CEVA 17Q3

CEVA, Inc. (NASDAQ:CEVA) Q3 2017 Results Earnings Conference Call November 1, 2017 8:30 AM ET

Executives

Richard Kingston - VP, Market Intelligence, Investor & Public Relations

Gideon Wertheizer - Chief Executive Officer

Yaniv Arieli - Chief Financial Officer

Analysts

Gary Mobley - Benchmark

Matthew Ramsay - Canaccord Genuity

Suji Desilva - ROTH Capital

Operator

Good morning, and welcome to the CEVA, Incorporated, Third Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Richard Kingston. Please go ahead.

Richard Kingston

Thank you. Good morning, everyone, and welcome to CEVA's third quarter 2017 earnings conference call. I'm joined today by Gideon Wertheizer, Chief Executive Officer of CEVA; and Yaniv Arieli, Chief Financial Officer of CEVA. Gideon will cover the business aspects and highlights from the quarter and provide general qualitative data. Yaniv will then cover the financial results for the third quarter and provide fourth quarter and full-year guidance for 2017.

I will start with the forward-looking statements. 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. These forward-looking statements include our financial guidance for the fourth quarter and full-year 2017, optimism about the license in pipeline and our product portfolio, anticipated licensing opportunities and potential royalty revenue and trends relating to 5G and LTE IoT, projected customer ramp up schedules and optimism about the success of growth in the non-handset space.

The risks, uncertainties and assumptions include the ability of the CEVA signal processing IPs for smarter connected devices to continue to be strong growth drivers for us; our success in penetrating new markets, specifically non-baseband markets, and maintaining our market position in existing markets; the ability of new products incorporating our technologies to achieve market acceptance; the speed and extent of the expansion of the LTE and 5G networks, LTE IoT and IoT space generally, our ability to execute more broad portfolio license agreements, customer ramp-up schedules and the impacts on royalty revenues, the effect of intense industry competition and consolidation, global chip market trends and general market conditions; and other risks relating to our business, including, but not limited to those that are described from time to time in our SEC filings. CEVA assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates.

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

Gideon Wertheizer

Thank you, Richard, and welcome, everyone. Our third quarter financial results dramatically exceeded our expectations driven by record licensing revenue and activities. The quarter-over-quarter [indiscernible] are experiencing favorable licensing revenue as customers are increasingly placing our vehicle radio in our platform based strategy which offers holistic solutions to highly entry level of technologies in particular 5G in your networks in short range wireless.

Revenue for the third quarter came in at record high of $24 million significantly higher than our guidance and up 35% year-over-year. Licensing and related revenue was also an all time record high at $14 million up 88% year-over-year. GAAP and non-GAAP net income and non-GAAP EPS also set company records. During the third quarter we completed 8 deals of which 2 were for our DSP cores and platform, and for our connectivity IPs. All of the deals were for non-handset baseband applications and 3 [ph] were for first time customers.

Customer target markets for the licenses completed in the quarter were 5G base stations, surveillance, industrial and consumer IoTs. On royalties, revenue came in at $10 million down 4% year-over-year this year versus last year [indiscernible] from seasonal weakness in the smartphone market. This was however partially offset by new shipments of our non-handset baseband segments primarily for base station chips and computer vision products within smartphones, action camera and 360 degrees camera.

Let me take the next few minutes to update you on recent market developments which we claim to capitalize on by leveraging our technology excellence and strong track record in cellular. Those developments present ongoing licensing opportunities and substantial royalty revenue potential as chips enabled our technologies reach mass production.

As much, the 3GPP which is the body in charge of cellular standardization decided to accelerate demands for finalizing the 5G new radio standards towards the end of 2017. This paves the way for 5G to us as early as 2018 following the commercial products in 2019. One week ahead of what was originally claimed 5G is a disruptive technology [indiscernible] for multiple new services and products a non-[indiscernible] high definition video streaming un-detailed or virtual reality organization [indiscernible] autonomous driving, AI and more. 5G will also be the key enabler for industry 4.0 initiatives for which machines and structural dimensions will be revolutionized by using AI algorithms as variables in the cloud that will be accessible through fast and reliable 5G network.

These substantial opportunities drives governments and wireless carriers to expedite investments and regulation for 5G. In June the Chinese Government announced that it will invest over $400 billion in 5G deployment over the next 10 years. In the U.S. the FCC has been working to free up minimal [indiscernible] spectrums for carriers to enable faster 5G network. [Indiscernible] Verizon and AT&T have announced 5G services in 28 and 29 gigahertz spectrum for the last mile delivery, which enable a much cheaper alternative to non-broadband internet services compared to fiber routing [ph].

We are planning a commercial 5G network in time for the 2018 Winter Olympics. Last, the approval of the Department of Justice on the pending acquisition of Time Warner by AT&T and Verizon acquisitions of AOL and Yahoo set the stage for radio surveillance services over 5G. [Indiscernible] DSO platform [indiscernible] is already being licensed to be out of the top 5 base station OEMs who are intensively working on in-house chip solutions for 5G. They are also making progress with few other key players in this space which we have not had business relationships with in the past.

Furthermore a number of customers desiring 5G mobile broadband chip for smartphone and home routers based on our CEVA X and XC platform. 5G is a technology breakthrough requiring new expertise in product offerings. We foresaw this and invested ahead of the market enabling us to offer our customer a head start as the 5G market takes over.

In addition, recent market acceleration sees LTE IoT. For a region of [indiscernible] standout significant targets for low power, low data for IoT applications. According to recent report from GSMA by 2026 as many as 308 billion [indiscernible] IoT connections will be in operation for applications such as smart meter, smart cities, shared by agriculture and more.

China Mobile is leading the pace aiming to invest $6 billion in the next two years. The pension of the proliferation of LTE IoT based chip in applications we are taking significant steps with our technologies to reduce the entry barrier for many semiconductor companies who have no prior experience in cellular and are looking to benefit from this sizable and the low fee price market.

In [indiscernible] we have recently expanded our partnership with [indiscernible] a reputable other than [indiscernible] analog [indiscernible] service and food company. [Indiscernible] is a one-stop-shop for complete European low band IoT solutions. China [indiscernible] formally known as [indiscernible] Microelectronics with over the launch there was a [indiscernible] 71,000 personal bank IoT [indiscernible] based around CEVA Inc.'s IoT [indiscernible]. This chip is expected to be high volume production here in the United States.

Moving towards the third quarter royalty revenue reflects a soft smartphone market with what appears to be combination of transformation in the high growth Indian smartphone market where entry penetration is still small and push out of stock deal flagship [indiscernible]. We however were encouraged by the growing shipments of base station, base bed and vision products in smartphone and camera which partially offset the decline in the handset royalty revenue.

Before I close, I am very pleased with our one time high licensing performance and profitability in the third quarter on the back of stellar first half of the year. We are extremely excited about the recent licensing revenue driven by lucrative opportunities in 5G and the IoT in your networks, Wi-Fi, Bluetooth and both. In fact this licensing momentum goes far beyond the initial revenue from this fee. This momentum presents significant future royalty revenue potential for those extremely sizable markets.

That said let me turn the call over to Yaniv for the financials and the guidance.

Yaniv Arieli

Thank you, Gideon. I'll start by reviewing the results of our operations for the third quarter of 2017. Revenue for the third quarter was an all time record high of $25.6 million, up 35% on a yearly basis. The revenue breakdown is as follows. Licensing and related revenue was approximately $14 million, representing 58% of our total revenue 88% higher as compared to the third quarter of 2016 second sequential record high.

Royalty revenue was $10 million, reflecting 42% of our total revenue and 4% lower on a year-over-year basis. Gross margins were 93% on both U.S. GAAP and non-GAAP basis. Our non-GAAP quarterly gross margin excluded approximately $0.1 of equity based compensation expenses.

Total operating expenses for the third quarter were just over the mid range of our guidance at $16.1 million. OpEx also included an aggregated equity-based compensation expense of approximately $2.1 million and $0.3 million for the amortization of acquired intangibles of RivieraWaves. Total operating expenses for the third quarter excluding these two items were $13.7 million, just over the mid range of our guidance.

U.S. GAAP net income and diluted EPS for the quarter both increased dramatically by 73% to $5.8 million and to $0.26 per share respectively third quarter of last year. U.S. GAAP net income also reached an all time record high. Non-GAAP net income and diluted EPS for the third quarter both reached an all time record high and increased 59% and 50% year-over-year to $8.3 million and $0.36 per share. Those figures exclude equity-based compensation expenses, net of taxes of $2.1 million, and the impact of amortization of acquired intangibles of RivieraWaves of $0.3 million.

Other related data. Shipped units by CEVA licensees during the third quarter of 2017 were 250 million, down 7% and 10% sequentially and from the third quarter reported shipments in the last year respectively. 250 million units shipped 189 million or 76% were for handset baseband chips, reflecting a sequential increase of 16% from 220 million units in handset baseband chips shipped during the second quarter of 2017, 16% [ph] decrease from 2080 [ph] million units shipped a year ago.

Non-handset baseband, volume shipments continued to increase about 30% sequentially and 3% on a year-over-year basis. The sequential decrease is due to higher [indiscernible] Bluetooth, vision and base station shipments. From a revenue perspective, third quarter non-baseband royalty revenue increased sequentially strong double-digits with volume increase and on a year-over-year basis approximately doubled contributing approximately $2 million of royalty revenue in the quarter.

Next on the balance sheet items. As of September CEVA's cash, cash equivalents, balances, marketable securities and bank deposits grew to over $178 million. Our DSOs for the third quarter were 49 days compared to the prior quarter of 46 days. During the third quarter we generated $7.1 million of net cash from operations. Depreciation was $0.5 million, and purchase of fixed assets were $1.1 million mainly due to new software accumulation. End of September 2017 our headcount was 306 people, of which 246 were engineers.

Now for our guidance, licensing has demonstrated throughout this year, we experienced good interest for out technologies. Also we expect the acceleration in 5G spend [indiscernible] and the proliferation of LTE IoT to create demand on our cellular solution. As such we are once again raising our annual licensing target the third time this year from approximately $32 million last year to a new annual target of just $43 million for 2017 representing over 35% annual growth.

Royalty after a soft third quarter in the handset space we expect sequential increase in the fourth quarter in both the handset baseband non-handset based products. Overall this will enable us to record a new all time annual royalty revenue of over $43 million or approximately 7% annual growth.

Our guidance for the fourth quarter of 2017 is as follows. Revenue for the fourth quarter is expected to be in the range of $20.5 million to $21.5 million. Gross margin is expected to be approximately 90% on GAAP basis and 91% on non-GAAP basis. This excludes an aggregate $0.1 million of equity based compensation expense.

Gross margins plan for the quarter are a bit lower than the norm due to the cost of good expenses associated with our new partnership in the narrow band IoT space. Overall OpEx should be similar to the third quarter. Q4 OpEx is expected to be in the range of $15.6 million to $16.6 million.

Our anticipated total operating expenses for the fourth quarter of $2.4 million expected to be attributed to equity based compensation expenses and $0.3 million to the amortization of acquired intangibles. Therefore our non-GAAP operating expense is expected to be slightly lower than the third quarter we just reported and in the range of $13 million to $14 million. And interest income is expected to about $0.75 million, tax rate for the fourth quarter similar to the third quarter actual levels on GAAP basis 17% and on non-GAAP basis 13%.

Share count for the fourth quarter is expected to be about 23 million shares and that will bring us to U.S. GAAP fully diluted earnings per share is expected to be in the range of $0.12 to $0.14. In non-GAAP EPS is forecast equity based compensation expenses and amortization is expected to be in the range of $0.23 to $0.25 per share. For the full year revenues are forecast to be in the highest level in the company’s history and just shy of $87 million and a non-GAAP fully diluted EPS of approximately $1.16 which represents over 20% year-over-year growth.

Operator, we can now open the Q&A session please.

Question-and-Answer Session

Operator

Okay. [Operator Instructions] Our first question comes from Gary Mobley with Benchmark. Please go ahead.

Gary Mobley

Okay, congratulations on a strong third quarter licensing number. It is as a play clarification, did you say base station SoC royalty dollars in the just reported quarter were $2 million?

Yaniv Arieli

Not just the base station, but all the non-handset it was royalties worth $2 million which is double than where we were a year ago.

Gary Mobley

What contribution are you now seeing, was seen on the base station front and is that from just one royalty contributor of the two so far?

Yaniv Arieli

It’s initial ramp ups and I think we said in the past that we are still sort of studying and learning as we go the timing, the magnitude, the ramp up of this and it's one customer for now and it started at least like two quarters ago, our first reports and then and its continuing. So we still don’t know the full effect and the full growth opportunity, but there is no doubt this is a very large market opportunity both for our C9 [ph] our customers which are gaining market share from free scale TIs of the world that have dominated this space.

Gideon Wertheizer

This is Gideon, one more thing to add to what Yaniv said was the quarter [indiscernible], the base station [indiscernible] quarter ago and last quarter we have seen another view or another chip that went into products.

Gary Mobley

Okay, what were the LTE royalty units in the quarter?

Yaniv Arieli

Gary, we didn’t hear the question.

Gary Mobley

What were the LTE royalty units in the quarter?

Yaniv Arieli

A $66 million. One thing to remember back on the base station we signed another deal with a new customer on the base station front this last quarter. So that’s of course no royalties yet, but another deal this is the third out of five big players that we could enabling their solutions.

Gideon Wertheizer

All these three base station deals are for 5G.

Gary Mobley

Okay, one last question I want to address related to the licensing front. So I’m curious to know what drove the average deal size up? Presumably it was up substantially since you had only 8 license deals versus 13 last quarter and obviously a big sequential increase in revenue, but as your deferred revenue went up sequentially is the main source of backlog and so point questions are, what drove the average deal size increase and why are you expecting a low in licensing revenue on what has been a pretty stellar fiscal year 2017?

Yaniv Arieli

Good question and I’ll start to help you out. We always explain from time to time that it’s not right to think the licensing revenue and divided by the number of deals because not necessarily you are able to recognize all the deals that you signed within the quarter. We are reporting deals that were signed. It’s not necessarily the deal that you recognized.

In the last two quarters if you recall we have increased our backlog last quarter we reached all time record high in backlog and that backlog we were able to pull it in into Q3 because of the methodology [ph] investments and that we have to deliver by the end of the quarter to significant customer a big piece of it people technology and assuming we have done that we were able to release the backlog.

So the backlog is not necessarily deferred revenue. It depends if they have paid or not, but more importantly and the fact that in the last two quarters we signed deals not necessarily recorded or recognized all of them and two very large deals were delivered and fully executed from an R&D point of view from a delivered point of view in Q3 and that’s what pulled in revenue may be from Q4 for future quarters because we were able to get the work done.

Gary Mobley

Let me ask a follow up to that, so then is the backlog down substantially on the sequential basis and how would you characterize the overall license pipeline?

Gideon Wertheizer

We didn’t say that the backlog went down substantially. Let me give you the context of what is referred to backlog. This is in connection to whether I said about the 5G. People are rushing to go into the 5G and we will ask the customers to deliver technology in Q4 we will ask to expedite deliver it and that's the reason if you recognize out of this, the licensing and I think I’ve said it in the [indiscernible] looks very good not just in the 5G space but also [indiscernible] region in the case of total products to reach change in this regard. It was that backlog, that large backlog – from customization, that we finish it and deliver it and the customer can go ahead.

Yaniv Arieli

Does the actual backlog at the end of the third quarter is lower of course than the second quarter because of that. But back to the other part of your second question the Q4 guidance for licensing were back to normal. I mean this was a nice add on, hopefully we could add more like this in the future, but I think we’re looking at the same level in the Q1, $9 million to $10 million that we started the year with and we've seen quite a few achievements around that. So there is like business, normal business nothing is wrong. We didn’t take the licensing down for the next quarter because this Q4 was much higher than that, but on the contrary we're back to the normal level although we had a very good quarter and this was the reason that we have taken the annual licensing revenue up from $40 million a few months ago to north of $43 million, that’s the reason.

Gary Mobley

All right, from me, thanks guys.

Operator

The next question comes from Matt Ramsay with Canaccord Genuity. Please go ahead.

Matthew Ramsay

Thank you very much. I appreciate you taking my questions. I guess the first question I would ask then and congratulations on add the third base station player into the licensing mix, Gideon may be you could talk a little bit about in aggregate what percentage of the I guess 4.9 or 5G base station roll out volumes you guys are anticipating being represented by CEVA based silicon in the base station modems from the aggregate of those three, three big players that you now have, just so we can get an idea of context as to what it means for your business as the 5G business rolls out?

Gideon Wertheizer

Thanks. I don’t want to be specific on what would be the percentage, but you can say that for me. Thanks to 5G the landscape and in the ranking of who will be first, second and third is about to change because there are few companies that invested ahead and they have an advantage and this year landscape favors us. LTE we just stopped checking a few quarters ago inside a more – I said, I also said that we are seeing another chip, another skew that just came out award we shipped in this quarter, yes we have few more quarters. We better see the trend and the – back on the call.

Matthew Ramsay

Thanks guys. Sorry I think I’m having some audio issues on my end, but thank you for that Gideon. And follow up there on the licensing side, Yaniv may be you could talk about expectations for next year, I know its early, but this year was obviously great organic performance in licensing business and had an couple of one time big bumps, so like how should we think about licensing business in aggregate for 2018 and the run rate going forward? Thanks.

Yaniv Arieli

Yes, what we have seen this year is these new technologies, new markets they only managed to open up much bigger opportunities for us to license our technology and to offer our technology in multiple markets, multiple customers in each of these markets and the licensing activity has paid off. Our R&D investments have paid off and we have seen that in the licensing line. As you said, it’s a bit early next quarter and general earnings call we will give much more detail there, guidance on licensing. But I think we said already throughout the year that we would like to keep the types of the 40-ish type of licensing revenue most of the 30^, that we were for the last couple of years before 2017.

So where exactly we end up and how we will guide and what will be the input we need to do a little bit of research and talk with our customers and the potential ones and new ones and each of these markets we will try to prepare and get you a good answer in few months. But there is no doubt that we’re seeing more interest and we will want a few deals, higher numbers as part of our model going forward.

Matthew Ramsay

Got it. And just let me squeeze one more in Gideon, the 3G number in terms of baseband unit shipments in the royalty businesses declined pretty sharply and I think market is certainly moving to 4G quickly, but I guess a couple of quarters ago Samsung brought and Midia Tech as the supplier in that mid tier range and a few bumps in the row potentially for spectrum. So I just wanted to, maybe you could talk us through a look bit about how that 2G, 3G combined base of your royalty business in terms of unit shipments with partners might go from here or potentially stabilize or just how those trends are in the mid year? Thank you guys, I appreciate the questions.

Gideon Wertheizer

I gave you a little bit about 3G is something like in between – and the 2G and LTE, so the 2G has still life in particularly in India and you mentioned probably into feature phone which is in. In terms of growth today and too big flagship is have in India and emerging markets and then particular of these the penetration rate is very low, it’s a transition that’s the reason that we had, we say some softness in the second quarter which we spread that it doesn’t look like an industrial issue or market issue.

It is more like a transition to go to a good price for assuming to do some work in this price point I think and this will take, the spread will be flowish [ph] and potential is there, now the question is the pace how fast India will move through LTE and they will move to LTE and [indiscernible] all the emerging markets they are is good billions of subscribers that are about to upgrade. We will be there big time.

Matthew Ramsay

Thank you.

Yaniv Arieli

Thank you.

Operator

Your next question comes from Suji Desilva with ROTH Capital. Please go ahead.

Suji Desilva

Hi, Gideon, hi Yaniv. Congratulations on the strong licensing progress here. Thanks for breaking out the non-base standard, I mean it is helpful royalty revenue came at 20% and grew nicely last three quarters. May be I wanted to, you can talk about what the expectation of mix would be, I know there are a lot of moving parts in the royalty with the baseband smartphone and the non-baseband several segments, but could you handicap for us what you think the non-baseband percent might be as we look out 4 to 8 quarters or so?

Yaniv Arieli

Sure and I mean sure, it's not easy, but we've promised you guys that probably early next week we’ll update our three, yes next year not next week, we'll update the same as three-year or four-year expectation and volume and may be even the dollars and royalties, this is what we had put in place back in 2015 when we started this diversification and looked at the four-year from beginning of 2015 till the end of say 2018 and wanted to see and paying and print out how we see these markets evolving for us.

Some numbers were hitting, some may be not on the volume side and some are doing very well may be but slower. Two years ago when we started we were less than 40 million units a year and we are up to may be 200 million two and a half years after. And this is the run rate for the end of more or less the end of this year. So we’re seeing a lot of these markets start to build in. There is no doubt that this in the past for many, many years 90% of our royalties came from handsets. This last quarter was the first time that that 10% grew to 20%.

And of course we want to see it. We want to be, we want to be in a position that non-baseband is as big as the handset size. It’s not even potentially bigger, is all these design wins that we’re seeing and the licensing activities will flourish in three or four years down the road. So again I don’t have the full future how that slide yet will look like, but all our licensing activity now our customers are eager to get into production, are eager to sell the new chips into the new markets.

I'm not sure if we mentioned it yet, but in the prepared remarks, but in the last quarter we saw two consumer devices go into production for the first time with our solutions inside, one in the vision, one in the - another consumer device and the more we continue to see them then we'll have a better picture of how those royalties will look like for sure it’s evident. We don’t want to say 10% or 20% but much, much larger.

Gideon Wertheizer

The non-handset base what we call non-handset baseband frequent markets and has declined into cellular and cellular we did this major a customer and the sales – again it go from zero to 110. [indiscernible] contribution of and its more companies that are guessing and because we are the licensing that we see it [indiscernible] all of them are more or less getting into – mentioned last quarter the royalty payers from the only non-handset baseband started to ship and we tried to introduce one of newest skew in the base station this against [indiscernible] quarter to see how far, how much you need to a get to a point to the full swing point and then we'll be able to be more specific.

Suji Desilva

Yes, hello, Sorry, and then on the licensing effort, you talked about some customers expediting it this past quarter? Can you talk about what end markets and products those customers were targeting, what whether the rush to get into that you saw this quarter?

Gideon Wertheizer

The contribution of the license revenue in the quarter is basically two components, one is licensing revenues that we saw, [indiscernible] improving both delivery to a customer, I mentioned that we see expedition in the 2 million of [indiscernible] and we will ask for 2 million and in our R&D - in expediting the [indiscernible] we could recognize this or that licensing business.

Suji Desilva

Yes okay, thanks guys.

Operator

[Operator Instructions] At this time, this concludes our question-and-answer session. I would like to turn the conference back over to Richard Kingston for any closing remarks.

Richard Kingston

Thank you and thank you all for joining us today and for your continued interest in and support of CEVA. We will be attending the following upcoming events and invite you to meet us there and get an update. The ROTH Technology Corporate Access Day on November 15 in New York, Exane BNP Paribas Mid Cap Forum on November 29 in London, and Barclays Global Technology, Media and Telecommunications Conference on December 6 in San Francisco. Please visit the investor section of our website for further information on these events and other events that we will be attending. Thank you all and good bye.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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