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Executives

Christine Russell - CFO

Dan McCranie - President and CEO

Analysts

Mike Crawford

Steve DeLuca - Spinner Asset

Rich Valera - Needham & Company

Virage Logic Corporation (VIRL) F1Q08 (Qtr End 12/29/07) Earnings Call January 30, 2008 4:30 PM ET

Operator

Good afternoon. At this time, I would like to welcome everyone to the Virage Logic First Quarter 2008 Fiscal Results Conference Call. (Operator Instructions)

At this time, I would like to turn the call over to Christine Russell, Chief Financial Officer. Please go ahead ma'am.

Christine Russell

Thank you for joining us today to review the financial results of Virage Logic for the first quarter of fiscal 2008, which ended December 31, 2007. The call is also being webcast on the Virage Logic website at viragelogic.com. The financial results for the quarter will be released today after market close. A copy of that news release has also been posted on the company's website. After I review the financial results and provide an outlook for the second quarter fiscal 2008, I will turn the call over to our President and CEO, Dan McCranie, to discuss the business overview. We will then open the call for your questions.

Before we begin our prepared remarks, I would like you to know that statements made in this conference call, other than statements of historical fact, are forward-looking statements including, for example, statements relating to industry and company trends, business outlook, and products. Forward-looking statements are subject to a number of risks and uncertainties, which might cause actual results to differ materially from those expressed or implied by such statements.

These risks and uncertainties include Virage Logic's ability to improve its operations, forecast its business, revenue and income. Virage Logic's ability to execute on its strategy to serve as a semiconductor industry's trusted IP partner, business and economic conditions generally, and in the semiconductor industry in particular, competition in the market for semiconductor IP components and other risks including those described in the company's periodic reports filed with the SEC. Virage Logic disclaims any intention or duty to update any forward-looking statements made in this conference call.

Now let's review the financial results. We reported revenues of $14.1 million for the first quarter of fiscal 2008 compared with $ 13.1 million for the previous quarter, which represents a 7% sequential increase. License revenue for the quarter was $10.8 million compared to $ 9.9 million in the previous quarter, or an 8% sequential increase in license revenues. Royalties for the quarter were $ 3.3 million compared with $ 3.2 million in the previous quarter.

As reported under US Generally Accepted Accounting Principles, net income for the first quarter of fiscal 2008 was $1.1 million or $ 0.5 per share compared with a net loss of $376,000 or $0.02 per share for the previous quarter. Our profits were the result of a combination of pipeline growth and holding expenses relatively flat. Excluding the effects of stock based compensation and amortization of intangibles; we posted a profit for the first quarter of $1.4 million or $0.06 per share.

As in the prior quarter, the geographic diversification of our sales weighted in favor of North America, which comprised 58% of sales, Asia comprised 24% and EMEA contributed 18%. EMEA, which was up from 10% of sales in the prior quarter, had particular success in bringing in the first booking of our new Star Yield Accelerator product and also contributed a substantial amount in terms of ASIP, DDR deals in the quarter. The ASAP product line, which includes double data rate controllers PHY and DLL was added to our product portfolio after our August acquisition of Ingot Systems.

In the first quarter, the majority of our physical IP license revenue came from the 65-nanometer products followed closely by the 90-nanometer products. Specifically, the 65-nanometer contributed 43% of physical IP licensee revenue. The 90-nanometer node contributed 28% of physical IP license revenue. The 130 node was 19% and the 45 node was 10%.

The percentage of physical IP license sales in the 65-nanometer technology has continued to increase substantially each quarter this year and the 45 is contributing to revenue as well. This trend indicates customers are adopting our newest technology. We had eight new customers in the quarter. We are always pleased to add new names to our customer list, since most of the customers return to us for add-on business, which includes new design and projects. This expands our potential for future orders.

Royalties were $3.3 million, with the mature technologies at 180-nanometer and 130-nanometer nodes contributing 57% of royalties. The 90-nanometer and 65-nanometer technologies contributed 43% of royalties. We have our spending basically flat at $13.2 million for the quarter excluding the effects of stock based compensation and amortization of intangibles. With the 7% increase in our top line revenue the effects of disciplined approach was $1.1 million of GAAP net income.

We are particularly gratified with posting this level of profit, as unlike many companies, we have no NOL tax offset to leverage our net income. Our profits were the result of management of our business and assets. We expect Q2 expenses to increase due to higher payroll taxes, which substantially dropped at the end of the calendar year primarily FICA and they restart in January. With over 60% of our expenses in payroll this impact is significantly close to $0.5 million in the second quarter.

Commissions are also expected to increase as sales bookings increased. Stock compensation expense is expected to return to the more normalized rate of around $1.2 million in the second fiscal quarter. We had a onetime reduction in this expense in Q1 '08 due to cancellation of stock options that were forfeited. We have a metric, we discuss every quarter called the license coverage ratio; this measurement shows how close we are to covering or paying for a 100% of our spending with license revenues.

Spending includes cost of sales and operating expenses and excludes stock based compensation. The reason we highlight this metric is that where all cost and expenses are covered by license revenues, royalty revenue, which is a 100% gross margin can fall to the bottom line as EPS.

To give you an idea of how we are achieving this target could enhance our P&L at our current royalty run rate of around $3 million royalty revenue per quarter. This could translate to $0.13 earnings per share pretax on a quarterly basis.

So, to return to the first quarter's coverage ratio metric, licensed revenues for the first quarter covered 82% of cost and expenses compared to 76% in the prior quarter. This is the highest coverage ratio we have achieved in the past three years.

At December 31, 2007 we had 408 employees compared to 414 employees at the end of the September quarter. The headcount split by functional area is 327 in engineering or 80%, 55 in sales and marketing or 14% and 26 in G&A or 6%. We are a company committed to advanced technology as represented by the predominance of the engineering employees in our functional mix.

During the quarter, Virage recognized $416,000 of stock compensation expense with $102,000 related to cost of revenue, $221,000 related to R&D, $88,000 related to sales and marketing and $5,000 related to G&A. Amortization of intangibles was $69,000 which was expensed in R&D.

Now looking at our balance sheet, cash was $77.8 million compared to $75.2 million for the previous quarter, an increase of $2.6 million in the quarter. Collections and accounts receivable accounted for the majority of the increase in cash. Accounts receivable was $9.3 million compared to $12.2 million for the previous quarter.

DSO, day sales outstanding, was 59 days compared to the prior quarter's 83 days. This DSO was a historical low for Virage and reflects our discipline around doing deals with reasonable payment terms and focusing on collections.

Now, let's turn to our guidance. In terms of providing guidance for the second quarter of fiscal 2008 ending March 31, we expect revenues to be in the range of $14.3 to $14.8 million with license revenues of $11.3 to $11.8 million and royalty revenues of around $3 million. We expect stock based compensation expense of $1.2 million. We expect to report GAAP net loss of approximately $0.01 per share to net income of $0.01 per share.

The GAAP lower net income range in our guidance, as compared to Q1 '08 net income, is driven primarily by stock based compensation expense returning to normal run rate level as well as the restart of (inaudible) payroll taxes and higher sales commissions. Excluding the effect of stock based compensation and amortization of intangibles; we expect non-GAAP results to fall within the range of $0.03 to $0.05 per share profit. Shares outstanding are expected at approximately $23.8 million fully diluted.

Now, I'll turn the call over to Dan McCranie, our President and CEO.

Dan McCranie

Thanks, Christine. Good job on covering the critical metrics of this past quarter. So, once again and in the interest of time and to give the listeners on this conference call plenty of time for any questions, I'm going to limit my comments to just three items. First, I wanted to update everyone on the progress we are making on delivering both front-ends and GDS files for the advanced node memory compliers and logic libraries. By advanced node, I mean 65-nanometer, 55-nanometer, 45-nanometer and 40-nanometer.

As of at the end of this quarter, we successfully delivered the grand bulk of front-end at 65, 55, 45 and 40 process nodes, as well as selected back-ends, that is GDS files, for some 45 and 40-nanometer compliers. We have additionally delivered complete front-end and GDS files for almost all of our, entire 65-nanometer product portfolio.

Our newest family of memory compilers and logic libraries of these advance nodes, which were developed by our advanced technology, grouped as brand named SiWare. The SiWare memory provides a feature rich set of options that I believe are first and premier in the market regarding a wide range of power control options for architects, while the SiWare Logic Libraries enable designers to manage tradeoffs to achieve superior gate density as well as effective power management. We are receiving very encouraging feedback from our customers on this product family and we have closed the first significant pieces of businesses with large IDMs during the past several months.

Next, I want to discuss our initial progress and monetizing our investment in Ingot Systems, the small DDR IP company we purchased in August of 2007. As I mentioned in the press release, we had strong success in our first full quarter of promoting a product to customers resulted in lengthening B007 1:17 of orders that were over twice our original projections and many times more than Ingot themselves have been able to achieve previously as an independent entity.

In addition, we built up their opportunity pipeline to over $7.5 million to this product family and we now believe that we will handily beat our original FY 2008 revenue projections, the revenue projections, by which you purchased this business unit.

Then finally, I want to mention that we are continuing to make positive steps in our goals to diversify the product portfolio of Virage Logic. In addition to our first significant orders coming from the Ingot acquisition, we are also starting to receive new license bookings on our non-volatile operating NOVeA as well as first orders on a newly introduced STAR Accelerator product.

For the near future, we are already in several new product families encompassing our SRAM memory libraries, our non volatile products and our application specific IP business. Our goal, as we have previously stated, is to directly expand our product offerings through both organic and inorganic growth in order to capture a larger share of our customers SoC development budget.

That's the end of my prepared remarks. I'd like to open this conference up now for your questions. Operator, Kristin.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from Mike Crawford.

Mike Crawford

Since you mentioned TI and AMD is new customers, of 45-nanometer, can you talk a little bit more about those engagements?

Dan McCranie

Hi, Mike this is Dan. I'm not going to be able to talk in too much detail because of the requirements of TI and AMD to maintain confidentiality. However, we've been able to get permission to say that they have engaged with us in our cyber product offerings and that we are selling both 45-nanometer memories and 45-nanometer compilers to them to those IDMs for their generic business. We are currently selling them both GS and LP versions.

Mike Crawford

Okay, great. And then the comment on the royalty, so with 65 and 90 still narrowing in, is it just seasonal: why you don't expect it to pickup in March? I mean: shouldn't we start to expect pretty much pickup in royalty line over the next couple of years?

Dan McCranie

Mike I should, however, as I think, I said in the press release I'm quite surprised at the news coming out from my semiconductor brother B009 0:16 and as well as by the foundries themselves. I've said in my conferences that I believe and I've shown lots of detail, why I think that when 65-nanometer really becomes a large entity with both TSMC, UMC and then hopefully with a combined organization then I got to see a big kick up in royalties.

I'm not ready to say it's going to happen in the March quarter. I don't have enough data to say that it won't. But it seems to me form what I know of our customer base, it's more likely that I'm going to see a kick up in royalties in 65-nanometer in the second half of fiscal 2008. That's frankly how I'm forecasting it.

Mike Crawford

Great! And a final question on the royalties: let say for the March quarter those are the products that shipped in the December quarter, am I right?

Dan McCranie

Yeah, correct.

Mike Crawford

And: when do you typically have the bulk of these reports in to the company?

Dan McCranie

Well I haven't received any reports yet and I'm going to work [with five]. I received indications from a couple of the houses, but I haven't received reports. One of the things, I do want our royalty is hard to do is get it more robust loop with our major foundries so that they can have a little more intelligent guess when I talk to you about my royalty forecasting. But, last quarter is an example, I didn't get the large guys until mid-quarter and I didn't get the small guys until workweeks 11, 12 and 13. So, I've got to improve on that. So, even though in a rear, I'm just not getting the material impact enough.

Mike Crawford

All right. Thank you very much.

Dan McCranie

You bet.

Operator

(Operator Instructions) And your next question comes from Steve DeLuca with Spinner Asset.

Steve DeLuca - Spinner Asset

Hi guys, how are you? Thanks for a good December report. Christine what drives cost of revenue down so much sequentially? And it looks like R&D is up a bit, I'm assuming a lot of that's from Ingot, but: if you guys can give me some detail there that will be great?

Christine Russell

Yeah, actually we do have improved gross margins in this quarter and some of that has to do with the fact that we're shipping a little bit more off the shelf product than we typically do and those are of course a 100% gross margin. Just to give you a little more color on that the off the self products of course there is no cost associated with them and then we've what we call light touch products, which are almost off the self but maybe it was running the 85% to 90% gross margin. And then custom deals have a wide range of gross margins.

Steve DeLuca - Spinner Asset

So, Dan to just get back to your efforts of trying to do less custom and more off the shelf stuff and: is it sustainable?

Dan McCranie

It is just get back to that as what Christine was alluding to. We're far from declaring victory on that Steve. But still, there are too many one of things but we've increased our standard product offering and we've increased the number of repeat licenses that we are doing. But we are still may I guess, I'm reported but we're still in the 30% to 40% of standard product range.

Steve DeLuca - Spinner Asset

Okay.

Dan McCranie

And I guess, we're not reporting that means we're in the 60% to 70% of custom and that just a, it’s an unhealthy it think it’s an unhealthy relationship for a highly scalable business.

Steve DeLuca - Spinner Asset

Okay. So, it sounds like there is more room there for profit at the bottom line?

Dan McCranie

That's a positive way to say: “yes”. There is a lot more room to move into standard products and we are spending an awful lot of energy real fast I've said this every quarter but I'm just proud of what they did. Alex Shubat, the co-founder of the company. In January, we established an advanced technology group and only gave them one charter which is to get us current and 65-nanometer ahead of the market then 45-nanometer with this advanced SiWare and their leadership position in 40 and 32-nanometer all in standard products.

And so he doesn’t do custom. There is ATG and the first board I brought up in my prepared remarks, I think the indication that Alex and his team did a good job. We were hideously behind in January and maybe wrong adverb, we were behind in January on 65-nanometer. We are no longer behind. I think we're world class because of SiWare and I don’t think anybody is ahead of us at all in 45-nanometer and it's all standard product.

Steve DeLuca - Spinner Asset

And it hasn't affected the top line either. It's actually helped it so that's good. On the R&D side is most of that bumped? The sequential bump from Ingot?

Dan McCranie

Are you talking about Ingot over this last quarter, Steve?

Steve DeLuca - Spinner Asset

Yeah the non GAAP

Dan McCranie

Yes, that certainly is 30 bodies or 30 engineers and whatever that costs associated with it. I believe that the core business, it could be called the classic business. I think that was down a few bodies in engineering. I'm not quite sure about that. But I think it was down a few bodies. So, this increase was 100% of full quarter of the DDR group, which is formally Ingot.

Christine Russell

Yeah exactly, R&D went up $800,000 over the prior quarter and that is the Ingot acquisition.

Steve DeLuca - Spinner Asset

Last question, Christine are you projecting interest income to be down this quarter given that rates are down quite a bit in your guidance?

Christine Russell

No, not by much at all.

Steve DeLuca - Spinner Asset

Okay. Thanks, guys.

Dan McCranie

Thanks, Steve.

Operator

(Operator Instructions) Your next question comes from Rich Valera with Needham & Company.

Rich Valera - Needham & Company

Yeah, I'm just wondering, if you can talk about your bookings both -- qualitatively because I know you don't want to get specific metrics, but during this just completed quarter: how the bookings pipeline looks in March and June?

And just kind of talk about your confidence and your outlook, it sounds like you've basically been building sort of a firmer bookings pipeline and backlog and that should have been helping your revenue visibility. So: can you just give us a little more color on how that shaping up? And: how it looks for the next couple of quarters? That would be helpful.

Dan McCranie

Hey, good afternoon Rich, I can. Our booking pipeline, excuse me, since the beginning of quarter backlog, as a result of the strong bookings we've had for the last several quarters is indeed helpful. And we walk into this quarter with a nice strong booking backlog. Pete Rodriguez is here with me.

Our opportunity forecast for this quarter in bookings is extremely high and if we achieve that and it's extremely high and some very new important pieces of business primarily in memory and logic compilers at the 50,45 and 40-nanometer nodes as well as the DDR business. If we achieve anywhere near our annual operating plan quarterly bookings forecast for this quarter, we are going to have very good June.

So, I'd say that the pipelines are up because they are less several quarters of bookings. We walk into the quarter with much better backlog and the current sales forecasts from Pete and his team is for extremely strong bookings and those bookings are some of them have come in nicely now.

We are looking for more on the coming in the next two weeks and so it looks like right now they are not going to be so backend loaded and therefore not put as much fear and loathing in my heart as we wait up the quarter. So, I think if we are right we are going to have a very strong backlog at the end of March for the June and September quarter of course we will wait and see. But I've never seen so much action and we are all pretty energized by it.

At the same time, I'm aware that the semiconductor industry in general and foundries in particular seem to be struggling in the March quarter so that's why I'm balancing my forecast enthusiasm.

Rich Valera - Needham & Company

Well that's very helpful and congratulations on nice progress you've made in the last year Dan.

Dan McCranie

Thanks, Rich.

Operator

(Operator Instructions) And there are no questions at this time are there any closing remarks.

Dan McCranie

Thanks. Kristin. Okay, we want to thank you all for attending the conference and I think I'll be seeing some of you in a couple of presentations this quarter and come up and give us a call Christine and I and we will talk to you about how the quarter is progressing. Take care.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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