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DSP Group, Inc. (NASDAQ:DSPG)

Q2 2014 Earnings Conference Call

July 31, 2014 08:30 ET

Executives

Dror Levy - Chief Financial Officer

Ofer Elyakim - Chief Executive Officer

Analysts

Charlie Anderson - Dougherty and Company

Dror Levy - Chief Financial Officer

Good morning ladies and gentlemen. I am Dror Levy, Chief Financial Officer at DSP Group. Welcome to our Second Quarter of 2014 Earnings Conference Call. On today’s call, we have with us Mr. Ofer Elyakim, Chief Executive 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 third quarter of 2014, optimism about market opportunities from new product lines that should allow us to resume revenue growth, timetable for product ramp-ups and mass production of products in corporate and other technologies by our customers, optimism about our successful turnaround and ability to meet key milestones, 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 endmarkets, 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 2013 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 - Chief Executive Officer

Thank you, Dror, and good morning everyone, and thank you for joining us today. I am glad to open this discussion about our second quarter financial results, and I hope you had the opportunity to read our press release that was released earlier today. I would like to begin this discussion by reviewing our results for the second quarter of 2014 and then comment on the progression of our business plan including design wins and recent market developments for our new product offering.

In a short while, Dror will provide you with detailed comments on our financial results and update you on our outlook for the third quarter of 2014. We are very pleased with our second quarter results. That highlights two key directives that we have been pursuing rigorously. The first is prudent execution, focus on profitability and the second one is promising progress and results from our new product initiatives, which are building a solid base of revenues and design activity that will enable DSP Group to resume revenue growth.

Our second quarter financial results exceeded our guidance in almost every financial metric. Second quarter revenues of $36.3 million were ahead of the midpoint of our guidance. Our revenues for the second quarter were down by approximately 11% versus the second quarter of 2013, but up 10% sequentially. Record high non-GAAP gross margins of 41% were better than expected and benefited from a favorable mix and higher demand for new products.

The better gross margins combined with lower operating expenditures resulted in non-GAAP operating profit of approximately $2.6 million, driving seventh consecutive quarter of non-GAAP operating profitability and the ninth consecutive quarter of non-GAAP net income. Our cash and marketable securities balance increased to $120 million at the end of June.

We generated operating cash flows of $5.5 million and also continue to execute on our active share repurchase program buying back 313,000 shares of our common stock for a total consideration of approximately $2.6 million and since the initiation of this program about eight months ago, we have bought back approximately 1.3 million shares of our common stock for roughly $11.4 million at an average share price of $8.7.

Before moving to an update of each of our business segments, I would like to start by describing a big picture of DSP Group’s business and our market position to-date. On the one hand, we have built a leading market position in the cordless market and despite the maturity of this market; the business still provides solid cash flow strength. On the other hand, we have been investing our resources in three growth initiatives, the fruits of which are materializing this year.

To-date, we are standing on a solid foundation for new revenue sources across the number of product offerings including Enterprise VoIP, ULE and Mobile. And these investments are paying off. We are confident in our long-term growth prospect and in meeting our business plan objectives for this year by continuing to secure strategic design wins and generating revenues and growth across these markets.

Now, I would like to review the specific segments. The home vertical, which is comprised of cordless phones, home gateways and ULE, and will start with cordless market. During the second quarter, DECT revenues accounted for approximately 81% of revenues versus 84% in the first quarter of the year. Sales were down by 14% year-over-year, but increased by 7% sequentially. We attribute some of the sharper than average year-over-year decline in DECT revenues to shift in the seasonality pattern.

We expect that demand will be less volatile in the third quarter for DECT’s product. Sales of our DECT’s products for the European and Rest of the World endmarket showed stability and were down only 3% year-over-year and down by 2% sequentially and accounted for approximately 46% of revenues. Sales of DECT’s products for the North American market were soft and declined by 25% year-over-year, but increased by 23% sequentially.

DECT 6.0 product for the North American endmarket accounted for approximately 35% of our revenues. In Home Gateways, we are encouraged by another strong quarter with record shipments and solid demand for our DECT CAT-iq product, which are embedded into Home Gateways of leading U.S. and European Tier 1 telecommunication service provider.

Shipments for these segments were up 55% year-over-year and 3% sequentially. Moreover, as many of you know, Cablevision, a major U.S. cable MSO launched in HD voice service on its network in June.

Cablevision subscribers can now make and receive high definition quality voice calls with improved speech intelligibility to both fixed and mobile numbers through HD-enabled cordless phone based on DSP Group’s SoCs. We hope that following this launch more U.S. based service providers will follow and offer high definition voice services to their subscribers. DSP Group’s SoC should play an instrumental role in bringing HD voice to the end user.

Turning to ULE. We’re pleased with the market recognition and the growing customer traction for our ULE technology. More and more players are realizing the key attributes that DECT and ULE have over other available short-range wireless technology. As evidenced by our growing and promising pipeline of engagements with leading security and telecommunication service providers, OEMs and ODMs.

We’re also very happy to share with you that during the second quarter, we backed another important milestone, our DHX91, which is the ULE SoC, entered mass production phase through shipments to a major OEM that is launching the home sec and automation system targeting the U.S. and European market.

We see this as a first sign that ULE is beginning to see broader market adoption. The key values of ULE and DECT include better coverage at dedicated frequency band, natural support for two-way voice and visual, a feature which is in high demand in security and safety system. The value of two-way voice call at home between the indoor location and the service provider or an emergency call by push of a button is enormous.

Now I would like to move to the Office/VoIP vertical. Our second quarter voice, VoIP revenues were approximately $3.8 million up 66% year-over-year and 73% sequentially and significantly exceeded our expectations for this quarter. And based on our backlog and customer focus, we expect that the solid momentum and growth to continue into the third quarter and we see DSP Group well positioned in this market.

During the second quarter, we had significant design activity with our flagship DVF99 product with additional Tier 1 customers. In addition more news and existing customers announced new IP phone product launches based on our Voice-over-IP SoCs. And during the second quarter, a leading Chinese OEM selected DVF99 for its next generation Voice-over-IP product line and two Tier 1 OEMs launched new IP phone powered by our VoIP SoC. In summary, we are well positioned for revenue growth in our Office/VoIP business in 2014 and to a much greater extent in 2015.

Now moving to the Mobile segment. We see strong interest in ultra-low power voice processing Always-On voice functionality and more sophisticated noise suppression requirement. Our HDClear technology is an ideal fit.

It includes a comprehensive suite of voice enhancement features for mobile and wearable devices incorporating proprietary noise reduction technology, Always-On functionality, speech recognition maximization and additional voice enhancement algorithms. All of which dramatically improve user experience and deliver unparalleled voice quality and call intelligibility to mobile device users. And during the second quarter, we’ve made significant progress in our design and effort, with mobile phone products of the leading OEM customer. We remain on track to meet our goal for design win in the coming months and commence shipment this year.

Turning now to our business outlook for the third quarter of 2014. Based on forecast received from customers, our backlog in our assessment, we believe our revenue for the third quarter to be in the range of $34 million to $37 million, implying a flat sequential quarter when compared with the mid-point of our projection and flat to half versus the same quarter last year driven primarily by better demand for our new product.

In summary, we are successfully executing on our business plan and continue to plan the promising feet that are already successfully transitioning DSP Group from a company with high dependency and revenue focus on existing cordless telephony products to one with diversified product line in new market domains that can drive revenue growth. We will continue to share with you our progress in the meaningful design win and revenues from these new market verticals this year and onwards. We are on track to meet our goal of reaching an inflection point in our business and resume revenue growth in 2015, thereby creating meaningful value for all of our stock holders.

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

Dror Levy - Chief Financial Officer

Thank you, Ofer. I will now review the income statement for the second quarter of 2014 from top to bottom. For each line item, I will provide the U.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 $36.3 million. Gross margin for the quarter was 40.7%. Gross margin for the quarter included equity-based compensation expenses in the amount of $0.1 million. R&D expenses were $8 million including equity-based compensation expenses in the amount of $0.7 million.

Operating expenses for the quarter were $14 million including equity-based compensation expenses in the amount of $1.4 million and the amortization of acquired intangible assets in the amount of $0.4 million. Financial income for the quarter was $0.3 million. We had immaterial tax benefit for the quarter due to a tax benefit resulting from the amortization of deferred tax liability related to intangible assets; it was in the amount of $0.1 million. Our net income was $1.1 million including equity-based compensation expenses of $1.5 million.

Amortization of intangible assets of $0.4 million and tax benefits resulting from the amortization of deferred tax liability in the amount of $0.1 million. Non-GAAP net income excluding these items I just described was $2.8 million. GAAP diluted earnings per share was $0.05. The negative impact of equity-based compensation expenses on the EPS was $0.06. 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 the items I just described were $0.12. Please see the current report on Form 8-K that we filed with the SEC this morning for a full reconciliation of the non-GAAP presentation to the GAAP presentation.

Now turning to the balance sheet. Our accounts receivable increased from $21.2 million at the end of the first quarter to $23.8 million, representing the level of 59 days of sales compared to 63 days of sales in the end of the first quarter. Inventories slightly decreased from $12.2 million at the end of the first quarter to $12 million, representing the level of 50 days.

Our cash and marketable securities increased by $2.8 million during the second quarter and were at the level of $119.9 million at the end of June. Our cash and marketable security position during the quarter was affected by the following. $5.5 million of cash was generated from operations. $3 million of cash was used for purchase of property and equipment. $2.6 million of cash was used for repurchase of approximately 313,000 shares of our common stock at an average price of $8.4 per share, and approximately $0.2 million with an increase in the market value of marketable securities.

Now I would like to provide you with our projection for the third quarter of 2014. Our third quarter projection on the U.S. GAAP basis including impact of equity-based compensation expenses and acquisition-related amortization expenses are as follows. Revenues are expected to be in the range of $34 million to $37 million. We expect our gross margin to be in the range of 39% and 40%.

R&D expenses are expected to be in the range of $8 million to $10 million. Total operating expenses are expected to be in the range of $14.5 million to $16 million. The financial income is expected to be approximately $0.3 million and the provision for income tax for the third quarter is expected to be approximately $0.1 million.

Shares outstanding are expected to be 23 million shares to 24 million shares. Our third quarter projections include approximately $0.4 million of amortization of intangible assets. The projection for the third quarter also includes the following amount for equity-based compensation expenses. The cost of goods sold includes approximately $0.1 million. R&D expenses include $0.5 million to $0.7 million. And total operating expenses include $1.2 million to $1.4 million.

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

Question-And-Answer Session

Operator

Thank you. (Operator Instructions) We will now take our first question from Charlie Anderson from Dougherty and Company. Please go ahead.

Charlie Anderson - Dougherty and Company

Hi, thank you for taking my questions and congrats on the strong quarter and guidance. So, I wanted to talk first about ULE. You talked about that reaching mass, going into mass production. If you could just give us a flavor of the type of customers it’s going into and what kind of deployment they are looking at compared to maybe some of the other home automation deployments we’ve seen for some similar technologies?

Ofer Elyakim

Sure, Charlie, and thank you for your question. So, with respect to ULE, we are classified the customer types into two main groups, one group is the Do-It-Yourself system that consumers are buying at retail or in the Do-It-Yourself store. And the other category is the service providers, so these are service provider-led models which are relying on service provider subscriber base end marketing, back office and call center.

This product that we’ve announced entering into mass production and starting mass shipment as we had indicated before, this product that goes into the Do-It-Yourself category targeting consumers in the North American and European markets. The system is from a Tier 1 type of brand, Tier 1 type of cost – consumer brand. And it is about home safety and automation. I am sorry that I cannot share more information because the product is just about to be launched and we are already starting the mass shipment, but it is a product which is a system that can buy in the retail or in the Do-It-Yourself shop and enables installing all kinds of sensors and that provide safety and security features for kind of the residence or the small office, the small business.

Charlie Anderson - Dougherty and Company

Perfect. Thank you that. And then turning to HDClear, I think you mentioned some more progress there. I wonder if you could just maybe elaborate on, we are at maybe the closing phases if you will the design cycle for some major smartphones for early next year. Just sort of handicap for us what you think you are with some of those folks in terms of getting into phones next year?

Ofer Elyakim

Yes. So, I think that the timeline that we have indicated that we will secure a design win or our plans to secure design win in the coming month or months is on track. We are making all the necessary product and kind of really kicking on all cylinders and we believe that it is supporting the timeline that you have indicated about product that will actually be offered to consumers next year, but as the buildup of the supply chain start a bit earlier than that, that you compel a supply to furnish the market with product.

Charlie Anderson - Dougherty and Company

Perfect.

Ofer Elyakim

So, we are definitely kind of looking at this exact timeline and schedule and we hope that we are going to be successful in meeting that and providing kind of more clarity on where we start the next quarter. We have considered our focus as we have said has been mainly with Tier 1 mobile OEMs. This is where we think we can get the most amount of support and partnership in creating and finding a good way to commercialize technologies that we have been developing.

And actually if you paid attention to some of the guidance that Dror provided for the third quarter, you do see there an uptake in our R&D expenses and we do believe that we will see a little bit of an uptake also into the fourth quarter as we were also now ramping up our future product, basically our roadmap that will lead us into the next year, design cycle. So, this is basically a part of that of us getting prepared for kind of the next gen chipset and algorithms that will go hand-in-hand for this market.

Charlie Anderson - Dougherty and Company

A follow-up on that. Your competitor, I’d say the main incumbent in that market is increasingly collapsing in audio codec capability Sensor Hub. I think you even talked about Sensor Hub, Mobile World Congress. If you could just maybe elaborate on sort of where that roadmap goes for you in terms of extra capabilities as you look for improving your position?

Ofer Elyakim

Yes. So, our product offering today is mainly concentrated around kind of the low power voice processing, voice enhancement that basically includes Always-On, noise suppression from all kinds. And also in the future as what we are seeing today kind of the future of voice inside this phone is going to be not only limited to voice communication but actually to utilizing voice as a important and key sensor inside phone, which basically enables to kind of better understand activities what that the user is actually is doing or saying and help to authenticate or provide all kinds of validation.

And when we look at that it basically voice is becoming just also another sensor inside the Fiber Optic Sensors that exist today inside the phone. And with that the fact it’s Always-On, it could definitely kind of carry and process and support more functionality such as seeing (ph) also serving in Sensor Hub and this is also definitely part of our overall plan in going forward.

Charlie Anderson - Dougherty and Company

Perfect. Then last one from me, in terms of just general seasonality, I think traditionally your core business could be a little bit up, a little bit down in Q4 the last couple of years. What is your view right now on where the seasonality is in that business?

Ofer Elyakim

Really I wish to have the crystal ball here. But as you know we are one of kind of the major handicap that we have in our business in the cordless business is lack of visibility about kind of how things are progressing. One thing that I can share with you is that as you can see the seasonality has been in the last four years definitely squeezed towards the Q1 is first half, I mean so the first two quarters of the year were much higher than the second half.

And so kind of – if you go like for the last four years and compare between the first and second half, you’ll see that about four years ago first half was higher by 8% than the second half. And that delta went down and our expectation is that this year the delta we are really kind of narrowed down to a very small percent or maybe even first half and second half will be even. But I cannot say that this is kind of based on a backlog because as we said we suffer today from very short visibility. So, we don’t really have like good visibility into the trends in the fourth quarter, but in terms of our expectation this is kind of how we look at things that second half will be kind of stable compared to the first half.

Charlie Anderson - Dougherty and Company

Perfect. Thank you so much.

Ofer Elyakim

Thank you, Charlie.

Operator

(Operator Instructions) There are no questions in the queue at this time.

Ofer Elyakim - Chief Executive Officer

Great. Thank you all for joining us and we look back to reporting again in 90 days. Thank you.

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