CEVA, Inc.
Q3 2009 Earnings Call Transcript

Published: 28 Oct 2009

[Operator:]

Good morning. At this time I would like to welcome everyone to the CEVA Q3 2009 earnings conference call. (Operator Instructions). I would now like to turn the conference over to Mr. Yaniv Arieli, Chief Financial Officer. Please go ahead, sir.

[Yaniv Arieli:]

Good morning everyone and welcome to CEVA's third quarter 2009 earnings conference call. Today's conference call contains forward-looking statements that involve risks and uncertainties as well as assumptions that if they materialize or prove incorrect could cause the results of CEVA to differ materially from those expressed or implied by such forward-looking statements and assumptions. Forward-looking statements include financial guidance for the fourth quarter and fiscal 2009, general outlook of the market and economy and our licensing pipeline, market statistics gathered from analysts, projected increase in our market share, design wins with our customers, new product introduction by our customers, their production schedules and our ability to generate revenues from new products, our ability to capitalize on trends for greater usage of ultra low cost phones, data cards, e-readers, netbooks, MIDs and machine-to-machine products. The risk and uncertainties and assumptions include the ability of CEVA DSP cores and other technologies to continue to be a strong growth driver for us, our success in penetrating new markets and maintaining our market position in existing markets, the effect of the intense competition in our industry, the effect of the challenging period of growth experienced by the industries in which we license our technologies to, the possibility that the markets for our technologies may not develop as expected or that products incorporating our technologies do not achieve market acceptance. Our ability to timely and successfully develop and introduce new technologies, our ability to continue and improve our royalty revenue in future periods and general market conditions and other risks relating to our business, including but not limited to those that are described from time to time in our SEC filings. CEVA assumes no obligation to update any forward-looking statements or information which speak of their representative date. This conference call will be conducted by Gideon Wertheizer, Chief Executive Officer of CEVA and I, Yaniv Arieli, Chief Financial Officer of the company. Gideon will cover the business aspects and highlights for the quarter while I will cover the financial results for the third quarter of 2009, as well as the financial guidance for the fourth quarter and fiscal '09. With that said I would now like to turn the call over to Gideon.

[Gideon Wertheizer:]

Good morning, everyone, and thank you for joining us today. I hope you had the opportunity to review our press release with the financial results for the third quarter of 2009. During the quarter we achieved revenues of $9.7 million, a 6% sequential increase over the second quarter of 2009 and 5% decrease compared to the third quarter of 2008. This revenue figure exceeded our expectation and was above our previously stated guidance. Royalty revenue for the third quarter of 2009 was $3.7 million, representing a 19% sequential increase over the second quarter of 2009, excluding approximately $0.9 million of catch-up royalties and 12% higher than the $3.3 million resulted for the third quarter of 2008. During the third quarter we concluded six new license agreements, five with a German work for CEVA DSP core platform in [Foster] and one agreement was for Bluetooth technology. Geographically three of the license agreements were in Europe and three in Asia. Target applications for the licenses concluded during the quarter are primarily 2G internal [inaudible] handset, small form data cards, mobile TVs, portable and home multimedia and Passive Optical Networks. Our third quarter results indicate an improving pattern of licensing and royalties from our customers. We believe our licensing business has started to recover and customers are more receptive to upgrade for the new generation of our best-of-breed DSP cores and other technologies, rather to reusing existing platforms. Visibility is starting to improve as well and our licensing pipeline has strengthened, specifically regarding advanced technology such as LTE terminals, data card synthesis, [high to finish] and multimedia, solid state drive and Voice-over-IP. Turning to royalties, our results reflect a return to seasonality as well as continued market share gains for CEVA this quarter, particularly in the business market. The royalty contribution from the consumer front has shown some improvement, but still constrained by overall weakness of the economy. We continue to show robust and systematic progress with our profitability and our debt-free balance sheet is stronger than ever. Both our GAAP and non-GAAP operating margins reached record high of 17% and 24% respectively. Our gross margin for the quarter also reached a record high of 91%. Our non-GAAP net income and EPA also reached all-time highs of $2.4 million and $0.12 respectively. Now a few observations about the cellular handset market, the global cellular handset shipments for the second quarter of 2009 [derives] supply were $265 million. Our third quarter royalties which represent second quarter shipments included approximately 61 million handset units shipped. These strong results driven by higher handset sales of local form in China and India, their market, improved for 3G Smartphone for the rest of the world. These trends increase CEVA worldwide market share for base product to record high of 23% versus 18% for the prior quarter. Based on Nokia public announcement, it's expected that 2009 worldwide shipments to be nearly 1.1 billion, down 7% from 2008, but an improved [tick up] from prior expectations of 10% worldwide decline. A substantial proportion of our customer shipments were for local phones for emerging market. The Juniper Research by 2014 50% of the global shipments will be for local phone. In India, just in the month of August 2009, 15 million new subscribers were added. In China, based on the [Sullivan] report, there are 618 million subscribers which equates to only 51% penetration rate. Our [kick-off] and our focus on this significant market opportunities in our local [low] power DSP provides tremendous value proposition that speak well with their [main]. Mobile broadband data cards, which provides direct interconnectivity for laptops is becoming an increasingly important market segment for CEVA as we are able to leverage our strength in handset to drive innovation and reduce costs for these products. The LTE or the feel of ST-Ericsson, next year mobile broadband subscribers will overtake fixed -line broadband users and by 2014 2/3 of the broadband subscribers will be mobile users. Our advanced DSP are now being designed into the products of the largest vendors in the data card space. Per an ABL Research report, this market is expected to grow to 230 million units in 2013 versus 45 million in 2009. At the October 2009 Intel Developer Forum in San Francisco, Ericsson unveiled the C3607W HSPA module that is enabled by our DSPs. Ericsson is working slowly with Intel on module for Intel 800 [inaudible] processor [inaudible] for MIDs and netbook. Given Intel's power in the PC and in the netbook ecosystem, Ericsson partnership with the chip giant is increasingly important. The C3607W is one-third of the size of the previous Ericsson module, consume only 40% of the power and will be commercially available in the first quarter of 2010. In addition to MID base on the [inter-mustal] platform a C3607W has targeted a broad range of e-readers and personal devices, picture frames, gaming consoles and other portable consumer electronics. With regard to the e-readers that I just mentioned, Sony unveiled its the first wireless e-reader, the Daily Edition with a seven inch touch screen. It's wireless connectivity is based on our CEVA-X DSP. According to [InSTAT], e-reader shipment for 2009 will total around 1 million units, but is expected to go to 30 million units by 2013. Before handing the call over to Anil for financial, I would like to summarize that we are encouraged by the progress made in our business. Our pipeline is strong driven by strong interest in our new CEVA-XC DSP which is being currently evaluated by many of the key players in the space. We continue to expand in the handset market and our world provision to capture market share for netbook, MID, data card, e-readers, machine-to-machine and consumer products. With that said I will now turn the call over to Yaniv to review the third quarter of 2009 financial and provide future guidance.

[Yaniv Arieli:]

I'll now review the results of operations for the third quarter of '09. Revenue for the third quarter was $9.7 million which was above the higher end of guidance compared to $10.2 million for the third quarter of 2008. The revenue breakdown is as follows

[Operator:]

(Operator Instructions). Your first question comes from Anil Doradla – William Blair & Company.

[[Brian]:]

Good morning, it's [Brian] for Anil. Can you just elaborate a little bit on the overall design pipeline? Are you guys seeing customers opening up R&D broadly? And also do you feel like there's some pent up demand there still?

[Gideon Wertheizer:]

Well, I would say there is openness to explore seriously new projects. It started in this quarter. This was not the case in the second quarter and thus we have a very distant pipeline for technologies that we think are next generation product. And I mentioned in my prepared remarks this is in HD and data cards. These are the projects that people are looking out to do.

[[Brian]:]

And can you just elaborate on the higher rate per contract this quarter? Did you guys have any CEVA-XC licenses and broadly on the applications, are there any application processors that you feel like you're winning licenses there, too?

[Yaniv Arieli:]

I'll start with the quarter. In Q2 we did not have yet any CEVA-XC licenses, although as we mentioned earlier in the prepared remarks we see and are very active with numerous customers that are evaluating this technology. So we're quite bullish that this is going to be leading edge technology and one of the strong licensing revenue contributors for 2010. We will see if we could also accommodate such a deal in the fourth quarter, but until the deal is signed it's not signed yet. But we have a healthy pipeline around this new core. And the other part of your question, if you could repeat please?

[[Brian]:]

I'm just trying to figure out why the rate per contract was so much higher this quarter and how sustainable that is?

[Yaniv Arieli:]

Oh, I see. No, no, the simple math of taking the overall licensing revenues and dividing it by the number of deals has always been a bit misleading. It's simple math that the one does every quarter but it doesn't have that much to do with reality. I think our business model has been intact meaning some companies ,usually large name employers, like to have a multi-use license for technology. For that they pay us few millions of dollars and then they have the right to use a specific DSP core or platform across all their industry or product lines shipped. Some other deals are smaller deals, either a single use and these are hundreds of thousands of dollars and as you know we have a bunch of different applications that we license these days, Bluetooth, SATA, audio, Voice-over-IP, video CODECs and software that run on these DSP processors and these, of course, are a lower than millions of dollars. These are again in the hundreds of thousands. So in every single quarter we always have a mix of some new licensees using us across multiple product lines and these are the bigger licenses and then smaller ones with more different offerings, but they're not million dollar deals like that. So it's a combination. We have both this quarter and we're quite pleased with the names and the players that license our technology.

[[Brian]:]

And then, sorry if I missed this on the prepared comments, but on the Ericsson device that you were mentioning, is that the LTE device that they're testing?

[Yaniv Arieli:]

No, that's a data card. It's HSPA. It's in-house G.

[[Brian]:]

And then, but looking forward longer term, I mean it's going to take a long time for 4G to get ramping up, but – and particularly hitting the P&L, but just looking longer term as an upgrade cycle like that, do you see that as an overall positive or negative? It seems like you're having a lot more success in the low end? I don't know if that's the right way to look at it in terms of your baseband market share, but longer term, when we look at LTE do you see that as positive or negative both in terms of your market share and your royalty rate per unit?

[Gideon Wertheizer:]

The 2G is royalty contribution. Eventually people are not now buying licenses to develop 2G platforms. Going forward the 4G is the licensing activities and going forward in 2013, '14 royalties are supposed to be mainstream. We're going to see contributions for in royalties for 4G and then well, we'll see. The low cost market or what is called 2G, it's a huge market. Now I mentioned in my part in the prepared remarks, about 51% in China using it. So you have another 50% that you can go. And this market by itself is evolving so now it's a 2G. In two years from now those people will replace it with 2.5G and these are all products that we have in place that will be contributing to royalties.

[[Brian]:]

That's great. That's helpful. But just to clarify, I mean you wouldn't see the outsourcing trend be more or less as we transition to 4G. It would be kind of what you're seeing in 2G now, you know, five years from now. That's what I'm just trying to clarify.

[Yaniv Arieli:]

Yes, that's the idea. These types of design cycles as Gideon explained just now, you have the licensing kicking in first with multiple customers in there to start their design activities and usually two, three years down the road then you have the royalties kicking in, same exact cycle that we had in 2G and we have with the video technologies and we don't see a phase out and phase in. We see all this one mix and every quarter we can analyze together what are the different trends. Right now we know the trends are very strong with the royalties. And with the 2G solutions and platforms and are starting to get new design wins into the higher end and foreboding that to the licensing side and in between we have lots of other offerings like video, Voice-over-IP, Bluetooth and sub-systems.

[Operator:]

Your next question comes from Daniel Meron – RBC Capital Markets.

[Daniel Meron:]

Just a question on the outlook in the licensing business into 2010, do you see this increased momentum in this business? How should we think about this business on a longer term basis? Do you think it's going to stay steady around the $5 million, $6 million level or increase from here going forward? And what will be the drivers for that?

[Yaniv Arieli:]

I'll start with the numbers. Unfortunately at this point in time we usually don't give guidance for 2010. We will do so and give much more detailed outlook like we usually do in the January conference call. So I'll refrain from giving any specific numbers. The business environment hasn't changed. The licensing business is the most very important part of our growth because that generates the royalty streams two or three years down the road. So this is something we're putting a lot of efforts to. We're introducing and will introduce in 2010 two very interesting technologies. One is the CEVA [S] which will be a finished and off the shelf product by then and then later in that year we will also have an HD video solution so on the licensing front the – we're very actively promoting these activities, but again, I don't think there's a big change in overall business and number-wise we'll be happy to get into when we guide for the rest of 2010. Gideon, do you want to add anything?

[Gideon Wertheizer:]

The only thing that I would like to add is that drivers for revenue for 2010, the way I see it now is definitely CEVA-XC and we are encouraged by the pipeline and we see companies that in the past weren't in our list as a potential licensee now evaluating the technology. And as Yaniv mentioned later the second half of next year we'll see new multimedia platforms that will go to the connected DTV and connected SATA boxes. These are things that we see a lot of interest coming from customers.

[Daniel Meron:]

So maybe on another front, as you looking to prospects in the business, in what areas can you expand your portfolio, I mean as far as M&A? You do have a rising cash pile here and can –looks like your business plan's working pretty well on both fronts of licenses and the royalties. How should we think about CEVA next few years as just staying the course or are you looking into expanding this business through M&A down the road? And if you can just broadly outline for us what areas you may be considering here?

[Gideon Wertheizer:]

I would say this. When it comes to M&A the general thinking that we have and the practices that we do and the things that we are checking here is to for technologies that will grow our business in our main market. We are active, as you know, in the handset space and in the handset space you have evolution in the baseband going to 4G and you have evolution where people are familiar with Smartphone and a whole lot of technology is involved there. And that's one segment. The other segment is the consumer electronics and we have we are now active in the multimedia audio-video activities and other technologies that are of interest for us to complement and to provide to the customers a higher level portfolio for the customers. Definitely today they are expecting a more integrated higher valued platforms and not just cores as it used to be three, four years ago.

[Yaniv Arieli:]

But when we started this trend a few years ago with adding the video and the Voice-over-IP platforms and they were our first steps into that space, that our DSPs could be multi-used for different applications and a much more consolidated and one-stop shop type of approach. So we already started that and I think we used our plan, as Gideon said, to continue the same route and with that said, just to remind us all, that even without any active M&A we still find ourselves in a very strong position organically to continue add value to our shareholders and continue to grow the business and its profitability. That's our main course.

[Operator:]

Your next question comes from the line of Matt Robison – Wedbush Morgan Securities.

[Matt Robison:]

First, before I forget, headcount?

[Yaniv Arieli:]

182 versus 178 in the prior quarter.

[Matt Robison:]

Gideon, do you have your baseband market share from a year ago? I'll circle back with you on that if you want.

[Gideon Wertheizer:]

A year ago it would be –

[Matt Robison:]

I know it was 12% for the second –you quoted for the June quarter. Gideon Yes, I think we were at the end of Q308 at the same, 12% or 13% because Q3 and Q4 stayed at the same level. We ended 2008 with 12% market share. I think that's the same number.

[Matt Robison:]

Okay. Your average royalty, your royalty ASP declined a lot again. Is that – can you give us a flavor of the percentage of royalties that came from consumer and how that changed versus the number you reported last quarter?

[Yaniv Arieli:]

I'm not sure though that your math is 100% accurate. Let's do it together.

[Matt Robison:]

Please correct me. I may have the wrong denominator here.

[Yaniv Arieli:]

Yes, I think it's pretty much flat. If you take the $3.7 million that we just reported and divide it by about $75 million paying royalties and then do the same for the previous quarter with $3.1 million of royalties divided by 57, you'll find that the average is about $0.05 for the company. So I –

[Matt Robison:]

Yes, $0.07 in the prior quarter but it was –

[Yaniv Arieli:]

Prior year maybe, yes. Prior year we had more consumers. The last two quarters, even this quarter, the consumer did not contribute as it was in the past. It's still slow. It has some positive contribution compared to Q2 but a very low contribution so the main growth came from volume at the lower end of the phone. Those are the 2G phones, very strong momentum there and by the way, we do see that trend continue into Q4. Based on a few of the royalty reports that we have already received we see at least a 20% growth sequentially, at least, for the next quarter. So that trend is continuing and what we have recently seen again in reports for the next quarter is some pickup in consumer. Now bear in mind that these are Q3 shipments so these are the pre-Christmas and stronger quarter, much better than the number, again, we don't have the full picture but at least from the initial report the consumer seems to have picked up in Q3 compared to Q2 shipments.

[Matt Robison:]

So even though the semiconductor industry benefited from restocking activity in the June quarter, which showed up in your royalties you're reporting today, you think you'll still see a 20% unit pickup in the royalties you report in January, which will be the – reflecting the third quarter?

[Yaniv Arieli:]

One correction, 20% at least in royalties, dollars. I don't know about the quantities. I was talking dollars.

[Matt Robison:]

Okay

[Yaniv Arieli:]

Around $3.7 million, do the math, but this is the trend we're seeing on the royalty side.

[Matt Robison:]

So the sell-through obviously at your customers continues to be pretty good, at least in the applications that you serve?

[Yaniv Arieli:]

Absolutely.

[Matt Robison:]

What is –what are you – FOREX volatility you have, what should we be thinking in terms of your incremental hedging expenses for next year on your largely Israeli R&D OpEx?

[Yaniv Arieli:]

Again, very similar to the prior question. We'll give more detail as we go along in the next quarter. Overall we haven't changed our FX strategy over the last two or three years, so it's the same answer. We usually hedge somewhere between six to nine months in advance, so part of 2010 is already hedged and not all of it. And of course if the average hedge rate is smaller than it is today due to the dollar valuation, which is quite low these days, and the expenses [I] have in OpEx, but I don't have the magnitude nor the numbers yet to back up that.

[Matt Robison:]

Do you do it on a rolling basis or do you just do a 12-month every year?

[Yaniv Arieli:]

No, no, rolling basis.

[Matt Robison:]

And you go out six to nine months?

[Yaniv Arieli:]

Yes.

[Operator:]

Your next question comes from the line of Allan Mishan – Brigantine Advisors.

[Allan Mishan:]

Hey guys, can you please just review who the top baseband royalty payers were for you in the quarter?

[Yaniv Arieli:]

We hire – we don't give specific names and we don't list them by importance or dollar contributors, but if you look just at the portfolio of customers that we have, and let's start with OEM, of course the bigger OEM that are using our technology. There's Sony Ericsson, Samsung, LG, iPhones, a lot of the Chinese, black-box types of players. Gideon, did I miss anything there? These are the big names in the OEM side, I believe. If you look at who are the chip providers or suppliers to these Tier 1 OEMs, you'll find a bunch of names. These are the ST-Ericsson, these are the [Infineon] that are working with us, these are the [dot coms] of the world, these are the [inaudible] and maybe a few others that we didn't highlight as much yet. And this is mainly in Asia and some other parts of the world, pretty much all the big ones. The ones that are left that are not using our technology these days are obviously TI, Qualcomm and MediaTech. These are the only big players that do not work essentially with us.

[Allan Mishan:]

Fair enough. And then, I don't need exact numbers, but if you look at sort of blended royalty rate you get for baseband and the blended royalty rate you get for everything else, which of those two is higher?

[Yaniv Arieli:]

The fewer. The everything else.

[Allan Mishan:]

Okay, so baseband would actually drag down, maybe only in a minor way, but it would drag down the overall rate for you?

[Yaniv Arieli:]

In principle, yes. It's a much bigger market so there is the idea in our business and in the ASP for the royalties are built in in every license agreement. We don't have to redefine it. So the larger the quantities, we have an automatic step down in the first payment that the customer needs to pay us. So of course if the markets are larger and you're already shipping to existing customers, they may be in the lower bracket than a new customer now shipping into the consumer side, whether it's in the e-reader that we talked about, which is a brand new opportunity for us, or some of these other data cards or video type of applications.

[Allan Mishan:]

Great, and then last one for me, in the non-baseband category, which I guess was about 28 million units this quarter, what are the top couple of applications? And I don't mean in terms of licensing, I mean in terms of what's actually paying today? And if you could segment it out to things like, whether it's game consoles or DVD, just so I can understand the top couple of applications describing that?

[Gideon Wertheizer:]

It's SATA boxes. It's game consoles and the DTVs.

[Operator:]

Our next question comes from the line of Steven Glass – STG Capital.

[Steven Glass:]

I wonder if you could touch base a little bit more on the [SSD] opportunity. What's the magnitude of the opportunity? Can you talk about, if you're comfortable talking about it, whether it's enterprise-focused or whether it's a client-based application that you're focusing on? So are you focused on that in terms of material revenue opportunities or is it a longer-term build we're looking at? Thank you.

[Gideon Wertheizer:]

Steve, still it's in, I would say, infancy. We are working with big names. It's enterprise, this is the activities. With some customers we have product, and the shipment is still the quantities of one. In some other customers, we are in, I would say, 50% through with the design.

[Yaniv Arieli:]

I would add we have maybe two customers that have started to ship products. We've seen the initial royalty reports. Still, as Gideon said, minor, small numbers, but two have just recently started to ship out.

[Operator:]

Your next question comes from [Robert Morrison], a private investor.

[[Robert Morrison]:]

Hi, my recollection is that you were – and correct me if I've got this wrong – you were anticipating a license of the C and the XC in the third quarter, and that that didn't happen. And if that's correct, it would be particularly impressive that you beat on revenues. I'm wondering if you can comment on that, and if you could say anything about why you might expect with the C and XC just around the corner, that you'd see weakness in your licensing, with people holding off for the XC, and yet that doesn't seem to be happening. So is there any general comments you can make? Are there people licensing the CEVA-X in anticipation of the XC? Any coloration you can give to that?

[Yaniv Arieli:]

No, I don't recall us saying that we will have the deal or that we're looking for a deal in Q3. We did say that we will be very happy. It's going to be very important milestone for us to achieve such a deal in 2009. Or as we said maybe back then at the later part of 2009, so if that happens again in Q4, and we have a line of customers that are evaluating the technology as we speak, that would be a very nice and strong achievement. If that does not mature then I'm sure we'll see that numerous deal in 2010. So the timing is still on track and we have the opportunity to do it, and I hope we'll be able to update you all next quarter. If not, this is going to be a 2010 event. And with regards to the type of the product cycle or replacement cycle that you were referring to, I don't think that's the case at all with CEVA. CEVA-X is a totally different market and customer base and a target base, than other DSP cores which are for other applications, whether it's for gaming consoles or eBook type of applications or Voice-over-IP applications. I think we'll continue to see a parallel mix between newer technologies toward a very high end 4G type of application. And in Asia we could see more cost reduction activities with older cores, because the end application is different. So we don't forecast or anticipate a product cycle replacement or replacement cycle. On the contrary, we expect that the new core will be just an add-on to the existing portfolio of products that we have today.

[[Robert Morrison]:]

Thanks very much, and sorry if I was mistaken on that, then. One last question, I may have not heard that correctly, but did you mention that [RIM] has adopted your technology through one of your licensees? And if so, is that new?

[Yaniv Arieli:]

No, we did not comment about them. None of that happened yet.

[[Robert Morrison]:]

I have to go back and listen again. I just didn't hear correctly. Thanks very much.

[Operator:]

Thank you. (Operator instructions.) And at this time there are no further questions. Are there any closing remarks?

[Yaniv Arieli:]

Yes, we would like to thank you again for joining us, and your continued interest in CEVA. We'll be attending and presenting at the AA Classic Investor Conference next week on Tuesday, November 3rd in San Diego, California, and invite you to join us there. Thank you, and goodbye.

[Operator:]

Thank you. This concludes today's conference call.