VIRAGE INC - 10-K Annual Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE FISCAL YEAR ENDED MARCH 31, 2001

OR

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

COMMISSION FILE NUMBER: 0-30903
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VIRAGE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 38-3171505
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)

177 BOVET ROAD, SUITE 520
SAN MATEO, CALIFORNIA 94402-3116
(650) 573-3210
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF THE REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)

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. [X] Yes [ ] No

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

As of June 4, 2001, there were approximately 20,370,154 shares of the
registrant's Common Stock outstanding. The aggregate market value of the voting
stock held by non-affiliates of the registrant, based on the closing sale price
of the Common Stock on June 4, 2001 as reported on the Nasdaq National Market
was approximately $59,518,000. Shares of Common Stock held by each current
executive officer and director have been excluded from this computation in that
such persons may be deemed to be affiliates of the Company. This determination
of affiliate status is not a conclusive determination for other purposes.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's Proxy Statement for the registrant's 2001 Annual
Meeting of Stockholders are incorporated by reference into Part III of this Form
10-K to the extent stated herein. The Proxy Statement will be filed within 120
days of registrant's fiscal year ended March 31, 2001.

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VIRAGE, INC.

INDEX

PAGE

PART I

Item 1. Business .................................................................................. 3

Item 2. Properties ................................................................................ 22

Item 3. Legal Proceedings ......................................................................... 22

Item 4. Submission of Matters to a Vote of Security Holders ....................................... 22

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ..................... 25

Item 6. Selected Consolidated Financial Data ...................................................... 26

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ..... 27

Item 7A. Quantitative and Qualitative Disclosures About Market Risk ............................... 33

Item 8. Financial Statements and Supplementary Data ............................................... 34

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ...... 56

PART III

Item 10. Directors and Executive Officers of the Registrant ....................................... 56

Item 11. Executive Compensation ................................................................... 56

Item 12. Security Ownership of Certain Beneficial Owners and Management ........................... 56

Item 13. Certain Relationships and Related Transactions ........................................... 56

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K .......................... 56

Signatures ........................................................................................ 58

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PART I

This annual report on Form 10-K contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 (the "Securities
Act"), as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), including statements using terminology such as
"can," "may," "believe," "designed to," "will," "expect," "plan," "anticipate,"
"estimate," "potential," or "continue," or the negative thereof or other
comparable terminology regarding beliefs, plans, expectations or intentions
regarding the future. Forward-looking statements involve risks and uncertainties
and actual results could differ materially from those discussed in the
forward-looking statements. All forward- looking statements and risk factors
included in this document are made as of the date hereof, based on information
available to the Company as of the date thereof, and the Company assumes no
obligation to update any forward-looking statement or risk factors.

ITEM 1. BUSINESS

OVERVIEW

Virage is a leading provider of software products and services that
enable media and entertainment companies, corporate enterprises, educational
institutions, and government agencies to publish, manage and distribute their
video content over the Internet and intranets. Our Video Application Platform
provides the necessary infrastructure for seamlessly integrating Internet-ready
video into an internal or external website, transforming video into an effective
online medium. Our platform includes our SmartEncode products, which encode and
index video within a single automated process, and our server products, which
enable the publishing and distribution of streaming video. Owners of video
content can leverage our technology either by licensing our products or by
employing our application services to outsource their needs. We currently have
over 250 customers including media and entertainment corporations such as CNET,
CNN, Disney and Warner Bros.; sports leagues such as Major League Baseball
Advanced Media and the National Hockey League; global corporations such as
Boeing, Cisco and Coca-Cola; educational institutions such as Harvard Business
School, Princeton University and Stanford University Graduate School of
Business; and government entities such as the FBI and the Library of Congress.

We were founded in April 1994 and incorporated in Delaware in March 1995.
Our principal executive offices are located at 177 Bovet Road, Suite 520, San
Mateo, California 94402 and our telephone number is (650) 573-3210.

INDUSTRY BACKGROUND

The emergence and rapid growth of broadband networks is enabling the use
of streaming video across a variety of industry sectors. For many media and
entertainment companies, video assets are central to their business. Conversion
of those assets to digital formats is a requisite step to an increasingly
digital future and offers both productivity as well as revenue enhancing
potential. For example, conversion to digital video increases productivity by
allowing staff to view and edit video on their corporate intranets, eliminating
the need to find and handle videotapes. Digital video allows media companies to
produce new content more quickly and to reuse existing content more effectively.
In addition, video content can now be distributed directly to consumers with
broadband access at work, in school, or in their homes, providing additional
sources of revenue for content owners. For corporate enterprises, the value of
web video distribution can be realized through more effective communication
throughout the organization. The use of streaming video in the enterprise can
also deliver increased productivity and significant cost savings. For example, a
web-based video training course can substitute for expensive and time-consuming
travel to a training site. Similarly, educational institutions can use video on
their intranet or on the Internet to expand the reach of their courses or to
enhance the research resources of their students.

According to a study released by Jupiter Media Metrix in April 2001,
corporations will spend significantly higher amounts on streaming video
technology in the next four years. Jupiter estimates that

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spending will reach $2.8 billion in 2005, up from $140 million in 2000. The
Federal Communications Commission also predicts that half of all Internet
connections in the US will be broadband by 2004.

Even with significant improvements in networks and high-speed network
access, further roadblocks inhibit the mass adoption of streaming video. First,
the transformation to and management of digital video are complex and costly for
the content owner. Second, current streaming media deployments and techniques
result in an undesirable viewing experience for the end-user.

To effectively deliver video to the Internet or intranet, video must
first be converted to a digital format such as RealVideo, QuickTime, Windows
Media, or MPEG. This conversion process, known as encoding, produces digital
video files that are stored in a wide variety of file storage systems or storage
area networks. In order to reach the end-user or consumer, encoded video is
distributed through hosting, caching, and backbone service providers either
while it is encoded (live webcasting) or after the fact, when requested by the
viewer (on-demand). Until recently, the only commercial products available for
implementing streaming video were basic encoding tools and streaming servers.
These basic tools were highly manual and ineffective for deploying and managing
streaming video content at an enterprise scale. These techniques did not provide
the content management capabilities necessary to deploy large video collections
across multiple Internet or intranet sites in a timely and cost-effective
manner.

To date, the end-user's streaming video viewing experience has been very
poor. Although rapid improvements in networks and servers continue to improve
the reliability and image quality of streaming video, most web video is lacking
in other ways. First, streaming video is usually presented in a linear fashion,
reflecting and inheriting the limitations of its technical predecessor, the
television. Streaming video has also resided on the web in isolation because it
lacks the data to interact properly with other textual or multimedia
information. As the amount of video on the Internet or on a corporate intranet
grows, the viewer's inability to locate the video they want, view just the
segments they want, and retrieve or view related textual material will lead to
an increasingly frustrating and time-consuming experience. To make matters
worse, this frustrating user experience also results in inefficient and costly
use of network bandwidth as users struggle to find the relevant information.

Content owners require an enterprise-class solution to deploy, manage and
distribute video content over the Internet and intranets while enhancing the
user's viewing experience.

THE VIRAGE SOLUTION

Virage provides a robust platform that supports enterprise-scale
streaming media deployments. Our products allow customers to transform, manage
and distribute their video in a way that is efficient, scalable, and of the
highest quality. At the front end, Virage transforms video from an amorphous
analog source into a structured digital video database quickly and efficiently.
Our products eliminate much of the complexity, time, and effort required to
encode and index video properly. In addition, our platform allows customers to
administer and manage their collections of digital video content, integrating
them dynamically throughout one or more Internet or intranet sites. Just as
importantly, our products dramatically improve the end-users' experience by
allowing them to quickly locate and view just the content that they want. As
enterprises begin to deploy streaming media, Virage's solutions provide the
content management capabilities required to scale these efforts successfully.

The Virage Internet Video Application Platform consists of several
modules that can be implemented together or separately. Customers can employ
these modules either by purchasing a license to our software or by outsourcing
their needs to our Application Services division, which is powered by the same
software we sell commercially.

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[FLOW CHART]

SMARTENCODE(TM) PRODUCTS

VideoLogger(R)

With a single pass of the video content, our VideoLogger application
generates a rich information index and simultaneously encodes the video into the
selected digital formats. The video index and digital video files are time
synchronized, allowing the index data to reference particular moments in the
video. The indexing process converts video into data that computers can
recognize. The index, or video database, acts like an index found at the back of
a book, allowing pinpoint access into video content. Indexing information can be
derived from automated analysis of the video stream, from external sources of
time-coded data, or from information entered by a user. Automatically extracted
information includes a visual storyboard of scene changes, a transcription of
spoken words (via speech recognition), audio classification, closed captioning
or teletext, names of recognized faces and speakers, on-screen text, and time
code. External sources of data could include an "edit decision list" from
non-linear video editing software such as Avid, a transcript of words spoken, or
a real-time statistics feed from a sports stadium. User entered information can
include clip titles, clip descriptions, categories, clip in and out points,
event dates, and other custom descriptions. The easy-to-use VideoLogger
interface allows a customer to monitor video capture and indexing, control
multiple encoders, and create clips on the fly. Once the index is produced, it
can be integrated with a number of different back-end solutions, including the
Virage Video Application Server. The Virage SmartEncode process is available
either through the latest release of the award-winning Virage VideoLogger
product or in an outsourced fashion through Virage application services.

Customers or third-party developers can enhance the SmartEncode process
through the VideoLogger Software Developer Kit (SDK). The VideoLogger SDK
provides developers and systems integrators access to the full range of
VideoLogger functions through a programming interface. This enables reliable
integration into a wide variety of automated workflows and allows developers to
add additional indexing and encoding functionality to VideoLogger as necessary.

Virage ControlCenter(TM)

The Virage ControlCenter product is a powerful workflow application that
remotely schedules, controls, and manages the SmartEncode process for multiple
VideoLoggers from a central console. Capture of the source video signal is the
starting point. Virage software can accept video from virtually any analog or
digital source: camera, satellite feed, television, video tape, or digital file.
Capture of multiple video

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feeds can be automated and managed centrally via ControlCenter for greater
efficiency. For outsourcing needs, Virage production facilities in the United
States and Europe can capture content from over 500 satellite channels
worldwide, from a range of professional satellites and fiber networks, and from
all major tape formats.

SERVER PRODUCTS

Virage Video Application Server(TM)

The powerful XML-based Video Application Server product provides a
comprehensive platform for publishing, managing and distributing Virage-enabled
content on the web. The Video Application Server hosts the video index generated
by the SmartEncode process. It is designed for high performance and can scale to
enterprise-wide and Internet-wide deployments. The Video Application Server
content management capabilities include account setup, deleting or inserting
video assets from the databases, editing existing video assets, and managing
multiple video collections.

The Video Application Server is used to publish and distribute content to
video rich websites. With the Video Application Server, a customer can
efficiently publish on demand video throughout a website, seamlessly integrated
with the existing website look and feel. Sample web templates provide an easy
"out of the box" experience, or customers can develop their own HTML templates
to create search and results pages and player windows tailored to their specific
needs. The Video Application Server supports all common streaming formats
including RealVideo, Windows Media, QuickTime, and MPEG. It can also extend the
viewing experience beyond the PC-based Internet to set top boxes, game consoles,
handheld and wireless devices.

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Features

SEARCH With Virage Video Application Server, content owners can
deliver video content to end-users through well-understood
navigation paradigms. This allows users to quickly find
the content of interest.
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DYNAMIC PUBLISHING Video Application Server can automate the process of delivering
video clips throughout a web site. Content can be automatically
published based on its category or keywords.
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REPORTING Daily, weekly and monthly traffic reports provide content owners
with Nielsen-type ratings for published content, with information
on most popular search terms, most accessed clips and best traffic
drivers.
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CDN MANAGEMENT Because many content owners use multiple content distribution
networks (CDNs), the Video Application Server provides an
abstraction layer to simplify content distribution.
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PERSONALIZATION Video Application Server provides a range of capabilities that
allow content owners to deploy personalized viewing experiences.
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SYNDICATION Because Video Application Server separates the content database
from the HTML templates, it allows a single content collection
to be syndicated to multiple sites, each with a unique look & feel.
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Other Server products include the following:

Video Application Server SDK

The Video Application Server Software Developer Kit (SDK) allows
developers and systems integrators to build custom applications to suit any
publishing environment.

Virage Syndication Manager(TM)

Our Syndication Manager application allows content owners to securely
syndicate their streaming video content to a variety of web affiliates. Content
owners can create discrete packages of video clips and assign rights to those
packages to an array of affiliates. Content owners can set up business rules for
each affiliate that will ensure that the video will be used only as
contractually specified.

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MediaSync(TM)

Our MediaSync product provides a fully integrated, end-to-end solution
for rapidly assembling, synchronizing and publishing streaming video with
PowerPoint slides to a website.

SERVICE OFFERINGS

Virage offers a wide variety of services to ensure our customers'
success. Customers are encouraged to choose the combination of products and
services that best meets their needs.

Software installation and training

License software customers increasingly are contracting with Virage for
software installation and training support. These services ensure that customers
can get up and running successfully with Virage software as quickly as possible.
These services are typically billed on a daily or hourly basis.

Development and implementation services

Virage offers a variety of professional services aimed at helping
customers to implement or customize our commercial software. The services
typically consist of implementing our SmartEncode products in a unique
production environment or building specialized plug-ins to our products. We can
also build custom web templates for Video Application Server installations and
help with website integration. We offer these services to customers regardless
of whether they license software products, or opt for our outsourced, hosted
solution. These services are typically billed on an hourly basis, though in some
cases we offer a fixed fee project based upon the size of the project.

SmartEncode services

Instead of purchasing our SmartEncode products, customers can instead
outsource their video processing needs to us. Using our own SmartEncode
products, we process content from a variety of analog or digital sources and
produce multiple formats and bit rates of high quality encoded video along with
a rich video database. Editorial services include custom headlines,
descriptions, keywords, and other useful information added by our expert content
editors to suit a customer's requirements. We also can transcribe content to
produce an exact text of the speech. We typically bill for such services as a
charge per hour of video processed depending upon the level of services
required. These services are provided out of our production facilities in the
United States and Europe.

Application hosting services

Instead of purchasing our server products, customers can instead choose
to have Virage host the Video Application Server and related applications on
their behalf. Virage hosts the video information, also known as metadata, and
surrounding application logic while one of our content distribution partners
typically hosts the streaming video files. We provide daily, weekly, and monthly
traffic reports to the content owner. We also provide a secure administration
and publishing interface that provides our customers complete control of how and
where their content gets published. We typically charge for application hosting
services with both a fixed monthly minimum charge, and a variable component that
increases based upon accesses to our video database. Virage has two datacenters
that provide fault-tolerant arrays of servers, global load-balancing, and 24/7
monitoring to ensure reliable and scalable hosting.

BUSINESS STRATEGY

Our goal is to strengthen our position as a leading provider of products
and application services that enable owners of content to publish, manage and
distribute their video content over the Internet and intranets. To achieve this
objective, our business strategy includes the following key components:

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BECOME THE STANDARD FOR DEPLOYING, MANAGING AND DISTRIBUTING VIDEO CONTENT OVER
THE INTERNET AND INTRANETS.

We intend to establish Virage as the standard for the deployment,
management and distribution of video content over the Internet and intranets. To
achieve this goal, we focus our direct and indirect selling and marketing
activities on industry leaders in the media and entertainment, corporate
enterprise, education, and government markets. Many major media companies,
broadcast networks and large corporations already use Virage. We can grow our
revenues through additional sales to our existing customers and sales to new
customers. We believe that our penetration rate into most existing customers is
low; most have done small pilot implementations which can lead to much larger
sales opportunities. A small group of customers have made larger purchases, but
even these larger customers offer significant new sales opportunities. For
example, we have licensed our products to a number of larger broadcasters such
as CNN primarily to automate their newsroom operations. We have recently
obtained additional business from CNN for their video archives and from Turner
Broadcasting Europe. We believe that there are additional archive opportunities
with each of our broadcast customers, as well as opportunities to expand our
software and services into additional newsrooms or affiliates. We also have a
number of corporate customers who have made small initial purchases for either
archives or for consumer focus groups. We believe we have opportunities in each
of these corporations as they roll out additional streaming video initiatives
such as corporate communications or training.

GENERATE INCREASING REVENUE STREAMS THROUGH NEW PRODUCTS AND SERVICES.

We intend to generate additional revenues by introducing new products and
services. We have added, and will continue to add, to our licensed software
product offering. For example, in the past fiscal year, we added several new
applications including the Video Application Server, ControlCenter, and
MediaSync products. We also introduced multi-byte support for Asian languages,
along with new audio analysis support for Spanish, Italian, German, UK English,
Brazilian Portuguese, Japanese, and Mandarin. In the fourth quarter of fiscal
2001, we also introduced a professional services offering to assist licensed
software customers with implementation of our software products. We grew our
applications services outsource solution in the fourth quarter of fiscal 2001 to
over $1,000,000, a greater than three-fold increase over the same quarter of
fiscal 2000. Virage expects to continue a significant investment in product
development. Our development efforts will include both continued expansion of
the base technology as well as development of specific applications to support
customers in media and entertainment, sports, corporations, education, and
government.

EMPOWER CONTENT PROVIDERS WITHOUT COMPETING AGAINST THEM.

Our licensed products and application services enable our customers to
retain control over their video content and brands. We allow our customers to
maintain a direct relationship with their user audience by distributing their
video content directly from their own Internet sites, while extending the reach
of their content through syndication. We do not aggregate our customers' video
content on our own Internet site, and we do not depend on advertising and
commerce revenue streams from our own Internet site to drive our business. We
intend to maintain this business model, which supports content providers, as
well as to enhance this model by providing products and application services
that will drive more traffic to our customers' Internet sites.

ENHANCE AND LEVERAGE OUR TECHNICAL LEADERSHIP POSITION.

We combine the use of our proprietary technologies with proven
third-party technologies to create technically advanced products and application
services. Our internal technologies include our video indexing and management
technologies, our configurable track architecture and an extensible software
plug-in framework. We have filed 19 patent applications in the United States,
six of which have resulted in issued patents. We will continue to aggressively
develop and protect our intellectual property. We have designed our architecture
and application programming interfaces to enable both rapid integration and easy
interchangeability of proven third-party technologies into our products. We will
continue to evaluate and integrate multiple third-party technologies into our
products, selecting and substituting these technologies

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based on technical superiority and favorable business economics. We have also
designed our architecture and application programming interfaces to allow rapid
integration of our products with the products of our value-added resellers and
system integrators. As a result, our products are currently integrated with
products from over 25 other vendors. We will continue to develop products that
integrate easily with the products of other vendors in our markets.

EXPAND OUR INTERNATIONAL PRESENCE.

Potential customers for our products and services are located throughout
the world. We intend to develop local sales, technical support and application
services operations that can support these customers. We have an established
subsidiary in London, England through which we have sold our products and
services to a number of European customers including the BBC, Cable and
Wireless, Ferrari Racing Team, Reuters, Schlumberger and Turner Broadcasting
Europe. We also initiated sales operations in Latin America and Asia in fiscal
2001 and we plan to expand those operations in fiscal 2002.

PURSUE STRATEGIC RELATIONSHIPS.

We intend to pursue strategic relationships with, or acquisitions of,
other companies to increase our customer base, expand our products and services,
and strengthen our management team. By developing strategic relationships with
leading technology providers, we believe we will be able to proliferate our
products and services and improve our access to our target customer base. In
addition, we may acquire companies to enhance our product and service offerings,
to increase our workforce and to broaden our market opportunities.

CUSTOMERS

Our customers represent large media and entertainment corporations, other
global corporations, educational institutions and government entities. For the
year ended March 31, 2001, no customer accounted for more than 10% of our total
revenues. For the year ended March 31, 2000, two customers each accounted for
13% and 10% of our total revenues. For the year ended March 31, 1999 three
customers each accounted for 17%, 14% and 13% of our total revenues.

RESEARCH AND DEVELOPMENT

We believe that our future success will depend in part on our ability to
continually develop new and enhance existing products and services. Accordingly,
we invest a significant amount of our resources in research and product
development activities. Our research and development expenses totaled
$9,101,000, $4,182,000, and $2,325,000 for the years ended March 31, 2001, 2000
and 1999 respectively.

SALES AND MARKETING

SALES AND DISTRIBUTION STRATEGY

We sell our products and application services through a direct sales
force and through indirect distribution channels. We currently target customers
in several markets including media and entertainment, and enterprises such as
corporations, government entities and universities. Our sales strategy is to
pursue multiple opportunities for large-scale deployments within each customer
account. Through our direct sales force in Boston, Chicago, London, Los Angeles,
Munich, New York, San Francisco, Tampa/St. Petersburg, Atlanta, Houston, and
Washington D.C., we focus on larger customers in North America, Europe, Latin
America, and Asia. Our field representatives sell our products and services to
customers who have been qualified by our telesales personnel. In addition, our
direct sales force manages local relationships with key resellers. Our indirect
distribution channels include major industry vendors, domestic and international
distributors, system integrators and value-added resellers. Together, these
distributors and value-added resellers accounted for approximately 33% of total
revenues for the year ended March 31, 2001.

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MARKETING ACTIVITIES

Since our inception, we have invested a substantial percentage of our
revenues in a broad range of marketing activities to generate demand, gain
corporate brand identity and educate the market about our products and services.
These activities have focused primarily on direct marketing, direct mail and
email, seminars, public relations, co-marketing and branding with our major
customer accounts and strategic partners, targeted trade shows, conferences,
speaking engagements, and product information through print collateral and our
Internet site. In addition, we have an established developer relations function
to encourage independent software developers to develop products and solutions
that are compatible with our products and technologies.

COMPETITION

The Internet video marketplace is new, rapidly evolving and intensely
competitive. As more companies begin to deploy searchable and interactive video
on the Internet, we expect competition to intensify. We currently compete
directly with other providers in the Internet video infrastructure marketplace
including Convera Corporation. We may also compete indirectly with larger system
integrators who embed or integrate these directly competing technologies into
their product offerings. It is possible that we may work with these same larger
companies on one customer bid and compete with them on another. In the future,
we may compete with other video services vendors and searchable video portals.
In addition, we may compete with our current and potential customers who may
develop software or perform application services internally.

We believe that the principal competitive factors in our market are:

- video indexing management functionality;

- services experience and expertise;

- demonstrated video technology expertise;

- customer references;

- company reputation;

- ease of installation and use;

- real-time processing capability;

- software reliability and stability;

- scalability;

- pricing;

- 24-by-7 customer support; and

- adoption by other customers

We believe we compete favorably with our competitors based on these
factors.

INTELLECTUAL PROPERTY

We depend on our ability to develop and maintain the proprietary aspects
of our technology. To protect our proprietary technology, we rely primarily on a
combination of patent, trademark and copyright laws, as well as confidentiality
and license agreements with our employees and others. We actively seek patent
protection for our intellectual property. We have filed 19 U.S. patent
applications on our proprietary technology. Six patents have been issued and a
seventh patent has been allowed by the Patent and Trademark Office. Our
remaining twelve patent applications are currently pending. In 1997, we entered
into a five-year patent cross-licensing agreement with IBM. The terms of this
agreement include our nonexclusive license of IBM's multimedia software patents
in return for an annual fee and a license to IBM of all of our current patents
as described above and any patents that may be issued to us in the future.

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We have seventeen trademarks, four of which are registered. We seek to
avoid disclosure of our trade secrets by limiting access to our proprietary
technology and restricting access to our source code. Despite these precautions,
it may be possible for unauthorized third parties to copy particular portions of
our technology or reverse engineer or obtain and use information that we regard
as proprietary. In addition, the laws of some foreign countries do not protect
proprietary rights to the same extent, as do the laws of the United States. Our
means of protecting our proprietary rights in the United States or abroad may
not be adequate and competing companies may independently develop similar
technology.

EMPLOYEES

As of March 31, 2001, we had 199 employees and 18 full time contractors.
Of our 217 total staff, 50 were employed in services, 76 were employed in
engineering, 67 were employed in sales and marketing, and 24 were employed in
general and administrative positions. None of our employees is subject to a
collective bargaining agreement, and we have never experienced a work stoppage.
We consider our relations with our employees to be good.

RISK FACTORS

The occurrence of any of the following risks could materially and
adversely affect our business, financial condition and operating results. In
this case, the trading price of our common stock could decline and you might
lose all or part of your investment.

RISKS RELATED TO OUR BUSINESS

OUR REVENUE, COST OF SALES, AND EXPENSE FORECASTS WERE ONLY RECENTLY INTRODUCED
TO THE PUBLIC AND THERE ARE A NUMBER OF RISKS THAT MAKE IT DIFFICULT FOR US TO
FORESEE OR ACCURATELY EVALUATE FACTORS THAT MAY IMPACT SUCH FORECASTS.

We have limited visibility into future demand, and our limited operating
history makes it difficult for us to foresee or accurately evaluate factors that
may impact such future demand. Visibility over potential sales is typically
limited to the current quarter. In order to provide a revenue forecast for the
current quarter, we must make assumptions about conversion of these potential
sales into current quarter revenues. Such assumptions may be materially
incorrect due to competition for the customer order including pricing pressures,
sales execution issues, customer selection criteria or length of the customer
selection cycle, the failure of sales contracts to meet our revenue recognition
criteria, our inability to hire and retain qualified personnel, our inability to
develop new markets in Europe or Asia, and other factors that may be beyond our
control. In addition, we are reliant on third party resellers for a significant
portion of our license revenues and we have limited visibility into the status
of orders from such third parties.

For quarters beyond the current quarter, we have very limited visibility
into potential sales opportunities, and thus we have a lower confidence level in
any revenue forecast or forward-looking guidance. In developing a revenue
forecast for such quarters, we assess any customer indications about future
demand, general industry trends, marketing lead development activities,
productivity goals for the sales force and expected growth in sales personnel,
and any demand for products that we may have.

Our cost of sales and expense forecasts are based upon our budgets and
spending forecasts for each area of the Company. Circumstances we may not
foresee could increase cost and expense levels beyond the levels forecasted.
Such circumstances may include competitive threats in our markets which we may
need to address with additional sales and marketing expenses, legal claims,
employee turnover, additional royalty expenses should we lose a source of
current technology, losses of key management personnel, unknown defects in our
products, and other factors we cannot foresee.

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BECAUSE WE HAVE ONLY RECENTLY INTRODUCED OUR VIDEO SOFTWARE PRODUCTS AND
APPLICATION SERVICES, WE FACE A NUMBER OF RISKS WHICH MAY SERIOUSLY HARM OUR
BUSINESS.

We incorporated in April 1994 and to date we have generated only limited
revenues. We introduced our first video software products in December 1997, our
application services in May 1999 and our professional services in March 2001.
Because we have a limited operating history with our video software products,
application services and professional services and because our revenue sources
may continue to shift as our business develops, you must consider the risks and
difficulties that we may encounter when making your investment decision. These
risks include our ability to:

- expand our customer base;

- increase penetration into key customer accounts;

- maintain our pricing structure;

- develop new video products and application services; and

- adapt our products and services to meet changes in the Internet
video infrastructure marketplace.

If we do not successfully address these risks, our business will be
seriously harmed.

OUR BUSINESS MODEL IS UNPROVEN AND MAY FAIL, WHICH MAY SIGNIFICANTLY DECREASE
THE MARKET PRICE OF OUR COMMON STOCK.

We do not know whether our business model and strategy will be
successful. Our business model is based on the premise that content providers
will use our licensed products and application services to catalog, manage, and
distribute their video content over the Internet and intranets. Our potential
customers may elect to rely on their internal resources or on lower priced
products and services that do not offer the full range of functionality offered
by our products and services. If the assumptions underlying our business model
are not valid or if we are unable to implement our business plan, our business
will suffer.

WE HAVE NOT BEEN PROFITABLE AND IF WE DO NOT ACHIEVE PROFITABILITY, OUR BUSINESS
MAY FAIL.

We have experienced operating losses in each quarterly and annual period
since we were formed and we expect to incur significant losses in the future. As
of March 31, 2001, we had an accumulated deficit of $61,174,000. We expect to
continue to incur increasing research and development, sales and marketing and
general and administrative expenses. Accordingly, our failure to increase our
revenues significantly or improve our gross margins will harm our business. In
addition, our cash, cash equivalent and short-term investment resources
(collectively, "cash resources") totaled $48,131,000 as of March 31, 2001 and we
used $16,863,000 in our operating activities during the year ended March 31,
2001. We anticipate that our operating activities will use additional cash
resources for at least the next 12 months. This may leave us with a deteriorated
cash position in comparison to our cash position as of March 31, 2001 and this
may affect our ability to transact future strategic operating and investing
activities in a timely manner, which may harm our business and cause our stock
price to fall. Even if we should achieve profitability, we may not be able to
sustain or increase profitability on a quarterly or annual basis in the future.
If our revenues grow more slowly than we anticipate, if our gross margins do not
improve, or if our operating expenses exceed our expectations, our operating
results will suffer and our stock price may fall.

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OUR QUARTERLY OPERATING RESULTS ARE VOLATILE AND DIFFICULT TO PREDICT. IF WE
FAIL TO MEET THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS OR INVESTORS, THE MARKET
PRICE OF OUR COMMON STOCK MAY DECREASE SIGNIFICANTLY.

Our quarterly operating results have varied significantly in the past and
are likely to vary significantly in the future. We believe that period-to-period
comparisons of our results of operations are not meaningful and should not be
relied upon as indicators of future performance. If securities analysts follow
our stock, our operating results will likely fall below their expectations in
some future quarter or quarters. Our failure to meet these expectations would
likely cause the market price of our common stock to decline.

Our quarterly revenues depend on a number of factors, many of which are
beyond our control and which makes it difficult for us to predict our revenues
going forward. We plan to increase our operating expenses and if our revenues
and gross margins do not increase, our business could be seriously harmed. We
plan to increase our operating expenses to expand our sales and marketing
operations, fund greater levels of research and development, expand our
application and professional services and develop our internal organization.
Many of these expenditures are planned or committed in advance in anticipation
of future revenues, and if our revenues in a particular quarter are lower than
we anticipate, we may be unable to reduce spending in that quarter. As a result,
any shortfall in revenues or a failure to improve gross margins would likely
hurt our quarterly operating results.

OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS CONTINUE TO WORSEN.

Our revenues are dependent on the health of the economy and the growth of
our customers and potential future customers. If the economy remains stagnant,
our customers may continue to delay or reduce their spending on our software and
service solutions. When economic conditions weaken, sales cycles for sales of
software products and related services tend to lengthen and companies'
information technology budgets tend to be reduced. If that happens, our revenues
could suffer and our stock price may decline. Further, if the economic
conditions in the United States worsen or if a wider or global economic slowdown
occurs, we may experience a material adverse impact on our business, operating
results, and financial condition.

OUR SERVICE REVENUES HAVE A SUBSTANTIALLY LOWER MARGIN THAN OUR LICENSE
REVENUES, AND AN INCREASE IN SERVICE REVENUES RELATIVE TO LICENSE REVENUES COULD
HARM OUR GROSS MARGINS.

Our service revenues, which includes fees for our application services as
well as professional services such as consulting, implementation, maintenance
and training, were 45% of our total revenues for the year ended March 31, 2001,
20% of our total revenues for the year ended March 31, 2000 and 8% of our total
revenues for the year ended March 31, 1999. Our service revenues have
substantially lower gross margins than our license revenues. Our cost of service
revenues for the years ended March 31, 2001, 2000 and 1999 were 144%, 218% and
168%, respectively, of our service revenues. An increase in the percentage of
total revenues represented by service revenues could adversely affect our
overall gross margins.

Service revenues as a percentage of total revenues and cost of service
revenues as a percentage of total revenues have varied significantly from
quarter to quarter due to our relatively early stage of development.
Historically, the relative amount of service revenues as compared to license
revenues has varied based on customer demand for our application services
revenues. However, we anticipate an increase in the percentage of license
customers requesting professional services as a result of our introduction of
professional services in the fourth quarter of fiscal 2001, which will also
impact the relative amount of service revenues as compared to license revenues.
We expect that the amount and profitability of our professional services will
depend in large part on:

- the software solution which has been licensed;

- the complexity of the customers' information technology
environments;

- the resources directed by customers to their implementation
projects;

- the size and complexity of customer implementations; and

- the extent to which outside consulting organizations provide
services directly to customers.

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IF OUR INTERNAL PROFESSIONAL SERVICES ORGANIZATION DOES NOT PROVIDE
IMPLEMENTATION SERVICES EFFECTIVELY AND ACCORDING TO SCHEDULE, OUR REVENUES AND
PROFITABILITY WOULD BE HARMED.

Customers that license our products may require consulting,
implementation, maintenance and training services and obtain them from our
internal professional services, customer support and training organizations.
When we provide these services, we may be required to recognize revenue from the
licensing of our software products as the implementation services are performed.
If our internal professional services organization does not effectively
implement and support our products or if we are unable to expand our internal
professional services organization as needed to meet our customers' needs, our
ability to sell software, and accordingly our revenues, will be harmed.

THE FAILURE OF ANY SIGNIFICANT FUTURE CONTRACTS TO MEET OUR POLICIES FOR
RECOGNIZING REVENUE MAY PREVENT US FROM ACHIEVING OUR REVENUE OBJECTIVES FOR A
QUARTER OR A FISCAL YEAR, WHICH WOULD HURT OUR OPERATING RESULTS.

Our sales contracts are typically based upon standard agreements that
meet our revenue recognition policies. However, our future sales may include
site licenses, consulting services or other transactions with customers who may
negotiate special terms and conditions that are not part of our standard sales
contracts. If these special terms and conditions cause sales under these
contracts to not qualify under our revenue recognition policies, we would defer
revenues to future periods, which may hurt our reported operating results and
cause our stock price to fall.

THE LENGTH OF OUR SALES AND DEPLOYMENT CYCLE IS UNCERTAIN, WHICH MAY CAUSE OUR
REVENUES AND OPERATING RESULTS TO VARY SIGNIFICANTLY FROM QUARTER TO QUARTER.

During our sales cycle, we spend considerable time and expense providing
information to prospective customers about the use and benefits of our products
and services without generating corresponding revenue. Our expense levels are
relatively fixed in the short term and based in part on our expectations of
future revenues. Therefore, any delay in our sales cycle could cause significant
variations in our operating results, particularly because a relatively small
number of customer orders represent a large portion of our revenues.

Some of our largest sources of revenues are government entities and large
corporations that often require long testing and approval processes before
making a decision to license our products. In general, the process of entering
into a licensing arrangement with a potential customer may involve lengthy
negotiations. As a result, our sales cycle has been and may continue to be
unpredictable. In the past, our sales cycle has ranged from one to 12 months.
Our sales cycle is also subject to delays as a result of customer-specific
factors over which we have little or no control, including budgetary constraints
and internal approval procedures. In addition, because our technology must often
be integrated with the products and services of other vendors, there may be a
significant delay between the use of our software and services in a pilot system
and our customers' volume deployment of our products and services.

IF OUR CUSTOMERS FAIL TO GENERATE TRAFFIC ON THE VIDEO-RELATED SECTIONS OF THEIR
INTERNET SITES, OUR RECURRING REVENUES MAY DECREASE, WHICH MAY ADVERSELY AFFECT
OUR BUSINESS AND FINANCIAL RESULTS.

Our ability to achieve recurring revenues from our application services
is largely dependent upon the success of our customers in generating traffic on
the video-related sections of their Internet sites. Generally, we generate
recurring revenue from our application services whenever our customers add more
hours of video to an existing project and with each additional video query on a
customer's site. If our customers do not attract and maintain traffic on
video-related sections of their sites, video queries may decrease and customers
may decide not to add more hours of video to existing projects. This result
would cause revenues from our application services to decrease, which will
prevent us from growing our business.

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IF WE FAIL TO INCREASE THE SIZE OF OUR CUSTOMER BASE OR INCREASE OUR REVENUES
WITH OUR EXISTING CUSTOMERS, OUR BUSINESS WILL SUFFER.

Increasing the size of our customer base and increasing the revenues we
generate from our customer base are critical to the success of our business. To
expand our customer base and the revenues we generate from our customers we
must:

- generate additional revenues from different organizations within
our customers;

- conduct effective marketing and sales programs to acquire new
customers; and

- establish and maintain distribution relationships with value added
resellers and system integrators.

Our failure to achieve one or more of these objectives will hurt our
business.

THE PRICES WE CHARGE FOR OUR PRODUCTS AND SERVICES MAY DECREASE, WHICH WOULD
REDUCE OUR REVENUES AND HARM OUR BUSINESS.

The prices we charge for our products and services may decrease as a
result of competitive pricing pressures, promotional programs and customers who
negotiate price reductions. For example, some of our competitors have provided
their services without charge in order to gain market share or new customers and
key accounts. The prices at which we sell and license our products and services
to our customers depend on many factors, including:

- purchase volumes;

- competitive pricing;

- the specific requirements of the order;

- the duration of the licensing arrangement; and

- the level of sales and service support.

If we are unable to sell our products or services at acceptable prices
relative to our costs, or if we fail to develop and introduce on a timely basis
new products and services from which we can derive additional revenues, our
financial results will suffer.

WE RELY ON, AND EXPECT TO CONTINUE TO RELY ON, A LIMITED NUMBER OF CUSTOMERS FOR
A SIGNIFICANT PORTION OF OUR REVENUES AND IF ANY OF THESE CUSTOMERS STOPS
LICENSING OUR SOFTWARE OR PURCHASING OUR PRODUCTS AND SERVICES, OUR OPERATING
RESULTS WILL SUFFER.

Historically, a limited number of customers has accounted for a
significant portion of our revenues. We anticipate that our operating results in
any given period will continue to depend to a significant extent upon revenues
from a small number of customers. We cannot be certain that we will retain our
current customers or that we will be able to recruit additional or replacement
customers. If we were to lose one or more customers, our operating results could
be significantly harmed.

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ANY FAILURE OF OUR NETWORK COULD LEAD TO SIGNIFICANT DISRUPTIONS IN OUR
APPLICATION SERVICES BUSINESS WHICH COULD DAMAGE OUR REPUTATION, REDUCE OUR
REVENUES OR OTHERWISE HARM OUR BUSINESS.

Our application services business is dependent upon providing our
customers with fast, efficient and reliable services. To meet our customers'
requirements, we must protect our network against damage from, among other
things:

- human error;

- physical or electronic security breaches;

- computer viruses;

- fire, earthquake, flood and other natural disasters;

- power loss;

- telecommunications failure; and

- sabotage and vandalism.

Our failure to protect our network against damage from any of these
events will hurt our business.

WE DEPEND ON OUTSIDE THIRD PARTIES TO MAINTAIN OUR COMMUNICATIONS HARDWARE AND
PERFORM MOST OF OUR COMPUTER HARDWARE OPERATIONS AND IF THESE THIRD PARTIES'
HARDWARE AND OPERATIONS FAIL, OUR REPUTATION AND BUSINESS WILL SUFFER.

We have communications hardware and computer hardware operations located
at Exodus Communications' facility in Santa Clara, California, at AboveNet
Communications' facility in New York City, and at Phoenix Communications in New
Jersey. We do not have complete backup systems for these operations. A problem
with, or failure of, our communications hardware or operations could result in
interruptions or increases in response times on the Internet sites of our
customers. Furthermore, if these third party partners fail to adequately
maintain or operate our communications hardware or do not perform our computer
hardware operations adequately, our services to our customers may not be
available. We have experienced system failures in the past. Other outages or
system failures may occur. Any disruptions could damage our reputation, reduce
our revenues or otherwise harm our business. Our insurance policies may not
adequately compensate us for any losses that may occur due to any failures or
interruptions in our systems.

POWER OUTAGES IN CALIFORNIA COULD ADVERSELY AFFECT US.

We have significant operations in the state of California and are
dependent on a continuous power supply. California's energy crisis could
substantially disrupt our operations and increase our expenses. California has
recently implemented, and may in the future continue to implement, rolling
blackouts throughout the state. Although state lawmakers are working to minimize
the impact, if blackouts interrupt our power supply, we may be temporarily
unable to continue operations at our California facilities. Any such
interruption in our ability to continue operation at our facilities could delay
the development of our products and services and disrupt communications with our
customers or other third parties on which we rely, such as web hosting service
providers. Future interruptions could damage our reputation and could result in
lost revenue, either of which could substantially harm our business and results
of operations. Furthermore, shortages in wholesale electricity supplies have
caused power prices to increase. If energy prices continue to increase, our
operating expenses will likely increase which could have a negative effect on
our operating results, which in turn may cause our stock price to fall.

IF WE ARE UNABLE TO PERFORM OR SCALE OUR CAPACITY SUFFICIENTLY AS DEMAND FOR OUR
SERVICES INCREASES, WE MAY LOSE CUSTOMERS WHICH WOULD BE DETRIMENTAL TO OUR
BUSINESS.

We cannot be certain that if we increase our customers we will be able to
correspondingly increase our personnel and to perform our application services
at satisfactory levels. Certain customer contracts contain cash penalty
provisions in the event that we do not perform our application services at
satisfactory levels

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and such penalty provisions will reduce our revenues and harm our business. In
addition, our application services may need to accommodate an increasing volume
of traffic. If we are not able to expand our internal operations to accommodate
such an increase in traffic, our customers' Internet sites may in the future
experience slower response times or outages. If we cannot adequately handle a
significant increase in customers or customers' traffic, we may lose customers
or fail to gain new ones, which may reduce our revenues and harm our business.

IF WE DO NOT SUCCESSFULLY DEVELOP NEW PRODUCTS AND SERVICES TO RESPOND TO RAPID
MARKET CHANGES DUE TO CHANGING TECHNOLOGY AND EVOLVING INDUSTRY STANDARDS, OUR
BUSINESS WILL BE HARMED.

The market for our products and services is characterized by rapidly
changing technology, evolving industry standards, frequent new product and
service introductions and changes in customer demands. The recent growth of
video on the Internet and intense competition in our industry exacerbate these
market characteristics. Our future success will depend to a substantial degree
on our ability to offer products and services that incorporate leading
technology, and respond to technological advances and emerging industry
standards and practices on a timely and cost-effective basis. To succeed, we
must anticipate and adapt to customer requirements in an effective and timely
manner, and offer products and services that meet customer demands. If we fail
to do so, our products and services will not achieve widespread market
acceptance, and we may not generate significant revenues to offset our
development costs, which will hurt our business.

The development of new or enhanced products and services is a complex and
uncertain process that requires the accurate anticipation of technological and
market trends. We may experience design, manufacturing, marketing and other
technological difficulties that could delay our ability to respond to
technological changes, evolving industry standards, competitive developments or
customer requirements. You should additionally be aware that:

- our technology or systems may become obsolete upon the
introduction of alternative technologies, such as products that
better manage and search video content;

- we could incur substantial costs if we need to modify our products
and services to respond to these alternative technologies;

- we may not have sufficient resources to develop or acquire new
technologies or to introduce new products or services capable of
competing with future technologies; and

- when introducing new or enhanced products or services, we may be
unable to manage effectively the transition from older products
and services and ensure that we can deliver products and services
to meet anticipated customer demand.

WE DEPEND ON TECHNOLOGY LICENSED TO US BY THIRD PARTIES, AND THE LOSS OF OR OUR
INABILITY TO MAINTAIN THESE LICENSES COULD RESULT IN INCREASED COSTS OR DELAY
SALES OF OUR PRODUCTS.

We license technology from third parties, including software that is
integrated with internally developed software and used in our products to
perform key functions. We anticipate that we will continue to license technology
from third parties in the future. This software may not continue to be available
on commercially reasonable terms, if at all. Although we do not believe that we
are substantially dependent on any licensed technology, some of the software we
license from third parties could be difficult for us to replace. The loss of any
of these technology licenses could result in delays in the licensing of our
products until equivalent technology, if available, is developed or identified,
licensed and integrated. The use of additional third-party software would
require us to negotiate license agreements with other parties, which could
result in higher royalty payments and a loss of product differentiation. In
addition, the effective implementation of our products depends upon the
successful operation of third-party licensed products in conjunction with our
products, and therefore any undetected errors in these licensed products could
prevent the implementation or impair the functionality of our products, delay
new product introductions and/or damage our reputation.

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IF WE ARE UNABLE TO RETAIN OUR KEY PERSONNEL, OUR BUSINESS MAY BE HARMED.

Our future success depends to a significant extent on the continued
services of our senior management and other key personnel, and particularly Paul
Lego, our Chief Executive Officer. The loss of either this individual or other
key employees would likely have an adverse effect on our business. We do not
have employment agreements with most of our senior management team. If one or
more of our senior management team were to resign, the loss could result in loss
of sales, delays in new product development and diversion of management
resources.

OUR COMMON STOCK PRICE HAS DECLINED IN VALUE BELOW THE EXERCISE PRICE OF MANY
EMPLOYEE STOCK OPTIONS AND, AS A RESULT, WE MAY EXPERIENCE DIFFICULTIES
RETAINING EMPLOYEES.

Our common stock price has recently declined in value below the exercise
price of many stock options granted to employees pursuant to our stock option
plans. Thus, the intended benefit of the stock option, the creation of
performance and retention incentives, may not be realized. As a result, we may
lose employees whom we would prefer to retain which would harm our business. We
may be required to create additional performance and retention incentives in
order to retain these employees including the granting of additional stock
options to these employees at current prices or issuing incentive cash bonuses.
Such incentives may either dilute our existing stockholder base or result in
unforeseen operating expenses, which may cause our stock price to fall.

BECAUSE COMPETITION FOR QUALIFIED PERSONNEL IS INTENSE, WE MAY NOT BE ABLE TO
RECRUIT OR RETAIN PERSONNEL, WHICH COULD IMPACT THE DEVELOPMENT AND ACCEPTANCE
OF OUR PRODUCTS AND SERVICES.

We expect that we will need to hire additional personnel in all
functional areas in the foreseeable future. Competition for personnel throughout
our industry is intense. We may be unable to attract or assimilate other highly
qualified employees in the future. We have in the past experienced, and we
expect to continue to experience, difficulty in hiring highly skilled employees
with appropriate qualifications. In addition, new hires frequently require
extensive training before they achieve desired levels of productivity. Some
members of our existing management team have been employed at Virage for less
than one year. We may fail to attract and retain qualified personnel, which
could have a negative impact on our business.

FAILURE TO PROPERLY MANAGE OUR POTENTIAL GROWTH WOULD BE DETRIMENTAL TO OUR
BUSINESS.

Any growth in our operations will place a significant strain on our
resources. As part of this growth, we will have to implement new operational and
financial systems, procedures and controls to expand, train and manage our
employee base and to maintain close coordination among our technical,
accounting, finance, marketing, sales and editorial staffs. We will also need to
continue to attract, retain and integrate personnel in all aspects of our
operations. To the extent we acquire other businesses, we will also need to
integrate and assimilate new operations, technologies and personnel. Failure to
manage our growth effectively could hurt our business.

WE HAVE LEASES FOR OUR FACILITIES THAT EXPIRE ON VARIOUS DATES THROUGH 2006 THAT
WE MAY NOT BE ABLE TO FULLY UTILIZE AND THIS MAY CAUSE US TO INCUR LARGE
ONE-TIME CHARGES FOR EXCESS CAPACITY.

Our principal administrative, research and development, sales, services
and marketing activities are conducted on two leased properties in San Mateo,
California: the first property consists of 21,000 square feet and expires in May
2002 and the second property consists of 48,000 square feet and expires in
September 2006. In addition, we lease a property in New York City for services
and sales under a lease that expires in March 2005, a property near Boston,
Massachusetts where we perform research and development under a lease that
expires in June 2003 and a property near London, England where we perform sales,
services, marketing and administrative activities and that expires in February
2002.

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During the year ended March 31, 2001, we were able to sublease our excess
capacity at our facilities and received rental payments of $1,185,000. These
sublease agreements will expire during the year ended March 31, 2002, and we may
not be successful in renewing our arrangements with our current sublease tenants
or finding new sublease tenants. If this should occur, we would be required to
record a one-time charge at the end of the sublease agreement for a portion of
the rental payments that we owe to our landlord relating to any excess capacity
that exists at our facilities. Such a charge will harm our operating results and
may cause our stock price to fall.

DEFECTS IN OUR SOFTWARE PRODUCTS COULD DIMINISH DEMAND FOR OUR PRODUCTS, WHICH
MAY CAUSE OUR STOCK PRICE TO FALL.

Our software products are complex and may contain errors that may be
detected at any point in the life of the product. We cannot assure you that,
despite testing by us and our current and potential customers, errors will not
be found in new products or releases after shipment, resulting in loss of
revenues, delay in market acceptance and sales, diversion of development
resources, injury to our reputation or increased service and warranty costs. If
any of these were to occur, our business would be adversely affected and our
stock price could fall.

Because our products are generally used in systems with other vendors'
products, they must integrate successfully with these existing systems. System
errors, whether caused by our products or those of another vendor, could
adversely affect the market acceptance of our products, and any necessary
revisions could cause us to incur significant expenses.

WE COULD BE SUBJECT TO LIABILITY CLAIMS AND NEGATIVE PUBLICITY IF OUR CUSTOMERS'
SYSTEMS, INFORMATION OR VIDEO CONTENT IS DAMAGED THROUGH THE USE OF OUR PRODUCTS
OR OUR APPLICATION SERVICES.

If our customers' systems, information or video content is damaged by
software errors, product design defects or use of our application services, our
business may be harmed. In addition, these errors or defects may cause severe
customer service and public relations problems. Errors, bugs, viruses or
misimplementation of our products or services may cause liability claims and
negative publicity ultimately resulting in the loss of market acceptance of our
products and services. Our agreements with customers that attempt to limit our
exposure to liability claims may not be enforceable in jurisdictions where we
operate.

OTHERS MAY BRING INFRINGEMENT CLAIMS AGAINST US WHICH COULD BE TIME CONSUMING
AND EXPENSIVE FOR US TO DEFEND.

Other companies, including our competitors, may obtain patents or other
proprietary rights that would prevent, limit or interfere with our ability to
conduct our business. These companies could assert, and it may be found, that
our technologies infringe their proprietary rights. We could incur substantial
costs to defend any litigation, and intellectual property litigation could force
us to do one or more of the following:

- cease using key aspects of our technology that incorporate the
challenged intellectual property;

- obtain a license from the holder of the infringed intellectual
property right; and

- redesign some or all of our products.

From time to time, we have received notices claiming that our technology
infringes patents held by third parties. In the event any such a claim is
successful and we are unable to license the infringed technology on commercially
reasonable terms, our business and operating results would be significantly
harmed.

IF THE PROTECTION OF OUR INTELLECTUAL PROPERTY IS INADEQUATE, OUR COMPETITORS
MAY GAIN ACCESS TO OUR TECHNOLOGY, AND WE MAY LOSE CUSTOMERS.

We depend on our ability to develop and maintain the proprietary aspects
of our technology. We seek to protect our software, documentation and other
written materials under trade secret and copyright laws, which afford only
limited protection. Our proprietary rights may not prove viable or of value in
the future

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since the validity, enforceability and type of protection of proprietary rights
in Internet related industries are uncertain and still evolving.

Unauthorized parties may attempt to copy aspects of our products or to
obtain and use information that we regard as proprietary. Policing unauthorized
use of our products is difficult, and while we are unable to determine the
extent to which piracy of our software or code exists, software piracy can be
expected to be a persistent problem. We license our proprietary rights to third
parties, and these licensees may not abide by our compliance and quality control
guidelines or they may take actions that would materially adversely affect us.
In addition, the laws of some foreign countries do not protect our proprietary
rights to as great an extent as do the laws of the United States, and effective
patent, copyright, trademark and trade secret protection may not be available in
these foreign jurisdictions. To date, we have not sought patent protection of
our proprietary rights in any foreign jurisdiction. Our efforts to protect our
intellectual property rights through patent, copyright, trademark and trade
secret laws may not be effective to prevent misappropriation of our technology,
or may not prevent the development and design by others of products or
technologies similar to or competitive with those developed by us. Our failure
or inability to protect our proprietary rights could harm our business.

AS WE EXPAND OUR OPERATIONS INTERNATIONALLY, WE WILL FACE SIGNIFICANT RISKS IN
DOING BUSINESS IN FOREIGN COUNTRIES.

As we expand our operations internationally, we will be subject to a
number of risks associated with international business activities, including:

- costs of customizing our products and services for foreign
countries, including localization, translation and conversion to
international and other foreign technology standards;

- compliance with multiple, conflicting and changing governmental
laws and regulations, including changes in regulatory requirements
that may limit our ability to sell our products and services in
particular countries;

- import and export restrictions, tariffs and greater difficulty in
collecting accounts receivable; and

- foreign currency-related risks if a significant portion of our
revenues become denominated in foreign currencies.

FAILURE TO INCREASE OUR BRAND AWARENESS AMONG CONTENT OWNERS COULD LIMIT OUR
ABILITY TO COMPETE EFFECTIVELY.

We believe that establishing and maintaining a strong brand name is
important to the success of our business. Competitive pressures may require us
to increase our expenses to promote our brand name, and the benefits associated
with brand creation may not outweigh the risks and costs associated with brand
name establishment. Our failure to develop a strong brand name or the incurrence
of excessive costs associated with establishing our brand name, may harm our
business.

WE MAY NEED TO MAKE ACQUISITIONS OR FORM STRATEGIC ALLIANCES OR PARTNERSHIPS IN
ORDER TO REMAIN COMPETITIVE IN OUR MARKET, AND POTENTIAL FUTURE ACQUISITIONS,
STRATEGIC ALLIANCES OR PARTNERSHIPS COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR
BUSINESS AND DILUTE STOCKHOLDER VALUE.

We may acquire or form strategic alliances or partnerships with other
businesses in the future in order to remain competitive or to acquire new
technologies. As a result of these acquisitions, strategic alliances or
partnerships, we may need to integrate products, technologies, widely dispersed
operations and distinct corporate cultures. The products, services or
technologies of the acquired companies may need to be altered or redesigned in
order to be made compatible with our software products and services, or the
software architecture of our customers. These integration efforts may not
succeed or may distract our management from operating our existing business. Our
failure to successfully manage future acquisitions, strategic alliances or
partnerships could seriously harm our operating results. In addition, our
stockholders would be

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diluted if we finance the acquisitions, strategic alliances or partnerships by
incurring convertible debt or issuing equity securities.

WE HAVE ADOPTED CERTAIN ANTI-TAKEOVER MEASURES THAT MAY MAKE IT MORE DIFFICULT
FOR A THIRD PARTY TO ACQUIRE US.

Our board of directors has the authority to issue up to 2,000,000 shares
of preferred stock and to determine the price, rights, preferences and
privileges of those shares without any further vote or action by the
stockholders. The rights of the holders of common stock will be subject to, and
may be adversely affected by, the rights of the holders of any preferred stock
that may be issued in the future. The issuance of shares of preferred stock,
while potentially providing desirable flexibility in connection with possible
acquisitions and for other corporate purposes, could have the effect of making
it more difficult for a third party to acquire a majority of our outstanding
voting stock. We have no present intention to issue shares of preferred stock.
Further, on November 8, 2000, our board of directors adopted a preferred stock
purchase rights plan intended to guard against certain takeover tactics. The
adoption of this plan was not in response to any proposal to acquire us, and the
board is not aware of any such effort. The existence of this plan could also
have the effect of making it more difficult for a third party to acquire a
majority of our outstanding voting stock. In addition, certain provisions of our
certificate of incorporation may have the effect of delaying or preventing a
change of control, which could adversely affect the market price of our common
stock.

RISKS RELATING TO THE INTERNET VIDEO INFRASTRUCTURE MARKETPLACE

COMPETITION AMONG INTERNET VIDEO INFRASTRUCTURE COMPANIES IS INTENSE. IF WE ARE
UNABLE TO COMPETE SUCCESSFULLY, OUR BUSINESS WILL FAIL.

Competition among Internet video infrastructure companies seeking to
attract new customers is intense and we expect this intensity of competition to
increase in the future. Our competitors vary in size and in the scope and
breadth of the products and services they offer and may have significantly
greater financial, technical and marketing resources. Our direct competition in
the marketplace comes primarily from Convera Corporation. We may also compete
indirectly with system integrators to the extent they may embed or integrate
competing technologies into their product offerings, and in the future we may
compete with video service providers and searchable video portals. In addition,
we may compete with our current and potential customers who may contemplate
developing software or performing application services internally. Increased
competition could result in price reductions, reduced margins or loss of market
share, any of which will cause our business to suffer.

IF BROADBAND TECHNOLOGY IS NOT ADOPTED OR DEPLOYED AS QUICKLY AS WE EXPECT,
DEMAND FOR OUR PRODUCTS AND SERVICES MAY NOT GROW AS QUICKLY AS ANTICIPATED.

Broadband technology such as digital subscriber lines, commonly referred
to as DSL, and cable modems, which allows video content to be transmitted over
the Internet more quickly than current technologies, has only recently been
developed and is just beginning to be deployed. The growth of our business
depends in part on the broad market acceptance of broadband technology. If the
market does not adopt broadband technology, or adopts it more slowly than we
anticipate, demand for our products and services may not grow as quickly as we
anticipate, which will harm our business.

We depend on the efforts of third parties to develop and provide the
technology for broadband transmission. Even if broadband access becomes widely
available, heavy use of the Internet may negatively impact the quality of media
delivered through broadband connections. If these third parties experience
delays or difficulties establishing the technology to support widespread
broadband transmission, or if heavy usage limits the broadband experience, the
market may not accept our products and services.

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Because the anticipated growth of our business depends in part on
broadband transmission infrastructure, we are subject to a number of risks,
including:

- changes in content delivery methods and protocols;

- the need for continued development by our customers of compelling
content that takes advantage of broadband access and helps drive
market acceptance of our products and services;

- the emergence of new competitors, including traditional broadcast
and cable television companies, which have significant control
over access to content, substantial resources and established
relationships with media providers;

- the development of relationships by our competitors with companies
that have significant access to or control over the broadband
transmission technology or content; and

- the need to establish new relationships with non-PC based
providers of broadband access, such as providers of television
set-top boxes and cable television.

GOVERNMENT REGULATION OF THE INTERNET COULD LIMIT OUR GROWTH.

We are not currently subject to direct regulation by any government
agency, other than laws and regulations generally applicable to businesses,
although certain U.S. export controls and import controls of other countries may
apply to our products. While there are currently few laws or regulations that
specifically regulate communications or commerce on the Internet, due to the
increasing popularity and use of the Internet, it is possible that a number of
laws and regulations may be adopted in the U.S. and abroad in the near future
with particular applicability to the Internet. It is possible that governments
will enact legislation that may be applicable to us in areas such as content,
network security, access charges and retransmission activities. Moreover, the
applicability to the Internet of existing laws governing issues such as property
ownership, content, taxation, defamation and personal privacy is uncertain. The
adoption of new laws or the adaptation of existing laws to the Internet may
decrease the growth in the use of the Internet, which could in turn decrease the
demand for our services, increase the cost of doing business or otherwise hurt
our business.

ITEM 2. PROPERTIES

Our principal administrative, research and development, sales, services
and marketing activities are conducted on two leased properties in San Mateo,
California: the first property consists of 21,000 square feet under a lease that
expires in May 2002 and the second property consists of 48,000 square feet under
a lease that expires in September 2006. In addition, we lease a property in New
York City for services and sales under a lease that expires in March 2005, a
property near Boston, Massachusetts where we perform research and development
under a lease that expires in June 2003 and a property near London, England
where we perform sales, services, marketing and administrative activities and
that expires in February 2002. We have additional domestic sales offices located
throughout the United States. We have foreign sales offices in various cities in
Europe and Asia to support our worldwide sales organization.

ITEM 3. LEGAL PROCEEDINGS

From time to time, we may become involved in litigation claims arising
from our ordinary course of business. We believe that there are no claims or
actions pending or threatened against us, the ultimate disposition of which
would have a material adverse effect on us.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of fiscal year 2001.

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The following table sets forth certain information regarding our
executive officers as of June 1, 2001:

- -----------------------------------------------------------------------------------------
NAME AGE POSITION
- -----------------------------------------------------------------------------------------

Paul G. Lego..................... 42 President, Chief Executive Officer and
Chairman of the Board of Directors
- -----------------------------------------------------------------------------------------
Alfred J. Castino................ 49 Chief Financial Officer
- -----------------------------------------------------------------------------------------
David J. Girouard................ 35 Vice President, Services & Strategy
- -----------------------------------------------------------------------------------------
Bradley J. Horowitz.............. 35 Chief Technology Officer
- -----------------------------------------------------------------------------------------
Joseph A. Hyrkin................. 30 Vice President, Strategic Accounts and
Asia Pacific Sales
- -----------------------------------------------------------------------------------------
Andrew P. Langhoff............... 39 Vice President, Business Development
- -----------------------------------------------------------------------------------------
Michael H. Lock.................. 38 Vice President, Worldwide Sales
- -----------------------------------------------------------------------------------------
Carlos O. Montalvo............... 44 Chief Marketing Officer
- -----------------------------------------------------------------------------------------
Frank H. Pao..................... 32 Vice President, Business Affairs
- -----------------------------------------------------------------------------------------
Mark K. Rattley.................. 40 Vice President and General Manager,
European Operations
- -----------------------------------------------------------------------------------------
Gilbert C. Wai................... 47 Vice President, Engineering
- -----------------------------------------------------------------------------------------

Paul G. Lego, chairman of the board of directors, president and chief
executive officer, joined Virage in January 1996. From January 1995 to January
1996, Mr. Lego was an associate at Sutter Hill Ventures, a venture capital firm.
From June 1988 to December 1994, Mr. Lego was the chief operating officer at
Digidesign, a manufacturer of digital audio recording and editing systems which
was acquired by Avid Technology in January 1995. Mr. Lego has also held various
marketing, manufacturing and engineering positions with Pyramid Technology
Corporation, the General Electric Company and Digital Equipment Corporation. Mr.
Lego holds a B.S. in electrical engineering from Cornell University and an
M.B.A. from Harvard Business School.

Alfred J. Castino, chief financial officer, joined Virage in January
2000. From September 1999 to January 2000, Mr. Castino was the chief financial
officer of RightPoint, a marketing software firm that was acquired by E.piphany.
From September 1997 to August 1999, Mr. Castino was employed at PeopleSoft as
vice president of finance and chief accounting officer, as senior vice president
of finance and administration, and chief financial officer. From April 1996 to
September 1997, Mr. Castino was vice president and corporate controller at
Chiron Corporation, a biotechnology company. From August 1989 to March 1996, Mr.
Castino held finance positions at Sun Microsystems, a computer hardware company,
including finance director of United States operations, director of finance and
planning for European operations, and assistant corporate controller. Mr.
Castino's prior experience also includes seven years at Hewlett-Packard Company
in various financial management positions. Mr. Castino is a certified public
accountant. Mr. Castino holds a B.A. in economics from Holy Cross College and an
M.B.A. from Stanford University.

David J. Girouard, vice president, services and strategy, joined Virage
in May 1997. Prior to becoming our vice president and general manager, Virage
Interactive, Mr. Girouard served as our director of product marketing from
November 1997 to May 1999. From December 1994 to April 1997, Mr. Girouard was a
product manager in the worldwide product marketing group at Apple Computer. Mr.
Girouard holds a B.A. in engineering sciences and a B.E. from Dartmouth College.
He also holds an M.B.A. from the University of Michigan.

Bradley J. Horowitz, chief technology officer, co-founded Virage in 1994.
From 1989 to April 1993, Mr. Horowitz was a consultant for various companies,
including Polaroid, TASC and Comtech Labs, in the area of digital image and
video understanding. Mr. Horowitz received a B.S. in computer science from the
University of Michigan and a M.S. in media science from the Media Lab at the
Massachusetts Institute of Technology.

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24

Joseph A. Hyrkin, vice president, strategic accounts and Asia Pacific
sales, joined Virage in 1999. Prior to joining Virage, Mr. Hyrkin ran sales for
Sina.com, a publicly listed company, that acts as the leading Chinese language
portal and destination site. Before joining Sina.com, Mr. Hyrkin resided in Hong
Kong and Beijing for seven years where he developed the China strategy for the
British-based Economist Group. Mr. Hyrkin received a double B.A. in Chinese and
Political Science from the State University of New York at Albany.

Andrew P. Langhoff, vice president, business development, joined Virage
in January 2000. Prior to joining Virage, Mr. Langhoff held a number of
positions within the online operations of the Walt Disney Company, most recently
as vice president of broadband development for Go.com. From March 1998 to
October 1999, Mr. Langhoff was vice president, business development for the
Buena Vista Internet Group of Walt Disney Company where he was responsible for
the strategic partnerships of ABCNEWS.com, ABC.com, ESPN.com and other Disney
websites. From March 1997 to March 1998, Mr. Langhoff was vice president,
business development for ABCNEWS Internet Ventures. From February 1996 to March
1997, Mr. Langhoff was vice president, business development for the ABC
Multimedia Group. From 1992 to 1996, Mr. Langhoff was a general attorney at
Capital Cities/ABC. Mr. Langhoff received a B.A. from Tufts University and a
J.D. from the University of Virginia School of Law.

Michael H. Lock, vice president, worldwide sales, joined Virage in
January 2001. Prior to joining Virage, Mr. Lock held various sales and marketing
positions at Oracle Corporation, most recently as Vice President, Sales and
Marketing, from 1996 to 2000. Mr. Lock also has served in a variety of sales,
marketing and general management positions with IBM, Dun and Bradstreet Software
and Drake International. Mr. Lock received a B.S. in Business Administration
from Wilfrid Laurier University in Ontario, Canada.

Carlos O. Montalvo, vice president, marketing, joined Virage in May 1998.
From March 1997 to April 1998, Mr. Montalvo served as vice president of
marketing at Cinebase, a provider of media asset management software. From March
1987 to March 1997, Mr. Montalvo held various product and regional marketing
positions and served as vice president of Apple Computer's interactive media
group. Mr. Montalvo studied political science and bioengineering at the
University of California at San Diego.

Frank H. Pao, vice president, business affairs and general counsel,
joined Virage in April 1997. From September 1994 to March 1997, Mr. Pao
specialized in intellectual property and licensing transactions at the law firm
of Gray Cary Ware & Freidenrich. He has also held various engineering positions
at Advanced Cardiovascular Systems and Lawrence Berkeley Laboratories. Mr. Pao
holds a B.S. in bioengineering from the University of California at Berkeley and
a J.D. from Boalt Hall School of Law at the University of California at
Berkeley.

Mark K. Rattley, vice president and general manager, European operations,
joined Virage as a full-time employee in March 2000. From November 1998 to March
2000, he held the position of vice president of Protege Software, a consulting
firm, where he was responsible for developing our European operations.
Previously, he spent six years as a director and general manager of Sun
Microsystems UK where he was responsible for the enterprise and Internet
software business in Europe. Prior to Sun Microsystems, Mr. Rattley held senior
sales, product marketing, general management and director positions at Informix,
Software Publishing Corporation, Rapid Recall and Technitron Systems. Mr.
Rattley graduated in 1982 with a Higher National Certificate in advanced
electronic engineering and a business administration diploma, studied at Reading
College of Technology and Thames Valley University, England.

Gilbert C. Wai, vice president, engineering, joined Virage in July 1997.
From October 1994 to June 1997, Mr. Wai was senior vice president of product
development at Legato Systems, a publicly-held enterprise storage management
software company. From September 1987 to September 1994, Mr. Wai held various
marketing and engineering executive positions, most recently as vice president
of product management and development, at Informix Software, a publicly-held
database software company. Mr. Wai holds a B.S. in electrical engineering and
computer science from the University of California at Berkeley.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

(a) Our common stock is listed on the Nasdaq National Market under the
symbol "VRGE".

Following our initial public offering on June 29, 2000, the following
high and low closing sales prices were reported by Nasdaq in each period
indicated:

- ---------------------------------------------------------------------------
HIGH LOW
- ---------------------------------------------------------------------------

YEAR ENDED MARCH 31, 2001
- ---------------------------------------------------------------------------
Fourth quarter $ 7.50 $ 2.00
- ---------------------------------------------------------------------------
Third quarter $18.38 $ 4.63
- ---------------------------------------------------------------------------
Second quarter $30.63 $10.00
- ---------------------------------------------------------------------------
First quarter (from June 29, 2000) $22.00 $14.47
- ---------------------------------------------------------------------------

The reported last sale price of our common stock on the Nasdaq National
Market on June 5, 2001 was $4.19. The approximate number of holders of record of
the shares of our common stock was 279 as of June 5, 2001. This number does not
include stockholders whose shares are held in trust by other entities. Because
many of our shares of common stock are held by brokers and other institutions on
behalf of stockholders, we are unable to estimate the total number of
stockholders represented by these record holders.

We have not paid any cash dividends on our capital stock. We currently
intend to retain future earnings, if any, to fund the development and growth of
our business and, therefore, do not anticipate paying any cash dividends in the
foreseeable future. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources."

(b) There has been no change to the disclosure contained in our report on
Form 10-Q for the nine months ended December 31, 2000 regarding the use of
proceeds generated by our initial public offering.

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26

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

SELECTED CONSOLIDATED FINANCIAL DATA

You should read the selected consolidated financial data set forth below
in conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our Consolidated Financial Statements
and the Notes thereto included elsewhere in this annual report. Historical
results are not necessarily indicative of results that may be expected for any
future period.

FISCAL YEARS ENDED
MARCH 31,
--------------------------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

CONSOLIDATED STATEMENTS OF OPERATIONS
DATA:
Revenues:
License revenues .......................... $ 6,161 $ 4,188 $ 1,956 $ 1,438 $ 376
Service revenues .......................... 5,136 1,102 253 130 43
Other revenues ............................ 104 271 1,141 1,134 1,026
-------- -------- -------- -------- --------
Total revenues ..................... 11,401 5,561 3,350 2,702 1,445
Cost of revenues:
License revenues .......................... 723 870 397 454 --
Service revenues .......................... 7,381 2,400 426 62 22
Other revenues ............................ 149 260 859 809 584
-------- -------- -------- -------- --------
Total cost of revenues ............. 8,253 3,530 1,682 1,325 606
-------- -------- -------- -------- --------
Gross profit ................................ 3,148 2,031 1,668 1,377 839
Operating expenses:
Research and development .................. 9,101 4,182 2,325 1,751 758
Sales and marketing ....................... 17,129 8,349 4,362 2,810 1,020
General and administrative ................ 5,298 2,653 1,273 935 694
Stock-based compensation .................. 3,294 1,070 -- -- --
-------- -------- -------- -------- --------
Total operating expenses ........... 34,822 16,254 7,960 5,496 2,472
-------- -------- -------- -------- --------
Loss from operations ........................ (31,674) (14,223) (6,292) (4,119) (1,633)
Interest and other income, net .............. 2,800 384 123 19 34
-------- -------- -------- -------- --------
Loss before income taxes .................... (28,874) (13,839) (6,169) (4,100) (1,599)
Provision for income taxes .................. -- (36) -- -- --
-------- -------- -------- -------- --------
Net loss .................................... (28,874) (13,875) (6,169) (4,100) (1,599)
Series E convertible preferred stock
dividend .................................. -- (4,544) -- -- --
-------- -------- -------- -------- --------
Net loss applicable to common
stockholders .............................. $(28,874) $(18,419) $ (6,169) $ (4,100) $ (1,599)
======== ======== ======== ======== ========
Basic and diluted net loss per share
applicable to common stockholders ......... $ (1.88) $ (8.06) $ (3.67) $ (2.84) $ (1.44)
======== ======== ======== ======== ========
Shares used in computation of basic and
diluted net loss per share applicable to
common stockholders ....................... 15,397 2,286 1,679 1,443 1,116

Pro forma basic and diluted net loss per
share applicable to common stockholders ... $ (1.59) $ (1.67) $ (0.80)
======== ======== ========
Shares used to compute pro forma basic and
diluted net loss per share applicable to
common stockholders ....................... 18,118 11,006 7,736

MARCH 31,
--------------------------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
(IN THOUSANDS)

CONSOLIDATED BALANCE SHEETS DATA:
Cash, cash equivalents and short-term investments ..... $ 48,131 $ 10,107 $ 4,357 $ 5,780 $ 2,387
Working capital ....................................... 40,588 8,101 3,879 4,723 2,273
Total assets .......................................... 60,206 18,872 6,605 7,289 3,418
Long-term obligations, net of current
portion ............................................. -- 83 241 311 163
Redeemable convertible preferred stock ................ -- 36,995 17,936 12,472 5,823
Accumulated deficit ................................... (61,174) (32,300) (13,881) (7,712) (3,612)
Total stockholders' equity (net capital
deficiency) ......................................... 49,706 (23,221) (13,326) (7,257) (3,224)

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion of the financial condition and results of
operations of Virage, Inc. should be read in conjunction with "Selected
Consolidated Financial Data" and our consolidated financial statements and notes
thereto.

OVERVIEW

Virage provides software products and application services that enable
video for strategic online applications. Depending on their particular needs and
resources, video content owners may elect either to license our software
products or to subscribe to our application services. Our customers include
media and entertainment companies, other corporations, government agencies and
educational institutions.

REVENUE RECOGNITION

We enter into arrangements for the sale of licenses of software products
and related maintenance contracts, application and professional services
offerings and we also receive revenues under U.S. government agency research
grants. Service revenues include revenues from maintenance contracts,
application services and professional services. Other revenues are primarily
U.S. government agency research grants.

Our revenue recognition policy is in accordance with the American
Institute of Certified Public Accountants, or AICPA's, Statement of Position No.
97-2, or SOP 97-2, "Software Revenue Recognition," as amended by Statement of
Position No. 98-4, "Deferral of the Effective Date of SOP 97-2, "Software
Revenue Recognition," or SOP 98-4, and Statement of Position No. 98-9,
"Modification of SOP No. 97-2 with Respect to Certain Transactions" or SOP 98-9.
For each arrangement, we determine whether evidence of an arrangement exists,
delivery has occurred, the fee is fixed or determinable, and collection is
probable. If any of these criteria are not met, revenue recognition is deferred
until such time as all of the criteria are met. We consider all arrangements
with payment terms extending beyond 12 months and other arrangements with
payment terms longer than normal not to be fixed or determinable. If
collectibility is not considered probable, revenue is recognized when the fee is
collected provided all other criteria are met. No customer has the right of
return.

Arrangements consisting of license and maintenance. For those contracts
that consist solely of license and maintenance, we recognize license revenues
based upon the residual method after all elements other than maintenance have
been delivered as prescribed by SOP 98-9. We recognize maintenance revenues over
the term of the maintenance contract as vendor specific objective evidence of
fair value for maintenance exists. In accordance with paragraph 10 of SOP 97-2,
vendor specific objective evidence of fair value of maintenance is determined by
reference to the price the customer will be required to pay when it is sold
separately (that is, the renewal rate). Each license agreement offers additional
maintenance renewal periods at a stated price. Maintenance contracts are
typically one year in duration. Revenue is recognized on a per copy basis for
licensed software when each copy of the license requested by the customer is
delivered. Revenue is recognized on licensed software on a per user or per
server basis for a fixed fee when the product master is delivered to the
customer. There is no right of return or price protection for sales to domestic
and international distributors, system integrators, or value added resellers. In
situations where the distributor, integrator or reseller has a purchase order
from the end user that is immediately deliverable, we recognize revenue on
shipment to the distributor, integrator or reseller, if other criteria in SOP
97-2 are met, since we have no risk of concessions. We defer revenues on
shipments to distributors, integrators or resellers if the party does not have a
purchase order from an end user that is immediately deliverable or other
criteria in SOP 97-2 are not met. We recognize royalty revenues upon receipt of
the quarterly reports from the vendors.

When licenses and maintenance are sold together with professional
services such as consulting and implementation, license fees are recognized upon
shipment, provided that (1) the criteria in the previous paragraph have been
met, (2) the Company believes that the services are not essential to the other
elements

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28

of the arrangement and the Company has sufficient experience in providing the
services, (3) the services do not involve a significant degree of risk or unique
acceptance, (4) payment of the license fee is not dependent upon the performance
of the services, (5) the services are available from other vendors, and (6) the
services do not include significant alterations to the features and
functionality of the software. In such an arrangement, the Company uses vendor
specific objective evidence of fair value for the services and the maintenance
to account for the arrangement using the residual method, regardless of any
separate prices stated within the contract for each element. Vendor-specific
objective evidence of fair value of services within a multiple element
arrangement is based upon hourly or daily rates--the same rates used when the
Company enters into stand-alone service contracts based upon time and materials.
Through March 31, 2001, very few license and maintenance arrangements were sold
together with professional services as the Company had not formally established
a professional services organization until the end of fiscal 2001.

Should professional services be essential to the functionality of the
licenses in a license arrangement which contains professional services or should
an arrangement not meet the criteria mentioned previously in the above
paragraph, both the license revenues and professional service revenues are
recognized in accordance with the provisions of the AICPA's SOP 81-1,
"Accounting for Performance of Construction Type and Certain Production Type
Contracts" ("SOP 81-1"). When reliable estimates are available for the costs and
efforts necessary to complete the implementation services and the implementation
services do not include contractual milestones or other acceptance criteria, the
Company accounts for the arrangements under the percentage of completion
contract method pursuant to SOP 81-1 based upon input measures such as hours or
days. When such estimates are not available, the completed contract method is
utilized. When an arrangement includes contract milestones, the Company
recognizes revenues as such milestones are achieved.

Application services. Our application services revenues consist of set-up
fees, video processing fees and application hosting fees. Set-up fees are
recognized ratably over the contract term, which is generally six to twelve
months. We generate video processing fees for each hour of video that a customer
deploys. Processing fees are recognized as encoding, indexing and editorial
services are performed and are based upon hourly rates per hour of video
content. We generate application hosting fees based on the number of video
queries processed, subject in some cases to monthly minimums and maximums. We
recognize revenues on transaction fees that are subject to monthly minimums
based on the greater of actual transaction fees or the monthly minimum, and
monthly maximums based on the lesser of actual transaction fees or the monthly
maximum, since we have no further obligations, the payment terms are normal and
each month is a separate measurement period.

Professional Services. The Company provides professional services such as
consulting, implementation and training services to its customers. Revenues from
such services, when not sold in conjunction with product licenses, are generally
recognized as the services are performed. To date, revenues recognized from
professional services have not been meaningful.

Other revenues. Other revenues consist primarily of U.S. government
agency research grants that are best effort arrangements. The
software-development arrangements are within the scope of the FASB's Statement
of Financial Accounting Standards No. 68, "Research and Development
Arrangements". As the financial risks associated with the software-development
arrangement rests solely with the U.S. government agency, we are recognizing
revenues as the services are performed. The cost of these services are included
in cost of other revenues. Our contractual obligation is to provide the required
level of effort (hours), technical reports, and funds and man-hour expenditure
reports.

Cost of license revenues consist primarily of royalty fees for
third-party software products integrated into our products. Our cost of service
revenues includes personnel expenses, related overhead, communication expenses
and capital depreciation costs for maintenance and support activities and
application services. Our cost of other revenues includes engineering personnel
expenses and related overhead for custom engineering and government projects.

We incurred net losses applicable to common stockholders of $28,874,000,
$18,419,000 and $6,169,000 during the three years ended March 31, 2001, 2000 and
1999, respectively. As of March 31,

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29

2001, we had an accumulated deficit of $61,174,000. We expect to continue to
incur operating losses for the foreseeable future. In view of the rapidly
changing nature of our market and our limited operating history, we believe that
period-to-period comparisons of our revenues and other operating results are not
necessarily meaningful and should not be relied upon as indications of future
performance. Our historic revenue growth rates are not necessarily sustainable
or indicative of our future growth.

RESULTS OF OPERATIONS

The following table sets forth consolidated financial data for the
periods indicated, expressed as a percentage of total revenues.

FISCAL YEARS ENDED
MARCH 31,
------------------------------------
2001 2000 1999
---- ---- ----

Revenues:
License revenues .................................... 54% 75% 58%
Service revenues .................................... 45 20 8
Other revenues ...................................... 1 5 34
---- ---- ----
Total revenues .............................. 100 100 100
---- ---- ----
Cost of revenues:
License revenues .................................... 6 16 12
Service revenues .................................... 65 43 13
Other revenues ...................................... 1 5 26
---- ---- ----
Total cost of revenues ...................... 72 64 51
---- ---- ----
Gross profit .......................................... 28 36 49
Operating expenses:
Research and development ............................ 80 75 69
Sales and marketing ................................. 150 150 130
General and administrative .......................... 47 48 38
Stock-based compensation ............................ 29 19 --
---- ---- ----
Total operating expenses .................... 306 292 237
---- ---- ----
Loss from operations .................................. (278) (256) (188)
Interest and other income, net ........................ 25 7 4
---- ---- ----
Loss before income taxes .............................. (253) (249) (184)
Provision for income taxes ............................ -- -- --
---- ---- ----
Net loss .............................................. (253) (249) (184)
Series E convertible preferred stock dividend ......... -- (82) --
---- ---- ----
Net loss applicable to common stockholders ............ (253)% (331)% (184)%
==== ==== ====

FISCAL YEARS ENDED MARCH 31, 2001 AND 2000

Total Revenues. Total revenues increased to $11,401,000 in fiscal 2001
from $5,561,000 in fiscal 2000, an increase of $5,840,000. This increase was due
to increases in lice