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Edited Transcript of DSPG earnings conference call or presentation 1-Nov-18 12:30pm GMT

Q3 2018 DSP Group Inc Earnings Call

San Jose Nov 5, 2018 (Thomson StreetEvents) -- Edited Transcript of DSP Group Inc earnings conference call or presentation Thursday, November 1, 2018 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel Louis Amir

DSP Group, Inc. - Corporate VP of Business Development, Strategy & IR

* Dror Levy

DSP Group, Inc. - CFO, Corporate VP of Finance & Secretary

* Ofer Elyakim

DSP Group, Inc. - CEO & Director

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Conference Call Participants

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* Alexander Kim

* Charles Lowell Anderson

Dougherty & Company LLC, Research Division - VP and Senior Research Analyst

* Jaeson Allen Min Schmidt

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Sujeeva Desilva

Roth Capital Partners, LLC, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good day and welcome to Q3 2018 DSP Group Inc. earnings conference call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Mr. Daniel Amir, Please go ahead, sir.

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Daniel Louis Amir, DSP Group, Inc. - Corporate VP of Business Development, Strategy & IR [2]

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Thank you. Good morning, ladies and gentlemen, I'm Daniel Amir, Corporate Vice President for Business Development at DSP Group. Welcome to our third quarter 2018 earnings conference call. On today's call, we also have with us, Mr. Ofer Elyakim, Chief Executive Officer, and Mr. Dror Levy, Chief Financial Officer.

Before we begin, I would like to remind you that during this conference call, we will be making forward-looking statements about our financial projections for the fourth quarter and full year 2018, optimism about our engagement pipeline and design wins, our positioning for 2019, the ability of our growth initiatives to drive revenue growth, their significance to our total revenues, and their ability to offset the decline of the cordless market and believe that headwinds in the fourth quarter are temporary. We assume no obligation to update these forward-looking statements. For more information about the risks and factors that could affect the forward-looking statements made herein, please refer to the risk factors discussed in our 2017 Form 10-K and our other SEC reports we have filed.

Now I would like to turn the call over to Ofer Elyakim, our Chief Executive Officer. Ofer, the floor is yours.

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [3]

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Thank you, Daniel, good morning everyone and thank you for joining us today. I hope that you had the opportunity to read our press release that we distributed earlier today. I would like to begin by reviewing our results for the third quarter, commencing on the progression of our business plan in light of the market environment and providing context for outlook for the fourth quarter and the full year 2018. In a short while, Dror will provide you with detailed comments on our financial results and outlook for the fourth quarter of 2018. I'm happy to announce that we achieved third quarter financial results that exceeded our guidance on most financial metrics. Revenues from growth initiative reached a record high of $18.9 million and accounted for 58% of sales, representing a year-over-year increase of 18% and a sequential increase of 20%.

Overall, we ended the third quarter with total revenues of $32.6 million, representing a decrease of 5% versus the third quarter of 2017 and a sequential increase of 6% versus the second quarter. Our performance reflects continuous positive execution on the growth initiatives, including the solid year-over-year revenue growth of 20% in the Office/VoIP segment and 123% in the SmartVoice segment. Growth initiatives comprised the majority of our revenues for the second consecutive quarter. We're at an inflection point where the majority of revenues are generated by these growth segments and we're transitioning from being primarily a cordless telephony company with years of growth are behind it to a growth company that is built on two unique pillars, IoT and voice as a user interface.

Moreover, this transition in our revenue mix from legacy to new, drove 15 consecutive quarters of year-over-year gross margin expansion. And in the third quarter, our non-GAAP gross margins improved by 340 basis points to a record high of 50.3%, and non-GAAP operating margin improved by 130 basis points to 7.4% of sales, both higher than our guidance. These are extremely exciting developments for DSP Group, the transition from legacy to new has been difficult at times, but we are absolutely thrilled with the customer acceptance of our new technologies and products. We are confident about our growth prospects for 2019 and beyond, driven by an exceptional pipeline of design wins across our growth initiatives. We expect these initiatives to be important revenue contributors next year and to account for over 2/3 of our total sales.

Further, solidifying our success in transitioning away from our legacy cordless business in favor of technologies, which enable the industry's current and future roadmaps. We view ourselves today as a growth technology company, where our traditional cordless business becomes a smaller and smaller part of our overall company's revenues. While we believe that our design wins pipeline and customer demand continue to strengthen for 2019 and beyond, we do expect a decline in the fourth quarter, which will negatively impact our full year 2018 results to be below our annual guidance, mainly due to weaker quarterly demand for cordless products that we attribute primarily to a supply chain correction as well as timing of orders for SmartHome and [Office/VoIP] product.

The expectations for tariff wars between China and the US have increased the level of uncertainty and drove many manufacturers with exposure to China to acquire factories offshore and make them operational in the event that the tariff war commences.

In addition, many OEMs have pulled in more finished good material from China factories to their warehouses offshore for a similar purpose. All of these events created an abnormal level of volatility in our end markets and drove the creation of inventory in the supply chain and timing shift of overall orders, especially in our cordless home gateway and Office/VoIP segment, where the exposure to China manufacturing is higher than for instance in SmartVoice. Most importantly, we believe that the anticipated decline in the fourth quarter is temporary and that our existing and confirmed design win, engagement pipeline, and customer demand, positions us well for future growth.

Moreover, during my recent customer visits to the US and Asia, I was encouraged by the product positioning and the overwhelming interest and demand for voice technologies. Another exciting observation was the high demand for convergence between our technologies. We have a growing number of engagements where DSP Group delivers a solution that combines technologies from two or more of our product offering, such as SmartVoice together with ULE, Voice-over-IP and SmartVoice, Voice-over-IP and ULE et cetera, et cetera, creating a need for better convergence across these initiatives and provides us with a competitive advantage.

Now, I'd like to provide you with some specific updates about our progress in each segment, starting with SmartVoice. During the quarter, sales of SmartVoice products totaled $3 million, which were in line with our guidance and reflected an increase of 133% year-over-year and 37% sequentially. Moreover, we are excited to announce that during the third quarter, we successfully accomplished a key milestone of being selected by a Tier 1 smartphone OEM from China. This OEM selected our SmartVoice SoCs for high volume smartphone models launching in the first quarter of 2019. We expect this win to be a major contributor to our SmartVoice revenues and growth in 2019. We're very pleased with the strength and diversity of our SmartVoice engagement pipeline as evidenced by a number of additional noteworthy design wins accomplished during the quarter across a variety of different product categories.

The first one is with the leading Korean mobile OEM that launch a series of public model based on our SmartVoice SoC. We believe that this design win in addition to the one from last year with Fujitsu solidifies our position to be the market leader in the voice-activated Android-based tablets market. The second one is with the leading camera OEM that launch its new action camera series using our DBMD SoC for its low power hands-free voice activation.

Jabra launch its new B550 BlueParrott Bluetooth headset based on our SmartVoice SoC. This is the first time our SmartVoice SoC is shipping in the headset category. The device leverages our SmartVoice SoC low power consumption in order to accomplish hands-free operation. This establishes a new end market for our SmartVoice products. Another noteworthy design wins with the leading Tier 1 home networking and smart home security company that selected our DBMD SoC for wireless home security camera leveraging our best-in-class full duplex AC capability.

And lastly, Turkish smartphone OEM selected our SmartVoice SoC for its new smartphone model. We are encouraged that the voice user interface is taking center stage everywhere. We see a growing demand for low power voice solutions more advanced solutions for far-field voice activation, machine learning and AI processing on the edge and many new use cases, including audio sensing for providing users with a more personalized and contextual response.

Looking ahead to the fourth quarter, we anticipate that our revenue will increase on a sequential basis to a level of $4 million to $5 million. At the mid-range our full year SmartVoice results will come in line with our annual guidance of $11 million to $16 million. We are pleased with our SmartVoice momentum and expect our SmartVoice business to be an important contributor to our future growth with a broader array of exciting application. We remain highly confident in the future success and revenue growth of this product category.

And now to an update on Voice over IP. For the third quarter, we surpassed $12 million in quarterly revenues for the first time. Voice revenues of $12.1 million represent an increase of 20% year-over-year and 24% sequentially. This result was well ahead of our previous guidance of $10 million to $12 million. We continue to strengthen our leadership position in the unified communication endpoint space and grow the engagement and design funnel. We're excited about the developments in the unified communication market towards systems with higher productivity, flexibility and a need for better quality voice and video communications.

Moreover, today's workspace is evolving, the Personal Desktop area is changing and new models of workforce collaborations are adopted. DSP Group is at the forefront of this product category and is well positioned to capitalize on such industry trends through our comprehensive SoC solutions for unified communications, portable terminals, IoT, voice user interface and artificial intelligence processing on the edge.

In addition, during the quarter, we had a number of noteworthy new product announcements, including Cisco the launched its new unified communication wireless headset for the professional market based on our DVF and DCX81 chipsets. Cisco also launched a new line of IP phone expansion models, its 68600 and 8851 and 61 based on our DVF99 SoC. Snom Technology, a specialist in IP telecommunications, launched its D735, a new top line IP phone, based on our DVF99 SoC.

Looking ahead, we expect fourth quarter voice revenues to decline on a sequential basis due to timing of orders and previously discussed macro trends. We project voice revenues to be in the range of $8 million to $9 million. While at the mid-range of our guidance, this is at the low end of our annual target of $38 million to $44 million. We are nonetheless able to exceed the annual market growth of approximately 5%. Despite the temporary weakness in the fourth quarter, we remain confident that with our current design pipeline, we are well positioned for annual double-digit revenue growth in 2019.

And now to an update on the Home segment, starting with SmartHome. Our SmartHome business is comprised of DECT ULE products shipping, primarily with IoT and home gateway products. Third quarter SmartHome revenues of $3.8 million were in line with our guidance range. However, SmartHome revenues decreased by 17% year-over-year and were flat sequentially. Demand for SmartHome products this year was lighter than our original expectation, mainly due to a prolonged inventory readjustments at one of our largest ULE customers, combined with softer demand in our home gateway segment.

Despite the setback, we experienced this year, we continue to be optimistic about the prospects of this business and anticipate that the SmartHome business will rebound next year on the heels of a Tier 1 European service provider, which is launching ULE services. The second one is a major European service provider launching a new line of home gateway product. And the third is an upcoming launch of new IoT products with two-way voice support that incorporate our ULE and SmartVoice technology. And the fourth is our new focus and investments in the U.S. market, which we view as a promising territory for our ULE products in market segments such as SmartHome, security, elderly care and industrial segments.

During the quarter, we had a number of noteworthy new product announcements by our customers, including Deutsche Telekom that selected our DECT ULE SoC solution for its new smart speaker with two-way high definition voice to support hands-free calling from the speaker leveraging our technology zero latency, high reliability, dedicated bandwidth, long bridge and lack of interference. Zipato, a leading European provider in home automation, incorporated our DECT ULE SoC solution into their new home automation controller. In AwoX, a leading European smart lighting provider, incorporated our DECT ULE SoC solution into their new connected LED bulb products.

We continue to see a growing momentum and demand for high quality real-time two-way communications in the IoT market, with emergence of voice-enabled devices and two-way voice interaction for smart speakers and other devices. Voice in the SmartHome is fast becoming the interface of choice and DECT ULE is gaining ground as the go to wireless standard for applications requiring transfer of high quality voice. While the cycle time in our SmartHome business is longer than in other segments, we remain encouraged by the pipeline and the opportunities that lie ahead. We're looking forward to the upcoming SmartHome service launch by a Tier 1 European service provider early next year.

Looking to the fourth quarter, we expect SmartHome revenues to be in the range of $2 million to $2.5 million at the mid-range of our guidance, this is below our projections of $18 million to $20 million for the year, mainly due to inventory readjustments at one of our largest ULE customers and demand slowdown in our home gateway segment. Nevertheless, we anticipate that our smartphone business will rebound and grow next year.

And now for an update on the cordless phone market. Our third quarter cordless revenues were below our guidance and accounted for 42% of third quarter revenues. Cordless revenues decreased by 8% on a sequential basis and by 25% year-over-year. We expect the slowdown in our cordless segment to continue in the fourth quarter, reflecting an inventory correction cycle that should be concluded by year-end. We continue to manage this business very well and the profit from this business has been instrumental in developing our well performing growth initiatives.

And now, to an update on our outlook. Based on our revenue expectations across our new product initiatives, we expect our fourth quarter 2018 revenues to be in the range of $25 million to $27 million. We are disappointed with our fourth quarter revenue outlook and consequently full-year results, which are due to weaker quarterly demand for cordless that we attribute primarily to supply chain correction as well as timing of orders for SmartHome and Office products. However, we believe that the anticipated slowdown in the fourth quarter is temporary, as our existing design wins, pipeline and customer demand continue to strengthen in the Office/VoIP, SmartHome and SmartVoice and position us well for future growth in 2019 and beyond. Additionally, we expect these initiatives to be an important revenue contributor next year and to account for over 2/3 of our total sales being meaningful enough to more than offset the continued secular decline of the cordless telephony business.

Now, I'd like to turn the call over to Dror, our Chief Financial Officer. Dror, the floor is yours.

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Dror Levy, DSP Group, Inc. - CFO, Corporate VP of Finance & Secretary [4]

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Thank you, Ofer. I will now review the income statement for the third quarter of 2018 from top to bottom. For each line item, I will provide the US GAAP results, as well as equity-based compensation expenses included in that line item and expenses related to previous acquisition.

Our revenues for the third quarter of 2018 were $32.6 million. Gross margin for the quarter was 50%. Gross margin for the quarter included equity-based compensation expenses in the amount of $0.1 million. R&D expenses were $9.6 million including equity-based compensation expenses in the amount of $0.8 million. Operating expenses for the quarter were $60 million including equity-based compensation expenses in the amount of $1.6 million and the amortization of acquired tangible assets in the amount of $0.4 million.

Financial income for the quarter was $0.5 million. Tax expenses for the quarter were $0.4 million and included tax expenses resulting from changes in deferred taxes related to intangible assets and equity-based compensation expenses in the net amount of $0.1 million. Tax expenses on a pro forma basis, excluding these deferred tax changes, were $0.3 million. Net income was $0.4 million including equity-based compensation expenses of $1.7 million, amortization of intangible assets of $0.4 million and tax effect of $0.1 million. Non-GAAP net income, excluding the items I just did described, was $2.6 million.

GAAP income per share for the quarter was $0.02. The negative impact of equity-based compensation expenses on the EPS was $0.07. The negative impact of the amortization of acquired intangible assets on the EPS was $0.02 and the non-GAAP income per share excluding the items I've just described was $0.11 for the quarter. Please see the current report on Form 8-K that we filed with this SEC this morning for full reconciliation of the non-GAAP presentation to the GAAP presentation.

Now turning to the balance sheet. Accounts receivable at the end of the third quarter of 2018, increased to $21.4 million compared to $16.6 million in the end of the second quarter, representing a level of 59 days of sale. Our inventory decreased from $8.4 million at the end of the second quarter to $8.2 million representing a level of 46 days. Our cash and marketable securities decreased by $4.3 million during the third quarter and were at a level of $119.7 million as of September 30, 2018. Our cash and marketable securities position during the quarter was affected by the following: No cash was used [or provided operations], this was mostly due to temporary increase in accounts receivable that were fully collected shortly after the quarter end; $0.2 million of cash was used for purchase of property and equipment; $3.9 million was used for repurchase of 313,000 shares of our common stock at an average price of $12.5 per share and $0.2 million was change in market value and amortization of the marketable securities.

Now I would like to provide you with our projections for the fourth quarter of 2018. Our fourth quarter projections, including the impact of equity-based compensation expenses and acquisition-related amortization expenses are as follows. Our revenue are expected to be in the range of $25 million to $27 million. We expect our gross margin to be in the range of 47% and 49%. R&D expenses are expected to be in the range of $8.5 million to $10 million. Operating expenses are expected to be in the range of $15 million to $16.5 million. Financial income is expected to be in the range of $400,000 to $500,000. Provision for income taxes for the fourth quarter is expected to be $0.1 million on a pro forma basis. Share outstanding are expected to be in the range of 22 million shares to 22.5 million shares. Our fourth quarter projections include $0.4 million for amortization of intangible assets. Our fourth quarter projections also include the following amount forecasted for equity-based compensation. Cost of goods sold include $0.1 million. R&D expenses include $0.6 million to $0.8 million and the total operating expenses include $1.5 million to $1.7 million.

Now I would like to open up the lines for questions and answers. Operator please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will take our first question from Rajvindra Gill from Needham & Co.

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Alexander Kim, [2]

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This is Alex Kim, doing in behalf of Rajiv Gill. I just wanted to ask a couple of questions. First question, can you provide some more details about the DECT ULE solution for the Deutsche Telekom and then (inaudible) smart speaker and what will the revenues be like for that speaker and how much do you expect in shipments relative to other smart speakers products using the same type of technology for calendar year 2019?

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [3]

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Yes, hi. So thanks for the question. So the question was around the expected contribution from the DECT smart speaker that was announced by Deutsche Telekom and how meaningful that could be. So, yes, Deutsche Telekom did announce in the third quarter it's new smart speaker that basically leverages 2 cloud engines and it provides the ability to do far field voice activation inducing an ability to run high definition two-way voice calls using the speaker as a conference system or as a telephone. This is a new device. We expect to see many more of these type of devices rolling out in different form factor during 2019 by some additional European customers. We see this market as a market that will help in reinventing telephones and utilization of these speakers that where you look very much like any echo device to build and provide high quality, full band type of voice calls. We believe the opportunity is significant. However, these are new products that need to be rolled out in the market and be embraced by consumers and based on that, we will know what the appetite is with respect to demand. Right now, we do expect these devices to sell in probably around, I'd say, 500,000 to 1 million units per year, perhaps in the first year. But I believe there is a lot of opportunity for much larger growth, especially once we see more of these important categories being launched by other -- whether these are service providers or consumer brands. But we do see very high adoption of the two-way voice capability together with smart speakers, far field voice activation as well as best-in-class voice communications. So all of that bundles in with the kind of the service provider type of grade of network to really provide a differentiated service class.

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Alexander Kim, [4]

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So just to clarify that 500k -- 500,000 units just for the Deutsche Telekom or for all of your smart speaker products?

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [5]

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So right now, we -- as I said, we don't really have a good number in our hand to say exactly what will be the demand for Deutsche Telekom. But I would think that this could be the area of the volume that we can get from something like such speaker assuming that the market acceptance is good. And as I said, we believe that we will see more type of products rolling out during next year.

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Alexander Kim, [6]

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And do you have a price point? So you're not for the Deutsche Telekom speaker at average selling price.

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [7]

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I do not know what the average selling price of the speaker is, but I'm pretty sure that there will be kind of -- be selling for a fairly attractive price points or maybe even bundled together with services.

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Alexander Kim, [8]

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And also I just wanted to ask in terms of the DECT ULE technology, how scalable is that for other types of applications beside home automation? And the second part how much R&D will be spent on the DECT ULE technology for 2019?

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [9]

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Sure, absolutely. So on the DECT ULE cycle, the technologies is robust. The technology today have the -- it's interference free, it enjoy the best range that is available today in the industry for an indoor a technology. It is real time, so it can really accommodate two-way type of the streaming of the audio, high definition voice, video, so it's fairly robust compared to the other competitive products or technologies that are in the market. So it is highly suitable for SmartHome for security, for the industrial market, for health care and elderly care. So we believe that the technology has a lot to offer and we are seeing that now already 2 major European telecos are recognizing the benefits and are bringing to market solutions and services based on that technology and in a way adopting just one technology for their SmartHome and smart life type of services. And we believe that there are many more in the pipe that are today in field trials, we're doing proof-of-concept with this technology in order to launch such services in the future. As I said, we're also now while having been focused mainly on the European market as the market for growth for ULE, today that we see kind of the technologies more widely adopted. It's already selling and proven in the field that we can actually now shoot and develop a new territory, which we believe can give us significant opportunities. And this is the U.S. market that we've started focusing on and marketing and promoting the ULE standard and all the merits it can bring. There is no other solution that can give you the two-way voice and the ability to conduct -- also voice activation at the range or at the zero latency that ULE can and not mentioning the interference-free band. So we believe there is a lot of opportunity for the technology.

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Alexander Kim, [10]

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How much R&D will be devoted to that technology for 2019?

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [11]

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We are not really splitting the R&D investments by the product. But I can tell you that on a standalone basis, looking at kind of the discretionary investment in this product line, it is and will be -- it is profitable this year and will be profitable also next year.

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Alexander Kim, [12]

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Got it. And my last question is, in terms of your cordless business, have you thought of potentially divesting that business to focus on other -- on your other growing areas of the business, such as SmartVoice and VoIP? And have you been [approached offers] that selling that business in the past?

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [13]

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So thank you for that. So we're always looking for kind of creative ideas on how to kind of position our business better, and actually separate between the legacy, which is providing ample cash flow. But on the other hand, declining versus the more exciting product areas where we have been investing heavily in the last couple of years, and today are also seeing the fruits and the very nice growth in the acceptance of these product categories. From the point of view of a divestiture or a sale of cordless, I think it's -- it could have been a very good idea to do that in the past. However, when you look forward and you pay attention to the color that we provided during the call, you will see that we are predicting that next year it will already be about below 1/3 of our revenues. So in a way, cordless will stop playing a key role influencing our financial results. And so we are very confident that by this correction that we're seeing now to our cordless revenues. And where they will be next year, of course, we will stop being a major factor that will be swinging our results and on the contrary, we are highly confident in the growth in our new businesses, each and every one of them. And we believe that in a way, kind of the migration from legacy to new is pretty much over and done. And we're today a growth company and cordless is just another asset that we have that will become a smaller and smaller part of our overall sales. So in a way, the time to do that in my view has passed. But of course, we are very much open to any suggestion or interest if we will see in the market.

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Operator [14]

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And our next question comes from Suji Desilva from ROTH Capital.

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Sujeeva Desilva, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [15]

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First question is on the slowdown in the tariff action in the supply chain. Can you just highlight for us, when those actions begin roughly in the supply chain? And how long you think it will take? How many quarters?

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [16]

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Suji, so with respect to what we see in the supply chain, so in a way, very hard to really time all those factors. But what we can do and what we have done is really kind of tried to look in and talk to our customers to exactly -- to find out exactly what has been going on. But in a bigger picture perspective, I can say that this year, because of the uncertainty that has to do with these potential a tariff wars. A lot of manufacturers that had a lot of exposure to China manufacturing have to figure out what they will do in the event of their -- where tariffs are placed and how will they be able to export their goods without being exposed to such a tariff, and they have to look for creative ideas. And in a way, what we understand is that, many of these manufacturers have acquired the JV, the partner et cetera, with overseas manufacturers and in a way, it hold or it partner with other facilities that are outside of the China market. And by that, in a way, also had to make sure that there is production readiness. And in a way, put more components and goods in these additional factors, all of that had created a swing. And when we look one layer above the manufacturers, we also see that the amount of goods that were ordered, perhaps let's say the first 3 quarters of the year, some of them were [unlucky in excess] of what was needed again to satisfy the same objective of having enough goods, finished goods that are not exposed, or that are not going to be exposed to any towers. So all of that created a bigger level of uncertainty in our business with respect to what we're seeing now happening in the fourth quarter and this inventory correction. I would say that in cordless, we've always said in the past and if you look at the previous earnings calls, I said every 6 quarters -- about every 6 quarters, there is an inventory adjustment in cordless. Fourth quarter for us, it's kind of the seventh after the previous one, which was on the first quarter of '17.

Now, we were surprised by the magnitude of the correction, especially because that -- we have seen in the last couple of years that the number of cordless brands that are selling in retail have shrunk and in a way, the level of inventory re-adjustments et cetera should shrink alongside via the limiting shelf space and also the smaller number of competitors, but from what we understand a lot of it had to do with these kind of re-adjustment and the preparations for a -- for such a tariff war.

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Sujeeva Desilva, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [17]

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And my second question is on Smart Voice. Can you talk about what kind of mix is smartphone, non-smartphone you'd expect in the next few quarters and for the first quarter in particular, would you expect seasonality or would you expect some of these new programs like the smartphone win a ramp in secular growth -- to offset that after the end of the year?

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [18]

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Yes, sure. So, on SmartVoice seasonality and also the new wins, we are very excited as you can understand with the developments and the momentum in the SmartVoice area. We are being designed into many new product categories, you heard about the security cameras, action cameras, speakers, tablets, headsets and the many, many additional devices, IoT devices. Of course, nothing has the volume of the Tier 1 type of a smartphone OEM that is -- that can ship in tens of millions of units and we do expect to see a diversification also on the smartphone side, together with our existing customers. We hope that during next year, we'll have more new customers that will come, one of them was announced today that will kind of drive our revenue growth in SmartVoice next year. We do expect to see hopefully an increase in [granular basis] but I would say that it's kind of too early to tell exactly how the seasonality will work next year, but right now, we're kind of confident that we will continue to see this ramp going forward. And we seek very nice demand for voice as a user interface in the kind of consumer electronics space from smartphones to tablets to headsets, and we believe we are well positioned, especially for the battery operated space where we have the lowest par consumption capability and also the flexibility to support a number of microphones. We also have all the algorithm suite and all of that kind of makes us unique in the market and I would say that we are also very pleased with what we're seeing with respect to our far field solution. Our partnership with the Amazon Alexa on some projects and so we're very happy with the momentum that is developing. And we believe that the next couple of quarters should be -- should be very kind of supportive of these comments.

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Sujeeva Desilva, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [19]

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And a last quick question on telco and SmartHome. Can you talk about why you've had -- you think you've had more success historically in European telcos and perhaps the US. I wonder whether there's is going to be moves made -- similar moves made by the US telcos, whether it's the hyperscale guys in the US that are dominating the market, any color there would be helpful. Thank you.

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [20]

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Sure. And so I think it all [spawns from] kind of the history. DECT is a European technology. It's supervised and standardized by the ITU and (inaudible) a lot of the invention and the patents in the IP is European. Telcos in Europe that play the -- a fairly active role in standardizing DECT and also Cat-iq and ULE. And the technology is just really well known and also installed everywhere. And so, the need and the -- for IoT kind of prompted to look for ULE as one of kind of the new emerging technologies, especially in Europe, because the technology there is well known, and as I said, the standardization is also being handled by many contributions from telcos. And so, we believe that in the European territory, we will see more and more uses of DECT and ULE for voice user interface, for two-way voice, for also video purposes, and right now, when we're looking to develop a new market, which is the US, I do believe that we will find many market segments that today are not aware of what ULE is and what it can offer and deliver. And I think that once we are on the ground and promoting to all the leading vendors as we did in Europe, we will find a very, very good home also in the US -- in market segments such as smart home, like security, we see a lot of elderly care projects coming in masses with very nice volume. Also in the industrial front, really kind of leveraging the best-in-class range, the fact it is interference-free wireless technology and also the real-time two-way communication that it can offer. So I don't think that we have put a lot of emphasis when promoting ULE in the US so far, but I do believe that starting from the third quarter, we are placing a lot of priority and putting much more, many more people on the ground to promote this technology and we believe that the fruits will come. And at the end of the day, it's all about the kind of the promotion, the marketing making people aware, appreciative of what it can deliver, and I think that we will find a lot of the end customers that will want to embrace such a technology with the unique merits that the technology offers.

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Operator [21]

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And our next question comes from Charlie Anderson from Dougherty & Company.

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Charles Lowell Anderson, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [22]

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Ofer, it sounds like the tariffs are certainly playing a part in Q4 here so I wondered, do you guys have visibility to maybe what percent of your revenue is associated with tariff to products, maybe little more description (inaudible) what some of those are and to the extent that people are moving production, I know it's -- the timing is a little bit uncertain, but do you have line of sight to any of those moves resolving themselves in the first half or is it more of the second half and then I've got a follow up.

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [23]

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Thanks, Charlie. So I definitely wish I had the crystal ball to answer all of those questions, but when we are looking at what would have happened this year, and again, we cannot say that it's over or close to over. We have no clue, but what we have seen this year that is very different from the pattern of demand and supply chain management that has existed for the last couple of years is the fact that many manufacturers are looking for operations offshore, and this was not the case on the contrary when you look at cordless, everything was actually consolidating into less and less factories. And now suddenly, we see like that there are many more factories and people are looking for all kind of backup plans to avoid any type of tariff. When you think about how exposed DSP Group is in that domain, first of all I think export. So everything that is exported from China is definitely exposed. And so when you think about our products, almost 100% or maybe 90% of the cordless phones are made for export. Home gateway, 100% of them are made for export. Voice-over-IP, I would say 80% of them are for export. So these are the areas where, on one hand, manufacturing is predominantly done in China. Number two, since they are intended for exports, there are definitely in exposure. And when you think about kind of our customer mix in SmartHome, there is a lot of non-China built products and hence less exposure. Of course, that will vary and change as this year will go on, but I would say that right now, also the exposure in China is not necessarily just for export. We also see a lot of, like, domestic China product that will leverage and utilize our SmartHome solutions for the first time and this is also very exciting development for us. So, to tell you exactly how that will play into next year, too early. We are definitely kind of studying that very closely and putting a lot of -- a lot more effort in understanding what is going on, so that we are better prepared also from our supply chain management perspective. So all in all, we tried to kind of characterize the environment, so it will be more easier for you guys to understand what we are going through, especially in this Q4. As we said, we believe that this is a temporary issue that will be resolved, hopefully by the end of Q4. And we believe that we are well positioned for growth in all of these growth segments going into next year. And it's all kind of based on additional wins that will -- that are going to production, and in a way lifting the rest of the quarterly revenue levels in each of these product initiatives.

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Charles Lowell Anderson, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [24]

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And then for my follow-up, I was curious about gross margin. I think we're down a little bit sequentially in Q4, I wondered, is that a function mostly of SmartVoice becoming a larger portion of the mix, because you sort of consider your business mix next year as -- it sounds like less than a third will be in cordless. How should we think about the progression of gross margin and I guess I suppose SmartVoice sounds like that'll be also a large portion of the mix next year. So just considering all those factors, how to think about gross margin going forward? Thanks.

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [25]

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Yes, hi, Charles. This is Ofer. So first in terms of the fourth quarter, so the -- what's happening with gross margin mostly has to do with the total level of revenues. So we also have, like, a portion of the gross margin that depends on the level of revenues. This is like the fixed portion. So when revenues are like declining or whenever it goes down, so the proportion of the fixed expenses is higher and margins are slightly lower. So this is mostly what's happening in Q4 because basically, our gross margins in the SmartVoice and in the Voice-over-IP and in what we call the new initiatives is higher than what you see in the cordless. So Q4, I would say mostly has to do with the lower revenues in the proportion of the fixed expenses. In 2019, I think that's what we've said in the past that, I think, our longer-term model, its gross margins should be, like, somewhere in the range of 50%. So I would say that this is also what we should see in '19. I would say something between 49% to 50% more or less where we are in the second half of this year.

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Operator [26]

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And our next question is Matt Ramsay from Cowen. Matt has disconnected out of the Q&A. So we now move on to Jaeson Schmidt from Lake Street Capital Bankers.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [27]

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Most of them have been answered, but just one to look at the cordless phone business with the pretty steep decline in Q4, do you expect a more muted seasonality in Q1 and relatedly with the cordless phone business, I believe declining about 21% based on the outlook for Q4 in 2018, which is sort of above that on a 10% to 20% annual decline that you guys have generally thought that business to be in. How should we think about 2019 and any changes on the annual decline within that business?

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Ofer Elyakim, DSP Group, Inc. - CEO & Director [28]

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Sure Jaeson, thanks for the questions. So with respect to quarterly sales you rightly mentioned, so this year, so fiscal 2018, we will most likely see cordless revenues declining by more than 20%. And when we started the year, we set 15% to 20% as the kind of the annual decline target. Some of it has to do with the phenomenon that we're experiencing kind of Q3, Q4, that has to do with this inventory readjustment. And I think that if you were to look at the cordless trends, so our revenue trends in cordless category, [it take it a couple] of year, how do you see that in years where we had inventory correction, we suffered declines that were well in excess of the market and in other years, especially where there was kind of a replenishment of inventory, we did see our cordless business performing better than market. Now, when we look into next year, we do believe that cordless will continue to be in secular decline. I don't think that we will see a change in '19. It's today kind of hard for us to really tell you what the decline will be. My best guess is that it will be in the same area that -- of what we said this year. But the most important part is that this will matter much less next year. Cordless will be about a third. The growth in the new products and the design wins that we have today secured are well in excess of that potential decline. So I think that as we move on for 2019 and 2020, the cordless decline will not be a major factor when building the financial model. It will be mostly driven by how well we execute and do on these new product initiatives, and this is kind of how we see ourselves positioned into 2019. So whether cordless next year will be down 15% or 20% or maybe above 20%, it will matter much less going into next year.

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Operator [29]

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It appears that there is no further questions at this time, Mr. Ofer, I'd like to turn the conference over to you for any closing or additional remarks.

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Daniel Louis Amir, DSP Group, Inc. - Corporate VP of Business Development, Strategy & IR [30]

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Yes, thanks. This is Daniel. So thanks for taking the time to dial into our Q3 earnings call either live or through the webcast. As I hope you can tell, we are very confident in the success and growth prospects of our growth initiatives. After several years, we have successfully achieved the inflection point whereby our growth initiatives are the vast majority of our sales and profit. We have successfully transitioned the company and are entering an exciting new chapter. We would like to thank our shareholders for their support during this transition and we look forward in providing an update in approximately 90 days. Thank you and have a great day.

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Operator [31]

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This concludes today's call. Thank you for your participation, you may now disconnect.