Q3 was a blow-out quarter, with revenues, gross margins and EPS easily exceeding expectations. As Deutsche Bank (DB) put it:

“Revenue of $939m was above the high-end of guidance ($725-775m), DBe at $774m and Street at $788m. This is the 3rd consecutive quarter SNDK exceeded the high-end of revenue guidance. The higher revenue was due to product sales, which came in at $814m, well above DBe of $659m as the company saw stronger than expected growth in its OEM business (+84% q/q) and stable Retail demand (flat q/q). SNDK believes it maintained market share in retail despite passing along selective ASP increases. For the first time in its history, SNDK’s retails sales were a minority (44%) of total Product revenue…

Product GM was 38.7% was well above DBe of 17%, but margins benefitted from an $139m inventory/utilization related charge. Excluding the benefit, product GM was 23% still well above DBe. …

PF EPS excluding amortization and ESO expense was $1.09, well above DBe of $0.14 as a lower tax rate and higher gross profit was partially offset by higher interest expense (+$13m). Net of the $92m tax benefit and higher interest expense, PF EPS would be $0.75, still well above DBe and Street estimate of $0.26. SanDisk is likely to see another $40m benefit to GM in 4Q09 as the company anticipates sales of previously written down inventory.”

I’m including more complete excerpts from DB’s 20 October report below. Worth the read.

My transcription of SanDisk’s Q3 cc is up now as well. It can be accessed either through this link or from the “Pages” box to the right where I post transcriptions.

Several interesting themes were addressed in the conference call: Favorable industry conditions with balanced supply/demand; The rise of new OEM business;  A new, most favorable, elasticity model where costs come down but prices remain more or less stable; and Consumer SSD adoption as a 2011/2012 story.

All deserve their own dedicated post, which hopefully I’ll get to over this next stretch.

While not directly addressed in depth in the conference call, another most relevant SanDisk theme is the rise of mobile computing and the adoption of SD (including microSD).

Last week Apple announced updated iMac models with SD slots. I suspect that Apple is setting up the context for an SD slot in its Tablet, now rumored to be an early 2010 event. The next logical step beyond the iTablet would be an SD slot in the iPhone.

But one step at a time.

Apple doesn’t appear to be the only company dreaming the tablet dream. An HP tablet is expected to follow Apple’s. The Microsoft Booklet is also expected sometime in 2010.

We’ll have to wait and see which have HDDs and which go with embedded NAND, but smaller and lighter with optimized battery power sure would seem to favor an embedded solid state solution.

2010 could be shaping up as the year of the Tablet. Between embedded and removable, the Tablet could eat up a lot of NAND on its own. I haven’t seen analysts factoring tablets into their NAND demand forecasts. If forecasts were tight before, tablet demand could well push 2010 over the top into NAND allocation.

Not a bad thing for SanDisk.

**** 10.20.09 DB Report Excerpts Below ****

Deutshe Bank

SanDisk

3Q09 Results – Returning to growth

Bob Gujavarty
Research Analyst

Revenue growth and EPS leverage

SanDisk posted strong 3Q09 results with upside on revenue translating into excellent EPS leverage. Exclusive of one-time events, PF EPS of $0.75 was well ahead of DBe of $0.14 and Street at $0.26. Although inventory benefits are likely to moderate we believe the company is poised to deliver organic margin improvement due to ongoing cost reductions and benign pricing. Combined with superior rev growth (+3% y/y in 2009E vs. industry -15%) and a focus on free cash flow suggest further upside is likely. We boost our P/T to $32 [from $23] and reiterate Buy.

Blow-out 3Q09 results

Revs of $939m was above the high-end of guidance ($725-775m), DBe at $774m and Street at $788m. This is the 3rd consecutive quarter SNDK exceeded the high- end of guidance. The higher revenue was due to product sales, which came in at $814m, well above DBe of $659m as the company saw stronger than expected growth in its OEM business (+84% q/q) and stable Retail demand (flat q/q). PF EPS ex-amort.ESO was $1.09, well above DBe of $0.14 as a lower tax rate and higher GP was partially offset by higher interest expense (+$13m). Net of the $92m tax benefit, PF EPS would be $0.75, still well above DBe and Street estimate of $0.26

Raising estimates sharply

Based on  3Q09 upside and constructive guidance we raise our 4Q09E to $1.13bn/PF EPS $0.69, up from $780m/PF EPS $0.23 previously. Our 2010E stand at $3.8bn/PF EPS $2.18, up from $3bn/PF EPS $0.49 previously. The new 2010E represents revenue growth of +9% y/y, up from +3% previously.

Raise P/T to $32

Our $32 P/T is set at a P/S of 2.0x our higher 2010E sales, slightly above 5-year average of 2.2x but well above trough (0.5x) to reflect more balanced supply growth and higher pricing in the short-term but partially offset by an uncertain demand environment especially in retail markets to which SNDK has high exposure. Downside risks: excess NAND supply, share loss, & manufacturing excursions. Upside risks: market share gains, improved brand awareness of SanDisk, and development of new royalty and IP around X3 and X4 technologies.

Details

3Q09 Results

SanDisk reported blow-out 3Q09 results. Revenue of $939m was above the high-end of guidance ($725-775m), DBe at $774m and Street at $788m. This is the 3rd consecutive quarter SNDK exceeded the high-end of revenue guidance. The higher revenue was due to product sales, which came in at $814m, well above DBe of $659m as the company saw stronger than expected growth in its OEM business (+84% q/q) and stable Retail demand (flat q/q). SNDK believes it maintained market share in retail despite passing along selective ASP increases. For the first time in its history, SNDK’s retails sales were a minority (44%) of total Product revenue.

OEM product revenue benefitted from growth of new customers and channels, which contributed nearly 33% of the OEM growth q/q. SNDK estimates 38% of its revenue in 3Q09 was driven by the mobile handset industry. Although SNDK is traditionally thought of as a removable card vendor, the company also has a substantial embedded business and iNAND reported an excellent quarter, with revenue up +100% q/q. License revenue of $121m was slightly above DBe of $115m as the company likely benefitted from higher royalties from SD card shipments.

Product GM was 38.7% was well above DBe of 17%, but margins benefitted from an $139m inventory/utilization related charge. Excluding the benefit, product GM was 23% still well above DBe. We note the inventory benefit increased from +$87m in 2Q09. Due to the the revenue upside in 3Q09 the SNDK was able to sell more inventory in 3Q09 and therefore recognize more of the benefit. Somewhat surprisingly SNDK ASP declined -3% q/q compared to blended contract ASPs which rose +8% q/q. The decline in ASP was largely due to mix as OEM sales typically have lower ASPs, but similar margins compared to Retail products. The lower ASP was more than offset by very strong bit growth of +37% q/q, well above DBe of 10%. SNDK channel inventory was 7.5 weeks, largely unchanged from 2Q09.

PF EPS excluding amortization and ESO expense was $1.09, well above DBe of $0.14 as a lower tax rate and higher gross profit was partially offset by higher interest expense (+$13m). Net of the $92m tax benefit and higher interest expense, PF EPS would be $0.75, still well above DBe and Street estimate of $0.26. SanDisk is likely to see another $40m benefit to GM in 4Q09 as the company anticipates sales of previously written down inventory.

Valuation & Risks

SanDisk remains a unique semiconductor company because of its vertical integration and branded systems business. Given the lack of an appropriate peer group we choose to base our valuation on SNDK’s own historical P/E and P/Sales metrics. Given the cyclical and seasonal nature of the NAND flash market we believe that historical data provides the best basis for peak, base, and trough valuations averaged over periods of excess supply and shortages.

Due to the improving outlook for NAND flash in 2010 (largely thanks to supply cuts implemented in 1H09) and the extension of the IP and supply agreement with Samsung we believe SNDK should trade at a premium to trough valuations, but at a discount to 5-year average due to the anticipation of lower license revenue and margins in the future. Our $32 P/T is set at 2.0x Price/2010E Sales estimate, above the 2-year average of 1.65x but slightly below 5-year average of 2.25x.

SNDK faces risks on multiple fronts, not least of all those associated with the broader NAND flash market. In terms of company-specific risks, we consider the most pertinent to be the sustainability of current License & Royalty revenue streams (particularly with Samsung post- 2009), the ability to cost effectively source NAND flash beyond its primary partner Toshiba, being more exposed to removable storage flash form factors (which are expected to grow less quickly than the embedded NAND segment), as well as the ability to stave off commoditization of flash cards and UFDs through IP and market leadership in new standards.

Positive risks include market share gains, slower industry supply growth, improved brand awareness of SanDisk outside of the flash card market, and development of new IP and royalties around X3 and X4 technologies.

I thought it would be entertaining to put up some excerpts from UBS as we roll into Q3 earnings.

Uche Orji, the UBS analyst, makes his best efforts to rationalize his recent downgrade to Sell.

Apparently its bad news that NAND prices are strong (negative price elasticity), while at the same time its bad news that prices could weaken (seasonal demand peak limiting further ASP increases).

Not surprisingly, Uche neglects to mention Sanjay’s 100% bit demand growth for 2009 Deutsche Bank comments. Neither does Uche mention SanDisk’s change of heart regarding the selling of wafers.

Tuesday will tell how the quarter played out. FWIW, my take is that the news will be good- much to Uche’s chagrin- but, it will take Q1 2010 to get a read on how 2010 is going to play out.

UBS has SanDisk’s Q3 top line coming in at $776M; L&R at $113M; Product GMs at 18%; and Pro Forma EPS at $0.15.

No consideration was given to a potential inventory charge reverse.

FWIW, my take is that top line has a good shot of exceeding $900M. The top up driven by wafer sales from (excess) inventory. Although we’ll probably never know, my guess is that the majority of these wafers are destined for Apple, probably via Toshiba.

If lots of wafers have been sold at good prices, SNDK will take an inventory charge reverse.

UBS probably has product GMs right at around 18%.

Non-GAAP EPS looks likely to be the show-stopper, easily exceeding Q2’s $0.36. Probably over $0.50. In the best case, if the stars align, over $0.60.

The bigger question is 2010. Should Q3 be outstanding, the bears such as UBS will argue that recent strength is simply attributable to one time events and the bottom will fall out in Q1 2010.

UBS has product GMs for Q1 2010 coming in at 17%. UBS also is estimating L&Rs for Q1 2010 to come in under $70M. Both these numbers look low to me.

The number to watch for 2010 is product GMs. UBS expects SNDK product GMs for 2010 to be under 20%. I think UBS estimates will prove really really low, but-

Time will tell.

*** UBS excerpts below ****

UBS
12 October 2009

Uche Orji, Analyst

Nearing Seasonal Peak. Downgrade to Sell

Expecting peak demand by mid-C4Q to limit further ASP appreciation

With NAND spot/contract pricing up 24%/9% in Q3 and holiday product builds typically complete by mid-C4Q, we downgrade SNDK to a Sell rating based on: 1) negative price elasticity that could limit bit sales, 2) a seasonal demand peak in Oct/Nov that could limit further ASP increases, a key catalyst for shares, 3) GM downside risk from new, lower Samsung royalty rates taking effect. Downgrade to Sell rating with an unchanged $18 PT.

Greater exposure to retail could limit bit shipment upside

Whilst we do expect SNDK margins to improve meaningfully in 2H09, retail card sales could be negatively impacted by higher prices or fewer promotions. Relative to peers, SNDK has low embedded NAND exposure in high capacity smartphones (16GB or higher), a product that we believe is driving much of the demand strength in Q3 and similar to late Q1/Q2. Though industry supply growth is moderate, Q1 demand seasonality is likely to be unsupportive for ASPs.

GM upside could be limited by new royalty rate, non-captive mix growth

We believe GM upside offered by higher prices and cost reductions from the 32nm migration could be partially offset by the effects of lower Samsung royalty rates, which have a partial quarter’s effect in Q4, and the shift to a more balanced 30% non-captive bit supply mix in coming quarters.

Valuation: $18 12-month PT; Downgrade to Sell Rating
Our DCF-based PT of $18 is equiv to 1.3x P/BV. Sell rating. SNDK trades at a P/BV of 1.4x or consistent with a more normalized mid-cycle range.

Investment Thesis

We are downgrading SanDisk to a Sell rating from Neutral with an unchanged price target of $18. Our new view on SanDisk is predicated on expectations for: 1) negative price elasticity that could limit the potential upside to earnings as a result of higher NAND flash prices leading to weaker unit or total bit capacity sales, 2) the approaching seasonal demand peak in October/November that could lead to weaker NAND flash ASPs starting in December, and thus serves as a negative catalyst for SanDisk shares given that it historically has tracked memory prices, 3) potential gross margin downside risk from the company’s royalty revenue stream which will see a pronounced decline starting in the December 2009 quarter and again in the March 2010 quarter due to new
Samsung royalty rates taking effect, and despite ongoing manufacturing cost reductions that should help to maintain or improve gross margin especially in a benign to improving price environment. Furthermore, SanDisk is also on track to move back to a more balanced fab-lite model where 25-30% of bits are sourced from external suppliers and thus could limit the upside to margins in coming quarters.

Negative Price Elasticity

We estimate that approx 85-90% of SanDisk’s revenues are from actual product sales and the majority of that comes from retail or bundled card sales vs. embedded NAND sales into mass storage applications. This large retail exposure leads SanDisk to be highly dependent on consumer trends and price elasticity. Though it is evident from company statistics over the past 7 years that an increase in ASP per bit will lead to a decrease in NAND content or bits per card sold, the R^2 is only 0.50. Since SanDisk is vertically integrated and currently purchases less than 5% of its bits sold from external suppliers, we believe the company has limited pressure to raise prices in order to maintain or improve gross margins given cost reductions enabled by the 32nm migration. However, depending on the financial health of SanDisk’s competitors and how much product margins are already compressed due to higher NAND contract prices, SanDisk may opt to follow competitors in raising prices or pursue less discounting in coming months. While it is unclear whether SanDisk would take advantage of the current environment to gain share, we do believe profitability is a key objective and maintaining market share.

We note that SanDisk does have a very modest amount of exposure to embedded NAND applications such as smartphones through its iNAND product family. Our own retail checks indicate that retail memory cards are still being discounted modestly whilst micro form factor cards are in some cases no longer being bundled with handsets/smartphones compared to the common practice of including at least a small capacity card. We believe much of the shelf space for flash products is devoted to USB flash drives and SD/Compact flash cards and generally less space for microSD or Memory Stick Pro Duo. We do note that SanDisk had the most shelf space of any other retail brand and fewer brands were competing for shelf space as a whole.

Seasonal Demand Peak Approaching

The manufacturing of products slated to be sold during the late November through year end holiday selling season typically concludes by late-October to mid-November and typically coincides with the peak in NAND flash price appreciation. Based on DRAMeXchange data, the NAND spot ASP M/M % change in October over the past 5 years was -5%, and compares to the up +9% seen in 2009 thus far. In the two month period ending in November, the 5-year average shows a -14% decline while the three month or quarterly Q4 average over the last 5 years is a -25% decline.

2005 was the last time ASP trends were up in October and the 2 month period ending in November. That period was marked by the strong growth of portable media players as a new demand catalyst, but seasonality still quickly came into play by December leading to a Q/Q ASP decline of -3%. We expect a similar trend to play out over the remainder of 2009 given that retailers are likely to not build significant amounts of inventory and the ramp of new smartphone products is likely timed to coincide with holiday launches and sales promotions.

New Lower Royalty Rate Could Affect Margins

From a gross margin perspective, we believe SanDisk’s core product manufacturing and sales operations should see stable to improving gross margin in Q3 and Q4 especially in a benign to improving price environment. From an overall gross margin perspective, the December 2009 quarter will be the first to take into account the new Samsung royalty rate (partial effect of 1 month) that is approximately half of the prior rate. Royalties remain a key or only source of profitability in SanDisk’s overall business given how competitive the retail NAND market remains.

Furthermore, SanDisk is also on track to move back to a more balanced fab-lite model where 25-30% of bits are outsourced and thus could limit the upside to margins in future quarters. This is not likely to have a significant impact until internal inventories are reduced to a more normalized level. If SanDisk’s procurement of external NAND supply coincides with further increases in NAND pricing due to limited supply growth, then we believe the incremental revenues could have lower margin associated with it.

Valuation

From a valuation perspective, SanDisk is trading at a P/BV ratio of 1.4x and compares to trough-peak range of 0.3-8.0x with a more “normalized” range of 1.5-3.0x. The current 1.4x ratio is also in line with Micron’s current P/BV and historical range of 1.0-2.0x. On an EV/Sales basis, SanDisk is trading at 1.3x or at a discount to Micron’s 2.1x vs a “normalized” range of 1.5-3.0x which is similar to Micron. We believe that with a move to a more balance fab-lite manufacturing model that includes 25-30% of bits procured from outside suppliers and a royalty revenue rate from Samsung that is effectively half of the prior rate, SanDisk may not garner the same peak multiples as it has in prior cycles given the changing nature of its operating model.

On August 12, 2009, Eli delivered a keynote address at the Flash Memory Summit in Santa Clara, California.

I wasn’t at Eli’s presentation, but SanDisk has posted the slides. Many are the same as those that Eli used the day before at his Oppenheimer Conference Presentation (OPCO).

Much of the same material appears to have been covered.

One of Eli’s main points at the Flash Memory Summit was that over the next three years, the NAND business is not going to play out along the lines currently modeled by analysts.

There is a disconnect.

Analysts project huge growth in NAND demand in 2010-2013. To keep up with this demand will take incremental Capex of about $25B to 30B in new NAND capacity. Analysts project cumulative incremental NAND revenues of only about $20B in 2010-2013.

Analysts project NAND price reductions that are not consistent with slower cost reductions due to slowing NAND technology transitions beyond 2010.

EE Times picked up the story with:

“The NAND industry is at the ”crossroads,” as there is a ”disconnect” between future capacity requirements and demand, warned the top executive at SanDisk Corp.”

Here is a link to the full article.

Here we are two months later and there does seem to be a disconnect.  More demand than supply. Not enough capacity. Predictably NAND prices continue to be strong.

Here is a slide from Sanjay’s Deutsche Bank (DB) presentation. Eli used an older version of the same slide at the Flash Memory Summit. Currently prices are up from this slide. 8 October DRAM eXchange 16 Gb average contract price= $4.98.

Such NAND pricing strength is unprecedented.

Eli’s OPCO comments on this same slide:

“You can see the positive impact for us of pricing rising. What I’m showing you here is every quarter for the last five years, 4 1/2 years. The ASP declines that SanDisk experienced on a quarterly basis and the red line is on an annual basis.

And you can see, its always negative, every quarter price reductions coming in, supported to a large extent by cost reductions, but not completely.

In 2008 you can see that price reductions are really cumulatively adding up to 62%. Deprived us of all profitability. Things started improving, though it is difficult to see here in the first quarter of 2009 and definitely on the upswing in Q2 of 2009.

So the trend is definitely moving in the right direction.

Of course the flip side of higher prices is that demand in terms of MBs/unit and even the number of units slows down. We know that elasticity works both ways. But we are very focused on profitability. This is our #1 concern right now.”

When SanDisk reports Q3 earnings on October 20, we’ll find out whether higher NAND prices have dampened demand. I doubt it, given that Sanjay noted at DB that bit demand growth would be upwards of 100% for 2009. Basically this means that SanDisk is selling all their NAND production and burning through inventory.

The slide below was used at both the Flash Summit and OPCO. SanDisk left off 2010e. Nonetheless, from his comments, Eli appears to think 2010 will look like 2009, with supply bit growth of 50%±.

Eli’s commentary at OPCO:

“One of the most important developments that the industry has gone through in the last 6 months is a significant deceleration in supply and that has occurred really in the first and second quarters through production cutbacks. Which heretofore, have been unheard of.

As well as delay or defer, basically nobody is talking about new wafer fabs for NAND. So I think things, have in Q4 of last year, have become very very difficult in the industry, and there was really no other direction to go, but to cutback.”

In OPCO Q&A Eli elaborated, pointing out that without adding new wafer capacity, bit growth won’t go above 50% for any NAND supplier:

“ We have said that for this year we expect our total bit growth, 2009, to be under 50%. And that is through technology transitions. 43nm and going to three bits per cell. The next technology transition will be 32nm both two and three bits per cell.

Typically in a technology transition like that you can expect between 30 and 50% more bits. You cannot expect 100%. You have to put in place new capacity for new wafers if you want to go above 50%. That’s true not just for SanDisk, its true for any other supplier.”

This last week the DRAM eXchange released their estimates for NAND demand and supply for 2010. For Q1 and Q2 2010 supply is expected to slightly exceed demand, then in Q3 and Q4 demand is forecast to exceed supply. Bottom line- Shortage in 2010.

See chart below.

I kept looking at the chart and something seemed wrong. Finally it dawned on me. Estimated supply growth looked remarkably strong. Given Eli’s comments I was expecting 50%± since industry wafer adds are expected to be minimal at best.

I went back to the commentary and sure enough the DRAM eXchange is expecting NAND supply bit growth of 79%.

Sure seems like a disconnect somewhere.

NAND supply could get really tight next year. No wonder Apple is locking in all they can.

I’m just back from vacation and it seems the last couple of weeks have been eventful in SanDisk World.

In the interests of getting this post up today, I’m going to keep my commentary short.

Share price is up and rightly so. Sanjay in his Deutsche Bank (DB) presentation of 14 September managed to slip in a zinger or two.

I’m including a transcription of a couple of his most interesting comments below.

Following on from Eli’s OPCO comments regarding managed NAND, Sanjay noted that SanDisk now considers “New Channels” among its growth opportunities. These new channels include private label cards, wafers and components.

Most significantly, Sanjay noted that for SanDisk bit demand growth would be upwards of 100% for 2009. New bit supply through technology transitions will be around 50% as expected. The difference will be made up from inventory.

These comments have incredibly bullish implications for Q3 and Q4- both top and bottom line. Not long ago there was great concern that when idled bit capacity came back online this quarter, the NAND market would slip back into oversupply. Not only does this not appear to be in the cards, but demand is so strong that excess inventory is being burned through as well.

Four days after Sanjay’s DB presentation, Bank of America/ Merrill Lynch (BoA-ML) released a bullish SanDisk report on 18 September.

BoA-ML’s analyst, Simon Dong-je Woo seems to have have gotten religion. I am including excepts below. Highly recommended reading. Its worth remembering that this commentary is coming from Seoul- Samsung’s home turf. Even with the Samsung spin, there is a lot to like.

Shlomi Cohen’s Globes’ article this week included a concise summary and put BoA-ML’s recent report in context:

“The turnaround in SanDisk’s business over the past half year can be seen in reports by Bank of America Securities-Merrill Lynch analyst Simon Dong-Je Woo, who began to cover the company in March, with an initial “Sell” rating and target price of $6, which slowly crawled up to $10, as the share price rose to $20.He forecast then heavy losses in 2009 and 2010 for SanDisk, and only slight recovery in 2011.

Woo figured that SanDisk’s partnership with Toshiba would burden it financially, and because of production costs which were higher than market prices, he also saw it at a disadvantage against competitors. Woo saw a difficult market ahead, where prices would collapse due to a chip surplus until at least the end of 2010.

Additionally, he suspected that Samsung would not renew its royalty agreement in which only one month later, in April, he was proven wrong, as Samsung and SanDisk did sign.

On Friday, he turned around, and switched to a “Buy” recommendation from “Sell”, and tripled his target price to $30, much higher than the most optimistic analysts who covered the company, such as Lazard’s Daniel Amir.

Today Woo sees the mirror image of what he saw in March. Instead of chip surpluses, he sees a shortage, because of a sharp cut in investment. Instead of a disadvantage in its joint venture with Toshiba, he sees a very big advantage in production line ownership. A wave is beginning, in his opinion, of positive trends in the NAND market, one which will last at least two years. From the demand side, it originates in higher usage of mobile storage in telephones and media players, led by Apple. In the case that SanDisk will need more chips than it produces by itself, it will be able to buy them from Samsung, which in its new royalties agreement committed to sell to it at low prices.”

Lastly, recent rumors have SD slots in the next generation of iMacs. If this proves true and I suspect it might, this is a trend to like from a trendsetter. The mac tablet now looks like a 2010 story. There would be a lot to like about an SD slot there.

**** Transcription excerpts from Sanjay’s 14 September Deutsche Bank presentation below****

Sanjay Mehrotra
President and Chief Operating Officer

“We have also begun to engage in terms of new channels related to private label cards and sales of wafers and components. I’m please with the progress that we are making in this area as well.”

…

Q: Of course the pricing dynamics is the thing that we’re probably all curious about. Can you talk about how quickly you think supply can ramp and what can happen and whether you shared [pause] you say you are optimistic, does that mean that you’ll be profitable going forward and GMs can stay at the current levels of 22%? Thank you.

Sanjay: We are certainly optimistic for the second half. As I have said, the bit growth in the future, we have not provided guidance for the bit growth.

But an important thing to note from an industry point of view, is that in 2009, there is no new wafer capacity that has come on line. And in the first half of the year, there was significant cut back in production.

Therefore the bit growth for the year in terms of supply is approximately 50%.

For SanDisk itself, in terms of our demand growth, of course our demand growth will be significantly larger than this 50% number of the supply bit growth because we have significant inventory that we entered the year with and using that inventory as well as using our new supply, new bit supply through our technology transitions, we expect to be doing significantly more than 50% growth in the year.

If you look at our first two quarters, we have done on a year-over-year basis, 100% plus kind of growth. So for the year I would expect our growth to be in the range of 100% plus. In terms of the demand growth.”

There is no update in terms of GM other than what we provided at the time of the Q2. I had noted that the pricing environment in the industry has been better than what we had expected at the time of the Q2 conference call and would expect that to have a positive impact on our revenues for the third quarter as well as on the GMs for the third quarter”

**** Excerpts from Bank of America/ Merrill Lynch 09.18.09 SanDisk Report Below ****

SanDisk Corp Inc

Rating Change BUY
18 September 2009

Simon Dong-je Woo, CFA
Research Analyst
Merrill Lynch (Seoul)

Expecting up cycle; upgrade to Buy

Buy on better-than-expected cyclical momentum

We upgrade SanDisk to Buy from Underperform with a new price objective of US$30, which is derived from the average of our mid- and up-cycle fair values (vs. the average of trough- and mid cycle fair values previously). We target about 2x P/BV (PO implies 1.7-1.8x based on 2010-11E) vs. 2-4x during mid- and up-cycle periods (2002-07) or 1-2x in the recent downturn (2008-2009). The high P/E (19x 2010E EPS using our PO) is a concern, but we think it will be offset by a dramatic earnings recovery through 2H09 and 2010-11. We expect EPS to exceed previous high levels (2006-07) in 2010-11, but remain lower than the 2005 peak.

Tight NAND supply presents new catalyst

SanDisk differs from typical OEMs such as Apple due to its captive chip production (JV fabs with Toshiba) and the option to purchase chips from Samsung. Consequently, the best case scenario for SanDisk should be a NAND shortage. Our research shows tight supply of NAND due to chipmakers’ record low capex spending in 2009-10. Against this backdrop, we raise our ASP assumptions for SanDisk’s products by 30-40% for 2010-11, leading to EPS revisions of over 100% on a higher OPM (15-17% in 2010-11 vs about breakeven previously).

Financials and technologies look good

Financial distress no longer concerns us. SanDisk’s B/S remains healthy (over US$1bn net cash including long-term financial investments), despite large losses in 2H08-1H09. We also note the successful deployment of new technologies such as 3-bit cell (vs. MLC) and 32nm (vs. 43nm) – about one or two quarters ahead of Samsung. We think Korean chipmakers will focus more on DRAM capacity expansion vs. NAND due to relatively better margins and market share gains at the expense of Taiwan DRAM vendors. This also suggests upside to NAND.

Company Description

SanDisk, was founded in 1988 by Dr. Eli Harari who is currently chairman of the board and CEO, manufactures and distributes NAND chip based products such as flash cards, USB drives, solid state drives, MP3 players, etc. The company also receives royalty revenue from various NAND chipmakers and OEMs such as Samsung. SanDisk has large exposure to NAND chip fabrication via JV fabs with Toshiba in Japan.

Investment Thesis

SanDisk should be a major beneficiary of NAND industry recovery. NAND capex spending among chipmakers has been abnormally low in 2009. We expect this to lead to a NAND shortage and new business opportunities for SanDisk through the leverage of its well established JV fabs and options to use Samsung capacity – the JV fabs were company-specific weaknesses during the NAND downturn. We expect 2010-11 profits to exceed the previous highs of 2006-07 but still remain below the 2005 peak.

Expecting up cycle; a new Buy

We are no longer bearish on SanDisk. We now expect a solid earnings recovery in 2H09 and 2010-11. Our new forecasts for OP and EPS indicate an almost up cycle level of earnings through 2010-11 – surpassing the previous upturn average (2006-07) but slightly lower than the 2005 peak. Against this backdrop, we upgrade SanDisk to Buy from Underperform with a new price objective of US$30, which is based on the average of mid and up cycle fair values (vs. our previous PO of US$9.9 based on the average of trough and mid cycle fair values). We revise our EPS estimates by more than 100% due to dramatic changes to our ASP assumptions for SanDisk’s flash card products (about 30-40% higher for 2010-11 on a better supply and demand outlook for NAND chips).

We present five reasons for our SanDisk upgrade:

1. NAND supply-demand will be favorable for SanDisk NAND price, which is a function of supply and demand, is the biggest swing factor for SanDisk’s overall earnings momentum. Since SanDisk has in-house chip production capacity and the option to use Samsung’s fabs under license agreements with Samsung for its end products such as flash cards (note: SanDisk is not engaged in chip sales), NAND chip supply shortage (NAND price hike) warrants a competitive advantage vs. OEMs, which usually purchase NAND chips from Samsung or other non-Samsung NAND chip makers such as Toshiba, Hynix and Micron/Intel.

We acknowledge that our view on the NAND industry has been too conservative, and the NAND price recovery YTD (more than doubled in the past nine months) has been much stronger than expected. Both supply and demand data points have been favorable for chip prices in 2009 – weaker supply (record low capex growth) and stronger demand (upbeat demand from handset applications).  We believe this kind of favorable industry momentum will continue in 2010-11, due to:

(1) Korean chipmakers’ focus on increasing DRAM capex over NAND to take advantage of Taiwanese/Japanese competitors’ financial difficulties and delay of new technology adoption;

(2) Toshiba’s ongoing budget constraints for NAND capex increase – Toshiba’s net debt remains high at over US$10bn vs. about US$4bn EBITDA pa in 2009-10;

(3) Micron’s minimal capex increase for NAND fabs which are under JV with Intel – Micron has actively expanded its DRAM capacity by acquiring a 35.5% stake in Inotera (JV with Nanya in Taiwan) rather than NAND, while its strategic NAND partner, Intel, has also maintained a conservative approach toward new NAND JV fab construction, particularly in Singapore (only shell fab for now); and

(4) our industry analysis now indicates a potential NAND supply shortage if handset applications (NAND embedded smartphones such as iPhones and flash cards for handsets’ external slots) absorb the increase in supply from new technologies such as 20-30nm and 3-bit-per-cell – we are now modeling a slight shortage of NAND chips in 2H09, slight oversupply in 1H10, but shortage again in 2H10 and 2011.

2. OP and EPS will exceed previous highs

We previously thought upbeat 2Q results (OPM: +9% actual vs. our previous estimate of -10%) would not signal a cyclical recovery due to our conservative view on margin recovery and NAND price momentum. However, 3Q data points already reveal another round of upbeat earnings momentum at about 16% OPM (vs. our previous estimate of 7%) due to better-than-expected NAND chip and flash card price momentum. SanDisk is able to source required NAND chips from its JV fabs in Japan (about 30-40% of JV production) at lower than spot prices or JV fabs’ manufacturing cost plus a minimal mark up. This represents a competitive weapon for SanDisk during periods of NAND shortage vs. typical OEMs such as Apple, which purchases NAND chips from Samsung, Toshiba, Hynix and Micron/Intel.

Overall NAND demand remains solid, despite the chip price strength, due to new applications such as smartphones and OEMs’ promotion of high density flash cards for high-end products (eg, solid demand for 4-16GB NAND-based products in various applications such as MP3 players, USB drives, flash cards for handsets and game consoles, etc).

Against this backdrop, SanDisk has raised its flash card product prices for two consecutive quarters (2Q-3Q09) vs. our previous estimate of 5-20% price cuts each quarter. Overall, we raise our ASP assumptions by 30-40% and this leads to EPS revisions of over 100%. Of course our EPS estimates could be revised down on lower ASP projections, but we now expect much lower risks to NAND ASP and tight supply to meet demand in 2H09 and 2010-11. Based on this, we expect SanDisk’s OP/EPS to exceed the previous high level (2006-07) in 2010-11.

If all non-Samsung NAND vendors fail to execute their target spending in 2010, upside to our new estimates could easily be more than 20% on better ASP assumptions. Potential capex increase among NAND chipmakers is a concern but we don’t expect abnormally high capex in 2010-11 due to the capex budget constraints and high gearing ratios of all non-Samsung NAND chipmakers.

3. Potential profit taking shouldn’t be a concern

SanDisk’s share price has doubled YTD along with NAND price strength. This may lead to profit taking among investors who bought the stock early this year. However, the current share price reveals low P/BV multiples (1.5x based on 2009E book) vs. its historical average (2.2x during 2002-07). The stock traded at 1x P/BV during the deep downturn in 2H08/1Q09, but our new forecast suggests better than mid level of earnings momentum or even higher than the previous upturn period (2006-07). Therefore, we think any profit taking driven stock price correction would offer a good entry point for new investors.

4. Financial risks appear low

SanDisk’s net D/E ratio was negative 12% in 2Q09 (net cash), despite large losses in 2H08 and 1Q09. Further, the company’s cash and long-term securities investments (mainly US government and municipal bonds) amounted to US$2.3bn as of 2Q09, which is close to the sum of its gross debt (US$0.98bn) and guaranteed lease obligations for the NAND JV fabs in Japan (about US$1.2bn). We also note lower capex burdens for the JV fabs – less than US$1bn capex pa for the JV fabs for the long term vs. the previous high of US$1.9bn in 2007 and US$1.6bn in 2008. Our model shows EBITDA will remain higher than capex in 2009-11.

5. Technologies better than Korean chipmakers

Samsung is not yet actively using 32nm and 3-bit-per-cell (3bpc) technologies in its NAND chip production (mainstream: 42nm, 2-bit-per-cell). In contrast, SanDisk’s JV fabs have already ramped up scale production using 32nm and 3bpc (smaller chip size vs Samsung’s). Our analysis shows about 20-30% lower cost at 3bpc vs 2bpc. Hynix’s new technology deployment is also lagging that of SanDisk’s JV fabs. Hynix’s mainstream technologies are still 48nm/41nm with minimal exposure to 32nm and 3bpc. Micron has also recently announced its 3bpc technologies using 34nm but Micron’s NAND JV fab capacity is far smaller than SanDisk/Toshiba JV fabs’ (about 110k wpm vs. about 260k wpm). Although new technologies do not necessarily lead to better margins and cost advantages due to different manufacturing yields and product mix (sometimes old generation chips offer better margins), SanDisk’s proven technology leadership via the JV fabs in Japan should be a competitive advantage vs. Asian players including Samsung.

Implications for our DRAM/NAND sector view

We now have three Buy-rated stocks in our global DRAM/NAND universe – Samsung Electronics, Hynix and SanDisk. Of course this is based on the better- than-expected DRAM and NAND price outlook and their respective better than mid-cycle levels of earnings momentum. However, we still remain cautious on the remaining stocks we cover in the sector such as Taiwanese and Japanese memory chipmakers due to their relatively weak margins (large losses among Taiwan DRAM vendors and minimal profit recovery among Japanese chipmakers) and unfavorable financial structure (minimal shareholder value after debts). We acknowledge that our non-Buy rated memory stocks could also outperform if the global supply of DRAM or NAND is insufficient to meet demand, but we remain worried about their inferior competitiveness and high gearing ratios vs. our Buy-rated stocks.

Our answers to frequently asked questions

1.Does BAS-ML expect a hard landing in NAND after 3Q?

No. We expect a soft landing in both NAND spot and SanDisk’s overall earnings momentum through 4Q09 and 1H10, followed by a better-than-seasonal recovery in 2H10 due to chip supply constraints. We do not anticipate any new fab construction for NAND in 2010, just ramp-ups among existing capacity led by Samsung (US fab), Toshiba (Fab 4) and Hynix (M11). Thus, NAND supply in 4Q09 and 2010 will be highly dependent on utilization increases (already over 90% as of September) and die shrinkage on new technologies such as 32nm and 3-bit-per-cell. NAND supply growth cannot be higher than 50% a year (in bit terms) if chipmakers merely rely on chip shrinkage, while our model shows over 50% demand growth in 2010 led by high-end phones and USB drives.

2. Does recent NAND price strength inhibit demand growth?
Yes, but we anticipate minimal impact on demand from stronger-than-expected price hikes YTD. NAND chip and flash card prices are still lower than normal levels following deep erosions through 2007-08, in our view. Retail prices for  1-8GB flash cards and USB drives are in the range of US$5-20, despite YTD price hikes more than doubling, which is still affordable for consumers for external memory expansion for digital products and PCs. Our survey also shows low price elasticity among NAND products with retail prices below US$10-20. That said, we model about a 10-15% QoQ price decline in NAND flash card and USB drives after 3Q but this should lead to margin improvement if SanDisk executes its target cost reductions well on the back of new technologies. We also note solid demand for NAND chips from new applications such as smartphones in 2010-11 and SSD after 2010, even at a 30% pa NAND chip price decline vs over 50% in 2006-08.

3. 3Q results will be an earnings surprise?

Yes, we expect SanDisk’s OP to exceed consensus (our estimate: US$138mn vs consensus: US$52mn) on upbeat ASP and well-deployed new technologies in JV fabs.

4. How will 1H10 seasonal weakness affect momentum?

We model quarterly OP to be about US$90-100mn OP in 1H10 vs US$120- 140mn in 2H09. This could suggest profit taking among investors focusing on near-term earnings momentum. However, we interpret this as a soft landing before an almost up-cycle level of earnings momentum through 2H10 onward – a bigger impact from chip supply constraints on solid demand from seasonality and new applications such as high-end phones and SSD.

5. Can chipmakers raise capex spending on NAND upturn?

Not easily. Including Samsung, all memory chipmakers will likely focus on technology upgrades rather than new fab construction. Further, balance sheets and cash flow at most non-Samsung NAND chipmakers’ are unlikely to remain healthy enough to be aggressive on capex spending in 2010. Samsung management has also addressed its more disciplined capex behavior well despite more visible macro recovery. No Taiwanese DRAM vendors will enter the NAND industry, at least in 2010-11, due to their prioritizing DRAM fab upgrades and ongoing budget constraints for overall capex.

6. Could SSD become upside catalyst?

Not for 2H09 or 2010, due to HDD’s relatively superior cost advantages vs SSD (SSD price is still over 5x higher vs HDD). Our demand model still shows a low contribution of SSD to total NAND demand (9-10% in 2009-10). This is in line with more conservative SSD guidance from Samsung and SanDisk. However, in 2011 or thereafter, SSD should lead overall NAND demand growth along with high-end handsets and USB drives (as external storage for PCs), competing strongly with HDD (the SSD price should be close to HDD for storage below 100GB in 2011).
7. Is M&A theme still valid?

No, Samsung has already addressed the termination of its plan to acquire SanDisk at various analyst meetings. We do not expect any chipmakers or OEMs to try to take over SanDisk unless SanDisk management offers a good M&A price (eg, Samsung’s offering price of US$26 was rejected by SanDisk’s BoD).

8. Long-term competitive landscape?

Samsung and Toshiba/SanDisk JV fabs should continue to occupy about 80% of NAND global market share. The rest (about 10% for each) should be for Hynix and Micron/Intel JV. Renesas (Japan) has already given up its NAND business and newcomers such as Powerchip have also suspended spending on NAND capacity expansion. Thus, the NAND industry will likely be dominated by two big camps, Samsung and the Toshiba/SanDisk JV, for a while.

Price objective basis & risk

We use three valuations to derive our PO of US$30.0. First, the average of mid- and up-cycle fair values based on long-term sales growth and OP margin assumptions at 14% and 15%, respectively (trough-cycle US$18, mid-cycle US$26, up-cycle US$40). Second, 2.0x P/B based on 2010E/11E book value vs historical average of 2.2x P/B. Third, DCF at 12% WACC. Per-share non-core asset book value from securities investments and JV fabs in Japan appears over US$10, which is included in our DCF valuations apart from business value.

Downside risks: (1) unexpected NAND price decline, (2) aggressive capex increases among chipmakers, (3) weak demand from new applications such as smartpohones and SSD, (4) a capacity shift from DRAM to NAND among Korean chipmakers, (5) execution risks to deploy new technologies, and (6) unexpected equity financing.

Upside potential: (1) NAND price strength coupled with more conservative capex among chipmakers, (2) stronger demand from high-end phones and notebooks, (3) market share gains on the back of well-established new technologies such as 30nm and 3 bits per cell, and (4) higher royalty revenue alongside NAND industry recovery.

This week I decided to finish up the transcription of SanDisk’s 16 August Oppenheimer Communications, Technology & Internet Conference (OPCO), instead of working on something new.

This isn’t to say that the last couple of weeks haven’t been both interesting and promising.

Top of the list is the International Trade Commission’s decision to review its 10 April, 2009 initial determination that went against SanDisk. FWIW, I had pretty much given up on this one. Its a good thing SanDisk didn’t.

SanDisk’s U.S. Patent No. 6,763,424 (the ‘424 patent) seems to be front and center of the review. The 424 patent is all about controllers. Controllers, of course, are the key to getting flash memory to perform. From cards to SSDs, the old ‘424, could go a long, long way for SanDisk. This is a big deal from many angles- not the least or which is L&Rs.

I find it very, very encouraging that the ITC even decided to review this case. This was hardly a given. As I understand it, review is usually the exception rather than the rule.

From where I sit, it appears that the ITC’s ALJ Bullock, who issued the initial determination, screwed up and screwed up to the extent that others felt compelled to step in.

In any case, we should know how this plays out by October 23, 2009.

Its worth noting that this is all upside for SanDisk. If the ruling should go against SanDisk, we would be right back where we are today. In other words, existing L&R agreements won’t be impacted at all.

If SanDisk should prevail, the upside should be really nice. Most interesting would seem to be the SSD controller angle, but, before going there, the ‘424 needs to be upheld. October should tell.

The second positive storyline is Apple. China Unicom just announced a deal with Apple to sell iPhones in China.  The iPhone is coming to the world’s largest mobile market for the first time. As the WSJ put it:

“The release of the iPhone in China — which has 687 million wireless subscribers, more than twice the population of the U.S. — is expected to be a boost for both Apple and Unicom, one of three Chinese state-owned telecommunications carriers…

Unicom, which had 141 million wireless users at the end of July, hopes the iPhone will attract high-spending customers who will boost its earnings and give it a leg up on dominant carrier China Mobile Ltd., which has more than triple Unicom’s subscriber base. The iPhone deal comes alongside Unicom’s rollout of a “third-generation,” or 3G, network that will enable functions like wireless video and high-speed surfing. Unicom’s 3G network is the only one among three in China that is currently technologically compatible with the iPhone..”

Apple uses a lot of NAND and China can only mean more.

According to iSuppli, in 2008 Apple was the fourth largest consumer of NAND accounting for 9.5% the market. Only Samsung, SanDisk, and Sony were ahead of Apple.

Next up for Apple appears to be the iTablet- another prime candidate for NAND, and hopefully cards. Rumors now have the iTablet introduction late this year or early 2010.

I am posting a full  transcription of OPCO at the bottom of this post. As an experiment I am inserting the accompanying slides. Eventually the plan is to pull the transcription over to the pages sections where I’ve been keeping transcriptions for reference.

I find this presentation- and especially the Q&A- to be remarkably informative.

**** OPCO Transcription Below****

11 August Oppenheimer
Eli Harari

[Safe Harbor]

[Skipped Agenda]

As you know SanDisk has the broadest range of products in flash storage. In the center there you can see the imaging and the USB and the Audio/Video. This is what is called our legacy business. Some of that is more mature and has become less price elastic, but even there we see growth. Particularly outside of the United States- in China, India, Latin America. Basically lots of places in APAC [Asia Pacific] that still have a lot of growth ahead.

The biggest opportunity that we see for growth is the mobile. I will talk a little bit more about that and then emerging markets for us the embedded, again mostly mobile and then SSDs. Again I’ll get back to that.

In the first half of 2009, you can see that mobile in terms of revenues was the largest part of our business. In terms of units its actually even more than 35%. You can see that imaging and USB are doing well holding their own. Combined about 45% of the business [including Audio/Video]. Gaming was a little bit down, but we see that as returning and of course license and royalty has been 14% in the first half in spite of a weak first quarter.

The mobile phone end market is very very strong both for embedded and for removable cards. In the removable card category we believe that microSD has now become the standard and of course there is also the M2 for Sony Ericcson phones which we supply.

The encouraging trend here is that in 2009 we expect more than 70% of all handsets to have a slot for a card. That is close to 800M handsets shipped in 2009 with a card slot and that represents a tremendous opportunity. The attach rate is still relatively low and the smartphones, the iPhone, the Blackberry, the Palm Pre and so on, and of course the Nokia phone, we believe are moving more towards computer-like devices with applications stored and driving the demand.

The Apple 8GB, $99 iPhone is the direction of kind of the baseline requirements on the high end. 8GB is becoming much more accepted in that category.

One of the most important developments that the industry has gone through in the last 6 months is a significant deceleration in supply and that has occurred really in the first and second quarters through production cutbacks. Which heretofore, have been unheard of.

As well as delay or defer, basically nobody is talking about new wafer fabs for NAND. So I think things have in Q4 of last year has become very very difficult in the industry, and there was really no other direction to go, but to cutback.

SanDisk was the first to take that move. We announced late in Q4 that we decided to cut back in Q1 by 30%. Others followed.

As a result we’ve seen pricing initially firm up, and then continue to rise and more recently we have stabilized.

What you are seeing here, the source is inSpectrum, updated through late July. You can see the spot price for 16Gb, 2GB MLC is about $4.47. Contract price about the same [$4.45]. That is more than double what it was at the end of Q4, and basically what it was about a year ago. So we have gone in pricing where we were about a year ago. As you can see the price at least in the last three months has been quite stable.

This is really quite unprecedented. The industry has gotten used to relentless cost reductions with price reductions. By the Q4 last year there was excess supply, excess inventories and the price reductions far exceeded cost reductions resulting in significant losses for all participants.

You can see the positive impact for us of pricing rising. What I’m showing you here is every quarter for the last five years, 4 1/2 years. The ASP declines that SanDisk experienced on a quarterly basis and the red line is on an annual basis.

And you can see, its always negative, every quarter price reductions coming in, supported to a large extent by cost reductions, but not completely.

In 2008 you can see that price reductions are really cumulatively adding up to 62%. Deprived us of all profitability. Things started improving, though it is difficult to see here in the first quarter of 2009 and definitely on the upswing in Q2 of 2009.

So the trend is definitely moving in the right direction.

Of course the flip side of higher prices is that demand in terms of MBs/unit and even the number of units slows down. We know that elasticity works both ways. But we are very focused on profitability. This is our #1 concern right now.

This one is looking at SanDisk’s Product Gross Margins through the second quarter. You can see that we had 2005, 2006, and 2007- good steady product gross margins in the range of 30 to 34% or so, 35% and then in 2008 things started deteriorating primarily because of the excess supply that came about from everybody mastering MLC- everybody in the industry mastering MLC. Lots of 300mm capacity coming on stream and very very productive technology migrations.

So by Q4 [2008] you can see pretty much a disaster scenario- excess supply and people really dumping at the end of the quarter. Excess inventory way below cost and at that point I think that it was very clear that, to us at least, that we really need to cut back with the global economy slowing down.

Anyway it was the right decision, and we took it at the right time. We also took very aggressive steps in restructuring the company.

Cutting quite substantially our operating expenses. Restructuring our supply agreement, or rather our joint venture agreement with Toshiba. Selling back to Toshiba in Q1 slightly over 20% of our captive capacity. As a result of that we have been able to gain much better control of our destiny, and really focus on the business that makes sense, the profitable higher margin business, frankly walking away from business that in Q4 and Q3 of last year with excess inventory we had to go after.

You can see here  our operating expenses really coming down very dramatically in 2009. Some of that came through layoffs about 12% of the company, very very tight controls on expenses but of course maintaining our spending on strategic programs, our core competencies, our advanced technology roadmap both in NAND and 3D R/W, controllers and systems.

You can see from this slide here that the diluted earnings per share, the bottom line here is that, BTW this is non-GAAP numbers, you can see in the second quarter, we had our first profitable quarter since the first quarter of 2008. This is very very good. Its heading in the right direction. It kind of demonstrates that Q4 was probably the bottom of the current prolonged downturn.

We see the downturn as really having started in the Q4 2007 and I think the worst is over and that’s basically the reason for our cautious optimism for the second half of the year.

In terms of the balance sheet, the balance sheet is very strong now. Through this restructuring of our joint venture with Toshiba, we were able to very substantially reduce our fab operating lease guarantees from over $2 billion, $2.1B to $1.2B and through cutting our capex from what was planned to be $1.6B down to about $500M. We were able to dramatically improve our cash position, our assets and so on.  So I am very very pleased. Really very pleased with where we are today in terms of our balance sheet and our preparedness in the next up cycle.

As far as what to expect on the technology migration. Lithography-wise we began the 32nm transition. Its looking good. We expect it to take several quarters to fully convert from 43nm to 32nm and that will carry 2 and 3 bits per cell.

43 nm is today the production workhorse. We expect slightly over 50% of our total output this year to be in three bits and 4 bits. 4 bits is a small part of that, but still shipping in production and in that regard we believe we are ahead of the industry in introduction of 3 and 4 bits per cell. We think it is going to happen industry-wide, but we think we have perhaps one generation head start.

We started with 3 bits per cell with 56nm technology. At 43nm it has been our production workhorse and we expect the same for 32nm.

All in all, after we completed the restructuring with Toshiba, we have about 1.5 million 300mm wafers per year. That is our total capacity. All of it is leading edge. All of it is capable of 32nm technology and beyond and we think that this is a  very very substantial amount of capacity on the captive side.

I estimate that the total number of wafers 300mm equivalent for the industry is in the range of 8 million wafers for the year. So that is 1.5 million out of 8. It is quite substantial.

It certainly allows us to focus both on the OEM side and the retail side and of course we have stated many times that we would like to move beyond this captive supply and leverage our non-captive supply agreements with Toshiba, Samsung and Hynix. In the future we will need additional supply to move in the direction of leveraging that supply to reduce our capex investments.

The growth opportunities again that we see- mobile handsets we do believe will be the #1 engine of growth for the flash industry in the next 5 years or so and we are very very well positioned in that.

Very strong in removable cards and getting stronger by the day in embedded OEM business. I am very very pleased with the progress that we are making there and the design wins that we have seen.

Legacy end markets. That is mostly retail. We are holding our own, but again, focussing very very much on profitability- even if it means sacrificing market share in markets where we don’t see the profits.

On emerging markets we see really two significant opportunities: Slot radio, slot media, slot music are basically physical media for content distribution particularly for handsets. There are billions of handsets out there that really cannot play a CD or a DVD and we think the medium for those is microSD.

SSD of course is a major emerging market. There really we are very strong on the low end, what we call modularized systems, pSSD.

And beginning to address the enterprise with what we call managed NAND.

On the notebook SSD which is the 3G products, I’ve said before, we’re not where we need to be today, however I would say that this market is still very very young and in terms of bottom line implications it should be very minimal. Being late to market at this stage is financially not an issue.

Technically we need to catch up and I believe we will.

And then the IP. We have signed an agreement with Samsung. I am very pleased to have that  in place for the next seven years. I do believe that our IP is very powerful. It has a lot of very significant IP in the area of storage systems/ SSD, security, and of course 3D R/W.

In just the last month or so, the Wall Street Journal published a semiconductor patent scorecard, which is an independent agency. Anyway, we are now #4 among 166 semiconductor companies for overall patent strength and more importantly #1 in industry impact and #1 in research intensity. That is very very good. We are a very good company, these are major semiconductor companies.

And I believe that is because we are very passionate about pursuing NAND to its scaling limits, driving the logical scaling in 3 bits and 4 bits per cell. And of course a very strong investment in 3D Read/Write, advanced controllers, embedded flash and removable card solutions, security and so on.

So we really are relentlessly of course driving this technology

So in summary, the industry demand/supply, I believe, is in better balance today than in any time in the last four years and we are seeing that with the pricing in the market, that allows the return of profitability and for ourselves definitely creating a much more healthy environment for growth for us. I am very pleased with that particularly given the fact that we are still in the midst of a global recession.

Second quarter results clearly indicate a very positive momentum that we are gathering from our very decisive actions in Q4 and in Q1 restructuring ourselves and restructuring the joint venture.

But we really see the very powerful impact of production cutbacks across the industry on returning stability to the industry.

SanDisk is very well positioned I believe in the mobile space. We are getting new designs in the embedded OEMs. Very focused on profitable growth and balance sheet strength through holding pricing where possible, raising pricing, continuing to drive costs down, product costs, operating costs and lower capex.

So we remain cautiously optimistic for the second half of 2009 and I will open it up now for questions.

Q&A

Q: Thanks Eli. I’ll kick it off. Can you help us understand near term fundamentals I know it is difficult .. back to school sales and seasonal second half. But, just in terms of how things are lining up. I’d just like to get a better understanding of what I think of as pretty muted expectations of bit growth in the September quarter. Its not only in terms of your guidance, but most everybody else like Hynix and Samsung, their commentary on bit growth for the September quarter was also muted. Historically the September quarter has been pretty decent in terms of bit growth. This is clearly not 100% bit growth across the course of the year for the industry, but historically it has been somewhere around 25 to 30%. I think you guys are talking about single digits, so what has changed, if anything and what kind of drives that cautiousness. Is there excess inventory out in the distribution channel that drives that cautiousness?

Eli: I think it is really still just the uncertainty as far as the economy and particularly the Q4 holiday sales season. People are very cautious about that. Really if you take a look at Q2. Q2 our bit growth also did not grow the way we expected.

Q: But higher prices.

Eli: That’s right. Still Q2, Moms, grads, mother’s day and so on, also was muted. Definitely in the US. It is very difficult to say if the sales by Q4 is going to have an impact and people are going to go to the store and buy at what we expect. I think that is really the underlying reason for cautiousness.

It is not pessimism. It is really much more on the side of optimism because supply and demand are pretty well balanced with the exception of some inventory that was sold in Q4 at incredibly low prices. Still you can see some of that in the market.

Q: Let me just follow on to that question about pricing..You were obviously pretty disciplined pricing. If you look here at the beginning of the September quarter, you see a lot of prepayment activity… a lot of longer term contracts being struck I guess, Are we in a much better pricing environment in September and how does the prepayment activity, not only from Apple but also from … as well . How does that drive the quarter to quarter improvement in pricing…?

Eli: I think in general demand overall for the industry keeps growing. There is no question about it. Particularly in the mobile environment. So the underlying dynamics is growing demand. Its not taking off- its not exploding, but it is definitely moving in the right direction. And its global.

And it is very very diffused. There are many many industries that absolutely need NAND. The pricing in many cases has reached the point where it doesn’t need to go any lower. It has matched consumer price points. If you lower it any further, you are not going to sell any more. And retailers understand that.

On the supply side there is no question that the supply is limited to what’s in place right now. And the profitability is still not there to warrant going out on a capex spree and building the next fab. I don’t think that that is in the cards anytime in the next several quarters.

I can tell you for ourselves we certainly don’t feel that today the ROI is there to build the next fab. It will take several good quarters of improved corporate profitability beyond what it is today before we would be even thinking about that.

So I think that the environment is stable and very very much moving in the direction of a much more healthy balance than we have seen in 2008.

Q: [Mostly inaudible] Can you talk a little bit about.. SSDs.

Eli: The question is on SSD and where we are in that market and how we see it.

I believe that SSD eventually will be, eventually let’s say 5 years out, will be between a third to a half of the total consumption of NAND flash. NAND or maybe at that time, 3D.

In other words, its going to grow from nothing to a very very substantial part of the market. And as far as technical difficulties, of mastering the performance requirements- endurance and so on – the industry and ourselves will obviously master that.

There is no gotchas, no .. [inaudible] we just have to get it right, we have gotten it right in some parts, but not on other parts.  But where we haven’t gotten it right, we will get it right.

Again its not rocket science. And we do have the know-how in the company. We just need to make sure that we get it right.

So the real issue is the economics of SSD. In the enterprise space, people are prepared to pay for the value, for the performance, the crash resistance, the very high IOPs, the low power and that is why the enterprise space looks very promising.

In both the netbook and the notebook there is this perception that NAND flash has got to match more or less the cost of hard disk drives even though at a lower density. And to achieve that in the next two years or so requires selling SSD at a loss and we are not prepared to do so. SanDisk is not prepared to subsidize that market.

That is because we have other opportunities where we don’t have to do that. We will prioritize those opportunities. Particularly in mobile where we are very very strong. We do see tremendous demand and where we don’t have to compete with the cost structure of HDDs.

There is no HDD that can go into a mobile phone.

For the SSD business to really take off, outside of enterprise. Enterprise as I’ve said is a profitable, but niche market. It will not move a lot of GBs, relatively speaking. Where a lot of GBs are going to move in SSD in the future is going to be in notebooks, desktops, and netbooks.

And there flash memory offers 10X the performance, far lower power dissipation (?), far smaller form factor, very reliable and I believe that once consumers start using it they will not want to go back to disk drives- ever.

But its the chicken and the egg and I believe that consumers will be prepared to pay for the value that they are getting. Today there is this perception that there is no value to SSD other than meeting the price point of hard disk drives. So long as that is the case, I think that we are just going to delay the introduction of the SSD.

Eventually it will happen because it really gives you a very compelling value proposition and the technology cost reduction that we see for SSDs, for flash memory, basically is saying look either you pay us for the value that we bring so we can justify investment in new capacity or you don’t. In which case you are just going to have to wait until the cost reductions get to the point that it becomes profitable.

Q [inaudible]

Eli: Niche does not necessarily mean small. It will be neither small nor unprofitable. But all I’m saying is that it will not need a lot of capacity. It will not move a lot of GBs.

I think that STEC has done a very good job- several years back basically recognizing that market. They have been totally focused on that.

Our focus frankly is on mobile. We are very very focused on mobile. I’m not saying that SSD is not important. But you’ve got to pick your front runners.

SSD will eventually be important enough for us, but today mobile really is where we see the greatest opportunity for us.

Now, the play for us I believe in enterprise is to deliver very high quality NAND flash, managed NAND, and let the STECs of the world and a hundred other players out there that want to explore the play in the enterprise, use our supply- supply of very high quality, very well tested, and very high performance flash memory.

Because frankly anybody that is in the enterprise space that wants to adopt flash will want to have in the supply chain a very good, reliable, captive supply, and there’s not too many of those around.

That’s really the direction we are going. We’re not ignoring the enterprise. But today, clearly we’re not there.

Question [inaudible]

Eli: The question is about back to school and of course we can’t comment in the middle of the quarter. I will say that it is kind of spotty. I mean there are some chains are doing very very well and some that are conversely are not doing well. And that’s in the United States.

In general I would say this is pretty much a global market and overall, things are cautiously optimistic.

Question [inaudible]

Eli: Today, the vast majority of our mobile shipments are in cards. And in cards, the direction is to move from basically regular cards to cards that use the intelligence of the controller to provide launchable applications. The card itself uses its intelligence.

The SDC, service delivery card. We think that that is a highly differentiated card, even though it looks like a microSD.

In the embedded, the main thing now is that the industry is kind of now settling on an embedded format, eMMC 4.3, 4.4, JEDEC and the flash industry has worked on this eMMC.

Our claim to fame if you will in that is that we have been the first to drive for bootability from that device using an MLC flash memory. This is part of the msystems’ legacy. MDOC was a bootable device.

And that is catching on for high capacity. Multi chip packages were used, mobile DRAM, is usually for very low storage capacities, 128 MB, 256 MB and so on. When you are looking at embedded 8GB, 16, 32 GB, eMMC I believe is the right way to go.

The industry is kind of adopting that. And we are doing very well in that, in terms of design wins and I believe it will become a substantial business for us.

Question [inaudible]

Eli: It should be about the same. The GMs should be about the same.

Q: … I think you guys mentioned that the gross margin number [in the long term] you’d like to reach was somewhere around 20%.

Eli: No, 20 to 30%.

Q: OK in the 20% range.

Eli: I’d like to get it higher of course.

Q: You are somewhere around 8% right now. What needs to happen from today through 2010 that could get you there?

Eli: First of all the markets as I said, are growing. We need to have differentiated products, like SDC for example.

Q: Does the market need to grow back at 100% per year?

Eli: No, you need to have good demand/ supply balance. This is very sensitive. I mean the things that drove pricing up by a factor of 100% was a 5% imbalance in favor of demand. The demand was 5% higher than supply. The prices doubled.

Likewise last year there was 5% excess supply and prices plunged. So there really needs to be a good balance between demand and supply.

And we continue our cost reduction. That is the one thing that is under our control and we expect to continue to do well.

However, flash is slowing down and flash cost reductions are not going to continue at the rate that we have seen in the last 3 to 4 years. The last 3 to 4 years cost reductions annually have been 50 to 55% annually. That will slow down quite substantially over the next 3 to 4 years, because of Moore’s Law.

Pricing has got to come down at a much slower rate than what we have experienced in the past for profitability to return and for the margins to approach the 20 to 30% net GMs, not including any kind of inventory reversals or anything of that nature. And I believe that that is possible, because of the inherent growth.

Question [inaudible]

Eli: The ramp of 3 bits is proceeding basically as I said. I think in the second quarter we were at 45% or so of bits shipped- three bits per cell.

Question [inaudible]

Eli: Good question. I’ll give you an idea. We said that for the year, the total number of bits will be around 50%, which means in the second half of the year it has to be higher than the first half.

In principle its all about qualifying customers and making sure that the application, that the performance of three bits fits the application. For the vast majority of the applications, that is the case.

So as far as I am concerned three bits now has become the mainstream technology and cost factor for the 43nm. Now we have to prove that, that’s the same for 32nm.

Question [inaudible]

Eli: Yes, but I don’t frankly know that number. From the 45% to whatever it is [pause].

Question [inaudible]

Eli: We have said that for this year we expect our total bit growth, 2009, to be under 50%. And that is through technology transitions. 43nm and going to three bits per cell. The next technology transition will be 32nm both two and three bits per cell.

Typically in a technology transition like that you can expect between 30 and 50% more bits. You cannot expect 100%. You have to put in place new capacity for new wafers if you want to go above 50%. That’s true not just for SanDisk, its true for any other supplier.

My plan of a week ago was to post today on SanDisk SSDs. The idea was to go over the last 9 months or so of cc’s/ presentations and track SSD discussions.

The first thing I noticed was that one of the punch lines has never been delivered. The mystery technology that was supposed to enable x3 for SSDs when coupled with ExtremeFFS, has never been announced.

CES came and went with nary a peep and no word since. Probably an indication that whatever SanDisk had/has up its sleeve isn’t ready for prime time.

That story line is going to have to wait.

First I was distracted by those interesting SanDisk slides from the 2009 Flash Memory Summit and then the Oppenheimer Communications, Technology & Internet Conference (OPCO) turned out to be surprisingly interesting.

The OPCO audio and slides are available on SanDisk’s Investor’s Relations page. Highly recommended.

I am posting a selective transcription from the Q&A at the bottom of this post. If I have the time, I will finish it off and post on the pages section of this blog, but no promises.

First, I’m behind on responding to comments, so I’m going to throw a couple of those in here.

Comments

hi savo,

one more clue to the SSSS LLC mystery.
“If we were to be in that market, it would be through partnership with other partners that are entrenched in the enterprise space”.
IBM

The SSSS LLC mystery aside, something does seem to be up in the SSD enterprise space.

As you point out from the SNDK Q2 cc:

“Eli Harari: Yeah, we are currently not in that market. And you cannot be in that market kind of like casually. You either are in it or not. So today we’re not in this market, as I said, if we were to be in that market, it would be through partnership with other partners that are entrenched in the enterprise space, not so much in the industrial space. The industrial space, we have been in – msystems has been in, and it’s just too small a market.”

And yes I agree, IBM should be on the short list as a potential enterprise SSD partner.

At OPCO Eli expanded on SanDisk’s emerging enterprise SSD strategy:

“Now, the play for us I believe in enterprise is to deliver very high quality NAND flash, managed NAND, and let the STECs of the world and a hundred other guys out there that want to explore the play in the enterprise, use our supply- supply of very high quality, very well tested, and very high performance flash memory.

Because frankly everybody that is in the enterprise space that wants to adopt flash will want to have in the supply chain a very good, reliable, captive supply, and there’s not too many of those around.

That’s really the direction we are going. We’re not ignoring the enterprise. But today, clearly we’re not there.”

hi,
pls. look at this :

http://www.eetimes.com/showArticle.jhtml;jsessionid=IS5CZKHS3XK2LQE1GHPSKH4ATMY32JVN?articleID=219200467

I find it hard to believe this is what eli said. he must have said something, do you know what it was? It looks like he is warning from the same situation we just experienced – over supply. is this going to happen after all the talking about the huge demand.
thanks.

I think Eli is warning that the return-on-investment (ROI) model  is broken. The massive capex outlays needed for new fabs currently can’t be justified. However this does not necessarily mean the sky is falling.

None of the NAND companies, including SanDisk, have to play this game along the lines of expectations built up over the last few years.

The next few years don’t have to be a replay of the last few.

Reading between the lines, Eli seems to be saying : “The days of our selling NAND below cost are over. We’re not going to subsidize tomorrow’s markets today.”

Kind of like cheap oil, cheap, cheap NAND was a blessing for many, but not for the suppliers. Given today’s market conditions, NAND manufacturers, including SanDisk, finally appear willing to be patient to the point of healthy profitability. We shall see.

Patience will allow cost reduction to work its magic. As Eli said at OPCO:

“Pricing has got to come down at a much slower rate than what we have experienced in the past for profitability to return and for the margins to approach the 20 to 30% net GMs, not including any kind of inventory reversals of that nature. And I believe that that is possible, because of the inherent growth [of end markets].”

A lot of folks hooked on cheap NAND [-50% to -60% ASP/GB decline per year] aren’t going to like this new market reality. But that’s kind of just too bad for them.

Selective OPCO transcript

11 August Oppenheimer
Eli Harari
[ See accompanying slides]

Selective transcript

Q&A

Eli: … On the supply side there is no question that the supply is limited to what’s in place right now. And the profitability is still not there to warrant going out on a Capex spree and building the next fab.  I don’t think that that is in the cards anytime in the next several quarters.

I can tell you for ourselves we certainly don’t feel that today the ROI is there to build the next fab. This will take several good quarters of improved corporate profitability beyond what it is today before we would be even thinking about that.

So I think that the environment is stable and very very much moving in the direction of a much more healthy balance than we have seen in 2008.

****
Q: inaudible:

The question is on SSD and where we are in that market and how we see it.

I believe the SSD eventually will be, eventually let’s say 5 years out, will be between a third to a half of the total consumption of NAND flash. NAND or maybe at that time, 3D.

In other words, its going to grow from nothing to a very very substantial part of the market. And as far as technical difficulties, of mastering the performance requirements- endurance and so on – the industry and us will obviously master that.

There is no gotchas, no .. [inaudible] to get it right, we have gotten it right in some parts, but not on other parts.  But where we haven’t gotten it right, we will get it right.

Again its not rocket science. And we do have the know-how in the company. We just need to make sure that we get it right.

So the real issue is the economics of SSD. In the enterprise space, people are prepared to pay for the value, for the performance, the crash resistance, the very high IOPs, the low power and that is why the enterprise space looks very promising.

In both the netbook and the notebook there is this perception that NAND flash has got to match more or less cost of hard disk drives even though at a lower density. And to achieve that in the next two years or so requires selling SSD at a loss and we are not prepared to do so. SanDisk is not prepared to subsidize that market.

That is because we have other opportunities. We don’t have to do that. We will prioritize those opportunities. Particularly in mobile where we are very very strong. We do see tremendous demand and where we don’t have to compete with the cost structure of HDDs.

There is no HDD that can go into a mobile phone.

For the SSD business to really take off, outside of enterprise. Enterprise as I’ve said is a profitable, but niche market. It will not move a lot of GBs, relatively speaking. Where a lot of GBs are going to move in SSD in the future is going to be in notebooks, desktops, and netbooks.

And there flash memory offers 10X the performance, far lower power dissipation (?), far smaller form factor, very reliable and I believe that once consumers start using it they will not want to go back to disk drives- ever.

But its the chicken and the egg…

Question [inaudible]

Niche does not necessarily mean small. It will be neither small nor unprofitable. But all I’m saying is that it will not need a lot of capacity. It will not move a lot of GBs.

I think that STEC has done a very good job- several years back basically recognizing that market. They have been totally focussed on that.

[29:00] Our focus frankly is on mobile. We are very very focussed on mobile. I’m not saying that SSD is not important. But you’ve got to pick your front runners.

SSD will eventually be important enough for us, but today mobile is where we see the greatest opportunity for us.

Now, the play for us I believe in enterprise is to deliver very high quality NAND flash, managed NAND, and let the STECs of the world and a hundred other guys out there that want to explore the play in the enterprise, use our supply- supply of very high quality, very well tested, and very high performance flash memory.

Because frankly everybody that is in the enterprise space that wants to adopt flash will want to have in the supply chain a very good, reliable, captive supply, and there’s not too many of those around.

That’s really the direction we are going. We’re not ignoring the enterprise. But today, clearly we’re not there.

….

Question [inaudible]

Today, the vast majority of our mobile shipments are in cards. And in cards, the direction is to move from basically regular cards to cards that use the intelligence of the controller to provide launchable applications. The card itself uses its intelligence.

The SDC, service delivery card. it is a highly differentiated card, even though it looks like a microSD.

In the embedded, the main thing now is that the industry is kind of now settling on an embedded format, eMMC 4.3, 4.4, JEDEC and the flash industry has worked on this eMMC.

Our claim to fame if you will in that is that we have been the first to drive for bootability from that device given an MLC flash memory. This is part of the msystems’ legacy. MDOC was a bootable device.

And that is catching on for high capacity. Multi chip packages were used, mobile DRAM, is usually for very low storage capacities, 128 MB, 256 MB and so on. When you are looking at embedded 8GB, 16, 32 GB, eMMC I believe is the right way to go.

The industry is kind of adopting that. And we are doing very well in that, in terms of design wins and I believe it will become a substantial business for us.

****

Q: I think you guys mentioned that the gross margin number [in the long term] you’d like to reach was somewhere around 20%.

Eli: No, 20 to 30%.

Q: OK in the 20% range.

Eli: I’d like to get it higher of course.

Q: You are somewhere around 8% right now. What needs to happen from today through 2010 that would get you there?

Eli: First of all the markets [we are in] are growing. We need to have differentiated products, like SDC for example.

Q: Does the market need to grow 100% per year?

Eli: No you need to have good demand/ supply balance. This is very sensitive. I mean the things that drove pricing up by a factor of 100% was a 5% imbalance in favor of demand. The demand was 5% higher than supply. The prices doubled.

Likewise last year there was 5% excess supply and prices plunged. So there really needs to be a good balance between demand and supply.

And we continue our cost reduction. That is the one thing that is under our control and we expect to continue to do well.

However, flash is slowing down and flash cost reductions are not going to continue at the rate that we have seen in the last 3 to 4 years. The last 3 to 4 year’s cost reductions annually have been 50 to 55% annually. That will slow down quite substantially over the next 3 to 4 years, because of Moore’s Law.

Pricing has got to come down at a much slower rate than what we have experienced in the past for profitability to return and for the margins to approach the 20 to 30% net GMs, not including any kind of inventory reversals of that nature. And I believe that that is possible, because of the inherent growth.

****
[inaudible question]

Eli: We have said that for this year we expect our total bit growth, 2009, to be under 50%. And that is through technology transitions. 43nm and going to three bits per cell. The next technology transition will be 32nm both two and three bits per cell.

Typically in a technology transition you can expect between 30 and 50% more bits. You cannot expect 100%. You have to put in place new capacity for new wafers if you want to go above 50%. That’s true not just for SanDisk, its true for any other supplier.

Q2 played out pretty much along the lines of the best case scenario- with the upside reinforced with one-time income events.

Release of inventory reserves accounted for an $87M benefit.

Licensing revenue of $120M exceeded guidance of $85-$95M. This was purportedly due to higher than expected sales prices of NAND in Q1 at Samsung and Hynix.

Personally I suspect that this licensing revenue also included a one-time boost from Samsung coughing up the $20M nicked last quarter.

In any case, I agree with Lazard that “GM is the real story.” and that the SanDisk “story is back on track.”

I am including excerpts from LCM’s 23 July report below. Dan Amir knows the company well and seems to be well ahead of the pack on the SanDisk story.

I am also including excerpts from Goldman Sachs’ 27 July 2009 report. GS has SanDisk on its mind. Following earnings, SanDisk had significant mentions in three GS reports in five days. I am including the last, in which GS contemplates SanDisk’s valuation through the prism of intellectual property.

Both LCM and GS agree that the biggest near-term threat to the stock price is demand. NAND supply will be up in the 2H of 2009. The outstanding question is whether demand will keep up.

When asked about such demand late this year by Craig Ellis on the cc, Eli pointed to Apple’s recent $500M prepayment agreement with Toshiba for NAND supply. Apparently Apple feels it prudent to lock up supply. Apple’d be whistling a different tune if they felt NAND market was over-supplied.

As Eli said, “So we’ll see.”

In the coming weeks, hopefully, I’ll get to some of the themes touched on in the conference call.

Two of the most interesting are the NAND shrink roadmap and Micron. SSD’s are right in there too- SanDisk’s products and purported SSD IP.

I’ve been on the road recently and otherwise occupied. Now that I’m back home, hopefully I’ll have the time to catch up with comments as well.

****23 July 2009 LCM Excerpts Below ****

July 23, 2009
Lazard Capital Markets
Daniel Amir
Lauren Stoller

SNDK: Moving in the right direction; bumping up our price target to $22 from $20; BUY

2Q results come in strong. SNDK reported a solid quarter with rev/EPS of $730.6M and $0.36, vs. our estimates of $713.9 M/$(0.16) and the Street’s $702.9M/$(0.17). The Q/Q ASP and bit change were +12% and -7%, vs. our estimates of 1% and 5% respectively. Licensing revenue of $120M exceeded guidance of $85-$95M due to higher than expected sales prices of NAND in 1Q.

GM is the real story. Product GM came in at 22%, leaving our 3.4% est. in the dust. Excluding an $87M benefit from the release of inventory reserves the product GM was 7.7%, still quite impressive.  The stronger GM was due to better pricing and lower COGS. The 3Q underlying product GM is expected to be slightly up from 2Q’s 7.7%; including the benefit of net inventory reserves, product GM should be 15%-20%. In 4Q, inventory reserves will have been depleted but underlying product GM should see a significant jump due to migration to 3xnm and 3bit/cell production. We estimate product GM of 17% in 3Q and 12.5% in 4Q.

Guidance somewhat conservative. SNDK’s 3Q guidance is $725-$775M, within range of consensus est. at $765M though softer at the mid range. We believe mgmt took a cautious approach on guidance due to the soft summer demand and lack of visibility. We are modeling -6% ASP/MB and MB shipments up 11%, although we could see upside if Sept. prices tend to be tighter.

The story is back on track. We believe SNDK is back on track to profitability, with a 2H stable NAND mkt, strong yields on 3bit, lower COGS, and lower inventory. Since cashflow was less dilutive at -$24M, we are encouraged that SNDK’s financial structure is improving.

Our estimates. We are revising our estimates to reflect guidance. Our 3Q estimates are now $747.9M/$0.09 vs. $787.4M/$(0.14) previously. Our new 2009 estimates are $2.9B/$(0.08) vs. $3.07B/$(0.97) previously.

Risk and valuation. Our price target of $22 is based on 1.5x 2010E sales. (Our previous target was based on 1.5x 2009E sales.) The primary risk relates to near- term NAND pricing and holiday demand.

INVESTMENT THESIS

We believe that the SanDisk story has turned around and that investors should continue to accumulate shares. We believe that the street continues to underestimate the earnings power, the improving business model and the balanced NAND industry as factors that will result in an improving story. Finally, as SNDK shifts to 3bit, we believe that it will have a cost advantage in the market. We are raising our price target from $20 to $22 which is 1.5x 2010E sales.

INVESTMENT SUMMARY

2Q results come in strong.  SNDK reported a solid quarter with rev/EPS of $730.6M and $0.36, vs. our estimates of $713.9M/$(0.16) and the Street’s $702.9 M/$(0.17). The Q/Q ASP and bit change were +12% and -7%, vs. our estimates of 1% and 5% respectively.  SNDK raised prices in both the retail and OEM channels which led to a decrease in MBs shipped. Capacity utilization exiting the quarter was 100% and should continue to be so for the rest of 3Q.  However, depending on demand, we could see utilization decline in 4Q. Licensing revenue of $120M exceeded guidance of $85-$95M due to higher than expected sales prices for NAND in 1Q at Samsung and Hynix.

GM is the real story. Product GM came in at 22%, leaving our 3.4% est. in the dust. Excluding an $87M benefit from the release of inventory reserves the product GM was 7.7%, still quite impressive.  The stronger GM was due to better pricing and lower COGS.  The 3Q underlying product GM is expected to be slightly up from 2Q’s 7.7%; including the benefit of net inventory reserves product GM should be 15%-20%.  In 4Q, inventory reserves will have been depleted but underlying product GM should see a significant jump due to migration to 3xnm and 3bit/cell production. We estimate product GM of 17% in 3Q and 12.5% in 4Q. We could see better product gross margins in 2010 due to continued migration to 3xnm and 3 and 4bit production; our estimate is somewhat cautious at ~15% product GM for 2010 as we wait to see how we exit
2009.

Guidance somewhat conservative. SNDK’s 3Q revenue guidance is $725- $775M, within the range of the Street’s expectation of $765M.  Overall, we believe that management is being conservative regarding demand expectations over the summer, especially considering shortages in parts of the market. GM should continue to expand in 3Q with costs/MB decreasing and volumes ramping. We are modeling -6% ASP/MB due to the slower seasonal demand and MB shipments to increase 11% in preparation for the holiday season.  The company may need to rely partially on non-captive supply in 3Q. NAND industry remains rational. NAND players are more rationale in their approach to pricing and supply since Feb. We believe this will continue into the
2H.  If demand picks up and Apple comes with additional orders in the fall, we could see a further tightening of the market, which would be favorable for SNDK.

Our estimates. Our 3Q est. are now $747.9M/$0.09 vs. $787.4M/$(0.14) previously. Our new 2009 estimates are $2.9B/$(0.08) vs. $3.07B/$(0.97) previously.  Our FY10 est. are $3.189B/$(0.18). We are taking a cautious approach to 2010 as demand remains unclear for the holiday season. We continue to see SSD as a potential long-term driver for the company; however, our current impression is that the company is not that well positioned with the G3. In addition, the recent up move in pricing pushes out the potential adoption of SSD.

**** 27 July 2009 Goldman Sachs Excerpts Below ****

July 27, 2009
James Covello
Kate Kotlarsky

Buy QCOM and SNDK: market eventually gets royalty streams right

SNDK (Buy): Significant upside to our royalty value of $22/share We believe that SanDisk has one of, if not the most, valuable IP portfolios in the memory industry, which remains significantly undervalued by the market. Today, SanDisk receives royalty payments or has cross licensing agreements with 3 out of 4 NAND flash manufacturers, as well as a number of third party flash card suppliers, and generates 40%-60% of its operating income via its royalty/licensing business. However, we believe the market continues to undervalue the royalty business, which we estimate is worth about $5 bn ($22/share) vs. SanDisk’s market cap of $4 bn ($18/share). We believe that the current market dislocation creates an attractive entry point in the stock and recommend adding to positions.

SanDisk (SNDK, Buy): We see significant upside in the stock given our view that the royalty business is worth $22/share vs. the stock at $18

SanDisk has arguably the best IP portfolio in the memory space. We continue to believe that SanDisk has one of, if not the most, valuable IP portfolios in the memory industry as it relates to multi-level cell (2-4 bit per cell) technology. Additionally, we believe the company has important IP around the next generation memory technology, called 3D, which could create significant upside to the company’s licensing/royalty business over the longer term, if SanDisk is successful at licensing the technology.

While the company has struggled to successfully monetize its IP through its product business (i.e. selling NAND flash cards), it has been, and continues to be successful in generating meaningful revenues and earnings via its license and royalty stream. Of the four NAND manufacturers that compete with SanDisk (Samsung, Hynix, Intel, and Micron), Micron is the only one that is not currently licensed to use SanDisk’s MLC technology. Both Samsung and Hynix pay SanDisk royalties in order to be able to sell their NAND- based products while Toshiba and Intel have a cross licensing agreement with the company. Although SanDisk believes that any company in the business of NAND manufacturing should be paying SanDisk royalties or be licensed to use its technology, Micron has been able to manufacture NAND without a payment to SanDisk thus far.

Our view is that over the last several years, SanDisk has been focused on renegotiating its royalty agreement with Samsung (which expires in August of 2009) and has not been focused on pursuing negotiations with Micron. However, now that the Samsung agreement has been successfully renegotiated, we expect SanDisk to focus more of its efforts on negotiating a form of payment with Micron.

The license/royalty business drives a significant part of SanDisk’s earnings…

Over time license and royalty revenues have accounted for 10%-15% of SanDisk’s total sales. However, the royalty stream has been a much more significant driver of the earnings power for the company, accounting for 40%-60% of SanDisk’s operating income when the company has generated positive earnings and significantly offsetting operating losses when the company has lost money during industry downturns (see Exhibit 7).

…however, the IP remains significantly undervalued by the market. However, despite the company’s strong IP portfolio and the importance of the IP in driving SanDisk’s operating model, we believe the market is significantly undervaluing SanDisk’s royalty business today, which we estimate is worth approximately $5.0 bn (about $22/share) vs. SanDisk’s market cap of $4 bn (about $18/share).

As we showed in Exhibit 2 above (replicated in Exhibit 8 below), the market appears to be ascribing a negative value to SanDisk’s royalty business today as most of the focus has shifted to the losses in the company’s product business. Note that we arrived at the implied negative value for the royalty business by doing the following. Firstly, we applied Micron’s historical EV/Sales multiple to SanDisk’s product business as we view Micron as the closest comp to SanDisk’s product business. We then backed out the product business valuation from the company’s historical enterprise value, to arrive at the implied historical royalty value, which is negative today.

We would highlight that the implied value is negative despite: (1) its significant positive contribution to both SanDisk’s operating income and free cash flow, in contrast to the product business (for both SanDisk and Micron), which is being ascribed a significant value despite generating little/no earnings over the course of a full cycle, and (2) the fact that SanDisk was successful in renegotiating its licensing/royalty agreement with Samsung in May of 2009, which we believe has been an overhang on the stock and the royalty valuation for some time.

Interestingly, our analysis also shows that the last time the implied market value for SanDisk’s royalty business significantly deteriorated and ultimately turned negative was around the last royalty negotiation with Samsung, which took place in August of 2002,  following the burst of the tech bubble in 2000/2001. We believe a similar scenario is materializing today, where the value of the royalty stream has been declining as industry fundamentals have deteriorated, and ultimately turned negative in late 2008 as the expiration of the royalty agreement with Samsung drew closer.

While the value of the royalties can fluctuate slightly with the market, as approximately 2/3 of the royalty stream is tied to Samsung’s revenue trends, we estimate that the royalty value has been in the $5 bn to $7 bn range (about $20-$30 per share) over the last several years versus the severe fluctuations that have been implied by the market. We would also note that SanDisk’s new agreement with Samsung does not include rights to SanDisk’s 3D technology, which if licensed to Samsung in the coming years, would imply significant upside to the current royalty value of $5 bn.

As we mention above, SanDisk’s stock is currently trading approximately 20% below our estimated valuation of the royalty stream, which we believe significantly undervalues the company’s IP portfolio. We expect this valuation discount to correct, as NAND fundamentals recover and SanDisk’s profitability improves, as was the case in 2H05/1H06, and 2007. Similar to Qualcomm, the market valuation of the royalty stream had previously reached, and even exceeded our implied value estimate during industry upturns, and we expect a similar pattern to take place, beginning in 2H09.

Our DCF model values the royalty business at $22/share vs. the stock at $18.

We continue to value SanDisk’s royalty stream at $22/share, as we show in Exhibit 9 below. Our view continues to be that SanDisk derives most of its value from the company’s royalty stream and we ascribe zero value to the company’s product business, which generates little earnings over the course of the cycle. Our valuation methodology for the license/royalty business is as follows:

• Our valuation is based on a DCF model, which forecasts SanDisk’s royalty business out to 2016 (year when the current agreement with Samsung expires) and assigns a terminal value to the royalty business post 2016.

• The terminal value calculation is a perpetuity value. However, while a typical DCF model would assume a certain growth rate in the business into perpetuity, our terminal value for SanDisk’s royalty stream assumes zero growth, and is arguably more conservative.

• The component of the royalty business that is tied to Samsung is based on a royalty rate applied to Samsung’s NAND revenues in any given quarter or year, which we forecast based on our views of bit shipment growth and ASPs. While most of Samsung’s NAND business today is based on MLC (multi level cell technology) vs. SLC (single level cell technology), we have separate royalty rate assumptions for the MLC and SLC business in the model.

Beginning in 4Q09, we have assumed a 50% reduction in the royalty rate Samsung will pay SanDisk, in-line with the recently negotiated agreement. Since SanDisk receives royalty payments from Samsung on a one quarter lag, we assumed a 50% reduction to Samsung’s royalty rate beginning in 2010. However, our estimate for 4Q09 assumes that half of the royalty payments from SanDisk during the quarter will be based on the old rate and half will be based on the new rate, which is consistent with SanDisk’s guidance. [Note that Exhibit 9 below has been cropped for legitability. The original chart goes out to 2014. Starting with 2010 GS estimates IP revenue other than Samsung as flat-lining at $160M through 2014. SNDK should do far better]

We recommend buying the stock, particularly given the recent pull back. We believe that the pull back in the stock last week creates an attractive entry point in the stock and recommend that investors aggressively add to positions. We see about 25% upside to our 12-month price target of $23, which is based on:

(1) An 85% weighting of our fundamental implied value of $22/share, or the implied value/DCF value of SanDisk’s royalty stream.

(1) A 15% weighting of our M&A component for SanDisk (to reflect our view that the company could be an attractive takeout candidate) with a 40% premium to our royalty implied value estimate of $22/share. The premium is roughly in line with the historical premia paid for tech deals since 2001, which have ranged from 30% to 50%, and slightly below the 56% premium offered by Samsung in May 2008 when initial discussions between Samsung and SanDisk took place.

Importantly, our price target for SanDisk assumes zero value for the company’s product business given our view that the product business generates minimal earnings over the course of a cycle. As a result, we assume that the value for the company resides primarily in the company’s license and royalty business vs. the product business.

The key downside risks to our price target include a significant leg down in demand in 2H2009 and inability to monetize its memory IP.

This turned out to be an interesting week after all, even with no news. I had been expecting that we’d coast into earnings under the radar.

For better or worse SanDisk is now back in the limelight. I’m not sure the mainstream media exactly gets the story, but no matter.

I’m still expecting curiously remarkable numbers, thanks to the strength of NAND pricing, inventory and so forth. While this may be something of a one time event, there also appears to be a lot of promising stuff going on behind the scenes.

Soon enough we’ll find out whether SanDisk decides to share on the conference call, or whether analysts ask the right questions. I’m not expecting much. The numbers themselves will likely blind everyone.

In any case, recently I’ve been spinning the wheels on obscure trails.

SiliconSystems

SiliconSystems is no more. The company was acquired by Western Digital Corp (WDC) in March of this year as part and parcel of a WDC’s entry into SSDs.

I stumbled onto the SanDisk/ SiliconSystems angle, while working on SSSS LLC. SiliconSystems had a penchant for referring to its products as “Solid State Storage Solutions” so it showed up in a couple of searches related to SanDisk and that phrase.

The name rang a bell and sure enough after a little more digging I realized why.

Back in 2004 SanDisk and SiliconSystems signed a cross license agreement covering flash patents.

Some think this license agreement will now give WDC open-ended access to SanDisk’s patent portfolio. Highly unlikely. The original press release is clear. The patent license is a limited deal:

“This license agreement is tailored to SiliconSystems’ exclusive focus on the enterprise system OEM market. We are pleased with the agreement and look forward to future business cooperation with SiliconSystems.”

I really have no idea what sort of “business cooperation” could have been contemplated back in 2004. SSSS LLC would be one possibility. More on that later.

SanDisk was one of the early investors in SiliconSystems, probably 2003 or 2004.

SiliconSystems was founded in 2002 by Michael Hajeck, an ex-SanDisk employee. After a three year stopover at STEC, he started up SiliconSystems, initially working out of his home.

Micheal Hajeck is continuing on now as Senior Vice President & General Manager, Solid State Storage Business Unit, Western Digital.

From the beginning SiliconSystems’ focus was exclusively the Enterprise System OEM market- a market that SanDisk essentially abandoned early in 2005 when it discontinued its industrial and standard grade families of industrial products.

SiliconSystems was one of the companies that aggressively moved in to fill the void left by SanDisk.

The strategic retreat made perfect sense for SanDisk with its focus on consumer markets and MLC NAND.

SiliconSystems was happy to stay with SLC, the name of the game for markets where performance and reliability take precedence over cost.  As one would expect, Siliconsystems’ SLC seems to have come primarily from Samsung, which also took a stake in the company.

By 2008 SiliconSystems had reached a respectable #9 in the SSD games.

Interestingly, SanDisk was #3. Not a bad showing considering.

SanDisk’s SSD strategy is MLC/consumer-market centric. A market which is taking its time developing.

On the other hand, the enterprise space has already taken off. SLC’s cost works just fine for those enterprise players with the deep pockets.

For consumer markets, NAND costs need to drop further. We are probably a couple of years, and two technology nodes, away from lift-off.

As an aside- a few more thoughts on SSSS LLC.

Solid State Storage Solutions LLC

I am starting to feel that there is a distinct possibility that (SanDisk’s) SSSS LLC is not the Microsoft/ SanDisk licensing entity.

This doesn’t take anything away from the Microsoft/Sandisk U3+ effort, it just means that the MSFT/SNDK joint effort, if it is still alive, is just something else, with another name we don’t know yet.

The MSFT/SNDK effort is about “a next-generation software and hardware solution to place application programs and personal customization on USB flash drives and flash memory cards.”  Something like “U4”, “StartKey”, or “Window’s Companion” or some such would fit the bill.

The name “SSSS LLC” is all wrong for this endeavor.

“Solid State Storage Solutions” is something of a catch phrase for just that- and seems to be usually used these days to describe SSDs in all their permutations.

The MSFT/SNDK effort was announced publicly. When SSSS LLC was mentioned back in 2007 it was essentially a stealth venture with an unnamed partner. If the partner were MSFT, there would seemingly be no need to keep it quiet.

Then there is the slide from SanDisk’s 2007 Nasdaq 20th Investor Program presentation, that said:

“Solid-State Storage Solutions licensing entity formed: captures third party flash systems IP portfolio.”

It isn’t obvious to me why SNDK/MSFT would need a third party flash systems IP portfolio for software delivered on USB drives and cards. I can rationalize it, but that’s something else entirely.

If SSSS LLC were set up in an attempt to profit from licensing IP for SSDs, it would make perfect sense to try to leverage flash systems IP reinforced by a third party portfolio of such IP.

Following this logic, I’ve asked myself whether SiliconSystems might have been SanDisk’s mystery SSSS LLC partner? Lots of pieces fit.

There were close relations between the two companies. Each company was targeting different, but related markets targeting solid state storage solutions.

The problem is that I’m not confident that SiliconSystems patent portfolio measured up.

In SanDisk’s 12.04.07 Nasdaq 20th Investor Program presentation, Eli described “a partnership with another major owner of system level flash IP, [the partnership is] called Solid State Storage Solutions.”

While SiliconSystems had some patents, it would seem a stretch to refer to them as a “major owner of system level flash IP.”

In any case, it will be interesting to revisit that SSD vendor list over the next several years. In 2008, Samsung STEC and SanDisk accounted for over 56% of the SSD market. Intel at #4 had 6.9% of the market.

In acquiring SiliconSystems WDC bought its way into the top ten, but only picked up 1.7% of the SSD market, and this is in the enterprise space.

In 2011 when the consumer SSD market explodes, its going to be those who can deliver SSD performance at best prices, that will be sitting pretty and in a position to deliver the volumes required. This is going to take MLC systems expertise combined with in-house (or guaranteed) NAND supply.

Samsung, Toshiba and SanDisk look like players. Intel, if they can stand the heat, could ante up.

Maybe I’m missing something, but it looks like the hard disk drive players, the incumbent consumer storage heavyweights, are in for a world of hurt. Picking up bit players like SiliconSystems might buy some time.

The insurmountable hurdle looks to be shaping up as in-house (or guaranteed) NAND supply.

As of 8 June, Apple’s new MacBook Pro 13″ and 15″ models now come equipped with an SD card slot.

I find this very curious and seemingly very out of character and I’m not alone.

How far this goes and what implications there might be for SanDisk and Sandisk’s relationship with Apple remains to be seen. This could be a simple blip on the screen or it could be far more significant.

In any case its all good news for SanDisk.

Not only does SanDisk have the opportunity to sell more cards, but the more SD cards that are sold by virtually all of the competition (except Toshiba and Panasonic), the more money SanDisk collects in licenses and royalties.

The Apple/ SanDisk relationship bears watching. Recently SanDisk’s tone when talking about Apple has softened remarkably. Gone are the days of SanDisk’s “iDon’t” ads.

The new refrain is, “You can’t out-iPod the iPod.”

SanDisk could be making nice, because it could soon have a new customer. In all likelihood, Apple has some new products in its pipeline tailor made for SanDisk’s products, both removable and embedded.

Last, but hardly least, Apple is both a trendsetter and a trend indicator. In those MacBook Pro models where Apple has added an SD card slot, it has dropped ExpressCard.

For the longest time ExpressCard has looked like the future of removable solid-state storage for the consumer notebook/netbook market. The ExpressCard SSD looked positioned to be a game changer in SSD evolution.

With a high speed interface, compact form factor, and a large installed base, ExpressCard SSD seemed a natural.

This was going to be a thorny problem for SanDisk, looking to monetize its IP in the SSD marketplace. ExpressCard is an open standard and hence there would be no royalties flowing to SanDisk from that format.

ExpressCard

ExpressCard’s roots go way back to 1989 and the Personal Computer Memory Card International Association, or PCMCIA. The PCMCIA was, and is, a non-profit trade association dedicated to standardizing modular peripherals and promoting their adoption.

The PCMCIA was founded to standardize and promote PC Card technology.

By 2003, the PC Card was getting long in the tooth and ExpressCard was introduced as its 21st century replacement. This hot-swappable expansion module for PCs and laptops is supported by a coalition of system OEMs, card manufacturers and connector and component manufacturers including Dell, HP, IBM, Intel, Micron (Lexar Media), Microsoft, SCM Microsystems and Texas Instruments.

According to market reports, in 2008, more than 50% of the consumer notebook PCs that shipped had ExpressCard slots. Included in those numbers are all the MacBook Pros.

Now Apple is dropping ExpressCard in its MacBook Pro 13″ and 15″ models in favor of SD cards. Sure SD cards are far smaller and used in tons of consumer gizmos, but is that enough to overcome ExpressCard’s sophistication, installed base and support of industry heavyweights?

Apparently it is.

Apple

When asked directly about the decision making process, Apple’s director of portables, Todd Benjamin, said Apple opted for a SD Card slot because that format has become “really ubiquitous.”

A safe and many layered answer. True too. SD is indeed ubiquitous. Just not in laptops.

SD technology is the de-facto industry standard for solid state removable storage- in consumer electronics. The center of gravity in the computing space has moved to devices smaller than laptops. For these products, the SD Card and its cousin microSD are indeed ubiquitous.

It seems highly likely Apple is working on both a netbook and media tablet for release sometime in the next 12 months.

Not only will these new products probably not have ExpressCard slots, they may not have optical drives either- DVD or otherwise. It seems entirely possible that both will depend on SD cards for removable storage.

In addition Apple has some issues with Blu-ray. I wouldn’t be at all surprised if Apple is looking at SD Cards as both a workaround and a jump ahead.

This post is about SD becoming the potential defacto standard for removable storage in notebooks and netbooks, but I should probably mention the embedded-storage angle and Apple.

To date, at least prior to the iPhone 3GS, there have been no signs of Apple and SanDisk working together, or put another way- to date, there have been no signs of SanDisk winning any embedded design-ins with Apple.

To my mind, this is not a question of if, but rather a question of when. SanDisk’s strengths are in solid-state devices for consumer electronics. Apple is becoming ever more the consumer electronics’ company- where embedded solid-state storage is the name of the game.

Toshiba and SanDisk are NAND fab partners. Toshiba has NAND wins with Apple. SanDisk doesn’t sell chips per se to others, but as chips are stacked and packaged as devices in their own right, the line blurs.

As this recent teardown from techonline reveals, Toshiba’s latest win with Apple is for a 16 GB device in the iPhone 3GS.

In the video, the folks at techonline note that this Toshiba device, with four 32 Gbit dies tied together, is the “largest single IC memory device that we have ever seen.”

Then as they get into the chip package itself, the image below flashes onscreen.

Does the fact that the SanDisk name appears in an Apple product mean that SanDisk is selling product to Apple? Not necessarily.

But in this case, it does mean that SanDisk’s chips have been qualified at Apple.  And it would follow that SanDisk could be selling embedded storage to Apple if it wanted to.

So far Apple has resisted adding removable storage to the iPhone. To my mind, its only a matter of time, and economics, until Apple gives in. If and when Apple does- the winner looks to be a member of the SD family.

In any case, as far as removable storage goes, it appears that the pendulum’s swinging SD card’s way in the notebook (netbook) arena.  SanDisk looks to be sitting pretty- as market leader and locked in to collect royalties on every SD card sold (except from Toshiba and Panasonic).

As Eli and Sanjay said in SanDisk’s 21st birthday email, “The SD and microSD that we invented have now become the primary global card formats. Tenacity, patience and the right strategy triumphed.”

So what’s a global standard worth in licenses and royalties? As I posted recently SanDisk is likely collecting something on the order of $60M a year, at least as of 2008. How high this could go, is anyone’s guess- but the direction is up and this up could go far.

Curiously sometimes you don’t always have to chase the market. ExpressCard (potentially) losing out to SD is a case in point.

The mountain can come to Mohammed.

Of course, such a pleasant scenario is far from a foregone conclusion, but the SD trend, seems to be SanDisk’s friend.

Today a friend passed along a second hand email from Eli and Sanjay to SanDisk employees- see below.  No secrets, but some interesting reflections on SanDisk’s positioning in the card business with SD.

I have a post about 95% written on Apple and SD cards, which I’ll post this Sunday. Hopefully soon thereafter I’ll have the time to expand on SD and microSD. The story continues to go unappreciated, yet holds much promise.

My friend thought it would be just fine for me to post this email, so here it is:

To the SanDisk team!

We have just celebrated SanDisk’s 21st birthday, so we we should pause for a moment and reflect on a few recent developments in our business that went somewhat unnoticed, yet are quite profound.

1. Two weeks ago Apple launched their new Mac Book notebook PC’s with for the first time SD card slots. Their decision is an acknowledgement that more people around the world capture their precious memories and family photos and video clips on the SD format than on any other format.

2. Fuji Film and Olympus recently introduced their new lineups of  digital cameras. Virtually all of these models now support both XD card as well as SD or microSD. Some models altogether eliminate the XD card slot in favor of SD or microSD cards. This ends a 10 years format battle. Fuji and Olympus wanted to have a proprietary format that would allow them to capture higher margins. The market decided otherwise; the XD proprietary card was way more expensive than SD cards, and this limited its attractiveness to consumers. Lack of open competition limited XD maximum capacity to 2GB, compared to 32GB for SD cards.

The SD and microSD that we invented have now become the primary global card formats. Tenacity, patience and the right strategy triumphed.

3. Yesterday Kodak announced that they are discontinuing their famous KodakChrome film. When we started developing flash digital film cards no one took us seriously. It was difficult for camera makers to see how a 2MB Flash card selling for $100 would ever compete with a $3.99 roll of film that had been perfected over nearly 100 years. There was no infrastructure to support digital film, no easy way to make quality prints, and numerous other obstacles. Despite all our detractors we never lost faith. We followed our convictions and never doubted our technology roadmap, our passion for performance and innovation, our relentless pursuit of cost reductions, and our belief in open standard formats and market competition.

4. Walk into any BestBuy store: More than half their digital camcorders now use flash storage. Almost all their portable GPS units use Flash. Several of their latest netbook models use flash SSD. Notebook PC’s will soon follow. Of course, virtually all MP3 players have adopted Flash.

5. Almost 1 billion handsets today have a slot for the microSD card that we invented. More and more smart phones employ between 8GB and 32GB of flash storage, and this trend is expected to grow with a multitude of third party apps stores offered with the iPhone, Rim, and other competitors.

We can all be proud of our achievements in the past 21 years. We have stayed true to our core values- integrity, courage to pursue bold visions, passion and teamwork.

We achieved together more than any of us dared to dream. Yet, we believe that SanDisk’s best days are still ahead.

May the Force be with SanDisk!

Thank you
Eli and Sanjay