DSP Group, Inc. (NASDAQ:DSPG)
Q2 2016 Earnings Conference Call
August 1, 2016 8:00 AM ET
Daniel Amir – Corporate Vice President-Business Development
Ofer Elyakim – Chief Executive Officer
Dror Levy – Chief Financial Officer
Jaeson Schmidt – Lake Street Capital Markets
Rajvindra Gill – Needham and Co.
Charlie Anderson – Dougherty & Company
Matt Robinson – Wunderlich
Matt Ramsay – Canaccord Genuity
Roni Lifshitz – TechTime
Good morning ladies and gentlemen. I’m Daniel Amir, Corporate Vice President for Business Development at DSP Group. Welcome to our Second Quarter 2016 Earnings Conference Call. On today’s call, we also have with us Mr. Ofer Elyakim, Chief Executive Officer; and 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 third quarter of 2016, including by segment and full year 2016, anticipated gradual improvement of the cordless business, anticipated gross margin improvement, our ability to secure additional design wins, mass production timetables, optimism about our ULE and SparkPA technologies, general and market demand for products that incorporate our technologies in the market. We assume no obligation to update these forward-looking statements. For more information about the risks and factors that could affect the forward-looking statements made herein, please refer to the risk factors discussed in our 2015 Form 10-K and other SEC reports that we have filed.
Now, I would like to turn the call over to Ofer Elyakim, our Chief Executive Officer. Ofer, the floor is yours.
Thank you, Daniel. Good morning, everyone, and thank you for joining us today. I hope that you have the opportunity to read our press release that we distributed earlier today. I would like to begin by reviewing our results for the second quarter, commenting on the progression of our business plan, and providing context for our outlook. In a short while, Dror will provide you with detailed comments on our financial results and outlook for the second third quarter of 2016.
Our second quarter revenues came in slightly above the midpoint of our guidance range and increased sequentially. Record new product revenues of $15.9 million growing 55% year-over-year and a recovery in our cordless phone segment following a sharp inventory correction cycle, supported our performance. The second quarter continue to reflect the transition of our business model towards our new product initiative, including mobile, voice-over-IP and IoT product categories.
These new products accounted for 44% of second quarter revenues and supported the 310 basis point annual expansion in non-GAAP gross margins to 44.2% and non-GAAP EPS of $0.11. The improved second quarter operating profitability also reflected a continued focus on achieving operating leverage. Moreover, we generated $9 million of cash from operation in the second quarter, contributing to an increase in our cash balance to approximately $123 million at the end of June.
Second quarter revenues of approximately $36.2 million were higher by 31% on a sequential basis, although lower by 3% versus the second quarter of 2015. While softer demand for cordless phone SoCs in the first half of 2016 was the main reason behind the annual revenue decline, our new product continued to achieve record results. And looking forward, we expect that in the third quarter, we will experience continued solid year-over-year growth from new products which should support further operating margin enhancement, as well as a gradual improvement in our cordless telephony business.
We remain optimistic regarding our business outlook for both the short and long-term, as well as the opportunities that lie ahead. As our new products across office, mobile, and home are more widely adopted in growing markets and are gaining increased penetration in the product pipelines of Tier 1 customers and service providers, we anticipate that these categories should account for a majority of our revenues in 2017.
Now, I would like to provide specific updates about our progress in each segment. Starting with mobile, during the quarter we generated a record of approximately $4.6 million from sales of HDClear products, an increase of 16% compared to the $3.9 million in the first quarter, driven by the successful ramp of Samsung products. We are happy to inform you that during the second quarter we secured an additional design win for a known smartphone application with the leading North American OEM for a product that should be launched in 2017.
We also made solid progress with a number of additional customer engagements for DBMD, HDClear product, which offers the lowest power consumption and best-in-class performance for always-on voice, voice user interface, and noise suppression. Additionally, the demand for adding voice activation and control capability devices is on the rise as the quality and maturity of the technology are ripe, and paving the path towards a voice-activated world in which natural language will become the preferred way to interact with devices.
Our existing HDClear solutions and our product roadmap are focused on addressing these growing needs. Looking ahead to the third quarter, we expect our mobile segment to continue and benefit from the demand for Samsung products; although we anticipate our shipments of HDClear in the third quarter will decline slightly compared to the second quarter, due to a natural slowdown in the unit ramp of flagship mobile handsets. As a result, we forecast third quarter mobile revenues to be in the range of $3 million to $4 million. Given our design win pipeline, we currently expect that our mobile revenues for 2016 will exceed $15 million, which was the high end of our previous revenue target.
Moving on to voice-over-IP in the office segment. We continue to solidify our leadership position in the enterprise voice, as demonstrated by a strong and growing design pipeline with Tier 1 OEMs and with other customers. For the second quarter, we achieved record revenues of $7.4 million, representing an increase of 42% year-over-year and 46% sequentially; this performance was ahead of our previous guidance of $6 million to $7 million.
Contributing to the better results was the commencement of high-volume shipments to another Tier 1 OEM customer, with actual demand for products from this OEM exceeding our expectations. During the second half of this year, we expect a third Tier 1 OEM customer to move from initial shipments to high volume shipment. Moreover, during the quarter, we secured additional design wins with existing Tier 1 customers for high-end products, which are expected to go into production in the late 2017 and 20185. The achievement of these milestones give us confidence in our long-term outlook and our growth prospects in the voice-over-IP business as we target to become a dominant player in this market.
For the third quarter, we expect voice-over-IP revenues to be in the range of $6 million to $7 million suggesting a temporary sequential decline, mainly as a result of the exceptionally quick ramp in the second quarter which we initially expected to take place mostly in the third quarter. We are optimistic about the outlook for our VoIP business, and believe that this segment is well positioned for year-over-year solid revenue growth. And now to an update about the home segment, which includes home gateways, IoT, SparkPA, and cordless. I will start with home gateways.
Second quarter revenues of $2.6 million decreased by 2% on a sequential basis, and were down by 37% year-over-year, but in line with our forecast. This year-over-year decline was attributable to exceptionally robust demand for DECT and CAT-iq in the first and second quarter results 2015 from two large telecom operators. We expect third quarter home gateway revenues to be slightly higher on a sequential basis, and there to further accelerate in 2017, coinciding with new product launches by a number of telecom operators.
During the quarter, Orange, a leading Tier 1 European operator, launched its new high-definition, voice-enabled home gateway integrating our DECT and CAT-iq products. Also, Motorola announced its first certified HD voice cordless handset by SGW, based on our DECT and CAT-iq platform. The underlying market trend behind integration of DECT into home gateways is the growing adoption of high-definition voice. Many service providers are upgrading their infrastructure and home gateway terminals to support high-definition voice, which provide us with further growth opportunities.
Moreover, we are seeing a growing number of telecom service providers that are already leveraging their DECT and hay build from gateway infrastructure as a hook to offer subscribers out-of-the-box home-based IoT services, which are easy to install, plug, and play, and at a much lower cost of ownership. We anticipate new service provider home gateway deployments towards the end of 2016 and early 2017.
Turning to IoT, during the second quarter, solid momentum around ULE technology continued. We generated $1.3 million in revenues from IoT, representing a growth of 42% year-over-year, and a growth of 21% on a sequential basis. We remain well on track to achieve our previously stated $4 million to $5 million revenue goal for IoT in 2016. During the quarter, we announced a number of design wins, first with Smarte: a smart home energy management company selected our DECT ULE SoCs for its new smart home solutions.
Second, Ball-b, a German smart city pest-control company selected our ULE SoCs for its rodent control product. This announcement represents the first time that ULE is being used for a smart city application. Ball-b benchmarked competing technology, and selected ULE because of its lower power, better range, and high reliability versus other connectivity technologies. We believe that our past efforts are bearing fruits as evidenced by the strong interest from a number of customers, including leading service providers and home automation vendors covering a wide range of consumer products.
These potential customers showed enormous interest in the key attributes of DECT and ULE; in particular, ULE’s range and natural support for two-way voice. Looking forward, we expect a continued ramp of new IoT products into the market, and that our third quarter IoT revenues will be similar to the second quarter levels. Now to the SparkPA. In the beginning of the year, we unveiled a new, highly innovative product category that leverages our decades of CMOS RF design expertise.
SparkPA is a 5 gigahertz Wi-Fi power amplifier, or PA, with the highest RF transmit power and best linearity available in CMOS technology. SparkPA also supports the new Wave 2 and Wave 3 802.11ax access point requirements; and multiuser MIMO at 4-by-4 and 8-by-8 topologies, as well as the future 1024 QAM. The initial target market for this PA is Wi-Fi 1102ac 5 gigahertz and in particular, access points. Wi-Fi products would typically ship with 4 to 8 power amplifiers in high-end access points, and with at least two PAs per Wi-Fi client. We believe that this market represents an initial annual revenue opportunity of approximately $100 million.
During the quarter, we continued our engagement with selected customers that are undergoing advanced evaluation savings. We expect to make progress during 2016 with the goal of commercial shipments in the second half of 2017. And now for an update on the cordless phone market. Please note that all figures and comparisons in these sections are for cordless phone SoCs only, and do not include revenues for home gateways and IOT. Second quarter cordless revenues gradually recovered, following the inventory correction of the previous two quarters.
Cordless revenues declined by 25% year-over-year, but increased by 36% on a sequential basis and accounted for 56% of second quarter total revenues. The year-over-year decline was in excess of the secular decline trend of the 10% to 15%, and was mainly attributable to the inventory adjustment cycle in DECT for European markets and also for the U.S. cordless market. In the third quarter, we anticipate the market to continue and recover, but at a slightly lower pace than our previous expectations.
And now to an update on our outlook. Based on the expectations across our new product initiative and a continued sequential recovery in cordless revenues, we projected an increase in third quarter revenues both on an annual and a sequential basis. We expect revenues for the third quarter of 2016 to be in the range of $37 million to $40 million, which at the midpoint of the guidance suggests a 9% year-over-year increase.
Now to summarize: during the second quarter, we successfully executed on our business objectives which are primarily focused on driving accelerated growth by expanding the market adoption of our new products in the VoIP, mobile, and IoT, and a gradual improvement in the cordless telephony segment. We are confident that the new products will be the foundation to achieve gross margin increases and operating leverage for the full year 2016 and beyond.
Now, I would like to turn the call over to Dror, our Chief Financial Officer. Dror, the floor is yours.
Thank you, Ofer. I will now review the income statements for the second quarter of 2016 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 expenses related to previous acquisitions. Our revenues for the second quarter of 2016 were $36.2 million. Gross margin for the quarter was 43.9%. Gross margin for the quarter included equity-based compensation expenses in the amount of $0.1 million. R&D expenses were $9 million, including equity-based compensation expenses in the amount of $0.5 million.
Operating expenses for the quarter were $50 million, including equity-based compensation expenses in the amount of $1.2 million, and amortization of acquired intangible assets in the amount of $0.3 million. Financial income for the quarter was $0.3 million. Income tax expenses for the quarter were $0.1 million, and included an income tax benefit resulting from the amortization of deferred tax liabilities in the amount of $0.1 million. Net income was $1.1 million, including equity-based compensation expenses of $1.3 million, amortization of intangible assets of $0.3 million, and tax benefits resulting from the amortization of the deferred tax liabilities in the amount of $0.1 million.
Non-GAAP net income, excluding the items I just described, was $2.6 million. GAAP net income per share for the quarter was $0.05. The negative impact of equity-based compensation expenses on the EPS was $0.06. The negative impact of amortization of acquired intangible assets on the EPS was $0.01. And the positive impact on the tax benefits resulting from the amortization of deferred tax liability was another $0.01 of EPS. Non-GAAP net income, excluding the items I just described, was $0.11 per share. 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 turning to the balance sheet. Accounts receivable at the end of the second quarter of 2016 decreased to $17.1 million compared to $19.5 million at the end of the first quarter, representing a level of 43 days of service. Inventory decreased from $13.5 million at the end of the first quarter $12.9 million, representing a level of 57 days. Our cash and marketable securities increased by $7.6 million during the second quarter, and were at the level of $122.7 million as of June 30. Our cash and marketable securities position during the quarter was affected by the following: $9 million of cash were generated from operations; $0.4 million of cash was used for purchase of property and equipment; $1.3 million of cash was used for repurchase of approximately 132,000 shares of our common stock, at an average price of $9.6 per share; $0.1 million of cash received from exercise of options by employees; and $0.2 million was an increase in the market value of marketable securities, net of amortization.
Now I would like to provide you with our full projections for the third quarter of 2016. Our third quarter 2016 projection on a U.S. GAAP basis, including the impact of equity-based compensation expenses, and acquisition-related amortization expenses, are as follows. Revenue are expected to be in the range of $37 million to $40 million. We expect our gross margin to be in the range of 43% to 45%. R&D expenses are expected to be in the range of $8 million to $10 million. Operating expenses are expected to be in the range of $14.5 million to $16.5 million. Financial income is expected to be in the range of 250,000 shares and 350,000 shares.
Provision for income taxes for the third quarter is expected to be approximately $0.3 million. Shares outstanding are expected to be approximately 23.5 million shares. Our third quarter projection include approximately $0.3 million of amortizations intangible assets, and also include the following amount forecasted for equity-based compensation expenses: cost of goods include approximately $0.1 million. R&D expenses include $0.5 million to $0.7 million. And operating expenses include $1.2 million to $1.4 million.
And now, I would like to open up the line for questions and answers. Operator, please.
Thank you. [Operator Instructions] We will now take our first question from Jaeson Schmidt from Lake Street Capital Markets. Please go ahead.
Hey guys, thanks for taking my questions. Wondering if you can provide any additional commentary on that new mobile – when you guys can be secured, as far as what end product it is for, and how we should think about the revenue opportunity for this next year.
Hi, Jaeson. Thanks for joining, and thanks for the question. With respect to the new mobile design win, as you know, one of our goals for 2016 is to diversify and build a larger customer base targeting a number of the product design wins, as we stated in our prepared remarks. We see the need to add voice activation, or the need to use voice user interface is growing across a number of segments, products, consumer IoT, and mobile, et cetera. And we see greater demand and great interest in adding these capabilities and mobile phones, wearables; but also across a variety of many different devices, from what we call today smart stickers, the Echo-like type – the Amazon Echo-like product category, and many other different areas where voice activation is in high demand.
This new design win that we have reported today is a – for a non-mobile application, meaning it’s more from, I would say, kind of the IOT kind of audio category. With respect to the expectation from these design wins, we believe that these products should be launched, I would say, during 2017, and the potential here is many million unit volume. So that’s kind of the potential. So we believe there is a great opportunity both in the mobile segment as well as in the wearable segment, but we also see a great future for additional products and wins in the kind of the IoT audio category.
And as we’ve also said, we are today engaged with a number of new kind of prospect customers to integrate and to design in our DBMD HDClear product ranging from always-on, noise suppression, and a combination of – so there is an enormous amount of interest out there, and there’s a lot of technical activities that is going on. And we believe this bodes well for our technology and kind of the value proposition that we are bringing to the domain.
Okay, great, that’s helpful. And then just shifting to the cordless phone business, I know you expected to continue to recover in Q3. But can you talk a little bit about your general visibility into that market, and how confident you are that there won’t be another inventory correction, at least in the near term?
Yes, thank you. Thank you, Jason. So with respect to our visibility with regards to the cordless business, today our visibility into cordless business continues to be fairly, I would say, a blur. We stay about four weeks ahead in terms of kind of demand. So it is kind of very hard for us to kind of focus for longer-term periods beyond a given quarter. But what we can say is that we believe, and we can see from the way customers are ordering; from the way customers are forecasting from our information about the health of our customers’ inventories and also the end market, we do believe that we are now in the restocking phase, I would say. If we were at the kind of the inventory depletion or kind of destocking phase, this is the period there we were probably kind of in the Q4 2015, Q1 2016.
And, I would say, today, we are seeing these gradual improvements across most of the customer base. So we believe that right now, we’re not the best of our knowledge and limited visibility. We are not facing an additional inventory correction cycle anytime soon. And you can also look at the kind of the historical behavior of the cordless market, and you would see that about every six to seven quarters, we do see this kind of inventory correction cycle happening, which I am pretty sure is pretty common also in another consumer areas. And so right now, kind of based on the information we have on hand, the historical analysis, et cetera, et cetera, we don’t see a risk for a near-term inventory correction.
Okay. And then just one last housekeeping question before I jump back into queue. How much is left on your current buyback program?
It’s about $2 million, something like that. As of today – as of the end of the quarter to date, it’s around – between $1.5 million to $2 million.
Perfect. Thanks a lot, guys.
Thank you. We will now take our next question from Rajvindra Gill from Needham and Co. Please go ahead. Your line is open.
Yes, thanks for taking my questions, and congrats on the progress on the new product initiatives. My question is really around seasonality in Q4, as well as the kind of year-over-year growth figures for 2016. Any clarity on Q4 would be helpful in terms of seasonality. And if I look at the growth of the new products versus the legacy products, and assume an acceleration in year-over-year growth in Q4 from third quarter, it seems like revenue would be – would still be down about 1% to 2%.
So I’m wondering when do we think we’re going to see the crossover in terms of seeing positive year-over-year growth. Any color there would be helpful.
Hi, Raji, and thank you for your question. So with respect to the seasonality, so I must admit there has been a lack of seasonality in our business and it kind of changes from year to year. And I’m mainly referring to cordless here. So we have seen years in which there was seasonality in a way kind of represented in end customer demands and I would say that for the last three years, we don’t really see a seasonality.
Right now, from where we stand, what we can see during this year from the cordless product demand is gradual recovery. So that means sequential increase from quarter to quarter. As I’ve said before, our visibility for cordless products is fairly limited, so making a comment right now about a re-focus for Q4 would be premature. However, I do see, this year, from the way things are happening that we are in a gradual improvement type of a year from cordless product point of view.
Again, it’s too early to say exactly what will be the numbers, the ranges for Q4. But as we sit from where we stand today, we’re seeing a gradual improvement in cordless because of the replenishment of stocks, and, I would say, some healing effect in some of the end markets that these products serve. Now with respect to new products, here it is a completely different story. And I think the cordless [indiscernible] is in a way sequential growth from quarter to quarter, and the contribution of the new products. We expect this to continue.
Again, premature to make a case right now and provide a detailed forecast for Q4. But from where we stand, and as you saw from our prepared comments, we believe that new products are going to continue and do well, and grow year-over-year. And if you are looking at the year-over-year revenue growth from the point of view of where the story becomes a growth story, I think that from our guidance for Q3, we are definitely guiding there at the midpoint of our guidance.
So we are both guiding for sequential increase as well as year-over-year increase. And I would assume that this also holds for Q4. And again, this is not to state any focus, because it is premature. But we do believe that we are there. We are at the year-over-year revenue growth. And I think that when we would look at early 2017, we will have some – I would say some very helpful comparisons to grow again.
So I think that we’re there from both the health of the legacy market, the great success the DSP Group is seeing in these new product initiatives in which we are growing from quarter to quarter, from year to year. And we’re showing the real proof in this strategy and in our execution. And I think that this is here to stay. And so when I combine these two together, I would say that DSPG today is in annual revenue growth territory.
Thanks for that color. And on the mobile HDClear business and the ramp with Samsung, can we talk a little bit about the further – the increase in attach rates for HDClear going forward next year, in the smartphone market specifically, given the fact – this demand for always-on voice technology seems to be ramping. How do you intend – or what’s the strategy of further increasing that technology in the smartphone environment?
So, thanks, Raji. So first of all, we are of course today engaged in a number of such projects. Some are already in production; some others are in production, and these are the ones who are today kind of making the revenue for 2016. We believe that we will continue and secure additional design wins, both in the smartphone space as well as outside of the smartphone space, targeting from what I said earlier from smart audio to IOT devices. And together with these engagements that will hopefully and gradually transition from an engagement to a real design win will propel our expectations for revenue growth in the mobile category into next year.
So we believe that for us mobile is a growth domain; so 2017, we should see a stronger result than we saw in 2016. 2016 is, in a way, the first year in which we are actually shifting in high volume and generating – crossing, I would say, the $1 million range. And I would say that based on this success, based on the momentum that we’ve achieved in the market this year, we are today able to cross and reach to many additional customers for new and innovative products across the smartphone, wearable, as well as the IOT and smart audio space.
And so we are very optimistic about the future of this always-on natural voice user interface, and I believe that we will continue to do well here.
Great, thank you.
Thank you. We will now take our next question from Charlie Anderson from Dougherty & Company. Please go ahead.
Yes, thanks for taking my question. I just want to go back to the design win for HDClear, Ofer. I wonder if you could speak to the competitive dynamics of winning that. Are you replacing an incumbent? Or is this a net new product, where everybody was competing? And then maybe just talk a little bit about what technologies allowed you to win that cycle. What seems to be the focus that customer needed?
Hi, Charlie, and thanks for the good question. So I think, indeed, when we see the competitive landscape today in our mobile category, but it really addresses a much wider variety of devices. We are actually seeing a real renaissance or completely new type of markets and devices that are embracing voice. And when we think about what we bring to the table, it is in a way a mix of both providing very low power consumption voice product that can enable devices to move from being attached to a cord to being – to going and being cordless, and being basically wireless and battery-operated and last for a fairly long period, both in – when they are expecting voice activity, but also when they are doing the voice processing part.
And in addition to that, we are also bringing a suite of very exciting technologies that enable noise suppression, acoustic echo cancellation, beamforming, and all kinds of the algorithms that are highly desired to basically build these voice capabilities in the right performance and at the right distances to allow this great user experience, which of course is not solely at the endpoint. It's also – a lot of it comes from the cloud. But whatever is necessary to be supported at the end product is something that we bring.
So in a way, we bring here a variety of both a low-power chip; but also all the expertise in a processing voice at very low power, at very high performance. And all of that is today enabling us to win versus competition. And many of these products are in a way integrating these voice capabilities for the first time. So we're not really taking – it's not really a zero-sum game. It's really a growing market.
Great. And then follow-up for me, you guys mentioned there's not a lot of money left on the buyback, and you are sitting here weighing a number of Tier 1s. And so I imagine your financial profile is fine in everybody's eyes. Do you still feel like you need to carry this level of cash, or there could be potentially other uses for cash going forward? Thanks.
Yes, Charlie. So about the cash, so I think that if you look at our past records, you would see that we do indeed continue to buy back our shares. We believe that buying back our shares is a good use of cash. We believe that we are today at an inflection point. We feel that our growth prospects are great. We believe that we are executing well to achieve these growth prospects. So today, we use a lot of the – I would say the free cash flow of the Company, or even in excess of that, to buy back our own shares. We will of course evaluate what to do next with our Board, and decide what is the next step forward.
But I would say that the fact that we have a healthy cash balance has helped us a lot in getting into a menu of these new design wins with these Tier 1 customers. And I think this war chest, an asset that in a way shows the ability for DSP Group to continue as a going concern, despite the fact that we are from, I would say, our size, a small cap in the semiconductor landscape. We are able to live up to our promises, and we are able to serve our customers well. And there is no risk whatsoever that this Company is facing in a way that has helped us to win the support of many new customers.
I would say that as we are moving in this transition, of course this cash will move from being a real good asset of securing customers and providing votes of confidence to something which will become more of an excess cash. And we will have to think about what is the best way to make this cash actionable, whether it's in a form of a return to shareholders; whether it's a different use.
Great thanks so much.
Thank you. We will now take our next question from Matt Robinson from Wunderlich. Please go ahead you line is open.
He thanks for the question and congrats especially on that cash flow. You think we could see the office business recover sequentially in the fourth quarter, given your additional design win?
Hi, Matt. And thanks for the question. So, yes, for sure we believe that our voice-over-IP business is strong. We see the Q3 guide that we said $6 million to $7 million, and something very temporary. Our business today and our – I would say the quarterly intake by the customers that we represent is much higher than the $6 million to $7 million. It's really in a way better than expected ramp that is succeeded by, I would say, a much slower intake from that customer. So that product represents, we expect our voice-over-IP quarterly intake to be much higher going forward, and I see that as a gradually growing business from quarter-to-quarter.
And I think besides having these one-time events, that that is how this business should be. A lot of the new design wins that I have alluded to are going to go to production, especially the Tier 1 part is going to go to production late 2017 into 2018. So they are really today supporting the gross but from where we sit, and where we look at from the focus that we're getting from these customers, voice-over-IP this year and next year is a very nicely growing business. I would say that there is, we have no concerns whatsoever about any deterioration or flattish type of behavior in the near-term.
So I would say we see that as a temporary type of hiccup because of the fast ramp of this new Tier 1 customer is Q2.
Is the gateway business setting up like it was two years ago?
So the question is about home gateway. So can you maybe elaborate about…
You mentioned some more service provider customers. But late – very late this year and into next year, it sounded like – and two years ago, you had kind of a moderate increase in the back half of 2014, then strong sales in the first half of 2015. So it seems like – what you've described sounds like a potential repeat of that pattern.
It could be. Perhaps right now, we are kind of less comfortable talking about exactly what will happen in the fourth quarter. Not because we don't want to; just because we don't have that today like in backlog. It's too early. But of course it could be that way. And if not, it should resemble a faster ramp, I would say, in early 2017 on the heels of these new gateway launches from at least three operators that are taking our solutions. So we do see also the home gateway business as a growth business going forward. We did of course mention that we're seeing these kind of year-over-year declines in the first half because we had this spectacular ramp in the first half 2015. I hope that we are going to see the same thing happening in the early part of 2017. But again, it's kind of too early to give kind of exact numbers around that.
Your big HDClear volume is associated with one particular regional design with that customer. Have you seen – have you any visibility of getting involved with some of the other designs that that customer – where you perhaps move the exogenous chips?
So, first of all, we are today very focused on making sure that we are gaining more wins; that we are progressing to become a bigger supplier for these customers – for this customer as well as for other new customers. I believe of course we will see us being designed into more products that – what we are focused on doing. And once these products will be in the market, and there will be teardowns, of course we will be able to share where these designs are coming from. But, for sure, we are focused as I said on mobile handsets, as well as on some other exciting opportunities outside of that market. And we are very optimistic about our ability to continue and gain additional design wins in the coming quarters. So I think we are kind of well set there for growth.
And Dror, one last one. Thanks, Ofer. Any change in depreciation?
No, no. It is around $400,000 per quarter.
Thanks a lot.
Thank you. We will now take our next question from Matt Ramsay from Canaccord Genuity. Please go ahead. Your line is open.
Yes, thank you very much. Thanks for taking my question. The rest of the callers have talked quite a bit on the revenue side, Ofer. So I wanted to talk a little bit about margins and costs. It was nice to see the really strong gross margins. I wonder if you guys might talk about the sustainability of that gross margin as your business transitions into new growth products. You mentioned that the growth products being over half of the revenue next year. Maybe you could talk about the gross margin progression, and how we should think about that mix going forward. Because things get pretty interesting if the margins stay in the mid-40s. Thanks.
Hi, Matt, and welcome to our call, and thanks for the question. So question about the margin profile. So we've announced second-quarter gross margins of 44.2% which is of course higher on a year-over-year basis, but also it shows a sequential increase from Q1. And I believe that we are, I would say, kind of well positioned to continue and see our gross margins expanding to the mid-40s range. And of course if we are able to continue and grow our revenues sequentially, I would say that our gross margin profile would support that. As you know, with our two pieces here, one is there are of course fixed expenses as part of the cost of goods sold. So as revenues grow higher, the proportion of that fixed expense is lower.
And of course that enables us to get a better margin profile. Number two, the new products are carrying a higher gross margin profile than our cordless products, which of course are more mature. And we do expect that our mix will continue to shift more in favor of new products on the heels of the design wins that we are announcing this quarter, and also during the last quarter. And in a way, they are kind of the pipeline that is supposed to serve as the seed for this growth across VoIP, across mobile, and also IOT. So I believe we are well positioned to go into this mid-40s range right now. I would say it's too early to say kind of where that could go from there.
But I would say that right now the way our products are designed, and the fact that in many cases these are products that are going to – first of all, growing markets – and I alluded to it in my earlier comments about some of these products also going to new market opportunities. In a way, we are not replacing anyone. This is basically a new requirement which, in a way, is today is entertaining which type of technology to utilize. So of course, many of these opportunities do support a much better and healthier gross margins for us, and I do expect this trend to continue. And right now our target is the mid-40s.
Thank you. That perspective is helpful. And then just one more for me. It looks like in the Q3 guidance, maybe on a non-GAAP basis, R&D down a hair; but the total operating expenses up fairly sharply. I assume that's sales and marketing. But maybe you could talk a bit about what is driving that sequential increase in OpEx, and what the sustainable run rate of non-GAAP OpEx would be sort of exiting the year. Are we moving up to the 14s on a sustainable basis? Or is this a one-quarter blip? Any help there would be great. Thanks, guys.
No, Matt. This is Dror. I think that maybe you didn't get the reconciliation right. Because actually if you take the midpoint of our guidance for the third quarter, excluding the non-GAAP items – so excluding the amortization and the result [ph] expenses – you should get to something non-GAAP of around $13.5 million to $14 million for the third quarter, which is slightly above the second quarter. And it's still too early to foresee the fourth quarter, but this should also be a line. So overall, I would say the average OpEx per quarter for this year should not exceed $13 million or 13-point-something – $13.1 million, $13.2 million per quarter. And this would also be like the rate when we enter the year.
Thank you. [Operator Instructions] As there are no further questions in the queue. Pardon the interruption. We have one more question from Roni Lifshitz from TechTime. Please go ahead. Your line is open.
Thank you for taking my question. I would like to ask something less financial. Regarding that, have you seen to find a place in the automotive market, and whether you can give some more details regarding the [indiscernible] product which looks something surprising. What are your expectation from these products? Thank you.
Thanks, Roni. So I think – it was very hard to hear your question – but I believe you asked about whether HDClear has any prospects in the automotive market, that was number one. And perhaps the second question was about SparkPA and what our expectations are? Is that correct?
Exactly, yes, go ahead.
Okay, absolutely. So first, for sure, audio and voice are highly important in the automotive market. Today, people are using their phone to – while driving. And of course, I would say that in many countries, it is today becoming increasingly problematic to utilize a smartphone while driving. And the ability to utilize voice in a good and very productive way is – would provide very, very beneficial in the automotive market. So, for sure, the technology has a lot of merit in the automotive space. I will say that today from the focus areas of the Company, it is one of the topics that we plan to address in the near future.
But today, most of our attention is really focused on mobile, wearable IoT, which includes also a smart audio product. But definitely yes; there is an enormous potential also in the automotive market. Automotive market is today exposed to a number of issues related to the amount of noise, and the way this noise is impacting ASR or featured commission engines, which in a way results in very low accuracy and low productivity from voice. But there is for sure a lot of things that can be done to correct that and to enable great technologies and great solutions to make voice utilization in the car much more powerful. And, indeed, we have very good product portfolio that can adjust that well. And this is one of the areas where we plan to focus in the future.
The second question about the SparkPA, which is a power amplifier in CMOS targeted for the Wi-Fi 5 gigahertz technology which is the 11ac technology, a 1-gigabit per second over the air. So our expectation there is to reach a point in which we have design wins and we can start commercial shipments. And we believe that will happen in the second half of 2017. Our plan there is to generate revenues and sell products, but of course we are exploring also additional business models there.
So one business model is basically to be part of a reference design of a Wi-Fi subsystem, meaning to work together closely with Wi-Fi SoC vendors; and the other is to go direct, and design the products with access point vendors. So we're pursing both directions. Today, these products are under evaluation. And we hope that these evaluations would be completed in a successful manner, and result in us going into design win and a mass production in next year. So I hope addressed your questions.
Yes, thank you very much.
Thank you. That will conclude today's Q&A session. I will now turn the call back to your host, Mr. Daniel Amir, for any additional or closing remarks.
Yes. Thank you for joining us today, and for your continued interest and support in DSP Group. We will be attending the Canaccord Genuity Growth Conference in Boston, on August 11, and we invite you to join us there. For further investor information and a calendar of events that we will be attending, please visit our investor website at www.dspg.com. Thank you and goodbye.
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