DSP GROUP, INC.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock (Nasdaq symbol "DSPG") began trading publicly on
the Nasdaq National Market on February 11, 1994 in connection with the
Company's initial public offering. Prior to that date, there was no public
market for the Company's Common Stock. The following table presents for the
periods indicated the intraday high and low sale prices for the Common Stock
as reported by the Nasdaq National Market.
1996 HIGH LOW
---- ---
First Quarter $13.75 $8.25
Second Quarter $15.00 $8.75
Third Quarter $10.50 $6.75
Fourth Quarter $11.25 $7.38
1995 HIGH LOW
---- ---
First Quarter $23.25 $13.75
Second Quarter $26.00 $19.25
Third Quarter $26.00 $17.50
Fourth Quarter $19.25 $ 7.75
As of December 31, 1996, there were approximately 180 holders of record of
the Company's common stock, which the Company believes represents
approximately 9,000 beneficial holders. The Company 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, and in any case, the
Company is prohibited from paying dividends until its accumulated deficit of
$12,342,000 is eliminated.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF
OPERATIONS: 1996
RESULTS OF OPERATIONS
1996 has been a unique year for DSP Group. Results of operations for 1996
must be viewed as a two-phase era divided by the turnaround the Company went
through in the second half of 1996. A major setback, showing signs back in
the fourth quarter of 1995, affected the first half of 1996, resulting in the
decline of product gross margins, accumulation of inventories and negligible
operating income.
The second half of 1996 is marked by the introduction of a new management
team and the Company's turnaround. Product costs decreased, R&D sensibly
redirected and G&A expenses reduced. The turnaround resulted in gradually
improving margins which stabilized in the fourth quarter on new profitable
levels.
TOTAL REVENUES
Total revenues were $52.9 million in 1996, $50.4 million in 1995 and
$28.6 million in 1994, representing an increase over the prior year of 5% for
1996 compared with 76% for 1995. These results reflect the major setback the
Company went through, beginning in the fourth quarter of 1995, as well as the
marked turnaround performed by the new management in the second half of 1996.
This setback was a result of a decline in revenues of TAD speech processors
(due to softness in the TAD market caused by declining average selling
prices). The new management targeted the high costs of manufacturing and
operating expenses and succeeded in reducing both to create higher profits.
Through 1996 the Company maintained its role as a leading supplier of
technologically advanced, cost effective speech processors. The Company's
future operating results will be dependent upon a variety of factors - see
also "Factors Affecting Operating Results" in this report and in Form 10K.
Export sales, primarily consisting of TAD speech processors shipped
to manufacturers in Asia and Europe, represented 91%, 81% and 80% of total
revenues for the Company in 1996, 1995 and 1994 respectively.
All export sales are denominated in U.S. dollars.
SIGNIFICANT CUSTOMERS
Revenues from a distributor, Tomen Electronics, accounted for 17% of
total revenues in 1996 compared to 25% in 1995. Revenues from the Samsung
group accounted for 11% of total revenues in 1996.
In 1994 revenues from three customers, Tomen Electronics, RTI Industries
(a distributor) and Texas Instruments, accounted for 22%, 16% and 10% of
total revenues, respectively. The loss of one or more major distributors or
major customers could have an adverse effect on the Company's business,
financial condition and results of operations.
GROSS PROFIT
Gross profit as a percentage of total revenues was 42% in 1996, 48% in
1995 and 50% in 1994. The overall decline in gross margin was due to
competitive market pricing pressure for TAD products and the setback
discussed earlier. In the fourth quarter of 1996 gross margins increased to
44%.
Product gross profit as a percentage of product sales decreased to 29% in
1996 from 40% in 1995 and 35% in 1994. The low margins were primarily due to
lower average selling prices which were not accompanied by a reciprocal
decrease in product costs. However, product gross margin in the fourth
quarter of 1996 increased to 35% from an average gross margin of 26% in the
first three quarters.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased marginally in 1996 to $8.5
million from $8.4 million in 1995. However, through 1997 the Company expects
R&D expenses to stabilize on an annual rate of $8.0 million. This slightly
lower level of R&D expenses, achieved while maintaining R&D capacity, is
attributable to the consolidation of R&D activities in Israel and elimination
of redundancies. The outcome is a closely managed, leaner and better focused
research team. Other factors contributing to lower R&D were a reduction in
the tape-out counts per chip and a decrease in the cost of materials
associated with the Company's development of new speech processors for TAD
products and personal computer telephony applications. Research and
development expenses as a percentage of total revenues decreased to 16% in
1996 from 17% in 1995.
19
Research and development expenses increased to $8.4 million in 1995 from
$4.4 million in 1994. The increase was due primarily to the reinforcement
and build up of a stronger R&D work-force to maintain revenues in excess of
$50 million a year. As a result of these increases, research and development
expenses as a percentage of total revenues increased to 17% in 1995 from 15%
in 1994.
SALES AND MARKETING EXPENSES
Sales and marketing expenses decreased in 1996 to $4.4 million from $5.1
million in 1995. The annualized rate for the second half of 1996 was even
lower at $4.1 million. This decrease was due primarily to the consolidation
of sales and sales related activities in the U.S., a reduction in sales and
marketing personnel including the elimination of redundant managerial layers
and strict monitoring of expenses. The above decrease was partially offset by
higher marketing expenses in the European office which had started to operate
at the end of 1995.
Sales and marketing expenses increased to $5.1 million in 1995 from $3.8
million in 1994. The increase was due primarily to expenses associated with
increased sales and marketing staff essential for the penetration stage to
the market of TAD, DSPCore and TrueSpeech-Registered Trademark- technologies.
Sales and marketing expenses as a percentage of total revenues declined to 8%
in 1996 from 10% and 13% in 1995 and 1994, respectively.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased marginally to $5.7 million
in 1996 from $5.6 million in 1995. G&A expenses in 1996 contain one time
charges associated with the departure of senior management in the Santa Clara
office offset by reduced legal expenses. In the second half of 1996 the
annualized rate of G&A expenses was $4.9 million compared to $6.5 million in
the first half.
General and administrative expenses increased to $5.6 million in 1995
from $4.1 million in 1994. The increase was due primarily to legal,
insurance and other expenses as well as expenses associated with litigation
against Rockwell International ("Rockwell") for unfair trade practices.
General and administrative expenses as a percentage of total revenues
decreased to 11% in 1996 and 1995 from 14% in 1994 due primarily to the
growth in total revenues.
UNUSUAL ITEMS
In July 1996 the Company invested $2.0 million of cash for approximately
40% of the equity interests in Aptel Ltd. ("Aptel"), a related party, which
is located in Israel. Aptel is an emerging Company in its product development
stage. Aptel has expertise in spread spectrum direct sequence modulation
technology, which is applicable to the development of products for two-way
paging systems and telemetry applications. In connection with the
acquisition, the Company recorded a one-time write-off of acquired in-process
R&D technology of $1.5 million based on an independent estimate of value.
In the second quarter of 1995, the Company decided to sell its 89% equity
interest in its subsidiary Nogatech Inc. Accordingly, the Company incurred a
charge of $500,000 to write down Nogatech Inc., to its estimated fair value
less costs to sell. In addition, in April 1995, the former chairman of the
board resigned to pursue other business interests and the Company incurred
$413,000 of severance expense as a result.
In May 1994, the Company expensed $1.1 million of acquired research and
development obtained in connection with the purchase of all the outstanding
stock of Nogatech, Inc., not previously held by the Company amounting to
approximately an additional 50% of the then outstanding stock of Nogatech,
Inc. In September of 1994, the Company sold its optical disk technology
obtained in the purchase of Nogatech to an investor group, and recorded a
gain of $646,000.
OTHER INCOME (EXPENSE)
Interest and other income increased to $1.6 million in 1996 from $1.4
million in 1995 and $1.2 million in 1994. The increase in 1996 and 1995 is a
result of higher average cash, cash equivalents and marketable securities
balances while the increase in 1994 was attributed to the investment of the
proceeds from the Company's initial public offering in February 1994. In the
last quarter of 1996, cash and cash equivalents and marketable securities
rose by more than
20
$9.0 million to $43.0 million. Other income in 1994 also included $205,000 of
previously unrecognized gains due to adjustments to stockholder notes
receivable resulting from changes in the consumer price index.
Equity in loss of unconsolidated subsidiaries was $457,000, $212,000 and
$238,000 in 1996, 1995 and 1994 respectively. The increase in 1996 was mainly
due to equity loss of Aptel since July of 1996, when the Company acquired a
40% equity ownership interest. Equity in loss of unconsolidated subsidiaries
also included amortization of the excess of purchase price over net assets
acquired for an equity investment in AudioCodes, Ltd., made in the second
quarter of 1994.
GAIN ON SETTLEMENT OF LITIGATION
In October 1996, the Company entered into a settlement agreement with
Rockwell International Corporation. As part of the litigation settlement a
one time gain of $3.8 million, net of legal expenses was recorded.
GAIN ON SALE OF STOCK IN AFFILIATE
The Company sold its remaining equity interest in DSP Communications,
Inc. ("DSPC"), in DSPC's initial public offering in 1995. DSPC is the
successor of a former subsidiary of the Company, DSP Telecommunications,
Ltd. The equity interest, which had no book value, was sold for $1.9 million
of cash. In 1994, the Company sold a portion of its equity interest in DSPC
for $1.9 million of cash, including amounts to related parties of $1.4
million, resulting in a pretax gain of $1.9 million.
PROVISION FOR INCOME TAXES
The effective tax rate for the years ended December 31, 1996, 1995 and
1994 was 15%, .7% and 8%, respectively. The tax rate for 1996 is greater than
1995 due to decreased benefits from the utilization of net operating loss
carry forwards and other deferred tax assets, offset slightly by greater
benefits received from tax exempt interest income and foreign tax holidays.
In 1995 and 1994, the Company benefited, for federal, state, and Israeli tax
purposes, from the utilization of its net operating loss carry forwards as
well as the recognition of certain other deferred tax assets in 1995. The tax
provision for 1994 consisted primarily of federal alternative minimum tax,
and withholding taxes on royalties from an independent foundry.
DSP Semiconductors Ltd. in Israel has been granted "Approved Enterprise"
status by the Israel government according to two investment plans. The
Approved Enterprise status allows a tax holiday for a period of 2 - 4 years
and a corporate tax rate of 10% for additional 6 - 8 years on the respective
investment plans' proportionate share of taxable income. The Company
believes its effective tax rate may remain lower than the statutory rate in
the future due to increased benefits of the Israeli tax holiday.
A net deferred tax asset of approximately $1.0 million is reflected in
the financial statements. Approximately $3.0 million of the future U.S.
taxable income will be necessary to realize this deferred tax asset. While
there can be no assurance that future U.S. income will be sufficient to
realize this benefit, management is of the opinion that it is more likely
than not that this benefit will be realized in the near future based upon
projected income. A valuation allowance of approximately $3.7 million was
provided in the financial statements. Approximately, $2.2 million of the
valuation allowance for deferred tax assets is attributable to stock option
deductions, the benefit of which will be credited to equity when realized.
The remaining valuation allowance relates to U.S. operating losses, tax
credit carry forwards, and temporary differences for which the generation of
U.S. taxable income in the near future is not projected.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. In 1996, net cash provided by operating activities
was $11.3 million provided primarily by (i) $6.0 million of net income of
which $3.8 million was derived from the settlement with Rockwell, (ii) $1.7
million of depreciation and amortization and a $1.5 million write-off of
acquired in-process technology R&D from a related party (iii) a $1.2 million
decrease in deferred income tax and a $2.6 million decrease in accounts
receivable. These were partially offset by (i) a $1.0 million decrease in
accounts payable and (ii) a $0.6 million decrease in income taxes payable.
It should be noted that cash provided by operating activities for the
second half of 1996 was $13.1 million compared
21
with $1.8 million of cash used in operating activities in the first half.
In 1995, net cash provided by operations was $4.1 million, provided
primarily by (i) $7.2 million of net income of which $1.9 million was derived
from the sale of stock in an affiliate, (ii) $1.6 million of depreciation and
amortization and a $500,000 non-cash charge to write-down of impaired assets,
and (iii) a $1.3 million increase in income taxes payable. These were
partially offset by (i) a $1.7 million decrease in accounts payable, (ii) a
$1.5 million increase in accounts receivable associated with growth in
revenues, (iii) a $1.0 million increase in inventories to maintain
availability of finished TAD products, and (iv) a $2.2 million increase in
deferred income taxes.
In 1994, net cash used in operations was $356,000, caused primarily by a
$3.9 million increase in accounts receivable associated with the increase in
revenues, and a $2.3 million increase in inventories to maintain availability
of finished TAD products and to introduce the Nogavision product line. These
uses were partially offset by (i) $4.0 million of net income, of which $1.9
million was derived from the sale of stock in an affiliate and $1.0 million
was derived from the reimbursement of expenses and gain on sale of technology
to related party in exchange for notes receivable, (ii) a $2.9 million
increase in accounts payable associated with the growth in business, and
(iii) a charge to income of $1.1 million for acquired research and
development.
INVESTING ACTIVITIES
In 1996, 1995 and 1994, the Company purchased $32.2 million, $28.3 and
$21.0 million, respectively, and sold $20.6 million, $18.2 million and $12.0
million, respectively, of investments classified as marketable securities.
Capital equipment additions in 1996, 1995 and 1994 were $0.8 million, $3.1
million and $1.7 million, respectively, for computer hardware and software
used in engineering development, engineering test equipment, vehicles, and
furniture and fixtures. The 1995 acquisitions of capital equipment were
primarily in response to increased headcount and new facility requirements in
Israel. The Company capitalized $173,000, $265,000 and $288,000 of software
development costs in 1996, 1995 and 1994, respectively.
In July 1996, the Company invested $2.0 million of cash for
approximately 40% of the equity interests in Aptel, a related party.
Expenses related to the acquisition were $158,000. The total cost of the
acquisition was allocated to the estimated fair value of the assets acquired,
and as a result the Company incurred a one-time write-off of acquired
in-process technology of $1.5 million based on an independent estimate of
value. The Company has a two-year option to purchase additional stock from
Aptel at the same valuation to enable the Company to increase its ownership
interest to 51% in Aptel, and an additional option to acquire the then
remaining outstanding stock of Aptel from its shareholders payable at the
seller's option in either cash or stock of the Company.
In March 1995 the Company sold all of its shares of DSPC Common Stock in
DSPC's initial public offering and in April 1995 upon the exercise of the
underwriters' overallotment option. Net proceeds of the sales, after
underwriters' commissions, amounted to $1.9 million in 1995. In 1994, the
Company had previously sold a portion of its holding in DSPC for $1.9 million
of cash.
In August, 1995, the Company concluded the sale of its equity interest
in Nogatech to two purchasers for $1.5 million of cash. In addition, in
exchange for the receipt from Nogatech of certain fixed assets, reimbursement
of post June 30, 1995 cash fundings of Nogatech, a $400,000 secured
promissory note and future sales of certain Nogatech products, the Company
issued limited licenses to Nogatech to use certain technology of the Company
and canceled all other amounts owed the Company by Nogatech. The Company has
attributed $250,000 of the purchase price to the value of these limited
licenses sold to Nogatech based upon the Company's licensing pricing
structure.
22
In 1994, the Company acquired from Scitex Corporation, Ltd, the then
remaining 50% of outstanding capital stock of Nogatech, Inc. not previously
held by the Company for cash payment of $2.0 million. Legal, accounting and
professional costs associated with the purchase were $100,000. In 1994, the
Company also increased its equity interests in AudioCodes, Ltd., by purchasing
common stock directly from AudioCodes for $1.6 million of cash and purchasing
common stock and options from two founders of AudioCodes for $280,000 of cash
to each founder. In 1993, the Company made a $500,000 investment in AudioCodes.
The Company now has a 35% equity interest in AudioCodes.
FINANCING ACTIVITIES
In 1996, the Company received $0.5 million compared to $1.9 million and
$2.0 million in 1995 and 1994, respectively, upon the exercise of employee
stock options and issuance of Common Stock under the employee stock purchase
plan. Repayment of stockholders' notes receivable accounted for $0.4 million,
$0.7 million and $0.9 million in 1996, 1995 and 1994, respectively.
The Company's revolving line of credit with a domestic bank provides for
borrowings of up to $2.0 million and expires in June 1997. Amounts borrowed
under the line of credit are collateralized by substantially all of the
Company's U.S. tangible assets and the Company is also subject to certain
financial covenants. At December, 1996, the aggregate amount available to be
borrowed under the revolving line of credit was $2.0 million.
In July 1995, the former Chairman of the Board paid $1.1 million as full
payment on two full-recourse promissory notes and accrued interest. The notes
had been issued in 1994 in connection with a warrant exercise and related
withholding taxes.
The Company completed its initial public offering in February 1994. Net
proceeds, after underwriting commissions and expense associated with the
offering, were $27.6 million. The Company also received cash of $2.0 million
upon the exercises of common stock options and warrants in 1994. In 1994,
the Company repaid the $1.5 million note to a foreign bank as well as repaid
$335,000 owed under a line of credit with the same foreign bank.
At December 31, 1996, the Company's principal source of liquidity
consisted of cash and cash equivalents totaling $12.2 million, marketable
securities of $30.8 million and amounts available under the domestic bank
line of credit of $2.0 million. The Company's working capital at December 31,
1996 was $47.9 million up from $39.3 million at December 31, 1995.
The Company believes that its current cash and its available line of
credit will be sufficient to meet its cash requirements through at least the
next twelve months. The Company has investigated, and continues to
investigate, means to acquire greater control over wafer production, whether
by joint venture, equity investments in or loans to wafer suppliers. There
can be no assurance that the Company will consummate any such transactions.
As part of its business strategy, the Company occasionally evaluates
potential acquisitions of business, products and technologies. Accordingly,
a portion of its available cash may be used for the acquisition of
complementary products or business. Such potential transactions may require
substantial capital resources, which may require the Company to seek
additional debt or equity financing.
FACTORS AFFECTING OPERATING RESULTS
The stockholders' letter and discussion in this annual report concerning
the Company's future products, expenses, revenue, liquidity and cash needs as
well as the Company's plans and strategies contain forward-looking statements
concerning the Company's future operations and financial results. These
forward-looking statements are based on current expectations and the Company
assumes 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.
The Company's revenues are derived predominantly from product sales and
accordingly vary significantly depending on the volume and timing of product
orders. The Company's quarterly operating results also depend on the timing
of the recognition of license fees and the level of per unit royalties. The
uncertain timing of such license fees has caused, and may continue to cause,
quarterly fluctuations in the Company's operating results. The Company's per
unit royalties
23
are dependent upon the success of its original equipment manufacturer ("OEM")
licensees in introducing products utilizing the Company's technology and the
success of those OEM products in the marketplace. In the fourth quarter of
1995, the first shipment of products utilizing the Company's PineDSPCore
technology occurred. However, royalties from such shipments and TrueSpeech
have not been significant to date.
The Company's quarterly operating results may fluctuate significantly as
demand for TADs varies during the year due to seasonal customer buying
patterns, and other factors, including the mix of products sold; fluctuations
in the level of sales by OEMs and other vendors of products incorporating the
Company's products; changes in general economic conditions; and other
factors, including those documented elsewhere in this report.
The Company has experienced and is experiencing a decrease in the average
selling prices of its TAD speech processors. During 1996, the Company was
able to partially offset this decrease on an annual basis through
manufacturing cost reductions and the introduction of new higher priced
products with higher performance. However, any inability of the Company to
respond to increased price competition for these and other products through
the continuing and frequent introduction of new products or reductions of
manufacturing costs would have a material adverse effect on the Company's
business, financial condition and results of operations. The markets for the
Company's products are extremely competitive and the Company expects this
competition will increase. The Company's existing and potential competitors
in each of its markets include large and emerging domestic and foreign
companies, many of which have significantly greater financial, technical,
manufacturing, marketing, selling and distribution resources and management
expertise than the Company. Sales of TAD products comprise a substantial
part of the Company's product sales. Any adverse change in the digital TAD
market or the Company's ability to compete and maintain its position in that
market would have material adverse effect on the Company's business,
financial condition and results of operations.
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
manufacturing yields, quality levels and costs, and to allocate to the
Company a sufficient portion of foundry capacity to meet the Company's needs
in a timely manner. To meet increased wafer requirements, the Company has
added additional independent foundries to manufacture its TAD speech
processors. The Company believes that it now has sufficient foundry capacity
through 1998. Revenues could be materially and adversely affected, however,
should any of these foundries fail to meet the Company's request for products
due to a shortage of production capacity, process difficulties or low yield
rates.
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. Distribution shortages or termination of certain of these sources
of supply could occur. For example, the Company's customers for TAD speech
processors have experienced difficulties obtaining sufficient timely supplies
of Audio-grade random access memories ("ARAMs") which are included in current
digital TADs. These shortages were due to the increasing demand for ARAMs
for TAD products, and fluctuations in ARAM production as ARAMs are a
by-product in the fabrication of dynamic random access memories ("DRAMs")
with ARAM yields varying inversely with the DRAM yield. Supply disruptions,
shortages or termination could have an adverse effect on the Company's
business and a result of operations due to its customer's delay or
discontinuance of orders for the Company's products until such components are
available.
The Company's prospects are partially dependent upon the establishment of
industry standards for digital speech compression based on TrueSpeech
algorithms in the computer telephony markets. This would create an
opportunity for the Company to develop and market speech co-processors that
provide TrueSpeech solutions and enhance the performance and functionally of
products incorporating these co-processors. In the fourth quarter of 1995,
the International Telecommunications Union ("ITU") gave final approval to
TrueSpeech as the speech compression technology for low bit-
24
rate video conferencing (G.723.1). For simultaneous voice and data ("DSVD")
modems, the ITU has adopted a proposed audio standard based on an existing
standard (G.729) sponsored by the University of Sherbrooke rather than a
standard based on TrueSpeech. The Company intends to license the speech
compression standard selected by the ITU to be included in the Company's DSVD
co-processors. The failure to establish industry standards based on
TrueSpeech algorithms or to develop and market competitive speech
co-processors would have material adverse effect on the Company's business,
financial condition and results of operations.
G.723.1 is also one of the speech coders for the H.323 based conferencing
applications. This standard provides conferencing capabilities over the
packet-based networks, most significantly the Internet and other IP networks.
Since G.723.1 is the lowest bit-rate technology in the list of speech coders
for this standard, it may be adopted by the industry as the choice of speech
coder for the Internet conferencing applications.
As is typical in the semiconductor industry, the Company has been and may
from time to time be notified of claims that it 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 TrueSpeech algorithm,
includes certain elements covered by patents held by AT&T and has requested
that video conferencing manufacturers license such technology from AT&T.
Other organizations including Lucent, NTT and VoiceCraft recently raised
claims in public that they have patents related to the G.723.1 technology. If
it appears necessary or desirable, the Company may seek licenses under such
patents or intellectual property rights that it is allegedly infringing.
Although holders of such intellectual property rights commonly offer such
licenses, no assurances can be given that licenses will be offered or that
terms of any offered licenses will be acceptable to the Company. The failure
to obtain a license for key intellectual property rights from a third party
for technology used by the Company could cause the Company to incur
substantial liabilities and to suspend the manufacture of products utilizing
the technology used by the Company could cause the Company to incur
substantial liabilities and to suspend the manufacture of products utilizing
the technology. However, the Company in its licensing activities represents
only the four co-developers' patents and intellectual property rights as they
relate to the G.723.1 technology. The Company believes that the ultimate
resolution of these matters will not have material adverse effect on the
Company's financial position and results of operations, or cash flows.
In November 1995, after the Company's stock price declined, several
lawsuits were filed in the United States District Court for the Northern
District of California accusing the Company, its former Chief Executive
Officer, and its former Chief Financial Officer of issuing materially false
and misleading statements in violation of the federal securities laws. These
lawsuits were consolidated into a single amended complaint in February 1996.
In the amended complaint, plaintiffs sought unspecified damages on behalf of
all persons who purchased shares of the Company's Common Stock during the
period June 6, 1995 through November 10, 1995. On June 11, 1996, the Court
granted the Company's motion to dismiss the lawsuit, with leave to amend.
The plaintiffs filed an amended complaint on July 11, 1996, and the Court on
August 14, 1996, held a hearing on the Company's motion to dismiss the
complaint. On March 7, 1997, the Court issued an order dismissing with
prejudice all claims based on statements issued by the Company. The Court is
permitting the plaintiffs to proceed with their claims regarding statements
the Company allegedly made to securities analysts, and is also permitting the
plaintiffs to amend their complaint as to their claim that the Company is
responsible for the statements contained in analysts' reports. The Company
believes the lawsuit to be without merit and intends to defend itself
vigorously.
Variety and uncertainty of the factors affecting the Company's operating
results, and the fact that the Company participates in a highly dynamic
industry, may result in significant volatility in the Company's Common Stock
price.
25
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Stockholders
DSP Group, Inc.
We have audited the accompanying consolidated balance sheets of DSP Group,
Inc. as of December 31, 1996 and 1995, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1996. 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. 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of DSP Group, Inc. at December 31, 1996 and 1995, and the consolidated
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally accepted
accounting principles.
/s/ Ernst & Young LLP
San Jose, California
January 26, 1997,
except for Stockholders' Litigation under
Note 5, as to which the date is
March 7, 1997
DSP GROUP, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
1996 1995
-------------------------
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
ASSETS
Current assets:
Cash and cash equivalents $12,172 $14,679
Marketable securities 30,762 19,149
Accounts receivable, less allowance for returns and
doubtful accounts of $636 in 1996 and $613 in 1995 4,833 7,461
Accounts and notes receivable from related parties
and officers 28 668
Inventories 2,957 3,000
Deferred income taxes 500 784
Prepaid expenses and other current assets 1,357 876
------------------------
Total current assets 52,609 46,617
Property and equipment, at cost:
Computer equipment 5,985 5,518
Furniture and fixtures and other 1,040 718
Leasehold improvements 299 452
------------------------
7,324 6,688
Less accumulated depreciation and amortization 4,033 2,591
------------------------
3,291 4,097
Investments in unconsolidated subsidiaries, net of
accumulated amortization of $695 in 1996 and
$409 in 1995 relating to excess of purchase price
over net assets acquired 2,415 2,244
Other assets, net of accumulated amortization of $284
in 1996 and $98 in 1995 388 507
Deferred income taxes 504 1,389
------------------------
Total assets $59,207 $54,854
------------------------
------------------------
See accompanying notes.
DSP GROUP, INC.
CONSOLIDATED BALANCE SHEETS (continued)
DECEMBER 31,
1996 1995
------------------------
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,428 $ 2,437
Accrued compensation and benefits 1,739 1,891
Income taxes payable 908 1,517
Accrued royalties 176 547
Deferred revenue - 50
Accrued expenses and other 507 871
------------------------
Total current liabilities 4,758 7,313
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 - 20,000
Issued and outstanding shares - 9,540 in 1996
and 9,439 in 1995 10 9
Additional paid-in capital 66,781 66,287
Stockholders' notes receivable - (434)
Accumulated deficit (12,342) (18,321)
------------------------
Total stockholders' equity 54,449 47,541
------------------------
Total liabilities and stockholders' equity $59,207 $54,854
------------------------
------------------------
See accompanying notes.
DSP Group, Inc.
Consolidated Statements of Income
YEARS ENDED DECEMBER 31,
1996 1995 1994
------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Revenues:
Product sales $41,290 $41,425 $20,170
Licensing, royalties, and other (includes
related party revenues of $1,709 in 1996,
$884 in 1995, and $308 in 1994) 11,620 9,012 8,434
------------------------------------------
Total revenues 52,910 50,437 28,604
Cost of revenues:
Cost of product sales 29,432 24,775 13,083
Cost of licensing, royalties, and other (includes
related party costs of $355 in 1996 and
$179 in 1995) 1,096 1,308 1,146
------------------------------------------
Total cost of revenues 30,528 26,083 14,229
------------------------------------------
Gross profit 22,382 24,354 14,375
Operating expenses:
Research and development (includes related party
expenses of $269 in 1996, $127 in 1995,
and $672 in 1994) 8,481 8,396 4,350
Sales and marketing (includes related party
expenses of $0 in 1996, $85 in 1995,
and $2 in 1994) 4,429 5,135 3,779
General and administrative (includes related party
expenses of $0 in 1996, $34 in 1995,
and $100 in 1994) 5,669 5,624 4,074
Unusual items 1,529 913 458
------------------------------------------
Total operating expenses 20,108 20,068 12,661
------------------------------------------
Operating income 2,274 4,286 1,714
Other income (expense):
Interest and other income 1,627 1,399 1,214
Interest expense and other (158) (102) (142)
Gain on settlement of litigation, net of expenses 3,750 - -
Equity in income (loss) of unconsolidated
subsidiaries, net of amortization of goodwill
of $286 in 1996, $273 in 1995, and $136 in 1994 (457) (212) (238)
Gain on sale of stock in affiliated company
(includes gain on sale to related party of
$1,351 in 1994) - 1,893 1,851
------------------------------------------
Income before provision for income taxes 7,036 7,264 4,399
Provision of income taxes 1,057 53 367
------------------------------------------
Net income $ 5,979 $ 7,211 $ 4,032
------------------------------------------
------------------------------------------
Net income per share $ 0.62 $ 0.75 $ 0.44
Shares used in per share computation 9,581 9,658 9,135
See accompanying notes.
DSP GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL STOCKHOLDERS' TOTAL
------------------------------------------- PAID-IN NOTES ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL RECEIVABLE DEFICIT EQUITY
---------------------------------------------------------------------------------------------
(IN THOUSANDS)
Balance at December 31, 1993 3,446 $ 4 2,705 $ 3 $32,952 $(878) $(29,564) $ 2,517
Exercise of Common Stock
options by employees and
third parties for cash and
notes receivable - - 395 - 2,001 (181) - 1,820
Sale of Common Stock for cash
upon exercise of warrants - - 63 - 132 - - 132
Exercise of Common Stock
warrants in exchange for
notes receivable and cash - - 141 - 427 (425) - 2
Conversion of Preferred Stock
to Common Stock (3,446) (4) 3,512 4 - - - -
Cashless exercise of warrants - - 83 - - - - -
Sale of Common Stock, net of
issuance costs - - 2,300 2 27,639 - - 27,641
Repayments on notes - - - - - 862 - 862
Consumer price index
adjustment - - - - - (205) - (205)
Net income - - - - - - 4,032 4,032
-------------------------------------------------------------------------------------------------
Balance at December 31, 1994 - - 9,199 9 63,151 (827) (25,532) 36,801
Exercise of Common Stock
options by employees and
third parties for cash and
notes receivable - - 224 - 1,986 (313) - 1,673
Compensation expense upon
acceleration of stock option
vesting - - - - 130 - - 130
Sale of Common Stock under
employee stock purchase plan - - 16 - 222 - - 222
Income tax benefit from stock
options exercised - - - - 798 - - 798
Payments on notes receivable
from stockholders - - - - - 706 - 706
Net income - - - - - - 7,211 7,211
-------------------------------------------------------------------------------------------------
Balance at December 31, 1995 - - 9,439 9 66,287 (434) (18,321) 47,541
Exercise of Common Stock
options by employees - - 77 1 283 - - 284
Sale of Common Stock under
employee stock purchase plan - - 24 - 211 - - 211
Payments on notes receivable
from stockholders - - - - - 434 - 434
Net income - - - - - - 5,979 5,979
-------------------------------------------------------------------------------------------------
Balance at December 31, 1996 - $ - 9,540 $10 $66,781 $ - $(12,342) $54,449
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
See accompanying notes.
DSP GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
1996 1995 1994
----------------------------------------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net income $ 5,979 $ 7,211 $ 4,032
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,729 1,551 911
Amortization of software development costs 185 98 -
Loss (gain) on disposal of equipment - (30) 22
Deferred revenue (50) (53) (78)
Deferred income tax 1,169 (2,173) -
Reimbursement of expenses and gain on sale
of technology to related party - - (977)
Gain on sale of stock of affiliated company - (1,893) (1,851)
Gain on write-off of deferred rent (380) - -
Consumer price index and foreign currency
translation adjustments to stockholders'
notes receivable - - (205)
Acquired research and development from
related party 1,529 - 1,104
Equity in (income) loss of unconsolidated
subsidiaries 171 (61) 96
Write-down/write-off of assets 290 500 -
Write-off of capitalized software development
cost 31 89 -
Compensation expense upon acceleration of
stock option vesting - 130 -
Changes in operating assets and liabilities:
Accounts receivable 2,628 (1,521) (3,861)
Accounts and notes receivable from
related parties 640 742 (743)
Inventories 43 (1,044) (2,317)
Prepaid expenses and other current assets (481) (297) 1,005
Other assets (14) 41 (142)
Accounts payable (1,009) (1,673) 2,889
Accrued compensation and benefits (152) 600 17
Income taxes payable (609) 1,344 133
Accrued royalties (371) 249 (188)
Accrued expenses and other 16 335 (203)
----------------------------------------
Net cash provided by (used in) operating activities 11,344 4,145 (356)
See accompanying notes.
DSP GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31,
1996 1995 1994
----------------------------------------
(IN THOUSANDS)
INVESTING ACTIVITIES
Purchase of available-for-sale marketable
securities $(32,217) $(28,310) $(21,009)
Sale of available-for-sale marketable securities 20,604 18,171 12,000
Purchases of equipment (836) (3,060) (1,664)
Sale of equipment - 75 40
Purchase of Nogatech, Inc., net of cash acquired - - (2,034)
Sale of Nogatech, Inc. - 1,259 -
Equity investment in AudioCodes, Ltd. - - (2,194)
Sale of stock of affiliated company - 1,893 1,851
Equity investment in Aptel Ltd. (2,158) - -
Capitalized software development costs (173) (265) (288)
Payment on note receivable issued in connection
with reimbursement of expenses and sale of
technology to related party - - 250
----------------------------------------
Net cash used in investing activities (14,780) (10,237) (13,048)
----------------------------------------
FINANCING ACTIVITIES
Line of credit - 5 (165)
Repayments of debt and notes payable to
related parties - - (1,540)
Sale of Common Stock for cash upon exercise
of options, warrants, and employee stock
purchase plan 495 1,895 1,954
Sale of Common Stock, net of issuance costs - - 27,641
Repayment of stockholders' notes receivable 434 706 862
Income tax benefit from stock option exercises - 798 -
----------------------------------------
Net cash provided by financing activities 929 3,404 28,752
----------------------------------------
Increase (decrease) in cash and cash equivalents (2,507) (2,688) 15,348
Cash and cash equivalents at beginning of year 14,679 17,367 2,019
----------------------------------------
Cash and cash equivalents at end of year $ 12,172 $ 14,679 $ 17,367
----------------------------------------
----------------------------------------
See accompanying notes.
DSP GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31,
1996 1995 1994
------------------------------------------
(IN THOUSANDS)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash paid during the period for:
Interest expense $ 17 $ 7 $ 49
Income taxes $372 $221 $ 73
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES
Issuance of Common Stock in exchange for notes
receivable, net of repurchases $ - $313 $181
Exercise of Common Stock warrants in exchange
for notes payable $ - $ - $425
Conversion of Preferred Stock into Common Stock $ - $ - $ 4
See accompanying notes.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
DSP Group, Inc. (the "Company") is engaged in the development of
high-performance, cost-effective DSP-based software and integrated circuits
for digital speech products targeted at the convergence of the personal
computer, communications, and consumer electronics markets. The Company has
three wholly owned subsidiaries: DSP Semiconductors Ltd. (DSP Semiconductors
Israel), an Israeli corporation primarily engaged in VLSI design; Nihon DSP
K.K. (DSP Japan), a Japanese corporation primarily engaged in marketing and
sales; and DSP Group Europe SARL, a French corporation primarily engaged in
marketing and sales.
CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly and majority owned subsidiaries. Intercompany accounts and
transactions have been eliminated in consolidation.
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 relate to shipments of speech processors for digital telephone
answering machines. Revenue is 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 cost of warranty when specific problems are identified.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION (CONTINUED)
LICENSING AND ROYALTY REVENUES
Licensing revenues, including technology revenues, are generally recognized
on shipment by the Company provided that no significant vendor or
post-contract support obligations remain outstanding and collection of the
resulting receivable is deemed probable. Insignificant vendor and
post-support obligations are accrued upon shipment. 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.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Depreciation and amortization are provided using the straight-line method
over the estimated useful lives of the assets, which range from three to
seven years, or the life of the lease, whichever is shorter.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or
market and are composed of the following:
DECEMBER 31,
-------------------
1996 1995
-------------------
(IN THOUSANDS)
Raw materials $ - $ 2
Work-in-process 217 28
Finished goods 2,740 2,970
-------------------
$2,957 $3,000
===================
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EQUITY INVESTMENTS
The Company has investments in two companies which are accounted for under
the equity method.
AUDIOCODES, LTD.
The Company has a 35% ownership interest in AudioCodes, Ltd. (AudioCodes), an
Israeli corporation primarily engaged in DSP-related contract engineering
relating to speech and audio algorithm technologies. In 1993, the Company
purchased stock of AudioCodes for a total cost of $500,000, representing a
26% equity interest. In 1994, the Company acquired additional stock
representing approximately a 9% equity interest for $2,172,000 in cash. The
Company purchased this stock directly from AudioCodes for $1,612,000 in cash
and from two founders of AudioCodes for $280,000 in cash to each individual.
The Company also obtained options to purchase an additional 5% of the
outstanding stock of AudioCodes.
The Company accounts for its ownership in AudioCodes using the equity method.
The investment amount includes the excess of purchase price over net assets
acquired (approximately $1,907,000 at the date of purchase), which was
attributed to developed technology, and is being amortized over a seven-year
period. The Company contributed almost all of the cash of AudioCodes, and as
such, it will record 100% of any cumulative losses incurred by AudioCodes
from the date of the Company's investment. If AudioCodes has cumulation
profits from the date of the Company's investment, the Company will record
only its percentage share of earnings. The Company and AudioCodes have joint
ownership of any speech-related technology developed by AudioCodes, and the
Company has a license to such technology in exchange for quarterly license
fees and royalties payable by the Company to AudioCodes. The Company's equity
in the net income (loss) of AudioCodes was $36,000 in 1996, $61,000 in 1995,
and $(102,000) in 1994. As of December 31, 1996, the difference in the
investment in AudioCodes and the Company's proportionate share of net assets
is $1,269,000, primarily related to the unamortized portion of developed
technology.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EQUITY INVESTMENTS (CONTINUED)
APTEL LTD.
In July 1996, the Company invested $2,000,000 of cash for approximately 40%
of the equity interests in Aptel Ltd. (Aptel), which is located in Netanya,
Israel. Aptel is an emerging company in its product development stage. Aptel
has expertise in spread spectrum direct sequence modulation technology, which
is applicable to the development of products for two-way paging systems and
telemetry applications. Expenses related to the acquisition were $158,000. In
accordance with Accounting Principles Board Opinion No. 16, the total cost of
the acquisition was allocated to the estimated fair value of the assets
acquired, and as a result, the Company incurred a one-time write-off of
acquired in-process technology of $1,529,000 based on an independent estimate
of value.
The Company has a two-year option to purchase additional stock from Aptel at
the same price to enable the Company to increase its ownership interest to
51% and an additional option to acquire the then remaining outstanding stock
of Aptel from its stockholders payable at the seller's option in either cash
or stock of the Company. Igal Kohavi, Chairman of the Company, is Chairman of
Polaris Venture Capital Fund which, together with other associated parties
under its leadership, held an approximate 70% equity interest in Aptel prior
to the Company's investment, and is a director of Aptel. The Company's equity
in the net losses of Aptel, including amortization of related intangibles,
was $221,000 in 1996. As of December 31, 1996, the difference between the
Company's recorded investment in Aptel and its proportionate share of net
assets is $53,000.
FOREIGN CURRENCY TRANSACTIONS
Foreign operations are measured using the U.S. dollar as the functional
currency. Accordingly, monetary accounts (principally cash, receivables, and
liabilities) 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.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME PER SHARE
Net income per share is computed using the weighted average number of shares
of Common Stock and dilutive common equivalent shares from Convertible
Preferred Stock (using the if-converted method). Net income per share
includes the dilutive effect of stock options and warrants (using the
treasury stock method). Fully diluted earnings per share is not presented
because it is not significantly different than primary earnings per share.
CONCENTRATION OF CREDIT RISK
Financial instruments that subject the Company to credit risk consist
principally of cash, cash equivalents, marketable securities, and trade
receivables. By policy, the Company places its cash, cash equivalents, and
marketable securities only with high-credit quality financial institutions
and corporations and, other than U.S. Government Treasury instruments, limits
the amounts invested in any one institution or type of investment. The
majority of the Company's product sales 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 DSPCore microprocessor architectures and speech compression
technology. No collateral is required from the Company's customers; however,
some of the customers pay using letter of credit. Write-offs for bad debts
have not been significant to date.
CONCENTRATION OF OTHER RISKS
Sales of TAD products comprise a substantial portion of the Company's product
sales. Any adverse change in the digital TAD market or the Company's ability
to compete and maintain its position in that market would have a material
adverse effect on the Company's business, financial condition, and results of
operations. The Company's operating results also depend on the timing of the
recognition of license fees and the level of per unit royalties. During 1997,
the Company expects that revenues from its DSPCore designs and TrueSpeech
will continue to be derived primarily from license fees rather than per unit
royalties. However, the uncertain timing of such license fees may continue to
cause fluctuations in the Company's operating results. The Company's
royalties from such products are totally dependent upon the success of its
original equipment manufacturer (OEM) licenses in introducing these products
and the success of such products in the marketplace.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF OTHER RISKS (CONTINUED)
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 business, the Company is and will continue
to be dependent upon these foundries to achieve acceptable manufacturing
yields, quality levels, costs, and to allocate to the Company sufficient
foundry capacities to meet the Company's needs in a timely manner. 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, or low yield rates. 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.
ACCOUNTS AND NOTES RECEIVABLE FROM RELATED PARTIES AND OFFICERS
Accounts and notes receivable from related parties and officers included
$400,000 of notes receivable from related parties at December 31, 1995. Such
notes receivable were repaid in full in fiscal 1996.
NOTES FROM OFFICERS
In July 1995, the Company accepted from the former Chairman a $383,000
full-recourse promissory note as consideration for his exercise of an option
to purchase 22,000 shares of Common Stock and payment for related withholding
taxes. The note's interest rate was prime plus 1% per annum (9.75% at
December 31, 1995). The former Chairman paid $70,000 of principal in
September 1995 and paid the remaining principal and interest in February
1996. In August 1994, the Company agreed to accept from its former Chairman a
$425,000 full-recourse promissory note bearing interest at 6.5% per annum,
due in August 1997, as consideration for a warrant exercise of approximately
141,000 shares of Common Stock and a $592,000 full-recourse promissory note
bearing interest at 8.76% per annum, due in August 1995, for withholding
taxes on this exercise. Both notes were repaid in 1995.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original maturity
of three months or less to be cash equivalents. The carrying amount (at cost)
of cash and cash equivalents as of December 31, 1995 and 1996 approximates
fair value (quoted market price).
SECURITIES AVAILABLE-FOR-SALE
All debt and equity securities have been designated as available-for-sale
under Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" (FAS 115). The amortized
cost of available-for-sale debt securities is adjusted for the amortization
of premiums and accretion of discounts to maturity. Such amortization is
included in investment income. Realized gains and losses and declines in
value judged to be other-than-temporary on available-for-sale securities are
included in investment income. The cost of securities sold is based on the
specific identification method. Interest and dividends on securities
classified as available-for-sale are included in interest and other income.
The following is a summary of available-for-sale securities at December 31,
1996 and 1995:
AMORTIZED COST
1996 1995
---------------------
(IN THOUSANDS)
Obligations of states and political subdivisions $16,891 $14,753
Municipal auction rate preferred stock 2,200 4,400
Corporate obligations 19,301 -
Other - 636
---------------------
$38,392 $19,789
=====================
Amounts included in marketable securities $30,762 $19,149
Amounts included in cash and cash equivalents 7,630 640
---------------------
$38,392 $19,789
=====================
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SECURITIES AVAILABLE-FOR-SALE (CONTINUED)
At December 31, 1996 and 1995, the carrying amount of securities approximated
the fair value (quoted market price), and the amount of unrealized gain or
loss was not significant. Gross realized gains or losses for 1996, 1995, and
1994 were not significant.
The amortized cost of available-for-sale debt securities at December 31,
1996, by contractual maturities, are shown below:
AMORTIZED
COST
--------------
(IN THOUSANDS)
Due in one year or less $31,196
Due after one year to eighteen months 4,996
--------------
$36,192
==============
CAPITALIZED SOFTWARE DEVELOPMENT COSTS
The Company capitalizes software development costs beginning at the time
technological feasibility is determined to have occurred using either the
detailed program design or working model approach. Capitalized software
development costs are stated at the lower of cost or net realizable value and
are amortized on a straight-line basis over the greater of their estimated
economic life, generally from two to five years, or the ratio of current
revenues to estimated current and future revenues for the software products.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1994 and 1995 consolidated
financial statements to conform to the 1996 presentation.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GAIN ON SETTLEMENT OF LITIGATION
In October 1996, the Company entered into agreements with Rockwell
International, Inc. (Rockwell) to license certain of the Company's TrueSpeech
speech technologies and to settle all pending litigation between the
companies. In connection with the litigation settlement in fiscal 1996, the
Company recorded in other income a one time gain on settlement of litigation,
net of expenses of $3,750,000.
2. STOCKHOLDERS' EQUITY
PUBLIC OFFERING
In February 1994, the Company sold a total of 2,300,000 shares of Common
Stock at $14.00 per share through its initial public offering. The net
proceeds (after underwriters' commissions and fees and other costs associated
with the offering) totaled $27,641,000. In connection with the offering, all
Convertible Preferred Stock totaling 3,446,000 shares with an aggregate
paid-in value of $29,535,000 was converted into 3,512,000 shares of Common
Stock of the Company. At December 31, 1996, the Company had an accumulated
deficit of approximately $12,342,000 and, until this deficit is eliminated,
will be prohibited from paying dividends.
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.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK PURCHASE PLAN, STOCK OPTION PLANS, AND WARRANTS
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 nonqualified 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 2,800,000 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, 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 five years after the date of
grant.
During October 1995, employees and officers holding options to purchase
shares of the Company's Common Stock were offered the opportunity to exchange
their existing options for the same number of options at the then current
market price. Under the terms of the program, options to purchase 395,000
shares of the Company's Common Stock were exchanged and are reflected in
grant and cancelation activity for fiscal 1995.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK PURCHASE PLAN, STOCK OPTION PLANS, AND WARRANTS (CONTINUED)
DIRECTORS' PLAN
The Directors' Stock Option Plan (the Directors' Plan) was adopted in January
1994. Under the Directors' Plan the Company is authorized to issue
nonqualified stock options to purchase up to 175,000 shares of the Company's
Common Stock at an exercise price equal to the fair market value of the
Common Stock on the date of grant. The Directors' Plan 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 8,000
shares (the First Option). Additionally, each outside director shall
automatically be granted an option to purchase 2,000 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.
In May 1996, the stockholders approved certain amendments to the plan to
increase the First Option grant from 8,000 shares to 15,000 shares. In
addition, Subsequent Option grants were increased from 2,000 shares to 5,000
shares commencing with the grants to be made on January 1, 1997.
Options granted under the Directors' Plan generally have a term of ten years.
The First Option is exercisable 25% 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).
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK PURCHASE PLAN, STOCK OPTION PLANS, AND WARRANTS (CONTINUED)
1993 ISRAELI PLAN
In 1993, the Company adopted the 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. Nonvested shares are
subject to repurchase by the Company at the original issuance price.
A summary of activity under the U.S. Plan, the 1993 Israeli Plan, and the
Directors' Plan is as follows:
OPTIONS OUTSTANDING
--------------------------
SHARES SHARES
AVAILABLE UNDER PRICE PER
FOR GRANT OPTION SHARE
--------------------------------------
(SHARES IN THOUSANDS)
Balance at December 31, 1993 269 556 $ 1.80 - $ 9.75
Authorized 600 - $ -
Granted (754) 754 $11.00 - $22.50
Exercised - (392) $ 1.80 - $14.00
Canceled 29 (29) $ 1.80 - $14.00
----------------------
Balance at December 31, 1994 144 889 $ 1.80 - $22.50
Authorized 500 - $ -
Granted (902) 902 $15.13 - $24.25
Exercised - (224) $ 1.80 - $15.40
Canceled 505 (505) $ 1.80 - $24.25
----------------------
Balance at December 31, 1995 247 1,062 $ 1.80 - $24.25
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK PURCHASE PLAN, STOCK OPTION PLANS, AND WARRANTS (CONTINUED)
OPTIONS OUTSTANDING
--------------------------
SHARES SHARES WEIGHTED
AVAILABLE UNDER AVERAGE
FOR GRANT OPTION EXERCISE PRICE
--------------------------------------
Balance at December 31, 1995 247 1,062 1.80 - $24.25
Authorized 875 - $ -
Granted (990) 990 $9.61
Exercised - (77) $3.71
Canceled 500 (500) $13.00
---------------------
Balance at December 31, 1996 632 1,475 $10.94
=====================
A summary of the Company's stock option activity and related information for the
year ended December 31, 1996, is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------------------
WEIGHTED NUMBER OF
NUMBER OF AVERAGE WEIGHTED EXERCISABLE WEIGHTED
OUTSTANDING REMAINING AVERAGE AS OF AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 1996 LIFE PRICE 1996 PRICE
- -----------------------------------------------------------------------------------------
$ 1.80 - $ 7.99 246,596 4.91 $ 6.90 52,026 $ 4.18
$ 8.00 - $ 9.99 356,258 4.81 $ 8.45 22,350 $ 9.75
$10.00 - $14.99 656,544 4.07 $12.27 201,831 $13.10
$15.00 - $24.25 215,635 3.66 $15.25 99,091 $15.25
--------------- --------------
$ 1.80 - $24.25 1,475,033 4.33 $10.94 375,298 $12.29
=============== ==============
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK PURCHASE PLAN, STOCK OPTION PLANS, AND WARRANTS (CONTINUED)
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). An
aggregate of 350,000 shares of the Company's Common Stock have been reserved
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
24,000 shares issued under the 1993 Purchase Plan in 1996, 16,000 in 1995,
and none in 1994.
COMMON STOCK RESERVED FOR FUTURE ISSUANCE
Shares of Common Stock of the Company reserved for future issuance at December
31, 1996 are as follows:
1996
----------------
(IN THOUSANDS)
Employee Stock Purchase Plan 310
Stock Options 2,107
Undesignated Preferred Stock 5,000
----------------
7,417
================
STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB Opinion No. 25) and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (FAS 123), requires the use of option valuation
models that were not developed for use in valuing employee stock options.
Under APB Opinion No. 25, because the exercise price of the Company's stock
options generally equals the market price of the underlying stock on the date
of grant, no compensation expense is recognized.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK-BASED COMPENSATION (CONTINUED)
Pro forma information regarding net income and earnings per share is required
by FAS 123 which also requires that the information be determined as if the
Company has accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of FAS 123. The fair value of
these 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 6.10% and 6.30% for 1996 and 1995,
respectively; a dividend yield of 0.0%; a volatility factor of the expected
market price of the Company's Common Stock of 0.55; and a weighted average
expected life of the option of 3.6 years. The weighted average net fair value
of options granted in 1996 and 1995 was $4.53 per share and $6.58 per share,
respectively.
The Company does not recognize compensation cost related to employee purchase
rights under the Employee Stock Purchase Plan. To comply with the pro forma
reporting requirements of FAS 123, compensation cost is estimated for the
fair value of the employees' purchase rights using the Black-Scholes model
with the following assumptions for those rights granted in 1995 and 1996;
dividend yield of 0.0%; an expected life ranging up to 0.5 years; expected
volatility factor of 0.55; and a risk free interest rate of 5.72%. The
weighted average fair value of those purchase rights granted in January 1995,
July 1995, January 1996, and July 1996 were $6.29, $10.96, $2.99, and $2.46,
respectively.
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.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK-BASED COMPENSATION (CONTINUED)
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 FAS 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
1996 1995
--------------------------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
Pro forma net income $2,843 $5,112
Pro forma earnings per share $ 0.31 $ 0.53
For pro forma disclosure under FAS 123, the repricing of stock options in
October 1995 is treated as a modification of an award. Any additional
compensation arising from the modification is recognized over the remaining
vesting period of the new grant. FAS 123 is effective for options granted by
the Company commencing January 1, 1995. All options granted before January 1,
1995 have not been valued and no pro forma compensation expense has been
recognized. However, any option granted before January 1, 1995, that was
repriced in 1995, is treated as a new grant within 1995 and is valued
accordingly. In addition, since compensation expense is recognized over the
vesting period of the related options, which are generally four years, and
because pro forma disclosure is only required commencing with 1995, the
initial impact on pro forma income may not be representative of compensation
expense in future years.
3. BORROWINGS
In June 1996, the Company renewed its revolving line of credit with a
domestic bank that provides for borrowings of up to $2,000,000, including
secured letters of credit. The line of credit expires June 1, 1997.
Borrowings are collateralized by substantially all of the Company's U.S.
assets. The Company is also subject to certain financial covenants. At
December 31, 1996, the aggregate amount available to be borrowed under the
revolving line of credit was $2,000,000.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. BORROWINGS (CONTINUED)
In June 1995, the domestic bank renewed a $350,000 standby letter of credit
used as a security deposit for the sublease of the building the Company rents
as its corporate headquarters. Borrowings against the line bear interest at
prime (8.25% at December 31, 1996).
4. INDUSTRY SEGMENT REPORTING
The Company and its subsidiaries operate in one industry segment, 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,
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:
1996 1995 1994
----------------------------------
(IN THOUSANDS)
Sales to unaffiliated customers:
United States $51,883 $49,163 $28,299
Israel 1,027 1,274 305
---------------------------------
$52,910 $50,437 $28,604
=================================
Transfers between geographic
areas (eliminated in consolidation):
Israel $ 7,435 $ 4,846 $ 3,282
Japan 574 542 583
Europe 436 - -
---------------------------------
$ 8,445 $ 5,388 $ 3,865
=================================
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INDUSTRY SEGMENT REPORTING (CONTINUED)
1996 1995 1994
----------------------------------
(IN THOUSANDS)
Income (loss) before provision
for income taxes (including
intercompany amounts):
United States $ 7,504 $ 7,183 $ 5,492
Israel (596) 123 (1,204)
Japan 7 36 111
France 121 (78) -
----------------------------------
$ 7,036 $ 7,264 $ 4,399
==================================
Identifiable assets:
United States $54,880 $51,614 $40,928
Israel 4,039 3,045 2,432
Japan 219 195 203
France 69 - -
----------------------------------
$59,207 $54,854 $43,563
==================================
Export sales:
Asia $35,477 $27,636 $14,322
Europe 10,853 12,188 8,357
Israel 1,747 1,274 305
----------------------------------
$48,077 $41,098 $22,984
==================================
Sales to one distributor totaled 17% of total revenues in 1996, and sales to
one other customer totaled 11% of total revenues for 1996. Sales to the same
distributor totaled 25% of total revenue in 1995. In 1994, sales to two
distributors totaled 22% and 16% of total revenues, and sales to another
customer accounted for 10% of total revenues.
5. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
The Company leases certain equipment and facilities under noncancelable
operating leases. The Company has significant leased facilities in Givat
Shmuel, Israel and in Santa Clara, California. The Santa Clara facility was
leased by the Company through 2003, and portions of the facility were
subleased to other tenants. In October 1996, however, the Company negotiated
an assignment of its lease obligations to another Company (the Assignee)
effective January 1997. Accordingly, as of January 1, 1997, the Company is no
longer obligated under its former Santa Clara facility lease and is no longer
a sublessor to other tenants. In connection with the assignment of the lease,
the Company wrote off approximately $205,000 of leasehold improvements and
recorded a gain of approximately $380,000 related to deferred rent on the
facility. Beginning in fiscal 1997, the Company will receive payments from
the lessor of $322,000 in 1997, $322,000 in 1998, $322,000 in 1999, and
$295,000 in 2000 as compensation for the higher rents to be paid by the
Assignee. 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.
At December 31, 1996, the Company is required to make the following minimum
lease payments, as revised to reflect the assignment of the Santa Clara
facility lease, the payments to be received from the lessor on the Santa
Clara facility leases, and the Company's sublease of the new space as
described above (IN THOUSANDS):
1997 $ 720
1998 724
1999 634
2000 151
2001 354
Thereafter 143
------------
$2,726
============
Total rental expense for all leases was approximately $334,000 (net of
sublease income of $546,000, and a gain of $380,000 on write-off of deferred
rent), $656,000 (net of sublease income of $171,000), and $546,000 for the
years ended December 31, 1996, 1995, and 1994, respectively.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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.
The estimate of the potential impact on the Company's financial position or
overall results of operations or cash flows for the above matter could change
in the future.
STOCKHOLDERS' LITIGATION
In November 1995, after the Company's stock price declined, several lawsuits
were filed in the United States District Court for the Northern District of
California (the Court) accusing the Company, its Chief Executive Officer, and
its former Chief Financial Officer of issuing materially false and misleading
statements in violation of the federal securities laws. These lawsuits were
consolidated into a single amended complaint in February 1996. In the amended
complaint, plaintiffs seek unspecified damages on behalf of all persons who
purchased shares of the Company's stock during the period from June 6, 1995
through November 10, 1995. On June 11, 1996, the Court granted the Company's
motion to dismiss the lawsuit with leave to amend. The plaintiffs filed an
amended complaint on July 11, 1996. On March 7, 1997, the Court issued an
order dismissing with prejudice all claims based on statements issued by the
Company. The Court is permitting the plaintiffs to proceed with their claim
regarding statements the Company allegedly made to securities analysts and is
also permitting the plaintiffs to amend their complaint as to their claim
that the Company is responsible for the statements contained in the analysts'
reports. The Company believes the lawsuit to be without merit and intends to
defend itself vigorously. The Company believes the ultimate resolution of
this matter will not have a material adverse effect on the Company's
financial position, results of operations, or cash flows.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES
The tax provision (benefit) for the years ended December 31, 1996, 1995, and
1994 consists of the following:
1996 1995 1994
----------------------------------
(IN THOUSANDS)
Federal taxes:
Current $ (180) $ 1,898 $ 154
Deferred 1,099 (2,173) -
----------------------------------
919 (275) 154
State taxes:
Current 3 239 10
Deferred 70 - -
----------------------------------
73 239 10
Foreign taxes:
Current 65 89 203
----------------------------------
Provision (benefit) for
income taxes $ 1,057 $ 53 $ 367
==================================
Pretax income (loss) from foreign operations, exclusive of an in-process
technology write-off of $1,529,000 in 1996, was $1,061,000 in 1996, $(81,000)
in 1995, and $(1,093,000) in 1994.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES (CONTINUED)
A reconciliation between the Company's effective tax rate and the U.S.
statutory rate of 34% in 1996 and 35% in 1995 and 1994 is as follows:
YEARS ENDED DECEMBER 31,
1996 1995 1994
----------------------------------
(IN THOUSANDS)
Tax at U.S. statutory rate $ 2,396 $ 2,646 $ 1,539
Operating losses utilized (2,117) (2,603) (1,443)
Valuation of temporary differences 948 (779) (219)
Alternative minimum tax in excess
of regular tax - - 73
State taxes 3 155 -
Tax exempt interest income (422) (177) -
Foreign withholding tax - 31 92
Foreign income taxed at rates other
than U.S. rate (306) 13 23
Research and development expensed
upon acquisition 520 - 175
Basis difference upon sale of
subsidiary - 711 -
Research credit utilized - (126) -
Amortization of intangible assets 92 162 79
Other individually immaterial items (57) 20 48
----------------------------------
$ 1,057 $ 53 $ 367
==================================
As of December 31, 1996, the Company had federal net operating loss and tax
credit carryforwards of approximately $8,000,000 and $450,000, respectively.
The federal net operating loss carryforward will expire at various dates
beginning in the years 2006 through 2009, if not utilized.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES (CONTINUED)
In September 1993, the Company issued Series F Preferred Stock. The issuance
of such stock resulted in a change in ownership pursuant to the provisions of
the Tax Reform Act of 1986. Accordingly, the Company's federal net operating
losses incurred prior to the change of ownership are subject to an annual
limitation in future periods. Utilization of the net operating loss
carryforwards is limited to approximately $3,300,000 per year.
Significant components of the Company's deferred tax assets and liabilities
as of December 31, 1996 and 1995 are as follows:
1996 1995
---------------------
(IN THOUSANDS)
Deferred tax assets:
Research credits $ 450 $ 100
Net operating loss carryforwards 2,700 4,200
Capitalized research and development 450 540
Other 1,100 840
---------------------
Total deferred tax assets 4,700 5,680
Valuation allowance (3,696) (3,507)
---------------------
Net deferred tax assets $ 1,004 $ 2,173
=====================
Approximately $2,227,000 of the valuation allowance at December 31, 1996 is
related to benefits of stock option deductions, which will be allocated to
paid-in capital when realized.
DSP Semiconductors Israel (DSP Israel) has been awarded "Approved Enterprise"
status by the Israeli government according to two investment plans that
included investments of $3,788,000 and $760,000, respectively. The "Approved
Enterprise" status allowed DSP Israel a two-year tax holiday on undistributed
earnings commencing with the year 1992 for which taxable income had been
attained and a corporate tax rate of 10%, for an additional eight years, on
the first investment plan's proportionate share of income. The proportionate
share of income related to the second investment plan will entitle DSP Israel
to a four-year tax holiday on undistributed earnings commencing with the 1996
tax year and a corporate tax rate of 10% for an additional six years. The
aggregate dollar and per share benefit of the Israeli tax holiday was
$306,000 and $0.03, respectively, for 1996.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. RELATED PARTY TRANSACTIONS
In 1996, 1995, and 1994, the Company performed certain contract engineering,
research and development, sales and marketing, and general and administrative
services for and received certain research and development, sales and
marketing, and general and administrative services from DSP Communications,
Inc. (DSPC), amounting to approximately $0 and $0 in 1996, $919,000 and
$122,000 in 1995, and $454,000 and $394,000 in 1994, respectively.
In 1994, the Company entered into a license agreement with DSPC that gave
DSPC rights to develop five integrated circuits using the Company's
OakDSPCore digital signal processor technology. DSPC had previously licensed
the Company's PineDSPCore digital signal processor technology. The Company
recorded $305,000 of licensing and other revenues in connection with this
transaction in 1994.
In 1995 and 1994, the Company performed certain research and development and
general and administrative services for Zen Research, amounting to
approximately $127,000 in 1995 and $41,000 in 1994.
In 1993, the Company entered into a development and licensing agreement with
AudioCodes (SEE NOTE 1). 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 licensing fee and
maintenance fees of approximately 15% to 24% of the net revenue and 8% of the
gross revenue realized from the sale of the technology. In 1996, 1995, and
1994, the Company recorded approximately $0, $527,000, and $380,000,
respectively, of research and development costs related to this agreement and
$260,000 in 1996 and $179,000 in 1995 of licensing fees.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. SALE OF STOCK OF DSPC
The Company sold its remaining 131,000 shares of Common Stock of DSPC, the
successor of a former subsidiary of the Company, DSP Telecommunications Ltd.,
in April 1995 upon the exercise of the underwriters' overallotment option in
connection with DSPC's initial public offering. As the Company's basis in the
investment had no book value, the sale resulted in a gain of approximately
$1,200,000 in the second quarter of 1995. The Company had sold 73,000 shares
of Common Stock of DSPC in DSPC's March 1995 initial public offering,
resulting in a gain of approximately $666,000 in the first quarter of 1995.
DSPC is a Delaware corporation primarily engaged in the development and
marketing of integrated circuits based on digital signal processing for the
wireless communications market. In 1994, the Company sold 1,234,000 shares of
DSPC stock to a group of investors for $1,851,000 in cash of which $1,551,000
and $300,000 were sold during the second and fourth quarter of 1994,
respectively. Of this amount, $1,351,000 was sold to investors who were also
stockholders of the Company. As the Company's basis in the investment had no
book value, the sale resulted in a gain of $1,851,000.
9. ACQUISITIONS AND DISPOSALS
The Company had a joint development agreement with Scitex Corporation, Ltd.,
an Israeli corporation, under which Nogatech, Inc. (Nogatech) was formed to
engage in the development and marketing of DSP-based image processing and
video compression technology for products targeting the consumer electronics
and office automation markets. Nogatech was incorporated in January 1993. The
Company contributed technology with no book value in exchange for stock
representing a 50% ownership in Nogatech. The Company accounted for this
investment using the equity method; however, since the Company's basis in the
investment had no book value and the Company was not obligated to fund any
losses under the joint development agreement, the Company did not recognize
any losses on this investment.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. ACQUISITIONS AND DISPOSALS (CONTINUED)
On May 3, 1994, the Company acquired the remaining 50% of the outstanding
capital stock of Nogatech from Scitex Corporation, Ltd., for $2,000,000 cash.
Legal, accounting, and appraisal costs related to the transaction were
$100,000. The acquisition was accounted for as a purchase in accordance with
Accounting Principles Board Opinion No. 16. The excess of the total
acquisition cost over the recorded value of assets acquired was approximately
$2,015,000 and was allocated, based on values determined by an independent
appraisal, to existing technology which had reached technological
feasibility, in-process research and development, and other tangible and
intangible assets.
To determine the value of the existing technology, the expected future cash
flows of each existing technology product were discounted taking into account
risks related to the characteristics and applications of each product,
existing and future markets, and assessments of the life cycle stage of each
product. Based on this analysis, the existing technology, which had reached
technological feasibility, was assigned a value of $853,000 and capitalized.
This capitalized technology was amortized over a three-year period beginning
with first product shipment in October 1994.
To determine the value of the technology in the development stage, the
Company considered, among other factors, the stage of development of each
project, the time and resources needed to complete each project, expected
income, and associated risks. Associated risks included the inherent
difficulties and uncertainties in completing the project and thereby
achieving technological feasibility and risks related to the viability of and
potential changes to future target markets. This analysis resulted in a value
of $1,104,000 being assigned to technology in the development stage that had
not yet reached technological feasibility and did not have alternative future
uses. Therefore, in accordance with generally accepted accounting principles,
the $1,104,000 of technology in the development stage was expensed.
Other identifiable tangible assets, intangible assets, and liabilities were
also identified in this process and were determined to have a net asset value
of $143,000. The statement of operations includes Nogatech's results of
operations for the eight months ended December 31, 1994, as Nogatech was
acquired on May 3, 1994.
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. ACQUISITIONS AND DISPOSALS (CONTINUED)
Pursuant to the Stock Purchase Agreement, on August 11, 1995, the Company
sold its equity interest in Nogatech to two purchasers for $1,500,000 in
cash. The purchasers consisted of a customer of the Company and a stockholder
of the Company. The Company also agreed to cancel all other amounts that
Nogatech owed the Company and grant limited licenses to Nogatech to use
certain technology of the Company in exchange for: (i) the receipt of certain
fixed assets; (ii) reimbursement of post-June 30, 1995 cash fundings to
Nogatech; (iii) royalties not to exceed $750,000 on any future sales of
certain Nogatech products; and (iv) a $400,000 promissory note to the Company
from Nogatech. The promissory note and interest computed at a rate of 8.75%
per annum was paid in January 1996. The Company attributed $250,000 of the
sales price to the value of these limited licenses sold to Nogatech based
upon the Company's licensing pricing structure.
10. UNUSUAL ITEMS
During the second quarter of 1995, the Company formulated a plan to divest
its 89% equity interest in its Nogatech subsidiary. The Company incurred a
$500,000 charge for the write-down of Nogatech's intangible assets in
accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of." Nogatech's revenues for the period from January 1, 1995
through August 11, 1995 were $500,000, and Nogatech incurred an operating
loss, exclusive of the $500,000 write-off, of $767,000.
In April 1995, the former Chairman of the Board of Directors resigned to
focus his efforts on DSPC where he serves as Chairman. The Company incurred
$413,000 of severance expense as a result of this resignation. The expense
consisted $283,000 for severance payments to be made over a two-year period
and a $130,000 charge for accelerated vesting of the former Chairman's
outstanding stock options.
In September 1994, the Company sold its optical disk technology to an
investor group who formed Zen Research and recorded a gain of $646,000. On
May 3, 1994, the Company acquired from Scitex Corporation, Ltd. the remaining
50% of the outstanding capital stock of Nogatech not previously held by the
Company and consequently recorded a $1,104,000 charge for acquired research
and development from a related party in the second quarter of 1994 (SEE NOTE
9, ACQUISITIONS AND DISPOSALS).
DSP GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. UNUSUAL ITEMS (CONTINUED)
In July 1996, the Company acquired a 40% equity ownership interest in Aptel,
Ltd., a company located in Israel. In connection with the acquisition, the
Company recorded a charge of $1,529,000 for acquired research and development
from a related party in the third quarter of 1996 (SEE NOTE 1, EQUITY
INVESTMENTS).
DSP GROUP, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
YEARS ENDED DECEMBER 31,
---------------------------------------------------
1996 1995 1994 1993 1992
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(In thousands, except per share amounts)
STATEMENT OF OPERATIONS DATA:
Revenues $52,910 $50,347 $28,604 $12,447 $ 8,860
Net income (loss) $ 5,979 $ 7,211 $ 4,032 $ (467) $ (7,874)
Net income (loss) per share $ .62 $ .75 $ .44 $ (.13) $ (2.42)
Shares used in per share computation 9,581 9,658 9,135 3,504 3,248
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities $42,934 $33,828 $26,376 $ 2,019 $ 2,641
Working capital (deficit) $47,851 $39,304 $29,824 $ 1,797 $ (8,197)
Total assets $59,207 $54,854 $43,563 $ 8,070 $ 5,015
Long-term obligations, less current portion $ - $ - $ - $ 1,211 $ 4,267
Total stockholders' equity (deficit) $54,449 $47,541 $36,801 $ 2,517 $(11,179)
FISCAL YEARS BY QUARTER
------------------------------------------------------------------------------
1996 | 1995
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(Unaudited, in thousands, except per share amounts)
QUARTERLY DATA: 4TH 3RD 2ND 1ST 4TH 3RD 2ND 1ST
------------------------------------------------------------------------------
Revenues $15,081 $13,611 $13,021 $11,197 $13,023 $13,068 $12,462 $11,884
Gross Profit $ 6,660 $ 5,015 $ 4,940 $ 5,767 $ 4,837 $ 6,607 $ 6,722 $ 6,188
Net income (loss) (1) $ 5,400 $ (263) $ 268 $ 574 $ 570 $ 2,490 $ 2,438 $ 1,713
Net income (loss) per share $ .56 $ (.03) $ .03 $ .06 $ .06 $ .26 $ .25 $ .18
- ---------------------------------------------------------------------------
(1) See Notes 8, 9, and 10 of Notes to Consolidated Financial Statements
for explanation of gain on sale of stock in affiliate in first and second
quarters of 1995, write-down of impaired asset and charge for severance
expense in second quarter of 1995, charge for acquired in process research
and development in third quarter of 1996, and the gain on settlement of a
lawsuit in the fourth quarter of 1996.