DSP Group, Inc.
Q4 2008 Earnings Call Transcript

Published: 2 Feb 2009

[Operator:]

Good day ladies and gentlemen, and welcome to the Q4 2008 DSP Group earnings conference call. (Operator instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Dror Levy, Chief Financial Officer. Please proceed.

[Dror Levy:]

Good morning, ladies and gentleman. I am Dror Levy, Chief Financial Officer of DSP Group. Welcome to our fourth quarter 2008 earnings conference call. On today’s conference call we have with us Mr. Eli Ayalon, Chairman and Chief Executive Officer of DSP Group; Mr. Boaz Edan, Chief Operating Officer; Mr. Brian Robertson, President and Mr. Ofer Elyakim, President of our Southeast Asia operations. 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 2009 and general outlook for 2009. 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

[Eli Ayalon:]

Thank you Dror and thank you all for joining us today. I am glad to open this discussion on the results of the fourth quarter of 2008. I assume you had the opportunity to read our press release that was released earlier today. In a short while Dror Levy, our CFO, will go through the details of our financials. Before doing so I would like to highlight how the company is addressing the pronounced challenges in our markets we face today and give you some background related to market trends. Despite the economic downturn and challenging market conditions in the consumer electronics market not only were our fourth quarter results solid and within the range of our guidance we also generated positive operating cash flow at the level of $8.2 million in the quarter, the details of which will be given in a moment by Dror Levy. It is common knowledge today and an undeniable fact that the current economic downturn severely impacts consumer spending. This in turn has a market effect on worldwide consumer electronics demand as evidenced by the announcement in November that an additional consumer electronic brand intends to exit its retail telephony activities in North America. It is this uncertainty regarding consumer consumption and the ongoing concerns related to the underlying global economy which place limitations on our visibility for 2009. We are also experiencing a relative slow down in bookings. As a result we are witnessing more caution across the supply chain and a reduction in lead times. With our customers and our customers’ customers adjusting their inventory policy to better cope and align themselves with the present situation and to minimize working capital exposure. We believe that these adjustments will certainly affect the revenues for the first quarter of 2009 but having said so we do believe that our key customers continue to be financially strong and that we will see a gradual return to improved revenue levels towards the second half of 2009. Despite our expectation for ASP erosion in 2009 in the range of 15-20% as compared to 2008 which is in line with prior years we anticipate that our annual gross margins will decline only by 1-3% in 2009 as compared to 2008. We expect that our gross margin will be lower in the first quarter and improved during the second half of 2009. We have annual range of 34-38%. This will be achieved by securing better pricing with silicon and back end suppliers introducing more cost effective RFIC’s from tech products and improving yields in certain higher end products. In light of the uncertain market conditions in 2009 and our objective to generate positive operating cash flows in the second half of 2009 we will continue to closely monitor trends in our markets and where appropriate take additional measures and implement further synergies to meet these goals. In the fourth quarter, Q4 2008, sales of tech products accounted for 70% of our revenue in the quarter as compared to 75% in the third quarter of 2008. Sales of 5.8 GHz and 2.4 GHz products generated 20% of our revenues as compared with 16% in the third quarter of 2008. For 2009 we expect that sales of tech products will account for even a higher percent of our revenue mix mainly due to a conversion of analog products to digital DECT-6, the DECT versions of the U.S. market. During the fourth quarter our stock repurchasing activity continued subsequent to our [25/1] plan. We used during the fourth quarter $5.3 million for the repurchase of 850,000 shares of our common stock and an aggregate of $49 million since January 1, 2008 for the repurchase of 4.9 million shares. In addition, in an action we believe to be in the interest of the company and its shareholders the company has seized the opportunity to buy back NXP’s stake in DSPG, approximately 4.2 million shares or approximately 16% of the outstanding shares of the company. We believe that this act is very advantageous to the company and its shareholders. The purchase price will be 15% lower than the average trading price of our common stock during a 20 business day period commencing on February 5th. Upon closing of the repurchase, the stockholders agreement with NXP will be terminated and the NXP board members will resign. Now turning to our new multimedia product line. This year’s Consumer Electronics Show was an important event for DSP Group during which our XpandR product line received a clear vote of confidence and proof from the marketplace that the strategic decisions and investments we previously made were right. We accurately forecasted the market trends as evidenced by our securing additional design wins and design ins that Ofer Elyakim will shortly report to you in more detail. As you saw in our financial report, we took a one-time impairment charge of $182 million related to the impairment of goodwill and intangible assets. The factors that led to the impairment charge are the decline in the market capitalization of the company’s shares, combined with a decline in the company’s forecast business outlook which we believe is mainly attributable to the impact of the weakening macro economic environment for the consumer electronics market. To summarize, 2009 is a challenging year in our market and as indicated by leading semiconductor companies in their projections for 2009 a severe impact on the semiconductor industry is expected. However, we feel that DSP Group with its cash position, exciting products and technologies, it is well equipped to use 2009 to improve its position in order to take advantage of the economic recovery that will follow. Now I would like to turn to Ofer Elyakim, President of DSP Group Southeast Asia to discuss our participation at CS and our activities in the new multimedia product line. Ofer the floor is yours.

[Ofer Elyakim:]

Thank you Eli. This year’s Consumer Electronics Show in Las Vegas was a milestone event for DSP Group. For the first time all the participants in our market including operators, OEM’s, ODM’s and consumer brands shifted the emphasis of their product offering to wireless multimedia from voice communication only. For us it was a clear signal and proof from the marketplace that the decisions and investments we made in this domain were spot on and that we correctly anticipated the changing market trends. During CS companies like [inaudible], Samsung, Nortel and others presented infotainment center like products. These products are either sold today by operators or plan to be delivered towards the end of 2009. At CS we demonstrated the fully functional infotainment center reference design driven by our XpandR silicon platform with improved CPU horsepower and support for advanced telephony, audio, video and multimedia applications with integrated WiFi and DECT communications. Our new products drew an overwhelming level of interest and positive feedback from all of the major players in this domain including leading consumer brands and service providers. Special highlights from customers include our advantage in software and hardware integration which mean a faster time to market and lower NRE for our customers. Following discussions with many prospective customers we secured several design wins and design ins with key industry players among them two major consumer brands. At this stage we have secured design wins and design ins with five customers that intend to design nine products based on our platform. These products include several digital home devices with big and small screens like infotainment centers, multimedia phones, connective digital picture frames, internet radio and others. First deliveries are expected to begin in the fourth quarter of 2009. In addition, [TMCS] will own several important and innovative technologies for the core telephony market that demonstrated to our customers our clear technological advantages and our leadership position in this market. The new features focus on three main topics; one, making our products greener and more environmentally friendly by using less power and minimizing the amount of over the air emissions. The second one is technologies to expand the effective range between base and handset by about 30%. The third is features to improve sound quality like wide band audio and algorithms for background noise reduction and amplification of speaker volume. As you can tell, we believe that this year’s CS successfully showcased our advanced technologies and demonstrated to our customers our ability to participate in the next strategic investment based on future market trends that bear fruit. I will now turn the floor over to Dror Levy, our CFO, to review the financial statement. Dror the floor is yours.

[Dror Levy:]

Thank you Ofer. I will now review the income statement for the fourth quarter of 2008 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 the acquisition of cordless and voice over business lines from NXP. As Eli indicated, our operating results for the quarter included a one-time impairment charge of $182 million relating to the impairment of goodwill and other intangible assets as required by accounting rules. The impairment amount includes $142.5 million of goodwill impairment and $39 million of technology and customer base impairment. As a result, our amortization for 2009 will be in the range of $11 million to $13 million. Our revenues for the quarter were $71.6 million. Gross margin for the quarter was 39.4%. Gross margin for the quarter included $0.2 million of equity based compensation expense. R&D expenses were $17 million including $1.6 million of equity based compensation expenses. Operating expenses for the quarter were $214.3 million including $3 million of equity based compensation expenses, amortization of acquired intangible assets in the amount of $5.7 million and impairment charge in the amount of $181.5 million. Interest expenses for the quarter were $1.8 million. Interest expenses in the quarter included unrealized loss of $2.3 million resulting from the decline in market value of available for sale securities. Income tax expenses for the quarter were $6.5 million. This figure includes $5.7 million resulting from the write off of deferred tax assets which resulted in the decline in business forecast for future periods that is expected to result in a decline in future taxable income. Net loss was $194.4 million including $3.2 million associated with equity based compensation expenses, $5.7 million associated with the amortization of intangible assets, $181.5 million of impairment charges, $2.3 million of decline in market value for sale securities and $5.7 million associated with the deferred tax assets write off. Non-GAAP net income excluding the items I just described was $4 million. Loss per share was $7.23. The negative impact of the equity based compensation expenses on EPS was $0.12. The negative impact of the amortization of acquired intangible assets and the EPS was $0.21. The negative impact of the impairment charge on EPS was $6.75. The negative impact of the decline in market value of available for sale securities was $0.09 and the negative impact of the deferred tax asset write off was $0.21. Non-GAAP EPS excluding the items I just described was $0.50 on a diluted basis. Please see the current report on form 8K 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 increased from the last quarter by $4.6 million to $39.6 million representing a level of days of sales. Inventories decreased by $7.7 million from last quarter to $14.1 million representing a level of 29 days. Our cash and marketable securities at the end of the quarter were $121.4 million representing an increase of $1 million during the quarter. Our cash and marketable securities position during the quarter was affected by the following

[Boaz Edan:]

Thank you. Good morning everybody. [Product] challenges faced by our customers during the current economic crisis has reduced visibility along the complete consumer chain. This in turn makes our ability to forecast revenues significantly more difficult. Taking this challenge into consideration we have prepared revenue projections for Q1 2009 based on initial and partial forecasts received from our customers and our own assessment. Our Q1 2009 projections on a U.S. GAAP basis including the impact of equity based compensation expenses and acquisition related amortization expenses are as follows

[Operator:]

(Operator Instructions) The first question comes from the line of Daniel Amir – Lazard Capital Markets.

[Daniel Amir:]

First of all, considering your big decline in sales a couple of questions related to that. First of all, the magnitude I guess is a bit more than even most of the average semiconductor companies here in the first quarter at least in the mid-range here of $40 million. Can you comment a bit about what you are seeing in the current environment, why it seems like a little bit worse? The second is the operating expenses it seems like you are not making significant changes at least right now on the Opex line. Is there a plan to adjust Opex with the lower level of sales or do you plan to run at the current level here for the next few quarters?

[Eli Ayalon:]

We are also very closely analyzing the results of other semiconductor companies and we have reviewed the results of TNC whom we consider to be the simulator of this area and of all companies that have released their earnings in the last days or weeks and you see gross [inaudible] in most of these companies a significant decrease in revenues in Q1. None of the companies that we have reviewed have given any projections for the annual revenue figure except I believe TSMC gave a range and if you look at their announcement you will see for yourself what is the range they have given. As I said that would be considered as a meter for the semiconductor area. When you look at this you really understand that the economy and specifically the semiconductor technology area is in a deep crisis. And if you look at our projections they are definitely in line with what we see around us. With respect to the operating expenses in the last quarter if you recall we announced we took actions to reduce our operating expenses in 2009 as compared to 2008. If I recall we said $10 million. We also said that all the related expenses to implementing these synergies are already taken in the financials of 2008. So there is no cost that will be carried with respect to these synergies in 2009. Today we have said that we plan on being both operationally profitable and operational cash positive in the second half of the year. We did not give annual projections but believe me we have made our internal annual plans because we work on plans. When we make a statement like this that we plan on being operationally positive on both cash and profit it is based on a detailed plan. We have also said that due to the macro economic situation that nobody really knows how it will develop which we will closely monitor; the markets, our customers and all the other factors and if necessary take additional steps. With what we have done and announced in the previous quarter we believe that this is the optimal platform for DSP growth during this period of time. Without renouncing to the projects that we have in place and we have to continue and develop especially given the enthusiasm and prospects that we have with the new line of products so that by the end of the year when hopefully there is an economic recovery in the semiconductor market we shall be well equipped to take advantage of it and begin to deliver the new stuff.

[Daniel Amir:]

Regarding the NXP repurchase can you just expand was this an opportunistic move? Was this something more strategic you were thinking of all along? What was kind of the background there? Does it change anything from your perspective?

[Eli Ayalon:]

No, it doesn’t change anything from our perspective except that first with these prices it is a very, very in my opinion, advantageous move for our company and shareholders and with the agreement with NXP they had a lock out period if I recall of two years. When the lock out period ends and it was scheduled to end in September 2009…when the lock out period ends and the big shareholders have a threat of putting in the market a big portion of shares it is very negative. So from both sides to avoid this and because of the reduced share price we think it was a very good move for us and we offered this and we reached an agreement.

[Daniel Amir:]

My final question is on your opportunities, obviously in your new product line you said Q4 2009, is this going to be a meaningful contribution in terms of sales by your best estimation or is it really more we should look into 2010 as something that might move the needle?

[Eli Ayalon:]

All of these customers, and correct me if I’m wrong, I think all of them are scheduling the beginning of deliveries from us to them in the fourth quarter of 2009 and this is the beginning. This is what it begins with small quantities and it begins to ramp up afterwards. So significant figures we hope to see in 2010 and not in the fourth quarter.

[Operator:]

The next question comes from Shaul Eyal – Oppenheimer.

[Shaul Eyal:]

This quarter, the December quarter, you had all in all a very, very solid gross margin and were talking about 15-20% ASP declines. What was the main reason for the better than expected gross margin in this specific quarter?

[Eli Ayalon:]

If you remember in 2008 we had a gross margin issue, if I am not mistaken the first quarter and we explained that we had a low product line from NXP that had a yield lower than expected. We said that we are taking corrective actions and that we expect the gross margin to increase. We took these corrective actions and we succeeded to perform to meet the engineering goals and cost goals that we had set for ourselves. This is the main reason for the gross margins to get back to these levels. As Boaz explained in the first quarter gross margins are going to decline mainly because products sold in the first quarter bear the cost of the material and inventory of 2008. Before the decline and decrease and adjustment in costs from our silicon and assembly manufacturers and on the other hand we have the ASP’s of 2009 and I would say this is the main reason.

[Dror Levy:]

The other point that we see is of course when the revenue is going down then the percentage of fixed costs of operations has a higher impact on the gross margin so I would say these are the three main elements. As revenue will go up this impact will decrease.

[Shaul Eyal:]

One other question, you said that the NXP director is going to be sitting on your board. Are you going to be replacing him?

[Eli Ayalon:]

We may replace him in the future but we do not have immediate plans to replace him. But you can apply for the position.

[Operator:]

The next question comes from Matt Robinson – Pacific Growth Equities.

[Matt Robinson:]

I wanted to ask you first of all this is the conference call when we ask the backlog question. Can you give us your backlog last year and also talk a little bit about GE and how the other brands may be doing?

[Eli Ayalon:]

At the beginning of the year we always give the backlog. Dror will give it to you in a minute.

[Dror Levy:]

The backlog at the end of 2008 was $35.1 million.

[Matt Robinson:]

As you look at the departure of this brand and the failure of some of the retailers or at least one big one in the consumer electronics space and you look at how your ODM’s are positioning do you see any trends that may be in response to these other than just low bookings? Are there any trends that are more qualitative that we can think about in terms of how the industry is adjusting to these changes?

[Eli Ayalon:]

Computer demand is actually the key issue here. When there is such a global problem we see when discussing with our customers usually the way it works is our guys go and speak to the OEM’s and ODM’s and get projections and background why they think the projection is going to be this and that, why the mix of product is going to be this and that. People seem to be quite scared all along the food chain and they have good reason. They do not see visibility on their side. They probably do not get any kind of visibility from their customers down to the retail channels. In situations like this people do not want to commit. People try to keep their cash. So on and so forth. I would say this is the general environment that all of us in this industry I believe are faced with. I have discussed with other people in the industry and it is all around the place. We have no visibility. People first of all they hold. They do not give any projection. They don’t want to commit. At the end of the day companies have to plan and we make also our plans and we have what we think are our realistic figures and we shall monitor as we said and take corrective actions. We do not see any, I would say, drastic moves on the side of our key customers. The key customers look at this stage quite stable as we said and maybe down the road we should see here and there additional consolidations or somebody going out of the market but generally speaking we think the key customers are quite stable.

[Matt Robinson:]

That is not surprising. Right now you pretty much have the customers that would potentially pick up whatever slack or whatever opportunity would arise from a brand leaving the market. You pretty much have the design in with any potential beneficiaries do you not?

[Boaz Edan:]

Correct.

[Matt Robinson:]

So everybody is just throttling and trying to manage their business? Nobody is being particularly proactive about taking share? They are just trying to deal with the circumstances it sounds like.

[Boaz Edan:]

Yes.

[Operator:]

The next question comes from Daniel Meron – RBC.

[Daniel Meron:]

Can you give us a bit more details on the design wins, customer names, and also what is your projection as we had into 2010 as far as the contribution of these new design wins?

[Ofer Elyakim:]

We can give you some more color on the type of products that these customers are designing. Names that we have not announced we will not announce today. Also, it is too early to tell what will be the impact on 2010. We have very high expectations from these products and from our ability to generate revenues next year. If you have any questions about the type of products I can definitely elaborate more.

[Daniel Meron:]

Can you give us a sense maybe how many product applications are for frames, how many are for internet radios, how many are for the more advanced combined telephony with applications that are basically home based communications?

[Ofer Elyakim:]

As we said it is five customers, nine design wins and design ins for big screen and small screen. Most of them are for convert communications so they have telephony and picture frame and widgets and basically our connect terminals to network and they can basically receive a lot of content and distribute it to the users. I would say all in all it is mainly convert type terminals. It is less of a one type of application product but a terminal that has a media player with internet radio with the ability to show picture both from the network like websites like Picasso and others to streamlined information like quotes, weather and traffic that includes yellow pages, etc. So we are talking about convert type of terminals. This is not a stand alone, internet radio device or stand alone digital picture frame.

[Daniel Meron:]

Are any one of these devices going from the convert solutions to specifically going to a Telco customer at the end of the day or are they going to market it down the road to the Telco’s? I’m thinking about what you guys had to try and figure out if there are more wins like that down the road.

[Ofer Elyakim:]

Certainly and as we said in the prepared remarks some of these products will be going to the operator channels while others are going to be launched in retail. The market is right for both ends, retail and also the operator side.

[Daniel Meron:]

So basically those wins are for carriers eventually?

[Eli Ayalon:]

Yes. Also the part that goes to carriers we sell to OEM’s. So we have two types of customers here. One is OEM which are going to put these products in retail and the second are OEM that are going to develop the products for [operators].

[Daniel Meron:]

The second set of questions I have revolve around the new level of sales we are reaching here. Can we expect a typical seasonality from that and sequential build but this is the baseline we are looking at as far as demand? How much of a drop, almost 50% here sequentially, is because of the drop in demand itself as far as the actual demand in the market? How much has to do with the supply chain changes? How much also has to do with the pricing of the end price or that you guys are giving the drops in the phone ASP’s as well?

[Eli Ayalon:]

The one that is right from the price we get. We indicated 15-20% ASP decline which is not something unusual in our market. Regarding all the rest, as I said we have very low visibility and if we were more sure about the figures we would have given the projections for the year like we did up until now. It wouldn’t be appropriate with this lack of visibility to give the market any specifics about it. It is a combination of everything.

[Daniel Meron:]

Do you have a sense of what is the actual amount of inventory in the supply chain right now? Or on the other end what is the actual demand from end users for an X amount of handsets or cordless handsets per quarter or per annum?

[Eli Ayalon:]

No. We are lacking specific information. We have much less information than we had in previous years. Thank you all for joining us on the conference call and we look forward to reporting to you in 90 days.

[Operator:]

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.