Summary of CEVA INC - Yahoo! Finance

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion together with the unaudited financial statements and related notes appearing elsewhere in this quarterly report. This discussion contains forward-looking statements that involve risks and uncertainties. Any or all of our forward-looking statements in this quarterly report may turn out to be wrong. These forward-looking statements can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. Factors which could cause actual results to differ materially include those set forth under in Part II - Item 1A - "Risk Factors," as well as those discussed elsewhere in this quarterly report. See "Forward-Looking Statements."
BUSINESS OVERVIEW
The financial information presented in this quarterly report includes the results of CEVA, Inc. and its subsidiaries. CEVA is the leading licensor of DSP cores. Our technologies are widely licensed and power some of the world's leading handset and consumer electronics semiconductor companies. In 2007, our licensees shipped over 227 million CEVA-powered chipsets, an increase of 19% over 2006 shipments of 190 million chipsets. In 2008, analyst firm Gartner Inc. reported CEVA's share of the licensable DSP market for 2007 was 61%, 10% higher than 2006.
Our revenue mix contains IP licensing fees, per unit and prepaid royalties and other revenues. Prepaid royalties are recognized under the licensing revenue line. Other revenues include revenues from maintenance, support, training and sale of development systems. We have built a strong customer base which relies on our technology to deploy their silicon solutions. We license our technology as intellectual property (IP) to semiconductor companies who manufacture, market and sell DSP application-specific integrated circuits ("ASICs") and application-specific standard products ("ASSPs") based on CEVA technologies to systems original equipment manufacturer (OEM) companies for incorporation into a wide variety of end products. Our IP is primarily deployed in high volume markets, including handsets (e.g. ultra-low-cost phones, multimedia phones and smart phones), notebooks, mobile Internet devices, portable multimedia (e.g. portable video players, MobileTVs, personal navigation devices and MP3/MP4 players), home entertainment (e.g. DVD/HD DVD/Blu-ray players, game consoles, set-top boxes and Digital TVs), storage (e.g. hard disk drives and Solid Storage Devices (SSD)) and telecommunication devices (e.g. residential gateways, femto cells, VoIP phones and network infrastructure).
Given the technological complexity of DSP-based applications, there are increased requirements to supplement the basic DSP core IP with additional technologies in the form of integrated application-specific hardware peripherals and software components. Therefore, we believe there is an industry shift towards licensing DSP technology from third party IP providers as opposed to developing it in-house, due to the design cycle time constantly shortening and the cost of ownership and maintenance of such architectures. In order to grow our business by capitalizing on this industry shift, we introduced in the last few years the MobileMedia and CEVA-Audio product lines aimed at the growing video and audio penetration into handset devices, CEVA-VoP for the growing use of VoIP in broadband networks and wireless phones, CEVA-Bluetooth for handset, headset and mobile devices and CEVA-SATA for the growing market for Solid State Drives (SSD) and set-top boxes. Also, in recognition of the need for high performance, scalable architectures for emerging applications such as fourth generation cellular (also referred to as WiMax or LTE) and Standard Definition Video, we introduced a new DSP architecture, the CEVA-X DSP with three new cores CEVA-X1620, CEVA-X1622 and CEVA-X1641. We believe that the growing demand for highly integrated, licensable application platforms incorporating DSP cores and the necessary hardware and software for their target applications will drive demand for our technology. In view of the current market trends, our planned future products are targeted at next generation handset and multimedia devices. We believe that our future solutions will provide the desired flexibility needed for the always-connected Internet trend. We also believe that our introduction of additional technologies, such as high performance DSP cores for the fourth generation handset, and high definition audio and video, will contribute to our growth in future periods. However, our ability to introduce new products and expand into new markets may not occur and may require us to substantially increase our operating expenses. We cannot provide any assurances that our planned features will achieve market acceptance, and allow us to maintain our market share or provide for our future growth.
Moreover, our business operates in a highly competitive environment. Competition has historically increased pricing pressures for our products and decreased our average selling prices. In order to penetrate new markets and maintain our market share with our existing products, we may need to offer our products in the future at lower prices which may result in lower profits. Our future growth is dependent not only on the continued success of our existing products but also the successful introduction of new products. We also must continue to monitor and control our operating costs and to maintain our current level of gross margin in order to offset any future declines in shipment quantities of products based on our technologies or any future declines in any per-unit royalty rates. In addition, since our products are incorporated into end products of our OEM customers, our business is very dependent on our OEM customers' ability to achieve market acceptance of their end products in the handsets and consumer electronic markets, which are similarly very competitive.

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The ever-changing nature of the market also affects our continued business growth potential. For example, the success of our video products are highly dependent on the market adoption of new services and products, such as Mobile Internet, Internet Video, the migration from audio players to Personal Multimedia Players (PMP), as well the migration to digital TVs and set-top boxes with high definition audio. In addition, our business is affected by market conditions in developing markets, such as China, India and Brazil, where the penetration of ultra-low-cost (ULC) handsets in rural sites could generate future growth potential for our business.
Furthermore, the current general worldwide economic downturn has resulted in slower economic activity, concerns about inflation and deflation, decreased consumer confidence, reduced corporate profits and capital spending, adverse business conditions and liquidity concerns. We also operate primarily in the semiconductor industry, which is cyclical, and the recent worldwide economic downturn may result in a significant downturn of the semiconductor industry. These downturns are characterized by a decrease in product demand, excess customer inventories, and accelerated erosion of prices. These conditions make it extremely difficult for our customers, our vendors and us to accurately forecast and plan future business activities, and could cause reduced spending on our products and services. In addition, our royalty revenues currently are primarily generated from sales of chipsets used in handsets and consumer electronics equipment, the demand for which may be adversely affected by decreased consumer confidence and spending. Therefore, the worldwide economic downturn and specifically the volatility in the semiconductor industry could seriously impact our revenue and harm our business, financial condition and operating results. As a result, our past operating results should not be relied upon as an indication of future performance.
RESULTS OF OPERATIONS
Total Revenues
Total revenues increased 17% and 22% for the third quarter and first nine months of 2008, respectively, compared to the corresponding periods in 2007. These increases reflected higher licensing revenues from our technology product lines and significantly higher royalty revenues. The five largest customers accounted for 70% and 53% of total revenues for the third quarter and first nine months of 2008, respectively, as compared to 64% and 55% for the comparable periods of 2007.
Three customers accounted for 14%, 26% and 14% of total revenues for the third quarter of 2008, as compared to two customers that accounted for 30% and 17% of total revenues for the third quarter of 2007. One customer accounted for 20% of total revenues for the first nine months of 2008, as compared to two customers that accounted for 13% and 19% of total revenues for the first nine months of 2007. Because of the nature of our license agreements and the associated large initial payments due, the identity of major customers generally varies from quarter to quarter.
We generate our revenues from licensing our technology, which in certain circumstances is modified to customer-specific requirements. Revenues from license fees that involve customization of our technology to customer specifications are recognized in accordance with Statement of Position ("SOP") 81-1, "Accounting for Performance of Construction-Type and Certain Production-Type Contracts." We account for all of our other IP license revenues and related services in accordance with SOP 97-2, "Software Revenue Recognition," as amended.
We generate royalties from our licensing activities in two manners: royalties paid by our customers during the period in which they ship units of chipsets incorporating our technology, which we refer to as per unit royalties, and royalties which are paid in a lump sum and in advance to cover a fixed number of future unit shipments, which we refer to as prepaid royalties. In either case, these royalties are non-refundable payments and are recognized when payment becomes due, provided no future obligation exists. Prepaid royalties are recognized under our licensing revenue line and accounted for 0% and 23% of total revenues for the third quarter of 2008 and 2007, respectively, and 4% and 21% of total revenues for the first nine months of 2008 and 2007, respectively. Only royalty revenue from customers who are paying as they ship units of chipsets incorporating our technology is recognized in our royalty revenue line. These per unit royalties are invoiced and recognized on a quarterly basis in arrears as we receive quarterly shipment reports from our licensees. Licensing Revenues
Licensing revenues were $6.0 and $17.1 million for the third quarter and first nine months of 2008, respectively, an increase of 12% and 10% from the third quarter and first nine months of 2007. The increase in licensing revenues for the third quarter of 2008 as compared to the corresponding period of 2007 resulted mainly from licensing revenue received pursuant to our agreement with u-blox AG to resolve a license dispute, partially offset by lower revenues from our CEVA-X IP DSP core. The increase in licensing revenues for the first nine months of 2008 as compared to the corresponding period of 2007 resulted mainly from the u-blox AG agreement mentioned above.

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Licensing revenues accounted for 59% and 56% of our total revenues for the third quarter and first nine months of 2008, compared to 61% and 62% for the comparable periods of 2007. During the third quarter of 2008, we signed six new license agreements. Five agreements were for CEVA DSP cores and platforms, and one agreement was for our communication technology. Target applications for customer deployment are 3.5G, LTE modems, femto cells and consumer electronics. Geographically, three of the six deals signed were in Europe, while two were in the U.S. and one was in the Asia Pacific region. Royalty Revenues
Royalty revenues were $3.3 and $10.1 million for the third quarter and first nine months of 2008, respectively, an increase of 51% and 66% from the third quarter and first nine months of 2007, respectively. Royalty revenues accounted for 32% and 33% of our total revenues for the third quarter and first nine months of 2008, compared to 25% and 24% for the comparable periods of 2007. The increase in royalty revenues for the third quarter and first nine months of 2008, as compared to the corresponding periods of 2007, reflected increased unit shipments and market share expansion in 3G and 2G handset markets. This increase was mainly due to a substantial production ramp-up by one of our customers in the handset market, an increase in unit shipments of our other customers' products incorporating our technology and an increase in the average royalty rate per unit. Our per unit and prepaid royalty customers reported aggregate sales of 72 and 228 million units incorporating our technology for the third quarter and first nine months of 2008, respectively, compared to 55 and 141 million units for the comparable periods of 2007. Five largest customers paying per unit royalty accounted for 82% and 81% of total royalty revenues for the third quarter and first nine months of 2008, respectively, compared to 71% and 70% for the comparable periods of 2007.
We had 27 customers shipping units incorporating our technology during both the third quarter of 2008 and 2007. As of September 30, 2008, we had 21 per unit royalty customers and 6 prepaid royalty customers, compared to 20 per unit royalty customers and 7 prepaid royalty customers as of September 30, 2007. Other Revenues
Other revenues were $0.9 and $3.2 million for the third quarter and first nine months of 2008, respectively, a decrease of 24% and 7% from the third quarter and first nine months of 2007, respectively. The decrease in other revenues for the third quarter of 2008, as compared to the corresponding period of 2007, reflected lower support-related revenues and lower sales of development systems. The decrease in other revenues for the first nine months of 2008, as compared to the corresponding period of 2007, reflected lower sales of development systems, offset by higher support-related revenues. Other revenues accounted for 9% and 11% of our total revenues for the third quarter and first nine months of 2008, respectively, compared to 14% for both comparable periods of 2007. Other revenues include support and training for licensees and sale of development systems.
Geographic Revenue Analysis

                          Nine months                  Nine months                Third Quarter                Third Quarter
                              2008                        2007                        2008                         2007
                            (in millions, except percentages)                        (in millions, except percentages)
United States       $      4.5            15 %     $   6.5          26 %    $      2.4             24 %    $    1.3           15 %
Europe and
Middle East         $     15.2            50 %     $   9.5          38 %    $      5.5             54 %    $    4.3           49 %
Asia Pacific        $     10.7            35 %     $   9.0          36 %    $      2.3             22 %    $    3.1           36 %

Within the Europe and Middle East region, we derived approximately 86% of total revenues in that region from three countries and 90% of total revenues in that region from four countries, during the third quarter and first nine months of 2008, respectively, and 85% and 79% of total revenues in that region from three countries for the comparable periods of 2007. Within the Asian Pacific region, we derived approximately 96% and 89% of total revenues in that region from three countries during the third quarter and first nine months of 2008, respectively, and 84% and 90% of total revenues in that region from two countries and three countries, respectively, for the comparable periods of 2007. Due to the nature of our license agreements and the associated potential large individual contract amounts, the geographic split of revenues both in absolute and percentage terms generally varies from quarter to quarter.

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Investment in Other Company, Net
On June 23, 2006, we divested our GPS technology and associated business to a U.S. based company, GloNav Inc. ("GloNav") (for more information see Note 5 to the attached Notes to Condensed Consolidated Financial Statement for the quarter ended September 30, 2008).
In January 2008, we divested our equity investment in GloNav following GloNav's acquisition by NXP Semiconductors for an initial cash payment of $85 million, plus up to an additional $25 million in cash payable to all of GloNav's stockholders, contingent upon GloNav reaching certain revenue and product development milestones within two years of the acquisition. In February 2008, we received our portion of the initial cash payment, less 10% which is being held in escrow to satisfy indemnification claims and less our portion of certain fees and expenses incurred in connection with the transaction. After the deductions, our initial cash payment totaled $14.6 million. In March 2008, we received an additional payment of $0.5 million in connection with GloNav's achievement of its first product development milestone. In July 2008, we received an additional payment of $0.4 million in connection with GloNav's achievement of its second product development milestone. In total, we received $15.5 million during the first nine months of 2008. During the first nine months of 2008, we recorded a capital gain of $11.2 million from the divestment of our equity investment in GloNav (including the deferred gain of $1.75 million from the recognition of the deferred gain resulting from the divestment of the GPS technology and associated business to GloNav in June 2006, as detailed in Note 5 to the attached Notes to Condensed Consolidated Financial Statement for the quarter ended September 30, 2008), and a tax expense of $3.2 million related to such capital gains. Cost of Revenues
Cost of revenues were $1.1 and $3.5 million for the third quarter and first nine months of 2008, respectively, compared to $1.0 and $2.9 million for the comparable periods of 2007. The increase for the third quarter of 2008 principally reflected higher labor-related costs mainly due to the recruitment of additional employees for our support team. The increase for the first nine months of 2008 principally reflected (i) the execution of a larger number of license agreements with engineering customization requirements which increased cost of goods labor expenses during the first nine months of 2008, as compared to the corresponding period in 2007, (ii) higher royalty payback expenses paid to the Chief Scientist of Israel and (iii) higher labor-related costs mainly due to the recruitment of additional employees for our support team. Royalty payback expenses relate to royalties amounting to 3%-3.5% of the actual sales of certain of our products the development of which previously obtained grants from the Chief Scientist of Israel. Cost of revenues accounted for 11% and 12% of total revenues for the third quarter and first nine months of both 2008 and 2007, respectively. Included in cost of revenues for the third quarter and first nine months of 2008 was a non-cash stock compensation expense of $28,000 and $83,000, respectively, compared to $19,000 and $55,000 for the comparable periods of 2007.
Gross Margin
Gross margin for the third quarter and first nine months of both 2008 and 2007 were 89% and 88%, respectively. The increase in gross margin principally reflected higher royalty revenues which has higher gross margin, offset by an increase of cost of revenues.
Operating Expenses
Total operating expenses were $8.3 and $29.1 million for the third quarter and first nine months of 2008, respectively, compared to $7.7 and $22.9 million for the comparable periods of 2007. The net increase in total operating expenses for the third quarter of 2008 principally reflected higher salary and related cost, partially as a result of the devaluation of the U.S. dollar against the Euro and the Israeli NIS, higher commission expenses and higher non-cash equity-based compensation expenses, offset by an increase in research and development grants received from the Israeli and Irish governments. The net increase in total operating expenses for the first nine months of 2008 principally reflected a restructuring expense in the amount of $3.5 million, mainly as a result of the termination of the Harcourt property lease in Dublin, Ireland during the first quarter of 2008, as well as higher salary and related costs, partially as a result of the devaluation of the U.S. dollar against the Euro and the Israeli NIS, higher project-related expenses, higher commission expenses, higher professional services costs and higher non-cash equity-based compensation expenses, partially offset by an increase in research and development grants received from the Israeli and Irish governments.

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Research and Development Expenses, Net
Our research and development expenses, net were $4.8 and $15.1 million for the third quarter and first nine months of 2008, respectively, compared to $4.7 and $14.0 million for the comparable periods of 2007. The net increase for the third quarter of 2008 primarily reflected higher salary and related costs, mainly as a result of the devaluation of the U.S. dollar against the Euro and the Israeli NIS, offset by an increase in research and development grants received from the Israeli and Irish governments. The net increase for the first nine months of 2008 primarily reflected higher salary and related cost, mainly as a result of the devaluation of the U.S. dollar against the Euro and the Israeli NIS, higher project-related expenses and higher non-cash equity-based compensation expense, offset by an increase in research grants received from the Israeli and Irish governments. Included in research and development expenses for the third quarter and first nine months of 2008 was a non-cash equity-based compensation expense of $273,000 and $805,000, respectively, compared to $234,000 and $646,000 for the comparable periods of 2007. Research and development expenses as a percentage of total revenues decrease to 47% and 50% for the third quarter and first nine months of 2008, respectively, compared to 54% and 56% for the comparable periods of 2007.
The number of research and development personnel was 123 at September 30, 2008, compared to 135 at September 30, 2007.
Sales and Marketing Expenses
Our sales and marketing expenses were $1.8 and $5.4 million for the third quarter and first nine months of 2008, respectively, compared to $1.5 and $4.6 million for the comparable periods of 2007. The increase for the third quarter of 2008 primarily reflected higher salary and related costs and higher commission expenses. The increase for the first nine months of 2008 primarily reflected higher salary and related costs, higher commission expenses, as well as higher marketing expenses due to more marketing-related activities, mainly associated with trade shows and technology conferences in Asia, Europe and the US. Included in sales and marketing expenses for the third quarter and first nine months of 2008 was a non-cash equity-based compensation expense of $143,000 and $380,000, respectively, compared to $76,000 and $250,000 for the comparable periods of 2007. Sales and marketing expenses as a percentage of total revenues were 18% for both the third quarter and first nine months of 2008, respectively, compared to 17% and 19% for the comparable periods of 2007.
The total number of sales and marketing personnel was 19 at September 30, 2008, compared to 18 at September 30, 2007.
General and Administrative Expenses
Our general and administrative expenses were $1.7 and $5.0 million for the third quarter and first nine months of 2008, respectively, compared to $1.5 and $4.1 million for the comparable periods of 2007. The increase for the third quarter of 2008 primarily reflected higher higher non-cash equity-based compensation expenses. The increase for the first nine months of 2008 primarily reflected higher salary and related cost, higher professional services costs and higher non-cash equity-based compensation expenses. Included in general and administrative expenses for the third quarter and first nine months of 2008 was a non-cash equity-based compensation expense of $343,000 and $816,000, respectively, compared to $196,000 and $558,000 for the comparable periods of 2007. General and administrative expenses as a percentage of total revenues were 17% and 16% for the third quarter and first nine months of 2008, respectively, compared to 17% for both comparable periods of 2007.
The number of general and administrative personnel was 24 at September 30, 2008, compared to 25 at September 30, 2007.
Amortization of Other Intangibles
Our amortization charges were $12,000 and $53,000 for the third quarter and first nine months of 2008, respectively, compared to $41,000 and $124,000 for the comparable periods of 2007. The amount of other intangible assets was $0 at September 30, 2008.
Reorganization
On January 18, 2008, we signed an assignment agreement with the Harcourt landlord for the surrender and termination of the Harcourt lease in Dublin, Ireland. We paid approximately $5.9 million for the termination of the lease and related termination costs, consisting primarily of legal and professional fees, during the first nine months of 2008. We also successfully managed during the first quarter of 2008 to terminate part of our lease obligation in another office in Limerick, Ireland, where we had unused space. We recorded during the first nine months of 2008 an aggregate of $3.5 million for the above lease terminations as an additional reorganization expense. As a result of the above lease terminations, we have no under-utilized building operating lease obligations as of September 30, 2008.

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Financial Income, Net (in millions)

                                                             Nine months       Nine months       Third Quarter       Third Quarter
                                                                2008              2007               2008                2007
Financial income, net                                       $        1.98     $        2.19     $          0.65     $          0.74
of which:
Interest income and gains from marketable securities, net   $        2.18     $        2.27     $          0.64     $          0.78
Foreign exchange gain (loss)                                $       (0.20 )   $       (0.08 )   $          0.01     $         (0.04 )

Financial income, net, consists of interest earned on investments, gains from marketable securities and foreign exchange movements. The decrease in interest earned during the third quarter and first nine months of 2008, as compared to the corresponding periods of 2007, reflected lower interest rates as well as higher realized loss from marketable securities, offset by higher combined cash and marketable securities balances held.
We review our monthly expected non-US dollar denominated expenditure and look to hold equivalent non-U.S. dollar cash balances to mitigate currency fluctuations, and this resulted in a foreign exchange gain of $12,000 and a foreign exchange loss of $200,000 for the third quarter and first nine months of 2008, respectively, and a loss of $38,000 and $79,000 for the corresponding periods of 2007.

Other Income (in millions)
. . .