Virage Logic (VIRL)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission file number 000-31089

 

 

 

 

Virage Logic Corporation

(Exact name of registrant as specified in its charter)

 

 

47100 Bayside Parkway, Fremont, California 94538

(Address of principal executive offices)

 

Registrants’ telephone number, including area code:

(510) 360-8000

 

Securities registered pursuant to Section 12(b) of the Act:

Common stock, $0.001 par value

(Title of class)

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer (as defined in Exchange Act Rule 12b-2).

 

Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The Aggregate market value of the registrant’s common stock held by non-affiliates of the Registrant as of March 31, 2006 was approximately $86 million based upon the closing price reported for such date on the Nasdaq National Market. For purposes of this disclosure, shares of common stock held by persons who hold more than 5% of the outstanding shares of common stock and shares held by officers and directors of the Registrant have been excluded because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

The number of shares of the registrant’s Common Stock outstanding as of November 30, 2006 was 23,058,414.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s proxy statement for its 2007 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

VIRAGE LOGIC CORPORATION

INDEX TO
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED SEPTEMBER 30, 2006

 

TABLE OF CONTENTS

 

PART I

 

With the exception of statements of historical fact, all statements made in this Form 10-K, including in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, are forward-looking statements that involve risks and uncertainties. These forward-looking statements include statements relating to strategy, products, customers, business prospects, relationships and trends. 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 ability to forecast our business, including our revenue, income and order flow outlook, our ability to meet financial expectations, our ability to deliver products that meet customer specifications, our ability to deliver our customized products in the time-frame demanded by our customers, our ability to execute on our strategy of being a leading provider of semiconductor IP platforms, our ability to continue to develop new products and maintain and develop new relationships with third-party foundries and integrated device manufacturers, 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 platform, 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 do not intend, and undertake no obligation to release publicly any updates or revisions to any forward-looking statements contained herein. The following discussion of our financial condition and results of operations should be read together with the consolidated financial statements and the notes thereto included elsewhere in this filing.

 

General

 

Virage Logic Corporation (Virage Logic or the Company) provides semiconductor intellectual property (IP) platforms based on memory, logic and I/Os (input/output interface components). These various forms of IP are utilized by our customers to design and manufacture system-on-chip (SoC) integrated circuits that increasingly are forming the foundation of today’s consumer, communications and networking, hand-held and portable devices, computer and graphics applications. Our semiconductor IP offering consists of (1) embedded memories, (2) compilers that allow chip designers to configure our memories into different sizes and shapes on a single silicon chip, (3) memory test processor and fuse box components for embedded test and repair of defective memory cells, (4) software development tools that can be used to build memory compilers, (5) embedded Non-Volatile memory instances, (6) logic elements, and (7) I/Os. We also provide custom design services to the semiconductor industry.

 

Historically, we were primarily engaged in the development and marketing of embedded memory products. After the acquisition of In-Chip Systems, Inc. in May 2002, we expanded our product offering to also include logic and I/O products, and have been marketing these components as a semiconductor IP platform for our customers’ SoC designs. The expanded product offering positions us to be even more attractive to our customers’ semiconductor design efforts by providing IP across a broad spectrum of the functional elements of the chip.

 

Our customers include leading fabless semiconductor companies such as Altera Corporation (Altera), Broadcom Corporation (Broadcom), Ikanos Communications Inc. (Ikanos), Marvell Technology Group, Ltd (Marvell), PMC-Sierra, Inc. (PMC-Sierra), Sandisk Corporation (Sandisk), SigmaTel, Inc. (SigmaTel), TranSwitch Corporation (TranSwitch), Thomson Silicon Components (Thomson), Via Technologies, Inc. (Via Technologies), and Vitesse Semiconductor (Vitesse), as well as leading integrated device manufacturers (IDMs) such as Agere Systems, Inc. (Agere), Agilent Technologies, Inc. (Agilent), AMI Semiconductor, Inc. (AMI Semiconductor), Analog Devices, Inc. (Analog Devices), Atmel Corporation (Atmel), Conexant Systems, Inc. (Conexant), Freescale Semiconductor, Inc. (Freescale), Infineon Technologies, Inc. (Infineon), Intel Corporation (Intel), Kawasaki Microelectronics America, Inc. (KMicro), LSI Logic Corporation (LSI Logic), NEC Corporation (NEC), Philips Semiconductor B.V. (Philips), Sharp Electronics Corporation (Sharp), Sony Corporation (Sony), STMicroelectronics (STMicro) and Toshiba

Corporation (Toshiba). Finally, we have strategic commercial relationships with semiconductor foundries such as Taiwan Semiconductor Manufacturing Company (TSMC), United Microelectronics Company (UMC), Chartered Semiconductor Manufacturing (Chartered), Dongbu Electronics Co. Ltd. (Dongbu Electronics), Grace Semiconductor (Grace), IBM Corporation (IBM), SilTerra Malaysia Sdn. Dhd. (SilTerra), Silicon Manufacturing International Corporation (SMIC), and Tower Semiconductor, Ltd. (Tower).

 

We develop our embedded memory, logic and I/O elements to comply with the manufacturing processes used to create the silicon chips for our customers’ products. For our integrated device manufacturers customers, we develop our products to comply with the processes used by their internal manufacturing facilities. For our fabless semiconductor customers, we develop our products to comply with the processes of the third-party semiconductor manufacturing facilities, or foundries, which these companies rely on to manufacture the silicon chips for their products. We also pre-test certain products before their release to the market by having actual chips containing our semiconductor IP produced by third-party foundries, so that we can provide our customers with test chip data and help ensure that chips produced using our semiconductor IP will be manufacturable, while providing improved silicon wafer yields. Our products are certified for production by several of the established third-party foundries used by fabless semiconductor companies, such as TSMC, UMC, Chartered, and IBM, as well as some of the emerging third-party foundries such as SMIC, SilTerra, Dongbu Electronics, Tower and Grace. Because we ensure that certain products are silicon-proven and production ready, our customers can proceed with confidence and benefit from shorter design times for new product development and reduced design and manufacturing costs.

 

Corporate Information

 

We incorporated in California on November 27, 1995. We reincorporated in Delaware on July 25, 2000. Our principal executive offices are located at 47100 Bayside Parkway, Fremont, California 94538. Our telephone number is (510) 360-8000. Our website address is www.viragelogic.com. Information on our website, and websites linked to it, is not intended to be part of this report. We make available free of charge on our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or otherwise furnish it to, the Securities and Exchange Commission, or the SEC.

 

The public may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Rooms by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The SEC’s Internet website is located at http://www.sec.gov.

 

Industry Background

 

The proliferation of consumer and wireless products, the growth of the Internet, and the development of higher-speed computers and more robust visual communication systems are creating demand for electronic devices that offer lower power consumption and higher performance in order to achieve lower system operating power and faster processing capability. The designers of these products are seeking technologies that will enable them to decrease the size, reduce the manufacturing costs and enhance the performance of their products. In response to this demand, semiconductor companies have developed technologies that permit entire electronic systems, including the microprocessor, communications, logic, graphics and memory elements, to be contained on a single silicon chip, called system-on-chip (SoC), rather than on a circuit board.

 

Successful SoC design depends upon the reliable integration of the various components of the chip. Each component must comply with the manufacturing standards, or design rules, of the manufacturing facility that will produce the chip. Since different technical expertise and IP is required for each component of a SoC, it is difficult for many companies to internally develop all of the various IP needed for these components. In addition, the designers of products that use SoCs are facing increased market pressure to rapidly introduce new products, which shortens the time available for research and development involved in the design of a SoC. In order to meet the continuously increasing technical expertise requirements for the design of a SoC and the time constraints involved

in such design, many semiconductor companies are increasingly relying on external sources for the technical expertise and IP for various components of their SoC designs. The use of silicon-proven third-party IP components helps enable semiconductor companies to meet market pressures while allowing them to continue to focus on the components of the SoC that constitute their core competencies.

 

The increasing demand for a broad range of consumer electronics, high-performance computing and communications applications and the availability of increased bandwidth for Internet applications has made memory an increasingly critical element of the overall operation of SoCs used for these applications. Historically, integrated circuit designs were dominated by the logic function, while memory storage was typically provided in external devices. However, the market demand for increased system operating speed and increasingly smaller consumer devices has driven the memory storage elements to be coupled with the logic inside the same silicon chip, resulting in smaller, faster and more power efficient products. This trend of embedded memory also resulted in the requirement for more customized memory elements. The need for this proximity, as well as advances in semiconductor technology and the ability to customize the size and configuration of memory functions within a SoC, is creating increased demand for embedded memory. It is now common for SoCs to contain many memories with different functions configured in different sizes and shapes to optimize the area and functionality of the chip. The Semiconductor Industry Association (SIA) forecasts that the amount of area dedicated to memory in a typical SoC will grow to approximately more than 80 percent in 2010.

 

Semiconductor companies face significant challenges in designing low power, high-performance and area efficient memories that can be easily integrated with other components, including logic, for their SoC devices. Due to continuing advancements in the semiconductor manufacturing lithography processes, new circuit design elements have generally been required every one to two years. The internal design teams of semiconductor companies typically lack the dedicated resources necessary to keep pace with rapidly evolving memory design technology advancements. Suppliers of stand-alone memories for personal computers and other devices that include memory as a separate element on a circuit board often lack sufficient design expertise and software tools to provide custom high-performance memory for SoC designs. Similarly, suppliers of stand-alone logic and I/O components generally lack the focus and expertise necessary to develop embedded logic and I/O elements for SoC designs. These factors have created a market need for third-party providers of highly reliable, low power, high-performance and area efficient memory, logic and I/O IP for SoC design.

 

The Virage Logic Solution

 

We provide semiconductor IP platforms as well as embedded memory, logic and I/O IP elements used in SoC designs, and software development tools and custom design services. Our goal is to be the semiconductor industry’s trusted IP partner and as such, we offer our customers embedded memories, logic and I/Os that are optimized for area, low power consumption and speed, and that are available for the manufacturing processes of both the established and emerging third-party semiconductor foundries. Key benefits of our solution include:

 

 

 

The Virage Logic Strategy

 

Our objective is to be the leading supplier of semiconductor IP platforms comprising memories, logic and I/Os. Because these IP elements are integrated and tuned to work together, we believe our customers will choose to

include an increasing amount of Virage Logic semiconductor IP when designing and manufacturing their complex SoCs. Key elements of our strategy include the following:

 

 

 

 

We offer a wide range of semiconductor IP including:

 

 

Our Semiconductor IP Platforms.  We provide semiconductor IP platforms called IPrima Foundation^tm.  These platforms, comprising the Area, Speed and Power (ASAP) Memory^tm High-Density (HD) Memories, ASAP Logic^tm HD Standard Cells and Base I/O Libraries, are technology optimized meaning they are tuned to a particular foundry and process and are built to satisfy a wide range of design requirements. IPrima Foundation users also have optional access to Virage Logic’s rich portfolio of highly differentiated IP, including the industry’s first commercially available integrated embedded self-test and repair memory, the STAR Memory System, as well as the ASAP Memory High-Speed (HS) and Ultra-Low-Power (ULP) product lines, the patented ASAP Logic Ultra-High-Density (UHD), High-Density (HD), and High-Speed (HS) Standard Cell Libraries and the patented ASAP Logic HD and HS Metal Programmable Cell Libraries. The IPrima Foundation platforms meet the critical requirements of reducing SoC costs, boosting performance and ensuring reliability, while satisfying shrinking development budgets and improving time-to-profitability.

 

Our Embedded Memory Semiconductor IP.  We provide embedded memory semiconductor IP in predetermined shapes, sizes and types that can be incorporated by semiconductor designers into their SoC designs. We deliver our memory semiconductor IP to our customers through downloads from secure servers or on computer disks in a form that can be integrated directly into the design of the SoC.

 

Our Embedded Memory Compilers.  A compiler is a software program that allows semiconductor designers to configure memories to the desired specifications for their SoC designs. Our compiler products include:

 

 

 

Our Logic Semiconductor IP.  We provide logic libraries through our ASAP Logic product line. These products are designed to improve logic block area utilization and SoC performance while decreasing the price and power consumption of the overall chip. We deliver our logic semiconductor IP to our customers through the same manner as our embedded memory semiconductor IP.

 

 

Our Base I/O Library.  In 2003, we added an input/output (I/O) library to our product portfolio. It contains all necessary elements to complete an I/O ring, a key element for the SoC’s communication with external electrical components.

 

Our Software Development Tools.  Our primary software development tool is Embed-It!^® Architect, which allows semiconductor design companies to develop their own compilers with re-characterization capabilities. We also provide a software tool called Embed-It! Integrator to facilitate the design of multiple memory configurations used with SoCs.

 

During fiscal year 2006, our license revenues for 0.18 micron technology accounted for 12% of our total license revenues, license revenues for 0.13 micron technology was 33% of total license revenues, license revenues for 90-nanometer technology was 43% of total license revenues, license revenues for 65-nanometer technology was 10% of total license revenues and license revenues from the sale of other products was 2% of total license revenues. Included within the 2% other products category are our products on the older process nodes, 0.25 and 0.35 micron technology. We expect royalty revenue from these products to be declining and license revenue to be insignificant in future periods. In fiscal year 2005, our license revenues for 0.18 micron technology accounted for 12% of our total license revenues, license revenues for 0.13 micron technology was 40% of total license revenues, license revenues for 90-nanometer technology was 36% of total license revenues, license revenues for 65-nanometer technology was 6% of total license revenues and license revenues from the sale of other products was 6% of total license revenues. Included within the 6% other products category are our products on the older process nodes of 0.25 micron technology.

 

IPrima Foundation, IPrima Mobile, IPrima Graphics, IPrima Automotive, IPrima Networking, Silicon Aware IP and STAR Memory System are trademarks of Virage Logic Corporation. Embed-It!, Custom-Touch, Netcam, NOVeA and IPrima are registered trademarks of Virage Logic Corporation in the United States. IPrima and Silicon Aware IP are registered trademarks of Virage Logic Corporation in Europe and Japan.

 

Markets and Applications

 

We focus on markets and companies that utilize SoC technologies with high-performance, low-power architectures and high-density requirements where we believe our semiconductor IP platforms provide customers

with significant time-to-market, design and manufacturing cost advantages. Examples of the markets and applications in which our IP is implemented include:

 

 

Research and Development

 

We believe that our future success will depend in large part on our ability to continue developing new products and expanding our existing products for advanced manufacturing processes. To this end, we have assembled a team of engineers with significant experience in the design and development of embedded memory, logic and I/O semiconductor IP. Currently, we are focusing our research and development efforts on various configurations for memories, logic and I/O platforms that support the latest manufacturing processes such as 90-nanometer, 65-nanometer and 45-nanometer.

 

We have entered into agreements with TSMC, UMC, Chartered, Dongbu Electronics, Grace, IBM, SilTerra, SMIC and Tower for the development and licensing of various semiconductor IP platform products which are targeted to these foundries’ design rules. Leveraging our relationship with these foundries, we were able to shape the focus of our research and development activities. Under our agreement with each foundry, Virage Logic owns its own IP and the foundry owns its own IP, however, both Virage Logic and the foundry jointly own any IP that is co-developed by the parties during the term of the agreement. Following any such development, we license the developed IP to third-parties that manufacture their silicon chips at the foundry. As consideration for our development efforts, the foundries pay us licensing fees, as well as royalties based on silicon chips manufactured at the foundries using our semiconductor IP. In addition, both parties agree to provide technical, marketing and sales support as appropriate.

 

As of October 31, 2006, we had 318 employees engaged in the engineering related activities of research, development and operations. We expect to identify and hire additional technical personnel in fiscal year 2007 for our planned research and development activities, and we expect that these costs will increase in the future in order to maintain a lead position as a third-party provider of silicon infrastructure in the form of semiconductor IP.

 

Sales and Marketing

 

We focus our sales efforts through direct sales in North America, Europe and Asia. In Asia, we also derive indirect sales through distributors.

 

Direct Sales.  We maintain a network of direct sales representatives and field application engineers serving the United States, Asia, Canada and Europe. Substantially all of our direct sales representatives and field application engineers are located in North America, Europe and Japan and serve our customers in those regions. The sales force is distributed throughout North America with employees in the following locations: Austin, Boston, Fremont, Los

Angeles, Newark, West Palm Beach, Ottawa and Toronto. To serve our European customers, we have a direct sales organization based in the United Kingdom with additional sales personnel in Germany and Israel. We also have direct sales personnel in Japan. Our sales force’s primary responsibility is to secure and maintain direct account relationships with fabless semiconductor companies and integrated device manufacturers for the license of our products. Developing a customer relationship typically involves weeks or months and can extend beyond this timeframe.

 

We enter into license agreements with our customers for a range of embedded memory, logic and I/O technologies. For our ASAP Memory, ASAP Logic and Base I/O products, in addition to collecting license and consulting fees from the customers, we receive royalties from third-party foundries that manufacture chips for our fabless customers. For our STAR Memory System, NetCAM and NOVeA products, we receive both license and royalty fees directly from our customers, as well as royalties from the third-party foundries that manufacture their chips.

 

We have developed relationships through the Virage Logic IP (VIP) Partner Program with the following types of companies:

 

 

Indirect Sales.  In addition to our direct sales force, we also sell our technologies through distributors in Taiwan. These indirect sales organizations have expertise in selling semiconductor IP and software design tools. None of these relationships are exclusive.

 

Customers

 

Our customers are semiconductor companies that use our semiconductor IP to design complex SoCs. Purchasers of our semiconductor IP platforms as well as embedded memory, logic and I/O elements include fabless semiconductor companies, integrated device manufacturers and third-party foundries. For fabless semiconductor and integrated device manufacturer customers, we license our semiconductor IP on either a single or multiple project basis. The following chart provides a representative list of our major customers by customer type.

 

 

 

 

We expect a small number of companies to collectively represent between 20% and 40% of our revenues for the next few years. In fiscal year 2006 and fiscal year 2005, TSMC represented 17% and 10% of our revenues, respectively. In fiscal year 2004, no customer generated 10% or more of our revenues. As our customer base grows and the number of fabless semiconductor companies increases, we expect our dependence on any one customer for revenues to decline. We expect that our sales to fabless semiconductor companies will grow, and as a result we will become more dependent on the availability of new manufacturing process technologies and capacity from third-party foundries to manufacture our customers’ products.

 

Proprietary and Intellectual Property

 

We rely on a combination of nondisclosure agreements and other contractual provisions, as well as patent, trademark, trade secret and copyright law to protect our proprietary rights. Our general policy has been to seek patent protection for those inventions and improvements likely to be incorporated in our technologies or otherwise expected to be of value. We have an active program to protect our proprietary technology through the filing of patents.

 

As of October 31, 2006, we had 56 U.S. patents issued and 36 U.S. patent applications on file with the U.S. Patent and Trademark Office (USPTO). Our patents expire at various dates between 2019 and 2026, and we expect that once granted, the duration of patents covered by patent applications will be 20 years from the filing of the application. These patents will allow us to prevent others from infringing on some of our core technologies in the United States. We intend to continue to file patent applications as appropriate in the future. We cannot be sure, however, that our pending patent applications will be allowed, that any issued patents will protect our IP or will not be challenged by third parties, or that the patents of others will not seriously harm our ability to do business. In addition, others may independently develop similar or competing technology or design around any of our patents. We also have not secured patent protection in foreign countries, and we cannot be certain that the steps we have taken to protect our IP abroad will be effective.

 

In addition to patent protection, as of October 31, 2006, we had five U.S. trademarks registered and three pending U.S. trademark applications on file with the USPTO. If the applications mature to registrations, these registrations would allow us to prevent others from using other similar marks on similar goods and services in the United States. We cannot be sure, however, that the USPTO will issue trademark registrations for any of our pending applications. Further, any trademark rights we hold or may hold in the future may be challenged or may not be of sufficient scope to provide meaningful protection. In addition, we had four foreign trademarks registered: two in the European Community and two in Japan. We also had two foreign trademark applications pending in China. The foreign applications are subject to the same conditions as the U.S. trademark applications with respect to their applicable jurisdictions.

 

We protect the source code of our technologies as both trade secrets and unpublished copyrighted works. We license the object code to our customers for limited uses and maintain contractual controls over the use of our software, but we may not have the resources to enforce such controls, and further such contractual controls may be declared invalid or unenforceable. Wide dissemination of our software makes protection of our proprietary rights difficult, particularly outside the United States, and we may not be able to assert equivalent rights with respect to

source code developed by our employees in the Republic of Armenia (Armenia) and India as we could if it were developed in the United States.

 

We protect our trade secrets and other proprietary information through nondisclosure agreements with our employees and customers and other security measures, although others may still gain access to our trade secrets or discover them independently.

 

Although we believe that our technologies do not infringe any patent, copyright or other intellectual proprietary rights of third parties, from time to time, third parties, which may include our competitors, may assert claims of infringement of patent, copyright or other intellectual property rights to technologies that are important to us. There is no such claim to date.

 

Competition

 

The semiconductor IP industry is very competitive and is characterized by constant technological change, rapid rates of technology obsolescence and the emergence of new suppliers. Our primary competition comes from the internal development groups of large integrated device manufacturers that develop semiconductor IP for their own use. In addition, we face competition from other third-party providers of semiconductor IP, such as ARM Ltd.’s Physical IP Division (formerly Artisan Components which was acquired by ARM in December 2004), Synopsys and certain DRAM IP providers, such as Monolithic System Technology, Inc. Additionally, the electronic design automation (EDA) companies such as Synopsys, Cadence, Mentor Graphics and Magma could play a more significant role in the IP marketplace.

 

As we continue to introduce new technologies, we may face competition from both existing semiconductor IP suppliers and new ones entering the market. We may also face competition from semiconductor companies that currently offer stand-alone memory technologies, such as Cypress Semiconductor Corporation (Cypress), Magnachip Semiconductor, Inc. (Magnachip), IDT Corporation (IDT), Micron Technology, Inc. (Micron) and Samsung Co. Ltd. (Samsung), if these companies were to make their technologies available in embedded form.

 

In addition, third-party foundries may decide in the future to distribute embedded memories, logic and I/O components themselves, in addition to manufacturing chips containing third-party IP. TSMC, one of our third-party foundry customers, has historically produced intellectual property components for use by third-parties in designs to be manufactured at TSMC’s foundry. These components are designed to serve the same purpose as components produced by us. The intellectual property components developed by TSMC have competed and are expected to continue to compete with our products. We believe that TSMC is more aggressively developing and distributing these products to encourage its customers to use TSMC to manufacture their current and future designs. TSMC has substantially greater financial, manufacturing and other resources, name recognition and market presence than we do and the internal design group at TSMC has greater access to technical information about TSMC’s manufacturing processes. If TSMC is successful in supplying its own intellectual property components to third-parties either directly or through distribution arrangements with other companies, our revenue from TSMC, our revenue from other customers and our operating results could be negatively affected.

 

We believe that important competitive factors in our market include performance and functionality of product, the ability to customize products for customer needs, length of development cycle, price, compatibility with prevailing design methodologies, interoperability with other devices or subsystems, reputation for successful designs and installed base, overall product quality and reliability, and the level of technical service and support provided.

 

Employees

 

As of October 31, 2006, we had 410 employees, including 62 in sales and marketing, 251 in engineering, 67 in operations and 30 in general and administrative functions. We have 224 of our employees located outside of the United States. We believe that our future success will depend in part on our continued ability to attract, hire and retain qualified personnel. None of our employees are represented by a labor union, and we believe our employee relations are good.

Executive Officers of the Registrant

 

The names and ages of our executive officers as of November 30, 2006 are set forth below:

 

 

Adam A. Kablanian co-founded Virage Logic and has served as our President, Chief Executive Officer and Chairman of the Board of Directors since January 1996. In August 2003, Mr. Kablanian resigned his position as Chairman of the Board of Directors but continued to serve as President, Chief Executive Officer and a member of the Board of Directors. Before co-founding Virage Logic, Mr. Kablanian was a Department Manager for LSI Logic, a semiconductor integrated device manufacturer, from August 1994 to December 1995 where he was responsible for the embedded memory design division. Before joining LSI Logic, Mr. Kablanian managed multi-foundry technology transfer programs as an engineering manager at Waferscale Integration, a designer of programmable system devices, from April 1990 to January 1994. Mr. Kablanian holds a B.A. in Physics from the University of California at Berkeley and an M.S. in Electrical Engineering from Santa Clara University.

 

J. Daniel McCranie has served as our Executive Chairman of the Board of Directors and Co-Principal Executive Officer since March 2006. Previously, Mr. McCranie was our Chairman of the Board of Directors, from August 2003 to March 2006. Before joining Virage Logic, Mr. McCranie was Vice President of Sales and Marketing for Cypress Semiconductor, from September 1993 to February 2001. Mr. McCranie was Chairman, Chief Executive Officer and President of SEEQ Technology, from February 1984 to September 1993. Mr. McCranie has served as Chairman of the Board of Directors of ON Semiconductor Corp. since November 2001, as a member of the Board of Directors of Actel Company and a member of the Board of Directors of Cypress Semiconductor. Mr. McCranie holds a B.S. in Electrical Engineering from Virginia Polytechnic Institute.

 

Christine Russell joined Virage Logic as our Vice President of Finance and Chief Financial Officer in June 2006. Ms. Russell has served as a financial executive in Silicon Valley for over twenty years with experience in both emerging and larger companies. Before joining Virage Logic, Ms. Russell served as Chief Financial Officer of OuterBay Technologies, Inc., a database archiving company, from May 2005 to June 2006. Previously, Ms. Russell served as Chief Financial Officer of Ceva, Inc., a digital signal processing IP company, from October 2003 to May 2005, and as Chief Financial Officer of Persistence Software, Inc., a software company, from October 1997 to October 2003. She also held Chief Financial or senior financial positions at Cygnus Solutions, Valence Technology, Inc., Covalent Systems, Stellar Systems, Inc. and Xerox Corporation, from the period May 1978 to October 1997. Ms. Russell holds bachelors and masters of business administration degrees in Finance from Santa Clara University.

 

Alexander Shubat co-founded Virage Logic and has served as our Vice President of Research and Development and Chief Technical Officer and a member of the Board of Directors since January 1996. Before co-founding Virage Logic, Mr. Shubat was a Director of Engineering at Waferscale Integration from November 1985 to December 1995, where he managed various groups, including design, application-specific integrated circuit and high-speed memory. He holds fourteen patents and has contributed to more than 25 publications. Mr. Shubat holds a B.S. and a M.S. in Electrical Engineering from the University of Toronto, Canada and a Ph.D. in Electrical Engineering from Santa Clara University.

 

James J. Ensell joined Virage Logic as our Vice President of Marketing in October 2003 and in March 2005, took on the additional responsibility of Business Development. In April 2006, Mr. Ensell was promoted to Senior

James J. Ensell joined Virage Logic as our Vice President of Marketing in October 2003 and in March 2005, took on the additional responsibility of Business Development. In April 2006, Mr. Ensell was promoted to Senior Vice President of Marketing and Business Development. Before joining Virage Logic, Mr. Ensell served as Vice President, Business Development and Chief Information Officer for eSilicon Corporation, a fables custom integrated circuit maker from August 2000 to October 2003. Previously, Mr. Ensell held positions as Senior Vice President of Products and Services at Zland.com, Inc., an internet eBusiness provider, from July 1999 to August 2000, and as Vice President of Marketing at Cadence Design Systems, Inc.’s Deep Submicron Business Unit from April 1997 to January 1999. Mr. Ensell currently serves as chairman of the IP Committee of the Fabless Semiconductor Association (FSA). Mr. Ensell holds a B.S. in Electrical Engineering from Villanova University and a M.S. in Electrical Engineering from the University of Pennsylvania.

 

James Bailey joined Virage Logic as our Vice President of Worldwide Sales in October 2005. Before joining Virage Logic, Mr. Bailey served as President and Chief Executive Officer at Accenia, Inc. from April 2004 to February 2005. Previously, Mr. Bailey served as a General Manager in the Design For Manufacture (DFM) business unit at Cadence Design Systems, Inc. through the acquisition of Simplex Solutions, from 2002 to 2004. While at Simplex Solutions, Mr. Bailey held various management positions including Vice President and General Manager, Vice President Worldwide Sales, and Sales Director for North America, from 2000 to 2002. Mr. Bailey holds a B.S. in Computer Science and a B.A. in Mathematics from St. Cloud State University.

 

Ehsan Rashid joined Virage Logic as our Vice President of Operations in October 2004. Mr. Rashid was Senior Director of Operations of Virage Logic in April 2003. Before joining Virage Logic, Mr. Rashid served as Senior Vice President and General Manager, Access Product Division, at Com21, Inc., from January 2000 to April 2003. Previously, Mr. Rashid served as Senior Director at Philips Semiconductor after it acquired VLSI Technology from May 1999 to January 2000. Mr. Rashid served as Senior Director of Hardware and Software Engineering, and System Applications in the Consumer Digital Entertainment Division of VLSI Technology, from December 1997 to May 1999, and as Director of Engineering at Hitachi Micro Systems, Inc. Mr. Rashid holds a B.S. in Electrical Engineering from the University of California, Berkeley.

 

Risk Related to Our Business

 

Inability or delayed execution on our strategy to be a leading provider of semiconductor IP platforms could adversely affect our revenues and profitability.

 

From inception to May 2002, most of our revenues derived from the license of our embedded memory products. After our acquisition of In-Chip Systems, Inc. in May 2002, we expanded our product offering to also include logic products. In 2003, we added I/Os to our product offering to enable us to offer 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 any reason, our revenues and profitability could be adversely affected. In addition, our profitability could also be adversely affected due to investment of resources directed to the development and/or acquisition of logic and I/O products and due to lower than anticipated revenues from the sale of such products. Factors that could prevent us from gaining market acceptance of our semiconductor IP platform include:

 

 

Our quarterly operating results may fluctuate significantly and any failure to meet financial expectations for any fiscal quarter may cause our stock price to decline.

 

Our quarterly operating results are likely to fluctuate in the future from quarter to quarter and on an annual basis due to a variety of factors, many of which are outside of Virage Logic’s control. Factors that could cause our revenues and operating results to vary from quarter to quarter include:

 

 

As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and may not be reliable as indicators 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 quarters, which could cause the market price of our stock to decline significantly.

 

If we are unable to continue establishing relationships on favorable contractual terms with semiconductor companies to license our IP, our business will be harmed.

 

We currently rely on license fees from the sale of perpetual and term licenses to generate a large portion of our revenues. These licenses produce streams 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:

 

 

 

These factors may make it difficult for us to maintain our current relationships or establish new relationships with additional customers. Further, there are a finite number of fabless semiconductor companies and integrated device manufacturers to which we can license our IP. If we are unable to establish and maintain these relationships, we will be unable to generate license fees, and our revenues will decrease.

 

If we are unable to maintain existing relationships and/or develop new relationships with third-party semiconductor manufacturers or foundries, we will be unable to verify our technologies on their processes and license our IP to them or their customers and our business will be harmed.

 

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 help define the focus of our research and development activities. We currently have agreements with TSMC, UMC, Chartered, Tower, Silterra, SMIC and Dongbu Electronics. 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. As of consequence, we would 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.

 

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 agreements require us to provide customized products to our customers within a specified delivery timetable. While we have experienced delays in delivering products to our customers, the durations of these delays have typically been short in length so as to not materially damage our relationship with our customers. However, these delays could adversely impact our operations and our financial performance. Future failures to meet significant customer milestones could damage our reputation in our industry and harm our ability to attract new customers.

 

If we are unsuccessful in increasing our royalty revenues, our revenues and profitability may not be as large as we anticipate.

 

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 and more recently with the introduction of our NOVeA technology, in addition to collecting royalties from third-party semiconductor foundries, we intend to increase our royalty base by collecting royalties directly from our integrated device manufacturer and fabless customers. However, we may not be successful in convincing all customers to agree to pay us royalties. For the fiscal years ended September 30, 2006, 2005 and 2004, we recorded royalty revenues of approximately $16.1 million, $11.0 million and $8.2 million, respectively. The continued growth of our revenues depends in part on increasing our royalty revenues, but we may not be successful in increasing our royalty revenues as expected and we face difficulties in forecasting our royalty revenues because of many factors beyond our control, such as fluctuating sales volumes of products that incorporate our IP, short or unpredictable product life cycles for some customer products containing our IP, potential slow down for manufacturing of certain newer process technology, foundry rate adjustments, the cyclical nature of the semiconductor industry that affects the number of designs, commercial acceptance of these products, accuracy of revenue reports received from our customers and difficulties in the royalty collection process. In addition, occasionally we have completed agreements whereby significant upfront license fees are reduced or limited in exchange for higher royalty rates, which should result in future royalty revenues, but these royalty arrangements may not provide us with the anticipated benefits as sales of products incorporating our IP may not offset lower license fees.

It is difficult for us to verify royalty amounts owed to us under our licensing arrangements, and this may cause us to lose revenues or inaccurately report revenues.

 

The standard terms of our license agreements require our customers 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 customers to verify this information, audits can be expensive, time consuming and potentially detrimental to our ongoing business relationship with our customers. Our inability to audit all of our customers’ 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 customers’ underpayment, or decrease, as a result of a customers’ overpayment, to royalty revenues. Such adjustments, as a result of the audit, are recorded in the period they are determined. Any adverse material adjustments resulting from royalty audits may cause our revenues and operating results to be below market expectations, which could cause our stock price to decline. The royalty audit may also trigger disagreements over contractual terms with our customers and such disagreements could adversely affect customer relationship, divert the efforts and attention of our management from normal operations and impact our business operations.

 

Products that do not meet customer specifications or contain defects that harm our customers could damage our reputation and cause us to lose customers and revenue.

 

The complexity and ongoing development of our products could lead to design or manufacturing problems. Our semiconductor IP products may fail to meet our customers’ technical requirements, or may contain defects, which may cause our customers to fail to complete the design and manufacturing of their products in a timely manner. Any of these problems may harm our customers’ businesses. If any of our products fail to meet specifications or have reliability or quality problems, our reputation could be damaged significantly and customers might be reluctant to buy our products, which could result in a decline in revenue, an increase in product returns and the loss of existing customers or failure to attract new customers. These problems may adversely affect customer relationships, as well as our business, financial condition and results of operations.

 

As advanced process nodes become more complex we may have difficulty in delivering product specifications in similar timeframes and at comparable costs to older process nodes.

 

The increasing complexity of our product at advanced nodes requires different customer engagements and validation strategies. Such changes require the acceptance of different business terms and schedules by our customers. They also may require an increase of test silicon for purposes of validating performance parameters. Such changes may impact our ability to acquire new customers and could increase our operating expenses.

 

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 experiencing rising costs. Armenia, only independent since 1991, has suffered significant political and economic instability. Accordingly, conditions in areas of the world in which we operate may adversely affect our business in a number of ways, including the following:

 

 

 

Problems associated with international business operations could affect our ability to license our IP.

 

Sales to customers located outside North America accounted for 60%, 63% and 62% of our revenues for fiscal years 2006, 2005, and 2004, respectively. For the three months ended September 30, 2006 and 2005, sales to customers located outside North America accounted for 68% and 61% of our revenues, respectively. We anticipate that sales to customers located outside North America will increase and will continue to represent a significant portion of our total revenues in future periods. In addition, most of our customers that do not own their own foundries rely on third-party foundries located outside of North America. Accordingly, our operations and revenues are subject to a number of risks associated with international business operations, including the following:

 

 

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 foundries, may decrease.

 

We have a long and unpredictable sales cycle, which can result in uncertainty and delays in generating additional revenues.

 

Historically, because of the complexity of our products, it can take a significant amount of time and effort to explain the benefits of our products and to negotiate a sale. For example, it generally takes at least three to nine months after our first contact with a prospective customer before we begin licensing our IP to that customer. In addition, purchase of our products is usually made in connection with new design starts, the timing of which is 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. One customer, TSMC, generated 10% or more of our revenues for the years ended September 30, 2006 and 2005. No single customer generated 10% or more of our revenues for the year ended September 30, 2004. Since fiscal year 2001, our five largest customers have represented between 25-47% of our revenues. The license agreements we enter into with our customers do not obligate them to license future generations of our IP and, as a result, we cannot predict if and when they will purchase additional products from us. As a result of this customer concentration, we could experience a dramatic reduction in our revenues if we lose one or more of our significant customers and are unable

to replace them. In addition, since our accounts receivable are concentrated in a relatively small number of customers, a significant change in the liquidity, financial position, or issues regarding timing of payments of any one of these customers could have a material adverse impact on the collectability of our accounts receivable, historical revenues recorded and our future operating results.

 

We may have difficulty sustaining profitability and may experience additional losses in the future.

 

We recorded a net loss of $0.9 million for fiscal year 2006 and a net loss of $0.3 million for fiscal year 2005. In order to 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 return to profitability with this growth. Any failure to increase our revenues and control costs as we pursue our planned growth would harm our profitability and would likely negatively affect the market price of our stock. In addition, if we incurred losses for a sustained period we may be prevented from being able to fully utilize our deferred tax asset which will result in the need for a valuation allowance to be recorded.

 

We may be unable to attract and retain key personnel who are critical to the success of our business.

 

We believe our future success depends on our ability to attract and retain engineers and other highly skilled personnel and senior managers. In addition, in order to grow our business we must increase our sales force, both domestic and international, with qualified employees. Hiring qualified technical, sales and management personnel is difficult due to a limited number of qualified professionals and competition in our industry for these types of employees. We have in the past experienced delays and difficulties in recruiting and retaining qualified technical and sales personnel and believe that at times our employees are recruited aggressively by our competitors and start-up companies. Our employees are “at will” and may leave our employment at any time, and under certain 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 Mr. Shubat and do not maintain “key person” life insurance policies on their lives. If Mr. Kablanian or Mr. Shubat were to leave or become unable to perform services for our Company, our business could be severely harmed.

 

We may need additional capital that may not be available to us and, if raised, may dilute our stockholders’ ownership interest in us.

 

We may need to raise additional funds to develop or enhance our technologies, to fund expansion, to respond to competitive pressures or to acquire complementary products, businesses or technologies. Additional financing may not be available on terms that are acceptable to us. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced and these securities might have rights, preferences and privileges senior to those of our current stockholders. If adequate funds are not available on acceptable terms, our ability to fund our expansion, take advantage of unanticipated opportunities, develop or enhance our products or services, or otherwise respond to competitive pressures would be significantly limited.

 

If we are unable to effectively manage our growth, our business may be harmed.

 

Our future success depends on our ability to successfully manage our growth. Our ability to manage our business successfully in a rapidly evolving market requires an effective planning and management process. Our customers rely heavily on our technological expertise in designing and testing our products. Relationships with new customers may require significant engineering resources. As a result, any increase in the demand for our products will increase the requirements on our personnel, particularly our engineers.

Our historical growth, international expansion, and our strategy of being a provider of semiconductor IP platforms, have placed, and are expected to continue to place, a significant challenge on our managerial and financial resources as well as our financial and management controls, reporting systems and procedures. Although some new controls, systems and procedures have been implemented, our future growth, if any, will depend on our ability to continue to implement and improve operational, financial and management information and control systems on a timely basis, together with maintaining effective cost controls. Our inability to manage any future growth effectively would be harmful to our revenues and profitability.

 

New financial accounting standards related to equity compensation will cause us to recognize an additional expense and we expect the adoption of such standards will have a significant effect on our consolidated statements of operations.

 

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123R, “Shared-Based Payments” (SFAS 123R), which requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value based method and the recording of such expense in our consolidated statements of operations. The accounting provisions of SFAS No. 123R are effective for reporting periods beginning after June 15, 2005. On October 1, 2005, we adopted SFAS 123R. The adoption of this new financial accounting standard has had a significant effect on our consolidated statements of operations.

 

We have received assessment orders from the Government of India, Income Tax Department, Office of the Director of Income Tax (Indian Tax Authorities) proposing a tax deficiency in certain of our tax returns, and the outcome of the assessment or any future assessment involving similar claims may have an adverse effect on our consolidated statements of operations.

 

The Indian Tax Authorities completed its assessment of our tax returns for the tax years 2000 through 2003 and issued assessment orders in which the Indian Tax Authorities proposes to assess an aggregate tax deficiency for the three year period of approximately $1.5 million, plus interest, which interest will accrue until the matter is resolved. The Indian Tax Authorities may also make similar claims for years subsequent to 2003 in future assessment. The assessment orders are not final notices of deficiency, and we have immediately filed appeals to the appellate tax authorities. We believe that the assessments are inconsistent with the applicable tax laws and that we have meritorious defense to the assessments. However, the ultimate outcome cannot be predicted with certainty, including the amount payable or the timing of any such payments upon resolution of the matter. Should the Indian Tax Authorities assess additional taxes as a result of a current or a future assessment, we may be required to record charges to operations in future periods that could have an adverse effect on our consolidated statements of operations.

 

Risk Related to Our Industry

 

If demand for products incorporating complex semiconductors and semiconductor IP platforms does not increase, our business may be harmed.

 

Our business and the adoption and continued use of our IP by semiconductor companies depends on continued demand for products requiring complex semiconductors, embedded memories and logic elements, such as cellular and digital phones, pagers, PDAs, digital cameras, DVD players, switches and modems. The demand for such products is uncertain and difficult to predict, and it depends on factors beyond our control such as the competition faced by each customer, market acceptance of products that incorporate our IP and the financial and other resources of each customer. A reduction in the demand for products incorporating complex semiconductors and semiconductor IP or a decline in the general economic environment which results in the cutback of research and development budgets or capital expenditures would likely result in a reduction in demand for our products and could harm our business. In addition, with increasing complexity in each successive generation of semiconductors, we face the risk that the rate of adoption of smaller technology processes may slow down.

 

In addition, the semiconductor industry is highly cyclical. Significant economic downturns characterized by diminished demand, erosion of average selling prices, production overcapacity and production capacity constraints

are other factors affecting the semiconductor industry. As a result, we may face a reduced number of design starts, tightening of customers’ operating budgets, extensions of the approval process for new orders and projects and consolidation among our customers, all of which may harm the demand for our products and may cause us to experience substantial period-to-period fluctuations in our operating results. Further, the markets for third-party semiconductor IP have emerged only in recent years. Because of the recent emergence of these markets, it is difficult to forecast whether these markets will continue to develop or grow at a rate sufficient to support our business.

 

The market for semiconductor IP platforms can be highly competitive and dynamic. We may experience loss in market share to larger competitors with greater resources and/or our customer base may choose to develop semiconductor IP platforms using their own internal design teams.

 

We face competition from both existing suppliers of third-party semiconductor IP, as well as new suppliers that may enter the market. We also compete with the internal design teams of large, integrated device manufacturers. Many of these internal design teams have substantial programming and design resources and are part of larger organizations with substantial financial and marketing resources. These internal teams may develop technologies that compete directly with our technologies or may actively seek to license their own technologies to third parties, which could negatively affect our revenue and operating results. In addition, our existing customers may choose to develop their own technology solutions internally.

 

Many of our existing competitors have longer operating histories, greater brand recognition and larger customer bases, as well as greater financial and marketing resources, than we do. This may allow them to respond more quickly than we can to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources than we can to the development and promotion of their products. In addition, the intense competition in the market for semiconductor IP could result in pricing pressures, reduced license revenues, reduced margins or lost market share, any of which could harm our operating results and cause our stock price to decline.

 

The technology used in the semiconductor industry is rapidly changing and if we are unable to develop new technologies and adapt our existing IP to new processes, we will be unable to attract or retain customers.

 

The semiconductor industry has been characterized by an increasingly rapid rate of development of new technologies and manufacturing processes, rapid changes in customer requirements, frequent product introductions and ongoing demands for greater speed and functionality. Our future success depends on our ability to develop new technologies and introduce new products to the marketplace in a timely manner, and to adapt our existing IP to satisfy the requirements of new processes and our customers. If our development efforts are not successful or are significantly delayed, or if the enhancements or new generations of our products do not achieve market acceptance, we may be unable to attract or retain customers and our operating results could be harmed.

 

Our ability to continue developing technical innovations involves several risks, including:

 

 

If we are unable to adequately address these risks, our IP will become obsolete and we will be unable to sell our products. Further, as new technologies or manufacturing processes are announced, customers may defer licensing our IP until those new technologies become available or our IP has been adopted for that manufacturing process.

 

In addition, research and development requires a significant expense and resource commitment. Since we have a limited operating history, we are unable to predict our future resource requirements. As a result, we may not have the financial and other resources necessary to develop the technologies demanded in the future and may be unable to attract or retain customers.

 

General economic conditions and future terrorist attacks may reduce our revenues and harm our business.

 

As our business has grown, we have become increasingly subject to the risks arising from adverse changes in domestic and global economic conditions. Continued unrest in Israel and the Middle East may negatively impact the investments that our worldwide customers make in these geographic regions. If businesses or consumers defer or cancel purchases of new products that contain complex semiconductors, purchases by fabless semiconductor companies, integrated device manufacturers and production levels by semiconductor manufacturers could decline. This could adversely affect our revenues which in turn would have an adverse effect on our results of operations and financial condition.

 

Risk Related to Our Intellectual Property Rights

 

We rely on our proprietary technologies and we cannot assure you that the precautions taken to protect our rights will be adequate or that we will continue to be able to adequately secure such proprietary technologies from third parties.

 

We rely on a combination of patent, trademark, copyright, mask work and trade secret laws to protect our proprietary rights in our technologies. We cannot be sure that the United States Patent and Trademark Office will issue patents or trademarks 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. Furthermore, the laws of some foreign countries may not adequately protect our IP to the same extent as applicable laws protects our IP in the United States. For instance, some 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 license 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. 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 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 and patent the same technologies 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 and improperly disclose our proprietary technologies to others.

 

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.

 

We believe that our technologies do not infringe the IP rights of third parties to date. However, there are numerous patents in the semiconductor industry and new patents are being issued at a rapid rate. It is not always practicable to determine in advance whether our technologies infringe the patent right of others. As a result, we may be compelled to respond to infringement claims by third parties to protect our rights or defend our customers’ rights. These infringement claims, regardless of merit, could be costly and time-consuming, and divert our management

and key personnel from our business operations. In settling these claims, we may be required to pay significant damages and may be prevented from licensing some of our technologies 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. If available, the royalty or license agreement may include terms which require us to obtain a license from the third party to sell or use the relevant technology which may result in significant expenses to the Company or to redesign the technology which would be time consuming and costly to the Company. In the event that we are not be able to obtain such royalty or license agreements on terms acceptable to us, we may be prevented from licensing or developing our technology.

 

Risk Related to Our Stock

 

Our stock price may be volatile and could decline substantially.

 

The market price of our common stock has fluctuated significantly in the past, will likely continue to fluctuate in the future and may decline. Fluctuations or a decline in our stock price may occur regardless of our performance. Among the factors that could affect our stock price, in addition to our performance, are:

 

 

A sale of a substantial number of shares of our common stock may cause the price of our common stock to decline.

 

Sales of a substantial number of shares of our common stock in the public market could adversely affect the market price of our common stock. Adam Kablanian, President, Chief Executive Officer and a member of the Board of Directors, and Alexander Shubat, Vice President of Research and Development, Chief Technology Officer and a member of the Board of Directors, have adopted stock trading plans under Rule 10b5-1 of the Securities Exchange Act of 1934. Both plans are in effect for a one-year period ending on December 11, 2006, and are subject to predetermined price and volume limits. Sales transactions are also subject to the restrictions and filing requirements mandated by Securities and Exchange Commission Rule 144. Furthermore, our officers, directors and principal stockholders controled as of November 30, 2006 approximately 62% of our common stock. As a result, this significant concentration of share ownership may adversely affect the trading price of our common stock because investors often perceive disadvantages to owning stock in companies with controlling stockholders.

 

We determined that we had material weaknesses in our internal control over financial reporting as of September 30, 2005, and upon such determination we have implemented supplemental procedures to remediate identified material weaknesses and to ensure that our financial statements are fairly stated in all material respects. Such material weaknesses could adversely affect investor confidence in our financial reports and the market price of our common stock.

 

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, our management is required to access effectiveness of our internal control over financial reporting and assert that such internal control is effective. Our independent registered public accounting firm must evaluate management’s assessment concerning the effectiveness of our internal control over financial reporting and render an opinion on our assessment and the effectiveness of our internal control over financial reporting.

As reported in our Annual Report on Form 10-K for the year ended September 30, 2005, our management had identified three material weaknesses in our internal control over financial reporting. Specifically, we had material weaknesses in the calculation and recording of foreign currency translations, the presentation and disclosure of income taxes and the presentation and disclosure of the investments in the statements of cash flows. We have implemented procedures and processes to remediate such material weaknesses, which are costly and require significant efforts by management and other employees. As of September 30, 2006, we had remediated all of our material weaknesses. However, we can give no assurance that other material weaknesses will not be identified in the future. If further material weaknesses in our internal control are identified, this could cause our investors to lose confidence in the accuracy and completeness of our financial reports, which could adversely affect the market price of our common stock.

 

Our certificate of incorporation and bylaws as well as Delaware law contain provisions that could discourage transactions resulting in a change in control, which may negatively affect the market price of our common stock.

 

Our certificate of incorporation, our bylaws and Delaware law contain provisions that make it more difficult for another company to acquire control of our Company. In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our common stock. These provisions include:

 

 

We are also subject to Section 203 of the Delaware General Corporation Law, which provides, subject to enumerated exceptions, that if a person acquires 15% or more of our outstanding voting stock, the person is an “interested stockholder” and may not engage in any “business combination” with us for a period of three years from the time the person acquired 15% or more of our outstanding voting stock.

 

Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.

 

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ National Market rules, are creating uncertainty for companies such as ours. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed.

 

None.

 

Facilities

 

Our principal administrative, sales, marketing and research and development facility is in Fremont, California, and occupies approximately 61,500 square feet. This facility is leased through December 2007. We also lease additional offices in Seattle, Washington, and Clinton, New Jersey, that are occupied mainly by research and development and engineering personnel. The Seattle office, which occupies approximately 12,300 square feet, is leased through August 2010. The Clinton office, which occupies approximately 10,900 square feet, is leased through November 2010. In addition, we have development centers in Armenia and India. In September 2003, our development center in Armenia moved into a building owned by us. The office space is approximately 40,000 square feet and the total cost of the building was approximately $2.2 million. The development center in India is located in Noida, near Delhi, and occupies approximately 26,000 square feet in a building leased with a lease term under which the Company has the right, but not the obligation, to occupy the facility through July 2009.

 

The Company is not a party to any material legal proceeding which would have a material adverse effect on our consolidated financial position or results of operations.

 

None.

PART II

 

Market Price and Dividends on Virage Logic Common Stock

 

Our common stock is traded on the NASDAQ National Market under the symbol VIRL. The following table sets forth, for the periods indicated, the high and low closing prices for the common stock as reported on the NASDAQ National Market.

 

 

As of November 30, 2006, there were approximately 63 stockholders of record of our common stock.

 

The Company has never paid or declared any cash dividends on our common stock or other securities and does not anticipate paying cash dividends in the foreseeable future.

 

Equity Compensation Plan Information

 

The equity compensation plan information required to be provided in this Annual Report on Form 10-K is incorporated by reference to the Company’s proxy statement for the 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of our fiscal year ended September 30, 2006.

 

The selected consolidated financial data set forth below should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes thereto included elsewhere in this filing. The consolidated statements of operations data for each of the fiscal years ended September 30, 2006, 2005 and 2004 and the consolidated balance sheet data as of September 30, 2006 and 2005 have been derived from our audited consolidated financial statements included elsewhere in this filing. The consolidated statements of operations data for the fiscal years ended September 30, 2003 and 2002 and the consolidated balance sheet data as of September 30, 2004, 2003 and 2002 have been derived from our audited consolidated financial statements not included in this filing. The historical financial information may not be an accurate indicator of our future performance.

 

SELECTED CONSOLIDATED CONDENSED FINANCIAL DATA

 

 

 

The following discussion of our financial condition and results of operations should be read together with the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K . This discussion contains forward-looking statements, which involve risk and uncertainties. Our actual results could differ materially from those anticipated in the forward looking statements as a result of certain factors, including but not limited to those discussed in “Risk Factors” and in other documents we file from time to time with the Securities and Exchange Commission. See “Forward Looking Statements” in Part I of this Annual Report on Form 10-K.

 

Overview

 

Business Environment

 

Virage Logic provides semiconductor intellectual property (semiconductor IP) platforms comprising memories, logic and I/Os (input/output interface components). These various forms of IP are utilized by our customers to design and manufacture system-on-chip (SoC) integrated circuits that power today’s consumer, communications, internet infrastructure, handheld and portable devices, computer and graphics applications.

 

Our customers include fabless semiconductor companies, integrated device manufacturers and foundries. As semiconductor companies face increasing pressures to bring products to market faster and semiconductors have shorter product cycles, we focus on providing our customers a broad product offering as a means to satisfy a larger portion of our customers’ semiconductor IP needs, while positioning ourselves to offer advanced products as the semiconductor industry migrates to smaller geometries.

 

The timing of customer purchases of our products is typically related to new design starts by fabless companies and migration to new manufacturing processes by integrated device manufacturers and foundries. Because of the high costs involved in new design starts and migration to new manufacturing processes, our customers’ decision regarding these matters is heavily dependent on their long-term business outlook. As a result, our business, and specifically our license revenues, is likely to grow at times of positive outlook for the semiconductor industry.

 

In fiscal year 2006, we derived 53% of our license revenue from the more advanced processes, 90-nanometer and 65-nanometer technologies and 47% from the older process nodes, predominantly 0.13, 0.18, 0.25 and 0.35 micron technologies. The Company expects the 90-nanometer and 65-nanometer technologies to drive revenue growth in the foreseeable future while license revenues from the older process nodes decline. Our royalty revenue to date has been from production on the older process nodes, and we expect future growth in royalty revenues to be driven by the advanced processes, 65-nanometer and 90-nanometer technologies, in addition to continued production on the 0.13 and 0.18 micron technologies.

 

We sell our product early in the design process, and there are time delays of 24 to 36 months between the sale of our products and the time we expect to receive royalty revenues. These time delays are due to the length of time required for our customers to implement our semiconductor IP into their designs, and then to manufacture, market and sell a product incorporating our products. As a result, we expect our royalty revenues to increase in periods in

which manufacturing volumes of semiconductors are growing. Future growth of our royalty revenue is dependent on our ability to increase the number of designs incorporating our products and on such designs achieving substantial manufacturing volumes.

 

Sources of Revenues

 

Our revenues are derived principally from licenses of our semiconductor IP products, which include:

 

 

We also derive revenues from royalties, custom design services, maintenance services and library development and consulting services related to the license of logic components. Our revenues are reported in two separate categories: license revenues and royalty revenues. License revenues are derived from license fees, maintenance fees, fees for custom design services, library design services and consulting services. Royalty revenues are derived from fees paid by a customer or a third-party foundry based on production volumes of wafers containing chips utilizing our semiconductor IP technologies.

 

The license of our semiconductor IP typically covers a range of platform, embedded memory, logic and I/O products. Licenses of our semiconductor IP products can be either perpetual or term-based. In addition, maintenance can be purchased for both types of licenses.

 

We derive our royalty revenues from third-party foundries that manufacture chips incorporating our Area, Speed and Power (ASAP) memory products for our fabless customers, and from integrated device manufacturers and fabless customers that utilize our STAR Memory System^tm and NOVeA^® technologies. Royalty payments are in addition to the license fees we collect from our customers, and are calculated based on production volumes of wafers containing chips utilizing our semiconductor IP technologies based on a rate per-chip or rate per-wafer depending on the terms of the respective license agreement. Royalty revenues are generally determined and recognized one quarter in arrears, when a production volume report is received from the customer or foundry.

 

Currently, license fees represent a significant portion of our revenues, although over the last few years royalties have represented an increased percentage of our revenues. Royalty revenues for the years ended September 30, 2006, 2005, and 2004 were $16.1 million, $11.0 million, and $8.2 million, respectively.

 

We have been dependent on a limited number of customers for a substantial portion of our annual revenues, although that dependency continues to decrease. Customers comprising our top 10 customer group have changed from time to time. In each of fiscal year 2006 and fiscal year 2005 one customer, TSMC, generated 10% or more of our revenues. In fiscal year 2004, no single customer generated 10% or more of our revenues.

 

Sales to customers located outside North America accounted for 60%, 63% and 62% of our revenues in fiscal years 2006, 2005 and 2004, respectively. Substantially all of our direct sales representatives and field application engineers are located in North America and Europe and serve those regions. In Japan and the rest of Asia, we use both indirect sales through distributors and direct sales through sales representatives. All revenues to date have been denominated in U.S. dollars.

 

Significant Events in Fiscal Year 2006

 

 

 

Critical Accounting Policies and Estimates

 

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

 

The Company’s revenue recognition policy is based on the American Institute of Certified Public Accountants Statement of Position 97-2, “Software Revenue Recognition”, as amended by Statement of Position 98-4 and Statement of Position 98-9. Additionally, revenue is recognized on some of our products, according to Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.”

 

Revenues from perpetual licenses for the semiconductor IP products are generally recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable, and collectibility is reasonably assured. If any of these criteria are not met, revenue recognition is deferred until such time as all criteria are met. Revenues from term-based licenses are recognized ratably over the term of the license, which are generally twelve months in duration, provided the criteria mentioned above are met.

 

License of custom memory compilers and logic libraries may involve customization to the functionality of the software; therefore revenues from such licenses are recognized in accordance with Statement of Position 81-1 over the period that services are performed. Revenue derived from library development services are recognized using a percentage-of-completion method, and revenues from technical consulting services are recognized as the services are performed. For all license and service agreements accounted for using the percentage-of-completion method, the Company determines progress-to-completion based on labor hours incurred in comparison to the estimated total service hours required to complete the development or service or on the value of contract milestones completed. The Company believes that it is able to reasonably and reliably estimate the costs to complete projects accounted for using the percentage-of-completion method based on historical experience of similar project requirements. If the Company cannot reasonably and reliably estimate the costs to complete a project, the completed contract method of accounting is used, such that costs are deferred until the project is completed, at which time revenues and related costs are recognized. A provision for estimated losses on any project is made in the period in which the loss becomes probable and can be reasonably estimated. Costs incurred in advance of revenue recognition are recorded as costs in excess of related revenue on uncompleted contracts. If customer acceptance is required for completion of specified milestones, the related revenue is deferred until the acceptance criteria are met. If a portion of the value of a contract is contingent based on meeting a specified criteria, then the contingent value of the contract is deferred until the contingency has been satisfied or removed.

For agreements that include multiple elements, the Company recognizes revenues attributable to delivered or completed elements when such elements are completed or delivered. The amount of such revenues is determined by applying the residual method of accounting by deducting the aggregate fair value of the undelivered or uncompleted elements, which the Company determines by each such element’s vendor-specific objective evidence of fair value, from the total revenues recognizable under such agreement. Vendor-specific objective evidence of fair value of each element of an arrangement is based upon the higher of the normal pricing for such licensed product and service when sold separately or the actual price stated in the contract, and for maintenance, it is determined based on the higher of the actual price stated in the contract or the stated renewal rate in each contract. Revenues are recognized once the Company delivers the element identified as having vendor-specific objective evidence or once the provision of the services is completed. Maintenance revenues are recognized ratably over the remaining contractual term of the maintenance period from the date of delivery of the licensed materials receiving maintenance, which is generally twelve months.

 

The Company assesses whether the fee associated with each transaction is fixed or determinable and collection is reasonably assured and evaluates the payment terms. If a portion of the fee is due beyond normal payment terms, the Company recognizes the revenues on the payment due date, as long as collection is reasonably assured. The Company assesses collectibility based on a number of factors, including past transaction history and the overall credit-worthiness of the customer. If collection is not reasonably assured, revenue is deferred and recognized at the time collection becomes reasonably assured, which is generally upon receipt of the payment.

 

Amounts invoiced to customers in excess of recognized revenues are recorded as deferred revenues. Amounts recognized as revenue in advance of invoicing the customer are recorded as unbilled accounts receivable. 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 and unbilled accounts receivable in any given period. All of the criteria under SOP 97-2 or SOP 81-1, as applicable, have been met, prior to the recognition of any revenue that would create an unbilled accounts receivable balance.

 

Royalty revenues are generally determined and recognized one quarter in arrears based on SOP 97-2, 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. Prepaid royalties are recognized as revenue upon either the receipt of a corresponding royalty report or if the prepaid royalty is non-refundable.

 

Valuation of Accounts Receivable

 

We monitor collections and payments from our customers and maintain an allowance for estimated credit losses based upon 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 Purchased Intangibles, Including Goodwill

 

We periodically evaluate purchased intangibles, including goodwill, for impairment. An assessment of goodwill is subjective by nature, and significant management judgment is required to forecast future operating results, projected cash flows and current period market capitalization levels. If our estimates or related assumptions change in the future, these changes in conditions could require material write-downs of net intangible assets, including impairment charges for goodwill. The valuation of intangible assets was based on management’s estimates. Intangible assets with finite useful lives are amortized over the estimated life of each asset. As of September 30, 2006, management believes no impairment of intangible assets has occurred. The carrying value of purchased intangibles, including goodwill, is $11.8 million and $12.2 million as of September 30, 2006 and 2005, respectively. If the asset is deemed impaired, the maximum amount of impairment would be the full carrying value of the asset.

Valuation of Long-Lived Assets

 

We review the carrying value of our long-lived assets whenever events or changes in business circumstances or our planned use of assets indicate that their carrying amounts may not be fully recoverable or that their useful lives are no longer appropriate. This review is based upon our projections of anticipated future cash flows from such assets. While we believe that our estimates of future cash flows are reasonable, different assumptions regarding such cash flows could materially affect our evaluations, which could result in an impairment charge. As of September 30, 2006 the Company had an intangible value of $1.8 million related to technology acquired through the acquisition of In-Chip Systems, Inc.

 

Stock-based compensation

 

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123R, “Shared-Based Payments” (SFAS 123R), which requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value based method and the recording of such expense in our consolidated statements of operations. The accounting provisions of SFAS 123R are effective for fiscal periods beginning after June 15, 2005.

 

As of October 1, 2005, we adopted SFAS 123R. We now use the fair value method to apply the provisions of SFAS 123R with a modified prospective application which provides for certain changes to the method for valuing stock-based compensation. The valuation provisions of SFAS 123R apply to new awards and to unvested awards that were outstanding on the effective date. Under the modified prospective application, prior periods are not revised for comparative purposes. Total SFAS 123R compensation expense recognized for fiscal year ended September 30, 2006 was $6.7 million. As of September 30, 2006, total unrecognized estimated compensation expense related to non-vested stock options granted prior to that date was $7.9 million and will be amortized over the average of 1.6 years.

 

Prior to October 1, 2005, we accounted for stock-based awards under the intrinsic value method, which followed the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB Opinion No. 25), and related Interpretations. The intrinsic value method of accounting resulted in compensation expense for restricted stock and restricted stock units at fair value on date of grant based on the number of shares granted and the quoted price of our common stock, and for stock options to the extent option exercise prices were set below market prices on the date of grant. Also, to the extent stock awards were subject to an exchange offer, other modifications, or performance criteria, such awards were subject to variable accounting treatment. To the extent stock awards were forfeited prior to vesting, the corresponding previously recognized expense was reversed as an offset to operating expenses.

 

On November 10, 2005, FASB issued FASB Staff Position (FSP) FAS 123R-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” Effective upon issuance, this FSP describes an alternative transition method for calculating the tax effects of stock-based compensation pursuant to SFAS 123R. The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and the statement of cash flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123R. Companies have one year from the later of the adoption of SFAS 123R or the effective date of the FSP to evaluate their transition alternatives and make a one-time election. As a result, we have elected the “short-cut” method, as defined in the FAS 123R-3 to establish our APIC pool required under SFAS 123R for fiscal year ended September 30, 2006.

 

We value our stock-based awards on the date of grant using the Black-Scholes model. Prior to the adoption of SFAS 123R, the value of each stock-based award was estimated on the date of grant using the Black-Scholes option-pricing model (Black-Scholes model) for the pro forma information required to be disclosed under SFAS 123. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

For purposes of estimating the fair value of stock options granted during the fiscal year ended September 30, 2006 using the Black-Scholes model, we have made an estimate regarding our stock price volatility using the historical volatility in our stock price for the expected volatility assumption input to the model. This approach is consistent with the guidance in SFAS 123R and the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107 (SAB 107).

 

The risk-free interest rate is based on the implied yield currently available on United States Treasury zero-coupon issues with a remaining term equal to the expected term of the options on the grant date.

 

Furthermore, as required under SFAS 123R, we now estimate forfeitures for options granted which are not expected to vest. We calculate the pre-vesting forfeiture rate by using our historical option cancellation information.

 

If factors change and we employ different assumptions in the application of SFAS 123R in future periods, the compensation expense that we record under SFAS 123R may differ significantly from what we have recorded in the current period. Therefore, we believe it is important for investors to be aware of the high degree of subjectivity involved when using option pricing models to estimate stock-based compensation under SFAS 123R. There is a risk that our estimates of the fair values of our stock-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those stock-based payments in the future. Certain stock-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. There is currently no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values. Although the fair value of employee stock-based awards is determined in accordance with SFAS 123R and SAB 107 using an option-pricing model, such value may not be indicative of the fair value observed in a willing buyer /willing seller market transaction.

 

Accounting for Income Taxes

 

We calculate our income taxes based on an estimated annual effective tax rate in compliance with SFAS No. 109 “Accounting for Income Taxes.” Under SFAS No. 109, income tax expense (benefit) is recognized for the amount of taxes payable or refundable for the current year, and for deferred tax assets and liabilities for the tax consequences of events that have been recognized in an entity’s financial statements or tax returns. However, as required by FASB Interpretation No. 18, “Accounting for Income Taxes in Interim Periods” (FIN 18), the impact of items of tax expense (or benefit) that do not relate to “ordinary income” in the current year generally should be accounted for discretely in the period in which it occurs and be excluded from the effective tax rate calculation. As a result the Company reported a discrete tax benefit of approximately $95,000 relating primarily to disqualifying dispositions of incentive stock options which had previously been expensed for generally accepted accounting principles purposes. Significant components affecting the tax rate include an increase from stock-based compensation relating to non-deductible incentive stock options and the composite state tax rate.

 

For financial statement purposes, we make certain estimates and judgments in determining income tax expense. These estimates and judgments occur in the calculation of tax credits, tax benefits, deductions and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. If actual results differ from our estimates, future income tax expense could be materially affected.

 

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 $10.1 million and deferred tax liabilities of $0.7 million as of September 30, 2006. We assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not more likely than not, we increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that substantially all of the deferred tax assets recorded on our balance sheet will ultimately be recovered. However, should there be a change in our ability to recover our deferred

tax assets, our tax provision would increase in the period in which we determined that the recovery was not more likely than not.

 

In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for anticipated tax audit issues in the United States and other tax jurisdictions based on our estimate of whether, and the extent to which, additional tax payments are probable. If we ultimately determine that payment of these amounts is unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is less than we expect the ultimate assessment to be. Taxes payable were $2.6 million and $1.4 million as of September 30, 2006 and 2005, respectively.

 

Results of Operations

 

Comparison of the Years Ended September 30, 2006 and 2005

 

Revenues

 

The table below sets forth the changes in revenues from fiscal year 2005 to fiscal year 2006 (in thousands, except percentage data):

 

 

Revenues increased $5.9 million or 11.1% from fiscal year 2005 to fiscal year 2006. The fiscal year 2006 increase in revenue was primarily due to increase in royalty revenue of $5.1 million.

 

The following table lists the percentage of license revenues by process node for the years ended September 30, 2006 and 2005.

 

 

License revenues for the year ended September 30, 2006 were $43.2 million, representing an increase of $0.8 million or 1.9% as compared to $42.4 million for fiscal year 2005. License revenue increased in fiscal year 2006 mainly attributable to increases of $3.5 million on our 90-nanometer technology and $1.6 million on our 65-nanometer, partially offset by decreases of $2.4 million on the 0.13 micron and $1.9 million on the older technologies. From a product perspective, 90-nanometer technology contributed sales of 43% of total in fiscal year 2006 up from 36% in fiscal year 2005, while 65-nanometer technology license revenue grew from 6% in fiscal year 2005 to 10% of total license revenue in fiscal year 2006. These sales were derived from all categories of our customers: integrated device manufacturers, fabless and foundry semiconductor customers.

 

Royalties increased $5.1 million from fiscal year 2005 to fiscal year 2006. The fiscal year 2006 increase was primarily attributed to the growth in royalties associated with our 90-nanometer technology processes. We expect growth in royalty revenues to be driven by the advanced 90-nanometer and 65-nanometer technology processes, in addition to continued production on the older process nodes.

For the years ended September 30, 2006 and 2005, total revenues by geographic area are as follows:

 

 

From a geographic perspective, the fiscal year 2006 increase was a result from significant sales increases due to new license agreements with certain existing customers using our memory systems substantially in Taiwan of $3.8 million and in North America of $3.8 million, partially offset by declining volumes in Japan of $1.2 million.

 

Cost and Expenses

 

The table below sets forth the changes in cost and expenses from fiscal year 2005 to fiscal year 2006 (in thousands, except percentage data):

 

 

Cost of Revenues

 

Cost of revenues is determined principally based on allocation of costs associated with custom contracts and maintenance contracts, which consist primarily of personnel expenses, allocation of facilities costs, and depreciation expenses of acquired software and capital equipment. Cost of revenues in fiscal year 2006 totaled $14.8 million, representing an increase of $1.8 million or 13.6% compared to $13.0 million in fiscal year 2005. The increase from fiscal year 2005 to fiscal year 2006 was primarily attributable to $1.0 million of stock-based compensation expense related to the adoption of SFAS 123R and $0.4 million related to previously deferred contract expenses associated with custom projects. We believe that cost of revenues will continue to fluctuate in the future, both in absolute dollars and as a percentage of revenues, based the impact on SFAS 123R and the level of license revenues.

 

Research and Development

 

Research and development expenses primarily include personnel expense, software license and maintenance fees, as well as capital equipment depreciation expenses. Research and development expense for the year ended September 30, 2006 was $21.4 million, representing an increase of $1.6 million or 7.9%, from $19.8 million for the year ended September 30, 2005. Research and development expense as a percentage of total revenue for the year ended September 30, 2006 decreased to 36.1% from 37.2% for the same period in fiscal year 2005. The increase in research and development expense from fiscal year 2005 to fiscal year 2006 was primarily due to $1.6 million

expense in stock-based compensation related to the adoption of SFAS 123R and an increase of $0.6 million in software license and maintenance fees, partially offset by decreases of $0.3 million in depreciation and $0.3 million of bonus expenses.

 

Sales and Marketing

 

Sales and marketing expense consists mainly of personnel expenses, commissions, advertising and promotion-related costs. Sales and marketing expense for the year ended September 30, 2006 was $16.9 million, representing an increase of $1.3 million or 8.0% over $15.6 million for the same period in fiscal year 2005. For the year ended September 30, 2006, sales and marketing expense as a percentage of revenue was 28.4%, compared to 29.2% for the same period in fiscal year 2005. The increase in sales and marketing expense in fiscal year 2006 was primarily due to $1.7 million expense in stock-based compensation related to the adoption of SFAS 123R and an increase of $1.0 million in personnel related expenses mainly in commissions for internal sales reps, partially offset by decreases in marketing programs of $0.8 million related to tradeshow and advertising expenses and travel expenses of $0.3 million due to cost reduction. In addition, the increase was partially offset by stock-based compensation expense under APB Opinion No. 25 of $0.3 million in fiscal year 2005 related to the accelerated vesting of certain stock options.

 

General and Administrative

 

General and administrative expense consists primarily of personnel, corporate governance and other costs associated with the management of our business. General and administrative expense for the year ended September 30, 2006 was $10.3 million, representing an increase of $1.2 million or 13.6% over $9.1 million for the year ended September 30, 2005. General and administrative expense as a percentage of total revenue was 17.4% for the year ended September 30, 2006, compared to 17.0% for the same period in fiscal year 2005. The increase in general and administrative expense from fiscal year 2005 to fiscal year 2006 was primarily due to $2.4 million expense in stock-based compensation related to the adoption of SFAS 123R and an increase of $0.3 million of personnel related expenses due to increase in headcount, partially offset by decreases in bad debt expenses of $1.1 million primarily related to the collection of previously reserved accounts receivable and professional fees of $0.4 million primarily related to accounting fees and insurance.

 

Interest Income and Other Income (Expenses), net

 

The table below sets forth the changes in interest income and other income (expenses), net from fiscal year 2005 to fiscal year 2006 (in thousands, except percentage data):

 

 

Interest Income

 

Interest income was $3.1 million and $1.7 million for the years ended September 30, 2006 and 2005, respectively. Interest income increased from fiscal year 2005 to fiscal year 2006 due to increased average balances of our investment holdings and higher interest rate received on our portfolio of marketable securities.

Other Income (Expenses), net

 

Other income (expenses), net resulted in a net other income of $270,000 in the year ended September 30, 2006 and net other expense of $37,000 for the year ended September 30, 2005. The net other income in fiscal year 2006 and net other expense in fiscal year 2005 were primarily due to foreign exchange gain (loss) on foreign currencies.

 

Income Tax Provision (Benefit)

 

The table below sets forth the changes in income tax provision (benefit) from fiscal year 2005 to fiscal year 2006 (in thousands, except percentage data):

 

 

For fiscal year 2006, we recorded a tax provision of $0.1 million on a pre-tax loss of $0.8 million, yielding an effective tax rate of (16%). For fiscal year 2005, we recorded a tax benefit of $2.2 million on a pre-tax loss of $2.5 million, yielding an effective benefit tax rate of 87%. The fiscal year 2005 effective tax rate differs from the United States statutory tax rate primarily due to benefits related to current year research credits, recovery of tax deductions related to stock-based compensation and other immaterial items. The change in the effective tax rate from fiscal year 2005 to fiscal year 2006 was primarily due to the change in the Company’s pre-tax position, research credits, stock-based compensation related to the non-deductibility of incentive stock options and recovery of tax deductions for stock-based compensation.

 

Additionally, the Indian Tax Authorities completed its assessment of our tax returns for the tax years 2000 through 2003 and issued assessment orders in which the Indian Tax Authorities proposes to assess an aggregate tax deficiency for the three year period of approximately $1.5 million, plus interest, which interest will accrue until the matter is resolved. The Indian Tax Authorities may also make similar claims for years subsequent to 2003 in future assessment. The assessment orders are not final notices of deficiency, and we have immediately filed appeals. We believe that the assessments are inconsistent with applicable tax laws and that we have meritorious defense to the assessments.

 

In fiscal year 2005, we made a deposit in local currency equivalent to approximately $260,000 U.S. dollars with the Indian Tax Authorities, as required.

 

The ultimate outcome of the tax assessment cannot be predicted with certainty, including the amount payable or the timing of any such payments upon resolution of the matter. Should the Indian Tax Authorities assess additional taxes as a result of a current or a future assessment, we may be required to record charges to operations that could have an adverse effect on our consolidated statements of operations.

 

Comparison of the Years Ended September 30, 2005 and 2004

 

Revenues

 

The table below sets forth the changes in revenues from fiscal year 2004 to fiscal year 2005 (in thousands, except percentage data):

 

Revenues increased $0.4 million or 0.7% in fiscal year 2005 from fiscal year 2004. The fiscal year 2005 increase in revenue was the result of increases in royalty revenue of $2.7 million partially offset by a decline in license revenue of $2.3 million.

 

The following table lists the percentage of license revenues by process node for the years ended September 30, 2005 and 2004.

 

 

License revenue for the year ended September 30, 2005 was $42.4 million, representing a decrease of $2.3 million or 5.2% as compared to $44.7 million for the year ended September 30, 2004. From a product perspective, 65-nanometer technology license revenue grew $2.3 million, while 90-nanometer technology contributed sales of 36% of total in fiscal year 2005 up from 32% in fiscal year 2004. These sales were derived from all categories of our customers: integrated device manufacturers, fabless and foundry semiconductor customers. During fiscal year 2005, the percent of our license revenues derived from 0.13 micron technology decreased from 47% for fiscal year 2004 to 40% for fiscal year 2005, a drop of $4.1 million from fiscal year 2004. The decrease in license revenues was primarily due to what we believe are fewer project design starts by fabless semiconductor customers on the 0.13 micron technology.

 

Royalties increased $2.7 million or 33.3% from fiscal year 2004 to fiscal year 2005. The fiscal year 2005 increase was supported by customers using our memory based product family.

 

For the years ended September 30, 2005 and 2004, total revenues by geographic area are as follows:

 

 

From a geographic perspective, the fiscal year 2005 increase resulted primarily from significant sales increases in Taiwan of $4.9 million, the United States of $0.8 million and other geographic segments of $0.2 million, partially offset by declining volumes in Europe, Middle East and Africa of $3.3 million, Japan of $1.2 million and Canada of $1.0 million.

Cost and Expenses

 

The table below sets forth the changes in cost and expenses from fiscal year 2004 to fiscal year 2005 (in thousands, except percentage data):

 

 

Cost of Revenues

 

Cost of revenues is determined principally based on allocation of costs associated with custom contracts and maintenance contracts, which consist primarily of personnel expenses, allocation of facilities costs, and depreciation expenses of acquired software and capital equipment. Cost of revenues for the year ended September 30, 2005 totaled $13.0 million, representing an increase of $1.8 million or 15.9% over $11.2 million for the year ended September 30, 2004. The increase between fiscal year 2004 and fiscal year 2005 was due to increases of $1.6 million in personnel expenses associated with increased headcount and $0.5 million in third-party contractor expenses, partially offset by a decrease of $0.3 million in hardware and software tools expenses. Cost of revenues included $0 and $29,000 of amortization of stock-based compensation under APB Opinion No. 25 for the years ended September 30, 2005 and 2004, respectively.

 

Research and Development

 

Research and development expenses primarily include personnel expense, software license and maintenance fees, as well as capital equipment depreciation expenses. Research and development expense for the year ended September 30, 2005 was $19.9 million, an increase of $1.4 million, or 7.4%, from $18.5 million for the year ended September 30, 2004. Research and development expense as a percentage of total revenue for the year ended September 30, 2005 increased to 37.2% from 34.9% for the same period in fiscal year 2005. The increase in research and development expense from fiscal year 2004 to fiscal year 2005 was due to increases in software license and maintenance fees of $1.0 million, contractor expenses of $0.8 million, travel and telecommunications of $0.3 million and personnel expenses of $0.2 million. This increase was partially offset by decreases in bonus expense of $0.5 million and depreciation expense of $0.4 million. Research and development expense included $0 and $48,000 of amortization of stock-based compensation under APB Opinion No. 25 for the years ended September 30, 2005 and 2004, respectively.

 

Sales and Marketing

 

Sales and marketing expense consists mainly of personnel expenses, commissions, advertising and promotion-related costs. Sales and marketing expense for the year ended September 30, 2005 was $15.6 million, representing an increase of $1.0 million or 6.5% over $14.6 million for the same period in fiscal year 2004. Sales and marketing as a percentage of revenues was 29.2% in fiscal year 2005, increase from 27.6% in fiscal year 2004. The increase in sales and marketing expense in fiscal year 2005 compare to fiscal year 2004 was primarily due to $0.3 million of stock-based compensation under APB opinion No. 25 and increases of $0.8 million in personnel expenses due to increased headcount, $0.4 million in marketing communications, advertising and promotion costs, $0.2 million in travel costs associated with increased headcount, $0.1 million in telecommunication costs and $0.1 million in recruiting expenses, partially offset by decreases of $0.5 million in commissions for third party sales reps, $0.1 million in bonuses for internal sales reps and $0.3 million in facilities and IT expenses allocated to marketing

and sales. Sales and marketing expense included $339,000 and $37,000 of amortization of stock-based compensation under APB Opinion No. 25 for the years ended September 30, 2005 and 2004, respectively.

 

General and Administrative

 

General and administrative expense consists primarily of personnel, corporate governance and other costs associated with the management of our business. General and administrative expense for the year ended September 30, 2005 was $9.1 million, representing an increase of $2.5 million or 37.2% over $6.6 million for the year ended September 30, 2004. General and administrative expense as a percentage of total revenue was 17.0% for the year ended September 30, 2005, compared to 12.5% for the same period in fiscal year 2004. The increase in general and administrative expense between fiscal year 2004 and fiscal year 2005 was primarily due to additional costs of $1.8 million related to Sarbanes-Oxley implementation costs, $0.5 million of increased accounting, audit and outside service fees, the increase in personnel related expense of $0.8 million, an aggregate increase in IT, employee benefits and facilities of $0.5 million and increased legal fees of $0.2 million. These increases were partially offset by the decreases in business insurance, bonuses, depreciation and facilities expense of $1.2 million. General and administrative expense included $0 and $16,000 of amortization of stock-based compensation under APB Opinion No. 25 for the years ended September 30, 2005 and 2004, respectively.

 

Interest Income and Other Income (Expenses), net

 

The table below sets forth the changes in interest income and other income (expenses), net from fiscal year 2004 to fiscal year 2005 (in thousands, except percentage data):

 

 

Interest Income

 

Interest income was $1.7 million and $0.7 million for the years ended September 30, 2005 and 2004, respectively. Interest income increased from fiscal year 2004 to fiscal year 2005 due to higher interest rates and increased average balances of our investment holdings.

 

Other Income (Expenses), net

 

Other income (expenses), net resulted in a net other expense of $37,000 in the year ended September 30, 2005 and net other income of $37,000 for the year ended September 30, 2004. The net other expense in fiscal year 2005 is primarily due to foreign exchange loss on foreign currencies in the amount of $23,000. The net other income in fiscal year 2004 primarily includes foreign exchange gain on foreign currencies in the amount of $27,000.

Income Tax Provision (Benefit)

 

The table below sets forth the changes in income tax provision (benefit) from fiscal year 2004 to fiscal year 2005 (in thousands, except percentage data):

 

 

For fiscal year 2005, we recorded a tax benefit of $2.2 million on a pre-tax loss of $2.5 million, yielding an effective benefit tax rate of 87%. For fiscal year 2004, we recorded a provision of $0.9 million on a pre-tax income of $2.8 million, yielding an effective tax rate of 31%. The fiscal year 2005 effective tax rate differs from the United States statutory tax rate primarily due to benefits related to current year research credits, recovery of tax deductions related to stock based compensation programs and other immaterial items. The change in the effective tax rate from fiscal year 2004 to fiscal year 2005 is primarily due to the change in the Company’s pre-tax position, research credits and recovery of tax deductions for stock based compensation programs.

 

Additionally, the Indian Tax Authorities completed its assessment of our tax returns for the tax years 2000 through 2003 and issued assessment orders in which the Indian Tax Authorities proposes to assess an aggregate tax deficiency for the three year period of approximately $1.5 million, plus interest, which interest will accrue until the matter is resolved. The Indian Tax Authorities may also make similar claims for years subsequent to 2003 in future assessment. The assessment orders are not final notices of deficiency, and we have immediately filed appeals. We believe that the assessments are inconsistent with applicable tax laws and that we have meritorious defense to the assessments.

 

In fiscal year 2005, we made a deposit in local currency equivalent to approximately $260,000 U.S. Dollars with the Indian Tax Authorities, as required.

 

Liquidity and Capital Resources

 

 

As of September 30, 2006, cash, cash equivalents and investments were $77.6 million compared to $67.8 million as of September 30, 2005, and $63.1 million as of September 30, 2004. We had an increase of $9.8 million in cash, cash equivalents and investments from fiscal year 2005 to fiscal year 2006 and an increase of $4.7 million from fiscal year 2004 to fiscal year 2005. In fiscal years 2006, 2005 and 2004, operations were funded primarily from cash collections of accounts receivable.

Net cash provided by operating activities was $8.5 million, $2.5 million and $3.5 million for fiscal years 2006, 2005 and 2004, respectively. Net cash provided by operating activities was $8.5 million for the year ended September 30, 2006, representing an increase of $6.0 million over net cash provided in operating activities of $2.5 million for the year ended September 30, 2005. The increase in cash provided by operating activities was due to an increase of $3.6 million in non-cash items primarily associated with stock-based compensation expense due to the adoption of SFAS 123R, partially offset by a decrease in provision for (recovery of) doubtful accounts, lower cash generated from tax benefit on employee stock plans and less depreciation and amortization due to more fully depreciated assets during the current fiscal year compared to the same period in prior year. In addition, we had change in operating assets and liabilities that resulted in cash increases of $3.0 million primarily related to increases in income taxes payable, accrued expenses, deferred tax assets and prepaid expenses related to software license contracts partially offset by changes in accounts receivable due to more billings at the end of fiscal year 2006 and in taxes receivable. These increases were partially offset by an increase in net loss of $0.6 million.

 

Net cash provided by operating activities of $2.5 million for the year ended September 30, 2005, representing a decrease of $1.0 million over net cash provided in operating activities of $3.5 million for the year ended September 30, 2004. The decrease in cash provided by operating activities was primarily due to a decrease in net income of $2.2 million. The decrease was partially offset by an increase of $1.1 million in non-cash items primarily associated with higher tax benefit on employee stock plans, partially offset by depreciation and amortization due to more fully depreciated assets during the current fiscal year compared to the same period in prior year. In addition, we had an increase in operating assets and liabilities of $0.1 million primarily related to increases of accounts receivable and taxes receivable partially offset by decreases in income taxes payable, deferred revenue, accrued expenses and deferred tax assets.

 

Net cash used in investing activities was $17.0 million, $10.5 million and $15.8 million for fiscal years 2006, 2005 and 2004, respectively. The increase of $6.5 million in net cash used in investing activities in fiscal year 2006 from fiscal year 2005 was primarily due to lower proceeds from the maturity of investments reinvested. The decrease of $5.3 million in net cash used in investing activities in fiscal year 2005 from fiscal year 2004 was due to higher proceeds from the maturity of investments, partially offset by higher purchases of investments related to short-term treasury investing activities.

 

Net cash provided by financing activities was $2.8 million, $6.1 million and $2.1 million for fiscal years 2006, 2005 and 2004, respectively. Net cash provided by financing activities in fiscal 2006, fiscal 2005 and fiscal 2004 reflects proceeds from the issuance of common stock of $2.8 million, $6.1 million and $2.1 million, respectively, associated with our employee stock options and employee stock purchase plans during the respective periods. The decrease in fiscal year 2006 was due to lower employee stock purchase plan purchases during the year.

 

The Company has no off-balance-sheet financing arrangements other than operating leases.

 

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 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 (in thousands):

 

 

 

Quarterly Results of Operations

 

The following tables contain unaudited consolidated statement of operations data for our eight most recent quarters. The first table contains revenue and expense data expressed in dollars, while the second table contains the same data expressed as a percentage of our revenues for the periods indicated. This data has been derived from unaudited consolidated financial statements that, in our opinion, include all adjustments necessary for a fair statement of the information. Our quarterly results have been in the past, and in the future may be, subject to fluctuations. As a result, we believe that results of operations for the interim periods may not be an accurate indicator of results for any future period.