DSP Group Inc. Annual Report 2012

Plain-text annual report

Table of Contents SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934For the Fiscal Year Ended December 31, 2012Commission File Number 001-35256 DSP GROUP, INC.(Exact name of registrant as specified in its charter) Delaware 94-2683643(State or other jurisdiction ofincorporation and organization) (I.R.S. EmployerIdentification No.)2580 North First Street, Suite 460, San Jose, CA 95131(Address of principal executive offices, including zip code)(408) 986-4300(Registrant’s telephone number) Securities registered pursuant to Section 12(b) of the Act:NoneSecurities registered pursuant to Section 12(g) of the Act:Common Stock, $.001 per share(Title of class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No xIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No xIndicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x No ¨Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data Filerequired to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorterperiod that the registrant was required to submit and post such files). Yes x No ¨Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, tothe best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K. ¨Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer ¨ Accelerated filer xNon-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No xAs of June 30, 2012, the aggregate market value of voting stock held by non-affiliates of the Registrant, based on the closing price of the Common Stockon June 29, 2012 as reported on the NASDAQ Global Select Market, was approximately $88,042,762. Shares of Common Stock held by each officer anddirector and by each person who owns 5% or more of the outstanding Common Stock (other than Starboard Value LP and its affiliates) have been excludedfrom this computation in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determinationfor other purposes.As of March 4, 2013, the Registrant had outstanding 21,916,855 shares of Common Stock.Documents incorporated by reference: Portions of the Registrant’s proxy statement to be filed pursuant to Regulation 14A within 120 days afterRegistrant’s fiscal year end of December 31, 2012 are incorporated herein by reference into Item 5 of Part II and Items 10, 11, 12, 13 and 14 of Part III of thisannual report. Table of ContentsINDEXDSP GROUP, INC. Page No. PART I Item 1. BUSINESS 2 Item 1A. RISK FACTORS 11 Item 1B. UNRESOLVED STAFF COMMENTS 27 Item 2. PROPERTIES 27 Item 3. LEGAL PROCEEDINGS 27 Item 4. MINE SAFETY DISCLOSURES 27 PART II Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES 28 Item 6. SELECTED FINANCIAL DATA 31 Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 33 Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 51 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 52 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE 103 Item 9A. CONTROLS AND PROCEDURES 103 Item 9B. OTHER INFORMATION 103 PART III Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 104 Item 11. EXECUTIVE COMPENSATION 104 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATEDSTOCKHOLDER MATTERS 104 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 104 Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 104 PART IV Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 105 SIGNATURES 110 iTable of ContentsThis report and certain information incorporated herein by reference contain forward-looking statements, which are provided under the “safeharbor” protection of the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this report, otherthan statements that are purely historical in nature, are forward-looking statements. Forward-looking statements are generally written in the futuretense and/or are preceded by words such as “will,” “may,” “should,” “could,” “expect,” “suggest,” “believe,” “anticipate,” “intend,” “plan,” orother 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 2013; • 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 otherconnectivity, the traditional cordless telephony market using fixed-line telephony is declining and will continue to decline, which will reduceour revenues derived from, and unit sales of, cordless telephony products; • Our belief that the market will remain price sensitive for 2013 for our traditional cordless telephony products and expect that price erosionand the decrease in the average selling prices of such products to continue; • Our belief that our cost reduction programs implemented in 2012 will result in an additional decrease in operating expenses for 2013; • Our anticipation that annualized revenues generated from our next generation products to increase significantly in 2013 as compared to2012; • Our belief that commercial shipments of products incorporating our next generation products will continue during 2013; • Our focus remains on generating non-GAAP operating income for 2013; • Our anticipation that there will be a significant decrease in our operating expenses for 2013, as compared to 2012; • Our belief that our available cash and cash equivalents at December 31, 2012 should be sufficient to finance our operations for theforeseeable future; and • Market data prepared by third parties, including IDC.This Annual Report on Form 10-K includes trademarks and registered trademarks of DSP Group. Products or service names of othercompanies mentioned in this Annual Report on Form 10-K may be trademarks or registered trademarks of their respective owners.DSP Group, Inc. is referred to in this Annual Report as “DSP Group,” “we,” “us,” “our” or “company.” 1Table of ContentsPART I Item 1.BUSINESS.IntroductionDSP Group, Inc. (NASDAQ: DSPG) is a leading global provider of wireless chipset solutions for converged communications. Delivering semiconductorsystem solutions with software and reference designs, DSP Group enables original equipment manufacturers (OEMs), original design manufacturers(ODMs), consumer electronics (CE) manufacturers and service providers to cost-effectively develop new revenue-generating products with fast time to market.At the forefront of semiconductor innovation and operational excellence for over two decades, DSP Group provides a broad portfolio of wireless chipsetsintegrating DECT (Digital Enhanced Cordless Telecommunications)/CAT-iq (Cordless Advanced Technology—Internet and Quality), DECT ULE (UltraLow Energy), Wi-Fi, PSTN (Public Switched Telephone Network), HDClear™ (previously BoneTone™) intelligent voice enhancement, background noiseelimination and speech recognition accuracy enhancement, video and VoIP (Voice over Internet Protocol) technologies.DSP Group enables converged voice, audio, video and data connectivity across diverse consumer and business products, including connectedmultimedia terminals, mobile devices, home automation & security, cordless phones, VoIP systems and home gateways. Leveraging industry-leadingexperience and expertise, DSP Group partners with CE manufacturers and service providers to shape the future of converged communications at home andoffice.We were incorporated in California in 1987 and reincorporated in Delaware in 1994. We completed our initial public offering in February 1994.In November 2002, we transferred the assets and liabilities of our DSP cores licensing business to one of our then wholly-owned subsidiaries andimmediately after the separation, the subsidiary affected a combination with Parthus Technologies plc to form CEVA, Inc. (NASDAQ: CEVA).In September 2007, we acquired the cordless and VoIP terminals business (the “CIPT Business”) of NXP B.V. (“NXP”), then a part of NXP’s Mobileand Personal Business Unit. The CIPT Business products have been fully integrated within DSP Group’s product offerings.In December 2011, we exercised our option from 2009 to acquire all of the equity interests of BoneTone Communications Ltd. (“BoneTone”), a providerof innovative bone conduction technology for intelligent voice enhancement and noise elimination that redefine audio quality and voice intelligibility in mobiledevices and headsets, enabling us to enter new markets.Industry Environment and Our BusinessOver the past two decades, the desire to leverage existing telecommunications infrastructure, compounded by the increased use of new data-intensivecomputing, communication and video applications, is driving the convergence of voice, audio, data and video.Our focus on the design of highly-integrated, mixed-signal devices that combine complex RF (radio frequency), analog and digital functions enables usto address the complex challenges of integrating various technologies, platforms and processes posed by these emerging trends in the communications industry.Our integrated circuit (IC) products are customizable, achieve high functionality and performance at reduced power consumption, especially for cordlesstelephony, IP telephony, multimedia products and home automation devices that require very low power consumption, and can be manufactured in highvolumes using cost-effective process technologies. Our systems architecture provides an open design environment for ODMs to design and market their ownend products with maximum differentiation. 2Table of ContentsOur expertise and investment in software development, including Board Support Package (BSP) and drivers layer, telephony, communication andpower management stacks, application layer in Real-time Operating System (RTOS) and Full Featured Operating System (FFOS) frameworks, enable ourcustomers fast time to market with cost- and performance-optimized solutions.In response to the growing trend towards wireless residential and business connectivity in the past few years, we developed and are offering leadingwireless voice and data transmission solutions for various applications. Since 1999, we have developed various technologies, including Direct SequenceSpread Spectrum (DSSS), Frequency Hopping Spread Spectrum (FHSS), Orthogonal Frequency Digital Modulation (OFDM), Digital Narrow Band,Complementary Metal Oxide Semiconductor (CMOS), Gallium Arsenide (GaAs) technology, and Silicon Germanium (SiGe) RF chips for 900MHz, 2.4GHzand 5.8GHz Industry Scientific and Medical (ISM) bands, European DECT (1.9GHz), DECT 6.0 (1.8GHz), Korean DECT (1.7GHz), Bluetooth(2.4GHz) and Wi-Fi (802.11, 2.4GHz/5GHz). With the acquisition of the CIPT Business in 2007, we added both BiCMOS (Bipolar CMOS) and deep sub-micron CMOS technologies to our portfolio of technologies.Recently, we expanded into chips and phones for office and business applications, and have quickly gained market share in this growing segment.Today, DSP Group offers a comprehensive solution for voice-over-IP (VoIP) home and office products. VoIP is a technology that enables users to make voicecalls via a broadband Internet connection rather than an analog phone line.Committed to advancing technology across the CE and telecommunications markets, DSP Group is actively involved in prominent industryassociations, including the DECT Forum, the European Telecommunications Standards Institute and the Wi-Fi Alliance. DSP Group is also deeply involvedin all stages of defining DECT CAT-iq as well as DECT ULE standards and ULE Alliance and is building full eco-systems to support these solutions. Weare an active member of the Home Gateway Initiative (HGI), and support the specification activities of CableLabs, which is contributing to the evolution andimplementation of CAT-iq in various markets and applications. Such involvement enables us to define standards and keep abreast of the latest innovationsand requirements. We also maintain close relationships with many world-leading telecommunication service providers, thereby providing us with insight intofuture plans across the industry.Furthermore, with mobile devices playing an increasingly significant role in peoples’ lives, in February 2013, we unveiled our revolutionary HDClearsolution, a comprehensive voice enhancement product for mobile devices. According to a recent Reuters report, market research firm IDC estimates that 63percent of all mobile units will incorporate technology to eliminate background noise by 2015, or about 1.7 billion units, up from 500 million units in 2012.Incorporating proprietary noise cancellation algorithms, HDClear dramatically improves user experience and delivers unparalleled voice quality and callintelligibility. This technology will enable people to use their cell phones for conversation in virtually any condition, whether in a car, on a train or in anynoisy surroundings. HDClear will also facilitate the use of speech recognition and voice commands by eliminating background noise. Our HDClear productfamily was developed through the acquisition of BoneTone and the addition of their innovative intelligent voice enhancement.With our in-house innovations and acquired intellectual property, we are now able to bring additional value to our existing market verticals and addressnew market verticals, including markets for office phones, mobile devices and headsets, thus expanding our market opportunities.Target Markets and DSP Group ProductsOur work in the field of wireless residential and business technologies, as well as our prior acquisitions, have yielded various synergistic productfamilies. As further discussed below, the acquisition of the CIPT Business significantly enhanced our product portfolio, especially in the cordless telephonyand VoIP areas, whereas the acquisition of BoneTone enhanced our offerings in the cellular telephony, headsets and portable devices areas. 3Table of ContentsIn response to market trends, we are concentrating our development efforts on new products, also referred to as next generation products, andopportunities to leverage our strong technology base and customer relationships to address evolving market opportunities and take advantage of the currentmarket trends in our domain. Our next generation products include three main groups of products: (i) DECT/CAT-iq ICs targeted for residential gatewaydevices supplied by telecommunication service providers and which integrate the DECT/CAT-iq functionality and address the newly evolving market of smarthome phones and home automation applications; (ii) VoIP products for enterprise, home and SoHo; and (iii) products for the mobile market in the form offixed-mobile convergence solutions, headsets (Bluetooth, DECT, wired and gaming) and products targeted for mobile devices that incorporate our HDClearproduct family.Products Targeted for Cordless Telephony, Home Gateways and Home Automation MarketOur DECT, 2.4 GHz and 5.8 GHz technologies are targeted at three broad categories of products: (a) digital cordless telephony, (b) home automation &security applications and (c) gateways, both home gateways and fixed mobile convergence.We are a world-leading provider of chipsets for cordless telephony applications. Our XceedR cordless chipsets provide a total integrated digital cordlesssolution, home automation & security solution and home gateway solution, all of which include all required digital baseband, analog interface and RFfunctionality.XceedR enables worldwide coverage, supporting all RF bands and cordless protocols, such as:1.7GHz -1.9GHz DECT—used in Europe, U.S. (DECT6.0), Korea, Japan and Latin America;2.4GHz—used in Japan, China and the U.S.; the dominant protocols for this RF band is our proprietary EDCT (Enhanced Digital CordlessTechnology) and WDCT (Wireless Digital Cordless Technology) protocols; and5.8GHz—used in the U.S., Australia and several other countries with our proprietary EDCT cordless protocol.The XceedR chipset portfolio combines wireless communications technology with a range of telephony features, and audio and voice-processingalgorithms to provide the industry a low cost and small footprint solution. Enhanced with our hardware and software packages, XceedR chipsets are highlyversatile and enable the development of an array of cordless telephony solutions at a lower effort and faster time to market than alternative silicon offerings.The XceedR chipset portfolio supports cordless phones, cordless headsets, remote controls, home gateways, fixed-mobile convergence solutions and homecontrol, monitoring and automation devices.The XceedR chipset portfolio is comprised of two families—XceedR DCE and XceedR DCX.The XceedR DCE chipset family is a mature and field-proven family of integrated digital baseband processor RF chipsets. The chipset is used todevelop fully integrated cordless telephone systems, digital answering machines, digital voice recorders (DVRs), digital baby monitors, and other low-to-mid-range audio applications. Including the industry’s most advanced digital cordless solutions, the XceedR DCE family maintains multi-line, multi-handset anddigital answering machine capabilities, while supporting various RF protocols such as DECT (1.7GHz-1.9GHz), FHSS DECT 2.4GHz, EDCT 2.4GHz and5.8GHz. Integration of the TeakLite™ RISC DSP core into the DE56 and DCE58 baseband chip enables software implementation of a variety of voicecoders, and provides a flexible platform for developing a wide range of solutions. With its DSP-based architecture, the chipset enables cost-effectiveincorporation of the most advanced audio and telephony features.The XceedR DCX chipset family is the next step in flexibility and performance for digital cordless applications. Combining state-of-the-art RF andARM9 baseband functions in a single package with a rich set of telephony features and advanced audio-processing capabilities, the DCX provides the bestcost-performance 4Table of Contentssolution for mid-to-high-range DECT/DECT6.0/CAT-iq and WDCT cordless applications, home gateway applications and fixed mobile convergenceapplications.In 2012, we launched DCX81 SoC featuring advanced QSPI Flash architecture and 208MHz ARM926 core targeted solution for digital cordlesstelephony and cordless products.In 2012, we also taped-out DHX91, a DECT ULE SoC targeting home automation and security applications.Supporting all RF bands and comprised of Flash-based chips and a full set of ROM-based products with various memory configurations, the XceedRDCX chipset family offers a total integrated solution that includes a digital baseband controller, analog interface, RF transceiver and power amplifier.Products Targeted for Multimedia Connected ScreensTo capitalize on the increasing convergence of voice, data, audio and video, we offer the XpandR family of multimedia chipset solutions. XpandR is asystem-on-a-chip (SoC) solution based on dual-core and integrating application processors, Wi-Fi and DECT baseband and comprehensive multimediaperipherals, along with companion analog front-end and power management units as well as Wi-Fi and cordless RF chips, to enable the development ofalways-on, portable, connected multimedia products.The XpandR solution supports an array of telephony and non-telephony connected applications, including smart home phone, video/media phone, Wi-Fi VoIP phone, home automation and control center, security and video monitoring center, media/streaming set-top box, smart universal remote control, mobileInternet device, portable media player and Internet radio, based on open platform frameworks such as Android.In 2008 and 2009, we introduced XpandR-I and XpandR-II—the first and second members of the XpandR product family. The XpandR-II chipset hasbeen designed by several vendors into enhanced products such as Wi-Fi handsets, Internet radios and Android cordless multimedia phones.XpandR-III—In 2011, we taped-out XpandR-III, our third generation XpandR processor. XpandR-III is a state-of-the-art system-on-a-chip that featurestwo application processing cores, ARM Cortex A8 and ARM9, an advanced low-power media system that integrates smart acceleration engines for HD videodecode and encode, 2D/3D Graphics Processing Unit (GPU), as well as a dedicated security controller and Wi-Fi 802.11n that will complement a full offeringfor converged voice, data, audio and video processor. XpandR-III has a wide range of interfaces, including display up HD resolution and dual camera sensors.Target applications include smart home telephony, video telephony, home security, media/streaming set-top box and portable multimedia.Products Targeted for the VoIP MarketIn 2004, we developed an IP cordless phone that enables connectivity to a broadband line feeding VoIP with cordless phone capabilities.We continue to sell our current line of VoIP speech co-processors, which are DSP core-based, highly-integrated speech processors, targeted at the low tomedium density Integrated Access Device (IAD), residential gateway and VoIP telephony markets.In 2005, we developed an integrated CoIP (Communications over Internet Protocol) telephony system that supports both PSTN line and broadband forthe VoIP residential market, supporting Session Initiation Protocol together with advanced TR-069 protocol, thereby enabling telecommunication operators’remote control and remote upgrade of VoIP products.The acquisition of the CIPT Business enhanced our customer base for the VoIP market by adding major telecom brands to our customer base in Europeand Asia. 5Table of ContentsSince 2008, we have been selling products for the CoIP market while developing a new platform based on ARM9, the VegaFireBird and VegaOnesystem-on-a-chip (SoC) products, to the advanced IAD (Integrated Access Device) market.During 2010, we launched a new VoIP chipset based on the VegaFireBird SoC and our RF products combining ARM9 and VoIP processing basebandfunctions in a single package with a rich set of telephony features targeting Corded IP phones for home and office, Analog Terminal Adaptors and Cordless IPPhones. These products support multi line and multi HD voice channels, superior audio processing capabilities including acoustic echo cancellation andsuperior full duplex speakerphone technologies.In 2012, we taped-out a new VoIP SoC DVF99xx. Built with two ARM926EJ-S™ cores, this new VoIP SoC provides combined processing speed of 1.1GHz, and is designed to support IP phone processing needs—from basic single-line IP phones to high-end multi-line gigabit Ethernet IP phones with large colordisplay and advanced GUI. The DVF99 also integrates multiple hardware accelerators, including a hardware security engine which enables a new class ofsecure IP phones, an LCD controller, a 2D graphics engine, a high-speed USB 2.0 port, DDR3 memory and minimal power consumption during low-usageperiods. This product was designed to meet the needs of the enterprise IP telephony market.The XciteR family of chipsets is based on VegaFireBird SoC and provides embedded solutions for low-cost corded IP-phones to advanced cordless IP-phones with DECT handsets and headsets. Our VoIP chipset family is most suitable for office and enterprise IP telephony products as well as AnalogTelephone Adapters and some of the leading vendors have developed and are already developing their IP telephones and ATAs with our chipsets.Products Targeted for Mobile Phones, Fixed-Line Phones and Headsets (Bluetooth, DECT, Wired and Gaming)As a result of the acquisition of BoneTone, we enhanced our product portfolio with technology of intelligent voice enhancement and noise elimination.This technology supports two solutions: HDClear and HDMobileSurround™ which are offered as part of the XsoundR product line.HDClear-based solution offers mobile voice quality and intelligibility, while completely removing background noise. Delivering clearer voice calls madefrom noisy environments, HDClear also maximizes accuracy of Automatic Speech Recognition (ASR) applications in noisy environments by leveraging robustand powerful noise cancellation algorithms. HDClear more effectively isolates voice from ambient noise, thereby drastically lowering Word Error Rate (WER)and dramatically improves the user experience for speech-enabled applications like virtual assistants, voice search, and speech-to-text on mobile devices,tablets and other consumer devices.HDMobileSurround™ solution provides true 5.1 surround true sound on the go. As a result, users of tablets, smartphones and other mobile devices canenjoy either HD movies with a true sense of sound, or gaming with natural surround sound.XsoundR enables a new experience for mobile users. Our HDClear technology fully removes background noise for far-end users, while maintainingprivacy for near-end speakers. As such, our XsoundR mobile chipset offerings enable high voice quality and intelligibility for calls made in the noisiestenvironments. The solutions are anchored by the DBM family – DBMD11 (BTHD100) and DBMD12, mixed-signal DSP-based processor for voicecommunication applications. They also feature a superior background noise cancellation algorithm, on-chip ADC, and diverse digital interfaces for seamlessintegration into current dense mobile device systems. Offered in a low-power, small footprint package, XsoundR is the ultimate noise-cancellation chip solutionfor mobile phones, Bluetooth and DECT wireless headsets, wired headsets and fixed-line phones.In 2012, we taped-out a new DBMD2, one of the most efficient voice enhancement processors in the market, in our belief. It is measured just 3.0 x 3.0 x0.65mm. Offered with a 36-pin BGA and 0.4mm ball pitch, DBMD2 6Table of Contentsembeds a programmable 32-bit DSP, incorporates advanced connectivity options, including four TDM/I2S ports and SLIMbus, and equipped with acomprehensive software framework that enables rapid development and fast time-to-market, thereby overcoming the challenges of portable design, real estateand power consumption.DBMD2 enables mobile OEMs to offload voice and audio tasks from mobile device CPUs, in addition to running HDClear to enhance ASR accuracy.OEMs can leverage DBMD2’s open and flexible architecture to differentiate their products by utilizing the free DSP MIPS headroom and memory to run theirown or third party voice/audio enhancement software for pre- and post-processing.CustomersWe sell our products primarily through distributors and directly to OEMs and ODMs who incorporate our products into consumer products for theworldwide residential wireless communications market. In 2012, we continued expanding our customer base, and in some cases, increased our share ofbusiness with existing customers. Our customer list now includes additional major brand names and direct OEMs and ODMs worldwide. The majorconsumer electronics manufacturers and brands that have incorporated our ICs into their products include: Accton, AEG, Alcatel, AT&T, Audioline,Belgacom, Binatone, British Telecom, Brother, CCT Tech, Cetis, China Telecom, Cisco, Cybertan, Grandstream, Deutsche Telekom, Doro, FranceTelecom, Freebox, Giant, Gaoxinqi, Gemtek, Global China Technologies, Grandstream, Hagenuk, Huawei, Intelbras, JXE, Korea Telecom, KPN, LGElectronics, Matsushita, Motorola, Moimstone, NEC, NTT, OnReal, Ooma, Panasonic, Philips, Pioneer, Plantronics, Sagemcom, Samsung, Sanyo, SGW,Sharp, Siemens (Gigaset), SK Telecom, Sony, Spracht, Sumitomo, Swissvoice, Swisscom, TCL, Tecom, Telecom Italia, Telefonica, Telstra, Technicolor,Telefield (RCA), Topcom, Uniden, Unihan, Urmet, Turkcell, Verizon, VTech, WNC, Xingtel, Yamaha, Yealink and ZTE.International Sales and OperationsExport sales accounted for 99% of our total revenues for 2012, 2011 and 2010. Although most of our sales to foreign entities are denominated in UnitedStates dollars, we are subject to risks of conducting business internationally. These risks include unexpected changes in regulatory requirements, fluctuationsin exchange rates that could increase the price of our products in foreign markets, delays resulting from difficulty in obtaining export licenses for certaintechnology, tariffs, other barriers and restrictions and the burden of complying with a variety of foreign laws. See Note 16 of the attached Notes toConsolidated Financial Statements for the year ended December 31, 2012, for a summary of the geographic breakdown of our revenues and location of ourlong-lived assets.Moreover, a portion of our expenses in Israel is paid in the Israeli currency (New Israeli Shekel (NIS)), which subjects us to the risks of foreigncurrency fluctuations between the U.S. dollar and the NIS. Our primary expenses paid in NIS are employee salaries and lease payments on our Israelifacilities. As a result, an increase in the value of Israeli currency in comparison to the U.S. dollar could increase the cost of our technology development,research and development expenses and general and administrative expenses. From time to time, we use derivative instruments to minimize the effects ofcurrency fluctuations, but our hedging positions may be partial, may not exist at all in the future or may not succeed in minimizing our foreign currencyfluctuation risks.In addition, a portion of our expenses in Europe is paid in Euro, which subjects us to the risks of foreign currency fluctuations between the U.S. dollarand the Euro. Our primary expenses paid in Euro are employee salaries and lease and operational payments on our European facilities. As a result, an increasein the value of the Euro in comparison to the U.S. dollar also could increase the cost of our technology development, research and development expenses andgeneral and administrative expenses.Sales, Marketing and DistributionWe market and distribute our products through our direct sales and marketing offices, as well as through a network of distributors. Our sales andmarketing team, working out of our sales offices in Hong Kong, China; 7Table of ContentsNierenberg, Germany; San Jose, California; Tokyo, Japan; Herzelia Pituach, Israel and Edinburgh, Scotland, pursues business with our customers in Northand South America, Europe and Asia. In territories where we do not have sales offices, we operate solely through a network of distributors and representatives.Revenues derived from sales through our Japanese distributor, Tomen Electronics, represented 21% of our total revenues for 2012, 19% for 2011 and 25% for2010. We also derive a significant amount of revenues from a limited number of customers. Sales to VTech represented 35% of our total revenues for 2012,33% for 2011 and 31% for 2010. Sales to Panasonic through Tomen Electronics represented approximately 15%, 13% and 16% of our revenues for 2012,2011 and 2010, respectively. Sales to Uniden represented 11%, 10% and 9% of our total revenues for 2012, 2011 and 2010, respectively. Sales to CCTTelecom represented 8%, 11% and 10% of our total revenues for 2012, 2011 and 2010, respectively. The loss of any of our significant customers ordistributors could harm our business, financial condition and results of operations. In addition, our customers and distributors are not subject to minimumpurchase requirements and can cease making purchases of our products at any time.As our products are generally incorporated into consumer products sold by our OEM customers, our revenues are affected by seasonal buying patternsof consumer products sold by our OEM customers. 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 ourproducts in anticipation of the fourth quarter holiday season. However, the magnitude of this trend varies annually and is affected by macro-economic trends.Manufacturing and Design MethodologyWe contract product wafer fabrication services from TSMC, TriQuint and IBM. A majority of our integrated circuit products at this time aremanufactured by TSMC. We intend to continue to use independent foundries to manufacture our products. Our reliance on independent foundries involves anumber of risks, including the foundries’ ability to achieve acceptable manufacturing yields at competitive costs and their allocation of sufficient capacity tous to meet our needs. While we currently believe we have adequate capacity to support our current sales levels, we may encounter capacity issues in the future.In the event of a worldwide shortage in foundry capacity, we may not be able to obtain a sufficient allocation of foundry capacity to meet our product needs.Shortage or lack of capacity at the foundries we use to manufacture our products may lead to increased operating costs and lower gross margins. In addition,such a shortage could lengthen our products’ manufacturing cycle and cause a delay in the shipment of our products to our customers. Moreover, as TSMCproduces a significant portion of our wafer supply, earthquakes, aftershocks or other natural disasters in Asia could preclude us from obtaining an adequatesupply of wafers to fill customer orders. Unforeseen difficulties with our independent foundries could harm our business, financial condition and results ofoperations.As part of the acquisition of the CIPT Business, we entered into a Manufacturing Services Collaboration Agreement, as amended, with NXP pursuantto which NXP agreed to provide us with specified manufacturing, pre-testing, assembling and final-testing services relating to CIPT Business products. Theservices under the agreement are provided by NXP on a purchase order basis and will expire by December 31, 2014. The agreement sets forth specifiedcapacity guarantees by NXP, logistics for our provision of production schedules, penalties for late/non delivery by NXP for specified products, our purchaseobligations and various technical specifications for the manufacturing services. Products from the CIPT Business that are still manufactured by NXPcurrently do not represent a substantial portion of our total revenues. However, our business could be still harmed if NXP, or third parties NXP hascontracted, fails to achieve acceptable manufacturing yields, quality levels or allocate to us a sufficient portion of its foundry, and assembly and testingcapacities to meet our needs for the CIPT Business products.We use independent subcontractors located in Asia, to assemble and test certain of our products. We develop detailed testing procedures andspecifications for each product and require each subcontractor to use these procedures and specifications before shipping us the finished products. We testand/or assemble our products at ASE, ASEN, KYEC, SPIL and Giga Solutions. 8Table of ContentsFurthermore, our Digital Cordless products require an external component in the finished product, which is supplied by a third party, to provide flashmemory. Temporary fluctuations in the pricing and availability of this component could negatively impact sales of our Digital Cordless products, which couldin turn harm our business, financial condition and results of operations.CompetitionThe principal competitive factors in the cordless telephony market include price, performance, system integration level, range, voice quality, customersupport and the timing of product introductions by us and our competitors. We believe that we are competitive with respect to most of these factors. Ourprincipal competitors in the cordless market include Lantiq and Dialog Semiconductors, and we have also noted efforts by Beken, a Chinese supplier ofbasebands for analog cordless phones, to penetrate the DECT market.Similar principal competitive factors affect the VoIP market. We also believe that we are competitive with respect to most of these factors. Our principalcompetitors in the VoIP market include Broadcom, Dialog Semiconductors, Infineon, Texas Instruments and new Taiwanese IC vendors. Our principalcompetitors in the multimedia market include Wi-Fi and multimedia application processor IC vendors like Atheros, Broadcom, CSR, Freescale, Intel, Marvel,Ralink, Samsung and Texas Instruments.Similar principal competitive factors affect the Home Automation (DECT ULE) market. We also believe that we are competitive with respect to most ofthese factors. Our principal competitors are developers of different wireless home automation technologies, including Analog, Z-wave and Zigbee. Amongthose, the major competition in digital home automation is Zigbee and the principal competitors are Freescale, NXP, Texas Instruments and Silicon Lab.Similar principal competitive factors affect the mobile audio noise reduction market. An additional competitive factor relating to this market is that weare a newcomer to this market and this market already has a number of dominant, well-established companies with significant existing market shares.Nonetheless, we believe that we are competitive in this market with HDClear’s outstanding performance. Competitors in this market include Audience andCirrus Logic and developers of noise cancellation software running on mobile phones.Price competition in the markets in which we currently compete and propose to compete is intense and may increase, which could harm our business,financial condition and results of operations. We have experienced and will continue to experience increased competitive pricing pressures for our ICs. We wereable to partially offset price reductions which occurred during 2012 through manufacturing cost reductions, improvements in our yield percentages and byachieving a higher level of product integration. However, we cannot assure that we will be able to further reduce production costs, or be able to competesuccessfully with respect to price or any other key competitive factors in the future.In future periods, due to various new developments in the residential telephony and mobile markets, we intend to enter into new markets withcompetitors that have more established presence, and significantly greater financial, technical, manufacturing, marketing, sales and distribution resourcesthan we do.Furthermore, there is a growing threat from alternative technologies accelerating the decline of the fixed-line telephony market. This competition comesfrom mobile telephony, including emerging dual-mode mobile Wi Fi phones, and other innovative applications, such as Skype and iChat. Given that wederive a significant amount of revenues from chipsets incorporated into fixed-line telephony products, if we are unable to develop new technologies in the faceof the decline of this market, our business could be materially adversely affected. 9Table of ContentsResearch and DevelopmentWe believe that timely development and introduction of new products are essential to maintain our competitive position. We currently conduct most ofour product development at our facilities. At December 31, 2012, we had a staff of 190 research and development personnel, of which 142 were located inIsrael. We also employ independent contractors to assist with certain product development and testing activities. We spent approximately $42.5 million in2012, $53.2 million in 2011 and $55.6 million in 2010 on research and development activities.As noted above, due to various new developments in the home residential market, including the rapid deployment of new communication accessmethods and the rise of alternative technologies in lieu of fixed-line telephony, we are expanding our current product lines and develop products and servicestargeted at wider markets, including the intensively competitive mobile device market. We will need to continue to invest in research and development, and ourresearch and development expenses may increase in the future, including the addition of new research and development personnel, to keep pace with new andrapidly changing trends in our industry.Licenses, Patents and TrademarksAs of December 31, 2012, we have been granted a total of 168 patents and 98 patents are pending.We actively pursue foreign patent protection in countries of interest to us. Our policy is to apply for patents or for other appropriate statutory protectionwhen we develop valuable new or improved technology. The status of any patent involves complex legal and factual questions, and the breadth of claimsallowed is uncertain. Accordingly, we cannot assure that any patent application filed by us will result in a patent being issued, or that our patents, and anypatents that may be issued in the future, will afford adequate protection against competitors with similar technology; nor can we provide assurance that patentsissued to us will not be infringed or designed around by others. In addition, the laws of certain countries in which our products are or may be developed,manufactured or sold, including China, Hong Kong, Japan, Korea and Taiwan, may not protect our products and intellectual property rights to the sameextent as the laws of the United States.We attempt to protect our trade secrets and other proprietary information through agreements with our customers, suppliers, employees and consultants,and through other security measures. Although we intend to protect our rights vigorously, we cannot assure that these measures will be successful.The technology industry is subject to frequent litigation regarding patent and other intellectual property rights. While claims involving any materialpatent or other intellectual property rights have not been brought against us to date, we cannot provide assurance that third parties will not assert claims againstus or our customers with respect to existing or future products, or that we will not need to assert claims against third parties to protect our proprietarytechnology. In addition, patent infringement claims are increasingly being asserted by patent holding companies (so-called patent “trolls”), which do not usetechnology and whose sole business is to enforce patents against companies, such as us, for monetary gain. Because such patent holding companies do notprovide services or use technology, the assertion of our own patents by way of counter-claim may be ineffective. We have received claims that our productsinfringe upon the proprietary rights of such patent holding companies. In addition, third parties have asserted and may in the future assert intellectual propertyinfringement claims against our customers, which we have agreed in certain circumstances to indemnify and defend against such claims. If litigation becomesnecessary to determine the validity of any third party claims or to protect our proprietary technology, it could result in significant expense to us and coulddivert the efforts of our technical and management personnel, whether or not the claim has any merit and notwithstanding that the litigation is determined inour favor. In the event of an adverse result in any litigation, we could be required to expend significant resources to develop non-infringing technology or toobtain licenses to the technology that is the subject of the litigation. We cannot provide assurance that we would be successful in developing non-infringingtechnology or that any licenses would be available on commercially reasonable terms. 10Table of ContentsWe have trademark registration for the following marks in the United States: DSP Group, TRUESPEECH and XpandR. We also are in the process ofregistering the HDClear and HDMobileSurround marks in the United States.While our ability to compete may be affected by our ability to protect our intellectual property, we believe that because of the rapid pace of technologicalchange in our industry, our technical expertise and ability to innovate on a timely basis and in a cost-effective manner will be more important in maintainingour competitive position than the protection of our intellectual property. In addition, we believe that due to rapid technological changes in residential telephony,computer telephony and personal computer markets, patents and trade secret protection are important but must be supported by other factors, includingexpanding the knowledge, ability and experience of our personnel, new product introductions and frequent product enhancements. Although we continue toimplement protective measures and intend to defend our intellectual property rights vigorously, we cannot assure that these measures will be successful.BacklogAt December 31, 2012, our backlog was approximately $32.7 million, compared to approximately $36.7 million and $43.8 million at December 31,2011 and 2010, respectively. We include in our backlog all accepted product purchase orders with respect to which a delivery schedule has been specified forproduct shipment within one year. Our business is characterized by short-term order and shipment schedules. Product orders in our current backlog aresubject to change, sometimes on short notice, due to changes in delivery schedules or cancellation by a purchaser. Accordingly, although useful for schedulingproduction, backlog as of any particular date may not be a reliable measure of our sales for any future period.EmployeesAt December 31, 2012, we had 317 employees, including 186 in research and development, 60 in marketing and sales and 71 in corporate,administration and manufacturing coordination. Competition for personnel in the semiconductor industry in general is intense. We believe that our futureprospects will depend, in part, on our ability to continue to attract and retain highly-skilled technical, marketing and management personnel, who are indemand. In particular, there is a limited supply of RF chip designers and highly-qualified engineers with digital signal processing experience. We believe thatour relations with our employees are good.Web Site Access to Company’s ReportsOur Internet Web Site address is www.dspg.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, andamendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge through our Web site as soonas reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. We will also provide the reports inelectronic or paper form free of charge upon request.Our website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K. Item 1A.RISK FACTORS.The following risk factors, among others, could in the future affect our actual results of operations and could cause our actual results to differmaterially from those expressed in forward-looking statements made by us. These forward-looking statements are based on current expectations andwe assume no obligation to update this information. Before you decide to buy, hold, or sell our common stock, you should carefully consider the risksdescribed below, in addition to the other information contained elsewhere in this report. The following risk factors are not the only risk factors facingour company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. Ourbusiness, financial condition, and results of operation could be seriously harmed if any of the events underlying any of these risks or uncertaintiesactually occurs. In that event, the market price for our common stock could decline, and you may lose all or part of your investment. 11Table of ContentsWe generate a significant amount of our total revenues from the sale of digital cordless telephony products and our business and operatingresults may be materially adversely affected if we do not continue to succeed in this highly competitive market or if sales within the overall cordlessdigital market decreases.Sales of our digital cordless telephony products comprised a significant majority of our total revenues for 2012. Specifically, sales of our DECT,2.4GHz, and CoIP products comprised 94% of our total revenues for 2012, 2011 and 2010. Revenues from our DECT products represented 82% of our totalrevenues 2012, 82% of our total revenues 2011 and 78% for 2010. Revenues from our 2.4 GHz products represented 7% of our total revenues for 2012, 9%for 2011 and 13% for 2010.Any adverse change in the digital cordless market or in our ability to compete and maintain our competitive position in that market would harm ourbusiness, financial condition and results of operations. The digital cordless telephony market is extremely competitive and is facing intense pricing pressures,and we expect that competition and pricing pressures may increase. Our existing and potential competitors in this market include large and emerging domesticand foreign companies, many of whom have significantly greater financial, technical, manufacturing, marketing, sales and distribution resources andmanagement expertise than we do. It is possible that we may one day be unable to respond to increased pricing competition for digital cordless telephonyprocessors or other products through the introduction of new products or reduction of manufacturing costs. This inability to compete would have a materialadverse effect on our business, financial condition and results of operations. Likewise, any significant delays by us in developing, manufacturing or shippingnew or enhanced products in this market also would have a material adverse effect on our business, financial condition and results of operations.In addition, to general market competitiveness, the digital cordless telephony market is undergoing a challenging period of transition. With the rapiddeployment of new communication access methods, including mobile, wireless broadband, cable and other connectivity, the traditional cordless telephonymarket using fixed-line telephony is declining and will continue to decline, which reduces our revenues derived from, and unit sales of, cordless telephonyproducts. Macro-economic trends in the consumer electronics industry may adversely impact our future revenues.Furthermore, the decline in fixed line telephony together with the rapid deployment of new communication access methods, including mobile, wirelessbroadband, cable and other connectivity will decrease sales of products using fixed-line telephony. Our business also may be affected by the outcome of thecompetition between cellular phone operators and fixed-line operators for the provision of residential communication. A significant majority of our revenues arecurrently generated from sales of chipsets used in cordless phones that are based on fixed-line telephony, and the continued decline in fixed-line telephonywould reduce our revenues derived from, and unit sales of, our digital cordless telephony products.We rely significantly on revenue derived from a limited number of customers.We expect that a limited number of customers, varying in identity from period-to-period, will account for a substantial portion of our revenues in anyperiod. Our four largest customers—VTech, Panasonic, Uniden and CCT Telecom accounted for approximately 68% of our total revenues for 2012, 67% for2011 and 66% for 2010. Sales to VTech represented 35% of our total revenues for 2012, 33% for 2011 and 31% for 2010. Sales to Panasonic through ourdistributor represented 15% of our total revenues for 2012, 13% for 2011, and 16% for 2010. Sales to Uniden represented 11% of our total revenues for 2012,10% for 2011 and 9% for 2010. Sales to CCT Telecom represented 8% of our total revenues for 2012, 11% for 2011 and 10% for 2010. Typically, our salesare made on a purchase order basis, and none of our customers has entered into a long-term agreement requiring it to purchase our products. Moreover, we donot typically require our customers to purchase a minimum quantity of our products, and our customers can generally cancel or significantly reduce theirorders on short notice without significant penalties. A significant amount of our revenues will continue to be derived from a limited number of large customers.Furthermore, the primary customers for our products are original equipment manufacturers (OEMs) and original design manufacturers (ODMs) in thecordless digital market. This industry is 12Table of Contentshighly cyclical and has been subject to significant economic downturns at various times, particularly in recent periods. These downturns are characterized byproduction overcapacity and reduced revenues, which at times may affect the financial stability of our customers. Therefore, the loss of one of our majorcustomers, or reduced demand for products from, or the reduction in purchasing capability of, one of our major customers, could have a material adverseeffect on our business, financial condition and results of operations.Our future success is dependent on market acceptance of our HDClear product family targeted for the mobile device market, which is anintensively competitive market with dominant and established players.Our ability to increase our revenues and offset declining revenues from our cordless product family are substantially dependent on our ability to gainmarket share for our HDClear product family, a comprehensive voice enhancement and noise cancellation product targeted for mobile devices. Although anumber of potential customers have expressed interest, we do not currently have any design wins for this product family, which is the initial step toincorporating OEM design wins, and we cannot assure that we will be successful in doing so. Even if we achieve design wins, the design-in process is laborintensive, long and often delayed. Therefore, the period from design-in to revenue generation may be long, and during the interim period, we would beexpending significant time and resources through our sales and development cycles, potentially without achieving any economic return. Moreover, we aretargeting a new market with our HDClear product family, a market with dominant and established players selling to OEM customers with whom they haveestablished relationships. We will need to win over such customers, with whom we do not have established relationships, to gain market share. If we areunable to generate revenues from our HDClear product family and gain significant market share in the mobile device market, our operating results would beadversely affected.The market for mobile device components is highly competitive and we expect competition to intensify in the future.The market for mobile device components is highly competitive and characterized by the presence of large companies with significantly greater resourcesthan we have. Our HDClear product family relates only to the voice and audio subsystem of a mobile device and there are only a limited number of OEMstargeted for this market. Our competitors include Audience and Cirrus Logic. We also face competition from smaller, privately held companies and could facecompetition from new market entrants. We also compete against solutions internally developed by OEMs, as well as combined third-party software andhardware systems. If we are unable to compete effectively, we may not succeed in achieving design wins and may have to lower our pricing to gain designwins, both of which would adversely impact our operating results.Because our products are components of end products, if OEMs do not incorporate our products into their end products or if the end products ofour OEM customers do not achieve market acceptance, we may not be able to generate adequate sales of our products.Our products are not sold directly to the end-user; rather, they are components of end products. As a result, we rely upon OEMs to incorporate ourproducts into their end products at the design stage. Once an OEM designs a competitor’s product into its end product, it becomes significantly more difficultfor us to sell our products to that customer because changing suppliers involves significant cost, time, effort and risk for the customer. As a result, we mayincur significant expenditures on the development of a new product without any assurance that an OEM will select our product for design into its own productand without this “design win” it becomes significantly difficult to sell our products. This is especially the case for our HDClear product family. Moreover,even after an OEM agrees to design our products into its end products, the design cycle is long and may be delayed due to factors beyond our control whichmay result in the end product incorporating our products not to reach the market until long after the initial “design win” with the OEM. From initial productdesign-in to volume production, many factors could impact the timing and/or amount of sales actually realized from the design-in. These factors include, butare not limited to, changes in the competitive position of our technology, our customers’ financial stability, and our ability to ship products according to ourcustomers’ schedule. Moreover, the continued uncertainty about the sustainability of the global economic recovery and outlook may further prolong an OEMcustomer’s decision-making process and design cycle. 13Table of ContentsFurthermore, we rely on the end products of our OEM customers that incorporate our products to achieve market acceptance. Many of our OEMcustomers face intense competition in their markets. If end products that incorporate our products are not accepted in the marketplace, we may not achieveadequate sales volume of our products, which would have a negative effect on our results of operations.We rely on a primary distributor for a significant portion of our total revenues and the failure of this distributor to perform as expected wouldmaterially reduce our future sales and revenues.In addition to direct sales, we use a network of distributors to sell our products. Particularly, revenues derived from sales through our Japanesedistributor, Tomen Electronics, accounted for 21% of our total revenues for 2012, 19% for 2011 and 25% for 2010. Our future performance will depend, inpart, on this distributor to continue to successfully market and sell our products. Furthermore, Tomen Electronics sells our products to a limited number ofcustomers. One customer, Panasonic, has continually accounted for a majority of the sales through Tomen Electronics. Sales to Panasonic through TomenElectronics generated approximately 15% of our total revenues for 2012, 13% for 2011 and 16% for 2010. The loss of Tomen Electronics as our distributorand our inability to obtain a satisfactory replacement in a timely manner would materially harm our sales and results of operations. Additionally, the loss ofPanasonic and Tomen Electronics’ inability to thereafter effectively market our products would also materially harm our sales.Because our quarterly operating results may fluctuate significantly, the price of our common stock may decline.Our quarterly results of operations may vary significantly in the future for a variety of reasons, many of which are outside our control, including thefollowing: • fluctuations in volume and timing of product orders; • timing, rescheduling or cancellation of significant customer orders and our ability, as well as the ability of our customers, to manage inventory; • changes in demand for our products due to seasonal consumer buying patterns and other factors; • timing of new product introductions by us and by our customers or competitors; • changes in the mix of products sold by us or our competitors; • fluctuations in the level of sales by our OEM customers and other vendors of end products incorporating our products; • timing and size of expenses, including expenses to develop new products and product improvements, and expenses resulting from restructuringactivities; • entry into new markets, including China, Korea and South America; • our ability to scale our operations in response to changes in demand for our existing products and services or demand for new products requestedby our customers; • mergers and acquisitions by us, our competitors and our existing and potential customers; and • general economic conditions, including current economic conditions in the United States and worldwide, and the adverse effects on thesemiconductor and consumer electronics industries.Each of the above factors is difficult to forecast and could harm our business, financial condition and results of operations. Also, we sell our productsto OEM customers that operate in consumer markets. As a result, our revenues are affected by seasonal buying patterns of consumer products sold by ourOEM customers that incorporate our products and the market acceptance of such products supplied by our OEM customers. The fourth quarter in any givenyear is usually the strongest quarter for sales by our OEM customers in the consumer markets, and thus, our third quarter in any given year is usually thestrongest quarter for revenues as our OEM 14Table of Contentscustomers request increased shipments of our products in anticipation of the increased activity in the fourth quarter. By contrast, the first quarter in any givenyear is usually the weakest quarter for us. However, the magnitude of this trend varies annually and is affected by macro-economic trends. For example, dueto the slowdown in demand for consumer electronics products in 2012, particularly cordless telephony products, our revenues for 2012 were weaker than2011.Our revenues, gross margins and profitability may be materially adversely affected by the continued decline in average selling prices of ourproducts and other factors, including increases in assembly and testing expenses, and raw material and commodity costs.We have experienced and will continue to experience a decrease in the average selling prices of our products. Decreasing average selling prices could resultin decreased revenues even if the volume of products sold increases. Decreasing average selling prices may also require us to sell our products at much lowergross margin than in the past and reduce profitability. Although we have to date been able to partially offset on an annual basis the declining average sellingprices of our products through general operational efficiencies and manufacturing cost reductions by achieving a higher level of product integration andimproving our yield percentages, there is no guarantee that our ongoing efforts will be successful or that they will keep pace with the anticipated, continueddecline in average selling prices of our products.Moreover, we believe there are significant pressures in the supply chain as a result principally of the uncertainty relating to the sustainability of theglobal economic recovery, which has negatively affected the consumer electronics industry. The pressures in the supply chain make it very difficult for us toincrease or even maintain our product pricing, which could further adversely affects our gross margins.In addition to the continued decline in the average selling prices of our products, our gross profit may decrease in the future due to other factors,including the roll-out of new products in any given period and the penetration of new markets which may require us to sell products at a lower margin, ourfailure to introduce new engineering processes and mix of products sold.Our gross margins also are affected by the product mix. For example, DECT products have lower average gross margins than other products, such asour 2.4GHz products. The DECT product line represented 82% of our total revenues for 2012. Therefore, increased sales of our DECT products could lowerour gross margins.Furthermore, increases in the price of silicon wafers, testing costs and commodities such as gold and oil, which may result in increased productioncosts, mainly assembly and packaging costs, may result in a decrease in our gross margins. Moreover, our suppliers may pass the increase in raw materialsand commodity costs which could further reduce the gross margin of our products. In addition, as we are a fabless company, global market trends such as“over-capacity” problems so that there is a shortage of capacity to fulfill our fabrication needs also may increase our raw material costs and thus decrease ourgross margin.There are several emerging market trends that may challenge our ability to continue to grow our business.New technological developments in the home connectivity market may adversely affect our operating results. For example, the rapid deployment of newcommunication access methods, including mobile, wireless broadband, cable and other connectivity, as well as the lack of growth in products using fixed-linetelephony would reduce our total revenues derived from, and unit sales of, cordless fixed-line telephony products. Our ability to maintain our growth willdepend on the expansion of our product lines to capitalize on the emerging access methods and on our success in developing and selling a portfolio of “system-on-a-chip” solutions targeted at wider markets, including the intensively competitive mobile devices market. We cannot assure that we will succeed inexpanding our product lines or portfolio of “system-on-a-chip” solutions, or that they would receive market acceptance. 15Table of ContentsFurthermore, there is a growing threat from alternative technologies accelerating the decline of the fixed-line telephony market. This competition comesfrom mobile telephony, including emerging dual-mode mobile Wi Fi phones and other innovative applications, such as Skype and iChat. Given that we derivea significant amount of revenues from chipsets incorporated into fixed-line telephony products, if we are unable to develop new technologies in the face of thedecline of this market, our business could be materially adversely affected.Our future business growth depends on the growth in demand for mobile devices with improved sound quality.Our HDClear product family is designed to enhance the sound quality and eliminate background voices for mobile device users. OEMs and ODMs maydecide that the costs of improving sound quality outweigh the benefits which could limit demand for our HDClear product family. Moreover, users may alsobe satisfied with existing sound quality or blame poor quality on their phone carriers. The market that we are targeting is evolving rapidly and istechnologically challenging. New mobile devices with different components or software may be introduced that provide the same functionality as HDClearproduct family. Alternatively, wireless network technology may be improved to serve the same functionality. Our future business growth will depend on thegrowth of this market and our ability to adapt to technological changes, user preferences and OEM demands. Our business could be materially adverselyaffected if we fail to do so.Because we have significant international operations, we may be subject to political, economic and other conditions relating to our internationaloperations that could increase our operating expenses and disrupt our business.Although the majority of end users of the consumer products that incorporate our products are located in the U.S., we are dependent on sales to OEMcustomers, located outside of the U.S., that manufacture these consumer products. Also, we depend on a network of distributors to sell our products that alsoare primarily located outside of the U.S. Export sales, primarily consisting of digital cordless telephony products shipped to manufacturers in Europe andAsia, including Japan and Asia Pacific, represented 99% of our total revenues for 2012, 2011 and 2010. Furthermore, pursuant to the acquisition of the CIPTBusiness from NXP, we established new foreign subsidiaries, and currently have material operations in Germany, Hong Kong and India and employ anumber of individuals within those foreign operations. As a result, the occurrence of any negative international political, economic or geographic events, aswell as our failure to mitigate the challenges in managing an organization operating in various countries, could result in significant revenue shortfalls anddisrupt our workforce within our foreign operations. These shortfalls and disruptions could cause our business, financial condition and results of operationsto be harmed. Some of the risks of doing business internationally include: • unexpected changes in foreign government regulatory requirements; • fluctuations in the exchange rate for the United States dollar; • import and export license requirements; • imposition of tariffs and other barriers and restrictions; • burdens of complying with a variety of foreign laws, treaties and technical standards; • uncertainty of laws and enforcement in certain countries relating to the protection of intellectual property; • difficulty in collecting accounts receivable and longer payment cycles for international customers than existing customers; • difficulty in staffing and managing foreign operations and maintaining the morale and productivity of employees within foreign operations; • multiple and possibly overlapping tax structures and potentially adverse tax consequences; • political and economic instability; and • changes in diplomatic and trade relationships. 16Table of ContentsOne or more of these factors may have a material adverse effect on our future operations and consequently, on our business, financial conditions andoperating results.In order to sustain the future growth of our business, we must penetrate new markets and our new products must achieve widespread marketacceptance.In order to increase our sales volume and expand our business, we must penetrate new markets and introduce new products, especially our HDClearproduct family. We are exploring opportunities to expand sales of our products in China, Japan, Korea and South America. However, there are no assurancesthat we will gain significant market share in those competitive markets. In addition, due to the cyclical nature of manufacturing capacity issues, the increasingcost of silicon integrated circuits, the continued decline of average selling prices of chipsets and other industry-wide factors, many North American, Europeanand Japanese OEMs are moving their manufacturing sites to Asia. This trend may cause the mix of our OEM customers to change in the future, therebyfurther necessitating our need to penetrate new markets. Furthermore, to sustain the future growth of our business, we need to introduce new products as salesof our older products taper off. Moreover, the penetration of new competitive markets and introduction of new products could require us to reduce the saleprices of our products or increase the cost per product and thus reducing our total gross profit in future periods. Our future growth is dependent on marketacceptance and penetration of our new products, especially our HDClear product family, for which we can provide no assurances. Our revenue growth is alsodependent on the successful deployment of our new VoIP products. Our inability to penetrate the market or lack of customer acceptance of these products mayharm our business and potential growth.Because the markets in which we compete are subject to rapid changes, our products may become obsolete or unmarketable.The markets for our products and services are characterized by rapidly changing technology, short product life cycles, evolving industry standards,changes in customer needs, demand for higher levels of integration, growing competition and new product introductions. This is especially the case for themobile device market. Our future growth is dependent not only on the continued success of our existing products but also successful introduction of newproducts. Our ability to adapt to changing technology and anticipate future standards, and the rate of adoption and acceptance of those standards, will be asignificant factor in maintaining or improving our competitive position and prospects for growth. If new industry standards emerge, our products or ourcustomers’ products could become unmarketable or obsolete, and we could lose market share. We may also have to incur substantial unanticipated costs tocomply with these new standards. If our product development and improvements take longer than planned, the availability of our products would be delayed.Any such delay may render our products obsolete or unmarketable, which would have a negative impact on our ability to sell our products and our results ofoperations.Because of changing customer requirements and emerging industry standards, we may not be able to achieve broad market acceptance of our products.Our success is dependent, in part, on our ability to: • successfully develop, introduce and market new and enhanced products at competitive prices and in a timely manner in order to meet changingcustomer needs; • convince leading OEMs to select our new and enhanced products for design into their own new products; • respond effectively to new technological changes or new product announcements by others; • effectively use and offer leading technologies; and • maintain close working relationships with our key customers.There are no assurances that we will be successful in these pursuits, that the demand for our products will continue or that our products will achievemarket acceptance. Our failure to develop and introduce new products 17Table of Contentsthat are compatible with industry standards and that satisfy customer requirements, and the failure of our products to achieve broad market acceptance, couldhave a negative impact on our ability to sell our products and our results of operations.Because we depend on independent foundries and other third party suppliers to manufacture and test all of our integrated circuit products, weare subject to additional risks that may materially disrupt our business.All of our integrated circuit products are manufactured and tested by independent foundries and other third party suppliers. While these foundries andother third party suppliers have been able to adequately meet the demands of our increasing business, we are and will continue to be dependent upon thesefoundries and third party suppliers to achieve acceptable manufacturing yields, quality levels and costs, and to allocate to us a sufficient portion of theirfoundry, assembly and test capacity to meet our needs in a timely manner.While we currently believe we have adequate capacity to support our current sales levels pursuant to our arrangement with our foundries and other thirdparty suppliers, we may encounter capacity shortage issues in the future. In the event of a worldwide shortage in foundry, assembly and/or test capacity, wemay not be able to obtain a sufficient allocation of such capacity to meet our product needs or we may incur additional costs to ensure specified quantities ofproducts and services. Over-capacity at the current foundries and other third party suppliers we use, or future foundries or other third party suppliers we mayuse, to manufacture and test our integrated circuit products may lead to increased operating costs and lower gross margins. In addition, such a shortage couldlengthen our products’ manufacturing and testing cycle and cause a delay in the shipment of our products to our customers. This could ultimately lead to aloss of sales of our products, harm our reputation and competitive position, and our revenues could be materially reduced. Our business could also be harmedif our current foundries or other third party suppliers terminate their relationship with us and we are unable to obtain satisfactory replacements to fulfillcustomer orders on a timely basis and in a cost-effective manner. Moreover, we do not have long term capacity guarantee agreements with our foundries andwith other third party suppliers.In addition, as TSMC produces a significant portion of our integrated circuit products and ASE tests and assembles a significant portion of them,earthquakes, aftershocks or other natural disasters in Asia, or adverse changes in the political situation in Taiwan, could preclude us from obtaining anadequate supply of wafers to fill customer orders. Such events could harm our reputation, business, financial condition, and results of operations.Because NXP still manufactures certain of the CIPT Business products, we are subject to additional risks that may materially disrupt ourbusiness.As part of the Acquisition of the CIPT Business, we entered into a Manufacturing Services Collaboration Agreement (“MSCA”), as amended, withNXP pursuant to which NXP agreed to provide us with specified manufacturing, pre-testing, assembling and final-testing services relating to the CIPTBusiness products. The services under the MSCA were to be provided by NXP at agreed upon prices initially for up to seven years following the closing of theacquisition and will expire by the end of 2014. Our business could be harmed if NXP, or third parties NXP has contracted, fails to achieve acceptablemanufacturing yields, quality levels or allocate to us a sufficient portion of its foundry, and assembly and testing capacities to meet our needs for the CIPTBusiness products.Our operating results are affected by general economic conditions and the highly cyclical nature of the semiconductor industry.During the global downturn that started in the second half of 2008 and continued throughout 2009, general worldwide economic conditions significantlydeteriorated. This downturn resulted in decreased consumer confidence and spending, reduced corporate profits and capital spending, adverse businessconditions and liquidity concerns among business. Notwithstanding improvements in business conditions since the second half of 2009, sustainability of theglobal economic recovery is uncertain, which continues to make it difficult for our customers, the end-product customers, our vendors and us to accuratelyforecast and plan future business activities and make reliable projections. 18Table of ContentsMoreover, we operate within the semiconductor industry which experiences significant fluctuations in sales and profitability. The industry wasmaterially adversely affected by the 2008-2009 global downturn. Downturns in the semiconductor industry are characterized by diminished product demand,excess customer inventories, accelerated erosion of prices and excess production capacity. These factors could cause substantial fluctuations in our revenuesand in our results of operations.If global economic and market conditions remain uncertain or deteriorate, we could experience a material adverse impact on our business and results ofoperations.Because the manufacturing of our products is complex, the foundries on which we depend may not achieve the necessary yields or productreliability that our business requires.The manufacturing of our products is a highly complex and precise process, requiring production in a highly controlled environment. Changes inmanufacturing processes or the inadvertent use of defective or contaminated materials by a foundry could adversely affect the foundry’s ability to achieveacceptable manufacturing yields and product reliability. If the foundries we currently use do not achieve the necessary yields or product reliability, our abilityto fulfill our customers’ needs could suffer. This could ultimately lead to a loss of sales of our products and have a negative effect on our gross margins andresults of operations.Furthermore, there are other significant risks associated with relying on these third-party foundries, including: • risks due to the fact that we have reduced control over production cost, delivery schedules and product quality; • less recourse if problems occur as the warranties on wafers or products supplied to us are limited; and • increased exposure to potential misappropriation of our intellectual property.As we depend on independent subcontractors, located in Asia, to assemble and test our semiconductor products, we are subject to additional risksthat may materially disrupt our business.Independent subcontractors, located in Asia, assemble and test our semiconductor products. Because we rely on independent subcontractors to performthese services, we cannot directly control our product delivery schedules or quality levels. We are dependent on these subcontractors to allocate to us asufficient portion of their capacity to meet our needs in a timely manner. Our future success also depends on the financial viability of our independentsubcontractors. If the capital structures of our independent subcontractors weaken, we may experience product shortages, production delays, qualityassurance problems, increased manufacturing costs, and/or supply chain disruption. All of this could ultimately lead to a loss of sales of our products, harmour reputation and competitive position, and our revenues could be materially harmed.Moreover, the economic, market, social, and political situations in countries where some of our independent subcontractors are located areunpredictable, can be volatile, and can have a significant impact on our business because we may not be able to obtain product in a timely manner. Marketand political conditions, including currency fluctuation, terrorism, political strife, war, labor disruption, and other factors, including natural or man-madedisasters, adverse changes in tax laws, tariff, import or export quotas, power and water shortages, or interruption in air transportation, in areas where ourindependent subcontractors are located also could have a severe negative impact on our operating capabilities.We are subject to order and shipment uncertainties and if we are unable to accurately predict customer demand, our business may be harmed.We typically sell products pursuant to purchase orders rather than long-term purchase commitments. Customers can generally cancel, change or deferpurchase orders on short notice without incurring a significant penalty. Given current market conditions, we have less ability to accurately predict what orhow many products our customers will need in the future. In addition, we have little visibility into and no control of the demand byour customer’s customers – generally consumer electronics retailers. Furthermore, based on discussions with our 19Table of Contentscustomers, we understand that our customers also have less visibility into their product demands. A decrease in the consumer electronics retailers’ demand ora build-up of their inventory, both of which are out of the control of our customers and us, may cause a cancellation, change or deferral of purchase orders onshort notice by our customers. Anticipating demand is difficult because our customers and their customers face volatile pricing and unpredictable demand fortheir own products, and are increasingly focused on cash preservation and tighter inventory management. Based on these trends, our customers are reluctant toplace orders with normal lead times, and we are seeing a shift to shorter lead-times and rush orders. However, we place orders with our suppliers based onforecasts of our customers’ demand and, in some instances, may establish buffer inventories to accommodate anticipated demand. Our forecasts are based onmultiple assumptions, each of which may introduce error into our estimates. If we overestimate our customers’ demand or our customers overestimate theirdemand, we may allocate resources to manufacturing products that we may not be able to sell when we expect to, if at all. As a result, we could hold excess orobsolete inventory, which would reduce our profit margins and adversely affect our financial results. Conversely, if we underestimate our customers’ demandor our customers underestimate their demand and insufficient manufacturing capacity is available, we could forego revenue opportunities and potentially losemarket share and damage our customer relationships.As a result of the acquisition of the CIPT business, we now maintain inventory, or hubbing, arrangements with certain of our customers. Pursuant tothese arrangements, we deliver products to a customer or a designated third party warehouse based upon the customer’s projected needs, but do not recognizeproduct revenue unless and until the customer reports that it has removed our product from the warehouse to incorporate into its end products. Since we owninventory that is physically located in a third party’s warehouse, our ability to effectively manage inventory levels may be impaired, causing our totalinventory turns to decrease, which could increase expenses associated with excess and obsolete product and negatively impact our cash flow.We are dependent on a small number of OEM customers, and our business could be harmed by the loss of any of these customers or reductionsin their purchasing volumes.We sell our products to a limited number of OEM customers directly or through a network of distributors. Moreover, many North American, Europeanand Japanese OEMs are moving their manufacturing sites to Asia, as a result of the cyclical nature of manufacturing capacity issues and cost of siliconintegrated circuits, the continued decline of average selling prices of chipsets and other industry-wide factors. In addition, OEMs located in Asia are growingand gaining competitive strength. As a result, the mix of our OEM customers may change in the future. However, we may not succeed in attracting newcustomers as these potential customers may have pre-existing relationships with our current or potential competitors. This trend also may promote theconsolidation of OEMs located in North America, Europe and Japan with OEMs located in Asia, which may reduce the number of our potential customersand reduce the volume of chipsets the combined OEM customer may purchase from us. However, as is common in our industry, we typically do not enter intolong term contracts with our customers in which they commit to purchase products from us. The loss of any of our OEM customers may have a materialadverse effect on our results of operations. To attract new customers, we may be faced with intense price competition, which may affect our revenues andgross margins.The possible emerging trend of our OEM customers outsourcing their production may cause our revenue to decline.We believe there may be an emerging trend of our OEM customers outsourcing their production to third parties. We have invested substantial resourcesto build relationships with our OEM customers. However the outsourcing companies whom our OEM customers may choose to outsource production may nothave prior business relationship with us or may instead have prior or ongoing relationships with our competitors. The emergence of this trend may require usto expend substantial additional resources to build relationships with these outsourcing companies, which would increase our operating expenses. Even if wedo expend such resources, there are no assurances that these outsourcing companies will choose to incorporate our chipsets rather than our competitors’. Ourinability to retain an OEM customer once such customer chooses to outsource production could have a material adverse effect on our future revenue. 20Table of ContentsThird party claims of infringement or other claims against us could adversely affect our ability to market our products, require us to redesign ourproducts or seek licenses from third parties, and seriously harm our operating results and disrupt our business.As is typical in the semiconductor industry, we and our customers have been and may from time to time be notified of claims that we may be infringingpatents or intellectual property rights owned by third parties. In addition, patent infringement claims are increasingly being asserted by patent holdingcompanies (so-called patent “trolls”), which do not use technology and whose sole business is to enforce patents against companies, such as us, for monetarygain. Because such patent holding companies do not provide services or use technology, the assertion of our own patents by way of counter-claim may beineffective. We have received claims that our products infringe upon the proprietary rights of such patent holding companies. In addition, third parties haveasserted and may in the future assert intellectual property infringement claims against our customers, which we have agreed in certain circumstances toindemnify and defend against such claims. If litigation becomes necessary to determine the validity of any third party claims, it could result in significantexpense to us and could divert the efforts of our technical and management personnel, whether or not the claim has merit and notwithstanding that the litigationis determined in our favor.If it appears necessary or desirable, we may try to obtain licenses for those patents or intellectual property rights that we are allegedly infringing.Although holders of these types of intellectual property rights commonly offer these licenses, we cannot assure that licenses will be offered or that the terms ofany 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 uscould cause us to incur substantial liabilities, suspend the manufacturing of products utilizing the technology or damage the relationship with our customers.Alternatively, we could be required to expend significant resources to develop non-infringing technology. We cannot assure that we would be successful indeveloping non-infringing technology. The occurrence of any of these events could harm our business, financial condition or results of operations.Because we have significant operations in Israel, we may be subject to political, economic and other conditions affecting Israel that could increaseour operating expenses and disrupt our business.Our principal facilities are located in the State of Israel and, as a result, at December 31, 2012, 215 of our 317 employees were located in Israel,including 142 out of 186 of our research and development personnel. In addition, although we are incorporated in Delaware, a majority of our directors andexecutive officers are residents of Israel. Although substantially all of our sales currently are being made to customers outside of Israel, we are nonethelessdirectly influenced by the political, economic and military conditions affecting Israel. Any major hostilities involving Israel, or the interruption or curtailmentof trade between Israel and its present trading partners, could significantly harm our business, operating results and financial condition.Israel’s economy has been subject to numerous destabilizing factors, including a period of rampant inflation in the early to mid-1980s, low foreignexchange reserves, fluctuations in world commodity prices, military conflicts and civil unrest. In addition, Israel and companies doing business with Israelhave been the subject of an economic boycott by the Arab countries since Israel’s establishment. Although they have not done so to date, these restrictive lawsand policies may have an adverse impact on our operating results, financial condition or expansion of our business.Since the establishment of the State of Israel in 1948, a state of hostility has existed, varying in degree and intensity, between Israel and the Arabcountries. Although Israel has entered into various agreements with certain Arab countries and the Palestinian Authority, and various declarations have beensigned in connection with efforts to resolve some of the economic and political problems in the Middle East, hostilities between Israel and some of its Arabneighbors have recently escalated and intensified. We cannot predict whether or in what manner these conflicts will be resolved. Our results of operations maybe negatively affected by the obligation of key personnel to perform military service. In addition, certain of our officers and employees are currently obligated toperform annual reserve duty in the Israel Defense Forces and are subject to being called for active military dutyat any time. Although we have operated effectively under these requirements since our inception, we cannot 21Table of Contentspredict the effect of these obligations on the company in the future. Our operations could be disrupted by the absence, for a significant period, of one or moreof our officers or key employees due to military service.The tax benefits available to us under Israeli law require us to meet several conditions, and may be terminated or reduced in the future, whichwould increase our taxes.Our facilities in Israel have been granted Approved Enterprise and Beneficiary Enterprise status under the Law for the Encouragement of CapitalInvestments, 1959, commonly referred to as the “Investment Law,” as amended. The Investment Law provides that capital investments in a productionfacility (or other eligible assets) designated as an Approved Enterprise or Beneficiary Enterprise receive certain tax benefits in Israel. Our investment programsthat generate taxable income are currently subject to an average tax rate of up to approximately 10% based on a variety of factors, including percentage offoreign ownership and approvals for the erosion of the tax basis of our investment programs. To be eligible for tax benefits, we must meet certain conditions,relating principally to adherence to the investment program filed with the Investment Center of the Israeli Ministry of Industry and Trade and periodic reportingobligations. Although we believe we have met such conditions in the past, should we fail to meet such conditions in the future, we would be subject tocorporate tax in Israel at the standard corporate tax rate (25% for 2013) and could be required to refund tax benefits (including with interest and adjustmentsfor inflation based on the Israeli consumer price index) already received. Our average tax rate for our investment programs also may change in the future due tocircumstances outside of our control, including changes to legislation. Therefore, we cannot provide any assurances that our average tax rate for ourinvestment programs will continue in the future at their current levels, if at all. The termination or reduction of certain programs and tax benefits or arequirement to refund tax benefits (including with interest and adjustments for inflation based on the Israeli consumer price index) already received may have amaterial adverse effect on our business, operating results and financial condition.We may engage in future acquisitions that could dilute our stockholders’ equity and harm our business, results of operations and financialcondition.We have 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 other prospective acquisition will be completed. The process of integrating anacquired business may be prolonged due to unforeseen difficulties and may require a disproportionate amount of our resources and management’s attention.We cannot assure that we will be able to successfully identify suitable acquisition candidates, complete acquisitions, integrate acquired businesses into ouroperations, or expand into new markets. Further, once integrated, acquisitions may not achieve comparable levels of revenues, profitability or productivity asour existing business or otherwise perform as expected. The occurrence of any of these events could harm our business, financial condition or results ofoperations. Future acquisitions may require substantial capital resources, which may require us to seek additional debt or equity financing.Future acquisitions by us could result in the following, any of which could seriously harm our results of operations or the price of our stock: • issuance of equity securities that would dilute our current stockholders’ percentages of ownership; • large one-time write-offs; • the incurrence of debt and contingent liabilities; • difficulties in the assimilation and integration of operations, personnel, technologies, products and information systems of the acquiredcompanies; • diversion of management’s attention from other business concerns; • contractual disputes; • risks of entering geographic and business markets in which we have no or only limited prior experience; and 22Table of Contents • potential loss of key employees of acquired organizations.We may not be able to adequately protect or enforce our intellectual property rights, which could harm our competitive position.Our success and ability to compete is in part dependent upon our internally-developed technology and other proprietary rights, which we protect througha combination of copyright, trademark and trade secret laws, as well as through confidentiality agreements and licensing arrangements with our customers,suppliers, employees and consultants. In addition, we have filed a number of patents in the United States and in other foreign countries with respect to new orimproved technology that we have developed. However, the status of any patent involves complex legal and factual questions, and the breadth of claimsallowed is uncertain. Accordingly, we cannot assure that any patent application filed by us will result in a patent being issued, or that the patents issued to uswill not be infringed by others. Also, our competitors and potential competitors may develop products with similar technology or functionality as ourproducts, or they may attempt to copy or reverse engineer aspects of our product line or to obtain and use information that we regard as proprietary. Moreover,the laws of certain countries in which our products are or may be developed, manufactured or sold, including Hong Kong, Japan, Korea and Taiwan, maynot protect our products and intellectual property rights to the same extent as the laws of the United States. Policing the unauthorized use of our products isdifficult and may result in significant expense to us and could divert the efforts of our technical and management personnel. Even if we spend significantresources and efforts to protect our intellectual property, we cannot assure that we will be able to prevent misappropriation of our technology. Use by others ofour proprietary rights could materially harm our business and expensive litigation may be necessary in the future to enforce our intellectual property rights.Because our products are complex, the detection of errors in our products may be delayed, and if we deliver products with defects, our credibilitywill be harmed, the sales and market acceptance of our products may decrease and product liability claims may be made against us.Our products are complex and may contain errors, defects and bugs when introduced. If we deliver products with material errors, defects or bugs, ourcredibility and the market acceptance and sales of our products could be significantly harmed. Furthermore, the nature of our products may also delay thedetection of any such error or defect. If our products contain material errors, defects and bugs, then we may be required to expend significant capital andresources to alleviate these problems. This could result in the diversion of technical and other resources from our other development efforts. Any actual orperceived problems or delays may also adversely affect our ability to attract or retain customers. Furthermore, the existence of any defects, errors or failures inour products could lead to product liability claims or lawsuits against us or against our customers. We generally provide our customers with a standardwarranty for our products, generally lasting one year from the date of purchase. Although we attempt to limit our liability for product defects to productreplacements, we may not be successful, and customers may sue us or claim liability for the defective products. A successful product liability claim couldresult in substantial cost and divert management’s attention and resources, which would have a negative impact on our financial condition and results ofoperations.We are exposed to the credit risk of our customers and to credit exposures in weakened markets, which could result in material losses.Most of our sales are on an open credit basis. Because of current conditions in the global economy, our exposure to credit risks relating to sales on anopen credit basis has increased. We expect demand for enhanced open credit terms, for example, longer payment terms, to continue and believe that sucharrangements are a competitive factor in obtaining business. Although we monitor and attempt to mitigate credit risks, including through insurance coveragefrom time to time, there can be no assurance that our efforts will be effective. Moreover, even if we attempt to mitigate credit risks through insurance coverage,such coverage may not be sufficient to cover all of our losses and we would be subject to a deductible under any insurance coverage. As a result, our futurecredit risk exposure may increase. Although any losses to date relating to credit exposure of our customers have not been material, future losses, if incurred,could harm our business and have a material adverse 23Table of Contentseffect on our operating results and financial condition. Moreover, the loss of a customer due to its financial default also could harm our future business andpotential growth.Our executive officers and key personnel are critical to our business, and because there is significant competition for personnel in our industry,we may not be able to attract and retain such qualified personnel.Our success depends to a significant degree upon the continued contributions of our executive management team, and our technical, marketing, salescustomer support and product development personnel. The loss of significant numbers of such personnel could significantly harm our business, financialcondition and results of operations. We do not have any life insurance or other insurance covering the loss of any of our key employees. Because our productsare specialized and complex, our success depends upon our ability to attract, train and retain qualified personnel, including qualified technical, marketing andsales personnel. However, the competition for personnel is intense and we may have difficulty attracting and retaining such personnel.We may have exposure to additional tax liabilities as a result of our foreign operations.We are subject to income taxes in the United States and various foreign jurisdictions. In addition to our significant operations in Israel, pursuant to theAcquisition, we currently have operations in Germany, Hong Kong and India. Significant judgment is required in determining our worldwide provision forincome taxes and other tax liabilities. In the ordinary course of a global business, there are many intracompany transactions and calculations where theultimate tax determination is uncertain. We are regularly under audit by tax authorities. Our intracompany transfer pricing may be reviewed by the U.S.Internal Revenue Service and by foreign tax jurisdictions. Although we believe that our tax estimates are reasonable, due to the complexity of our corporatestructure, the multiple intracompany transactions and the various tax regimes, we cannot assure that a tax audit or tax dispute to which we may be subject willresult in a favorable outcome for us. If taxing authorities do not accept our tax positions and impose higher tax rates on our foreign operations, our overall taxexpenses could increase.We are exposed to fluctuations in currency exchange rates.A significant portion of our business is conducted outside the United States. Export sales to manufacturers in Europe and Asia, including Japan andAsia Pacific, represented 99% of our total revenues for 2012, 2011 and 2010. Although most of our revenue and expenses are transacted in U.S. dollars, wemay be exposed to currency exchange fluctuations in the future as business practices evolve and we are forced to transact business in local currencies.Moreover, part of our expenses in Israel are paid in Israeli currency, which subjects us to the risks of foreign currency fluctuations between the U.S. dollarand the New Israeli Shekel (NIS) and to economic pressures resulting from Israel’s general rate of inflation. Our primary expenses paid in NIS are employeesalaries and lease payments on our Israeli facilities. Furthermore, a portion of our expenses for our European operations are paid in the Euro, which subjectsus to the risks of foreign currency fluctuations between the U.S. dollar and the Euro. Our primary expenses paid in the Euro are employee salaries, lease andoperational payments on our European facilities. As a result, an increase in the value of the NIS and Euro in comparison to the U.S. dollar, which has beenthe trend in most of the year due to the devaluation of the U.S. dollar, could increase the cost of our technology development, research and developmentexpenses and general and administrative expenses, all of which could harm our operating profit. From time to time, we use derivative instruments in order tominimize the effects of currency fluctuations, but our hedging positions may be partial, may not exist at all in the future or may not succeed in minimizing ourforeign currency fluctuation risks. Our financial results may be harmed if the trend relating to the devaluation of the U.S. dollars continues for an extendedperiod.Because the markets in which we compete are highly competitive, and many of our competitors have greater resources than we do, we cannot becertain that our products will be accepted in the marketplace or capture market share.The markets in which we operate are extremely competitive and characterized by rapid technological change, evolving standards, short product lifecycles and price erosion. We expect competition to intensify as 24Table of Contentscurrent competitors expand their product offerings and new competitors enter the market. Given the highly competitive environment in which we operate, wecannot be sure that any competitive advantages enjoyed by our current products would be sufficient to establish and sustain our new products in the market.Any increase in price or competition could result in the erosion of our market share, to the extent we have obtained market share, and would have a negativeimpact on our financial condition and results of operations.In each of our business activities, we face current and potential competition from competitors that have significantly greater financial, technical,manufacturing, marketing, sales and distribution resources and management expertise than we do. These competitors may also have pre-existing relationshipswith our customers or potential customers. Further, in the event of a manufacturing capacity shortage, these competitors may be able to manufacture productswhen we are unable to do so. Our principal competitors in the cordless market include Lantiq and Dialog Semiconductors, and we have also noted efforts byBeken, a Chinese supplier of basebands for analog cordless phones, to penetrate the DECT market. Our principal competitors in the VoIP market includeBroadcom, Dialog Semiconductors, Infineon, Texas Instruments and new Taiwanese IC vendors. Our principal competitors in the multimedia market includeWi-Fi and multimedia application processor IC vendors like Atheros, Broadcom, CSR, Freescale, Intel, Marvel, Ralink, Samsung and Texas Instruments.As discussed above, various new developments in the home residential market may require us to enter into new markets with competitors that have moreestablished presence, and significantly greater financial, technical, manufacturing, marketing, sales and distribution resources and management expertise thanwe do. The expenditure of greater resources to expand our current product lines and develop a portfolio of “system-on-a-chip” solutions that integrate video,voice, data and communication technologies in a wider multimedia market may increase our operating expenses and reduce our gross profit. We cannot assurethat we will succeed in developing and introducing new products that are responsive to market demands.An unfavorable government review of our federal income tax returns or changes in our effective tax rates could adversely affect our operatingresults.Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates andhigher than anticipated in countries where we have higher statutory rates, by changes in the valuation of our deferred tax assets and liabilities, or by changes intax laws, regulations, accounting principles or interpretations thereof. In addition, we are subject to the periodic examination of our income tax returns by theIRS and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of ourprovision for income taxes. The outcomes from these examinations may have an adverse effect on our operating results and financial condition.Our business operations would be disrupted if the information technology systems we rely on fail to function properly.We rely on complex information technology systems to manage our business which operates in many geographical locations. For example, to achieveshort delivery lead times and superior levels of customer service while maintaining low levels of inventory, we constantly adjust our production schedules withmanufacturers and subcontractors. We develop and adjust these schedules based on end customer demand as communicated by our customers anddistributors and based on our inventory levels, manufacturing cycle times, component lead times, and projected production yields. We combine and distributeall of this information electronically over a complex global communications network. Our ability to estimate demand and to adjust our production schedules ishighly dependent on this network. Any delay in the implementation of, or disruption in the transition to, new or enhanced processes, systems or controls,could adversely affect our ability to manage customer orders and manufacturing schedules, as well as generate accurate financial and management informationin a timely manner. These systems are also susceptible to power and telecommunication disruptions and other system failures. Failure of our IT systems ordifficulties in managing them could result in business disruption. Our business could be significantly disrupted and we could be subject to third party claimsassociated with such disruptions. 25Table of ContentsWe may experience difficulties in transitioning to smaller geometry process technologies or in achieving higher levels of design integration, whichmay result in reduced manufacturing yields, delays in product deliveries and increased expenses.A growing trend in our industry is the integration of greater semiconductor content into a single chip to achieve higher levels of functionality. In order toremain competitive, we must achieve higher levels of design integration and deliver new integrated products on a timely basis. This requires us to expendgreater research and development resources, and may require us to modify the manufacturing processes for some of our products, to achieve greaterintegration. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies to reduce our costs.Although this migration to smaller geometry process technologies has helped us to offset the declining average selling prices of our products, this effort maynot continue to be successful. Also, because we are a fabless semiconductor company, we depend on our foundries to transition to smaller geometry processessuccessfully. We cannot assure that our foundries will be able to effectively manage the transition. In case our foundries or we experience significant delays inthis transition or fail to efficiently implement this transition, our business, financial condition and results of operations could be materially and adverselyaffected.The anti-takeover provisions in our certificate of incorporation and bylaws, as well as our rights plan, could prevent or discourage a third partyfrom acquiring us.Our certificate of incorporation and bylaws contain provisions that may prevent or discourage a third party from acquiring us, even if the acquisitionwould be beneficial to our stockholders. We have a staggered board, which means it will generally take two years to change the composition of our board. Ourboard of directors also has the authority to fix the rights and preferences of shares of our preferred stock and to issue such shares without a stockholder vote.Our bylaws also place limitations on the authority to call a special meeting of stockholders. Our stockholders may take action only at a meeting ofstockholders and not by written consent. We have advance notice procedures for stockholders desiring to nominate candidates for election as directors or tobring matters before an annual meeting of stockholders. In addition, these factors may also adversely affect the market price of our common stock, and thevoting and other rights of the holders of our common stock.Our business could be negatively affected as a result of a proxy fight and the actions of activist stockholders.Starboard Value and Opportunity Master Fund Ltd (collectively “Starboard”) has nominated candidates for each director position to be elected at our2013 annual meeting of stockholders. Starboard is an activist stockholder that has engaged in numerous proxy contests. In April 2012, to avoid a proxycontest with Starboard at the 2012 annual meeting, we entered into an agreement with Starboard pursuant to which two directors selected by Starboard,Thomas Lacey and Kenneth Traub (the “Starboard Nominees”), were named to our board of directors. Each of the Starboard Nominees has been named atStarboard’s insistence to boards of other public companies in which Starboard has acquired a stake. In connection with its decision to nominate candidates forelection at the upcoming 2013 annual meeting, that would result in a majority of the board being directors hand-picked by Starboard, Starboard has advisedour CEO and the chairman of our board that it is dissatisfied because during the past year DSP Group has not been sold as requested by Starboard. IfStarboard is successful in a proxy contest at our 2013 annual meeting, and a majority of our directors are persons selected by Starboard, we believe that wouldsubject DSP Group to undue influence and control by Starboard, which we believe would seek to pursue policies contrary to the best interests of DSP Groupand all of its stockholders, and that it would adversely affect our ability to effectively and timely implement strategic plans that we believe are in the bestinterests of DSP Group and its stockholders.Our efforts to convince Starboard not to engage in a proxy contest have been unsuccessful to date. If a proxy contest occurs litigation could ensue,including over statements made by us concerning the Starboard Nominees. In connection or as a result of such a contest, litigation and related matters, ourbusiness, business prospects and results of operations and financial condition could be subject to a material adverse effect, including because: (i) respondingto proxy contests and other actions by activist stockholders can be costly and time-consuming, disrupting our operations and diverting the attention of ourmanagement and employees; (ii) perceived 26Table of Contentsuncertainties as to our future direction may result in the loss of existing customers and potential business opportunities, and (iii) it may make it more difficultfor us to attract and retain qualified personnel and business partners. A proxy contest could also cause our stock price to experience periods of volatility.In connection with these matters, you should know that, despite having been selected by Starboard to serve on our board, and the board of othercompanies, the Starboard Nominees have claimed that they are entirely independent and have said that our statements about Starboard and the wisdom ofallowing Starboard nominees to constitute a majority of our board have included false and misleading statements about the two Starboard Nominees,particularly in relation to their independence. The majority of our board of directors respectfully disagrees. The Starboard Nominees have also refused to signour Annual Report on Form 10-K for the year ended December 31, 2012 as they claim that disclosure in this risk factor is inaccurate, a claim which the otherdirectors of the company disagree.Our stock price may be volatile so you may not be able to resell your shares of our common stock at or above the price you paid for them.Announcements of developments related to our business, announcements by competitors, quarterly fluctuations in our financial results, changes in thegeneral conditions of the highly dynamic industry in which we compete or the national economies in which we do business, and other factors could cause theprice of our common stock to fluctuate, perhaps substantially. In addition, in recent years, the stock market has experienced extreme price fluctuations, whichhave often been unrelated to the operating performance of affected companies. These factors and fluctuations could have a material adverse effect on the marketprice of our common stock. Item 1B.UNRESOLVED STAFF COMMENTS.None. Item 2.PROPERTIES.Our principal offices in the United States are located in San Jose, California, where we lease approximately 3,800 square feet under a lease that expires inFebruary 2014. Portions of our U.S. operations are located in leased facilities in El Dorado Hills, California under a lease that expires in March 2015. Ouroperations in Israel are located in leased facilities, with the primary leased facility of approximately 45,359 square feet located in Herzelia Pituach, Israel.These facilities are leased through November 2018. Our subsidiary in Tokyo, Japan has a lease that terminates in October 2014. Our subsidiary inNuremberg, Germany has a lease that terminates in December 2015. Our subsidiary in Scotland has lease agreements for its facilities with automatic renewalson a month-to-month basis. Our subsidiary in India has sublease agreements with NXP for its facilities that terminate in March 2017. Our subsidiary in HongKong entered into a lease agreement that is effective until November 2013. We believe that our existing facilities are adequate to meet our needs for the immediatefuture. Item 3.LEGAL PROCEEDINGS.From time to time, we may become involved in litigation relating to claims arising from our ordinary course of business activities. Also, as is typical inthe semiconductor industry, we have been and may from time to time be notified of claims that we may be infringing patents or intellectual property rightsowned by third parties. We currently believe that there are no claims or actions pending or threatened against us, the ultimate disposition of which would havea material adverse effect on us. Item 4.MINE SAFETY DISCLOSURESNot applicable. 27Table of ContentsPART II Item 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASESOF EQUITY SECURITIES.Our common stock, par value $0.001, trades on the NASDAQ Global Select Market (NASDAQ symbol “DSPG”). The following table presents for theperiods indicated the high and low sales prices for our common stock as reported by the NASDAQ Global Select Market: Year EndedDecember 31, 2011 High Low First Quarter 8.57 7.06 Second Quarter 9.24 7.52 Third Quarter 8.81 5.86 Fourth Quarter 6.75 5.12 Year EndedDecember 31, 2012 High Low First Quarter 6.79 4.85 Second Quarter 6.95 5.77 Third Quarter 6.40 5.36 Fourth Quarter 6.02 5.05 As of March 4, 2013, there were 21,916,855 shares of common stock outstanding. As of March 11, 2013, the company had approximately 37 holdersof record and approximately 2,717 beneficial holders. We have never paid cash dividends on our common stock and presently intend to continue a policy ofretaining any earnings for reinvestment in our business.Equity Compensation Plan InformationInformation relating to our equity compensation plans will be presented under the caption “Equity Compensation Plan Information” of our definitiveproxy statement pursuant to Regulation 14A in connection with the annual meeting of stockholders to be held on June 10, 2013. The definitive proxy statementwill be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year covered by this report. Such information isincorporated herein by reference.Issuer Purchases of Equity SecuritiesDuring the fourth quarter of 2012, we repurchased 100,840 shares of our common stock at an average price of $5.44 per share for approximately$548,000. The table below sets forth the information with respect to repurchases of our common stock during the three months ended December 31, 2012. Period (a) TotalNumber ofSharesPurchased (b) AveragePrice Paid perShare (c) Total Numberof SharesPurchased as Partof PubliclyAnnounced Plansor Programs (d) MaximumNumber of Sharesthat May Yet BePurchased Underthe Plans orPrograms)(1) Month #1 (October 1, 2012 to October 31, 2012) 50,256 $5.42 50,256 358,333 Month #2 (November 1, 2012 to November 30, 2012) 12,800 $5.46 12,800 345,536 Month #3 (December 1, 2012 to December 31, 2012) 37,784 $5.46 37,784 307,749(1) (1)The number represents the number of shares of our common stock that remain available for repurchase pursuant to our board’s authorizations as ofDecember 31, 2012. 28Table of ContentsPursuant to authorizations in March 1999, July 2003, October 2004, January 2007 and January 2008, our board of directors authorized a sharerepurchase program for the repurchase of an aggregate of 14.9 million shares of our common stock. Also in January 2008, our board approved the company’sentry into a share repurchase plan, in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, for the repurchase of 5.0 million of the aggregateshares of our common stock authorized for repurchase, which plan has since expired. In October 2010, our board of directors authorized an increase in thenumber of shares available for repurchase, thereby increasing the aggregate number of shares authorized for repurchase under our share repurchase program totwo million shares. In July 2011, our Board of Directors authorized an increase in our share repurchase program by an additional one million shares ofcommon stock.At December 31, 2012, 307,749 shares of our common stock remained available for repurchase under our board authorized share repurchase program.The repurchase program is being affected from time to time, depending on market conditions and other factors, through open market purchases and privatelynegotiated transactions as well as through entry into a share repurchase plan, in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934. Therepurchase program has no set expiration or termination date.Information relating to our equity compensation plans will be presented under the caption “Equity Compensation Plan Information” of our definitiveproxy statement pursuant to Regulation 14A in connection with the annual meeting of stockholders to be held on June 10, 2013. The definitive proxy statementwill be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year covered by this report. Such information isincorporated herein by reference. 29Table of ContentsStock Performance GraphNotwithstanding anything to the contrary set forth in any of the Company’s previous or future filings under the Securities Act of 1933, asamended, or the Securities Exchange Act of 1934, as amended, that might incorporate this proxy statement or future filings made by the Companyunder those statutes, the Stock Performance Graph shall not be deemed filed with the United States Securities and Exchange Commission and shall notbe deemed incorporated by reference into any of those prior filings or into any future filings made by the Company under those statutes.The graph below compares the cumulative total stockholder return on our common stock with the cumulative total return on the Standard & Poor’s 500Index and Standard & Poor’s Information Technology Index. The period shown commences on December 31, 2007 and ends on December 31, 2012, the endof our last fiscal year. The graph assumes an investment of $100 on December 31, 2007, and the reinvestment of any dividends.Comparisons in the graph above are based upon historical data and are not indicative of, nor intended to forecast, future performance of our commonstock. 30Table of ContentsItem 6.SELECTED FINANCIAL DATAThe selected historical consolidated financial data presented below is derived from our consolidated financial statements. The selected consolidatedfinancial data set forth below is qualified in its entirety by, and should be read in conjunction with, our consolidated financial statements for the year endedDecember 31, 2012, and the discussion of our business, operations and financial results in the section captioned, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.” Year Ended December 31, 2012 2011 2010 2009 2008 (U.S. dollars in thousands) Statements of Operations Data: Revenues $162,790 $193,861 $225,482 $212,186 $305,800 Cost of revenues 101,660 123,734 137,571 133,590 191,811 Gross profit 61,130 70,127 87,911 78,596 113,989 Operating expenses Research and development, net 42,539 53,244 55,588 56,148 73,856 General, administrative, sales and marketing 24,875 29,417 31,561 33,117 40,583 Amortization of intangible assets 2,310 7,972 9,975 12,258 22,853 Impairment of goodwill and other intangible assets — — — — 181,534 Restructuring cost (income) 2,008 (170) 463 — 1,870 Total operating expenses 71,732 90,463 97,587 101,523 320,696 Operating loss (10,602) (20,336) (9,676) (22,927) (206,707) Financial and other income Financial income, net 2,388 1,885 1,468 2,857 160 Other income from remeasurement of investment in a businessCombination — 1,343 — — — Loss before taxes (8,214) (17,108) (8,208) (20,070) (206,547) Taxes on income (benefit) (172) (866) (783) (11,634) 5,847 Net loss $(8,042) $(16,242) $(7,425) $(8,436) $(212,394) Weighted average number of Common Stock outstanding during the periodused to compute basic net earnings per share 21,950 23,247 23,229 23,655 28,387 Weighted average number of Common Stock outstanding during the periodused to compute diluted net earnings per share 21,950 23,247 23,229 23,655 28,387 Basic net loss per share $(0.37) $(0.70) $(0.32) $(0.36) $(7.48) Diluted net loss per share $(0.37) $(0.70) $(0.32) $(0.36) $(7.48) Balance Sheet Data: Cash, cash equivalents, marketable securities and bank deposits,including restricted deposits $120,339 $117,909 $139,761 $123,065 $121,501 Working capital $49,102 $60,010 $72,073 $68,013 $92,359 Total assets $185,182 $197,625 $222,555 $219,769 $249,254 Total stockholders’ equity $142,227 $148,624 $167,103 $165,489 $178,627 31Table of Contents Year Ended December 31, Fiscal Years by Quarter 2012 2011 Quarterly Data: 4th 3rd 2nd 1st 4th 3rd 2nd 1st (Unaudited, U.S. dollars in thousands, except per share amount) Revenues $38,429 $36,666 $44,191 $43,504 $38,195 $48,373 $58,517 $48,776 Gross profit $14,739 $13,902 $16,511 $15,978 $13,628 $17,520 $21,751 $17,228 Other income from remeasurement of investmentin a business Combination — — — — $1,343 — — — Net loss $(141) $(2,415) $(2,224) $(3,262) $(4,823) $(4,814) $(2,041) $(4,564) Net loss per share—Basic $(0.01) $(0.11) $(0.10) $(0.14) $(0.21) $(0.21) $(0.09) $(0.19) Net loss per share—Diluted $(0.01) $(0.11) $(0.10) $(0.14) $(0.21) $(0.21) $(0.09) $(0.19) 32Table of ContentsItem 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.The following discussion and analysis is intended to provide an investor with a narrative of our financial results and an evaluation of our financialcondition and results of operations. The discussion should be read in conjunction with our consolidated financial statements and notes thereto.Business OverviewDSP Group is a leading global provider of wireless chipset solutions for converged communications, delivering system solutions that combinesemiconductors and software with reference designs. We provide a broad portfolio of wireless chipsets integrating DECT, Wi-Fi, PSTN and VoIP technologieswith state-of-the-art application processors. We also enable converged voice, audio, video and data connectivity across diverse consumer products – fromcordless and VoIP phones to home gateways and connected multimedia screens. 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 2012.Our revenues were $162.8 million for 2012, a decrease of 16.0% in comparison to 2011, mainly due to a decrease in sales, and reduction in averageselling prices, of our cordless telephony products. Sales of our DECT 6.0 products for the U.S. market decreased from $75.4 million for 2011 to$69.1 million for 2012. Sales of our DECT products for the European market decreased from $79.3 million for 2011 to $56.7 million for 2012. Revenuesderived from the sale of DECT products represented 82% of our total revenues for both 2012 and 2011. Our gross margin increased to 37.6% of our totalrevenues for 2012 from 36.2% for 2011, primarily due to (i) a decrease in the provision for slow or obsolete inventories, (ii) an improvement in the productionyield 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 manufacturing and other related operational expenses such as boards, materials and subcontractors.Our operating loss decreased to $10.6 million for 2012, as compared to $20.3 million for 2011. The decrease in operating losses for 2012 was mainlyas a result of a decrease in operating expenses in all expense categories in 2012 as compared to 2011, offset to some extent by a decrease in total revenues during2012 as compared to 2011. Our operating expenses decreased by 20.7% to $71.7 million for 2012, as compared to $90.5 million for 2011. In addition, weimplemented two cost reduction programs during 2012, and expect the programs to result in an additional decrease in operating expenses for 2013.Notwithstanding our success in reducing our operating expenses, revenues derived from our cordless products are continuing to decline. This isprimarily due to the lack of growth of the cordless telephony market, as well as continuing decline in the average selling prices of all of our cordless products.The cordless telephony market is undergoing a challenging period of transition. With the rapid deployment of new communication access methods, includingmobile, wireless broadband, cable and other connectivity, the traditional cordless telephony market using fixed-line telephony will likely continue to decline,which will continue to reduce our revenues derived from, and unit sales of, cordless telephony products. Furthermore, our business also may be significantlyaffected by the outcome of the competition between cellular phone operators and fixed-line operators for the provision of residential communication. Asignificant majority of our revenues are currently generated from sales of chipsets used in cordless phones that are based on fixed-line telephony. If we areunable to develop new technologies to address alternative connectivity methods, our business could be materially adversely affected.Therefore, in order to increase our revenues and offset the declining revenues generated from our cordless products, we need to introduce new productsand penetrate new markets. We recently unveiled our revolutionary HDClear solution, a comprehensive voice enhancement product for mobile devices.Incorporating proprietary noise cancellation algorithms, HDClear improves user experience and delivers high voice quality and call 33Table of Contentsintelligibility. This technology will enable people to use their cell phones for conversation in virtually any condition, whether in a car, on a train or in othernoisy surroundings. HDClear will also facilitate the use of speech recognition and voice commands by eliminating background noise.In addition, we are concentrating our development efforts on other next generation products. Our next generation products also include: (i) DECT/CAT-iqintegrated circuits targeted for residential gateway devices supplied by telecommunication service providers and which integrate the DECT/CAT-iqfunctionality and can also address home automation applications, as well as fixed-mobile convergence solutions, which products are included in our homesegment; and (ii) VoIP products for enterprise which products are included in our office segment. We hope to leverage our strong technology base and customerrelationships with our next generate products to maximize growth and revenue opportunities.We are seeing evidence that our past research and development investments in new technologies are beginning to materialize. We have achieved a numberof design wins for our next generation products. Commercial shipments for some products have begun with more shipments to occur during 2013. Aggregaterevenues derived from our next generate products were 11.9%, 10.3% and 7.1% of our total revenues for 2012, 2011 and 2010, respectively. Based on a strongpipeline of design wins, our current mix of next generation products and anticipated commercialization schedules of customers incorporating our nextgeneration products, we anticipate annualized revenues generated from our next generation products to increase significantly in 2013 as compared to 2012.However, we can provide no assurances about our success in introducing new products and penetrating new markets, as well as our predictionsregarding market trends. For example, although a number of potential customers have expressed interest, we have not achieved a design win for our HDClearproduct for mobile devices. Furthermore, although next generation products targeted at the convergence of voice and data connectivity, enterprise VoIP solutionsand mobile device market are gradually being introduced into the market, market adoption of such products is at early stages. Although we have achieved anumber of design wins with top-tier OEMs for next-generation products, revenue generated from the commercialization of new products is a measured processas there is generally a long lead time from a design win to commercialization. From initial product design win to volume production, many factors couldimpact 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 weoperate, the introduction of next-generation productions may accelerate price erosion of older products. As a result, we expect the market to remain pricesensitive for our traditional cordless telephony products and expect that price erosion and the decrease in the average selling prices of such products tocontinue. Furthermore, various other factors, including increases in the cost of raw materials and commodities and our suppliers passing such increases ontous, increases in silicon wafer costs and increases in production, assembly and testing costs, and shortage of capacity to fulfill our fabrication, assembly andtesting needs, all may decrease our gross profit and harm our ability to grow our revenues in future periods.Nonetheless, we remain focused on generating non-GAAP operating income for 2013, and continue to closely monitor market trends. As a result of ourcost cutting measures implemented during 2012, we anticipate a significant decrease in our operating expenses for 2013, as compared to 2012.As of December 31, 2012, our principal source of liquidity consisted of cash and cash equivalents of $21.7 million and marketable securities and shortterm deposits of $98.5 million, totaling $120.2 million. 34Table of ContentsCritical Accounting policiesOur consolidated financial statements are prepared in accordance with U.S. GAAP. In connection with the preparation of the financial statements, we arerequired to make assumptions and estimates about future events, and apply judgment that affect the reported amounts of assets, liabilities, revenue, expensesand the related disclosure. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that managementbelieves to be relevant at the time the consolidated financial statements are prepared. On a regular basis, management reviews our accounting policies,assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with U.S. GAAP. However, becausefuture events and their effects cannot be determined with certainty, actual results could differ from our assumption and estimates, and such differences couldbe material.Our significant accounting policies are discussed in Note 2, Significant Accounting Policies, of the notes to our consolidated financial statements for theyear ended December 31, 2012.Management believes that the following accounting policies require management’s most difficult, subjective and complex judgments, resulting from theneed to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting policies and relateddisclosures with our independent auditors and audit committee. Description Judgments & Uncertainties Effect if Actual Results Differ fromAssumptionsTax Contingencies:Like most companies, domestic and foreign taxauthorities periodically audit our income tax returns.These audits include questions regarding our taxfiling positions, including the timing and amount ofdeductions and the allocation of income amongvarious tax jurisdictions. In evaluating the exposureassociated with our various tax filing positions,including state, foreign and local taxes, we recordreserves for probable exposures. A number of yearsmay elapse before a particular matter, for which wehave established a reserve, is audited and fullyresolved. We report a liability for unrecognized tax benefitsresulting from uncertain tax positions taken orexpected to be taken in a tax return. We recognizeinterest and penalties, if any, related to unrecognizedtax benefits in income tax expense. The estimate of our tax contingency reservecontains uncertainty because management mustuse judgment to estimate the exposure associatedwith our various tax filing positions. According to Financial Accounting StandardsBoard (“FASB”) Accounting StandardsCodification (“ASC”) No. 740, “Income Taxes,”the first step is to evaluate the tax position forrecognition by determining if the weight ofavailable evidence indicates it is more likely thannot that the position will be sustained on audit,including resolution of related appeals or litigationprocesses, if any. The second step is to measurethe tax benefit as the largest amount which is morethan 50% likely of being realized upon ultimatesettlement. Although management believes that its estimatesand judgments about tax contingencies arereasonable, actual results could differ, and wemay be exposed to gains or losses that could bematerial. To the extent we prevail in matters forwhich reserve has been established, or are requiredto pay amounts in excess of the reserve, oureffective tax rate for a given financial statementperiod could be materially affected. Anunfavorable tax settlement would require use ofour cash and result in an increase in our effectivetax rate for the year of resolution. A favorable taxsettlement would be recognized as a reduction inour effective tax rate for the year of resolution. 35Table of ContentsDescription Judgments & Uncertainties Effect if Actual Results Differ fromAssumptionsTax Valuation Allowance:We have a valuation allowance for deferred tax assetsbased on the determination that it is more likely thannot that some of these assets will not be realized. Our management inherently must make estimatesto determine the ultimate realization of these assets.The estimate of our tax valuation allowancecontains uncertainty because management mustuse judgment to estimate the expected results fortax purposes. Although management believes that its estimatesand judgments about expected results for taxpurposes are reasonable, actual results coulddiffer, and we may be required to record anadditional valuation allowance for our deferred taxassets.Valuation of Long-Lived Assets, IntangibleAssets and Goodwill :Goodwill represents the excess of purchase price overthe fair value of identifiable net assets acquired inbusiness combination. The goodwill on ourconsolidated balance sheet is a result of ouracquisition of BoneTone. Goodwill and theidentifiable intangible assets included on ourconsolidated balance sheet are current customerrelations, acquired from NXP in the Acquisition andin-process R&D and non-competition agreementacquired in the BoneTone acquisition. We perform our annual impairment analysis ofgoodwill and indefinite-lived intangible assets (suchas in-process research and development) in the fourthquarter of each fiscal year, or more often if there areindicators of impairment. We review intangible assetswith finite useful life for potential impairment whenevents or changes in circumstances indicate thecarrying value of those intangible assets may beimpaired. We may obtain an appraisal from anindependent valuation firm to determine the amountof impairment, if any. In addition to the use of anindependent valuation firm, we perform internalvaluation analyses and consider other publiclyavailable market information. We determine fair value using widely acceptedvaluation techniques, including discounted cashflow and market multiple analyses. These types ofanalyses require us to make assumptions andestimates regarding industry economic factors andthe profitability of future business strategies. It isour policy to conduct impairment testing based onour current business strategy in light of presentindustry and economic conditions, as well asfuture expectations. If management’s estimates or related assumptionschange in the future, we may be required to recordimpairment charges for our intangible assets. 36Table of ContentsDescription Judgments & Uncertainties Effect if Actual Results Differ fromAssumptionsContingencies and Other Accrued Expenses:We are from time to time involved in legal proceedingsand other claims. We are required to assess thelikelihood of any adverse judgments or outcomes tothese matters, as well as potential ranges of probablelosses. A determination of the amount of reserve required,if any, for any contingencies and accruals is madeafter careful analysis of each individual issue.The required reserve may change due to futuredevelopments, such as a change in the settlementstrategy in dealing with any contingencies, whichmay result in higher net losses. If actual results are not consistent withmanagement’s assumptions and judgments, wemay be exposed to gains or losses that could bematerial.Inventory Write-Off:We value our inventory at the lower of the cost of theinventory or fair market value through theestablishment of write-off and inventory loss reserve.We have not made any changes in the accountingmethodology used to establish our markdown orinventory loss reserves during the past four fiscalyears. Our write-off represents the excess of the carryingvalue, typically cost, over the amount we expect torealize from the ultimate sale or other disposal ofinventory based upon our assumptions regardingforecasted consumer demand, the promotionalenvironment, inventory aging and technologicalobsolescence. If management’s estimates regarding consumerdemand are inaccurate or changes in technologyaffect demand for certain products in anunforeseen manner, we may be exposed to lossesor gains in excess of our established write-off thatcould be material. 37Table of ContentsDescription Judgments & Uncertainties Effect if Actual Results Differ fromAssumptionsEquity-Based Compensation Expense:Equity-based compensation expense is measured onthe grant date based on the fair value of the awardand is recognized as an expense over the requisiteservice periods. Determining the fair value of equity-based awardson the grant date requires the exercise of judgment,including the amount of equity-based awards thatare expected to be forfeited. We consider manyfactors when estimating expected forfeitures,including types of awards, employee class, andhistorical experience. Actual results, and futurechanges in estimates, may differ substantiallyfrom our current estimates. Although management believes that their estimatesand judgments about equity-based compensationexpense are reasonable, actual results could differ. We estimate the fair value of equity-based awardsusing a binomial option pricing model. The fairvalue of an award is affected by our stock priceon the date of grant as well as other assumptions,including expected stock price volatility and theexpected term of the equity-based award. The risk-free interest rate is based on the yield from U.S.treasury bonds with an equivalent term. Expectedvolatility is calculated based upon actual historicalstock price movements. The expected term of theequity-based award granted is based uponhistorical experience and represents the period oftime that the award granted is expected to beoutstanding. Our expected dividend rate is zerosince we do not currently pay cash dividends anddo not anticipate doing so in the foreseeable future. 38Table of ContentsDescription Judgments & Uncertainties Effect if Actual Results Differ fromAssumptionsPension Liability:We account for pension liability in accordance withFASB ASC No. 715, “Defined Benefit Plans.” The costs and obligations of our defined benefitpension plans are dependent on actuarialassumptions. The two critical assumptions used,which impact the net periodic pension cost(income) and the benefit obligations, are thediscount rate and expected return on plan assets.The discount rate represents the market rate for ahigh quality government bond, and the expectedreturn on plan assets is based on current andexpected asset allocations, historical trends andexpected returns on plan assets. These keyassumptions are evaluated annually. Changes inthese assumptions can result in different expenseand liability amounts. Although management believes that their estimatesand judgments about pension liability arereasonable, actual results could differ, and wemay be exposed to gains or losses that could bematerial.Marketable Securities:Management determines the appropriate classificationfor our investments in debt and equity securities atthe time of purchase and re-evaluates suchdetermination at each balance sheet date. The marketable securities are periodicallyreviewed for impairment. If it is concluded thatany of these investments are impaired,management determines whether such impairmentis “other-than-temporary.” Factors that areconsidered in making such a determinationinclude the duration and severity of theimpairment, the reason for the decline in value andthe potential recovery period, and our intent to sell,or whether it is more likely than not that we will berequired to sell, the investment before recovery ofits cost basis. If any impairment is considered“other-than-temporary,” the investment is writtendown to its fair value and a corresponding chargeis recorded in financial income, net. Although management believes that theirconsiderations and judgments about fair value andwhether a loss associated with a marketablesecurity is other-than-temporary, actual resultscould differ. Given current market conditions anduncertainty, management’s judgments could proveto be wrong, and companies with relatively highcredit ratings and solid financial conditions maynot be able to fulfill their obligations and therebycause other-than-temporary losses. 39Table of ContentsDescription Judgments & Uncertainties Effect if Actual Results Differ fromAssumptionsBusiness Combination:In December 2011, we exercised our option to acquirethe remaining 70% equity interest our, on a fullydiluted basis, in BoneTone for a purchase price of$8.6 million. The acquisition was recorded inaccordance with ASC 805, “Business CombinationAccounting.” We have allocated the purchase price ofBoneTone to tangible and acquisition-relatedintangible assets acquired and liabilities assumedbased on their estimated fair values. Management makes estimates of fair value usingreasonable assumptions based on historicalexperience and information obtained from theBoneTone management in order to allocate thepurchase price to the tangible and intangibleassets. The valuation requires significant estimates andassumptions, especially with respect toacquisition-related intangible assets. Althoughmanagement believes that their estimates andjudgments about the business combination arereasonable, actual results could differ.Results of Operations:Total Revenues. Our total revenues were $162.8 million for 2012, $193.9 million for 2011 and $225.5 million for 2010. The decrease of 16% inrevenues for 2012 as compared to 2011 and the decrease of 14% in revenues for 2011 as compared to 2010 were both primarily as a result of decreased sales ofour 2.4GHz and DECT products. Sales of DECT products were $133.9 million, $159.4 million and $176.8 million for the years ended 2012, 2011 and2010, respectively, representing approximately 82%, 82% and 78% of our total revenues for 2012, 2011 and 2010, respectively. The decrease of 16% inabsolute dollars of DECT sales in 2012 as compared to 2011 and the decrease of 10% in absolute dollars of DECT sales in 2011 as compared to 2010 weremainly attributable to a decline in market demands and the decrease in average selling prices of our products. In addition, sales of our DECT 6.0 products forthe U.S. end market were $69.1 million, $75.4 million and $84.2 million for 2012, 2011 and 2010, respectively, representing 42%, 39% and 37% of ourtotal revenues for 2012, 2011 and 2010, respectively. Sales of our DECT products for the European market decreased from $84.2 million in 2010 to$79.3 million for 2011 and to $56.7 million for 2012.Sales of 2.4GHz products were $12.1 million, $18.3 million and $29.3 million for 2012, 2011 and 2010, respectively, representing 7%, 9% and 13%of our total revenues for 2012, 2011 and 2010, respectively. This represents a decrease of 34% in absolute dollars when comparing sales for 2012 to 2011,which resulted mainly from the decrease of sales of our 2.4 GHz products in the Japanese domestic and the U.S. markets. When comparing 2.4 GHz sales for2011 to 2010, there was a decrease of 38% in absolute dollars which resulted mainly from the decrease of sales of our 2.4 GHz products in the Japanesedomestic market. 40Table of ContentsThe following table shows the breakdown of revenues for all product lines for the periods indicated by geographic location based on the geographiclocation of our customers (in thousands): Year Ended December 31, 2012 2011 2010 United States $2,028 $1,836 $1,423 Hong Kong 84,736 100,894 112,319 Japan 51,033 57,260 76,986 Europe 7,429 9,180 13,043 Korea 1,968 5,909 8,081 China 6,270 8,577 6,807 Taiwan 6,496 7,225 3,208 Other 2,830 2,980 3,615 Total revenues $162,790 $193,861 $225,482 Sales to our customers in Hong Kong decreased for 2012 as compared to the same period of 2011, representing a decrease of 16% in absolute dollars.The decrease in our sales to Hong Kong for the comparable periods resulted mainly from the decrease in sales to Vtech Holding Ltd. (“Vtech”) of 10% whencomparing 2012 to 2011 and a decrease in sales to CCT Telecom Holdings Ltd. of 40% when comparing 2012 to 2011. Sales to our customers in Japandecreased for 2012 as compared to the same period of 2011, representing a decrease of 11% in absolute dollars. The decrease in our sales to Japan for thecomparable periods resulted mainly from (i) a decrease in sales to Panasonic Communications Co. Ltd. (“Panasonic”), representing a 7% decrease in absolutedollars for 2012 as compared to 2011, (ii) a decrease in sales to the Japanese domestic market, representing a 15% decrease in absolute dollars for 2012 ascompared to 2011, and (iii) a decrease in sales to the Uniden America Corporation (“Uniden”), representing a 14% decrease in absolute dollars for 2012, ascompared to 2011. Sales to our customers in Hong Kong decreased for 2011 as compared to 2010, representing a decrease of 10% in absolute dollars. Thedecrease in our sales to Hong Kong for the comparable periods resulted from the decrease in sales to all of our Hong Kong-based customers, including adecrease of 9% in sales to Vtech when comparing 2011 to 2010. Sales to our customers in Japan decreased for 2011 as compared to 2010, representing adecrease of 26% in absolute dollars. The decrease in our sales to Japan for the comparable periods resulted mainly from (i) a decrease in sales to Panasonic,representing a 28% decrease in absolute dollars for 2011, as compared to 2010, and (ii) a decrease in sales to the Japanese domestic market, representing a41% decrease in absolute dollars for 2011, as compared to 2010.As our products are generally incorporated into consumer products sold by our OEM customers, our revenues are affected by seasonal buying patternsof consumer products sold by our OEM customers that incorporate our products.Significant Customers. The Japanese and Hong Kong markets and the OEMs that operate in those markets are among the largest suppliers ofresidential wireless products with significant market share in the U.S. market. The loss of any of our significant customers or distributors could have amaterial adverse effect on our business, financial condition and results of operations.VTech is a significant OEM customer based in Hong Kong. Sales to VTech represented 35%, 33% and 31% of our total revenues for 2012, 2011 and2010, respectively. Another significant customer of the company in Hong Kong is CCT Telecom, whose sales represented 8%, 11% and 10% of our totalrevenues for 2012, 2011 and 2010, respectively.Revenues derived from sales through our largest distributor, Japan-based Tomen Electronics Corporation (“Tomen Electronics”), accounted for 21% ofour total revenues for 2012, as compared to 19% for 2011 and 25% for 2010. Sales to Uniden America Corp. (“Uniden”) represented 11%, 10% and 9% ofour total revenues for 2012, 2011 and 2010, respectively. 41Table of ContentsTomen Electronics sells our products to a limited number of customers. One customer, Panasonic, has continually accounted for a majority of salesthrough Tomen Electronics. Sales to Panasonic through Tomen Electronics generated approximately 15%, 13% and 16% of our total revenues for 2012, 2011and 2010, respectively.Significant Products. Revenues from our DECT products represented 82%, 82% and 78% of our total revenues for 2012, 2011 and 2010,respectively. Revenues from our 2.4GHz products represented 7%, 9% and 13% of our total revenues for 2012, 2011 and 2010, respectively. We believe thatsales of DECT and 2.4GHz products will continue to represent a substantial percentage of our revenues for 2013. We believe that the rapid deployment of newcommunication access methods, as well as the lack of growth in fixed-line telephony, will reduce our total revenues derived from, and unit sales of, cordlesstelephony products, including our DECT and 2.4GHz products, for the short and long term.Gross Profit. Gross profit as a percentage of revenues was 37.6% for 2012, 36.2% for 2011 and 39% for 2010. The increase in our gross profit for2012 as compared to 2011 was primarily due to (i) a decrease in the provision for slow or obsolete inventories, (ii) an improvement in the production yield ofcertain 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, internal headcount and subcontractors. The decrease in our gross profit for 2011 ascompared to 2010 was primarily due to (i) a decrease in overall revenues, (ii) a decrease in average selling prices of our products, (iii) an increase in certainproduction costs and related materials, such as gold, and (iv) income from a reversal of a reserve, during 2010, amounting to $2.5 million associated with apotential patent infringement claim that was determined to be no longer needed due to the expiration of the applicable statute of limitations. As gross profitreflects 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 grossprofit 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 ofour 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 inintroducing new engineering processes to reduce manufacturing costs, increases in the cost of raw materials such as gold, oil and silicon wafers, and increasesin production, assembly and testing costs. Moreover, our suppliers may pass the increase in the cost of raw materials and commodities onto us which wouldfurther reduce the gross margins of our products. We cannot guarantee that our ongoing efforts in cost reduction and yield improvements will be successful orthat they will keep pace with the anticipated continuing decline in average selling prices of our products. Steps we are taking include the implementation of costimprovement plans to reduce testing costs and offering our customers more cost effective products by, for example, replacing gold wiring with copper wiring.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 usoffset 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 relatedoverhead costs, and compensation and associated expenses related to manufacturing and testing support, inventories obsolesce and logistics personnel.Operating Expenses. Our operating expenses were $71.7 million for 2012, $90.5 million for 2011 and $97.6 million for 2010. The decrease inoperating expenses for 2012 as compared to 2011 was primarily attributable to a decrease in research and development expenses in the amount of $10.7 millionin 2012 as compared to 2011, which was attributed mainly to (x) the restructuring of our U.S. operations, implemented during the third quarter of 2011which reduced our research and development expenses for 2012, (y) a decrease in projects-related expenses (mainly tape-out, materials, subcontractors andtravel expenses), and (z) a decrease in labor and employee-related expenses, (in addition to the restructuring of our U.S. operations that was initiated during thethird quarter of 2011). This decrease in labor and employee-related expenses for both comparable periods was mainly due to (a) a decrease in the number ofemployees, (b) the devaluation of the New Israeli Shekel (“NIS”) against the U.S. dollar, which decreased the Israeli employee labor expenses, and (c) therestructuring of our operations that was initiated during the second and the third quarters of 2012. Other factors that contributed to the decrease in ouroperating expenses are: (i) a decrease in general and administrative 42Table of Contentsexpenses such as legal and stockholders and investors relations expenses in the amount of $1.2 million in 2012 as compared to 2011, (ii) a decrease in salescommission paid in 2012 as compared to 2011 in the amount of $0.6 million due to a lower level of revenues subject to sales commissions, (iii) a decrease inequity-based compensation expenses in the amount of $1.2 million, and (iv) a decrease in the amortization cost for intangible assets related mostly to the CIPTAcquisition in the amount of $5.7 million. These decreases were offset to some extent by an increase in expenses in the amount of $2.2 million, which wererelated to the above mentioned restructuring plans executed in 2012. Our operating losses were $10.6 million for 2012, as compared to $20.3 million for 2011and $9.7 million for 2010. The decrease in operating losses for 2012 as compared to 2011 was mainly due to an increase in gross margins and a decrease inoperating expenses as noted above, offset to some extent by a decrease in revenues in 2012 as compared to 2011. The decrease in operating expenses for 2011as compared to 2010 was primarily attributable to (i) a decrease in payroll and facilities expenses derived from the reorganization of our European operationsand the closure of our Swiss operations in the amount of $3.6 million, (ii) a decrease in equity-based compensation expenses in the amount of $3.3 million,and (iii) a decrease in the amortization cost for intangible assets related to the CIPT Acquisition in the amount of $2.0 million. These decreases were offset tosome extent by an increase in other general and administrative expenses, such as legal and stockholders and investors relations expenses. The increase inoperating losses in 2011 as compared to 2010 was mainly as a result of a decrease in total revenues and gross margins during 2011 as compared to 2010,offset to some extent by a decrease in operating expenses in 2011 as compared to 2010.Research and Development Expenses. Our research and development expenses were $42.5 million for 2012, $53.2 million for 2011 and $55.6million for 2010. The decrease for 2012 in research and development expenses, as compared to 2011, was mainly due to (i) the restructuring of our U.S.operations, which was implemented during the third quarter of 2011 and reduced our research and development expenses for 2012 as compared to 2011 in theamount of $2 million (ii) a decrease in projects-related expenses (mainly tape-out, materials, subcontractors and travel expenses) in the amount of $3.7 million,(iii) a decrease in equity-based compensation expenses in the amount of $0.3 million, and (iv) a decrease in labor and employee-related expenses in the amountof $3.1 million (in addition to the planned restructuring of our U.S. operations initiated during the third quarter of 2011). This decrease in labor and employee-related expenses for 2012 was mainly due to (x) a decrease in the number of employees, (y) the devaluation of the NIS against the U.S. dollar, which decreasedour Israeli employee labor expenses, and (z) the restructuring of our operations that was initiated during the second and the third quarters of 2012, which aredescribed in greater detail in Note 15 of the notes to our consolidated financial statements for the year ended December 31, 2012. In addition, during 2012, werecorded grants receivable in the amount of $0.4 million from the Office of Chief Scientist in Israel in support of one of our research and development projects,which also decreased our research and development expenses, in comparison to 2011.The decrease for 2011 in research and development expenses, as compared to 2010, was mainly due to (i) a decrease in equity-based compensationexpenses in the amount of $1.9 million, (ii) a decrease in the number of research and development employees and payroll related expenses in the amount of$1.9 million, and (iii) a decrease in subcontractor expenses in the amount of $0.8 million. The decrease in research and development expenses for 2011, ascompared to 2010, was offset mainly by an increase in projects-related expenses, mainly tape-out expenses.Our research and development expenses as a percentage of our total revenues were 26%, 27% and 25% for 2012, 2011 and 2010, respectively. Thedecrease in research and development expenses as a percentage of total revenues for 2012 as compared to 2011 was mainly due to a decrease in a research anddevelopment expenses in 2012 as compared to 2011, which was offset to some extent by a decrease in absolute dollars of our total revenues in 2012 ascompared to 2011. The increase in research and development expenses as a percentage of total revenues for 2011 as compared to 2010 was mainly due to adecrease in absolute dollars of our total revenues for 2011 as compared to 2010.Research and development expenses consist mainly of payroll expenses to employees involved in research and development activities, expenses related totapeout and mask work, subcontracting, labor contractors and engineering expenses, depreciation and maintenance fees related to equipment and softwaretools used in research and development, and facilities expenses associated with and allocated to research and development activities. 43Table of ContentsSales and Marketing Expenses. Our sales and marketing expenses were $14.2 million for 2012, $16.5 million for 2011 and $17.2 million for2010. The decrease in sales and marketing expenses between 2012 and 2011 was mainly attributed to (i) a decrease in the number of sales and marketingemployees and labor expenses in the amount of $1 million, (ii) a decrease in the amount of $0.6 million in sales commission paid due to a lower level ofrevenues subject to sales commissions, (iii) a decrease in overseas travel expenses in the amount of $0.3 million, and (iv) a decrease in equity-basedcompensation expenses in the amount of $0.2 million.The decrease in sales and marketing expenses between 2011 and 2010 was mainly attributed to (i) a decrease in equity-based compensation expenses inthe amount of $0.5 million, and (ii) a decrease in commission paid to distributors due to a lower level of revenues subject to sales commissions in the amountof $0.7 million. The decrease in sales and marketing expenses for 2011 as compared to 2010 was offset to some extent by an increase in the number of salesand marketing employees and payroll related expenses in the amount of $0.6 million.Our sales and marketing expenses as a percentage of our total revenues were 9% for both 2012 and 2011 and 8% for 2010. The increase in sales andmarketing expenses as a percentage of total revenues for 2011 as compared to 2010 was mainly due to a decrease in absolute dollars of our total revenues for2011 as compared to 2010.Sales and marketing expenses consist mainly of sales commissions, payroll expenses to direct sales and marketing employees, travel, trade showexpenses, and facilities expenses associated with and allocated to sales and marketing activities.General and Administrative Expenses. Our general and administrative expenses were $10.6 million, $12.9 million and $14.4 million for 2012,2011 and 2010, respectively. The decrease in general and administrative expenses for 2012 as compared to 2011 was mainly attributed to (i) a decrease ininvestors relations, legal and accounting expenses in the amount of $1.3 million, (ii) a decrease in equity-based compensation expenses in the amount of $0.6million, and (iii) a decrease in payroll related expenses in the amount of $0.3 million mainly due to the devaluation of the NIS against the U.S. dollar, whichdecreased our Israeli employee payroll expenses in U.S. dollar.The decrease in general and administrative expenses for 2011 as compared to 2010 was mainly attributed to (i) a decrease in payroll and facilitiesexpenses derived from the reorganization of our European operations and the closure of our Swiss operations, and (ii) a decrease in equity-based compensationexpenses in the amounts of $0.6 million. These decreases were offset to some extent by an increase in other general and administrative expenses, such as legaland stockholders and investors relations expenses.General and administrative expenses as a percentage of our total revenues were 7% for both 2012 and 2011, and 6% for 2010. The increase in generaland administrative expenses in 2011 as a percentage of total revenues as compared to 2010 was due to a decrease in absolute dollars of our total revenues in2011 as compared to 2010.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.Until the second quarter of 2012, we operated under one reporting segment.During the third quarter of 2012, following a change in the manner our management evaluates financial information, management determined that thecompany operates under three reportable segments in accordance with ASC 280 “Disclosure about Segments of an Enterprise and Related Information.” 44Table of ContentsOur operating segments are as follows: Home, Office and Mobile. The classification of our business segments is based on a number of factors thatmanagement uses to evaluate, view and run our business operations, which include, but are not limited to, customer base, homogeneity of products andtechnology.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 phonessold in retail or supplied by telecommunication service providers, residential gateway devices supplied by telecommunication service providerswhich integrate the DECT/CAT-iq functionality and also wireless chipsets for home automation applications, as well as fixed-mobile convergencesolutions.Office—Comprehensive solution for Voice-over-IP (VoIP) office products, including office solutions that offer businesses of all size low-cost VoIPterminals 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 mobileheadsets.Segment data:We derive the results of our business segments directly from our internal management reporting system and by using certain allocation methods. Theaccounting 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 theseresults, 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 certainoperating expenses, which are managed separately at the corporate level. These unallocated costs include primarily restructuring charges, amortization ofpurchased intangible assets, equity-based compensation expenses and certain corporate governance costs.Selected operating results information for each business segment was as follows for the year ended December 31, 2012 and 2011: Twelve months ended December 31 Revenues Income (loss) from operations 2012 2011 2010 2012 2011 2010 Home $155,211 $188,192 $223,354 $15,040 — * — * Office $7,579 $5,669 $2,128 $(5,156) — * — * Mobile $— $— $— $(8,585) — * — * Total $162,790 $193,861 $225,482 $1,299 $(2,830) $10,234 *)It is impracticable to present 2011 and 2010 income (loss) from operations by segments due to lack in internal management reporting and trackingsystem, which tracks and reports employees actual hours in the various projects.Sales to our customers in the home segment decreased for 2012 as compared to the same period of 2011, representing a decrease of 17% in absolutedollars and decreased for 2011 as compared to the same period of 2010, representing a decrease of 14% in absolute dollars. The decrease in our sales in thehome segment for the comparable periods was mainly attributable to the decline in market demands and the decrease in the average selling prices of cordlessphones over the comparative periods.Sales to our customers in the office segment increased for 2012 as compared to the same period of 2011, representing an increase of 34% in absolutedollars. Sales to our customers in the office segment increased for 2011 as compared to the same period of 2010, representing an increase of 166% in absolutedollars. The increase in our sales in the office segment for both comparable periods was mainly due to the increase in market share in sales to this new segmentand in increase in market demand for VoIP products. 45Table of ContentsThe reconciliation of segment operating results information to our consolidated financial information was as follows: Year ended December 31, 2012 2011 2010 Income (loss) from operations $1,299 $(2,830) $10,234 Unallocated corporate, general and administrative expenses (2,600) (3,485) (2,419) Restructuring (expenses) income (2,008) 170 (463) Equity-based compensation expenses (4,983) (6,220) (9,553) Intangible assets amortization expenses (2,310) (7,972) (9,975) Other income from remeasurement of initial investment in an affiliated company — 1,343 — Reversal of a reserve that was determined to be no longer needed due to the expiration of applicable statute oflimitations included in costs of goods sold — — 2,500 Financial income, net 2,388 1,885 1,468 Total consolidated loss before taxes $(8,214) $(17,108) $(8,208) Amortization of Intangible Assets. During 2012, 2011 and 2010, we recorded an expense of $2.3 million, $8.0 million and $10.0 million,respectively, relating to the amortization of intangible assets associated with the CIPT acquisition and the acquisition of BoneTone in 2011. The sequentialdecrease in 2012 as compared to 2011 and 2010 is consistent with, and is based on, the original amortization schedule determined following the impairment ofgoodwill and other intangible assets that took place in 2008 in relation to the CIPT Acquisition.Restructuring Costs and Other. During 2012, we recorded an expense of $2.0 million in connection with the restructuring of our operations, whichwas composed of two restructuring plans executed during the second and third quarters of 2012. As part of these restructuring plans, we executed terminationagreements with certain of our employees and recorded an expense related to the future expected under-utilization of existing development tool agreements withexpiry dates in 2013 and 2014. During 2011, as part of our plan to improve operational efficiencies and reduce our operating expenses for fiscal year 2012, werestructured our U.S. operations. As part of this restructuring plan, we executed termination agreements with certain of our U.S. employees and renegotiated thelease for our U.S. facilities. We recorded an income in the amount of $0.2 million during 2011 which was composed of an income of $0.6 million associatedwith the restructuring plan that we initiated during the third quarter of 2010, offset by restructuring expenses in the amount of $0.4 million associated with therestructuring of our U.S. operations as noted above. The above referenced income resulted mainly from the closure of our Swiss facilities and the terminationof employment of the employees of our Swiss subsidiary, which resulted in a curtailment and settlement of our Swiss pension plan during the first quarter of2011.Financial income, net. Financial income, net, was $2.4 million for 2012, $1.9 million for 2011 and $1.5 million for 2010. The increase infinancial income, net, for 2012 as compared to 2011 was mainly due to a profit in the amount of $0.7 million resulting from the sale of certain marketablesecurities during 2012, as compared to a $0.2 million profit recorded during 2011. The increase in financial income, net, for 2011 as compared to 2010 wasmainly due to (i) the devaluation of the Euro against the U.S. dollar and the devaluation of the U.S. dollar against the Swiss Franc, which resulted in higherexpenses associated with the exchange rate differences during 2010 as compared to 2011, and (ii) a profit in the amount of $0.2 million resulting from the saleof certain marketable securities during 2011, as compared to a $0.1 million profit recorded during 2010.Our total cash, cash equivalents, marketable securities and short term deposits, including restricted deposits, were $120.3 million as of December 31,2012, as compared to $117.9 million as of December 31, 2011.Other income. We recorded other income in the amount of $1.3 million during the fourth quarter of 2011. Other income was derived from theremeasurement to fair value of our investment in BoneTone when we 46Table of Contentsexercised our option to acquire the remaining 70% equity interest in BoneTone, on a fully diluted basis, for a purchase price of $8.6 million inDecember 2011. We initially acquired 30% of BoneTone’s then outstanding equity, on a fully diluted basis, in November 2009.Provision for Income Taxes. Our income tax benefit was $0.2 million for 2012, as compared to a tax benefit of $0.9 million for 2011 and a taxbenefit of $0.8 million for 2010. The income tax benefit for 2012 was mainly attributed to a reversal of an income tax contingency reserve in the amount of$0.5 million that was determined to be no longer required due to the expiration of the applicable statutes of limitation during the third quarter of 2012. Theincome tax benefit for 2011 resulted mainly from a tax benefit of $0.6 million resulting from the reversal of an income tax contingency reserve that wasdetermined to be no longer needed due to the expiration of the applicable statute of limitations and from an approval that was received from the Israeligovernmental authorities with respect to the recognition for tax purposes of our research and development expenses for previous years. The income tax benefitfor 2010 resulted mainly from a tax benefit of $0.6 million resulting from the reversal of an income tax contingency reserve that was determined to be no longerneeded due to the expiration of applicable statutes of limitation.During 2012, we did not record any significant changes to the net deferred tax assets due to our current estimate of future taxable income.DSP Group Ltd., our Israeli subsidiary, was granted “Approved Enterprise” status by the Israeli government with respect to six separate investmentplans. Approved Enterprise status allows our Israeli subsidiary to enjoy a tax holiday for a period of two or four years, and a reduced corporate tax rate of10%-25% (based on the percentage of foreign ownership) for an additional six or eight years, on each investment plan’s proportionate share of taxable income.The tax benefits under our Israeli subsidiary’s first five investment plans have expired and those under the sixth investment plan are scheduled to expire by2015.On April 1, 2005, an amendment to the Israeli Investment Law came into effect (the “Amendment”). The Amendment revised the criteria for investmentsqualified to receive tax benefits. An eligible investment program under the Amendment qualifies for benefits as a Beneficiary Enterprise (rather than theprevious terminology of Approved Enterprise). Among other things, the Amendment provides tax benefits to both local and foreign investors and simplified theapproval process. The Amendment does not apply to investment programs approved prior to December 31, 2004. The new tax regime applies to newinvestment programs only.For 2006 and 2009, DSP Group Ltd. elected the status of a Beneficiary Enterprise under the Amendment for its seventh and eight plans, respectively.The seventh and eight plans entitle DSP Group Ltd. to a corporate tax exemption for a period of two years and a reduced corporate tax rate of 10%-25% (basedon the percentage of foreign ownership) for an additional period of eight years from the first year it has taxable income. The tax benefits under the seventh andeighth investment plans are scheduled to gradually expire between 2016 and 2021.In December 2010, the Knesset (Israeli parliament) passed the New Amendment which prescribes, among other things, for a further amendment of theIsraeli Investment Law. The New Amendment became effective as of January 1, 2011. Among other things, the New Amendment sets forth the followingamended tax rates for income generated from qualified investment programs: • for 2011 and 2012—15%; • for 2013 and 2014—12.5%; and • for 2015 and thereafter—12%.We do not currently intend to implement the New Amendment; rather we intend to continue to comply with the Investment Law as in effect prior toenactment of the New Amendment until the earlier of such time that compliance with the Investment Law prior to enactment of the New Amendment is nolonger in our best interests or until the expiration of our current investment programs. We are required to comply with the New Amendment 47Table of Contentssubsequent to the expiration of our current investment programs and for any new qualified investment program after a transitional period. As a result, the NewAmendment may increase our average tax rate in future years.In November 2012, the Knesset passed Amendment No. 69 to the Investment Law (the “Trapped Earnings Law”) which provides a temporary, partial,relief from taxation on a distribution from exempt income for companies which elect the relief through November 2013. The Trapped Earnings Law allows acompany to qualify a portion of its exempt income (“Elected Earnings”) for a reduced tax rate ranging between 17.5% and 6%. While the reduced tax ispayable within 30 days of election, an electing company is not required to actually distribute the Elected Earnings within a certain period of time. Theapplicable rate is based on a linear formula involving the portion of Elected Earnings to exempt income and the applicable tax rate prescribed in the InvestmentLaw. A company electing to qualify its exempt income must undertake to make designated investments in productive fixed assets, research and development,or wages of new employees (“Designated Investment”). The Designated Investment amount is defined by a formula which considers the portion of ElectedEarnings to the exempt income and the applicable tax rate prescribed by the Investment Law. In addition to the reduced tax rate, a distribution of ElectedEarnings would be subject to a 15% withholding tax. The Trapped Earnings Law provides an exemption from the 15% withholding tax for a distribution toan Israeli resident company from companies which have elected the Beneficiary Enterprise status and waived their Approved Enterprise and BeneficiaryEnterprise Status through June 2015. At this time, we do not believe the Trapped Earnings law has any effects on our financial statements.To be eligible for tax benefits under the investment programs, we must meet certain conditions, relating principally to adherence to the investmentprogram filed with the investment Center of the Israeli Ministry of Industry and Trade and to periodic reporting obligations. We believe that our investmentprograms are currently in compliance with these requirements. However, if we fail to meet these requirements, we would be subject to corporate tax in Israel atthe regular statutory rate (25%, 24% and 25% for 2010, 2011 and 2012, respectively). We also could be required to refund tax benefits, with interest andadjustments for inflation based on the Israeli consumer price index.In connection with the CIPT Acquisition, we received a tax ruling from the Swiss tax authorities with respect to the taxable income generated by ourSwiss subsidiary, including the amortization period for tax purposes of goodwill and all other intangible assets acquired in the CIPT Acquisition by our Swisssubsidiary. Pursuant to the tax ruling, our Swiss subsidiary is entitled to reduced tax rates of approximately 10% to 15%, depending on the source of income,and tax amortization period of up to 10 years for the goodwill and other intangible assets acquired in the CIPT Acquisition by our Swiss subsidiary.LIQUIDITY AND CAPITAL RESOURCESOperating Activities. We generated $10.2 million of cash and cash equivalents from our operating activities during 2012. In 2011, we used $0.6million of cash and cash equivalents from operating activities, and in 2010 we generated $22.3 million of cash and cash equivalents from operating activities.The increase in net cash generated by operating activities for 2012, as compared to 2011, was mainly as a result of (i) a decrease in net loss, excluding non-cash items, such as depreciation, equity-based compensation expenses, amortization of intangible assets and a gain from remeasurement to fair value of aninvestment as a result of a business combination, in the amount of $1.0 million, (ii) a decrease in trade receivable in the amount of $5.3 million during 2012,as compared to an increase in trade receivable in the amount of $0.6 million during 2011, (iii) a decrease in other accounts receivable and prepaid expenses inthe amount of $2.2 million during 2012, as compared to a decrease in other accounts receivable and prepaid expenses in the amount of $0.5 million during2011, (iv) a decrease in inventories in the amount of $3.5 million during 2012, as compared to a decrease in inventories in the amount of $2.4 million during2011, and (v) an increase in accrued compensation and benefits in the amount of $1.3 million during 2012, as compared to a decrease in accruedcompensation and benefits in the amount of $1.6 million during 2011. The increase in the amount of cash generated from operating activities for 2012, ascompared to 2011, was offset to some extent by a decrease in trade payable in the amount of $4.0 million during 2012, as compared to an increase in tradepayable in the amount of $1.2 million during 2011. The decrease in net cash provided by operating activities for 2011, as compared to 2010, was mainly as aresult of (i) an increase in net loss, excluding non-cash items, such as depreciation, equity-based 48Table of Contentscompensation expenses, amortization of intangible assets and other income, in the amount of $16.3 million for 2011, as compared to 2010, (ii) an increase inaccounts receivable by $0.6 million during 2011, as compared to a decrease in accounts receivable of $3.0 million during 2010, (iii) a decrease in otheraccounts receivable and prepaid expenses of $0.5 million during 2011, as compared to a decrease in other accounts receivable and prepaid expenses of $8.0million during 2010, mainly due to a higher amount of advances that were returned from tax authorities in 2010 as compared to 2011, and (iv) a decrease inaccrued compensation and benefits of $1.6 million during 2011, as compared to an increase in accrued compensation and benefits of $3.0 million during2010. The decrease in the amount of cash generated from operating activities for 2011, as compared to 2010, was offset to some extent by a decrease ininventories of $2.4 million during 2011, as compared to an increase in inventories of $6.5 million during 2010.Investing Activities. We invest excess cash in marketable securities of varying maturities, depending on our projected cash needs for operations,capital expenditures and other business purposes. During 2012, we purchased $78.2 million of investments in marketable securities and deposits, ascompared to $86.0 million during 2011 and $95.5 million during 2010. During the same periods, $25.9 million, $68.1 million and $35.2 million,respectively, of investments in marketable securities matured and were called by the issuer. During the same periods, $39.1 million, $11.9 million and $25.4million, respectively, of investments in marketable securities were sold. Additionally, during 2012, 2011 and 2010, $15.7 million, $10.0 million and $12.5million, respectively, of short term deposits matured.As of December 31, 2012, the amortized cost of our marketable securities and deposits was $97.6 million and their stated market value was $98.5million, representing an unrealized gain of $0.9 million.During November 2009, we made an investment of $2.2 million in BoneTone in return for approximately 30% of the then outstanding equity of thecompany, on a fully diluted basis. We also had the option to acquire the remaining equity of BoneTone within a 24-month period. In December 2011, weexercised our option to acquire the remaining 70% equity interest of BoneTone, on a fully diluted basis, for a net purchase price of $8.3 million ($8.6 millionwas paid, net of cash and cash equivalents of $0.3 million that was in the company on the date of the acquisition).Our capital equipment purchases for 2012, consisting primarily of research and development software tools, computers and other peripheral equipment,engineering test and lab equipment, leasehold improvements, furniture and fixtures, totaled $1.1 million, as compared to $2.3 million for 2011, and $3.5million for 2010.Financing Activities. During 2012, we repurchased 1.3 million shares of our common stock at an average purchase price of $6.28 per share for anaggregate amount of $8.06 million. No exercises of employee stock options were executed during 2012. We cannot predict cash flows from exercises of stockoptions for future periods.During 2011, we repurchased 1.3 million shares of our common stock at an average purchase price of $6.74 per share for an aggregate amount of$8.75 million. In addition, we received $0.4 million upon the exercise of employee stock options. During 2010, we repurchased 111,000 shares of ourcommon stock at an average purchase price of $7.74 per share for an aggregate amount of $0.9 million. In addition, we received $0.3 million upon the exerciseof employee stock options.Pursuant to authorizations in March 1999, July 2003, October 2004, January 2007 and January 2008, our board of directors authorized a sharerepurchase program for the repurchase of an aggregate of 14.9 million shares of our common stock. Also in January 2008, our board of directors approved thecompany’s entry into a share repurchase plan, in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, for the repurchase of 5.0 million of theaggregate shares of our common stock authorized for repurchase, which plan has since expired. In October 2010, our board of directors authorized an increasein the number of shares available for repurchase, thereby increasing the aggregate number of shares authorized for repurchase under our share repurchaseprogram to two million shares. In July 2011, our board of directors authorized an increase in our share repurchase program by one million shares of commonstock. 49Table of ContentsAt December 31, 2012, approximately 0.3 million shares of our common stock remained available for repurchase under our board authorized sharerepurchase program.As of December 31, 2012, we had cash and cash equivalents totaling approximately $21.7 million and marketable securities and time deposits ofapproximately $98.5 million. We believe that our available cash and cash equivalents at December 31, 2012 should be sufficient to finance our operations forthe foreseeable future.Our working capital at December 31, 2012 was approximately $49.1 million, as compared to $60.0 million as of December 31, 2011. The decrease inworking capital was mainly due to the repurchase of our common stock in the amount of $8.06 million during 2012 and the replacement of short termmarketable securities and deposits with long term marketable securities, offset to some extent by the cash and cash equivalents generated during 2012 from ouroperating activities.In addition, as part of our business strategy, we may evaluate potential acquisitions of businesses, products and technologies. Accordingly, a portion ofour available cash may be used at any time for the acquisition of complementary products or businesses. Such potential transactions may require substantialcapital resources, which may require us to seek additional debt or equity financing. We cannot assure that we will be able to successfully identify suitableacquisition candidates, complete acquisitions, integrate acquired businesses into our current operations, or expand into new markets. Furthermore, we cannotassure that additional financing will be available to us in any required time frame and on commercially reasonable terms, if at all. See the section of the riskfactors entitled “We may engage in future acquisitions that could dilute our stockholders’ equity and harm our business, results of operations and financialcondition.” for more detailed information.Contractual Obligations –The following table aggregates our material expected obligations and commitments as of December 31, 2012 (in thousands): Payment Due By Period Contractual Obligations Total Less Than1 Year 2-3 Years 4-5 Years More Than5 Years Operating Lease Commitments(1) $11,267 $2,923 $3,995 $3,032 1,317 Net Pension Liability(2) 1,610 67 77 60 $1,406 Development tools lease(3) 975 975 Total Contractual Obligations $13,852 $3,965 $4,072 $3,092 $2,723 (1)Represents mainly operating lease payments for facilities and vehicles under non-cancelable lease agreements. See Note 12 to notes to our consolidatedfinancial statements for the year ended December 31, 2012.(2)Includes estimates of gross contributions and future payments required to meet the requirements of several defined benefit plans. The amounts presentedin the table are not discounted and do not take into consideration staff turnover assumptions.(3)Represents lease payments for development tools under non-cancelable lease agreements.At December 31, 2012, we had a liability for unrecognized tax benefits and an accrual for the payment of related interests totaling $1.8 million. Due touncertainties related to those tax matters, we currently are unable to make a reasonably reliable estimate of when cash settlement with a taxing authority willoccur.Off-Balance Sheet ArrangementsWe do not have any off-balance sheet arrangements, as such term is defined in recently enacted rules by the Securities and Exchange Commission, thathave or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results ofoperations, liquidity, capital expenditures or capital resources that are material to investors. 50Table of ContentsItem 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKInterest Rate Risk. It is our policy not to enter into interest rate derivative financial instruments, except for hedging of foreign currency exposuresdiscussed below. We do not currently have any significant interest rate risk since we do not have any financial obligations.The majority of our cash and cash equivalents are invested in high grade certificates of deposits with major U.S., European and Israeli banks.Generally, cash and cash equivalents and short term deposits may be redeemed and therefore minimal credit risk exists with respect to them. Nonetheless,cash deposits with these banks exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limits in the U.S. or similar limits in foreignjurisdictions, to the extent such deposits are even insured in such foreign jurisdictions. While we monitor on a systematic basis the cash balances and adjustthe balances as appropriate, these balances could be impacted if one or more of the financial institutions with which we deposit our funds fails or is subject toother adverse conditions in the financial or credit markets. To date we have experienced no loss of principal or lack of access to our cash; however, we canprovide no assurances that access to our cash will not be affected if the financial institutions that we hold our cash fail or the financial and credit marketscontinue to worsen.We hold an investment portfolio of marketable securities consisting principally of debentures of U.S. and European corporations, and state and politicalsubdivisions of the U.S. government. We intend, and have the ability, to hold investments in marketable securities with a decline in fair value until ananticipated recovery of any temporary declines in their market value. We typically do not attempt to reduce or eliminate our market exposures on ourinvestment securities because the majority of our investments are short-term. However, we can provide no assurances that we will recover present declines inthe market value of our investments.Interest rate fluctuations relating to our cash and cash equivalents and within our investment portfolio have not had, and we do not currently anticipatesuch fluctuations will have, a material affect on our financial position on an annual or quarterly basis.Foreign Currency Exchange Rate Risk. A significant part of our sales and expenses are denominated in U.S. dollars. Part of our expenses in Israelis paid in NIS, which subjects us to the risks of foreign currency fluctuations between the U.S. dollar and the NIS. Our primary expenses paid in NIS areemployee salaries and lease payments on our Israeli facilities. Furthermore, due to the Acquisition, a portion of our expenses for our European operations arepaid in the Euro, which subjects us to the risks of foreign currency fluctuations between the U.S. dollar and the Euro. Our primary expenses paid in Euro areemployee salaries, lease and operational payments on our European facilities. To partially protect the company against an increase in value of forecastedforeign currency cash flows resulting from salary and lease payments denominated in NIS during 2012, we instituted a foreign currency cash flow hedgingprogram. The option and forward contracts used are designated as cash flow hedges, as defined by FASB ASC No. 815,” Derivatives and Hedging,” and areall effective as hedges of these expenses. For more information about our hedging activity, see Note 2 to our notes to our consolidated financial statement for theyear ended December 31, 2012. An increase in the value of the NIS and the Euro in comparison to the U.S. dollar could increase the cost of our research anddevelopment expenses and general and administrative expenses, all of which could harm our operating profit. Although we currently are using a hedgingprogram to minimize the effects of currency fluctuations relating to the NIS, our hedging position is partial, may not exist at all in the future and may notsucceed in minimizing our foreign currency fluctuation risks. 51Table of ContentsItem 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATACONSOLIDATED FINANCIAL STATEMENTSAS OF DECEMBER 31, 2012IN U.S. DOLLARSINDEX Page Reports of Independent Registered Public Accounting Firm 53 Consolidated Balance Sheets 56 Consolidated Statements of Operations 58 Consolidated Statements of Comprehensive Loss 59 Statements of Changes in Stockholders’ Equity 60 Consolidated Statements of Cash Flows 62 Notes to Consolidated Financial Statements 64 52Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMThe Board of Directors and Stockholders ofDSP GROUP, INC.We have audited the accompanying consolidated balance sheets of DSP Group, Inc. (the “Company”) as of December 31, 2012 and 2011, and therelated consolidated statements of operations, comprehensive loss, changes in stockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and scheduleare the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on ouraudits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of theCompany at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period endedDecember 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, whenconsidered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), DSP Group, Inc.’sinternal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our report dated March 18, 2013 expressed an unqualified opinion thereon. /s/ KOST FORER GABBAY & KASIERERKOST FORER GABBAY & KASIERERA Member of Ernst & Young GlobalTel-Aviv, IsraelMarch 18, 2013 53Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMThe Board of Directors and Stockholders ofDSP GROUP INC.We have audited DSP Group, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2012, based on criteria established inInternal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). TheCompany’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internalcontrol over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility isto express an opinion on the Company’s internal control over financial reporting based on our audit.We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weaknessexists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are beingmade only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluationof effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based onthe COSO criteria. 54Table of ContentsWe also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balancesheets of the Company as of December 31, 2012 and 2011, and the related consolidated statements of operations, changes in stockholders’ equity and cashflows for each of the three years in the period ended December 31, 2012 and our report dated March 18, 2013 expressed an unqualified opinion thereon. /s/ KOST FORER GABBAY & KASIERERKOST FORER GABBAY & KASIERERA Member of Ernst & Young GlobalTel-Aviv, IsraelMarch 18, 2013 55Table of ContentsDSP GROUP, INC.CONSOLIDATED BALANCE SHEETSU.S. dollars in thousands December 31, 2012 2011 ASSETS CURRENT ASSETS: Cash and cash equivalents $21,684 $18,109 Restricted deposits 121 128 Marketable securities and short-term deposits (Note 3) 20,201 30,626 Trade receivables 20,403 25,643 Deferred income taxes 101 89 Other accounts receivable and prepaid expenses (Note 4) 3,656 5,343 Inventories (Note 5) 12,916 16,434 Total current assets 79,082 96,372 PROPERTY AND EQUIPMENT, NET (Note 6) 3,706 5,803 LONG-TERM ASSETS: Long-term marketable securities (Note 3) 78,333 69,046 Long-term prepaid expenses and lease deposits 208 466 Severance pay fund 10,197 9,974 Intangible assets, net (Note 7) 8,380 10,688 Goodwill 5,276 5,276 102,394 95,450 Total assets $185,182 $197,625 The accompanying notes are an integral part of the consolidated financial statements. 56Table of ContentsDSP GROUP, INC.CONSOLIDATED BALANCE SHEETSU.S. dollars in thousands, except share and per share data December 31, 2012 2011 LIABILITIES AND STOCKHOLDERS’ EQUITY CURRENT LIABILITIES: Trade payables $14,027 $17,989 Accrued compensation and benefits 7,545 8,236 Income tax accruals and payables 1,894 2,582 Accrued expenses and other accounts payable 6,514 7,555 Total current liabilities 29,980 36,362 LONG-TERM LIABILITIES: Deferred income taxes 1,569 1,569 Accrued severance pay 10,436 10,278 Accrued pensions (Note 9) 970 792 Total long-term liabilities 12,975 12,639 COMMITMENTS AND CONTINGENCIES (Note 12) STOCKHOLDERS’ EQUITY (Note 11): Capital stock: Preferred stock, $0.001 par value—Authorized: 5,000,000 shares at December 31, 2012 and 2011; Issuedand outstanding: none at December 31, 2012 and 2011 — — Common stock, $0.001 par value—Authorized: 50,000,000 shares at December 31, 2012 and 2011; Issuedand outstanding: 21,673,779 and 22,501,644 shares at December 31, 2012 and 2011, respectively 22 23 Additional paid-in capital 346,335 341,352 Treasury stock (125,724) (122,236) Accumulated other comprehensive income (loss) 988 (1,756) Accumulated deficit (79,394) (68,759) Total stockholders’ equity 142,227 148,624 Total liabilities and stockholders’ equity $185,182 $197,625 The accompanying notes are an integral part of the consolidated financial statements. 57Table of ContentsDSP GROUP, INC.CONSOLIDATED STATEMENTS OF OPERATIONSU.S. dollars in thousands, except share and per share data Year ended December 31, 2012 2011 2010 Revenues $162,790 $193,861 $225,482 Costs of revenues(1) 101,660 123,734 137,571 Gross profit 61,130 70,127 87,911 Operating expenses: Research and development, net(2) 42,539 53,244 55,588 Sales and marketing(3) 14,237 16,497 17,199 General and administrative(4) 10,638 12,920 14,362 Amortization of intangible assets 2,310 7,972 9,975 Restructuring expenses (income) 2,008 (170) 463 Total operating expenses 71,732 90,463 97,587 Operating loss (10,602) (20,336) (9,676) Financial income, net 2,388 1,885 1,468 Other income from remeasurement of investment in a business combination — 1,343 — Loss before income tax benefit (8,214) (17,108) (8,208) Income tax benefit (172) (866) (783) Net loss $(8,042) $(16,242) $(7,425) Net loss per share: Basic and diluted $(0.37) $(0.70) $(0.32) Weighted average number of shares used in per share computations of net loss per share: Basic and diluted 21,950 23,247 23,229 (1)Includes equity-based compensation expense in the amount of $330, $403 and $704 for the years ended December 31, 2012, 2011 and 2010,respectively.(2)Includes equity-based compensation expense in the amount of $2,425, $2,767 and $4,712 for the years ended December 31, 2012, 2011 and 2010,respectively.(3)Includes equity-based compensation expense in the amount of $778, $987 and $1,493 for the years ended December 31, 2012, 2011 and 2010,respectively.(4)Includes equity-based compensation expense in the amount of $1,450, $2,063 and $2,644 for the years ended December 31, 2012, 2011 and 2010,respectively.The accompanying notes are an integral part of the consolidated financial statements. 58Table of ContentsDSP GROUP, INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS(U.S. dollars in thousands) Year Ended December 31, 2012 2011 2010 Net loss: $(8,042) $(16,242) $(7,425) Other comprehensive income: Available-for-sale securities: Changes in unrealized gains (losses) 2,621 (809) (1,188) Reclassification adjustments for (gains) losses included in net loss (670) (155) (67) Net change 1,951 (964) (1,255) Cash flow hedges: Changes in unrealized gains (losses) 635 (325) 772 Reclassification adjustments for (gains) losses included in net loss 325 (625) (525) Net change 960 (950) 247 Change in unrealized components of defined benefit plans: Losses arising during the period (161) (1) (516) Amortization of actuarial loss and prior service benefit 2 2 (22) Curtailments, settlements and other — 36 — Net change (159) 37 (538) Foreign currency translation adjustments, net (8) (234) (273) Other comprehensive income (loss) 2,744 (2,111) (1,819) Comprehensive loss $(5,298) $(18,353) $(9,244) 59Table of ContentsDSP GROUP INC.STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYU.S. dollars and shares in thousands, except share data Number ofshares ofcommonstock Commonstockamount Additionalpaid-incapital Treasurystock Accumulatedothercomprehensiveincome (loss) Accumulateddeficit Totalstockholders’equity Balance at January 1, 2010 22,901 $23 $325,579 $(123,350) $2,174 $(38,937) $165,489 Issuance of treasury stock upon purchase of commonstock under employee stock purchase plan 388 *)— — 4,138 — (2,293) 1,845 Issuance of treasury stock upon exercise of stockoptions and stock appreciation rights byemployees and directors 75 *)— — 794 — (472) 322 Purchase of treasury stock (111) *)— — (862) — — (862) Equity-based compensation expenses — — 9,553 — — — 9,553 Net loss — — — — — (7,425) (7,425) Change in Accumulated other comprehensiveloss — — — — (1,819) — (1,819) Balance at December 31, 2010 23,253 $23 $335,132 $(119,280) $355 $(49,127) $167,103 *) Represents an amount lower than $1.The accompanying notes are an integral part of the consolidated financial statements. 60Table of ContentsDSP GROUP, INC.STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYU.S. dollars and shares in thousands, except share data Number ofshares ofcommonstock Commonstockamount Additionalpaid-incapital Treasurystock Accumulatedothercomprehensiveincome (loss) Accumulateddeficit Totalstockholders’equity Cont. Balance at December 31, 2010 23,253 $23 $335,132 $(119,280) $355 $(49,127) $167,103 Issuance of treasury stock upon purchase of commonstock under employee stock purchase plan 423 1 — 4,483 — (2,448) 2,036 Issuance of treasury stock upon exercise of stockoptions and stock appreciation rights byemployees and directors 124 *)— — 1,309 — (942) 367 Purchase of treasury stock (1,298) (1) — (8,748) — — (8,749) Equity-based compensation expenses — — 6,220 — — — 6,220 Net loss — — — — — (16,242) (16,242) Change in Accumulated other comprehensiveloss — — — — (2,111) — (2,111) Balance at December 31, 2011 22,502 23 341,352 (122,236) (1,756) (68,759) 148,624 Issuance of treasury stock upon purchase of commonstock under employee stock purchase plan 446 *)— — 4,485 — (2,507) 1,978 Issuance of treasury stock upon exercise of stockoptions and stock appreciation rights byemployees and directors 9 *)— — 86 — (86) — Purchase of treasury stock (1,283) (1) — (8,059) — — (8,060) Equity-based compensation expenses — — 4,983 — — — 4,983 Net loss — — — — — (8,042) (8,042) Change in Accumulated other comprehensiveincome — — — — 2,744 — 2,744 Balance at December 31, 2012 21,674 $22 $346,335 $(125,724) $988 $(79,394) $142,227 *) Represents an amount lower than $1.The accompanying notes are an integral part of the consolidated financial statements. 61Table of ContentsDSP GROUP, INC.CONSOLIDATED STATEMENTS OF CASH FLOWSU.S. dollars in thousands Year ended December 31, 2012 2011 2010 Cash flows from operating activities: Net loss $(8,042) $(16,242) $(7,425) Adjustments required to reconcile net loss to net cash provided by operating activities: Depreciation 3,168 4,244 5,732 Equity-based compensation expenses related to employees’ stock options and SARs 4,983 6,220 9,553 Capital loss (gain) from sale and disposal of property and equipment (57) 22 (40) Gain from sale of marketable securities (670) (155) (67) Amortization of intangible assets 2,310 7,972 9,975 Accrued interest and amortization of premium on marketable securities and short-term deposits 1,295 1,267 531 Gain from remeasurement to fair value of investment as a result of business combination — (1,343) — Change in operating assets and liabilities: Deferred income tax assets, net (12) 32 65 Trade receivables, net 5,281 (562) 3,010 Other accounts receivable and prepaid expenses 2,175 502 8,019 Inventories 3,535 2,395 (6,505) Long-term prepaid expenses and lease deposits 264 175 (39) Trade payables (3,965) (1,216) 903 Accrued compensation and benefits 1,277 (1,562) 3,044 Income tax accruals and payables (705) (1,179) (390) Accrued expenses and other accounts payable (567) (463) (4,085) Accrued severance pay, net (65) (783) 32 Accrued pensions — 78 20 Net cash (used in) provided by operating activities 10,205 (598) 22,333 Cash flows from investing activities: Purchase of marketable securities (75,483) (73,002) (95,510) Purchase of deposits (2,670) (13,000) — Proceeds from maturity of marketable securities 25,911 68,072 35,180 Proceeds from sales of marketable securities 39,063 11,910 25,352 Proceeds from maturity of deposits 15,643 10,000 12,500 Proceeds from sales of property and equipment 81 59 48 Purchases of property and equipment (1,094) (2,317) (3,463) Acquisition of initially consolidated subsidiary(1) — (8,320) — Net cash (used in) provided by investing activities 1,451 (6,598) (25,893) The accompanying notes are an integral part of the consolidated financial statements. 62Table of ContentsDSP GROUP INC.CONSOLIDATED STATEMENTS OF CASH FLOWSU.S. dollars in thousands Year ended December 31, 2012 2011 2010 Cash flows from financing activities: Issuance of common stock and treasury stock upon exercise of stock options and SARs — 367 322 Purchase of treasury stock (8,060) (8,749) (862) Net cash used in financing activities (8,060) (8,382) (540) Increase (decrease) in cash and cash equivalents 3,596 (15,578) (4,100) Cash and cash equivalents at the beginning of the year 18,109 33,912 37,986 Cash (erosion) due to exchange rate differences (21) (225) 26 Cash and cash equivalents at the end of the year $21,684 $18,109 $33,912 Supplemental disclosures of cash flows activities: Cash paid during the year for: Taxes on income $145 $332 $424 (1)The net fair value of the assets acquired and the liabilities assumed, on the date of acquisition of BoneTone Communications Ltd. (“BoneTone”), was asfollows: Year endedDecember 31,2011 Working capital, excluding cash and cash equivalents $(91) Property and equipment 26 Long-Term deferred tax liabilities, net (1,569) In-process R&D 7,702 Non-competition agreement 519 Goodwill 5,276 11,863 The acquisition date fair value of the Company’s previously held equity interest inBoneTone (3,543) $8,320 The accompanying notes are an integral part of the consolidated financial statements. 63Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSU.S. dollars in thousands, except share and per share dataNOTE 1:- GENERALDSP Group, Inc. (the “Company”), a Delaware corporation, and its subsidiaries, collectively, are a fabless semiconductor company offering advancedchipset solutions for a variety of applications. The Company is a worldwide leader in the short-range wireless communication market, enabling homenetworking convergence for voice, audio, video and data.All of the Company’s integrated circuit products are manufactured and tested by independent foundries and test houses. While these foundries and testhouses have been able to adequately meet the demands of the Company’s business, the Company is and will continue to be dependent upon these foundriesand test houses to achieve acceptable manufacturing yields, quality levels and costs, and to allocate to the Company a sufficient portion of foundry and testcapacity to meet the Company’s needs in a timely manner. Revenues could be materially and adversely affected should any of these foundries and test housesfail to meet the Company’s request for product manufacturing due to a shortage of production capacity, process difficulties, low yield rates or financialinstability. Additionally, certain of the raw materials, components, and subassemblies included in the products manufactured by the Company’s originalequipment manufacturer (OEM) customers, which 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 and could negatively affect the Company’s financial condition and results ofoperations.The Company sells its products primarily through distributors and directly to OEMs and original design manufacturers (ODMs) who incorporate theCompany’s products into consumer products. The Company’s future performance will depend, in part, on the continued success of its distributors inmarketing and selling its products. The loss of the Company’s distributors and the Company’s inability to obtain satisfactory replacements in a timelymanner may harm the Company’s sales and results of operations. In addition, the Company expects that a limited number of customers, varying in identityfrom period-to-period, will account for a substantial portion of its revenues in any period. The loss of, or reduced demand for products from, any of theCompany’s major customers could have a material adverse effect on the Company’s business, financial condition and results of operations.Sales to Hong Kong-based VTech Holdings Ltd. (“VTech”) represented 35%, 33% and 31% of the Company’s total revenues for 2012, 2011 and 2010,respectively. Revenues derived from sales through one distributor, Tomen Electronics Corporation (“Tomen Electronics”), accounted for 21%, 19% and 25%of the Company’s total revenues for 2012, 2011 and 2010, respectively. Tomen Electronics sells the Company’s products to a limited number of customers.One customer, Panasonic Communications Co., Ltd. (“Panasonic”), has continually accounted for a majority of the sales of Tomen Electronics. Sales toPanasonic through Tomen Electronics generated approximately 15%, 13% and 16% of the Company’s total revenues for 2012, 2011 and 2010, respectively.Additionally, sales to Uniden America Corporation (“Uniden”) represented 11%, 10% and 9% of the Company’s total revenues for 2012, 2011 and 2010,respectively. Sales to CCT Telecom Holdings Ltd. represented 8%, 11% and 10% of the Company’s total revenues for 2012, 2011 and 2010, respectively. TheJapanese and Hong Kong markets and the OEMs that operate in those markets are among the largest suppliers in the world with significant market share inthe U.S. market for residential wireless products.Acquisition of BoneTone CommunicationsIn November 2009, the Company made an investment of $2,200 in BoneTone Communications Ltd. (“BoneTone”), an Israeli private company andprovider of innovative chip solutions that redefine audio quality and voice intelligibility in mobile devices and headsets, in return for approximately 30% of theequity of 64Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data BoneTone, on a fully diluted basis. The Company also signed a call option agreement pursuant to which the Company had the option to purchase from allholders of BoneTone all of the remaining outstanding securities for a period of 24 months commencing on the closing date of the initial investment.On December 1, 2011, the Company exercised the option and acquired the remaining equity of BoneTone for a net purchase price of $8,600 (the“BoneTone Acquisition”).The BoneTone Acquisition has been accounted for using the purchase method of accounting as determined by Financial Accounting Standards Board(“FASB”) Accounting Standards Code (“ASC”) 805, “Business Combinations.” Accordingly, the purchase price has been allocated to the assets acquired andthe liabilities assumed based on the estimated fair value on the date of the acquisition.Subsequent to the BoneTone Acquisition and as a result of the remeasurement of the initial 30% equity interest in BoneTone in accordance with ASC805-25, the Company recorded other income in the amount of $1,343 that was calculated as follows: The acquisition-date fair value of the equity interest immediately before the acquisition date $3,543 Equity interest immediately before the acquisition date on a cost basis (2,200) Gain as a result of remeasuring the fair value of the equity interest $1,343 The Company used an income approach to measure the acquisition-date fair value of the equity interest in BoneTone held by the Company immediatelybefore the acquisition date.The BoneTone Acquisition provides the Company with diversification and cutting-edge technology in the promising and fast-growing mobile devicesmarket.The results of operations of BoneTone have been included in the Company’s consolidated financial statements since December 1, 2011.Based upon a valuation of the tangible and intangible assets acquired and liabilities assumed, the Company has allocated the total purchase price of theBoneTone Acquisition as follows: December 1, 2011 Cash $267 Other current assets 32 Property and equipment 26 Other non-current assets 68 Current liabilities (107) Long-term deferred tax liability, net (1,569) Accrued severance pay (73) Net liabilities assumed (1,356) Intangible assets: In-process research and development 7,702 Non-competition agreement 519 Total intangible assets 8,221 Goodwill - 5,276 Net assets acquired $12,141 65Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data In performing the purchase price allocation, the Company considered, among other factors, the intention for future use of the acquired assets, analysesof historical financial performance and estimates of future performance of BoneTone products. The fair value of the intangible assets was based on a valuationcompleted by a third party valuation firm using an income approach and estimates and assumptions provided by management.The amount allocated to in-process research and development (“IPR&D”) was determined using the income approach, on the basis of the present valueof cash flows attributable to the IPR&D. The guidance in ASC 350 “Intangibles—Goodwill and Other” specifies that intangible assets acquired in a businesscombination for use in a particular R&D project are considered indefinite-lived intangible assets until the completion or abandonment of the associated R&Defforts. Accordingly, during the development period after the BoneTone Acquisition, these assets should not be amortized but, instead, should be subject toimpairment review and testing provisions of ASC 350-30-35-18 and 35-18A for indefinite-lived intangibles.Upon completion of the development process for the acquired R&D, the associated assets will be considered to be finite-lived intangible assets andamortized on a straight line basis over its expected future life. The expected future life period is estimated based on the duration of the cash flow associated withthe technologies created by the IPR&D once they are completed and start generating revenues.The amount assigned to the non-competition agreement relates to the non-competition agreement that the Company entered into with the founder ofBoneTone in connection with the BoneTone Acquisition, which was determined using the income approach and is amortized on a straight line basis over threeyears, which represents the non-competition period between the Company and BoneTone founder.The excess of the purchase price of $5,276 over the net tangible assets and identifiable intangible assets acquired in the BoneTone Acquisition isrecognized as goodwill. An acquired workforce and control premium that did not meet the separability criteria have been included in the amount assigned togoodwill. The goodwill recognized represents mainly the synergies the Company expects from the BoneTone Acquisition, both in revenues and expenses, andthe expected benefits to the Company from the acquisition. The goodwill associated with the BoneTone Acquisition is expected not to be deductible for taxpurposes.NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES a.Use of estimates:The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates,judgments and assumptions. The Company’s management believes that the estimates, judgments and assumptions used are reasonable based uponinformation available at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect thereported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts ofrevenue and expenses during the reporting period. Actual results could differ from those estimates. b.Financial statements in U.S. dollars:Most of the revenues of the Company and its subsidiaries are generated in U.S. dollars (“dollar”). In addition, a substantial portion of the costs of theCompany and its subsidiaries are incurred in dollars. The Company’s management believes that the dollar is the currency of the primary economicenvironment in which the Company and its subsidiaries operate. Thus, the functional and reporting currency of the Company and its subsidiaries is thedollar. 66Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data Monetary accounts maintained in currencies other than the dollar are remeasured into dollars in accordance with ASC No. 830-30, “Translation ofFinancial Statements.” All transaction gains and losses resulting from the remeasurement of monetary balance sheet items are reflected in the consolidatedstatements of operations as financial income or expenses as appropriate.As a result of an acquisition of the Cordless and VoIP Terminals Business (the “CIPT Business”) of NXP B.V. (“NXP”) (the “CIPT Acquisition”), thefinancial statements of the Company’s subsidiary – DSP Group Technologies GmbH whose functional currency is not the dollar, has been translated intodollars. All amounts on the balance sheets have been translated into the dollar using the exchange rates in effect on the relevant balance sheet dates. All amountsin the consolidated statements of operations have been translated into the dollar using the average exchange rate for the relevant periods. The resultingtranslation adjustments are reported as a component of accumulated other comprehensive income (loss) in changes in stockholders’ equity.Accumulated other comprehensive loss related to foreign currency translation adjustments, net amounted to $183 and $175 as of December 31, 2012and 2011, respectively. c.Principles of consolidation:The consolidated financial statements include the accounts of the Company and its subsidiaries. Intracompany transactions and balances have beeneliminated in consolidation. d.Cash and cash equivalents:The Company and its subsidiaries consider all highly liquid investments, which are readily convertible to cash with a maturity of three months or lesson the date of acquisition, to be cash equivalents. e.Restricted deposits:Restricted deposits include cash which is used as security for one of the Company’s lease agreements. f.Short-term deposits:Bank deposits with original maturities of more than three months and less than one year are presented at cost, including accrued interest. g.Marketable securities:The Company and its subsidiaries account for investments in debt securities in accordance with FASB ASC No. 320-10, “Investments in Debt andEquity Securities.” Management determines the appropriate classification of the Company’s investments in debt securities at the time of purchase andreevaluates such determinations at each balance sheet date.The Company classified all of its investments in marketable securities as available for sale.Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of taxes, reported in other comprehensive income (loss)using the specific identification method. Unrealized losses determined to be other-than-temporary are recorded as a financial expense. The amortized cost ofmarketable securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in financial income.Interest and dividends on securities are included in financial income. 67Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data The marketable securities are periodically reviewed for impairment. If management concludes that any of these investments are impaired, managementdetermines whether such impairment is other-than-temporary. Factors considered in making such a determination include the duration and severity of theimpairment, the reason for the decline in value and the potential recovery period, and the Company’s intent to sell, or whether it is more likely than not that theCompany will be required to sell the investment before recovery of cost basis. For debt securities, only the decline attributable to deteriorating credit of an-other-than-temporary impairment is recorded in the consolidated statement of operations, unless the Company intends, or more likely than not it will be forced, tosell the security. During the years ended December 31, 2012, 2011 and 2010, the Company did not record an-other-than-temporary impairment loss (see Note3). h.Fair value of financial instruments:Cash and cash equivalents, restricted deposits, short-term deposits, trade receivables, trade payables and accrued liabilities approximate fair value dueto short term maturities of these instruments. Marketable securities and derivative instruments are carried at fair value. See Note 3 for more information.Fair value is an exit price, representing the amount that would be received for selling an asset or paid to transfer a liability in an orderly transactionbetween market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participantswould use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used invaluation methodologies to measure fair value: Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.Level 2 — Include other inputs that are directly or indirectly observable in the marketplace.Level 3 — Unobservable inputs which are supported by little or no market activity.The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuringfair value. i.Inventories:Inventories are stated at the lower of cost or market value. Inventory reserves are provided to cover risks arising from slow-moving items or technologicalobsolescence.The Company and its subsidiaries periodically evaluate the quantities on hand relative to historical, current and projected sales volume. Based on thisevaluation, an impairment charge is recorded when required to write-down inventory to its market value.Cost is determined as follows:Work in progress—on the basis of raw materials and manufacturing costs on an average basis.Finished products—on the basis of raw materials and manufacturing costs on an average basis. 68Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data j.Property and equipment:Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is calculated using the straight-line method over the estimateduseful lives of the assets, at the following annual rates: %Computers and equipment 20 - 33Office furniture and equipment 7 - 10Motor vehicles 15Leasehold improvements Over the shorter of the related lease period or the life of the assetProperty and equipment of the Company and its subsidiaries are reviewed for impairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. The recoverability of assets to be held and used is measured by a comparison of the carrying amount ofsuch assets to the future undiscounted cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to berecognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.During the years ended December 31, 2012, 2011 and 2010, no impairment losses were identified for property and equipment.The Company accounts for costs of computer software developed or obtained for internal use in accordance with FASB ASC No. 350-40, “The InternalUse Software.” FASB ASC 350-40 requires the capitalization of certain costs incurred in connection with developing or obtaining internal use software. During2012, 2011 and 2010, the Company capitalized $22, $253 and $1,087, respectively, of internal use software cost. Such costs are amortized using thestraight-line method over their estimated useful life of three years. k.Goodwill and other intangible assetsThe goodwill and certain other purchased intangible assets have been recorded as a result of the BoneTone Acquisition and the CIPT Acquisition.Goodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangible assets acquired. Goodwill andindefinite-lived intangible assets (such as In-process R&D) are not amortized, but rather is subject to an annual impairment test. The Company performs anannual impairment test during the fourth quarter of each fiscal year, or more frequently if impairment indicators are present.For goodwill, the Company may first assess qualitative factors , in accordance with ASU 2011-08, to determine whether the existence of events orcircumstances leads to a determination that it is “more likely than not” that the fair value of the reporting unit is less than its carrying amount and whether thetwo-step impairment test on goodwill is required. If based upon qualitative factors it is “more likely than not” that the fair value of a reporting unit is greaterthan its carrying amount, it will not be required to proceed to a two-step impairment test on goodwill. However, the Company also has the option to proceeddirectly to a two-step impairment test on goodwill. In the first step of the two-step impairment test, the Company compares the fair value of each reporting unitto its carrying value. If the fair value exceeds the carrying value of the net assets, goodwill is considered not impaired and the Company is not required toperform further testing. If the carrying value of the net assets exceeds the fair value, then the Company must perform the second step of the two-stepimpairment test in order to determine the implied fair value of goodwill. If the carrying value of goodwill exceeds its implied fair value, then the Companywould record an impairment loss equal to the difference. 69Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data The Company’s reporting units are consistent with the reportable segments identified in Note 16.Fair value is determined using discounted cash flows, market multiples and market capitalization. Significant estimates used in the methodologiesinclude estimates of future cash-flows, future short-term and long-term growth rates, weighted average cost of capital and market multiples for the reportingunit.For indefinite-lived intangible assets, the Company also has the option to first assess qualitative factors to determine whether events and circumstancesindicate that it is more likely than not that the indefinite-lived intangible asset is impaired and determine whether further action is needed. For the fiscal yearended December 31, 2012, the Company performed a quantitative assessment on its indefinite-lived intangible assets and goodwill.Intangible assets that are not considered to have an indefinite useful life are amortized using the straight-line basis over their estimated useful lives,which range from 3 to 7.3 years. The carrying amount of these assets is reviewed whenever events or changes in circumstances indicate that the carrying valueof an asset may not be recoverable. Recoverability of these assets is measured by comparison of the carrying amount of the asset to the future undiscountedcash flows the asset is expected to generate.If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of theimpaired asset.During 2012, 2011 and 2010, no impairment losses were identified. l.Severance pay:DSP Group Ltd., the Company’s Israeli subsidiary (“DSP Israel”), has a liability for severance pay pursuant to Israeli law, based on the most recentmonthly salary of its employees multiplied by the number of years of employment as of the balance sheet date for such employees. DSP Israel’s liability isfully provided for by monthly accrual and deposits with severance pay funds and insurance policies.The deposited funds include profits accumulated up to the balance sheet date. The deposited funds may be withdrawn only upon the fulfillment of theobligation pursuant to Israel’s Severance Pay Law or labor agreements.Severance expenses for the years ended December 31, 2012, 2011 and 2010, were $1,660, $2,089 and $1,851, respectively. m.Employee benefit plan:The Company has a 401(K) deferred compensation plan covering all employees in the U.S. All eligible employees may elect to contribute up to 75% oftheir compensation to the plan through salary deferrals, subject to IRS limits. The maximum deferral for calendar year 2012 was $17 ($22.5 if the employeereached the age of 50 by December 31, 2012). The Company currently offers an employer matching program. The matching contribution currently is 50% onthe first 6% of compensation contributed per year. This matching contribution vests 25% per year over the first four years of the employee’s service in theCompany. Employer contribution to the plan for the years 2012, 2011 and 2010 was $28, $56 and $60, respectively. n.Revenue recognition:The Company and its subsidiaries generate their revenues from sales of products. The Company and its subsidiaries sell their products through a directsales force and through a network of distributors. 70Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data Product sales are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable,collectability is reasonably assured, and no significant obligations remain.Persuasive evidence of an arrangement exists—The Company’s sales arrangements with customers are pursuant to written documentation,either a written contract or purchaser order. The actual documentation used is dependent on the business practice with each customer. Therefore, theCompany determines that persuasive evidence of an arrangement exists with respect to a customer when it has a written contract, or a written purchaseorder from the customer.Delivery has occurred—Each written documentation relating to a sale arrangement that is agreed upon with the customer specifically sets forthwhen risk and title are being transferred (based on the agreed International Commercial terms, or “INCOTERMS”). Therefore, the Company determinesthat risk and title are transferred to the customer when the terms of the written documentation based on the applicable INCOTERMS are satisfied andthus delivery of its products has occurred.Separately, the Company has consignment inventory which is held for specific customers at the customers’ premises. It recognizes revenue on theconsigned inventory when the customer consumes the products from the warehouse, as that is when per the consignment inventory agreements, risk andtitle passes to the customer and the products are deemed delivered to the customer.The fee is fixed or determinable—Pursuant to the customer agreements, the Company does not provide any price protection, stock rotation, rightof return and/or other discount programs and thus the fee is considered fixed and determinable upon execution of the written documentation with thecustomers. Additionally, payments that are due within the normal course of the Company’s credit terms, which are currently no more than four monthsfrom the contract date, are deemed to be fixed and determinable based on the Company’s successful collection history for such arrangements.Collectibility is reasonably assured—The Company determines whether collectability is reasonably assured on a customer-by-customer basispursuant to its credit review policy. The Company typically sells to customers with whom it has a long-term business relationship and a history ofsuccessful collection. A significant number of the Company’s customers are also large original equipment manufacturers with substantial financialresources. For a new customer, or when an existing customer substantially expands its commitments, the Company evaluates the customer’s financialposition, the number of years the customer has been in business, the history of collection with the customer and the customer’s ability to pay andtypically assigns a credit limit based on that review. The Company increases the credit limit only after it has established a successful collection historywith the customer. If the Company determines at any time that collectability is not reasonably assured under a particular arrangement based upon itscredit review process, the customer’s payment history or information that comes to light about a customer’s financial position, it recognizes revenueunder that arrangement as customer payments are actually received.With respect to product sales through the Company’s distributors, such product revenues are deferred until the distributors resell the Company’sproducts to the end-customers (“sell through”) and recognized based upon receipt of reports from the distributors, provided all other revenue recognition criteriaas discussed above are met.The Company views its distributor arrangements as that of consignment because, although the actual sales are conducted through the distributors andlegally title for the products passes to the distributors upon delivery to the distributors, in substance inventory is simply being transferred to another locationfor sale to the end-user customers as the Company’s primary business relationships and responsibilities are directly with the end-user customers. Because theCompany views its arrangements with its distributors as that of consignment 71Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data relationships, delivery of goods is not deemed to have occurred solely upon delivery to the distributors. Therefore, the Company recognizes revenues fromdistributors under the “sell-through” method. As a result, revenue is deferred at the time of shipment to the distributors and is recognized only when thedistributors sell the products to the end-user customers. o.Warranty:The Company warrants its products against errors, defects and bugs for generally one year. The Company estimates the costs that may be incurredunder its warranty and records a liability in the amount of such costs. The Company periodically assesses the adequacy of its recorded warranty liabilitiesand adjusts the amounts as necessary. Warranty costs and liability were immaterial for the years ended December 31, 2012, 2011 and 2010. p.Research and development costs:Research and development costs, net of grants received, are charged to the consolidated statement of operations as incurred. q.Non-royalty bearing grants:In 2012, the Company received non-royalty-bearing grants from the Israeli Office of the Chief Scientist (“OCS”). The grants are not required to berepaid unless the technology that was developed using those grants will be sold directly or indirectly, and are recognized at the time the Company is entitled tosuch grants, on the basis of the costs incurred. These grants are recorded as a deduction of research and development costs and amounted to $386. r.Equity-based compensation:At December 31, 2012, the Company had three equity incentive plans from which the Company may grant future equity awards and two expired equityincentive plans from which no future equity awards may be granted but had outstanding equity awards granted prior to expiration. The Company also hadone employee stock purchase plan. See full description in Note 11.The Company accounts for equity-based compensation in accordance with FASB ASC No. 718, “Stock Compensation” (“FASB ASC No. 718”).FASB ASC No. 718 requires companies to estimate the fair value of equity-based awards on the date of grant using an option-pricing model. The value of theportion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in the Company’s consolidated statementsof operations.The Company recognizes compensation expenses for the value of its awards granted based on the accelerated attribution method, rather than a straight-line method over the requisite service period of each of the awards, net of estimated forfeitures. FASB ASC No. 718 requires forfeitures to be estimated at thetime of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Estimated forfeitures are based on actualhistorical pre-vesting forfeitures.FASB ASC No. 718 requires cash flows resulting from tax deductions in excess of the compensation costs recognized for those equity-based awards tobe classified as financing cash flows.The Company selected the lattice option pricing model as the most appropriate fair value method for its equity-based awards and values options andstock appreciation rights (SARs) based on the market value of the underlying shares on the date of grant. The option-pricing model requires a number ofassumptions, of which the 72Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data most significant are the expected stock price volatility and the expected term of the equity-based award. Expected volatility is calculated based upon actualhistorical stock price movements. The expected term of the equity-based award granted is based upon historical experience and represents the period of timethat the award granted is expected to be outstanding. The risk-free interest rate is based on the yield from U.S. treasury bonds with an equivalent term. TheCompany has historically not paid dividends and has no foreseeable plans to pay dividends. s.Basic and diluted loss per share:Basic net loss per share is computed based on the weighted average number of shares of common stock outstanding during the year. Diluted net lossesper share further include the dilutive effect of stock options and stock appreciation rights (SARs) outstanding during the year, all in accordance with FASBASC No. 260, “Earnings Per Share.”The total weighted average number of shares related to the outstanding stock options and SARs excluded from the calculation of diluted net loss pershare due to their anti-dilutive effect was 7,584,336, 7,980,475 and 8,751,751 for the years ended December 31, 2012, 2011 and 2010, respectively. t.Income taxes:The Company and its subsidiaries account for income taxes in accordance with FASB ASC No. 740, “Income Taxes.” This topic prescribes the use ofthe liability method, whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and tax bases ofassets and liabilities and are measured using the enacted tax rates that will be in effect when the differences are expected to reverse. The Company and itssubsidiaries provide a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value.Deferred tax liabilities and assets are classified as current or non-current based on the classification of the related asset or liability for financial reporting,or according to the expected reversal dates of the specific temporary differences if not related to an asset or liability for financial reporting.The Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. TheCompany recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense. u.Concentrations of credit risk:Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, short-termdeposits, trade receivables, long-term lease deposits and marketable securities.The majority of cash and cash equivalents and short-term deposits of the Company and its subsidiaries is invested in dollar deposits with major U.S.,European and Israeli banks. Such cash and cash equivalents in U.S. banks may be in excess of insured limits and are not insured in other jurisdictions.Generally, cash and cash equivalents and short-term deposits may be redeemed on demand and therefore a minimal credit risk exists with respect to thesedeposits and investments.The Company’s marketable securities consist of investment-grade corporate bonds and U.S. government-sponsored enterprise (“GSE”) securities. As ofDecember 31, 2012, the amortized cost of the Company’s marketable securities was $94,904, and their stated market value was $95,826, representing anunrealized gain of $922. 73Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data A significant portion of the products of the Company and its subsidiaries is sold to original equipment manufacturers of consumer electronics products.The customers of the Company and its subsidiaries are located primarily in Japan, Hong Kong, Taiwan, China, Korea, Europe and the United States. TheCompany and its subsidiaries perform ongoing credit evaluations of their customers. A specific allowance for doubtful accounts is determined, based onmanagement’s estimates and historical experience. Under certain circumstances, the Company may require a letter of credit. The Company covers most of itstrade receivables through credit insurance. As of December 31, 2012 and 2011, no allowance for doubtful accounts was provided.The Company and its subsidiaries have no off-balance-sheet concentration of credit risk, except for certain derivative instruments as mentioned below. v.Derivative instruments:FASB ASC No. 815,” Derivatives and Hedging,” requires companies to recognize all of their derivative instruments as either assets or liabilities on thebalance sheet at fair value.For derivative instruments that are designated and qualify as a cash flows hedge (i.e., hedging the exposure to variability in expected future cash flowsthat is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensiveincome and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Any gain or loss on a derivativeinstrument in excess of the cumulative change in the present value of future cash flows of the hedged item is recognized in current earnings during the period ofchange.To protect against the increase in value of forecasted foreign currency cash flows resulting from salary and rent payments in New Israeli Shekel (“NIS”)during the year, the Company instituted a foreign currency cash flow hedging program. The Company hedges portions of the anticipated payroll and rent ofits Israeli facilities denominated in NIS for a period of one to 12 months with put and call options and forward contracts. These forward contracts and put andcall options are designated as cash flow hedges and are all effective as hedges of these expenses.The fair value of the outstanding derivative instruments at December 31, 2012 and 2011 is summarized below: Fair value of derivative in struments As of December 31, Derivative assets (liabilities) Balance sheet location 2012 2011 Foreign exchange forward contracts and put and call options Other accounts receivable andprepaid expenses (*) $484 $— Accrued expenses and otheraccounts payable — (476) Total $484 $(476) *)Estimated to be reclassified into earnings in the following year. 74Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data The effect of derivative instruments in cash flow hedging transactions on income and other comprehensive income (“OCI”) for the years endedDecember 31, 2012, 2011 and 2010 is summarized below: Gains (losses) on derivatives recognized in OCI Year ended December 31, 2012 2011 2010 Foreign exchange forward contracts and put and call options $635 $(325) $771 Gains (losses) on derivatives reclassified from OCI to income Year ended December 31, Location 2012 2011 2010 Foreign exchange forward contracts and put andcall options Operating expenses $(325) $625 $525 As of December 31, 2012 and 2011, the Company had outstanding forward contracts in the amount of $0 and $3,550, respectively, and outstandingoption contracts in the amount of $15,800 and $16,500, respectively. w.Comprehensive income:The Company accounts for comprehensive income in accordance with FASB ASC No. 220, “Comprehensive Income.” This topic establishes standardsfor the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive incomegenerally represents all changes in stockholders’ equity during the period except those resulting from investments by, or distributions to, stockholders. TheCompany determined that its items of comprehensive income relate to gains and losses on hedging derivative instruments, unrealized gains and losses onavailable-for-sale securities, unrealized gains and losses from pension and unrealized gain and losses from foreign currency translation adjustments. December 31,2012 December 31,2011 Accumulate other comprehensive income (loss) on: Available-for-sale securities $922 $(1,029) Cash flow hedges 484 (476) Benefit plans (237) (78) Foreign currency translation adjustments, net (181) (173) Total accumulate other comprehensive income (loss): $988 $(1,756) x.Treasury stock:The Company repurchases its common stock from time to time on the open market or in other transactions and holds such shares as treasury stock.The Company presents the cost to repurchase treasury stock as a reduction of stockholders’ equity.From time to time, the Company reissues treasury shares under its employee stock purchase plan and equity incentive plans, upon purchases orexercises of equity awards under the plans. When treasury stock is reissued, 75Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data the Company accounts for the re-issuance in accordance with FASB ASC No. 505-30, “Treasury Stock” and charges the excess of the purchase cost over there-issuance price (loss) to retained earnings. The purchase cost is calculated based on the specific identification method. In case the purchase cost is lower thanthe re-issuance price, the Company credits the difference to additional paid-in capital. y.Reclassification:Certain amounts previously reported in the consolidated financial statements have been reclassified to conform to current year presentation. Suchreclassifications did not affect net loss, shareholders’ equity or cash flows z.Impact of recently issued accounting pronouncements:Indefinite-lived intangible assets impairmentIn July 2012, the FASB issued an update to the authoritative guidance related to testing indefinite-lived intangible assets impairment. This update givesan entity the option to first consider certain qualitative factors to determine whether the existence of events and circumstances indicates that it is more likelythan not that the fair value of an indefinite-lived intangible asset is less than its carrying amount as a basis for determining whether it is necessary to performthe quantitative impairment test. This update is effective for the indefinite-lived intangible asset impairment test performed for fiscal years beginning afterSeptember 15, 2012. Early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company’s consolidatedfinancial statements.Reclassification of accumulated other comprehensive lossIn February 2013, the FASB issued an accounting standards update requiring new disclosures about reclassifications from accumulated othercomprehensive loss to net income. These disclosures may be presented on the face of the statements or in the notes to the consolidated financial statements. Thestandard update is effective for fiscal years beginning after December 15, 2012. The adoption of this guidance is not expected to have a material impact on theCompany’s financial statements.NOTE 3:- MARKETABLE SECURITIES AND TIME DEPOSITSThe following is a summary of marketable securities and time deposits at December 31, 2012 and 2011: Amortized cost Unrealized gains(losses), net Fair value 2012 2011 2012 2011 2012 2011 Short and long-term deposit $2,708 $15,803 $— $— $2,708 $15,803 U.S. GSE securities 1,506 10,725 4 (29) 1,510 10,696 Corporate obligations 93,398 74,173 918 (1,000) 94,316 73,173 $97,612 $100,701 $922 $(1,029) $98,534 $99,672 76Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data The amortized cost of marketable debt securities and time deposits at December 31, 2012, by contractual maturities or anticipated dates of sale, areshown below: AmortizedCost Unrealized gains (losses) Gains Losses Fair value Due in one year or less $20,162 $40 $(1) $20,201 Due after one year to six years 77,450 1,018 (135) 78,333 $97,612 $1,058 $(136) $98,534 The amortized cost of marketable debt securities and time deposits at December 31, 2011, by contractual maturities or anticipated dates of sale, areshown below: AmortizedCost Unrealized gains (losses) Gains Losses Fair value Due in one year or less $30,616 $23 $(13) $30,626 Due after one year to six years 70,085 175 (1,214) 69,046 $100,701 $198 $(1,227) $99,672 The actual maturity dates may differ from the contractual maturities because debtors may have the right to call or prepay obligations without penalties.The total fair value of marketable securities with outstanding unrealized losses as of December 31, 2012 amounted to $31,546. Of the $136 unrealizedlosses outstanding as of December 31, 2012, a portion of which in the amount of $13 was outstanding for more than 12 months and the remaining portion of$123 was outstanding for less than 12 months.Management believes that as of December 31, 2012, the unrealized losses in the Company’s investments in all types of marketable securities weretemporary and no impairment loss was realized in the Company’s consolidated statements of operations.The unrealized losses related to U.S. treasury and GSE securities were primarily due to changes in interest rates. Because the Company does not intendto sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases,which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2012.Proceeds from maturity of available-for-sale marketable securities during 2012, 2011 and 2010 were $25,911, $68,072 and $35,180, respectively.Proceeds from sales of available-for-sale marketable securities during 2012, 2011 and 2010 were $39,063, $11,910 and $25,352, respectively. Net realizedgains from the sale of available-for sale marketable securities for 2012, 2011 and 2010 were $670, $155 and $67, respectively. The Company determinesrealized gains or losses on the sale of available-for-sale marketable securities based on a specific identification method. 77Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data NOTE 4:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES December 31, 2012 2011 Tax receivables $508 $662 Prepaid expenses 2,651 3,490 Deposits 419 1,031 Others 78 160 $3,656 $5,343 NOTE 5:- INVENTORIESInventories are composed of the following: December 31, 2012 2011 Work-in-progress $6,821 $8,096 Finished products 6,095 8,338 $12,916 $16,434 Inventory write-downs amounted to $29, $759 and $615 for the years ended December 31, 2012, 2011 and 2010, respectively.NOTE 6:- PROPERTY AND EQUIPMENTComposition of assets, grouped by major classifications, is as follows: December 31, 2012 2011 Cost: Computers and equipment $39,647 $43,570 Office furniture and equipment 1,574 1,636 Leasehold improvements 4,496 4,407 45,717 49,613 Less—accumulated depreciation 42,011 43,810 Depreciated cost $3,706 $5,803 During 2012, the Company recorded a disposal of equipment, which ceased to be used, in the amount of $4,503 (accumulated depreciation ofapproximately $4,493). The capital loss that was recorded due to this disposal of equipment in the consolidated statement of operations was $10.During 2011, the Company recorded a disposal of equipment, which ceased to be used, in the amount of $5,920, (accumulated depreciated ofapproximately $5,898). The capital loss that was recorded due to this disposal of equipment in the consolidated statement of operations was $22. Thedisposed assets included computer and equipment in the amount of $2,665, which were accounted for as capital leases. 78Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data Depreciation expenses, which also include amortization expenses of assets recorded under capital leases, amounted to $3,168, $4,244 and $5,732 forthe years ended December 31, 2012, 2011 and 2010, respectively.NOTE 7:- INTANGIBLE ASSETS, NETThe following table shows the Company’s intangible assets for the periods presented: Useful life(years) December 31, 2012 2011 Cost: Current technology 4.2 - 5.3 $77,080 $77,080 Customer relations 7.3 23,477 23,477 In-process R&D 6 7,702 7,702 Non-competition agreement 3 519 519 108,778 108,778 Accumulated amortization: Current technology 48,263 46,473 Customer relations 13,060 12,715 In-process R&D — — Non-competition agreement 188 15 61,511 59,203 Impairment: (Note 7b) Current technology 28,817 28,817 Customer relations 10,070 10,070 38,887 38,887 Amortized cost $8,380 $10,688 a.Amortization expenses amounted to $2,310, $7,972 and $9,975 for the years ended December 31, 2012, 2011 and 2010, respectively.b.In 2008, as a result of circumstances which indicated that the carrying amount of certain intangible assets would not be recoverable, the Companyreassessed the fair value of its intangible assets, which resulted in impairment charges of approximately $39,084.c.Estimated amortization expenses for the years ending (assuming the development process for In-process R&D is completed during the first quarter of2013, and its useful life is determined to be 6 years): Year ending December 31, 2013 $1,672 2014 1,573 2015 1,284 2016 1,284 Thereafter 2,567 $8,380 79Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data NOTE 8:- FAIR VALUE MEASUREMENTSThe Company measures its cash equivalents, short-term deposits, marketable securities and foreign currency derivative contracts at fair value. Cashequivalents, short-term deposits, marketable securities and foreign currency derivative contracts are classified within Level 1 or Level 2 value hierarchies.This is because cash equivalents, short-term deposits and marketable securities are valued using quoted market prices or alternative pricing sources andmodels utilizing market observable inputs. Foreign currency derivative contracts are classified within Level 2 value hierarchy as the valuation inputs are basedon quoted prices and market observable data of similar instruments.The following table provides information by value level for financial assets and liabilities that are measured at fair value on a recurring basis as ofDecember 31, 2012: Description Balance as ofDecember 31, 2012 Fair value measurements Level 1 Level 2 Level 3Assets Cash equivalents Time deposits $1,668 $1,668 Money market mutual funds $3,548 $3,548 Short-term marketable securities and time deposits U.S. GSE securities $— $— Corporate debt securities $17,493 $17,493 Time deposits $2,708 $2,708 Long-term marketable securities U.S. GSE securities $1,510 $1,510 Corporate debt securities $76,823 $76,823 Derivative assets $484 $484 The following table provides information by value level for financial assets and liabilities that are measured at fair value on a recurring basis as ofDecember 31, 2011. Description Balance as ofDecember 31, 2011 Fair Value Measurements Level 1 Level 2 Level 3Assets: Cash equivalents: Time deposits $1,137 $1,137 Money market mutual funds $2,934 $2,934 Short-term marketable securities and time deposits: U.S. GSE securities $563 $563 Corporate debt securities $14,260 $14,260 Time deposits $15,803 $15,803 Long-term marketable securities: U.S. GSE securities $10,133 $10,133 Corporate debt securities $58,913 $58,913 Derivative liabilities $476 $476 80Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data In addition to the assets and liabilities described above, the Company’s financial instruments also include cash and cash equivalents, trade receivables,other accounts receivable, trade payables, accrued expenses and other payables. The fair value of these financial instruments was not materially different fromtheir carrying value at December 31, 2012 and 2011 due to the short-term maturity of these instruments.NOTE 9:- PENSION LIABILITIESThe Company acquired the CIPT Business on September 4, 2007. This business sponsors various defined benefits schemes for their employees,including pension funds, early retirement benefits, lump sum retirement indemnities and jubilee awards in several countries.As of December 31, 2011 and 2012, the defined benefits plans that the Company assumed in connection with the CIPT Acquisition that are accountedfor in the Company’s consolidated financial statements are the pension plans in Germany and India. Consistent with the requirements of local law, theCompany deposits funds for certain plans with insurance companies, third-party trustees, or into government-managed accounts, and/or accrues for theunfunded portion of the obligation.For 2012 year end accounting purposes, liabilities associated with the German plans, which represented 97% of the pension liability in the Company’sconsolidated financial statements, have been recalculated based on updated employee numbers and asset values at December 31, 2012.The Company’s pension obligation in Germany relating to the unvested pension claims (i.e. future obligation that will result from future service period)of the employees were outsourced in November 2010 to an external insurance company (“Nuremberger Versicherung”). From and after the outsourcing date, theCompany is required to pay premiums to the external insurance company and in return the pension benefits earned by the German employees are covered bythe Company’s arrangement with the external insurance company. The Company legally is released from its obligations to the German employees once thepremiums are paid, and it is no longer subject to any of the risks and rewards associated with the benefit obligations covered and the plan assets transferred tothe external insurance company. Since the outsourcing arrangement meets the requirements of a nonparticipating annuity contract, the Company treats thecosts of the outsourcing arrangement as the costs of the benefits being earned in accordance with ASC Paragraph 715-30-25-7 of ASC 715 “Compensation—Retirement Benefits.” 81Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data The following tables provide a reconciliation of the changes in the pension plans’ benefit obligation and fair value of assets for the years endedDecember 31, 2012 and 2011, and the statement of funded status as of December 31, 2012 and 2011: December 31, 2012 2011 Accumulated benefit obligation $1,321 $1,197 Change in benefit obligation Benefit obligation at beginning of year $1,208 $5,870 Service cost 61 153 Interest cost 47 62 Employee contributions — 14 Plan curtailments — (660) Plan settlements — (4,173) Benefits paid from the plan (172) (31) Premiums paid — (3) Actuarial loss 165 1 Exchange rates and others 25 (25) Benefit obligation at end of year $1,334 $1,208 Change in plan assets Fair value of plan assets at beginning of year 416 $4,448 Actual return on plan assets 12 28 Employer contributions to plan 28 147 Employee contributions — 14 Plan settlements — (4,173) Benefits paid from the plan (100) (31) Premiums paid — (3) Exchange rates 8 (14) Fair value of plan assets at end of year $364 $416 The assumptions used in the measurement of the Company’s pension expense and benefit obligations as of December 31, 2012, 2011 and 2010 are asfollows: Year endedDecember 31, 2012 2011 2010 Weighted-average assumptions Discount rate 3.6% 5.4% 2.75% Expected return on plan assets 2.88% 1.54% 3.5% Rate of compensation increase 2.5% 2.5% 2.89% The amounts reported for net periodic pension costs and the respective benefit obligation amounts are dependent upon the actuarial assumptions used.The Company reviews historical trends, future expectations, current market conditions, and external data to determine the assumptions. The discount rate isdetermined considering the yield of government bonds. The rate of compensation increase is determined by the Company, based on its long-term plans forsuch increases. 82Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data The following table provides the components of net periodic benefit cost for the years ended December 31, 2012, 2011 and 2010: December 31, 2012 2011 2010 Components of net periodic benefit cost Service cost 61 $153 $326 Interest cost 47 62 150 Expected return on plan assets (12) (28) (116) Amortization of net loss (gain) 2 39 (102) Curtailment gain(1) — (660) — Net periodic benefit cost $98 $(434) $258 (1)The curtailment gain is derived from the closure of the Company’s Swiss facilities and the termination of employment of the employees of theCompany’s Swiss subsidiary, which resulted in a curtailment and settlement of the Swiss pension plan. December 31, 2012 2011 Net amounts recognized in the consolidated balance sheets as of December 31, 2012 and 2011 consist of: Current liabilities $— $— Noncurrent liabilities 970 792 Net amounts recognized in the consolidated balance sheets $970 $792 Net amounts recognized in accumulated other comprehensive income as of December 31, 2012 and 2011 consist of: Net actuarial loss $(237) $(78) Other — — Net amounts recognized in accumulated other comprehensive loss $(237) $(78) The estimated amount that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost in 2013 is as follows: 2013 Net actuarial loss and other $11 Benefit payments are expected to be paid as follows: Year ending December 31, 2013 $183 2014 $154 2015 $112 2016 $64 2017 $31 2018-2022 $88 83Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data The plan asset allocations at December 31 of the relevant years are as follows: December 31, 2012 2011 Bonds — — Real estate — — Cash — — Shares — — Other 100% 100% 100% 100% The fair value of the Company’s pension plan assets at December 31, 2012 by asset category, classified by the three levels of inputs described in Note2, are as follows: Fair value measurements at December 31, 2012 using: Totalfair value atDecember 31,2012 Quotedpricesin activemarkets(Level 1) Significantotherobservableinputs(Level 2) Significantunobservableinputs (Level 3) Cash $— $— $— $— Equity securities — — — — Real estate — — — — Corporate bonds — — — — Others 364 — 364 — Total assets measured at fair value $364 $— $364 $— Valuation techniques—for Level 1 inputs, the Company utilizes quoted market prices as these instruments have active markets. For Level 2 inputs,the Company utilizes quoted market prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels ofprice transparency.Regarding the policy for amortizing actuarial gains or losses for pension and post-employment plans, the Company has chosen the “corridor” option.This option consists of recognizing in the consolidated statements of operations, the part of unrecognized actuarial gains or losses exceeding 10% of the greaterof the PBO or the market value of the plan assets. If amortization is required, the minimum amortization amount is that excess divided by the averageremaining service period of the active employees expected to receive benefits under the plan.Actuarial losses were recognized in other comprehensive income (loss) in the amount $160, $1 and $694 for the years ended December 31, 2012, 2011and 2010, respectively. 84Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data NOTE 10:- FINANCIAL INCOME, NETThe components of financial income, net were as follows: Year ended December 31, 2012 2011 2010 Foreign exchange gains $120 $60 $— Interest income from marketable securities and deposits, net of amortization of premium on marketable securities 1,859 2,014 2,183 Realized gains on marketable securities 708 181 924 Other 1 7 8 Financial income 2,688 2,262 3,115 Realized losses on marketable securities 38 26 856 Foreign exchange losses 88 95 517 Interest expenses 35 42 103 Other 139 214 171 Financial expense 300 377 1,647 Financial income, net $2,388 $1,885 $1,468 NOTE 11:- STOCKHOLDERS’ EQUITY a.Preferred stock:The Company’s Board of Directors has the authority, without any further vote or action by the stockholders, to provide for the issuance of up to5,000,000 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, sinkingfund provisions, conversion rights and voting rights. No shares of preferred stock are currently outstanding. b.Common Stock:Currently, 50,000,000 shares of common stock are authorized. Holders of common stock are entitled to one vote per share on all matters to be voted uponby the Company’s stockholders. Subject to the rights of holders of preferred stock, if any, in the event of liquidation, dissolution or winding up, holders ofcommon stock are entitled to share ratably in all of the Company’s assets. The Company’s Board of Directors may declare a dividend out of funds legallyavailable therefore and, subject to the rights of holders of preferred stock, if any, the holders of common stock are entitled to receive ratably any suchdividends.Holders of common stock have no preemptive rights or other subscription rights to convert their shares into any other securities. There are no redemptionor sinking fund provisions applicable to common stock. c.Dividend policy:At December 31, 2012, the Company had an accumulated deficit of $79,394. The Company has never paid cash dividends on the common stock andpresently intends to follow a policy of retaining earnings for reinvestment in its business. 85Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data d.Share repurchase program:In March 1999, the Company’s Board of Directors authorized the repurchase of up to 4.0 million shares of its common stock. In July 2003, October2004, January 2007, January 2008, the Company’s board authorized an additional 2.5 million shares, 2.5 million shares, 3.0 million shares, and 2.9 millionshares of common stock, respectively, for repurchase. In October 2010, the Company’s board of directors authorized an increase in the number of sharesavailable for repurchase, thereby increasing the aggregate number of shares authorized for repurchase under our share repurchase program to 2.0 millionshares. In July 2011, the Company’s board of directors authorized an increase in the share repurchase program by an additional one million shares ofcommon stock.In 2012, 2011 and 2010, the Company repurchased approximately 1,283,000, 1,298,000 and 111,000 shares, respectively, of common stock at anaverage purchase price of $6.28, $6.74 and $7.74 per share, respectively, for an aggregate purchase price of $8,060, $8,749 and $862, respectively. As ofDecember 31, 2012, 307,749 shares of common stock remained authorized for repurchase under the Company’s board-authorized share repurchase program.In 2012, 2011 and 2010, the Company issued 455,000, 547,000 and 463,000 shares, respectively, of common stock, out of treasury stock, toemployees who exercised their equity awards under the Company’s equity incentive plans or purchased shares from the Company’s 1993 Employee StockPurchase Plan (“ESPP”). e.Stock purchase plan and equity incentive plans:The Company has various equity incentive plans under which employees, officers, non-employee directors of the Company and its subsidiaries andothers, including consultants, may be granted rights to purchase the Company’s common stock. The plans authorize the administrator to grant incentivestock options at an exercise price of not less than 100% of the fair market value of the common stock on the date the option is granted and non-qualified stockoptions. It is the Company’s policy to grant options with an exercise price that equals the fair market value.Equity awards granted under all stock incentive plans that are cancelled or forfeited before expiration become available for future grant.During 2012, 2011 and 2010, the Company granted to employees and executive officers of the Company and its subsidiaries primarily shareappreciation rights (“SARs”), capped with a ceiling, under the various equity incentive plans. The SAR unit confers the holder the right to stock appreciationover a preset price of the Company’s common stock during a specified period of time. When the unit is exercised, the appreciation amount is paid through theissuance of shares of the Company’s common stock. The ceiling limits the maximum income for each SAR unit. SARs are considered an equity instrument asit is a net share settled award capped with a ceiling.A summary of the various plans is as follows:1993 Director Stock Option PlanUpon the closing of the Company’s initial public offering, the Company adopted the 1993 Director Stock Option Plan (the “Directors Plan”). Under theDirectors Plan, which expires in 2014, the Company is authorized 86Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data to issue nonqualified stock options to the Company’s outside non-employee directors to purchase up to 1,980,875 shares of common stock at an exerciseprice equal to the fair market value of the common stock on the date of grant. The Directors Plan, as amended, provides that each person who becomes anoutside, non-employee director of the Board of Directors shall automatically be granted an option to purchase 30,000 shares of common stock (the “FirstOption”). Thereafter, each outside director shall automatically be granted an option to purchase 15,000 shares of common stock (a “Subsequent Option”) onJanuary 1 of each year if, on such date, he shall have served on the Board of Directors for at least six months. In addition, an option to purchase an additional15,000 shares of common stock (a “Committee Option”) is granted on January 1 of each year to each outside director for each committee of the Board onwhich he shall have served as a chairperson for at least six months.Options granted under the Directors Plan generally have a term of 10 years. One-third of the shares are exercisable after the first year and thereafter one-third at the end of each twelve-month period.As of December 31, 2012, 294,086 shares of common stock remained available for grant under the Directors Plan.1998 Non-Officer Employee Stock Option PlanIn 1998, the Company adopted the 1998 Non-Officer Employee Stock Option Plan (the “1998 Plan”). Under the 1998 Plan, employees may begranted non-qualified stock options for the purchase of common stock. The 1998 Plan currently provides for the purchase of up to 5,062,881 shares ofcommon stock. As of December 31, 2012, 340,689 shares of common stock remained available for grant under the 1998 Plan.The exercise price of options under the 1998 Plan shall not be less than the fair market value of common stock for nonqualified stock options, asdetermined by the Company’s Board of Directors or a committee appointed by the Company’s Board of Directors.Options under the 1998 Plan are generally exercisable over a 48-month period beginning 12 months after issuance, or as determined by the Company’sBoard of Directors or a committee appointed by the Company’s Board of Directors. Options under the 1998 Plan expire up to seven years after the date ofgrant.2001 Stock Incentive PlanIn 2001, the Company adopted the 2001 Stock Incentive Plan (the “2001 Plan”). The 2001 Plan expired in 2011 and no further grants of awards may bemade thereunder. As of December 31, 2012, 2,194,847 shares of common stock were granted under the plan, stock options to acquire 10,000 shares remainedoutstanding in the plan prior to its expiration.The 2001 Plan authorized the administrator to grant incentive stock options at an exercise price of not less than 100% of the fair market value of thecommon stock on the date the option is granted.Equity awards under the 2001 Plan were generally exercisable over a 48-month period beginning 12 months after issuance or as determined by theCompany’s Board of Directors or a committee appointed by the Company’s Board of Directors. Equity awards under the 2001 plan expired up to seven yearsafter the date of grant.2003 Israeli Share Option PlanIn 2003, the Company adopted the 2003 Israeli Share Option Plan (the “2003 Plan”), which complies with the Israeli tax reforms. The 2003 Planterminated upon approval of the Company’s 2012 Equity Incentive Plan 87Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data (the “2012 Plan”). As of December 31, 2012, 10,700,543 shares of common stock were granted under the plan and stock option and stock appreciation rightsto acquire 4,349,094 shares of common stock remained outstanding under the plan.Equity awards under the 2003 Plan were generally exercisable over a 48-month period beginning 12 months after issuance, or as determined by theCompany’s Board of Directors or a committee appointed by the Company’s Board of Directors. Equity awards under the 2003 Plan expired up to seven yearsafter the date of grant.2012 Equity Incentive PlanIn 2012, the Company adopted the 2012 Plan, which complies with the Israeli tax reforms. Under the 2012 Plan, employees, directors and consultantsmay be granted incentive or non-qualified stock options, stock appreciation rights, restricted stock units and other awards under the plan. The exercise priceof the equity awards under the 2012 Plan shall not be less than the fair market value of common stock at the time of grant, unless otherwise determined by theCompany’s Board of Directors or a committee appointed by the Company’s Board of Directors. The 2012 Plan currently provides for the purchase of up to350,000 shares of common stock. As of December 31, 2012, 350,000 shares of common stock remained available for grant under the 2012 Plan.Equity awards under the 2012 Plan are generally exercisable over a 48-month period beginning 12 months after issuance, or as determined by theCompany’s Board of Directors or a committee appointed by the Company’s Board of Directors. Equity awards under the 2012 Plan expire up to seven yearsafter the date of grant.1993 Employee Stock Purchase Plan (ESPP)Upon the closing of the Company’s initial public offering, the Company adopted the ESPP. The Company has reserved an aggregate of 3,300,000 sharesof common stock for issuance under the ESPP. The ESPP provides that substantially all employees of the Company may purchase Company common stockat 85% of its fair market value on specified dates via payroll deductions. There were approximately 446,000, 423,000 and 388,000 shares of common stockissued at a weighted average purchase price of $4.42, $4.81 and $4.75 per share under the ESPP in 2012, 2011 and 2010, respectively. As of December 31,2012, 588,000 shares of common stock were reserved under the ESPP.Stock Reserved for Future IssuanceThe following table summarizes the number of outstanding shares of common stock available for future issuance at December 31, 2012 (after givingeffect to the above increases in the equity incentive plans): ESPP 588,000 Equity awards 985,000 Undesignated preferred stock 5,000,000 6,573,000 88Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data The following is a summary of activities relating to the Company’s stock options and SARs granted among the Company’s various plans: Year ended December 31, 2012 2011 2010 Amountofoptions/SARs Weightedaverageexerciseprice Aggregateintrinsicvalue(4) Amountofoptions/SARs Weightedaverageexerciseprice Aggregateintrinsicvalue(4) Amountofoptions/SARs Weightedaverageexerciseprice Aggregateintrinsicvalue(4) inthousands inthousands inthousands Options outstanding at beginning of year 10,564 $12.22 $— 11,305 $12.94 $— 10,433 $15.20 $— Changes during the year: Granted(1) 1,410 $6.05 $— 1,263 $7.58 $— 2,675 $7.21 $— Exercised (127) $5.97 $62 (339) $6.22 $647 (163) $6.07 $280 Forfeited and cancelled (2,225) $15.14 $— (1,665) $14.86 $— (1,640) $18.62 $— Options/SARs outstanding at end of year(2) 9,622 $10.72 $98 10,564 $12.22 $— 11,305 $12.94 $7,724 Options/SARs exercisable at end of year(3) 7,223 $12.07 $28 7,669 $14.10 $— 6,492 $16.90 $2,462 (1)SAR grants made prior to January 1, 2009 are convertible for a maximum number of shares of the Company’s common stock equal to 50% of the SARunits subject to the grant. SAR grants made on or after January 1, 2009 and before January 1, 2010 are convertible for a maximum number of shares ofthe Company’s common stock equal to 75% of the SAR units subject to the grant. SAR grants made on or after January 1, 2010 are convertible for amaximum number of shares of the Company’s common stock equal to 66.67% of the SAR units subject to the grant. SAR grants made on or afterJanuary 1, 2012 are convertible for a maximum number of shares of the Company’s common stock equal to 50% of the SAR units subject to the grant.(2)Due to the ceiling imposed on the SAR grants, the outstanding amount above can be exercised for a maximum of 6,630,135 shares of the Company’scommon stock as of December 31, 2012.(3)Due to the ceiling imposed on the SAR grants, the exercisable amount above can be exercised for a maximum of 5,018,877 shares of the Company’scommon stock as of December 31, 2012.(4)Calculation of aggregate intrinsic value for options and SARs outstanding and exercisable is based on the share price of the Company’s common stockas of December 31, 2012, 2011 and 2010 which was $5.76, $5.21 and $8.14 per share, respectively. The intrinsic value for options and SARsexercised during those years represents the difference between the fair market value of the Company’s common stock on the date of exercise and theexercise price of each option or SAR, as applicable. 89Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data The stock options and SARs outstanding as of December 31, 2012, have been separated into ranges of exercise price as follows: Range of exercise price Outstanding Remainingcontractuallife (years) Weightedaverageexerciseprice Exercisable Remainingcontractuallife (years) Weightedaverageexerciseprice $ thousands $ thousands $ 5.21—5.76 270 6.42 5.40 120 3.69 5.53 5.81—7.26 4,513 3.80 6.53 2,817 2.77 6.59 7.49—10.23 2,797 3.07 9.03 2,244 2.47 9.38 11.60—15.79 170 3.49 12.53 170 3.49 12.53 15.82—28.72 1,872 1.00 23.94 1,872 1.00 23.94 9,622 3.11 10.72 7,223 2.25 12.07 As of December 31, 2012, the outstanding number of SARs was 7,449,747 and based on the share price of the Company’s common stock as ofDecember 31, 2012 ($5.76 per share), no SARs were in-the-money.The weighted-average estimated fair value of employee stock options and SARs granted during the years ended December 31, 2012, 2011 and 2010 was$2.39, $3.26 and $3.19 per stock option and SAR, respectively, using the binomial model with the following weighted-average assumptions (annualizedpercentages): Year ended December 31, 2012 2011 2010 Volatility 48.23% 54.60% 64.47% Risk-free interest rate 2.20% 2.23% 2.25% Dividend yield 0% 0% 0% Pre-vest cancellation rate *) 3.50% 3.37% 2.92% Post-vest cancellation rate **) 2.58% 2.21% 2.23% Suboptimal exercise factor ***) 1.60 1.59 1.63 Expected life 4.19 years 4.14 years 4.07 years *)The pre-vest cancellation rate was calculated on an annual basis and is presented here on an annual basis.**)The post-vest cancellation rate was calculated on a monthly basis and is presented here on an annual basis.***)The ratio of the stock price to strike price at the time of exercise of the option.The computation of volatility uses a combination of historical volatility and implied volatility derived from the Company’s exchange traded options withsimilar characteristics.The risk-free interest rate assumption is based on U.S. treasury bill interest rates appropriate for the term of the Company’s employee equity-basedawards.The dividend yield assumption is based on the Company’s historical and expectation of future dividend payouts and may be subject to substantialchange in the future.The expected term of employee equity-based awards represents the weighted-average period the awards are expected to remain outstanding and is aderived output of the binomial model. The expected life of employee 90Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data equity-based awards is impacted by all of the underlying assumptions used in the Company’s model. The binomial model assumes that employees’ exercisebehavior is a function of the award’s remaining contractual life and the extent to which the award is in-the-money (i.e., the average stock price during the periodis above the strike price of the award). The binomial model estimates the probability of exercise as a function of these two variables based on the history ofexercises and cancellations on past award grants made by the Company.As equity-based compensation expense recognized in the consolidated statement of operations is based on awards ultimately expected to vest, it should bereduced for estimated forfeitures. The forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differfrom those estimates.Pre and post-vesting forfeitures were estimated based on historical experience.The fair value for rights to purchase shares of common stock under the Company’s ESPP was estimated on each enrollment date using the sameassumptions set forth above for the years ended 2012, 2011 and 2010 except the expected life and the volatility. The expected life was assumed to be betweensix to 24 months based on the contractual life of the plan, and the expected volatility was assumed to be in a range of 35.79%-42.02% in 2012, 28.37%-61.02% in 2011 and 50.25%-78.61% in 2010.The Company’s aggregate compensation expenses for the years ended December 31, 2012, 2011 and 2010 totaled $4,983, $6,220 and $9,553,respectively. The Company recognized no tax benefit in its consolidated statements of operations for the years ended December 31, 2012, 2011 and 2010 forthe Company’s equity-based compensation arrangements.A summary of the status of the Company’s non-vested stock options and SARs as of December 31, 2012, and changes during the year endedDecember 31, 2012, is presented below: Non-vested Units Weightedaverage grantdate fair value (In thousands) Non-vested at January 1, 2012 2,895 3.09 Granted 1,410 2.39 Vested (1,530) 3.03 Forfeited (376) 2.87 Non-vested at December 31, 2012 2,399 2.76 As of December 31, 2012, equity-based compensation arrangements to purchase a maximum of 6,100 shares of common stock were vested andexpected to vest (the calculation takes into consideration the forfeiture rate).As of December 31, 2012, there was a total unrecognized compensation expense of $2,629 related to non-vested equity-based compensationarrangements granted under the Company’s various equity incentive plans. That expense is expected to be recognized during the period from 2013 through2016.NOTE 12:- COMMITMENTS AND CONTINGENCIESCommitmentsThe Company and its subsidiaries lease certain equipment and facilities under non-cancelable operating leases. The Company has significant leasedfacilities in Herzliya Pituach, Israel. The lease agreement for the Israeli facilities is effective until November 2018. The Company has various agreements forits facilities in the 91Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data U.S. that terminate in 2014 through 2015. The Company’s subsidiaries in Scotland, Japan, Germany and Hong-Kong have lease agreements for theirfacilities that terminate in 2013, 2014, 2015 and 2013, respectively. The Company’s subsidiary in India has sublease agreements with NXP for their facilitiesthat terminate in 2017. The Company has operating lease agreements for its motor vehicles which terminate in 2013 through 2015.At December 31, 2012, the Company is required to make the following minimum lease payments under non-cancelable operating leases for its motorvehicles and facilities: Year ended December 31, 2013 $2,923 2014 2,171 2015 1,824 2016 and thereafter 4,349 $11,267 Facilities rental expenses amounted to $2,891, $3,375 and $3,391 for the years ended December 31, 2012, 2011 and 2010, respectively.Claims a.The Company is involved in certain claims arising in the normal course of business. However, the Company believes that the ultimate resolution ofthese matters will not have a material adverse effect on its financial position, results of operations, or cash flows. b.From time to time, the Company may become involved in litigation relating to claims arising in the ordinary course of business activities. Also, as istypical in the semiconductor industry, the Company has been and, from time to time may be, notified of claims that it may be infringing on patents orintellectual property rights owned by third parties. During 2010, the Company recorded an income of $2,500 in cost of revenues (the account in whichthe provision was originally recorded) resulting from the reversal of a provision that was determined to be no longer needed due to the expiration of theapplicable statute of limitations.NOTE 13:- TAXES ON INCOME a.The provision for income taxes is as follows: Year ended December 31, 2012 2011 2010 Domestic taxes Federal taxes: Current $(465) $36 $(931) State taxes: Current 1 (623) 34 Foreign taxes: Current 304 (311) 52 Deferred (12) 32 (81) Valuation allowance — — 143 292 (279) 114 Income tax benefit $(172) $(866) $(783) 92Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data There were no tax benefits associated with the exercise of non-qualified stock options in 2012, 2011 and 2010. b.Loss before taxes is comprised as follows: Year ended December 31, 2012 2011 2010 Domestic $(844) $(3,162) $(2,794) Foreign (7,370) (13,946) (5,414) $(8,214) $(17,108) $(8,208) c.A reconciliation between the Company’s effective tax rate assuming all income is taxed at statutory tax rate applicable to the income of the Company andthe U.S. statutory rate is as follows: Year ended December 31, 2012 2011 2010 Losses before taxes on income $(8,214) $(17,108) $(8,208) Theoretical tax at U.S. statutory tax rate (35%) $(2,875) $(5,988) $(2,873) State taxes, net of federal benefit 2 2 1 Foreign income taxed at rates other than the U.S. rate (including deferred taxes that were notprovided, valuation allowance and current adjustment and interest on uncertain tax positionliability) 1,253 2,563 (1,082) Nondeductible equity-based compensation expenses 1,744 2,177 3,344 Current adjustment and interest on uncertain tax position liability in U.S. (465) (598) (517) Valuation allowance in U.S. 154 957 723 Other 15 21 (379) $(172) $(866) $(783) 93Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data d.Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reportingpurposes and the amounts used for income tax purposes. December 31, 2012 2011 Deferred tax assets (short-term): Reserves and accruals $101 $89 Total deferred tax assets (short-term) 101 89 Valuation allowance — — Total 101 89 Deferred tax assets (long-term): Reserves and accruals 1,070 1,044 Equity-based compensation 2,372 2,252 Intangible assets 1,621 4,272 Carryforward tax losses 31,449 29,411 Other 51 137 Total deferred tax assets (long-term) 36,563 37,116 Valuation allowance (36,563) (37,116) Total — — Total deferred tax assets $101 $89 Deferred tax liabilities: Acquired intangible assets – long-term 1,569 1,569 Total deferred tax liabilities $1,569 $1,569 Management believes that the deferred net tax assets will not be realized based on current levels of future taxable income and potentially refundable taxes.Accordingly, a valuation allowance in the amount of $36,563 and $37,116 was provided as of December 31, 2012 and 2011, respectively. The Companydoes not have a provision for U.S. income taxes on the undistributed earnings of its international subsidiaries since the Company intends to indefinitelyreinvest these earnings outside the U.S. e.Uncertain tax positions:A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows: 2012 2011 2010 Gross unrecognized tax benefits at January 1 $1,115 $2,442 $3,107 Decrease in tax positions for previous years — (729) (193) Increases in tax positions for previous years 1,220 — 316 Increase in interest related to tax positions 102 37 18 Lapse in statute of limitations (622) (635) (806) Gross unrecognized tax benefits at December 31 $1,815 $1,115 $2,442 The total amount of net unrecognized tax benefits that, if recognized, would affect the effective tax rate was $1,815 and $1,115 at December 31, 2012and 2011, respectively. The Company accrues interest and penalties 94Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data relating to unrecognized tax benefits in its provision for income taxes. At December 31, 2012 and 2011, the Company had accrued interest and penalties relatedto unrecognized tax benefits of $435 and $276, respectively.The Company reversed income tax contingency reserves that were determined to be no longer required due to the expiration of applicable statute oflimitations. Pursuant to this reversal, the Company recorded a tax benefit of $622, $635 and $806 during 2012, 2011 and 2010, respectively.The Company and certain of its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The lastexamination conducted by U.S. tax authorities was with respect to the Company’s U.S. federal income tax returns for 2004. The statute of limitations relatingto the consolidated Federal income tax return is closed for all tax years up to and including 2003.With respect to DSP Israel, the Israeli tax authorities audited its income tax returns for the years up to and including 2003. The statue of limitationsrelated to such tax returns is closed for all tax years up to and including 2005.With respect to the Company’s Swiss subsidiary, the statute of limitations related to its tax returns is opened for all tax years since its incorporation. f.Tax benefits under the Law for the Encouragement of Capital Investments, 1959 (“Investment Law”): Six separate investment programs of DSP Israel’sproduction facilities have been granted “Approved Enterprise” status and two investment programs of DSP Israel’s production facilities was filed under“Beneficiary Enterprise” status under the Investment Law. The Investment Law provides certain Israeli tax benefits for eligible capital investments in aproduction facility, as discussed in greater detail below.On April 1, 2005, an amendment to the Investment Law came into effect (the “Amendment”) and significantly changed the provisions of the InvestmentLaw. Generally, DSP Israel’s investment programs that obtained approval for Approved Enterprise status prior to enactment of the Amendment will continue tobe subject to the old provisions of the Investment Law.The Amendment enacted major changes in the manner in which tax benefits are awarded under the Investment Law so that companies are no longerrequired to get the Investment Center’s prior approval to qualify for tax benefits. An enterprise that receives tax benefits without the initial approval from theInvestment Center is called a “Beneficiary Enterprise,” rather than the previous terminology of Approved Enterprise. The period of tax benefits for a newBeneficiary Enterprise commences in the “Year of Commencement,” which is the later of: (1) the year in which taxable income is first generated by thecompany, or (2) the year of election.In addition, under the Amendment, tax benefits are available to production facilities, which generally are required to derive more than 25% of theirbusiness income from export. Furthermore, in order to receive the tax benefits under the Amendment, a company must make an investment in the BenefitedEnterprise exceeding a certain percentage or a minimum amount specified in the Investment Law.DSP Israel has chosen the “alternative benefits” track for all of its investment programs. Accordingly, DSP Israel’s income from an “ApprovedEnterprise” and “Beneficiary Enterprise” is tax-exempt for a period of two or four years and is subject to a reduced corporate tax rate of 10%-25% (based on thepercentage of foreign ownership) for an additional period of eight or six years, respectively.DSP Israel’s first and second investment programs, which were completed and commenced operations in 1994 and 1996, respectively, were tax exemptfor two and four years, respectively, from the first year they had 95Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data taxable income and were entitled to a reduced corporate tax rate of 10%-25% (based on the percentage of foreign ownership) for an additional period of eight andsix years, respectively. As of 2012, those investment programs were no longer entitled to a reduced corporate tax.DSP Israel’s third investment program, which was completed and commenced operations in 1998, was tax exempt for two years from the first year ithad taxable income and was entitled to a reduced corporate tax rate of 10%-25% (based on the percentage of foreign ownership) for an additional period of eightyears from the first year it had taxable income. As of 2012, this investment program was no longer entitled to a reduced corporate tax.DSP Israel’s fourth, fifth and sixth investment programs were approved in 1998, 2001 and 2003, respectively, which entitled DSP Israel to a corporatetax exemption for a period of two years and to a reduced corporate tax rate of 10%-25% (based on the percentage of foreign ownership) for an additional periodof eight years from the first year the production facility subject to the investment program had taxable income. As of 2012, the fourth and fifth investmentprograms were no longer entitled to a reduced corporate tax.DSP Israel’s seventh and eighth investment programs have been in operation since 2006 and 2009, respectively, and entitles DSP Israel to a corporate taxexemption for a period of two years and a reduced corporate tax rate of 10%-25% (based on the percentage of foreign ownership) for an additional period ofeight years from the first year it has taxable income.Since DSP Israel is operating under more than one approval, its effective tax rate is the result of a weighted combination of the various applicable taxrates and tax exemptions and the computation is made for income derived from each investment program on the basis and formulas specified in the InvestmentLaw and the approvals.During 2006, DSP Israel received an approval for the erosion of tax basis in respect to its fifth and sixth investment programs. During 2008, DSP Israelreceived an approval for the erosion of tax basis with respect to its second, third and fourth investment programs. Those approvals resulted in increasing thetaxable income attributable to the later investment programs, which are currently in operation and will be taxed at a lower tax rate than the previous investmentprograms, which in turn will decrease the overall effective tax rate.The Company’s investment programs that generate taxable income are currently subject to an average tax rate of up to approximately 10% based on avariety of factors, including percentage of foreign ownership and approvals for the erosion of the tax basis of our investment programs. The Company’saverage tax rate for its investment programs may change in the future due to circumstances outside of its control and therefore, the Company cannot provideany assurances that its average tax rate for its investment programs will continue at an approximate rate of 10% in the future.In January 2011, the Knesset (Israeli parliament) passed the Law for Economic Policy for 2011 and 2012 (Amended Legislation), 2011, whichprescribes, among other things, for a further amendment of the Israeli Investment Law. The amendment became effective as of January 1, 2011. Among otherthings, the amendment sets forth the following amended tax rates for income generated from qualified investment programs: • for 2011 and 2012—15%; • for 2013 and 2014—12.5%; and • for 2015 and thereafter—12%. 96Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data The Company does not currently intend to implement the amendment, and intend to continue to comply with the Investment Law as in effect prior toenactment of the amendment until the earlier of such time that compliance with the Investment Law prior to amendment is no longer in the Company’s interestsor until the expiration of the Company’s current investment programs. The Company is required to comply with the amendment subsequent to the expirationof its current investment programs and for any new qualified investment program, after a transitional period. As a result, the amendment may increase theCompany’s average tax rate in future years.As of December 31, 2012, DSP Israel believed that it met all the conditions required under the plans, which include inter-alia an obligation to investcertain amounts in property and equipment and an obligation to finance a percentage of investments by share capital.Should DSP Israel fail to meet such conditions in the future, it could be subject to corporate tax in Israel at the standard tax rate (25% for 2013) plus aconsumer price index linkage adjustment and interest and could be required to refund tax benefits already received.As of December 31, 2012, approximately $33,293 was derived from tax exempt profits earned by DSP Israel’s “Approved Enterprises” and“Beneficiary Enterprise”. The Company has determined that such tax-exempt income will not be distributed as dividends and intends to reinvest the amount ofits tax exempt income earned by DSP Israel. Accordingly, no provision for deferred income taxes has been provided on income attributable to DSP Israel’s“Approved Enterprises” and “Beneficiary Enterprise” as such income is essentially permanently reinvested.If DSP Israel’s retained tax-exempt income is distributed in a manner other than on its complete liquidation, the income would be taxed at the applicablecorporate tax rate (currently 10%) as if it had not elected the alternative tax benefits under the Investment Law and an income tax liability of approximately$3,699 would have been incurred as of December 31, 2012.In November 2012, the Knesset passed Amendment No. 69 to the Investment Law (the “Trapped Earnings Law”) which provides a temporary, partial,relief from taxation on a distribution from exempt income for companies which elect the relief through November 2013. The Trapped Earnings Law allows acompany to qualify a portion of its exempt income (“Elected Earnings”) for a reduced tax rate ranging between 17.5% and 6%. While the reduced tax ispayable within 30 days of election, an electing company is not required to actually distribute the Elected Earnings within a certain period of time. Theapplicable rate is based on a linear formula involving the portion of Elected Earnings to exempt income and the applicable tax rate prescribed in the InvestmentLaw. A company electing to qualify its exempt income must undertake to make designated investments in productive fixed assets, research and development,or wages of new employees (“Designated Investment”). The Designated Investment amount is defined by a formula which considers the portion of ElectedEarnings to the exempt income and the applicable tax rate prescribed by the Investment Law.In addition to the reduced tax rate, a distribution of Elected Earnings would be subject to a 15% withholding tax. The Trapped Earnings Law providesan exemption from the 15% withholding tax for a distribution to an Israeli resident company from companies which have elected the Beneficiary Enterprisestatus and waived their Approved Enterprise and Beneficiary Enterprise Status through June 2015.At this time, the Company does not believe the Trapped Earnings Law has any effects on its financial statements.DSP Israel’s income from sources other than the “Approved Enterprises” and “Beneficiary Enterprise” during the benefit period will be subject to tax atthe effective standard corporate tax rate in Israel (25% for 2012). 97Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data By virtue of the Investment Law, DSP Israel is entitled to claim accelerated rates of depreciation on equipment used by an “Approved Enterprise” and“Beneficiary Enterprise” during the first five tax years from the beginning of such use. g.Tax benefits under Israel’s Law for Encouragement of Industry (Taxation), 1969:DSP Israel is an “industrial company” under the Law for the Encouragement of Industry (Taxation), 1969, and as such is entitled to certain taxbenefits, mainly the amortization of costs relating to know-how and patents, over eight years and accelerated depreciation. h.Israeli tax rates:The rate of the Israeli corporate tax is as follows: 2010—25%, 2011—24% and 2012—25%. Tax at a rate of 25% applies on capital gains arising afterJanuary 1, 2003.On December 5, 2011, the Israeli Parliament (the Knesset) passed the Law for Tax Burden Reform (Legislative Amendments), 2011 which, amongothers, canceled effective in 2012, the scheduled progressive reduction in the corporate tax rate. This law also increased the corporate tax rate to 25% for 2012. i.In connection with the CIPT Acquisition, the Company received a tax ruling from the Swiss tax authorities with respect to the taxable income generatedby its Swiss subsidiary, including the amortization period for tax purposes of goodwill and all other intangible assets acquired in the CIPT Acquisitionby its Swiss subsidiary. Pursuant to the tax ruling, the Company’s Swiss subsidiary is entitled to reduced tax rates of approximately 10% to 15%,depending on the source of income, and tax amortization period of up to 10 years for the goodwill and other intangible assets acquired in the CIPTAcquisition by its Swiss subsidiary. j.The Company has accumulated losses for U.S. federal and state tax purposes as of December 31, 2012 of approximately $7,315 and $3,238 ,respectively, which may be carried forward and offset against future taxable income for a period of fifteen to twenty years from its creation. In addition,the Company has accumulated capital losses of approximately $1,678, which may be carried forward and offset against future capital gains for aperiod of five years from its creation. DSP Israel has accumulated losses for tax purposes as of December 31, 2012, of approximately $48,567(including research and development expenses carry forward), which may be carried forward and offset against future taxable income for an indefiniteperiod. The Swiss subsidiary has accumulated losses for tax purposes as of December 31, 2012, of approximately $232,274, which may be carriedforward and offset against future taxable income for a period of seven years from its creation. 98Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data NOTE 14:- BASIC AND DILUTED LOSS PER SHAREThe following table sets forth the computation of basic and diluted net loss per share: Year ended December 31, 2012 2011 2010 Numerator: Net loss $(8,042) $(16,242) $(7,425) Denominator: Weighted average number of shares of common stock outstanding during the year used to compute basic net lossper share (in thousands) 21,950 23,247 23,229 Incremental shares attributable to exercise of outstanding options and SARs (assuming proceeds would be usedto purchase treasury stock) (in thousands) — — — Weighted average number of shares of common stock used to compute diluted net loss per share (in thousands) 21,950 23,247 23,229 Basic net loss per share $(0.37) $(0.70) $(0.32) Diluted net loss per share $(0.37) $(0.70) $(0.32) NOTE 15:- RESTRUCTURING COSTS AND OTHER a.During the third quarter of 2012, the Company initiated a restructuring plan in order to improve operating efficiencies and reduce its operating expensesfor fiscal year 2012 and subsequent periods. As part of this restructuring plan, the Company executed termination agreements with certain of itsemployees. During the third quarter of 2012, the Company recorded an expense in the amount of $1,315, consisting mainly of employee severance costsand the future expected under-utilization of existing development tool agreements with expiry dates in 2013 and 2014. The Company anticipates that theremaining accrued restructuring cost balance of $538 will be paid out in cash throughout 2013. b.During the second quarter of 2012, as part of the Company’s plan to improve operating efficiencies and reduce its operating expenses for fiscal year2012 and subsequent periods, it restructured its operations. As part of this restructuring plan, the Company executed termination agreements withcertain of its employees. During the second quarter of 2012, the Company recorded an expense in the amount of $693, consisting mainly of employeeseverance costs. The Company anticipates that the remaining accrued restructuring cost balance of $116 will be paid out in cash throughout 2013. c.During the third quarter of 2011, as part of the Company’s plan to improve operating efficiencies and reduce its operating expenses for fiscal year 2012and subsequent periods, it restructured its U.S. operations. As part of this restructuring plan, the Company executed termination agreements withcertain of its U.S. employees and renegotiated the lease for its U.S facilities. In 2011, the Company recorded an expense in the amount of $419,consisting of employee severance costs and lease agreement termination. During 2012, the remaining restructuring expenses related to the restructuring ofU.S. operations were included in research and development expenses due to the immateriality of such expenses. As of December 31, 2012, the $419restructuring expenses mentioned above have been paid. d.During the first quarter of 2011, the Company recorded total income of $590 in connection with its restructuring plan implemented during the thirdquarter of 2010. The income resulted mainly from the 99Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data closure of the Company’s Swiss facilities and the termination of employment of the employees of its Swiss subsidiary, which resulted in a curtailmentand settlement of the Swiss pension plan during the first quarter of 2011.NOTE 16:- SEGMENT INFORMATIONDescription of segments:Until the second quarter of 2012, the Company operated under one reporting segment. During the third quarter of 2012, following a change in themanner management evaluates financial information, the Company determined that it operates under three reportable segments in accordance with ASC 280“Disclosure about Segments of an Enterprise and Related Information.”The Company’s operating segments are as follows: Home, Office and Mobile. The classification of the Company’s business segments is based on anumber of factors that management uses to evaluate, view and run the Company’s business operations, which include, but are 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 inretail or supplied by telecommunication service providers, residential gateway devices supplied by telecommunication service providers which integrate theDECT/CAT-iq functionality and 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 VoIPterminals 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:The Company derives the results of its business segments directly from its internal management reporting system and by using certain allocationmethods. The accounting policies the Company uses to derive business segment results are substantially the same as those the Company uses forconsolidation of its financial statements. Management measures the performance of each business segment based on several metrics, including earnings fromoperations. Management uses these results, in part, to evaluate the performance of, and to assign resources to, each of the business segments. The Companydoes not allocate to its business segments certain operating expenses, which it manages separately at the corporate level. These unallocated costs includeprimarily restructuring charges, amortization of purchased intangible assets, equity-based compensation expenses and certain corporate governance costs.The Company does not allocate any assets to segments and, therefore, no amount of assets is reported to management and disclosed in the financialinformation for segments. 100Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data Selected operating results information for each business segment was as follows for the year ended December 31, 2012 and 2011: Year ended December 31 Revenues Income (loss) from operations 2012 2011 2010 2012 2011 2010 Home $155,211 $188,192 $223,354 $15,040 — * — * Office $7,579 $5,669 $2,128 $(5,156) — * — * Mobile $— $— $— $(8,585) — * — * Total $162,790 $193,861 $225,482 $1,299 $(2,830) $10,234 *)It is impracticable to present 2011 and 2010 income (loss) from operations by segments due to lack in internal management reporting and trackingsystem, which tracks and reports employees actual hours in the various projects.The reconciliation of segment operating results information to the Company’s consolidated financial information was as follows: Year ended December 31, 2012 2011 2010 Income (loss) from operations $1,299 $(2,830) $10,234 Unallocated corporate, general and administrative expenses (2,600) (3,484) (2,419) Restructuring expenses (2,008) 170 (463) Equity-based compensation expenses (4,983) (6,220) (9,553) Intangible assets amortization expenses (2,310) (7,972) (9,975) Other income from remeasurement of initial investment in an affiliated company — 1,343 — Reversal of a reserve that was determined to be no longer needed due to the expiration ofapplicable statute of limitations included in costs of goods sold — — 2,500 Financial income, net 2,388 1,885 1,468 Total consolidated loss before taxes $(8,214) $(17,108) $(8,208) Major customers and geographic informationThe following is a summary of operations within geographic areas based on customer locations: Year ended December 31, 2012 2011 2010 Revenue distribution Hong-Kong $84,737 $100,894 $112,319 Japan 51,033 57,260 76,986 Korea 1,968 5,909 8,081 Europe 7,429 9,180 13,043 United States 2,028 1,836 1,423 China 6,270 8,577 6,807 Taiwan 6,496 7,225 3,208 Other 2,829 2,980 3,615 $162,790 $193,861 $225,482 101Table of ContentsDSP GROUP INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)U.S. dollars in thousands, except share and per share data For a summary of revenues from major customers, please see Note 1. Sales to these customers were primarily related to the Company’s Home reportablesegment.The following is a summary of long-lived assets within geographic areas based on the assets’ locations: December 31, 2012 2011 Long-lived assets Europe $120 $131 Israel 3,151 4,981 United States 9 40 Other 426 651 $3,706 $5,803 102Table of ContentsItem 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.None. Item 9A.CONTROLS AND PROCEDURES.Evaluation of Disclosure Controls and ProceduresAs of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, ourChief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2012.There has been no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affectedor is reasonably likely to materially affect our internal control over financial reporting.Management’s Annual Report on Internal Control over Financial ReportingOur management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) and Rule 15d-15(f) promulgated under the Securities Exchange Act of 1934, as amended. Our internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detectmisstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies or procedures may deteriorate.Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, weconducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, our management concluded thatour internal control over financial reporting was effective as of December 31, 2012.The effectiveness of our internal control over financial reporting as of December 31, 2012 has been audited by Kost, Forer, Gabbay & Kasierer, amember of Ernst & Young Global, an independent registered public accounting firm, who audited and reported on the consolidated financial statements of thecompany for the year ended December 31, 2012, as stated in their report which is presented in this Annual Report on Form 10-K under Item 8. Item 9B.OTHER INFORMATION.None. 103Table of ContentsPART IIICertain information required by Part III of this Annual Report is omitted and will be incorporated by reference herein from our definitive proxy statementpursuant to Regulation 14A in connection with the 2013 Annual Meeting of Stockholders to be held on June 10, 2013. Item 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.Information relating to our directors and executive officers will be presented under the captions “Proposal No. 1—Election of Directors” and “ExecutiveOfficers and Directors” in our definitive proxy statement. Such information is incorporated herein by reference. Item 11.EXECUTIVE COMPENSATION.Information relating to executive compensation will be presented under the caption “Executive Compensation” in our definitive proxy statement. Suchinformation is incorporated herein by reference. Item 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS.Information relating to the security ownership of our common stock by our management and other beneficial owners will be presented under the caption“Security Ownership of Certain Beneficial Owners and Management” in our definitive proxy statement. Such information is incorporated herein by reference.Information relating to our equity compensation plans will be presented under the caption “Equity Compensation Plan Information” in our definitiveproxy statement. Such information is incorporated herein by reference. Item 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.Information relating to certain relationships of our directors and executive officers and related transactions, as well as director independence information,will be presented under the caption “Certain Relationships and Related Transactions” in our definitive proxy statement. Such information is incorporatedherein by reference. Item 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES.Information relating to principal accountant fees and services will be presented under the caption “Principal Accountant Fees and Services” in ourdefinitive proxy statement. Such information is incorporated herein by reference. 104Table of ContentsPART IV Item 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a)The following documents have been filed as a part of this Annual Report on Form 10-K. 1.Index to Financial Statements.Description: Report of Kost, Forer, Gabbay & Kasierer, a member of Ernst & Young Global Consolidated Balance Sheets as of December 31, 2012 and 2011 Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 2010 Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2012, 2011 and 2010 Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010 Notes to Consolidated Financial Statements 2.Index to Financial Statement Schedules.The following financial statement schedule and related auditor’s report are filed as part of this Annual Report on Form 10-K:Description: Valuation and Qualifying Accounts Schedule II All other schedules are omitted because they are not applicable or the required information is included in the attached consolidated financialstatements or the related notes for the year ended December 31, 2012.List of Exhibits: ExhibitNumber Description 2.1 Share and Business Sale Agreement, dated September 3, 2007, by and among DSP Group, Inc., DSP Group Ltd. and NXP, B.V. (filed asExhibit 2.1 to the Registrant’s Current Report on 8-K filed September 7, 2007, and incorporated herein by reference). 3.1 Amended and Restated Certificate of Incorporation (filed as Exhibit 3.1B to the Registrant’s Registration Statement on Form S-1, file no. 33-73482, as declared effective on February 11, 1994, and incorporated herein by reference). 3.2 Certificate of Amendment of the Amended and Restated Certificate of Incorporation, Effective as of July 19, 1999 (filed as Exhibit 3.2 to theRegistrant’s Annual Report on Form 10-K for the year ended December 31, 2006, and incorporated herein by reference). 3.3 Amended and Restated Bylaws, effective as of July 25, 2011 (filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed onJuly 26, 2011, and incorporated herein by reference). 3.4 Amendment to the DSP Group, Inc. Bylaws, effective as of April 3, 2012 (filed as Exhibit 10.2 to Registrant’s Current Report on 8-K filed onApril 5, 2012, and incorporated herein by reference). 10.1 Amended and Restated 1991 Employee and Consultant Stock Plan (filed as Exhibit 10.1 to the Registrant’s Annual Report on Form 10-K forthe year ended December 31, 2003, and incorporated herein by reference). †† 10.2 Amended and Restated 1993 Director Stock Option Plan (filed as Exhibit 10.2 to the Registrant’s Annual Report on Form 10-K for the yearended December 31, 2011, and incorporated herein by reference). †† 105Table of ContentsExhibitNumber Description 10.3 Form of Option Agreement for Israeli Directors under the Amended and Restated 1993 Director Stock Option Plan (filed as Exhibit 10.4 to theRegistrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, and incorporated herein by reference). †† 10.4 Form of Option Agreement for Non-Israeli Directors under the Amended and Restated 1993 Director Stock Option Plan (filed as Exhibit 10.4 tothe Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, and incorporated herein by reference). †† 10.5 Amended and Restated 1993 Employee Stock Purchase Plan and form of subscription agreement thereunder (filed as Exhibit 10.5 to theRegistrant’s Annual Report on Form 10-K for the year ended December 31, 2011, and incorporated herein by reference). †† 10.6 Form of Indemnification Agreement for directors and executive officers (filed as Exhibit 10.1 to the Registrant’s Registration Statement onForm S-1, file no. 33-73482, as declared effective on February 11, 1994, and incorporated herein by reference). 10.7 Employment Agreement, dated April 22, 1996, by and between the Registrant and Eliyahu Ayalon (filed as Exhibit 10.3 to the Registrant’sQuarterly Report on Form 10-Q for the quarter ended June 30, 1996, and incorporated herein by reference). †† 10.8 Amendment to Employment Agreement with Eliyahu Ayalon, dated as of November 3, 1997 (filed as Exhibit 10.26 to the Registrant’s AnnualReport on Form 10-K for the year ended December 31, 1997, and incorporated herein by reference). †† 10.9 Amendment to Employment Agreement with Eliyahu Ayalon, effective as of November 11, 1999 (filed as Exhibit 10.26 to the Registrant’sAnnual Report on Form 10-K for the year ended December 31, 1999, and incorporated herein by reference). †† 10.10 Amendment to Employment Agreement by and among DSP Group, Inc., DSP Group, Ltd. and Eli Ayalon, as amended, effective as ofOctober 27, 2009 (filed as Exhibit 10.1 to Registrant’s Current Report on 8-K filed on October 29, 2009, and incorporated herein byreference). †† 10.11 Amendment to Employment Agreement by and among DSP Group, Inc., DSP Group, Ltd. and Eli Ayalon, as amended, effective as ofMay 24, 2010 (filed as Exhibit 10.1 to Registrant’s Current Report on 8-K filed on May 28, 2010, and incorporated herein by reference). †† 10.12 Amendment to Employment Agreement by and among DSP Group, Inc., DSP Group, Ltd. and Eli Ayalon, as amended, effective as of May24, 2010 (filed as Exhibit 10.1 to Registrant’s Current Report on 8-K filed on May 28, 2010, and incorporated herein by reference). †† 10.13 Amendment to Employment Agreement by and among DSP Group, Inc., DSP Group, Ltd. and Eli Ayalon, as amended, effective as of May16, 2011 (filed as Exhibit 10.1 to Registrant’s Current Report on 8-K filed on May 20, 2011, and incorporated herein by reference). †† 10.14 Lease, dated November 28, 1996, by and between DSP Semiconductors Ltd. and Gav-Yam Lands Company Ltd., relating to the propertylocated on Shenkar Street, Herzelia Pituach, Israel (filed as Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the quarterended September 30, 1997, and incorporated herein by reference). 10.15 Lease, dated September 13, 1998, between DSP Group, Ltd. and Bayside Land Corporation Ltd., relating to the property located on ShenkarStreet, Herzelia Pituach, Israel (filed as Exhibit 10.22 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1998,and incorporated herein by reference). 10.16 Amended and Restated 1998 Non-Officer Employee Stock Option Plan (filed as Exhibit 10.19 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003, and incorporated herein by reference). †† 106Table of ContentsExhibitNumber Description 10.17 Appendix Agreement, dated May 5, 1999, by and between DSP Group, Ltd. and Bayside Land Corporation Ltd., relating to the propertylocated on Shenkar Street, Herzelia Pituach, Israel (filed as Exhibit 10.25 to the Registrant’s Annual Report on Form 10-K for the year endedDecember 31, 1999, and incorporated herein by reference). 10.18 Non-Exclusive Distribution Agreement between the Registrant and Tomen Electronics Corporation as amended on October 12, 2000 (filed asExhibit 10.28 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2000, and incorporated herein by reference). 10.19 Amended and Restated 2001 Stock Incentive Plan and form of option agreement thereunder (filed as Exhibit 10.31 to the Registrant’s AnnualReport on Form 10-K for the year ended December 31, 2003, and incorporated herein by reference). †† 10.20 Amended and Restated 2003 Israeli Share Incentive Plan (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on May 4,2011, and incorporated herein by reference) and form of option agreement thereunder (filed as Exhibit 10.32 to the Registrant’s Annual Reporton Form 10-K for the year ended December 31, 2003, and incorporated herein by reference). †† 10.21 Agreement, dated March 5, 2003, between DSP Group, Ltd. and The Gav-Yam Real Estate Company Ltd., relating to the property located onShenkar Street, Herzelia Pituach, Israel (filed as Exhibit 10.33 to the Registrant’s Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2003, and incorporated herein by reference). 10.22 Form of Option Agreement under DSP Group, Inc.’s 2001 Stock Incentive Plan for Eliyahu Ayalon (filed as Exhibit 10.41 to Registrant’sAnnual Report on Form 10-K for the year ended December 31, 2003, and incorporated herein by reference). †† 10.23 Manufacturing Capacity Agreement, effective as of July 1, 2004, by and among DSP Group, Inc., DSP Group, Ltd, and TaiwanSemiconductor Manufacturing Company Ltd (filed as Exhibit 10.4 to the Registrant’s Quarterly Report on Form 10-Q for the quarter endedSeptember 30, 2004, and incorporated herein by reference) (confidential treatment has been granted for portions of this exhibit). 10.24 Form of Non-Qualified Stock Option Agreement Providing for the Grant of Options as a Material Inducement of Employment (filed asExhibit 4.1 to Registrant’s Registration Statement on Form S-8 filed on July 21, 2005, and incorporated herein by reference). †† 10.25 Form of Stock Appreciation Right Agreement for Executive Officers pursuant to the Amended and Restated 2003 Israeli Share Incentive Plan(filed as Exhibit 99.2 to Registrant’s Current Report on 8-K filed on April 11, 2006, and incorporated herein by reference). †† 10.26 Stock Appreciation Right Agreement with Eliyahu Ayalon, dated July 2, 2006 (filed as Exhibit 99.1 to Registrant’s Current Report on 8-Kfiled on July 5, 2006, and incorporated herein by reference). †† 10.27 Manufacturing Services Collaboration Agreement, dated September 4, 2007, by and among DSP Group, Inc., DSP Group Ltd. and NXP,B.V. (filed as Exhibit 10.39 to Registrant’s Quarterly Report on 10-Q for the quarter ended September 30, 2007, and incorporated herein byreference) (confidential treatment has been granted for portions of this exhibit). 10.28 Amendment Agreement to Manufacturing Services Collaboration Agreement, dated January 27, 2009, by and among DSP Group, Inc., DSPGroup Ltd. and NXP, B.V. (filed as Exhibit 10.38 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008, andincorporated herein by reference) (confidential treatment has been granted for portions of this exhibit). 107Table of ContentsExhibitNumber Description 10.29 Agreement to Amend the Manufacturing Services Collaboration Agreement, dated December 8, 2010, by and among DSP Group, Inc., DSPGroup, Ltd. and NXP B.V. (filed as Exhibit 10.1 to Registrant’s Current Report on 8-K filed on December 10, 2010, and incorporated hereinby reference) (confidential treatment has been granted for portions of this exhibit). 10.30 Intellectual Property Transfer and License Agreement, dated September 4, 2007, by and among DSP Group, Inc., DSP Group Ltd. and NXP,B.V. (filed as Exhibit 10.40 to Registrant’s Quarterly Report on 10-Q for the quarter ended September 30, 2007, and incorporated herein byreference) (confidential treatment has been granted for portions of this exhibit). 10.31 Intellectual Property Library Services and R&D Agreement, dated September 4, 2007, by and among DSP Group, Inc., DSP Group Ltd. andNXP, B.V. (filed as Exhibit 10.41 to Registrant’s Quarterly Report on 10-Q for the quarter ended September 30, 2007, and incorporated hereinby reference) (confidential treatment has been granted for portions of this exhibit). 10.32 Umbrella Transitional Services Agreement, dated September 4, 2007, by and among DSP Group, Inc., DSP Group Ltd. and NXP, B.V. (filedas Exhibit 10.42 to Registrant’s Quarterly Report on 10-Q for the quarter ended September 30, 2007, and incorporated herein by reference)(confidential treatment has been granted for portions of this exhibit). 10.33 Employment Agreement by and between DSP Group, Ltd. and Ofer Elyakim, effective June 25, 2009 (filed as Exhibit 10.32 to Registrant’sAnnual Report on 10-K for the year ended December 31, 2010, and incorporated herein by reference). †† 10.34 Amendment to Employment Agreement by and between DSP Group, Ltd. and Ofer Elyakim, effective January 31, 2011 (filed asExhibit 10.33 to Registrant’s Annual Report on 10-K for the year ended December 31, 2010, and incorporated herein by reference). †† 10.35 Amendment to Employment Agreement by and between DSP Group, Ltd. and Ofer Elyakim, as amended, effective as of May 16, 2011(filedas Exhibit 10.2 to Registrant’s Current Report on 8-K filed on May 20, 2011, and incorporated herein by reference). †† 10.36 Employment Agreement by and between DSP Group, Ltd. and Dror Levy, effective June 9, 2002 (filed as Exhibit 10.34 to Registrant’s AnnualReport on 10-K for the year ended December 31, 2010, and incorporated herein by reference). †† 10.37 Amendment to Employment Agreement by and between DSP Group, Ltd. and Dror Levy, effective January 31, 2011 (filed as Exhibit 10.35 toRegistrant’s Annual Report on 10-K for the year ended December 31, 2010, and incorporated herein by reference). †† 10.38 Amendment to Employment Agreement by and between DSP Group, Ltd. and Dror Levy, as amended, effective as of May 16, 2011 (filed asExhibit 10.3 to Registrant’s Current Report on 8-K filed on May 20, 2011, and incorporated herein by reference). †† 10.39 Employment Agreement by and between DSP Group, Ltd. and David Dahan, effective February 1, 2012 (filed as Exhibit 10.41 to theRegistrant’s Annual Report on Form 10-K for the year ended December 31, 2011, and incorporated herein by reference). †† 10.40 Amendment to Employment Agreement by and among DSP Group, Inc., DSP Group, Ltd. and Ofer Elyakim, as amended, effective as ofNovember 5, 2012(filed as Exhibit 10.1 to Registrant’s Current Report on 8-K filed on November 9, 2012, and incorporated herein byreference). †† 10.41 Amendment to Employment Agreement by and among DSP Group, Inc., DSP Group, Ltd. and Dror Levy, as amended, effective as ofNovember 5, 2012 (filed as Exhibit 10.2 to Registrant’s Current Report on 8-K filed on November 9, 2012, and incorporated herein byreference). †† 108Table of ContentsExhibitNumber Description 10.42 Settlement Agreement, dated April 4, 2012, by and between DSP Group, Inc. and the entities and natural persons listed on Exhibit A to theagreement and their respective affiliates (collectively, “Starboard”) (filed as Exhibit 10.1 to Registrant’s Current Report on 8-K filed on April5, 2012, and incorporated herein by reference). 10.43 DSP Group, Inc. 2012 Stock Incentive Plan (filed as Exhibit 10.3 to Registrant’s Registration Statement on S-8 filed in August 10, 2012,and incorporated herein by reference). †† 10.44 Amendment to Employment Agreement of Ofer Elyakim, effective March 5, 2013 (filed as Exhibit 10.1 to Registrant’s Current Report on8-K filed on March 8, 2013, and incorporated herein by reference). †† 10.45 Amendment to Employment Agreement of Dror Levy, effective March 5, 2013 (filed as Exhibit 10.2 to Registrant’s Current Report on 8-Kfiled on March 8, 2013, and incorporated herein by reference). †† 10.46 Amendment to Employment Agreement of David Dahan, effective March 5, 2013 (filed as Exhibit 10.3 to Registrant’s Current Report on 8-K filed on March 8, 2013, and incorporated herein by reference). †† 21.1 Subsidiaries of DSP Group, Inc.* 23.1 Consent of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, Independent Registered Public Accounting Firm.* 24.1 Power of Attorney (See signature page of this Annual Report on Form 10-K).* 31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.* 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.* 32.1 Section 1350 Certification of Chief Executive Officer.* 32.2 Section 1350 Certification of Chief Financial Officer.*101.INS XBRL Instance Document101.SCH XBRL Taxonomy Extension Schema Document101.CAL XBRL Taxonomy Extension Calculation Linkbase Document101.DEF XBRL Taxonomy Extension Definition Linkbase Document101.LAB XBRL Taxonomy Extension Labels Linkbase Document101.PRE XBRL Taxonomy Extension Presentation Linkbase Document ††Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 15(c) of Form 10-K.*Filed herewith. 109Table of ContentsSIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized. DSP GROUP, INC.By: /S/ OFER ELYAKIM Ofer ElyakimChief Executive Officer (Principal Executive Officer)Date: March 18, 2013Power of AttorneyKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Ofer Elyakim and Dror Levyor either of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and re-substitution, for him and in his name, place andstead, in any and all capacities to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and otherdocuments in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, fullpower and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents andpurposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their or hissubstitutes or substitute, may lawfully do or cause to be done by virtue hereof.Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the dates indicated. Signature Title Date/S/ ELIYAHU AYALONEliyahu Ayalon Chairman of the Board March 18, 2013/S/ OFER ELYAKIMOfer Elyakim Chief Executive Officer (Principal Executive Officer) andDirector March 18, 2013/S/ DROR LEVYDror Levy Chief Financial Officer and Secretary (PrincipalFinancial Officer and Principal AccountingOfficer) March 18, 2013/S/ REUVEN REGEVReuven Regev Director March 18, 2013 Thomas A. Lacey Director March , 2013/S/ ZVI LIMONZvi Limon Director March 18, 2013 110Table of ContentsSignature Title Date/S/ YAIR SHAMIRYair Shamir Director March 18, 2013/S/ YAIR SEROUSSIYair Seroussi Director March 18, 2013 Kenneth H. Traub Director March , 2013/S/ PATRICK TANGUYPatrick Tanguy Director March 18, 2013 111Table of ContentsSchedule IIDSP GROUP, INC.VALUATION AND QUALIFYING ACCOUNTS(in thousands) Description Balance atBeginningof Period Charged to(deductedfrom) Costsand Expenses Balance atEnd of Period Year ended December 31, 2010: Allowance for doubtful accounts Sales returns reserve 117 (117) — Year ended December 31, 2011: Allowance for doubtful accounts Sales returns reserve — — — Year ended December 31, 2012: Allowance for doubtful accounts Sales returns reserve — — — Exhibit 21.1LIST OF SUBSIDIARIES Name of Subsidiary Jurisdiction ofIncorporation1. DSP Group Ltd. Israel2. Nihon DSP K.K. Japan3. RF Integrated Systems, Inc. Delaware, U.S.4. DSPG Edinburgh Ltd. Scotland5. DSPG Technologies GmbH Germany6. DSP Group HK Limited Hong Kong7. DSP Technology Indian Private Limited India8. DSP Switzerland AG Switzerland9. BoneTone Communications LTD IsraelExhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 333-183219, 333-175172, 333-161206, 333-151527, 333-140233, 333-135220, 333-131324, 333-126773, 333-112417, 333-108937, 333-147561) pertaining to the 1991 Employee and Consultant Stock Plan, 1993Director Stock Option Plan, 1998 Employee Stock Purchase Plan, 2001 Stock Incentive Plan, 2003 Israeli Share Option Plan and 2012 Equity Incentive Planof DSP Group, Inc., the 239,000 shares of common stock of DSP Group, Inc. issuable pursuant to options granted on December 1, 2004, and the 235,000shares of common stock of DSP Group, Inc. issuable pursuant to options granted on October 31, 2007, of our reports dated March 18, 2013, with respect tothe consolidated financial statements and schedule of DSP Group Inc., and the effectiveness of internal control over financial reporting of DSP Group Inc.included in this Annual Report on Form 10-K for the year ended December 31, 2012. /s/ Kost Forer Gabbay & Kasierer KOST FORER GABBAY & KASIERERA Member of Ernst & Young Global Tel-Aviv, Israel March 18, 2013 Exhibit 31.1DSP GROUP, INC.CERTIFICATIONI, Ofer Elyakim, certify that: 1.I have reviewed this annual report on Form 10-K of DSP Group, Inc.; 2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4.The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have: a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this report is being prepared; b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles; c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d)disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the registrant’s internal control over financial reporting; and 5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controlover financial reporting.Date: March 18, 2013 /s/ Ofer ElyakimOfer ElyakimChief Executive OfficerExhibit 31.2DSP GROUP, INC.CERTIFICATIONI, Dror Levy, certify that: 1.I have reviewed this annual report on Form 10-K of DSP Group, Inc.; 2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4.The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)for the registrant and have: a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this report is being prepared; b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles; c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d)disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the registrant’s internal control over financial reporting; and 5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controlover financial reporting.Date: March 18, 2013 /s/ Dror LevyDror LevyChief Financial OfficerExhibit 32.1DSP GROUP, INC.CERTIFICATIONIn connection with the annual report of DSP Group, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2012 as filed with theSecurities and Exchange Commission (the “Report”), I, Ofer Elyakim, Chief Executive Officer of the Company, hereby certify as of the date hereof, solely forpurposes of Title 18, Chapter 63, Section 1350 of the United States Code, that to the best of my knowledge: (1)the Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, and (2)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company atthe dates and for the periods indicated.A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting thesignature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company andwill be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.This Certification has not been, and shall not be deemed, “filed” with the Securities and Exchange Commission.Date: March 18, 2013 /s/ Ofer ElyakimOfer ElyakimChief Executive OfficerExhibit 32.2DSP GROUP, INC.CERTIFICATIONIn connection with the annual report of DSP Group, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2012 as filed with theSecurities and Exchange Commission (the “Report”), I, Dror Levy, Chief Financial Officer of the Company, hereby certify as of the date hereof, solely forpurposes of Title 18, Chapter 63, Section 1350 of the United States Code, that to the best of my knowledge: (1)the Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, and (2)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company atthe dates and for the periods indicated.A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting thesignature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company andwill be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.This Certification has not been, and shall not be deemed, “filed” with the Securities and Exchange Commission.Date: March 18, 2013 /s/ Dror LevyDror LevyChief Financial Officer

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