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Executives

Christopher Basta - Director of Investor Relations

Ofer Elyakim - Chief Executive Officer and Affiliated Director

Dror Levy - Chief Financial Officer, Principal Accounting Officer, Corporate Vice President of Finance and Secretary

DSP Group (DSPG) Q4 2013 Earnings Call January 30, 2014 8:30 AM ET

Operator

Good day, and welcome to the Q4 2013 DSP Group Earnings Conference Call. For your information, today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Chris Basta, Director of Investor Relations. Please go ahead, sir.

Christopher Basta

Good morning, ladies and gentlemen. I am Chris Basta, Director of Investor Relations at DSP Group. Welcome to our fourth quarter of 2013 earnings conference call. On today's call, we have with us Mr. Ofer Elyakim, Chief Executive Officer; and Mr. Dror Levy, Chief Financial Officer.

Before we begin, I would like to remind you that during this conference call, we will be making forward-looking statements about our financial projections for the first quarter of 2014; optimism about market opportunities for our new product lines, including HDClear, DECT/CAT-iq, ULE and office Voice over IP products; optimism about opportunities presented by the CAT-iq 2.0 certification program; prevalence of ULE; timetable for product ramp-ups by our customers; and optimism about our successful turnaround and ability to enter into market domains and create new revenue streams.

Actual results or trends could differ materially from our forecast, including the impact of reduction in lead times and inventory levels by our customers and their customers; continued uncertainty in consumer demand for traditional cordless telephony products in our major end markets; unexpected delays in commercial launch or mass production of new products incorporating our technologies; the growth of new market verticals; our ability to manage operating expenses; our ability to secure additional design wins; and general market demand for products that incorporate our technologies in the market.

We assume no obligation to update these forward-looking statements. For more information, please refer to the risk factors discussed in our 2012 Form 10-K and other SEC reports we have filed.

Now I would like to turn the call over to Ofer Elyakim, our Chief Executive Officer. Ofer, the floor is yours.

Ofer Elyakim

Thank you, Chris. Good morning, everyone, and thank you for joining us today. I hope that you had the opportunity to read our press release that was released earlier today. I will begin this discussion by reviewing our results for the fourth quarter of 2013 and the full year and then comment on the progress we are making with our business plan, including design wins and recent market developments around the new product segments. In a short while, Dror will provide you with detailed comments on our financial results and update you on our outlook for the first quarter of 2014.

Despite the continued uncertainty in the cordless market, our financial results for the fourth quarter exceeded our guidance in almost every financial metric and demonstrate continued progress in our turnaround and in our business performance. Fourth quarter revenues of $35.3 million were slightly ahead of the midpoint of our guidance range. Our revenues declined by approximately 8% year-over-year and were flat on a sequential basis. Better non-GAAP gross margins of 40.2% and lower operating expenditures drove a fifth consecutive quarter of non-GAAP operating profitability and our fourth consecutive quarter of positive GAAP net income.

Moreover, during the quarter, we generated approximately $8.3 million in cash flow from operations and used our active share repurchase program to buy back 390,000 shares of our common stock at an average price of $8.97 per share for a total consideration of $3.5 million. Our net cash and cash equivalents increased in the fourth quarter by $2.6 million to approximately $127.6 million at the end of December.

Now turning to our full year results. Our revenues were $151.1 million. Despite revenues declining by 7% year-over-year and due to a prudent execution of our business plans with a key focus on generating profit and cash flows, we achieved a significant improvement in overall operating results. Non-GAAP gross margins for the year improved by 200 basis points to 39.8% versus 37.8% in 2012. Cost control initiatives drove a return to non-GAAP operating profit of $7.3 million and non-GAAP net income of $9.5 million, meaningfully above the non-GAAP operating loss of $1.3 million and non-GAAP net income of $0.8 million in 2012. Last but not least, in 2013, we generated $13.3 million in cash flows from operations and fully met the objective we laid out last January of generating positive cash flow from operations.

Before moving on to an update on each of our business segments, I would like to put some context around where we stand now versus where we were a year ago. Today, we have a solid foundation for new revenue sources across a number of product segments including Enterprise Voice over IP, ULE and Mobile. The core of this foundation are the 3 new products we launched roughly 12 months ago. The first is our DHX91, our first ULE system on chip targeting the home automation market. The second is the DVF99, a powerful Voice-over-IP processor that help us cover the complete range of IP fronts and compete for Tier 1 business. And finally, the DBMD2 high-performance, low-power voice enhancement chipset powered by our proprietary HDClear noise suppression technology for mobile. Then on a quarterly basis, we have shared with you the progress we have made with these products in the form of field trials, design wins, mass productions and revenues. The hard work and accomplishments of our team are paving a solid path towards meeting key milestones including securing design wins with Tier 1 OEMs in Mobile, Enterprise Voice and ULE this year.

Now I'd like to review the specific segments. The first is the home vertical, and the home vertical comprises of cordless phones, home gateways and ULE. In the cordless phone market, we continue to experience significant volatility in the demand for cordless telephony products.

In the fourth quarter, our overall DECT revenues were down by 5% year-over-year and increased by approximately 2% versus the third quarter of 2013. Sales of our DECT products for the European and rest of the world end markets in the fourth quarter were ahead of plan, up 6% sequentially and 12% year-over-year and accounted for approximately 51% of revenues. Sales of DECT products for the North American end market were lower than expected and declined by 5% sequentially and by 23% year-over-year. DECT 6.0 products for the North American end market accounted for approximately 33% of our revenues. The weakness in the North American market during the fourth quarter and second half of the year is mainly attributed to one of our OEM customers that has gradually exited the U.S. market.

In home gateways, we are encouraged by the continued momentum of growth in shipments of our DECT/CAT-iq ICs to DECT-enabled home gateways. The strong demand from major European telecommunication operators continued in the fourth quarter. In addition, Swisscom successfully launched its target home gateway, which is the first home gateway product launched with both our CAT-iq and our ULE technologies. We expect that this positive momentum that we saw in the fourth quarter will continue in the first quarter of 2014.

We saw solid progress of the CAT-iq 2.0 certification program launched for the U.S. market, which we discussed on our last earnings call. U.S. fixed line and cable operators are gaining confidence in high-definition voice, and one of our OEM customers, Sagemcom, announced the launch of a certified CAT-iq 2.0 DECT phones for the U.S. market. Moreover, during the fourth quarter, we saw continued growth in demand for DECT/CAT-iq products from a leading U.S. cable MSO, shipping cable modems, home gateways with our DECT/CAT-iq product. This new certification program, as well as the rollout of DECT-enabled home gateways in the U.S. market, creates additional growth opportunities for DSP Group with additional U.S. service providers and MSOs.

Now moving to the ULE segment. OEMs and leading service providers are realizing the value proposition that ULE technology brings with its proven reliability, extended range and 2-way voice. During the quarter, we continued to expand our ecosystem of solution partners. In that regard, at CES, we announced that Everspring, a leading home security and automation products company, have selected our DHX91 ULE SoC to power 5 new smart home sensors. These sensors include security detector, motion detectors, smoke detectors and home automation sensors were demonstrated at CES show in Las Vegas earlier this month. And moreover, Crow, a leading provider of advanced security and control solutions, launched a full range of ULE-enabled security and life safety sensors based on our DHX91 ULE SoC.

As preparations are underway at Deutsche Telekom to conduct a field trial for ULE technology to enable smart home services, major service providers across the world are highly interested in ULE and are actively testing the technology and confirming its benefits over other competing solutions. We have been pleasantly surprised by the relatively early market recognition of the key attributes that ULE has over other short-range wireless securities technologies like ZigBee and Z-wave. One positive attribute in particular that has been increasing momentum as of late is ULE's ability to transmit both 2-way voice and visuals. ULE and DECT naturally supports 2-way voice, a feature which is in high demand in security safety and well-being systems. The value of the 2-way voice call at home between the indoor location and the service provider or an emergency call by a push of a button is enormous. Many service providers are realizing this as well as the other advantages that ULE brings.

Also noteworthy is the installed base of DECT-enabled home gateways. An increasing number of home gateways that are already deployed in the field and include DECT connectivity can easily support ULE through a simple software upgrade. Any service provider deploying these DECT-enabled home gateway CPEs can expand its offering to include home monitoring and automation services, thereby driving higher ARPU from its consumer base.

Moving from the home to the office vertical. Sales of our VoIP products were approximately $2.3 million during the quarter, above our expectations. We ended the year with approximately $9 million in revenues, representing growth of approximately 20% over 2012. We are well positioned to expand our office VoIP business further in 2014 and meet our goal of securing of design wins with Tier 1 OEMs in the Enterprise Voice market.

The interest in our solution is on the rise, as evidenced by the robust pipeline of design opportunities. And during the fourth quarter, 2 leading customers, Panasonic and Grandstream, have launched and started production of multiple IP phone models based on our DVF99 SoC, crossing the mass production milestone successfully. And the variety of IP phone models launched by these 2 leading OEMs are an important evidence of our product's maturity, quality and performance. The performance of DVF99 and our capability for fast design cycles are well appreciated by other OEMs. We are encouraged by the level of engagement and interest in this platform and continue to secure additional design wins.

Now into the Mobile segment. During the fourth quarter, we made significant progress and successfully passed a full evaluation phase of our HDClear technology by a leading OEM, which is a vote of confidence in our solution's performance and readiness. And we remain on track to meet the design win milestone this year.

On a different note, as we firm up our readiness from the R&D side, we are also making the necessary preparation on the sales and technical support funds. And during the fourth quarter, we made an investment in a private company in Asia, which will enable us to expand our reach and presence, as well as leverage a base of local professional experts. Our HDClear technology includes a comprehensive suite of voice enhancement features for mobile devices incorporating proprietary noise reduction technology, speech recognition maximization and additional voice enhancement algorithms, which dramatically improve user experience and deliver unparalleled voice quality and call intelligibility to mobile device users. And at CES, we demonstrated our HDClear technology and its performance and saw a high level of interest in our technology from the smartphone, PC and mobile device OEMs. And we are seeing successful progression of HDClear into advanced stages of evaluation across these several market segments.

In summary, as we enter the new fiscal year, we'll remain focused on executing on our business plan of a successful transition from existing telephony products to new product line and market domains that will bring new revenue streams to DSP Group and create value for all of our stockholders. We expect to show you progress and meaningful design wins and revenues from these new market verticals this year and onwards.

Turning to our business outlook for the first quarter of 2014. Based on forecasts received from customers, our backlog and our own assessment, we expect that sales of cordless products to soften in the first quarter. The weakness is primarily related to lower demand for DECT phone ICs and mostly related to continued softness in demand in the North American end market and weaker-than-expected demand in European and rest of the world end markets, which based on our checks relate to finished product excess inventory buildup across the supply chain. We view this weakness as temporary and expect that any excess inventory will be depleted during the first quarter. As a result, we expect our revenues for the first quarter to be in the range of $30 million to $35 million. Despite these uncertain market conditions surrounding our cordless market, we plan to continue and execute on our business plan in a prudent manner, as our track record has shown, with the objective of generating positive cash flow from operations in 2014.

Now I would like to turn the call over to Dror, our Chief Financial Officer. Dror, the floor is yours.

Dror Levy

Thank you, Ofer. I will now review the income statement for the fourth quarter of 2013 from top to bottom. For each line item, I will provide the year's GAAP results, as well as the equity-based compensation expenses included in that line item and the expenses related to previous acquisitions.

Our revenues for the quarter were $35.3 million. Gross margin for the quarter was 40%. Gross margin for the quarter included equity-based compensation expenses in the amount of $0.1 million. R&D expenses were $8.5 million, including equity-based compensation expenses in the amount of $0.5 million. Operating expenses for the quarter were $14.5 million, including equity-based compensation expenses in the amount of $1 million and amortization of acquired intangible assets in the amount of $0.4 million.

Financial income for the quarter was $0.6 million. Income tax benefit for the quarter was $0.1 million and included the tax benefits resulting from the amortization of deferred tax liability related to intangible assets in the amount of $0.1 million. Net income was $0.4 million, including equity-based compensation expenses of $1 million, amortization of intangible assets of $0.4 million and tax benefit resulting from the amortization of deferred tax liability in the amount of $0.1 million. Non-GAAP net income, excluding the items I've just described, was $1.7 million.

GAAP diluted earnings per share was $0.02. The negative impact of equity-based compensation expenses on the EPS was $0.04. The negative impact of the amortization of acquired intangible assets on the EPS was $0.02, and the positive impact of the tax benefit on the EPS was $0.01. Non-GAAP diluted earnings per share, excluding these items that I just described, were $0.07. Please see the current report on 8-K that we filed with the SEC this morning for a full reconciliation of the non-GAAP presentation to the GAAP presentation.

Turning to the balance sheet. Our accounts receivable decreased from $22.7 million at the end of the third quarter of 2013 to $21.2 million, representing the level of 54 days of sales. Our inventories decreased from $13.1 million at the end of the third quarter to $12.3 million, representing the level of 53 days.

Our cash and marketable securities increased by $2.6 million during the quarter and reached a level of $127.6 million. Our cash and marketable security position during the quarter was affected by the following. $8.3 million of cash was generated by operations. $2.2 million of cash was used for investment of a minority stake in a private company in Asia. $0.2 million of cash was used for purchase of property and equipment. $3.5 million of cash was used for repurchase of 390,000 shares of our common stock at an average price of $8.97 per share, and $0.1 million of cash received from stock option exercised by employees. Overall, during 2013, we generated $13.3 million of cash from operations and increased our cash position by $7.4 million.

Now I would like to provide you with our projections for the first quarter of 2014. Our first quarter projections on a year-ago basis including the impact of equity-based compensation expenses and acquisition-related amortization expenses are as follows. Our revenues are expected to be in the range of $30 million to $35 million. We expect our gross margin to be in the range of 37% and 40%. R&D expenses are expected to be in the range of $8 million to $9.5 million. Operating expenses are expected to be in the range of $14 million to $15.5 million. Financial income is expected to be in the range of $0.3 million to $0.4 million. Provision for income tax for the first quarter is expected to be approximately $0.1 million. And our shares outstanding are expected to be 23 million shares to 24 million shares. Our first quarter projections include approximately $0.4 million of amortization of intangible assets, and our first quarter projections also include the following amount forecasted for equity-based compensation expenses. Cost of goods sold includes approximately $0.1 million. R&D expenses include $0.7 million to $0.8 million. And operating expenses include $1.4 million to $1.6 million.

Now I would like to open up the line for questions and answers. Operator, please.

Question-and-Answer Session

Operator

[Operator Instructions] At this time, there are no questions in the queue.

Ofer Elyakim

Thank you, all, for participating on the call, and we look back to reporting again in 90 days. Thank you very much.

Operator

That should conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.

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