Q4 2004 M-Systems Flash Earnings Conference Call - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

OPERATOR: Good morning, ladies and gentlemen, and welcome to the M-Systems fourth- quarter and year-end financial results conference call. At this time, all participants have been placed on a listen-only mode and the floor will be opened for your questions following today's presentation. It is now my pleasure to introduce Mr. Jeff Corbin. Sir, the floor is yours.

JEFF CORBIN, MANAGING PARTNER, KCSA WORLDWIDE: Thanks very much, Elsa. Good morning, everybody. This is Jeff Corbin, Managing Partner of KCSA Worldwide, investor relations consultants to M-Systems. With me on the call today are Dov Moran, President and Chief Executive Officer; Ronit Maor, Chief Financial Officer; and Noam Kedem, Vice President of Business Development in the US. By now, you should have all received a copy of M-Systems' earnings release, which was issued earlier this morning. If you haven't received a release, you can refer to M-Systems website at www.M-SYSTEMS.com.

Now, before starting the call, I would like to mention that the matters discussed in the conference call include forward-looking statements that may involve a number of risks and uncertainties. We caution you not to place undue reliance on these forward-looking statements, as they are subject to various risks which may cause actual results to vary significantly. These results include, but are not limited to, the risk factors detailed in the company's most recent annual report on form 20-F and form F-3 filed with the SEC and all of its other filings with the SEC.

Also, the Company assumes no obligation to update such forward-looking statements and disclaims any obligation to publicly revise any such statements to reflect any change in its expectations or in events, conditions, or circumstances on which any such statements may be based.

With that said, I would now like to turn the call over to Norm, who will provide you with an update on the business during the quarter, including a review of the financials. And after that, Dover, Ronit, and Norm will be happy to answer any questions that you have. Dov?

DOV MORAN, CEO, PRESIDENT, AND CHAIRMAN, M-SYSTEMS FLASH DISK PIONEERS LTD.: Thanks, Jeff, and welcome, everybody. This was a remarkable quarter which came at the end of an even more extraordinary year for M-Systems. In 2004, not only did our revenues increase significantly, but we also remained at the forefront of innovation in our industry. With the introduction of the Mega Sym U3 and the new DiskOnChip products for the mobile industry, the H series, and the G4. I will elaborate on this later during the call, but first, Ronit will discuss the numbers and the financial analysis. Ronit?

RONIT MAOR, CFO, M-SYSTEMS FLASH DISK PIONEERS LTD.: Thank you, Dov, and good morning, everyone. I would first like to indicate that all 2004 numbers discussed on this call are based on the new presentation recently announced. I will start with the revenues. This quarter reported revenues of $114.1 million, which were represent significant increase of 33 percent, compared to $85.7 million in revenues in the third quarter, and a 136-percent increase, compared to $48.3 million in the fourth quarter of 2003.

As we previously indicated, the increase in revenues was the outcome of seasonably strong DiskOnKey and mobile DiskOnChip sales. Gross margins reported on a non-GAAP basis were 21.7 percent in the fourth quarter, a decrease compared with 24.5 percent in the third quarter of 2004 and compared with 25.3 percent in the fourth quarter of 2003. The decrease in gross margins from Q3 to Q4 is primarily attributed to the product mix, as the sales of DiskOnKey, which has lower margins than corporate average, grew both in absolute dollars and as percentage of revenues.

Gross margins of DiskOnKey were impacted by a decline in selling prices per megabyte throughout the fourth quarter, combined with the fact that a major portion of those sales were still of inventory that was purchased at the beginning of Q3. However, strong Q4 sales helped us reduce Flash inventory, and as such, we're starting '05 with significantly lower level of Flash inventory, most of which was purchased recently.

While we are expecting Flash prices to decrease throughout '05, we believe that are enhanced agreement with our Flash suppliers, as well as strict inventory control, will allow us to show a meaningful improvement to our margins as early as the first quarter of '05.

Operating expenses -- This quarter, our operating expenses grew by $1.4 million or 9 percent, compared to the third quarter. The growth resulted mainly from a 13-percent increase in R&D expenses to support the development of new products and technology and a 26-percent increase in G&A expenses. G&A grew as a result of expansion of our infrastructure to support the overall growth of the company, as well as our preparation towards compliance with section 404 of Sarbanes-Oxley.

The aggregate result of the above is that our net income grew by 47 percent to 9 million, with our EPS increasing from 16 cents in Q3 to 24 cents in Q4. The inventory balance at the end of the fourth quarter decreased to $56 million, compared to $79 million at the end of the third quarter. The inventory includes $24 million of shipments to customers which have not yet been recognized as revenues and, to a lesser extent, inventory on consignment. Excluding this, the level of our on-hand inventory at the end of the fourth quarter was $32 million, a 40-percent decrease from $53 million of such inventory at the end of the third quarter. This significant decrease in our on-hand inventory has enabled us to begin '05 with a low level of recently purchased Flash inventory.

Cash -- Our cash went up by $12.3 million during the fourth quarter. The geographical sales breakdown for revenues for the fourth quarter was as follows -- U.S. 33 percent, Far East, excluding Japan, 35 percent, Japan 15 percent, and Europe and Israel 17 percent. The breakdown by business section, including related license fees, royalties, and income from the venture, was as follows -- DiskOnKey $75.2 million or 66 percent of revenues, a 54-percent increase, compared with the third quarter, and 152 percent, compared with the fourth quarter of 2003.

Mobile DiskOnChip was $24.3 million or 21 percent of revenue, a 23- percent increase, compared to the third quarter, and 200-percent increase, compared to the fourth quarter of 2003. Sales to the embedded systems market were $14.6 million or 13 percent of revenues, a 15-percent decrease from the third quarter but 41 percent increase, compared to the fourth quarter of 2003. Dov?

DOV MORAN: Thank you, Ronit. Thank you. In 2004, we began to realize the benefits of our efforts in the past few years, a time in which we brought to market innovative products which created and defined the personal storage category. In Q4, we broke the $100 million sales barrier and also achieved our 14th consecutive quarter of growth. M-Systems' financial results speak for themselves. Revenues go from $113 million in 2003 to $348 billion, an almost 170-percent increase, with that profit jumping from $914,000 in 2003 to $24.2 million, an increase of 2500 percent.

We are not playing in a completely different code (ph) than we did a year ago. We proved that we not only have great IP and can develop innovative products, but we can also create the market for these products and deliver them to our customers in millions of units.

As may be seen by the 2004 numbers, strategic decisions that we made have proven to be the right ones, such as regulating our IP to get preferential purchasing terms from Flash partners, which helps us stay competitive in the market. We also made the decision to become the #1 choice for the OEM market, a decision …