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DSP Group, Inc. (NASDAQ:DSPG)

Q3 2008 Earnings Call Transcript

October 30, 2008, 8:30 am ET

Executives

Ofer Elyakim – President of Southeast Asia Operations

Eli Ayalon – Chairman and CEO

Dror Levy – VP of Finance and CFO

Boaz Edan – EVP and COO

Analysts

Elrad-Jakoby – Susquehanna

Hugh Cunningham – Oppenheimer

Daniel Amir – Lazard Capital Markets

Daniel Meron – RBC

Operator

Good day, ladies and gentlemen, and welcome to the 2008 third quarter DSP Group earnings conference call. My name is Ann, and I'll be your coordinator for today’s call. (Operator instructions) At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the presentation.

I would now like to turn the call over to Ofer Elyakim. Please proceed.

Ofer Elyakim

Thank you, operator. Good morning, ladies and gentleman, I am Ofer Elyakim, President of Southeast Asia Operations for DSP Group and welcome to our third quarter 2008 earnings conference call. On today’s conference call we have with us Mr. Eli Ayalon, Chairman & Chief Executive Officer of DSP Group; Mr. Boaz Edan, Chief Operating Officer; Mr. Brian Robertson, President; and Mr. Dror Levy, Chief Financial Officer.

Before we begin, I would like to remind you that during this call, we will be making forward-looking statements about our financial projections for the fourth quarter of 2008 and our decision to implement further synergies to reduce 2009 operating expenses. We assume no obligation to update these forward-looking statements. Actual results or trends could differ materially from our forecast for a variety of factors including fluctuations in sales of our 5.8GHz and DECT 6.0 products; successful implementation of the synergies to reduce 2009 operating expenses; slower than expected change in the nature of the residential communication domain; unexpected delays in the introduction of new products or failure of such products to achieve broad market acceptance; our inability to develop and produce new products at competitive costs; and declines or fluctuations in gross margins. For more information, please refer to the risk factors discussed in our 2007 Form 10-K and other SEC reports we have filed.

Now, I would like to turn the call to Eli Ayalon, Chairman & Chief Executive Officer of DSP Group. Eli, the floor is yours.

Eli Ayalon

Thank you, Ofer, and thank you all for joining us today. I am glad to open this discussion on the results of the third quarter of 2008. I assume that you had the opportunity to read our press release. It was released earlier today. In a short while, Dror Levy, our CFO, will go through the details of our financials.

I would like to relate to the recent market trends and discuss steps we are taking to soften the impact of the present financial and economic climate. Our revenues were at the high end of our previous guidance for the third quarter of 2008. We end this quarter [ph] at operating cash flow at the level of $7.6 million, the details of which will be given in a moment by Dror Levy, our CFO.

Sales of DECT products continued to grow both in Europe and the US, and accounted this quarter for 75% of our revenue in the quarter as compared to 70% in the second quarter of 2008. Sales of the 5.8GHz and 2.4GHz products generated 15% of our revenue, very similar to the second quarter of 2008. We also succeeded in implementing improvements in our gross margins, as projected in our previously announced cost cutting plans.

Now turning to our new multimedia product line, during the third quarter of 2008 we secured two design wins with two leaders in the home communication domain. Both Giant Wireless Technology Limited with whom we had put a press release earlier this quarter and another leading European based OEM customer decided to develop products for the digital home based on our XpandR platform. The decision to use our platform was driven by XpandR’s broad application capability, including multimedia and telephony and high level of integration compared to the other alternatives in the market.

After analyzing the recent forecasts received from our customers, we leave unchanged our projections for the full-year 2008 as previously announced. Boaz Edan, our chief operating officer, will provide you later with the various items of our P&L projection as we usually do. Despite the encouraging results of our third quarter, we cannot ignore the world economic crisis and its possible impact on consumer spending in 2009. Therefore we continue to implement further synergies and to reduce our operating expenses in 2009 by approximately $10 million as compared to the operating expenses of 2008.

These synergies are based on rationalizing and streamlining the activities of (inaudible) to our VoIP applications and improve efficiency. As a result, a one-time of approximately $1.9 million was recorded in our operating expense for this quarter. Most of the measures necessary for the implementation of this plan have already been taken and we expect to operate starting in January 2009 with a reduced run rate for operating expenses. During the third quarter, our stock repurchasing activity continued pertinent [ph] to our 10b5 (1) plan. We used during the quarter $6 million for the repurchase of 0.9 million shares of our common stock in an aggregate of $43.9 million since January 1, 2008, for the repurchase of 4 million shares.

Now, I would like to turn to Dror Levy our CFO. Dror, the floor is yours.

Dror Levy

Thank you, Eli. Good morning everyone. I will now review the income statement for the third quarter of 2008 from top to bottom. For each line item I will provide the US GAAP results as well as the equity-based compensation expenses included in that line item and the expenses related to the acquisition of the cordless and Voice-over-IP business from NXP.

Revenues for the quarter were $87.4 million. Gross margin for the quarter was 37.6%. Gross margin for the quarter included $0.2 million of equity-based compensation expense. R&D expenses were $17.9 million, including $1.6 million of equity-based compensation expenses. Operating expenses for the quarter were $35.5 million, including $3 million of equity-based compensation expenses and also included amortization of acquired intangible assets of $5.7 million. Operating expenses for the quarter also included restructuring charge in the amount of $1.9 million related to our decision to implement further synergies as Eli discussed earlier.

Interest expenses for the quarter were at $0.2 million. Interest expenses included unrealized loss of $0.7 million resulting from the decline in fair market value of available-for-sale securities.

Income tax expenses for the quarter were $0.2 million. This figure includes $0.1 million of tax credit relating to equity-based compensation, $0.7 million of tax credit associated with amortization of acquired intangible assets, and $0.2 million of tax credit related to the restructuring charge.

Net loss was $3 million, including $5 million associated with the amortization of intangible assets, net of tax benefits, and net effect of $3.1 million associated with equity based compensation expenses, $1.7 million of restructuring charges net of tax benefit, and $0.7 million of declining fair value of available-for-sale securities. Non-GAAP net income, excluding equity-based compensation expenses, the net effect of amortization of intangible assets, the restructuring charges, and the declining fair value of available-for-sale securities was $7.4 million. Loss per share was $0.11. The net negative impact of equity-based compensation expenses on the EPS was $0.11. The negative impact of the amortization of the acquired intangible assets net of tax benefit on the EPS was $0.18.

The impact of the restructuring charge net of tax benefit on the EPS was $0.06, and the effect of the decline in fair value of available-for-sale securities was $0.03. Non-GAAP EPS, excluding equity-based compensation expenses, the net effect of amortization of acquired intangible assets, restructuring charges, and decline in fair value of available-for-sale marketable securities was $0.27 on a diluted basis. Please see the current report on Form 8-K that we filed with the SEC this morning for a reconciliation of the non-GAAP presentation to the GAAP presentation.

Now to the balance sheet, accounts receivable decreased from the last quarter by $2.3 million to a level of $44.2 million, representing a level of 46 days of sales. Inventory increased by $2.3 million from last quarter to $21.8 million, representing a level of 36 days. Our cash and marketable securities at the end of the quarter were $120.4 million, representing a decrease of $1.4 million during the quarter.

Our cash position during the quarter was affected by the following

$7.6 million of cash generated from operation, $6 million of cash used for repurchase of 0.9 million shares at an average price of $6.9 per share, and $1.4 of cash used for purchase of property and equipment.

Now, I would like Boaz Edan, our Chief Operating Officer to present our forecast for the fourth quarter of 2008. Boaz, please.

Boaz Edan

Thank you, Dror. Good morning, everybody. I'll now provide you with our projected plans for Q4 '08.

Based on forecasts received from our customers, and our own assessment, our Q4 2008 projections on a US GAAP basis, including the impact of equity-based compensation expenses and acquisition-related amortization expenses, are as follows. Revenues are expected to be in the range of $68 million to $84 million. The expected gross margin to be in the fourth quarter between 37% to 40%. R&D expenses will be in the range of $17 million to $19 million and operating expenses will be in the range of $33 million to $35 million. Interest income will be in the range of $0.7 million to $1.1 million. Income tax is expected to be in the range of $0.1 million to $0.4 million. Shares outstanding are expected to be in the range of 26.5 million to 27.5 million shares.

Our Q4 ‘08 projection includes the following amounts forecasted for acquisition-related amortization of intangibles; operating expenses include $5.5 million to $6 million, and income tax benefit includes $0.5 million to $0.7 million. Our Q4 ‘08 projection includes the following amounts forecast for equity-based compensation expenses: cost of goods sold $0.1 million to $0.3 million; R&D expenses include $1.5 million to $1.7 million; operating expenses include $2.8 million to $3.2 million; and income tax benefit include of $0.1 million to $0.2 million.

Thank you for your attendance, and we will now open the floor for questions.

Question-and-Answer Session

Operator

(Operator instructions) And the first question comes from the line of Elrad-Jakoby of Susquehanna. Please proceed.

Elrad-Jakoby – Susquehanna

Hi, good morning and thank you. For revenue guidance in Q4 you gave a very wide range, but if we take the mid point of this range, I think it contemplates a bigger decrease than we expected. Is this a result of what you are seeing in the macro, is this a trend that you expect to carry through into 2009?

Eli Ayalon

No Elrad. What I explained is that we kept the revenues of 2008 as projected in the last conference call. If I recall the mid range of this projection was $310 million. This is how we gave it in the last conference projection and we left it as it is. The wide range is due to the lowered visibility that the consumer market is facing now. We cannot ignore the economic turmoil in which all of us are and the reluctance on the part of our customers to be more specific in projecting and our assurance that we can rely on figures that we receive is by nature lower than before the crisis, and because of this we decided to take our precautions and expand the range. And we feel comfortable with the range that we have given.

Elrad-Jakoby – Susquehanna

Okay. Fair enough. So, moving along to XpandR, you mentioned two design wins with – on the consumer electronics front, what are you seeing from operators in this area?

Eli Ayalon

What we keep seeing from operators is one, great interest, two, discussing details of the project, three, discussions between operators and OEMs about joint projects for the next year. We have to remember that we are the not the ones that will have to sign with the operator at the end. At the end of the day, we are selling to the OEMs, but as I mentioned before, because of the chain of the decision making (inaudible) we are in close contact also with that link of the chain, the operators.

Elrad-Jakoby – Susquehanna

Okay. So, do you expect any operator-related deals and design wins to be signed this year too?

Eli Ayalon

We hope so, yes.

Elrad-Jakoby – Susquehanna

Okay, thank you and I will pass it on.

Operator

And the next question comes from the line of Hugh Cunningham of Oppenheimer. Please proceed.

Hugh Cunningham – Oppenheimer

This is Hugh Cunningham for Shaul Eyal at Oppenheimer. Can you talk a little bit about the XpandR platform, these two wins that you mentioned, just in general terms, what sort of products do you think XpandR will end up supporting or being including it in and also are there any other – is there anyone else out there with a chip that is comparable to the XpandR. What I think you have DECT capabilities in Wi-Fi built into the chip. So multimedia capability is there. Anyone else with a similar chip?

Eli Ayalon

There is no one that has a combination in one piece of silicon of both DECT and Wi-Fi. With respects to the applications of these deals that customers are developing and will develop more in the future. I will let Ofer elaborate on this (inaudible) which we had the first deal signed. Ofer.

Ofer Elyakim

With respect to the type of product that we are seeing and I think we discussed it in the last quarterly call, one of the major products that we see is what we call interactive base, or interactive handset that basically serves as an device that both utilizes DECT for voice communications and uses Wi-Fi for all the rest from audio streaming to infotainment services to any other non-voice related services that the operator will have to have control of. We also see a similar trend also in the retail market in phones or home communication devices that we utilize both the DECT and the Wi-Fi link, and I think that we will start seeing these in the market sometime next year.

Hugh Cunningham – Oppenheimer

So, you think in 2009 we will start seeing those products out there?

Ofer Elyakim

Yes.

Hugh Cunningham – Oppenheimer

Okay, and just a little bit more detail I guess, or a little bit more color in terms of what you are actually seeing out there. Maybe some anecdotal evidence regarding the macro economy and the impact on your customers, can you give a little bit more color there?

Eli Ayalon

I am confused as any inhabitant of the globe. Really nobody knows what the near-term or mid-range future will bring in terms of dynamics of the consumer market everywhere. We were surprised by the high demand that we have seen in the third quarter. I can tell you that the degree of visibility we have in the other links of the chain, beyond the OEM where the retailers and so on is very, very limited and therefore because of this, as I explained before, we have expanded the range of our projection in the fourth quarter. But you know, we do not hear any from our customers, any sign of panic or things like this. This is not the case.

Hugh Cunningham – Oppenheimer

Okay, thank you for taking my question.

Operator

And the next question comes from the line of Daniel Amir from Lazard Capital Markets. Please proceed.

Daniel Amir – Lazard Capital Markets

Thanks a lot. Thank you for taking my call. Maybe following up to the previous question, can you comment on the – is there any difference between the regions in terms of visibility or in terms of kind of customer projections, you know, most of your business is in North America but is there any difference between the areas?

Eli Ayalon

No, most of the business is not in North America. It is quite evenly divided between Europe and North America. And I wouldn’t say that at this stage we see differences in attitude or in visibility. I think that this was in past. Now, I think that it is quite equal. People are waiting to see what the macro economy will bring and we live from quarter to the other. And if the remaining quarters until the end of ’09 will be as good as this quarter, this will be good enough I think. I don’t know if this is the case, I would say from quarter to the other. (inaudible)

Daniel Amir – Lazard Capital Markets

Do you see any inventory build up in the channel right now or you don’t have that visibility?

Eli Ayalon

As I explained a couple of (inaudible), we do not have a clue about inventories far away from us in the chain, but we have seen a strong demand this quarter and when we are asking our customers, are you sure, you really want it, and so on. They answer is yes. That you know, we have already a year in which we had the problem of inventories in the retail chains and our OEMs didn’t know about it. I don’t want to say that this is the trend this year. I hope not. But our visibility is not bigger.

Daniel Amir – Lazard Capital Markets

Okay, regarding the – some of the cost savings, what are you doing on the cost side to improve your gross margins next year or do you think that gross margins are not necessarily going to improve next year?

Boaz Edan

As we do every year, we are working in optimizing (inaudible) the device that we have, introducing a new device at a better cost and working on improving yield and cash. This is an ongoing activity that you run on the consumer business and of course, working with our foundries and assembly and test as to improve the cost structures, and in part working with the customers in order to find the directions to optimize the cost (inaudible).

Daniel Amir – Lazard Capital Markets

Though as you diversify into some of these product categories, are they higher margins or lower margins than corporate?

Boaz Edan

As earlier mentioned, we are looking currently at the high volume products we are selling in the same DECT market at 70% of the products we are selling currently on DECT. And the rest are mainly 5.8GHz and 2.4GHz and this is what we plan to continue to serve going forward to Q4.

Daniel Amir – Lazard Capital Markets

I mean, my question more into next year, do you XpandR in that. I mean, is that going to be lower or higher gross margins?

Eli Ayalon

Daniel with respect to next year, every year, gross margin is composed of the selling price and the cost of the product. This is what – this is the composition of the gross margin. Now, Boaz explained what we are doing every year on product in order to reduce the cost. The gross margin will depend a lot on the dynamics of ASPs in ’09 and this is in my opinion early, too early to predict.

Daniel Amir – Lazard Capital Markets

Okay, and then just to on the Opex thing, so (inaudible) the March quarter, we should already see the lower Opex level going forward, is that correct?

Eli Ayalon

Yes.

Daniel Amir – Lazard Capital Markets

In both R&D and SG&A.

Eli Ayalon

Yes.

Daniel Amir – Lazard Capital Markets

Okay, all right. Thanks a lot.

Eli Ayalon

Thank you.

Operator

(Operator instructions) And the next question comes from the line of Daniel Meron from RBC. Please proceed.

Daniel Meron – RBC

Thank you. Eli and Boaz, I understand that you don’t have visibility looking into 2009, but what are the parameters that you are looking at to define where exactly where we should be looking at. I mean basically you are planning some cost cuts and also on reducing the headcount. What are you basing those cost cuts on as you move into 2009? Thank you.

Eli Ayalon

Cost cuts are based on – we are using more synergies from the deal signed with NXT and improving the efficiency at a (inaudible) various sites of the company that enables us to reduce not only headcount but also related expenses through the activities that were carried out in the sites.

Daniel Meron – RBC

But should we assume that the reduction in cost synergies that you have derived from this acquisition, assume the worst case scenario from your standpoint and either way regardless of where the revenue goes, assuming obviously that it doesn’t drop by 50% year-on-year, you will still be on operating breakeven or at least or even in profitability?

Eli Ayalon

Daniel, you see, what you mean asking – your question is (inaudible) on our sales projections for next year and this is something that we are not going to give at this stage. We are collecting information. We are too far away. It wouldn’t be serious on our side to give any sales projections for next year now. I think that no company is doing it. And we shall be more clever about next year promises in the next conference call. So, I like to (inaudible).

Daniel Meron – RBC

Okay, and couple of questions on the FX side. Was there any impact whatsoever either in revenue from the low Euro dollar or on the expense side then also from the shekel rebounding versus the – sorry the dollar rebounding versus the shekel?

Eli Ayalon

No the shekel versus the dollar was quite flat in the Q3 for we didn’t see any (inaudible) there. The Euro versus the dollar did contribute to some extent to the lower Opex than we had and then predicted but this is a not a big number. I would say something in the range of no more than $200,000 (inaudible). And in revenues the number is negligent because most of our revenues are in dollars.

Daniel Meron – RBC

Okay, and then on the buyback, how much is left there, I might have missed that, how much is left in the buyback plan and do you have plans to extend if there is – or what is the limit of your buyback plan?

Eli Ayalon

The buyback plan which was approved is ending on the 1st or 2nd of November, (inaudible) at the end of this month. We have 2 days remaining and we have a few 100,000 shares remaining. We work by the plan so whatever we succeed to do we shall do. With respect to the future and in the past we shall consider everything in due time (inaudible).

Daniel Meron – RBC

Is there a flow for the net cash that you want to retain here?

Eli Ayalon

Yes, I think that the companies are trying [ph] at the level of $300 million of sales. So does the cash. And the rest, the answer is yes. You shouldn’t conclude from this that we shall not have in the future repurchase plans, that we shall not have in the future other activities that will make use of this cash, but (inaudible) yes, we need cash.

Daniel Meron – RBC

But what is the amount that you think is the right amount, is it $100 million, is it $50 million, can you give us a range of what is the minimum cash level that you want to retain in your balance sheet.

Eli Ayalon

Well, we didn’t set a minimum.

Daniel Meron – RBC

Okay, very good. Thank you. Good luck going forward.

Eli Ayalon

Operator.

Operator

Yes.

Eli Ayalon

Can you check if there are any more questions?

Operator

One moment. (Operator instructions)

Eli Ayalon

Okay, operator.

Operator

Yes, and there are no further questions at this time. I will now turn the conference back over to Ofer Elyakim for closing remarks.

Ofer Elyakim

So, thank you for joining today’s earnings conference call and we look forward to reporting to you in 90 days. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference.

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