron technology
    
    
    17
    %
    
    
    18
    %
    
    
    13
    %
    
    
    18
    %0.13 micron technology
    
    
    45
    
    
    
    48
    
    
    
    48
    
    
    
    5590 nanometer technology
    
    
    31
    
    
    
    18
    
    
    
    31
    
    
    
    8Other
    
    
    7
    
    
    
    16
    
    
    
    8
    
    
    
    19
 Included in the Other category total revenues by geography above are revenues from the
customers in China, Korea, Malaysia and Singapore. 10




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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 a cost of approximately $1.8
million. Note 5. Recently Issued Accounting Pronouncements In December 2003, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 104, Revenue Recognition (SAB 104). SAB 104 revises
or rescinds portions of the interpretative guidance related to revenue
recognition included in Topic 13 of the codificaton of the staff accounting
bulletins. The Company has assessed the impact of SAB 104 and concluded that
the adoption of SAB 104 by the Company did not have a material impact on its
financial statements. In December 2003, the FASB issued additional guidance clarifying the
provisions of FASB Interpretation No. 46, Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51 (FIN 46-R). FIN 46-R provides a
deferral of FIN 46 for certain entities. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. The Company believes that the adoption of this
standard will have no material impact on its financial statements. In November 2003, the Emerging Issues Task Force reached consensus on
Issue No. 03-01 (EITF 03-01), The Meaning of Other-Than-Temporary Impairment
and Its Application to Certain Investments. EITF 03-01 requires that certain
quantitative and qualitative disclosures should be required for debt and
marketable equity securities classified as available-for-sale or
held-to-maturity under SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securitiesand SFAS No. 124, Accounting for Certain
Investments Held by Not-for-Profit Organizationsthat are impaired at the
balance sheet date but for which an other-than-temporary impairment has not
been recognized. The Company has assessed the impact of EITF 03-01 and
concluded that the adoption of this issue will have no material impact on its
financial statements. 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 June 30, 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. 11




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Accordingly, the Company has no liabilities recorded for these warranties as of
June 30, 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. 
 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, 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, 2003 filed with the Securities and Exchange Commission. Overview Virage Logic provides semiconductor intellectual property (IP) platforms
that are based on memory, logic, and I/Os (input/output interface components)
that are silicon-proven and production ready. Virage Logics product portfolio
provides foundries, integrated device manufacturers (IDMs) and fabless
customers with key competitive advantages including higher performance, lower
power, higher density and optimal yield. Virage Logics customers are
primarily focused on the consumer, communications and networking, handheld and
portable, and computer and graphics markets. We continue to see signs of improved business activity in the
semiconductor industry which has translated into increased customer momentum
for our semiconductor IP 12




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platforms for the 0.13 micron and 90-nanometer processes and for our
Self-Test and Repair (STAR) Memory System. As more designs move to the 0.13
micron and 90-nanometer process nodes, the capabilities offered by our STAR
Memory System become more important to improve yield and time-to-market and
help to reduce our customers overall costs. Our revenues continue to grow from licenses of our semiconductor IP
platforms, which are based on the following products:  
    
    embedded memories, including memory compilers for static RAM,
register files, CAMs and non-volatile memory, as well as memory test
processor and fuse box components for embedded test and repair of
defective memory cells;
    
    logic elements, including Metal Programmable Cell Libraries that
save configuration costs by reprogramming only a few masks and
Standard Cell Libraries that deliver up to a 30% smaller area over
conventional standard cell implementations; and
    
    I/O libraries, providing a rich set of I/O cells. In addition to licensing, royalty and maintenance revenues for our
standard logic products, we also derive licensing and royalty revenues for
custom design and consulting services of our logic offering. Our revenues are reported in two separate categories: license revenues and
royalty revenues. License revenues are derived from license fees, maintenance
fees, fees for custom design services, library design services and consulting
services. Royalty revenues are derived from fees paid by a customer on a
per-chip design basis 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. All revenues to date have been denominated in U.S.
dollars. We derive our royalty revenues from third-party foundries, fabless customers
and integrated device manufacturers that manufacture chips incorporating our
Area, Speed and Power (ASAP) Memory products, ASAP Logic products, Self-Test
and Repair (STAR) Memory System, NetCAM, NOVeA®, and Base I/O Library
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. Time delays for receiving royalty revenues are due to the typical
length of time required for the customer to implement our semiconductor IP into
their design, and then to manufacture and bring to market a product
incorporating our products. 13




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Currently, license fees represent the majority of our revenues. Royalty
revenues for the three months ended June 30, 2004 and 2003 were $1.9 million
and $1.1 million, respectively, and for the nine months ended June 30, 2004 and
2003 were $5.1 million and $2.2 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 June 30, 2004, Agere Systems accounted for
12% of our revenues. For the three months ended June 30, 2003, Silterra
Malaysia accounted for 12% of our revenues. No single customer generated more
than 10% of our revenues for the nine months ended June 30, 2004 and 2003. 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 follows specific and detailed guidelines
and 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, Statement of Position 98-9 and Statement of
Position 81-1. 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, there are no significant remaining
obligations on our part, the fee is fixed or determinable, and collectability
is reasonably assured. If any of these criteria are not met, 14




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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, logic libraries and I/Os may involve
customization to the functionality of the software, therefore revenues from
such licenses are recognized over the period that we perform the services. Our
contracts are established as fixed fee arrangements. Revenue derived from
custom products are recognized using a percentage-of-completion method or as
services are performed. For all license and service agreements accounted for
using the percentage-of-completion method, we determine progress-to-completion
based on labor hours incurred and estimates of efforts required to complete
each project. These estimates are based on the amount of work we require for
comparable projects, and we believe we are able to reasonably and reliably
estimate the costs to complete projects accounted for using the
percentage-of-completion method. However, use of different assumptions under
the percentage-of-completion method could affect our revenues and the timing of
recognizing certain revenues. Alternatively, for customers transactions for
which 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 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 in-process contracts. If customer acceptance is required
for completion of specified milestones, the related revenue is deferred until
the acceptance criteria is met. For agreements which 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 maintenance, it is determined
based on the stated renewal rate in each contract. Maintenance revenues are
recognized ratably over the contractual term of the maintenance period, which
is generally one year. 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. From time to time, we may exercise our audit rights under our
contracts with customers to audit our licensees royalty records. The results
of such royalty audits could result in an increase, as a result of a licensees
underpayment, or decrease, as a result of a licensees overpayment, to royalty
revenues. Such adjustments are recorded in the period they are determined. 15




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Valuation of Accounts Receivable We perform ongoing credit evaluations of our customers and adjust
customers credit limits based upon payment history and the customers current
credit worthiness, as determined by our review of their then-current credit
information. We continuously 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,
different assumptions regarding the amount and timing of such cash flows
resulting from 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. In connection with the acquisition of In-Chip Systems
Inc., 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 June 30, 2004, management believes
no impairment of intangible assets has occurred. The carrying value of
purchased intangibles, including goodwill, is $12.6 million at June 30, 2004.
If the asset is deemed impaired, the maximum amount of impairment would be the
full carrying value of the asset. Accounting for Stock Options We account for outstanding stock options under Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and
Financial Accounting Standards Board Interpretation No. 44 (FIN 44), and comply
with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based
Compensation 16




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(SFAS 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 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. The Company accounts for stock options or warrants granted to
non-employees, excluding non-employee directors, under SFAS 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. Expenses recorded for stock
options granted to non-employees for the three months ended June 30, 2004 and
2003 were $0 and $35,000, respectively, and for the nine months ended June 30,
2004 and 2003 were $0 and $790,000, respectively. 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 $2.9 million and deferred tax liabilities of $1.2
million at June 30, 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. 17




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Results of Operations  Three and Nine Months Ended June 30, 2004 and 2003 The following table lists the percentage of revenues for certain items in
our consolidated statements of operations for the periods indicated: Three Months Ended
    
    Nine Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenue:License
    
    
    86.1
    %
    
    
    88.5
    %
    
    
    86.5
    %
    
    
    92.9
    %Royalties
    
    
    13.9
    
    
    
    11.5
    
    
    
    13.5
    
    
    
    7.1Revenues
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Cost and expenses:Cost of revenues
    
    
    20.7
    
    
    
    23.2
    
    
    
    21.7
    
    
    
    23.1Research and development
    
    
    33.6
    
    
    
    48.9
    
    
    
    36.3
    
    
    
    46.6Sales and marketing
    
    
    27.9
    
    
    
    35.0
    
    
    
    28.8
    
    
    
    30.4General and administrative
    
    
    12.7
    
    
    
    11.9
    
    
    
    12.8
    
    
    
    11.8Stock-based compensation
    
    
    0.2
    
    
    
    1.4
    
    
    
    0.4
    
    
    
    3.8Total cost and expenses
    
    
    95.1
    
    
    
    120.4
    
    
    
    100.0
    
    
    
    115.7Operating income (loss)
    
    
    4.9
    
    
    
    (20.4
    )
    
    
    0.0
    
    
    
    (15.7
    )Interest and other expenses
    
    
    1.2
    
    
    
    1.5
    
    
    
    1.3
    
    
    
    1.7Income tax provision (benefit)
    
    
    1.9
    
    
    
    (6.2
    )
    
    
    0.2
    
    
    
    (3.7
    )Net income (loss)
    
    
    4.2
    %
    
    
    (12.7
    )%
    
    
    1.1
    %
    
    
    (10.3
    )%
 Revenues.Revenues increased by 45% to $13.9 million from $9.6 million for
the three months ended June 30, 2004 and 2003, respectively, and increased by
22% to $37.7 million from $30.8 million for the nine months ended June 30, 2004
and 2003, respectively. The increase in revenues for the three and nine months
ended June 30, 2004 and 2003 was due to increased license revenues from
customers across all global regions and increased royalty revenue. License revenues increased by 40% to $11.9 million from $8.5 million for
the three months ended June 30, 2004 and 2003, respectively, and increased 14%
to $32.6 million from $28.6 million for the nine months ended June 30, 2004 and
2003, respectively. The increase in license revenue was primarily due to a few
large agreements in each of the North America, Europe and Asia global regions.
Additionally, we experienced increased sales of our 90-nanometer technology
products. Royalties increased 73% to $1.9 million from $1.1 million for the three
months ended June 30, 2004 and 2003, respectively, and 132% to $5.1 million
from $2.2 million for the nine months ended June 30, 2004 and 2003,
respectively. The increase was due to macroeconomic factors associated with
the overall industry-wide increase in production volumes, higher number of
specific products incorporating our semiconductor IP on the 0.13 micron process
moving into production and increased royalties from our customers using our
STAR Memory System product family as they increase production. For the three and nine months ended June 30, 2004 and 2003, total revenues by
geography and license revenues by geometry are as follows (in thousands): 18




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Three Months Ended
    
    Nine Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Total revenues by geography:United States
    
    $
    6,019
    
    
    $
    4,341
    
    
    $
    13,049
    
    
    $
    13,414Canada
    
    
    711
    
    
    
    232
    
    
    
    1,812
    
    
    
    1,122Japan
    
    
    892
    
    
    
    921
    
    
    
    3,597
    
    
    
    3,614Taiwan
    
    
    1,392
    
    
    
    1,130
    
    
    
    4,681
    
    
    
    4,548EMEA
    
    
    2,916
    
    
    
    1,636
    
    
    
    8,803
    
    
    
    5,512Other
    
    
    1,922
    
    
    
    1,304
    
    
    
    5,747
    
    
    
    2,544Total
    
    $
    13,852
    
    
    $
    9,564
    
    
    $
    37,689
    
    
    $
    30,754License revenues by geometry:0.18 micron technology
    
    
    17
    %
    
    
    18
    %
    
    
    13
    %
    
    
    18
    %0.13 micron technology
    
    
    45
    
    
    
    48
    
    
    
    48
    
    
    
    5590 nanometer technology
    
    
    31
    
    
    
    18
    
    
    
    31
    
    
    
    8Other
    
    
    7
    
    
    
    16
    
    
    
    8
    
    
    
    19
 Sales to customers in EMEA region increased in the third quarter and first
nine months of 2004 as compared to 2003 primarily due to additional license
revenue from Philips Semiconductor of $1.1 million in the third quarter, $3.1
million for first nine months of 2004 and $600,000 of license revenue from a
third quarter Tower arrangement. Sales to customers in the United States were
higher in the third quarter of 2004, but slightly lower for the first nine
months of 2004 as compared to 2003 reflecting a continuing focus on global
markets, specifically continued penetration of the emerging foundries in Asia
and large integrated device manufacturer customers in Europe. License revenues on the 90-nanometer technology products increased to 31%
from 18% for the third quarter of 2004 and to 31% from 8% for the nine months
ended June 30, 2004 and 2003, respectively. This increase in the 90-nanometer
process node is due to higher number of design starts at this process node.
Revenues for the 0.13 micron technology decreased to 45% from 48% for the third
quarter of 2004 and to 48% from 55% for the nine months ended June 30, 2004 and
2003, respectively. While license revenues from 0.13 micron technology
products increased in absolute dollars in the third quarter and in the first
nine month of fiscal 2004, they were lower on a percentage basis as a result of
the industry transition towards the 90-nanometer process node. Cost of Revenues.Cost of revenues consists primarily of personnel
expenses and the allocation of facilities, software and equipment expenses.
Cost of revenues increased 29% to $2.9 million for the third quarter of fiscal
2004 from $2.2 million in 2003 and increased 15% to $8.2 million for the first
nine months of 2004 from $7.1 million for the comparable prior period as a
result of higher license revenues and amortization of the purchase cost of
software tools for the engineering design teams. The cost of revenues for the
third quarter of fiscal 2004 also included costs associated with outsourced
engineering design work specific to projects delivered during the quarter. The
Company believes cost of revenues will continue to fluctuate in the future,
both in absolute dollars and as a percentage of revenues, based on the
percentage of customized products sold by us and the level of license revenues.
Cost of revenues excludes $7,000 and $27,000 of amortization of stock- 19




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based compensation for the three months ended June 30, 2004 and 2003,
respectively, and $29,000 and $245,000 of amortization of stock-based
compensation for the nine months ended June 30, 2004 and 2003, respectively. Research and Development Expense.Research and development expense
primarily includes personnel expense, software license and maintenance fees,
and depreciation related to capital spending. Research and development expense
decreased 1% to $4.6 million for the three months ended June 30, 2004 from $4.7
million for the same period last fiscal year and decreased 4% to $13.7 million
for the nine months ended June 30, 2004 from $14.3 million for the comparable
prior period. Research and development expense as a percentage of revenues
decreased during the third quarter and the first nine months of 2004 compared
to the same periods in the prior year. The decrease in research and
development expense during the third quarter of 2004 and first nine months of
2004, respectively, compared to the same periods in the prior year was
primarily due to lower depreciation expense of $97,000 and $257,000 resulting
from fixed assets purchased in prior periods which are fully depreciated.
Research and development expense was also lower for the first nine months ended
June 30, 2004 as compared with the nine months ended June 30, 2003 in the
amount of $453,000 in cost savings from a reduction in the number of employees
involved in research and development activities as several employees
responsibilities were re-focused to cost of revenue activities associated with
the higher 2004 license revenue. Headcount directly reporting to the research
and development group decreased in fiscal year 2004 to 135 at period end from
140 the prior year period. Despite the recent decrease, we anticipate that
research and development expense will increase as we expand our product
offerings and invest in technologies for future delivery. Research and
development expense excludes $12,000 and $56,000 of amortization of stock-based
compensation for the three months ended June 30, 2004 and 2003, respectively,
and $49,000 and $479,000 of amortization of stock-based compensation for the
nine months ended June 30, 2004 and 2003, respectively. Sales and Marketing Expense.Sales and marketing expense consists
primarily of personnel expenses, commissions, advertising and promotion-related
costs. Sales and marketing expense increased 16% to $3.9 million for the three
months ended June 30, 2004 from $3.3 million for the same period last fiscal
year, and increased 16% to $10.8 million for the nine months ended June 30,
2004 from $9.4 million for the comparable prior year period. Sales and
marketing expense as a percentage of revenues decreased 7.1% for the three
months ended June 30, 2004, and decreased 1.7% as a percentage of revenues for
the nine months ended June 30, 2004 when compared with the respective periods
of the prior year. Sales commissions increased $35,000 and $364,000 during the
third quarter of 2004 and first nine months of 2004, respectively, compared to
the same periods in the prior year due to higher revenues in fiscal 2004. While headcount increased by
1 to 53 over the respective periods, salary and related expenses increased
$228,000 and $549,000 during the third quarter of 2004 and first nine months of
2004, respectively, compared to the same periods in the prior year as a result
of positions, such as the Vice President of Marketing, being filled and the
reinstatement of salary levels in effect prior to a 5% salary reduction
effected last year. Travel expense increased $79,000 and $225,000 during the
third quarter of 2004 and first nine months of 2004, respectively, compared to
the same periods in the prior year as a result of increased travel to develop
customer relationships internationally. Consulting expense decreased $129,000
and $142,000 during the third quarter of 2004 and first nine 20




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months of 2004, respectively. Combined rent and insurance costs for our
global sales offices increased $94,000 and $340,000 during the third quarter of
2004 and first nine months of 2004, respectively, compared to the same periods
prior year. We anticipate that sales and marketing expense will continue to
increase as we expand our product lines and target new customers and markets
for our technologies. Sales and marketing expense excludes $9,000 and $40,000
of amortization of stock-based compensation for the three months ended June 30,
2004 and 2003, respectively, and $37,000 and $306,000 of amortization of
stock-based compensation for the nine months ended June 30, 2004 and 2003,
respectively. General and Administrative Expense.General and administrative expense
consists primarily of personnel, corporate governance and other costs
associated with the management of our business. General and administrative
expense increased by 55% to $1.8 million for the three months ended June 30,
2004 from $1.1 million for the same period last fiscal year and increased 33%
to $4.8 million from $3.6 million for the nine months ended June 30, 2004 from
the comparable prior period. General and administrative expense as a
percentage of revenues increased approximately 1% for the third quarter and
increased 1% for the first nine months of 2004 as compared to 2003. The
increase in general and administrative expense for the third quarter of 2004
and nine months ended June 30, 2004 was due to higher payroll and related,
recruiting and consulting expenses. Payroll and related costs increased
$415,000 and $493,000 for the third quarter of 2004 and first nine months of
2004, respectively, compared to the same period in the prior year primarily due
to headcount increase, and the reinstatement of salary levels in effect prior
to a 5% salary reduction effected last year. Combined rent and insurance costs
increased $84,000 and $376,000 during the third quarter of 2004 and first nine
months of 2004, respectively, compared to the same periods in the prior year
associated with contractual rent increases and broader insurance coverage
worldwide. Consulting expense increased $70,000 and $181,000 for the third
quarter of 2004 and first nine months of 2004, respectively over the comparable
prior year periods, due to corporate governance matters. Recruiting expense
increased $10,000 and $131,000 during the third quarter of 2004 and first nine
months of 2004, respectively, compared to the same periods in the prior year
related to the recruitment or replacement of several employees. We anticipate
that general and administrative expense will increase as we add additional
headcount in key positions and continue to incur professional service costs in
preparation for compliance under Sarbanes-Oxley Section 404 regulations.
General and administrative expense excludes $4,000 and $14,000 of amortization
of stock-based compensation for the three months ended June 30, 2004 and 2003,
respectively, and $16,000 and $123,000 of amortization of stock-based
compensation for the nine months ended June 30, 2004 and 2003, respectively. Stock-Based Compensation.With respect to the grant of stock options and
restricted stock to employees, the remaining deferred stock-based compensation
was fully amortized in the third quarter of 2004 in the amount of $32,000. Interest Income and Other Expenses.Interest income increased to $164,000
for the three months ended June 30, 2004 from $145,000 for the same period last
fiscal year. Interest income decreased $65,000 to $468,000 for the nine months
ended June 30, 2004 from $533,000 the comparable prior year period. This
decrease was due to the overall declining interest rate environment from fiscal
year 2003 to fiscal year 2004. 21




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Income Tax Provision.For the three months ended June 30, 2004, we
recorded an income tax provision of $268,000 on pre-tax income of $839,000,
yielding an effective tax rate of 32%. For the three months ended June 30,
2003, we recorded an income tax benefit for income taxes of $596,000 on a
pre-tax loss of $1.8 million, yielding an effective tax rate of (33%). For the
nine months ended June 30, 2004, we recorded an income tax provision of $82,000
on a pre-tax income of $483,000, yielding an effective tax rate of 17%. For
the nine months ended June 30, 2003, we recorded an income tax benefit of $1.1
million on a pre-tax loss of $4.3 million, yielding an effective tax rate of
(26%). The fiscal 2003 rates differ from the U.S. statutory rates primarily due to the
impact of stock-based compensation related charges that are non-deductible for
tax purposes. In fiscal 2004, the rates differ from the U.S. statutory rates primarily due to
the Research and Development tax credits. The change in the effective tax rate from the three months ended
June 30, 2004 to 2003 is primarily due to the smaller amount of stock-based
compensation recorded in the three months ended June 30, 2004 and the change
from a taxable loss position to a taxable net income position. Liquidity and Capital Resources At June 30, 2004, the Company had $43.0 million in cash and cash
equivalents, as compared with $38.9 million at September 30, 2003. The
increase in the cash balance at June 30, 2004 was due primarily to cash
provided by operating activities. Additionally, we held $20.2 million in
investments at June 30, 2004 and September 30, 2003. For the three and nine
months ended June 30, 2004 and 2003, operations were funded primarily from net
operating cash flows. Net cash provided by operating activities was $3.9 million for the first
nine months of fiscal 2004 and net cash provided by operating activities was
$102,000 for the first nine months of fiscal 2003. Net cash provided by
operating activities resulted from net income of $401,000, net income adjusted
for the following items: depreciation and amortization of $2.7 million,
increase in accrued expenses of $1.4 million and an increase in deferred
revenues of $3.3 million resulting from a greater number of orders with
deferred maintenance, offset by the net effect of the increase in income taxes
receivable and income tax payable of $830,000 and an increase in accounts
receivable of $3.2 million. Net cash used in investing activities was $1.3 million for the first nine
months of 2004 and $5.1 million was provided by investing activities for the
first nine months of 2003. Net cash used in investing activities was due to
the maturing of $17.2 million of investments in government agency securities,
offset by the purchase of $17.3 million in similar treasury investments,
payment of merger-related liabilities of $500,000 and acquisitions of property
and equipment of $742,000. Net cash provided by financing activities was $1.4 million and $765,000
for the first nine months of fiscal 2004 and 2003, respectively. Net cash
provided by financing activities was primarily due to proceeds from the
purchase of stock under the Companys Employee Stock Purchase Plan in February
2004 and from the issuance of common stock upon the exercise of options by
employees. Our future capital requirements 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 22




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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. The following table summarizes our contractual obligations: Payments Due by Period (in thousands)Less than
    
    1-3
    
    4-5
    
    After 5Contractual obligations
    
    Total
    
    1 Year
    
    Years
    
    Years
    
    YearsOperating lease obligations
    
    $
    4,125
    (1)
    
    $
    1,490
    (1)
    
    $
    2,250
    (1)
    
    $
    291
    
    
    $
    94Merger-related obligations
    
    
    500
    
    
    
    500Purchase obligations
    
    
    1,125
    (2)
    
    
    525
    (2)
    
    
    600
    (2)
    
    
    
    
    
    
    Total contractual obligations
    
    $
    5,750
    
    
    $
    2,515
    
    
    $
    2,850
    
    
    $
    291
    
    
    $
    94
  (1)
    
    Includes $873,000, $1.1 million and $553,000, respectively, payable
under the lease agreement for our corporate office lease in Fremont,
California, which was extended through fiscal year 2006.(2)
    
    Reflects amounts payable under an agreement with a third party for
the right to market certain semiconductor I/O technology developed by
such third party and create, modify and market derivatives of this
technology. Risk Factors 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 purchase of logic and I/O products
and lower than anticipated revenues from the sale of such products. Factors
that could prevent us 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 new foundries due to less design experience;
    
    Limited experience in sales and marketing of the platform strategy and knowledge of the market; and 23




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
    
    Difficulties and delays in expanding our logic and I/O product offerings. 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. 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 resources. 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. 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. 24




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Our quarterly operating results were lower than expected in the first and
second quarters of fiscal 2003 and are likely to fluctuate in the future 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;
    
    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;
    
    shifts in demand for products that incorporate our IP;
    
    constrained or deferred spending decisions by customers;
    
    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 and the number of such semiconductors actually produced (manufactured);
    
    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. 25




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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 Armenia
and India. Israel continues to face an increased level of violence and terror,
India is experienced 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. 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
Virage Logic products causing our accounts receivable to increase. In addition,
continued unrest in Israel and the Middle East may negatively impact the
investments 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. If we are unable to maintain existing relationships and 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. 26




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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
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 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 the 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. A reduction in the demand
for products incorporating complex semiconductors and semiconductor IP or 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, the semiconductor industry is highly cyclical and has
fluctuated between significant economic downturns characterized by diminished
demand, accelerated 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 been experiencing a
downturn during a significant economic slowdown resulting in lower levels of
technology expenditures by businesses and individuals. 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. Problems associated with international business operations could affect our
ability to license our IP. Sales to customers located outside North America accounted for 52%, 44%
and 42% of our revenues for fiscal years 2003, 2002, and 2001, respectively.
For the three months ended June 30, 2004 and 2003, sales to customers located
outside North America accounted for 51% and 52% of our revenues, respectively,
and for the nine months ended June 30, 2004 and 2003, accounted for 61% and 53%
of our revenues, respectively. We 27




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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. If we are unable to continue establishing relationships 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: 28




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
    
    the lengthy and expensive process of building a relationship with a potential licensee;
    
    competition with the internal design teams of semiconductor companies; and
    
    the need to persuade semiconductor companies 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 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. For the three months ended June 30,
2004 and 2003, we recorded royalty revenues of approximately $1.9 million and
$1.1 million, respectively and for the nine months ended June 30, 2004 and
2003, royalties were $5.1 million and $2.2 million, respectively. The continued
growth of our revenues depends in part on increasing our royalty revenues, but
we may not be successful in convincing all customers to agree to pay us
royalties. Recently 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. Additionally, these royalty
arrangements may not provide us with the anticipated benefits as sales of
products incorporating our IP may not offset lower license fees. Many factors
beyond our control, such as fluctuating sales volumes of products that
incorporate 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, commercial
acceptance of these products, accuracy of revenue reports and difficulties in
the royalty collection process, all impact our ability to forecast our royalty
revenues. It is difficult for us to verify royalty amounts owed to us under our licensing
arrangements, and this may cause us to lose 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 29




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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. We have a long and variable 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, 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. For the three months
ended June 30, 2004, Agere Systems accounted for 12% of revenues. For the
three months ended June 30, 2003, Silterra Malaysia accounted for 12% of
revenues. No single customer generated more than 10% of our revenues for the
nine months ended June 30, 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
receivables, historical revenues recorded and our future operating results. 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 30




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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. 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. We may be unable to attract and retain key personnel who are critical to the
success of our business. We believe that one of our significant competitive advantages is the size
and quality of our engineering team. Our future success also depends on our
ability to attract and retain engineers and other highly skilled personnel and
senior managers. In addition, in order to meet our planned growth 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 31




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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 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
man 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 would be severely harmed. 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 product to our customers, the duration of these delays was
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 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. We may have difficulty sustaining profitability and may experience additional
losses in the future. For the recent three month periods ended June 30, 2004, and March 31, 2004
we recorded net income of $571,000 and $189,000 respectively, following five
quarters of consecutive net losses. In fiscal year 2002, we recorded our first
profitable year of operations. The losses recorded in fiscal 2003 and the first
quarter of 2004 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 32




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technology. Continued losses would prevent us from being able to fully
utilize our deferred tax asset therefore resulting in the need for a valuation
allowance to be recorded. 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. If we are required to record compensation expense in connection with stock
option grants, our profitability may be reduced significantly. The Financial Accounting Standards Board (FASB) has recently proposed an
accounting standard that will require the fair value of all equity-based awards
granted to employees be recognized in the income statement as compensation
expense. 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. FASB is expected to issue
final rules on stock option expensing in late 2004. We will continue to monitor
FASBs progress on the issuance of this standard. 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 the acquisition of
In-Chip Systems, Inc. in May 2002, have placed, and are expected to continue to
place, a significant strain on our managerial and financial resources as well
as our limited 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 33




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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 the business of In-Chip and of other
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. 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
work-for-hire basis. Even though we have taken all customary industry
precautions, 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 any of our technology infringes the valid IP
rights of third parties, we may be unaware of IP rights of others that may
cover some of our technology. 34




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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. 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, such as employee stock option grants may
adversely affect our reported financial results. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk 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 foreign subsidiaries incur most of their expenses in the local
currency. 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.
International operations have not been material, therefore, we do not
anticipate our future results to be materially adversely impacted by changes in
these factors. 35




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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 $9.6 million at June 30, 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 $10.6 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
with the Chief Financial Officer, concluded that the Companys disclosure
controls and procedures were effective. There have been no significant changes
in the Companys internal controls or in other factors that could significantly
affect internal controls subsequent to their evaluation. 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. 36




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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 Security Holders None 
 ITEM 5. Other Information None 
 ITEM 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits:  31.1
    
    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  (b)
    
    Reports on Form 8-KThe registrant furnished a Current Report on Form 8-K on April 20, 2004 to
provide its earnings release for the second fiscal quarter of fiscal 2004. 37




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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: August 13, 2004
    
    VIRAGE LOGIC CORPORATION/s/ Adam A. KablanianADAM A. KABLANIANPresident and Chief Executive Officer/s/ Michael E. SeifertMICHAEL E. SEIFERTVice President, Finance and Chief Financial Officer(Principal Financial and Accounting Officer)
 38




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EXHIBIT INDEX 31.1
    
    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
 39