DSP Group, Inc.
Q3 2013 Earnings Call Transcript

Published: 31 Oct 2013

[Operator:]

Good day, and welcome to the Q3 2013 DSP Group Earnings Conference Call. 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, sir.

[Christopher Basta:]

Good morning, ladies and gentlemen. I am Chris Basta, Director of Investor Relations at DSP Group. Welcome to our third 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 fourth quarter of 2013; optimism about market opportunities for our new product lines, including HDClear, DECT/CAT-iq and office Voice over IP products; prevalence of 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 Form 10-K in 2012 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 hope that 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 third quarter 2013 and then comment on the progress that we're making in our business plan, including design wins and recent market developments around the new product segments. And in a short while, Dror will provide you with detailed comments on our financial results and update you on our outlook for the fourth quarter. Our financial results for the third quarter exceeded our guidance in almost every financial metric and demonstrate continued progress in our turnaround and in our business performance, and all of that despite the uncertain market dynamics surrounding the cordless market. Third quarter revenues of $35.4 million were slightly ahead of the midpoint of our guidance range. Our revenues declined by approximately 4% year-over-year and by 13% sequentially, reflecting the emerging seasonal pattern of our business in recent years where a higher first half of the fiscal year is followed by a lower second half. Our customs code initiative drove a 10th straight quarter of improvements in operating costs, our fourth consecutive quarter of non-GAAP operating profitability and our third consecutive quarter of GAAP net income for the first time since 2007. Additionally, our cash and cash equivalents balance grew by $5 million in the third quarter to approximately $125 million. Now moving onto business segments and the recent events. During this year, we have successfully executed on our business plan and have built a solid foundation for new revenue sources across enterprise Voice over IP, mobile and home automation. Our products and technologies are being recognized and adopted by the market. And our efforts are starting to bear fruits in the form of field trials, design wins and initial revenue generation. The hard work and accomplishments of our team to-date are paving a smooth path towards meeting key milestones, including securing design wins with Tier 1 OEMs and generating meaningful revenues. Now I will review the specific segments. In the home vertical, which is comprised out of cordless phones, home gateways and ULE, I'll start by the cordless market. Our sales of DECT products for the European and in rest of the world end markets in the third quarter were ahead of plan and were flat, both sequentially and year-over-year, and accounted for approximately 48% of revenues. Sales of DECT products for the North American end markets were lower than expected and declined by 8% versus the third quarter of 2012. Sales of DECT 6.0 products for the North American end market accounted for approximately 35% of our revenues. In the home gateways, we are encouraged by the strong market adoption of DECT/CAT-iq by leading service providers worldwide. Swisscom, a major European telecommunication operator, should start next shipments of its new line home gateways in the fourth quarter. This gateway integrates our DECT/CAT-iq 2.0 product across its target lineup. Moreover, the DECT phone has recently launched a CAT-iq 2.0 certification program for the U.S. market. CAT-iq 2.0 will enable U.S. fixed line and cable customers to make high-definition voice calls, as well as benefit from other valuable services. We believe that the time is of importance as a major U.S. cable MSO has already begun to update its entire network to offer high-definition voice. This new certification program opens up for DSP Group additional growth opportunities in the U.S. with additional U.S. service providers and MSOs. Turning now to home automation. OEMs and leading service providers are realizing the benefits and value that ULE technology brings with its proven reliability and the extended range of the DECT's radio technology, as well as its large installed base of hundreds of millions of homes worldwide. We recently announced that Deutsche Telekom, one of the world's leading and influential telecommunication operators, would trial our ULE technology in its Speedport home gateways, which already include DECT's connectivity to enable smart home services to its end customers. This is an important development. It provides a clear signal of awareness to ULE of viability and fit, creates an immediate need for ULE-enabled devices and home gateways. It creates a catalyst for additional service providers to try the ULE technology. The unique benefits of ULE technology make it a natural choice for service providers who would like to leverage the existing home gateway boxes and extend their offering to include home monitoring and automation services. Moving to the office vertical. Sales of our Voice over IP products were approximately $1.9 million below our expectation, due to weaker product demand by 2 OEM customers, mainly attributed to inventory accumulation. We view this weakness as temporary and expect the inventory rebalancing situation to be resolved by the first quarter of 2014. Despite this shortened softness, we remain well-positioned to expand our Voice over IP business in 2014 and meet our goal of securing design wins with Tier 1 OEMs in the enterprise Voice over IP market as evidenced by the strong interest from target customers and a robust pipeline of design opportunities. And during the third quarter, Yealink, a top 5 global SIP phone vendor, began shipments of several IP phone models based on our highly integrated Voice over IP chipset. As reported in our previous call, we successfully met the milestone of mass production over our new DVF99 Voice over IP IC, and are pleased to announce that our 2 leading customers, a Japanese OEM and a U.S.-based IP Voice over IP telephony OEM, have already launched multiple models to the market based on DVF99 resourcing. Passing the mass production milestone successfully is an important step in the path towards securing design wins with other Tier 1 OEMs. Now moving onto the mobile segment. During the third quarter, we successfully progressed towards advanced stages of evaluation of the HDClear technology. HDClear includes a comprehensive suite of voice enhancement features for mobile devices incorporating proprietary noise reduction technology, speech recognition maximization and additional voice enhancement algorithm, which dramatically improves user experience and deliver unparalleled voice quality and call intelligibility to mobile device users. We are seeing successful progression of HDClear into advanced stages of evaluations across several market segments, including smartphones, PCs and wearable devices. Moreover, the mobile industry is driving fast towards better voice experience and improving call intelligibility and a growing number of mobile handsets in there to incorporate to support high-definition voice today over 2G and 3G networks and will offer, in 2 to 3 years time, high-definition voice via Voice over LTE or VoLTE. This transition requires even better noise suppression and voice enhancement features. Beyond voice communications, over-the-top video calls through Skype, FaceTime and the likes are becoming a popular use case. And there's also a growing use of speech recognition for search and command in smartphones, PCs, tablets and wearable devices. All of this translates into a growing need for noise suppression and speech enhancement technologies to maximize intelligibility and accuracy. In summary, we remain focused on executing our business plan and are diligently continuing our successful transition from existing cordless telephony product to new product line and market domains that we bring new revenue streams to DSP Group and create value for all of our stockholders. We expect to show you a successful transition and meaningful wins and revenues from these new market verticals in the next quarters. 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 third quarter of 2013 from top to bottom. For each line item, I will provide the U.S. GAAP results, as well as the equity-based compensation expenses included in that line item and the expenses related to previous acquisitions. Our revenues for the quarter were $35.4 million. The gross margin for the quarter was 39%. Gross margin for the quarter included equity-based compensation expenses in the amount of $0.1 million. R&D expenses were $8.1 million, including equity-based compensation expenses in the amount of $0.5 million. R&D expenses were lower than previously expected, mainly due to the receipt of funding from the Israeli chief scientist in the amount of approximately $1.2 million. Out of this amount, approximately $0.8 million is their interactive [ph] contribution and relates to the first half of the year. As such, we expect our R&D expenses to go back to the level of $8 million to $10 million in the fourth quarter of 2013. Operating expenses for the quarter were $13.9 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. The financial income for the quarter was $0.5 million. Income tax for the quarter was $0.1 million and included the tax benefit resulting from the amortization of deferred tax liability relates to intangible assets in the amount of $0.1 million. Our net income was $0.4 million, including equity-based compensation expenses in the amount of $1.1 million, amortization of intangible assets of $0.4 million and a tax benefit in the amount of $0.1 million. Non-GAAP net income, excluding the items I've just described, was $1.8 million. GAAP diluted earnings per share was $0.02. The negative impact of equity-based compensation expenses on the EPS was $0.05. The negative impact of the amortization of acquired intangible assets was $0.02. And the positive impact of the tax benefit was $0.01. The non-GAAP diluted earnings per share, excluding the items I've just described, were $0.08. 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 decreased from $24.9 million at the end of the second quarter to $22.7 million, representing a level of 58 days of sales. Inventory decreased from $15.3 million at the end of the second quarter of 2013 to $13.1 million, representing a level of 55 days. Our cash and marketable securities increased by $5.3 million during this quarter and reached a level of $125.1 million. Our cash and marketable security position during the quarter was affected by the following

[Operator:]

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

[Daniel L. Amir:]

So a few questions here. First of all, in some of your new markets here, the home automation, the Voice over IP and the mobile, it looks like you're ending the year here with probably a little less revenues than what you thought you would here in these segments. Can you walk us through each segment? What are the points that we need to look at for next year in order to show success in these markets? I'm just trying to look at certain milestones that we should be looking at in order to see whether you've been successful here or not.

[Ofer Elyakim:]

Daniel, thanks for the question. So with respect to these different market verticals, as you define them, home automation, voice and mobile, each of them has its own way of development and progress. And as I said, some of these markets, in some of these markets, the opportunity is really to get a design win, a meaningful design win with Tier 1 OEMs. Some of these verticals are already generating revenues. And some of them are basically proving the technology and making sure that it gets adopted by the leading vendors in the market. So if we start with Voice over IP. So Voice over IP today is a revenue-generating business from us. We believe that during 2014, it will continue to grow from the levels of -- sorry, in 2013, it will continue to grow versus what we've achieved in 2012. We are confident in our market position. We rank today #3 in Voice over IP silicone. There are 2 companies that are ahead of us. One of them is in the process of going out. So that will create -- and that creates already a significant market opportunity that we're already realizing and getting design win as a result of this vendor exiting this market. Our DVF99, the fact that it went to production, is a very important step in actually assuring that the Tier 1 OEMs that we're targeting for a design win in, let's say, in the next couple of months, a quarter or 2, will actually be able to select us because they will see that our platform is already in production. And as the market -- available in the market in many models, in different ways, shapes and forms of the IP phones. And this is kind of the key milestone for Voice over IP to turn from a level of a couple of million dollars per quarter or $10 million per year to something more significant. And this is very high up on our plan. And these are the key milestones. And we expect to meet them in the next couple of quarters. On the Voice over IP side, we believe that once we will be able to establish in the Tier 1 side, we will be able to advance to become the #2, and later on, the #1 in this market domain. So today, we're definitely recognized as a market leader as 1 of the top 3. And after we execute well on the milestones, we'll be able to advance much higher. On the home automation front, as you know, we're promoting a new technology called ULE ultralow technology. This is a new variable of DECT that is basically taking all the goods and all the strengths of DECT and repackaging it in an ultralow energy protocol stock for home automation, home monitoring, security systems, et cetera. These standards will officially launch. And there is basically a draft of this standard available from March of this year. There's a new alliance called the ULE Alliance that was also put together in March of this year. It already has about 40 members, including a lot of parties that are not necessarily DECT incumbents, including many operators, companies like Netgear and then many other type of kind of nonstandard DECT vendors. The main goal with ULE is, first of all, to get it well-established, recognized, to bring the buzz that there's another ultralow energy technology in addition to the incumbent standouts like ZigBee and Z-Wave, a technology that has a lot of merit with respect to interference-free spectrum with respect to a better range, with respect to more services, so DECT can do in addition to just signaling also voice and video. And I would say that we're coming to a phase where this awareness is happening. And as we told you, and as we've announced, Deutsche Telekom, which is one of the more influential operators, is starting the field trial for ULE in its gateway. There are a number of other operators that are asking and demanding that the gateways with DECT are also going to support ULE. We're seeing security companies starting to embrace DECT, first from the main merits of DECT like voice. And so this market is, for us, already now in production. So meaning, we're generating revenues, initial revenues from ULE. But in order to make it a much bigger part of the pie, we need to go through this introduction phase, complete field trials and then go to kind of the next phase, which will constitute launch of new services by this type of service providers, whether these are telecommunications service providers or security service provider or utility service providers. And then this will become kind of the next phase of growth. Our early revenues are coming from usage of ULE for a retail product. So the do-it-yourself category. And the next phase will also come from a service provider market. So this is on the ULE side. On mobile, as you know, we've launched, in the Mobile World Congress, the HDClear technology targeted for telephones and other mobile devices. And we've basically began the sampling phase in May of this year. So today, we're able to demonstrate very, very good performance. And we are already engaged with top OEMs that are taking us through all the process of the evaluation and the validations of our solution. And we're in fairly advanced phases. And what we need this to be concluded in a design win and to then go to the next chapter, which is production. And we expect that to happen in 2014.

[Daniel L. Amir:]

So in 2014, you expect both the design win and shipments for an OEM handset player?

[Ofer Elyakim:]

Right, right. So yes, both revenues in 2014. Correct.

[Daniel L. Amir:]

Okay, great. And then just in terms of your gross margins outlook, how should we be looking at that as your mix changes here? Should it remain kind of in this 38% to 40% range? Or should we expect any changes there?

[Ofer Elyakim:]

So I think that we're comfortable at the levels that we're in, in the area of the high 30s. So 38 to 40s is, I think, kind of the right number or the right range.

[Daniel L. Amir:]

Got you. And then last question, and then I'll get back in queue. In terms of just seasonality of your business, I mean, obviously, I mean it's changed a lot over the years. I mean, how should we be looking at Q1 in terms of typical seasonality in the DECT business?

[Ofer Elyakim:]

So I think that the best guidance for that is to look at the last 3 to 4 years and how the seasonality pattern really shaped up. It was like a higher first fiscal or calendar year followed by a softer second half and then kind of resumed back in the first half that followed. So right now, since we're not ready to give any kind of specific guidance, and our visibility remains fairly low. I would say that the best way is to look at kind of how historically or in the last 3 years seasonality has shaped up and kind of based on that, try to model our performance.

[Operator:]

[Operator Instructions] As there are no further questions in the queue, that will conclude today's Q&A session. I would now like to turn the call back to Mr. Dror Levy for any additional or closing remarks.

[Dror Levy:]

Thank you, operator. Thank you, all, for joining us today. And we look forward to reporting back 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.