Annual Statements Open main menu

CEVA INC - Quarter Report: 2005 June (Form 10-Q)

Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q

(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended: June 30, 2005

OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from              to             

Commission file number: 000-49842
 
CEVA, Inc.
(Exact Name of Registrant as Specified in Its Charter)

Delaware
77-0556376
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
2033 Gateway Place, Suite 150, San Jose, California
95110-1002
(Address of Principal Executive Offices)
(Zip Code)

(408) 514-2900
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant: (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x  No ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: 18,923,071 shares of common stock, $0.001 par value, as of August 2, 2005.


 
TABLE OF CONTENTS

 
Page

PART I.   FINANCIAL INFORMATION
 
 
 
Item  1.    Financial Statements (Unaudited)
 
4
 
                Interim Condensed Consolidated Balance Sheets at June 30, 2005 and December 31, 2004
 
4
 
                Interim Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2005 and 2004
 
5
 
                Interim Statements of Changes in Stockholders’ Equity for the three and six months ended June 30, 2005 and 2004
 
6
 
                Interim Condensed Consolidated Statements of Cash Flows for the three and six months ended June 30, 2005 and 2004
 
7
 
                Notes to the Interim Condensed Consolidated Financial Statements
 
8
 
Item  2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
12
 
Item  3.    Quantitative and Qualitative Disclosures About Market Risk
 
27
 
Item  4.    Controls and Procedures
 
27
 
PART II. OTHER INFORMATION
 
 
 
Item  1.    Legal Proceedings
 
28
 
Item  6.    Exhibits and Reports on Form 8-K
 
29
 
SIGNATURES
 
30
 

2

 
FORWARD-LOOKING STATEMENTS

This quarterly report includes forward-looking statements that are subject to a number of risks and uncertainties. All statements, other than statements of historical facts, included in this quarterly report regarding our strategy, future operations, financial position, estimated revenues, projected costs, prospects, plans, and objectives of management are forward-looking statements. The words “will”, “believe”, “anticipate”, “intend”, “estimate”, “expect”, “project”, and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements in this report contain these identifying words. We cannot guarantee future results, levels of activity, performance or achievements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or strategic alliances. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including the risks described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That Could Affect Our Operating Results” and elsewhere in this quarterly report. We do not assume any obligations to update any of the forward-looking statements we make.

*****
 
3


PART I. FINANCIAL INFORMATION

Item 1.    FINANCIAL STATEMENTS

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share and per share data)

   
June 30,
2005
 
December 31,
2004
 
   
Unaudited
 
Audited
 
ASSETS
         
Current assets:
         
Cash and cash equivalents
 
$
37,929
 
$
28,844
 
Marketable securities
   
21,717
   
30,794
 
Trade receivables, net
   
9,284
   
10,835
 
Deferred tax assets
   
147
   
125
 
Prepaid expenses
   
1,295
   
703
 
Other current assets
   
1,564
   
647
 
Total current assets
   
71,936
   
71,948
 
               
Severance pay fund
   
1,725
   
1,713
 
Deferred tax assets
   
56
   
70
 
Property and equipment, net
   
4,066
   
4,471
 
Goodwill
   
38,398
   
38,398
 
Other intangible assets, net
   
1,843
   
2,563
 
Total assets
 
$
118,024
 
$
119,163
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
             
Current liabilities:
             
Trade payables
 
$
1,702
 
$
1,714
 
Accrued expenses and other payables
   
8,755
   
9,816
 
Taxes payable
   
676
   
707
 
Deferred revenues
   
2,056
   
1,751
 
Total current liabilities
   
13,189
   
13,988
 
Long term liabilities:
             
Accrued severance pay
   
1,890
   
1,844
 
Accrued liabilities
   
671
   
782
 
Total long-term liabilities
   
2,561
   
2,626
 
Stockholders’ equity:
             
Common Stock:
             
$0.001 par value: 100,000,000 shares authorized; 18,779,394 and 18,557,818 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively
   
19
   
19
 
Additional paid in-capital
   
138,182
   
136,868
 
Accumulated deficit
   
(35,927
)
 
(34,338
)
Total stockholders’ equity
   
102,274
   
102,549
 
Total liabilities and stockholders’ equity
 
$
118,024
 
$
119,163
 
 
The accompanying notes are an integral part of the interim condensed consolidated financial statements
 
4


INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(U.S. dollars in thousands, except per share data)

   
Six months ended
June 30,
 
Three months ended
June 30,
 
   
2005
 
2004
 
2005
 
2004
 
   
Unaudited
 
Unaudited
 
Unaudited
 
Unaudited
 
Revenues:
                 
Licensing and royalties
 
$
17,066
 
$
15,949
 
$
8,219
 
$
8,180
 
Other revenue
   
2,503
   
2,841
   
1,309
   
1,396
 
Total revenues
   
19,569
   
18,790
   
9,528
   
9,576
 
Cost of revenues
   
2,409
   
2,961
   
1,116
   
1,451
 
Gross profit
   
17,160
   
15,829
   
8,412
   
8,125
 
Operating expenses:
                         
Research and development, net
   
10,441
   
8,231
   
5,515
   
4,222
 
Sales and marketing
   
3,236
   
3,391
   
1,560
   
1,718
 
General and administrative
   
3,082
   
2,954
   
1,611
   
1,495
 
Amortization of intangible assets
   
441
   
446
   
218
   
223
 
Reorganization and severance charge
   
1,657
   
-
   
1,657
   
-
 
Impairment of assets
   
510
   
-
   
510
   
-
 
Total operating expenses
   
19,367
   
15,022
   
11,071
   
7,658
 
Operating income (loss)
   
(2,207
)
 
807
   
(2,659
)
 
467
 
Other income, net
   
778
   
351
   
443
   
162
 
Income (loss) before taxes on income
   
(1,429
)
 
1,158
   
(2,216
)
 
629
 
Taxes on income
   
160
   
255
   
-
   
135
 
Net income (loss)
 
$
(1,589
)
$
903
 
$
(2,216
)
$
494
 
Basic net income (loss) per share
 
$
(0.08
)
$
0.05
 
$
(0.12
)
$
0.03
 
Diluted net income (loss) per share
 
$
(0.08
)
$
0.05
 
$
(0.12
)
$
0.03
 
Weighted-average number of shares of Common Stock used in computation of net income (loss) per share (in thousands):
                         
Basic
   
18,713
   
18,353
   
18,742
   
18,380
 
Diluted
   
18,713
   
19,083
   
18,742
   
18,909
 
 
The accompanying notes are an integral part of the interim condensed consolidated financial statements.
 
5


INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)
(U.S. dollars in thousands, except share data )
 
   
Common stock
 
Additional
paid-in
capital
 
Accumulated
deficit
 
Total
stockholders’
equity
 
   
Six months ended June 30, 2005
 
Shares
 
Amount
 
Balance as of January 1, 2005
   
18,557,818
 
$
19
 
$
136,868
 
$
(34,338
)
$
102,549
 
Net loss
   
   
   
   
(1,589
)
 
(1,589
)
Stock-based compensation
   
   
   
195
   
   
195
 
Issuance of Common Stock upon exercise of stock options
   
68,338
   
—(*
)
 
360
   
   
360
 
Issuance of Common Stock upon purchase of ESPP shares
   
153,238
   
(*
)
 
759
   
   
759
 
Balance as of June 30, 2005
   
18,779,394
 
$
19
 
$
138,182
 
$
(35,927
)
$
102,274
 
 
   
Common stock
 
Additional
paid-in
capital
 
Accumulated
deficit
 
Total
stockholders’
equity
 
   
Six months ended June 30, 2004
 
Shares
 
Amount
 
Balance as of January 1, 2004
   
18,167,332
 
$
18
 
$
134,449
 
$
(35,988
)
$
98,479
 
Net income
   
   
   
   
903
   
903
 
Stock-based compensation
   
   
   
135
   
   
135
 
Issuance of Common Stock upon exercise of stock options
   
117,733
   
—(*
)
 
1,072
   
   
1,072
 
Issuance of Common Stock upon purchase of ESPP shares
   
99,018
   
(*
)
 
377
   
   
377
 
Balance as of June 30, 2004
   
18,384,083
 
$
18
 
$
136,033
 
$
(35,085
)
$
100,966
 
 
(*) Amount less than $1.
 
The accompanying notes are an integral part of the interim condensed consolidated financial statements.
 
6

 
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands )
 
   
Six months ended
June 30,
 
   
2005
 
2004
 
   
Unaudited
 
Unaudited
 
Cash flows from operating activities:
         
Net income (loss)
 
$
(1,589
)
$
903
 
Adjustments required to reconcile net income to net cash provided by (used in) operating activities:
             
Depreciation
   
1,062
   
1,311
 
Amortization of intangible assets
   
846
   
446
 
Stock-based compensation
   
195
   
135
 
Gain on disposal of property and equipment
   
(5
)
 
(8
)
Unrealized loss on marketable securities
   
61
   
 
Currency translation differences
   
(92
)
 
(7
)
Marketable securities
   
9,016
   
 
Changes in operating assets and liabilities:
             
Trade receivables
   
1,418
   
(487
)
Other current assets and prepaid expenses
   
(1,565
)
 
174
 
Deferred income taxes
   
(8
)
 
 
Trade payables
   
92
   
(157
)
Deferred revenues
   
305
   
(289
)
Accrued expenses and other payables
   
(572
)
 
(2,931
)
Taxes payable
   
(31
)
 
(154
)
Accrued severance pay, net
   
34
   
49
 
Net cash provided by (used in) operating activities
   
9,167
   
(1,015
)
 
Cash flows from investing activities:
             
Purchase of property and equipment
   
(660
)
 
(2,577
)
Proceeds from sale of property and equipment
   
8
   
42
 
Purchase of technology
   
(71
)
 
(30
)
Net cash used in investing activities
   
(723
)
 
(2,565
)
 
Cash flows from financing activities:
             
Proceeds from issuance of Common Stock upon exercise of options
   
360
   
1,072
 
Proceeds from issuance of Common Stock under employee stock purchase plan
   
759
   
377
 
Net cash provided by financing activities
   
1,119
   
1,449
 
Effect of exchange rate movements on cash
   
(478
)
 
(167
)
Changes in cash and cash equivalents
   
9,085
   
(2,298
)
Cash and cash equivalents at the beginning of the period
   
28,844
   
59,130
 
Cash and cash equivalents at the end of the period
 
$
37,929
 
$
56,832
 
 
The accompanying notes are an integral part of the interim condensed consolidated financial statements.
 
7

NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(U.S. dollars in thousands, except share and per share amounts)

NOTE 1:    BUSINESS

The financial information in this quarterly report includes the results of CEVA, Inc. and its subsidiaries (the “Company” or “CEVA”). CEVA licenses Digital Signal Processor (DSP) intellectual property and related technologies. CEVA designs, develops and supports DSP cores and integrated application solutions that power wireless and digital multimedia products such as cellular phones, music players, digital television and personal digital assistants. Licensees of CEVA technology either source chips for these devices and applications from foundries or manufacture them in-house.

NOTE 2:    BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (including non-recurring adjustments attributable to reorganization and severance and impairment) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, reference is made to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

The interim condensed consolidated financial statements incorporate the financial statements of the Company and all of its subsidiaries. All significant intercompany balances and transactions have been eliminated on consolidation.

The significant accounting policies applied in the annual consolidated financial statements of the Company as of December 31, 2004, contained in the Company’s Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on March 31, 2005, as further amended on April 26, 2005 (File No. 000-49842), have been applied consistently in these unaudited interim condensed consolidated financial statements.

NOTE 3:    GEOGRAPHIC INFORMATION AND MAJOR CUSTOMER DATA

a. Summary information about geographic areas:

The Company manages its business on the basis of one industry segment: the licensing of intellectual property to semiconductor companies and electronic equipment manufacturers (see Note 1 for a brief description of the Company’s business).

The following is a summary of operations within geographic areas:
 
   
Six months ended
 June 30,
 
Three months ended
June 30,
 
   
2005
(unaudited)
 
2004
(unaudited)
 
2005
(unaudited)
 
2004
(unaudited)
 
Revenues based on customer location:
                 
United States
 
$
8,210
 
$
3,182
 
$
6,019
 
$
1,363
 
Europe, Middle East and Africa
   
4,095
   
9,833
   
1,572
   
5,689
 
Asia (1)
   
7,264
   
5,775
   
1,937
   
2,524
 
 
 
$
19,569
 
$
18,790
 
$
9,528
 
$
9,576
 
Individual countries representing 10% or more of total revenues included in the table above are as follows:                           
(1) Japan
 
$
3,238
 
$
2,948
 
$
1,484
 
$
1,662
 

b. Major customer data as a percentage of total revenues:

The following table sets forth the customers that represented 10% or more of the Company’s net revenue in each of the periods set forth below.

   
Six months ended
June 30,
 
Three months ended
June 30,
 
   
2005
(unaudited)
 
2004
(unaudited)
 
2005
(unaudited)
 
2004
(unaudited)
 
Customer A
   
18.0
%
 
   
36.9
%
 
 
Customer B
   
12.0
%
 
   
   
 
Customer C
   
   
17.5
%
 
   
34.3
%
Customer D
   
   
   
   
11.9
%
Customer E
   
   
   
   
11.8
%

8

NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(U.S. dollars in thousands, except share and per share amounts)
 
NOTE 4:    NET INCOME (LOSS) PER SHARE OF COMMON STOCK

Basic net income (loss) per share is computed based on the weighted-average number of shares of Common Stock outstanding during each period. Diluted net income (loss) per share is computed based on the weighted average number of shares of Common Stock outstanding during each period, plus potential dilutive shares of Common Stock considered outstanding during the period, in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 128, “Earnings Per Share”.

   
Six months ended
June 30,
 
Three months ended
June 30,
 
   
2005
(unaudited)
 
2004
(unaudited)
 
2005
(unaudited)
 
2004
(unaudited)
 
Numerator:
                 
Numerator for basic and diluted net income (loss) per share
 
$
(1,589
)
$
903
 
$
(2,216
)
$
494
 
 
Denominator:
                         
Denominator for basic net income (loss) per share
                         
Weighted-average number of shares of Common Stock
   
18,713
   
18,353
   
18,742
   
18,380
 
Effect of employee stock options
   
-
   
730
   
-
   
529
 
 
   
18,713
   
19,083
   
18,742
   
18,909
 
Net income (loss) per share
                         
Basic
 
$
(0.08
)
$
0.05
 
$
(0.12
)
$
0.03
 
Diluted
 
$
(0.08
)
$
0.05
 
$
(0.12
)
$
0.03
 
 
    The total number of shares related to the outstanding options excluded from the calculations of diluted net income (loss) per share were 4,993,542 for the three-and six-month periods ended June 30, 2005, and 4,693,973 and 4,493,518 for the corresponding periods respectively, of 2004.
 
NOTE 5:    MARKETABLE SECURITIES

Marketable securities consist of certificates of deposits and U.S. government and agency securities. Marketable securities are stated at market value, and by policy, CEVA invests in high grade marketable securities to reduce risk of loss. All marketable securities are defined as trading securities under the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, and unrealized holding gains and losses are reflected in the Condensed Consolidated Statements of Operations.

   
As at June 30, 2005
 
   
Cost
(unaudited)
 
Unrealized Loss
(unaudited)
 
Market Value
(unaudited)
 
               
U.S. government and agency securities
 
$
21,728
 
$
(11
)
$
21,717
 

NOTE 6:    COMMON STOCK AND STOCK-BASED COMPENSATION PLANS

At the annual meeting of stockholders held on July 19, 2005, the stockholders voted to amend the Company’s Amended and Restated Certificate of Incorporation to reduce the number of shares of Common Stock authorized for issuance from 100,000,000 shares to 60,000,000 shares.

The Company issues stock options to its employees, directors and certain consultants and provides the right to purchase stock pursuant to approved stock option and employee stock purchase programs. The Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Options Issued to Employees” (“APB No. 25”), and related interpretations (collectively “APB No. 25”), in accounting for its stock option plans. Under APB No. 25, when the exercise price of an employee stock option is less than the market price of the underlying stock on the date of grant, compensation expense is recognized. All options granted under these plans had an exercise price equal to the fair market value of the underlying Common Stock on the date of grant.

Certain stock options issued to non-employee consultants are accounted for under SFAS No. 123 “Accounting for Stock Based Compensation” using the fair value method. A stock compensation charge of $148 and $195 in respect of 96,000 fully vested options granted to non-employee consultants is reflected in the Condensed Consolidated Statements of Operations for the three-and six-month periods ended June 30, 2005, as required under APB No.25. There was a similar charge of $135 for the three-and six-month periods ended June 30, 2004. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rate of 2%; dividend yield of 0%; volatility factor of 80%; and a weighted-average expected life of the options of four years. No options were exercised during the three-and six-month periods ended June 30, 2005 and options to purchase 96,000 shares were outstanding as of June 30, 2005.
 
9

NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(U.S. dollars in thousands, except share and per share amounts)

During the first quarter of 2005, the Company granted options to purchase 51,000 shares of Common Stock, at exercise prices ranging from $7.93 to $8.51 per share, and the Company issued 175,235 shares of Common Stock under its stock option and purchase programs for consideration of $880. Options to purchase 5,820,471 shares were outstanding at March 31, 2005. During the comparable period of 2004, the Company granted options to purchase 382,000 shares of Common Stock, at exercise prices ranging from $8.75 to $11.75 per share, and the Company issued 212,425 shares of Common Stock under its stock option and purchase programs for consideration of $1,433. Options to purchase 5,219,065 shares were outstanding at March 31, 2004.

During the second quarter of 2005, the Company granted options to purchase 196,700 shares of Common Stock, at exercise prices ranging from $5.85 to $7.12 per share, and the Company issued 46,341 shares of Common Stock under its stock option and purchase programs for consideration of $239. Options to purchase 4,993,542 shares were outstanding at June 30, 2005. During the comparable period of 2004, the Company granted options to purchase 143,000 shares of Common Stock, at exercise prices ranging from $7.91 to $9.40 per share, and the Company issued 4,326 shares of Common Stock under its stock option and purchase programs for consideration of $16. Options to purchase 5,223,141 shares were outstanding at June 30, 2004.

Under SFAS No. 123, pro forma information regarding net income (loss) per share is required, and has been determined as if CEVA had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:

   
Three and six months ended
June 30,
 
   
2005
(unaudited)
 
2004
(unaudited)
 
Dividend yield
   
0
%
 
0
%
Expected volatility
   
36-39
%
 
80
%
Risk-free interest rate
   
2
%
 
2
%
Expected life
   
3-4 Years
   
4 Years
 

The fair value for rights to purchase awards under the Employee Share Purchase Plan was estimated at the date of grant using the same assumptions above except the expected life was assumed to be 6 months.

The weighted-average fair value of the options granted during the three months ended March 31, 2005 and June 30, 2005 was $8.21 and $6.15, respectively. During the comparable periods of 2004 the weighted-average fair value of the options granted was $10.25 and $8.39, respectively. The exercise prices of such options were equal to the market price of the Company’s Common Stock at the date of the respective option grants.

The following pro forma information includes the effect of the options granted to the Company’s employees. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period.

   
Six months ended
June 30,
 
Three months ended
June 30,
 
   
2005
(unaudited)
 
2004
(unaudited)
 
2005
(unaudited)
 
2004
(unaudited)
 
Net income (loss) as reported
 
$
(1,589
)
$
903
 
$
(2,216
)
$
494
 
Add (deduct): Total stock-based employee compensation credit (expense) determined under fair value based method for all awards, net of related tax effects
   
(919
)
 
(5,822
)
 
457
   
(2,596
)
Pro forma net (loss)
 
$
(2,508
)
$
(4,919
)
$
(1,759
)
$
(2,102
)
Net income (loss) per share:
                         
Basic as reported
 
$
(0.08
)
$
0.05
 
$
(0.12
)
$
0.03
 
Basic pro forma
 
$
(0.13
)
$
(0.27
)
$
(0.09
)
$
(0.11
)
Diluted as reported
 
$
(0.08
)
$
0.05
 
$
(0.12
)
$
0.03
 
Diluted pro forma
 
$
(0.13
)
$
(0.27
)
$
(0.09
)
$
(0.11
)

10

NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(U.S. dollars in thousands, except share and per share amounts)

NOTE 7:    REORGANIZATION AND SEVERANCE CHARGE

The Company’s management and board of directors approved a reorganization plan in the second quarter of 2005, which resulted in a charge of $1.7 million. The charge arose in connection with the decision to restructure the Company’s corporate management, reduce overhead and consolidate its activities. Included are severance charges and employee related liabilities arising in connection with a head-count reduction of nine employees and provision for future operating lease charges on idle facilities.
 
Management was required to make certain estimates and assumptions in assessing the underutilized building operating lease charge arising from the reduction in facility requirements. The underutilized building operating lease charge was calculated by taking into consideration (1) the committed annual rental charge associated with the vacant square footage, (2) an assessment of the sublet rents that could be achieved based on current market conditions, vacancy rates and future outlook, (3) the estimated periods that facilities would be empty before being sublet, (4) an assessment of the percentage increases in the primary lease rent and the sublease rent at each five-year rent review, and (5) the application of a discount rate of 4.75% over the remaining period of the lease. The Company expects to revise its assumptions quarterly, as appropriate in respect of future vacancy rates and sublet rents in light of current market conditions and the applicable discount rate based on projected interest rates. There was a charge of $294 on net income in the three-and six-month periods ended June 30, 2005 for future operating lease charges on idle facilities.

The major components of the restructuring and other charges of which $2,499 is included in accrued expenses and other payables and $671 is included in long term accrued liabilities, at June 30, 2005 are as follows:

   
Severance and related costs
(unaudited)
 
Provision for future operating lease charges on idle facilities
(unaudited)
 
Legal and professional fees
(unaudited)
 
Total
(unaudited)
 
                   
Balance as of December 31, 2004
 
$
855
 
$
2,211
 
$
-
 
$
3,066
 
Charge
   
1,259
   
294
   
104
   
1,657
 
Non-cash stock compensation charge
   
(117
)
 
-
   
-
   
(117
)
Cash outlays
   
(610
)
 
(826
)
 
-
   
(1,436
)
Balance as of June 30, 2005
 
$
1,387
 
$
1,679
 
$
104
 
$
3,170
 

NOTE 8:    IMPAIRMENT OF ASSETS

The Company recorded an impairment charge of $400 in the second quarter of 2005 in respect of Bluetooth technology acquired in the combination with Parthus Technologies plc (Parthus) as the Company has decided to cease the development of this product line due to the minimal differentiation between competing solutions. The Company also recorded an impairment charge of $110 in the period in respect of non-performing assets following the implementation of its reorganization plan.

11

 
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. Actual results may differ materially from those indicated by such forward-looking statements. Factors which could cause actual results to differ materially include those set forth under “—Factors That Could Affect Our Operating Results”, as well as those otherwise discussed in this section and elsewhere in this quarterly report. See “Forward-Looking Statements”.

BUSINESS OVERVIEW

The financial information in this quarterly report includes the results of CEVA, Inc. and its subsidiaries (the “Company” or “CEVA”). CEVA is one of the world’s leading licensor of DSP cores and related application solutions to the semiconductor and electronics industry. For more than ten years, CEVA has been licensing DSP cores and application-specific intellectual property “IP” to leading semiconductor and electronics companies worldwide.

We design and license high performance, low-cost, power-efficient embedded DSP cores and integrated application solutions. We license our technology as intellectual property to leading electronics companies, which in turn manufacture, market and sell DSP application specific integrated circuits (“ASICs”) and application specific standard products (“ASSPs”) based on CEVA technology to systems companies for incorporation into a wide variety of end products. Our IP is primarily deployed in high volume wireless (e.g. cellular baseband and application solutions), portable consumer multimedia (e.g. portable digital players), consumer home multimedia (e.g. DVD systems, gaming consoles), storage markets (e.g. hard disk drive), location markets (eg: GPS for automotive and wireless handsets), and communication markets (e.g. serial ATA).

CEVA addresses the requirements of the embedded communications and multimedia markets by designing and licensing programmable DSP cores, system platform, software and system solutions tools which enable the rapid design of embedded DSP and application specific solutions for use across a wide variety of applications. Our solution includes a family of programmable DSP cores with a range of cost, power-efficiency and performance points; associated system-on-chip (SoC) system -- platform (the essential SoC hardware and software infrastructure integrated with the core); and a portfolio of complete system-solutions in the areas of video processing, audio processing, speech processing, GPS location, and VoIP communications. Our services division assists our customers in the deployment of their CEVA based solutions.

We believe that the growth in DSP based solutions will drive demand for our technology. We believe that the growing complexity of applications will drive demand for licensing of more powerful and sophisticated cores and solutions to meet the demands of smart, digital connected devices. We also believe that the increased cost, complexity and time-to-market pressures of modern DSP applications, have led companies to license completed system solutions rather than just the core. As CEVA offers expertise in DSP cores combined with integrated system-solutions, we believe we are well positioned to take full advantage of these major industry shifts. To do so we intend to:

 Continue to develop sophisticated cores and SoC platforms. We seek to enhance our existing family of DSP cores and SoC platforms with additional features, performance and capabilities.

 Provide an integrated system-solution. We seek to offer integrated IP solutions which combine application specific software and dedicated logic - such as video processing or GPS - built around our DSP cores, and delivered to our licensing partners as a complete and verified system solution.

 Provide an integrated, open-standard solution. We seek to offer integrated IP solutions which combine application specific software and logic - such as video processing or GPS - built around our DSP cores which further reduces the cost, risk and time-to-market for our licensing partners.

 Capitalize on our relationships and leadership. We seek to expand our worldwide community of semiconductor and system OEM licensees who are developing CEVA based solutions.

 Capitalize on our IP licensing and royalty business model. We seek to maximize the advantages of our IP model which we believe is the best vehicle for pervasive adoption of our technology. Furthermore, by not having to focus on manufacturing or selling of silicon products, we are free to focus most of our resources on research and development.
 
12

 
RESULTS OF OPERATIONS

Total Revenues

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
Total revenues (in millions)
 
$
18.8
 
$
19.6
 
$
9.6
 
$
9.5
 
Change from first half 2004
                   
4.1
%
Change from second quarter 2004
                     
(0.5
)%

The increase in total revenues for the first half of 2005 over the first half of 2004 reflects higher licensing and royalty revenues offset somewhat by lower service revenues. The modest decrease in total revenues for the second quarter of 2005 compared to the second quarter of 2004 reflects small increases in licensing and royalty revenues that were offset by lower service revenues.

Licensing and royalty revenues accounted for 87% of our total revenues in the first half of 2005 compared with 85% for the first half of 2004. Licensing and royalty revenues accounted for 86% of our total revenues in the second quarter of 2005 compared with 85% for the second quarter of 2004. Two customers accounted for more than 10% of revenues in the first half of 2005 compared to one customer in the first half of 2004. One customer accounted for more than 10% of revenues in the second quarter of 2005 compared to three customers in the second quarter of 2004. Due to the nature of our license agreements and the associated large individual contract amounts, our major customers generally vary from quarter to quarter.

We generate our revenues from licensing IP, which in certain circumstances is modified to customer-specific requirements. Revenues from license fees that involve customization of the our IP to customer specifications are recognized in accordance with Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts”. We account for all of our other IP license revenues in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition”, as amended.

We generate royalties from its licensing activities in two manners: royalties paid by our customers over the period in which they ship units which we refer to as per unit royalties and royalties which are paid in a lump sum which cover a fixed number of future unit shipments which we refer to as prepaid royalties.  The prepaid royalties may be negotiated as part of an initial license agreement or may be subsequently negotiated with an existing licensee who has begun making unit shipments and has used up all of the prepayments covered in their initial license agreement.  In the latter case, we negotiate an additional lump sum payment to cover a fixed number of additional future unit shipments.  In either case, these prepaid royalties are non-refundable payments and are recognized upon invoicing for payment, provided that no future obligation exists. Prepaid royalties are recognized under our licensing revenue line and accounted for 20% of total revenue in the first half of 2005, compared to 8% of total revenue for the first half of 2004. All of the prepaid royalties recognized in the first half of 2004 and 2005 were subsequently negotiated with existing prepaid licensees. Only royalty revenue from customers who are paying as they ship units is recognized in our royalty revenue line.  These per unit royalties are invoiced and recognized on a quarterly basis as we receive quarterly shipment reports from our licensees.

Licensing and Royalty Revenues

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
Licensing and royalty revenues (in millions)
 
$
15.9
 
$
17.1
 
$
8.2
 
$
8.2
 
Change from first half 2004
                     
7.0
%
Change from second quarter 2004
                     
0.5
%
 
of which:
                         
Licensing revenues (in millions)
 
$
13.5
 
$
13.7
 
$
6.9
 
$
6.6
 
Change from first half 2004
                     
1.2
%
Change from second quarter 2004
                     
(4.8
)%
Royalty revenues (in millions)
 
$
2.4
 
$
3.4
 
$
1.3
 
$
1.6
 
Change from first half 2004
                     
39.2
%
Change from second quarter 2004
                     
29.8
%

The increase in licensing revenues for the first half of 2005 over the first half of 2004 reflects revenue growth from our serial ATA technology offset somewhat by lower revenues from our DSP and GPS 4000 technologies. Licensing revenues for the second quarter of 2005 compared to the second quarter of 2004 declined modestly as revenue growth from our serial ATA technology was more than offset by lower revenues from our DSP and GPS 4000 technologies in the current period.
 
13


The increase in royalty revenue in the second quarter and first half of 2005 over the corresponding periods of 2004 was driven by increases in the underlying unit shipments of customers’ products incorporating our IP. In particular licensees of our Ceva Teak and Teaklite cores continued to report increased unit shipments in 2/2.5G baseband cellular and portable audio players, camcorders, disk drive controllers and DSL chips. Our customers reported sales of 27 and 57 million chips incorporating our technology in the second quarter and first half of 2005, respectively, compared with 24 and 43 million in the comparable periods of 2004. Our first quarter 2005 royalty revenue was $1.8 million compared to $1.6m in the second quarter of 2005. Our customers reported sales of 30 million chips incorporating our technology in the first quarter of 2005. The decrease from the first quarter of 2005 reflects the seasonality of the end markets of a number of our licensees’ customers.

We had 22 customers shipping units incorporating our technology offerings in the first and second quarter of 2005 compared with 26 customers in the first and second quarters of 2004. At March 31 and June 30, 2005 we had 15 customers paying per unit royalty and 7 in prepaid royalty compared to 17 and 9 at June 30, 2004.

The five largest customers paying per unit royalty accounted for 71% and 72% of total royalty revenues in the second quarter and first half of 2005, respectively compared to 88% and 77% for the corresponding periods of 2004. Five customers, including those in prepaid royalty shipped in excess of 5 million units in the first half of 2005, compared to three customers in the first half of 2004. One customer, shipped in excess of 5 million units in the second quarter of 2005, compared to two customers in the both the second quarter of 2004 and the first quarter of 2005.
 
Other Revenues

Other revenues include services and maintenance and support for licensees. 

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
Other revenues (in millions)
 
$
2.8
 
$
2.5
 
$
1.4
 
$
1.3
 
Change from first half 2004
                     
(11.9
)%
Change from second quarter 2004
                     
(6.2
)%

The decrease in other revenues in the second quarter and first half of 2005 from the second quarter and first half of 2004 reflects the completion of a number of services contracts during 2004.

Geographic Revenue Analysis

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
       
(in millions,except percentages)
     
United States
 
$
3.2
   
17
%
$
8.2
   
42
%
$
1.4
   
14
%
$
6.0
   
63
%
Europe, Middle East, Africa
 
$
9.8
   
52
%
$
4.1
   
21
%
$
5.7
   
59
%
$
1.6
   
17
%
Asia
 
$
5.8
   
31
%
$
7.3
   
37
%
$
2.5
   
27
%
$
1.9
   
20
%

Due to the nature of our license agreements and the associated large individual contract amounts, the geographic split of revenues both in absolute and percentage terms generally varies from quarter to quarter depending on the timing of deals in each region.

Cost of Revenues

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
Cost of revenues (in millions)
 
$
3.0
 
$
2.4
 
$
1.5
 
$
1.1
 
Change from first half 2004
                     
(18.6
)%
Change from second quarter 2004
                     
(23.1
)%

Cost of revenues accounted for 12% of total revenues for the second quarter and first half of 2005, compared with 15% and 16%, respectively, for the corresponding periods of 2004. Gross margins for the second quarter and first half of 2005 were 88%, compared with 85% and 84%, respectively, for the corresponding periods of 2004. The decrease in the dollar amount of cost of revenues and the increase in gross margins in the second quarter and first half of 2005 compared with the corresponding periods in 2004 reflect the shift in revenue mix with increased higher gross margin royalty revenue as a percentage of total revenues in 2005.

14

 
Operating Expenses

(in millions)
 
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
Research and development, net
 
$
8.2
 
$
10.4
 
$
4.2
 
$
5.5
 
Sales and marketing
 
$
3.4
 
$
3.2
 
$
1.7
 
$
1.6
 
General and Administration
 
$
3.0
 
$
3.1
 
$
1.5
 
$
1.6
 
Amortization of intangible assets
 
$
0.4
 
$
0.4
 
$
0.2
 
$
0.2
 
Reorganization and severance charge
 
$
-
 
$
1.7
 
$
-
 
$
1.7
 
Impairment of assets
 
$
-
 
$
0.5
 
$
-
 
$
0.5
 
Total operating expenses
 
$
15.0
 
$
19.4
 
$
7.6
 
$
11.1
 
Change from first half 2004
                     
28.9
%
Change from second quarter 2004
                     
44.6
%
Sub-totals are not adjusted for rounding
                         

The increase in total operating expenses before reorganization, severance and impairment charges in the second quarter and first half of 2005 from the corresponding periods in 2004 principally reflects increased costs associated with our research and development programs.

Reorganization and severance charge totaled $1.7 million in the second quarter and first half of 2005. The charge arose in connection with the decision to restructure our corporate management, reduce overhead and consolidate our activities. We also recorded impairment charges of $0.5 million in the second quarter and first half of 2005 of which $0.4 million related to the impairment of intangible assets following the cessation of our Bluetooth product line and the balance related to non-performing assets following the implementation of our reorganization plan.

Research and Development Expenses, Net

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
Research and development expenses, net (in millions)
 
$
8.2
 
$
10.4
 
$
4.2
 
$
5.5
 
Change from first half 2004
                     
26.8
%
Change from second quarter 2004
                     
30.6
%

The increase in research and development expenses in the second quarter and first half of 2005 from the corresponding periods of 2004 principally reflects a combination of increased headcount and increased sub-contract design primarily in our DSP and serial ATA research and development programs.

The number of research and development personnel was 175 at June 30, 2005, compared with 159 at June 30, 2004.

Sales and Marketing Expenses

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
Sales and Marketing expenses, net (in millions)
 
$
3.4
 
$
3.2
 
$
1.7
 
$
1.6
 
Change from first half 2004
                     
(4.6
)%
Change from second quarter 2004
                     
(9.2
)%

The decrease in sales and marketing expenses in 2005 from 2004 principally reflects lower marketing activity. Sales and marketing expenses as a percentage of total revenues were 16.4% and 16.5% for the second quarter and first half of 2005 compared with 17.9% and 18.0%, respectively, for the corresponding periods respectively, of 2004. The total number of sales and marketing personnel was 19 at June 30, 2005, compared with 20 at June 30, 2004.

General and Administrative Expenses

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
General and Administrative expenses, net (in millions)
 
$
3.0
 
$
3.1
 
$
1.5
 
$
1.6
 
Change from first half 2004
                     
4.3
%
Change from second quarter 2004
                     
7.8
%

15

 
The increase in general and administrative expenses in 2005 from 2004 principally reflects increased professional fees offset by reduced headcount costs. The number of general and administrative personnel was 32 at June 30, 2005 compared with 36 at June 30, 2004.

Amortization of Other Intangibles

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
Amortization of intangible assets (in millions)
 
$
0.4
 
$
0.4
 
$
0.2
 
$
0.2
 
Change from first half 2004
                     
(1.1
)%
Change from second quarter 2004
                     
(2.2
)%

The amount of other intangible assets was $1.8 million at June 30, 2005 and $2.6 million at December 31, 2004. Following the impairment of the Bluetooth intangible assets of $0.4 million in the second quarter of 2005, we anticipate ongoing expense in connection with the amortization of remaining intangibles of approximately $190,000 per quarter.

Reorganization and severance charge

Our management and board of directors approved a reorganization plan in the second quarter of 2005, which resulted in a charge of $1.7 million. The charge arose in connection with the decision to restructure our corporate management, reduce overhead and consolidate our activities. Included are severance charges and employee-related liabilities arising in connection with a headcount reduction of nine employees and provision for future operating lease charges on idle facilities.

Management was required to make certain estimates and assumptions in assessing the provision for future operating lease charges on idle facilities from the reduction in facility requirements. The provision for future operating lease charges on idle facilities was calculated by taking into consideration (1) the committed annual rental charge associated with the vacant square footage, (2) an assessment of the sublet rents that could be achieved based on current market conditions, vacancy rates and future outlook, (3) the estimated periods that facilities would be empty before being sublet, (4) an assessment of the percentage increases in the primary lease rent and the sublease rent at each five-year rent review, and (5) the application of a discount rate of 4.75% over the remaining period of the lease. Management expect to revise their assumptions quarterly, as appropriate in respect of future vacancy rates and sublet rents in light of current market conditions and the applicable discount rate based on projected interest rates. There was a charge of $0.3 million on net income in the three-and six-month periods ended June 30, 2005 for future operating lease charges on idle facilities.

Impairment of assets

We recorded an impairment charge on our intangible assets of $0.4 million in the second quarter of 2005 in respect of Bluetooth technology acquired in the combination with Parthus following the decision to cease the development of this product line due to the minimal differentiation between competing solutions. We also recorded an impairment of $0.1 million in the period in respect of non-performing assets following the implementation of our reorganization plan.

Other Income, Net

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
Other income, net (in millions)
 
$
0.35
 
$
0.78
 
$
0.16
 
$
0.44
 
of which:
                         
Interest income (in millions)
 
$
0.35
 
$
0.68
 
$
0.17
 
$
0.39
 
Foreign exchange gains (in millions)
 
$
0.00
 
$
0.10
 
$
(0.01
)
$
0.05
 

Other income, net consists of interest earned on investments and foreign exchange movements. The increase in interest earned in the second quarter and first half of 2005 from the corresponding periods of 2004 reflects a combination of a higher interest rate environment and 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 gain of $95,000 in the first half of 2005 and $9,000 for the corresponding period of 2004.
 
16


Provision for Income Taxes

   
First Half
2004
 
First half
2005
 
Second Quarter
2004
 
Second Quarter
2005
 
Provision for income taxes (in millions)
 
$
0.3
 
$
0.2
 
$
0.1
 
$
0.0
 

The provision for income taxes in the second quarter and first half of 2004 and 2005 reflects lower profits incurred domestically and in certain foreign jurisdictions.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2005, the Company had approximately $37.9 million in cash and cash equivalents and $21.7 million in marketable securities, totaling $59.6 million compared to $59.6 million at December 31, 2004. During the first half of 2005, the Company invested $24.4 million of its cash in certificates of deposits and U.S. government and agency securities with maturities from 4 to 9 months. In addition, certificates of deposits and U.S. government and agency securities were sold for cash amounting to $33.4 million. These instruments are classified as marketable securities and the purchases and sales are considered part of operating cash flow.

Net cash provided by operating activities in the first half of 2005 was $9.2 million, compared with $1.0 million of net cash used in operating activities for the comparable period in 2004. Included in the operating cash inflow in the first half of 2005 were net proceeds of $9.0 million from marketable securities and $1.4 million outflow in connection with restructuring and reorganization costs. Included in the operating cash outflow in the first half of 2004 was $1.3 million outflow in connection with restructuring and reorganization costs. Excluding these items net cash provided by operations during the first half of 2005 was $1.6 million and $0.3 million for the corresponding period in 2004.

Cash flows from operating activities may vary significantly from quarter to quarter depending on the timing of our receipts and payments. Of the $3.2 million of restructuring and reorganization costs accrued at June 30, 2005, we expect a cash outflow of approximately $2.2 million in the second half of 2005, primarily relating to underutilized building rental payments, severance and employee-related costs, including the repayment of government grants related to employee numbers. Our ongoing cash outflows from operating activities principally relate to payroll-related costs and obligations under our property leases and design tool licenses. Our primary sources of cash inflows are receipts from our customers and interest earned from our cash and marketable securities holdings. The timing of receipts from customers is based upon the completion of agreed milestones or agreed dates as set out in the applicable contracts.

Cash has been used to fund working capital requirements, as well as property and equipment expenditures, which to date have been relatively low due to the fact that our licensing business model requires no manufacturing facilities. Capital equipment purchases of computer hardware and software used in engineering development, company vehicles, furniture and fixtures amounted to approximately $0.7 million in the first half of 2005 and $2.6 million for the comparable period in 2004. The high level of capital expenditures in the first half of 2004 was principally due to investment in new design tools and tenant improvements associated with the move of our facility in Israel to new premises. Proceeds from the sale of property and equipment amounted to $8,000 in the first half of 2005 and $42,000 for the corresponding period in 2004.

Net cash provided by financing activities of $1.1 million in the first half of 2005 and $1.4 million for the corresponding period in 2004 reflects proceeds from the issuance of shares upon the exercise of stock options and the issuance of shares under our employee stock purchase plans.

We believe that our current cash on hand, along with cash from operations, will provide sufficient capital to fund our operations for at least the next 12 months. We cannot provide assurances however, that the underlying assumed levels of revenues and expenses will prove to be accurate which would likely detrimentally impact our cash on hand.

   
Payments Due by Period
(in thousands)
 
Contractual Obligations
 
Total
 
Less than 1 year
 
1-3 Years
 
3-5 Years
 
More than 5 years
 
Operating Lease Obligations - Leasehold properties
 
$
27,488
 
$
2,352
 
$
3,591
 
$
3,096
 
$
18,449
 
Operating Lease Obligations - Other
   
1,415
   
1,049
   
366
   
   
 
Purchase Obligations
   
137
   
137
   
   
   
 
Total
 
$
29,040
 
$
3,538
 
$
3,957
 
$
3,096
 
$
18,449
 

Operating leasehold obligations are principally on our leasehold properties located in the United States, Ireland, Israel and the United Kingdom. An amount of $1.7 million included in Operating Lease Obligations - Leasehold properties has been provided in the restructuring accrual at June 30, 2005.
 
17


Other operating lease obligations relate to license agreements entered into for design tools maintenance of $0.4 million and obligations under motor vehicle leases of $1.0 million. Purchase obligations consist of capital commitments of $0.1 million.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND ASSUMPTIONS

Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The significant accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

Ÿ  
Revenue Recognition
Ÿ  
Allowances for Doubtful Accounts
Ÿ  
Accounting for Income Taxes
Ÿ  
Goodwill
Ÿ  
Other intangible assets
Ÿ  
Reorganization, restructuring and severance charge
Ÿ  
Foreign Currency

In many cases, the accounting treatment of a particular transaction is specifically dictated by U.S. GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting among available alternatives would not produce a materially different result.

Revenue Recognition

Significant management judgments and estimates must be made and used in connection with the recognition of revenue in any accounting period. Material differences in the amount of revenue in any given period may result if these judgments or estimates prove to be incorrect or if management’s estimates change on the basis of development of the business or market conditions. Management judgments and estimates have been applied consistently and have been reliable historically.

A portion of our revenue is derived from license agreements that entail the customization of our application IP to the customer’s specific requirements. Revenues from initial license fees for such arrangements are recognized in accordance with Statement of Position 81-1, “Accounting for Performance of Construction—Type and Certain Production—Type Contracts”, based on the percentage of completion method over the period from signing of the license through to customer acceptance, as such IP requires significant modification or customization that takes time to complete. The percentage of completion is measured by monitoring progress using records of actual time incurred to date in the project compared with the total estimated project requirement, which corresponds to the costs related to earned revenues. Estimates of total project requirements are based on prior experience of customization, delivery and acceptance of the same or similar technology and are reviewed and updated regularly by management.

We believe that the use of the percentage of completion method is appropriate as we have the ability to make reasonably dependable estimates of the extent of progress towards completion, contract revenues and contract costs. In addition, contracts executed include provisions that clearly specify the enforceable rights regarding services to be provided and received by the parties to the contracts, the consideration to be exchanged and the manner and terms of settlement. In all cases we expect to perform our contractual obligations and our licensees are expected to satisfy their obligations under the contract. The complexity of the estimation process and the issues related to the assumptions, risks and uncertainties inherent with the application of the percentage of completion method of accounting affect the amounts of revenue and related expenses reported in our consolidated financial statements. A number of internal and external factors can affect our estimates, including labor rates, utilization and specification and testing requirement changes.

We account for our other IP license revenue in accordance with the provisions of SOP 97-2, “Software Revenue Recognition,” issued by the American Institute of Certified Public Accountants and as amended by SOP 98-4 and SOP 98-9 and related interpretations (collectively, “SOP 97-2”). We exercise judgment and use estimates in connection with the determination of the amount of software license and services revenues to be recognized in each accounting period.
 
18


Under SOP 97-2, revenues are recognized when: (1) collectability is probable; (2) delivery has occurred; (3) the fee is fixed or determinable; and (4) persuasive evidence of an arrangement exists. SOP 97-2 generally requires revenue earned on licensing arrangements involving multiple elements to be allocated to each element based on the relative fair value of the elements, as determined by “vendor specific objective evidence .” Vendor specific objective evidence of fair value for each element of an arrangement is based upon the normal pricing and discounting practices for each element when sold separately, including the renewal rate for support services. We have also adopted SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions” (“SOP 98-9”), for multiple element transactions entered into after January 1, 2000. SOP 98-9 requires that revenue be recognized under the “residual method” when VSOE of fair value exists for all undelivered elements and VSOE does not exist for one of the delivered elements. The VSOE of fair value of the undelivered elements normally is determined based on the price charged for the undelivered element when sold separately.

We assess whether collectability is probable at the time of the transaction based on a number of factors, including the customer’s past transaction history and credit worthiness. If we determine that the collection of the fee is not probable, we defer the fee and recognize revenue at the time collection becomes probable, which is generally upon the receipt of cash.

When a sale of our IP is made to a third party who also supplies us with goods or services under separate agreements, we evaluate each of the agreements to determine whether they are clearly separable, and independent of one another and that reliable fair value exists for either the sales or purchase element in order to determine the appropriate revenue recognition.

Allowances for Doubtful Accounts

We make judgments as to our ability to collect outstanding receivables and provide allowances for the portion of receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding receivables. In determining the provision, we analyze our historical collection experience and current economic trends. We reassess these allowances each accounting period. Historically, our actual losses and credits have been consistent with these provisions. If actual payment experience with our customers is different than our estimates, adjustments to these allowances may be necessary resulting in additional charges to our statement of operations.

Accounting for Income Taxes

Significant judgment is required in determining our worldwide income tax expense provision. In the ordinary course of a global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of cost reimbursement arrangements among related entities, the process of identifying items of revenue and expense that qualify for preferential tax treatment and segregation of foreign and domestic income and expense to avoid double taxation. Although we believe that our estimates are reasonable, the final tax outcome of these matters may be different than that which is reflected in our historical income tax provisions and accruals. Such differences could have a material effect on our income tax provision and net income (loss) in the period in which such determination is made.

Deferred tax assets and liabilities are determined using enacted tax rates for the effects of net operating losses and temporary differences between the book and tax bases of assets and liabilities. We have provided a valuation allowance on the majority of our net deferred tax assets, which includes federal and foreign net operating loss carryforwards, because of the uncertainty regarding their realization. Our accounting for deferred taxes under Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes”, involves the evaluation of a number of factors concerning the realizability of our deferred tax assets. In concluding that a valuation allowance was required, we primarily considered such factors as our history of operating losses and expected future losses in certain jurisdictions and the nature of our deferred tax assets. We provide valuation allowances in respect of deferred tax assets resulting principally from the carryforward of tax losses. We currently believe that it is more likely than not that the deferred tax assets regarding the carryforward of losses and certain accrued expenses will not be realized in the foreseeable future. In the event that we were to determine that we would not be able to realize all or part of our deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such determination. Likewise, if we later determine that it is more likely than not that the net deferred tax assets would be realized, we would reverse the applicable portion of the previously provided valuation allowance. In order for us to realize our deferred tax assets we must be able to generate sufficient taxable income in the tax jurisdictions in which the deferred tax assets are located.
 
We do not provide for US Federal Income taxes on the undistributed earnings of our international subsidiaries because such earnings are re-invested and, in our opinion, will continue to be re-invested indefinitely. In addition, we operate within multiple taxing jurisdictions involving complex issues and we provide for tax liabilities on investment activity as appropriate.
 
19

 
Goodwill

Under SFAS No. 142, “Goodwill and Other Intangible Assets”, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests based on estimated fair value in accordance with SFAS No. 142.
 
We conduct our annual test of impairment for goodwill in October of each year. In addition we test for impairment periodically whenever events or circumstances occur subsequent to our annual impairment tests that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Indicators we considered important which could trigger an impairment include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a significant decline in our stock price for a sustained period and our market capitalization relative to net book value.

The goodwill impairment test, which is based on fair value, is performed on a reporting unit level. A reporting unit is defined by SFAS No. 131, “Disclosure About Segments of an Enterprise and Related Information,” as an operating segment or one level lower. We market our products and services in one segment and thus allocate goodwill to one reporting unit. Therefore, impairment is tested at the enterprise level using our market capitalization as fair value. Accordingly, in conducting the first step of this impairment test, we compare the carrying value of our assets and liabilities to our market capitalization. If the carrying value exceeds the fair value, the goodwill is potentially impaired and we then complete the second step in order to measure the impairment loss. If the fair value exceeds the carrying value, the second step in order to measure the impairment loss is not required.

In the second step of the impairment test, the fair value of all the unit’s balance sheet assets and liabilities, as well as the Company’s identifiable intangible assets, excluding goodwill, must be determined at the valuation date. We estimate the future cash flows to determine the fair value of these assets and liabilities. These cash flows are then discounted at rates reflecting the respective specific industry’s cost of capital. The discounted cash flows are then compared to the carrying amount of the Company’s assets and liabilities to determine if an impairment exists. If, upon review, the fair value is less than the carrying value, the carrying value is written down to estimated fair value.

Should our market capitalization decline, in assessing the recoverability of our goodwill, we may be required to make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. This process is subjective and requires judgment at many points throughout the analysis. If our estimates or their related assumptions change in subsequent periods or if actual cash flows are below our estimates, we may be required to record impairment charges for these assets not previously recorded.

In October 2004, we completed our annual impairment test and assessed the carrying value of goodwill as required by SFAS No. 142. The goodwill impairment test compared the carrying value of the Company (the “reporting unit”) with the fair value at that date. Because the market capitalization exceeded the carrying value significantly, no impairment arose. No indicators of impairment were identified between the date of the annual impairment test and June 30, 2005.  Subsequent to June 30, 2005 our share price has declined below $5.40 resulting in our market capitalization being lower than the carrying value of our net assets as of  June 30, 2005.  We will continue to monitor our share price as well as any other indicators of impairment over the coming periods to consider whether the decline in share price is for a sustained period. A sustained decrease would require the second step of the impairment test to be undertaken to determine whether our goodwill is potentially impaired.

Other Intangible Assets

Other intangible assets represents costs of technology acquired from acquisitions which have reached technological feasibility. The costs of technology have been capitalized and are amortized to the Consolidated Statements of Operations over the period during which benefits are expected to accrue, currently estimated at five years. We recorded an impairment charge in the second quarter of 2005 on our intangible assets of $0.4 million in respect of Bluetooth technology acquired in the combination with Parthus following the decision to cease the development of this product line due to the minimal differentiation between competing solutions. We are required to test our other intangible assets for impairment whenever events or circumstances indicate that the value of the assets may be impaired. Factors we consider important, which could trigger impairment include:

Ÿ  
significant underperformance relative to expected historical or projected future operating results;
Ÿ  
significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
Ÿ  
significant negative industry or economic trends;
Ÿ  
significant decline in our stock price for a sustained period; and
Ÿ  
significant decline in our market capitalization relative to net book value.

20

 
Where events and circumstances are present which indicate that the carrying value may not be recoverable, we will recognize an impairment loss. Such impairment loss is measured by comparing the fair value of the asset with its carrying value. The determination of the value of such intangible assets requires us to make assumptions regarding future business conditions and operating results in order to estimate future cash flows and other factors to determine the fair value of the respective assets. If these estimates or the related assumptions change in the future, we could be required to record additional impairment charges.

Reorganization, restructuring and severance charge

In the second quarter of 2005, we recorded a reorganization and severance charge of $1.7 million. The charge arose in connection with the decision to restructure our corporate management, reduce overhead and consolidate our activities. Included are severance charges and employee related liabilities arising in connection with a headcount reduction of nine employees and provision for future operating lease charges on idle facilities.

We were required to make and are required to review certain estimates and assumptions in assessing the underutilized building operating lease charges arising from the reduction in facility requirements. The provision for future operating lease charges on idle facilities was calculated by taking into consideration (1) the committed annual rental charge associated with the vacant square footage, (2) an assessment of the sublet rents that could be achieved based on current market conditions, vacancy rates and future outlook, (3) the estimated periods that facilities would be empty before being sublet, (4) an assessment of the percentage increases in the primary lease rent and the sublease rent at each five-year rent review, and (5) the application of a discount rate of 4.75% over the remaining period of the lease. We review and revise our assumptions quarterly in respect of future vacancy rates and sublet rents in light of current market conditions and our discount rate based on projected interest rates now applicable. There was a charge of $0.3 million on net income in the three-and six-month periods ended June 30, 2005. Revisions to our estimates of this liability could materially impact our operating results and financial position in future periods if anticipated events and assumptions either change or do not materialize. 

Foreign Currency

The U.S. dollar is the functional currency for the Company. The majority of our revenues and a portion of our expenses are transacted in U.S. dollars and our assets and liabilities together with our cash holdings are predominately denominated in U.S. dollars. However, a significant portion of our expenses are denominated in currencies other than the U.S. dollar, principally the euro and the Israeli NIS. Assets and liabilities denominated in foreign currencies are translated at year end exchange rates while revenues and expenses are translated at rates approximating those ruling at the dates of the related transactions. Increases in the volatility of the exchange rates of the euro and the NIS versus the U.S. dollar could have an adverse effect on the expenses and liabilities that we incur when translated into U.S. dollars. We review our monthly expected non-US dollar denominated expenditures and look to hold equivalent non-U.S. dollar cash balances to mitigate currency fluctuations and this has resulted in a small foreign exchange impact in the second quarter and first half of 2004 and 2005.

As a result of currency fluctuations and the conversion to U.S. dollars for financial reporting purposes, we may experience fluctuations in our operating results on an annual and a quarterly basis going forward. We have not in the past, but may in the future, hedge against fluctuations in exchange rates. Future hedging transactions may not successfully mitigate losses caused by currency fluctuations. We expect to continue to experience the effect of exchange rate fluctuations on an annual and quarterly basis, and currency fluctuations could have a material adverse impact on our results of operations.
 
RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, Share-Based Payment (“SFAS No. 123R”). This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and its related implementation guidance. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant date fair value of those awards (with limited exceptions). SFAS 123R as published was to be effective for the first interim or annual reporting period that begins after June 15, 2005. In March 2005, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin (SAB) 107, Share-Based Payment, which expresses views of the SEC Staff about the application of SFAS No. 123(R).
 
On April 14, 2005, the SEC announced the adoption of a rule that defers the required effective date of SFAS No. 123R. The SEC rule provides that SFAS No. 123R is now effective for registrants as of the beginning of the first fiscal year beginning after June 15, 2005, instead of at the beginning of the first quarter after June 15, 2005, delaying the required change until January 1, 2006. We are evaluating the requirements of SFAS 123R and expect that the adoption of SFAS 123R will have a material impact on our Condensed Consolidated Statements of Operations and net income (loss) per share. We have not yet determined the method of adoption or the effect of adopting SFAS 123R, and we have not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123.
 
21

 
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections" ("SFAS 154") which replaces Accounting Principles Board Opinions No. 20 "Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements—An Amendment of APB Opinion No. 28." SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We are evaluating the effect that the adoption of SFAS 154 will have on our Condensed Consolidated Statements of Operations and financial condition but do not expect it to have a material impact.
 
22

 
FACTORS THAT COULD AFFECT OUR OPERATING RESULTS
We caution you that the following important factors, among others, could cause our actual future results to differ materially from those expressed in forward-looking statements made by or on behalf of us in filings with the Securities and Exchange Commission, press releases, communications with investors and oral statements. Any or all of our forward-looking statements in this quarterly report, and in any other public statements we make, may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in the discussion below will be important in determining future results. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make in our reports filed with the Securities and Exchange Commission.

RISKS RELATING TO OUR MARKETS

The industries in which we license our technology have experienced a challenging period of slow growth that has negatively impacted and could continue to negatively impact our business and operating results.

The primary customers for our products are semiconductor design and manufacturing companies, system OEMs and electronic equipment manufacturers, particularly in the telecommunications field. These industries are highly cyclical and have been subject to significant economic downturns at various times, particularly in recent periods. These downturns are characterized by production overcapacity and reduced revenues, which at times may encourage semiconductor companies or electronic product manufacturers to reduce their expenditure on our technology. During 2001, the semiconductor industry as a whole experienced the most severe contraction in its history, with total semiconductor sales worldwide declining by more than 30%, according to the Semiconductor Industry Association. The market for semiconductors used in mobile communications was particularly hard hit, with the overall decline in sales worldwide estimated by Gartner Dataquest to have been well above 30%. These adverse conditions stabilized but did not improve during the course of 2002. During the course of 2003 and 2004, a recovery appeared to begin although this recovery began to slow in the later half of 2004. For example semiconductor companies, OEM's and ODM's continue to delay GPS adoption until they have better visibility on 3G deployment. If this apparent recovery is not sustained through 2005 and beyond our business could be further materially and adversely affected.

The markets in which we operate are highly competitive, and as a result we could experience a loss of sales, lower prices and lower revenue.

The markets for the products in which our technology is used are highly competitive, for example customers of the semiconductor companies may choose to adopt a multi-chip solution versus licensing and integrating our DSP core into a single chip. Aggressive competition could result in substantial declines in the prices that we are able to charge for our intellectual property. It could also cause our existing customers to move their orders to our competitors. Many of our competitors are large companies that have significantly greater financial and other resources than we have.
 
In addition, we may face increased competition from smaller, niche semiconductor design companies in the future. Some of our customers may also decide to satisfy their needs through in-house design and production. We compete on the basis of price, product quality, design cycle time, reliability, performance, customer support, name recognition and reputation, and financial strength. Our inability to compete effectively on these bases could have a material adverse effect on our business, results of operations and financial condition.

Our operating results fluctuate from quarter to quarter due to a variety of factors, including our lengthy sales cycle, and are not a meaningful indicator of future performance.

In some quarters our operating results could be below the expectations of securities analysts and investors, which could cause our stock price to fall. Factors that may affect our quarterly results of operations in the future include, among other things:
 
Ÿ  
the timing of the introduction of new or enhanced technologies, as well as the market acceptance of such technologies;
Ÿ  
new product announcements and introductions by competitors;
Ÿ  
the timing and volume of orders and production by our customers, as well as fluctuations in royalty revenues resulting from fluctuations in unit shipments by our licensees;
Ÿ  
our lengthy sales cycle
Ÿ  
the gain or loss of significant licensees
Ÿ  
changes in our pricing policies and those of our competitors; and
Ÿ  
restructuring, asset impairment and related charges.

23


We rely significantly on revenue derived from a limited number of licensees.

We expect that a limited number of licensees, varying in identity from period-to-period, will account for a substantial portion of our revenues in any period. Moreover, license agreements for our DSP cores have not historically provided for substantial ongoing license payments, although they may provide for royalties based on product shipments. Significant portions of our anticipated future revenue, therefore, will likely depend upon our success in attracting new customers or expanding our relationships with existing customers. Our ability to succeed in these efforts will depend on a variety of factors, including the performance, quality, breadth and depth of our current and future products and our sales and marketing skills. In addition, some of our licensees may decide to satisfy their needs through in-house design and production. Our failure to obtain future customer licenses would impede our future revenue growth.

We depend on market acceptance of third-party semiconductor intellectual property.

Our future growth will depend on the level of acceptance by the market of our third-party, licensable intellectual property model and the variety of intellectual property offerings available on the market, which to a large extent are not in our control. If the market shifts and third-party SIP is no longer desired by our customers, our business, results of operations and financial condition could be materially harmed.

We depend on the success of our licensees to promote our solutions in the marketplace.

We do not sell our technology directly to end-users; we license our technology primarily to semiconductor companies and to electronic equipment manufacturers, who then incorporate our technology into the products they sell. Because we do not control the business practices of our licensees, we do not influence the degree to which they promote our technology or set the prices at which they sell products incorporating our technology. We cannot assure you that our licensees will devote satisfactory efforts to promote our solutions. In addition, our unit royalties from licenses are totally dependent upon the success of our licensees in introducing products incorporating our technology and the success of those products in the marketplace. If we do not retain our current licensees and continue to attract new licensees, our business may be harmed.

We depend on a limited number of key personnel who would be difficult to replace.

Our success depends to a significant extent upon our key employees and senior management; the loss of the service of these employees could materially harm us. Competition for skilled employees in our field is intense. We cannot assure you that we will be successful in attracting and retaining the required personnel.

RISKS RELATING TO OUR
SEPARATION FROM DSP GROUP

We could be subject to joint and several liability for taxes of DSP Group.

As a former member of a group filing consolidated income tax returns with DSP Group, we could be liable for federal income taxes of DSP Group and other members of the consolidated group, including taxes, if any, incurred by DSP Group on the distribution of our stock to the stockholders of DSP Group. DSP Group has agreed to indemnify us against these taxes, other than taxes for which we have agreed to indemnify DSP Group pursuant to the terms of the tax indemnification and allocation agreement and separation agreement we entered into with DSP Group.
 
ADDITIONAL RISKS RELATING TO OUR BUSINESS

Our success will depend on our ability to manage our geographically dispersed operations successfully.

Most of our employees are located in Israel and Ireland. Accordingly, our ability to compete successfully will depend in part on the ability of a limited number of key executives located in geographically dispersed offices to integrate management, address the needs of our customers and respond to changes in our markets. If we are unable to effectively manage our remote operations, our business may be harmed.

Our operations in Israel may be adversely affected by instability in the Middle East region.

One of our principal research and development facilities is located in, and our executive officers and some of our directors are residents of, Israel. Although substantially all of our sales currently are being made to customers outside Israel, we are nonetheless directly influenced by the political, economic and military conditions affecting Israel. Any major hostilities involving Israel could significantly harm our business, operating results and financial condition.
 
24


In addition, certain of our officers and employees are currently obligated to perform annual reserve duty in the Israel Defense Forces and are subject to being called for active military duty at any time. Although we have operated effectively under these requirements since our inception, we cannot predict the effect of these obligations on the company in the future. Our operations could be disrupted by the absence, for a significant period, of one or more of our officers or key employees due to military service.

If we are unable to meet the changing needs of our end-users or to address evolving market demands, our business may be harmed.

The markets for programmable DSP cores and application IP are characterized by rapidly changing technology, emerging markets and new and developing end-user needs, requiring significant expenditure for research and development. We cannot assure you that we will be able to introduce systems and solutions that reflect prevailing industry standards on a timely basis, to meet the specific technical requirements of our end-users or to avoid significant losses due to rapid decreases in market prices of our products, and our failure to do so may seriously harm our business. For example, we have already licensed our multi-media solution, however, this technology has not yet been deployed by our licensees to their end market and may be subject to further modifications to address evolving market demands. In addition, the reduction in the number of our employees in connection with our recent restructuring efforts could adversely affect our ability to attract or retain customers who require certain R&D capabilities from their IP providers.

We may seek to expand our business through acquisitions that could result in diversion of resources and extra expenses.

We may pursue acquisitions of businesses, products and technologies, or establish joint venture arrangements in the future that could expand our business. The negotiation of potential acquisitions or joint ventures, as well as the integration of acquired or jointly developed businesses, technologies or products could cause diversion of management’s time and our resources. We may not be able to successfully integrate acquired businesses or joint ventures with our operations. If we were to make any acquisition or enter into a joint venture, we may not receive the intended benefits of the acquisition or joint venture. If future acquisitions or joint ventures disrupt our operations, or if we have difficulty integrating the businesses or technologies we acquire, our business, financial condition and results of operations could suffer.

We may not be able to adequately protect our intellectual property.

Our success and ability to compete depend in large part upon the protection of our proprietary technologies. We rely on a combination of patent, copyright, trademark, trade secret, mask work and other intellectual property rights, confidentiality procedures and licensing arrangements to establish and protect our proprietary rights. These agreements and measures may not be sufficient to protect our technology from third-party infringement, or to protect us from the claims of others. As a result, we face risks associated with our patent position, including the potential need to engage in significant legal proceedings to enforce our patents, the possibility that the validity or enforceability of our patents may be denied, the possibility that third parties will be able to compete against us without infringing our patents and the possibility that our products may infringe patent rights of third parties.

Our trade names or trademarks may be registered or utilized by third parties in countries other than those in which we have registered them, impairing our ability to enter and compete in these markets. If we were forced to change any of our brand names, we could lose a significant amount of our brand equity.

Our business will suffer if we are sued for infringement of the intellectual property rights of third parties or if we cannot obtain licenses to these rights on commercially acceptable terms.

Although we are not currently involved in any litigation, we are subject to the risk of adverse claims and litigation alleging infringement of the intellectual property rights of others. There are a large number of patents held by others, including our competitors, pertaining to the broad areas in which we are active. We have not, and cannot reasonably, investigate all such patents. From time to time, we have become aware of patents in our technology areas and have sought legal counsel regarding the validity of such patents and their impact on how we operate our business, and we will continue to seek such counsel when appropriate in the future. Claims against us may require us to enter into license arrangements or result in protracted and costly litigation, regardless of the merits of these claims. Any necessary licenses may not be available or, if available, may not be obtainable on commercially reasonable terms. If we cannot obtain necessary licenses on commercially reasonable terms, we may be forced to stop licensing our technology, and our business would be seriously harmed.

Our business depends on OEMs and their suppliers obtaining required complementary components.

Some of the raw materials, components and subassemblies included in the products manufactured by our OEM customers are obtained from a limited group of suppliers. Supply disruptions, shortages or termination of any of these sources could have an adverse effect on our business and results of operations due to the delay or discontinuance of orders for products containing our IP, especially our DSP cores, until those necessary components are available.
 
25


The future growth of our business depends in part on our ability to license to system OEMs and small-to-medium-sized semiconductor companies directly and to expand our sales geographically.

Historically a substantial portion of the revenues from the licensing of our products has been derived in any period from a relatively small number of licensees. Because of the substantial license fees we charge, our customers tend to be large semiconductor companies or vertically integrated system OEMs. Part of our current growth strategy is to broaden the adoption of our products by small to mid-size companies by offering different versions of our products, targeted at these companies. In addition we plan to continue expanding our sales to include additional geographies. Asia, in particular, is a region we have targeted for growth. If we are unable to effectively develop and market our intellectual property through these models, our revenues will continue to be dependent on a smaller number of licensees and a less geographically dispersed pattern of licensees, which could harm our business and results of operations.

Our independent registered public accounting firm may qualify in their attestation on the adequacy of our internal controls over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002.

The Securities and Exchange Commission, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a report of management on internal controls over financial reporting in their annual reports on Form 10-K that contain an assessment by management of the effectiveness of the Company’s internal controls over financial reporting. In addition, the Company’s independent registered public accounting firm must attest to and report on management’s assessment of the effectiveness of the internal controls over financial reporting. Although we intend to diligently and vigorously review our internal controls over financial reporting in order to ensure compliance with the Section 404 requirements on an annual basis, if our independent registered public accounting firm is not satisfied with our internal controls over financial reporting or the level at which these controls are documented, designed, operated or reviewed, or if the independent registered public accounting firm interprets the requirements, rules and/or regulations differently from us, then they may decline to attest to management’s assessment or may issue a report that is qualified. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our consolidated financial statements, which ultimately could negatively impact our stock price.
 
Changes in accounting rules for stock-based compensation may adversely affect our operating results, our stock price and our competitiveness in the employee marketplace.

We have a history of using employee stock options and other stock-based compensation to hire, motivate and retain our workforce.  Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment, as amended” will require us, starting in 2006, to measure compensation costs for all stock-based compensation (including stock options and our employee stock purchase plan) at fair value and to recognize these costs as expenses in our statements of operations.  The recognition of these expenses in our statements of operations will result in lower net income (loss) per share, which could negatively impact our future stock price.  In addition, if we reduced or alter our use of stock-based compensation to minimize the recognition of these expenses, our ability to recruit, motivate and retain employees may be impaired, which could put us at a competitive disadvantage in the employee marketplace.
 
ADDITIONAL RISKS RELATING TO OUR
INTERNATIONAL OPERATIONS

The Israeli tax benefits that we currently receive and the government programs in which we participate require us to meet certain conditions and may be terminated or reduced in the future, which could increase our costs.

We enjoy certain tax benefits in Israel, particularly as a result of the “Approved Enterprise” status of our facilities and programs. To maintain our eligibility for these tax benefits, we must continue to meet certain conditions, relating principally to adherence to the investment program filed with the Investment Center of the Israeli Ministry of Industry and Trade and to periodic reporting obligations. We believe that we will be able to continue to meet such conditions. Should we fail to meet such conditions in the future, however, these benefits would be cancelled and we would be subject to corporate tax in Israel at the standard rate of 36% and could be required to refund tax benefits already received. In addition, we cannot assure you that these grants and tax benefits will be continued in the future at their current levels or otherwise. The termination or reduction of certain programs and tax benefits (particularly benefits available to us as a result of the Approved Enterprise status of our facilities and programs) or a requirement to refund tax benefits already received may seriously harm our business, operating results and financial condition.
 
26


Our corporate tax rate may increase, which could adversely impact our cash flow, financial condition and results of operations.

We have significant operations in the Republic of Ireland and a substantial portion of our taxable income historically has been generated there. Currently, some of our Irish subsidiaries are taxed at rates substantially lower than U.S. tax rates. Although there is no expectation of any changes to Irish tax law, if our Irish subsidiaries were no longer to qualify for these lower tax rates or if the applicable tax laws were rescinded or changed, our operating results could be materially adversely affected. In addition, because our Irish and Israeli operations are owned by subsidiaries of a U.S. corporation, distributions to the U.S. corporation, and in certain circumstances undistributed income of the subsidiaries, may be subject to U.S. tax. Moreover, if U.S. or other foreign tax authorities were to change applicable foreign tax laws or successfully challenge the manner in which our subsidiaries’ profits are currently recognized, our overall taxes could increase, and our business, cash flow, financial condition and results of operations could be materially adversely affected.

Item 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

A majority of our revenues and a portion of our expenses are transacted in U.S. dollars and our assets and liabilities together with our cash holdings are predominately denominated in U.S. dollars. However, the bulk of our expenses are denominated in currencies other than the U.S. dollar, principally the euro and the Israeli NIS. Increases in the volatility of the exchange rates of the euro and the NIS versus the U.S. dollar could have an adverse effect on the expenses and liabilities that we incur when translated into U.S. dollars. 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 has resulted in a gain of $95,000 in the first half of 2005 and $9,000 for the corresponding period of 2004.

As a result of currency fluctuations and the conversion to U.S. dollars for financial reporting purposes, we may experience fluctuations in our operating results on an annual and a quarterly basis going forward. We have not in the past, but may in the future, hedge against fluctuations in exchange rates. Future hedging transactions may not successfully mitigate losses caused by currency fluctuations. We expect to continue to experience the effect of exchange rate fluctuations on an annual and quarterly basis, and currency fluctuations could have a material adverse impact on our results of operations.

We invest our cash in high grade certificates of deposits and U.S. government and agency securities. Cash held by foreign subsidiaries is generally held in short-term time deposits denominated in the local currency.

Net interest income was $683,000 in the first half of 2005 and $343,000 for the corresponding period of 2004. We are exposed primarily to fluctuations in the level of U.S. and EMU interest rates. To the extent that interest rates rise, fixed interest investments may be adversely impacted, whereas a decline in interest rates may decrease the anticipated interest income for variable rate investments.

We are exposed to financial market risks, including changes in interest rates. We typically do not attempt to reduce or eliminate our market exposures on our investment securities because the majority of our investments are short-term. We do not have any derivative instruments.
 
Item 4.    CONTROLS AND PROCEDURES 

Our management evaluated, with the participation of our chief executive officer and chief financial officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) during the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our chief executive officer and chief financial officer have concluded that, as of such date, our disclosure controls and procedures were (1) designed to ensure that information relating to CEVA, including our consolidated subsidiaries, is made known to them by others within those entities, particularly in the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
 
As we disclosed in our 10-K/A filed with the SEC on April 26, 2005 (the "10-K/A"), during the first quarter of 2005, we began analyzing the steps to be taken to remediate the material weakness described in our 10-K/A. We have completed the following remediation actions during the first half of 2005:
 
·  
set up procedures to ensure that a comprehensive review of all past and future agreements is undertaken when we are entering into a new revenue generating agreement with a customer where we have an existing relationship with this party such as an existing customer, supplier or service provider relationship;
 
27

 
·  
retained a third party accounting firm to consult on complicated technical accounting issues; and
 
·  
ensured that our accounting and finance personnel have attended U.S. G.A.A.P courses on revenue recognition policies.
 
While we believe that these corrective actions, taken as a whole, remediate the material weakness referenced above, a control system, no matter how well designed or operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in any control systems, no evaluation of controls and procedures can provide absolute assurance that all control issues and instances of fraud, if any, will be detected on a timely basis. These inherent limitations include the possibility that judgments in decision-making can be faulty and that breakdowns can occur because of errors or mistakes. Our disclosure controls and procedures can also be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Furthermore, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
 
PART II.    OTHER INFORMATION
 
Item 1.    LEGAL PROCEEDINGS

The Company is not party to any litigation or other legal proceedings that the Company believes could reasonably be expected to have a material adverse effect on the Company’s business, results of operations and financial condition. 
 
28


Item 6.    EXHIBITS AND REPORTS ON FORM 8-K  

(a) Exhibits

Exhibit
No.
 
Description
   
 
31.1
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
   
 
31.2
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
   
 
32
 
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
 
 
29


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
     
  CEVA, INC.
 
 
 
 
 
 
Date: August 9, 2005 By:   /s/ GIDEON WERTHEIZER
 
Gideon Wertheizer
 
Chief Executive Officer
(principal executive officer)
     
   
 
 
 
 
 
 
Date: August 9, 2005 By:   /s/ YANIV ARIELI
 
Yaniv Arieli
 
Chief Financial Officer
(principal financial officer and principal accounting officer)
 
30


INDEX TO EXHIBITS

Exhibit
No.
 
Description
   
 
31.1
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
   
 
31.2
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
   
 
32
 
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer

31