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CEVA, Inc. (NASDAQ:CEVA)

Q3 2012 Earnings Conference Call

November 1, 2012, 08:30 AM ET

Executives

Richard Kingston – Director, Marketing and IR

Gideon Wertheizer – Chief Executive Officer

Yaniv Arieli – Chief Financial Officer

Analysts

Gary Mobley - Benchmark

Anil Doradla - William Blair & Company

Joseph Wolf - Barclays Capital

Matt Robison - Wunderlich Securities

Daniel Meron - RBC Capital Markets

Vijay Rakesh - Sterne Agee

Operator

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

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

Richard Kingston

Thank you very much and good morning everyone. Welcome to CEVA's third 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 from the quarter, Yaniv will then cover the financial results for the third quarter of 2012, and provide guidance for the fourth quarter of 2012.

I'll start with the forward-looking statement. 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 fourth quarter and year of 2012, market data from ABI Research and Strategy Analytics incorporated herein; optimism about our royalty revenue growth and long term growth opportunities generally, growth in the 3G space for emerging markets, particularly in China. Growth in the 2.5G space, the design wins of our customers, market acceptance of smartphones incorporating CEVA technology, the gesture technology markets and our advances in the LTE advanced space.

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 trend; 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 will start by reviewing the result of the third quarter. The reported third quarter revenue of $12 million. Licensing revenue was $4.2 million, royalty revenue was $7 million and the remainder was derived from support and maintenance revenue.

We executed seven new license agreements in the third quarter. Five agreements were for CEVA DSP cores, platforms, and software. One agreement was for CEVA SATA/SAS product line and one agreement was for CEVA Bluetooth technology.

Target market for customers deployments are 3G and 4G baseband processor, digital cameras, next-generation vision related products, connectivity and SATA interface chips for enterprise applications. Geographically, one of the agreements signed was in Europe and six were in Asia Pacific, including Japan.

Of the licensing agreement executed, three are particularly noteworthy. The first is a new strategic licensing for CEVA-XC4000 based on the DSP targeting next generation LTE-Advanced platforms. The second is a new licensing for CEVA-MM3101 imaging and vision technology targeting gesture recognition and the third is an audio DSP license for a Tier 1 OEM in the DSLR camera space.

In general, third quarter license revenue reflects a level of caution attributable to general macro-economic concern by certain customer prospects. We have either continued to see robust demand for our based on DSP technologies targeting next generation products and in this respect our customer prospect remain solid. We expect these licensing environment to expand into the fourth quarter.

Moving on towards revenue, third quarter royalty revenue which relates to the second quarter shipment came out as anticipated. As we explained in last quarter call, during the first half of 2012 it was widely understood that consumer were withholding purchases of new handsets in anticipation of new more advanced smartphones in developed markets and the availability of local smartphones to replace future phones in emerging markets. Despite these general market weakness, 3G shipment based on CEVA DSP are consistently growing showing 7% growth on a quarter-over-quarter basis and 11% growth on a year-over-year basis.

Further royalty growth is anticipated in the coming quarters as new CEVA based smartphone are rolling out from HTC, Huawei, Lenovo, LG, Samsung, ZTE and others. In particular, to address the transition from 2G feature phone to low cost 3G smartphone in China. Now, let me show with you some key points on our markets and customer traction during the quarter.

One of the key agreements signed during the quarter was for the CEVA-XC4000 DSP targeting LTE-Advanced. LTE-Advanced is the next evolution of LTE technology these are up to ten times higher performance versus the existing LTE technology. Our new licensee is the first time customer of CEVA, but although they have LTE baseband chip available, it elected to switch to CEVA-XC DSP framework due to the increased performance requirements for LTE-Advanced and because of the softer defined architecture of the CEVA-XC which allows it to seamlessly support multiple radios.

I want to demonstrate the customer benefit of using the CEVA-XC platform is to compare it with an equivalent LTE offering for an incumbent such as Qualcomm. The LTE, Qualcomm offers two different SKUs, MDM 8960 for the U.S. and MDN 8960 for the U.S. and MDN AP8930 for China, as these two geographies adopted two different variants of LTE and has different needs for roaming, however; a customer adopting a CEVA-XC based solution is diagnostic to those different requirements, meaning that a single CEVA-XC based chip can support both LTE variant and roaming[ph] in it. In addition, the new CEVA-XC 4000 already supports LTE-Advanced and thus saves the customer a costly redesign of a new baseband chip to egg[ph] these advanced standard.

Recent data from Market 316 during strategy analytics shows the CEVA DSP based LTE chips are now shipping second to Qualcomm in volumes. As we had previously discussed, Samsung in-house LTE chips enrollments are based on our DSPs in addition to more than 20 other LTE design wins. While LTE shipments are progressing in the developed countries and CEVA based phones are rolled out to the market, 3G expansion is increasing in the emerging markets of particular interest is the China mobile TD-SCDMA market. China Mobile announce acclaimed to expand it’s TD-SCDMA base station deployment from 57,000 to 400,000 in 2014. It also increased it’s subsidy for TV Smartphone for this year from $3.3 billion to $4.1 billion. As of September, China Mobile has more than 698 million subscribers, but still only 75 million of the subscribers are using 3G services.

Spreadtrum and CEVA customer is performing very well in the TD-SCDMA space with a range of new smartphones from multiple brands like Haier, Hisense, Huawei, Konka, Lenovo (inaudible) and ZTE. The targeting pricing point for these smart phones are 80 to 110 U.S dollars, which makes them very affordable for the mass market consumers.

Addressing the HSPA 3G space which is the largest standard by volume for 3G worldwide. Broadcom will have [ph] higher DSPs echoes all of its baseband products. It continues to expand into Samsung Duos and EPL smartphone. Its single chip 14-nanometer baseband chips is now in production in Samsung low-end smartphones such as Galaxy chat and with BCM21553 chip installing Galaxy pocket duo, the most affordable Dualsim Android based smartphone. ZTE also chosen Broadcom BCM21553 to power new local smartphone for T-Mobile US known as T-Mobile Concord.

T-Mobile announced that this is the most affordable, no annual contract under its smartphone available from it at less than $100. For Broadcom, this is the latest design for a local smartphone, following other recent design wins like TCL and Vodaphone [ph] branded devices. Intel also uses our DSP for all their baseband product, it’s been progressing nicely in the HSPA 3G space with a number of new customer and design wins of note. ZTE and Motorola, both recently announced their first Intel Maxi based 3G smartphone for which the baseband processor is based on CEVA DSP. The ZTE Grand X IN and the Motorola Razr i both went on sale during the third quarter.

Intel’s slim model chip CIM continues to show slow traction. It’s HSPA class chip set power many new smartphone side by side is leading the application processors, such as NVIDIA Tegra 3, Samsung Exynos and more. Recent, lot of the design wins include Samsung Galaxy Note II and N7100, HTC 1X+ for Europe, the LG Optimus 4X HD and the Huawei Ascend D1 XL.

For less developed areas, where 3G coverage is limited, 2.5G phones are gaining attraction. Many of these phones have all the feature and enhancement of a regular smartphone, but without the 3G connectivity, yet has the advantage of cost and battery life. The majority of Nokia shipment target these 2.5G space in emerging market. In the second quarter, Nokia shipped 74 million units and its market share in the low cost phone space rolls to 35%, the highest in the last two years. The main catalyst for this progress has been feature enrichment such as better web experience, online games and touch free. The new local smartphone Asia 305, 306, 308 and 309 models are all based on CEVA DSPs.

Spreadtrum also has a sizeable volume shipment in the 2.5G smartphone space. Spreadtrum has produced last quarter its 40 nanometer SC6530 baseband chip and its 1GIGA 6828 smartphone chip targeting these markets.

Turning back to licensing agreement sign dealing the third quarter. As I mentioned one of the agreement was for our MM3101 platform targeted the Gesture market. Gesture recognition is another dimension to interaction with smartphone, PCs and tablets. And according to a study by ABI Research, 600 million smartphones will be shipped with vision-based gesture by 2017. Gesture-based technology enabled by the MM3101 shows 10 times higher performance versus ARM-based solutions. Also, as we previously announced, CEVA has an equity stake in startup eyeSight, which specializes in gesture technology and whose technology is already deployed in various (inaudible) and smartphones.

Finally, I would like to acknowledge a significant milestone for the company that we announced recently. Shipments with CEVA-powered chips has now surpassed 4 billion units. This is an outstanding achievement that was brought about by a combination of the quality of our DSP and our strong customer base that relies on our technology to power the industry-leading product.

With that said, I will now turn the call over 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 third quarter 2012. Revenue for the third quarter was $12 million, within the guidance range we provided, but a 19% decrease compared to last year. The revenue breakdown is as follows.

Licensing revenue was $4.2 million, reflecting 35% of our total revenue, down 19% from the third quarter of last year. Our royalty revenue was $7 million, reflecting 59% of our total revenue and down 20% from the third quarter of last year. Service revenue was $0.7 million, reflecting 6% of our total revenue and down 13% from the third quarter of last year. Our quarterly gross margin was 91% on U.S. GAAP basis and 92% on non-GAAP basis as forecasted.

Non-GAAP quarterly gross margin exclude approximately $70,000 of equity-based compensation expense. Total operating expense for the third quarter were $8.8 million, at the mid range of our guidance, which included an aggregated equity-based compensation expense of approximately $1.3 million.

Our total operating expenses for the third quarter, excluding equity-based compensation expense, were $7.5 million, reflecting again the mid range of our guidance and at the lower level than the operating expense levels for the first and second quarters of 2012.

U.S. GAAP net income for the third quarter decreased 47% to $2.6 million and fully diluted net income per share decreased 45% to $0.11. This compares to $4.9 million and $0.20 respectively for the third quarter of 2011. Non-GAAP net income decreased by 40% to $3.8 million as compared to the same period last year. Our non-GAAP fully diluted net income per share decreased 38% to $0.16 per share as compared to the same period a year ago. The figure excludes approximately $1.2 billion and $1.3 billion of equity-based compensation expense net of taxes.

Other-related data, shipped units by CEVA licensees during the second quarter of 2012 were 254 million, up 2% and 3% from the second quarter of 2011 and the first quarter of 2012. Of the 254 million units shipped, 226 million units or approximately 89% are for baseband chips and reflect 1% as compared to the prior quarter, in which 228 million units of baseband chips were shipped.

As of September 30th this year, 29 licensees were shipped in products incorporating our technologies, one more than the prior quarter and we have 37 shipping customers under licensing agreement, again one higher than the prior quarter.

As for the balance sheet items, as of September 30th, 2012, CEVA’s cash, cash equivalents, balances, marketable securities and long-term bank deposits were approximately $156 million, similar to the level at the end of June.

In the current environment, we are focused on maintaining a strong balance sheet, which will allow us to address near-term challenges and capture new opportunities in the future. During the third quarter of 2012, we generated positive cash flow of approximately $2.7 million, offset by $2.9 million used for buyback program.

Our DSOs for the third quarter was 46 days as compared to 31 days in the prior quarter. As previously disclosed, we have a share purchase program up to 2 million shares. We continue to actively exercise this plan. During the third quarter, we purchased approximately 170,000 shares of our common stock, an average price of $16.06 per share for a total consideration of approximately $2.9 million, and we have additional 730,000 shares available to fully purchase under the existing 10b-18 plan.

We believe the continued execution of our buyback program illustrates our confidence in the long-term growth opportunity for CEVA, its strong fundamentals and earnings leverage.

Now, for the guidance. A key component of our quarterly revenue guidance is the royalty revenue derived from customer shipments one quarter in the year. We do not get all the royalty reports from our shipping customers. However, initial indications suggest a return to growth in royalty revenue derived from accelerated growth in 3G shipments and higher shipments of 2.5G smartphones in China and higher ASPs from future phones which are undergoing pricing pressures.

This positive momentum is partially offset by the wind down of the 2G phone at Nokia by one of our key customers and end-of-life of older iPhone 3GS and 4 models that are based on our DSPs.

Overall, we expect to record sequential low-double digit royalty growth for the fourth quarter of this year. On the licensing, we believe the environment didn’t strive earlier were prolonged in the fourth quarter.

To the numbers, revenue for the fourth quarter is expected to be in the range of $12.4 million to $13.4 million. Gross margin is expected to be approximately 93%. Operating expenses including equity-based compensation expense are expected to be in the range of $8.9 million to $9.9 million. Of the anticipated total operating expenses for the fourth quarter, $1.3 million is expected to be attributed to be equity-based compensation expense. So, non-GAAP operating expense is forecasted to be between $7.6 million to $8.6 million.

Net interest income is expected to be around $750,000, tax rate for the fourth quarter, same rate as last quarter, 16% GAAP and 14% non-GAAP. And the non-GAAP tax rate excludes the tax effect of equity-based compensation expenses.

Share count for the fourth quarter is expected to be in the range of 22.6 million to 23.0 million shares. U.S. GAAP EPS is expected to be in the range of $0.10 to $0.14 per share and non-GAAP EPS excluding $1.2 million of equity-based compensation expenses net of taxes is expected to be in the range of $0.16 to $0.20 per share.

Our annual guidance. Total 2012 revenue is expected to be in range of $53.1 million to $54.1 million. Gross margins for the year expected to be approximately 93%. Operating expenses are forecasted to be in the range of $36.7 million to $37.7 million, including equity-based compensation expenses of approximately $4.8 million and approximately $0.2 million recorded in our cost of goods.

Our annual operating expenses excluding equity-based compensation expenses are expected to be in the range of $31.9 million to $32.9 million. Net interest income is expected to be around $3.5 million for the year. Tax rate is expected to be around 14%. Share count for 2012 is expected to be in the range of 23.1 million to 23.5 million shares. As for the EPS, on the GAAP basis, we are expecting EPS to be in the range of $0.57 to $0.61 per share and our non-GAAP fully diluted EPS excluding $4.4 million of equity-based compensation expenses, net of taxes, is expected to be in the range of $0.76 to $0.80 per share.

Operator, you could now open the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Gary Mobley from Benchmark. Please go ahead, sir.

Gary Mobley - Benchmark

Hi guys, good morning or good afternoon. So, I wanted to explore some of the variables involved in the licensing revenue. If I am not mistaken, the number of license deals signed each quarter is somewhere in the range of six to eight and seven this quarter. Wondering what the puts and takes are there driving down the average deal size on the licensing front. And then if you can as well describe what the licensing pipeline looks. I know you are certainly dealing with the broader product portfolio in the company’s history, but I am just wondering if you have seen a marked slowdown in chip design activity?

Gideon Wertheizer

Gary, it’s Gideon. Generally, in every quarter, we have different types of deals. Some of them could be single deal, some of them could be multiple deals. Customers are buying product. And looking into the quarter, I don’t see any change in the mix and it could be in one quarter more in this type of deal, probably another type of deal. So, the ASP for a deal does – the ASP per deal is not indicative to the overall pipeline or market situation. In general, as I said in my prepared remarks, we feel some closures, in specific customers, those customers that are more closed to their OEM customers, looking more in general to single use per project, one set at a time.

However, when it comes to a strategic customer, customer building broad net [ph], and I mentioned the XC4000 deal that we signed, the MM3101 customer, these guys are building the next-generation product. The pipeline and the execution in the quarter is solid.

Gary Mobley - Benchmark

Okay. Just one last follow-up. Of the 226 million royalty units derived from the baseband market, what was that mix between 2G, 3G and 4G basebands?

Yaniv Arieli

Hi Gary. I will try to help out. Usually we don’t break that much detail, but 4G still relatively small. A lot of the Samsung socket are using us and potentially few other customers are aligned to start production in the next quarter or two. I would say a very small handful million or less, and then the bulk of the volume is still probably 75% to 80% is the 2G related. That’s what we have, somewhere between 55% to 60% worldwide market share. And 3G which is starting to pick up, we saw at last quarter, we saw a 7% sequential increase, this quarter probably represents a worldwide market share of somewhere between 25% to 30%. So, from volume the bulk of 75% to 80% is 2G, very small 4G, and rest is the 3G ramping up.

Gideon Wertheizer

Gary, I just want to add that to effective of their fourth quarter shipments. We see (inaudible) especially, when it comes to 2.5G, I mentioned, we seen growth in smartphone, 2.5G smartphone. I mentioned in my prepared remarks, the (inaudible) region in the world that you don’t have 3G coverage and 2.5G smartphone is the things that people want to go. When it comes to 3G it’s clear, we continue to grow in all the segment, the TV, the HSPA space, we continue to grow there.

Gary Mobley - Benchmark

Thanks guys.

Gideon Wertheizer

Thank you.

Operator

The next question is Anil Doradla, William Blair, please go ahead.

Anil Doradla - William Blair & Company

Hi guys. A couple of questions. When I look at the non-baseband during the quarter, I mean from Q2 to Q3, it clearly looks like you had some strong growth there. Can you give some sense of what it was? As we look in 2013 how do you expect the composition to look like? And I have a follow-up question.

Gideon Wertheizer

You mean, in 3G, you are looking on the units or --?

Anil Doradla - William Blair & Company

Yes, just the units on a sequential basis. I think you said the non-baseband units seem to have grown sequentially, right?

Yaniv Arieli

No, we’ve talked about 3G growing sequentially 7%, I don’t think we have talked about the non-handset. I think so from the licensing point of view we have a few very interesting deals the last quarter around gesture that Gideon mentioned about our deal for DSLR camera. So I think from the licensing we are seeing some very nice traction. The royalties just (inaudible) but not necessarily it takes time, it takes at least a year, a year-and-a-half before we see this getting into production.

Anil Doradla - William Blair & Company

Okay. And then when I switch gears to the royalty rate, if my calculation is right, it’s down about 10% sequentially. The mix is moving towards 3G, can you help us understand how we should be looking at the trends on the mix, would the 2G aspect continue weighing on the overall mix over the next 2 or 3 quarters? Or do you think 3G would really start moving the needle?

Yaniv Arieli

I think you answered the question that yourself asked. 2G is still the bulk of our business. We are seeing the price erosion in the 2G continue throughout 2012, this is not something new, we’ve been talking about it and we have seen a lot of the companies in this space deal with the price erosion. With that said, we are seeing healthy volume, we are not seeing the volume fall off the cliff. It’s a healthy volume, even growing through our third quarter shipments, meaning what we report next quarter has a significantly in the 2G volume. And the name of the game for growth for us and for our customers over the next couple of quarters is going to be the taste of adoption of these 3G devices. You could see in our website, on the twitter, and the bunch of different articles that we publish, a lot and lot of new phones by numerous players in the market. We mentioned some of them are (inaudible). As soon as these guys reach mass productions of not millions, but tens of millions, in the future hundreds of millions, those will be the bulk of the revenue. Of course, that will enhance not just the growth of our royalties from the volume perspective but also ASP. In the near future it’s very difficult to predict for one or two quarters. On the longer term I think it’s a very – the fundamentals and specifically for LTE and 3G are quite easy to understand but pace is something that we all need to monitor on a quarterly basis.

Gideon Wertheizer

Anil, just information that we saw from (inaudible). 3G shipments based on CEVA went quarter over quarter 7%, Qualcomm went down in units, 3G units 10%.

Anil Doradla - William Blair & Company

Right.

Gideon Wertheizer

So, if our market share –

Anil Doradla - William Blair & Company

So, what would please you as we exit 2013, I know it’s a little too far, but you talked about the mix as we exit 2012, but by 2013, where do you think from a units points of view you expect the 3G and the non-3G to breakout?

Gideon Wertheizer

Well, it’s too early to speak about it for now. We have to see how the last quarter is evolving. But, in terms of triumph, it will continue. It will not stop, meaning, in the 3G we will keep expanding because we see all these models coming, which will go in production and go to from a ramp-up to production in 3G. We expect LTE coming other than Samsung that now increasingly growing their LTE shipments based on us, other than Samsung, we have a bunch of other customers that are now in (inaudible) level, testing, producing new products. This will appear, this about materializing into next year.

Anil Doradla - William Blair & Company

Thanks a lot, guys.

Gideon Wertheizer

Thank you.

Operator

You next question is Joseph Wolf of Barclays, please go ahead.

Joseph Wolf - Barclays Capital

Thanks. I have two questions. One is, I know it’s a little bit early but last year the phenomena was that the third quarter, which is your fourth quarter I guess, was seasonally very strong but the fourth quarter was a little bit disappointing. I am wondering what do you think there will be that kind of – what you are seeing right now is a polling that’s a repeat of last year. That’s my first question. And the second question I have is, with regard to just MStar, they seemed to have written down some inventory with their baseband ICs as part of the MediaTek combination. I am wondering if you could just give us some thoughts on that transaction and those two companies getting together with regard to your ongoing business?

Yaniv Arieli

I will start maybe with the first one, Gideon, you could tackle the second one. I think we are pretty clear with our guidance for the fourth quarter. So, you are right, that last year was normal in inventory and ramp up but we believe that our royalty revenue from the $7 million that we recorded now in Q3 will grow at least low two-digit, meaning 10% and above sequentially. So, for now we are seeing a pretty nice tick in the royalties for Q4. How Q4 will play along we need to see how the market, the economy, the rampups that we talked about will do in the lot of the players in the industry. I think there are a lot of new phones that are introduced and are ramping up now. So, we not necessarily we’ll see the same effect that we had last year, I think it’s a whole different market skiing this year. On the contrary, the first two quarters were very slow because of the anticipation of the introduction of these new phones or customers that waited and did not buy phone, which is exactly the opposite in what happened a quarter ago, a year ago. So, hopefully Q4 kicks in well that our Q1 royalties will continue to grow. But that’s all depend on natural shipments in the market.

Gideon Wertheizer

With regard to MStar, right now I am not familiar with it as far as we can see from the report they are progressing.

Joseph Wolf - Barclays Capital

So, you don’t feel like changed --?

Gideon Wertheizer

No. They are specializing in the very low tier of 2G space. I think to say it’s big volumes there, but then they are not that big enough, but they are progressing there.

Joseph Wolf - Barclays Capital

Okay, great. Thank you.

Gideon Wertheizer

Thank you.

Operator

The next question is from Matt Robison of Wunderlich, please go ahead.

Matt Robison - Wunderlich Securities

Hey, gents. Can you comment on how many XC4000 license deals you have gotten to-date and if this gesture recognition deal with 3101 is first in that space. If the EMCORE relationship has begun to bear any fruit if these XC4000 licenses are starting to work the 802.11ac that are programmed? And I have a couple of follow on?

Gideon Wertheizer

Okay. Matt, I will take the first question, which I believe are related here. Right now two XC4000 deals we signed on last quarter. This quarter is also based on growth. The EMCORE investment they played later in investment in a company that we developed a WiFi software that will align on the XC4000. So, we are in a process of developing it and reaching customers. They purchase the go ahead to say, new customers with LTE, the WiFi folks, or the EMCORE software is basically on top of the LTE. So, we will continue developing it and hopefully we will get some traction. It’s a very attractive value proposition because a lot of people that feel that they can do LTE, they still needs the WiFi. The 802.11ac, the next one is a pretty complicated one. When it comes to the MM3101 this is the second agreement that we have. First in the gesture area. We see many – gesture is by the way is part of whole lot of other technologies that relate to a vision. It’s gesture and eye tracking and it goes to automotive. You see a lot of traction, it will design underlying technology, and the customer that we address is going to use it for gesture I would say because it’s a platform.

Matt Robison - Wunderlich Securities

When you talk about the 2.5G, are you able to – I know you made the transition towards for a variable pricing in this year, is that – when you talk about 2.5G and more features wrapped in that are adjacent to a traditional baseband, are you able to pick up any ASP from that, or such as WiFi and that sort of thing? How does 2.5G affect you there?

Yaniv Arieli

The 2.5G is overall a better performance and feature rich type of phones. So, these are touchscreen, WiFi connectivity, music capabilities, audio – all this at the end of the day has a higher selling price versus a simple $20 phone. These are probably priced somewhere between $70 to $110, but that said this is fully comparable to the iPhones and Galaxys and very high end phones. Starts to the emerging economies. From our point of view if we had a 2G product in a $20 phone, of course the dollar content in these phones are lower than the 2.5 half sophisticated phone which run somewhere between $17 to $100. So, that’s what we feel added. We don’t get any additional incremental royalties for the WiFi or the touch screen, we get them with the speed, but the chipset itself found the whole solution as a higher priced device.

Matt Robison - Wunderlich Securities

I got you. Why was R&D down, yet sales and marketing up when the top line comparison was down?

Yaniv Arieli

The R&D is mainly timing of grant that you got in this quarter, which calls about the need to be lower. In marketing we added a few personnel, so the marketing teams across the board. They had some very interesting advance recently and concentrated in China, Taiwan with very nice attendees and a lot of the nice fair reception to the technologies. So, these are pure marketing activities and some increase in headcount.

Matt Robison - Wunderlich Securities

Some of the semi-conductor companies have talked about normal or maybe a little bit better than normal seasonality in the fourth quarter. This goes to one of their earlier questions, maybe a slight sequential decline for their shipments in the fourth quarter. It sounds like you are thinking mix be offsetting a little bit to keep the path or the uptrain going into the first quarter. Is that the right take way?

Gideon Wertheizer

These kind of things, I would prefer to take Phoenix as a result throughout the quarter, I don’t know. I hear things, but from our standpoint, it could be – the same could be different because we are in a market share, a market capture mode. So, how much more are we going to get in 3G, what will be the pay for 2.5G, which also kicks momentum on the 2G. These are type of questions that we need post-mortem to understand.

Matt Robison - Wunderlich Securities

Right. One more, and I will get off. Just depreciation, CapEx and headcount change?

Gideon Wertheizer

Headcount overall increased by one from 194 to 195. We still have few open reps [ph\ of hiring due to some changes. And CapEx and depreciation, both around $130,000 to $140,000 in the quarter.

Matt Robison - Wunderlich Securities

Thanks.

Gideon Wertheizer

Thank you.

Operator

The next question is Daniel Meron, RBC Capital Markets. Please go ahead.

Daniel Meron - RBC Capital Markets

Thank you. A few questions on my end. First of all, you guys had an interesting move with gesture recognition. What kind of other technologies you think maybe you want to look for going forward? If you can just give us a sense on what’s on your timing board?

Gideon Wertheizer

Well, first of all, when it comes to the baseband activities, we mentioned last quarter, our target market and in a way, traction in the base station market. Base station is the macro base station and also into small base. That’s an area that we are with XC4000 addressing. And also the investment that we made in (inaudible) will help us to increase the value offering by adding the Wi-Fi on top of it. And also, to address connectivity space in the entrant space.

When it comes to the vision and imaging platform, the MM3101, it’s families of technology that we generate, starting from gesture recognition, and as I answered from other, I think it was somebody else, it’s not just gesture, it’s different technologies and market, like eye tracking. And if you go to automotive, with detection and other things that relates to safety. That’s one element in the offering. The other element is things that relates to the camera enhancement. If you go to iPhone 5, you will see all these new features – we are working on the next level of camera enhancement. And again, it takes us to a different categories of customers.

Now, the baseband customers, the people dealing with replication processes, people that are targeting the automotive market, people that are targeting the CPU market, we are speaking with all of them.

Daniel Meron - RBC Capital Markets

Okay. Understood. And I may have missed it earlier, but on the license, as I understand that this was like this quarter and next quarter. Is there something a little bit more going on that we should think about as far as innovation or is it just you think kind of like macro-related issue or some hesitancy in that status?

Yaniv Arieli

Let me try to address that. The way we see this and I think as long as I know, Gideon, and he knows me, this is how we convey the licensing business is that our comfort zone is $4 million to $5 million. And we are not doing the comfort zone. Some quarters could be slightly better on the high end of the – it’s like, some quarters, that this quarter could be in the low end of this guidance or comfort zone. As we talked about this quarter from a quality perspective, it was an excellent quarter. So, we – just in major type of technology, our audio, our gesture and our highest band LTE-Advanced. I don’t recall a quarter like this from a qualitative point of view ever almost for a very long time. So, from that aspect, I am okay. With that said, if you look outside, it is a bit more difficult when the companies are taking sometimes a more prudent approach. I think that’s what we mentioned, and this is why a few deals, one or two extra deals, $300,000 or $400,000 [ph] either re-use fees or some software changes, and we could have been in the mid range or the higher end of the licensing numbers. So, we don’t see that, other than the fact that it’s lower than what previously we have come up within the last couple of quarters or year, too. Overall, we don’t see that as a big hurdle and continue to ramp up the business and offer our technologies to different market segment and to new customers.

Daniel Meron - RBC Capital Markets

Okay. Thanks. That’s useful insights, Yaniv. Is there a way, when you are looking at the quality of the license deals that you are providing or getting to look at the long-term prospects of transiting those licenses into royalties, so we can be assured that maybe this couple of weaker quarters don’t necessarily mean that royalty stream down the line, two, three, four years necessarily gets impacted one way or the other?

Yaniv Arieli

That’s an excellent point. That’s very true and sometimes when you count the deals and one nice startup, which is a good, nice deal for the quarter, it doesn’t necessarily mean that they could generate millions of dollars of royalties three or four years down the road. So, that’s an excellent point. And it’s true, it’s hard to quantify it. In the press release and this is why I think in the prepared remarks, Gideon was trying to highlight every quarter one of the more interesting and more strategic deals that could generate these numbers in these royalties, as we mentioned, down the road.

Daniel Meron - RBC Capital Markets

Okay. Thank you, good luck.

Yaniv Arieli

Thank you.

Operator

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

Vijay Rakesh - Sterne Agee

Hi guys. I was just wondering, when you look at your royalty revenues, obviously, it was trying to show a little bit of a pickup here. Given all the tablet and handset wins you have with the 3G licensees in China, etcetera, ramping, when do you see getting back to that kind of 9 million range? And I think you guys peaked at 9 million to 10 million last year, or late last year. Do you see getting to those levels actually going into 2013? You are almost at $8 level a share now – 8 million quarterly level.

Yaniv Arieli

Yes, it’s a good question. I think we were asked that earlier maybe a little bit differently when Gideon then answered. It’s started to have a crystal ball. I think that we have a market and the trends in the market that we try to explain and we also said that correctly, but 3G, 4G offsetting some of the 2G price erosion, but knowing to come up with the numbers, you really need to see the royalty plays into CEVA execution, maybe in our semiconductors players and OEMs in the field.

We could help you out by saying how would we get there, but I don’t think we have an exact timeframe. And quarter in for now, two quarters for now, it all really depends on the market and execution of the Nokia, ZTEs, Huawei, Samsungs of the world. These are the OEMs powered by our technology. So, I am not sure exactly how we could help with the specific date, but overall, expanding the segment and the growth prospects going forward.

Vijay Rakesh - Sterne Agee

Got it. And I know somebody asked this question before, but when you look at your 3G mix here, exiting 2012, where do you see? And as you look at 2013, given all the ramps, how do you see your unit growth on the 3G side, year-on-year for 2013, if you had a crystal ball there?

Gideon Wertheizer

We don’t have – Yaniv does not have crystal ball, I don’t have a crystal ball for 3G. Vijay, I think the way to do with it is to see the consistency of the growth, 11% year-over-year last quarter, 7% sequential growth in 3G. And let me add something there. One of the things that muted our growth in the last few quarters is headwinds, the 2G rend down at Nokia by Broadcom, they spoke about it openly. So, we see this going down. On the iPhones, they have substantial volume, (inaudible) becomes less and less significant. So, what we are going to see from now on is just growth, ultimately without losing anymore headwinds that are related to legacy. What we have now is what we are gaining, and we are not losing anymore.

Vijay Rakesh - Sterne Agee

Got it. On the licensing side, obviously it tends to be lumpy. How do you feel are order licensing pipeline actually looking at next year? And the quarter-to-quarter obviously, it’s a little bit tougher to kind of guide. But when you look at next year year-on-year, how do you think about your licensing pipeline and prospects there?

Gideon Wertheizer

It’s difficult to say that, to speak about next year’s pipeline and licensing. We have, and I think somebody mentioned, we have lot of more products to offer than introduced before. At the beginning, we didn’t have the XC4000, we didn’t have the TeakLite-4, at the beginning, we had all the previous generation of the MM3000. So, all these things are being offered to the market. We see all these strategic customers interested in these kinds of product, not the legacy type of things. They are interested in these kinds of products. And that encourage us. I mean, in the last quarter, on the revenue terms was a bit slow. We still had this two strategic business.

Yaniv Arieli

I could also add that if you look at the longer prospects of CEVA over the last couple of years, our annual licensing revenues were always in the 18 million to 20ish million dollars. We don’t see that changing, as Gideon said, just because of this bit shy Q3 licensing numbers. I think that overall the business and licensing is making sure we keep that 18 million to 20 million, and if we are successful regarding the time, then those at least the strategic deals could generate very positive royalties there as we have seen before.

Vijay Rakesh - Sterne Agee

Agreed. That’s why I asked about the full-year and not the quarterly numbers on licensing. Last question here on the XC4000, is that a 3G, 4G, 3G LTE, both on a single chip kind of IP? I know you guys gave some color. That’s the last question, can you give some more elaboration on that?

Gideon Wertheizer

You mean, from a technology standpoint or from a marketing?

Vijay Rakesh - Sterne Agee

Yes, from a technology standpoint, there is a IP-enabled, it would make a backward compatible LTE and 3G all on one chip or --?

Gideon Wertheizer

As far as I can see, there is no, any XC equivalent in the market today that can run all those different kind of starting from LTE-Advanced down to 3G. We are the only one that are able to offer these kind of things.

Vijay Rakesh - Sterne Agee

Got it, great. Thanks a lot. Appreciate it.

Gideon Wertheizer

Thank you. Richard, you want to ramp up?

Richard Kingston

Sure. Operator?

Operator

This completes our question-and-answer session. I would like to turn the conference back over to Richard Kingston for any closing remarks.

Richard Kingston

Thank you very much. Thanks again for joining us today and for your continued interest and support at CEVA. Please check in on the Investor Relations section of our website to see the schedule of upcoming conferences and road show days for you to be able to meet the CEVA management. Thanks very much and good bye.

Operator

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

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Source: CEVA's CEO Discusses Q3 2012 Results - Earnings Call Transcript

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