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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the transition period from                          to                          

Commission File Number 0-23006

DSP GROUP, INC.
(Exact name of registrant as specified in its charter)

Indicate 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 1934 during 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 filing requirements for the past 90 days: Yes x No o

As of August 1, 2002, there were 27,096,443 shares of Common Stock ($.001 par value per share) outstanding.

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INDEX

DSP GROUP, INC.

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PART 1.   FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

DSP GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(US dollars in thousands)

Note: The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date.

See notes to condensed consolidated financial statements.

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DSP GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(US dollars in thousands, except per share amounts)

See notes to condensed consolidated financial statements.

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DSP GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(US dollars in thousands)

See notes to condensed consolidated financial statements.

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DSP GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(UNAUDITED)
(US dollars in thousands)

See notes to condensed consolidated financial statements.

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DSP GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(UNAUDITED)

NOTE A—BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation of the results for the interim periods have been included. Operating results for the three and six months ended June 30, 2002, are not necessarily indicative of the results that may be expected for the year ending December 31, 2002 or any future period. For further information, reference is made to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2001.

Combination Agreement with Parthus Technologies plc. On April 4, 2002, DSP Group, Inc. (the “Company”), Ceva, Inc. (one of its wholly-owned subsidiaries to which the Company intends to transfer its DSP cores licensing business) (“Ceva”) and Parthus Technologies plc (“Parthus”) entered into a combination agreement, as may be amended from time to time (the “Combination Agreement”) pursuant to which Parthus and the Company agreed to affect a combination of Ceva with Parthus, whereby, immediately after the Company contributing its DSP cores licensing business and the operations and related assets and liabilities of such business to Ceva (the “Separation”), Parthus will be acquired by Ceva in exchange for the common stock of Ceva (the “Combination”). The new combined company will be called ParthusCeva, Inc. (“ParthusCeva”).

On July 11, 2002, the Company received a ruling from the United States Internal Revenue Service that the contribution of its DSP cores licensing business to Ceva and the distribution of the shares of Ceva’s common stock to the Company’s stockholders will be treated as a tax-free transaction for United States federal income tax purposes. The Combination is to be effected by a scheme of arrangement (the “Scheme”) and is subject to, among other things, the approval of the Scheme by the Parthus shareholders and the sanction of the Scheme by the High Court of Ireland. Subject to the approval of the Combination by the Parthus shareholders and the satisfaction of the other closing conditions set forth in the Combination Agreement, the Company will distribute on a pro rata basis all of the Ceva common stock it holds immediately prior to the Separation to its stockholders. Immediately following the Separation and pursuant to the terms of the Combination Agreement and Scheme, the parties anticipate that Ceva will issue its common stock to the Parthus shareholders and Parthus will become a wholly-owned subsidiary of Ceva. If these transactions are consummated as currently anticipated, upon consummation, the stockholders of the Company will hold shares representing approximately 50.1% of ParthusCeva’s common stock and the former Parthus shareholders will hold shares representing approximately 49.9% of ParthusCeva’s common stock.

As from June 30, 2002, the Company has begun to report the statements of income of its DSP cores licensing business as a discontinued operation (see Note M - Discontinued Operation).

VoicePump, Inc.: VoicePump, Inc. (“VoicePump”) is a U.S. corporation primarily engaged in the design, research, development and marketing of software applications for Voice over DSL (VoDSL) and Voice over Internet Protocol (VoIP). In March 2000, the Company acquired a majority of the outstanding stock of VoicePump, and was granted an option to purchase the remaining shares. In March 2001, the Company acquired the remaining shares of VoicePump, and it became one of the Company’s wholly-owned subsidiaries. The Company’s investment in VoicePump included the excess of its purchase price over the net assets acquired (approximately $5,804,000 as of December 31, 2001), which was attributed to goodwill and was recorded in “Other assets, net” on the Company’s consolidated balance sheets for the fiscal year ended December 31, 2001. The Company ceased amortization of the goodwill relating to the acquisition of VoicePump after December 31, 2001. For more information about goodwill amortization, see Note J -Change in Accounting for Goodwill Amortization and Certain Other Intangibles.

The unaudited condensed consolidated statements of income for the six months ended June 30, 2001 include the minority interest in the Company’s equity investment in VoicePump in the amount of $173,000 (all of which was recorded in the first quarter of 2001).

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NOTE B—INVENTORIES

Inventories are stated at the lower of cost or market value. Cost is determined using the average cost method. The Company periodically evaluates the quantities on hand relative to current and historical selling prices and historical and projected sales volume. Based on these evaluations, provisions are made in each period to write down inventory to its net realizable value. Inventories are composed of the following (U.S. dollars in thousands):

NOTE C—NET EARNINGS PER SHARE

Basic net earnings per share is computed based on the weighted average number of shares of the Company’s common stock outstanding during the period. For the same periods, diluted net earnings per share further includes the effect of dilutive stock options outstanding during the period, all in accordance with SFAS No. 128, “Earnings per Share”. The following table sets forth the computation of basic and diluted net earnings per share (U.S. dollars in thousands, except per share amounts):

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NOTE D—INVESTMENTS

The following is a summary of the held-to-maturity securities and short term bank deposits (U.S. dollars in thousands):

The amortized cost of held-to-maturity debt and securities at June 30, 2002, by contractual maturities, are shown below (U.S. dollars in thousands):

NOTE E—INCOME TAXES

The effective tax rate used in computing the provision for income taxes is based on projected fiscal year income before taxes, including estimated income by tax jurisdiction. The difference between the effective tax rate and the statutory rate is due primarily to foreign tax holiday and tax exempt income in Israel.

NOTE F—SIGNIFICANT CUSTOMERS

Product sales to one distributor accounted for 78% and 69% of the Company’s total revenues for the three months ended June 30, 2002 and 2001, respectively, and 75% and 67% of the Company’s total revenues for the six months ended June 30, 2002 and 2001, respectively. The loss of this one distributor or one or more other major distributors or customers could have a material adverse effect on the Company’s business, financial condition and results of operations.

NOTE G—OTHER INVESTMENTS

The Company accounts for its investments in marketable securities using Statement of Financial Accounting Standard No. 115 “Accounting for Certain Investments in Debt Equity Securities” (“SFAS 115”). Management determines the appropriate classification of its investments in marketable debt and equity securities at the time of purchase and re-evaluates such determinations at each balance sheet date. Debt securities for which the Company does not have the intent or ability to hold to maturity are classified as available-for-sale, along with any investments in equity securities that have not been classified as “trading securities”. As of June 30, 2002, all marketable securities covered by SFAS 115 were designated as available-for-sale. Accordingly, these securities are stated at fair value, with the unrealized gains and losses reported as a separate component of stockholders’ equity, accumulated other comprehensive income (loss). Realized gains and losses on sales of investments, as determined on a specific identification basis, are included in the Company’s consolidated statement of operations. According to the Staff Accounting Bulletin No. 59 issued by the Securities and Exchange Commission, management is required to evaluate during each quarterly period whether a security’s decline in value is other than temporary.

Other investments are comprised of:

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AudioCodes, Ltd:  AudioCodes, Ltd. (“AudioCodes”) is an Israeli corporation primarily engaged in design, research, development, manufacturing and marketing of hardware and software products that enable simultaneous transmission of voice and data over networks such as the Internet, ATM and Frame Relay.

The Company currently owns approximately 4.5 million of AudioCodes’ ordinary shares, which represents approximately 11% of its outstanding shares. Since April 1, 2001, the Company ceased to have a representative on AudioCodes’ Board of Directors, and was not involved in AudioCodes’ policy-making processes. Therefore, since April 1, 2001, the Company has not had a significant influence over the operating and financial policies of AudioCodes and thus stopped accounting for this investment under the equity method of accounting. As of April 1, 2001, the carrying amount of the Company’s investment in AudioCodes, under the equity method of accounting, amounted to $20.5 million. At April 1, 2001, the Company’s investment in AudioCodes was reclassified as available-for-sale marketable securities in accordance with SFAS 115.

As of June 30, 2002, the evaluation by the Company’s management indicated that the decline in value of AudioCodes’ ordinary shares was other than temporary. As a result, the Company realized a loss in its investment in Audiocodes in the amount of $9.8 million, which was recorded as “Impairment of available-for-sale marketable securities” on the Company’s unaudited condensed consolidated statements of income as of June 30, 2002.

Prior to the reclassification into available-for-sale marketable securities, the Company’s equity in the net income of AudioCodes was $105,000 in the first quarter of 2001.

As of June 30, 2002, in accordance with the classification into available-for-sale marketable securities, the fair market value of the Company’s investment in AudioCodes was approximately $10.7 million.

Tomen Corporation:  In September 2000, the Company invested approximately $485,000 (50.0 million Yen) in the ordinary shares of its Japanese distributor’s parent company, Tomen Corporation (“Tomen”), as part of the Company’s long-term strategic relationship with Tomen. Tomen’s ordinary shares are traded on the Japanese stock exchange, and are recorded on the Company’s unaudited condensed consolidated statement of income at fair market value as available-for-sale marketable securities in accordance with SFAS 115.

As of June 30, 2002, and 2001, the fair market value of the Company’s investment in Tomen was approximately $352,000 and $684,000, respectively. The Company’s unaudited condensed consolidated balance sheets at June 30, 2002 included unrealized loss on available-for-sale marketable securities of $133,000 for its investment in Tomen. The Company’s unaudited condensed consolidated balance sheets at June 30, 2001 included unrealized gain on available-for-sale marketable securities of $198,000 for its investment in Tomen.

Tower Semiconductor Ltd:  Tower Semiconductor Ltd. (‘Tower’) is an independent wafer manufacturer, strategically focused on advanced Flash memory and CMOS Image Sensor technologies. Tower provides manufacturing and turnkey services for integrated circuits (IC) on silicon wafers in geometries from 1.0 to 0.35 micron, using its advanced technological capabilities and the proprietary designs of its customers.

In January 2002, DSP Group, Ltd., the Israeli wholly-owned subsidiary of the Company (“DSP Group, Ltd.”), invested in the common stock of Tower for a total consideration of $2,000,000, which was recorded at fair market value as available-for-sale marketable securities in accordance with SFAS 115.

In June 2002, DSP Group, Ltd sold 250,000 shares of Tower’s common stock for approximately $1.5 million without any significant capital gain.

As of June 30, 2002, the fair market value of the Company’s investment in Tower was approximately $478,600.

The Company’s unaudited condensed consolidated balance sheets as of June 30, 2002 include unrealized loss on available-for-sale marketable securities of approximately $19,600 for its investment in Tower.

NOTE H—DERIVATIVE INSTRUMENTS

SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), requires companies to recognize all of its derivative instruments as either assets or liabilities in the statement of financial position at fair value.

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For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that 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 comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in current earnings during the period of change. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in current earnings during the period of change.

To protect against the increase in value of forecasted foreign currency cash flows resulting from payroll expenses during the year denominated in New Israeli Shekels (NIS) payable by DSP Group, Ltd., the Company has instituted a foreign currency cash flow hedging program. The Company hedges portions of the anticipated payroll expenses denominated in NIS for a period of two to ten months with forward contracts.

These forward contracts are designated as cash flow hedges, as defined by SFAS 133 and are all effective as hedges of these expenses.

As of June 30, 2002, the Company recorded a comprehensive loss an amount of $69,000 derived from its forward contracts with respect to anticipated payroll payments denominated in NIS during the next three months.

NOTE I—CONTINGENCIES

The Company is involved in certain claims arising in the normal course of business, including claims that it may be infringing patent rights owned by third parties. The Company is unable to foresee the extent to which these matters will be pursued by the claimants or to predict with certainty the eventual outcome. However, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on its financial position, results of operations, or cash flows.

NOTE J—CHANGE IN ACCOUNTING FOR GOODWILL AND CERTAIN OTHER INTANGIBLES

Effective July 1, 2001, the Company adopted certain provisions of SFAS No. 141 “Business Combinations” (“SFAS 141”), and effective January 1, 2002, the Company adopted the full provisions of SFAS 141 and SFAS No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, and broadens the criteria for recording intangible assets other than goodwill. SFAS 142 establishes new standards for the accounting treatment of goodwill acquired in a business combination by eliminating the amortization of goodwill and instead sets forth methods to periodically evaluate goodwill for impairment. Intangible assets with a determinable useful life will continue to be amortized over that period.

SFAS 142 prescribes a two-phase process for testing the impairment of goodwill. The first phase, required to be completed by June 30, 2002, screens for impairment; while the second phase (if necessary), required to be completed by December 31, 2002, measures the impairment. The Company completed its first phase of impairment analysis during the first quarter of 2002 and found no instances of impairment of its recorded goodwill; accordingly, the second testing phase, absent future indicators of impairment, is not necessary during 2002. In accordance with SFAS 142, the effect of this accounting change is reflected prospectively. Unaudited supplemental comparative disclosure as if the change had been retroactively applied to the prior year periods is as follows (U.S. dollars in thousands, except per share amounts):

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NOTE K—ABORTED SPIN-OFF EXPENSE AND OTHER

In the first quarter of 2002, the Company recorded two unusual expense items amounting to approximately $865,000. An expense of approximately $767,000 was recorded relating to the aborted spin-off of the DSP cores licensing business by way of an initial public offering of the common stock of Ceva, which did not occur. These expenses were comprised mainly of legal and accounting services rendered in 2001. Additionally, an expense of approximately $98,000 was recorded reflecting the write-off of all of the Company’s investment in Messagebay, Inc., a private company that develops both turnkey and customized software that enable two-way voice, video, and animated messaging for web applications and wireless devices.

NOTE L—NEW ACCOUNTING PRONOUNCEMENTS

In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and superseded SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of”. SFAS 144 applies to all long-lived assets (including discontinued operations) and consequently amended APB Opinion No. 30, “Reporting the Results of Operations for a Disposal of a Segment of a Business”. SFAS 144 develops one accounting model for long-lived assets that are to be disposed of by a sale. SFAS 144 requires that long-lived assets that are to be disposed of by a sale be measured at the lower of book value or fair value less this cost of sell. SFAS 144 is effective for fiscal years beginning after December 15, 2001, with earlier application encouraged. The Company adopted SFAS 144 as of January 1, 2002 and the adoption did not have a material effect on its financial position and results of operations.

FASB recently issued SFAS No. 145 “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS 145”). SFAS 145 rescinds FASB Statement No. 4, “Reporting Gains and Losses from Extinguishment of Debt”, and FASB Statement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements”. SFAS 145 also rescinds FASB Statement No. 44, “Accounting for Intangible Assets of Motor Carriers”. SFAS 145 also amends FASB Statement No. 13, “Accounting for Leases”, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. Adoption of SFAS 145 is not expected to have a material effect on the Company’s financial position or operating results.

FASB recently also issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”. SFAS 146 improves financial reporting by requiring that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. Adoption of SFAS 146 is not expected to have a material effect on the Company’s financial position or operating results.

NOTE M—DISCONTINUED OPERATION

Pursuant to the Combination Agreement entered into on April 4, 2002, the Company agreed to affect a combination of its DSP cores licensing business with the business of Parthus. For more details of the Separation and the Combination, see Note A.

In anticipation of the Separation and Combination with Parthus, the results of operations, including revenue, operating expenses, financial income and income taxes of the DSP cores licensing business for the three and six months ended June 30, 2002 and 2001, have been reclassified in the accompanying statements of operations as a discontinued operation. The Company’s balance sheets at June 30, 2002 and December 31, 2001 reflect the assets and the liabilities of the DSP cores licensing business as assets and liabilities of the discontinued operation within current assets and liabilities.

Operating results from the discontinued operation for the three months and six months ended June 30, 2002 and 2001 are as follows (U.S. dollars in thousands):

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As a result of the Separation and pursuant to the terms of the Combination Agreement, the Company will transfer $40 million in cash as initial working capital for the DSP cores licensing business plus cash equal to the amount by which the transaction costs of the Separation and Combination exceeds $2 million to Ceva at the time of the Combination. This contribution of cash is reported as “Cash designated for combination” in the Company’s unaudited condensed consolidated balance sheets at June 30, 2002. In addition, as part of the Separation, Ceva agreed with the Company to settle the intercompany investment account between them by (i) converting part of the Company investment account in Ceva (consisting of the value of the property, equipment and inventory) into Ceva’s stockholders’ equity, (ii) allowing the Company to retain all rights to Ceva’s accounts receivable existing on the date of the Separation, and (iii) having the Company retain certain of Ceva’s current liabilities existing on the date of the Separation, such that the settlement arrangement resulted in the net amount of assets retained by the Company to equal the amount of the intercompany account on the date of Separation (as of June 30, 2002, approximately $8.7 million).

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

Total Revenues.  Our total revenues were $31.9 million in the second quarter of 2002, as compared to $19.3 million in the second quarter of 2001, primarily as a result of strong demand, especially from our OEMs in Japan, for our 2.4 single handset as well as our newly-introduced 2.4 GHz multi handset products. Total revenues in the first half of 2002 increased to $53.0 million from $37.5 million in the same period in 2001, primarily as a result of strong demand, especially from our OEMs in Japan, for our 900 MHz, 2.4 GHz single handset as well as our newly-introduced 2.4 GHz multi handset products.

Export sales, primarily consisting of Integrated Digital Telephony (IDT) speech processors shipped to manufacturers in Europe and Asia, including Japan, represented 99% of our total revenues for the three months ended June 30, 2002, as compared to 98% of our total revenues for the three months ended June 30, 2001. Additionally, these sales represented 99% of our total revenues for the six months ended June 30, 2002 and 98% of our total revenues for the six months ended June 30, 2001. All export sales are denominated in U.S. dollars.

Significant Customers.  Revenues from one distributor, Tomen Electronics, accounted for 78% and 69% of our total revenues for the three months ended June 30, 2002 and 2001, respectively. Additionally, Tomen Electronics, accounted for 75% and 67% of our total revenues for the six months ended June 30, 2002 and 2001, respectively. The increase in

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revenues attributed to Tomen Electronics for both the three and six months ended June 30, 2002, as compared to the three and six months ended June 30, 2001, was primarily due to a higher volume of sales made by them in Japan. The loss of Tomen Electronics or one or more of our other major distributors or customers could harm our business, financial condition and results of operations.

Gross Profit.  Gross profit as a percentage of total revenues decreased to 40% for the second quarter of 2002 from 41% for the second quarter of 2001. Gross profits as a percentage of total revenues decreased to 40% for the six months ended June 30, 2002 from 44% for the same period in 2001. The decrease for both comparative periods was primarily due to the continued decline in average selling prices of cordless telephony products, which we managed to partially offset with a decrease in manufacturing costs, partially due to technological improvements.

Research and Development Expenses.  Our research and development expenses increased slightly to $5.0 million in the second quarter of 2002 from $4.9 million in the second quarter of 2001. In the first half of 2002, research and development expenses decreased slightly to $9.9 million from $10.0 million in the first half of 2001. The slight increase for both comparative periods was primarily attributed to higher levels of subcontractors and semiconductor mask work expenses incurred as part of the introduction of new products, offset by lower payroll expenses denominated in New Israeli Shekel (NIS) of our research and development employees employed by our Israeli subsidiary due to a decrease in the value of NIS in comparison to the United States dollar. Our research and development expenses as a percentage of total revenues were 16% and 25% for the three months ended June 30, 2002 and 2001, respectively, and 19% and 27% for the six months ended June 30, 2002 and 2001, respectively. Research and development expenses consist mainly of payroll for employees involved in research and development, mask work, subcontracting, depreciation and maintenance fees relating to equipment and software tools and associated facilities expenses.

Sales and Marketing Expenses.  Our sales and marketing expenses increased to $2.5 million in the second quarter of 2002 from $2.3 million in the second quarter of 2001. For the six months ended June 30, 2002, sales and marketing expenses were $4.5 million as compared to $4.4 million for the same period in 2001. The slight increase for both comparative periods was primarily attributed to payment of higher sales commissions due to greater revenues for both the three month and six month ended June 30, 2002, partially offset by lower payroll expenses denominated in NIS of our sales and marketing employees employed by our Israeli subsidiary due to a decrease in the value of NIS in comparison to the United States dollar, as well as lower marketing activities. Our sales and marketing expenses as a percentage of total revenues were 8% and 12% for the three months ended June 30, 2002 and 2001, respectively, and 8% and 12% for the six months ended June 30, 2002 and 2001, respectively. Sales and marketing expenses consist mainly of payroll of direct sales and marketing employees, sales commissions, and trade show expenses.

General and Administrative Expenses.  Our general and administrative expenses were $1.0 million for the three months ended June 30, 2002, as compared to $1.2 million for the three months ended June 30, 2001. In the first half of 2002, general and administrative expenses were $1.9 million compared to $2.2 million for the same period in 2001. The decrease for both comparative periods was primarily due to the amortization of goodwill associated with the acquisition of VoicePump during the three and six months ended June 30, 2001, which ceased as of January 1, 2002 in accordance with SFAS No. 142 “Goodwill and Other Intangible Assets.” General and administrative expenses as a percentage of total revenues were 3%, and 6% for the three months ended June 30, 2002 and 2001, respectively, and 4% and 6% for the six months ended June 30, 2002 and 2001, respectively. General and administrative expenses consist mainly of payroll for administrative employees and accounting and legal costs.

Aborted Spin-Off and Other Expenses.  In the first quarter of 2002, we recorded two unusual expense items amounting to approximately $865,000. An expense of approximately $767,000 was recorded relating to the aborted spin-off of the DSP cores licensing business by way of an initial public offering of the common stock of Ceva, which did not occur. These expenses were comprised mainly of legal and accounting services rendered in 2001. Additionally, an expense of approximately $98,000 was recorded reflecting the write-off of all of our investment in Messagebay, Inc., a private company that develops both turnkey and customized software that enable two-way voice, video, and animated messaging for web applications and wireless devices.

Interest and Other Income (Expense).  Interest and other income (expense), net, for the three months ended June 30, 2002 decreased to $2.5 million from $3.3 million for the three months ended June 30, 2001 and decreased to $5.2 million for the six months ended June 30, 2002 from $6.6 million for the six months ended June 30, 2001. The decrease for both comparative periods was primarily due to a decline in returns as a result of overall lower market interest rates for the comparative periods, offset by higher levels of cash, cash equivalents, marketable securities and short term bank deposits during the same periods.

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Equity in Earnings of Affiliate.  Since April 1, 2001, we no longer had significant influence over the operating and financial policies of AudioCodes, Ltd. and thus stopped accounting for this investment under the equity method of accounting. Our equity in the net income of AudioCodes was $105,000 for the six months ended March 31, 2001 (all of which was recorded in the first quarter of 2001).

Minority Interest in Losses of Subsidiary.  We included in our unaudited condensed consolidated statements of income for the six months ended June 30, 2001, an amount of $173,000 for our minority interest in VoicePump’s losses (all of which was recorded in the first quarter of 2001).

Impairment of Available-for-Sale Marketable Securities.  As of June 30, 2002, our management’s evaluation indicated that the decline in value of AudioCodes’ ordinary shares was other than temporary. Therefore, in accordance with SFAS No. 115 “Accounting for Certain Investments in Debt Equity Securities,” we realized a loss in our investment in Audiocodes in the amount of $9.8 million, which was recorded as “Impairment of available-for-sale marketable securities” on our unaudited condensed consolidated statements of income as of June 30, 2002.

Provision (Benefit) for (from) Income Taxes.  Our tax provision for the second quarter of 2002 and for the first half of 2002 was $1.4 million and $1.7 million, respectively. In addition, we recorded tax benefit in the second quarter of 2002 and in the first half of 2002 in the amount of $3.5 million related to the amortization of AudioCodes. In 2002 and 2001, we benefited for federal and state tax purposes from foreign tax holiday and tax exempt income in Israel.

Discontinued Operation.   On April 4, 2002, we entered into a combination agreement, as amended with Ceva, Inc. (one of our wholly-owned subsidiaries to which we intend to transfer our DSP cores licensing business) and Parthus Technologies plc pursuant to which we agreed with Parthus to affect a combination of Ceva with Parthus, whereby, immediately after the contribution of our DSP cores licensing business and the operations and related assets and liabilities of such business to Ceva, Parthus will be acquired by Ceva in exchange for the common stock of Ceva. The new combined company will be called ParthusCeva, Inc.

On July 11, 2002, we received a ruling from the United States Internal Revenue Service that the contribution of our DSP cores licensing business to Ceva and the distribution of the shares of Ceva’s common stock to our stockholders will be treated as a tax-free transaction for United States federal income tax purposes. This satisfied one of the conditions to closing of this transaction, although others still remain.

We expect that the combination of Ceva with Parthus will be effected by a scheme of arrangement and is subject to, among other things, the approval of the scheme by Parthus shareholders and the sanction of the scheme by the High Court of Ireland. Subject to the approval of the combination by the Parthus shareholders and satisfaction or waiver of the other conditions to closing of the combination agreement, we will distribute on a pro rata basis all of the Ceva common stock we hold immediately prior to the separation to our stockholders. Immediately following the separation and pursuant to the combination, Ceva will issue its common stock to Parthus’ shareholders and Parthus will become a wholly-owned subsidiary of Ceva. If these transactions are consummated as currently anticipated, upon consummation, our stockholders will hold shares representing approximately 50.1% of ParthusCeva’s common stock and the former Parthus shareholders will hold shares representing approximately 49.9% of ParthusCeva’s common stock.

In anticipation of the consummation of these transactions, as of June 30, 2002, we began to report the statements of income of our DSP cores licensing business as a discontinued operation.

Net income derived from our DSP cores licensing business was $1.0 million for the three months ended June 30, 2002, as compared to $3.7 million for the three months ended June 30, 2001. In the first half of 2002, net income derived from our DSP cores licensing business was $1.5 million as compared to $6.1 million for the comparable period in 2001. The decrease for both comparative periods was primarily due to a decrease in total revenues for the DSP cores licensing business for both the three months and six months ended June 30, 2002. Our total revenues for the DSP cores licensing business decreased to $4.6 million for the second quarter of 2002, as compared to $7.0 million for the same period in 2001. The decrease for the three months ended June 30, 2002 was primarily due to (i) lower licensing revenues in our DSP cores licensing business, primarily due to additional revenues received from existing license agreements in the second quarter of 2001, as compared to the same period in 2002, partially offset by additional revenues received from three new license agreements in the second quarter of 2002 as compared to one new license agreements in the same period in 2001, (ii) lower per-unit royalties from some of the license agreements in our DSP cores licensing business primarily due to volume pricing, and (iii) lower technical support and other revenues primarily due to the provision of fewer technical support and related services to our DSP cores licensees during the second quarter of 2002, as compared to the same period in 2001, primarily as a result of the slowdown in

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the global wireless and cellular markets. Our total revenues for the DSP cores licensing business decreased to $8.7 million for the first half of 2002, as compared to $13.0 million for the same period in 2001. The decrease for the six months ended June 30, 2002 was primarily due to (A) lower licensing revenues primarily because we were able to negotiate higher licensing fees for certain of our products in 2001, (B) lower per-unit royalties from some of the license agreements in our DSP cores licensing business primarily due to volume pricing, as well as lower overall quantities of products shipped by our licensees that incorporated our DSP cores technology (mostly in the cellular and hard disk drive markets), and (C) lower technical support and other revenues primarily due to the provision of fewer technical support and related services to our DSP cores licensees during the first six months of 2002 as compared to 2001, primarily as a result of the slowdown in the global wireless and cellular markets.

In 2001 and the first half of 2002, we witnessed a challenging environment in the telecommunication and semiconductors industries, resulting in longer sales cycles and delays in the purchase decision-making processes of potential customers for our DSP core technologies. This resulted in fewer new license agreements being executed in 2001 and in the first half of 2002, as compared to 2000, and limited business visibility for the number and timing of future license agreements. Accordingly, we may have difficulty in accurately forecasting our licensing revenues for the DSP cores licensing business for any future quarter.

LIQUIDITY AND CAPITAL RESOURCES

Operating Activities.  During the six months ended June 30, 2002, we generated $9.4 million of cash from our operating activities, as compared to $10.9 million during the six months ended June 30, 2001. The decrease in cash provided by our operations for the six months ended June 30, 2002 as compared to the six months ended June 30, 2001 was primarily due to (A) a decrease in net income in 2002, partially offset by the impairment in our investment of AudioCodes and (B) increases in accounts receivables and inventories, partially offset by increases in accounts payable, income tax payable and accrued expenses.

Our inventories increased to $9.7 million in June 30, 2002 from $2.0 million in December 31, 2002, which was mainly an increase in work-in-process inventories (see Note B to the Notes to the Unaudited Condensed Consolidated Financial Statements). The increase in work-in-process was primarily attributed to our preparation for the production of the high level of orders received at the end of the second quarter of 2002 and which are currently expected to be delivered in the third quarter of 2002.

Investing Activities.  We invest excess cash in short-term bank deposits and marketable securities of varying maturity, depending on our projected cash needs for operations, capital expenditures and other business purposes. During the first six months of 2002, we purchased $37.5 million of investments classified as short-term and long-term bank deposits and held-to-maturity marketable securities, as compared to $79.9 million during the first six months of 2001. During the same periods, $63.7 million and $67.2 million, respectively, of investments classified as held-to-maturity marketable securities matured. Additionally, in anticipation of our cash contribution of $40 million (plus the amount by which transaction expenses exceed $2 million) to Ceva in connection with the separation of our DSP cores licensing business and combination of Ceva with Parthus, we are currently building this cash reserve to be transferred to Ceva. Accordingly, our income from investing activities for future quarters may decrease. See Note A to the Notes to the Unaudited Condensed Consolidated Financial Statements for more information about the combination.

Our capital equipment purchases for the first six months of 2002, consisting primarily of research and development software and computers, totaled $1.0 million, as compared to $1.4 million for the first six months of 2001. In addition, in January 2002, we invested $2.0 million in an independent wafer manufacturer company, Tower Semiconductor Ltd., and in June 2002, we sold 250,000 shares of Tower Semiconductor’s ordinary shares for approximately $1.5 million. The investment was recorded as available-for-sale marketable securities in accordance with SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities” and was recorded in our condensed consolidated balance sheets under “Other assets.” See Note G to the Notes to the Unaudited Condensed Consolidated Financial Statements for more information about our investment in Tower Semiconductor.

Additionally, our cash contributed to discontinued operation for the first six months of 2002 was $4.4 million, as compared to $3.3 million for the first six months of 2001 mainly due to an increase in deferred accounting and legal expenses incurred in relation to consummating the separation of our DSP cores licensing business and combination with Parthus.

Financing Activities.  During the six months ended June 30, 2002, we received $2.0 million upon the exercise of employee stock options and through purchases pursuant to our employee stock purchase plan, as compared to $2.2 million during the

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six months ended June 30, 2001.

At June 30, 2002, our principal source of liquidity consisted of cash and cash equivalent deposits totaling $30.0 million and marketable securities and short-term cash deposits of $222.9 million. Our working capital at June 30, 2002 was $133.5 million.

We believe that our current cash, cash equivalents, cash deposits and marketable securities will be sufficient to meet our cash requirements for at least the next twelve months.

In addition, as part of our business strategy, we occasionally evaluate potential acquisitions of businesses, products and technologies. Accordingly, a portion of our available cash may be used at any time for the acquisition of complementary products or businesses. Such potential transactions may require substantial capital resources, which may require us to seek additional debt or equity financing. We cannot assure you that we will consummate any such transactions. Furthermore, we cannot assure you that additional financing will be available to us in any required time frame on commercially reasonable terms, if at all. See “Factors Affecting Future Operating Results—There are Risks Associated with our Acquisition Strategy” for more detailed information.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk.  It is our policy not to enter into interest rate derivative financial instruments, except for hedging of foreign currency exposures discussed below. We do not currently have any significant interest rate exposure since we do not have any financial obligation, and our financial assets are measured on a held-to-maturity basis.