M-Systems Flash Disk Pioneers Ltd. (FLSH)
Q2 2006 Earnings Conference Call
August 7, 2006 10:00 am ET
Dov Moran – President, CEO
Ronit Maor - CFO
Lee Ross - KCSA Worldwide, Investor Relations
At this time, I would like to welcome everyone to the M-Systems second quarter 2006 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Mr. Lee Ross. Sir, you may begin your conference.
Thank you and good morning everyone. This is Lee Ross of KCSA Worldwide, investor relations consultants to M-Systems. With me on the call are Dov Moran, President and Chief Executive Officer; and Ronit Maor, Chief Financial Officer.
At this point, you should have all received a copy of the press release which was issued earlier this morning. If you have not received this release, please refer to the M-Systems website at www.msystems.com.
Before we begin, I would like to mention that the matters discussed on this conference call include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, including statements about our business outlook for the year 2006. that are based on our current expectations and may involve a number of risks and uncertainties.
In addition, any statement that refers to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. We caution you not to place undue reliance on these forward-looking statements, as they are subject to significant risks and uncertainties that could cause our actual results to differ materially from those expressed in these forward-looking statements.
These risks include, but are not limited to, the risk factors detailed in the Company’s most recent Form F-20 filed with the SEC and all of its other filings or furnishings with the SEC including Form 6-K. Listeners are cautioned not to place undue reliance on those forward-looking statements which speak only as of the date hereof. M-Systems assumes no obligation to update such forward-looking statements, and disclaims any obligation to publicly revise any such statement to reflect any change in expectations, events, conditions or circumstances on which any such statements may be based.
Also, as already stated in this morning’s press release, in light of the pending transaction with SanDisk, there will be no question-and-answer session following management’s prepared remarks on the call.
With that said, I would now like to turn the call over to Dov and Ronit, who will provide you with an update on the business during the quarter, including a review of the financials. Dov, go ahead please.
Thank you. Good morning, everyone. Thank you for joining us for our second quarter earnings conference call. As you all know, last week we announced the proposed acquisition of M-Systems by SanDisk, which is expected to close during the fourth quarter of 2006, pending our shareholders’ approval as well as other regulatory approvals. We are excited about our future as part of the combined company.
Nevertheless, until the merger is approved and completed we, of course, continue to work independently to grow our business and share information about our business. With that, I will turn the call over to Ronit to discuss our second quarter financial results.
Thank you, Dov and good morning, everyone. Before beginning, I would like to emphasize that the following discussion will include GAAP and non-GAAP numbers. Our second quarter non-GAAP results reflect adjustments for the following items:
- Equity-based compensation expenses, which totaled in Q2 $2.3 million, and withholding taxes related to prior stock option grants in the amount of $1.9 million.
- Amortization costs related to the acquisition of Microelectronica, which totaled in Q2 $0.3 million net of taxes.
- G&A expenses which totaled $3.2 million, relating to the review of prior stock option grants and the previously planned security offering.
A full reconciliation of the non-GAAP results to GAAP results discussed on this call is currently available for review on our website at www.msystems.com and in the press release issued today.
Going back to the numbers and starting with revenues. Our second quarter revenues totaled $209.5 million. These revenues reflect a slight decrease of 4% compared with the previous quarter, but represent a 72% increase compared with the second quarter of 2005. Second quarter revenues include $40.6 million resulting from the consolidation of our venture with a Flash partner.
In terms of where our revenues came from, the geographical breakdown of revenues is as follows. Please note that the following breakdown does not include revenues attributable to the venture to our Flash partner.
Revenues in the U.S. totaled 33% of revenues, compared with 38% in the first quarter of 2006. Revenues in the Far East, excluding Japan and the rest of the world, totaled 41% revenues compared with 32% in the previous quarter. Revenues in Europe totaled 16% compared with 18% in the first quarter. Revenues in Japan totaled 10% compared with 12% in the first quarter.
Revenue breakdown by market for the second quarter was as follows: revenue to the USB Flash drive market totaled $113 million, which represents 54% of revenues in the second quarter. As already indicated, this amount includes $40.6 million as a result of the consolidation of the venture with our Flash partner. Revenues to the USB flash drive markets decreased 14% compared with the previous quarter and they increase 24% compared with the second quarter of 2005. The main reason for the decrease in revenues to the USB flash drive market is a sequential decrease in ASP per unit, partially offset by an increase in units sold.
Revenues to the mobile market, which include revenues from the sale of mDOC for handsets and other portable devices, as well as SIM cards to mobile network operators total $76 million, which represents 36% of revenues in the second quarter. Mobile revenues increased 24% compared with the first quarter of 2006 and almost 300% compared with the second quarter of 2005.
The increase in mobile revenues were derived from both an increase in quantity of units sold and an increase in ASP per unit. The increase in ASP per unit resulted from an increase in average density, partially offset by a decrease in price per megabyte.
Revenues to the embedded systems market totaled $20.4 million or 10% of revenues. This represents a 23% decrease compared with the first quarter, and an 84% increase compared with the second quarter of last year.
Moving to gross margins. Non-GAAP gross margin in the second quarter was 23.4% compared with 20.6% in the first quarter. The improvement in gross margins was in all markets and was derived mainly from favorable purchasing terms for our standard Flash components.
Moving to operating expenses. Non-GAAP operating expenses in the second quarter totaled $28 million. Non-GAAP operating expenses were up $2 million or 7% compared with the first quarter. GAAP G&A expenses include $3.2 million incurred in connection with the secondary equity offerings planned for the second quarter and which was not completed, as well as review of prior stock option grants.
Now moving to non-operating income and expenses. Financial income increased slightly from $1.4 million in the first quarter to $1.5 million in the second quarter. The taxable income of $1.1 million include taxes on interest income and taxes on operating income. Our equity losses of an affiliate subsidiary in the amount of $1.3 million relates to the activities of U3, our joint venture with SanDisk. Our minority interest in the amount of $8.8 million relates to our venture with a Flash partner. All of these resulted in the GAAP net income for the second quarter of $3.1 million with EPS of $0.08 and non-GAAP net income of $10.8 million with EPS of $0.26.
As for the inventory level, the inventory balance at the end of the second quarter was $84 million, an 11% increase compared with the first quarter inventory of $76 million. Our on-hand inventory, which consists of our GAAP inventory less $24 million of shipments to customers which have not yet been recognized as revenue, inventory on consignment and inventory held by debenture on behalf of our Flash partner totaled $60 million compared to $58 million in the first quarter.
Our cash balance at the end of the second quarter was $179 million, up from $160 million at the end of the first quarter. The increase resulted from positive cash flow of operations of $33 million.
One last note: in light of the pending transaction with SanDisk, we have decided to refrain from providing forward guidance. I will now turn the call back to Dov.
Thank you, Ronit. I am pleased with our second quarter financial results. As we projected in our last earnings call, second quarter revenues were down sequentially, but our non-GAAP net income was better than what we had anticipated.
Touching briefly on our activities in the USB and mobile markets, U3 is continuing to expand its ecosystem, reaching new consumers and developers. U3 was launched in Japan and China, and over 20 new applications were introduced during the second quarter, with over 6,000 developers who have already joined the U3 Developers Program to-date. We believe this will lead to the long-term growth in the USB market.
Our performance in the mobile market was especially strong in the second quarter. During this quarter, we sold more than the first three quarters of 2005 combined. Although our near-term results are still expected to be affected by ongoing supply constraints, our second quarter performance demonstrates that our product for the mobile market, the mDOC is a significant long-term growth engine for us.
During the second quarter, we also announced our breakthrough x4 technology which enables, for the first time, the use of 4 bits per cell NAND. The use of 4 bits per cell was considered impossible and impractical before our announcement. We expect the design of x4, which includes a controller packaged with the raw NAND will facilitate the adoption of x4 in the market. We remain focused on our efforts to bring x4 to mass production in 2007.
The SanDisk acquisition. As you all know, last week SanDisk announced that we have entered into definitive agreements for SanDisk to acquire M-Systems in an all-stock transaction. M-Systems implied equity value, based on the deal terms, was $1.55 billion at announcement. M-Systems is a strong company, with invaluable assets which include its IP technology and know-how, more product offerings and most important, it’s just the right thing. I believe that M-Systems could continue achieving impressive growth as an independent company driven by the underlying growth in the NAND market, as well as the mobile and USB Flash drive markets.
The decision to accept SanDisk’s offer was made based on our belief that with the strength of the joint company, M-Systems could go even farther. By merging with SanDisk, we will strengthen our business, accessing SanDisk’s leading edge, low-cost fab capacity, as well as complementary technology and products.
I am fully confident that this merger is the right thing for our shareholders and employees, and it is my philosophy to optimize value creation in the most effective manner.
I would like to close my remarks today by taking this opportunity to thank our shareholders and our remaining, dedicated and talented employees. None of this would be possible without you. Thank you for being with us today. Good bye.
Thank you. This does conclude today’s M-Systems conference call. You may disconnect your lines at this time and have a wonderful day.