Microelectronica Espanola Acquisition FLSH cc
November 14, 2005
Dov Moran President and CEO
Ronit Maor CFO
Arnon Dinur, M-Systems senior VP strategy and M&A
Dov: Thank you all for joining us today. As you all know, this morning we announced the acquisition of Microelectronica Espanola, a leading European smart card company. As I commented a couple of weeks ago in our Q3 earnings cc, we believe that the mobile market and in particular the market for multimedia handsets offers M-Systems its greatest growth opportunity.
Some industry analysts project that within three years there will be over 1 billion mobile handsets sold annually worldwide. Most of these phones are expected to have multimedia functionality. This means they will have some form of high capacity storage, whether embedded, removable, or as with SIM cards, semi-removable.
We intend to capitalize on this market opportunity by offering a wide range of storage solutions for mobile phones. Our embedded MDOC product, our removable memory card and our cellular mobile MegaSIM product and to complement our strong portfolio of storage solutions with the right partners and channels to distribute our products.
With this acquisition we took an important step forward in enhancing our capabilities for the mobile market. We established direct access to the mobile network operators which have a central role in the mobile market, adding them to our existing channel to handset manufacturers.
In addition we acquired technology and manufacturing capabilities that will allow us to integrate security and storage into our products. A combination which is very important to the mobile market.
Our strategy is to leverage this capability both the channel to the mobile network operators as well as the technology in secured manufacturing to grow our business for both the MegaSIM product and for our newly introduced line of memory cards. As a technology enabler for this industry we are taking this action to help ensure quick, quicker and more widespread penetration of our MegaSIM product through the industry. At the same time we will continue to seek cooperation with selected industry partners to achieve this goal.
M-Systems’ success is based upon our ability to innovate and introduce new products that will revolutionize our target markets. Our introduction of the MDOC, the first embedded flash drive for mobile handsets back in 2001, was a revolutionary breakthrough for storage in mobile handsets. Today our MDOC is designed into phones from top handset manufacturers. We have made tremendous progress with our MDOC. In the first 9 months of 2005, our MDOC revenues were about 20 times the annual 2002 MDOC revenue.
We introduced a second revolutionary product for the mobile market about a year ago, our MegaSIM, which as you know is a high density storage SIM card. Having spent the past year in the mobile market, promoting the MegaSIM product. Speaking with mobile network operators and SIM card vendors, we realized the great potential of this channel for the mobile market, both for MegaSIM products and for memory cards.
We reached the conclusion that the best way to maximize the benefits from this market and channels is by having direct access to the mobile operator community as well as by being an operator approved secured manufacturer.
As you may know, today there are only a handful of companies mostly based in Europe that are approved as secured manufacturers of SIM cards and smart cards and which also have achieved the trust and direct access to mobile operators. Therefore in order to insure that we obtain such capabilities quickly and at a lower risk and in order to avoid losing critical time to market, we decided that the most efficient approach would be to acquire a smart card company which already has a strong reputation among tier one operators as a secured trusted manufacturer.
Before turning the call over to Arnon to further discuss the decision to acquire Microelectronica, I would like to welcome another valuable addition to M-Systems family. Simone Cavallo has recently joined M-Systems and will oversee the operations of Microelectronica. Simone joins us after spending five years as CEO of Incard, a leading smart card manufacturer.
Simone brings with him vast international experience in both the telecom and the smart card industries. On behalf of everyone at M-Systems I would like to welcome Simone into our company and wish him best of luck. I would like now to turn the call over to Arnon Dinur, our senior VP for Strategy and M&A, who led the deal on our end to elaborate further on the decision to acquire Microelectronica. Arnon.
Arnon: Thank you Dov. Good morning everyone. As Dov mentioned, we made a specific decision to acquire a SIM card company. We evaluated various options in the market and decided that Microelectronica is the right partner for us based on the fit of Microelectronica to M-Systems strategy, its technology, price, customer base, management depth and experience and the chances of the successful post merger integration based on the cultural match of the two companies.
We had three strategic goals we wanted to accomplish with this move. The first to own smart card security technology. The second to own approved smart card infrastructure. Third to gain direct access to mobile network operators.
With the acquisition of Microelectronica, we believe that we will be able to accomplish all these three goals.
On the technology front Microelectronica remains at the forefront of developing operating systems and secured solutions for the smart card industry.
With respect to manufacturing infrastructure, Microelectronica has a top notch secured manufacturing facility, validated and approved for use by the telecom industry and financial institutions.
Lastly, Microelectronica has been for many years an approved and respected vendor for some of the world’s leading mobile network operators.
In acquiring Microelectronica we are also bringing into M-Systems a committed and respected management team as well as a dedicated group of employees who have contributed greatly to Microelectronica’s success. We are excited by this new addition to our family.
We believe that these newly acquired assets will enable us to successfully bring MegaSIM to the market. Our intention to have MegaSIM products widely available via multiple vendors remains unchanged. The market will need multiple sources to be able to fulfill its requirements and we will cooperate with selected partners to insure that it is widely accessible to the mobile network operator community from other SIM card vendors as well. Our MegaSIM solution has been widely recognized in this market as being a key enabler of its future growth and we believe that added value and exciting new possibilities that it enables, will insure quick and significant market penetration.
In addition the acquired assets both Microelectronica’s security technology and infrastructure and its access to mobile operators, will allow us to offer memory cards which fit the requirements of the mobile markets as we announced earlier today.
With enhanced product offerings we will have our successful embedded solution, the MDOC, our semi-removable MegaSIM product and the removable memory cards. We believe that we will have a unique and powerful product portfolio.
I would like now to turn the call over to Ronit who will discuss the financial aspects of the acquisition.
Ronit: Thank you Dov and Arnon and good morning everyone. Let me share with you some of the financial and accounting details of the transaction which was both signed and closed today.
M-Systems has acquired 100% of the shares of Microelectronica with the consideration all in cash. The net consideration of the acquisition following completion of all related transactions is approximately $40M. This net consideration amount excludes Microelectronica’s net working capital which is about $35M. Most of the net working capital, approximately $27M, is the cash balance. All of which was also acquired in the transaction.
Since we have both signed and closed the transaction today, we will consolidate Microelectronicas results starting today. Microelectronica’s 2005 revenues are expected to total approximately $25M. However in light of the fact that there are only 6 weeks left until the end of 2005, we do not expect any meaningful effect from this transaction on our P&L, other than a one time expense for in process R&D and amortization of the deal cost in the total amount of about $3M.
As for 2006, we currently expect this transaction to be neutral to the earnings excluding the amortization of the deal costs on the P&L estimated to be a few million dollars for the year.
Ronit reads Safe Harbor
Eric Gomberg, Thomas Weisel: Hi congratulations on the transaction. Could you talk a little bit about some of the key carrier relationships that Microelectronica has as well as when you would expect to start shipping MegaSIM? How quickly that could come to fruition now that the acquisition is closed?
Dov: Microelectronica has great relations with leading operators in Spain and in South America. We are not disclosing names of customers but its first tier mobile network operators. Great relations that go for many many years and will continue, I believe, going forward.
We of course intend to present to those operators, the MegaSIM, and take advantage of the relations existing, but we cannot disclose exact time when these operators will deploy the MegaSIM.
Eric Gomberg, Thomas Weisel: OK and maybe Ronit or Dov, if either of you could give us some sense of the margin structure of Microelectronica as it stands today and how you would expect that to change? What type of R&D commitment you need to make to the company?
Ronit: Yeah, currently Microelectronica’s margins [pause]. As you know we don’t disclose exact margins, but currently they are higher than the corporate average of M-Systems. This is quite typical for the SIM market. Next year, again we need to distinguish between the SIM markets and the MegaSIM. We don’t have the final answer. Clearly we will try to leverage those benefits that allow GMs to be higher than the corporate average, although again, it is too early to guide for the margins.
Eric Gomberg, Thomas Weisel: One last question. On the news regarding your entrance into the mobile card market. I would take it that it is not a coincidence. Are you planning on using the relationships with operators as an avenue to grow those sales or is this something where you are going to be offering to existing customers, the Memorexes and Kingstons of the world, so that they could participate in these form factors at retail?
Dov: Clearly the main target is to sell those memory cards to mobile network operators, to utilize our current relations with Microelectronica with their customers and to offer it to many other potential customers in this field.
Eric Gomberg, Thomas Weisel: Thank you.
Craig Ellis, Citigroup: Yes good day everybody and congratulations. First question would be on the memory card side of the announcement today. What memory card formats would you expect to be producing as you ramp up the effort initially and how would you expect formats offered to evolve over time?
Dov: We believe that we will be offering to the market, the whole range of memory cards. Whatever will be required by mobile network operators whether this MMC card, or microMMC or SD or miniSD or whatever will be there that is required by the mobile network operators.
We do have the technology. We invested recently in learning how to do it. How to manufacture and how to do it with the right subcontractors. We have a very high confidence that we can fulfill quite well the requirements of this market.
Craig Ellis, Citigroup: Right and then on the Microelectronica side. Can you just give us some parameters on their revenue leverage whether it be to financial services or MNOs [Mobile Network Operators] etc and would you expect that revenue mix to stay relatively constant over time or will you be pushing it more in the direction of the MNOs?
Ronit: I am not sure I understood the question?
Craig Ellis, Citigroup: The question was Microelectronica’s sales mix by application if you will. Will they have leverage in the financial services, security applications as well as MNOs? I am wondering what that mix is generally speaking and how that might change over time?
Ronit: In general, the vast majority of Microelectronica’s sales are of the SIM cards to network operators. They are selling also to other areas, but their focus by far is the MNOs. They are selling SIM cards that is one of the advantages with Microelectronica. Since we did the acquisition in order to have these channels of SIM and MegaSIM cards to the MNOs. Clearly we are going to maintain this business model and keeping the mobile network operators as a priority.
Craig Ellis, Citigroup: Thanks Ronit and then one last question for you, as we think about the ramp-up of the memory card business, how should we think about the revenue potential of that business as we look out into 2006. Is there any chance you would be shipping memory cards for revenue in 2005?
Dov: Let me answer it. The revenues for Microelectronica for 2005 is estimated as $25 million euros. This is the number. Clearly going forward with the addition of the memory cards, with the addition of the MegaSIM, we expect this number to grow significantly. We believe that memory cards for this market of mobile network operators, the potential here is huge.
We prefer not to be now in the position to dictate numbers or provide projections for 2006. I think that it is too early. We clearly will have to go through a process of market education. Expanding the current sales force and the channels for Microelectronica. Getting them to understand. To know this product. It takes time. We don’t expect immediate results. For long term, we have no doubts that the effect on the company. The effect of the results going forward will be tremendous. We expect that in several years this will become a very big portion, if not the majority of the company’s revenue.
Craig Ellis, Citigroup: Great and then maybe one last detail. Given that Microelectronica does has its own manufacturing capability. Can you tell us a little bit about where utilization is presently?
Ronit: Currently they are not at their maximum utilization. Capacity utilization?
Craig Ellis, Citigroup: Yeah.
Ronit: They are not at their maximum. We still have enough room to grow with the existing facilities that they have and more important, clearly we investigated this point, in order to increase the capacity on the existing facility the investment required is not expected to be material.
Dov: Just to complement the answer, basically with the know-how that they have, and with the know-how that Simone brings with him, we believe that there will not be any problem to expand the capacity. The buildings are here ready for that. The people that know how to do that are part of the company. We see no problem to expand. We don’t believe that the manufacturing capacity is going to be the limiting factor.
Craig Ellis, Citigroup: Right. Thanks so much Dov.
Dov: Thank you.
Daniel Amir, WRH: Thanks a lot. Congratulations on the acquisition. Most of my questions have been answered. What is your thought process on how you are going to integrate the company? Have you already gone through structural changes in the company? Are you still reviewing it? How are you going to integrate it, considering that this is probably the first big acquisition you’ve done in a number of years here? The company is also located in Spain where you haven’t had a presence before.
Arnon: Hi Daniel, this is Arnon. We put a lot of thought into that. Spent many months preparing for this and the key factor that was also mentioned in the pr was getting a veteran of the industry to lead this new entity. It will be integrated into M-Systems as a division. Basically merging with our MegaSIM division to create one bigger division. Managing out of Spain is indeed new for us. Never-the-less it is pretty close. We spent a lot of time in Spain learning the facility and the team. Together with Simone we feel comfortable that this is a natural integration. The fact that this is an OEM business fits well with our culture and our business style. So we have a pretty high confidence in our ability to merge it successfully into the company.
Daniel Amir, WRH: From a sales force perspective, are you using the sales force of Microelectronica.? Are you using some of the sales team of M-Systems?
Arnon: We are going to use both. The idea is to create one + one = three. To take the sales force of Microelectronica, it is complementing us geographically, they are operating in geographies that we have not operated in yet, to complement it with our own infrastructure worldwide.
Daniel Amir, WRH: Just one follow-up question, I know you touched on it before Dov, but could you highlight what type of end markets does the company sell to outside the phone market? Smart cards etc. What types of products could we see in the future? Are we seeing already now that use their technology?
Dov: Well, Microelectronica is making SIM cards. Clearly will continue to do and sell SIM cards. In addition to MegaSIM and in addition to memory cards. All of this product to the market of mobile network operators.
They do have a small other business that is selling to banking. It is interesting. It is a very small part of the business today. We are looking at this part and there is some synergy between what we are doing at M-Systems with the special version of the XKey and what is done at Microelectronica. [note corporate market pr: two form factor] We will of course, evaluate this business and see how much we would like to continue and invest, selling to this market.
Daniel Amir, WRH: OK thanks a lot.
Dov: Thank you.
Dan Harverd, Deutsche Bank: Hi congratulations on this deal. On the acquisition, would you anticipate that all of MegaSIM manufacturing will be done via Microelectronica?
Dov: No, clearly not. We are a technology enabler. We have very good relations with the other SIM vendors. We are building very good relations with companies who are manufacturing SIM components. The first target is clearly making a large market with several participants. With standards which are very strong, very solid. So a few years from today, we will see a market of many hundreds of millions of units where M-Systems is going to be, or will be, part of this market and I hope very much, the majority part of it, a big part of this market. But we will continue to work with our current partners. We will continue to work with Oberthur. We talk to the other SIM vendors. We have some plans with them. We will continue with these plans. We told them ahead of time about this activity and I do believe that the relations with them will continue in order to make it a big market. Good for us, and of course, good for them.
Dan Harverd, Deutsche Bank: So just to clarify, so they don’t perceive Microelectronica to be competition? And then also I just wanted to ask whether you will support existing SIM products of Microelectronica and how long it will take to integrate some of their technology into MegaSIM?
Dov: Currently Microelectronica is a very small player in this field of SIMs and it is not a threat, I believe, to the large players. Clearly we hope and we will do everything that Microelectronica will grow, but still, the way we look at this market, this market of SIMs has to go through a change. The change needs to be MegaSIM. The MegaSIM solution will allow all the participants in this market, all the SIM vendors, to increase their revenues, to build better models, better business models, that will provide prosperity to all of them. Based on this feedback, based on this function and theory, we believe that the fact that we entered into this market selling directly to the mobile network operators, will not cause a situation that the rest of the players will not continue with their activity to adapt the MegaSIM solution and therefore we believe that we will be selling MegaSIM as well as well as many of our partners. Again we talk about a very large market that is spread through many many geographical areas. Microelectronica today is very limited in its spread of geographical areas. Its Spain and South America. We will expand clearly but we don’t intend to go head-to-head against others and become a destructive power in this industry. We prefer to do it with others as partners.
Dan Harverd, Deutsche Bank: Just one question on the memory card market. Obviously you have been familiar with the market for a number of years. What has changed now and what do you see as your competitive advantage?
Dov: I can answer it. If you look at this market. This market until recently was a market selling on the retail and the majority of the market was memory cards for digital cameras. In this market we did not want to participate. We think that our power [strength] was not there, were not our channels. There are other companies that are doing very well selling and servicing this market.
The change is that memory cards are becoming part of the mobile market and we do see a totally new channel that is emerging and this is the channel of selling cards to mobile network operators. It fits much better, our OEM model, and OEM capabilities when selling to the mobile network operators requirements are modification, service, support, selling not under our name, but under our partner’s name. This is what we know how to do. We do it very well with the DOK. I think that we proved already that the model fits very well our knowledge, know-how and capabilities. Therefore that is the reason that we are entering this market now, when the market is just beginning and is ready for our capabilities.
Dan Harverd, Deutsche Bank: OK thank you very much. Good luck.
Dov: Thank you.
Daniel Gelbtuch, CIBC: Hey. Thank you very much and congratulations. Most of my questions have been answered. What would you project as the MegaSIM unit number or any industry-wide number for memory on a SIM card in 2006 and 2007? In addition who would you project to be your likely competitor and where do you see them right now?
Dov: Well the market for SIM in 2006 is expected to be close to 1 billion units. That is a huge market. Clearly it is SIM, it is not MegaSIM. We will begin to see in 2006 a shift from the standard SIM to the MegaSIM. Again our projection for 2006 is that the number will be relatively to the size of the market of SIM, very very low. Clearly going forward, 2007 and 2008, these numbers will grow. I believe that several years from today the market of MegaSIM is going to be a market of 100s of millions of units.
Who is going to be our competitors? I think that the biggest competition that we have today is not a company, but is lack of standards. Lack of standards is the situation where with the mobile network operators are not there. Understanding the needs, understanding the capabilities of such a solution. I believe that once a mobile network operator will be there in the market seeing new revenue generation from services, from cards, from capacity that he is selling. From flash capacity that he is selling. From music. From video. From many things that he can do with such a device, from such a product. I think that once such an operator will be there in the field, many will follow and will make it a huge market. So the biggest competition to us today is how good we execute in convincing the operators how good we succeed in getting them in the field tests. How successful are the field tests and how fast this standard becomes the best solution of the market.
Daniel Gelbtuch, CIBC: Now just moving back to Microelectronica, what was their core competency, on the security side? or were they just merely a module builder?
Arnon: Hi. This is Arnon. Their core competency was, because of being relatively small, they were quicker. The time to market for their operating system was always among the first and always at the top end of the game which we found very attractive to what we need. Aside from that, the SIM card is close to a commodity so the room for competition was based on time to market, who was able to come first with a more quality product? to customize faster and to answer the security needs of the mobile operator.
Daniel Gelbtuch, CIBC: Within their key regions who were they up against? Were they seeing Gemplus and Oberthur? or were they pretty much alone in their markets?
Arnon: Without going into specifics, most of the operators have several vendors and you would expect to see in every country a few of the leading names that you mention. Usually between three to four vendors per operator. The number of players in this market is relatively limited so the same names are repeating again and again.
Daniel Gelbtuch, CIBC: OK thank you very much. Congratulations.
Arnon: Thank you.
Sam Doctor, JP Morgan: Thank you and congratulations. Most of my questions have been answered already, but Dov you touched on this briefly regarding the opportunity for network operators for microtransactions, does Microelectronica bring any technology on the smart card side that would enable this?
Dov: Microelectronica developed many tools for the SIMs that allow the mobile network operator load the stuff into the SIM cards and basically with our R&D, with our development we believe that we can offer a full solution for the operators that will provide all the means to create revenue generation coming from the music video and all rest. We will continue to work on improving those kinds of tools clearly. The solution that has to be provided to the mobile network operators is a full solution. This should of course includes DRM. We believe that digital rights management is critical to the success of this concept and the memory cards concept and we will work on all of those solutions and we will offer a full set of solutions to the customers.
Sam Doctor, JP Morgan: Does Microelectronica have any of the technology already?
Dov: Oh yes. They do have many parts of this technology.
Sam Doctor, JP Morgan: Can you give us some kind of idea about what is the differentiated technology that they have? How are they different from other SIM card vendors in their ability to enable their DRM or security or any transactions?
Dov: We think it is too early to get into defining the differentiators, but again we are combining the technologies that they have with the technologies which we have. Some of them are still in development, but some of them are already developed. We believe that in a short time we will bring a whole set of tools and applications for the mobile network operators and a complete solution which is required by this market.
Sam Doctor, JP Morgan: OK good. Thanks.
Dov: Thank you.
Satya Chilara, American Technology Research: Yeah, congrats on the deal Dov. A couple of questions. I wanted to ask about the memory card market that you wanted to get in. Are you planning to manufacture this card using this newly acquired facility? or where exactly will you be doing this memory card and what kind of margin structure do you have on this?
Dov: We intend to manufacture those cards using subcontractors and partners. We do not have the plan to design or manufacture today such memory cards at Microelectronica. Although going forward, using the secured facilities that they have, we might manufacture such cards at Microelectonica or under Microelectronica’s supervision.
Satya Chilara, American Technology Research: What would be the margin structure of this memory card that you said you are going to go for selling into mobile network operators. Is this below or above corporate margins at this point?
Dov: It is too early now to get into the margins of such cards. Clearly we believe that we can bring to this market tools and software that surround the card and services and DRM and security that will provide us the ability to charge better prices than prices existing today in the market and see better GMs compared to other companies.
Satya Chilara, American Technology Research: So should be modeling for 2006 any revenues from the memory card market or what’s the guidance at this point?
Dov: Satya, I would be very careful and I would not project high numbers, a high revenue level in 2006 from such cards and such activity. It is the beginning of an activity. We believe that it is very important long term. We did not do this acquisition and did not enter into this market in order to achieve a short term target of revenues. As I mentioned long term I believe that revenue generated from selling overall to mobile network operators, SIM, MegaSIM and memory cards, will be a very high part, maybe a majority of the revenues of M-Systems, but I think that giving projections for 2006 is too early and I would not provide such projections. As an analyst, I would not put any large number for 2006.
Satya Chilara, American Technology Research: OK. Thank you.
Rami Rosen, Oscar Gruss: Thank you and congratulations. Two quick questions Ronit. What is the Microelectronica’s current head count? and what was the operating profit etc for 2005?
Dov: Microelectronica has about 140 employees today plus something like 50 which are part time or temporary. What was the second part of the question?
Rami Rosen, Oscar Gruss: If you can discuss the operating profit for 2005 for Microelectronica?
Ronit: Microelectronica does have on a stand alone basis some profit on their current business. It is coming from higher margins than what we have today as a corporate average with their current Opex model.
Rami Rosen, Oscar Gruss: OK thank you.
Dov: [closing remarks] Thank you. Over the past 5 years M-Systems has experienced tremendous growth. Our revenues grew from $44.7M in 2001 to projected revenues of at least $490M this year. More than 10 times growth. Earlier this year we expressed our intention to actively review opportunities to gain new capabilities through acquisitions. We believe that Microelectronica brings to M-Systems great assets in the areas of technology, know how, manufacturing and channels. Merging Microelectronica’s activities into ours is a great challenge for us and one that we look forward to. I am confident that we will meet this challenge head on and realize great success in this new venture. I would like to thank at this opportunity everybody at Microelectronica and M-Systems who worked so hard to complete this mission. We are moving united and stronger to achieve new higher targets. To break new records and to continue our adventure. Thank you.