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Virage Logic 10-Q 2009

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q for the quarterly period ended December 31, 2008
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(MARK ONE)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2008

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

FOR THE TRANSITION PERIOD FROM              TO             

COMMISSION FILE NUMBER: 000-31089

 

 

VIRAGE LOGIC CORPORATION

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

 

 

DELAWARE   77-0416232

(STATE OR OTHER JURISDICTION OF

INCORPORATION OR ORGANIZATION)

 

(I.R.S. EMPLOYER

IDENTIFICATION NO.)

VIRAGE LOGIC CORPORATION

47100 BAYSIDE PARKWAY

FREMONT, CALIFORNIA 94538

(510) 360-8000

(ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER,

INCLUDING AREA CODE, OF PRINCIPAL EXECUTIVE OFFICE)

 

 

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer x
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)    Smaller reporting company ¨

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

As of January 30, 2009, there were 22,846,871 shares of the Registrant’s Common Stock outstanding.

 

 

 


Table of Contents

VIRAGE LOGIC CORPORATION

FORM 10-Q

INDEX

 

          PAGE
   Part I. Financial Information   
Item 1.    Financial Statements   
   Unaudited Condensed Consolidated Balance Sheets – December 31, 2008 and September 30, 2008    3
   Unaudited Condensed Consolidated Statements of Operations – Three Months Ended December 31, 2008 and December 31, 2007    4
   Unaudited Condensed Consolidated Statements of Cash Flows – Three Months Ended December 31, 2008 and December 31, 2007    5
   Notes to Unaudited Condensed Consolidated Financial Statements    6
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    16
Item 3.    Quantitative and Qualitative Disclosures about Market Risks    25
Item 4.    Controls and Procedures    25
   Part II. Other Information   
Item 1.    Legal Proceedings    25
Item 1A.    Risk Factors    26
Item 2.    Unregistered sales of equity securities    35
Item 3.    Exhibits    35
Signatures    36
Exhibit Index    37

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

VIRAGE LOGIC CORPORATION

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

 

     December 31,
2008
    September 30,
2008
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 31,876     $ 13,214  

Short-term investments

     28,844       31,148  

Accounts receivable, net

     12,145       16,526  

Costs in excess of related billings on uncompleted contracts

     1,001       972  

Deferred tax assets – current

     1,320       1,255  

Prepaid expenses and other

     4,757       4,995  

Taxes receivable

     2,837       2,733  
                

Total current assets

     82,780       70,843  

Property, plant and equipment, net

     4,324       3,966  

Goodwill

     11,781       11,751  

Other intangible assets, net

     5,939       6,270  

Deferred tax assets – long-term

     14,759       14,548  

Long-term investments

     4,573       21,443  

Other long-term assets

     379       383  
                

Total assets

   $ 124,535     $ 129,204  
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities:

    

Accounts payable

   $ 1,179     $ 1,023  

Accrued expenses

     6,630       5,678  

Deferred revenues

     8,020       8,866  

Income taxes payable

     —         1,702  
                

Total current liabilities

     15,829       17,269  

Income tax liabilities

     1,083       1,083  

Other long-term accruals

     151       150  
                

Total liabilities

     17,063       18,502  
                

Commitments and contingencies (Note 7)

     —         —    

Stockholders’ equity:

    

Common stock, $.001 par value; Authorized shares – 150,000,000 as of December 31, 2008 and September 30, 2008; issued and outstanding shares – 23,736,871 and 23,649,295 as of December 31, 2008 and September 30, 2008, respectively

     24       24  

Additional paid-in capital

     141,175       141,220  

Accumulated other comprehensive income

     199       207  

Treasury stock, at cost (890,000 shares as of December 31, 2008 and 700,000 shares as of September 30, 2008)

     (5,130 )     (4,564 )

Accumulated deficit

     (28,796 )     (26,185 )
                

Total stockholders’ equity

     107,472       110,702  
                

Total liabilities and stockholders’ equity

   $ 124,535     $ 129,204  
                

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

 

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VIRAGE LOGIC CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts)

 

     Three Months Ended
December 31,
 
     2008     2007  

Revenues:

    

License

   $ 6,561     $ 8,443  

Maintenance

     1,940       2,318  

Royalties

     2,848       3,299  
                

Total revenues

     11,349       14,060  
                

Costs and expenses:

    

Cost of revenues

     2,569       2,447  

Research and development

     9,019       5,858  

Sales and marketing

     2,667       3,593  

General and administrative

     2,121       1,775  

Restructuring

     —         (3 )
                

Total costs and expenses

     16,376       13,670  
                

Operating income (loss)

     (5,027 )     390  

Interest income

     388       966  

Other income

     260       201  
                

Income (loss) before income taxes

     (4,379 )     1,557  

Income tax provision (benefit)

     (1,768 )     465  
                

Net income (loss)

   $ (2,611 )   $ 1,092  
                

Net income (loss) per share:

    

Basic

   $ (0.11 )   $ 0.05  
                

Diluted

   $ (0.11 )   $ 0.05  
                

Weighted average shares used in computing per share amounts:

    

Basic

     22,936       23,419  
                

Diluted

     22,936       23,733  
                

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

 

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VIRAGE LOGIC CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Three Months Ended  
     December 31,
2008
    December 31,
2007
 

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income (loss)

   $ (2,611 )   $ 1,092  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

    

Depreciation and amortization

     315       392  

Amortization of intangible assets

     331       147  

Stock-based compensation

     75       416  

Excess tax benefit from stock-based compensation

     (99 )     —    

Changes in operating assets and liabilities:

    

Accounts receivable

     4,381       2,891  

Costs in excess of revenue on uncompleted contracts

     (39 )     (255 )

Prepaid expenses and other

     218       753  

Taxes receivable

     (105 )     (230 )

Deferred tax assets

     (278 )     (150 )

Other long-term assets

     5       107  

Accounts payable

     160       (441 )

Accrued expenses and other long-term liabilities

     851       (502 )

Deferred revenue

     (846 )     (3,085 )

Current and non-current income taxes liability

     (1,691 )     362  
                

Net cash provided by operating activities

     667       1,497  
                

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Purchase of property, plant and equipment

     (717 )     (148 )

Purchase of investments

     (2,405 )     (26,301 )

Proceeds from maturities of investments

     21,966       30,596  
                

Net cash provided by investing activities

     18,844       4,147  
                

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from issuance of common stock

     6       1,355  

Cash paid for stock repurchase

     (566 )     —    

Excess tax benefit from stock-based compensation

     99       —    
                

Net cash provided by (used in) financing activities

     (461 )     1,355  
                

Effect of exchange rates on cash

     (388 )     (164 )
                

Net increase in cash and cash equivalents

     18,662       6,835  

Cash and cash equivalents at beginning of period

     13,214       14,820  
                

Cash and cash equivalents at end of period

   $ 31,876     $ 21,655  
                

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

 

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VIRAGE LOGIC CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Description of Business

Virage Logic Corporation (Virage Logic or the Company) was incorporated in California in November 1995 and subsequently reincorporated in Delaware in July 2000. The Company provides semiconductor intellectual property (IP) including the following embedded memories including SRAM and non-volatile memory (NVM): logic libraries, IP and development infrastructure for embedded test and repair of on-chip memory instances, software development tools used to build memory compilers, and Double Date Rate (DDR) memory controllers, Physical Interfaces (PHYs) and Delay Locked Loops (DLLs). These various forms of IP are utilized by the Company’s customers to design and manufacture system-on-a-chip (SoC) integrated circuits that power today’s consumer, communications and networking, handheld and portable devices, computer and graphics, and automotive applications.

Basis of Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, and in accordance with the instructions to Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements, and should be read in conjunction with the Company’s audited consolidated financial statements for the fiscal year ended September 30, 2008 contained in the Company’s 2008 Annual Report on Form 10-K. In the opinion of management, the unaudited interim financial statements reflect all adjustments, consisting only of normal, recurring adjustments necessary for a fair statement of the financial position, results of operations and cash flows for the periods indicated. Operating results for the three months ended December 31, 2008 are not necessarily indicative of the results that may be expected for any subsequent interim period or for the fiscal year ending September 30, 2009.

The accompanying unaudited condensed consolidated financial statements include the accounts of Virage Logic Corporation and its wholly-owned subsidiaries and operations located in the Republic of Armenia (Armenia), Germany, India, Israel, Japan and the United Kingdom. All intercompany balances and transactions have been eliminated upon consolidation.

Reclassification

Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation. Specifically, the Company has reclassified certain prior year amounts relating to the classification of revenues to show maintenance revenues separately. The effects of these reclassifications are not material to the consolidated financial statements.

Foreign Currency

The financial position and results of operations of the Company’s foreign operations are measured using currencies other than the U.S. dollar as their functional currencies. Accordingly, for these operations all assets and liabilities are translated into U.S. dollars at the current exchange rates as of the respective balance sheet dates. Revenue and expense items are translated using the weighted average exchange rates prevailing during the period. Cumulative gains and losses from the translation of these operations’ financial statements are reported as a separate component of stockholders’ equity, while foreign currency transactions gains or losses, resulting from remeasuring local currencies to the U.S. dollar are recorded in the consolidated statements of operations in other income (expenses), net.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Accounting for Internal-Use Computer Software

In March 1998, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” (SOP 98-1). SOP 98-1 provides guidance on accounting for the costs of computer software developed or obtained for internal use and identifies the characteristics of internal-use software. SOP 98-1 permits the capitalization of certain costs, including internal payroll costs, incurred in the connection with the development or acquisition of software for internal use. These costs are capitalized beginning when the Company has entered the application development stage and ceases when the software is substantially complete and is ready for its intended use. In accordance with SOP 98-1, the Company purchased and capitalized costs of approximately $113,000 and $0 during the three months ended December 31, 2008, and 2007, respectively. Software is amortized for financial reporting purposes using the straight-line method over the estimated useful life of three years.

 

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Revenue Recognition

The Company’s revenue recognition policy is based on the American Institute of Certified Public Accountants Statement of Position (SOP) 97-2, “Software Revenue Recognition” as amended by SOP 98-4 and SOP 98-9. Additionally, revenue is recognized on some of the Company’s products, according to SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” The Company recognizes intellectual property revenue in accordance with SOP 97-2 because the software is not incidental to the IP as the IP is embedded in the software and the intellectual property is, in essence, a software product.

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. The Company uses a completed performance model for perpetual licenses that do not include services to provide significant production, modification or customization of software as all of the elements have been delivered. The Company determines delivery has occurred when all the license materials that are specified in the evidence of a signed arrangement including any related documentation and the license keys are delivered electronically through the FTP server or via Electronic mail (e-mail). 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 that do not require specific customization for the semiconductor IP and software products are recognized ratably over the term of the license, which is generally between twelve to thirty-six months in duration, provided the criteria mentioned above are met. The Company uses a proportional performance model for term-based licenses as these licenses have a right to receive unspecified additional products that are granted over the access term of the license. Consulting services represent an immaterial amount of the Company’s revenue thus are recorded as part of license revenue. These consulting services are not related to the functionality of the products licensed. Revenue from consulting services is recognized on the time and materials method or as work is performed.

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 SOP 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 20% of the net selling price of the license for new agreements starting in fiscal 2007 or the higher of the actual price stated in the contract or the stated renewal rate in each contract for all contracts entered into prior to fiscal 2007. 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.

 

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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 the Company’s semiconductor IP technologies based on a rate per-chip or rate per-wafer depending on the terms of the respective license agreement. Depending on the contractual terms, prepaid royalties are recognized as revenue upon either the receipt of a corresponding royalty report or after all related license deliverables have been made.

Fair Value of Financial Instruments

The Company has determined that the amounts reported for cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value because of their short maturities and/or variable interest rates. Available-for-sale investments are reported at their fair market value based on quoted market prices.

In September 2006, the Financial Accounting Standard Board (“FASB”) issued FASB Statement No. 157, Fair Value Measurements, or (“SFAS 157”). The standard defines fair value, establishes a framework for measuring fair value and expands fair value meansurement disclosures. Effective October 1, 2008, the Company adopted the measurement and disclosure requirements related to financial assets and financial liabilities and provided disclosure in Note 9. The adoption of SFAS 157 for financial assets and financial liabilities did not have any impact on the Company’s results of operations or the fair values of its financial assets and liabilities.

Cash and Cash Equivalents, Short-term and Long-term Investments

For purposes of the accompanying consolidated statements of cash flows, the Company considers all highly liquid instruments with an original maturity on the date of purchase of three months or less to be cash equivalents. Cash and cash equivalents as of December 31, 2008 consisted of money market funds and treasury bills. Cash and cash equivalents as of September 30, 2008 consisted of money market funds and commercial paper. The Company determines the appropriate classification of investment securities at the time of purchase. As of December 31, 2008, all investment securities are designated as “available-for-sale” and are carried at fair value. The Company considers all investments that are available-for-sale that have a maturity date longer than three months and less than twelve months to be short-term investments. The Company considers all investments that have a maturity of more than twelve months to be long-term investments. Long-term investments include government sponsored enterprise bonds of $4.6 million and $21.4 million with maturity dates greater than one year for the fiscal quarter ended December 31, 2008 and fiscal year ended September 30, 2008, respectively.

The available-for-sale securities are carried at fair value based on quoted market prices, with the unrealized gains (losses) reported as a separate component of stockholders’ equity. The Company periodically reviews the realizable value of its investments in marketable securities. When assessing marketable securities for other-than-temporary declines in value, the Company considers such factors as the length of time and extent to which fair value has been less than the cost basis, the market outlook in general and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. If an other-than-temporary impairment of the investments is deemed to exist, the carrying value of the investment would be written down to its estimated fair value.

Goodwill and Intangible Assets

Goodwill

In accordance with Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), goodwill and intangible assets deemed to have indefinite lives are no longer to be amortized, but instead are subject to annual impairment tests. As required by the provisions of SFAS 142, the Company evaluates goodwill for impairment on an annual basis on September 30 each year or more frequently if impairment indicators arise. A significant impairment could have a material adverse effect on the Company’s financial position and results of operations. No impairment charge or amortization of goodwill was recorded during the first quarter of fiscal year 2009. The Company continues to monitor its fair value and operating results, and the carrying value of goodwill will be written down to its estimated fair value, if an impairment of goodwill is deemed to exist in the future.

Acquired Intangible Assets

Other intangible assets, net are as follows (in thousands):

 

     December 31, 2008    September 30, 2008
     Gross
Amount
   Accumulated
Amortization
    Total    Gross
Amount
   Accumulated
Amortization
    Total

Amortized intangible assets:

               

Patents

   $ 4,800    $ (2,536 )   $ 2,264    $ 4,800    $ (2,403 )   $ 2,397

Customer lists, contracts and trade names

     700      (133 )     567      700      (98 )     602

Technology

     3,300      (475 )     2,825      3,300      (321 )     2,979

Trade name

     300      (17 )     283      300      (8 )     292
                                           

Total

   $ 9,100    $ (3,161 )   $ 5,939    $ 9,100    $ (2,830 )   $ 6,270
                                           

 

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The aggregate amortization expense related to acquired intangible assets totaled approximately $0.3 million and $0.1 million for the three months ended December 31, 2008 and 2007, respectively. In June 2008, the Company recorded $4.5 million of intangible assets related to the acquisition of the non-volatile memory segment of Impinj, Inc. (excluding $0.2 million of acquired in-process technology of Impinj, Inc. that was written off in June 2008).

Estimated amortization expenses of intangible assets for the remainder of fiscal 2009, the next four fiscal years and all years thereafter are as follows (in thousands):

 

Estimated Amortization Expense

  

2009

   $ 991

2010

     1,322

2011

     1,300

2012

     943

2013

     733

Thereafter

     650
      

Total

   $ 5,939
      

Stock-Based Compensation

Stock Options and Stock Settled Appreciation Rights (“SSARS”)

As outlined in Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), the Company uses the fair value method to apply the provisions of SFAS 123R. Total SFAS 123R compensation expense recognized for the three months ended December 31, 2008 and 2007 were $0.1 million and $0.4 million, respectively. As of December 31, 2008, total unrecognized estimated compensation expense net of forfeitures related to stock options and SSARs prior to that date was $4.7 million and will be amortized over a weighted average period of 2.9 years.

The estimated stock-based compensation expense related to the Company’s stock-based awards for the three months period ended December 31, 2008 and 2007 was as follows (in thousands, except per share data):

 

     Three Months
Ended
December 31,
2008
    Three Months
Ended
December 31,
2007
 

Cost of revenues

   $ 70     $ 102  

Research and development

     130       221  

Sales and marketing

     (163 )     88  

General and administrative

     38       5  
                

Stock-based compensation expense

     75       416  

Related income tax benefits

     (30 )     (152 )
                

Stock-based compensation expense, net of tax benefits

   $ 45     $ 264  

Net stock-based compensation expense, per common share:

    

Basic

   $ 0.00     $ 0.01  
                

Diluted

   $ 0.00     $ 0.01  
                

As of December 31, 2008 and 2007, the Company capitalized approximately $52,000 and $101,000, respectively, of stock-based compensation expense related to its custom contracts which have not been completed.

The Company is using the Black-Scholes option pricing model to value the compensation expense associated with its stock-based awards under SFAS 123R. As required by SFAS 123R, employee stock-based compensation expense is calculated based on estimated forfeiture rate. The Company uses an annualized forfeiture rate of 13% as a best estimate of future forfeitures based on its historical forfeiture experience and future expectations. SFAS 123R requires forfeitures to be estimated at the time of the grant and revised as

 

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necessary in subsequent periods if actual forfeitures differ from those estimates. If factors change and the Company employs different assumptions in the application of SFAS 123R in future periods, the stock-based compensation expense recognized under SFAS 123R may differ significantly from what have been recorded in the current period. During the three months ended December 31, 2008 the Company recorded reversals of stock-based compensation expense recognized in prior periods as a result of an increase in our estimated forfeiture rate in accordance with SFAS 123R.

The following weighted average assumptions were used in the estimated grant date fair value calculations for stock options and stock settled appreciation rights awards:

 

     Three Months Ended  
     December 31,
2008
    December 31,
2007
 

Volatility

   48.5 %   43.8 %

Risk-free interest rate

   1.5 %   3.4 %

Dividend yield

   0.0 %   0.0 %

Expected life (years)

   4.8 years     4.63 years  

The expected stock price volatility rates are based on historical volatilities of its common stock. The risk free interest rates are based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the options and SSARs. The average expected life represents the weighted average period of time that options and SSARs granted are expected to be outstanding giving consideration to vesting schedules and its historical exercise patterns. The Black-Scholes weighted average fair values of options and SSARs granted during the three months ended December 31, 2008 and 2007 were $1.63 and $3.45, respectively.

Restricted Stock Units

The Company issues restricted stock unit awards as an additional form of equity compensation to its employees and officers, pursuant to Company’s stockholder-approved 2002 Equity Incentive Plan. Restricted stock units generally vest over a two or four year period and unvested restricted stock units are forfeited and cancelled as of the date that employment terminates. Restricted stock units are settled in shares of the Company’s common stock upon vesting. The cost of restricted stock unit awards is determined using the fair value of the Company’s common stock on the date of the grant, and compensation expense is recognized over the vesting period.

The following table summarizes the activity of the Company’s unvested restricted stock units as of December 31, 2008 and changes during the three months ended December 31, 2008:

 

     Restricted Stock Units
     Number of
shares
    Weighted-
average grant-
date fair value

Nonvested as of September 30, 2008

   1,016,262     $ 6.84

RSU granted

   66,315     $ 3.92

RSU vested

   (85,117 )   $ 6.90

RSU canceled

   (50,517 )   $ 7.50
        

Nonvested as of December 31, 2008

   946,943     $ 6.59
        

Stock-based compensation cost for restricted stock units for the three months ended December 31, 2008 was $0.6 million. As of December 31, 2008, the total unrecognized compensation cost net of forfeitures related to unvested awards not yet recognized is $4.1 million and is expected to be recognized over a period of 2.14 years.

Equity Incentive Plans

The Company has two active incentive plans: the 2001 Incentive and Non-statutory Stock Option Plan and the 2002 Equity Incentive Plan. The Company continues to have awards outstanding under its expired 1997 Equity Incentive Plan. In November 2006, the Company began issuing SSARs which provide the holder the right to receive an amount settled in stock at the time of the exercise. Under the Company’s equity incentive plans, stock options and SSARs generally have a vesting period of four years, are exercisable for a period not to exceed ten years from the date of grant and are generally granted at prices not less than the fair value of the Company’s common stock at the time of grant. Information with respect to the Equity Incentive Plans is summarized as follows:

 

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     Shares
Available
for Grant
    Number of
Options/SSARs
Outstanding
    Weighted
Average
Exercise Price

Balance at September 30, 2008

   780,185     3,977,726     $ 8.43

Options and SSARs granted

   (221,863 )   221,863     $ 3.82

RSUs granted

   (66,315 )   —         —  

Options and SSARs exercised

   —       (32,000 )   $ 0.17

Options and SSARs canceled

   130,659     (130,659 )   $ 9.97

RSUs canceled

   50,517     —         —  

Awards expired (unissued)

   (25,117 )   —         —  
              

Balance at December 31, 2008

   648,066     4,036,930     $ 8.19
              

The following table summarizes information about stock options and SSARs outstanding and exercisable at December 31, 2008:

 

     Awards Outstanding    Awards Exercisable

Range of Exercise Prices

   Number
of
Shares
    Weighted
Average
Remaining
Contractual
Life
   Weighted
Average
Exercise
Price
   Aggregate
Intrinsic
Value
   Number of
Shares
   Weighted
Average
Remaining
Contractual
Life
   Weighted
Average
Exercise
Price
   Aggregate
Intrinsic
Value
           (In years)         (In thousands)         (In years)         (In thousands)

$0.23 - $4.84

   479,761     6.90    $ 3.65    $ 121    168,173    1.58    $ 2.84    $ 121

$5.00 - $6.38

   532,200     7.38    $ 5.97    $ —      209,393    3.98    $ 5.59    $ —  

$6.63 - $7.47

   644,036     8.40    $ 7.21    $ —      468,463    8.34    $ 7.29    $ —  

$7.48 - $7.89

   565,880     7.29    $ 7.84    $ —      419,295    7.22    $ 7.84    $ —  

$8.02 - $8.74

   435,367     6.59    $ 8.59    $ —      309,421    5.71    $ 8.64    $ —  

$8.82 - $9.08

   410,434     7.40    $ 8.91    $ —      255,929    7.11    $ 8.93    $ —  

$9.16 - $10.30

   488,922     6.28    $ 9.93    $ —      439,486    6.01    $ 10.00    $ —  

$10.31 - $16.55

   454,580     4.03    $ 14.01    $ —      454,155    4.02    $ 14.01    $ —  

$16.70 - $22.37

   25,500     5.96    $ 16.99    $ —      24,979    5.96    $ 16.99    $ —  

$22.81 - $22.81

   250     3.03    $ 22.81    $ —      250    3.03    $ 22.81    $ —  
                                    

Total

   4,036,930 *   6.87    $ 8.19    $ 121    2,749,544    6.19    $ 8.91    $ 121
                                    

 

*  Table of awards outstanding does not include 946,943 unvested restricted stock units.

Vested and expected to vest as of December 31, 2008

   3,743,206     6.71    $ 8.32    $ 121            
                              

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $2.99 as of December 31, 2008, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of December 31, 2008 and 2007 was 59,000 and 1.0 million, respectively.

The total intrinsic value of options exercised during the three month periods ended December 31, 2008 and 2007 was $0.1 million and $0.7 million, respectively. The total cash received from employees as a result of employee stock option exercises during the three months ended December 31, 2008 and 2007 was approximately $5,400 and $1.4 million.

NOTE 2 – RESTRUCTURING CHARGES

During fiscal 2008, the Company initiated a plan of restructuring in an effort to reduce operating expenses and improve operating margins and cash flows. The restructuring plan was intended to decrease costs through job eliminations. The Company reduced its workforce by approximately 13 employees primarily in engineering. Costs resulting from the restructuring plan included severance payments and severance-related benefits. Total restructuring expense was $316,000 of which $312,000 was paid as of September 30, 2008.

 

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Total restructuring costs accrued as of December 31, 2008 and September 30, 2008 were $0 and $4,000 which were recorded in accrued expenses on the consolidated balance sheet.

The following table summarizes restructuring activity for the three months ended December 31, 2008 as follows (in thousands):

 

     Severance     Total  

Balance at September 30, 2008

   $ 4     $ 4  

Cash payments

     (4 )     (4 )
                

Balance at December 31, 2008

   $ —       $  —    
                

NOTE 3 – NET INCOME (LOSS) PER SHARE

Basic and diluted net income (loss) per share is presented in conformity with Statement of Financial Accounting Standards No. 128, Earnings Per Share (“SFAS 128”). Accordingly, basic and diluted net income (loss) per share have been computed using the weighted average number of shares of common stock outstanding during the period, plus weighted average share equivalents, unless anti-dilutive.

The following table presents the computation of basic and diluted net income (loss) per share applicable to common stockholders (in thousands, except for per share data):

 

     Three months Ended
December 31,
     2008     2007

Net income (loss)

   $ (2,611 )   $ 1,092
              

Shares used in computation:

    

Shares used in computing basic net income (loss) per share

     22,936       23,419

Add: Effect of potentially diluted securities

     —         214
              

Shares used in computing diluted net income (loss) per share

     22,936       23,733
              

Basic net income (loss) per share

   $ (0.11 )   $ 0.05
              

Diluted net income (loss) per share

   $ (0.11 )   $ 0.05
              

For the computation of diluted net income (loss) per share for the three months ended December 31, 2008 and December 31, 2007, the Company excluded awards totaling approximately 4.9 million shares and 5.1 million shares, respectively, from the calculation of the net income (loss) per share as they are anti-dilutive.

NOTE 4 – COMPREHENSIVE INCOME (LOSS)

Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (“SFAS 130”) established standards for the reporting and display of comprehensive income (loss). Comprehensive income (loss) includes unrealized gains (losses) on investments, net of related tax effects and foreign currency translation adjustments. These items have been excluded from net income (loss) and are reflected instead in Stockholders’ Equity.

Total comprehensive income (loss) for the three and nine month periods ended December 31, 2008 and 2007, respectively, is as follows:

 

     Three Months Ended
December 31,
     2008     2007

Net income (loss)

   $ (2,611 )   $ 1,092

Foreign currency translation adjustments, net of tax

     (417 )     98

Changes in unrealized gain (loss) on investments, net of tax

     409       58
              

Comprehensive income (loss), net of tax

   $ (2,619 )   $ 1,248
              

 

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NOTE 5 – SEGMENT INFORMATION

The Company operates in one industry segment, the sale of semiconductor IP including embedded SRAM and NVM, logic libraries, IP and development infrastructure for embedded test and repair of on-chip memory instances, software development tools used to build memory compilers, and DDR memory controllers, PHYs and DLLs.

The Chief Executive Officer has been identified as the Chief Operating Decision Maker (CODM) because he has final authority over resource allocation decisions and performance assessment.

Revenues by geographic region are based on the region in which the customers are located.

Total revenues by geography are as follows:

 

     Three Months Ended
December 31,
     2008    2007

Total Revenue by Geography

     

United States

   $ 4,913    $ 6,209

Canada

     267      966

Japan

     919      198

Taiwan

     2,350      2,230

Europe, Middle East and Africa (EMEA)

     1,641      2,600

Other Asia (China, Malaysia, South Korea and Singapore)

     1,259      1,857
             

Total

   $ 11,349    $ 14,060
             

Total license revenues by process node are as follows:

 

     Three Months Ended
December 31,
 
     2008     2007  

Total License Revenue by Process Node

    

45 Nanometer technology

   34 %   12 %

65 Nanometer technology

   30     38  

90 Nanometer technology

   15     18  

0.13 Micron technology

   10     15  

0.18 Micron technology

   6     5  

Other

   5     12  
            

Total

   100 %   100 %
            

Total maintenance revenues by process node are as follows:

 

     Three Months Ended
December 31,
 
     2008     2007  

Total Maintenance Revenue by Process Node

    

45 Nanometer technology

   15 %   —   %

65 Nanometer technology

   22     41  

90 Nanometer technology

   41     31  

0.13 Micron technology

   15     23  

0.18 Micron technology

   6     5  

Other

   1     —    
            

Total

   100 %   100 %
            

The Company has only one product line, and as such disclosure by product groupings is not applicable.

Long-lived assets are located primarily in the United States, with the exception of a building in Armenia, which is owned by the Company. The building in Armenia and its leasehold improvements are valued at cost less accumulated depreciation and amortization and amounted to approximately $2.3 million and $2.5 million as of December 31, 2008 and 2007, respectively.

 

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NOTE 6 – RECENT ACCOUNTING PRONOUNCEMENTS

In April 2008, the Financial Accounting Standard Board (“FASB”) issued FASB Staff Position (FSP) FAS 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008 and early adoption is prohibited. The Company is currently evaluating what impact this standard will have on its financial position or results of operations.

In December 2007, the FASB issued FASB Statement No. 141 (revised 2007) (“SFAS 141R”), Business Combinations and FASB Statement No. 160 (“SFAS 160”), Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51. SFAS 141R will change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. SFAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 141R and SFAS 160 are effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is not permitted. The Company is currently evaluating the impact SFAS 141R and SFAS 160 will have on its financial position or results of operations.

In February 2008, the FASB issued FSP FAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronoucements That Address Fair Value Measurements for Purpose of Lease Classification or Measurement under Statement 13 and FSP FAS 157-2, Effective Date of FASB Statement No. 157, or (“FSP FAS 157-2”). Collectively, the Staff Positions defer the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for nonfinancial assets and nonfinancial liabilities except for items that are recognized or disclosed at fair value on a recurring basis at least annually, and amend the scope of Statement 157. As described in Note 9, the Company has adopted Statement 157 except for those items specifically deferred under FSP FAS 157-2. The Company is still evaluating the impact of the full adoption of SFAS 157 on its financial position or results of operations.

NOTE 7 – COMMITMENTS AND CONTINGENCIES

Indemnification. The Company enters into standard license agreements in its ordinary course of business. Pursuant to these agreements, the Company agrees to indemnify its customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement claims by any third party with respect to the Company’s products. These agreements generally have perpetual terms. The maximum amount of indemnification the Company could be required to make under these agreements is generally limited to the license fees received by the Company. The Company has minimal history of claims, and accordingly, no liabilities have been recorded for indemnification under these agreements as of December 31, 2008.

Warranties. The Company offers its customers a warranty that its software products will substantially conform to their functional specifications. To date, there have been no payments or material costs incurred related to fulfilling these warranty obligations. Accordingly, the Company has no liabilities recorded for these warranties as of December 31, 2008. The Company assesses the need for a warranty reserve on a quarterly basis and there can be no guarantee that a warranty reserve will not become necessary in the future.

NOTE 8 – INCOME TAXES

The Company calculates its income taxes based on an annual effective tax rate in compliance with SFAS No. 109, Accounting for Income Taxes (“SFAS 109”). Under SFAS 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.

The Company recorded a tax benefit of $1.8 million for the first quarter of fiscal year 2009 and recorded a tax provision of $0.5 million for the same quarter of fiscal year 2008. The Company assesses the likelihood that it will be able to recover its deferred tax assets. If recovery is not more likely than not, the Company increases its income tax provision (benefit) by recording a valuation allowance against the deferred tax assets that it estimates will not ultimately be recoverable. The Company believes that substantially all of the deferred tax assets recorded on its balance sheet will ultimately be recovered. The Company has determined that the realization of the current year generated R&D credits and foreign tax credits to be included in the deferred tax assets is not more likely than not. Based on these facts, the Company has placed a valuation allowance on these assets in computing its estimated annual tax rate for the fiscal year 2009.

The Indian Tax Authorities completed its assessment of the Company’s tax returns for the tax years 2001 through 2006 and issued assessment orders in which the Indian Tax Authorities proposes to assess an aggregate tax deficiency for the six year period of approximately $1.2 million, net of deposits of $260,000 as required by the Indian Tax Authorities. Interest will continue to accrue until the matter is resolved. The Indian Tax Authorities may also make similar claims for years subsequent to 2006 in future

 

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assessment. The assessment orders are not final notices of deficiency, and the Company has immediately filed appeals. The Company believes that the assessments are inconsistent with applicable tax laws and that it has meritorious defense to the assessments.

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, the Company may be required to record charges to operations that could have an adverse effect on its consolidated statements of operations.

NOTE 9 – FAIR VALUE DISCLOSURE

The Company accounts for investments in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Management determines the appropriate classification of securities at the time of purchase. All securities are classified as available-for-sale. The Company’s short-term and long-term investments are carried at fair value, with the unrealized holding gains and losses reported in accumulated other comprehensive income. The Company evaluates declines in market value for potential impairment if the decline results in a value below cost and is determined to be other than temporary. Realized gains and losses and declines in the value judged to be other than temporary are included in other income and expenses. The cost of securities sold is based on the specific identification method.

The Company has invested its excess cash in money market accounts, corporate debt, commercial paper, government agency securities and government sponsored enterprise bonds and considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Investments with original maturities greater than three months and remaining maturities less than one year are classified as short-term investments. Investments with remaining maturities greater than one year are classified as long-term investments.

On October 1, 2008, the Company adopted FASB Statement No. 157, Fair Value Measurements, or (“SFAS 157”). The adoption of SFAS 157 did not have a material impact on its consolidated financial statements. SFAS 157 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and consider assumptions that market participants would use when pricing the asset or liability. SFAS 157 also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. SFAS 157 establishes three levels of inputs that may be used to measure fair value:

Level 1 – Inputs used to measure fair value are unadjusted quoted prices that are available in active markets for the identical assets or liabilities as of the reporting date.

Level 2 – Inputs used to measure fair value, other than quoted prices included in Level 1, are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full term of the financial instrument.

Level 3 – Inputs used to measure fair value are unobservable inputs that are supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

Investments primarily include money market funds, U.S. government sponsored enterprise bonds, commercial paper, corporate debt securities, and common stock securities. The Company uses quoted prices in active markets for identical assets or liabilities to determine fair value. This pricing methodology applies to Level 1 investments such as money market funds and corporate common stock securities. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then the Company uses quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. These investments are included in Level 2 and consist primarily of government sponsored enterprise bonds, U.S. treasury bills, commercial paper debt securities, corporate debt securities.

In accordance with SFAS 157, the following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents and short and long-term available-for-sale investments) as of December 31, 2008 (in thousands):

 

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     December 31, 2008
     Fair Value    Level 1    Level 2

Assets:

        

Money market funds

   $ 18,985    $ 18,985    $ —  

Corporate common stock securities

     116      116      —  

U.S. Government sponsored enterprise bonds

     15,671      —        15,671

Commercial paper debt securities

     12,398      —        12,398

U.S. treasury bills

     10,909      —        10,909

Corporate debt securities

     3,044      —        3,044
                    

Total financial assets

   $ 61,123    $ 19,101    $ 42,022
                    

NOTE 10 – STOCK REPURCHASE PROGRAM

On May 6, 2008, the Company adopted a stock repurchase program to purchase up to $20 million in shares of the common stock in the open market or negotiated transactions through May 2009. On August 4, 2008, 700,000 shares were repurchased in the open market at a price per share of $6.49. On December 8, 2008, 190,000 shares were repurchased in the open market at a price per share of $2.95.

NOTE 11 – SUBSEQUENT EVENT

On January 21, 2009, the Company announced a restructuring plan to reduce operational costs and increase efficiencies. The restructuring plan involves various measures, including the consolidation of two smaller research and development (R&D) sites into four major R&D centers and closer alignment of sales resources to market opportunities. The restructuring plan will result in the closing of the Company’s R&D centers in New Jersey and Minnesota. The development previously done at these locations will be transferred to the company’s larger R&D centers located in its Fremont, California headquarters or development centers in Armenia and India. In addition, the company is consolidating its NVM development to its Seattle, Washington R&D center that was established as a result of the acquisition of Impinj Inc.’s NVM IP business in June of 2008. The Company estimates that the total cost expected to be incurred in connection with the restructuring is approximately $1.7 million, which is expected to be completed during the second fiscal quarter of 2009.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Statements made in this section, other than statements of historical fact, are forward-looking statements that involve risks and uncertainties. Some of these statements relate to products, customers, business prospects, technologies, trends and effects of acquisitions. In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate,” “potential,” or “continue,” the negative of these terms or other comparable terminology. Forward-looking statements are subject to a number of known and unknown risks and uncertainties which might cause actual results to differ materially from those expressed or implied by such statements. These risks include our ability to forecast our business, including our revenue, income and order flow outlook, our ability to execute on our strategy of being a provider of highly differentiated semiconductor IP, our ability to continue to develop new products and maintain and develop new relationships with third-party foundries, integrated device manufacturers, and fabless semiconductor companies, our ability to overcome the challenges associated with establishing licensing relationships with semiconductor companies, our ability to obtain royalty revenues from customers in addition to license fees, our ability to receive accurate information necessary for calculation of royalty revenues and to collect royalty revenues from customers, business and economic conditions generally and in the semiconductor industry in particular, pace of adoption of new technologies by our customers and increases or fluctuations in the demand for their products, competition in the market for semiconductor IP, and other risks and uncertainties including those set forth below under “Risk Factors”. These forward-looking statements speak only as of the date hereof, we expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein. The following information should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of the Company’s Form 10-K for the fiscal year ended September 30, 2008 filed with the Securities and Exchange Commission.

Overview

Business Environment

Virage Logic provides semiconductor intellectual property (IP) to the global semiconductor industry. These various forms of IP are utilized by our customers to design and manufacture System-on-Chip (SoC) integrated circuits that are the foundation of today’s consumer, communications and networking, hand-held and portable devices, computer and graphics, automotive, and defense

 

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applications. Our semiconductor IP offering consists of (1) compilers that allow chip designers to configure our memories, or SRAMs, into different sizes and shapes on a single silicon chip, (2) IP and development solutions for embedded test and repair of on-chip memory instances, (3) software development tools used to design memory compilers, (4) NVM instances, (5) logic cell libraries, and (6) DDR memory controller interface IP components. We also provide design services related to our IP to the semiconductor industry.

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’ decisions regarding these matters are 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 the first quarter of fiscal year 2009, we derived 79% of our license revenue and 78% of our maintenance revenue from the more advanced processes, 90-nanometer, 65-nanometer, and 45-nanometer technologies and 21% of license revenue and 22% of maintenance revenue from the older process nodes, predominantly 0.13, 0.18, 0.25 and 0.35 micron technologies. The Company expects the 90-nanometer, 65-nanometer and 45-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, however we expect future growth in royalty revenues to be driven by the advanced processes, 45-nanometer, 65-nanometer and 90-nanometer technologies, in addition to continued production on the 0.13 and 0.18 micron technologies.

We sell our products 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.

Acquisition of Non-Volatile Memory Business Segment of Impinj, Inc.

In June 2008, we completed the acquisition of the logic non-volatile memory intellectual property business segment of Impinj, Inc., a provider of radio frequency identification (RFID) solutions. The acquisition extends the Company’s embedded memory leadership position in the rapidly growing NVM embedded memory market for standard CMOS processes. The Company believes the acquisition of Impinj’s logic NVM IP business represents another element toward attainment of its core vision of establishing the Company as a broad line supplier of highly differentiated physical and interface IP solutions to the semiconductor industry.

Stock Repurchase Program

On May 6, 2008, we announced that our Board of Directors authorized a stock repurchase program to purchase up to $20 million in shares of our common stock in the open market or negotiated transactions through May 2009. We intend to use available cash to effect any stock repurchases. At December 31, 2008, the Company’s balance sheet reflected cash and investments totaling $65.3 million. On August 4, 2008, 700,000 shares were repurchased in the open market at a price per share of $6.49. On December 8, 2008, 190,000 shares were repurchased in the open market at a price per share of $2.95.

Our common stock trades on the Nasdaq Global Market. We may plan to make purchases from time to time in the open market or through privately negotiated transactions. The number, price and timing of the repurchases, which may include, without limitation round lot or block transactions, will be at our sole discretion and may be re-evaluated depending on market conditions, liquidity needs or other factors. Our board of directors may suspend, terminate, modify or cancel the program at any time without notice.

Sources of Revenues

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

 

   

embedded memories including SRAM and NVM, logic libraries;

 

   

IP and development infrastructure for embedded test and repair of on-chip memory instances;

 

   

software development tools used to build memory compilers; and

 

   

DDR memory controllers, PHYs, and DLL.

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

 

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

Currently, license fees represent the majority of our revenues. License revenues for the three months ended December 31, 2008 and 2007 were $6.6 million and $8.4 million, respectively. Maintenance revenues for the three months ended December 31, 2008 and 2007 were $1.9 million and $2.3 million, respectively. Royalty revenues for the three months ended December 31, 2008 and 2007 were $2.8 million and $3.3 million, respectively.

We have been dependent on a limited number of customers for a substantial portion of our revenues, although our dependence on certain customers over the long term continues to decrease. Our customers comprising the top 10 customer group have changed from time to time. We have one customer that generated 10% or more of our revenue for the three months ended December 31, 2008 and three customers that generated 10% or more of our revenue for the three months ended December 31, 2007.

Sales to customers located outside of North America accounted for approximately 54% and 42% for the three months ended December 31, 2008 and 2007, respectively. Substantially all of our direct sales representatives and field application engineers are located in North America and Europe and service those regions. In Japan and the rest of Asia, we use both indirect sales through distributors and direct sales through sales representatives. All revenues to date have been denominated in U.S. dollars.

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;

 

   

valuation of accounts receivable;

 

   

valuation of purchased intangibles, including goodwill;

 

   

valuation of long-lived assets;

 

   

stock-based compensation; and

 

   

accounting for income taxes.

Revenue Recognition

The Company’s revenue recognition policy is based on the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, “Software Revenue Recognition”, as amended by SOP 98-4 and SOP 98-9. Additionally, revenue is recognized on some of our products, according to SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” The Company recognizes intellectual property revenue in accordance with SOP 97-2 because the software is not incidental to the IP as the IP is embedded in the software and the intellectual property is, in essence a software product.

Revenues from perpetual licenses for the semiconductor IP products are generally recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable, and collectability is reasonably assured. The Company uses a completed performance model for perpetual licenses that do not include services to provide significant production, modification or customization of software as all of the elements have been delivered. The Company determines delivery has occurred when all the license materials that are specified in the evidence of a signed arrangement including any related documentation and the

 

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license keys are delivered electronically through the FTP server or via Electronic mail (e-mail). 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 that do not require specific customization for the semiconductor IP and software products are recognized ratably over the term of the license, which are generally between twelve to thirty-six months in duration, provided the criteria mentioned above are met. The Company uses a proportional performance model for term-based licenses as these licenses have a right to receive unspecified additional products that are granted over the access term of the license. Consulting services represent an immaterial amount of our revenue thus are recorded as part of license revenue. These consulting services are not related to the functionality of the products licensed. Revenue from consulting services is recognized on the time and materials method or as work is performed.

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 SOP 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 20% of the net selling price of the license for new agreements starting in fiscal 2007 or the higher of the actual price stated in the contract or the stated renewal rate in each contract for all contracts entered into prior to fiscal 2007. 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.

We assess 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 collectability 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 after all related license deliverables have been made.

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.

 

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Valuation of Purchased Intangibles, Including Goodwill

We periodically evaluate purchased intangibles, including goodwill, for impairment at least annually. 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 December 31, 2008, management believes no impairment of intangible assets has occurred. The carrying value of purchased intangibles, including goodwill, is $17.7 million and $18.0 million as of December 31, 2008 and September 30, 2008, 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 December 31, 2008 the Company had intangible assets of $5.9 million related to technology and other intangibles acquired through the acquisitions of In-Chip Systems, Inc., Ingot Systems, Inc., and the logic non-volatile memory intellectual property business of Impinj, Inc.

Stock-based compensation

In accordance with SFAS 123R, we recognized stock-based compensation of $0.1 million and $0.4 million for the three months ended December 31, 2008 and 2007, respectively. At December 31, 2008, total unrecognized estimated compensation expenses net of forfeitures related to non-vested equity awards prior to that date were $8.8 million.

We value our stock-based awards on the date of grant using the Black-Scholes option-pricing. The determination of the fair value of stock-based payment awards on the date of grant using a 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 equity awards exercise behaviors, risk-free interest rate and expected dividends.

For purposes of estimating the fair value of equity awards granted during the fiscal quarters ended December 31, 2008 and 2007, 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 awards on the grant date.

Furthermore, as required under SFAS 123R, we estimate forfeitures for equity awards granted which are not expected to vest. We calculate the pre-vesting forfeiture rate by using our historical equity grants 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 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 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 consolidated financial statements. Alternatively, value may be realized from these instruments significantly in excess of the fair values originally estimated on the grant date and reported in our consolidated 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 a pricing model, such value may not be indicative of the fair value observed in a willing buyer /willing seller market transaction.

 

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RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2008 AND 2007

Revenues

The table below sets forth the changes in revenues from the three months ended December 31, 2008 to the three months ended December 31, 2007 (in thousands, except percentage data):

 

     Three Months Ended
December 31, 2008
    Three Months Ended
December 31, 2007
       
     Amount    % of total
revenues
    Amount    % of total
revenues
    Year-Over-Year Change  

Revenues:

              

License

   $ 6,561    57.8 %   $ 8,443    60.0 %   $ (1,882 )   (22.3 )%

Maintenance

     1,940    17.1 %     2,318    16.5 %     (378 )   (16.3 )%

Royalties

     2,848    25.1 %     3,299    23.5 %     (451 )   (13.7 )%
                                    

Total revenues

   $ 11,349    100.0 %   $ 14,060    100.0 %   $ (2,711 )   (19.3 )%
                                    

Revenues for the three months ended December 31, 2008 totaled $11.3 million, decreasing 19.3% from $14.1 million for the three months ended December 31, 2007. The decrease resulted from a $1.9 million decrease in license revenues, $0.4 million decrease in maintenance revenues, and a decrease of $0.5 million in royalty revenues.

For the three months ended December 31, 2008 and 2007, total license revenues by process node are as follows:

 

     Three Months Ended
December 31,
 
     2008     2007  

Total License Revenue by Process Node

    

45 Nanometer technology

   34 %   12 %

65 Nanometer technology

   30     38  

90 Nanometer technology

   15     18  

0.13 Micron technology

   10     15  

0.18 Micron technology

   6     5  

Other

   5     12  
            

Total

   100 %   100 %
            

License revenues for the three months ended December 31, 2008 were $6.6 million, representing a decrease of $1.9 million or 22.3% as compared to $8.4 million for the three months ended December 31, 2007. License revenues decreased for the three months ended December 31, 2008 mainly attributed to decreases of $1.2 million on the 65-nanometer process, $0.5 million on the 90-nanometer process, $1.4 million on 0.13 micron process and other technologies, partially offset by an increase of $1.2 million on the 45-nanometer process.

For the three months ended December 31, 2008 and 2007, total maintenances by process node are as follows:

 

     Three Months Ended
December 31,
 
     2008     2007  

Total Maintenance Revenue by Process Node

    

45 Nanometer technology

   15 %   —   %

65 Nanometer technology

   22     41  

90 Nanometer technology

   41     31  

0.13 Micron technology

   15     23  

0.18 Micron technology

   6     5  

Other

   1     —    
            

Total

   100 %   100 %
            

 

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Maintenance revenues for the three months ended December 31, 2008 were $1.9 million, representing a decrease of $0.4 million or 16.3% as compared to $2.3 million for the three months ended December 31, 2007. Maintenance revenues decreased for the three months ended December 31, 2008 mainly attributed to decreases of $0.5 million on the 65-nanometer process, $0.2 million on the 0.13 micron process, partially offset by an increase of $0.3 million on the 45-nanometer process.

Royalties decreased by $0.5 million, or 13.7%, from $3.3 million in the three months ended December 31, 2007 to $2.8 million for the three months ended December 31, 2008.

For the three months ended December 31, 2008 and 2007, total revenues by geography were as follows:

 

     Three Months Ended
December 31,
     2008    2007

Total Revenue by Geography

     

United States

   $ 4,913    $ 6,209

Taiwan

     2,350      2,230

Europe, Middle East and Africa (EMEA)

     1,641      2,600

Other Asia (China, Malaysia, South Korea and Singapore)

     1,259      1,857

Japan

     919      198

Canada

     267      966
             

Total

   $ 11,349    $ 14,060
             

Cost and Expenses

The table below sets forth the changes in cost and expenses for the three months ended December 31, 2008 and for the three months ended December 31, 2007 (in thousands, except percentage data):

 

     Three Months Ended
December 31, 2008
    Three Months Ended
December 31, 2007
    Year-Over-Year Change  
     Amount    % of total
revenues
    Amount     % of total
revenues
   

Cost and expenses:

             

Cost of revenues

   $ 2,569    22.6 %   $ 2,447     17.4 %   $ 122     5.0 %

Research and development

     9,019    79.5 %     5,858     41.7 %     3,161     54.0 %

Sales and marketing

     2,667    23.5 %     3,593     25.5 %     (926 )   (25.8 )%

General and administrative

     2,121    18.7 %     1,775     12.6 %     346     19.5 %

Restructuring

     —      —         (3 )   —         3     —    
                                     

Total cost and expenses

   $ 16,376    144.3 %   $ 13,670     97.2 %   $ 2,706     19.8 %
                                     

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 three months ended December 31, 2008 totaled $2.6 million, representing an increase of $0.1 million, or 5.0%, from $2.4 million for the three months ended December 31, 2007. The increase for the three months was primarily attributable to an increase of $0.1 million in expenses due to contract related expenses.

Research and Development Expenses

Research and development expenses primarily include personnel expense, software license and maintenance fees and capital equipment depreciation expenses. Research and development expenses for the three months ended December 31, 2008 totaled $9.0 million, an increase of $3.2 million, or 54.0%, from $5.9 million for the three months ended December 31, 2007. Research and development expenses as a percentage of total revenue for the three months ended December 31, 2008 increased to 79.5% from 41.7% for the same period in fiscal 2008. The increase was primarily due to increases of $1.8 million of retention bonus earned by the former Ingot employees, $0.6 million in consulting expenses and $0.8 million additional recurring expenses incurred due to the acquisition of NVM IP business segment of Impinj.

 

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Sales and Marketing Expenses

Sales and marketing expenses consist mainly of personnel expenses, commissions, advertising and promotion-related costs. Sales and marketing expenses for the three months ended December 31, 2008 totaled $2.7 million, representing a decrease of $0.9 million, or 25.8%, over the same period in fiscal 2008. Sales and marketing expenses as a percentage of revenue were 23.5% for the three months ended December 31, 2008, compared to 25.5% for the three months ended December 31, 2007. The decrease in sales and marketing expenses for the three months ended December 31, 2008 was primarily attributable to decreases of $0.4 million of sales commissions, $0.4 million of payroll related expenses and $0.2 million in stock-based compensation expense. These decreases were offset by an increase of $0.1 million of advertising and promotional expenses.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel, corporate governance and other costs associated with the management of our business. General and administrative expenses for the three months ended December 31, 2008 totaled $2.1 million, representing an increase of $0.3 million, or 19.5%, over the three months ended December 31, 2007. General and administrative expenses, as a percentage of total revenue were 18.7% for the three months ended December 31, 2008, compared to 12.6% for the same period in fiscal 2008. The increase in general and administrative expenses for the three months ended December 31, 2008 was mainly attributable to increases of $0.1 million of recruiting expense and $0.1 million of consulting expense.

Interest Income and Other Income (Expenses), net

The table below sets forth the changes in interest income and other income (expenses), net from the three months ended December 31, 2008 to the three months ended December 31, 2007 (in thousands, except percentage data):

 

     Three Months Ended
December 31, 2008
    Three Months Ended
December 31, 2007
    Year-Over-Year Change  
     Amount    % of total
revenues
    Amount    % of total
revenues
   

Interest income and other income (expenses), net:

              

Interest income

   $ 388    3.4 %   $ 966    6.9 %   $ (578 )   (59.8 )%

Other income (expenses), net

     260    2.3 %     201    1.4 %     59     29.4 %
                                    

Total interest income and other income (expenses), net

   $ 648    5.7 %   $ 1,167    8.3 %   $ (519 )   (44.5 )%
                                    

Interest income and other income (expenses), net, for the three months ended December 31, 2008 totaled $0.6 million compared to $1.2 million for the same period in fiscal 2008. The decrease is due to lower investment balances and lower interest rates earned in our treasury investment portfolio of marketable securities.

Income Tax Provision (Benefit)

The table below sets forth the changes in income tax provision (benefit) from the three months ended December 31, 2008 to the three months ended December 31, 2007 (in thousands, except percentage data):

 

     Three Months Ended
December 31, 2008
    Three Months Ended
December 31, 2007
    Year-Over-Year Change  
     Amount     % of total
revenues
    Amount    % of total
revenues
   

Income tax provision (benefit)

   $ (1,768 )   (15.6 )%   $ 465    3.3 %   $ (2,233 )   (480.2 )%
                                     

For the first quarter of fiscal year 2009, we recorded a tax benefit of $1.8 million on a pre-tax loss of $4.4 million, yielding an effective tax rate of 40.3%. For the same quarter of fiscal year 2008, we recorded a tax provision of $0.5 million on a pre-tax income of $1.6 million, yielding an effective tax rate of 29.8%.

LIQUIDITY AND CAPITAL RESOURCES

 

     December 31,
2008
   September 30,
2008
   Change  

Cash and cash equivalents

   $ 31,876    $ 13,214    $ 18,662  

Short-term and long-term investments

     33,417      52,591      (19,174 )
                      

 

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     December 31,
2008
   September 30,
2008
   Change  

Total cash, cash equivalents and marketable debt securities

   $ 65,293    $ 65,805    $ (512 )
                      

As of December 31, 2008, our cash and cash equivalents totaled $31.9 million, as compared to $13.2 million as of September 30, 2008. As of December 31, 2008 and September 30, 2008, our short-term and long-term investments totaled $33.4 million and $52.6 million, respectively. In aggregate, cash, cash equivalents and short- and long-investments in marketable securities as of December 31, 2008 totaled $65.3 million, compared to $65.8 million at September 30, 2008. The primary source of our cash in the three months ended December 31, 2008 was proceeds from maturity of investments.

 

     Three months Ended     Change  
     December 31,
2008
    December 31,
2007
   

Cash provided by operating activities

   $ 667     $ 1,497     $ (830 )

Cash provided by investing activities

     18,844       4,147       14,697  

Cash provided by (used in) financing activities

     (461 )     1,355       (1,816 )

Effect of exchange rates on cash

     (388 )     (164 )     (224 )
                        

Net increase in cash and cash equivalents

   $ 18,662     $ 6,835     $ 11,827  
                        

Net cash provided by operating activities was $0.7 million for the three months ended December 31, 2008, representing a decrease of $0.8 million over net cash provided by operating activities of $1.5 million for the three months ended December 31, 2007. The decrease in cash provided by operating activities was primarily attributable to changes in net income of $3.7 million. This decrease was offset by a decrease in changes of operating assets and liabilities of $3.2 million. In addition, we had decreases of $0.4 million of stock-based compensation expense and $0.1 million of depreciation expense, offset by an increase of $0.2 million of amortization expense.

Net cash provided by investing activities was $18.8 million for the three months ended December 31, 2008, representing an increase of $14.7 million over net cash provided by investing activities of $4.1 million for the three months ended December 31, 2007. The increase of $14.7 million from the investing activities resulted from a decrease in purchases of investments of $23.9 million offset by a decrease in proceeds from maturity of investments of $8.6 million and an increase in property and equipment purchases of $0.6 million.

Net cash used in financing activities totaled $0.5 million for the three months ended December 31, 2008, representing a decrease of $1.8 million over net cash provided by financing activities of $1.4 million for the three months ended December 31, 2007. The decrease of $1.8 million was attributed to $0.6 million in the purchase of treasury stock and a decrease of $1.3 million in proceeds from issuance of common stock during the first quarter of fiscal 2009.

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 R&D expenditures, the timing of the introduction of new technologies, expansion of sales and marketing efforts, acquisitions we may pursue, and levels of working capital, primarily accounts receivable. There can be no assurance that additional equity or debt financing, if required, will be available on satisfactory terms. We believe that our current capital resources and cash generated from operations will be sufficient to meet our needs for at least the next twelve months, although we may seek to raise additional capital during that period and there can be no assurance that we will not require additional financing beyond this time frame.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

The following table summarizes our contractual obligations and commercial commitments at December 31, 2008 (dollars in thousands):

 

Contractual Obligations

   Total    Less Than
1 Year
   1-3
Years
   4-5
Years
   After
5 Years

Operating lease obligations

   $ 3,405    $ 1,256    $ 1,703    $ 446    $ —  

Purchase obligations (1)

     16,657      8,616      7,458      583      —  
                                  

Total operating lease and purchase obligations

   $ 20,062    $ 9,872    $ 9,161    $ 1,029    $ —  
                                  

 

(1) Reflects amounts payable under contracts primarily for product development software licenses, maintenance and payments due under other technology licensing agreements.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our core business, the sale of semiconductor IP for the design and manufacture of system-on-a-chip integrated circuits, has exposure to financial market risks, including changes in foreign currency exchange rates and interest rates. A significant portion of our customers are located in Asia, Canada and Europe. However, to date, our exposure to foreign currency exchange fluctuations has been minimal because all of our license agreements provide for payment in U.S. dollars.

Our international business is subject to risks typical of an international business, including, but not limited to differing economic conditions, changes in political climate, differing tax environments, other regulations and restrictions and foreign exchange rate volatility. Our foreign subsidiaries incur most of their expenses in the local currency. To date these expenses have not been significant, therefore, we do not anticipate our future results will be materially adversely impacted by changes in factors affecting international operations.

We are exposed to the impact of interest rate changes and changes in the market values of our investments. We maintain an investment portfolio of various issuers, types and maturities. These securities are classified as available-for-sale and, consequently, are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of stockholders’ equity. Our investments primarily consist of short-term commercial paper, U.S. government sponsored enterprise bonds and U.S. treasury bills. Our short term investments balance of $28.8 million at December 31, 2008 consists of instruments with original maturities of less than one year. We also hold approximately $4.6 million in U.S. government sponsored enterprise bonds with maturities greater than one year. The estimated fair value of our investment portfolio as of December 31, 2008, assuming a 100 basis point increase in market interest rates, would decrease by approximately $0.2 million, which would not materially affect our operations. We have the ability to hold our fixed income investments until maturity and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. If necessary, we may sell short-term investments prior to maturity to meet our liquidity needs.

 

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act of 1934, as of the end of the period covered by this quarterly report. Our Chief Executive Officer and Chief Financial Officer supervised and participated in the evaluation. Based on the evaluation, our Chief Executive Officer and Chief Financial Officer each concluded that, as of the date of the evaluation, our disclosure controls and procedures were effective in providing reasonable assurance that material information relating to us and our consolidated subsidiaries is recorded, processed and made known to management on a timely basis, including during the period when we prepare our periodic SEC reports. The design and operation of any system of controls is based in part upon certain assumptions about the likelihood of future events and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 that occurred during the quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

We are a party to legal proceedings and claims of various types in the ordinary course of business. We believe based on information currently available to management that the resolution of such claims will not have a material adverse impact on our consolidated financial position or results of operations.

 

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ITEM 1A. RISK FACTORS

Risk Related to Our Business

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

From inception to May 2002, most of our revenues were derived from the license of our embedded memory products. In May 2002, we expanded our product offering to also include logic products. In 2003, we added I/Os to our product offering. During fiscal 2007, we acquired Ingot Systems, Inc., a provider of memory controller products and design services and in June 2008, we acquired the non-volatile memory business segment of Impinj, Inc. If our strategy to be a broad line provider of semiconductor IP is not widely 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 products that generate lower than anticipated revenues from the sale of such products. Factors that could prevent us from gaining market acceptance of our semiconductor IP products include the following:

 

   

difficulties in convincing customers of our memory products to purchase other products from us;

 

   

difficulties and delays in expanding our product offerings; and

 

   

hurdles we may encounter in building and expanding customer relationships.

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

We recorded a net loss of $2.6 million for the first three months of fiscal 2009 and a net income of $1.1 million for the same period of fiscal 2008. 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. 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 assets which would result in the need for a valuation allowance to be recorded.

We intend to continue to engage in acquisitions, joint ventures and other transactions that may complement or expand our business. We may not be able to complete such transactions and such transactions, if executed, pose significant risks and could have a negative effect on our operations.

In each of fiscal 2007 and 2008 we made small acquisitions and concurrently hired a number of employees who provided services relevant to the business or assets acquired and we regularly consider other acquisition opportunities. Achievement of our business goals may be dependent on opportunities to buy other businesses or technologies that could complement, enhance or expand our current business or products or that might otherwise offer us growth opportunities. We may not be able to complete such transactions for a variety of reasons, including our inability to structure appropriate financing for larger transactions. Any transactions that we are able to identify and complete may involve a number of risks, including the following:

 

   

the diversion of our management’s attention from our existing business to integrate the operations and personnel of the acquired or combined business or technology;

 

   

possible adverse effects on our operating results during the integration process;

 

   

the potential failure and realize the expected benefits from a transaction; and

 

   

our possible inability to achieve the intended objectives of the transaction.

In addition, we may not be able to successfully or profitably integrate, operate, maintain and manage our newly acquired operations or employees. We may not be able to maintain uniform standards, controls, procedures and policies, and this may lead to operational inefficiencies. Moreover, successful acquisitions in the semiconductor industry may be more difficult to accomplish than in other industries because such acquisitions require, among other things, integration of product offerings, manufacturing relationships and coordination of sales and marketing and R&D efforts. The difficulties of such integration may be increased by the need to coordinate geographically separated organizations and the complexity of the technologies being integrated. Furthermore, products acquired in connection with acquisitions may not gain acceptance in our markets, and we may not achieve the anticipated or desired benefits of such transactions. The inability of management to successfully integrate any future acquisition could harm our business.

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 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.

 

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We face numerous challenges in entering into license agreements with semiconductor companies on terms beneficial to our business, including the following:

 

   

the lengthy and expensive process of building a relationship with potential customers;

 

   

competition with the customers’ internal design teams and other providers of semiconductor IP as our customers may evaluate these alternatives for each design; and

 

   

the need to persuade semiconductor companies to rely on us for critical technology.

These factors may make it difficult for us to maintain our current relationships or establish new relationships with additional 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 pure-play 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 pure-play foundries to provide us with access to these processes. In addition, we rely on pure-play foundries to manufacture our silicon test chips, to provide referrals to their customer base and to help define the focus of our R&D activities. We currently have foundry agreements with Chartered Semiconductor Manufacturing (Chartered), Dongbu Hitek Ltd. (Dongbu HiTek), SilTerra Malaysia Sdn. Dhd. (SilTerra), Silicon Manufacturing International Corporation (SMIC), Tower Semiconductor, Ltd. (Tower), Taiwan Semiconductor Manufacturing Company (TSMC), and United Microelectronics Company (UMC). 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 must appropriately manage our relationships with foundries and other strategic partners in order to effectively execute on our business strategy.

In relying on foundry manufacturing relationships and other strategic alliances, we face the following risks:

 

   

reduced control over delivery schedules and product costs;

 

   

manufacturing costs that may be higher than anticipated;

 

   

inability of our manufacturing partners to develop manufacturing methods appropriate for our products and their unwillingness to devote adequate capacity to produce our products;

 

   

decline in product reliability;

 

   

inability to maintain continuing relationships with our foundry manufacturers due to competition or market consolidation; and

 

   

restricted ability to meet customer demand when faced with product shortages.

If any of these risks are realized, we could experience an interruption in our supply chain or an increase in costs, which could delay or decrease our revenue or adversely affect our business, financial condition and results of operations.

If we are unsuccessful in increasing our royalty revenues, our revenues and profitability may not grow as desired.

We have agreements with pure-play 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 pure-play 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 first three months of fiscal 2008 and 2007, we recorded royalty revenues of approximately $2.8 million and $3.3 million, respectively. The 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

 

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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.

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.

We may be unable to deliver our customized memory and logic 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.

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

It can take a significant amount of time and effort to negotiate a sale. Typically, it generally takes at least three to nine months after our first contact with a prospective customer before we start licensing our IP to that customer. In addition, purchase of our products is usually made in connection with new design starts, the timing of which 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.

Winning business is subject to a competitive selection process that can be lengthy and requires us to incur significant expense, and we may not be selected.

Our primary focus is on winning competitive bid selection processes, known as “design wins,” to develop products for use in our customers’ equipment. These selection processes can be lengthy and can require us to incur significant design and development expenditures. We may not win the competitive selection process and may never generate any revenue despite incurring significant design and development expenditures. Because we typically focus on only a few customers in a product area, the loss of a design win can sometimes result in our failure to offer a generation of a product. This can result in lost sales and could hurt our position in future competitive selection processes because we may be perceived as not being a technology leader.

After winning a product design for one of our customers, we may still experience delays in generating revenue from our products as a result of the lengthy development and design cycle. In addition, a delay or cancellation of a customer’s plans could significantly adversely affect our financial results, as we may have incurred significant expense and generated no revenue. Finally, if our customers fail to successfully market and sell their equipment it could materially adversely affect our business, financial condition and results of operations as the demand for our products falls.

Products that do not meet customer specifications or contain material defects 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’ design or 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.

 

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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 products 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 the Republic of 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 a significant level of civic unrest. India is experiencing rising costs and in certain industries, intense competition for highly qualified personnel. Armenia has in recent years 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:

 

   

changes in the political or economic conditions in Armenia and changes in the economic conditions in India and the surrounding region, such as fluctuations in exchange rates, changes in laws protecting IP, the imposition of currency transfer restrictions or limitations, or the adoption of burdensome trade or tax policies, procedures, rules, regulations or tariffs, changes in the demand for technical personnel could adversely affect our ability to develop new products, to take advantage of the cost savings associated with operations in Armenia and India, and to otherwise conduct business effectively in Armenia and India;

 

   

our ability to continue conducting business in Israel and other countries in the normal course may be adversely affected by increased risk of social and political instability; and

 

   

our Israeli customers’ demand for our products may be adversely affected because of negative economic consequences associated with reduced levels of safety and security in Israel.

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

Sales to customers located outside North America accounted for 54% and 42% of our revenues for the fiscal quarters ended December 31, 2008 and 2007, respectively. We anticipate that sales to customers located outside North America will continue to increase and will represent a significant portion of our total revenues in future periods. In addition, most of our customers that do not own their own fabrication plants rely on pure-play foundries located outside of North America. Accordingly, our operations and revenues are subject to a number of risks associated with doing business in international markets, including the following:

 

   

managing distributors and sales partners outside the U.S.;

 

   

staffing and managing non-U.S. branch offices and subsidiaries;

 

   

political and economic instability;

 

   

greater difficulty in collecting account receivables resulting in longer collection periods;

 

   

foreign currency exchange fluctuations;

 

   

changes in tax laws and tariffs or the interpretation of such laws and tariffs;

 

   

trade protection measures that may be adopted by other countries;

 

   

compliance with, and unexpected changes in, a wide variety of foreign laws and regulatory environments with which we are not familiar;

 

   

timing and availability of export licenses;

 

   

inadequate protection of IP rights in some countries;

 

   

different labor standards; and

 

   

United States government licensing requirements for exports, which may lengthen the sales cycle or restrict or prohibit the sale or licensing of certain products.

If these risks actually materialize, our international operations may be adversely affected and sales to international customers, as well as those domestic customers that use foreign fabrication plants, may decrease.

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. We have one customer that generated 10% or more of our revenue for the three months ended December 31, 2008 and three customers that generated 10% or more of our revenue for the

 

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three months ended December 31, 2007. 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 significant 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 collectibility of our accounts receivable, revenues recorded and our future operating results.

Our quarterly operating results may fluctuate significantly and the 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 our control. Factors that could cause our revenues and operating results to vary materially from quarter to quarter include the following:

 

   

large orders unevenly spaced over time, or the cancellation or delay of orders;

 

   

pace of adoption of new technologies by customers;

 

   

timing of introduction of new products and technologies and technology enhancements by us and our competitors;

 

   

our lengthy sales cycle and fluctuations in the demand for our products and products that incorporate our IP;

 

   

constrained or deferred spending decisions by customers;

 

   

delays in new process qualification or verification;

 

   

capacity constraints at the facilities of our foundries;

 

   

inability to collect or delay in collection of receivables;

 

   

the timing and completion of milestones under customer agreements;

 

   

the impact of competition on license revenues or royalty rates;

 

   

the cyclical nature of the semiconductor industry and the general economic environment;

 

   

consolidation, merger and acquisition activity of our customer base may cause delays or loss of sales;

 

   

the amount and timing of royalty payments;

 

   

changes in development schedules; and

 

   

R&D expenditures.

As a result, we believe that quarter-to-quarter comparisons of our results of operations are not necessarily meaningful and may not be reliable as indicators of future performance. These factors 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.

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 the semiconductor industry’s trusted IP partner, 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.

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 2001 through 2006 and issued assessment orders in which the Indian Tax Authorities proposes to assess an aggregate tax deficiency for the six year period of approximately $1.2

 

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million, net of deposits of $260,000 as required by the Indian Tax Authorities. Interest will continue to accrue until the matter is resolved. 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.

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 equity incentives 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.

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 fund growth of our business and any acquisitions we may pursue, to respond to competitive pressures or to acquire complementary products or technologies. Additional equity or debt 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 ownership of our stockholders would be diluted 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.

Risk Related to Our Industry

We operate in the highly cyclical semiconductor industry, which is subject to significant downturns.

The semiconductor industry is highly cyclical and is characterized by constant and rapid technological change, rapid product obsolescence and price erosion, evolving standards, short product life-cycles and wide fluctuations in product supply and demand. The industry has experienced significant downturns, often in connection with, or in anticipation of, maturing product cycles of both semiconductor companies’ and their customers’ products and declines in general economic conditions. At present, overall economic conditions during the first quarter of fiscal 2009, which may continue throughout 2009, have negatively impacted sales. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. We have experienced these conditions in our business in the past and may experience such downturns in the future. We may not be able to manage these downturns. Any future downturns of this nature could have a material adverse effect on our business, financial condition and results of operations.

If demand for products incorporating complex semiconductors and semiconductor IP 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 R&D 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 adversely affect the demand for our products and may cause us to experience substantial period-to-period fluctuations in our operating results.

 

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The market for semiconductor IP 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 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 the following:

 

   

our ability to anticipate and respond in a timely manner to changes in the requirements of semiconductor companies;

 

   

the emergence of new semiconductor manufacturing processes and our ability to enter into strategic relationships with pure-play semiconductor foundries to develop and test technologies for these new processes and provide customer referrals;

 

   

the significant R&D investment that we may be required to make before market acceptance, if any, of a particular technology;

 

   

the possibility that the industry may not accept a new technology or may delay use of a new technology after we have invested a significant amount of resources to develop it; and

 

   

new technologies introduced by our competitors.

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

In addition, R&D requires a significant expense and resource commitment. 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.

 

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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 Furthermore, the laws of some foreign countries may not adequately protect our IP to the same extent as applicable laws protect 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.

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 the following:

 

   

variations between our operating results and the published expectations of securities analysts;

 

   

changes in financial estimates or investment recommendations by securities analysts who follow our business;

 

   

announcements by us or our competitors of significant contracts, new products or services, acquisitions, or other significant transactions;

 

   

the inclusion or exclusion of our stock in various indices or investment categories, especially as compared to the investment profiles of our stockholders at a given time;

 

   

changes in economic and capital market conditions;

 

   

changes in business regulatory conditions; and

 

   

the trading volume of our common stock.

 

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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. Alexander Shubat, our Chief Executive Officer and a member of the Board of Directors, holds a large block of our common stock. Dr. Shubat has established a sales plan, or other sales accounts, to sell shares of our common stock and diversify his holdings. Significant sales by insiders, or the perception that large sales could occur, could adversely impact the public market for our stock. Sales transactions are also subject to the restrictions and filing requirements mandated by Securities and Exchange Commission Rule 144. Our officers, directors and principal stockholders controlled as of December 31, 2008 approximately 54% 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 significant block stockholders.

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:

 

   

our Board of Directors is authorized, without prior stockholder approval, to create and issue preferred stock, commonly referred to as “blank check” preferred stock, with rights senior to those of common stock;

 

   

our Board of Directors is staggered into three classes, only one of which is elected at each annual meeting;

 

   

stockholder action by written consent is prohibited;

 

   

nominations for election to our Board of Directors and the submission of matters to be acted upon by stockholders at a meeting are subject to advance notice requirements;

 

   

certain provisions in our bylaws and certificate may only be amended with the approval of stockholders holding 80% of our outstanding voting stock;

 

   

the ability of our stockholders to call special meetings of stockholders is prohibited; and

 

   

our Board of Directors is expressly authorized to make, alter or repeal our bylaws.

We are also subject to Section 203 of the Delaware General Corporation Law, which provides, subject to enumerated exceptions, that if a person acquires 15% or more of our outstanding voting stock, the person is an “interested stockholder” and may not engage in any “business combination” with us for a period of three years from the time the person acquired 15% or more of our outstanding voting stock. In addition, in February 2007, we executed change in control agreements with our executive officers, which provide severance benefits following a termination without cause, or for good reason, following a change in control. The existence of these agreements and potential pay-outs could act as a deterrent to a potential acquirer.

 

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES

The following table provides the specified information about the repurchase of shares by the Company in the first quarter of fiscal year 2009.

 

Period

   Total number
of shares
purchased
   Price paid per
share
   Total number
of shares
purchased as
part of
publicly
announced
plans or
programs
   Maximum
approximate
dollar value of
shares that may
yet be
purchased
under the plans
or programs

August 4, 2008

   700,000    $ 6.49    700,000    $ 15,457,000

December 8, 2008

   190,000    $ 2.95    890,000    $ 14,896,500
             

Total

   890,000         
             

On May 6, 2008, the Company adopted a stock repurchase program to purchase up to $20 million in shares of the common stock in the open market or negotiated transactions through May 2009. “See Note 10. Stock Repurchase Program.”

 

ITEM 3. EXHIBITS

 

Exhibit No

  

Exhibits

31.1    Certification Pursuant to Rule 13(a)-14(a) of the Securities and Exchange Act as amended, as Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification Pursuant to Rule 13(a)-14(a) of the Securities and Exchange Act as amended, as Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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SIGNATURES

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

 

Date: February 9, 2009   VIRAGE LOGIC CORPORATION
 

/s/ Alexander Shubat

  Dr. Alexander Shubat
  President and Chief Executive Officer
 

/s/ Brian Sereda

  Brian Sereda
  Chief Financial Officer
  (Principal Financial and Accounting Officer)

 

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EXHIBIT INDEX

 

31.1   Certification Pursuant to Rule 13(a)-14(a) of the Securities and Exchange Act as amended, as Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2   Certification Pursuant to Rule 13(a)-14(a) of the Securities and Exchange Act as amended, as Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1   Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2   Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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