CEVA, Inc. (CEVA) Q2 2019 Earnings Report, Transcript and Summary

Good morning, and welcome to the CEVA, Inc. Second Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Richard Kingston, Vice President of Market Intelligence and Investor Relations. Please go ahead, sir.

Thank you. Good morning, everyone, and welcome to CEVA's Second Quarter 2019 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 the highlights from the second quarter and provide general qualitative data. Yaniv will then cover the financial results for the second quarter and also provide qualitative data for the third quarter and the rest of 2019. I will start with the forward-looking statements. Please note that today's discussions contain forward-looking statements that involve risks and uncertainties as well as assumptions that if they materialize or prove incorrect, could cause the results of CEVA to differ materially from those expressed or implied by such forward-looking statements and assumptions. Forward-looking statements include our financial qualitative data for the third quarter and remainder of 2019, including royalty revenues and the mobile market stabilization; optimism about CEVA doubling its 2018 royalty revenue by 2022; ability to capitalize on a healthy design environment to sign licensing agreements and maintain a robust licensing pipeline; optimism about synergies associated with the acquisition of the Hillcrest Labs business and the license arrangement with Immervision, including leveraging Hillcrest Lab's customer base and revenue contribution relating to the Hillcrest Labs business in the second half of the year; and full year expense levels. For information on the factors that could cause a difference in our results, please refer to our filings with the Security and Exchange Commission. These include the ability of CEVA's IP for smarter, connected devices to continue to be strong growth drivers for us; our ability to realize the benefits from the acquisition of certain assets of Hillcrest Labs and license arrangement with Immervision; our success in penetrating new markets and maintaining our market position in existing markets; the ability of new products incorporating our technologies to achieve market acceptance and offset the maturity of the handset markets; the speed and extent of the expansion of the 4G LTE and 5G networks and wireless connectivity, AI, LTE-IoT and the IoT space generally; our ability to execute more non-handset baseband license agreements; the effect of trade tariffs and political tensions; the effect of intense industry competition and consolidation, including the effect of Apple's announced acquisition of a majority of Intel's smartphone modem business; and global chip market trends. CEVA assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates. In addition to the financial results prepared in accordance with generally accepted accounting principles or GAAP, we will also present certain non-GAAP financial measures today. CEVA's management believes that in addition to using GAAP results in evaluating our business, it can be useful to review results using certain non-GAAP financial measures. Investors and potential investors are encouraged to review the reconciliation of non-GAAP financial measures with their most direct comparable GAAP financial results, which can be found in the earnings press release issued today. A copy of today's press release for the quarter ended June 30, 2019, and the related financial tables and management's commentary, which were included in our Current Report on Form 8-K filed today, also can be found on the investor relations portion of our website after this call. With that said, I will now turn the call over to Gideon.

Thank you, Richard. Welcome, everyone, and thank you for joining us today. We delivered a robust financial performance in the second quarter driven by excellent execution in licensing and noticeable uptrend in royalties. We also expanded our market reach and product portfolio by acquiring U.S.-based Hillcrest Labs, specializing in sensor fusion software technologies and formed a strategic partnership with Immervision, a Canadian-based company with advanced digital imaging software technologies. Total revenue for the second quarter was $18.4 million, up 5% on a year-over-year basis. License revenue was $10.8 million, up 8% year-over-year. Royalty revenue was $7.6 million, up 2% on a year-over-year. Royalty revenue grew 27% sequentially as handset inventory level normalized, which benefit one of our customers supplying cellular baseband to U.S.-based premium smartphone OEM and one of our large China-baseband customer. On the licensing front, we continued the fast pace of customer design wins with 9 new agreements, of which 6 are for our connectivity product and 3 for our smart sensing product. Four of the agreements are with first-time customers. Our second quarter licenses are targeting a diverse range of end markets and applications among which are cellular IoT, wireless earbud, AI and computer vision for consumer and surveillance product and WiFi access points. The wireless earbud or True Wireless Stereo design win is particularly notable as we provide both the sound and the Bluetooth technologies for this target market. With the acquired Hillcrest Labs technology base, we can further extend our offering for this market with sensor fusion software. In the first six months of 2019, we signed a total of 17 deals. That accomplishments bring the total number of deals to more than 160 licensing agreements since the beginning of 2016. These accumulated licenses and ongoing chip and software design are the foundation for royalty generation towards our strategic goal of doubling our 2019 royalty level by 2022. Overall, we are capitalizing on healthy design environment, in particular in China, Japan and the U.S. and our technology excellence in wireless connectivity and smart sensing to sign lucrative licensing agreements and maintain a robust licensing pipeline. On royalties, our second quarter royalty revenue reflects stabilization in the baseband space following an inventory cleanup at the large U.S.-based premium handset supplier and new production ramps and design wins by our China-based customers in the low and mid-tier LTE smartphone market. We believe these positive trends will accelerate as we head into the high season in this space. In the base station market, we are particularly encouraged by the recent progress with our key customer ZTE in 5G base station who recently publicly commented that it was, has secured more than 25 commercial 5G network contracts to date. ZTE is capitalizing on its first-mover advantage, a lot of which relates to our advanced DSP platforms, to gain market share in the expedited 5G deployment in China following the government's grant of commercial 5G licenses to telecom operators and cable network operators. Overall, royalties from non-handset customer continued to show solid growth, up 50%, 52% in revenue versus the second quarter of 2018. Now, on the strategic transactions, we have concluded recently. In July, we acquired the Hillcrest Labs business from InterDigital for $11 million in cash. Hillcrest Labs is a global supplier of software IP, complimentary services and components that process data from sensors. HIllcrest Labs' advanced MotionEngine algorithm and software platform fuse data captured from a diverse range of sensors, such as accelerometer, gyro, magnetometer, barometer and other to reflect the accurate orientation and the heading of a device in the 3D domain. Sensor fusion is broadly used in smartphone, laptops, tablets, wireless earbud, remote controls of smart TV and set-top boxes, drones, automotive, AR and VR robots and numerous other devices. Hillcrest Labs' technology compensates, competencies and customer base add new revenue sources and market opportunities to our smart sensing portfolio that currently includes vision, sound and AI products. Hillcrest Labs' software products have shipped in more than 100 million devices to date and among its customers are Hisense, LG Electronics, Samsung and some of the leading robotics companies. Its revenue for the first six months of the year was approximately $3 million, of which 80% were royalties. With Hillcrest Labs technologies on board, we plan to offer comprehensive and integrated software stack that will combine Hillcrest Labs motion sensing with sound and vision to address multiple market opportunities. We expect to couple this motion-sensing technology with our broad portfolio of DSP-based wireless and cellular connectivity IP. We also anticipate to capitalize on Hillcrest Labs mature software stack and experience to engage and license directive to OEMs to benefit from shorter time to royalties and adopt royalty payment scheme based on device rather than chips. I'd like to take this opportunity to welcome the Hillcrest Labs' team to the CEVA family and to thank the InterDigital team for their support during the acquisition process. Another production that we executed a few days ago is a $10 million investment and strategic partnership within Immervision, a Canada-based private and government-funded technology company. Immervision offers very promising software technologies relating to wide-angle camera. Wide-angle camera offer of field of view of between 80 degrees to 260 degrees and is commonly used in the surveillance market and recently expanded to smartphones, ADAS and robots, all primary markets for CEVA. With that said, wide-angle lens suffer from inherent distortion in the image quality, particularly at the edge of the frame. Through advanced imaging algorithms and in-depth know-how of lens optics, Immervision is able to correct the distortion and provide smooth and clean 360 degrees views by stitching the snaps of multiple wide-angle camera. Under this partnership agreement, CEVA will have an exclusive license right to all Immervision's image enhancement software portfolio. We expect to offer the software as a royalty-bearing value-add to our customer base or independently to OEMs. So in summary, I'm very pleased with the performance in the second quarter. We continue to expand our licensee base and to diversify our royalties revenue sources. The weakness in demand our mobile customers faced last year, shows good sign of stabilization, and we expect a strong second half in royalty revenue. Last, our recent cash investment in acquiring certain assets of Hillcrest Labs, and for licensing rights of the imaging software from Immervision are in line with our strategy to go up in the value chain, creating tighter relationship with our customers and incremental royalty sources from semiconductor companies and OEMs. With that said, I'll now turn the call over to Yaniv, who will outline our financials and guidance.

Thank you, Gideon. I'll start by reviewing the results of our operations for the second quarter of 2019. Revenue for the second quarter was $18.4 million, up 5% as compared to $17.5 million for the same quarter last year. The revenue breakdown is as follows: licensing and related revenue was approximately $10.8 million, reflecting 59% of our total revenue, 8% higher as compared to the second quarter of '18; royalty revenue was $7.6 million, reflecting 41% of our total revenues, up 2% from $7.5 million for the same quarter last year; quarterly gross margins was 86% on GAAP basis and 88% on non-GAAP basis as projected. Non-GAAP quarterly gross margin excluded approximately $0.1 million of equity-based compensation expenses and $0.1 million of the impact of the amortization of the acquired intangibles for our investment in the Narrowband IoT technologies. Our total operating expenses for the second quarter came in at the mid-range of our guidance at $18.1 million. OpEx also included aggregate-based compensation expenses of approximately $2.5 million and $0.2 million for the amortization of acquired intangibles of RivieraWaves. Total operating expenses for the second quarter, excluding these items, were $15.4 million, also at the midpoint of our guidance. U.S. GAAP net loss for the second quarter decreased by 28% to $1.5 million and diluted net income per share decreased 22% to $0.07 compared to a net loss of $2.1 million and $0.09 for the second quarter of 2018. Non-GAAP net income and diluted EPS for the second quarter of 2019 were up 42% and 25% to $1.2 million and $0.05, respectively, from net income and diluted EPS for the second quarter of 2018 was $2.9 million and $0.04. Other related data. Shipped units by CEVA's licensees during the second quarter of 2019 were 217 million units, up 24% sequentially and down 2% year-over-year from the second quarter of 2018 reported shipments. Of the 217 million units shipped, 122 million or 56% were for handset baseband chips. This reflects an increase of 37% sequentially from 89 million units that are shipped in the first quarter of 2019 and a 26% decrease from 165 million units shipped a year ago. In the non-baseband, volume shipments were up 11% sequentially and 8% on a year-over-year basis. As for our balance sheet. As of the end of June, CEVA's cash, cash equivalent balances, marketable securities and bank deposits were $166 million. We continued our buyback repurchasing program and purchased approximately 103,000 shares during the second quarter for approximately $2.3 million. A year ago, our Board of Directors approved the expansion of the existing buyback plan. And as of the end of June this year, we had a total of 161,000 shares available under this repurchase program. Our DSOs for the second quarter was 52 days. During the quarter, we generated a negative of $3.8 million of cash from operations. Depreciation was $0.7 million and purchase of fixed assets were $0.7 million as well. At the end of the quarter, our headcount was 358 people of which 294 were engineers. These numbers do not include yet 22 people from Hillcrest Labs, which were added in July. Yearly guidance. As Gideon pointed out, we are experiencing an overall healthy environment, both on licensing and royalty funds. We also expect the Hillcrest business to continue, to contribute to revenues in the second half of this year. Therefore, we are now anticipating that our annual revenue will be in the range of $3 million to $4 million higher than the current street estimates. On the operating side, we continue to be cautious and disciplined in our expense control. As a result, including the addition of Hillcrest Labs, we expect to remain or to record a slight increase in the annual non-GAAP operating expense level that we guided earlier in the year for 2019. Cumulative data, specifically for the third quarter of 2019. We expect a substantial increase in royalties in the second half of the year, starting with more than 60% sequential increase for the third quarter. This includes the initial contribution from Hillcrest Labs and should account for one of the highest royalty revenue quarters in the company's history. Gross margin is expected to be approximately 88% on GAAP basis and 89% on non-GAAP basis. Overall OpEx is expected to be in the range of $19.7 million to $20.7 million after adding in new Hillcrest business, excluding deal costs and new amortization but including approximately $0.3 million of deal-related write-offs. The anticipated total operating expenses for the third quarter, $2.9 million is expected to be attributed to equity-based compensation expenses, $0.2 million of amortization of the acquired intangibles, not including Hillcrest and Immervision. Another $0.3 million for deal-related write-offs. Our total non-GAAP OpEx is expected to be in the range of $16.4 million to $17.4 million. Net interest income is expected to be approximately $750,000 for the quarter. Taxes for the quarter, approximately $0.3 million on GAAP basis and $0.5 million on non-GAAP basis. And our share count for the third quarter is expected to be approximately 22.9 million shares. With that, we could open the Q&A session.

[Operator Instructions] And our first question today comes from Peter Zdebski with Barclays.

This is Peter on for Tavy Rosner from Barclays. So you mentioned the inventory normalization in smartphone, was that specific to the U.S. customers? Or is that broad-based geographically? And then I have a follow-up.

This is Gideon. We don't sell to the overall industry, we just focus on what we know about our customers.

And then in terms of inventory levels going into the fall, we understand shipments for your units for your large U.S. premium smartphone customer have been a bit above seasonal in the second quarter. So going into the fall, do you see inventory levels just maybe back down to closer to historical? Or are they even maybe below historical? And maybe how does that factor into your royalty guidance for the third quarter?

Look here, so you need to remember that there is seasonality which is playing in our favor in all the markets, whether it's consumer or handset, and this is not only CEVA, usually, we're in the third and fourth quarter stronger than the first 2 quarters of the year. I think that's what the first we're referring to, on top of that, like we started very last year as well, in our business, it has changed from prior years. And on top of that, you need to fine-tune, as Gideon said, to our specific customers in different markets and different regions. And we have high-end devices as well as low-end devices and we have baked in, to the best of our knowledge, all of that data. First, when we get the Q3 royalty reports, and we'll report it, in early November then we'll have the real numbers, and we'll have a better picture to provide.

Got it. Yes. No, I was just trying to get a bigger picture of seasonality, it looks like it might be a bit stronger this year than last year based on your guide.

Well, it's very similar. It's very similar. We have seen improvement with the Chinese, our Chinese customer. We have talked about that in the prepared remarks, we've seen more design wins, you could look on the web and find them and much more announcements of new chips rolling out the new phones. So that's encouraging. And with that said, we are on top of that of last year, we also have the initial contribution from Hillcrest. So together, given maybe higher sequential increases than last year, the concept is quite similar.

And our next question comes from Suji Desilva with Roth Capital.

Congratulations on the improving results here. So the third quarter '19, you guided very strong royalties. Can you give us some sense of what are the drivers beyond Hillcrest? Just to understand which segments of the business are improving the most here?

Even for the second half of this year?

Yes, sure, for third quarter, second half, yes.

So what we came out after analyzing the second quarter royalty reports is that the inventory was -- it was a stumbling issue in the first quarter and as a concern to us, this kind of normalized. And we are going to regular in -- on the handset side regular -- typical up season, where we have new models and new design comings to the market. So overall, if you look on the -- on our guidance, it's composed of the seasonal uptrend, both in the mobile, in the non-handset. Keep in mind that the non-handset, in general, we have new models coming. So there is a contribution from that -- for that with the strength. Then Hillcrest and of course, the base stations, as we mentioned, ZTE, they are doing well. So all in all, these are the cylinders that are firing in the second half. With that said, there is this -- the global macro that is around us which we keep close eye, and that's the reason that we are also careful with expenses. So overall, we did whatever we can do, you can think in this -- in term of this event, we are generally optimistic.

Okay. And then specifically on wireless infrastructure, can you talk about the shape of the ramp here? Is it steady? Or will there be an inflection quarter ahead? Is -- what's the run rate you'll expect in the next 6 to 12 months from the current levels?

So that's a difficult answer -- question and answer to date. Clearly, you got -- in this space, you see all the global dispute there, whether VP -- how far VP can go to outside of China? What about the other customers that we have? These are kind of thing that we don't know where we are today. Our guidance is -- assume kind of a growth until we see really the 5G coming out and people already start building the base station or upgrading the base station. So it looks positive in terms of this one, it's not a healthy stick, though, for now.

Okay. That's helpful. And then last question, one of your customers, Intel, their assets were acquired, most recently, any insight into the 5G planner opportunity, how to model that for us? Any color you have would be helpful.

You see, we heard about this acquisition of the Intel in -- like anybody else. It's -- they have to conclude on the implication of these deals, I don't know when they -- I think generally, it's good for the industry that OEMs are taking the lead in doing the launches. We -- I believe there will be other. We said it in the past, we believe that people -- OEM people wants to have a control on 5G model, and they will do step in. You can see that CEVA has sold so much substance in this space that any newcomer or incumbent that wants to go to, to step into the modem business, will find the technology CEVA into them in different flavors. So that's what we know now, but we know that we have got to, we can also lot of things to the newcomers.

[Operator Instructions] And this will conclude our question-and-answer session. I'd like to turn the conference back over to Richard Kingston, for any closing remarks.

Thank you. Thank you, everybody, for joining us today, and for your continued interest in and support of CEVA. As a reminder, the prepared remarks for this conference call are filed as an exhibit to the Current Report on Form 8-K and accessible through the Investors section of our website at investors.ceva-dsp.com. With regards to upcoming events we will be attending, these include: The Jefferies 2019 Semiconductor, Hardware and Communications Infrastructure Summit, August 27 and 28 in Chicago; the Citi 2019 Global Technology Conference, September 4 to 6 in New York; and the Deutsche Bank Technology Conference, September 10 and 11 in Las Vegas. Please visit the investors section of our website for further information on these events and other events that will, we will be attending. Thank you, and goodbye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time, and have a wonderful day.