DSP Group, Inc.
Q1 2013 Earnings Call Transcript

Published: 29 Apr 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the DSP Group Q1 2013 DSP Group Earnings Conference Call. For your information, today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Chris Basta, Director of Investor Relations. Please go ahead.

[Christopher Basta:]

Good morning, ladies and gentlemen. I am Chris Basta, Director of Investor Relations of DSP Group. Welcome to our first quarter of 2013 Earnings Conference Call. On today's call, we have with us Mr. Ofer Elyakim, Chief Executive Officer; and Mr. Dror Levy, Chief Financial Officer. Before we begin, I would like to remind you that during this conference call, we'll will be making forward-looking statements about our financial projections for the second quarter of 2013, optimism about our market opportunities for our new product lines, including HDClear, DECT ULE and office Voice over IP products and the timetable for product ramp-ups. Actual results or trends could differ materially from our forecast, including the impact of reductions in lead times and inventory levels by our customers and their customers; continued uncertainty in consumer demand for traditional cordless telephony products and on major end markets; unexpected delays in commercial launch or mass production of new products incorporating our technologies; the growth of new market verticals; our ability to lower operating expenses; our ability to secure additional design wins; and general market demand for our products that incorporate our technologies in their market. We assume no obligation to update these forward-looking statements. For more information, please refer to the risk factors discussed in our 2012 Form 10-K and other SEC reports we have filed. Now, I would like to turn the call over to Ofer Elyakim, our Chief Executive Officer. Ofer, the floor is yours.

[Ofer Elyakim:]

Thank you, Chris. Good morning, everyone, and thank you for joining us today. I'm glad to open this discussion about our quarterly results and I hope that you have the opportunity to read our press release that was released earlier today. I will begin this discussion by reviewing our results for the first quarter of 2013 and then comment on the progress we are making in new product segments and finally, update you on our outlook for the second quarter. Our financial results for the first quarter exceeded our guidance in almost every financial metric and demonstrate a successful turnaround, return to GAAP operating profitability despite the uncertain market dynamics surrounding our DECT business. Our non-GAAP gross margins for the first quarter of 2013 was 39.8%, exceeding the higher end of our guidance range. Our first quarter marks the sixth consecutive quarter of gross margin improvement. This was achieved despite a year-over-year decline in revenues. Our first quarter revenues were $39.7 million, up approximately 3% on a sequential basis, but down by 9% year-over-year. Our gross margins were higher by 130 basis points versus the fourth quarter of 2012, and increased by 220 basis points year-over-year. The increase was attributed to our cost reduction activities on the R&D front, a favorable mix of products, and continuous measures to optimize production efficiency and tight inventory control. Our first quarter 2013 non-GAAP gross margin excluded equity based compensation expenses. Our cost control initiatives implemented in 2012 improved operating profitability for the second consecutive quarter. This, again, was achieved at a much lower level of revenues. Moreover, our first quarter marks the eighth straight quarter of improvement in our operating costs. The improvement in our financial result is evident when comparing our performance in the first quarter of 2013 with the same period in 2012, for which we reported revenues that were higher by 9%. We ended the fourth quarter of 2013 -- sorry, we ended the fourth quarter of 2012 with non-GAAP operating expenses of $13.8 million, representing a steep reduction of 22% year-over-year and slightly down sequentially. Our non-GAAP operating income for the first quarter was $1.9 million or 5% of revenues, as compared to non-GAAP operating loss of $1.6 million for the first quarter of 2012. Our first quarter also marks another important milestone of returning to positive GAAP operating income. Our non-GAAP net income for the fourth quarter was $2.5 million and non-GAAP diluted EPS were $0.11, compared to a net loss of approximately $1.2 million and a loss per share of $0.05 for the first quarter of 2012. Our non-GAAP result excluded equity-based compensation expenses, tax benefit and amortization from acquisitions. We also successfully grew our EBITDA for the sixth consecutive quarter to approximately $2.6 million or 7% of revenues. Our cash and cash equivalents balance remained healthy at the end of the quarter and was approximately $120 million. Moving now to the business initiatives and recent events. We launched our HDClear product for mobile devices at the Mobile World Congress in Barcelona and are happy to report that an overwhelming level of interest and excitement around advanced voice features that exceeded expectations. We ran successful demonstrations of our solution to many mobile OEMs and mobile network operators, which expressed interest to evaluate our solution. HDClear is a comprehensive voice enhancement product for mobile devices, incorporating proprietary noise cancellation algorithms, powerful acoustic echo cancellation and additional voice enhancement algorithms, which dramatically improves user experience and delivers unparalleled voice quality and call intelligibility to mobile device users. Our new DBMD2 chipset, the voice enhancement processor that runs our HDClear algorithms is the smallest, yet most efficient voice enhancement processor in the market, measuring as tiny as 2 x 2 millimeters, and is equipped with a comprehensive software framework that enables rapid development and fast time to market, overcoming the challenges in portable design, including scarce real estate and low power-consumption requirements. When incorporated into smartphones and other mobile devices, this solution effectively isolates voice from surrounding environmental noise, leading to a noise-free conversation experience, dramatically improves voice call quality and enhances accuracy of automatic speech recognition applications, thereby enabling them to work just the way they were designed to. I believe that the market opportunity for our technology is significant with IDC projecting over 1 billion devices incorporating such voice enhancement processors in calendar year 2014. And as reported to you last quarter, we are on track to deliver engineering samples in May, and have began evaluations of our technologies with leading OEMs and mobile network operators. We are encouraged by the positive feedback and the potential of our offering. Now turning to DECT ULE. The misconception around the DECT standard that is suitable only for voice communication encoded phones is about to change. During the Mobile World Congress, the DECT forum announced the foundation of the ULE Alliance. The mission of the Alliance is to establish DECT Ultra Low Energy or in its new name, ULE, as the world's leading control network ecosystem for home and building use. ULE is based on the program reliability and range of the DECT radio technology currently in use in hundreds of million of products worldwide. The ULE Alliance will promote the worldwide allocation and market adoption of the ULE technology and address the growing requirements of Smart Home and Smart Energy devices. In addition, on April 9, the DECT ULE standard specification was officially published by ETSI, which is a message to the world about DECT and its future in the home. Telecommunication carriers across the globe are turning to home automation as a new potential revenue source and are paying close attention to ULE. There are such industry bellwethers anticipate testing ULE technology this year and launching services thereafter. We're confident that with the growing number of Home Gateways with DECT inside, the DECT ULE will play an increasing role in the burgeoning home automation and building management market. Now turning to DECT. Geographically, sales of DECT products for the European and rest of the world end markets were strong and continue the product replenishment cycles. Revenues were up approximately 18% sequentially and 22% year-over-year. Sales of DECT product to the European and rest of the world end markets accounted for 48% of revenues, as compared to 36% in the first quarter of 2012, and 42% for the fourth quarter of 2012. Sales of DECT products for North American end markets in the first quarter were on the low side, but in line with our expectations. Our DECT 6.0 revenues from the North American end markets were down 30% year-over-year and 9% versus the fourth quarter of 2012. Sales of DECT 6.0 products for the North American end markets accounted for 35% of our revenues versus 45% for the first quarter of 2012, and 40% during the fourth quarter of 2012. Now turning to the Voice over IP product line. The first quarter was a strong quarter for our office Voice-over IP segment and continued a healthy trajectory. Sales of our office Voice over IP products were approximately $2.4 million, about flat sequentially and up 39% year-over-year. Based on our bookings and customer forecast, we expect second quarter's revenues in the Voice over IP segment to grow on a sequential basis. Moreover, we are well-positioned to expand our business, and grow our market share in the office Voice over IP business in the next few years. Based on market research reports and our own assessment, there are approximately 45 million to 50 million IP terminals sold yearly and the market is growing unit volume in the mid-teens percentage annually. We are bullish about the growth opportunity that exists for us in this market and are seeing the fruits of our R&D investment and focus on this segment. Our unique value proposition enables us today to expand our market share moving forward especially with Tier 1 customers as the leading incumbent chief vendor go out. We're well-positioned to win key design wins with our recently announced next-generation DVF99 chipsets and are in discussion with several Tier 1 enterprise telephony OEMs. During the first quarter, we secured 3 design wins for DVF99 with leading customers. We further expect to accelerate production ramp-up to the fourth quarter of this year from early 2014 due to customer requests. Moreover, a leading call center and office headset OEM, launched an enterprise grade wireless audio headset for the office environment based on our DCX81 DECT product. This headset support major unified communications applications, including Microsoft Lync and Cisco platforms and the product also achieves 10 hours of HD voice talk time, which is the longest in the industry. We're excited about our growing presence in this domain, which is poised to quadruple over the next 5 years. DECT's range is ideal for deployment in crowded offices, exceeding what's possible with most Bluetooth devices and avoiding the Bluetooth WiFi interference issues. Now turning to our business outlook. Despite the uncertain market conditions in our cordless market, we shall continue to execute prudently on our business plan with a focus on enhancing shareholder value and generating positive operating cash flows and EBITDA in 2013 year as we have successfully demonstrated during prior quarters. Moreover, we expect our non-GAAP financial results for the second quarter to be in line with those reported for the first quarter and for revenues to be in the range of $38 million to $41 million. We endeavor to diligently continue our successful transition from existing cordless telephony products to new product lines and market domains that will bring new revenue streams to DSP Group and create value for all of our shareholders. Before turning the call over to Dror to discuss the financial results and our forecast for the third quarter, I would like to make a few brief comments about the efforts of Starboard, a minority shareholder with approximately 10% of our outstanding shares to elect a number of candidates to our Board of Directors, in addition to the 2 directors designated by Starboard, who already serve on our Board as a result of our settlement with Starboard last year. First, let me say that we did our utmost to avoid this faulty contest with Starboard. And the resulting distraction and expense it represents for the company and its Board and Management. We offered Starboard increased board representation by nominating 2 additional directors, which would have meant that 4 Board members out of 9 would have been either designated or nominated by Starboard. Additionally, we offered the appointment of certain Starboard nominees to all committees, including 2 Starboard nominees out of 4 members in the compensation committee, one of whom would serve as Chairman of this committee having a tie breaking vote. We also offered to form a new strategic committee of the Board consisting of 5 directors, including 2 Starboard nominees, one of whom would serve as Chairman of such committee. Unfortunately, this proposal was rejected and we were not able to reach a settlement. As I mentioned, in 2012, Starboard designated 2 Directors for appointment to our Board in connection with settlement negotiations, which averted a proxy fight last year. This year, Starboard has nominated 3 additional directors. If elected, Starboard would have designated 5 out of 9 Directors, which would constitute a majority of our Board of Directors. Starboard nominees would achieve majority without Starboard paying any premium and despite the fact that Starboard only owns 1/10 of the company's shares. Management and representative of the Board have met with Starboard on numerous occasions and based on these conversations, we are convinced that Starboard's goal is to effect a sale of the company as soon as possible. The company believes that the best shareholder value can be obtained by taking advantage of the current market opportunities to capitalize on the research and development investments already made over the past few years, which are now poised to bear fruit. We expect that the company's stock price will rise as a result. A fire sale of the company now would not, therefore, be in the best interest of DSP Group, our fellow shareholders, our customers around the world or our employees. DSP Group is poised for growth. The anticipated commercialization of our innovative HDClear technology offers evidence to the success of the company's current strategy to capitalize on its R&D investment. We have launched 2 additional new products in 2013. As our R&D investment bear fruit, we expect the first product to enable us to grow rapidly, our market share in the enterprise and voice-over IP market and we expect the second new product targeted at Ultra Low Energy to facilitate the company's expansion of its leadership position in DECT into the growing home automation market. As our operating results from the last quarter demonstrate, with our return to GAAP profitability, this is precisely the wrong time to engage in a fire sale of the company. I want to emphasize that this proxy contest is about allowing all of the company's shareholder to participate in DSP Group's growth and success. I'd like to make one final point. The Board does not rule out any alternative. The Board has been, and continues to be active in exploring all alternatives that will help to maximize shareholder value regardless of the source. In the days to come, our shareholders will receive our proxy statement, as well as more detailed information on why it is in shareholders' best interest to defend DSP Group from this attempt by a minority shareholder to appoint a majority of its nominees to the Board. For all the reasons noted above, I urge shareholders to reelect our slate of nominees by voting the gold proxy card. Now I would like to turn the call to Dror, our Chief Financial Officer. Dror, the floor is yours.

[Dror Levy:]

Thank you, Ofer. I will now review the income statement for the first quarter of 2013 from top to bottom. For each line item, I will provide the year 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 $39.7 million. Gross margin for the quarter was 39.6%. Gross margin for the quarter included equity-based compensation expenses in the amount of $0.1 million. R&D expenses were $9.2 million, including equity-based compensation expenses in the amount of $0.5 million. Operating expenses for the quarter were $15.2 million, including equity-based compensation expenses in the amount of $1 million and amortization of acquired intangible assets in the amount of $0.4 million. Financial income for the quarter was $0.6 million. Income tax benefit for the quarter was $0.1 million. Our net income was $1.2 million, including equity-based compensation expenses in the amount of $1 million, amortization of intangible assets of $0.4 million, and tax benefit resulting from the amortization on deferred tax liability that is related to the above-mentioned intangibles in the amount of $0.1 million. Non-GAAP net income, excluding the items I just described, was $2.5 million. Our GAAP diluted earnings per share was $0.05. The negative impact of equity-based compensation expenses on the EPS was $0.05. The negative impact of the amortization of acquired intangible assets on the EPS was $0.02. The positive income of net tax benefit that's resulted from the amortization of deferred tax liability on the EPS was $0.01. Non-GAAP diluted earnings per share, excluding the items I just described, were $0.11. Please see the current report on Form 8-K that we filed with the SEC this morning for reconciliation of the non-GAAP presentation to the GAAP presentation. Now, turning to the balance sheet. Accounts receivable increased from $20.4 million at the end of the fourth quarter of 2012 to $24.5 million, representing a level of 56 days of sales. Inventory increased from $12.9 million at the end of the fourth quarter of 2012 to $14.1 million, representing a level of 53 days. Our cash and marketable securities at the end of the quarter were $119.8 million, representing a slight decrease of $0.4 million during the quarter. Our cash and marketable securities position during the quarter was affected by the following

[Operator:]

[Operator Instructions] We'll now take our first question from Daniel Amir of Lazard.

[Daniel L. Amir:]

So a couple of questions here. First of all, you talked about some of your growth drivers in the voice-based, in the DECT control business. When -- shall we start seeing revenues in this space later this year or is it next year? What really needs to happen to see the DSP Group will be the one to benefit from this trends and not other companies in the space. And then I have a couple of other questions.

[Ofer Elyakim:]

So the first question relates to the kind of the business growth drivers going forward. So you do see today that we are generating revenues from our penetration into the office enterprise market, and we have the products that we aim for the Tier 1s already going to mass production this year. So already in 2013, so that's 1 quarter ahead of plan. Last quarter, we said that we plan to do it in the first quarter of '14. Now, it's in the fourth quarter of 2013. So I would say that our entry and expansion in the enterprise voice market will happen gradually, so this year and into next year. And I think we're on solid grounds to achieve this plan. We see that there is little risk in being able to become a major player in this domain. We have already established our presence in our market share. We have the right products. Actually, the best products today in the markets to compete both from performance, architecture and cost. And so we feel very comfortable with our ability to grow in this market during the years to come. So starting this year into next year, and the following years. With respect to HDClear, so right now, we are preparing for shipping engineering samples to major OEMs. We are, today, in evaluation phases with a number of those OEMs, as well as major mobile network operators that are testing our solution. And are looking very favorably for the benefit that it brings to the networks especially in the areas of automatic speech recognition, in voice triggering and in many other aspects. And so we believe that we will see this year the evaluations, the designing process, the design win process and revenues as early as fourth quarter 2013 into first, second, third, fourth quarter of '14. With respect to DECT ULE, first of all, I did not discuss it in my prepared comment, but we already won -- we already secured design wins for our DHX91, which is the ULE chip that we launched at CS. We secured it with one of our major customers. I would tell you that all other customers that are today evaluating and beginning designings of this silicon are very enthusiastic of the performance, of the power consumption, of the quick synchronization wake-up that this device achieves. I have discussed in previous calls the fact that 3 major European telcos, so the real bellwethers of the industry in Europe, are starting to evaluate ULE as the way to offer home automation and building management services in their countries. So we are, as you can understand, in very active discussion with all of them. We're in very active, also, design activity. We're already going to see this year 2 DECT ULE products in the market, one, by a leading a consumer brand, the other by an Internet telephony service provider. So devices and systems that are basically a home in a box so an over-the-top gateway with a number of sensors for providing you with intelligent security safety analytics about your home and what's happening in your home. So this is, in essence, kind of the way that DECT ULE market will play out. And the fact that the ULE Alliance has been announced and launched and today consists of about 13 members already just with the 2 months that passed since this announcement makes us very positive about the future of ULE and the role that it will play in the market. And the fact that we have today a standard that basically enables anyone who wants to develop devices using the DECT ULE to actually develop devices, go to interop sessions. We have a real standard out there and I think that with time, we're going to see one more deployment. So first deployments are going to happen already this year, a major consumer brand and another internet and telephony provider and additional launches will happen in 2014.

[Daniel L. Amir:]

Yes, so just a follow-up question here on your OpEx forecast. Going forward, is there any further efficiencies you can do on the OpEx line? Or have you done most of your OpEx efficiencies at this point?

[Ofer Elyakim:]

Dan, that's a great question. The way we are forecasting our year is subject to the fact that we control expenses, not vice versa. So despite any type of uncertain dynamics surrounding the cordless and DECT markets, we are committed to generating a positive operating cash flows and EBITDA this year. And also, we have the goal to continue and stay a U.S. GAAP operating income positive, excluding one-time items, as Dror mentioned. And with respect to our OpEx, I would say that we have all the flexibility to control OpEx.

[Daniel L. Amir:]

Okay, great. And then the final question is with regards to the margin side, any more efficiencies you can do to increase your margins, or has that got to do much more with product mix issues?

[Ofer Elyakim:]

So, of course, margins have to do with product mix, but not only with product mix, it's also about reducing the cost of goods. So the cost of goods per unit is also an activity that we are doing on a yearly basis. So in cordless and other domains, we put efforts in redesigning products at much lower cost in order to improve the margin profile and we will continue and do so. And we, of course, have the long-term goal of going back to the low to mid-40s where we were a couple of years ago and this would be aided a lot by the mass production and volume growth in our HDClear activity and also in our Voice over IP activity with DVF99, as well as with DECT ULE. So this will definitely contribute on increasing the margin profile of the company.

[Operator:]

[Operator Instructions] As there are no further questions in the queue, I would now like to turn the call back to your host for any additional or closing remarks.

[Ofer Elyakim:]

Thank you, all, for participating and we look back to talking with you again. Thank you. Operator, you can now close the call, thank you.

[Operator:]

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