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CEVA, Inc. (NASDAQ:CEVA)

JPMorgan TMT Conference Call

May 15, 2012 14:50 ET

Executives

Gideon Wertheizer – Chief Executive Officer

Analysts

John Ahn – JPMorgan

John Ahn – JPMorgan

Okay. So, welcome everyone to the CEVA Meeting. My name is John Ahn and I am a semiconductor analyst here at JPMorgan. See CEVA is the leading licensor of DSP cores and platforms with a market cap about $385 million. Company develops and licenses its DSP technology for using, I think, mostly 2G, 3G, and 4G handsets at this point, but definitely diversifying into some other non-handset markets as well.

So, it is my pleasure to have the CEO of CEVA, Gideon Wertheizer here with us today. And I'd say we typically don't have the pleasure of hosting a non-US company much less somewhere all the way from Israel here. And I think maybe many of you are not very familiar with the CEVA story. So, I am going to let Gideon really devote a little bit more time than usual to introduce himself his company, his business, and then we'll just launch into Q&A today. Gideon?

Gideon Wertheizer – Chief Executive Officer

Yeah, good afternoon. For those of you that are not familiar with the CEVA story, we are what we call the IP company. If you look – think about other companies, very similar business model than our, more imagination, many could develop a piece of technology that is called DSP, digital signal processor and we license it to companies. When we license a technology, we charge or get the license fee, few hundred thousand to few million dollars depending on the business model. And they take this piece of technology integrated into their chip and when they sell their chip to their OEMs meaning handset is the place where we are, this is our space. They license. We are collecting royalty per chip few cents per each product.

Now, our main market is the baseband – the handset market, the stuff that you are familiar whether it's a smartphone, feature phone, and going forward, machine to machine. Our technology is basically generic in a way that you can find it in every phone that you know whether it's 2G phones that are going to into the emerging market and you have – they are in billions of units a year going to the 3G smartphone LTE. The DSP technology is something that you need in each of these products.

We have last year, they were more than 1.1 billion products that were sold or with our DSPs, we have 46% market share in handset meaning almost every two handset that is being sold today in the market has the CEVA DSP inside. This is a critical technology. With the DSP, you cannot do the – you need it for the communication purposes. Without the DSP, the handset cannot communicate, you cannot do a voice call, you cannot do a data call, you cannot do internet surfing, you need the DSP for this purpose. So, this is in a nutshell the space that we are.

John Ahn – JPMorgan

Okay, great. Thank you, Gideon. Thanks for that overview. Let's see – so, let's just start off with just I guess trying to get some market color for you. I mean, obviously with your revenue streams, I think you do see some very good visibility out there, just because you sign your license agreement. And I believe you recognize your revenues one quarter in your rears. So, like I said, I mean, you probably have some pretty good visibility into some of your end customers as well as their end customers. So, can you kind of give us a general idea of what you are seeing out there, especially in the – I think everybody is curious about what's going on in smartphones, handsets, overall communications?

Gideon Wertheizer – Chief Executive Officer

Yeah. First of all, in terms of what you mentioned visibility, our revenue mix is composed of three components. First one is what is called the licensor. This is our deals that we sign every quarter for new licenses or existing licenses that take our technology and build our chip. Usually, whenever customers sign the license agreement, it gets to a design cycle which can take between 18 to 24 months before we are collecting royalties. So, that's one element.

The license fee as I mentioned few hundred thousand to few million dollars depending on the business model to have the specific customers. Then we have the royalty component. And that's the visibility that I think you mentioned we are collecting royalties per chip and that's – and because we work with many customers this give us the visibility because we are not tied to specific customer, that if something happened to this specific customer things will collapse. So, that's the other component. The third component relates to the technology itself customer that take the IP needs to have a maintenance agreement in order to guarantee supply. They are supporting them throughout the design cycle.

Now, in terms of the market and what's going to happen as I said we are – because of our DSP, we are in 46% of the phones or basically in every phone, you have a baseband technology. The market, in general, is segmented to three categories, the 2G or the second generation cellular, these are voice phones that are capable to do texting and voice and also all sort of browsing like Facebook or Twitter and things like this. So, this is mainly in the emerging economy, China, India, Latin America, Eastern Europe, billions of unit, the size of this market on an annual basis, it's about 1.3 billion units a year. The overall market by the way is 2.2. So, still the lion's share of the market is 2G.

The second category is the 3G, most of the smartphone that you own – I believe most of you has the smartphones. This is a 3G third generation cellular. This is the majority of the market and this market going into a transition. And the transition is for voice – for what is called feature phones that are not smartphone to a smartphone in order to go to a smartphone to the mass-market in the 3G space even in places like Europe, U.S., you have to reduce the prices, the smartphone today that you own Apple or Galaxy, these are all 600 and above our retail price. You got it towards the subsidies, but you pay for it throughout the contract. So, the 3G segment is going into sub $300 smartphones that when you go to this price the scale that you can get is much higher and that's the point that we – our customer are getting. Today, in the 3G market, there is one income, but this is Qualcomm, it owns more than 50%. Two years ago, Qualcomm has close to 100%. One of the reason that their Qualcomm market shares goes down is because there are CEVA customer, companies by Broadcom, like Intel that are getting into this market with much cost, lower cost solutions that can drive the price of the smartphone down to the sub $300.

And the third segment just people start speaking it's still the size of this market is very emerging. This is the fourth generation of what is called the LTE. Just to give you some numbers in 2011, there were only 6 million phones that are being sold that are LTE capable, out of the 2.2 billion shipments of cellular handset in the year. The expectation for 2012 is about 67 million units, still very small, but definitely, the LTE is going to be at certain point to become a sizable one. And we have already customers that have introduced chips, lower cost chips for wealthy purposes. Just one example, Samsung – that is Samsung, Samsung is using our DSPs for LTE. They cut their chipset costs moving from one generation to the second generation that is based on our technology by 50%. So, that's the magnitude of the sales that you can get when you start using our technology.

John Ahn – JPMorgan

Okay, great. Thanks for that. See I think just kind of still looking at the overall market and your business sort of alleys for the near-term, I know during your last earnings call, you took your 2012 revenue guidance down, then you had a range of $62 million to $66.5 million for the year, I think it go down to $57.2 million to $61.2 million. You said it's some weakness in 2G and 3G, specifically at Nokia. So, just wondering if you could kind of elaborate a little bit, see what the situation there is, and just providing a color there?

Gideon Wertheizer – Chief Executive Officer

Yeah, in order to explain what led us to trim our annual guidance. First of all, I would like to explain how we see our growth in the royalty component, because we didn’t make any changes in other components of our business, which is the licensing and maintenance. The gross vector for CEVA in the royalty part is basically based on two components. One is 2G. 2G is based on the size of the market is big, we have about 60% of this market and the size of this market is expected to be according to strategy analysis at that level, the same level 1.2 billion, 1.3 billion units at least until 2016. So, one component in our royalty income relates to revenues coming from the 2G.

The other component in our royalty relates to the 3G. As I said, we are expanding. We are taking market share from Qualcomm in the 3G space and this is a process that started early this year. Our customer already said that they are expanding into Samsung in the 3G. Lot of phones are coming out from Samsung that is based on our technology. We said in our conference call that with key customer we sold is a 2x sequential increase in volume coming in the 3G space. So, we are expecting to grow in our 3G space replacing basically – displacing basically Qualcomm. We don’t need for our growth to -- the 3G market will go. The market grows in the modest rate of 6% or 7%, but we are displacing Qualcomm and that’s the component.

So, there are two parts in our royalty models that we are building internally, continuing – keeping the 2G position and expanding into 3G. Now, what we see – what we saw at the beginning of the year is two – basically two phenomenals that cause us to basically take a prudent approach. It’s not that we postmortem saw something it's something that we decided to take a prudent approach in order not to surprise the people. Number one is in the 2G space. In the 2G space, there is a transition from a very basic phone to a more advanced phones that are, I would call it, smartphone user experience. These are not Apple type of phones. These are phones that has a touch. These are phones that has internet access and things like this.

So, in the very low tier of the voice phones, we are seeing a significant notice, but I wouldn’t say significant price reduction that the size of this market is still big. We are basically see our royalty is big coming down, because of the price going, price reduction, we call it price erosion. Now, the market is going into this more advanced smartphone. When we go to these smartphone elements and this is the first transition already started, MediaTek commented about it, (indiscernible) commented about it, Nokia in their comments said that the market is going – is looking for more smart advance phone. When you go to this one, the ASP will be – will go back to the higher level, the levels that we used to be. So, that’s one element that we took a prudent approach and say we know that it's going to be there. We don’t know exactly the pace .We are speaking about between 70 million to 80 million units shipped in this segment per quarter. So, we don’t – right now, we see few millions going there, but we don’t know exactly when this comes to basically the replace, the basic phone was advanced smartphone. So, this one, as I said, it's a prudent approach, because we want to make sure that we have – how fast it's going be.

The other element relates to one specific customer is Nokia. And this is something that I would like to elaborate, because I see many people are confusing about, getting confused or in associating us to other issues that has Nokia, because there is one issue, big issue that Nokia has in the smartphone and the transition from Symbian phone to smartphone to Windows phone has nothing to do with CEVA, because we are not supplying them. 80% of Nokia shipments in the quarter and Nokia shipped about, in general, in the last, let's say, year or so between 100 to 110 million unit a quarter in which only 15% to 20% is smartphone, the other portion is mobile phone. And this is the CEVA play. In early 2009, we started to displace the R&D space and we grow our shareholder and we rely on Nokia not rely, but Nokia is a big user of us.

Last quarter after the posting the Q1 result, Nokia made a pre-announcement that they said that they see problem in the mobile phones segment. The volume went down from an average of 95 to 100 per quarter to 70. And they explained that and the reason that explained them relates to the same thing that I said before. They said we lack phone with smartphone user experience. We lack phone that has a touch-screen. No, they put some – they said that they are going to fix it. They said that they are going to come out with new phone as early as this quarter by the way, but we said let's see how things are shaping up, let's see how the volume going back to normal levels and then will deal with it. So, that’s – that’s the two main components that we are thinking about.

One relates to the low tier of the market of the 2G market that is transitioning to a higher tier product. And the other thing relates to Nokia in the mobile phone segment. There is nothing to do with the smartphone segment. I want to comment about the smartphone segment. This is not something that we are interested, that is more a Qualcomm space. In the mobile phone segment, this is – this used to be and still a very healthy segment for Nokia, but we have to see how they recover from the shortfall that they had last quarter.

John Ahn – JPMorgan

Okay, great. Thank you. Okay, so let's shift gears a little bit and talk about your go-forward strategy and obviously transition of 2G to 3G is a big driver. Transition from 4G to LTE is another big driver, but we are really talking about handsets. So, let's talk a little bit about your other drivers' growth, which is non-handset especially in baseband. What are you looking at, what's the size of the opportunity perhaps, what kind of growth rates are we looking at here, and what is the evolution in some of the technology that you are addressing?

Gideon Wertheizer – Chief Executive Officer

Yeah, that’s a good question. I know when we obviously every – I mean, we are looking for all sort of ways to enrich our offering. And we know what we are strong. We have a strong competency on DSP. And DSP is a technology that it's not just baseband. Every digital product it means that there is DSP. You need the audio. You need the DSP. Video, it's a DSP technology. Radio, digital radio is a DSP technology. Security is a DSP technology. There are lot of things that you can do.

Now, what we did, we pinpoint two major technologies that the advantages for us to get to this space is that we can take advantage or leverage on the customer relationship that we have in the handset space. In the handset space, we are familiar with the main semiconductor companies. We are familiar end customer, familiar with other OEMs, because all the OEMs, the big OEMs, the Tier 1 OEMs all of them are using CEVA. So, we pinpoint two areas that are DSP-oriented. So, we can take advantage of leverage, but it's incremental or and it is to our royalty, because what we are looking is to gain more royalty. That's the business of licensing. It's not the license fee that we get. It's the royalties. So, there are two trends, one is audio. If you take, for example, the smartphone area and (indiscernible) so far smart TV, people are expecting to get a better audio quality. When the smart – the third generation smartphone evolve, it was an analog, the quality was – the quality that you have in new phone, cordless – cordless phone that you have.

Throughout the second generation, third generation, fourth generation, the voice quality degraded because we have to compress the voice by making it digital and whenever you compress voice, it becomes worse than now today, you're seeing more and more and you heard – may be you heard about voice or LTE or HD voice. All these things are basically taking advantage of the much stronger DSP, much strong algorithms, DSP algorithms and in order to improve the voice or also cancel noise because if you have cell phone illustrate there is noised and the companies like audience coming was all sort of very complicate algorithms to suppress noise. So, we are resolve technologies and in last year, we announced three agreements in audio purposes. We are basically coming, we came out with a DSP software framework and with that we are basically see ourselves, the DSP getting either to the application processor chip or to achieve that 8 2D chips coming from Cirrus Logic or Wolfson and all these mixed signal type of companies. They are looking also to other DSP there and the bottom line from us is that for the same customer base for the same market we are collecting royalties for a call that there is nothing to do with the baseband. That's one element that we are well advancing in executing this strategy.

The next level of development is I would – I should say more towered 2014/2015 smart TV or smartphone. This is the announcement that people are expecting for imaging and vision. Vision is things like just show the cognition, phase detection, augmentation reality, these our next generation trend that we are coming today with a dedicated DSP and algorithms to support this going on forward and again this is in addition, it was not, it will not be bundled with our stuff, the royalty will be on top of what we are collecting in the baseband and the audio.

John Ahn – JPMorgan

Okay, great. Thank you. And anybody in the audience have any questions? Okay. And we'll just kind of move on here, okay, just kind of quick, I'm sorry about that.

Question-and-Answer Session

Unidentified Analyst

In terms of your market share on 3G side, where is that vis-à-vis Qualcomm, how has that changed over the last few years?

Gideon Wertheizer

We didn't formally came said this market share, still Qualcomm is – has the largest share, but we are consistently, I should say, consistently increasing the share. And going forward, we will have a majority of that, that's what we believe.

John Ahn – JPMorgan

Okay, great, anything else? Okay. How about some – talked a little bit more, I mean, you've talked about some of the end products that you can see your technology in, but where are some of your top licensees that you can talk about?

Gideon Wertheizer

In terms of top licensees, if you take the baseband space today, the market is consolidated, I mean through the year, it was consolidated, but 4 out of the largest 6 companies baseband company using CEVA. And they use CEVA in all their products. So, it’s Infineon, it's Broadcom, it’s a (indiscernible) on its spread room. Qualcomm and the MediaTek are not using our products anymore. We did have managed to penetrate those so far.

John Ahn – JPMorgan

Okay, second row?

Unidentified Analyst

Do you think it's possible for LTE license for a customer already doing its DSP like Qualcomm or MediaTek to move to your LTE DSP with the time, it maybe better in term of cost for the MR?

Gideon Wertheizer

Yeah, that’s a good question and thank you for asking it, because it's highlight something that I should highlight. When you move from 3G to LTE, there is a significant barrier – technology barrier that you have to cross. And there are two aspects for it. Number one, the LTE technology is significantly more complicate than the 3G. With the 3G, you get 21-megabit maybe 21 to 40-megabit per second. When you go to LTE, the staring point is 400-megabit per second. So, you have to do in due DSP for this purpose. That’s one thing.

The other thing is the legacy. Every LTE phone has to support 3G has to support CDMA bear in mind that you have different flavor of LTE, you have the LTE that goes to the U.S. which is called FD-LTE and if the one that goes to China is called TD, I am not talking about different spectrum, it becomes complex. So, the approach that we did with the LTE is that we define the new architecture that support what is called SDR. SDR will stand for software defined radio meaning that you can do this LTE, but if you can offline or in real time you can replace the software and support 3G and 2G and wideband CDMA or HSPA and all these different flavor of the standard. And when you do this roaming, so more automatically it does and you do it one DSP.

Without going too much is specific as far as we know the incumbents in DSP companies that in the past they designed their own DSP, do not have and decided not to start doing a DSP for LTE purposes. They are not doing it. So, we are in a position that we have something that customers that don’t have our technology are not aiming to do similar things. And I explain it why? If you are a smartphone company, let's take Broadcom, let's take Qualcomm, you have to deal with so many things. You have to take the leading-edge ARM you have to have the leading-edge GPU. You have to integrate the Android and Windows phones. You have to integrate connectivity. You have to integrate NFC.

You cannot do – you have to be first of all a good integrator of IP. You cannot do an integrator and have – and develop your own IP. It's huge amount of line – huge amount of effort, huge amount of money that you need to invest. It's much easier to come to a company like CEVA that we are expert in DSP we are not aiming to do anything else. This is what we do. This is what we do. In the last, we did it last 20 years and you can analyze it will be much cheaper. And in fact what we see that the licensing grade, the amount of licensing deals that we are singing for royalty is much bigger than we sign when we had this DSP for 3G. So, people are coming to us for royalty to more extent than in the 3G. So, and there is – and that’s what encourage us, because that's put us in a position that we know that people that use in-house technology do not have the similar DSP and we know that we can offer this to them.

John Ahn – JPMorgan

Okay, great. Just kind of maybe getting down to little bit more details about your company in terms of your license agreements, what – per license agreement, what is a typical dollar value or and then also getting down to what are your CEVA content for example cell phone?

Gideon Wertheizer

Yeah. First of all, the license arrangement that we have, we have two models, we have what is called single use where we allow our customer to use the product to use the DSP for one chip and this is called single use. And then we have the multiple use work, we give to the customer permission to do multiple use, multiple chips using the same DSP. Of course, the single use is lot cheaper and multiple use is few million dollars, single-use could be few hundred dollars depending whether it's the most advanced DSP or the mid-range DSP, we have different categories of DSP. So, that’s the business model. Now, what was the second question I forgot?

John Ahn – JPMorgan

I was just kind of curious about what is your typical handset dollar content for CEVA, I mean is it $0.10, is it a $1 per….

Gideon Wertheizer

The royalty.

John Ahn – JPMorgan

Right.

Gideon Wertheizer

It depends on the DSP sale depend of the standard, but we generally comment that in 2G is around $0.02, 3G is between $0.04 to $0.06 and when you go to LTE it's above $0.10.

John Ahn – JPMorgan

You said it's above $0.12.

Gideon Wertheizer

Above $0.10.

John Ahn – JPMorgan

Above $0.10, okay, okay, right. Any other questions out there? Okay, well, let's see, one more question and I guess kind of still going down into the basics everything, I mean so, your typical license agreement just kind of curious about how long is your license agreement usually (wrong for), I mean, you kind of talked about that usually takes about 18 to 24 months between the signing and then you're seeing some volume production?

Gideon Wertheizer

Production.

John Ahn – JPMorgan

So then you compose the royalty portion of that, I mean how long is this license usually lasts, I mean, do we also what we are better, you have to get a new license agreement?

Gideon Wertheizer

The lifecycle of product in the communication side is pretty long and that’s one thing. The other thing is the retention of customers. When customer developed a product and it has its own software, it becomes legacy software. The customer turned to come back to us and get the next new generation DSP because it's compatible in the software and it can maintain all its investments and thing like this. We – I would that 90% of our customers and we saw – we have 200 reach out how many deals, 200 deals that we saw in licensing, 300. I would say 90% of them are repeated customers.

John Ahn – JPMorgan

That's good. So, as always right about out of time. And unless you have any other questions you might have one minute left to fit it in. In the audience anybody wants, please. Okay. I think we'll just wrap it up Gideon.

Gideon Wertheizer – Chief Executive Officer

Okay, thank you.

John Ahn – JPMorgan

Okay, thank you very much, Gideon.

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