Selected Consolidated Financial Data
YEAR ENDED DECEMBER 31,
1999 1998 1997 1996 1995
--------------- -------------- --------------- --------------- ---------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
STATEMENTS OF OPERATIONS DATA:
Revenues $ 76,433 $ 63,850 $ 61,959 $ 52,910 $ 50,347
Income from continuing operations $ 54,579 $ 14,415 $ 11,034 $ 5,979 $ 7,211
Weighted average number of common shares
outstanding during the period used to
compute basic earnings per share 11,734 9,768 9,736 9,510 9,352
Weighted average number of common shares
outstanding during the period used to
compute diluted earnings per share 12,721 10,016 10,203 9,581 9,658
Net earnings per share - Basic $ 4.65 $ 1.48 $ 1.13 $ .63 $ .77
Net earnings per share - Diluted $ 4.29 $ 1.44 $ 1.08 $ .62 $ .75
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities $161,371 $ 66,989 $ 65,944 $ 42,934 $ 33,828
Working capital $163,747 $ 68,673 $ 66,947 $ 47,851 $ 39,304
Total assets $206,179 $ 85,791 $ 85,826 $ 51,778 $ 55,350
Total stockholders' equity $183,957 $ 75,695 $ 74,170 $ 54,449 $ 47,541
FISCAL YEARS BY QUARTER
----------------------------------------------------------------------------------------
1999 1998
------------------------------------------------ ---------------------------------------
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
QUARTERLY DATA: 4TH 3RD 2ND 1ST 4TH 3RD 2ND 1ST
Revenues $25,973 $23,296 $16,702 $10,462 $14,117 $17,308 $16,749 $15,676
Gross profit $14,418 $12,630 $ 9,543 $ 6,636 $ 8,742 $ 9,041 $ 8,756 $ 7,883
Net income $33,918 $ 5,770 $13,709 $ 1,182 $ 3,468 $ 3,475 $ 4,261 $ 3,211
Net earnings per share - Basic $ 2.70 $ .48 $ 1.19 $ .11 $ .37 $ .36 $ .43 $ .32
Net earnings per share - Diluted $ 2.46 $ .44 $ 1.13 $ .11 $ .36 $ .35 $ .42 $ .31
The accompanying notes are an integral part of the consolidated financial
statements.
15
Price Range of Common Stock
DSP Group's common stock trades on the Nasdaq National Market (Nasdaq
symbol "DSPG"). The following table presents for the periods indicated the
intraday high and low sale prices for DSP Group's common stock as reported by
the Nasdaq National Market:
HIGH LOW
---------------------- --------------------
1999
First Quarter $22.63 $12.63
Second Quarter $36.00 $14.69
Third Quarter $42.25 $34.50
Fourth Quarter $96.25 $38.00
1998
First Quarter $26.88 $16.75
Second Quarter $25.00 $16.88
Third Quarter $24.75 $13.13
Fourth Quarter $20.88 $9.63
As of December 31, 1999, there were approximately 61 holders of record
of DSP Group's Common Stock, which DSP Group believes represents approximately
5,578 beneficial holders. DSP Group has not paid cash dividends on its Common
Stock and presently intends to follow a policy of retaining any earnings for
reinvestment in its business.
The accompanying notes are an integral part of the consolidated financial
statements.
16
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
1999 has been a challenging year for DSP Group in all aspects. Our
research and development team successfully completed an ambitious project of
renewing our entire line of products. Our marketing and sales teams introduced
the new products and achieved record high revenue for DSP Group in our product
and licensing markets. In the first quarter of 1999, we entered the wireless
communication product market, which we believe to be synergistic with our
existing markets. We acquired two integrated groups of engineers specializing in
the design of integrated circuits for wireless communication. In addition, we
acquired technology and products, including associated intellectual property,
related to base band and RF for 900 Megahertz digital spread spectrum. Moreover,
our results of operations for 1999 show improved total and product gross
margins. DSP Group's liquidity and working capital continued to improve
significantly throughout 1999 and by year end we achieved new record highs for
DSP Group in cash and marketable securities and working capital. These increases
were attained mainly due to the sale of a portion of our equity investment in
AudioCodes Ltd. as well as to cash provided from our operating activities and
cash received by the issuance and sale of DSP Group common stock to an investor.
Our future operating results will be dependent upon a variety of factors. See
"Factors Affecting Operating Results" in this report and in our Annual Report on
Form 10-K for the year ended December 31, 1999.
TOTAL REVENUES
Our total revenues were $76.4 million in 1999, $63.9 million in 1998 and $62.0
million in 1997. This represents an increase in total revenues of 20% in 1999 as
compared with total revenues in 1998, and a 3% increase in total revenues in
1998 as compared with those in 1997. The increase in revenues in 1999 compared
to 1998 was the result of the introduction of our new line of D16K series
products. Our licensing revenues in 1999 were $19.0 million compared to $14.6
million in 1998, and $10.7 million in 1997. This represents an increase in
licensing revenues of 30% in 1999 as compared with 1998, and an increase of 36%
in our licensing revenues in 1998 as compared with those in 1997.
Export sales, primarily consisting of Integrated Digital Telephony
(IDT) speech processors shipped to manufacturers in Europe and Asia, including
Japan, represented 97% of DSP Group's total revenues in 1999, 95% in 1998 and
92% in 1997. All export sales are denominated in U.S. dollars.
SIGNIFICANT CUSTOMERS
Revenues from one of our distributors, Tomen Electronics, accounted for 47% of
our total revenues in 1999 as compared to 45% in 1998, and 33% in 1997. The loss
of one or more of our major distributors or customers could harm our business,
financial condition and results of operations.
GROSS PROFIT
Gross profit as a percentage of total revenues increased to 57% in 1999, from
54% in 1998 and from 48% in 1997. The increase in gross profit in both 1999
and in 1998 compared to 1998 and 1997 was primarily due to the increase in
our licensing revenues, which have a higher gross profit than product sales.
Product gross profit as a percentage of product sales slightly
increased to 42% in 1999, from 41% in 1998 and from 39% in 1997. This ongoing
increase was primarily due to the decrease in our costs of manufacturing. Our
manufacturing costs have decreased due to improvements in manufacturing
technology and the decreased manufacturing prices obtained from the foundries.
Importantly, this increase in gross profit was achieved even though we continue
to experience competitive, downward pricing pressure for our IDT products.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased significantly to $15.4 million in
1999, from $10.2 million in 1998 and from $8.4 million in 1997. The significant
increase in research and development expenses in 1999 as compared to those in
1998 primarily resulted from the following actions related to our RF cordless
telephone applications: support for our new product line introduction of the
D16K series; the acquisition of products, technology and RF laboratory
equipment; and an increase in our engineering headcount by approximately 20%.
The increase in research and development expenses in 1998 as compared to those
in 1997 was attributable mainly to an increase in the external services provided
to our research and development team, additional mask tapeouts for our new
enhanced line of products, and an increase in our research and development
personnel.
Research and development expenses as a percentage of total revenues
increased to 20% in 1999 from 16% in 1998 and from 14% in 1997.
SALES AND MARKETING EXPENSES
Our sales and marketing expenses increased to $9.3 million in 1999, from $5.2
million in 1998 and from $4.9 million in 1997. The significant increase in 1999
compared to 1998 was due to
17
our marketing and sales efforts of introducing our new line of IDT products,
the D16K series, and our new RF wireless products, as well as an increase in
our sales commissions, due to the increase in our revenues. The increase in
expenses in 1998 as compared to those in 1997 was due to an increase in our
sales and marketing personnel, which was partially offset by lower sales
commissions and lower consulting costs.
Sales and marketing expenses as a percentage of total revenues
increased in 1999 to 12% from 8% in both 1998 and 1997.
GENERAL AND ADMINISTRATIVE EXPENSES
Our general and administrative expenses increased to $5.5 million in 1999
from $4.6 million in 1998 and from $4.5 million in 1997. General and
administrative expenses increased in 1999 from 1998, mainly due to an
increase in our rented property and associated facility expenses as a result
of the increase in our total headcount. Additionally, we experienced an
increase in costs in connection with an increase in our general legal and
accounting services. However, we are closely monitoring all expenses and
believe that this contributed to our general and administrative expenses as a
percentage of total revenues remaining at 7% in the years 1999, 1998 and 1997.
INTEREST AND OTHER INCOME
Interest and other income increased significantly to $6.0 million in 1999 from
$3.8 million in 1998 and from $2.9 million in 1997. The increase in interest
income in 1999 as compared with 1998 and 1997, is a result of higher levels of
cash equivalents and marketable securities in 1999, mainly due to the issuance
and sale of shares of our common stock to an investor in February 1999, the sale
of a portion of our equity investment in AudioCodes Ltd., as well as higher
yields of financial investments.
Equity in income (loss) of equity method investees was $2,475,000 in
1999, $125,000 in 1998 and ($706,000) in 1997. In 1997 equity in losses of Aptel
Ltd. were included in our results of operations. In December 1997, Aptel's
shareholders, including DSP Group, exchanged their shares in Aptel for shares of
common stock of Nexus Telecommunications Systems Ltd., an Israeli company whose
shares are registered and traded on the Nasdaq SmallCap Market. DSP Group's
results of operations in 1998 do not include any equity gains (losses)
pertaining to Aptel or Nexus.
The equity loss in 1997 was due to our higher equity share in both
Aptel and AudioCodes Ltd., an Israeli corporation. See Note 1 of the Notes to
Consolidated Financial Statements for more information. Equity in income (loss)
of equity method investees also included amortization of the excess of the
purchase price over the net assets acquired for an equity investment in
AudioCodes, Ltd. made in the second quarter of 1994. As of May 1999, we
amortized all of the remaining excess over purchase price over the net assets
acquired.
GAIN ON SALE OF MARKETABLE EQUITY SECURITY
In April 1998, DSP Group sold all of its Nexus shares in a private transaction
and realized a pre-tax one time gain on marketable equity securities of
approximately $1.1 million, which is included under "Other income (expense)" in
our consolidated statements of income for 1998.
CAPITAL GAIN
In May 1999, we exercised our option to purchase approximately 3.5% of the
outstanding stock of AudioCodes for approximately $1.1 million. In the same
month, AudioCodes Ltd. completed its initial public offering (IPO) and is now
listed on the Nasdaq SmallCap Market under the symbol AUDC. In its IPO,
AudioCodes issued 3.5 million shares at a price of $14.00 per share. As a
result we recorded in "Other income (expense)" in our consolidated statements
of income for 1999 a one-time capital gain in the amount of $11.8 million.
This amount was comprised of $9.4 million, from the sale of our shares sold
in the IPO and $2.5 million from the sale of approximately 247,000 of our
AudioCodes shares to the underwriters to cover their over-allotment option.
The gross proceeds from our sale were approximately $3.2 million. In October
1999, AudioCodes successfully concluded a follow-on public offering of 3.0
million shares at a price of $41.00 per share. In the follow-on, AudioCodes
issued and sold 1.5 million shares and an additional 1.95 million shares were
sold by shareholders, of which approximately 1,069,000 shares were sold by us
in two separate transactions. Our proceeds from these transactions were
approximately $42.8 million, and we recorded an additional capital gain in
the amount of $47.1 million. This amount was comprised of $10.8 million,
which resulted from the public offering and $36.3 million from the sale of
approximately 1,069,000 AudioCodes shares. As of December 31, 1999, we held
approximately 2.9 million AudioCodes shares, which represented about 15% of
its outstanding shares. In January 2000, we sold an additional 600,000 shares
of AudioCodes for approximately $43.8 million, recording in the first quarter
of 2000, an additional capital gain in the amount of $40.0 million. After
this sale, we hold approximately 2.3 million AudioCodes shares, which
represent approximately 12% of its outstanding shares.
PROVISION FOR INCOME TAXES
The effective tax rate was 22% (excluding tax on capital gain) for the year
ended December 31, 1999, 25% for the year ended December 31, 1998 and 20% for
the year ended December 31, 1997. The tax rate for 1999 is lower compared to
1998 due mainly to our utilization of foreign tax holiday benefits. The tax rate
18
for 1998 is higher than 1997 due to previously unbenefited operating losses
and tax credit carry-forwards utilized in 1997, which were no longer
available in 1998, offset by increased foreign tax holiday benefits in 1998.
DSP Group Ltd., DSP Group's subsidiary in Israel, has been granted
"Approved Enterprise" status by the Israeli government according to four
investment plans. The Approved Enterprise status allows for a tax holiday for a
period of two to four years and a reduced corporate tax rate of 10% for an
additional eight or six years, on the respective investment plans' proportionate
share of taxable income. The tax benefits under these investment plans are
scheduled to gradually expire starting from 2002 through 2009.
Management has assessed the need for a valuation allowance against
deferred tax assets and has concluded that it is more likely than not that $2.2
million deferred tax assets will be realized based on current levels of future
taxable income and potentially refundable taxes.
LIQUIDITY AND CAPITAL RESOURCES
During 1999, DSP Group generated $18.3 million of cash and cash
equivalents from its operating activities as compared to $15.1 million during
1998 and $18.6 million in 1997. The increase in 1999 of cash and cash
equivalents as compared with that in 1998 occurred primarily because of our
significant increase in net income. The increase in cash and cash equivalents
was attributable primarily to the non-cash effects of the increase in
deferred income tax and the cash used by the increase in accounts payable.
However, the increase was mainly offset by the increase in capital gain and
partially offset by the increase in our inventories and an increase in
accounts receivable. The decrease in cash and cash equivalents in 1998
compared to 1997 was attributable primarily to the non-cash effects of
recognizing deferred revenue and the cash used by the increase in accounts
receivables and decrease in accounts payables, which in turn was partially
offset by the decrease in our inventories and in our deferred income tax.
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 1999, DSP Group
purchased $131.4 million of investments classified as short-term cash deposits
and marketable securities, $60.0 million in 1998 and $77.1 million in 1997. In
addition, DSP Group sold $48.7 million of investments classified as marketable
securities in 1999, $60.6 million in 1998 and $49.3 million in 1997. During
1999, the average maturity for our investments was less than 12 months from the
previous average of approximately 18 months in 1998.
Our capital equipment purchases amounted to $5.2 million in 1999,
$2.3 million in 1998 and $2.2 million in 1997 for computer hardware and
software used in engineering development, engineering test and lab equipment,
leasehold improvements, vehicles, and furniture and fixtures. The
acquisitions of capital equipment during 1999 were primarily for new lab
equipment associated with the RF technology, and other computer equipment,
testing equipment and software for our research and development efforts
during the year.
On February 2, 1999, DSP Group announced that it had entered into a
stock purchase agreement with Magnum Technologies, Ltd., an international
investment fund, in which DSP Group issued and sold 2,300,000 new shares of
DSP Group common stock to Magnum. Based in part on Magnum's representations,
the transaction was exempt from the registration requirements of the
Securities Act of 1933 according to Section 4(2) of the Securities Act. These
shares, representing 19.6% of DSP Group's outstanding common stock at the
time of the transaction, were issued for a price of $15 per share, or an
aggregate of $34.5 million in total net proceeds to DSP Group. As part of the
agreement, Magnum may acquire additional shares of DSP Group in the open
market, but may not bring its total holdings to more than 35% of DSP Group's
outstanding shares of common stock. Furthermore, Magnum agreed to restrict
its sales of the DSP Group shares it purchased for an eighteen-month period
from the date of the transaction under Rule 144(e)(i) of the Securities Act
of 1933, unless it received the prior written approval of DSP Group.
Additionally, DSP Group invited Magnum to appoint two new directors to the
Board of Directors, which currently brings the total number of members of the
Board of Directors to six. In February 2000, Magnum exercised their option to
sell our common stock, and sold 929,000 shares of its holdings. After the
sale, Magnum holds approximately 2.0 million DSP Group shares representing
approximately 15.5% of our outstanding shares of common stock.
In March 1999, our Board of Directors authorized a new plan to
repurchase up to an additional 1,000,000 shares of our common stock from time to
time on the open market or in privately negotiated transactions, increasing the
total shares authorized to be repurchased to 2,000,000 shares. Accordingly, in
1999 we repurchased 200,000 shares of our common stock at an average purchase
price of $13.55 per share, for an aggregate purchase price of approximately $2.7
million. In 1998, we repurchased 814,000 shares of our common stock at an
average purchase price of $17.53 per share for an aggregate purchase price of
approximately $14.3 million. In 1999, we issued 908,000 shares of our common
stock to employees who have exercised their stock options and in 1998 we issued
106,000 shares.
In 1997, DSP Group invested $176,000 in convertible debentures of
Aptel. Subsequently, in December 1997, Aptel's shareholders, including DSP
Group, exchanged their shares in Aptel for shares in Nexus. In April 1998, DSP
Group sold all of its
19
Nexus shares in a private transaction for approximately $1.3 million and
realized a pre-tax one time gain on marketable equity securities of
approximately $1.1 million, which is included under "Other income (expense)"
in our consolidated statements of income for the 1998.
Cash received upon the exercise of employee stock options and through
purchases pursuant to DSP Group's employee stock purchase plan in 1999 totaled
$20.4 million as compared with $1.2 million in 1998 and $6.6 million in 1997. In
addition, repayment of stockholders' notes receivable provided cash of $434,000
in 1996.
At December 31, 1999, DSP Group's principal source of liquidity
consisted of cash and cash equivalent deposits totaling $20.8 million and
marketable securities and short-term cash deposits of $140.6 million. DSP
Group's working capital at December 31, 1998 was $163.7 million, an increase
from the working capital of $68.7 million at December 31, 1998.
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 12 months. As part of DSP Group's business
strategy, we occasionally evaluate potential acquisitions of businesses,
products and technologies. Accordingly, a portion of our available cash may
be used for the acquisition of complementary products or businesses. These
potential transactions may require substantial capital resources, which may
require us to seek additional debt or equity financing. However, we cannot
provide assurance that we will consummate any of these transactions.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. It is DSP Group's policy not to enter into derivative
financial instruments. DSP Group does not currently have any significant foreign
currency exposure since it does not transact business in foreign currencies. Due
to this, DSP Group did not have significant overall currency exposure at
December 31, 1999.
FOREIGN CURRENCY RATE RISK
As nearly all of DSP Group's sales and expenses are denominated in U.S. Dollars,
DSP Group has experienced only insignificant foreign exchange gains and losses
to date, and does not expect to incur significant gains and losses in the next
12 months. DSP Group did not engage in foreign currency hedging activities
during 1999 and 1998.
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.
YEAR 2000 COMPLIANCE
DSP Group was aware of the issues associated with the programming code in
existing computer systems as the Year 2000 approached. The "Year 2000" problem
is concerned with whether computer systems will properly recognize date
sensitive information when the year changed to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Year 2000 problem is pervasive and complex as the computer
operation of virtually every company could have been affected in some way.
Beginning in 1997, and continuing in 1998 and 1999, DSP Group utilized
both internal and external resources to identify, correct or reprogram and test
DSP Group's systems for Year 2000 readiness. All reprogramming efforts,
including testing, was completed by December 31, 1999. Our efforts included the
evaluation of both information technology ("IT") and non-IT systems. Non-IT
systems include systems or hardware containing embedded technology such as
microcontrollers. The costs incurred by DSP Group with respect to this project
were not material.
Throughout 1998 and 1999, we took steps to ensure that our products and
services would continue to operate on and after January 1, 2000. We believe that
DSP Group's products being shipped today were Year 2000 ready and we have not
received any notification to the contrary from customers. In addition, we
received confirmations from DSP Group's primary processing vendors that plans
had been developed to address the processing of transactions in the Year 2000.
We also communicated with suppliers and other third parties that DSP Group does
business with to coordinate Year 2000 readiness. We have not experienced any
supply problems because of the year 2000 noncompliance problems with any of our
vendors or suppliers.
Based upon the steps we have taken to address this issue and the
progress to date, we believe that Year 2000 readiness expenses will not have a
material adverse effect on DSP Group's earnings. As a result of the year 2000
changeover, we know of no trend or event that could harm our business, financial
condition and results of operations. However, we will continue to monitor our
vendors manufacturing processors and the transactional based software for
potential embedded year 2000 problems.
20
SUBSEQUENT EVENTS
SALE OF COMMON STOCK
In February 2000, Magnum exercised its option to sell our common stock and sold
929,000 shares of its holdings. After the sale, Magnum holds approximately 2.0
million DSP Group shares representing approximately 15.5% of our outstanding
shares of common stock.
In January 2000, we sold an additional 600,000 shares of AudioCodes for
approximately $43.8 million, recorded in the first quarter of 2000, for an
additional capital gain in the amount of $40.0 million. After this sale we hold
approximately 2.3 million AudioCodes shares, which represent approximately 12%
of its outstanding shares.
STOCK SPLIT
On January 24, 2000, our Board of Directors declared a two-for-one stock
split of our common stock that was effected in the form of a 100% stock
dividend. The dividend was paid on March 1, 2000 to stockholders of record on
February 16, 2000.
RISK FACTORS AFFECTING OPERATING RESULTS
The stockholders' letter and the discussion in this annual report that concerns
DSP Group's future products, expenses, revenue, liquidity and cash needs as well
as DSP Group's plans and strategies contain forward-looking statements
concerning our future operations and financial results. These forward-looking
statements are based on current expectations and we assume no obligation to
update this information. Numerous factors could cause results to differ from
those described in these statements, and prospective investors and stockholders
should carefully consider the factors set forth below in evaluating these
forward-looking statements.
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;
- - timing of recognition of license fees;
- - 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 2000, we
expect that revenues from our DSP core designs 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
21
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 effect 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 DEPEND ON INTERNATIONAL OPERATIONS, PARTICULARLY IN ISRAEL
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:
- - unexpected changes in regulatory requirements;
- - fluctuations in the exchange rate for the U.S. dollar;
- - imposition of tariffs and other barriers and restrictions;
- - burdens of complying with a variety of foreign laws;
- - political and economic instability; and
- - changes in diplomatic and trade relationships.
In particular, our principal research and development facilities are located
in the State of Israel and, as a result, at December 31, 1999, 121 of our 161
employees were located in Israel, including 81 out of 93 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. Therefore, we are directly affected by the political, economic and
military conditions to which Israel is subject. 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 generally rate of inflation. The rate of inflation in Israel
was 1.3% in 1999 and 8.6% in 1998. While substantially all of our sales and
expenses are denominated in United States dollars, a 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.
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 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
22
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.
23
Report of Independent Auditors
To The Stockholders of
DSP Group, Inc.
We have audited the accompanying consolidated balance sheets of DSP Group, Inc.
and its subsidiaries as of December 31, 1999 and 1998, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of DSP Group, Inc.
and its subsidiaries as of December 31, 1999 and 1998, and the consolidated
results of their operations and cash flows for each of the three years in the
period ended December 31, 1999, in conformity with generally accepted accounting
principles in the United States.
/s/ KOST FORER & GABBY
KOST FORER & GABBAY
A member of Ernst & Young International
Tel Aviv, Israel
January 23, 2000,
Except for Note 9, as to which the date is March 1, 2000
24
Consolidated Statements of Income
YEARS ENDED DECEMBER 31,
1999 1998 1997
------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
REVENUES:
Product sales $57,397 $49,252 $51,238
Licensing, royalties and other 19,036 14,598 10,721
------------------------------------------------------
TOTAL REVENUES 76,433 63,850 61,959
COSTS OF REVENUES:
Product sales 33,051 29,002 31,143
Licensing, royalties and other 155 426 1,169
------------------------------------------------------
TOTAL COST OF REVENUES 33,206 29,428 32,312
------------------------------------------------------
GROSS PROFIT 43,227 34,422 29,647
OPERATING EXPENSES:
Research and development 15,404 10,181 8,420
Sales and marketing 9,309 5,222 4,934
General and administrative 5,511 4,632 4,505
------------------------------------------------------
TOTAL OPERATING EXPENSES 30,224 20,035 17,859
------------------------------------------------------
OPERATING INCOME 13,003 14,387 11,788
Other income (expense):
Interest and other income 6,048 3,810 2,936
Interest expense and other (232) (189) (226)
Gain on sale of available-for-sale marketable securities - 1,086 -
Equity in income (loss) of affiliates 2,475 125 (706)
Capital gains from realization of investments 58,931 - -
------------------------------------------------------
INCOME BEFORE PROVISION FOR INCOME TAXES 80,225 19,219 13,792
Provision for income taxes (25,646) (4,804) (2,758)
------------------------------------------------------
NET INCOME 54,579 $14,415 $11,034
======================================================
NET EARNINGS PER SHARE:
Basic $ 4.65 $ 1.48 $ 1.13
Diluted $ 4.29 $ 1.44 $ 1.08
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
25
Consolidated Balance Sheets
DECEMBER 31,
1999 1998
-------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $20,778 $9,038
Marketable securities and cash deposits 140,593 57,951
Trade receivable, less allowance for returns and doubtful accounts
of $663 in 1999 and $304 in 1998 10,435 5,721
Deferred income taxes 1,707 1,374
Other accounts receivable and prepaid expenses 1,362 1,608
Inventories 3,283 2,182
-------------------------------------
TOTAL CURRENT ASSETS 178,158 77,874
Property and equipment, net 6,948 4,236
-------------------------------------
Other investments, net of accumulated amortization 18,433 1,834
Other assets, net of accumulated amortization 1,250 135
Severance pay fund 1,390 864
Deferred income taxes -- 848
-------------------------------------
TOTAL ASSETS $206,179 $85,791
=====================================
THE ACCOMPANYING NOTES ARE INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
26
DECEMBER 31,
1999 1998
----------------------------------
(IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payable $6,079 $2,360
Accrued compensation and benefits 4,207 2,555
Income taxes payable 1,054 1,909
Accrued royalties 803 647
Deferred revenue 90 36
Accrued expenses and other accounts payable 2,178 1,694
----------------------------------
TOTAL CURRENT LIABILITIES 14,411 9,201
LONG TERM LIABILITIES:
Accrued severance pay 1,431 895
Deferred income taxes 6,380 -
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $0.001 par value:
Authorized shares -- 5,000
Issued and outstanding shares -- none - -
Common stock, $0.001 par value:
Authorized shares -- 50,000
Issued and outstanding shares -- 12,671 in 1999
and 9,406 in 1998 12 9
Additional paid-in capital 119,163 75,610
Retained earnings 64,782 12,129
Less cost of treasury stock -- (12,053)
-------------------------------------
TOTAL STOCKHOLDERS' EQUITY 183,957 75,695
-------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 206,179 $ 85,791
=====================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
27
Statements of Stockholders' Equity
THREE YEARS ENDED COMMON STOCK ADDITIONAL TREASURY STOCK RETAINED ACCUMULATED TOTAL
DECEMBER 31, 1999 SHARES AMOUNT PAID-IN AT COST EARNINGS OTHER STOCKHOLDERS'
CAPITAL (ACCUMULATED COMPREHENSIVE EQUITY
DEFICIT) INCOME
( IN
-----------------------------------------------------------------------------------------------
BALANCE AT JANUARY 1, 1997 9,540 10 66,781 -- (12,342) -- 54,449
Net income -- -- -- -- 11,034 -- 11,034
Other comprehensive income
unrealized gain on
marketable security -- -- -- -- -- 1,050 1,050
-----------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- -- -- -- 12,084
Exercise of Common Stock
options by employees 526 -- 6,382 -- -- -- 6,382
Sale of Common Stock under
employee stock purchase plan 28 -- 218 -- -- -- 218
Income tax benefit from
stock options exercised -- -- 1,037 -- -- -- 1,037
--------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 10,094 10 74,418 -- (1,308) -- 74,170
Net income -- -- -- -- 14,415 -- 14,415
Other comprehensive income
unrealized gain on
marketable security -- -- -- -- -- (1,050) (1,050)
Total comprehensive income -- -- -- -- -- -- 13,365
Purchase of Treasury Stock (814) (1) -- (14,273) -- -- (14,274)
Exercise of Common Stock
options by employees 94 -- -- 1,821 (908) -- 913
Sale of Common Stock under
employee stock purchase plan 32 -- -- 399 (70) -- 329
Income tax benefit from
stock options exercised -- -- 1,192 -- -- -- 1,192
--------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1998 9,406 $ 9 $ 75,610 $ (12,053) $ 12,129 $-- $ 75,695
28
STATEMENTS OF STOCKHOLDERS' EQUITY
Net income -- -- -- -- 54,579 54,579
Total comprehensive income -- -- -- -- 54,579
Purchase of Treasury Stock (200) -- -- (2,710) -- -- (2,710)
Issue of Common Stock to -- -- 34,369
investor 2,300 2 34,367 --
Exercise of Common Stock -- 5,640
options by employees 256 -- 5,640 -- --
Issue of Treasury Stock upon (1,813) 14,408
exercise of stock options 879 1 1,948 14,272
Issue of Treasury Stock upon (113) 385
purchase of ESPP shares 30 -- 7 491 --
Income tax benefit from
stock options exercised -- -- 1,591 -- -- -- 1,591
-----------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1999 12,671 $ 12 $ 119,163 $-- $ 64,782 $-- $ 183,957
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
29
Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31,
1999 1998 1997
--------------------------------------------------
OPERATING ACTIVITIES (IN THOUSANDS)
Net income $54,579 $14,415 $11,034
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 2,455 1,572 1,797
Amortization of software development costs - - 322
Increase (decrease) in deferred revenue 54 (2,324) 2,360
Increase (decrease) in deferred income tax, net 8487 2,470 (1,459)
Gain on sale of marketable equity security - (1,086) -
Capital gain from realization of investments (43,328) - -
Acquired assets and workforce (2,000) - -
Amortization of acquired assets 885 - -
Equity in (income) loss of affiliates (2,475) (125) 706
Changes in operating assets and liabilities:
Decrease (increase) in trade receivable (4,714) (2,127) 1,267
Decrease (increase) in inventories (1,101) 1,934 (1,159)
Decrease (increase) in other current assets 246 (167) (84)
Decrease (increase) in other assets - 15 (84)
Increase (decrease) in accounts payable 3,719 (959) 1,891
Increase in accrued compensation and benefits 1,652 384 432
Increase in severance pay - net 10 31 -
Increase (decrease) in income taxes payable (855) 218 783
Increase (decrease) in accrued royalties 156 476 (5)
Increase (decrease) in accrued expenses and other 484 408 779
accounts payable
--------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $18,254 $15,135 $18,580
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
30
Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31,
1999 1998 1997
--------------------------------------------------
(IN THOUSANDS)
INVESTING ACTIVITIES
Purchase of marketable securities and cash deposits $(131,357) $(59,980) $(77,135)
Sale and maturity of marketable securities and cash deposits 48,715 60,648 49,278
Purchases of property and equipment (5,167) (2,320) (2,160)
Proceeds from sale of equipment - - 166
Realization of investment in an investee 30,445 1,262 -
Investment in an investee (1,241) - (176)
--------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (58,605) (390) (30,027)
--------------------------------------------------
FINANCING ACTIVITIES
Issuance of Common Stock for cash upon exercise
of options, warrants, and employee stock
purchase plan 20,432 1,240 6,600
Issuance of Common Stock to investor 34,369 - -
Purchase of treasury stock (2,710) (14,273) -
--------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 52,091 (13,033) 6,600
--------------------------------------------------
Increase (decrease) in cash and cash equivalents 11,740 1,713 (4,847)
Cash and cash equivalents at beginning of year 9,038 7,325 12,172
--------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $20,778 $9,038 $7,325
==================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Income taxes $17,300 $1,530 $3,148
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1: GENERAL
DSP Group, Inc. (the "Company") is involved in the development and marketing of
digital signal processing cores used in a wide range of applications for
industries such as wireless communications, telephony and personal computing. By
combining its DSP core technology with its advanced speech processing
algorithms, DSP Group also delivers a wide range of enabling
application-specific Integrated Circuits (ICs), such as ICs for fully featured
Integrated Digital Telephony (IDT), for 900 MHz Spread Spectrum wireless
telephony products and for IP telephony applications. The Company has five
wholly owned subsidiaries: DSP Group Ltd. ("DSP Group Israel"), an Israeli
corporation primarily engaged in research, development, marketing, sales,
technical support and certain general and administrative functions; RF
Integrated Systems Inc. ("RF US"), a USA corporation primarily engaged in
research and development of RF technology for wireless products; Nihon DSP K.K.
("DSP Japan"), a Japanese corporation primarily engaged in marketing and
technical support activities; DSP Group Europe SARL, a French corporation
primarily engaged in marketing and technical support activities; and Voicecom
Ltd. ("Voicecom"), an Israeli corporation primarily engaged in research and
development for 900 MHz Spread Spectrum wireless telephony products.
Revenues derived from the Company's largest reseller Tomen Electronics
represented 47%, 45% and 33% of the Company's revenues for 1999, 1998 and 1997,
respectively.
2: SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from these estimates.
REVENUE RECOGNITION
PRODUCT SALES
Product sales of integrated digital telephony ("IDT") processors for
communications applications, telephony and other products are recognized upon
shipment. The Company has no ongoing commitments after shipment other than for
warranty and sales returns/exchanges by distributors. The Company accrues
estimated sales returns/exchanges upon recognition of sales. The Company has not
experienced significant warranty claims to date, and accordingly, the Company
provides for the costs of warranty when specific problems are identified.
LICENSING AND ROYALTY REVENUES
Revenues from software license agreements are recognized upon delivery of the
software in accordance with Statement of Position 97-2 (SOP 97-2) "Software
Revenue Recognition", (as amended by SOP 98-4), when: (1) collection is
probable; (2) all license payments are due within one year; (3) the license
fee is otherwise fixed and determinable; (4) vendor specific evidence exists
to allocate the total fee to the undelivered elements of the arrangements;
and (5) persuasive evidence of an arrangement exists. Revenues from
maintenance contracts are recognized ratably over the term of the agreement.
Costs related to insignificant obligations, primarily telephone support, are
accrued upon shipment and are included in cost of revenues. Certain royalty
agreements provide for per unit royalties to be paid to the Company based on
shipments by customers of units containing the Company's products. Revenue
under such agreements is recognized at the time of shipment by the customer
as they report to the Company.
In December 1998, the AICPA issued Statement of Position 98-9 ("SOP 98-9"),
"Modification of SOP 97-2, Software Revenue Recognition, With respect to Certain
Transactions". SOP 98-9 amends SOP 98-4 to extend the deferral to the
application of certain passages of SOP 97-2 provided by SOP 98-4 through fiscal
years beginning on or before March 15, 1999. All other provisions of SOP 98-9
are effective for transactions entered into in fiscal years beginning after
March 15, 1999.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure About Fair Value of Financial Instruments", requires
disclosures about the fair value of financial instruments. The carrying values
of cash and cash equivalents, marketable securities, trade receivables and trade
payables approximate fair values due to the short-term maturities of these
instruments.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its subsidiaries. Intercompany transactions and balances, including profits from
intercompany sales not yet realized outside the group, have been eliminated in
consolidation.
32
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is calculated using the
straight-line method over the estimated useful lives, at the following annual
rates:
%
- -------------------------------------------------------------------------------
Computers and peripheral equipment 33
- -------------------------------------------------------------------------------
Office furniture and equipment 7-10
- -------------------------------------------------------------------------------
Motor vehicles 15
- -------------------------------------------------------------------------------
Leasehold improvements (over the terms of the lease)
- -------------------------------------------------------------------------------
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) DECEMBER 31,
1999 1998
---------------------
Work-in-process $ 169 $ --
Finished goods 3,114 2,182
---------------------
$3,283 $2,182
=====================
OTHER INVESTMENTS
Other investments are comprised of (in thousands):
DECEMBER 31,
1999 1998
---------------------
Equity method investments:
Investment in AudioCodes Ltd., net of accumulated
amortization of $1,142 in 1999 and $891 in 1998 $ 18,335 $ 1,834
Cost method investments:
Other investments 98 --
---------------------
$ 18,433 $ 1,834
=====================
AUDIOCODES, LTD.
AudioCodes, Ltd. ("AudioCodes") is an Israeli corporation primarily engaged in
design, research, development, manufacturing and marketing hardware and software
products that enable simultaneous transmission of voice and data over networks
including Internet, ATM and Frame Relay. The Company acquired an approximate 35%
ownership in AudioCodes in two separate transactions in 1993 and 1994. In July
1997, AudioCodes completed a private placement of additional equity securities
without the participation of the Company and, as a result, the Company's equity
ownership interest in AudioCodes was diluted from 35% to approximately 29%. The
Company also has an option under certain conditions to purchase up to an
additional 5% of the outstanding stock of AudioCodes.
The Company accounts for its ownership in AudioCodes using the equity method.
The Company's original investment in AudioCodes included the excess of purchase
price over net assets acquired (approximately $1,907,000 at the date of
purchase), which was attributed to developed technology to be amortized over
seven years. The private placement by AudioCodes in July 1997 was at a price per
share greater than the Company's then current investment in AudioCodes. As a
result, even though the Company's ownership interest decreased from 35% to 29%,
the Company's proportionate share of the net assets of AudioCodes increased from
$816,000 to $1,481,000 at the date of the private placement. This increase in
the Company's proportionate share of the net assets of AudioCodes reduced the
remaining unamortized excess of purchase price
33
over net assets acquired from $1,080,000 to $415,000 as of the date of the
private placement.
In May 1999, the Company exercised its option to purchase approximately 3.5%
of the outstanding stock of AudioCodes for approximately $1.1 million. In the
same month AudioCodes completed its initial public offering (IPO) and is now
listed on the Nasdaq SmallCap Market under the symbol AUDC. In its IPO,
AudioCodes issued 3.5 million shares at a price of $14.00 per share. As a
result, the Company recorded in "Other income (expense)" in its consolidated
statements of income for 1999 a one-time capital gain in the amount of $11.8
million. This amount was comprised of $9.4 million, which was sold in the IPO
and $2.5 million from the sale of approximately 248,000 AudioCodes shares to
the underwriters, to cover their over-allotment option. The gross proceeds to
the Company from this sale were approximately $3.2 million. In October 1999,
AudioCodes successfully concluded a follow-on public offering of 3.0 million
shares at a price of $41.00 per share. In the follow-on, AudioCodes issued
and sold 1.5 million shares and an additional 1.95 million shares were sold
by shareholders, of which approximately 1,069,000 shares were sold by the
Company in two separate transactions. The gross proceeds to the Company from
these transactions were approximately $42.8 million, and were recorded as
additional capital gain in the amount of $47.1 million. This amount was
comprised of $10.8 million, which resulted in the public offering and $36.3
million from the sale of approximately 1,069,000 AudioCodes shares. As of
December 31, 1999, the Company held approximately 2.9 million of AudioCodes
shares which represents about 15% of the outstanding shares of AudioCodes.
In January 2000, the Company sold an additional 600,000 shares of AudioCodes for
approximately $43.8 million and recorded in the first quarter of 2000, an
additional capital gain in the amount of $40.0 million. After this sale, the
Company holds approximately 2.3 million of AudioCodes shares, which represents
approximately 12% of the outstanding shares of AudioCodes.
The Company's equity in the net income (loss) of AudioCodes was $2,475,000 in
1999, $230,000 in 1998, and ($103,000) in 1997. As of December 31, 1999, the
Company amortized all the remaining portion of the excess of purchase price over
net assets.
APTEL LTD. AND NEXUS TELECOMMUNICATIONS SYSTEMS LTD.
In July 1996, the Company invested in Aptel Ltd. ("Aptel"), which is located in
Israel. The Company accounted for its investment in Aptel using the equity
method. The Company's equity in the net losses of Aptel, including amortization
of related intangibles, was $408,000 in 1997. As of June 30, 1997, the Company
had fully written-off its investment in Aptel.
In December 1997, Aptel's shareholders, including the Company exchanged their
shares in Aptel for ordinary shares of Nexus Telecommunications Systems Ltd.
("Nexus"). Nexus is an Israeli company whose shares are registered and traded on
the Nasdaq SmallCap Market under the symbol NXUSF. In October 1997, the Company
invested $176,000 in a convertible debenture in Aptel which was converted into
ordinary shares of Aptel prior to the closing of the Nexus transaction. The
Company received approximately 297,000 ordinary shares of Nexus in the exchange
transaction amounting to approximately 3% ownership interest in Nexus. The
Company's basis in the Nexus stock received is $176,000 and the Company
accounted for the investment using the cost method. At December 31, 1997, the
Company's investment in Nexus was presented in the Company's consolidated
balance sheet at the market value of $1,226,000, with the unrealized gain of
$1,050,000 recorded as other comprehensive income, as a separate component of
stockholder's equity. In April 1998, the Company sold all of its Nexus shares in
a private transaction for approximately $1.3 million and realized a pre-tax gain
on marketable equity securities of approximately $1.1 million, which is included
under "Other income (expense)" in the Company's consolidated statements of
income for 1998.
CAPITALIZED ASSETS AND WORKFORCE
In the beginning of 1999, the Company acquired two integrated groups of
engineers, one located in Israel and the other in the United States. These
twenty-five engineers specialize in the design of integrated circuits for
wireless communications. In addition, the Company acquired technology and
products, including associated intellectual property, related to 900 Megahertz
narrow-band cordless telephones and 900 Megahertz spread spectrum cordless
telephones.
In connection with the above, the Company capitalized approximately $2.0 million
of acquired assets and work force. This amount is amortized over approximately 3
years. As of December 31, 1999, the net balance of these capitalized assets and
workforce was approximately $1.1 million.
FOREIGN CURRENCY TRANSLATIONS
The financial statements of certain subsidiaries and other entities reported
using the equity method of accounting, whose functional currency is not the
U.S. dollar, have been remeasured into U.S. dollars, in accordance with FASB
Statement No. 52, "Foreign Currency Translation". Accordingly, monetary
accounts are remeasured using the foreign exchange rate at the balance sheet
date. Operations accounts and nonmonetary balance sheet accounts are
remeasured at the rate in effect at the date of transaction. The effects of
foreign currency remeasurement are reported in current operations and have
not been significant to date.
34
NET EARNINGS PER SHARE
Basic net earnings 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 earnings per share further includes the effect of dilutive stock
options outstanding during the year, all in accordance with the Financial
Accounting Standards Board Statement No. 128, "Earnings per Share" ("SFAS 128").
The following table sets forth the computation of basic and diluted net earning
per share (in thousands except per share amounts):
1999 1998 1997
---------- --------- ---------
Numerator:
Net Income $ 54,579 $ 14,415 $ 11,034
----------
----------
Denominator:
Weighted average number of shares of common stock
outstanding during the period used to compute basic
earning per share....................................... 11,734 9,768 9,736
Incremental shares attributable to exercise of
outstanding options (assuming proceeds would be used to
purchase treasury stock)................................ 987 248 467
----------
Weighted average number of shares of common stock used
to compute diluted earnings per share................... 12,721 10,016 10,203
==========
Basic net earnings per share............................ $4.65 $1.48 $1.13
==========
Diluted net earnings per share.......................... $4.29 $1.44 $1.08
==========
Options outstanding to purchase approximately 91,000, 657,000 and 210,000 shares
of common stock for the years ended December 31, 1999, 1998 and 1997,
respectively, were not included in the computation of diluted net earning per
share, because option exercise prices were greater than the average market price
of the common shares and therefore, the effect would be antidilutive.
CONCENTRATION OF CREDIT RISK
SFAS No. 105, "Disclosure of Information About Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of
Credit Risk", requires disclosures of any significant off-balance-sheet and
credit risk concentrations. The Company has no significant off-balance-sheet
concentration of credit risk such as foreign exchange contracts, option
contracts or other foreign hedging arrangements. Financial instruments that
potentially subject the Company to concentrations of credit risk consist
principally of cash equivalents, marketable security and cash deposits,
short-term bank deposits and trade receivables.
The Company's cash and cash equivalents are invested in short-term deposits with
major U.S. and Israeli banks. Management believes that the financial
institutions holding the Company's investments are financially sound, and
accordingly, minimal credit risk exists with respect to these investments. The
majority of the Company's sales of products are to distributors who in turn sell
to manufacturers of consumer electronics products. The Company's licensing
revenues are primarily from customers that have licensed rights to use the
Company's DSP Core microprocessor architectures and speech compression
technology. No collateral is required from the Company's customers; however,
some of the customers pay using letters of credit. Write-offs for bad debts have
not been significant to date.
CONCENTRATION OF OTHER RISKS
All of the Company's integrated circuit products are manufactured by independent
foundries. While these foundries have been able to adequately meet the demands
of the Company's increasing business, the Company is and will continue to be
dependent upon these foundries to achieve acceptable
35
manufacturing yields, quality levels and costs, and to allocate to the
Company sufficient portion of foundry capacity to meet the Company's needs in
a timely manner. To meet the Company's increased wafer requirements, the
Company has added additional independent foundries to manufacture its
processors. Revenues could be materially and adversely affected should any of
these foundries fail to meet the Company's 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. Additionally, certain of the
raw materials, components, and subassemblies included in the products
manufactured by the Company's OEM customers, which also incorporate the
Company's products, are obtained from a limited group of suppliers.
Disruptions, shortages, or termination of certain of these sources of supply
could occur.
CASH EQUIVALENTS
The Company considers all highly liquid investments which are readily
convertible to cash with an original maturity of three months or less when
purchased to be cash equivalents.
MARKETABLE SECURITIES AND CASH DEPOSITS
At December 31, 1999, all marketable securities have been designated as held to
maturity under Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities" ("SFAS 115"). The
amortized cost of held to maturity securities is adjusted for the amortization
of premiums and accretion of discounts to maturity. Such amortization is
included in interest and other income. Realized gains and losses and declines in
value judged to be other-than-temporary on held to maturity securities are
included in interest and other income. The cost of securities sold is based on
the specific identification method. Interest and dividends on securities
classified as held to maturity are included in interest and other income. Cash
deposits originally purchased with a maturity of over three months are
considered as short-term investments and are presented as part of the marketable
securities.
The following is a summary of held to maturity securities and cash deposits at
December 31, 1999 and 1998:
(in thousands) AMORTIZED COST
1999 1998
-------------------------------
Obligations of states and
political subdivisions $96,312 $25,290
Corporate obligations 30,440 33,218
Cash deposits 21,961 --
-------------------------------
$148,713 $58,508
===============================
Amounts included in marketable
securities and cash deposits $140,593 $57,951
Amounts included in cash and
cash equivalents 8,120 557
-------------------------------
$148,713 $58,508
===============================
At December 31, 1999 and 1998, the carrying amount of securities approximated
the fair value and the amount of unrealized gain or loss was not significant.
Gross realized gains or losses for 1999, 1998, and 1997 were not significant.
The amortized cost of held to maturity debt and securities at December 31, 1999,
by contractual maturities, are shown below (IN THOUSANDS):
AMORTIZED
COST
-------------
Due in one year or less $100,656
Due after one year to two years 39,937
-------------
$140,593
=============
36
SEVERANCE PAY
The Company's subsidiaries, DSP Group Israel and Voicecom, have liability for
severance pay pursuant to Israeli law, based on the most recent salary of the
employees multiplied by the number of years of employment as of the balance
sheet date for all employees. The Company's liability is fully provided by
monthly deposits with severance pay funds and insurance policies.
The deposited funds include profits accumulated up to the balance sheet date.
The deposited funds may be withdrawn only upon the fulfillment of the obligation
pursuant to Israeli severance pay law or labor agreements. The value of these
policies is recorded as an asset in the Company's balance sheet.
Severance expenses for the years ended December 31, 1999, 1998 and 1997, were
approximately $593,000, $367,000 and $135,000, respectively.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company has chosen to continue accounting for stock-based compensation in
accordance with the provisions of Accounting Principles Board Opinion No. 25,
("APB-25"), "Accounting for Stock Issued to Employees". Under APB-25, when
the exercise price of the employee's options equals or is higher than the
market price of the underlying Company stock on the date of grant, no
compensation expense is recognized. The pro-forma information with respect to
the fair value of the options is provided in accordance with the provisions
of statement No. 123 (see Note 4).
In accounting for warrants granted to those other than employees, the provisions
of Statement of Financial Accounting Standards Board No. 123, "Accounting for
Stock-Based Compensation", were applied. The fair value of these warrants was
estimated at the grant date using the Black-Scholes option pricing model (see
Note 4).
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (the "FASB") issued No.
133, "Accounting for Derivative instruments and Hedging Activities" ("SFAS No.
133"). This statement established accounting and reporting standards requiring
that every derivative instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as either an asset
or liability measured at its fair value. The statement also requires that
changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting. The FASB has issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133". The Statement defers the effective date of SFAS No.
133 for one year. The rule will apply to all fiscal quarters of all fiscal years
beginning after June 15, 2000. The Company does not expect the impact of this
new statement on the Company's consolidated balance sheets or results of
operations to be material.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes". This
statement prescribes the use of the liability method, whereby deferred tax asset
and liability account balances are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse. The Company provides a valuation allowance, if
necessary, to reduce deferred tax assets to their estimated realizable value.
3. PROPERTY AND EQUIPMENT
Composition of assets, grouped by major classifications, is as follows:
(IN THOUSANDS) DECEMBER 31,
------------------------------
1999 1998
-------------- --------------
Computers and peripheral equipment $ 12,216 $ 8,209
Office furniture and equipment 985 808
Motor vehicles 1,163 933
Leasehold improvements 1,866 1,380
-------------- --------------
16,230 11,330
Less accumulated depreciation 9,282 7,094
-------------- --------------
$ 6,948 $ 4,236
============== ==============
37
4. STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Board of Directors has the authority, without any further vote or action by
the stockholders, to provide for the issuance of up to 5,000,000 shares of
Preferred Stock in one or more series with such designations, rights,
preferences, and limitations as the Board of Directors may determine, including
the consideration received, the number of shares comprising each series,
dividend rates, redemption provisions, liquidation preferences, sinking fund
provisions, conversion rights, and voting rights.
DIVIDEND POLICY
At December 31, 1999, the Company had retained earnings of approximately $64.8
million. The Company has never paid dividends on its Common Stock and presently
intends to follow a policy of retaining any earnings for reinvestment in its
business.
STOCK ISSUE TO INVESTOR
On February 2, 1999, the Company announced that it had entered into a stock
purchase agreement with Magnum Technologies, Ltd., an international investment
fund, in which the Company issued and sold 2,300,000 new shares of the Company's
common stock to Magnum. Based in part on Magnum's representations, the
transaction was exempt from the registration requirements of the Securities Act
of 1933 according to Section 4(2) of the Securities Act. These shares,
representing 19.6% of the Company's outstanding common stock at the time of the
transaction, were issued for a price of $15 per share, or an aggregate of $34.4
million in total net proceeds to the Company. As part of the agreement, Magnum
may acquire additional shares of the Company in the open market, but may not
bring its total holdings to more than 35% of the Company's outstanding shares of
common stock. Furthermore, Magnum agreed to restrict its sales of the Company's
shares it purchased for an eighteen-month period from the date of the
transaction under Rule 144(e)(i) of the Securities Act of 1933, unless it
received the prior written approval of the Company. Additionally, the Company
invited Magnum to appoint two new directors to the Board of Directors, which
currently brings the total number of members of the Board of Directors to six.
In February 2000, Magnum exercised its option and sold 929,000 shares of the
Company's Common Stock. After the sale, Magnum holds approximately 2.0 million
shares representing approximately 15.5% of the Company's outstanding shares of
common stock.
SHARE REPURCHASE PROGRAM
In March 1999, the Company's Board of Directors authorized a new plan
to repurchase up to an additional 1,000,000 shares of the Company's Common Stock
from time to time on the open market or in privately negotiated transactions,
increasing the total shares authorized to be repurchased to 2,000,000 shares.
Accordingly, in 1999 and 1998, the Company repurchased 200,000 and 814,000
shares, respectively, of its common stock at an average purchase price of $13.55
and $17.53 per share, respectively, for an aggregate purchase price of
approximately $2.7 million and $14.3 million, respectively. In 1999 and 1998,
the Company issued 908,000 and 106,000 shares, respectively, of the Company's
common stock to employees who have exercised their stock options.
Such repurchases of common shares are accounted for as treasury stock, and
result in a reduction of stockholders' equity. When treasury shares are
reissued, the Company charges the excess of the repurchase cost over issuance
price using the weighted average method to retain earnings.
STOCK PURCHASE PLAN AND STOCK OPTION PLANS
The Company has various stock plans under which employees, consultants,
officers, and directors may be granted options to purchase the Company's Common
Stock. A summary of the various plans is as follows:
1991 EMPLOYEE AND CONSULTANT STOCK PLAN In 1991, the Company adopted the 1991
Employee and Consultant Stock Plan (the "1991 Plan"). Under the 1991 Plan,
employees and consultants may be granted incentive or non-qualified stock
options or stock purchase rights for the purchase of the Company's Common Stock.
The 1991 Plan expires in 2001 and currently provides for the purchase of up to
4,300,000 shares of the Company's Common Stock.
The exercise price of options under the 1991 Plan shall not be less than the
fair market value of the Common Stock for incentive stock options and not less
than 85% of the fair market value of the common stock for nonqualified stock
options at the date of grant, as determined by the Board of Directors.
Options under the 1991 Plan are generally exercisable over a 48-month period
beginning twelve months after issuance or as determined by the Board of
Directors. Options under the 1991 Plan expire up to seven years after the date
of grant.
1993 DIRECTOR STOCK OPTION PLAN Upon the closing of the Company's initial public
offering, the Company adopted the 1993 Director Stock Option Plan (the
"Directors' Plan"). Under the Directors' Plan the Company is authorized to issue
nonqualified stock options to purchase up to 275,000 shares of the Company's
Common Stock at an exercise price equal to the
38
fair market value of the Common Stock on the date of grant. The Directors'
Plan, following certain amendments in 1996 approved by the Company's
stockholders, provides that each person who is an outside director on the
effective date of the Directors' Plan and each outside director who
subsequently becomes a member of the Board of Directors shall automatically
be granted an option to purchase 15,000 shares (the First Option).
Additionally, each outside director shall automatically be granted an option
to purchase 5,000 shares (a Subsequent Option) on January 1 of each year if,
on such date, he/she shall have served on the Board of Directors for at least
six months.
Options granted under the Directors' Plan generally have a term of ten years.
The First Option is 25% exercisable after the first year (one-third after the
first year for options granted after May 1996) and in quarterly installments
over the ensuing three years (one-third at the end of each twelve-month period
for options granted after May 1996). Each Subsequent Option becomes exercisable
in full on the fourth anniversary from the date of grant (one-third at the end
of each twelve-month period from the date of grant for options granted after May
1996).
1993 ISRAELI PLAN In 1993, the Company adopted the 1993 DSP Group, Inc. Israeli
Stock Option Plan (the "1993 Israeli Plan") under which the Company is
authorized to issue nonqualified stock options to purchase up to 167,000 shares
of the Company's Common Stock at an exercise price equivalent to fair market
value. Options are immediately exercisable and expire five years from the date
of grant. All options and shares are held in a trust until the later of 24
months from the date of grant or the shares are vested based on a vesting
schedule determined by a committee appointed by the Board of Directors.
1998 NON-OFFICER EMPLOYEE STOCK OPTION PLAN In 1998, the Company adopted the
1998 Non-Officer Employee Stock Option Plan (the "1998 Plan"). Under the 1998
Plan, employees may be granted non-qualified stock options for the purchase of
the Company's Common Stock. Officers and directors of the Company are excluded
from participating under the 1998 Plan. The 1998 Plan expires in 2008 and
currently provides for the purchase of up to 1,550,000 shares of the Company's
Common Stock.
The exercise price of options under the 1998 Plan shall not be less than the
fair market value of the Common Stock for nonqualified stock options, as
determined by the Board of Directors.
Options under the 1998 Plan are generally exercisable over a 48-month period
beginning twelve months after issuance or as determined by the Board of
Directors. Options under the 1998 Plan expire up to seven years after the date
of grant.
A summary of activity under the 1991 Plan, the 1993 Israeli Plan, the Directors'
Plan, and the 1998 Plan is as follows:
(SHARES IN THOUSANDS) OPTIONS OUTSTANDING
----------------------------------------
SHARES SHARES WEIGHTED
AVAILABLE UNDER AVERAGE
FOR GRANT OPTION EXERCISE PRICE
---------------------------------------------------------
BALANCE AT JANUARY 1, 1997 621 1,475 $10.94
Granted (797) 797 $21.67
Exercised - (526) $12.12
Canceled 429 (429) $11.18
-----------------------------------
BALANCE AT DECEMBER 31, 1997 253 1,317 $16.87
-----------------------------------
Authorized 1,950 - $ -
Granted (812) 812 $ 18.54
Exercised - (94) $ 9.95
Canceled 136 (136) $ 13.59
-----------------------------------
BALANCE AT DECEMBER 31, 1998 1,527 1,899 $18.17
-----------------------------------
Authorized 1,200 - $ -
Granted (1,800) 1,800 $28.66
Exercised - (1,136) $17.67
Canceled 158 (158) $19.86
-----------------------------------
BALANCE AT DECEMBER 31, 1999 1,085 2,405 $26.14
-----------------------------------
39
A summary of the average fair exercise price and the number of options
exercisable for the years 1999, 1998 and 1997, is as follows:
- ----------------------------------------------------------------------------
1999 1998 1997
- ----------------------------------------------------------------------------
Number of options excisable as of
December 31, (options in thousands)
39 469 375
- ----------------------------------------------------------------------------
Weighted average exercise price of
options granted during the year
$ 28.71 $ 18.54 $ 21.67
- ----------------------------------------------------------------------------
A summary of the Company's stock option activity and related information as of
December 31, 1999, is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------- --------------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED
RANGE OF NUMBER OF REMAINING AVERAGE NUMBER OF AVERAGE
EXERCISE OPTIONS CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICES OUTSTANDING LIFE PRICE OPTIONS PRICE
- --------------------------------------------------------------------------------------------------------------
$ 7.63 - $14.63 406,950 5.34 Years 12.50 10,815 9.72
$15.13 -$18.48 456,253 6.28 Years 18.27 2,066 15.35
$18.56 -$18.81 153,125 5.50 Years 18.57 0 0
$18.88 -$18.88 585,462 6.07 Years 18.88 6,878 18.88
$19.25 -$38.00 466,716 5.98 Years 29.71 19,693 22.33
$38.75- $66.88 337,000 7.21 Years 64.43 0 0
----------------------------------------------------------------------------------------
2,405,506 6.09 Years $26.14 39,452 $17.90
========================================================================================
Weighted average fair value of options whose exercise price is equal or less
than the market price of the shares at date of grant are as follows:
- --------------------------------------------------------------------------------------------------------------
Weighted average fair value of options grants 1999 1998 1997
- --------------------------------------------------------------------------------------------------------------
Exercise price equals to fair value at date of grants $10.61 $9.65 $9.90
-----------------------------------------
1993 EMPLOYEE STOCK PURCHASE PLAN Upon the closing of the Company's initial
public offering, the Company adopted the 1993 Employee Stock Purchase Plan (the
"1993 Purchase Plan"). The Company has reserved an aggregate amount of 350,000
shares of Common Stock for issuance under the 1993 Purchase Plan. The 1993
Purchase Plan provides that substantially all employees may purchase stock at
85% of its fair market value on specified dates via payroll deductions. There
were approximately 30,000, 32,000 and 28,000 shares issued under the Purchase
Plan in 1999, 1998 and 1997, respectively.
COMMON STOCK RESERVED FOR FUTURE ISSUANCE
Shares of Common Stock of the Company reserved for future issuance at December
31, 1999, are as follows (in thousands):
Employee Stock Purchase Plan 220
Stock Options 3,490
Undesignated Preferred Stock 5,000
-----------
8,710
===========
40
STOCK BASED COMPENSATION
Pro forma information regarding net income and earnings per share is required
by Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (SFAS 123"), which requires the use of option
valuation models that were not developed for use in valuing employee stock
options. For example, the Black-Scholes option valuation model was developed
for use in estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option models require
the input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
The fair value of the Company's employee stock options was estimated at the date
of grant using a Black-Scholes multiple option pricing model with the following
weighted average assumptions; risk-free interest rates of 5.5%, 5.02% and 6.15%
for 1999, 1998 and 1997, respectively; a dividend yield of 0.0% for each of
those years; a volatility factor of the expected market price of the Company's
Common Stock of 0.76, for 1999, 0.77 for 1998 and 0.70 for 1997; and a
weighted-average expected life of the option of 2.9 years for 1999, 3.0 years
for 1998 and 3.1 years for 1997. The weighed average net fair value of options
granted in 1999, 1998 and 1997 was $10.61, $9.65 and $9.90 per share,
respectively.
The Company does not recognize compensation cost related to employee stock
purchase rights under the Employee Stock Purchase Plan. To comply with the pro
forma reporting requirements of SFAS 123, compensation cost is estimated for the
fair value of the employees' stock purchase rights using the Black-Scholes model
with the following assumptions for those rights granted in 1999, 1998 and 1997;
dividend yield of 0.0%; an expected life ranging up to 0.5 years; expected
volatility factor of 0.70 in 1999, 0.71 in 1998 and 0.75 in 1997; and a risk
free interest rate of 6.33% in 1999, 4.84% in 1998, 5.49% in 1997. The weighted
average fair value of those purchase rights granted in January 1999, July 1999,
January 1998, July 1998, January 1997 and July 1997 were $6.33, $17.05, $10.70,
$9.57, $2.45 and $8.21, respectively.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of SFAS 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 1998 1997
-----------------------------------------------
Net income as reported $ 54,579 $ 14,415 $ 11,034
Pro forma net income $ 47,513 $ 10,428 $ 8,485
Pro forma basic earnings per share $ 4.05 $ 1.07 $ 0.87
Pro forma diluted earnings per share $ 4.05 $ 1.07 $ 0.85
41
5. INDUSTRY SEGMENT REPORTING
The Company operates in one business segment approach, principally the
development of affordable, high performance, cost effective DSP-based software,
integrated circuits, and circuit boards.
Operations outside the United States include research, development, sales,
marketing and certain general and administrative functions. The Company's
Israeli subsidiary performs research, development, sales, marketing,
technical support, and certain general and administrative functions. The
Company's Japanese and French subsidiaries perform marketing and technical
support activities. The following is a summary of operations within
geographic areas:
(IN THOUSANDS) 1999 1998 1997
----------------------------------------------
Sales to unaffiliated customers:
United States $ 9,649 $31,436 $57,364
Israel 66,784 32,414 4,595
----------------------------------------------
$76,433 $63,850 $61,959
==============================================
Revenues:
United States $ 7,098 $ 3,821 4,688
Export:
Japan 43,758 35,711 23,402
Europe 6,226 10,591 10,357
Asia 15,392 12,616 21,644
Israel 3,959 1,111 1,868
----------------------------------------------
$76,433 $63,850 $ 61,959
==============================================
Long-lived assets:
United States $21,694 $2,085 $2,252
Israel 4,742 4,783 4,751
Other 61 66 77
----------------------------------------------
$26,497 $6,934 $7,080
==============================================
6. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
The Company leases certain equipment and facilities under noncancelable
operating leases. The Company has significant leased facilities in Herzelia
Pituach, Israel and in Santa Clara, California. In 1996, the Company negotiated
the assignment of certain of its Santa Clara facility use obligations to another
company (the "Assignee"). The Company received payments from the Assignee in the
Santa Clara facility, of $322,000 in both 1999 and 1998 and will receive
$322,000 in 2000. In addition, commencing January 1, 1997, the Company began
subleasing a new space in the same building from the Assignee under a separate
sublease agreement that expires in December 1999. In August 1997, the Company
entered into a new lease for its Israel facilities in Herzelia Pituach. The
lease agreement is effective until November 2003. In December 1999, May 1999 and
September 1998, the Company entered into three new leases for additional office
space at its Israel facilities in Herzelia Pituach. The lease agreements for the
additional spaces are effective until November 2003.
At December 31, 1999, the Company is required to make the following minimum
lease payments:
(IN THOUSANDS) Year Amount
---- -----------
2000 $1,214
2001 846
2002 622
2003 570
------
$3,252
======
42
Total rental expense for all leases was approximately $736,000 (net of sublease
income of $322,000), $545,000 (net of sublease income of $365,000), $778,000
(net of sublease income of $469,000), for the years ended December 31, 1999,
1998, and 1997, respectively.
CONTINGENCIES
The Company is involved in certain claims arising in the normal course of
business, including claims that it may be infringing patent rights owned by
third parties. The Company is unable to foresee the extent to which these
matters will be pursued by the claimants or to predict with certainty the
eventual outcome. However, the Company believes that the ultimate resolution of
these matters will not have a material adverse effect on its financial position,
results of operations, or cash flows.
7. INCOME TAXES
The provision for income taxes is as follows (IN THOUSANDS):
1999 1998 1997
-------------------------------------------
Federal taxes:
Current $ 1,080 $ 2,751 $ 3,166
Deferred 6,168 1,181 (1,301)
------------------------------------------
7,248 3,932 1,865
State taxes:
Current 1,140 216 337
Deferred 209 97 (158)
------------------------------------------
1,349 313 179
Foreign taxes:
Current 16,684 559 714
Deferred 365 -- --
------------------------------------------
17,049 559 714
==========================================
==========================================
Provision for income taxes $ 25,646 $ 4,804 $ 2,758
==========================================
The tax benefits associated with the exercise of stock options reduced taxes
currently payable by $1,591,000 in 1999, $1,192,000 in 1998, and $1,037,000 in
1997. Such benefits were credited to paid in capital when realized.
Pretax income from foreign operations was $14,965,000, $7,330,000 and $3,495,000
in 1999, 1998 and 1997, respectively.
Unremitted foreign earnings that are considered to be permanently invested
outside of the U.S., and on which no deferred taxes have been provided, amount
to approximately $9,600,000 at December 31, 1999. If such amounts were remitted,
the Company would be subject to U.S. income taxes (subject to an adjustment for
foreign tax credits) and additional Israeli corporate income and withholding
taxes of approximately $2,300,000.
43
A reconciliation between the Company's effective tax rate and the U.S. statutory
rate
(IN THOUSANDS)
YEARS ENDED DECEMBER 31, 1999 1998 1997
--------------------------------------------
Tax at U.S. statutory rate $ 27,276 $ 6,534 $ 4,827
State taxes, net of federal benefit 890 207 116
Operating losses utilized - - (1,160)
Tax exempt interest income - - (26)
Foreign income taxed at rates other
than U.S. rate (3,934) (1,806) (813)
Different rate from sale of affiliate 1,179 - -
Tax credits utilized - (264) (480)
Nondeductible losses and expenses of investees - - 247
Other individually immaterial items 235 133 47
--------------------------------------------
$ 25,646 $ 4,804 $ 2,758
============================================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities as of December 31, 1999 and
1998 are as follows:
(IN THOUSANDS) 1999 1998
--------------------------
Deferred tax assets (liability):
Tax credit carryforwards $ 545 $ 108
Net operating loss carryforwards - 385
Capitalized research and development (229) 222
Reserves and accruals 1,349 690
Other 452 817
Investment in affiliate (6,790) -
--------------------------
Total deferred tax assets (liability) $(4,673) $ 2,222
Income tax payable (1,054) (1,909)
--------------------------
Net deferred tax assets (liability) $(5,727) $ 313
==========================
Management believes that the deferred tax assets will be realized based on
current levels of future taxable income and potentially refundable taxes. The
valuation allowance decreased by $1,250,000 in 1998.
DSP Group Israel's production facilities have been granted "Approved Enterprise"
status under Israeli law in connection with four separate investment plans.
According to the provisions of such Israeli law, DSP Group Israel has chosen to
enjoy "Alternative plans benefits," which is a waiver of grants in return for
tax exemption. Accordingly, DSP Group Israel's income from an "Approved
Enterprise" is tax-exempt for a period of two or four years and is subject to a
reduced corporate tax rate of 10% for an additional period of eight or six
years, respectively. The tax benefits under these investment plans are scheduled
to gradually expire starting from 2001 through 2009.
DSP Group Israel's first and second plans, which were completed and commenced
operation in 1992 and 1996, respectively, are tax exempt for two and four
years, respectively, and are entitled to a reduced corporate tax rate of 10%
for an additional period of six years. The third and fourth plans were
approved in 1996 and 1998, respectively. They entitle DSP Group Israel to a
corporate tax exemption for a period of two years for each plan and to a
reduced corporate tax rate of 10% for an additional period of eight years.
The period of tax benefits, as detailed above, is subject to limitations of the
earlier of 12 years from commencement of production, or 14 years from receipt of
approval.
The tax exempt income attributable to an "Approved Enterprise" can be
distributed to stockholders without subjecting DSP Group Israel to taxes only
upon the complete liquidation of DSP Group Israel. The Company has determined
44
that such tax exempt income will not be distributed as dividends.
Accordingly, no deferred income taxes have been provided on income
attributable to DSP Group Israel's "Approved Enterprise."
Through December 31, 1999, DSP Group Israel has met all the conditions required
under these approvals.
Should DSP Group Israel fail to meet such conditions in the future, however, it
could be subject to corporate tax in Israel at the standard rate of 36% and
could be required to refund tax benefits already received.
Income from sources other than the "Approved Enterprise" during the benefit
period will be subject to tax at the standard rate of corporate tax in Israel of
36%.
By virtue of such Israeli law, DSP Group Israel is entitled to claim accelerated
rates of depreciation on equipment used by an "Approved Enterprise" during the
first five tax years from the beginning of such use.
8. RELATED PARTY TRANSACTIONS
In 1993, the Company entered into a development and licensing agreement with
AudioCodes (see Note 2 Other Investments). Under the agreement, AudioCodes is
to perform certain research and development services for the Company. Upon
development of the technology, the Company is to pay AudioCodes a service fee
and additional royalty fees of 15% to 50% of the net revenue and 3% to 10% of
the gross margin realized from the sale of the technology incorporated in the
Company's products. In 1999, 1998 and 1997 the Company recorded the following:
-----------------------------------
(IN THOUSANDS) 1999 1998 1997
RELATED PARTY TRANSACTIONS -----------------------------------
REVENUES:
- ------------------------------------
Product sales $861 $944 $1,542
Licensing $ 92 $ 82 $206
COST OF REVENUES:
- ------------------------------------
Cost of products $324 $384 $291
Cost of licensing $ 63 $160 $268
OPERATING EXPENSES:
- ------------------------------------
Research and development $358 $345 $340
LIABILITIES AS OF DECEMBER 31, $109 $121 $107
9. SUBSEQUENT EVENTS
In February 2000, Magnum exercised its option and sold 929,000 shares of the
Company's Common Stock. After the sale, Magnum holds approximately 2.0 million
shares representing approximately 15.5% of the Company's outstanding shares of
Common Stock.
On January 24, 2000, our Board of Directors declared a two-for-one stock split
of our Common Stock that was effected in the form of a 100% stock dividend. The
dividend was paid on March 1, 2000 to stockholders of record on February 16,
2000.
45
CORPORATE DIRECTORY
OFFICERS AND KEY EMPLOYEES
ELI AYALON
Chairman of the Board
& Chief Executive Officer
BOAZ EDAN
Vice President, Products Division
Manager
RAFI FRIED
Vice President,
Research & Development
ROSS HAYDEN
Vice President, Sales
LEAH SADE
Vice President, Human Resources
GIDEON WERTHEIZER
Executive Vice President
MOSHE ZELNIK
Secretary, Vice President,
Finance & Chief Financial Officer
DIRECTORS
ELI AYALON
Chairman of the Board & CEO
DSP Group
ZVI LIMON
Chairman
Limon Holdings Ltd.
YAIR SHAMIR
President
VCON Telecommunications Ltd.
SHAUL SHANI
Managing Director
Limon Holdings Ltd.
PATRICK TANGUY
CEO, Technal S.A.
LOUIS SILVER
Counsel
Discount Bank & Trust Co.
INDEPENDENT AUDITORS
Kost, Forer & Gabai
A Member of Ernst & Young international
Tel Aviv, Israel
GENERAL LEGAL COUNSEL
Morrison & Foerster LLP
San Francisco, California
REGISTRAR AND TRANSFER AGENT
Northwest Bank Minnesota,
St. Paul, Minnesota
CORPORATE HEADQUARTERS
DSP Group, Inc.
3120 Scott Boulevard
Santa Clara, CA 95054
Tel. 408-986-4300
Fax. 408-986-4323
http://www.dspg.com
DSP Group Ltd.
5 Shenkar Street
Herzeliya, 46120, Israel
Tel. 972-9-9529696
Fax. 972-9-9541234
SALES, MARKETING AND SUPPORT OFFICES
U.S.A.:
DSP Group, Inc.
3120 Scott Boulevard
Santa Clara, CA 95054
Tel. 408-986-4300
Fax. 408-986-4323
http://www.dspg.com
ISRAEL:
DSP Group Ltd.
5 Shenkar Street
Herzeliya, 46120, Israel
Tel. 972-9-9529696
Fax. 972-9-9541234
http://www.dspg.com
EUROPE:
DSP Group Europe, SARL
18 rue de l'Effort Mutuel
91300, Massy, France
Tel. 33-607-686754
Fax. 33-1-6010-5187
JAPAN:
Nihon DSP K.K.
Yasuda Kasai Bldg.
2-3-1, Higashi-Gotanda
Shinagawa-Ku
Tokyo, 141, Japan
Tel. 81-3-3449-7863
Fax. 81-3-3449-8006
KOREA:
DSP Technology
Seoul, Korea
Tel. 82-2-554-7494
Fax. 82-2-554-7495
CHINA:
Beijing Link Televideo
Technology Co., Ltd.
Unit 2104, Landmark Tower 2,
8 North Donganhaun Road, Chaoyang
District, Beijing 100004, PR China
Tel. (8610) 6590 6372
Fax. (8610) 6590 6367
HONG KONG:
DSP Solutions Ltd.
Kowloon, Hong Kong
Tel. 852-2795-7421
Fax. 852-2305-0640
TAIWAN:
DSP Applications
Taipei, Taiwan, R.O.C.
Tel. 886-2-698-4320
Fax. 886-2-698-4133
SEC Form 10-K A copy of the company's Annual Report to the Securities and
Exchange Commission on Form 10-K is available without charge by writing to:
DSP Group, Inc.
Attn: Investor Relations
3120 Scott Boulevard
Santa Clara, CA 95054, USA
QUARTERLY EARNINGS RELEASE
Quarterly earnings releases will be made available to stockholders upon
request. Please note that quarterly reports to stockholders will no longer be
published.
ANNUAL MEETING
The Annual Meeting of stockholders will be held on May 16, 2000 at 9:00 a.m.
local time at DSP Group, Inc. Corporate Headquarters in the U.S.