DSP GROUP INC /DE/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) This report and certain information incorporated herein by reference contain forward-looking statements, which are provided under the "safe harbor" protection of the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this report, other than statements that are purely historical in nature, are forward-looking statements.

Forward-looking statements are generally written in the future tense and/or are preceded by words such as "will," "may," "should," "could," "expect," "suggest," "believe," "anticipate," "intend," "plan," or other similar words.

Forward-looking statements include statements regarding: • Our belief that sales of our DECT products will continue to represent a substantial percentage of our revenues for the remainder of 2012; • Our belief that our past research and development investments in new technologies are beginning to materialize; • Our belief that the rapid deployment of new communication access methods, including mobile, wireless broadband, cable and other connectivity, the traditional cordless telephony market using fixed-line telephony is declining and may continue to decline, which may reduce our revenues derived from, and unit sales of, cordless telephony products; • Our belief that the market will remain price sensitive for the rest of 2012 for our traditional cordless telephony products and expect that price erosion and the decrease in the average selling prices of such products to continue; • Our belief that the challenges associated with the European and North America markets for DECT products would negatively impact our revenues for the fourth quarter of 2012 and result in continued operating losses for the company; • Our focus on generating positive operating cash flows in 2012 and implementing additional cost cutting measures whenever necessary to ensure we achieve this objective; • Our anticipation that as a result of our cost cutting measures implemented during 2012, there will be a significant decrease in our operating expenses for 2012, as compared to 2011; and • Our belief that our available cash and cash equivalents at September 30, 2012 should be sufficient to finance our operations for both the short and long term.

All forward-looking statements included in this Quarterly Report on Form 10-Q are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward-looking statement. Many factors may cause actual results to differ materially from those expressed or implied by the forward-looking statements contained in this report.

These factors include, but are not limited to, our dependence on one primary distributor, our OEM relationships and competition, as well as those risks described in Part II - Item 1A - "Risk Factors" of this Form 10-Q.

Overview The following discussion and analysis is intended to provide investors with a narrative of our financial results and an evaluation of our financial condition and results of operations. The discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto.

Business Overview DSP Group is a leading global provider of wireless chipset solutions for converged communications, delivering system solutions that combine semiconductors and software with reference designs. We provide a broad portfolio of wireless chipsets integrating DECT, Wi-Fi, and VoIP technologies with state-of-the-art application processors. We also enable converged voice, audio, video and data connectivity for next-generation consumer products, including home 18 -------------------------------------------------------------------------------- Table of Contents gateways, IP phones, multimedia phones and home automation. Our current primary focus is digital cordless telephony with sales of our in-house developed DECT, CoIP, 2.4GHz and 5.8GHz chipsets representing approximately 94% of our total revenues for the first nine months of 2012.

As further described below, during the third quarter of 2012, we determined that the company operates under three reportable segments. Our operating segments are as follows: Home, Office and Mobile. The classification of our business segments is based on a number of factors that management uses to evaluate, view and run its business operations, which include, but not limited to, customer base, homogeneity of products and technology. The description of our operating segments is outlined in Note N to our financial statements for the period ended September 30, 2012 and below.

Our revenues were $124.4 million for the first nine months of 2012, a decrease of 20.0% in comparison to the same period of 2011. The decrease in our revenues for the first nine months of 2012 in comparison to the same period of 2011 was mainly due to a decrease in sales of DECT products to the European and the North American end markets. Revenues derived from the sale of DECT products represented 82% of our total revenues for the first nine months of 2012, as compared to 83% of our total revenues for the first nine months of 2011. Our gross margin increased to 37.3% of our total revenues for the first nine months of 2012 from 36.3% for the first nine months of 2011, primarily due to (i) a decrease in the provision for slow or obsolete inventories, (ii) an improvement in the production yield of certain of our products, (iii) a decrease in certain production costs such as gold due to the replacement of gold with copper in certain of our products, and (iv) a reduction in other operational expenses such as boards, materials and subcontractors. Our operating loss decreased to $9.9 million for the first nine months of 2012, as compared to $13.2 million of operating loss for the first nine months of 2011, mainly as a result of decreases in research and development expenses and amortization of intangible assets expenses, offset to some extent by a decrease in our revenues for the first nine months of 2012 as compared to 2011 and an increase in restructuring expenses for the first nine months of 2012 as compared to restructuring income for the first nine months of 2011.

In addition to general market competitiveness, the cordless telephony market, from which we derive most of our revenues, is undergoing a challenging period of transition. With the rapid deployment of new communication access methods, including mobile, wireless broadband, cable and other connectivity, the traditional cordless telephony market using fixed-line telephony is declining and may continue to decline, which may reduce our revenues derived from, and unit sales of, cordless telephony products. Furthermore, our business also may be significantly affected by the outcome of the competition between cellular phone operators and fixed-line operators for the provision of residential communication. A significant majority of our revenues are currently generated from sales of chipsets used in cordless phones that are based on fixed-line telephony. If we are unable to develop new technologies to address alternative connectivity methods, our business could be materially adversely affected.

Furthermore, current macro-economic trends will continue to negatively affect our financial results. For example, we are observing continuing weakness in demand for DECT products. The weakness is driven mainly by continued sluggish demand for our DECT products in the European and rest of the world end markets, as well as a softening demand for DECT 6.0 products in the North American end markets. In Europe, the consumer electronic market continues to face difficulties amid ongoing macro-economic concerns, exacerbated by ongoing debt crisis. This weak demand pattern has resulted in softer demand from our ODM and OEM customers of products targeting the European and rest of the world end markets for the third quarter of 2012 and we anticipate this trend to continue for the remainder of 2012. The market weakness also includes a lower demand for fixed wireless terminals and home gateway with DECT connectivity by service providers, mainly due to delays in new product ramp up.

In response to market trends and with a view to leveraging our strong technology base and customer relationships to maximize growth and revenue opportunities, we have concentrated our development efforts on next generation products. Our next generation products include three main groups of products: (i) DECT/CAT-iq ICs targeted for residential gateway devices supplied by telecommunication service providers and which integrate the DECT/CAT-iq functionality and also address home automation applications, as well as fixed-mobile convergence solutions, included in the Home segment ; (ii) VoIP products for enterprise included in the Office segment ; and (iii) products for the mobile market that provides voice enhancement and far-end noise elimination targeted for mobile phones and mobile headsets, included in the mobile segment.

We are seeing evidence that our past research and development investments in new technologies are beginning to materialize. We have achieved a number of design wins for these next generation products, where commercial shipments for some products have begun with more shipments to occur during the remainder of 2012.

19 -------------------------------------------------------------------------------- Table of Contents However, we can provide no assurances about our success in introducing new products and penetrating new markets, as well as our predictions regarding market trends. Although next generation products targeted at the convergence of voice, audio, video and data connectivity and at enterprise VoIP solutions are gradually being introduced into the market, market adoption of such products is at early stages. Although we have achieved a number of design wins with top-tier OEMs for next-generation products, revenue generated from the commercialization of new products is a measured process as there is generally a long lead time from a design win to commercialization. From initial product design win to volume production, many factors could impact the timing and/or amount of sales actually realized from the design win. In addition to general price sensitive and price erosion in the markets we operate, the introduction of next-generation productions may accelerate price erosion of older products. As a result, we expect the market to remain price sensitive for the rest of 2012 for our traditional cordless telephony products and expect that price erosion and the decrease in the average selling prices of such products to continue.

Furthermore, various other factors, including increases in the cost of raw materials and commodities and our suppliers passing such increases onto us, increases in silicon wafer costs and increases in production, assembly and testing costs, and shortage of capacity to fulfill our fabrication, assembly and testing needs, all may decrease our gross profit and harm our ability to grow our revenues in future periods.

We anticipate that these market challenges would continue to negatively impact our revenues for the fourth quarter of 2012 and result in continued operating losses for the company. Moreover, the continued uncertainty about the sustainability of the global economic recovery and outlook has resulted in longer product cycles and decision-making processes at our customers' organizations. We are observing our customers being reluctant in placing orders with normal lead times, with a shift to shorter lead-times and rush orders. This trend makes it very difficult for us to forecast our financial results.

Nonetheless, we remain focused on meeting our objective to generate positive operating cash flows in 2012, and continue to closely monitor market trends. As a result of our cost cutting measures implemented during 2012, we anticipate a significant decrease in our operating expenses for 2012, as compared to 2011.

As of September 30, 2012, our principal source of liquidity consisted of cash and cash equivalents of $19.2 million and marketable securities and short term deposits of $92.8 million, totaling $111.9 million.

RESULTS OF OPERATIONS Total Revenues. Our total revenues were $36.7 million for the third quarter of 2012, as compared to $48.4 million for the same period in 2011. Our total revenues were $124.4 million for the first nine months of 2012, as compared to $155.7 million for the same period in 2011. The decrease for the third quarter and the first nine months of 2012 was primarily as a result of decreased sales of our DECT and 2.4GHz products. Sales of DECT products for the third quarter of 2012 and 2011 were $30.4 million and $39.5 million, respectively, representing 83% and 82%, respectively, of our total revenues for the respective periods, representing a decrease of 23% in absolute dollars when comparing sales for the third quarter of 2012 to sales for the third quarter of 2011. Sales of DECT products for the first nine months of 2012 and 2011 were $102.5 million and $129.7 million, respectively, representing 82% and 83%, respectively, of our total revenues for the respective periods, representing a decrease of 21% in absolute dollars when comparing sales for the first nine months of 2012 to sales for the first nine months of 2011.

20 -------------------------------------------------------------------------------- Table of Contents The following table shows the breakdown of revenues for all product lines for the periods indicated by geographic location based on the geographic location of our customers (in thousands): Three months ended Nine months ended September 30, September 30, 2012 2011 2012 2011 United States $ 457 $ 788 $ 1,287 $ 1,490 Japan 10,333 15,333 41,073 48,070 Europe 1,829 2,312 5,152 7,120 Hong-Kong 19,370 23,381 63,704 78,710 Korea 337 873 1,608 4,864 China 1,615 2,423 4,694 6,726 Taiwan 1,724 2,180 4,580 6,242 Other 1,001 1,083 2,263 2,444 Total revenues $ 36,666 $ 48,373 $ 124,361 $ 155,666 Sales to our customers in Hong Kong decreased for the third quarter and the first nine months of 2012, as compared to the same periods of 2011, representing a decrease of 17% and 19%, respectively, in absolute dollars. The decrease in our sales to Hong Kong for the first nine months of 2012 resulted mainly from a decrease in sales to VTech Holdings Ltd. ("VTech"), representing a 13% decrease in absolute dollars for the first nine months of 2012, as compared to the same periods of 2011, and a decrease in sales to CCT Telecom Holdings Ltd. ("CCT Telecom"), representing a 43% decrease in absolute dollars for the first nine months of 2012, as compared to the same periods of 2011. The decrease in our sales to Hong Kong for the third quarter of 2012 resulted mainly from a decrease in sales to VTech, representing a 16% decrease in absolute dollars for the third quarter of 2012, as compared to the same period of 2011. Sales to our customers in Japan decreased for the third quarter and the first nine months of 2012 as compared to the same period of 2011, representing a decrease of 33% and 15%, respectively, in absolute dollars. The decrease in our sales to Japan for the comparable periods resulted mainly from a decrease in sales to Uniden America Corporation ("Uniden"), representing a 50% and 25% decrease, respectively, in absolute dollars for the third quarter and the first nine months of 2012, as compared to the same periods in 2011.

As our products are generally incorporated into consumer products sold by our OEM customers, our revenues are affected by seasonal buying patterns of consumer products sold by our OEM customers that incorporate our products. The fourth quarter in any given year is usually the strongest quarter of sales for our OEM customers and, as a result, the third quarter in any given year is usually the strongest quarter for our revenues as our OEM customers request increased shipments of our products in anticipation of the fourth quarter holiday season.

By contrast, the first quarter in any given year is usually the weakest quarter for us. This trend can be generally observed from reviewing our quarterly information and results of operations. However, the magnitude of this trend varies annually and is affected by macro-economic trends. For example, due to challenges associated with the European and the North American markets for our DECT products, our revenues for the third quarter of 2012 were weaker than the first and second quarters of 2012.

Significant Customers. VTech is a significant OEM customer based in Hong Kong.

Sales to VTech represented 33% and 29% of our total revenues for the three months ended September 30, 2012 and 2011, respectively. Sales to VTech represented 35% and 32% of total revenues for the nine months ended September 30, 2012 and 2011.

Sales to CCT Telecom represented 12% and 10% of our total revenues for the three months ended September 30, 2012 and 2011, respectively. Sales to CCT Telecom represented 8% and 11% of our total revenues for the nine months ended June 30, 2012 and 2011, respectively.

Sales to Uniden represented 7% and 10% of our total revenues for the three months ended September 30, 2012 and 2011. Sales to Uniden represented 11% and 12% of our total revenues for the nine months ended September 30, 2012 and 2011, respectively.

21 -------------------------------------------------------------------------------- Table of Contents The Japanese market and the OEMs that operate in that market are among the largest suppliers of residential wireless products with significant market share in the U.S. market. Revenues derived from sales through our largest distributor, Tomen Electronics Corporation ("Tomen Electronics") accounted for 21% of our total revenues for both the three months ended September 30, 2012 and 2011.

Revenues derived from sales through Tomen Electronics accounted for 22% and 19% of our total revenues for the nine months ended September 30, 2012 and 2011, respectively.

Tomen Electronics sells our products to a limited number of customers. One customer, Panasonic Communications Co., Ltd. ("Panasonic"), has continually accounted for a majority of sales through Tomen Electronics. Sales to Panasonic through Tomen Electronics generated 15% and 16% of our total revenue for the three months ended September 30, 2012 and 2011, respectively. Sales to Panasonic through Tomen Electronics generated 16% and 13% of our total revenues for the nine months ended September 30, 2012 and 2011, respectively. The loss of Tomen Electronics as a distributor and our inability to obtain a satisfactory replacement in a timely manner would harm our sales and results of operations.

Additionally, the loss of Panasonic and Tomen Electronics' inability to thereafter effectively market our products would also harm our sales and results of operations.

In addition to Tomen Electronics and Panasonic, the loss of any of our other significant customers or distributors, including VTech, or reduced demand for products from, or the reduction in purchasing capability of, one of our other significant customers, could have a material adverse effect on our business, financial condition and results of operations.

Significant Products. Revenues from our DECT products represented 83% and 82% of our total revenues for the three and nine months ended September 30, 2012, respectively. Revenues from our DECT products represented 82% and 83% of our total revenues for the three and nine months ended September 30, 2011, respectively. We believe that sales of DECT products will continue to represent a substantial percentage of our revenues for the remainder of 2012. We believe that the rapid deployment of new communication access methods, as well as the decline in fixed-line telephony, will continue to reduce our total revenues derived from, and unit sales of, cordless telephony products, including our DECT products.

Gross Profit. Gross profit as a percentage of revenues was 37.9% for the third quarter of 2012 and 36.2% for the third quarter of 2011. Gross profit as a percentage of revenues was 37.3% for the first nine months of 2012 and 36.3% for the first nine months of 2011. The increase in our gross profit for the comparable periods was primarily due to (i) a decrease in the provision for slow or obsolete inventories, (ii) an improvement in the production yield of certain of our products, (iii) a decrease in certain production costs such as gold due to the replacement of gold with copper in certain of our products and (iv) a reduction in other operational expenses such as boards, materials and subcontractors.

As gross profit reflects the sale of chips and chipsets that have different margins, changes in the mix of products sold have impacted and will continue to impact our gross profit in future periods. Our gross profit may decrease in the future due to a variety of factors, including the continued decline in the average selling prices of our products, changes in the mix of products sold, our failure to achieve cost reductions, roll-out of new products in any given period, our success in introducing new engineering processes to reduce manufacturing costs, increases in the cost of raw materials such as gold and copper, oil and silicon wafers, and increases in production, assembly and testing costs. Moreover, our suppliers may pass the increase in the cost of raw materials and commodities onto us which would further reduce the gross margins of our products. We cannot guarantee that our ongoing efforts in cost reduction and yield improvements will be successful or that they will keep pace with the anticipated continuing decline in average selling prices of our products. Steps we are taking to reduce our production costs include the implementation of cost improvement plans to reduce testing costs and offering our customers more cost effective products such as using copper instead of gold in the packaging process. However, we can provide no assurance that any alternative solutions we provide to our customers will be acceptable to them or that these steps will help us offset the continued decrease in gross margins of our products.

Cost of goods sold consists primarily of costs of wafer manufacturing and fabrication, assembly and testing of integrated circuit devices and related overhead costs, and compensation and associated expenses related to manufacturing and testing support and logistics personnel.

Research and Development Expenses, net. Our research and development expenses decreased to $9.6 million for the third quarter of 2012 from $12.6 million for the third quarter of 2011. Research and development expenses decreased to $33.0 million for the first nine months of 2012 from $41.0 million for the first nine months of 2011. The decrease for the third quarter and the first nine months of 2012 in research and development expenses, as compared to the comparable periods of 2011, was mainly due to (i) the restructuring of our U.S. operations, which was implemented during the third 22 -------------------------------------------------------------------------------- Table of Contents quarter of 2011 and reduced our research and development expenses for the third quarter and the first nine months of 2012 (ii) a decrease in projects-related expenses (mainly tape-out, materials, subcontractors and travel expenses), and (iii) a decrease in labor and employee-related expenses, which was in addition to the planned decrease that resulted from the restructurings of our U.S.

operations that were initiated during the third quarter of 2011. This decrease in labor and employee-related expenses for the both comparable periods was mainly due to (x) a decrease in the number of employees, (y) the devaluation of the New Israeli Shekel ("NIS") against the U.S. dollar, which decreased the Israeli employee labor expenses, and (z) the restructuring of our operations that was initiated during the second and the third quarters of 2012, which are described in greater detail in the Note M of our financial statements for the quarter ended September 30, 2012. In addition, during the third quarter of 2012 we recorded grants receivable in the amount of $0.3 million from the Office of Chief Scientist in Israel in support of one of our research and developments projects, which also decreased our research and development expenses, in comparison to the third quarter of 2011.

Our research and development expenses as a percentage of our total revenues were 26% for both the three months ended September 30, 2012 and 2011, respectively, and 27% and 26% for the nine months ended September 30, 2012 and 2011, respectively. The increase in research and development expenses for the nine months ended September 30, 2012 as a percentage of our total revenues was due to the decrease in absolute dollars of our total revenues for the nine months ended September 30, 2012, as compared to the comparable periods of 2011.

Research and development expenses consist mainly of payroll expenses to employees involved in research and development activities, expenses related to tapeout and mask work, subcontracting, labor contractors and engineering expenses, depreciation and maintenance fees related to equipment and software tools used in research and development, and facilities expenses associated with and allocated to research and development activities.

Sales and Marketing Expenses. Our sales and marketing expenses decreased to $3.5 million for the third quarter of 2012 from $4.2 million for the third quarter of 2011. Sales and marketing expenses decreased to $11.3 million for the first nine months of 2012 from $12.4 million for the first nine months of 2011.

The decrease in sales and marketing expenses for the third quarter and the first nine months of 2012, as compared to the comparable periods during 2011, was mainly attributed to (i) a decrease in payroll and payroll-related expenses, (ii) a decrease in sales commission paid due to a lower level of revenues subject to sales commissions, and (iii) a decrease in overseas travel expenses.

Our sales and marketing expenses as a percentage of total revenues were 10% and 9% for the three months ended September 30, 2012 and 2011, respectively, and 9% and 8% for the nine months ended September 30, 2012 and 2011, respectively. The increase in sales and marketing expenses as a percentage of our total revenues for the comparable periods was due to the decrease in absolute dollars of our total revenues for the three months and nine months ended September 30, 2012, as compared to the comparable periods of 2011.

Sales and marketing expenses consist mainly of sales commissions, payroll expenses to direct sales and marketing employees, travel, trade show expenses, and facilities expenses associated with and allocated to sales and marketing activities.

General and Administrative Expenses. Our general and administrative expenses decreased to $2.3 million for the third quarter of 2012 from $3.3 million for the third quarter of 2011. General and administrative expenses decreased to $8.2 million for the first nine months of 2012 from $10.0 million for the first nine months of 2011. The decrease in general and administrative expenses for the third quarter of 2012, as compared to the comparable period of 2011, was mainly due to a decrease in legal and shareholders' relations expenses. The decrease in general and administrative expenses for the first nine months of 2012, as compared to the comparable period of 2011, was mainly due to (i) a decrease in equity-based compensation expenses in the amount of $0.6 million, (ii) a decrease in payroll and payroll-related expenses mainly due to the devaluation of the NIS against the U.S. dollar, which decreased the Israeli employee payroll expenses in U.S. dollar, and (iii) a decrease in legal, accounting and shareholders' relations expenses.

General and administrative expenses as a percentage of our total revenues were 6% and 7% for the three months ended September 30, 2012 and 2011, respectively, and 7% and 6% for the nine months ended September 30, 2012 and 2011, respectively. The increase in general and administrative expenses for the first nine months of 2012 as compared to 2011, as a percentage of our total revenues for the comparable periods was due to the decrease in absolute dollars of our total revenues.

23 -------------------------------------------------------------------------------- Table of Contents Our general and administrative expenses consist mainly of payroll expenses for management and administrative employees, accounting and legal fees, expenses related to investor relations as well as facilities expenses associated with general and administrative activities.

Description of Segments.

During the third quarter of 2012, following an internal reorganization and a change in the manner management evaluates financial information we determined that the company operates under three reportable segments in accordance with ASC 280 "Disclosure about Segments of an Enterprise and Related Information." Our operating segments are as follows: Home, Office and Mobile. The classification of our business segments is based on a number of factors that management uses to evaluate, view and run its business operations, which include, but not limited to, customer base, homogeneity of products and technology.

A description of the types of products provided by each business segment is as follows: Home - Wireless chipset solutions for converged communication at home. Such solutions include integrated circuits targeted for cordless phones sold in retail or supplied by telecommunication service providers, residential gateway devices supplied by telecommunication service providers which integrate the DECT/CAT-iq functionality and also address home automation applications, as well as fixed-mobile convergence solutions.

Office - Comprehensive solution for Voice-over-IP (VoIP) office products, including office solutions that offer businesses of all size low-cost VoIP terminals with converged voice and data applications.

Mobile - Products for the mobile market that provides voice enhancement and far-end noise elimination targeted for mobile phone and mobile headsets.

Segment Data: We derive the results of our business segments directly from our internal management reporting system and by using certain allocation methods. The accounting policies we use to derive business segment results are substantially the same as those we use for consolidation of our financial statements.

Management measures the performance of each business segment based on several metrics, including earnings from operations. Management uses these results, in part, to evaluate the performance of, and to assign resources to, each of the business segments. We do not allocate to our business segments certain operating expenses, which we manage separately at the corporate level. These unallocated costs include primarily restructuring charges, amortization of purchased intangible assets, equity-based compensation expenses and certain corporate governance costs.

Selected operating results information for each business segment was as follows for the three months ended September 30, 2012 and 2011: Three months ended September 30 Income (loss) from Revenues operations 2012 2011 2012 2011 Home $ 34,726 $ 46,670 $ 3,225 - * Office $ 1,940 $ 1,703 $ (701 ) - * Mobile $ - $ - $ (2,542 ) - * Total $ 36,666 $ 48,373 $ (18 ) $ 72 24 -------------------------------------------------------------------------------- Table of Contents * It is impracticable to present 2011 income (loss) from operations by segments due to lack in internal management reporting and tracking system, which tracks and reports employees actual hours in the various projects. Selected operating results information for each business segment was as follows for the nine months ended September 30, 2012 and 2011: Nine months ended September 30 Income (loss) from Revenues operations 2012 2011 2012 2011 Home $ 119,269 $ 151,312 $ 10,138 - * Office $ 5,092 $ 4,354 $ (4,099 ) - * Mobile $ - $ - $ (5,851 ) - * Total $ 124,361 $ 155,666 $ 188 $ 859 * It is impracticable to present 2011 income (loss) from operations by segments due to lack in internal management reporting and tracking system, which tracks and reports employees actual hours in the various projects.

The reconciliation of segment operating results information to our consolidated financial information was as follows for the three and nine months ended September 30, 2012:

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