CEVA Inc (CEVA) 2004 Q3 法說會逐字稿

Good morning. Good afternoon. Thank you for standing by. Welcome to the CEVA third quarter earnings conference call. At this time all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS). Today's conference is being recorded. If you have any objections you may disconnect at this time. Now I will turn the meeting over your speaker Michael Polyviou with Financial Dynamics. Please go ahead.

Thank you Chris. Good morning everyone and good afternoon to you in the UK. Welcome to CEVA 2004 third quarter conference call. Anyone who has not received a copy of last evening's press release call our offices at 212/850-5600. A copy will be faxed or emailed to you. (inaudible) the Company's website at www.ceva-esp.com.

As is always the case, I need to remind you of the safe harbor regulations. Any matters today that are not historical facts, particularly comments regarding the Company's future plans, objectives, forecasts, and expected performance consist of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such estimates, whether expressed or implied, are being made based on currently available information and the Company's best judgment at this time. Within these is a wide range of assumptions that the Company believes to be reasonable. However it must be recognized that the statements are subject to a range of uncertainty that could the actual results to vary materially. In addition this call is being recorded on behalf of CEVA and is copyrighted material. It cannot recorded or rebroadcast without the Company's express permission. Your participation implies consent to this taping.

Before I introduce CEVA's management, I would like to remind you that CEVA will be presenting at the 34th annual AeA Classic financial conference in Monterey, California on November 9 & 10. We hope to see you there.

With us this morning are Chet Silvestri, Chairman and Chief Executive Officer; Christine Russell, Chief Financial Officer; and Barry Nolan, Senior Vice-President of Strategy, Marketing & Communications. We will open up the call for questions after CEVA's management has concluded their formal remarks. With that I would now like to turn the call over to Chet Silvestri. Chet.

Thank you, Michael. Good morning and good afternoon to you all. Thanks for joining CEVA's third quarter conference call. By way of introduction let me start by stating that I'm very pleased with our Q3 performance. In what is traditionally our weakest quarter, CEVA's revenue, gross margin, and net income all recorded sequential improvements. I'm also proud to say that we have achieved our eighth sequential quarter of licensing revenue growth and the third sequential quarter of profitability. Also, importantly in the quarter, we saw strong unit volume shipments by our licensees, with over 30 million units shipped in the quarter. Finally, our continued execution has seen our profitability sequentially increase 13 percent to $560,000 or 0.3 cents per share. We had positive operating cash flow of $500,000.

Now to discuss some more third quarter highlights. In the quarter we completed six new licensing agreements across almost the entire range of our technology. This means we did additional licensing deals for Teak and CEVA-X DSP cores, for Serial-ATA, for Bluetooth, and for our multi-media software. The only product line that we did not add an additional licensee for was our GPS product, but we had a very strong Q2 with two licensees signed and expect to see more in the near future. Stay tuned for Q4.

To be more specific, in the quarter we closed another strategic win for our CEVA-X DSP technology, which we announced with Atmel. Atmel, who was also a previous licensee of our DSP cores, now steps up to the more powerful CEVA-X for use in the high-growth storage market. The adoption of our Serial-ATA solution was very strong. We completed two significant license wins in the quarter, once again in the storage segment of the semiconductor market. Both licensees currently have significant market share in these markets. During the quarter we also achieved our first licensing win for our CEVA mobile multi-media software solution with a major Japanese wireless player. I'll talk more about this recently announced product solution in a few moments.

Continuing with additional Q3 highlights, we also had a partner announce the world's first multi-band chipset for China's PD SCDMA wireless standard, which is China's homegrown 3-D standard. It's the first full complete wireless chipset developed by a Chinese company and to be manufactured in China. Our licensee has already signed agreements with several Chinese handset makers such as Pamoi, (ph) Nimbo, (ph) and Heemset (ph) Electric. China's 3-G standard is due to go live in June 2005. We believe we are very well positioned to strongly benefit from what is expected to be explosive growth in this market. Finally, earlier this morning we announced that Zoran, the leading supplier of DVD chipsets has licensed and deployed our TeakLite DSP to power a broad range of its DVD chipset solutions. TeakLite's code compactness and small die size makes the core a very cost competitive solution for Zoran. So Zoran is an example of a semiconductor company that has a large market share in a high-volume market like DVD chipsets. This type of customer helps us achieve high unit volume shipments, which ultimately drive our world's performance. We are seeing continued growth in unit shipments from these kinds of companies in coming quarters.

Our excellent growth in unit shipments in the quarter highlights the fact that our customers do continue to gain market share using our DSP cores. As I previously mentioned, the shipped units by CEVA licensees increased 30 percent sequentially to over 30 million units in the third quarter compared to 23 million shipped in the second quarter. Year-on-year growth is an equally impressive 110 percent. Year-to-date our licensees have shipped in excess of 70 million units powered by CEVA technology. We expect our 2004 unit volume to exceed 100 million units, which is far in excess of our original forecast of 80 million units for the year. As Christine will later describe, some of these shipments will move from prepaid royalty mode today to royalty paying during 2005, meaning a strong driver for CEVA revenue growth and profitability next year.

Now more about our new products. Q3 was characterized by some very important product releases from CEVA. We expect more announcements in the coming quarter. In Q3, we launched our CEVA-X system platform, which incorporates the essential system-on-chip ecosystem around the DSP core. We released two versions of the CEVA-X system platform, one optimized for wireless handsets and the other optimized for multi-media products. This is valuable incremental IP for our customers as it saves them approximately a year in development time and millions of dollars in R&D expense in order to deploy CEVA-X solution. Of the five licensees of CEVA-X to date, four have now also adopted the system platform.

In the quarter we also made available the first CEVA-X silicon-based development chip. The CEVA-X silicon, which we procure from TSMZ (ph) can operate out to 550 (ph?) MHz, which is a major breakthrough in performance and all of this coming from our fully synthesizable soft core. This STK is already in use by our licensees and third parties for development of a broad portfolio of software and hardware IPs centered around the CEVA-X. The availability now of CEVA-X silicon will further encourage adoption of a CEVA-X core as it is now fully silicon proven. We're also currently working on innovative and aggressive roadmap extensions for future versions of our CEVA-X product. These versions includes one that combines a CPU and ESP in a single product (inaudible).

As I mentioned previously, in the quarter we also launched a CEVA mobile multi-media solution, a complete audio and video multi-media processing solution powered by our CEVA DSP cores. This solution exploits our unique and patented media magic acceleration algorithms to deliver performance and capability that is only today achieved by others by using expensive add-on hardware. So CEVA Mobile Media is the first and only truly software-only audio/video image platform that supports all key standards for mobile multi-media, including the new H.264 encoding-decoding and at CG (indiscernible) resolutions. It makes our cores programmable for a wide range of multi-media standards, resolutions, and frame-rates. So CEVA Mobile Media allows our licensees to retarget a single silicon platform for any multi-media processing scenario, eliminating the need for costly, time-consuming silicon and software re-spins.

As I also mentioned, we have licensed CEVA multi-media to a leading Japanese OEM who is targeting the H.264 mobile TV standard on cellular handsets. This is a very strong start for our newly introduced software products. We expect going forward to see software as an important part of our incremental sales - software on our DSP cores.

Turning to wire-line communications, we began shipment of our Serial-APA technology in the quarter. We had a strong quarter signing two licensing agreements. We expect to close further deals in Q4. We're also continuing to invest in our communications roadmap and will launch a three gigabit Serial-APA II product during 2005. The coming quarter will also see the launch of marketing initiatives and product solutions targeted at specific vertical markets. The initial product solutions will cover the wireless handset, consumer multi-media, and home entertainment markets, the strongest volume drivers for us today.

In terms of outlook, we believe the outlook and opportunity for CEVA remains bright. We have a strong product portfolio and a future roadmap. We have leadership in licensable DSP and an excellent customer base who are achieving very high unit volume shipments. Consequently, we anticipate that revenue growth and profitability will continue. We are, like most, cautious however that market conditions in the semiconductor industry have deteriorated over the past quarter and may continue the weakness in the near term. This will put pressure on R&D budgets at semiconductor companies, which may affect our licensing business in the coming quarters. For example, we are seeing the trend to more single-use licenses as opposed to multi-use. We'll still ultimately achieve the same result, but the license payments will be spread over multiple quarters as our customers start each new design and pay for each new use, the pay-as-you-go approach. In summary we may well remain very optimistic for CEVA's continued growth. We are cautious in the near term because of the current softness in the semiconductor industry.

With that I'll hand it over to Christine Russell who will elaborate more on our Q3 financials and the outlook for Q4. Christine.

Thank you Chet. For the third quarter, the reported revenues of $9.7 million and a profit of (inaudible) or 0.03 cents per share, both figures in line with our previous guidance. Revenues for the prior quarter were $9.6 million with a profit of 494,000 or 2.7 cents per share. Gross margins were 88 percent, up three points compared to gross margins in the prior quarter primarily due to increased royalty revenues, which are 100 percent gross margin. Of the 9.7 million total revenue, 6. 0 million was licenses, 1.6 was royalties. We posted 1.2 million from services. Licensing revenue was at the same level as the prior quarter and comprised 71 percent of total revenues. Royalty revenues increased by 24 percent over the prior quarter. The units shipped by our customers under royalty agreements increased by 30 percent to 30.5 million units. This sequential growth is on top of the second quarter's sequential growth of 25 percent and is the highest-ever royalty revenue posted by CEVA and highest units shipped in any one quarter. These revenues and unit shipments point to the success of our customers using the CEVA technology.

Of the total 30.5 million units shipped, 8.8 million units were attributable to licensees currently paying per-unit royalties and 21.7 million units were shipped by licensees who are burning through their prepay license volumes. This compares to a total 23 million units shipped in quarter two, of which five million were paid and 18 million were prepay translating to 76 percent sequential growth in paid royalties. Once these customers have shipped all their units, for which they prepaid in advance, they may choose either to extend their prepayment plan or move into a standard quarterly per-unit royalty payment. Either way CEVA will continue to benefit from the commercial success of our customers.

In the third quarter, our average paid royalty unit rate was 18 cents for the 8.8 million units shipped in the quarter. For our customers shipping in prepaid mode, we estimate the average royalty rates when they commence normal royalty payment modes for CEVA will be between 5 to 10 cents per unit as these customers have scaled through their price volume thresholds. What I mean by price volume thresholds is that our customers typically pay a higher per-unit royalty in the early volume stages of their production and receive a per-unit discount as their volumes ramp up.

For the second quarter we had a total of 26 shipping customers, 17 paying per-unit, and nine in prepay. In the third quarter, the quarter we just completed, one of our prepaid customers moved into paying per-unit and one of our prepaid customers extended their volume threshold. So for Q3 again, we had 26 shipping customers, 18 paying per-unit, and eight in prepay.

Looking forward, our latest survey of our customers indicates that we estimate that between three to five customers are expected to enter the royalty-paying phase over the next four quarters either by using up their prepays or to customers starting to ship their new products in volume.

Services are 13 percent of our revenues and are comprised of support and maintenance, and design services consulting.

Operating expenses for the second quarter were 7.9 million, which is a 4 percent increase compared to prior quarters primarily reflecting increased R&D and multi-media software. Third quarter net income increased 13 percent to 560,000 or 3 cents per share compared with the second quarter 2004 net income of 494,000 or 2.7 cents per share. Net income in the quarter was 6 percent, an increase from 5 percent in the second quarter and 4 percent in the first quarter, our third successive quarter of profit growth.

As of September 30, 2004 cash and marketable securities were 57.8 million, up 900,000 from the prior quarter, 500,000 of which were generated from operations. The balance was generated from the sale of stock to our employee stock purchase plan. DSOs increased by seven days from the prior quarter to 108 reflecting both continued non-linearity of sales in the quarter and semiconductor industry softness, which resulted in granting extended payment terms. We are putting in place a program to reduce these extended terms including changing the sales commission terms. We expect to see positive results over the next two quarters. We are targeting over the next two quarters to drop below 100 DSO. However, that being said, we were pleased to generate operating cash in the quarter in spite of the 7 percent increase in DSOs.

Looking ahead we expect total revenue for the fourth quarter to be between 9.7 and 10.2 million. Gross margins are expected to stay in the 85 percent to 88 percent range with operating expenses expected to be in the range of 8 to 8.2 million. We continue to target profitability for the fourth quarter. For the full year 2004, we're targeting revenues in the range of 38 to 39 million and profitability. Ending share count for 2004 is expected to be approximately 19 million shares.

This concludes our remarks. We will now be happy to take any questions.

Operator, we're ready to take some questions.

Thank you. Matt Robison.

How much revenue did you recognize from the customer whose royalty threshold you let slip?

The customer who extended?

Yes.

We don't disclose individual deals - the amount of individual deals. That is something we wouldn't talk about that.

(indiscernible) my question.

Okay, Thank you.

(OPERATOR INSTRUCTIONS). Gary Mobley.

Morning everyone. Chet, could you talk about the deal size of the Mobile Media solution and how that ranks relative to some of the other products.

Sure. We're just introducing and beginning to ship our audio and video software. The average deal size - it's licensed like software. There is no particular royalty associated with it. It's a license fee and maintenance as you would sell a software product. The general range for the video elements of the product line are around $0.5 million license fee. The audio products are the 100,000 to 200,000 per-product-license fee range.

Okay. Could you provide a little more color on some of your cautious comments with respect to the industry. I would assume that you are more cautious on the licensing front than the royalty front. Is it a function of the pipeline decreasing? Is it a function of your cautiousness in hoping to close some of the potential deals? Is it the high ticket price of the CEVA-X that is scaring most folks off?

Sure, I'd be glad to say a few more words. As you point out, we're not seeing any slowdown in the unit volume shipments obviously. We see increase in that. That has something to do with increased market share as opposed to the overall growth in the market as well. We continue to see the unit volume and royalty growth regardless of the current economic conditions. The only thing specifically that we're seeing - we're not seeing any slowdown in design starts. In other words, the number of R&D projects that companies are starting, which speaks to the need to license IP to do the design - we don't see a slowdown there. The only slowdown we're really seeing or change that we're seeing is that there seems to be percentage-wise more companies opting for the single-use license as opposed to the multi-use license. Historically the majority of companies took a multi-use license so they didn't have to pay higher per-unit use prices and worry about paying each time they had to use it. It was a better deal to take the multi-use license. Now they are going for single-use license, which means that R&D budgets to me are a little bit constrained. They don't want to - that each individual design project doesn't have as rich a budget as it used to have. They have to pay as they go with each use. In the long term this may be better for us because they are going to pay proportionally higher overall for the number of uses because they are paying as they go. In the short term it means you've got to close more deals every quarter because they are single-use deals not multi-use deals. That is basically it. There doesn't seem to be any downturn of any other kind or change.

Thanks a lot.

Thank you. Bill Frericks (ph).

Good morning. I realize I'm not asking about direct competitors, but could you address how the pending merger of Artisan (ph) and Arm (ph) might change your view of the world, if at all.

Artisan and Arm - I don't see it having any impact. It's completely orthogonal to everything we do, I believe. In the first place, Arm alone without Artisan is way more of a partner than a competitor. Approximately 80 percent of our DSP cores are going into a system which also has an Arm core in it. We tend to be co-existing side-by-side in most of the platforms in consumer products and wireless handsets. Artisan has really nothing to do with programmable CPUs whether it's an Arm product or a DSP product. They help the design get to production with libraries and so forth. It helps create silicon. Arm just sees it, I believe, as an added value to their IP license customers in that they can - they have a better portfolio of IPDUs to create silicon. It doesn't create new competitive products per se.

Great, thanks very much.

Thank you. David Fondry.

Good morning. Congratulations, nice quarter. I was trying to - Christine, you went through some of the numbers relatively quickly, particularly on the breakdown of revenues. Of the $8.almost-5-million of license revenue, I thought you said at some point that there was $6 million of license revenue. I was somewhat confused on that. I guess - I'm sorry - license and royalty. If I take 1.6 million of the royalty revenue off that 8.5, I am at about 7. I thought you said that there was also $6 million of licensing revenue.

The way that breaks down is we have $6.9 million of licensing revenue. That is pretty flat quarter-over-quarter. We have $1.6 million of royalties. That is up by 24 percent over the prior quarter. We have 1.2 million of services for a total of 9.7 revenue, which is up from 9.6 in the prior quarter.

Okay. Then I just misunderstood. You said the number for the license revenue was 6.9.

Then, two to Matt's question, when a customer extends his prepaid, does that go into license revenue? Or would that be reflected in your royalty revenue?

That would go into license revenue.

It would go into license revenue?

Yes.

Okay. Thanks very much.

Neal Gagnon. (ph)

Good morning. My question is to ask you to give us a quantitative report on how you feel you're - in developing licenses with the industry Q3, Q4, also your outlook into next year just from a quantitative standpoint.

The first part of the question, how we're developing the (inaudible - background noise), give me a little bit more on what you're looking for.

I am looking for you to give us a report on yourself. How did you do versus your own expectations? How do you think the outlook looks to you over the next 12 to 18 months, not the next five seconds.

Okay. I think the quarter from our point of view met our expectations. It's traditionally a weak quarter. Europe is asleep for much of the quarter. We weren't expecting any dramatic change in what happened. The deals - our pipeline went ahead as normal. Deals closed. And the numbers came in. It was an as-expected, although not a huge positive upside surprise quarter. We didn't expect any of that to happen.

I think what did please us and, to some extent, surprise us a little bit was how strong the unit volume growth still is, even with the overall weakness in the industry. We don't get affected by semiconductor companies shipping inventory and all of the manufacturing side of the business. We're on the front end with design. But we also are dependent on their success in the marketplace. That seems to be really doing very well. So that bodes well for next year in the sense that we see continued strong growth in royalty payments, both unit volume shipments growing and from companies burning through prepaid so we get proportionally more of the revenue recorded on the royalty line going forward.

I think I understand that dynamic. You talked about earlier more single-pays as opposed to multi license deals. What are some of the economics of that?

For example, the way our pricing goes, the breakeven is about between three and four licenses. If a CEVA-X per-use license costs $1 million, you can get a multi-use license for $3 to $4 million -- $3.5 million. That gives you unlimited uses for that particular product. We have that multi-use license for CEVA-X. Recently the Atmel license was a single-use license, but they have to pay every time. If they use it more than two or three or four times, we actually get more money out of them. But it is spread over multiple quarters. So it's good and bad.

And you're seeing a trend towards this now?

I think it's a short-term phenomenon. I think it's more a fact of the current conservatism in semiconductor companies on expense budget. I don't expect it to be a trend to continue. I think this quarter and maybe Q4, it could continue.

One more way of trying to look at it. How about the pipeline of things that your sales people are working on? How does that look versus what you hoped it might have been?

That's a good question. The pipeline is very strong. It's growing as faster or faster than I would hope. I mentioned very briefly - probably didn't give it enough highlight. The pipeline is very strong across our entire breadth of products. It's not just CEVA-X DSP core, our newest and greatest flagship. It's the older cores as well. The DSP cores continue to license very strongly. It's our Serial communications solutions that are licensing very strongly. We see GPS continuing to be strong. We even see - we had a great Bluetooth deal signed in the quarter. Many companies think Bluetooth is dead. Ericsson shut down their Bluetooth licensing division, which will give us in the medium term, more license opportunity because we're the last man standing in Bluetooth. Many companies still need to integrate Bluetooth into system-on-chip solutions. We're virtually the only they can come to to get it.

Good. That's a good review. Thank you.

Thank you. Doug Whitman.

Thank you. I apologize for asking you to repeat. You spoke very quickly, Christine. I apologize for it. Can you repeat what you said about the revenue guidance. Did you give 2005 guidance? What was the number for December? I heard that it was cut, but I could not follow you.

We're not going to be giving 2005 guidance until our February earnings call, in which we'll be discussing our fourth quarter and the 2005 guidance and the guidance for the first quarter of 2005. What we said about guidance is we said that for the full year 2004 we're targeting revenues in the range of 38 million to 39 million and profitability. I also gave an estimated share count of----

I'm sorry. Someone picked the telephone. What did you say the revenue would be for the fourth quarter?

We just said that we would be profitable in the first quarter, that we expected the full year to be 38 million to 39 million and profitable. We said for the fourth quarter that the revenues would be between 9.7 and 10.2 million. Gross margins are expected to stay in the 85 to 88 percent range. We also gave some guidance on operating expenses. We said that they would be in the range of 8 to 8.2 million. As I said, we continue to target profitability for the fourth quarter.

Could you give a little more - you had nice shift in your revenues in the last quarter of a pickup in the licensing business. Can you talk a little bit about, of the revenues, what kind of split you would expect that to be. Then also what that would mean to potentially DSO day changes up or down in the fourth quarter.

What we said about DSOs first of all, is that we are targeting to bring those under 100 over the next couple quarters. We're continuing to see some extended payment terms with the softness in the semiconductor industry. We do expect to see royalties continue to increase. We had a very nice increase, 24 percent quarter-over-quarter Q2 to Q3. We expect to see those continue to increase. As a percent of the revenue mix, royalties should increase. Services should probably stay flat for awhile. We announced a launch of our design services consulting product. We need a few quarters for that to take traction before the services line increases.

Since the royalties are paid in arrears does that make it tougher for you to collect on a shorter time basis for DSOs?

No. The royalties turn over pretty quickly. Those are not an issue. The large license deals are the deals that we are being pressed to grant extended payment terms on.

There has been some industry comments about one of your major customers, Samsung, loosing share last quarter and this quarter to Nokia. Can you talk a little bit about whether you are seeing that in the cell phone market. Is that having an affect on the quarterly guidance? It may just be industry pundits are all wrong as well.

We're not seeing - first of all, Samsung is at the very early stage of our royalty ramp in terms of CEVA-X has not shipped yet. That is where the substantial royalties would come - per-unit royalties as opposed to the older Teak-based that they are shipping now. They are not a big factor yet. Up or down it really isn't going to affect us until next year, I don't believe.

Okay. Could you give a little more color on the Zoran deal you announced this morning?

Color. Zoran is a high-volume customer of ours. They are very successful in their market spaces and in DVD chipsets where they are the leader. Zoran, as a semiconductor company, has their own P&L and issues like all semiconductor companies. We don't see that. It doesn't really affect us much.

Alright. So I'll try to understand more about the deal and what kind of revenue change this might be for you.

We expect Zoran to be a continued and large royalty payer in the future.

Just to clarify, Doug the announcement was that it is deployed. That means the license revenue is some time ago. They are coming into the royalty line in significant numbers. That is probably important.

Okay, thank you.

Thank you. (OPERATOR INSTRUCTIONS). Sean Murphy.

Hello from London. I missed the first few minutes of the call, so apologies if you've given the information. It's been a quiet quarter. You haven't really given color on where demand picture has changed either in current sales or in the pipeline. What are the target markets or geographies that look a bit better or worse than the others?

I think it's been what I'll call - and not negatively - it's been a usual quarter, a business-as-usual quarter for us in the sense that our primary thrust, the markets where we focus our efforts are cellular handsets, consumer multi-media, and home entertainment. We saw strong adoption and growth in our pipeline in those markets. We also see a continued balance in our geographic dispersion. On a yearly rolling average, we're about one-third, one-third, one-third distributed in our revenue between North America, Europe, and Asia. One quarter over the next we can see differences. Q2 was strong in Europe. Q3 was stronger in Asia. Q4 will probably stronger than US. It averages about equal. We don't see any change in that. I think we have a solid business foundation. We see pretty good growth prospects.

Just as a more general question, if you stood back you'd say you have a nice high operating leverage business. Your awaiting either dropping OpEx, which you probably would find hard to do, or growing revenues. This incidental growth - you've talked about in customers trading up the royalty model and generating more royalties or via unit shipments. In terms of growing license shipments, is the picture primarily getting customers to trade up to CEVA-X? Or would you have hopes of signing up new customers on top of existing customers?

Yes. For next year we see strong interest from many new customers, not only for our CEVA-X, but even for Teak and TeakLite as they use programmable DSPs in places where they used to use hard-wired logic. We see a strong growth in the number of licensees for our DSP cores. We also see growth in the average selling price of our cores because there will be a proportionately larger number using CEVA-X than our historical product. That is at much higher prices. And what I only briefly mentioned, but will play a big factor I believe, in our 2005 revenue is multi-media software. We see huge interest from customers to buy from us the software that will run the application software that runs on our DSPs for multi-media. This could add - the could equal the licensing software from cores.

Okay. Just one other question. Where a customer purchases CEVA-X, do they have a DSP software code portability issue where you need to sell them some services to port existing code? Or do your tools allow that to happen without generating service revenues as well?

We do have porting tools available. More and more customers want to program in C. They are going to port from C to C. Our C compiler is very good. They are happy with that. There is always some tweaking that goes on. Sometimes they want us to help with it. Most of the time they do it themselves. More of our customers want us to help with hardware porting. In other words, they want us to help them take our DSP core and put it into a foundries process, port if from one to the next, or help them add on the system framework SoC elements to the chip. It tends to be more chip design than customized software that they are asking us to do for them.

Okay, thank you.

Thank you. Robert Katz. (ph)

Nice quarter. I have two questions. One, how many 10 percent customers did you have? Who are they?

We don't disclose the names of our 10 percent customers.

(ph) We would have had one customer in the quarter above 10 percent.

One customer, okay. And then in terms of Zoran who is a high-volume customer, when they have an inventory issue, how does that impact you? When do they recognize revenue on or actual use of your product - if they had to write inventory down in the channel?

Is your question how we recognize the----?

How you recognize it. Is there a dispute over it? Are those guidelines set out already? How does that happen?

Zoran makes payments to us in royalties. We recognize the revenue. Let me explain royalties a little bit. First of all, if they are in a prepay mode, the revenue has been recognized in licenses. If they are in a paid mode, it is recognized in the royalty line.

I think the question is, if they are holding inventory, do they pay us a royalty on that unit that they've manufactured when they sell it through to the end customer or when they have it manufactured?

It's when it's manufactured.

If it is manufactured and then written down, it never gets used----?

That doesn't affect us.

That doesn't affect you?

No.

Great. Thanks a lot.

(OPERATOR INSTRUCTIONS). Michael McCormick. (ph)

Good morning. Could you break out the units by type, handsets and so forth. You've done that in the past.

I think that's a good question. I am not sure if we have the data right in front of us to do that.

I can tell you that the big growth this quarter is multi-media systems.

The big growth is multi-media systems. It has traditionally been about 50 percent handsets.

Yes, it was 47 percent, I think we recorded last quarter. Actually, (indiscernible). It takes us some time to do. The strong growth this quarter was primarily in multi-media.

If I remember correctly last quarter you had one customer, which represented 30 percent of sales, or even higher than that. So when you talk about this one customer that was over 10 percent of sales, is this customer over 20 percent?

I think it's in the 10 to 20 percent range.

Okay. But it's a little more evenly dispersed than the prior quarter?

Absolutely. The point, as you know, the licensing business is a lumpy business. With all of the products in our portfolio it tends to smooth things out a little bit.

Okay. Could you talk about, if you are a little nervous about the selling cycle, the development of the sales force. They are basically on board about nine months now. That is about when they should be hitting their stride from a productivity standpoint. They don't appear to be hitting that stride from a productivity standpoint. Can we talk strategically about what your thoughts are with the sales force and their productivity issues. What is constraining this right now?

Sure. As you point out, we have added to our sales force over the past year, particularly proportionately larger in Asia. It's hard to see the productivity because the productivity first of all shows up in the pipeline. We've seen very good growth in our pipeline. I think we're very pleased with what's going on there in terms of the number of prospects, the number of deals, the total dollars in our pipeline at the various stages in the funnel. That's all going very well. To get through the funnel and down into revenue, for an IP company is a much slower process. We don't have the huge swings like a chip company would have in our revenue. It just grows more slowly. I think we're going to see that play out over the coming quarters. The productivity and the pipeline increase is absolutely there.

So if the pipeline is there, it is somewhat puzzling about the guidance on licenses. On one hand you're saying the pipeline is fabulous. On the other side you're saying, but we don't expect to close any of that pipeline.

No, no. The only thing that I've said that we've seen for sure is that if you have 10 CEVA-X prospects in the pipe and more of them now are single-use - opting for a single-use license up front than a multi-use, that cuts your revenue down by a half to two-thirds in the short term.

So the number of deals are up significantly, but the dollar value is down in the pipeline?

Correct.

Okay from that standpoint. Could you speak a little bit - you talked about the multi-media software could equal core's in license value. You made some comment about that. I assume that's '05?

Yes.

Could you give us a little handle on what that would mean, how that might come to be?

Let's take a hypothetical example of CEVA-X DSP core. Whereas earlier this year we licensed the cores alone. The customer put their own software and put the rest of the system around it themselves. They built the SoC, whatever other elements they needed - memory, interfaces, caches, and so forth. We now are able to sell them both a system platform on top of the core and specific multi-media software. If the core of the single-use CEVA-X core is $1 million, the price that you want the SoC platform framework around it is $0.5 million. It is sold more like software. There is not incremental royalty. The royalty is attached to the core. But you pay for the use of this platform - $0.5 million. And if you want H.264 or video and imaging software, you would pay another $0.5 million license for that software on the core. It easily doubles the revenue from a single-use core license. That is about what is going on.

Right, okay from that standpoint. A couple other questions. How many first-time licensees did you have in the quarter? You gave that last quarter as well.

One new licensee.

One new customer name.

Maybe strategically you could talk about this idea - we've frequently talked about the idea that you didn't want to do extended terms or prepayments. We find this quarter you did one. Other than the short-term impact of taking revenue quicker, can you disclose why you would want to do that transaction.

Yes. I think - I'll make a comment. Then Christine can follow as well. We have a legacy to our customers that have prepaid agreements that were signed in the past, which entitles them to a certain per-unit royalty price, which albeit when they did the original prepayment deal was something of a "discount" from our standard price schedule. Otherwise - that's why they did it. Now they have burned through them. They come back and say, we want that same price going forward. We're prepared to extend our prepayment agreement. We don't want to ratchet up to a per-use royalty. First of all, we've got to be responsive to what our customers want. We're not going to be able to just raise the price on them. The next thing you can do is say, fine. Then make another big lump sum payment and you take the risk that you're going to make the shipment and not us.

That's the remark I was going to make. These prepayments are an insurance policy. We do have customers who have made prepayments on royalties and who never, never use them up or never came to commercial volume production. In a way, as Chet said, we're shifting the risk from CEVA to the customer (multiple speakers).

In this particular customer, though, it sounds to me it's a high-volume producer who sees that his rate is going to go higher and doesn't want to pay it. That is a different situation. They are shifting the risk to you in that situation.

You're right. It is a different situation. But it's a situation where you can't just erase the pact. The customer has had a certain deal. They want it continued. We just can't ignore that and make our customers mad. We're not going to operate that way. I think what we can say - what we have said is we are not signing new deals with these prepayments in them. We just aren't doing that anymore. But if existing guys come back to us and make it financially attractive, we'll take the money.

Okay, so then finally what gives you any kind of comfort level? The majority of these units being produced I imagine are from customers, let's say pre your time Chet, that they are going to convert to a royalty model and not pay one-time license fees to extend. The second on that question is, you did 30 million units, 8.8. Let's say a little less than a third of the revenue was in paying royalty mode. What would you anticipate that would be as a percentage of your fourth quarter next year royalties?

As we said, we expect to see probably three to five new customers entering the royalty payment stream. I think what you are gradually going to see is the number of (inaudible - background noise) going up in a steady-state and the number of prepaid as a percentage of total royalties going down. You are already seeing that in the second quarter to the third quarter.

Can you give me an approximate range on percentage.

By the fourth quarter of next year, I think what we said last quarter on the call and what we're saying this quarter, is we expect very little, if any, prepaids to remain. The other thing I'll add to that is that you asked the question earlier, how many new - we had one customer extend their prepaid and one customer go from prepaid to paying in the quarter. So we are starting that process. Some come back and say, I am willing to give you another big check if you extend me. One said, I've got to start paying as I go.

How many clients have the ability to do that extension of the producing customers? If I recall, you've got how many in prepaid mode right now?

We have eight in the prepaid mode.

How many have the ability to make an extension? How many of them are in a volume situation where it would benefit them to do an extension license?

I would say there are very few. There are probably only two or three who are high-volume shippers. We have a pretty high customer concentration in royalties. Probably five customers make up 70 percent of the royalty payments. I don't think you are going to see too many of these extensions. It's just not economical for the customer or for us.

It's time-value-money for them. They can decide whether they want to make a payment or pay quarterly.

One other question is, the incremental increased in operating costs when you believe the revenues are going to be flattish. Where is the incremental operating cost going to be deployed in the fourth quarter?

We are putting our emphasis on R&D, particularly in the multi-media area. These are engineers that are in high demand. You specifically have to go out and hire them for these programs. That is the focus. We have done some additional hiring in sales. Those are the two areas where we have increases.

We're not giving '05 guidance, although we'll talk----

This is Q4 '04?

Yes. Where we put our R&D investment in '04 is going to generate our revenue in '05. Multi-media software is a place we're increasing our investment. We see substantially incremental revenue in '05. I gave the example of a CEVA-X core and us being able to double our revenue per core by selling add-on software on platform.

Have you constructed any subscription agreements?

No, we haven't.

Okay. Thank you.

Thank you. (OPERATOR INSTRUCTIONS). David Fondry.

Thank you. I want to follow-up your comment on the CEVA-X. I think you said that if you just wanted the - CEVA-X was $1 million. Then if you wanted to build the system-on-a-chip platform over and above that, that might be another 500,000. If you wanted the multi-media software over and above that, that is another 500,000.

Yes.

There is no additional royalty stream as it relates to multi-media or the system-on-a-chip - just the basic royalty stream that you are going to get from the CEVA-X. Do I understand that correctly?

That's correct.

Why wouldn't you build in a royalty stream for their use of the - or increase the royalty rate for the use of the multi-media or the system-on-a-chip?

The multi-media is software rights. It's audio software, video software. It is customary for companies - and there are third-parties that companies could go do to buy some software. It's sold on an upfront-license and maintenance approach. It is not customary to do it. We'll take - the royalties for CEVA-X are already substantially higher than our earlier cores. We're happy that we drive more adoption of CEVA-X core.

And this helps drive adoption presumably of the CEVA-X core?

That's right.

On the question of prepays, when you recognize this prepaid license, do you create a deferred revenue account for that and only recognize it as they make progress towards actually going into the royalty mode? Or does all that get recognized as revenue at the outset?

All of that gets recognized as revenue at the outset. It fulfills all the requirements for recognizing revenue. Hence that is what we do.

Okay. Christina, I don't know if you did indicate. You said there was an extension in this past quarter. Did you indicate the amount of revenue that came from that extension?

No. What I said is that we don't disclose the amount of individual deals for commercial reasons.

Okay.

But you could back into that. We didn't have any customers like we described in Q2 that were a huge percentage of our business. We had one in the 10 to 20 percent range and nothing higher than that.

Very good. Thank you very much. I appreciate those clarifications.

At this time there no further questions.

Alright. Then we'll wrap it up. Thank you again for joining us today and for your continued interest in CEVA. I look forward to meeting with many of you before the end of the end. I'll remind you again that CEVA will be presenting at the annual AeA Classic financial conference in Monterey, California on November 9 and 10. We hope to see many of your there. Thank you for joining us and goodbye.

That concludes today's conference call. Thank you for participating.