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CEVA, Inc (NASDAQ:CEVA)

Q2 2012 Results Earnings Call

July 31, 2012 8:30 AM ET

Executives

Richard Kingston – Director, Marketing and IR

Gideon Wertheizer – Chief Executive Officer

Yaniv Arieli – Chief Financial Officer

Analysts

Suji De Silva – ThinkEquity

Anil Doradla – William Blair

Gary Mobley – Benchmark

Joseph Wolf – Barclays

Vijay Rakesh – Sterne Agee

Jay Srivatsa – Chardan Capital Markets

Blake Harper – Wunderlich

James Faucette – Pacific Crest

Operator

Good morning. And welcome to the CEVA Inc. Second Quarter 2012 Earnings Conference Call. All participants will be in a listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions)

Please note this event is being recorded. I'd now like to turn the conference over to Richard Kingston. Please go ahead.

Richard Kingston

Thank you and good morning everyone. Welcome to CEVA's second quarter 2012 earnings conference call. I'm joined today by Gideon Wertheizer, Chief Executive Officer of CEVA; and Yaniv Arieli, Chief Financial Officer of CEVA. Gideon will cover the business aspects and the highlights of the quarter, Yaniv will then cover the financial results for the second quarter of 2012, and will provide financial guidance for the third quarter and fiscal 2012.

I'll start with the forward-looking statements. Today's conference call contains forward-looking statements that involve risks and uncertainties, as well as assumptions that if they materialize or prove incorrect, could cause the results of CEVA to differ materially from those expressed or implied by such forward-looking statements and assumptions.

Forward-looking statements include financial guidance for the third quarter and full year of 2012, market data from ABI Research, Gartner Research, Strategy Analytics, and Wireless Intelligence incorporated herein; optimism about our royalty revenues generally, growth in the 3G space, particularly with smartphones for emerging markets; and our advances in small cells, LTE advanced and 4G LTE spaces, and our ability to capitalize on these trends.

The risks, uncertainties and assumptions include the ability of the CEVA DSP cores and other technologies to continue to be strong growth drivers for us. Our success in penetrating new markets and maintaining our market position in existing markets; the ability of products incorporating our technologies to achieve market acceptance; the effect of intense industry competition and consolidation, global chip market trends; the possibility that markets for our technologies may not develop as expected or that products incorporating our technologies do not achieve market acceptance, our ability to timely and successfully develop and introduce new technologies, and general market conditions and other risks relating to our business including, but not limited to those that are described from time to time in our SEC filings. CEVA assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates.

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

Gideon Wertheizer

Thank you Richard and welcome everyone. I’m pleased to be able to share with you the results for another well executed quarter. CEVA total revenue for the second quarter was $13.6 million, slightly higher than the midpoint of our guidance range. License revenue was particularly strong, at $5.4 million, which represents the best quarter to our licensing business in more than three and a half years.

We secured eight license agreements for a range of market applications, including the first lead customer of our in U.S. baseband and communication DSP, the CEVA XC4000. Three of the license agreements were in the U.S. and the rest in Asia-Pacific region.

As anticipated, royalty revenue was $7.6 million. This reflect the handset industry first quarter shipment, which was affected continuously more with seasonality, than as is currently being the case. According to Gartner, this was the first time since 2009, as the handset market experienced a decline on a year-over-year basis.

Our royalty revenue also reflects pricing pressure in the competitive 2G market, and weakness of Nokia mobile phone segment, which we discussed in detail during the first quarter earning call.

Despite the softness in royalties for mobile devices, we were able to offset it by securing licensing agreements with key customers for new design of next generation mobile products.

In addition to contributing to our topline revenue for the quarter, licensing agreements fuel our future royalty strength and open up further opportunities to extend our foothold in our customer new design.

The fundamentals that stimulate growth in the mobile market remains strong, with numerous opportunities to expand and differentiate. As a result, incumbents in new corners must develop and implement initiatives for designing highly integrated chips with the DSP playing a central role in communication and multimedia processing.

Our DSP technology provides the capability to reuse the same chip design for multiple products and multiple generations of products, via software programming. It is an advanced technology that enables a flexible and more affordable R&D expenditure profile, compared to the conventional hardware based design. This is of particular importance, in light of the significant rise in silicon manufacturing costs, and the recent capacity shortage in 28-nanometer.

Now let me make few comments about the key highlights of the quarter and few observations about the mobile market. Growing concentration in smartphone space is apparent.

The move to differentiate can be at the forefront of mobile technology, which has driven big OEMs to vertically integrate and develop their own chips. This is evident in OEMs including Samsung, Apple and Huawei, integrating their own chips into their smartphone designs.

Moreover, these key areas can have significant interest on their merchant chip supplier, to license our technology and allow consolidation of the same DSP architecture and software investment.

Similar strategy to engage with these dominant OEMs centers are offering a partnership, in technology excellence, and aligning our product plans and future roadmap to the customers mix.

An example of this strategy coming to fruition is the strategic agreement we concluded during the second quarter with a tier 1 OEM, who claims to use our DSP cores across a range of LTE products, ranging from mainstream LTE smartphone to next generation LTE advanced designs. For confidentiality reasons, we cannot elaborate more on this important deal at this time.

As I mentioned earlier, we found a new customer for our new and most advanced DSP architecture, the CEVA XC4000 during the quarter. This is a milestone for a technology that targets the next generation wireless technology. LTE Release 10, also referred as LTE-Advanced and for 8211 AC also known as 5G Wi-Fi.

Our lead customer is a major player in the growing market of small cell, a key enabler for the growth of LTEs, and yet untapped markets for CEVA. The mobile networks are exploding with users streaming video, social networks and other data related application.

A solution that will allow operators to support this greater demand, is to increase the 4G basestation density through a mass deployment of small cells, to augment the large basestation. According to ABI Research, by 2016, the vast majority of basestation deployments are expected to be small cell, with a projected achievement of 55 million small cells per year.

On 4G LTE, we continue to make progress in terms of customer attraction and design wins in this lucrative market. With the additional agreements we signed during the second quarter, we now have more than 20 LTE design wins with our DSPs.

Samsung recently launched its latest CEVA powered LTE chip in its Galaxy SIII LTE smartphone for Korea, which broke the Korean smartphone sales record on its launch day. In addition, we have a number of customers, who already have LTE silicon powered by our DSPs, and are currently in free trials with network operators, with the expectation to enter the market in 2013.

Coming to the handset space, in the first quarter of 2012, sales of mobile phone to end customers declined 2% versus the third quarter of 2011, according to Gartner Research. This was the first time since the second quarter of 2009 that the market has contracted.

This market downturn, which comes after 10 straight quarters of growth, is mainly due to the economic weakness in mature markets, and slowing demand in the Asia-Pacific region, as consumers wait for new smartphone launches.

As for CEVA shipment data, we managed to back this global handset market decline and extended our shipment volume by 2% versus last year. Within these two main segments of the market, the 3G segment is expected to grow significantly, driven by upgrade to a more advanced mobile phone in developed countries, and to a larger extent, migration from 2G to 3G in emerging markets.

According to Wireless Intelligence, at the end of June 2012, of the 1.8 billion 3G connections globally, there were greater than 900 million 3G connection in emerging regions, representing a 42% growth year-over-year.

We discussed 3G, [trended] the path and stated that we believe we will be a major beneficiary of this 3G growth, both from new design and from replacing the incumbent market participants, such as Qualcomm. This is evident from CEVA 3G shipment volume, which recorded a 16% sequential growth in the first quarter of 2012, as compared to a 2% decline for the overall 3G market, which is according to Strategy Analytics.

Among the numerous CEVA enabled smartphone that were recently introduced by Samsung -- introduced Samsung Galaxy SIII, targeted for Europe and China, and HTC One and HTC Desire, targeted for China Mobile 3G network.

In order to maximize 3G penetration in China and other emerging markets in the coming years, it is widely believed that the handset vendor will need to continue to focus on reducing handset costs. The variable price point is in the range of $300 to $500 per smartphone.

However, these will need to be reduced to the $75 to $150 range to attract an even larger pool of customers transitioning from 2G to 3G in emerging markets. We believe this strength our mark-to-market penetration and commoditization benefit CEVA and is already evident in development with some of our leading customers.

Last month, [Standard] won five out of the six Chinese 3G TD-SCDMA local smartphone softwares, which went out for bid at China Mobile. This is in addition to more than 200 other design wins for the low cost smartphone, that [Standard] has secured to date, including handsets from Samsung, ZTE and (inaudible) and the recently announced high profile smartphone design wins at Lenovo and Huawei, for their new 1 gigahertz smartphone platform.

Broadcom is consistently growing its 3G market share at Samsung, expanding from low end segment into new range model. Examples include the Samsung Galaxy Y, Y-Pro and Y Duos. Also announced during the quarter, was the Broadcom chipset power the new local – new local smart Android based phone that is shipping globally.

This month, two superfeed agreements with the addition of smart from term which used a Qualcomm chipset. Broadcom also disclosed that it has the full scale production for the CEVA powered 40-nanometer single core and dual core baseband chips to be shipped in the second half of this year.

As for our outlook, comments on quarterly reports by key players in the wireless industry indicate that handset sales were weaker than expected in the second quarter of 2012. The main reason cited for this trend was current economic environment, 3G inventory decline ahead of new smartphone releases in the third quarter, and smartphone displacement of featured phones in the Chinese market.

When single touch cell phones posted an initial review of the second quarter shipment reports, we can highlight the following, 3G, continuous sequential increase in shipment based on our DSP. This is particularly noteworthy, as this expansion mainly relates to market share captures by CEVA in a soft market environment, which is aberrated by reduction in the legacy iPhone shipment.

2G, production went up with higher value 2G smartphone by tier 1 OEMs, and is partially offset the wind down of Broadcom 2G chipset Nokia, and the continued intense pricing competition in the low end feature phones.

Looking forward into the third quarter shipment, which will be reflected in our fourth quarter royalty revenues, we believe that 3G global base of our technology will amplify, with new products entering mass production in China and throughout the world. 3G represents our major growth driver going forward.

In 2G, we expect the transition to new low cost smartphones to offset further decline in feature phone royalty revenues.

So in conclusion, we forecast that these products, condition and ramp-ups will trigger a return to royalty revenue growth in our fourth quarter earnings, and firmly believe that our royalty growth trajectory in the near and long term.

With that said, I will now turn the call to Yaniv, who will outline our financials and guidance.

Yaniv Arieli

Thank you, Gideon. I will start by reviewing the results of our operations for the second quarter of 2012.

Revenue for the second quarter was $13.6 million, at the midpoint of our revenue guidance, reflecting a 6% year-over-year decline. The revenue breakdown is as follows, Licensing revenues was $5.4 million, reflecting 39% of our total revenue, 9% sequentially higher, and the highest signal we have recorded in the last two and half years. Royalty revenue was $7.6 million, reflecting 76% of total revenues, and down 17% sequentially, as Gideon just explained.

Service revenue was $0.6 million, reflecting 5% of total revenue, compared to $0.9 million, which we recorded in the second quarter of 2011. Our total gross margin were 93% on both U.S. GAAP and non-GAAP basis as forecasted. Our non-GAAP total gross margin excludes approximately $50,000 of equity based compensation expense.

Our total operating expenses for the quarter were $9.4 million, at the lower end of our guidance, which included an unrelated equity based compensation of approximately $1 million. Our total operating expenses for the second quarter excluding equity based compensation expenses were $8.4 million, reflecting also the low end of our guidance range and at similar level to the operating expenses for the first quarter of this year.

U. S. GAAP operating margin for the second quarter declined to 24% of sales from 28% for the same quarter in 2011. Our non-GAAP operating margin for the second quarter was 31% compared to 36% for the second quarter of last year. Non-GAAP operating margin excludes approximately $1 million and $1.1 million of equity-based compensation expenses net of tax for the second quarters of 2012 and '11 respectively.

U.S. GAAP net income for the quarter decreased by 16% to $3.5 million and fully diluted net income per share decreased by 12% to $0.15. This compares to $4.1 million and $0.17 respectively for the second quarter of last year.

Non-GAAP net income decreased by 17% to $4.4 million as compared to the same period year ago and non-GAAP fully diluted net income per share decreased 14% to $0.19 per share as compared to the same period for the prior year. These figures exclude approximately $1 million and $1.3 million of equity-based compensation expense net of taxes for the second quarter of 2012 and '11 respectively.

Other related data, shipped units by CEVA licensees during the first quarter of 2012 was 247 million units, down 6% for the fourth quarter of 2011 and at the similar level to the first quarter of 2011 shipments. Of the 247 million units shipped, 228 million units or approximately 92% are for baseband chips and reflect 10% lower volume as compared to the prior quarter in which 254 million units of baseband chips were shipped.

As of June 30th this year, 28 licensees were shifting products incorporating our technologies one higher than the prior quarter and this reflects 36 shipping customers under licensing agreement at the same and the prior quarter.

As for the balance sheet items, as of the end of June, CEVA's cash, cash equivalent balances, and marketable securities and long-term bank deposits were approximately $156 million compared to approximately $163 million as of the end of the first quarter.

During the second quarter we generated positive cash flow of approximately $4.4 million, offset by $11.3 million of our buyback program. Our DSOs for the second quarter were 31 days as compared to 33 days for the first quarter of the year.

As we previously disclosed, in 2010 our Board authorized share repurchase program of up to 2 million shares. We continue to be actively exercising this again. And in the second quarter of 2012, we repurchased approximately 670,000 shares of common stock at an average price of $16.9 per share for total consideration of approximately $11.3 million, and we have additional 900,000 shares available for repurchase under our existing 10b-18 plan. We believe the continued execution of the buyback program demonstrates our confidence in the long-term growth opportunity for CEVA, its strong fundamental, and earnings leverage.

As for the guidance, as Gideon previously discussed, our third quarter and annual guidance reflects softness in royalty revenue derived from a weak global handset market and product transition. We do, however, forecast a return to royalty revenue growth in the fourth quarter.

Revenue for the third quarter is expected to be in the range of $11.8 million to $12.8 million. Gross margin is expected to be approximately 9.1% to 9.2%. Operating expenses including equity-based compensation expense are expected to be in the range of $8.3 million to $9.3 million. Of our anticipated total operating expenses for the third quarter, $1.3 million is expected to be attributed to equity-based compensation expenses. So, our non-GAAP guidance would be $7 million to $8 million of operating expenses.

Net interest income is expected to be approximately $800,000 for the quarter, and our tax rate for the third quarter similar to the previous guidance is 16% for GAAP and 14% for non-GAAP figures.

Share count for the third quarter is expected to be in the range of 23 million to 23.6 million shares. Our U.S. GAAP EPS is expected to be in the range of $0.11 to $0.13 per share, and our non-GAAP EPS excluding the aggregates $1.3 million of equity-based compensation expenses net of taxes is expected to be in the range of $0.16 to $0.18 per share.

Our revised guidance for the full year of 2012. Total annual revenue is expected to be in the range of $51.9 million to $55.9 million. Gross margin is expected to be approximately 93% Operating expenses are forecasted to be in the range of $35.9 million to $37.9 million excluding equity-based compensation expenses of approximately $5 million and approximately $0.2 million recorded in the cost of goods sold.

Annual operating expenses excluding equity-based compensation expenses are expected to be in the range of $31 million to $33 million. Net interest income is expected to be around $3.5 million, tax rate for the year approximately 15% on GAAP and 14% on non-GAAP basis.

And finally share count for 2012 is expected to be in the range of 23.2 million to 23.6 million shares.

As for the EPS, our U.S. GAAP EPS is expected to be in the range of $0.58 to $0.62 per share, and excluding equity-based compensation expenses of $5.2 million our non-GAAP EPS is expected to be $0.78 to $0.82 per share.

Operator, we will now open the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Suji De Silva of ThinkEquity. Please go ahead.

Suji De Silva - ThinkEquity

Hi, guys. Good morning. Can you talk first about the ASP delta between the 2G and the low end 3G smartphone markets and what kind of decline are you seeing in the 2G market versus typical trends?

Gideon Wertheizer

Well, in the 3G, the ASP, the royalties that we are getting are pretty much stable. In the 2G, and I’m referring specifically to the features phone space, this space is now being displaced to the smartphones. So here the pricing is going down significantly with the only price competition between few vendors and the volume is pretty much stable by the neutral pricing.

On the other hand, the smartphone space and this is where the market is growing, the pricing is stable and technology is much more complicated. The landscape there is not about that the, let's say the local OEMs there cannot go this far and I want to emphasize what I said in my prepared remark, the growth that we are expecting in the 2G smartphone relates to tier 1 OEMs.

Yaniv Arieli

Overall, maybe 2G, let me add that the difference and without going into the detail and specific agreements or name, of course which we could not reveal, there is a 2X type of change in highway speed when we refer to higher end phones versus the low end phone. So I think you could see that in the chip price that Gideon talked about and the market is still segmented around that and that also implies to our royalty rate, which could be twice as high in the higher end phone.

Suji De Silva – ThinkEquity

Okay. Good.

Gideon Wertheizer

And this is 2G.

Suji De Silva – ThinkEquity

Great. And the other question is on Nokia, can you talk about maybe what percent of your royalties are exposed to Nokia still? And then if you expect further year-on-year decline over the next 12 months or how that's going to trend versus the last 12 months?

Gideon Wertheizer

Well, we cannot speak specifically about Nokia there. First of all, what we said in the prepared remarks relate to a specific customer. This is Broadcom. They may be public. The (inaudible) 2G focusing on 3G and that’s we see there was significant volume two quarter ago, there was a very reduction last quarter, and we see in Q2 a further reduction, but that this would be superior and eventually Broadcom will not supply to Nokia.

Although Nokia is still customer, and if you had chance to listen to their conference call, their mobile space (inaudible) they raise volumes, they reiterated their commitment and support for the series 30, series 40 smartphones, which are basically smartphone in the Finish and they are Finish end, which is all based on us.

Yaniv Arieli

Suji, let me also add to that that as you recall last quarter we took down our forecast for 3G growth with Nokia because of the same reason Gideon just mentioned. With that said, we still were able I think we just said on the call to record a 16% growth in our 3G business and market capture without that piece as well, Nokia being and this is also with the headwinds of the iPhones also going down for us.

So 16% exclude Nokia, exclude the iPhone, the volume that went down. And even so as Gideon explained Nokia for now had been key in the 2G space if they do continue to be successful in their S30, S40 ramp ups which are their smartphone segment that will give us the first low cost type of smarphones that we will be powering to Nokia. So that's a little bit more of picture about them.

Suji De Silva – ThinkEquity

Good. Thanks, guys.

Yaniv Arieli

Thank you.

Operator

Our next question comes from Anil Doradla of William Blair. Please go ahead.

Anil Doradla - William Blair

Yeah. Good morning, guys. A couple of questions. When I look at the midpoint about the September and December quarter guidance, obviously you are assuming a certain sequential increase in the fourth quarter. I think couple of things. What gives you the confidence that the fourth quarter will witness sequential growth if you could walk us, do some puts and takes that will be wonderful? And perhaps from the last quarter till now, what's surprised you from your end over the course of three months that would be helpful? Thank you.

Gideon Wertheizer

Good morning, Anil. Let me take question, maybe Yaniv will add. First of all, what surprised us is the price reduction in the 2G space and that's the reason that we are now guiding a royalty down quarter in Q3, which relates to the Q2 shipment. So that's the key point there, but we see a trend change in the 2G and that bring me to the second – the first part of the question.

In the 2G, we see movement into the smartphones. And just to give you an indication in specific customer, there were few tens of thousands units in Q1 and went up in Q2 to few millions of units just in one quarter and that's a ramp up, this is not stabilization and this is in a quarter that is Christmas type of quarter. So that's the 2G. And we believe that the growth in the smartphone.

And as Yaniv stated, that the significantly higher there, they are still significantly higher. We will offset currently decline in ASP in the feature phone. Feature phone basically is if you are going to see something, there is still though decline, it's not we cannot forecast how far they will, it can growth next quarter.

In 3G, things are pretty focused. We see all those product that's coming into the market. As everybody is saying, this is all Q3, Q4 shipments, people are holding until they see all those new smartphone coming, different smartphone and we are going. I mean growth comes either they go in of course Samsung which is the largest, and all those could be from third world that new phones, and although bunch of costs. So we are optimistic about the 3G and it's all we do.

Yaniv Arieli

Anil, maybe when you add these some numbers, I think what also surprised us and not just see pretty much the whole industry is that the weakness in the second quarter. And I’m not sure if we had a chance to see the [ABI] research that came out this last night is same for the first time that is headed.

They believe that this could be now second quarter and second sequential downturn in the wireless industry. And of course, they quoted a bunch of big names whether it's a Apples down and RIM and Nokia, they mentioned that there is Samsung, even with 16% growth in smartphone, they are 13% down in feature phone and the risk goes down.

So from adding all these numbers, they are saying this would be the first target as this second quarter was down and second sequential down quarter which would be very difficult for us to forecast three months ago or even the months ago. And I have seen that that's key to understand a bit of the market dynamics.

If you take what Gideon just said we implemented to our model you will see that we are taking royalties down say Q3 in a single-digit figure, not significant but single digit. Of course, we will have different flavors, we believe we will have more 3G ticking in and we will still have some of the effects of the pricing of the low end 2G and the better pricing and initial ramp up is getting extreme of the higher end 2G, which is the smartphone.

And all in all, we guided and we are building the model that is on the licensing based on our traditional guidance which is somewhere between $4 million to $5 million. So that bring us to the guidance that we gave for Q3 and higher number and continued, that's a growth rate in all these for the fourth quarter which of course could be much stronger momentum in the first quarter of next year as well.

Anil Doradla - William Blair

Right. And finally, you talked about a strategic LT advanced licensee, when do you think this will bear volume shipments?

Yaniv Arieli

This could be a very fast. I cannot guarantee, but this could be a 2014 production.

Anil Doradla - William Blair

Thanks a lot guys.

Gideon Wertheizer

Thank you, Anil.

Operator

Our next question comes from Gary Mobley of Benchmark. Please go ahead.

Gary Mobley - Benchmark

Hi, guys. Am I correct in assuming that you're expecting about a 15% sequential decrease in the royalty rate per unit based on the comments just made? And given all the stars that need to align with respect to 3G mix versus 2G mix and the royalties, when would you expect some royalty rate per unit stabilization or perhaps increase?

Yaniv Arieli

Hi, Gary. I'll try to answer that. I'm not sure we are expecting, if you look at the overall assumption or summary of the model again without going to a specific customer, overall the number has been quite stable, around $0.03 in average for our business, and not slightly higher or lower. But that has been the case for a while.

Now normally, we see that changing soon. So we talked about earlier, higher price designs and volumes and lower prices, but I don't see any of these overall margin base any such decline as you just stated there. I think it would be overall quite stable with just slight knots maybe up and down based on the volume ramification.

Gary Mobley - Benchmark

Okay. So if we're assuming a mid-single digit sequential decrease in your mobile royalty units, I'm assuming that your non-cellular is going to continue to decline as it has for several quarters in a row? And/or your expecting license revenue to be down around $4.5 million towards the lower end of your typical range, while at the same time for five of the past six quarters, you've exceeded your long-term license revenue forecast.

I know there's a lot of the questions embedded in there, but I guess first to start out. Is there any indication in your license pipeline that you would expect license revenue to be down towards the $4.5 million mark? And then could you also answer the question regarding your non-cellular-related royalty outlook?

Gideon Wertheizer

Hi, Gary. This is Gideon. So you basically asked two questions. First of all, with regard to the royalty contributor of the consumer market, it's not that the -- the consumer market is not declining, it's a technical seasonal pattern. What we see this year, it's I believe relates to the economy that the amount ramping up inventory, not building up inventory in the second quarter as we usually do in typical here, probably it will be pushed out to the third quarter.

At the end of the day it will be Christmas season and they will have big inventory. So that's the concern. I don't see any outstanding, I don't see any market share loss. We have the product and shipping in the typical pattern that we have.

Now the second part about the license fee, I believe you know how we operate. License fee as you know is something that we have to proceed. It depends on timely manner and -- we did once again too good quarter and we are happy about it.

But going forward, we -- our recommendation for you guys is to stay in our range of $4 million to $5 million. No doubt it will be higher, we'll be happy. We'll not be -- we'll not make a big party out of it, that's the goes on.

And the idea it might be quantity of the license bill is the quality of the license bill, and this quarter we're have two key deals the OEMs and the XC4000. These now in my opinion quality type of license, not just quantity.

Gary Mobley - Benchmark

Okay. In your earnings press release, you talked about an engagement with a Tier 1 handset OEM. Is this your first such license agreement with this specific Tier 1 OEM? And could you talk about how many Tier 1 direct license agreements you have with these different handset OEMs?

Gideon Wertheizer

I don't want to elaborate further more with something that -- let me say, it's new to us, this specific. I think for cellular, we have four or five OEMs.

Gary Mobley - Benchmark

All right. Thank you, guys.

Gideon Wertheizer

Thank you.

Operator

Our next question comes from Joseph Wolf with Barclays. Please go ahead.

Joseph Wolf – Barclays

Thanks guys. Just maybe as a follow on to that question, is there anything you can tell us in terms of the geography of that vendor or if you're selling the USB technology in terms of directly, are you working with the chipset vendor or are they doing that internally as well? That would be my first question.

Gideon Wertheizer

Probably (inaudible) I'll give you the third with the relative geography, this finally, ask not to give too much build up about this, so we'll keep it as this, and when they get closer to production to some other type of image, mutual understanding and we'll be happy to talk about it.

Joseph Wolf – Barclays

Okay. So let me -- I guess just in terms of the 2G, 3G mix where you're seeing acceleration in market share gains. It is too early to talk about an actual mix of revenue. So in the royalty streams, as we move to the fourth quarter in terms of what you expect 3G to contribute?

Gideon Wertheizer

So really that's the key point although we're making excellent progress with the 16% growth and the market has gone down 2% in volume. And the overall 3G store facility is relatively new, our growth in the last five years was mainly around two G&A.

That's how we got into the business and we got the significant market share that we have. 3G was the marketplace which Qualcomm and TIs dominated 100% growth over the last two years maybe 2.5 or so years and we have started to gain market share and we believe somehow we have to be somewhere around 25% market share.

But the volumes are not yet as big if you talk about $228 million baseband that we sold, the majority of sales or the 2G and it was with different flavors. So assuming that becomes a more significant play, of course you'll see royalty around that in revenues and ASPs and we'll follow closely like it has in the 2G market space.

So we believe it's going to -- we have the same opportunity to copy that success and as we explained in the prepared remarks and in the end of Q&A for now that there is a big transition even to low cost smartphone and that is all -- stronger presence throughout. You see the first five then Q3 shipments which we reported in Q4, but that was bifurcated here in the Q2 quarter.

Joseph Wolf – Barclays

Okay. And just one last question with the Mediatech and Star combination, is there any color that you guys have heard from customers around the field with how this is progressing?

Gideon Wertheizer

No. We didn't have a chance yet to speak with them. We'd like to see (inaudible) how we're going to build them.

Joseph Wolf – Barclays

All right. Thanks, guys.

Gideon Wertheizer

Thank you, Joseph.

Operator

Our next question comes from Vijay Rakesh from Sterne Agee. Please go ahead.

Vijay Rakesh – Sterne Agee

All right. Good. Just wondering when you look at your quarter and the guide, what's your current 2G, 3G or TDS CDMA mix and how do you see that by Q4? And also do you see your units going back to that 250 million to 270 million unit’s quarterly shipments like in by Q3, Q4 -- by Q4 or Q1?

Gideon Wertheizer

Yeah…

Yaniv Arieli

Presently it's too low. Quarterly shipments presently is too low.

Gideon Wertheizer

We never tried to get upfront of the volumes. I don't think that has been our practice now. It doesn't makes sense for us to start and try it now. Overall, we can say that this last quarter in Q1, we powered $228 million, round it up to $230 million-ish baseband. The mix was different, more 3G than ever for us and we hope that that trend will continue.

To what numbers exactly it will reach, it also depends on the market. But if you refer to some of the conference calls that we're -- and then the comment that we made on the call, Broadcom (inaudible) Intel design win, all of them mainly talk about 3G these days and those will get into production mainly in the second half, as they also even last quarter ago. So that is our basic start. The second half starts in Q3 that means our Q4 royalty should already take that into account.

Vijay Rakesh – Sterne Agee

Sir, do you see 3G we are doing like 40%, 50% by Q4 given all the raps?

Gideon Wertheizer

By market share you mean or by…

Vijay Rakesh – Sterne Agee

Yeah. You're mix.

Gideon Wertheizer

I don’t think it'll get there. I don't think it could get there in one quarter. That's not -- those numbers are lower. I don't think we could double that overnight, but eventually there is no reason for us not to get there, because the forecast for 3G are quite robust.

Vijay Rakesh – Sterne Agee

Got it. And then last question -- there is how many Tier 1 OEMs do you have now licensed with LTE?

Gideon Wertheizer

Now, it's LTE -- I don't know may be I don't – two or three, Richard?

Richard Kingston

Yeah. We haven't fully disclosed the number publically but that's in the range, yeah.

Vijay Rakesh – Sterne Agee

Okay. Great. Thanks.

Gideon Wertheizer

Thank you.

Operator

That's a next question from Jay Srivatsa of Chardan Capital Markets. Please go ahead.

Jay SrivatsaChardan Capital Markets

Yeah. Thanks for taking my question Gideon. As you look ahead, you know, every quarter there seems to be some issues some pricing pressures, some product transitions. How do you, what are some of the initiatives you're taking, as you look to 2013, to circumvent some of this quarterly fluctuations and be able to run a more streamlined business?

Gideon Wertheizer

Hi, good morning. First of all, Jay, as what we said in this quarter, we said last quarter the dollar price erosion in 2G and these are – those will be the same issue in this quarter. So the stuff that we are doing in terms of working much closer with the customer and transitioning to 3G and 2G smartphones. We sold the new products that require all support and now we are a you know, accelerations and this is ongoing and then we see the crux of this work.

The 2G feature phone, this is a market that is stable, to a leisure extent and it would be superior somehow I mean in one way or another. And definitely people the trend is going either to smartphone 2G smartphone if we go to 3G.

Jay SrivatsaChardan Capital Markets

Okay. Looking ahead to the ramp up in 3G, what gives you the confidence that some of the pricing issues that saves the 2G business own clients for over to the 3G business, meaning that the ASP is that, you currently believe or now twice the 2G ASP that could pretty dramatically fall, you know when the ramp up happens, is it not?

Gideon Wertheizer

Okay. You know, that could take to maybe two years that eventually in every high-value market you have price erosion, and which is common factors, it's true for consumer, true for baseband, true for many other market.

So I don't think we're invented the real here, but the idea is that you all are happy, you will always have something new, like LTE, which has much higher price and potentially we'll get some of the multimedia stuff which are higher priced, application processors, gesture, audio, which we have talked about, in the last couple of quarters and now getting design wins from time to time and those will also kick in.

So when you look at an average, you have higher devices lower volumes and you have the mass market which you always have pricing in, this is how most of the semiconductors manage their business, and so do we or at least try to.

I think that, what's happening now in the last two quarters and we're quite transparent about it as much as you can a quarter ago, and that we are the market is going under a transition between 2G and 3G.

If we look at growth in 2G in the last couple of years, I think you could find the numbers there. And if you look at growth in 3G, and one of it we've just demonstrated today and for the last quarter, and it's by far in much more robust than Qualcomm's 3G business or any other play in the 3G business today.

So, the numbers are still small for us but if it all happens the way you would believe the market could move to -- I hope it will benefit our earnings or topline earnings and of course the rest of the business.

Jay SrivatsaChardan Capital Markets

All right. One last question, then can you talk to us on some of the work that's being done on the non- baseband side, i.e. the application processor and/or the recognitions and stuff. Where are things at in terms of revenue growth there for you and when do you expect some of that to become material as you look forward?

Gideon Wertheizer

Well, we have two different product line beyond baseband and they are relating to smart TV and so of course smartphone. One is the audio we mentioned, I think, it was last quarter that we had instrument licensing mode. And it's more to my opinion in the 2014 contributor, of course, it's in addition of the baseband.

Now, the other activity is the imaging and vision. This is a platform that opened up for us a significant modes, used models including automotive. So, I would say that we are in a trajectory mode, meaning we are coming to customers, let them evaluate, let them have their opinion and we would see licensing moved out licensing in this respect move out 2013.

Jay SrivatsaChardan Capital Markets

Okay. Thank you. Good luck.

Gideon Wertheizer

Thank you, Jay.

Operator

Our next question from Blake Harper of Wunderlich. Please go ahead.

Blake Harper – Wunderlich

Yeah. Thanks. Most of my questions have been answered, but I just wanted to ask you, you are going over whether royalties and licensing revenues. We expect to be contribute over the next quarter or two? And could you just talk about what the Design Services and how much of that and growth from there you've put into your guidance for Q3 and for the full year?

Gideon Wertheizer

Yeah. Thanks. We haven't covered that. Indeed, at least, you know we have a base lines regarding revenues which of the services and the support that we give to our customers and that's pretty flattish across the year in the quarter and piece that fluctuate in different tools, bolts sometimes chips, with the design tools, that we give our customers to – from time to time to help production.

And this could vary between a 100,000 -200,000 sometimes higher. And that's the variance that we have really going down from the first quarter of the $900,000 level to a $600,000 level, that's the main reason – not sure – we took that down between the $900,000 level to the $700,000, situation I hope that this is something that we could achieve.

Blake Harper – Wunderlich

Okay. Thanks. And then I just couple of housekeeping items, can you give us you a CapEx and depreciation numbers?

Gideon Wertheizer

Yeah. Both of them are above the $130,000, $150,000 in the last quarter.

Blake Harper – Wunderlich

Okay. And then what was your headcount at the end of the quarter?

Gideon Wertheizer

The 194 versus 191 in quarter ago.

Blake Harper – Wunderlich

Okay. Thanks. That's all I've got.

Gideon Wertheizer

Thank you.

Operator

And this is time our next question will be our final question from James Faucette, Pacific Crest. Please go ahead.

James Faucette – Pacific Crest

Thank you very much. Just a – most of my questions have also been answered. I just wanted to ask you about how you're thinking about the growth in the underlying handset market, particularly as you lookout to 2013 and beyond as you develop your development or you build your development plans. If you seen two quarters of contraction are you – I guess, I'm just wondering what kind of view you have into a return to growth if any and how you're thinking about that as you try to plan for future? Thanks.

Gideon Wertheizer

Well, I think the contraction in the market or going if you refer to the marketer to us I mean, we are more or less following the contraction in the market. There is – it looks like there is the change in the profiles of the way people in the buying from or making decision on quality, it's more like though the end of the year there is the smartphone market is a very you know competitive, lot of offering has been – our consumer it's – start to make a decision.

So as I said – I think I said it in the prepared remarks, what we are seeing from customer discussions, the fundamentals are I mean people eventually made 3G, 4G smartphone and you see the growth and we are in this highway, you know, and getting to it.

So you know conformation in the market people are don't to do -- don't want any more feature phones they want smartphone. You take your phone for example but only 42% of the people in the Europe have smartphone. So these eventually they need and there is a lot of optimism is going into the 2013 and onward.

James Faucette - Pacific Crest

Okay. Thank you very much.

Gideon Wertheizer

Thank you.

Operator

That concludes our question-and-answer question. I would like to turn the conference back over to Mr. Kingston for any closing remarks.

Richard Kingston

Thank you. Thanks everyone again for joining us today and for your continued interest and support in CEVA. We will be attending the following upcoming conferences and events and invite you to join us there. The first of these is the Oppenheimer 15th Annual Technology Internet and Communications Conference August 14th in Boston then we'd be at the Deutsche Bank dbAccess 2012 Technology Conference from September 11th to 13th in Las Vegas and finally, ThinkEquity's 9th Annual Growth Conference in September 12th and 13th in New York. Thank you and good bye.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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