CEVA Inc (CEVA) 2008 Q3 法說會逐字稿

Good morning. My name is Judith, and I will be your conference operator today. At this time, I would like to welcome everyone to the CEVA, Inc., third-quarter 2008 earnings conference call. (Operator Instructions)

Thank you. It is now my pleasure to turn the floor over to your host, Yaniv Arieli, Chief Financial Officer. Sir, you may begin.

Thank you. Good morning, everyone, and welcome to CEVA's third-quarter 2008 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 2008, our optimism about our licensing pipeline, continued progress in the market share expansion in the handset and consumer markets, our prospects within the femtocell market, and growth and market expansion of our customers, the competitive advantage presented by the trend towards the merchant solutions, consolidations of the semiconductor industry, and our expectations that royalties from the applications of our technology embedded in these new markets to impact our results in the near future, which is also in line with our handset penetration ramp up.

The risks and uncertainties and assumptions, including the ability of CEVA's DSP cores and other technologies to continue to be a growth driver for the Company, the effect of the intense competition within our industry, the possibility that the market for our technologies may not develop as expected, the possibility that our customers' products incorporating our technology do not succeed as expected, our ability on timely and successfully to develop and introduce new technologies, and our reliance on revenue derived from the limited number of licensees, including our ability to improve our licensing and royalty revenues in future periods, and general market conditions.

For more information, please refer to the risk factors discussed in our 2007 Form 10-K and prior SEC filings. CEVA assumes no obligation to update any forward-looking statements or information, which speak of their representative dates.

This conference call will be conducted by Gideon Wertheizer, Chief Executive Officer of CEVA, and myself, Yaniv Arieli, Chief Financial Officer of the Company. Gideon will cover the business aspects and the highlights from the quarter, while I will cover the financial results for the third quarter of 2008, and provide financial guidance for the fourth quarter and fiscal 2008.

With that said, I would now like to turn the call over to Gideon.

Good morning to everyone, and thank you for joining us today. I hope you had the opportunity to review our press release with the results of the third quarter of 2008.

During the quarter, we reported total revenue of $10.2 million, which represents an all-time record high for the third consecutive quarter, and the highest in CEVA's almost six years' history. This was 17% higher than the revenue for the third quarter of 2007, and slightly higher than the second quarter of 2008.

Royalty revenues for the third quarter of 2008 were $3.3 million, an 8% sequential increase as compared to the second quarter of 2008, and 51% higher than the royalty revenue for the third quarter of 2007.

During the third quarter, we signed six new license agreements, five of which were for our CEVA DSP cores, platforms, and software. Geographically, three of the license agreements were in Europe, one in Asia, and two in the United States. Target applications of the licenses concluded during the quarter are 3.5G, LTE modems, femtocells, and consumer electronics.

The third quarter of 2008 was another solid quarter, with record high achievements in revenues, operating margins, and operating income. Our royalty revenue grew 8% sequentially, mainly as a result of continued market share expansions from Texas Instruments and Qualcomm in 3.5G handsets, and higher shipments in consumer products.

Entering the fourth quarter, despite the recent market turmoil, we are comfortable with our licensing pipeline, which includes both strategic and new opportunities. Additionally, we also anticipate continued progress in our market share expansion in the handset and consumer markets. As a result, we are maintaining our positive view with regard to the fourth quarter, and increasing slightly our full-year guidance.

Next, I would like to provide business highlights and make a few observations regarding our key markets.

During the third quarter, we successfully concluded two strategic agreements for our advanced DSPs -- the TeakLite-III and the CEVA-X1641, to be used in conjunction in the serial market. The first agreement is with a major Asian OEM manufacturer that plans to develop a chip for next-generation wireless technology, the LTE. The chip will enable up to 100 megabits per second transfer rate.

The second agreement is with a major US-based semiconductor company that plans to develop an ASIC chip for a large customer in the femtocell application market. This agreement represents our fourth design win in the promising femtocell market.

We are also seeing a trend whereby the wireless user model is expanding beyond handsets to new applications. In this context, the GSM Association recently came out with an initiative to create a category of always-connected mobile broadband devices, which will be a technical alternative to WiFi services.

In the first phase of this initiative, model operator, PC manufacturer and chipset provider are united to preinstall mobile broadband into a range of notebook PC and mobile computing devices that will be ready to switch on and surf the Web straight out of the box in 91 countries.

This initiative is part of a more diversified strategy to deliver wireless Internet access to a wide range of previously unconnected devices, from cameras and MP3 players, to refrigerator, cars, and set-top boxes.

In August, ST-NXP Wireless, the new joint venture formed by ST and the wireless division of NXP, announced a joint venture with Ericsson Mobile Platform, EMP. According to a market research performed by Strategy Analytics, the ST-EMP-NXP joint venture creates a clear number three player in the cellular semiconductor industry, with combined revenue of $3.6 billion, and 19% market share.

This merger reflects a trend of moving to our merchant solution, as opposed to custom solutions developed by handset makers such as Nokia, Sony Ericsson and Motorola, using TI's or Freescale's DSPs. This trend favors CEVA, as our technologies are already widely used by the largest merchant market players.

In this respect, the latest announcement by TI, which does not (inaudible) DSP, that it plans to sell or exit the merchant market chip for baseband, will significantly strengthen the market position of CEVA's customers. In general, the recent consolidation in the semiconductor handset space also plays to our strengths, as the consolidated companies are looking for new ways to differentiate their product offering, rather than developing DSP technologies in-house.

This transition provides CEVA with a competitive advantage, as our DSP technology is essentially becoming a de facto standard in the wireless handset application.

Next, Samsung commenced shipments of their ultra-low-cost phone, using ST-NXP RF on single-chip baseband platform, powered by CEVA DSP. This is the first time that Samsung is using CEVA DSP for ultra-low-cost phones. Operating, including TMobile and AT&T, are carrying these handsets in their stores today.

Samsung, who was going to introduce a number of new 3G models using Infineon baseband chips, is continuing their plan to offer more 3G phones with baseband alternative to Qualcomm.

Sony Ericsson introduced a number of new phones deploying our DSP cores for 3G baseband and audio Walkman application. The T700, TM506, G705 and W902 are all expected to debut in time for the holiday season. Ericsson announced that they began shipping 3.5G broadband modules utilizing CEVA DSP in LG Electronics notebooks.

Intel announced last week that it will partner with Ericsson for its upcoming Moorestown platform for the MID market, which will also include 3.5G connectivity.

The LG and Intel announcement follows earlier announcement from Dell, Acer, Lenovo that they are also deploying Ericsson broadband module in their laptops and ultra-mobile PCs.

New product announcements from our customers during the quarter included two notable Asian customers targeting the growing Chinese telephone and multimedia players markets, that include our multimedia solutions.

Our customers Solomon Systech and [SoundPlus] recently announced availability of multimedia chips and [secure] customer wins. Both customers are expected to commence volume shipments in time for the upcoming holiday season.

Looking to 2009, our customers are consistently growing and winning designs at Nokia, Samsung, LG, Panasonic, ZTE, Acer, Dell, as well as with a well-known US-based company in the smartphone product category.

Two out of every three available merchant market 3G solutions are based on our technology, and are already in production. Additionally, three of the four largest merchant market chip suppliers in the [cellular] segment use our technology. As I explained about, there is a clear movement to our merchant solution to replace in-house or ASIC solutions such as the TI-based chips. And CEVA is positioned to exploit this trend.

We are also expanding into new segments of the wireless market, such as femtocells and mobile Internet device, which are all expected to bring full mobility to devices that currently are attached to hub-based WiFi or local area networks.

As we move toward 2009, we are expecting the momentum within the handset market to pay dividends for CEVA. Moreover, given our past efforts to diversify our customer base, we are also seeing opportunities in other business areas. For example, over the last three years, we have leveraged on our core technologies in DSP and multimedia technology, in order to expand into other applications such as PlayStation 3, BluRay DVD, portable games consoles, personal multimedia players, surveillance, and Voice-over-IP over optical network.

We expect royalties for these new markets to impact our results in the near term, which also coincides with our handset penetration ramp up.

With that said, I will now turn to Yaniv Arieli to review the third-quarter financials, and provide future guidance.

Thank you, Gideon. I'll now review the results of operations for the third quarter of 2008.

Revenue for the third quarter was $10.2 million, which is slightly higher than the second-quarter revenue of 2008, and 17% higher than the $8.7 million revenue for the third quarter of 2007.

Revenue breakdown was as follows. Licensing revenue was $6 million, reflecting 59% of total revenues, and 12% higher than the third quarter of 2007. Royalty revenue was $3.3 million, reflecting 32% of total revenues, and 51% higher than the third quarter of last year. Service revenue was $0.9 million, reflecting 9% of total revenue, and 24% lower than the third quarter of last year of $1.2 million.

Quarterly gross margins for the quarter were 89%, on US GAAP basis, for both 2007 and 2008.

For the operating expenses, R&D costs were $4.8 million for the quarter, including $0.3 million of equity-based compensation expenses. Sales and marketing costs were $1.8 million, including $0.1 million of equity-based compensation. G&A costs were $1.7 million, including $0.3 million of equity-based compensation expenses.

Total operating expenses for the quarter were $8.3 million, which included an aggregated equity-based compensation expense of approximately $700,000. Total operating expenses for this quarter were 5% lower than total operating expenses of $8.8 million for the prior quarter, mainly due to successful cost control measures, including higher R&D grants received, better vacation accrual utilization, and an overall improved FX environment associated with our foreign-based expenses.

US GAAP operating margins for the third quarter of 2008 was 8%, an all-time record high for CEVA. This compares to only 1% in the prior quarter, or operating losses for the third quarter of 2007.

Interest and other income for the third quarter of '08 accounted for $1 million, and that included $0.4 million of pre-tax capital gain for our equity investment in GloNav to NXP Semiconductors.

Due to the overall market volatility, we counted in our balance sheet unrealized losses on our bond investment portfolio of approximately $700,000. Based on discussions with financial advisors, in accordance with the accounting rules, we do not believe -- we do not have a need to currently write off any of these potential losses, as we will be holding these bonds to maturity.

On the tax front, we recorded a quarterly tax expense of $0.4 million. Our quarterly tax calculation includes, among other things, the consolidation of our geographical location on our executed licensing deals, and overall revenue per tax jurisdiction.

US GAAP net income for the quarter was $1.4 million, or fully diluted net income of $0.07 per share. Non-GAAP net income, excluding approximately $700,000 of equity-based compensation expenses and $400,000 of capital gain related to NXP net of tax effect for the quarter was $1.8 million, or a fully diluted net income per share of $0.09, 51% higher than the prior year.

Now I will talk about other related data. Shipped units by CEVA's licensees during the third quarter of '08 was 72 million, up 3%, and 32% higher than the second quarter of 2008 and the third quarter of last year. The continued growth from the prior quarters reflects typical seasonality and market share expansion.

Of the 72 million units shipped, 54 million units were attributed to licensees currently paying per-unit royalties, and 18 million units were shipped by licensees who were under a prepaid arrangement. This compares to 70 million units shipped during the second quarter of 2008, of which 48 million units were attributed to per-unit royalty payers, and 22 million were attributed to prepaid prior arrangements.

This represents a sequential increase of 13% in customers paying per-unit royalties, and a 67% increase on a year-over-year analysis.

As of September 30 of this year, our total number of shipping licensees were 27. Of them, 21 customers are paying per-unit royalties, and only six under prepaid arrangements. During this quarter, one customer exhausted its prepayment quota, and started to actually pay its per-unit royalty.

And now for some balance sheet items. During the quarter, we generated positive cash flow of $1.4 million. As of the end -- sorry, at quarter end, CEVA's cash and cash equivalents balances and marketable securities were $87.9 million, compared to $86.5 million for the end of the second quarter.

Our DSOs for the third quarter were 35 days, compared to 53 days in the prior quarter, and 116 days for the third quarter of '07.

As previously discussed, our Board authorized a share purchase program of up to 1 million shares. Of this amount, we established a 10b5-1 share repurchase plan for 500,000 shares. We repurchased approximately 200,000 shares at an average price of $8.20 per share, for a total amount of $1.6 million in the third quarter of 2008.

As of today, we purchased approximately 675,000 shares, an average price of $7.87 per share, for a total amount of approximately $5.1 million. We also fully utilized the shares available for repurchase under the 10b5-1 plan.

Now I'll move to the guidance for the full year and the fourth quarter of 2008.

Gideon explained in detail, a few minutes ago, CEVA's strategy, roadmap and growth prospects, especially in regards to market share expansion and new product introduction by our customers, even in these turbulent times. Currently, our licensing pipeline includes opportunities with strategic and new customers that we believe can be translated into licensing revenue, despite the overall perception of belt-tightening in research and development budgets.

On the royalty front, our early indications present continued fourth-quarter royalty growth.

For the full-year guidance, our total 2008 annual revenue guidance remains solid. We are increasing our annual guidance slightly. Revenue is expected to be in the range of $39.8 million to $40.8 million, reflecting a respectable 20% to 22% growth, annual growth.

Annual gross margin is expected to be in the range of 88% to 90%. Operating expenses, including equity-based compensation expense, and in the first quarter reorganization expense associated with the termination of the Harcourt lease, are expected to be in the range of $37.4 million to $38 million. And interest income, net, is expected to be approximately $2.6 million.

Annual equity-based compensation expenses is forecasted to be approximately $2.8 million, and our annual expenses, excluding 123R and the Harcourt-related reorganization expenses, would be in the range of $31.1 million to $31.7 million.

Tax rate for the year is expected to be in the range of 6% to 8%, and share count for 2008 is expected to be approximately 20.8 million shares.

For the guidance -- for the fourth-quarter guidance. Revenue is anticipated to be in the range of the prior quarter, $9.5 million to $10.5 million. Gross margin is expected to be approximately 90% -- 9-0. Operating expenses, including equity-based compensation, is expected to be in the range of $8.3 million to $8.9 million. Of our anticipated total operating expenses for the fourth quarter, $0.8 million is expected to be attributed to equity-based compensation. So non-GAAP operating expenses will be in the range of $7.5 million to $8.1 million.

Interest income, net, is expected to be about $600,000. Tax rate for the fourth quarter, approximately 15%. Share count for the fourth quarter is expected to be approximately 20.5 million shares, after taking into account the buyback program.

That concludes the guidance and the financial remarks, and I will be happy to open the floor for questions. Operator? Judith?

Thank you. (Operator Instructions) Your first question is coming from Daniel Meron, of RBC Capital Markets. Please go ahead.

Thank you. I congratulate a continued execution, Gideon and Yaniv. Can you provide us with a little bit more color as to what are the guidelines as we look into 2009? Thank you.

Yes. Let me try mainly first on the royalty front, and Gideon will add a little bit more flavor on the licensing side and some of the new markets that we talked about earlier.

On the royalty side, as we have talked about in the last couple of conference calls, nothing has changed on the negative side; but the contrary. What we have seen is a very big player in this market, like TI, announced a week ago their change in plans in the merchant market for wireless baseband applications, and this is exactly where CEVA's customers have started to win significant design wins and business in the last 18 months.

It's not new that we are forecasting our royalty revenue in 2009 to increase close to 50% over last year, which was also an increase of about 45% from 2006.

This trend, maybe not at these rates, should continue, even in these difficult market conditions, for a simple reason. Even if the whole wireless market does not grow as fast or it will be stable, or even lower expectations for next year of volume, we're still looking at a huge market opportunity of 1.2 billion phones sold each year.

CEVA is just started, a year ago, to gain market share from 3% or 4% a year [to us ago], to about 13% to 14% currently. And we anticipate this trend to continue, both into 2004 (sic), and especially in 2009. This is both from the wireless baseband market, tier 1 customers that I think you all are aware of -- Sony Ericsson, Samsung, LG, Acer, some American well-known brands -- are all using our customers or CEVA-based solutions, over the last 18 months.

That trend will continue, and other market segments -- for example, in the consumer. Now, of course, we hear and see and are well aware of the overall risks and worries about the holiday season and the consumer market as a whole.

But you need to understand that these customers, in our market share, multimedia are brand new opportunities. We're not active in these markets as of today. And these are add-ons to our overall royalty growth for the next couple of years, starting as we speak. They're already -- products are being talked about with our multimedia sold in China, in the Far East, for $60 or $50 a PMP device; that is being sold these days.

So these are all incremental new market segments for royalty revenues for us in these difficult times.

So, can you quantify what kind of market share you expect in 2009, in broad terms?

Unfortunately, on this conference call, we are just in October, and I'm not sure how many companies are yet guiding for 2009. We are not, and in prior years, we have guided in January. So in January, we will give the full scope and picture.

I think what we said in the past, we still believe that the overall growth for us in the cellular market in the next two to three years should be very, very significant. We're talking about somewhere between one-third to maybe even 50% in market share. And these recent trends that I just mentioned, and you're all aware of, they are just improving our confidence that we are on the right track.

Okay. And then, on the buyback front, you're pretty much almost exhausted the buyback plan. You're up to 900,000 shares, or to be more specific, 875,000 shares. And I think that initially you were targeting something to the tune of 1 million.

Are you going to extend that? How should we think about the buyback plan going forward?

Let me correct the numbers. You are right, about the million shares. We executed, thus far, 675,000, so we have plenty of shares available. As you know, the Board authorized this plan, it is active, and we will continue to buy from time to time, as we have and demonstrated in the last couple of months.

Okay. I'll yield the floor and queue in. Thank you.

Thanks, Daniel.

Thank you. (Operator Instructions) Your next question is coming from Robert Sanders of DKIB. Please go ahead.

Yes, hi, guys. Maybe a question for Yaniv. If you just look at the TI announcement, and the EMP/STM announcement, would you say your confidence has gone up that the share of STM versus TI is likely to go past the 50%, and move all the way towards 100% in terms of -- was that something that you're seeing as more likely now, given the deal that has just happened?

I think this is a question for Gideon.

Yes, but, you mean STM?

Yes, the deal that EMP has with STM, which currently is -- I think, as far as I'm aware, EMP is giving 50% of the business to STMicro, and 50% to TI. I mean, I assume now that STM and EMP setting out this joint venture, are you -- has your confidence gone up that that business will move pretty much wholesale to STMicro?

When it comes to Sony Ericsson, I believe so.

Okay.

When it comes to Nokia, it's a different -- it's more complex. Let me know if here you want to discuss Nokia. But in terms of Sony Ericsson, yes.

Okay. And maybe, just help me out here, one of you guys. I look at your consensus estimates. You've got -- your consensus is currently $44 million to $45 million for next year, so an additional $4 million versus, I think, where you're guiding to next year versus this year.

As far as I can see, you should fly past that, really, given the Infineon business at Apple, Infineon business at Nokia, the Broadcom business at Nokia, a whole range of new customers.

So, is that not something -- I mean, don't you see that as very achievable? Or is it just that the licensing -- you're not so confident on that, because of the environment that you thought -- you're basically factoring in that licensing might potentially decline in 2009?

Well, I think first of all, in order to fly, you need permits, and then not Gideon and I have these right now, so we may take a course.

But you know, we need to be prudent. In these markets, the opportunity for CEVA, I agree with you that it's very positive at the moment, because of these market trends. The numbers, we want to be cautious and see how things evolve.

As you know, a design win in any OEM takes quite a lot of time. So even if the announcements of market changes are there today, until a chip with all the relevant factor is deployed in a specific model, and then gets certified by the operator and sold to the market, takes some time.

So -- and these are still some uncertainties that we have, of the time frame, and I think this is why we -- again, we haven't guided anything for 2009, but I think it's going to be a slower process than everything moving automatically from TI to CEVA-based solution.

It's going to take some more time, but if you look at the time frame, two, three years, then there is no doubt that a significant amount of business from Nokia, from Sony Ericsson, from LG, from all the Chinese type of vendors like ZTE and Spreadtrum, and others, can be powered, hopefully will be powered, by a CEVA-based solution.

And last question for me, and then I'll get out of the queue. If you just look at -- just focus in on the HSPA design win that STM has with Nokia, could you just run through the process of how you would potentially get into that design?

Would it be a combination of dealing with STM and Nokia? Or now that Nokia has gone the way it has gone will it mean just totally, exclusively dealing with STMicro? And when would you potentially find out about that deal, given that it's shipping, I think, second-half 2010?

Well, we -- it really depends how the EMP merger -- when the EMP merger will take place. That's the point that I believe we will know exactly the 3G. But keep in mind that STM is using us for their NXP activities. And also, basically for the NXP.

So the 3G for Nokia is something that we'll know early next year.

Early next year? Okay. Thanks very much, guys.

Thank you.

Thank you. Your next question is coming from Matt Robison of Pacific Growth Equities. Please go ahead.

Hi, gentlemen. A couple of housekeeping items, I guess. Yaniv, do you expect the R&D grants to continue at similar levels? It sounds like you probably do, with your OpEx guidance.

And what -- is that 15% tax what you would -- what we should expect for next year as well? It seems -- or is that more of a function of the other income you achieved this year?

And so, the overall grants, this is something that we have been more active in the last couple of quarters. And precaution to these types of market environments, do better cost control. These are -- you get the grants based on R&D achievements on a quarterly basis, so we don't have a very detailed or 100% visibility of when we get it, whether it's Q4 or Q1, the next batch.

But overall, we are -- this is part of our efforts to slightly improve our R&D costs, and this is something that will continue. Q3 was much more significant than the prior two quarters, I could say that.

Another thing that helped us, the FX environment, which in Q3 and on Q4 are slightly better than where they used to be in the first half of this year. So both of these are benefiting our R&D costs. I don't think R&D, for Q4, will be as low as Q3. But similar levels, or slightly better than the first two quarters.

On the tax rate, it's just a quarterly event of 15%, as I mentioned; on an annual basis, 2008 should be 6% to 8%. And going forward, again, we don't have the models for 2009, but I believe it should still be, for next year, somewhere around the -- about 10%, like we originally guided for this year. But don't catch me on that, we'll have a more updated number in January.

Okay. And Gideon, a couple things. One, maybe you could provide a little bit of clarity on this legacy runoff business for TI at EMP and Nokia, versus newer designs, and how you see yourself positioned with the newer designs.

Also, curious to get your thoughts on when we might see confirmation of Infineon's shipments to Nokia.

Well, let's start with the second one, the second question. This has showed, we don't have still an answer when exactly the shipping should start. It should start pretty close. Let's wait for next week. I think the Infineon contract -- I don't recall exactly when we would have it and to ship. We don't know yet, other than there was an interview with a Nokia executive, and he confirmed that this is how it is going, and that's the plan, and they are not going to change it.

Now, regarding TI, let me put some color here. Texas Instruments has had -- or, still has between 40% to 50% of the overall baseband market share. It's composed of two different, I would say, business models. One is called merchant market; this is an off-the-shelf baseband chip. They called it eCosto and LoCosto, and this is roughly a $300 million, $350 million business, where they have a customer like LG, they have a bunch of Chinese, and I think also Motorola; I'm not so sure about Motorola, but I think so.

The other business is a bit more lucrative, and this is called ASIC. This is the business that they have with Sony Ericsson, or had in the past with Sony Ericsson and Nokia, where basically the design is being done by the Nokia and Sony Ericsson internal team, and they use the DSP of Texas Instruments for this purpose. And TI is basically a supply chain. And this is a $2.4 billion business.

So the announcement that they did last week, and they're going to exit, or try to sell the merchant market business, and in this space, they are competing with Infineon, Broadcom, NXP of course, and these are all customers of ours.

When it comes to the ASIC business, they announced that they -- that EMP and Sony Ericsson Mobile will select other technologies, and this is ongoing, and they cannot avoid this, and this is all they have.

So what is left for TI now is the business, the ASIC business at Nokia. But Nokia decided, announced a year ago that they're going to go to a multi-source, and they selected Infineon, and of course Broadcom for 3GSP.

So all these guys are actively using our technology, and now the ASIC part of Nokia will become a merchant market chip, and we'll be there.

Now, right now, ST is in the game with mixed signal baseband, not so much DSP, and that's where you guys fit in going forward, correct?

Yes. That's -- well, let me -- we want to be more accurate. There is a new joint venture running all of the ST-NXP Wireless, right?

Sure.

And these guys we're going to supply baseband with DSP.

Our DSP.

Right. Now, when you look at this Intel/Ericsson announcement, do you see that also being associated with the JV, or is that a separate part of Ericsson?

Well, the Intel design, or I would say reference design, or partnership is [released on] module that has our technology coming from -- today, with (inaudible).

Okay, so --

Part of Intel is Ericsson, the [tealsif] chip from ST, the (inaudible).

Yes, well -- a lot of interesting participants behind these press releases, it sounds like. I'll yield the floor to another caller. Thank you.

Thank you, Matt.

Thank you. Your next question is coming from [Robert Morrison], a private investor. Please go ahead.

Hi. I noticed that in your income statement, there was quite a drop, quarter over quarter, in terms of both costs of revenues and in research and development. Was that mostly because of moves in the currency, non US-dollar expenses, or is there something more fundamental involved in that?

The expense levels moved down, especially R&D, for three reasons. One is some FX, positive effect on us; a lot of -- or some vacation utilization by our employees, which helped to offset the quarterly expense; and some more grants, R&D grants, that we are getting. This is part of some tax benefits from the Israeli government and Irish government for doing R&D work.

So these three are the main factors for expenses to go down. As I mentioned, on a non-GAAP basis, we expect operating expenses next quarter to be slightly higher, but still lower than the one rate we had in the first and the second quarter. I believe I said about $7.5 million to $8.1 million, and if you recall though, in Q1 we had $8 million, in Q2 we had $8.1 million. So Q4 should be lower than the run rate in the beginning of the year.

Okay. And with regard to currency, I mean, I raised this once in the past, and of course, I would have been very wrong. It's a bit of a concern to me that in your cash balances it's just all US dollars, when the US is running the kind of deficits that it is, and so forth. As I say, if you'd followed my sentiments in the past, it would have been a mistake.

But nevertheless, for the future, I just sort of wonder if it's -- if you feel, in spite of the fact that your stock is listed in US dollars, and a good chunk of your expenses are in US dollars, whether it's really wise to be so committed to the US dollar in terms of your cash holdings.

Okay, the first, of course, we appreciate your view and concern here. Let me try to explain this.

Our cash is in dollars, and I don't think that's been an issue. What we have in place is a different mechanism that hedges our foreign expenses, mainly salaries and rents. And these are usually cylinders or put options against the dollar based on our monthly cash needs in different currencies.

So it has no -- you have no problem to hold $88 million in US dollars in the bank. You could still, through other mechanisms, which we do use, protect yourself from the FX, which has gone quite wild this year from down 20% to a strengthening in the dollar of about 15% in the last month or two. And we are not exposed to these drastic changes by hedging up ahead probably between three to nine months.

So there is a mechanism in place. We're not waiting for every month end to get a surprise of where the dollar is versus other currencies, and we have that planned quite a long way in advance, so we don't have any surprises.

Okay, certainly. One last quick question. I noticed from the balance sheet there was a drop of $120,000 in property and equipment. I was just wondering if that was anything that's worth knowing about.

No, just higher depreciation and CapEx this quarter. As you know, the IP model is not CapEx rich, other than computers and software to our engineers. There is no other capital expenditure, and this quarter is lower than previous quarters.

Okay, thanks, then.

Thank you. Your next question is coming from Robert Katz of Senvest. Please go ahead.

Hi, Gideon and Yaniv. A very nice quarter -- congratulations. I have a question about your guidance. Can you give us a little more insight into, I guess, the rev rec on royalties? Does that usually happen one quarter in arrears?

And in terms of unit expectations into, I guess, Q4, that would reflect what you've already seen in Q3 from your partners? And how do you think that impacts revenue in Q4? What's the split between license and royalties in your guidance?

Okay, so usually, we do give a very detailed guidance, as you know, but we never open up that much to licensing, royalties and services. Usually they're not that much of a change, between them.

For Q4 royalties, we actually report the actual shipments by our customers in Q3. And I think, most of our customers -- most of the major ones, for sure, already announced their results. I think LG was in line, I think Sony Ericsson was in line, I think Nokia -- not a customer yet, but on the line.

So if you look at just the wireless space, Q3 was still a solid or healthy quarter, with some risks going forward maybe, but not Q3. Q3 for us, we already -- we've seen some of these initial reports, and we were very confident that our royalty number in Q4 will be higher than what we just announced, of $3.3 million.

That's the color that I can give you. This is something that we don't have all the picture yet, but from the reports we already have, we are very comfortable about it.

So your initial comments are, the actual industry is holding up in Q3? And you think you're taking market share in those Q3 shipments?

Absolutely. Not just market share, but also seasonality. The typical seasonality, Sony Ericsson sold 25.7 million versus 24 million units. LG did well. Nokia [assumed] 10% growth overall, so there is no surprise there.

We talked about one well-known US brand that has sold very nicely in the last quarter, and it surprised some analysts. This is a CEVA-based product, and based on this market data, we are positive.

Do you think you see the same types of seasonality you saw last year in Q4 over Q3, on the unit shipments?

Q4 over Q3? Q4 of last year growth over Q3 of last year growth (inaudible), you mean?

Yes.

Yes, I would think it should be -- I don't recall what we had there, but it should be as strong, if not better, because of the market share.

Excellent. Thank you very much, guys.

Thank you, Robert.

Okay, bye.

Thank you. You have a follow-up question coming from Daniel Meron of RBC Capital Markets. Please go ahead.

Thank you. Just wanted to follow up on a couple of things. First of all, on the pricing front, did you see any changes in the pricing, or terms that you see there in the licenses or in the royalty agreements that you sign these days?

No.

Okay. Can you give us a sense of what is the broad terms of those prices that you quote per chip?

Yes, nothing has changed there. The same model we have been giving. Remember our model -- when we license our technology today, it takes probably two years to get it developed in and start getting into mass production, so the numbers of a signed deal does not really change. We wait patiently and help our customers get into production, and as soon -- only as soon as they do, we enjoy the royalties.

But nothing changes, when they start shipping their products. It's based on a sliding scale, based on quantity and cents per chip, and we always talked about a range of somewhere between $0.05 to $0.15. Depends on the end market, depends on the customer, on the application. But nothing has changed in our model today versus last quarter, or versus a year ago.

Okay. On the FX front, can you give us a sense of what is the impact, if any, positive or negative, for next quarter, that you're factoring in? Are you hedged for the next quarter? And if so, at what level do you assume in your budget?

Yes, not a problem. I think you are the expert in FX there. And we are covered fully until the end of Q1, and partially Q2 of next year. So we don't see any FX. And the expenses we have shown over the last three quarters I think are the evidence that we have no headwind and no risk associated with FX, and we will manage it -- trying to manage it, very, very prudent.

So the level that you're hedged at is, what, 3.7 or so?

No, hedging, you don't do one day for the whole quarter. You do over time, enough to get into different circle, into different changes, dramatic changes. You do it gradually over time. And I would say it's around 3.6, an average.

Okay. That's a (inaudible).

For some of our others listening in, listeners, we are talking about shekel versus dollar. And of course, although the euro is also helping us, and from a $1.60 per euro, today's rates are $1.20, $1.30'ish or so, that's also been helpful from across the board.

And then, the headcount, could you just give us a sense on what was the headcount in the second quarter, and also, what's the headcount in the third quarter?

Yes, of course. No significant changes. We were 183 at the end of June. We are 180 at the end of September. We should pick up those few headcounts back up. And we'll stay, and we mentioned earlier in our annual guidance back in January of this year, we are looking to continue to stay low, south of 200 employees for the whole Company.

Okay, very good. Good luck going forward. Thank you.

Thank you, Daniel.

Thank you.

Thank you. Your next question is coming from Doug Whitman of Whitman Capital. Please go ahead.

Thank you. Thank you for the impressive numbers, guys. I had basically one quick question, which is -- and I think it's kind of getting to what people are trying to ask you, but not that directly, which is -- you are actually one of the few companies able to maintain guidance for the fourth quarter, and actually hit their -- more than hit their third-quarter number.

Can you talk a little bit about -- you've talked about your gains in the market, but how much of a negative effect are you seeing from the economy, which is being more than offset, obviously, by your market share gains and new wins cutting in? How much bigger, is kind of the question I think people are trying to ask, would your numbers be if you hadn't seen the change in the economy?

Well, you know, we elaborated about the royalties and the market share expansion, that here, it -- [let's be frank]. We are -- no matter how the market goes, we are -- we have our own patterns that are going there.

Now in terms of licensing, this is something that we didn't touch, although in my prepared remarks, I did touch it. We have, in our pipeline -- pipeline is something that you build throughout a period of time. It's not something that you buy from today and tomorrow, and it's behind this pipeline, there are companies that have plans. And these companies are maintaining plans for future products. I mean, that's what they need to do.

So, even in this very tough period, we see companies -- our pipeline is composed of strategic. Strategic is companies that are going to sign a lucrative deal, few users to multi users, and these are the companies that we are negotiating today, and we don't see -- at least, the impression that we are getting is, they are not going to change. The companies that decide to go to LTE will not stop developing it and try to slow down things. So it means that they're out of LTE.

So, the pipeline and the companies that we are dealing to, we don't see any sign of, let's say, slowdown or change. I wouldn't use slowdown, but use change in plans, or saying, well, let's defer it, a project. No, this is not the case.

Okay, so you haven't seen, even on the license side yet, a change from -- due to based on the economy?

Yes, right.

Okay. Thank you.

Thank you, Doug.

Thank you. There appears to be no further questions. At this time, I would like to turn the floor back over to your hosts for any closing remarks.

Thank you again for joining us today, and for continued interest in CEVA. We'll be presenting next week at upcoming AeA Classic Financial Conference in San Diego on November 4 and 5, and invite you to join us there.

Thank you, and goodbye.

Thank you. This concludes today's CEVA third-quarter conference call. You may now disconnect.