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CEVA, Inc. (NASDAQ:CEVA)

Q3 2008 Earnings Call Transcript

October 29, 2008, 8:30 am ET

Executives

Yaniv Arieli – CFO

Gideon Wertheizer – CEO

Analysts

Daniel Meron – RBC Capital Markets

Robert Sanders – DKIB

Matt Robison – Pacific Growth Equities

Robert Morrison [ph]

Robert Katz – Senvest

Doug Whitman – Whitman Capital

Operator

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. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. (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.

Yaniv Arieli

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 proven incorrect, could cause the results of CEVA to differ materially from those expressed or implied by such forward-looking statement and assumption.

Forward-looking statements include financial guidance for the fourth quarter and fiscal 2008, our optimism about the 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 toward the merchant solutions and consolidation of the semiconductor industry, and our expectation 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 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 markets 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 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.

Gideon Wertheizer

Good morning to everyone and thank you for joining us today. I hope you had the opportunity to hear our press release with the results of the third quarter of 2008. During the quarter, we reported total revenue of $10.2 million, which at present an all time record high for the third consecutive quarter and the highest we’ve seen in 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 revenue for the third quarter of 2008 was $3.3 million, an 8% sequential increase as compared to the second quarter of 2008 and 15% 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 from our CEVA DSP core platforms and software. Geographically, three of the license agreements were in Europe, one in Asia, and two in the United States.

Target application for 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 achievement in revenues, operating margins, and operating income. Our royalty revenue grew 8% sequentially, mainly as a result of continuous 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 confident with our licensing pipeline, which included 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 few observations regarding our key market. During the third quarter, we successfully concluded two strategic agreements for advanced DSPs, the TeakLite-III and CEVA-X1641 to be used in conjunction in the fair market. The first agreement is with a major Asian OEM manufacturer that plan to develop a chip for next generation wireless technology, the LTE. The chip will enable up to 100 megabit per second transfer rate.

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

We are also seeing a trend while the wireless use model is expanding beyond handset 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, mobile operators, PC manufacturers and chipset providers are invited to pre-install mobile broadband into a range of notebook PC and mobile computing devices that we’ll be ready to switch on and serve the web straight out of the box in 91 countries. This initiative is part of a more diversified strategy to give [ph] wireless Internet access to a wide range of previously unconnected devices from cameras and MP3 players to (inaudible) 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 create a clear number three player in the cellular semiconductor industry with combined revenue of $3.6 billion, a 19% market share. This merger reflects a trend of moving toward merchant solutions as opposed to custom solutions developed by handset makers such as Nokia, Sony Ericsson and Motorola, using TI or freescale DSPs. The front face of CEVA is our technologies are already widely used by the largest merchant market players. In this respect, the latest announcement by TI would develop DSP that it plans to sell or exceed the merchant market [ph] chip or baseband will significantly strengthen the market position of CEVA’s customer.

In general, the recent consolidation in the semiconductor handset space also play to our strength, as the consolidated companies are looking for new ways to differentiate their product offering rather than developing DSP technologies enough. This vision provides CEVA is a competitive advantage, as our DSP technology is essentially becoming a de facto standard in the wireless handset applications.

Next, Samsung commenced shipments of their ultra low-cost phones using ST-NXP (inaudible) single-chip baseband platform powered by CEVA DSP. This is the first time that Samsung is using CEVA DSP for ultra low-cost phone. Operating including T-Mobile and AT&T are carrying these handsets in their stores today. Samsung, who also introduced a number of new 3G models using Infineon baseband chips, is continuing their plan to also more 3G phones with baseband and (inaudible) to Qualcomm.

Sony Ericsson introduced a number of new phones deploying our DSP code for 3G baseband and audio walkman applications. The D700, TM506, G705, and W902 are all also expected to debut [ph] in trying for the holiday season. Ericsson announced that they began shipping 3.5G broadband modules, utilizing CEVA DSPs and LG Electronics notebooks. Intel announced last week that it will partner with Ericsson for its upcoming Moorestown platform for their MID market, which will also include 3.5G connectivity. The LG and Intel announcement follows the earlier announcements from Dell, Acer, Lenovo that they are also deploying Ericsson broadband model into their laptops and ultra-mobile PCs.

New product announcements from our customer during the quarter included two notable Asian customers targeting the growing Chinese personal multimedia player market that include our multimedia solution. Our customers (inaudible) recently announced availability of multimedia chips and secured customer width. 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 above, there is a clear movement for our merchant solution to replace in-house or ASIC solutions such as the TI-based chips. And CEVA is positioned to explore these trends.

We are also expanding with the new segments of the wireless markets such as compressors and mobile Internet device, which are all expected to bring full mobility to devices that currently are attached to half of the base WiFi, our local area network. As we move to 2009, we are expecting the momentum within the handset market to pay dividend for CEVA. Given our past effort to diversify our customer base, we are also seeing opportunities in other business areas.

For example, over the last years we have leveraged on our core technologies and DSP and multimedia technology in order to extend into other applications such as PlayStation 3, Blu-ray DVD, portable games console, personal multimedia players, surveillance, and Voice-over-IP over optical network. We expect royalties of these new markets to impact our results in the near-term, which also concedes 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.

Yaniv Arieli

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 revenue and 12% higher than the third quarter of 2007. Royalty revenue was $3.3 million, reflecting 32% of total revenue 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 a $0.3 million of equity-based compensation expenses. Sales and marketing costs were $1.8 million, including $0.1 million of equity-based compensations. 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 about $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 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 2008 accounted for $1 million. And that included $0.4 million of pretax capital gain for our equity investment in GloNav to NXP Semiconductors. Due to the overall market volatility, we accounted on 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 rule, we do not believe – we do not have a need to currently write-off any of these potential offers. And 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 consideration 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 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’ll talk about other related data. Shipped units by CEVA 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 are under the prepaid arrangements. 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% 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 arrangement. During this quarter, one customer exhausted its prepayment quarter and decided to actually pay a per unit royalty.

And now for some balance sheet items. During the quarter we generated positive cash flow of $1.4 million. As of quarter-end, CEVA’s cash and cash equivalent 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 2007.

As previously discussed, our Board authorized a share repurchase program of up to 1 million shares. Of this amount, we establish a 10b5-1 share repurchase plan for 500,000 shares. We repurchased approximately 200,000 shares at an average price of $8.2 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 at an average price of $7.87 per share for a total amount of approximately $5.1 million. We also fully utilize 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 has explained in detail a few minutes ago CEVA’s strategy roadmap and growth prospects, especially in regard to market share expansion and new product introduction by our customers even in this 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 $38.0 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 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%. 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 attribute to equity-based compensation. The 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?

Question-and-Answer Session

Operator

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

Daniel Meron – RBC Capital Markets

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

Yaniv Arieli

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 the 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 60% over last year, which was also an increase of about 45% from 2006. This trend, maybe not at these rates, should continue even in the difficult market conditions for a simple reason. Even if the whole wireless market does not grow as fast or will be stable or even lower expectations for the next year volume, we are still looking at a huge market opportunity of 1.2 billion phones sold each year. CEVA has just started a year ago to gain market share from 3% or 4% a year plus ago to about 13% to 14% currently. And we anticipate this trend to continue both into 2012 [ph] and especially in 2009. This is both from the wireless baseband market, tier one customers. But I think you all are aware of Sony Ericsson, Samsung, LG, (inaudible) and 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 well aware of the order of risks and worries about the holiday season, 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 only 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 are really products, as Gideon talked about, with our multimedia sold in China, in the Far East for $60 or $50 PMP device that is being sold these days. So these are incremental new market segments for royalty revenues for us in these difficult times.

Daniel Meron – RBC Capital Markets

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

Yaniv Arieli

Unfortunately, in this conference call, we are just in October and I’m not sure how many companies are yet guiding for 2009. We are not – in the prior years, we have guided in January. So in January we’ll give the full scope and picture. I think what we’ve said n the past, say, we still believe that. The overall growth in the cellular market in the next two to three years should be very, very significant. We’re talking about somewhere between a third to maybe even 50% in market share, and these recent trends that I just mentioned and you’re all aware of, are just improving our confidence that we are on the right track.

Daniel Meron – RBC Capital Markets

Okay. And then on the buyback front, you are pretty much almost exhausted to buy back kind of your up to 900,000 shares, or to be more specific, eight times 75,000 shares, and I think that actually you are targeting something to the tune of 1 million. Are you going to extend it, or how should we think about the buyback time going forward?

Gideon Wertheizer

Let me correct the numbers. You are right about the million shares. We (inaudible) thus far 675,000, so we have plenty of shares available. As you know, the Board authorized this plan is active and we’ll continue to buy from time-to-time as we have been demonstrating in the last couple of months.

Daniel Meron – RBC Capital Markets

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

Gideon Wertheizer

Thanks, Daniel.

Operator

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

Robert Sanders – DKIB

Yes. Hi, guys. Maybe the question to Yaniv, if you just look at the TI announcement, the EMP, STM announcement, would you say a conference is going on that the share of STM versus TI is likely to go past the 50% and move all way towards 100% in terms of – is that something that you are saying as more likely now given the deal that has just happened?

Yaniv Arieli

I think this is a question for Gideon.

Gideon Wertheizer

Yes, but you mean STM?

Robert Sanders – DKIB

Yes, the deal with the EMP announced with STM, which currently has (inaudible) EMP is giving 50% of the business to STMicro and 50% to TI. I mean, assume now that STM and EMP are sitting at this joint venture, I mean your conference going out that that business will move pretty much wholesale to STMicro?

Gideon Wertheizer

When it comes to Sony Ericsson, I believe so.

Robert Sanders – DKIB

Okay.

Gideon Wertheizer

When it comes to Nokia, it is different. It’s more complex. Let me know if you want to discuss Nokia, but in terms of Sony Ericsson, it is.

Robert Sanders – DKIB

Okay. And maybe just help me on – one of you guys, I mean I look at your consensus estimates. Your consensus is currently $44 million to $45 million for next year. So, an additional $4 million versus I think what you’re guiding to next year versus this year. Certainly I can see you should do – 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 as a licensing you don’t feel confident on that because of the environment that you thought you’re basically factoring in the licensing might potentially decline in 2009?

Gideon Wertheizer

I think first of all, in order to draw [ph], we need permits, not Gideon and I have these right now, so they may take a course. But we need to be prudent. In these markets, the opportunity for CEVA, I agree with you that is very positive at the moment because of this market trend. The numbers, we want to be cautious and see how things evolve. As you know, a design win in an OEM takes quite a lot of time. Even with the announcement of market trends that are there today until a chip with all the relevant factor is deployed in a specific model, and then, say, get certified by the operator and sold to the market takes some time. And these are still some uncertainties that we have of the timeframe, 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 timeframe, two to three years, there is no doubt that the significant amount of business from Nokia, from Sony Ericsson, from LG, from all the Chinese type of vendors like ZTE and Spreadtrum and others, it can be powered – hopefully will be powered by CEVA-based solutions.

Robert Sanders – DKIB

And last question if I may and then I’ll get out of the queue. I mean, if you just look at the HSPA design win that STM has with Nokia, could you just run through the process as how you would potentially get into that design? Would it be a combination of dealing with STM and Nokia, or is it 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 (inaudible) second half of 2010?

Gideon Wertheizer

Well, 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 with 3G. But keep in mind that STM using us to the NXP activities and also basically for NXP. So the 3G for Nokia is something that will be in early next year.

Robert Sanders – DKIB

Early next year, okay. Thanks very much, guys.

Gideon Wertheizer

Thank you.

Operator

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

Matt Robison – Pacific Growth Equities

Couple housekeeping items, I guess. If you expect the R&D grants to continue with some more levels. It sounds like you probably do with your OpEx guidance. And is that 15% tax, what you would – we should expect for next year as well or is that more of a function of the other income you achieved this year?

Yaniv Arieli

The overall grants, this is something that we’ve been more active in the last couple of quarters as a precaution to these types of market environment to do better cost control. These are to get the grants based on R&D achievement 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 R&D cost and this is something that will continue. Q3 was much more significant in the prior two quarters, I could say that. Another thing that helped us is the FX environment, which in Q3 and on Q4 are slightly better than where we used to be in the first half of this year. Both of these are benefiting our R&D cost. I don’t think R&D for Q4 will be as low as Q3, but similar levels or slightly better than the first and third quarters. On the tax rate, it’s just a quarterly event of 15%. As I mentioned, an annual base of 2008 should be 6% to 8%. And going forward, again we don’t have the number 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 then we’ll catch you on that with an updated number in January.

Matt Robison – Pacific Growth Equities

Okay. And Gideon, a couple things. One, maybe you could provide a little bit of clarity on this legacy run-off business for TI at EMP and Nokia versus newer designs and how you see yourself positioned for the newer designs. Also I’m curious to get your thoughts on when we might see confirmation of Infineon’s shipments to Nokia.

Gideon Wertheizer

Well, let’s start with the second one – the second question. This (inaudible) we don’t have a final answer, where exactly this should – it should stop, it should start pretty close. Let’s wait for next week. I think in Infineon contract, I don’t recall it when they will be having (inaudible). We don’t know yet other than there was interview with Nokia executive. And he confirmed that this is how it’s going and that’s the plan, and I’m not going to change it. Now regarding TI, let me put some color here. Texas Instruments has had – or still have between 40% to 50% of the overall baseband market share. It’s composed of two different, I’ll say, business models. One is called merchant market. This is an off-the-shelf baseband chip. They call it eCosto and LoCosto, and this is roughly $300 million to $350 million business where they have customers like, gee, there 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 having in the past with Sony Ericsson and Nokia. Well, basically the design is being done by the Nokia and Sony Ericsson (inaudible) and they give the DSP of Texas Instruments for this purpose. And TI is basically a supply chain. And this is a $2.4 billion business. So – they announced what they did last week and they are going to exit or try to sell their merchant market business. And this is 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 the EMP and Sony Ericsson move will select the other technologies. And then this is ongoing and they cannot avoid it. And this is (inaudible). So what is meant for TI now is the business – the ASIC business at Nokia, that Nokia decided to announce – they are going to go to multi-cell and selected Infineon, and of course, Broadcom and for 3GSP. So all these guys like to use our technology, and now the ASIC part of Nokia will become a merchant market chip and we will be there.

Matt Robison – Pacific Growth Equities

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?

Gideon Wertheizer

Yes. That’s – let’s make sure. We want to be a molecular driven [ph], a new joint venture when they go to the ST-NXP wireless, right? And these guys, we’re going to supply basebands with DSP.

Yaniv Arieli

Our DSP.

Matt Robison – Pacific Growth Equities

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

Gideon Wertheizer

Well, the Intel reference design or partnership is (inaudible) module that has our technology coming from today with us from ST [ph].

Matt Robison – Pacific Growth Equities

Okay, so –

Gideon Wertheizer

Part of Intel is Ericsson that uses chip from ST that uses our technology.

Matt Robison – Pacific Growth Equities

Lot of interesting participants behind these press releases, it sound like. I’ll yield before there’s another caller. Thank you.

Gideon Wertheizer

Thank you, Matt.

Operator

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

Robert Morrison

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

Yaniv Arieli

The expense level is down, especially R&D of three reasons. One is some effects – positive effect on us; a lot of – or some vacation utilization by our employees, which helped offset the quarterly expense; and some more grants – R&D grants that we are getting. This will part us from tax benefit 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 the operating expenses next quarter to be slightly higher, but still lower than the run rate we had in the first and second quarter. I believe that I said about $7.5 million to $8.1 million, and if you recall, in Q1 we had $8 million and Q2 at $8.1 million. So Q4 should be lower than that run rate in the beginning of the year.

Robert Morrison

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 for that I say, if you had followed my sentiments in the past, it would have been a mistake. But nevertheless for the future, I just sort of wonder 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?

Yaniv Arieli

Okay. First, of course, we appreciate your view and concern. Let me try to explain this. Our cash is in dollars and I don’t think that’s a big issue. What we have in place is a different mechanism that hedges our foreign expenses, mainly salaries and rent. And these are used in cylinders or put options against the dollar based on our monthly cash need on different currencies. So it has no – probably you would have no problem to hold $88 million in US dollars in the bank. You could feel through other mechanisms, which we do use, and protect yourselves from the FX, which has gone quite wild this year from down 20% to strengthening the dollar of about 15% in the last month or two. And we are not exposed to give drastic changes by hedging up ahead probably between three to nine months. But we have the mechanism in place. We are not waiting for every month end to get the surprise of where the dollar is versus other currencies. And we have not planned quite long ways in advance, so we don’t have any surprises.

Robert Morrison

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

Yaniv Arieli

No, just high depreciation and CapEx this quarter. As you know, the IT model is not CapEx rich. Other than computers and software to our engineers, there is no other capital expenditure. And this quarter was lower than previous quarters.

Robert Morrison

Okay, thanks then.

Yaniv Arieli

Thank you.

Operator

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

Robert Katz – Senvest

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 that impacts revenue in Q4? What’s this part between license and royalties in your guidance?

Yaniv Arieli

Okay. So usually we do give a very detailed guidance, as you know, but we never open up documents to licensing, royalties and then services. Usually there are not that much of a change between them. For Q4 royalties, we actually report the actual shipments by customers – 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 was in line, I think Sony Ericsson was in line, I think Nokia – not a customer yet, but they are in 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 received some of these initial reports and we are very confident that our royalty number in Q4 will be higher than what we just announced of 3.3 area. That’s the color that I could give you. This is something that we don’t have a lot of big picture. We ask [ph] about from the reports we already have, we are very comfortable about it.

Robert Katz – Senvest

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?

Yaniv Arieli

Absolutely. There is lots of market share, but also seasonality. The typical seasonality, Sony Ericsson sold 25.7 million versus 24 million units. LG did well. Nokia had 10% [ph] growth overall. So there is no surprise there. We talked about one well-known US brand that is sold very nicely in the last quarter, even surprised (inaudible). Obviously we’ve seen a baseband product, and baseband in this market data, we are positive.

Robert Katz – Senvest

And do you think you see the same type of seasonality you saw last year in Q4 over Q3 on the unit shipment?

Yaniv Arieli

Q4 over Q3 – Q4 last year growth over Q3 of last year growth you mean?

Robert Katz – Senvest

Yes.

Yaniv Arieli

Yes, I would think it should be – I don’t recall what we have there, but it should be all strong if not better because of the market share.

Robert Katz – Senvest

All right. Thank you very much, guys.

Yaniv Arieli

Thank you, Rob.

Operator

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

Daniel Meron – RBC Capital Markets

Thank you. Just want to throw up on a couple of things. First of all, on the pricing front, did you see any changes in the pricing or the turn that you see there in the licenses or in the royalty agreements that you signed these days?

Yaniv Arieli

No.

Daniel Meron – RBC Capital Markets

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

Yaniv Arieli

Yes. Nothing has changed there. They are the same model. Again, remember our model, when we license our technology today, it takes probably two years to get it developed and start getting into mass production. So the numbers of the signed deals have not really changed. We wait patiently and help our customers get into production. And only as soon as they do, we enjoy the royalties, but nothing has changed when we start shipping their products. It’s based on a sliding scale, based on quantity, and (inaudible) talks about the range of somewhere between $0.05 to $0.15. It 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.

Daniel Meron – RBC Capital Markets

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

Yaniv Arieli

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

Daniel Meron – RBC Capital Markets

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

Yaniv Arieli

No, hedging, you don’t do one day for the whole quarter. You do over time enough to get into different circle [ph] and into different changes, of dramatic changes. You do it gradually over time. And I would say it’s around 3.6 in average.

Daniel Meron – RBC Capital Markets

Okay. That’s about –

Yaniv Arieli

For some of our other listeners, we are talking about shekel versus euro versus dollars. Of course, although the euro is also helping us from $1.6 per euro, today’s rates are $1.20, $1.30-ish or so. That’s also been helpful from across the board.

Daniel Meron – RBC Capital Markets

And then the headcount, can 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?

Yaniv Arieli

Yes, of course, no significant changes. We were 183 at the end of June. We were 180 at the end of September. We should pick up those few headcounts back up, and we’ll stay, as I mentioned – and we mentioned earlier in our annual guidance back in January of this year, we are looking to continue to stay lower [ph] at staff of 200 employees for the company.

Daniel Meron – RBC Capital Markets

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

Yaniv Arieli

Thank you, Daniel.

Gideon Wertheizer

Thank you.

Operator

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

Doug Whitman – Whitman Capital

Thank you. Thank you for the impressive numbers guys. I have basically one quick question, which is I think it’s kind of getting 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 the – more than hit the 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 economic, which is being more than offset obviously by your market share gains and you win cutting in. How much bigger? It’s kind of the question I think people are trying to ask with your numbers, if you haven’t seen the change in the economy?

Gideon Wertheizer

Well, we elaborated about the royalties in the market share expansion that the – clearly this is strength. I mean, we are – I mean, no matter how the market goes, we are the whole part and they are going down. Now in terms of licensing, this is something that we didn’t touch, although in my prepared remarks I did touch it. We have a pipeline. Pipeline is something that you build throughout the period of time. It’s not something that you buy from today and tomorrow, and it’s behind these pipelines are companies that has plans. And these companies are maintaining plans for future progress. I mean, that’s what they need to do. So even in this, I will say, tough period, we see companies – our pipeline is composed of strategic. Strategically companies that are going to sign lucrative deal, few users or multi-users, and these sort of companies that we are negotiating today. And we don’t see this – the impression that we are getting that they are not going to change. A company that decides to go to LTE will not stop developing it and tries to slow down things. So it means that they are out of healthy. So the pipeline and the companies that we are dealing with, we don’t see any sign of, let’s say, slowdown or change in – I wouldn’t use slowdown, but use change in plans and say, well, it’s different project. No, this is not the case.

Doug Whitman – Whitman Capital

Great. You haven’t seen even on the license side you had a change based on the economy?

Gideon Wertheizer

Yes, right.

Doug Whitman – Whitman Capital

Okay. Thank you.

Yaniv Arieli

Thank you, Doug.

Operator

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

Yaniv Arieli

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

Operator

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

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