DSP Group, Inc.
Q2 2013 Earnings Call Transcript

Published: 29 Jul 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Q2 2013 DSP Group Inc. Earnings Conference Call. For your information, today's conference is being recorded. At this time, I would like to turn the conference over to Chris Basta, Director of Investor Relations. Please go ahead, sir.

[Christopher Basta:]

Thank you. Good morning, ladies and gentlemen. I'm Chris Basta, Director of Investor Relations at DSP Group. Welcome to our second quarter of 2013 earnings conference call. On today's call, we have with us Mr. Ofer Elyakim, Chief Executive Officer; and Mr. Dror Levy, Chief Financial Officer. Before we begin, I would like to remind you that during this conference call, we will be making forward-looking statements about our financial projections for the third quarter of 2013; optimism about market opportunities for our new product lines, including HDClear and the DBMD2 audio processor; DECT/CAT-iq, and office Voice over IP products; prevalence of DECT ULE; timetable for product ramp-ups by our customers; and optimism about our successful turnaround and ability to enter into market domains and create new revenue streams. Actual results or trends could differ materially from our forecast, including the impact of reductions in lead times and inventory levels by our customers and their customers; continued uncertainty in consumer demand for traditional cordless telephony products in our major end markets; unexpected delays in commercial launch or mass production of new products incorporating our technologies; the growth of new market verticals; our ability to lower operating expenses; our ability to secure additional design wins; and general market demand for products that incorporate our technologies in the market. We assume no obligation to update these forward-looking statements. For more information, please refer to the risk factors discussed in our 2012 Form 10-K and other SEC reports we have filed. Now I would like to turn the call over to Ofer Elyakim, our Chief Executive Officer. Ofer, the floor is yours.

[Ofer Elyakim:]

Thank you, Chris. Good morning, everyone, and thank you for joining us today. I'm glad to open this discussion about our quarterly results for the second quarter 2013. I hope you had the opportunity to read our press release that was released earlier today. I will begin this discussion by reviewing our results for the second quarter 2013 and then comment on the progress we are making in new product segments, and finally, update you on our outlook for the third quarter. Our financial results for the second quarter exceeded our guidance in almost every financial metric and demonstrate sustained progress in our turnaround and in our business performance. And all of that are despite the uncertain market dynamics surrounding our cordless market. Our second quarter revenues of $40.7 million were at the higher end of our guidance range, up approximately 3% sequentially and down 8% year-over-year. Our non-GAAP gross margins for the second quarter was approximately 40%, at the higher end of our guidance range. Our non-GAAP gross margins in the quarter were 10 basis points higher when compared to the first quarter of 2013 and 230 basis points higher when compared to the second quarter of 2012. Our second quarter marks the seventh consecutive quarter of gross margin improvement. The improvement in gross margins was attributed to our cost-reduction activities of high runner ICs, a favorable mix of products and continuous measures to optimize production efficiencies and tight inventory controls. Our second quarter 2013 non-GAAP gross margins excluded equity-based compensation expenses. Our cost-control initiative drove a 9th straight quarter of improvements in operating cost and contributed to our third consecutive quarter of non-GAAP operating profitability. The financial restructures initiatives that began in mid-2011 have also enabled us to achieve GAAP profitability for the second consecutive quarter. We ended the second quarter with non-GAAP operating expenses of $13.3 million, representing a reduction of 20% year-over-year and 4%, sequentially. Our non-GAAP operating income for the second quarter was $2.9 million or 7% of revenues, as compared to non-GAAP breakeven for the second quarter of 2012 and non-GAAP profit of $1.9 million or 5% of revenues in the first quarter of 2013. As I already mentioned, the second quarter was also profitable on a GAAP operating income basis. This was achieved despite the inclusion of approximately $1.4 million of nonrecurring proxy contest-related cost in our second quarter operating expenditures. Our EBITDA grew for the seventh consecutive quarter to approximately $3.4 million, reaching 8% of revenues. Our non-GAAP net income for the second quarter was $3.5 million and non-GAAP diluted EPS were $0.15 per share, as compared to net income of approximately $0.5 million and EPS of $0.02 for the second quarter of 2012. Our non-GAAP results excluded proxy contest-related expenses, amortization of intangible asset, equity-based compensation expenses and the tax benefit from amortization of deferred tax liability related to intangible assets. Our cash and cash equivalents balance remained unchanged, and at the end of the quarter were approximately $120 million. In a moment, Dror will provide you with more details on our cash flow statement. Moving on to our business segment and recent developments. Our goal is to diversify our revenue base through investments in new market opportunities is on track. And we have unanimous support of our board for these growth plans. And now, starting to update you on the home vertical. So in the home gateways, we're very excited to report to you that Orange, one of Europe's leading service providers, chose to integrate our DECT/CAT-iq product across all of its recently launched third-generation gateways, including Livebox Play and Livebox Pro. These home gateways offer residential customers multiline, multi-handset support, easy pairing phonebook synchronization and high-definition voice. Orange Liveboxes are now shipping in mass quantities in France. And one of our other major OEM customers is offering matching DECT/CAT-iq handsets called Livephones [ph]. Another noteworthy development has been the mass deployment of a new mainstream cable modem for the client that integrates our DECT/CAT-iq ICs by a leading U.S. cable MSO. This is the first time that the major U.S. service provider has integrated DECT technology in a mainstream home gateway. A successful launch and deployment of new voice services by that cable operator should trigger more service providers to adopt DECT/CAT-iq in their offering and offer enhanced telephony services in high definition voice quality. Moving to the DECT ULE segment. The notion that DECT standard is relevant only for voice calls is changing. The ULE Alliance, which was established earlier this year, began promoting the worldwide availability and market adoption of the DECT ULE to address the growing requirements of smart home and smart energy. Device makers, technology vendors and service providers are adopting the ETSI specification for the ULE standard that was published in April of this year. These activities are sending a coherent message to the industry about ULE and its future in the home. Service providers worldwide are offering new services like home automation, safety and control as new potential revenue sources. Several such industry bellwether, including 2 of Europe's leading operators which already are using our DECT/CAT-iq 2.0 products in the home gateways, are in advanced stages of technology evaluation and launching new services and are committed to launch new home services on ULE, leveraging their existing infrastructures of millions of home gateway CPEs that already include DECT. By utilizing their existing home gateways, which are deployed in the field, they can support DECT ULE through software update only. This gives service providers unparalleled value proposition, allowing them to create an infrastructure to fully support new home services at little to no incremental cost. Geographically, sales of our cordless DECT product for the European and rest of the world end markets in the second quarter were within expectations and concluded the product replenishment cycle that began in the fourth quarter of 2012. Our revenues declined by approximately 9% sequentially, while grew by 9% year-over-year. Sales of DECTs products to the European and ROW and the rest of the world end markets accounted for 43% of our revenues as compared to 36% for the second quarter of 2012 and 48% for the first quarter of 2013. Now sales of DECT products for the North American end markets in the second quarter were better than expected and recovered from the weaker first quarter and advanced 22% sequentially, while declined by 19% versus the second quarter of 2012. Sales of DECT 6.0 products for the North American end markets accounted for 41% of our revenues versus 47% for the second quarter of 2012 and 35% for the first quarter of 2013. Now moving on to the voice and office products. Sales of our office Voice over IP products were approximately $2.3 million for the quarter, slightly below our expectations, mainly due to a push-out request by a single OEM customer. However, Voice over IP revenues were up still 62% year-over-year. We remain well positioned to expand our office Voice over IP business moving forward, with a strong pipeline of design opportunities and very strong interest from prospective customers. We're excited about this growth opportunity and are seeing the benefits of our investments and focus on this segment. Our unique value proposition enable us to expand our market share moving forward, especially with the Tier 1 customers, and to establish DSP Group among the 2 leading IC vendors in this domain. During the second quarter, we secured 2 additional design wins for DVF99, our new Voice over IP processor, with leading OEMs. We are on track to accelerate production ramp-up and have pulled in our schedule to late in the third quarter 2013 in order to support 2 leading OEMs mass production requirement, that from our original target schedule of early next year. Moreover, during the second quarter, Latin America's market leader, Intelbras, launched a lineup of IP phones powered by our Voice over IP platform. And this quarter, a leading Chinese OEM will launch a series of IP phones for small-medium enterprise based on our Voice over IP platform, followed by a leading U.S.-based, Tier 1 OEM customer, which will launch an analog terminal adapter product based and our Voice over IP ICs. Now I'm moving to the mobile market and as reported in our previous call, HDClear and the DBMD2 audio processor were launched at the Mobile World Congress in Barcelona in February. HDClear includes a comprehensive suite of voice enhancement features for mobile devices incorporating proprietary noise reduction, powerful acoustic echo canceller and additional voice enhancement algorithms, which dramatically improve user experience and deliver unparalleled voice quality and call intelligibility to mobile device users. As planned, we began in the second quarter to provide samples to select customers. We are working closely with these OEM and mobile network operators who are in the process of evaluating and testing our technology for their target products and requirements. We're seeing positive traction for HDClear and DBMD2 across a number of product segments including smartphones, PCs and wearable devices. We are further enhancing our offering by the inclusion of a voice activation feature from one of our partners, Sensory, targeted at smartphones and wearable devices. We see a growing demand for low-power voice activation features in the mobile device arena in which consumers require eyes-free and hands-free input option. We can now deliver an important feature as part of our comprehensive suite of voice enhancement features. Now turning to our business outlook. For the third quarter of 2013 and based on bookings we received from customers, we expect the sales of DECT products for the European and rest of the world end markets to soften in the third quarter, as the inventory replenishment cycle is over and demand in European countries remains sluggish. We're also seeing a weaker demand for our DECT 6.0 products for the North American end market in the third quarter following the softer-than-expected demand in May and June at U.S. retail stores. Our revenue guidance for the third quarter is expected to be in the range of $33 million to $37 million, implying a sequentially down third quarter. Despite the uncertain market condition that surround our cordless market, we shall continue to execute on our business plan in a prudent manner and continuously focus on generating positive operating profitability in the third quarter as our track record has shown. We remain focused on executing our business plan and diligently continuing our successful transition from existing cordless telephony product to new product lines and market domains that will bring new revenue streams to DSP Group and create value for all of our stockholders. 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 second quarter of 2013 from top to bottom. For each line item, I will provide the year's GAAP results, as well as the equity-based compensation expenses included in that line item and the expenses related to previous acquisitions. Our revenues for the quarter were $40.7 million. Gross margin for the quarter was 39.7%. 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 $16.1 million, including equity-based compensation expenses in the amount of $1 million, proxy contest-related expenses in the amount of $1.4 million, consisting of legal, solicitation and other consulting fees and amortization of acquired intangible assets in the amount of $0.4 million. Our financial income for the quarter was $0.8 million. Income tax for the quarter was $0.1 million, and included the tax benefit resulting from the amortization of deferred tax liability related to intangible assets in the amount of $0.1 million. Net income was $0.8 million, including equity-based compensation expenses of $1 million, amortization of intangible assets of $0.4 million, proxy contest-related expenses in the amount of $1.4 million and the tax benefit resulting from the amortization of deferred tax liability in the amount of $0.1 million. Non-GAAP net income, excluding the items I just described, was $3.5 million. U.S. GAAP diluted earnings per share was $0.03. The negative impact of proxy contest-related expenses on the EPS was $0.06. The negative impact of equity-based compensation expenses on the EPS was $0.05. The negative impact of amortization of the acquired intangible assets on the EPS was $0.02, and the positive impact of tax benefit was $0.01. Non-GAAP diluted earnings per share, excluding the items I just described, were $0.15. Please see the current report on Form 8-K that we filed with the SEC this morning for a full reconciliation of the non-GAAP presentation to the GAAP presentation. Now turning to the balance sheet. Accounts receivable increased from $24.5 million at the end of the first quarter to $24.9 million, representing a level of 55 days of sales. Inventory increased from $14.1 million at the end of the first quarter to $15.3 million, representing a level of 56 days. Our cash and marketable securities at the end of the quarter remained at the same level as it was at the end of the first quarter, the level of $119.8 million. Our cash and marketable securities position during the quarter was affected by the following

[Operator:]

[Operator Instructions] We will now take our first question from Daniel Amir from Lazard.

[Daniel L. Amir:]

So with the European market being, I guess, demand has been soft there for quite a while here. I mean, is there any change here in terms of the inventory correction that you're seeing here versus previous quarters? Because it doesn't sound like Europe has been strong for long a period. And then the second, what specifically is going on in the U.S.? I mean, you just said that U.S. had a pretty good June quarter, with May, June, being softer here as of late. So would like to get some clarification there.

[Ofer Elyakim:]

Daniel, so thanks for the question. So regarding the European market, so true, European market demands remain sluggish as kind of consumers' confidence is fairly low. Austerity measures are not helping any kind of discretionary consumption. But what you need to realize, since this is a fairly fragmented supply chain, then we are basically kind of going through this inventory replenishment to depletion cycles, which are kind of adding a lot more volatility in our result and the trends that we're seeing because this is kind of how things find their way to retail. So there the ODMs -- there's us, the semiconductor vendor, there are the ODMs, there are the brand and then there is retail. So the European market is a little bit kind of more fragmented and includes another station in the food chain. Having said that, while it is true that the European market has been weak for quite a while and what we have seen is that -- so since the Q4 of 2012 into Q1 and I would say til the middle of Q2, we did see kind of a replenishment cycle where you saw like a -- while European market was still down from a consumer standpoint, our shipments were higher than last year. And so this is kind of a summary of what's happening in Europe. We do hope that as we will see kind of the European economies recovering and getting out of this depression cycle, that we will start to see a back to normality with respect to these -- to our category. Some of our customers are launching kind of very nice and new features, like nuisance calls and all kinds of newly launched products that are actually seeing very nice reception and very nice demand. But I think that definitely, the environment out there in the consumer atmosphere is not helping sales and we're seeing a lot of kind of cyclical pressure as a result of a -- the sluggish European demand. Moving on to the U.S. market. So in the U.S. market, the market is mainly built out of brands, which are kind of vertically integrated. You don't have like the ODM in the food chain. And so the businesses should be kind of more simpler to understand. And what has happened during the last couple of years, I think, and you've seen it in our result, that we saw now for the fourth straight year where we see kind of a higher first half followed by a softer second half. And what is prompting this slightly softer third quarter in the U.S. market are actually trends that we're seeing at the kind of the point of sale in which indicate a slightly softer-than-expected May and June, and what our customers are doing, kind of trying to adjust their manufacturing to that. However, if we will see a stronger recovery during the third quarter and onwards as a result of many cyclical things that are happening, like a stronger real estate market, a lot more transaction, this is usually a catalyst for a new phone sale or a replacement cycle. And so kind of we're hopeful to see that change as we move along. So right now, July, I would say, looks better than the previous months. So we're hopeful that, that dynamic will change, but we're still not out of the woods yet.

[Daniel L. Amir:]

So given this type of seasonality change, I mean, is Q4 tends to be now down compared to Q3? Or this now an up quarter compared to Q3, given the change of your first half versus second half?

[Ofer Elyakim:]

It's really hard to call Q4 at the moment since, as you can understand, there's a lot of volatility that is kind of surrounding this market, with all these like replenishment-depletion cycles that we're talking about, so it's very hard to call Q4. Right now, we don't see a reason for, like, a major weakness or by -- in any way. But on the other side, it's kind of very hard to comment on whether Q4 would be stronger than Q3. So I would say that we'll need to wait kind of for the next call to kind of get a better view and clarity on how Q4 looks like.

[Daniel L. Amir:]

Okay. And then my final question then I'll get back into the queue. On just the HDClear, I mean, what are the couple of milestones that we should be looking at here in the next 6 months in terms of success with that product?

[Ofer Elyakim:]

So what we should be looking for are our ability to get a design in into the categories that I mentioned. And we mentioned 3 main categories of smartphone, which is a category that we've been focusing on since the Mobile World Congress. And we have started delivering engineering samples. I would say that so far, our performance is good. Our ability to do noise cancellation and still kind of hit the thresholds of voice quality is fairly good. And so what we need to do is kind of move from the evaluations into the design in and then to a design win phase. And this is kind of what we're focusing on, and I think that when we kind of look at, let's say, the next 12 months, and this is kind of where we need to see the design wins kind of being placed. So we are working hard on making sure that we will see these successful, entering into this market. Plus we have begun also to work on some new opportunities, and I discussed in the area of kind of the upcoming consumer -- new consumer products, we're also kind of active there. And there's a lot of interest and need for voice-related man-machine interface and a lot of the features, the unique features that HDClear can bring to the table. So over there, we're also -- we see some very promising new starts with some exciting products.

[Operator:]

[Operator Instructions] I'll take our next question from Jeff Meyers from Cobia Capital.

[Jeffrey Meyers:]

Great. Maybe you could talk a little bit more about the Voice over IP business, the sort of, the sort of wins you're getting and the sort of traction you're seeing in the wins that you already have?

[Ofer Elyakim:]

Sure. So, Jeff, thank you for the question. As I updated in my prepared comments, we have -- based on 2 customers' requirements, we have pulled in the mass production dates of the new voice processor into kind of late in September. And so we're seeing, actually, a lot of pressure for kind of pooling some customers. So the way that this silicone is going to get into mass production is we have 2 lead customers who are basically taking this chip to production. And following that, we have an additional 2 customers that will launch products following the launch of the first 2. We are, again, the -- our key milestone here is to win Tier 1 sockets. And this is what we are diligently working on. And I think that we're on the right track to win these kind of strategic opportunities and become among the 2 leading vendors in this domain. And so this is our plan. And so far, we have been very successful in penetrating all of the Tier 3 accounts, Tier 2. We have some Tier 1 business. But what we are after is kind of the real -- a higher-volume type of designs. And I think that today we have one of the best, actually the best product in the market with the right architecture and all the right features. The best -- one of the best acoustic echo cancellers in the market, a lot of voice features. And so I think we have a very good delivery and a very good product and also pipeline of opportunities.

[Operator:]

[Operator Instructions] It would appear that there are no questions at this time. I will now hand back to the speakers for any closing remarks.

[Ofer Elyakim:]

Thank you. Thank you, all, for participating and we look back to reporting again in 90 days. Thank you.

[Operator:]

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