DSP (DSPG) 10-Q 2001 Q1 Quarterly report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

/x/
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2001

or

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to              

Commission File Number 0-23006

DSP GROUP, INC.
(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)	94-2683643 (I.R.S. employer identification number)
3120 Scott Boulevard, Santa Clara, California (Address of Principal Executive Offices)	95054 (Zip Code)

Registrant's telephone number, including area code:(408) 986-4300

    Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/  No / /

    As of March 31, 2001 there were 26,520,541 shares of Common Stock ($.001 par value per share) outstanding.

INDEX

DSP GROUP, INC.

		Page No.
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed consolidated balance sheets—   March 31, 2001 and December 31, 2000	3
	Condensed consolidated statements of income—   Three months ended March 31, 2001 and 2000	4
	Condensed consolidated statements of cash flows—   Three months ended March 31, 2001 and 2000	5
	Condensed consolidated statements of Stockholders' Equity—   Three months ended March 31, 2001 and 2000	6
	Notes to condensed consolidated financial statements—   March 31, 2001	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of   Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	17
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	18
Item 2.	Changes in Securities and Use of Proceeds	18
Item 3.	Defaults upon Senior Securities	18
Item 4.	Submission of Matters to a Vote of Security Holders	18
Item 5.	Other Information	18
Item 6.	Exhibits and Reports on Form 8-K	18
SIGNATURES		19

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PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DSP GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(US dollars in thousands)

		March 31, 2001			December 31, 2000
		(Unaudited)			(Audited)
Assets
Current assets:
	Cash and cash equivalents	$	82,154		$	45,035
	Marketable securities and short term deposits		145,186			178,166
	Trade receivables, net		14,020			16,932
	Inventories		2,898			2,815
	Deferred income taxes		4,554			4,554
	Other accounts receivable and prepaid expenses		1,752			1,445
Total current assets			250,564			248,947
Property and equipment, at cost:			20,662			19,526
	Less accumulated depreciation and amortization		(13,620	)		(13,075	)
			7,042			6,451
Long term assets:
	Other investments, net of accumulated amortization		21,043			21,000
	Other assets, net of accumulated amortization		6,991			4,259
	Severance pay fund		2,116			2,150
Total long term assets			30,150			27,409
Total assets		$	287,756		$	282,807
Liabilities and Stockholders' Equity
	Current liabilities:
	Trade payables	$	6,964		$	8,092
	Other current liabilities		16,476			19,934
Total current liabilities			23,440			28,026
Long term liabilities
	Accrued severance pay		2,169			2,147
	Deferred income taxes		5,559			5,559
	Minority interest		—			910
			7,728			8,616
Commitments and contingencies
Stockholders' equity:
	Common Stock		27			27
	Additional paid-in capital		155,438			151,787
	Other comprehensive income (loss)		(82	)		—
	Retained earnings		118,463			114,291
	Less cost of treasury stock		(17,258	)		(19,940	)
Total stockholders' equity			256,588			246,165
Total liabilities and stockholders' equity		$	287,756		$	282,807

Note: The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date.
See notes to condensed consolidated financial statements.

3

DSP GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(US dollars in thousands, except per share amounts)

		Three Months Ended March 31,
		2001			2000
Revenues:
	Product sales	$	18,048		$	18,362
	Licensing, royalties and other		6,126			5,024
Total revenues			24,174			23,386
Cost of revenues:
	Cost of product sales		9,683			10,475
	Cost of licensing, royalties and other		324			323
Total cost of revenues			10,007			10,798
Gross profit			14,167			12,588
Operating expenses:
	Research and development, net		6,272			4,676
	Sales and marketing		2,735			2,853
	General and administrative		1,696			1,292
	Unusual items		—			14,154
Total operating expenses			10,703			22,975
Operating income (loss)			3,464			(10,387	)
Financial and other income (expense):
	Interest and other income		3,467			2,795
	Interest and other expense		(84	)		(42	)
	Equity in income of affiliates		105			437
	Minority interest in losses of subsidiary		173			—
	Capital gain from realization of investments		—			40,009
Income before provision for income taxes			7,125			32,812
Provision for income taxes			(1,463	)		(17,403	)
Net income		$	5,662		$	15,409
Net earnings per share:
	Basic	$	0.21		$	0.60
	Diluted	$	0.21		$	0.54
Shares used in per share computations:
	Basic		26,415			25,790
	Diluted		27,438			28,413

See notes to condensed consolidated financial statements.

4

DSP GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(US dollars in thousands)

		Three Months Ended March 31,
		2001			2000
Net cash provided by operating activities		$	4,205		$	5,422
Investing activities
	Purchase of marketable securities and short term deposits		(17,409	)		(21,674	)
	Maturity of marketable securities and short term deposits		50,423			18,212
	Purchases of property and equipment		(1,389	)		(393	)
	Proceeds from sale of property and equipment		97			—
	Proceeds from sale of investment—net		—			27,498
	Cash acquired in acquisition of consolidated subsidiary		—			106
Net cash provided by investing activities			31,722			23,749
Financial activities
Issuance of Common Stock for cash upon exercise of options and employee stock purchase plan			1,192			7,686
Net cash provided by financing activities			1,192			7,686
Increase in cash and cash equivalents		$	37,119		$	36,857
	Non-cash investing and financing information:
	Acquisition of VoicePump shares in exchange of Issuance of Common Stock	$	3,651		$	—

See notes to condensed consolidated financial statements.

5

DSP GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(US dollars in thousands)

		Common Shares	Stock Amount		Additional Paid-In Capital			Retained Earnings			Treasury Stock at Cost			Other Comprehensive Income (Loss)			Total Stockholders' Equity
Three Months Ended March 31, 2001
Balance at December 31, 2000		26,248	$	27	$	151,787		$	114,291		$	(19,940	)	$	—		$	246,165
Net income		—		—		—			5,662			—			—			5,662
Unrealized loss on held to maturity marketable securities		—		—		—			—			—			(62	)		(62	)
Unrealized loss from hedging activities		—		—		—			—			—			(20	)		(20	)
	Comprehensive income	—		—		—			—			—			—			5,580
Issue of Common Stock, upon purchase of subsidiary		161		—		3,651			—			—			—			3,651
Exercise of Common Stock Options by employees		82		—		—			(1,169	)		1,980			—			811
Sale of Common Stock under employee stock purchase plan		29		—		—			(321	)		702			—			381
Balance at March 31, 2001		26,520	$	27	$	155,438		$	118,463		$	(17,258	)	$	(82	)	$	256,588
Three Months Ended March 31, 2000
Balance at December 31, 1999		12,671	$	12	$	119,163		$	64,782		$	—		$	—		$	183,957
Net income		—		—		—			15,409			—			—			15,409
	Comprehensive income	—		—		—			—			—			—			15,409
Issue of Common Stock, upon purchase of subsidiary		261		—		14,897			—			—			—			14,897
Exercise of Common Stock options by employees		14		—		296			—			—			—			296
Sale of Common Stock under employee stock purchase plan		428		1		7,390			—			—			—			7,391
Stock split adjustment		13,069		13		(13	)		—			—			—			—
Balance at March 31, 2000		26,443	$	26	$	141,733		$	80,191		$	—		$	—		$	221,950

6

DSP GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2001
(UNAUDITED)

NOTE A—BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT

ACCOUNTING POLICIES

    The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2001, are not necessarily indicative of the results that may be expected for the year ended December 31, 2001. For further information, reference is made to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2000.

NOTE B—INVENTORIES

    Inventories are stated at the lower of cost or market value. Cost is determined using the average cost method. The Company periodically evaluates the quantities on hand relative to current and historical selling prices and historical and projected sales volume. Based on these evaluations, provisions are made in each period to write inventory down to its net realizable value. Inventories are composed of the following (in thousands):

	March 31, 2001		December 31, 2000
Work-in-process	$	175	$	34
Finished goods		2,723		2,781
	$	2,898	$	2,815

NOTE C—NET EARNINGS PER SHARE

    Basic net income per share is computed based on the weighted average number of shares of common stock outstanding during the period. For the same periods, diluted net income per share further includes the effect of dilutive stock options outstanding during the period, all in accordance with the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share"

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("SFAS 128"). The following table sets forth the computation of basic and diluted net income per share (in thousands except per share amounts):

		Three Months Ended March 31,
		2001		2000
Numerator:
	Net Income	$	5,662	$	15,409
Denominator:
Weighted average number of shares of common stock outstanding during the period used to compute basic earning per share			26,415		25,790
Incremental shares attributable to exercise of outstanding options (assuming proceeds would be used to purchase treasury stock)			1,023		2,623
Weighted average number of shares of common stock used to compute diluted earnings per share			27,438		28,413
Basic net earnings per share		$	0.21	$	0.60
Diluted net earnings per share		$	0.21	$	0.54

NOTE D—INVESTMENTS

    The following is a summary of the held to maturity securities and cash deposits (in thousands):

	March 31 2001		December 31, 2000
Obligations of states and political obligations	$	9,224	$	52,253
Corporate obligations		119,769		110,916
Cash deposits		98,347		58,270
	$	227,340	$	221,439
Amounts included in marketable Securities and cash deposits	$	145,186	$	178,166
Amounts included in cash and cash equivalents		82,154		43,273
	$	227,340	$	221,439

    At March 31, 2001 and at December 31, 2000, the carrying amount of securities approximated their fair market value and the amount of unrealized gain or loss was not significant. Gross realized gains or losses for the three months ended March 31, 2001 and December 31, 2000, were not significant. The amortized cost of held to maturity securities at March 31, 2001, by contractual maturities, is shown below (in thousands):

	Amortized cost
Due in one year or less	$	86,822
Due after one year to two years		58,364
	$	145,186

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NOTE E—INCOME TAXES

    The effective tax rate used in computing the provision for income taxes is based on projected fiscal year income before taxes, including estimated income by tax jurisdiction. The difference between the effective tax rate and the statutory rate is due primarily to foreign tax holiday and tax exempt income in Israel.

NOTE F—SIGNIFICANT CUSTOMERS

    Product sales to one distributor accounted for 49% and 47% of total revenues for the three months ended March 31, 2001 and 2000, respectively. The loss of one or more major distributors or customers could have a material adverse effect on our business, financial condition and results of operations.

NOTE G—OTHER INVESTMENTS

    Other investments are comprised of:

    AudioCodes, Ltd.: AudioCodes, Ltd. ("AudioCodes") is an Israeli corporation primarily engaged in design, research, development, manufacturing and marketing of hardware and software products that enable simultaneous transmission of voice and data over networks such as the Internet, ATM and Frame Relay.

    We currently own approximately 4.5 million of AudioCodes shares, which represents approximately 11.1% of that company's outstanding shares. The condensed consolidated statements of income for the three months ended March 31, 2001 and 2000 include equity gains of $105,000 and $437,000, respectively, in our investment in AudioCodes. As of March 31, 2001, the fair market value of our investment in AudioCodes was approximately $39.5 million.

    VoicePump, Inc.: VoicePump, Inc. ("VoicePump") is a U.S. corporation primarily engaged in the design, research, development and marketing of software applications for Voice Over DSL (VoDSL) and Voice Over Internet Protocol (VoIP). In February 2001, we acquired the remaining founders' shares of VoicePump, Inc., for 161,433 shares of DSP Group common stock, as provided in the original stock-purchase agreement executed March 22, 2000. As a result of the purchase of the remaining equity, VoicePump became part of DSP Group's U.S. based broadband products group and will continue to focus on the development of its VP100 family of products, first announced last October.

    Our current investment in VoicePump included the excess of purchase price over net assets acquired (approximately $2,913,000 at the date of purchase), which was attributed to goodwill (to be amortized in seven years). The condensed consolidated statements of income for the three months ended March 31, 2001 include losses in our equity investment in VoicePump of approximately $1,108,000 and include the minority interest in those losses in the amount of $173,000.

    Tomen Ltd.: In September 2000, we invested approximately $485,000 (31.0 million Yen) in shares of our Japanese distributor's parent company, Tomen Ltd., as part of a long term strategic relationship. Tomen's shares are traded on the Japanese stock exchange, and are recorded and accounted for in other assets on our balance sheets as marketable available for sale securities. The condensed consolidated balance sheets as of March 31, 2001 include unrealized loss on marketable available for sale securities of $62,000 in our investment in Tomen Ltd.

NOTE H—IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

    In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, which is required to be adopted in fiscal years beginning after June 15, 2000. The Company adopted SFAS No. 133, as amended, as of

9

January 1, 2001. This Statement requires that all derivatives be recorded in the balance sheet at fair value and that changes in fair value be recognized currently in earnings unless specific hedge accounting criteria are met.

    On the date the Company enters into a derivative contract, management designates the derivative as a hedge of the identified exposure. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions.

    For foreign currency forward contracts designated as cash flow hedges, hedge effectiveness is measured based on changes in the fair value of the contract attributable to changes in the forward exchange rate.

    For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in current earnings during the period of change. Changes in the expected future cash flows on the forecasted hedged transaction and changes in the fair value of the forward hedge are both measured from the contract rate to the forward exchange rate associated with the forward contract's maturity date.

    A purchased currency put option's premium is amortized over the life of the option while any intrinsic value is recognized in salary expenses during the same period as the hedged transaction.

    To protect against the reduction in value of forecasted foreign currency cash flows resulting from salary payments over the next year, the Company has instituted a foreign currency cash flow hedging program. The Company hedges portions of its forecasted expenses denominated in foreign currencies with forward contracts and put options.

    At the end of first quarter of year 2001, the Company purchased put option contracts and entered into forward contracts to hedge a portion of the anticipated NIS payroll of its Israeli subsidiary for a period of two to ten months. These options contracts are designated as cash flow hedges, as defined by SFAS No. 133, and are all effective as hedges of these expenses.

    The company has not recognized any revenues or losses with in respect to cash flow hedges to date.

    As part of the above-mentioned hedging transactions, the Company recorded comprehensive loss amounting to $20,000 during the period ended March 31, 2001.

    At March 31, 2001, the Company expects to reclassify $20,000 of net losses on derivative instruments from accumulated other comprehensive income to expenses during the next twelve months due to expected salary payments.

NOTE I—CONTINGENCIES

    We are involved in certain claims arising in the normal course of business, including claims that we may be infringing patent rights owned by third parties. We are unable to foresee the extent to which these matters will be pursued by the claimants or to predict with certainty the eventual outcome. However, we believe that the ultimate resolution of these matters will not have a material adverse effect on our financial position, results of operations or cash flow.

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ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This management's discussion and analysis of financial condition and results of operations and other sections of this Form 10-Q contain forward-looking statements concerning our future products, expenses, revenue, liquidity and cash needs as well as our plans and strategies. These forward-looking statements are based on current expectations and we assume no obligation to update this information. Numerous factors could cause our actual results to differ significantly from the results described in these forward-looking statements, including those set forth in "Factors Affecting Future Operating Results" below.

RESULTS OF OPERATIONS

    Total Revenues.  Our total revenues were $24.2 million in the first quarter of 2001 compared to $23.4 million in the first quarter of 2000. This slight increase in the first quarter of 2001 compared to the same period in 2000 was due to our increased revenues from licensing sales. Product sales were approximately the same in the first quarters of 2001 and 2000. Our licensing and royalty revenues increased to $6.1 million in the first quarter of 2001 compared to $5.0 million in the same period of 2000 primarily due to two new licensees which are: Mobilink Telecom, Inc. and Oki Electric Industry Co., Ltd.

    Export sales, primarily consisting of Integrated Digital Telephony (IDT) speech processors shipped to manufacturers in Europe and Asia, including Japan, as well as license fees on DSP core designs, represented 88% of our total revenues for the three months ended March 31, 2001 and 92% of our total revenues for the three months ended March 31, 2000. All export sales are denominated in U.S. dollars.

    Revenues from a distributor, Tomen Electronics, accounted for 49% and 47% of our total revenues for the three months ended March 31, 2001 and 2000, respectively.

    Gross Profit.  Gross profit as a percentage of total revenues increased to 59% in the first quarter of 2001 from 54% in the first quarter of 2000. The increase in gross profit was partly due to an increase in license revenues, which typically generate a significantly higher gross profit than product revenues, as a percentage of total revenues. In addition, product gross profit as a percentage of product sales increased to 46% in the first quarter of 2001 from 43% in the first quarter of 2000, primarily due to the decreases in our costs of manufacturing. The Company managed to off-set the continued decline in average selling prices of certain of its products with decreases in manufacturing costs, partially due to technological improvements.

    Research and Development Expenses.  Our research and development expenses increased to $6.3 million in the first quarter of 2001 from $4.7 million in the first quarter of 2000. This significant increase was primarily due to the hiring of additional engineers associated with the acquisition of VoicePump, as well as to the increase in external services provided to our research and development team. Our research and development expenses as a percentage of total revenues were 26% in the three months ended March 31, 2001 and 20% in the three months ended March 31, 2000.

    Sales and Marketing Expenses.  Our sales and marketing expenses decreased slightly to $2.7 in the first quarter of 2001 million from $2.9 million in the first quarter of 2000. Our sales and marketing expenses as a percentage of total revenues were 11% in the three months ended March 31, 2001 and 12% in the three months ended March 31, 2000.

    General and Administrative Expenses.  Our general and administrative expenses were $1.7 million in the three months ended March 31, 2001 and $1.3 million in the three months ended March 31, 2000. General and administrative expenses increased in 2001 from 2000, mainly due to additional employees and amortization related to the acquisition of VoicePump. Our general and administrative expenses in

11

the first quarter of 2001 as a percentage of total revenues increased to 7%, compared to 6% in the first quarter of 2000.

    Unusual items.  In the first quarter of 2000 we recorded two unusual expense items amounting to approximately $14.2 million. A write-off amount of $11.9 million was recorded relating to the acquired in-process research and development in connection with the acquisition of approximately 73% of the outstanding shares of VoicePump, Inc. An expense of $2.2 million was also recorded reflecting the accelerated amortization of acquired assets and intangibles related to the 1999 acquisition of 900 MHz RF and baseband technology from Applied Micro Devices, Inc.

    Other Income (Expense).  Interest and other income and interest expenses, net for the three months ended March 31, 2001 increased to $3.4 million compared to $2.8 million for the three months ended March 31, 2000. The increase was primarily the result of higher levels of cash, cash equivalents, marketable securities and cash deposits in 2001 as compared with 2000, as well as higher yields.

    Equity in Income (Loss) of Equity Method Investees, Net.  Equity in income (loss) of equity method investees, net was a $105,000 gain for the three months ended March 31, 2001 as compared to a $437,000 gain in the comparable period ended March 31, 2000. The reason for the decrease in income (loss) of equity method investees is due to a significant decrease of net income reported by AudioCodes, Ltd. In the three months ended March 31, 2001 we recorded VoicePump's losses in results of operations in our statements of income of approximately $1,108,000, which included the minority interest in those losses in the amount of $173,000.

    Capital Gain.  In January 2000, we sold 600,000 shares (pre-split 1:2) of AudioCodes for approximately $43.8 million and recorded in the first quarter of 2000 a capital gain in the amount of $40.0 million. We currently own approximately 4.5 million of AudioCodes shares, which represents approximately 11% of the outstanding shares.

    Provision for Income Taxes.  In 2001 and 2000, we benefited for federal and state tax purposes from foreign tax holiday and tax exempt income in Israel.

LIQUIDITY AND CAPITAL RESOURCES

    Operating Activities.  During the three months ended March 31, 2001, we generated $4.2 million of cash from our operating activities as compared to $5.4 million during the three months ended March 31, 2000. This decrease is mainly due to tax payment made in the three months ended March 31, 2001, which related to our profit in the year 2000, versus lower level of taxes paid in the same period of 2000.

    Investing Activities.  We invest excess cash in short-term cash deposits and marketable securities of varying maturity, depending on our projected cash needs for operations, capital expenditures and other business purposes. In the first three months of 2001, we purchased $17.4 million of investments classified as short-term cash deposits and marketable securities. In the same period, $50.4 million of investments classified as marketable securities matured. Our capital equipment purchases in the first three months of 2001, primarily research and development software and computers, totaled $1.4 million.

    Financing Activities.  During the three months ended March 31, 2001, we received $1.2 million upon the exercise of employee stock options and through purchases pursuant to our employee stock purchase plan.

    At March 31, 2001, our principal source of liquidity consisted of cash and cash equivalent deposits totaling $82.2 million and marketable securities and short-term cash deposits of $145.2 million. Our working capital at March 31, 2001 was $227.1 million.

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    We believe that our current cash, cash equivalent, cash deposits and marketable securities will be sufficient to meet our cash requirements through at least the next twelve months.

    In addition, as part of our business strategy, we occasionally evaluate potential acquisitions of businesses, products and technologies. Accordingly, a portion of our available cash may be used at any time for the acquisition of complementary products or businesses. Such potential transactions may require substantial capital resources, which may require us to seek additional debt or equity financing. There can be no assurance that we will consummate any such transactions. See "Factors Affecting Future Operating Results—There are Risks Associated with our Acquisition Strategy" for more detailed information.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

    Interest Rate Risk.  It is our policy not to enter into derivative financial instruments. We do not currently have any significant interest rate exposure since we do not have any financial obligation and our financial assets are measured on a held to maturity basis.

    Foreign Currency Rate Risk.  As most of our revenues are denominated in U.S. dollars, while the large majority of our costs are in New Israeli Shekels ("NIS"), we have instituted a foreign currency cash flow hedging program to protect from reduction in value of forecasted cash flows weigh against salary payments over the next year. At the end of first quarter of year 2001, we purchased put option contracts and entered into forward contracts to hedge a portion of the anticipated NIS payroll of our Israeli subsidiary. These options contracts are designated as cash flow hedges, as defined by SFAS No. 133. We have not recognized any revenues or losses with in respect to cash flow hedges to date.

    European Monetary Union.  Within Europe, the European Economic and Monetary Union (the "EMU") introduced a new currency, the Euro, on January 1, 1999. During 2002, all EMU countries are expected to be operating with the Euro as their single currency. Uncertainty exists as to the effect the Euro currency will have on the marketplace. Additionally, all of the final rules and regulations have not yet been defined and finalized by the European Commission with regard to the Euro currency. We are assessing the effect the Euro formation will have on DSP Group's internal systems and the sale of DSP Group products. We expect to take appropriate actions based on the results of such assessment. We believe that the cost related to this issue will not be material to us and will not have a substantial effect on our financial condition and results of operations.

FACTORS AFFECTING FUTURE OPERATING RESULTS

    Our Quarterly Operating Results May Fluctuate Significantly.  Our quarterly results of operations may vary significantly in the future for a variety of reasons, including the following:

•

fluctuations in volume and timing of product orders;



•

level of per unit royalties;



•

changes in demand for our products due to seasonal customer buying patterns and other factors;



•

timing of new product introductions by us or our customers, licensees or competitors;



•

changes in the mix of products sold by us;



•

fluctuations in the level of sales by original equipment manufacturers (OEMs) and other vendors of products incorporating our products; and



•

general economic conditions, including the changing economic conditions in Asia.

    Each of the above factors is difficult to forecast and thus could harm our business, financial condition and results of operations. Through 2001, we expect that revenues from our DSP core designs

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and TrueSpeech algorithms will be derived primarily from license fees rather than per unit royalties. The uncertain timing of these license fees has caused, and may continue to cause, quarterly fluctuations in our operating results. Our per unit royalties from licenses are dependent upon the success of our OEM licensees in introducing products utilizing our technology and the success of those OEM products in the marketplace. Per unit royalties from TrueSpeech licensees have not been significant to date.

    Our Average Selling Prices Continue to Decline.  We have experienced a decrease in the average selling prices of our IDT processors, but have to date been able to offset this decrease on an annual basis through manufacturing cost reductions and the introduction of new products with higher performance. However, we cannot guarantee that our on-going efforts will be successful or that they will keep pace with the anticipated, continuing decline in average selling prices.

    We Depend on the IDT Market Which is Highly Competitive.  Sales of IDT products comprise a substantial portion of our product sales. Any adverse change in the digital IDT market or in our ability to compete and maintain our position in that market would harm our business, financial condition and results of operations. The IDT market and the markets for our products in general are extremely competitive and we expect that competition will only increase. Our existing and potential competitors in each of our markets include large and emerging domestic and foreign companies, many of which have significantly greater financial, technical, manufacturing, marketing, sale and distribution resources and management expertise than we do. It is possible that we may one day be unable to respond to increased price competition for IDT processors or other products through the introduction of new products or reductions of manufacturing costs. This inability would have a material adverse effect on our business, financial condition and results of operations. Likewise, any significant delays by us in developing, manufacturing or shipping new or enhanced products also would have a material adverse effect on our business, financial condition and results of operations.

    The 900 Mhz Digital Spread Spectrum RF and Base Band technology acquired in 1999 from AMD gave us a "cheap entry ticket" to this market. This technology is not state of the art and the company has noticed a trend of decreasing sales for the product models which are based on this technology. The company may not succeed in its development of new RF and Base Band models and those which are going to be developed may not be accepted by the market.

    Despite the recent success of development and sales of our DSP Cores, the market needs extensive R&D efforts in new technologies not currently owned by the company, and we may not succeed in developing such technologies in due time, which could affect our competitive position.

    We Depend on Independent Foundries to Manufacture Our Integrated Circuit Products.  All of our integrated circuit products are manufactured by independent foundries. While these foundries have been able to adequately meet the demands of our increasing business, we are and will continue to be dependent upon these foundries to achieve acceptable manufacturing yields, quality levels and costs, and to allocate to us a sufficient portion of foundry capacity to meet our needs in a timely manner. To meet our increased wafer requirements, we have added additional independent foundries to manufacture our processors. Our revenues could be harmed should any of these foundries fail to meet our request for products due to a shortage of production capacity, process difficulties, low yield rates or financial instability. For example, foundries in Taiwan produce a significant portion of our wafer supply. As a result, earthquakes, aftershocks or other natural disasters in Asia, could preclude us from obtaining an adequate supply of wafers to fill customer orders and could harm our business, financial condition, and results of operations.

    We may need to increase our research and development efforts to remain competitive.  The DSP Cores market is experiencing extensive efforts by some of our competitors to use new technologies to manipulate the chip design programming to increase the parallel processing of the chip. One such technology used is Very Long Instruction Word (VLIW), which some of our competitors possess

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elements of, but which we do not possess at the present time. If such technology continues to improve the programming processing of these chips, then we may need to further our research and development to obtain such technology to remain competitive in the market.

    We Depend on International Operation.  We are dependent on sales to customers outside the United States. We expect that international sales will continue to account for a significant portion of our net product and license sales for the foreseeable future. As a result, the occurrence of any negative international political, economic or geographic events could result in significant revenue shortfalls. These shortfalls could cause our business, financial condition and results of operations to be harmed. Some of the risks of doing business internationally include:

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unexpected changes in regulatory requirements;



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fluctuations in the exchange rate for the U.S. dollar;



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imposition of tariffs and other barriers and restrictions;



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burdens of complying with a variety of foreign laws;



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political and economic instability; and



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changes in diplomatic and trade relationships.

    Risks of Operating in Israel.  Our principal research and development facilities are located in the State of Israel and, as a result, at March 31, 2001, 154 of our 200 employees were located in Israel, including 100 out of 122 of our research and development personnel. In addition, although DSP Group is incorporated in Delaware, a majority of our directors and executive officers are residents of Israel. Although substantially all of our sales currently are being made to customers outside Israel, we are nonetheless directly influenced by the political, economic and military conditions affecting Israel. Any major hostilities involving Israel, or the interruption or curtailment of trade between Israel and its present trading partners, could significantly harm our business, operating results and financial condition.

    Israel's economy has been subject to numerous destabilizing factors, including a period of rampant inflation in the early to mid 1980's, low foreign exchange reserves, fluctuations in world commodity prices, military conflicts and civil unrest. In addition, Israel and companies doing business with Israel have been the subject of an economic boycott by the Arab countries since Israel's establishment. These restrictive laws and policies may have an adverse impact on our operating results, financial condition or expansion of our business.

    Since the establishment of the State of Israel in 1948, a state of hostility has existed, varying in degree and intensity, between Israel and the Arab countries. Although Israel has entered into various agreements with certain Arab countries and the Palestinian Authority, and various declarations have been signed in connection with efforts to resolve some of the economic and political problems in the Middle East, we cannot predict whether or in what manner these problems will be resolved. Our results of operations may be negatively affected by the obligation of key personnel to perform military service. In addition, certain of our officers and employees are currently obligated to perform annual reserve duty in the Israel Defense Forces and are subject to being called for active military duty at any time. Although we have operated effectively under these requirements since our inception, we cannot predict the effect of these obligations on the Company in the future. Our operations could be disrupted by the absence, for a significant period, of one or more of our officers or key employees due to military service.

    Moreover, many of our expenses in Israel are paid in Israeli currency which subjects us to the risks of foreign currency fluctuations and to economic pressures resulting from Israel's general rate of inflation. While substantially all of our sales and expenses are denominated in United States dollars, a

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portion of our expenses are denominated in Israeli shekels. Our primary expenses paid in Israeli currency are employee salaries and lease payments on our Israeli facilities. As a result, an increase in the value of Israeli currency in comparison to the United States dollar could increase the cost of technology development, research and development expenses and general and administrative expenses. We cannot provide assurance that currency fluctuations, changes in the rate of inflation in Israel or any of the other factors mentioned above will not have a material adverse effect on our business, financial condition and results of operations. From time to time, we use derivative instruments in order to minimize the effects of such developments, but our hedging positions may be partial or may not exist at all in the future.

    Any Future Profitability May Be Diminished If Tax Benefits from the State of Israel Are Reduced or Withheld.  The Company receives certain tax benefits in Israel, particularly as a result of the "Approved Enterprise" status of the Company's facilities and programs. To be eligible for tax benefits, the Company must meet certain conditions, relating principally to adherence to the investment program filed with the Investment Center of the Israeli Ministry of Industry and Trade and to periodic reporting obligations. The Company believes that it will be able to meet such conditions. Should the Company fail to meet such conditions in the future, however, it would be subject to corporate tax in Israel at the standard rate of 36%, and could be required to refund tax benefits already received. There can be no assurance that such grants and tax benefits will be continued in the future at their current levels or otherwise. The termination or reduction of certain programs and tax benefits (particularly benefits available to the Company as a result of the Approved Enterprise status of the Company's facilities and programs) or a requirement to refund tax benefits already received may have a material adverse effect on the Company's business, operating results and financial condition.

    Proposed Tax Reform.  On May 4, 2000, a committee chaired by the Director General of the Israeli Ministry of Finance, Avi Ben-Bassat, issued a report recommending a sweeping reform in the Israeli system of taxation. The proposed reform would significantly alter the taxation of individuals, and would also affect corporate taxation. In particular, the proposed reform would reduce, but not eliminate, the tax benefits available to approved enterprises such as ours. The proposed reform would also impose a capital gains tax on individuals on the sale of shares, unless the selling shareholder is entitled to benefits under a tax treaty. The Israeli cabinet has approved the recommendations in principle, but implementation of the reform requires legislation by Israel's Knesset. The Company cannot be certain whether the proposed reform will be adopted, when it will be adopted or what form any reform will ultimately take.

    Israel has recently elected a new government. At this time this government has not taken any position with respect to these tax benefits or the proposed tax reforms discussed above, and we cannot predict what, if any, impact this new government will have on our Israeli operations and current tax benefits. Any significant adverse change in the government's position could harm our business, results of operations and financial condition.

    We Depend on OEMs and their Suppliers to Obtain Required Complementary Components.  Some of the raw materials, components and subassemblies included in the products manufactured by our OEM customers, which also incorporate our products, are obtained from a limited group of suppliers. Supply disruptions, shortages or termination of any of these sources could have an adverse effect on our business and results of operations due to the delay or discontinuance of orders for our products by customers until those necessary components are available.

    We Depend Upon the Adoption of Industry Standards Based on TrueSpeech.  Our prospects are partially dependent upon the establishment of industry standards for digital speech compression based on TrueSpeech algorithms in the computer telephony and Voice over IP markets. The development of industry standards utilizing TrueSpeech algorithms would create an opportunity for us to develop and

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market speech co-processors that provide TrueSpeech solutions and enhance the performance and functionality of products incorporating these co-processors.

    In February 1995, the ITU established G.723.1, which is predominately composed of a TrueSpeech algorithm, as the standard speech compression technology for use in video conferencing over public telephone lines. In March 1997, the International Multimedia Teleconferencing Consortium, a nonprofit industry group, recommended the use of G.723.1 as the default audio coder for all voice transmissions over the Internet or for IP applications for H.323 conferencing products.

    There Are Risks Associated with our Acquisition Strategy.  DSP Group has pursued, and will continue to pursue, growth opportunities through internal development and acquisition of complementary businesses, products and technologies. We are unable to predict whether or when any prospective acquisition will be completed. The process of integrating an acquired business may be prolonged due to unforeseen difficulties and may require a disproportionate amount of our resources and management's attention. We cannot provide assurance that we will be able to successfully identify suitable acquisition candidates, complete acquisitions, integrate acquired businesses into our operations, or expand into new markets. Once integrated, acquisitions may not achieve comparable levels of revenues, profitability or productivity as the existing business of DSP Group or otherwise perform as expected. The occurrence of any of these events could harm our business, financial condition or results of operations. Future acquisitions may require substantial capital resources, which may require us to seek additional debt or equity financing.

    Protection of Our Intellectual Property is Limited; Risks of Infringement of Rights of Others.  As is typical in the semiconductor industry, we have been and may from time to time be notified of claims that we may be infringing patents or intellectual property rights owned by third parties. For example, AT&T has asserted that G.723.1, which is primarily composed of a TrueSpeech algorithm, includes certain elements covered by patents held by AT&T and has requested that video conferencing manufacturers license the technology from AT&T. Other organizations including Lucent Microelectronics, NTT and VoiceCraft have raised public claims that they also have patents related to the G.723.1 technology. If it appears necessary or desirable, we may try to obtain licenses for those patents or intellectual property rights that we are allegedly infringing. Although holders of these types of intellectual property rights commonly offer these licenses, we cannot assure you that licenses will be offered or that terms of any offered licenses will be acceptable to us. Our failure to obtain a license for key intellectual property rights from a third party for technology used by us could cause us to incur substantial liabilities and to suspend the manufacturing of products utilizing the technology. We believe that the ultimate resolution of these matters will not harm our financial position, results of operations, or cash flows.

    Our Stock Price May Be Volatile.  Announcements of developments related to our business, announcements by competitors, quarterly fluctuations in our financial results, changes in the general conditions of the highly dynamic industry in which we compete or the national economies in which we do business and other factors could cause the price of our common stock to fluctuate, perhaps substantially. In addition, in recent years the stock market has experienced extreme price fluctuations, which have often been unrelated to the operating performance of affected companies. These factors and fluctuations could have a material adverse effect on the market price of our common stock.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

    See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Quantitative and Qualitative Disclosures About Market Risk."

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PART II. OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS None.
ITEM 2.	CHANGES IN SECURITIES AND USE OF PROCEEDS On February 14, 2001, DSP Group, Inc. exercised its right to purchase the remaining founders' shares of VoicePump, Inc. and issued 161,433 shares of DSP Group common stock to two VoicePump stockholders in exchange for their VoicePump Stock. The issuance of the shares was made in reliance on Section 4(2) of the Securities Act of 1933, as amended. These shares were subsequently registered for resale on Form S-3 in April 2001.
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES None.
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None.
ITEM 5.	OTHER INFORMATION None.
ITEM 6.	EXHIBITS AND REPORTS ON FORM 8-K
	(a)  Exhibits:
	None.
	(b)  Reports on Form 8-K:
	The Company did not file any reports on Form 8-K during the three months ended March 31, 2001.

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SIGNATURES

    Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	DSP GROUP, INC. (Registrant)
Date: May 14, 2001
	By:/s/ MOSHE ZELNIK                 Moshe Zelnik, Vice President of Finance, Chief Financial Officer and Secretary (Principal Financial Officer and Principal Accounting Officer)

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QuickLinks

INDEX

PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
PART II. OTHER INFORMATION

SIGNATURES