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Saifun Semiconductors Ltd., (SFUN)

Q2 2006 Earnings Conference Call

July 26, 2006, 8:30 a.m. EST

Executives:

Dr. Boaz Eitan, Chairman and CEO

Igal Shany, Chief Financial Officer

Kobi Rozengarten, President

Lee Roth, Investor Relations

Analysts:

Daniel Amir, W.R. Hambrecht

Jeff Rosenberg, William Blair

Craig Ellis, Citigroup

Daniel Gelbtuch, CIBC

Pranay Laharia, Deutsche Bank

Khameel Des, Lehman Brothers

Nimal Vallipuram, Halpoalim Securities

Operator

Good evening ladies and gentlemen. My name is Charita and I will be your conference facilitator today. At this time, I would like to welcome everyone to your Saifun Semiconductor Second Quarter 2006 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer period. If you would like to ask a question during this time, please press * then the number 1 on your telephone keypad. If you would like to withdraw your question press the # key. Thank you; it is now my pleasure to turn the floor over to your host, Mr. Lee Roth. Sir, you may begin your conference.

Lee Roth, Investor Relations

Thank you, Charita, and good morning everyone. This is Lee Roth of KCSA Worldwide, Investor Relations counsel for Saifun. With me on the call this morning are Dr. Boaz Eitan, Chairman and CEO of Saifun; Mr. Kobi Rozengarten, President; and Mr. Igal Shany, CFO.

Before we begin, I would like to remind you of the following Safe Harbor provisions that are in effect for today’s call. During the course of this conference call, the Company may make forward-looking statements regarding future events. We wish to caution you that such statements reflect only the Company’s current expectations and that actual events or results may differ materially. You are kindly referred to the risks factors and cautionary language contained in the Company’s annual report filed on Form 20-F with the US Securities and Exchange Commission dated April 11, 2006. The Company undertakes no obligation to update any projections or forward-looking statements in the future. With that said I’d now like to turn the call over to Dr. Boaz Eitan, Chairman and CEO of Saifun Semiconductors. Boaz, go ahead please.

Dr. Boaz Eitan, Chairman and CEO

Thank you, Lee. Good day everyone and welcome to our second quarter call. Before I turn the call over to Igal and Kobi for their review of the financials and the quarter highlights, I would like first to share the following.

The second quarter of 2006 was a successful quarter both operationally and strategically. On the operational side, we have exceeded the high end of our guidance range and achieved good year-over-year revenue growth. This growth was driven by an increase in our design activity resulting in an increase in our service revenue.

We continue working with our licensees towards bringing new NROM based flash memory solutions to the market. As these products reach mass production, we will see royalties taking a larger share of our revenue. We believe that this is shift is fueling Saifun’s future growth. Perhaps more important this quarter was the strategic progress we made with our licensees. During the second quarter we continued moving close to mass production of the first flash memory product based on our Quad NROM technology, an advanced manufacturing process.

The introduction of a real 4-bit per cell flash product this year will truly be a revolution for our industry and we are extremely proud that our technology is making this. On the research side, we continue to invest resources in research and development addressing further shrinking and increased performance.

Before Kobi elaborates on the development of the second quarter and outlook for the remainder of the year, I would like to turn the call over to Igal for a review of the financial results. Following these remarks, we will open the call for questions. Igal…

Igal Shany, Chief Financial Officer

Thank you, Boaz. Turning to our financial highlights, please note that we are referring to the non-GAAP information presented in our press release. Revenues for the second quarter were $17.4 million, an increase of 16% compared to $14.9 million in the second quarter of ’05. Our revenues are made up of licensing and service revenues as follows.

Licensing revenues for the second quarter were $11.1 million. Licensing revenues represented 64% of the total revenues this quarter. The majority of the licensing revenues this quarter were derived from Qimonda, Spansion, and SMIC. Service revenues for the second quarter continued to grow and were $6.2 million. Service revenues represented 36% of the total revenues this quarter. In this quarter most of the service activity was driven by data flash projects. Our top three service customers were Qimonda, Spansion, and SMIC.

Gross margin for the second quarter was 82%. Gross margin on the service revenues was 50% or 34% excluding service revenues for which cost of services was recorded in the previous quarters. Operating expenses for the second quarter were $5.2 million or 30% of revenues, which included 19% R&D and 11% SG&A. R&D together with cost of services in the second quarter was $6.5 million or 37% of revenues. This is compared to $4 million or 27% in the second quarter of ’05. The increase in our operating expenses this quarter resulted from increasing R&D expenses primarily. This is the ride from new research and development projects as well as from an increase in our engineering staff.

Operating income for the second quarter was $9 million or 52% of revenues, compared to $9 million in the second quarter of ’05. Net income for the second quarter was $11.3 million or 65% of revenues, compared to $8.9 million in the second quarter of ’05. Our non-GAAP EPS for the second quarter was $0.34 per diluted share. Our total shares outstanding at the end of the second quarter were 31.1 million shares. This includes 340,000 primary shares issued in our secondary offering that we completed in April. Finally, as of June ’06, cash and marketable securities were $207 million. The increase in cash and marketable securities is a result of the net proceeds from the secondary offering as well as from cash provided from operating activities.

Now, I would like to turn the call over Kobi.

Kobi Rozengarten, President

Thank you, Igal. This quarter, we continued our progress towards meeting our strategic goals. As planned, this quarter we saw significant increase in service activity, including several Quad NROM projects that address the data flash market. We expect this product to reach volume production on schedule. Our technology is taking a major share of the Quad flash market. This is reflected in Spansion’s statement that shows NROM accounting for 42% of Spansion’s total revenues. We are confident that NROM will lead the Quad flash segment in the near future.

Looking at the data market, we continue working on high-density Quad-based products with several of our licensees. In addition, SMIC has recently announced progress with our data products based on our technology. We believe that these products which are scheduled to move to production by the end of this year and early next year will position NROM technology as a real player in the data flash segment.

Finally, we see more and more flash companies addressing this capability issue related to floating gate. We believe that our NROM capability advantages will contribute to our success, especially in the data market segment. Looking at the third quarter, we expect revenues to be in the range of $15.5 million to $16.4 million. This forecast takes a conservative assumption that the new license agreement will be signed in the fourth quarter and not in the third quarter. Operation profit should be around 45% excluding stock-based compensation expenses.

To summarize, we met our objectives for the second quarter and are well positioned for the future success. Thank you everyone. I would now like to open the call to your questions. Operator…

Question-and-Answer Session

Operator

Thank you. At this time, I would like to remind everyone, if you would like to ask a question, please press * then the number 1 on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster. Our first question is coming from Daniel Amir with W.R. Hambrecht.

Daniel Amir, W.R. Hambrecht

A couple of questions; first of all, can you expand a bit on expectations of the Quad bits that will move into production at the end of the year? Can you say kind of where it’s standing now with your different licensees that have taken a license on this, what progress are they right now, and what challenges do they still face in order to reach that goal?

Kobi Rozengarten, President

As we mentioned in the past, we have four licensees that are actively working on the 4-bit and as we said samples of a few of those entities will reach the market by the end of this year, and we’ll see early next year mass production by two and then three licensees coming to the market with those products; that’s as to the activity. Boaz, do you want to add anything on the 4-bit?

Dr. Boaz Eitan, Chairman and CEO

Sure, you can imagine that by now we have seen silicon results. It’s no longer just a discussion about tape outs. So, the obstacles we see in taking this product to production are the usual yield improvements and detailed optimizations; we don’t see a roadblock and this is based on silicon results.

Daniel Amir, W.R. Hambrecht

Okay, the second question, can you expand anything about potential new licensees? You’re saying it’s not in the third quarter, it looks like that you think it’s going to be in the fourth quarter, can we definitely expect the new licensee here in the second half of the year?

Kobi Rozengarten, President

As we said in the past, we expect a new licensee by the end of this year. While we are discussing with few potential licensees we took a conservative approach as to the third quarter and are committed to additional licensees by the end of the year.

Daniel Amir, W.R. Hambrecht

Okay, and the final question, can you comment and give just an update compared to last quarter, are there any new developments in the emerging technologies area that you continue to track that you feel is something from a competitive landscape?

Dr. Boaz Eitan, Chairman and CEO

As you are well aware, there were many announcements and as far as commenting on what is our opinion about each and every announcement we will not do it. It is very clear that the true 4-bit collusion is only in the NROM field, and we maintain this opinion even after all the announcements. Some of the announcements that we have seen like the MROM, which is a magnetic-based solution that Freescale has announced, is more geared towards the embedded market where in general speaking the MROM solution has two elements or two transistors per 1-bit while we are talking 4-bit per one transistor. So, we don’t believe that this specific technology will be geared to really take on the main market. So, in conclusion, we are still very positive and strongly believe that we have the only solution for the 4-bit applications.

Kobi Rozengarten, President

Daniel, any more questions?

Daniel Amir, W.R. Hambrecht

No that’s it.

Kobi Rozengarten, President

Hey, by the way, congratulations.

Daniel Amir, W.R. Hambrecht

Thank you.

Operator

Thank you. Our next question is coming from Jeff Rosenberg with William Blair.

Jeff Rosenberg, William Blair

I guess the first question I want to ask was, when you look at Qimonda in the data market, can you talk a little bit about what densities they are in the market with and just a range of densities that they have out there today in volume?

Kobi Rozengarten, President

I believe that you follow the Qimonda latest F1 statement and they discussed their activity on their flash, and as I recall, they said that they are in production with the 170 nanometer and the 110 nanometer, discussing up to 1 GB product in the market. In addition, they discussed their activity on 75 nanometer products in which we are involved.

Jeff Rosenberg, William Blair

Can you say whether or not you expect them to be in the market with a higher density product soon or what the expectations are there?

Igal Shany, Chief Financial Officer

Jeff, this is Igal. Last time I seen a quote made by Qimonda was that early next year they expect to see products based on their 75 nanometer design.

Kobi Rozengarten, President

And they said that it could be ready.

Jeff Rosenberg, William Blair

Okay, thanks. Then, Igal, on the guidance, I just wanted to make sure in terms of translating what you said on the EPS number, it seems that towards the middle of your range at 45% operating margin I’m getting a pro-form EPS number in the high 20’s, am I missing something there or is that about the right way to look at it?

Igal Shany, Chief Financial Officer

Potentially the right way, yes.

Jeff Rosenberg, William Blair

Okay, thanks very much.

Operator

Thank you. Your next question is coming from Craig Ellis with Citigroup.

Craig Ellis, Citigroup

Good morning everybody, thanks for taking the question. First up, on the top line with respect to the guidance, Igal, how should we think about services sequentially relative to licensing?

Igal Shany, Chief Financial Officer

As you can see and we said it in the past, ’06 for us is a transition year in which we see a higher degree of service activity as part of the total revenues for us. You’ve seen it in the first quarter, in the second quarter, and we expect the trend to continue for the rest of the year. This service activity will translate later on in ’07 to products coming to the market and therefore additional growth that we expect to see later on. To which you asked, are we going to see a significant increase in the service revenues? I think that we reached a historical level that we will keep for the rest of the year and obviously the rest is coming from the licensing revenues. If we go back to the licensing revenues and the transition that we are seeing this year, what we see is that we have a tremendous increase in the royalty revenues and this increase offsets part of the decline that we have in the license fees revenues. As you recall, our licensing revenues comprise of royalties as well as from license fee revenues.

Craig Ellis, Citigroup

Okay that’s helpful, thanks. Then, Igal, on the balance sheet, we saw accounts receivable uptake sequentially, can you just provide some color on what was happening there?

Igal Shany, Chief Financial Officer

Just a peak at the end of June; I wouldn’t draw any conclusion out of it.

Craig Ellis, Citigroup

Okay, and then back on the topic of potential licensees, can you just discuss some of the gating factors with regards to securing new licensees, is it more bandwidth on your end, is it some uncertainty out there right now just given the pricing and some of the competitive dynamics, what are some of the gives and takes as it relates to securing a new licensee this year?

Kobi Rozengarten, President

Craig, we discussed it in the past and the process of engaging between new licensees is a long process. We are involved with many potential licensees for a long time. There are many aspects in which there are strategically decisions and then the aspect as to the agreements. However, this process is a process that takes time and basically we are on schedule with a few of those potential licensees.

Craig Ellis, Citigroup

Alright, thank you gentlemen.

Dr. Boaz Eitan, Chairman and CEO

If I many add to the same question, most of our licensees are taking a license for the long term. So, the current situation, the ups and downs, are not necessarily a reflection on the possibility of signing a new licensee.

Operator

Thank you. Your next question is coming from Daniel Gelbtuch with CIBC.

Daniel Gelbtuch, CIBC

Hi, great quarter, good morning. I was wondering with regard to potential licensees, do you expect licensees more on the de-ramp conversion side or do you expect existing mass producers who are using floating gate to be moving over to NROM?

Dr. Boaz Eitan, Chairman and CEO

As we expected in the past, we are discussing with both those potential licensees, those that are already active in this market and those that are planning to join the market. As well, as you know, we are also involved in the embedded side and we are also discussing with potential licensees.

Daniel Gelbtuch, CIBC

And with regard to Qimonda, you mentioned that they will be coming with an 8 gig 75 nanometer port in the Quad format, how do you expect that, in terms of die size, to compare to let’s say SanDisk 70 nanometer MLC on 8 gig that’s coming out right now?

Dr. Boaz Eitan, Chairman and CEO

First of all, I would like to remind you that this is what Qimonda had stated. They will come with an 8 gig and I’m not aware if they have mentioned it; it’s a true 4-bit and we are not to announce product for our licensees. As to the issue of a 4-bit 75 or 70 relative to any other technology in 70, it will always be a smaller die size, and again I will not give you the exact percentages, but it is of a real significance.

Daniel Gelbtuch, CIBC

Okay, and with regards to SMIC and Spansion on the Quad side, when should we expect to see products from them, is it also early ’07 or late ’06?

Kobi Rozengarten, President

Daniel, I would follow what those companies are saying. I recall Spansion mentioned that they will come with products in the fourth quarter this year and there was also some statement by SMIC that their next-generation activity will be based on a 4-bit, and we support those statements.

Daniel Gelbtuch, CIBC

Alright, thank you very much.

Operator

Once again, ladies and gentlemen, as a reminder, if you would like to ask a question please press * then 1 on your telephone keypad at this time. Your next question is coming from Pranay Laharia with Deutsche Bank.

Pranay Laharia, Deutsche Bank

Hi, fist question, Igal, for you, can you talk about where the upside to revenues relative to expectations came from, was it license, royalty or service? And then if I’m doing the math right, then there isn’t anymore unrecognized service revenues left to go, is that right?

Igal Shany, Chief Financial Officer

As to the upside, I think that most of the upside came on the service side this quarter and I think that you refer to this quarter, is that right?

Pranay Laharia, Deutsche Bank

Yes.

Igal Shany, Chief Financial Officer

And going forward, if you ask if we completely recognized 100% of these special revenues, at least the majority of it was recognized but there is a small amount that we would be recognizing in the future.

Pranay Laharia, Deutsche Bank

Okay, and then your deferred revenues are now close to zero, does that concern you at all?

Igal Shany, Chief Financial Officer

No, it’s quite expected that as our licensees move to the market we will see more and more royalties coming from them and the fact that the deferred revenue is going down is expected, it’s not a surprise to us.

Pranay Laharia, Deutsche Bank

Okay, Boaz, a technology question for you; now that you have working silicon for Quad bit, can you talk about how many cycles you expect to get with your Quad bit products, and maybe also talk about other characteristics such as voltage requirements of your Quad bit technology; that might dictate which segments of the data flash market it can be a big player in?

Dr. Boaz Eitan, Chairman and CEO

I believe that we have stated it in the past, but I’ll do it again very clearly. When we said that we have a true 4-bit we think that this is a standard performance on all aspects, and the cycling, the reliability, the performance is expected to become a standard, main market type of a result. So, there is no reason for us to downgrade the devices based on the 4-bit. As to the entry point of the 4-bit, since there is more than one product that is already now in silicon, each and every product is targeted as a decent market and of course as they will be unfolded into the market this year each and everyone of the companies, our licensees, will announce their detailed performance and densities, etc. So, I wouldn’t do it but I would state that this is a true 4-bit for all applications.

Pranay Laharia, Deutsche Bank

Okay, just a little bit of clarification on that; when I look at MLC products out there on floating gate from different vendors, there’s actually a wide range of ride cycles, anywhere from 1500 to 10,000 and I’m just wondering which end of that scale do you fall and do you expect to fall in the middle of it or the lower end of it, or maybe the higher end of it?

Dr. Boaz Eitan, Chairman and CEO

I can tell you without naming each and every product on the endurance side, all of those products should end up on the 10k range.

Pranay Laharia, Deutsche Bank

Okay, very good. Then, Kobi, with Qimonda entering the IPO process, do you have a view on how committed they are to the NROM technology and do you have a feel for whether they are feeling any pressure to exit a loss making business right now?

Kobi Rozengarten, President

I cannot speak for Qimonda. We don’t see any impact on driving the development activities that we are doing and we are on schedule with those programs. The bottom line is we wish them the best and we believe it is a good thing to do.

Pranay Laharia, Deutsche Bank

Okay, very good. Just one last question, Igal, what was the head count at the end of the quarter?

Igal Shany, Chief Financial Officer

Around 240.

Pranay Laharia, Deutsche Bank

Great, thank you.

Operator

Thank you. Your next question is coming from Khameel Des with Lehman Brothers.

Khameel Des, Lehman Brothers

Hello, good afternoon, this was a fabulous quarter. A few questions from my side; one would be, earlier we had stated that Spansion was likely to introduce Quad NROM in the fourth quarter ’06, do you see the commercial launch of that shifting to early ’07, and how do you expect that to impact your revenues?

Kobi Rozengarten, President

I will follow Spansion’s statement and we will not give a statement for Spansion; we believe that there was a statement a few weeks ago are correct, and as I understand it they are on schedule.

Khameel Des, Lehman Brothers

Okay, one more thing was on tax, how should we modulate going forward? If I remember correctly, last quarter your advice was to take around 25% of interest income as tax, this time I think it was only 6% of your interest income?

Igal Shany, Chief Financial Officer

So, let me take the time to just elaborate on the tax that we had this quarter, and you are right this quarter is the first time that we recorded a provision for income taxes. The tax provision is a result of our finance income only, and yes we were taxed on 25% on this finance income; however, we had some carry forward losses that we utilized this quarter and this is why you didn’t see the full effect of the 25%. And just the broader view of our tax, as you recall, we have an approved enterprise status that enables us not to be taxed on operations for the next two years. Yes, finance income is 25% going forward.

Khameel Des, Lehman Brothers

Okay, and how should we look at your interest income going forward, should it be in the $2.4 million range or should we expect it to get a bit lighter than this?

Igal Shany, Chief Financial Officer

The finance income reached the $2.4 million threshold this quarter, so we go by the interest rates of the fed, so the trend is that it’s not going down.

Khameel Des, Lehman Brothers

Okay, thank you for that. Just one more question, on licensees, next quarter, because you have been a bit conservative you’ve shifted new licensees to fourth quarter from third quarter, it’s a bit lower than…do you think it’s conservative and there will be room for upside, or how do you see the revenues next quarter being?

Igal Shany, Chief Financial Officer

As we said, we took a conservative approach, so for sure there is a place for upside, and overall I believe that the right way to look at that is look at the total year and I believe it will meet our projection for this year.

Khameel Des, Lehman Brothers

Okay, can you just reiterate your full year revenue guidance for us; I’m sorry I don’t have them right now.

Igal Shany, Chief Financial Officer

No, we are giving guidance quarter by quarter.

Khameel Des, Lehman Brothers

Okay, thank you; just one more question if I may. What is your mix of Quad and data business, and how do you see it going forward?

Kobi Rozengarten, President

You should look at the break between our licensees as I mentioned; our top three service and licensing customers where Qimonda who is focused on the data flash, Spansion who is focused on the Quad flash, but on the service side focused on more data related activity, and SMIC who is always focused on data flash. So, you can see that most of the revenues for us this quarter were derived form data flash related activity that we’re doing.

Khameel Des, Lehman Brothers

And moving forward, do you see it changing or will it remain steady?

Igal Shany, Chief Financial Officer

Going forward, as I mentioned and Kobi mentioned on this call, there is a lot of activity on our side on the data flash. On the service side that we’re doing, on the licensing side, as products come to the market, we’ll see a higher degree of floating coming from that end. So, the shift is that we will see more and more business coming from the data flash because we are focused on this market segment.

Khameel Des, Lehman Brothers

Okay, thank you.

Operator

Thank you. Your next question is coming from Nimal Vallipuram with Halpoalim Securities.

Nimal Vallipuram, Halpoalim Securities

Hi, good morning, thanks for the time. I have a couple of a questions; first of all, I might have missed the guidance you gave for the third quarter, if you can reiterate I would appreciate that and I have a couple of followup questions after that.

Igal Shany, Chief Financial Officer

As you know, we are giving guidance on a quarter by quarter and the guidance on revenues and profit on revenues we stated that it would be $15.5 million to $16.4 million, and then the operating profit should be around 45% excluding stock-based compensation.

Nimal Vallipuram, Halpoalim Securities

Okay, thanks a lot. There are two questions, I think one of them has already been asked and I to some extent I understood your answer that you are in a certain position not to be too open about it, because potentially some of these companies are your customers. Even given that, what exactly are companies like…I mean I’ll openly say Msystems and Samsung talking about having multi-bit technologies without in my opinion giving any architectural detail how it is going to be achieved; without mentioning customers specifically by name, from your point of view, since your are a multi-bit technology IP vendor, how do you view these announcements or actions by these companies in this market?

Dr. Boaz Eitan, Chairman and CEO

There are two ways to answer your question, is to give you a very technical answer on how floating gate devices can or cannot make 16 level cells, and our approach is not to comment on the other people technologies. We are experts in NROM and I would like to take and make a clear statement of what is our view on the NROM side. You can learn from it on what our opinion is on everything else. So, our opinion on the NROM side is that we are making 4-bit solutions, we have silicon at hand. This silicon has four levels of thresholds on two sides of the device which constitute 4-bits. Any technology on the floating gate to do the same needs to go to 16 levels. So, we believe that in the NROM technology it is very achievable and we are very committed to have this year sampling more than one vendor on this technology. So, we believe that the only solution for a true 4-bit for all applications of the data market are based on NROM, and we are stating it out loud and at least on our end there is no confusion about our solution.

Nimal Vallipuram, Halpoalim Securities

If I may; I mean that was very helpful and I think I did ask the question a lot of times as well and you gave a really descriptive answer to that question, but let me put you on the spot and ask you another way. It looks like that your technology seems like the genuine or the most legitimate technology on the solid state side, on the semiconductor device level, is there anyway — without naming companies — anyone can implement a 4-bit, 8-bit solution on somewhat higher level like a subsystem level or even higher level, and if they do so, would they sacrifice the speed of the device?

Dr. Boaz Eitan, Chairman and CEO

Again, since you are putting me on the spot, I will tell you one thing. God help one cannot create data out of no data. So, you must get the data out of your silicon first, then you can improve the data on the system level, but you can create the data on the system level. So, first answer, whatever the solutions are there, on any system level they will start with silicon, and if it is 4-bit it will have 16 levels. Second, as to the question of can you create data from the no data if they do only four levels for a 4-bit solution? At least from my understanding this is impossible.

Nimal Vallipuram, Halpoalim Securities

Okay, I guess that answers the question pretty clearly and thank you very much for that pretty detailed and scientific answer. If I may I have one followup on that. I think Spansion is talking about doing an ONAND product, would that be using technology from Saifun or would that be competitive technology to what they use from Saifun?

Kobi Rozengarten, President

Let me answer that, this is Kobi. I think Spansion was very clear presenting the royalties based on a near bit which is licensed from Saifun, and basically all future activity as to the Quad as we understand are based on our technology.

Nimal Vallipuram, Halpoalim Securities

Alright, thank you very much, Kobi, and thanks for your time.

Operator

Thank you. And as a final reminder, if you will like to ask a question at this time, please press * then the number 1 on your telephone keypad. Once again ladies and gentlemen that’s * and 1 to ask a question. Thank you and at this time there appears to be no further questions.

Dr. Boaz Eitan, Chairman and CEO

Thank you everyone.

Operator

Thank you. This does conclude today’s Saifun conference call. You may now disconnect.

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