DSP Group Inc.
Selected Consolidated Financial Data
YEAR ENDED DECEMBER 31,
1998 1997 1996 1995 1994
--------------- -------------- --------------- --------------- ---------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
STATEMENTS OF OPERATIONS DATA:
Revenues $63,850 $61,959 $52,910 $50,347 $28,604
Income (loss) from continuing operations $14,415 $11,034 $ 5,979 $ 7,211 $ 4,032
Weighted average number of common shares
outstanding during the period used to
compute basic earnings per share 9,768 9,736 9,510 9,352 8,111
Weighted average number of common shares
outstanding during the period used to
compute diluted earnings per share 10,016 10,203 9,581 9,658 9,135
Net income (loss) per share - Basic $ 1.48 $ 1.13 $ .63 $ .77 $ .50
Net income (loss) per share - Diluted $ 1.44 $ 1.08 $ .62 $ .75 $ .44
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities $66,989 $65,944 $42,934 $33,828 $26,376
Working capital $68,673 $66,947 $47,851 $39,304 $29,824
Total assets $85,791 $85,826 $59,778 $55,350 $43,832
Total stockholders' equity $75,695 $74,170 $54,449 $47,541 $36,801
FISCAL YEARS BY QUARTER
--------------------------------------------------------------------------------------------
1998 1997
------------------------------------------------ -------------------------------------------
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
QUARTERLY DATA: 4TH 3RD 2ND 1ST 4TH 3RD 2ND 1ST
Revenues $ 14,117 $ 17,308 $ 16,749 $ 15,676 $ 16,581 $ 16,558 $ 14,642 $ 14,178
Gross profit $ 8,742 $ 9,041 $ 8,756 $ 7,883 $ 8,697 $ 8,050 $ 6,595 $ 6,305
Net income $ 3,468 $ 3,475 $ 4,261 $ 3,211 $ 3,445 $ 3,348 $ 2,225 $ 2,016
Net income per share - Basic $ .37 $ .36 $ .43 $ .32 $ .34 $ .34 $ .23 $ .21
Net income per share - Diluted $ .36 $ .35 $ .42 $ .31 $ .33 $ .32 $ .23 $ .21
DSP Group Inc.
Price Range of Common Stock
The Company's common stock trades on the Nasdaq National Market
(Nasdaq symbol "DSPG"). The following table presents for the periods
indicated the intraday high and low sale prices for the Company's common
stock as reported by the Nasdaq National Market:
HIGH LOW
---------------------- --------------------
1998
First Quarter $26.88 $16.75
Second Quarter $25.00 $16.88
Third Quarter $24.75 $13.13
Fourth Quarter $20.88 $ 9.63
1997
First Quarter $13.00 $ 8.50
Second Quarter $15.50 $ 8.50
Third Quarter $40.38 $15.06
Fourth Quarter $42.25 $17.94
As of December 31, 1998, there were approximately 88 holders of record
of the Company's Common Stock, which the Company believes represents
approximately 4,230 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.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITIONS AND RESULTS OF OPERATIONS
1998
RESULTS OF OPERATIONS
1998 has been a successful year for DSP Group's research and development
team, which undertook and successfully completed an ambitious project of
renewing our entire line of products. We also launched two new Core
technology generations, the TeakDSPCore-Registered Trademark- and
PalmDSPCore.-TM- Moreover, our results of operations for 1998 show increased
licensing revenues and improved product gross margins. As a result, DSP Group
has entered 1999 as a world leader in its advanced technologies and products.
DSP Group's liquidity and working capital continually improved
throughout 1998 and by year end we achieved new record highs for DSP Group in
cash and marketable securities and working capital. These increases were
attained despite our repurchase program of DSP Group common stock during 1998
in the approximate aggregate amount of $14 million. Throughout 1998, DSP
Group maintained its role as a leading supplier of technologically advanced,
high performance, cost effective signal processors.
Our future operating results will be dependent upon a variety of
factors. See "Factors Affecting Operating Results" in this report and in our
Annual Report on Form 10-K for the year ended December 31, 1998.
TOTAL REVENUES. Our total revenues were $63.9 million in 1998, $62.0 million
in 1997 and $52.9 million in 1996. This represents an increase in total
revenues of 3% in 1998 as compared with total revenues in 1997, and a 17%
increase in total revenues in 1997 as compared with those in 1996. However,
in the fourth quarter of 1998, there was a sharp decline in our product
revenues as a result of the phasing out of our previous line of D6K series
products. Our licensing revenues in 1998 were $14.6 million compared to $10.7
million in 1997, and $11.6 million in 1996. This represents an increase in
licensing revenues of 36% in 1998 as compared with 1997,
and a decrease of 8% in our licensing revenues in 1997 as compared with those
in 1996.
Export sales, primarily consisting of TAD speech processors shipped to
manufacturers in Europe and Asia, including Japan, represented 95% of DSP
Group's total revenues in 1998, 92% in 1997 and 91% in 1996. All export sales
are denominated in U.S. dollars.
SIGNIFICANT CUSTOMERS. Revenues from one of our distributors, Tomen
Electronics, accounted for 45% of our total revenues in 1998 as compared to
33% in 1997, and 17% in 1996. In addition, revenues from Samsung
Semiconductor Inc. accounted for 11% of our total revenues in 1996. The loss
of one or more of our major distributors or customers could harm our
business, financial condition and results of operations.
GROSS PROFIT. Gross profit as a percentage of total revenues increased to 54%
in 1998, from 48% in 1997 and from 42% in 1996. The increase in gross profit
in 1998 compared to 1997 was primarily due to the increase in our licensing
revenues, which have a higher gross profit than product sales.
Product gross profit as a percentage of product sales increased to 41%
in 1998, from 39% in 1997 and from 29% in 1996. This ongoing increase was
primarily due to the decrease in our costs of manufacturing. Our
manufacturing costs have decreased due to improvements in manufacturing
technology and the decreased manufacturing prices obtained from our
foundries. Importantly, this increase in gross profit was achieved even
though we continue to experience competitive, downward pricing pressure for
our TAD products.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased to $10.2 million in 1998, from $8.4 million in 1997. This increase
in research and development expenses in 1998 as compared to those in 1997 was
attributable mainly to an increase in the external services provided to our
research and development team, additional mask tapeouts for our new enhanced
line of products, and an increase in our research and development personnel.
The slight decrease in research and development expenses to $8.4 million
in 1997 compared to $8.5 million in 1996 occurred as we finalized the
consolidation of
our research and development activities in Israel, which resulted in a
closely managed, more efficient and better focused research team. Research
and development expenses as a percentage of total revenues increased to 16%
in 1998, from 14% in 1997. In 1996, research and development expenses as a
percentage of total revenues was 16%.
SALES AND MARKETING EXPENSES. Our sales and marketing expenses increased to
$5.2 million in 1998, from $4.9 million in 1997 and from $4.4 million in 1996.
The increase in expenses in 1998 as compared to those in 1997 was due to an
increase in our sales and marketing personnel, which was partially offset by
lower sales commissions and lower consulting costs.
Sales and marketing expenses increased from $4.4 million in 1996 to $4.9
million in 1997 primarily due to our establishment of a new worldwide marketing
group and extensive participation in trade shows and professional conferences.
Sales and marketing expenses as a percentage of total revenues remained at
8% in 1998, 1997 and 1996.
GENERAL AND ADMINISTRATIVE EXPENSES. Our general and administrative expenses
increased only slightly to $4.6 million in 1998 from $4.5 million in 1997 as we
continued to closely monitor these expenses.
General and administrative expenses decreased significantly in 1997 to $4.5
million from $5.7 million in 1996 mainly due to a decrease in salary and fringe
benefits expense and legal expenses, as well as our closer monitoring of other
expenses, including facilities rent, maintenance and insurance expenses.
General and administrative expenses as a percentage of total revenues
remained at 7% in both 1998 and 1997 after a decrease from 11% in 1996.
UNUSUAL ITEMS. In July 1996, DSP Group made an initial cash investment of $2.0
million for approximately 40% of the equity interests in Aptel Ltd. ("Aptel"),
which is located in Israel. In connection with the acquisition, we incurred a
one-time write-off of acquired in-process technology of $1.5 million based on an
independent estimate of value.
INTEREST AND OTHER INCOME. Interest and other income increased to $3.8
million in 1998 from $2.9 million in 1997 and from $1.6 million in 1996. The
increase in
interest income in 1998 is a result of higher levels on cash equivalents and
marketable securities in 1998 as compared with 1997 and 1996, as well as higher
yields of financial investments.
Equity in income (loss) of equity method investees was $125,000 in 1998,
($706,000) in 1997 and ($457,000) in 1996. In both 1997 and 1996 equity in
losses of Aptel were included in our results of operations. In December 1997,
Aptel's shareholders, including DSP Group, exchanged their shares in Aptel for
shares of common stock of Nexus Telecommunications Systems Ltd. ("Nexus"), an
Israeli company whose shares are registered and traded on the Nasdaq SmallCap
Market. DSP Group's results of operations in 1998 do not include any equity
gains (losses) pertaining to Aptel or Nexus.
The increase in equity in losses in 1997 compared to those in 1996 was due
to our higher equity share in both Aptel and AudioCodes Ltd., an Israeli
corporation. See Note 1 of the Notes to Consolidated Financial Statements for
more information. Equity in income (loss) of equity method investees also
included amortization of the excess of the purchase price over the net assets
acquired for an equity investment in AudioCodes, Ltd. made in the second quarter
of 1994.
GAIN ON SETTLEMENT OF LITIGATION. In October 1996, DSP Group entered into
agreements with Rockwell International Inc. to license certain of DSP Group's
TrueSpeech technologies and to settle all pending litigation between the
companies. As part of the litigation settlement, DSP Group recorded a one
time pre-tax gain of $3.8 million, net of legal expenses.
GAIN ON SALE OF MARKETABLE EQUITY SECURITY. In April 1998, DSP Group sold all
of its Nexus shares in a private transaction and realized a pre-tax one time
gain on marketable equity securities of approximately $1.1 million, which is
included under "Other income (expense)" in our consolidated statements of income
for 1998.
PROVISION FOR INCOME TAXES. The effective tax rate for the years ended
December 31, 1998, 1997 and 1996 was 25%, 20% and 15%, respectively. The tax
rate for 1998 is higher than 1997 due to previously unbenefited operating
losses and tax credit carryforwards utilized in 1997 which are no longer
available in 1998, offset by
increased foreign tax holiday benefits in 1998. The tax rate for 1997 is
higher than 1996 due to decreased percentage benefits from the utilization of
net operating loss carry forwards, offset slightly by increased percentage
foreign tax holiday benefits and the recognition of previously unbenefited
deferred tax assets.
DSP Group Ltd., DSP Group's subsidiary in Israel, has been granted
"Approved Enterprise" status by the Israeli government according to four
investment plans. The Approved Enterprise status allows for a tax holiday for
a period of two to four years and a reduced corporate tax rate of 10% for an
additional eight or six years, on the respective investment plans'
proportionate share of taxable income. The tax benefits under these
investment plans are scheduled to gradually expire starting from 2002 through
2009.
Management has assessed the need for a valuation allowance against
deferred tax assets and has concluded that it is more likely than not that
$2.2 million deferred tax assets will be realized based on current levels of
future taxable income and potentially refundable taxes.
LIQUIDITY AND CAPITAL RESOURCES
During 1998, DSP Group generated $15.1 million of cash and cash
equivalents from its operating activities as compared to $18.6 million during
1997 and $11.3 million in 1996. The decrease in 1998 of cash and cash
equivalents as compared with that in 1997 occurred even though DSP Group
experienced an increase in net income in 1998. The decrease in cash and cash
equivalents was attributable primarily to the non-cash effects of recognizing
deferred revenue and the cash used by the increase in accounts receivables
and decrease in accounts payables, which in turn was partially offset by the
decrease in our inventories and in our deferred income tax. The increase in
cash and cash equivalents in 1997 as compared to 1996 was primarily due to
the increase in net income from our operations and the increase in our
deferred revenue.
We invest excess cash in marketable securities of varying maturity,
depending on our projected cash needs for operations, capital expenditures
and other business purposes. In 1998, DSP Group purchased $60.0 million of
investments classified as marketable securities, $77.1 million in 1997 and
$32.2 million in 1996. In addition, DSP Group sold $60.6 million of
investments classified as marketable securities in 1998, $49.3 million in
1997 and $20.6 million in 1996. During 1998 and late 1997,
we extended the average maturity for our investments to a maximum of 24
months from the previous maximum of 18 months in early 1997. As a result, as
of December 31, 1998 and December 31, 1997, a larger portion of our
investments had been held for a period greater than one year as compared to
the holding period of our investments as of December 31, 1996.
Our capital equipment purchases amounted to $2.3 million in 1998, $2.2
million in 1997 and $836,000 in 1996 for computer hardware and software used
in engineering development, engineering test equipment, leasehold
improvements, vehicles, and furniture and fixtures. The acquisitions of
capital equipment during 1998 were primarily for computer equipment, testing
equipment and software for our research and development efforts during the
year.
In 1996, DSP Group made an initial cash investment of $2.0 million for
approximately 40% of the equity interests in Aptel. In 1997, DSP Group
invested an additional $176,000 in convertible debentures of Aptel.
Subsequently, in December 1997, Aptel's shareholders, including DSP Group,
exchanged their shares in Aptel for shares in Nexus. In April 1998, DSP Group
sold all of its Nexus shares in a private transaction for approximately $1.3
million and realized a pre-tax one time gain on marketable equity securities
of approximately $1.1 million, which is included under "Other income
(expense)" in our consolidated statements of income for the 1998.
In January 1998, DSP Group announced a stock repurchase program
pursuant to which up to 1,000,000 shares of DSP Group common stock were to be
acquired in the open market or in privately negotiated transactions.
Accordingly, in 1998, we repurchased 814,000 shares of our common stock at an
average purchase price of $17.53 per share, for an aggregate purchase price
of approximately $14.3 million.
Cash received upon the exercise of employee stock options and through
purchases pursuant to DSP Group's employee stock purchase plan in 1998
totaled $1.2 million as compared with $6.6 million in 1997 and $495,000 in
1996. In addition, repayment of stockholders' notes receivable provided cash
of $434,000 in 1996.
At December 31, 1998, DSP Group's principal source of liquidity
consisted of cash and cash equivalents totaling $9.0 million and marketable
securities of $58.0
million. DSP Group's working capital at December 31, 1998 was $68.7 million,
an increase from the working capital of $66.9 million at December 31, 1997.
We believe that our current cash, cash equivalent and marketable
securities will be sufficient to meet our cash requirements through at least
the next 12 months. In February 1999, our Board of Directors approved another
stock repurchase program pursuant to which we may acquire up to 1,000,000
shares of DSP Group common stock in the open market or in privately
negotiated transactions. Accordingly, we will use part of our available cash
for this purpose. As part of DSP Group's business strategy, we occasionally
evaluate potential acquisitions of businesses, products and technologies.
Accordingly, a portion of our available cash may be used for the acquisition
of complementary products or businesses. These potential transactions may
require substantial capital resources, which may require us to seek
additional debt or equity financing. However, we cannot provide assurance
that we will consummate any such transactions.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK. It is DSP Group's policy not to enter into derivative
financial instruments. DSP Group does not currently have any significant
foreign currency exposure since it does not transact business in foreign
currencies. Due to this, DSP Group did not have significant overall currency
exposure at March 1, 1999.
FOREIGN CURRENCY RATE RISK. As nearly all of DSP Group's sales and expenses are
denominated in U.S. Dollars, DSP Group has experienced only insignificant
foreign exchange gains and losses to date, and does not expect to incur
significant gains and losses in the next 12 months. DSP Group did not engage in
foreign currency hedging activities during 1998.
EUROPEAN MONETARY UNION
Within Europe, the European Economic and Monetary Union (the "EMU")
introduced a new currency, the euro, on January 1, 1999. During 2002, all EMU
countries are expected to be operating with the euro as their single currency.
Uncertainty exists as to the effect the euro currency will have on the
marketplace. Additionally, all of the final rules and regulations have not yet
been defined and
finalized by the European Commission with regard to the euro currency. We are
assessing the effect the euro formation will have on DSP Group's internal
systems and the sale of DSP Group products. We expect to take appropriate
actions based on the results of such assessment. We believe that the cost
related to this issue will not be material to us and will not have a
substantial effect on our financial condition and results of operations.
YEAR 2000 COMPLIANCE
DSP Group is aware of the issues associated with the programming code in
existing computer systems as the Year 2000 approaches. The "Year 2000"
problem is concerned with whether computer systems will properly recognize
date sensitive information when the year changes to 2000. Systems that do
not properly recognize such information could generate erroneous data or
cause a system to fail. The Year 2000 problem is pervasive and complex as
the computer operation of virtually every company will be affected in some
way.
Beginning in 1997, during 1998 and going forward in 1999, DSP Group is
utilizing both internal and external resources to identify, correct or
reprogram and test DSP Group's systems for Year 2000 readiness. We anticipate
that all reprogramming efforts, including testing, will be completed by June
30, 1999. Our efforts include the evaluation of both information technology
("IT") and non-IT systems. Non-IT systems include systems or hardware
containing embedded technology such as microcontrollers. To date the costs
incurred by DSP Group with respect to this project are not material and we do
not believe that future costs for the completion of this project will be
material. However, if systems material to our operations have not been made
Year 2000 ready by the completion of the project, the Year 2000 issue could
have a material adverse effect on our financial statements. We have not
developed a contingency plan to operate in the event that a noncompliant
critical system is not remedied by January 1, 2000 and do not intend to do so.
Throughout 1998 and into 1999, we have been and continue to take steps
to ensure that our products and services will continue to operate on and
after January 1, 2000. We believe that DSP Group's products being shipped
today are Year 2000 ready. In addition, to date, confirmations have been
received from DSP Group's primary processing vendors that plans are being
developed to address the processing
of transactions in the Year 2000. We also have been communicating with
suppliers and other third parties that DSP Group does business with to
coordinate Year 2000 readiness. The responses received to date indicate that
such third parties are taking steps to address this concern.
Based upon the steps being taken to address this issue and the progress
to date, we believe that Year 2000 readiness expenses will not have a
material adverse effect on DSP Group's earnings. However, we cannot assure
that Year 2000 problems will not occur with respect to DSP Group's computer
systems. Furthermore, the Year 2000 problem may impact other entities with
which we transact business, and we cannot predict the effect of the Year 2000
problem on such entities or the resulting effect on DSP Group. As a result,
if preventative and/or corrective actions mainly by those which DSP Group
does business with are not made in a timely manner, the Year 2000 issue could
result in a failure of some of DSP Group's manufacturing operations, which
would harm our business, financial condition and results of operations.
SUBSEQUENT EVENTS
SALE OF COMMON STOCK. On February 2, 1999, DSP Group announced that it had
entered into a stock purchase agreement with Magnum Technologies, Ltd., an
international investment fund ("Magnum"), in which DSP Group issued and sold
2,300,000 new shares of DSP Group common stock to Magnum. Based in part on
Magnum's representations, the transaction was exempt from the registration
requirements of the Securities Act of 1933 according to Section 4(2) of the
Securities Act. These shares, representing 19.6% of DSP Group's outstanding
common stock at the time of the transaction, were issued for a price of $15
per share, or an aggregate of $34.5 million in total net proceeds to DSP
Group. As part of the agreement, Magnum may acquire additional shares of DSP
Group in the open market, but may not bring its total holdings to more than
35% of DSP Group's outstanding shares of common stock. Furthermore, Magnum
has agreed not to sell any of the DSP Group shares of common stock it
purchased without the prior written consent of DSP Group for a period of one
year following the date of this transaction, and also to restrict its sales
of the shares for an additional six-month period under Rule 144(e)(i) of the
Securities
Act of 1933. Additionally, DSP Group has invited Magnum to appoint two new
directors to the Board of Directors, bringing the total number of members of
the Board of Directors to seven.
ACQUISITIONS. In the first quarter of 1999, DSP Group entered the wireless
communication product market, which we believe to be synergistic with our
existing markets. We acquired two integrated groups of engineers specializing
in the design of integrated circuits for wireless communication. In addition,
we acquired technology and products, including associated intellectual
property, related to base band and RF for 900 Megahertz digital spread
spectrum.
RISK FACTORS AFFECTING OPERATING RESULTS
The stockholders' letter and the discussion in this annual report that
concerns DSP Group's future products, expenses, revenue, liquidity and cash
needs as well as DSP Group's plans and strategies contain forward-looking
statements concerning our future operations and financial results. These
forward-looking statements are based on current expectations and we assume no
obligation to update this information. Numerous factors could cause results
to differ from those described in these statements, and prospective investors
and stockholders should carefully consider the factors set forth below in
evaluating these forward-looking statements.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY. Our quarterly
results of operations may vary significantly in the future for a variety of
reasons, including the following:
- fluctuations in volume and timing of product orders;
- timing of recognition of license fees;
- level of per unit royalties;
- changes in demand for our products due to seasonal customer buying
patterns and other factors;
- timing of new product introductions by us or our customers, licensees
or competitors;
- changes in the mix of products sold by us;
- fluctuations in the level of sales by OEMs and other vendors of
products incorporating our products; and
- general economic conditions, including the changing economic
conditions in Asia.
Each of the above factors is difficult to forecast and thus could have a
material adverse effect on our business, financial condition and results of
operations.
Through 1999, we expect that revenues from our DSP core designs and
TrueSpeech algorithms will be derived primarily from license fees rather than
per unit royalties. The uncertain timing of these license fees has caused, and
may continue to cause, quarterly fluctuations in our operating results. Our per
unit royalties from licenses are totally dependent upon the success of our OEM
licensees in introducing products utilizing our technology and the success of
those OEM products in the marketplace. Per unit royalties from TrueSpeech
licensees have not been significant to date.
OUR AVERAGE SELLING PRICES CONTINUE TO DECLINE. We have experienced a decrease
in the average selling prices of our TAD speech processors, but have to date
been able to offset this decrease on an annual basis through manufacturing cost
reductions and the introduction of new products with higher performance.
However, we cannot guarantee that our on-going efforts will be successful or
that they will keep pace with the anticipated, continuing decline in average
selling prices.
WE DEPEND ON THE DIGITAL TAD MARKET WHICH IS HIGHLY COMPETITIVE. Sales of TAD
products comprise a substantial portion of our product sales. Any adverse
change in the digital TAD market or in our ability to compete and maintain our
position in that market would have a material adverse effect on our business,
financial condition and results of operations. The digital TAD market and the
markets for our products in general are extremely competitive and we expect that
competition will only increase. Our existing and potential competitors in each
of our markets include large and emerging domestic and foreign companies, many
of which have significantly greater financial, technical, manufacturing,
marketing, sale and distribution resources and management expertise than we do.
It is possible that we may one day be unable to respond to increased price
competition for TAD speech processors or other products through the introduction
of new products or reductions of manufacturing costs. This inability would have
a material adverse effect on our business, financial condition and
results of operations. Likewise, any significant delays by us in developing,
manufacturing or shipping new or enhanced products would also have a material
adverse effect on our business, financial condition and results of
operations.
WE DEPEND ON REVENUES FROM A CURRENTLY UNSTABLE ASIAN MARKET. In 1997, we
generated approximately $19.9 million, or 39% of our total product sales,
from sales to customers located in South Korea, Taiwan, Singapore and Hong
Kong. However, in 1998, due to economic problems in some of these countries,
most notably South Korea and Singapore, our product sales in this region
decreased to $10.9 million, or 22% of our total product sales. The decline in
sales from Southeast Asia countries resulted in a decrease in our backlog,
but was partially offset by increased orders from Japan. If this negative
economic trend in the Asian markets continues, it may result in a further
decrease of our backlog in 1999. We cannot provide assurance that continued
negative economic development in Asia will not have a material adverse effect
on our future operating performance.
WE DEPEND ON INDEPENDENT FOUNDRIES TO MANUFACTURE OUR INTEGRATED CIRCUIT
PRODUCTS. All of our integrated circuit products are manufactured by
independent foundries. While these foundries have been able to adequately
meet the demands of our increasing business, we are and will continue to be
dependent upon these foundries to achieve acceptable manufacturing yields,
quality levels and costs, and to allocate to us a sufficient portion of
foundry capacity to meet our needs in a timely manner. To meet our increased
wafer requirements, we have added additional independent foundries to
manufacture our TAD speech processors. Our revenues could be materially and
adversely affected should any of these foundries fail to meet our request for
products due to a shortage of production capacity, process difficulties, low
yield rates or financial instability.
WE DEPEND ON INTERNATIONAL OPERATIONS, PARTICULARLY IN ISRAEL. We are subject
to the risks of doing business internationally, including:
- unexpected changes in regulatory requirements;
- fluctuations in the exchange rate for the U.S. dollar;
- imposition of tariffs and other barriers and restrictions;
- burdens of complying with a variety of foreign laws;
- political and economic instability; and
- changes in diplomatic and trade relationships.
In particular, our principal research and development facilities are
located in the State of Israel and, as a result, at December 31, 1998, 97 of
our 120 employees were located in Israel, including all 66 of our research
and development personnel. In addition, although DSP Group is incorporated in
Delaware, a majority of our directors and executive officers are residents of
Israel. Therefore, we are directly affected by the political, economic and
military conditions to which Israel is subject.
Moreover, many of our expenses in Israel are paid in Israeli currency
which subjects us to the risks of foreign currency fluctuations and to
economic pressures resulting from Israel's generally high rate of inflation.
The rate of inflation in Israel was 8.6% in 1998 and 7.0% in 1997. While
substantially all of our sales and expenses are denominated in United States
dollars, a portion of our expenses are denominated in Israeli shekels. Our
primary expenses paid in Israeli currency are employee salaries and lease
payments on our Israeli facilities. As a result, an increase in the value of
Israeli currency in comparison to the United States dollar could increase the
cost of technology development, research and development expenses and general
and administrative expenses. We cannot provide assurance that currency
fluctuations, changes in the rate of inflation in Israel or any of the other
factors mentioned above will not have a material adverse effect on our
business, financial condition and results of operations.
WE DEPEND ON OEMS AND THEIR SUPPLIERS TO OBTAIN REQUIRED COMPLEMENTARY
COMPONENTS. Some of the raw materials, components and subassemblies included
in the products manufactured by our OEM customers, which also incorporate our
products, are obtained from a limited group of suppliers. Supply disruptions,
shortages or termination of any of these sources could have an adverse effect
on our business and results of operations due to the delay or discontinuance
of orders for our products by customers until those necessary components are
available.
WE DEPEND UPON THE ADOPTION OF INDUSTRY STANDARDS BASED ON TRUESPEECH. Our
prospects are partially dependent upon the establishment of industry
standards for digital speech compression based on TrueSpeech algorithms in
the computer
telephony and Voice over IP markets. The development of industry standards
utilizing TrueSpeech algorithms would create an opportunity for us to develop
and market speech co-processors that provide TrueSpeech solutions and enhance
the performance and functionality of products incorporating these
co-processors.
In February 1995, the ITU established G.723.1, which is predominately
composed of a TrueSpeech algorithm, as the standard speech compression
technology for use in video conferencing over public telephone lines. In
March 1997, the International Multimedia Teleconferencing Consortium, a
nonprofit industry group, recommended the use of G.723.1 as the default audio
coder for all voice transmissions over the Internet or for IP applications
for H.323 conferencing products.
THERE ARE RISKS ASSOCIATED WITH OUR ACQUISITION STRATEGY. DSP Group has
pursued, and will continue to pursue, growth opportunities through internal
development and acquisition of complementary businesses, products and
technologies. We are unable to predict whether or when any prospective
acquisition will be completed. The process of integrating an acquired
business may be prolonged due to unforeseen difficulties and may require a
disproportionate amount of our resources and management's attention. We
cannot provide assurance that we will be able to successfully identify
suitable acquisition candidates, complete acquisitions, integrate acquired
businesses into our operations, or expand into new markets. Once integrated,
acquisitions may not achieve comparable levels of revenues, profitability or
productivity as the existing business of DSP Group or otherwise perform as
expected. The occurrence of any of these events could harm our business,
financial condition or results of operations. Future acquisitions may require
substantial capital resources, which may require us to seek additional debt
or equity financing.
PROTECTION OF OUR INTELLECTUAL PROPERTY IS LIMITED; RISKS OF INFRINGEMENT OF
RIGHTS OF OTHERS. As is typical in the semiconductor industry, we have been
and may from time to time be notified of claims that we may be infringing
patents or intellectual property rights owned by third parties. For example,
AT&T has asserted that G.723.1, which is primarily composed of a TrueSpeech
algorithm, includes certain elements covered by patents held by AT&T and has
requested that video conferencing manufacturers license the technology from
AT&T. Other organizations including
Lucent Microelectronics, NTT and VoiceCraft have raised public claims that
they also have patents related to the G.723.1 technology.
If it appears necessary or desirable, we may try to obtain licenses for
those patents or intellectual property rights that we are allegedly
infringing. Although holders of these type of intellectual property rights
commonly offer these licenses, we cannot assure that licenses will be offered
or that terms of any offered licenses will be acceptable to us. Our failure
to obtain a license for key intellectual property rights from a third party
for technology used by us could cause us to incur substantial liabilities and
to suspend the manufacturing of products utilizing the technology. We believe
that the ultimate resolution of these matters will not have a material
adverse effect on our financial position, results of operations, or cash
flows.
OUR BUSINESS COULD BE ADVERSELY AFFECTED BY YEAR 2000 READINESS ISSUES.
During the next year, many software programs may not recognize calendar dates
beginning in the Year 2000. This problem could force computers or machines
that utilize date dependent software to either shut down or provide incorrect
information. To address this problem, we have examined our computer and
information systems and have contacted our primary processing vendors,
suppliers and other third parties.
Although we believe that our products are Year 2000 compliant,
undetected errors or defects may remain. Disruptions to our business or
unexpected costs may arise because of undetected errors or defects in the
technology used in our products. If we, or any of our key suppliers or
customers, fail to mitigate internal and external Year 2000 risks, we may
temporarily be unable to process transactions, manufacture products, send
invoices or engage in similar normal business activities or we may experience
a decline in sales, which could have a material adverse effect on our
business, financial condition and results of operations.
OUR STOCK PRICE MAY BE VOLATILE. Announcements of developments related to our
business, announcements by competitors, quarterly fluctuations in our
financial results, changes in the general conditions of the highly dynamic
industry in which we compete or the national economies in which we do
business and other factors could cause the price of our common stock to
fluctuate, perhaps substantially. In addition, in recent years the stock
market has experienced extreme price fluctuations, which
have often been unrelated to the operating performance of affected companies.
These factors and fluctuations could have a material adverse effect on the
market price of our common stock.
DSP Group, Inc.
Consolidated Statements of Income
YEARS ENDED DECEMBER 31,
1998 1997 1996
------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Revenues:
Product sales $49,252 $51,238 $41,290
Licensing, royalties and other 14,598 10,721 11,620
------------------------------------------------------
Total revenues 63,850 61,959 52,910
Costs of revenues:
Product sales 29,002 31,143 29,432
Licensing, royalties and other 426 1,169 1,096
------------------------------------------------------
Total cost of revenues 29,428 32,312 30,528
------------------------------------------------------
Gross profit 34,422 29,647 22,382
Operating expenses:
Research and development 10,181 8,420 8,481
Sales and marketing 5,222 4,934 4,429
General and administrative 4,632 4,505 5,669
Unusual items - - 1,529
------------------------------------------------------
Total operating expenses 20,035 17,859 20,108
------------------------------------------------------
Operating income 14,387 11,788 2,274
Other income (expense):
Interest and other income 3,810 2,936 1,627
Interest expense and other (189) (226) (158)
Gain on sale of available-for-sale marketable securities 1,086 - -
Gain on settlement of litigation, net of expenses - - 3,750
Equity in income (loss) of equity method investees,
net of amortization of goodwill
of $105 in 1998, $195 in 1997, and $286 in 1996 125 (706) (457)
------------------------------------------------------
Income before provision for income taxes 19,219 13,792 7,036
Provision for income taxes (4,804) (2,758) (1,057)
------------------------------------------------------
Net income $ 14,415 $ 11,034 $ 5,979
------------------------------------------------------
------------------------------------------------------
Net income per share:
Basic $ 1.48 $ 1.13 $ 0.63
Diluted $ 1.44 $ 1.08 $ 0.62
Shares used in per share computation:
Basic 9,768 9,736 9,510
Diluted 10,016 10,203 9,581
SEE ACCOMPANYING NOTES.
DSP Group, Inc.
Consolidated Balance Sheets
DECEMBER 31,
1998 1997
-------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
ASSETS
Current assets:
Cash and cash equivalents $ 9,038 $ 7,325
Marketable securities 57,951 58,619
Accounts receivable, less allowance for returns and
doubtful accounts of $304 in 1998 and $293 in 1997 5,721 3,594
Inventories 2,182 4,116
Deferred income taxes 1,374 2,850
Other accounts receivable 1,608 1,441
-------------------------------------
Total current assets 77,874 77,945
Property and equipment, net 4,236 3,488
-------------------------------------
Other investments, net of accumulated amortization 1,834 2,935
Other assets 135 150
Severance pay fund 864 658
Deferred income taxes 848 650
-------------------------------------
-------------------------------------
Total assets $ 85,791 $ 85,826
-------------------------------------
-------------------------------------
SEE ACCOMPANYING NOTES.
DSP Group, Inc.
Consolidated Balance Sheets (continued)
DECEMBER 31,
1998 1997
-------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,360 $ 3,319
Accrued compensation and benefits 2,555 2,171
Income taxes payable 1,909 1,691
Accrued royalties 647 171
Deferred revenue 36 2,360
Accrued expenses and other 1,694 1,286
-------------------------------------
Total current liabilities 9,201 10,998
Long term liabilities:
Accrued severance pay 895 658
-------------------------------------
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 -- 9,406 in 1998
and 10,094 in 1997 9 10
Additional paid-in capital 75,610 74,418
Other comprehensive income - 1,050
Retained earnings (accumulated deficit) 12,129 (1,308)
Less cost of treasury stock (12,053) -
-------------------------------------
Total stockholders' equity 75,695 74,170
-------------------------------------
Total liabilities and stockholders' equity $ 85,791 $ 85,826
-------------------------------------
-------------------------------------
SEE ACCOMPANYING NOTES.
DSP Group, Inc.
Consolidated Statements of Stockholders' Equity
THREE YEARS ENDED COMMON STOCK ADDITIONAL STOCKHOLDERS' TREASURY STOCK RETAINED OTHER TOTAL
DECEMBER 31, 1998 SHARES AMOUNT PAID-IN NOTES RECEIVABLE AT COST EARNINGS COMPREHENSIVE STOCKHOLDERS'
CAPITAL (ACCUMULATED INCOME EQUITY
(IN THOUSANDS) DEFICIT)
------- ------ ---------- ---------------- --------------- ------------ ------------- -------------
Balance at December 31, 1995 9,439 $ 9 $66,287 $ (434) $ -- $(18,321) $ -- $ 47,541
Net income -- -- -- -- -- 5,979 -- 5,979
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
------- ------ ---------- ---------------- --------------- ------------ ------------- ------------
Balance at December 31, 1996 9,540 10 66,781 -- -- (12,342) -- 54,449
Net income -- -- -- -- 11,034 -- 11,034
Comprehensive income
Unrealized gain on
Marketable security -- -- -- -- -- -- 1,050 1,050
------------
Total comprehensive income -- -- -- -- -- -- -- 12,084
Exercise of Common Stock
options by employees 526 6,382 -- -- -- -- 6,382
Sale of Common Stock under
employee stock purchase plan 28 -- 218 -- -- -- -- 218
Income tax benefit from
stock options exercised -- -- 1,037 -- -- -- -- 1,037
------- ------ ---------- ---------------- --------------- ------------ ------------- ------------
Balance at December 31, 1997 10,094 10 74,418 -- -- (1,308) 74,170
Net income -- -- -- -- 14,415 -- 14,415
Comprehensive income
Unrealized gain on
Marketable security -- -- -- -- -- -- (1,050) (1,050)
------------
Total comprehensive income -- -- -- -- -- -- -- 13,365
Purchase of Treasury Stock (814) (1) -- -- (14,273) -- -- (14,274)
Exercise of Common Stock
options by employees 94 -- -- -- 1,821 (908) -- 913
Sale of Common Stock under
employee stock purchase plan 32 -- -- -- 399 (70) -- 329
Income tax benefit from
stock options exercised -- -- 1,192 -- -- -- -- 1,192
------- ------ ---------- ---------------- --------------- ------------ ------------- ------------
Balance at December 31, 1998 9,406 $ 9 $75,610 $ -- $(12,053) $ 12,129 $ -- $75,695
DSP Group, Inc.
Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31,
1998 1997 1996
-------------------------------------------------------
OPERATING ACTIVITIES (IN THOUSANDS)
Net income $ 14,415 $ 11,034 $ 5,979
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 1,572 1,797 1,443
Amortization of software development costs - 322 185
Deferred revenue (2,324) 2,360 (50)
Deferred income tax 2,470 (1,459) 1,169
Gain on sale of marketable equity security (1,086) - -
Gain on write off of deferred rent - - (380)
Acquired research and development from
related party - - 1,529
Equity in (income) loss of equity method investees net
of amortization (125) 706 457
Write down/write off of assets - - 290
Write off of capitalized software development
cost - - 31
Changes in operating assets and liabilities:
Accounts receivable (2,127) 1,267 2,628
Accounts and notes receivable from
related parties - - 640
Inventories 1,934 (1,159) 43
Other current assets (167) (84) (481)
Other assets 15 (84) (14)
Accounts payable (959) 1,891 (1,009)
Accrued compensation and benefits 384 432 (152)
Severance pay - net 31 - -
Income taxes payable 218 783 (609)
Accrued royalties 476 (5) (371)
Accrued expenses and other 408 779 16
-------------------------------------------------------
Net cash provided by operating activities $15,135 $18,580 $11,344
SEE ACCOMPANYING NOTES.
DSP Group, Inc.
Consolidated Statements of Cash Flows (continued)
YEARS ENDED DECEMBER 31,
1998 1997 1996
-------------------------------------------------------
(IN THOUSANDS)
INVESTING ACTIVITIES
Purchase of marketable securities $(59,980) $(77,135) $(32,217)
Sale of marketable securities 60,648 49,278 20,604
Purchases of equipment (2,320) (2,160) (836)
Sale of equipment - 166 -
Investment in an investee - (176) (2,158)
Realization of investment in an investee 1,262 - -
Capitalized software development costs - - (173)
-------------------------------------------------------
Net cash used in investing activities (390) (30,027) (14,780)
-------------------------------------------------------
FINANCING ACTIVITIES
Sale of Common Stock for cash upon exercise
of options, warrants, and employee stock
purchase plan 1,240 6,600 495
Repayment of stockholders' notes receivable - - 434
Purchase of treasury stock (14,273) - -
-------------------------------------------------------
Net cash provided by (used in) financing activities (13,033) 6,600 929
-------------------------------------------------------
Increase (decrease) in cash and cash equivalents 1,713 (4,847) (2,507)
Cash and cash equivalents at beginning of year 7,325 12,172 14,679
-------------------------------------------------------
Cash and cash equivalents at end of year $ 9,038 $ 7,325 $ 12,172
-------------------------------------------------------
-------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash paid during the period for:
Interest expense $ - $ 6 $ 17
Income taxes $ 1,530 $ 3,148 $ 372
SEE ACCOMPANYING NOTES.
DSP Group, Inc.
Notes to Consolidated Financial Statements
December 31, 1998
NOTE 1: GENERAL
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 Group Ltd. ("DSP Group Israel"), an
Israeli corporation primarily engaged in research, development, marketing,
sales, technical support and certain general and administrative functions;
Nihon DSP K.K. ("DSP Japan"), a Japanese corporation primarily engaged in
marketing and technical support activities; and DSP Group Europe SARL, a
French corporation primarily engaged in marketing and technical support
activities.
Revenues derived from the Company's largest reseller Tomen Electronics
represented 45%, 33% and 17% of the Company's revenues for 1998, 1997 and
1996, respectively. Revenues derived from sales to another customer
represented 11% of the Company's revenues in 1996.
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States.
CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly 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.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
REVENUE RECOGNITION
PRODUCT SALES
Product sales of speech processors for digital telephone answering devices,
computer telephony and other products are recognized upon shipment. The
Company has no ongoing commitments after shipment other than for warranty and
sales returns/exchanges by distributors. The Company accrues estimated sales
returns/exchanges upon recognition of sales. The Company has not experienced
significant warranty claims to date, and accordingly, the Company provides
for the costs of warranty when specific problems are identified.
LICENSING AND ROYALTY REVENUES
Revenues from software license agreements are recognized upon delivery of
the software: (1) when collection is probable; (2) all license payments are
due within one year; (3) the license fee is otherwise fixed and determinable;
(4) vendor specific evidence exists to allocate the total fee to the
undelivered elements of the arrangements; and (5) persuasive evidence of an
arrangement exists. Revenues from maintenance contracts are recognized
ratably over the term of the agreement. Costs related to insignificant
obligations, primarily telephone support, are accrued upon shipment and are
included in cost of revenues. Certain royalty agreements provide for per
unit royalties to be paid to the Company based on shipments by customers of
units containing the Company's products. Revenue under such agreements is
recognized at the time of shipment by the customer.
DEFERRED REVENUE
In the first quarter of 1998, the Company recorded approximately $2.2 million
of revenue and approximately $1.2 million of related inventory cost, which
had been previously deferred at December 31, 1997, as the Company had not yet
finalized testing on a certain TAD chip shipped to a customer during 1997.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Depreciation is provided using the straight-line method over the estimated
useful lives of the assets, which range from three to ten years, or the life
of the lease, whichever is shorter.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
INVENTORIES
Inventories are stated at the lower of cost or market. Inventories are
composed of the following (IN THOUSANDS):
DECEMBER 31,
1998 1997
--------------------
Work-in-process $ -- $ 16
Finished goods 2,182 4,100
--------------------
$2,182 $4,116
--------------------
--------------------
OTHER INVESTMENTS
Other investments are comprised of (in thousands):
DECEMBER 31,
1998 1997
--------------------
Equity method investments:
Investment in AudioCodes Ltd., net of accumulated
amortization of $891 in 1998 and $876 in 1997 $ 1,834 $ 1,709
Cost method investments:
Investment in Nexus Telecommunications Systems
Ltd., at fair value (1997 - cost basis of $176) - 1,226
--------------------
$ 1,834 $ 2,935
--------------------
--------------------
AUDIOCODES, LTD.
AudioCodes, Ltd. ("AudioCodes") is an Israeli corporation primarily engaged
in design, research, development, manufacturing and marketing hardware and
software products that enable simultaneous transmission of voice and data
over networks such as Internet, ATM and Frame Relay. The Company acquired an
approximate 35% ownership in AudioCodes in two separate transactions in 1993
and 1994. In July 1997, AudioCodes completed a private placement of
additional equity securities without the participation of the Company and, as
a result, the Company's equity ownership interest in AudioCodes was diluted
from 35% to approximately 29%. The Company also has an option under certain
conditions to purchase up to an additional 5% of the outstanding stock of
AudioCodes.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
The Company accounts for its ownership in AudioCodes using the equity method.
The Company's original investment in AudioCodes included the excess of
purchase price over net assets acquired (approximately $1,907,000 at the date
of purchase), which was attributed to developed technology to be amortized
over seven years. The private placement by AudioCodes in July 1997 was at a
price per share greater than the Company's then current investment in
AudioCodes. As a result, even though the Company's ownership interest
decreased from 35% to 29%, the Company's proportionate share of the net
assets of AudioCodes increased from $816,000 to $1,481,000 at the date of the
private placement. This increase in the Company's proportionate share of the
net assets of AudioCodes reduced the remaining unamortized excess of purchase
price over net assets acquired from $1,080,000 to $415,000 as of the date of
the private placement.
The Company's equity in the net income (loss) of AudioCodes was $230,000 in
1998, ($103,000) in 1997, and $36,000 in 1996. As of December 31, 1998, the
difference between the investment in AudioCodes and the Company's
proportionate share of net assets is $251,000, primarily related to the
remaining unamortized portion of the excess of purchase price over net assets.
APTEL LTD. AND NEXUS TELECOMMUNICATIONS SYSTEMS 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 Israel.
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 accounted for its investment in Aptel using the equity method. The
Company's equity in the net losses of Aptel, including amortization of
related intangibles, was $408,000 in 1997 and $221,000 in 1996. As of June
30, 1997, the Company had fully written-off its investment in Aptel.
In December 1997, Aptel's shareholders, including the Company exchanged
their shares in Aptel for ordinary shares of Nexus Telecommunications Systems
Ltd. ("Nexus"). Nexus is an Israeli company whose shares are registered and
traded on the Nasdaq SmallCap Market under the symbol NXUSF. In October
1997, the Company invested $176,000 in a convertible debenture in Aptel which
was converted into ordinary shares of Aptel prior to the closing of the Nexus
transaction. The Company received approximately 297,000 ordinary shares of
Nexus in the exchange transaction amounting
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
to approximately 3% ownership interest in Nexus. The Company's basis in the
Nexus stock received is $176,000 and the Company accounted for the investment
using the cost method. At December 31, 1997, the Company's investment in
Nexus was presented in the Company's consolidated balance sheet at the market
value of $1,226,000, with the unrealized gain of $1,050,000 recorded as other
comprehensive income, as a separate component of stockholder's equity. In
April 1998, the Company sold all of its Nexus shares in a private transaction
and realized a pre-tax gain on marketable equity securities of approximately
$1.1 million, which is included under "Other income (expense)" in the
Company's consolidated statements of income for 1998.
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.
NET INCOME PER SHARE
Basic net income per share is computed based on the weighted average number
of shares of common stock outstanding during the period. For the same
periods, diluted net income per share further includes the effect of dilutive
stock options outstanding during the year, all in accordance with the
Financial Accounting Standards Board issued Statement No. 128, "Earnings per
Share" ("SFAS 128"). The following table sets forth the computation of basic
and diluted net income per share (in thousands except per share amounts):
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
1998 1997 1996
--------------- --------------- ---------------
Numerator:
Net Income $ 14,415 $ 11,034 $ 5,979
--------------- --------------- ---------------
--------------- --------------- ---------------
Denominator:
Weighted average number of shares of
common stock outstanding during the period
used to compute basic income per share........ 9,768 9,736 9,510
Incremental shares attributable to exercise
of outstanding options (assuming proceeds
would be used to purchase treasury stock)..... 248 467 71
------ ----- ------
Weighted average number of shares of
common stock used to compute diluted income
per share..................................... 10,016 10,203 9,581
--------------- --------------- ---------------
--------------- --------------- ---------------
Basic net income per share.................... $1.48 $1.13 $0.63
--------------- --------------- ---------------
--------------- --------------- ---------------
Diluted net income per share.................. $1.44 $1.08 $0.62
--------------- --------------- ---------------
--------------- --------------- ---------------
Options outstanding to purchase approximately 657,000, 210,000 and 1,067,000
of common stock for the years ended December 31, 1998, 1997 and 1996,
respectively, were not included in the computation of diluted net income per
share, because option exercise prices were greater than the average market
price of the common shares and therefore, the effect would be antidilutive.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially expose 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
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
type of investment. The majority of the Company's sales of products are to
distributors who in turn sell to manufacturers of consumer electronics
products. The Company's licensing revenues are primarily from customers that
have licensed rights to use the Company's DSP Core microprocessor
architectures and speech compression technology. No collateral is required
from the Company's customers; however, some of the customers pay using
letters of credit. Write-offs for bad debts have not been significant to
date.
CONCENTRATION OF OTHER RISKS
Sales of telephone answering device ("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 1999, the Company expects that revenues
from its DSP Core 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") licensees in introducing these products and the success of such
products in the marketplace.
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, low yield rates or financial instability.
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.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
CASH EQUIVALENTS
The Company considers all highly liquid investments which are readily
convertible to cash with an original maturity of three months or less when
purchased to be cash equivalents. The carrying amount of cash and cash
equivalents as of December 31, 1998 and 1997 approximates fair value.
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" ("SFAS 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 interest and other income. Realized gains and
losses and declines in value judged to be other-than-temporary on
available-for-sale securities are included in interest and other income. The
cost of securities sold is based on the specific identification method.
Interest and dividends on securities classified as available-for-sale are
included in interest and other income.
The following is a summary of available-for-sale securities at December 31, 1998
and 1997 (in thousands):
AMORTIZED COST
1998 1997
---------------------------------------
Obligations of states and
political subdivisions $25,290 $6,002
Corporate obligations 33,218 53,270
---------------------------------------
$58,508 $59,272
---------------------------------------
---------------------------------------
Amounts included in marketable
securities $57,951 $58,619
Amounts included in cash and
cash equivalents 557 653
---------------------------------------
$58,508 $59,272
---------------------------------------
---------------------------------------
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
At December 31, 1998 and 1997, 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 1998, 1997, and
1996 were not significant. The amortized cost of available-for-sale debt and
securities at December 31, 1998, by contractual maturities, are shown below
(IN THOUSANDS):
AMORTIZED
COST
---------
Due in 1999 $ 2,028
Due in 2000 55,923
---------
$ 57,951
---------
---------
SEVERANCE PAY
The Company's subsidiary, DSP Group Israel, has liability for severance pay
pursuant to Israeli law, which is fully provided by an accrual. The majority
of the liability is funded through insurance policies. The cash value of
these policies is recorded as an asset in the Company's consolidated balance
sheets.
Severance expenses for the years ended December 31, 1998, 1997 and 1996, were
approximately $367,000, $135,000 and $95,000, respectively.
GAIN ON SETTLEMENT OF LITIGATION
In October 1996, the Company entered into agreements with Rockwell
International, Inc. to license certain of the Company's TrueSpeech
technologies and to settle all pending litigation between the companies. In
connection with the litigation settlement in
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
1996, the Company recorded in other income a one time pre-tax gain on
settlement of litigation, net of expenses of $3.8 million.
ACCOUNTING FOR 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" ("SFAS 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. See pro forma disclosures
of applying SFAS 123 in Note 4 below.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"),
which establishes new rules for the reporting and display of comprehensive
income and its components. SFAS 130 requires unrealized gains or losses on
the Company's available for sale securities, which prior to adoption were
reported separately in stockholders' equity to be included in other
comprehensive income. Prior year financial statements have been reclassified
to conform to the requirements of SFAS 130. The adoption of this SFAS had
no impact on the company's results of operations or financial position.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). This Statement
establishes accounting and reporting standards requiring that every
derivative instrument, including certain derivative instruments embedded in
other contracts, be recorded in the balance sheet as either an asset or
liability measured at its fair value. The Statement also requires that
changes in a derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the respective
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of any transactions that
receive hedge accounting. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999 and cannot be applied retroactively. The
Company does not expect the impact of this new Statement on the Company's
consolidated balance sheets or results of operations to be material.
NOTE 3. PROPERTY AND EQUIPMENT
Composition of assets, grouped by major classifications, is as follows (IN
THOUSANDS):
DECEMBER 31,
-------------------------------------
1998 1997
------------------ -----------------
Computers and peripheral equipment $ 8,209 $ 6,341
Office furniture and equipment 808 774
Motor vehicles 933 654
Leasehold improvements 1,380 1,241
------------------ -----------------
11,330 9,010
Less accumulated depreciation 7,094 5,522
------------------ -----------------
$ 4,236 $ 3,488
------------------ -----------------
------------------ -----------------
NOTE 4. STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Board of Directors has the authority, without any further vote or action
by the stockholders, to provide for the issuance of up to 5,000,000 shares of
Preferred Stock in one or more series with such designations, rights,
preferences, and limitations as the Board of Directors may determine,
including the consideration received, the number of shares comprising each
series, dividend rates, redemption provisions, liquidation preferences,
sinking fund provisions, conversion rights, and voting rights.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
DIVIDEND POLICY
At December 31, 1998, the Company had retained earnings of approximately
$13.1 million. The Company has never paid dividends on its Common Stock and
presently intends to follow a policy of retaining any earnings for
reinvestment in its business.
SHARE REPURCHASE PROGRAM
In 1998, the Company commenced a program to buy an aggregate of up to
1,000,000 shares of Common Stock of the Company. As of December 31, 1998, the
Company had acquired 814,000 shares for an aggregate purchase price of $14.3
million. Such repurchases of ordinary shares are accounted for as treasury
stock, and result in a reduction of stockholders' equity. When treasury
shares are reissued, the Company charges the excess of the repurchase cost
over issuance price using the weighted average method to retain earnings.
STOCK PURCHASE PLAN AND STOCK OPTION PLANS
The Company has various stock plans under which employees, consultants,
officers, and directors may be granted options to purchase the Company's
Common Stock. A summary of the various plans is as follows:
1991 EMPLOYEE AND CONSULTANT STOCK PLAN
In 1991, the Company adopted the 1991 Employee and Consultant Stock Plan (the
"1991 Plan"). Under the 1991 Plan, employees and consultants may be granted
incentive or non-qualified stock options or stock purchase rights for the
purchase of the Company's Common Stock. The 1991 Plan expires in 2001 and
currently provides for the purchase of up to 3,800,000 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 up to seven years after the
date of grant.
1993 DIRECTOR STOCK OPTION PLAN
Upon the closing of the Company's initial public offering, the Company
adopted the 1993 Director Stock Option Plan (the "Directors' Plan"). Under
the Directors' Plan the Company is authorized to issue nonqualified stock
options to purchase up to 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, following certain amendments in 1996 approved
by the Company's stockholders, provides that each person who is an outside
director on the effective date of the Directors' Plan and each outside
director who subsequently becomes a member of the Board of Directors shall
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
automatically be granted an option to purchase 15,000 shares (the First
Option). Additionally, each outside director shall automatically be granted
an option to purchase 5,000 shares (a Subsequent Option) on January 1 of each
year if, on such date, he/she shall have served on the Board of Directors for
at least six months.
Options granted under the Directors' Plan generally have a term of ten years.
The First Option is 25% exercisable after the first year (one-third after the
first year for options granted after May 1996) and in quarterly installments
over the ensuing three years (one-third at the end of each twelve-month
period for options granted after May 1996). Each Subsequent Option becomes
exercisable in full on the fourth anniversary from the date of grant
(one-third at the end of each twelve-month period from the date of grant for
options granted after May 1996).
1993 ISRAELI PLAN
In 1993, the Company adopted the 1993 DSP Group, Inc. Israeli Stock Option
Plan (the "1993 Israeli Plan") under which the Company is authorized to issue
nonqualified stock options to purchase up to 167,000 shares of the Company's
Common Stock at an exercise price equivalent to fair market value. Options
are immediately exercisable and expire five years from the date of grant.
All options and shares are held in a trust until the later of 24 months from
the date of grant or the shares are vested based on a vesting schedule
determined by a committee appointed by the Board of Directors.
1998 NON-OFFICER EMPLOYEE STOCK OPTION PLAN
In 1998, the Company adopted the 1998 Non-Officer Employee Stock Option Plan
(the "1998 Plan"). Under the 1998 Plan, employees may be granted
non-qualified stock options for the purchase of the Company's Common Stock.
Officers and directors of the Company are excluded from participating under
the 1998 Plan. The 1998 Plan expires in 2008 and currently provides for the
purchase of up to 950,000 shares of the Company's Common Stock.
The exercise price of options under the 1998 Plan shall not be less than the
fair market value of the Common Stock for nonqualified stock options, as
determined by the Board of Directors.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
Options under the 1998 Plan are generally exercisable over a 48-month period
beginning twelve months after issuance or as determined by the Board of
Directors. Options under the 1998 Plan expire up to seven years after the
date of grant.
A summary of activity under the 1991 Plan, the 1993 Israeli Plan, the
Directors' Plan, and the 1998 Plan is as follows (SHARES IN THOUSANDS):
OPTIONS OUTSTANDING
---------------------------------------
SHARES SHARES WEIGHTED
AVAILABLE UNDER AVERAGE
FOR GRANT OPTION EXERCISE PRICE
------------------- ------------------ --------------------
OPTIONS OUTSTANDING
---------------------------------------
BALANCE AT DECEMBER 31, 1995 236 1,062 $ -
------------------- ------------------
Authorized 875 - $ -
Granted (990) 990 $ 9.61
Exercised - (77) $ 3.71
Canceled 500 (500) $13.00
------------------- ------------------
BALANCE AT DECEMBER 31, 1996 621 1,475 $10.94
------------------- ------------------
OPTIONS OUTSTANDING
---------------------------------------
SHARES SHARES WEIGHTED
AVAILABLE UNDER AVERAGE
FOR GRANT OPTION EXERCISE PRICE
------------------- ------------------ --------------------
OPTIONS OUTSTANDING
---------------------------------------
Authorized - - $ -
Granted (797) 797 $21.67
Exercised - (526) $12.12
Canceled 429 (429) $11.18
------------------- ------------------
BALANCE AT DECEMBER 31, 1997 253 1,317 $16.87
------------------- ------------------
Authorized 1,950 - $ -
Granted (812) 812 $18.54
Exercised (94) $ 9.95
Canceled (136) (136) $13.59
------------------- ------------------
BALANCE AT DECEMBER 31, 1998 1,527 1,899 $18.17
------------------- ------------------
------------------- ------------------
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
A summary of the average price per share and the number of options exercisable
for the years 1998, 1997 and 1996, is as follows:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Number of options
excisable as of
December 31, (OPTIONS
IN THOUSANDS) 469 375 144
- ------------------------------------------------------------------------------
Weighted average fair
value of options
granted during the year $ 18.54 $ 21.67 $ 9.61
- ------------------------------------------------------------------------------
A summary of the Company's stock option activity and related information as
of December 31, 1998, is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------- --------------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER OF OPTIONS CONTRACTUAL EXERCISE NUMBER OF OPTIONS EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ----------------------- -------------------- ------------------ ---------------- ------------------- ---------------
$ 7.63 - $11.75 393,440 3.55 Years 9.25 140,916 9.54
$12.00 -$18.56 533,299 3.89 Years 16.78 127,651 15.13
$18.81 -$18.88 294,000 4.58 Years 18.87 0 0
$19.25 -$24.25 347,300 4.23 Years 21.47 73,133 22.44
$25.38- $34.38 331,000 3.69 Years 26.99 127,311 26.79
-------------------- ------------------ ---------------- ------------------- ---------------
1,899,039 3.95 Years $18.17 469,011 $17.76
-------------------- ------------------ ---------------- ------------------- ---------------
-------------------- ------------------ ---------------- ------------------- ---------------
1993 EMPLOYEE STOCK PURCHASE PLAN
Upon the closing of the Company's initial public offering, the Company
adopted the 1993 Employee Stock Purchase Plan (the "1993 Purchase Plan"). The
Company has reserved an aggregate amount of 350,000 shares of Common Stock
for issuance under the 1993 Purchase Plan. The 1993 Purchase Plan provides
that substantially all employees may purchase stock at 85% of its fair market
value on specified dates via payroll deductions. There were approximately
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
32,000, 28,000 and 24,000 shares issued under the Purchase Plan in 1998, 1997
and 1996, respectively.
COMMON STOCK RESERVED FOR FUTURE ISSUANCE
Shares of Common Stock of the Company reserved for future issuance at
December 31, 1998, are as follows (in thousands):
Employee Stock Purchase Plan 250
Stock Options 3,426
Undesignated Preferred Stock 5,000
--------
8,676
--------
--------
STOCK BASED COMPENSATION
Pro forma information regarding net income and earnings per share is required
by Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (SFAS 123"), which requires the use of option
valuation models that were not developed for use in valuing employee stock
options. For example, the Black-Scholes option valuation model was developed
for use in estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option models require
the input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective assumptions can materially affect the fair
value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its
employee stock options.
The fair value of the Company's employee stock options was estimated at the
date of grant using a Black-Scholes multiple option pricing model with the
following weighted average assumptions; risk-free interest rates of 5.02%,
6.15% and 6.10% for 1998, 1997 and 1996, respectively; a dividend yield of
0.0% for each of those years; a volatility factor of the expected market
price of the Company's Common Stock of 0.77 for 1998, 0.70 for 1997 and 0.55
for 1996; and a weighted-average expected life of the option of 3.0 years for
1998, 3.1 years for 1997, and 3.6 years for 1996. The weighed average net
fair value of options granted in 1998, 1997 and 1996 was $9.65, $9.90 and
$4.53 per share, respectively.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
The Company does not recognize compensation cost related to employee stock
purchase rights under the Employee Stock Purchase Plan. To comply with the
pro forma reporting requirements of SFAS 123, compensation cost is estimated
for the fair value of the employees' stock purchase rights using the
Black-Scholes model with the following assumptions for those rights granted
in 1998, 1997 and 1996; dividend yield of 0.0%; an expected life ranging up
to 0.5 years; expected volatility factor of 0.71 in 1998, 0.75 in 1997 and
0.5 in 1996; and a risk free interest rate of 4.84% in 1998, 5.49% in 1997
and 5.72% in 1996. The weighted average fair value of those purchase rights
granted in January 1998, July 1998, January 1997, July 1997, January 1996 and
July 1996 were $10.70, $9.57, $2.45, $8.21, $1.31 and $1.17, respectively.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of SFAS 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
1998 1997 1996
---------------- ----------------- -----------------
(In thousands, except per share data)
Pro forma net income $ 10,428 $ 8,485 $ 2,843
Pro forma basic earnings per share $ 1.07 $ 0.87 $ 0.30
Pro forma diluted earnings per share $ 1.07 $ 0.85 $ 0.30
COMMON STOCK REPURCHASE
In 1998, the Company repurchased 814,000 shares of its Common Stock at an
average purchase price of $17.53 per share, for an aggregate purchase price
of approximately $14.3 million. The Company accounts for the investment in
its shares according to the treasury stock method.
NOTE 5. INDUSTRY SEGMENT REPORTING
The Company operates in one business segment approach, principally the
development of affordable, high performance, cost effective DSP-based
software, integrated circuits, and circuit boards.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
Operations outside the United States include research, development, sales,
marketing and certain general and administrative functions. The Company's
Israeli subsidiary performs research, development, sales, marketing,
technical support, and certain general and administrative functions. The
Company's Japanese and French subsidiaries perform marketing and technical
support activities. The following is a summary of operations within
geographic areas (IN THOUSANDS):
1998 1997 1996
--------------- --------------- ---------------
Sales to unaffiliated customers:
United States $31,436 $57,364 $51,883
Israel 32,414 4,595 1,027
-----------------------------------------------------
$63,850 $61,959 $52,910
-----------------------------------------------------
-----------------------------------------------------
Revenues:
United States $ 3,821 4,688 4,833
Export:
Japan 35,711 23,402 11,390
Europe 10,591 10,357 10,853
Asia 12,616 21,644 24,087
Israel 1,111 1,868 1,747
-----------------------------------------------------
$63,850 $61,959 $52,910
-----------------------------------------------------
-----------------------------------------------------
Long-lived assets:
United States $ 2,085 $ 2,252 $ 2,796
Israel 4,783 4,751 3,409
Other 66 77 70
-----------------------------------------------------
$ 6,934 $ 7,080 $ 6,275
-----------------------------------------------------
-----------------------------------------------------
NOTE 6. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
The Company leases certain equipment and facilities under noncancelable
operating leases. The Company has significant leased facilities in Herzelia
Pituach, Israel and in Santa Clara, California. In 1996, the Company
negotiated the assignment of certain of its Santa Clara facility use
obligations to another company (the "Assignee"). The Company received
payments from the Assignee in the Santa Clara facility, of $322,000 in both
1998
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
and 1997 and will receive $322,000 in 1999, and $295,000 in 2000. In
addition, commencing January 1, 1997, the Company began subleasing a new
space in the same building from the Assignee under a separate sublease
agreement that expires in December 1999. In August 1997, the Company
entered into a new lease for its Israel facilities in Herzelia Pituach. The
lease agreement is effective until May 2002. In September 1998, the Company
entered into a new lease for more office space at its Israel facilities in
Herzelia Pituach. The lease agreement for the additional space is effective
until November 2003.
At December 31, 1998, the Company is required to make the following minimum
lease payments, as revised to reflect the assignment of the lease and the
sublease of the new space by the Company in the same buildings as described
above (IN THOUSANDS).
Year Amount
---- ------
1999 $ 596
2000 263
2001 564
2002 291
2003 95
------
$1,809
------
------
Total rental expense for all leases was approximately $545,000 (net of
sublease income of $365,000), $778,000 (net of sublease income of $469,000),
$334,000 (net of sublease income of $546,000, and a gain of $380,000 on
write-off of deferred rent), for the years ended December 31, 1998, 1997, and
1996, respectively.
CONTINGENCIES
The Company is involved in certain claims arising in the normal course of
business, including claims that it may be infringing patent rights owned by
third parties. The Company is unable to foresee the extent to which these
matters will be pursued by the claimants or to predict with certainty the
eventual outcome. However, the Company believes that the ultimate resolution
of these matters will not have a material adverse effect on its financial
position, results of operations, or cash flows.
On February 12, 1997, BEKA Electronic GmbH ("BEKA") commenced an action in
the United States District Court for the Northern District of California
against DSP Group. The action alleges breach of contract, breach of implied
covenant of good faith and fair dealing and requests an accounting by us in
connection with our termination of the Sales Representative Agreement between
BEKA and us. The complaint seeks an unspecified amount of damages. The
parties completed non-binding mediation in May 1998, but were unable to
settle the case. Discovery in the case has been completed. Trial has been set
for May 11, 1999. DSP Group believes the lawsuit to be without merit and
intends to defend itself vigorously.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
NOTE 7. INCOME TAXES
The provision for income taxes is as follows (IN THOUSANDS):
1998 1997 1996
------------------------------------------------------
Federal taxes:
Current $ 2,751 $ 3,166 $ (180)
Deferred 1,181 (1,301) 1,099
------------------------------------------------------
3,932 1,865 919
State taxes:
Current 216 337 3
Deferred 97 (158) 70
------------------------------------------------------
313 179 73
Foreign taxes:
Current 559 714 65
------------------------------------------------------
Provision for income taxes $ 4,804 $ 2,758 $ 1,057
------------------------------------------------------
------------------------------------------------------
The tax benefits associated with the exercise of stock options reduced taxes
currently payable by $1,192,000 in 1998 and $1,037,000 in 1997. Such
benefits were credited to paid in capital when realized.
Pretax income (loss) from foreign operations was $7,330,000, $3,495,000 and
$1,061,000 in 1998, 1997 and 1996, respectively (exclusive of an in-process
technology write-off of $1,529,000 in 1996).
Unremitted foreign earnings that are considered to be permanently invested
outside of the U.S., and on which no deferred taxes have been provided,
amount to approximately $9,600,000 at December 31, 1998. If such amounts
were remitted, the Company would be subject to U.S. income taxes (subject to
an adjustment for foreign tax credits) and additional Israeli corporate
income and withholding taxes of approximately $2,300,000.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
A reconciliation between the Company's effective tax rate and the U.S.
statutory rate (IN THOUSANDS):
YEARS ENDED DECEMBER 31,
1998 1997 1996
----------------- ----------------- ---------------
Tax at U.S. statutory rate $ 6,534 $ 4,827 $ 2,396
State taxes, net of federal benefit 207 116 3
Operating losses utilized - (1,160) (1,169)
Tax exempt interest income - (26) (422)
Foreign income taxed at rates other
than U.S. rate (1,806) (813) (306)
Research and development expensed
upon acquisition - - 520
Tax credits utilized (264) (480) -
Nondeductible losses and expenses of investees - 247 92
Other individually immaterial items 133 47 (57)
----------------- ----------------- ---------------
$ 4,804 $ 2,758 $ 1,057
----------------- ----------------- ---------------
----------------- ----------------- ---------------
As of December 31, 1998, the Company had federal net operating loss and tax
credit carryforwards of approximately $1,132,000 and $108,000, respectively.
These carryforwards will expire in years 2007 through 2008, if not utilized.
Due to the change in ownership provisions of the Tax Reform Act of 1986, the
Company's federal net operating loss carryforwards are subject to an annual
limitation of approximately $3,300,000 per year.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets and liabilities as of
December 31, 1998 and 1997 are as follows (IN THOUSANDS):
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
1998 1997
------------------- ----------------
Deferred tax assets:
Tax credit carryforwards $ 108 $ 530
Net operating loss carryforwards 385 1,550
Capitalized research and development 222 330
Reserves and accruals 690 1,730
Other 817 610
------------------- ----------------
Total deferred tax assets $ 2,222 4,750
Valuation allowance -- (1,250)
------------------- ----------------
------------------- ----------------
Net deferred tax assets $ 2,222 $ 3,500
------------------- ----------------
------------------- ----------------
Management believes that the deferred tax assets will be realized based on
current levels of future taxable income and potentially refundable taxes. The
valuation allowance decreased by $1,250,000, $2,446,000 and $189,000 in 1998,
1997 and 1996, respectively.
DSP Group Israel production facilities have been granted "Approved
Enterprise" status under Israeli law in connection with four separate
investment plans.
According to the provisions of such Israeli law, DSP Group Israel has chosen
to enjoy "Alternative plans benefits," which is a waiver of grants in return
for tax exemption. Accordingly, DSP Group Israel's income from an "Approved
Enterprise" is tax-exempt for a period of two or four years and is subject to
a reduced corporate tax rate of 10% for an additional period of eight or six
years, respectively. The tax benefits under these investment plans are
scheduled to gradually expire starting from 2002 through 2009.
DSP Group Israel's first and second plans, which were completed and commenced
operation in 1992 and 1996, respectively, are tax exempt for four years and
are entitled to a reduced corporate tax rate of 10% for an additional period
of six years. The third and fourth plans were approved in 1996 and 1998,
respectively. They entitle DSP Group Israel to a corporate tax exemption for
a period of two years for each plan and to a reduced corporate tax rate of
10% for an additional period of eight years.
The period of tax benefits, as detailed above, is subject to limitations of
the earlier of 12 years from commencement of production, or 14 years from
receipt of approval.
The tax exempt income attributable to an "Approved Enterprise" can be
distributed to stockholders without subjecting DSP Group Israel to taxes only
upon the complete liquidation of DSP Group Israel. The Company has
determined that such tax exempt
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
income will not be distributed as dividends. Accordingly, no deferred income
taxes have been provided on income attributable to DSP Group Israel's
"Approved Enterprise."
If the retained tax exempt income is distributed in a manner other than in
the complete liquidation of DSP Group Israel, it would be taxed at the
corporate tax rate applicable to such profits as if DSP Group Israel had not
chosen the alternative tax benefits and an income tax liability would be
incurred of approximately $1,859 as of December 31, 1998.
Through December 31, 1998, DSP Group Israel has met all the conditions
required under the approvals.
Should DSP Group Israel fail to meet such conditions in the future, however,
it could be subject to corporate tax in Israel at the standard rate of 36%
and could be required to refund tax benefits already received.
Income from sources other than the "Approved Enterprise" during the benefit
period will be subject to tax at the standard rate of corporate tax in Israel
of 36%.
By virtue of such Israeli law, DSP Group Israel is entitled to claim
accelerated rates of depreciation on equipment used by an "Approved
Enterprise" during the first five tax years from the beginning of such use.
NOTE 8. RELATED PARTY TRANSACTIONS
In 1993, the Company entered into a development and licensing agreement with
AudioCodes (SEE NOTE 2 OTHER INVESTMENTS). Under the agreement, AudioCodes
is to perform certain research and development services for the Company.
Upon development of the technology, the Company is to pay AudioCodes a
service fee and additional royalty fees of 15% to 50% of the net revenue and
3% to 10% of the gross margin realized from the sale of the technology
incorporated in the Company's products. In 1998, 1997 and 1996 the Company
recorded the following (IN THOUSANDS):
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
------------- ------------ -------------
RELATED PARTY TRANSACTIONS 1998 1997 1996
------------- ------------ -------------
REVENUES:
- ----------------------------------------
Product sales 944 1,542 1,644
Licensing 82 206 65
COST OF REVENUES:
- ----------------------------------------
Cost of products 384 291 --
Cost of licensing 160 268 355
OPERATING EXPENSES:
- ----------------------------------------
Research and development 345 340 269
NOTE 9. SUBSEQUENT EVENTS
On February 2, 1999, the Company announced that it had entered into a stock
purchase agreement with Magnum Technologies, Ltd., an international
investment fund ("Magnum"), in which the Company issued and sold 2,300,000
new shares of its Common Stock to Magnum, which represented approximately 20%
of the Company's outstanding Common Stock at the time of the transaction, for
$15 per share, or an aggregate of $34.5 million in total gross proceeds to the
Company. As part of the agreement, Magnum may acquire additional shares of
the Company's Common Stock in the open market, but may not bring its total
holdings to more than 35% of the Company's outstanding shares of Common
Stock.
In February 1999, the Board of Directors authorized the Company's plan to
repurchase up to 1,000,000 shares of its Common Stock from time to time on
the open-market or in privately negotiated transactions.
DSP Group, Inc.
Notes to Consolidated Financial Statements (continued)
Report of 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, 1998 and 1997, and the related consolidated statements
of income, stockholders' equity, and cash flows for each of three years in
the period ended December 31, 1998. 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of DSP Group, Inc.
at December 31, 1998 and 1997, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles.
Palo Alto, California
January 25, 1999,
Except for Note 9, as to which the date is February 18, 1999