Q4 came in at $0.69 EPS (non-GAAP) on $1.246 billion in revenues, exceeding consensus estimates — once again. Although this part of the earnings’ report was somewhat mixed, it was basically good news.
The same can’t be said for guidance. SanDisk guided to the low end, or below, already lowered expectations, for both Q1 and 2008.
In general, it appears that softness in consumer demand coupled with expected aggressive first quarter NAND price declines will more than offset SanDisk’s strengths in mobile and international markets. SanDisk’s continuing success in fab ramps will help, but only some.
Not reassuringly, SanDisk pointed out the similarities between Q1 2008 and Q1 2007. Then, as now, apparently a least one component manufacturer decided to dump inventory and in the process destroyed pricing.
Guidance for 2008 as a whole is down, but not on the order of Q1’s misery.
One of the interesting twists to the 2008 guidance is an implied strong second half. For example in its 29 January, 2008 report following earnings, Bear Stearns lowered Q1:08 from $0.38 to $0.28; lowered Q2 from $0.35 to $0.21; raised Q3 from $0.50 to $0.55; and raised Q4 from $0.85 to $0.91. Net 2008 is now $1.96 down from $2.08. 2009 is estimated at $2.39. (Non-GAAP).
Although Citi lowered its estimates across the board, the numbers themselves follow a similar pattern (29 January 2008 report.) Citi lowered Q1:08 from $0.40 to $0.29; lowered Q2 from $0.49 to $0.29; lowered Q3 from $0.71 to $0.46; and lowered Q4 from $1.16 to $0.85. Net 2008 is now $1.90 down from $2.76. 2009 is estimated at $2.24. (Non-GAAP).
Although SanDisk refused to elaborate in the call, it appears that SanDisk expects fundamentals to improve in the second half of the year as the market moves to a better balance between NAND supply and demand.
Competitor’s supply cutbacks, including wafer cuts, capex cuts and 200mm shut down will likely play their part. It is not clear if a new catalyst (or two) for SanDisk is also in the pipeline.
In any case, SanDisk isn’t cutting back on the wafer front. No need. In fact SanDisk doesn’t expect to be able to keep up with product demand, without NAND supply from others. This appears to be primarily a second half story. Purchases of non-captive NAND will likely account for 5-10% of supply for the year, as SanDisk growth outpaces industry-wide bit growth in 2008.
One 2008/2009 story that I am watching closely is 43nm. This could prove to be an important milestone for SanDisk. It will mark the arrival of multi-bit technologies beyond 2 bits per cell and it should be the technology node which enables affordable viable MLC SSDs.
Next up is 3GSM on 11 February and this year’s SanDisk analyst day on 25 February.
I have included excerpts from recent analyst reports at the bottom of this post and a Q4 conference call transcript in the “Pages” sidebar.
Q4 and Full Year 2007
As expected, in Q4 international sales were strong and mobile was the number one revenue contributer.
International accounted for 56% of Q4 retail sales. SanDisk expects international growth in 2008 to outpace the U.S. growth with Asia/Pacific getting an extra boost from the Summer Olympics.
On a year-over-year (YoY) basis, Q4 U.S. retail revenue was down 13% and international retail revenue was up 32%. SanDisk’s weakness in the U.S. market appears to be more a case of overall slower Q4 holiday sales than loss of market share.
Mobile was SanDisk’s largest revenue generator by end market both for Q4 and for 2007 as a whole. For 2007, mobile accounted for 35% of total revenue. Mobile product unit sales more than doubled YoY led by continued strength in microSD cards in the retail and OEM channels.
Sales of imaging cards grew nicely in 2007, in part due to resurgence in the digital camera market. Unit sales of high-performance Extreme and Ultra cards targeting the image market doubled YoY. Sales of iNAND, SanDisk’s embedded flash product line, grew significantly in the fourth quarter as SanDisk made substantial gains in mobile and the portable navigation device market.
Sales of Sansa Clip MP3 players were strong during the holiday season. Interestingly SanDisk explicitly pointed to its sub-$100 product strategy for audio/video.
SanDisk reiterated the importance of its new Shanghai assembly and test factory for microSD and Memory Stick Micro cards. SanDisk was able to reach industry-leading capacities thanks to its nine die stack assembly technology.
In Q4 SanDisk repurchased $202M in stock completing its $300M buyback program. Citi thinks a new program is unlikely (near-term) given CapEx commitments and the cost of its operating lease in Japan. Personally I like the idea of a share buyback program to offset option dilution. I hope SanDisk puts another program in place.
SanDisk’s Q4 OEM revenue grew 26% sequentially to $391 million, driven by microSD and iNand products sold to mobile handset vendors. SanDisk also saw nice sequential growth in the GPS market, and in the industrial market.
L&R came in at a record $128 million. Up 51% YoY and 8% sequentially. For the full year of 2007, L&R revenue reached $450 million which was 12% of total revenue, increasing from 10% of revenue in 2006 largely due to the addition of Hynix as a new licensee.
Non-GAAP Q4 product gross margin (GM) came in at 29.7% at the high end of SanDisk’s 27-30% guidance.
As expected, non-captive NAND supply was an issue in Q4. SanDisk was supply constrained during the first half of Q4, but was able to secure the additional non-captive supply in the second half of the quarter.
Although SanDisk wouldn’t admit it, there seems to have been a self-conscious decision not to sacrifice GMs over an incremental increase in revenues. Product GMs at 29.7% were one of the bright spots in Q4. Even for Q1, if SanDisk can keep to its guidance of 23 to 26% this is still much better than the teens that some are fearing.
Curiously this Q4 conference call reminded me of Eli’s January CES presentation. Ordinary, vanilla, unexciting, and unexceptional, are all adjectives that come to mind.
Paul Coster from J.P. Morgan had his finger on the pulse of the conference call when he asked whether maybe NAND-based memory had “just kind of run out of steam.”
Clearly this is not the case. Solid state memory is key for the next generation of computing and consumer devices. The story doesn’t lack for color. So why did we get what felt like the same oft-told story on this conference call?
My guess is that there are inter-related explanations. First, SanDisk probably has things to say, but chose not to use this forum. Sometimes its better and necessary to wait on announcements. In addition, Analyst Day is only weeks away. Sometimes a story plays better when told in its entirety.
Another explanation is that quite likely the same old story is the story. In a nutshell, I think 43nm is a huge deal for SanDisk and for the rest of the NAND industry (4xnm). When SanDisk tells us that all is going well with the 56nm to 43nm transition, this simple story has a lot of ramifications. All positive for SanDisk.
The baseline is that the first to make the transition in volume to 43nm are going to have significant cost advantages over the competition. SanDisk/Toshiba look like winners. Immersion lithography seems like the key to 4xnm. As Eli described in the conference call, SanDisk/Toshiba decided to move to immersion lithography at the 56nm technology whereas the competition stuck with dry lithography. SanDisk/Toshiba has the edge in high volume experience.
Probably even more significant is that 43nm is where SanDisk has decided to ramp multi-bit technologies beyond traditional 2 bit MLC (x2). SanDisk has announced that x3 will be introduced in volume at 43nm and that x4 will also be introduced at this node.
Another SanDisk 43nm angle is the arrival of the 32Gb chip, for both regular MLC and x3. 32 Gb x3 and MLC 43nm chips will likely arrive later in 2008 after SanDisk has experience with both on 16Gb chips. If I’m reading the slide below from 2007 analyst day correctly, in the next two years, a 64Gb x4 chip at 43nm is on track to arrive at the end of the year. Even if these are just samples or they slip to early 2009, heads will turn.
It will be interesting to see the competition’s response. Would not be at all surprised if multi-bit technologies beyond x2 end up a key in the SanDisk/Samsung royalty agreement negotiations. In any case, I expect that Samsung will renew its license in 2009, but at lower rates than Samsung’s current IP license calls for.
In addition, from what I can tell, 200mm isn’t worth the effort at 4xnm and the DRAM to NAND capacity conversions are impractical for the 4xnm NAND technology generation. These issues aren’t relevant for SanDisk, but certainly are for the rest of the players.
Also it looks like the first significant skirmishes in the SSD wars will be fought at 43nm. In the Q4 cc SanDisk confirmed that its MLC SSDs will be arriving with 43nm MLC. MLC SSDs are expected to sample late in 2008.
In a most revealing aside during the Q&A Eli said that SanDisk wouldn’t do anything to “aggravate the component situation out there.” What wasn’t said is that SanDisk/Toshiba has already taken a big chunk of NAND market share. See the IDC (November 2007) graphic below.
**** Analyst report excerpts below ****
29 January 2008
Craig A Ellis
Buy/High Risk 1H
Price (28 Jan 08) US$25.89
Target price US$46.00
Expected share price return 77.7%
Expected dividend yield 0.0%
Expected total return 77.7%
Market Cap US$5,931M
SanDisk Corp (SNDK)
Margin Upside Adds Leverage Ahead Of An Eventual Upturn
Stock Strategy — Our bullish call on SNDK share has been the wrong one in the past four months. However, surprisingly robust 2H07 gross margins augur well for EPS revisions ahead if fundamentals firm as seasonal demand strength and supply headwinds converge in 2Q08 as we expect. US demand risks persist, though trough P/E multiples discount 2008 EPS power 10% below our just-lowered estimates, suggesting the stock may now be overshooting on the downside. Target to $46 from $57 for 89% ETR (aftermarket).
Results and 1Q08 Outlook Reveal US Demand Weakness But GM Positives – Clean EPS of $0.72 was $0.07 above the Street helped by pricing (-11% qq vs CIR -20%) and product GM (+330 bps to 29.7%, CIR 28.6%) while 37% bit growth disappointed (CIR 60%, guide 45-60%) on tight supply and US demand weakness. US weakness caps guidance at $775M-$875M in rev (misses Street’s $1.0B) but 23-26% product GM’s are well above high-teens fears.
While 2008’s Rev Growth And Margin Outlook Is At Low End Of Target Model – SNDK expects 15-25% rev growth, 24-28% product gross margins and 13-16% operating margins. The guidance range falls at the low end of the long-term rev growth and GM and OM outlook, unsurprising given US weakness (~33% of sls). Heightening the risk of a downward reset at the 2/25 analyst day, the variance seems significantly explained by visible US recession risks.
Estimates Move Toward Worst Case – CIR 2008E and 2009E EPS decrease 31% and 33% to $1.90/$2.24 (stock -40% and -22% in 4Q07 and 1Q08TD), with the Street likely settling near our estimates at the low to mid point of SNDK’s guidance range.
Sell-Off Looking Overdone, Time To Revisit
SNDK shares trade with NAND flash contract pricing (0.6 r-squared), given the direct relationship to SNDK’s royalty and product revenues. Our industry view has been that 2008’s unusually significant manufacturing supply headwinds (200mm decommissioning (Figure 3) and 40nm node shrinks (all players)) coupled with handset, imaging, video and PC (USB and SSD) demand drivers would bring supply and demand into balance in 1H08, a positive for contract pricing. Against this backdrop we have and continue to view SNDK as well positioned for revenue growth and margin improvement given a strong manufacturing cost position (300mm mix, strong mfg transitions in 2005- 2007), ramping global product market share, and a growing and diversifying royalty revenue stream (albeit with mid-2009 Samsung renewal risks).
On a P/E multiple basis, the 2003-2007 F12M trough is 13.7x (Figure 2), suggesting the $24.5 aftermarket price is discounting 2008 earnings power of $1.78, a level 9.6% below our new estimates. Viewed differently, the shares have pulled back 56% from 4Q07 highs, discounting 81% of the 2001 decline (Figure 1) when F12M EPS fell to -0.67 from $0.63. Such stock action looks extreme in our view, in particular with time increasingly on SNDK’s side as 2Q08’s US seasonal strength approaches and as OEM new product plans for 2H08 invite buyers back to merchant manufacturers at cash cost pricing. We conclude it makes sense to start building positions, adding intensity into 2Q08 as supply chain data points affirm tightening fundamentals.
Below we recap positives and negatives from the quarter and outlook and set forth our 1Q08 and 2008 modeling assumptions.
4Q07/1Q08 Result and Outlook Positives
Product gross margins grew 340 bps q/q to 29.7% on mix (high-end cards), the 56nm ramp (~67% of mix), and benign pricing (-11% q/q)
OEM revenues of $391M grew 26% q/q (above 21.7% q/q total product revenue) on strength in microSD, mobile handset, and GPS.
EMEA cards and USB drives market share grew 400 bps y/y in November
Mobile unit sales accounts for 35% of total revenue, doubled y/y.
Inventory DOI to 57 days from 74 days in 3Q07 and the lowest level in days since 4Q04.
Repurchased $202M in stock (~4.5M shares or 2% of shares out) and completed $300M repurchased program, though new program is unlikely given CapEx commitments and cost of operating lease in Japan.
2007 operating margins of 13% exceed company’s 2007E guide of 0% to 10%.
Gross Margin guided to 23-26% (down 375 to 675 bps q/q versus CIR’s -615 bps to 22.5%) on 56nm mix and lower Fab 4 startup cost ($30M in 4Q).
Full-year 2008 operating margin outlook of 13-16% implies a doubling through the year from ~9% to ~18%, helped by expense controls (hiring). 43nm ramp (in 2Q08) is said to be on-track given ‘significantly’ more experience (transitioned to immersion litho in 56nm).
4Q07/1Q08 Result and Outlook Negatives
4Q07 total revenues of $1246M (20.1% q/q) missed CIR/Street’s $1,315M/$1,267M (license revenues of $128M missed our $139M).
Bit growth of 37% was below guidance of 45-60% (CIR 60%) on weak US consumer spending and captive supply constraints.
OpEx grew $39M to 19% of sales, 100 bps above CIR’s 18% estimates on higher SG&A (seasonal ads and merchandising).
1Q08 total revenues guided to $775-875M (-38% to -30% q/q) below CIR/Street’s -27%/20% q/q, reflecting uncertain demand and more aggressive pricing.
1Q08 operating expense of $215 to $220M (25% qq) is above CIR’s $204M.
1Q08 Implied PF EPS of $0.22 to $0.35 below CIR/Street’s $0.40 and $0.42. While the US recession warrants a new degree of management caution, the 2008 margin and revenue guidance is nonetheless at the mid-to-low end of the company’s long term target financial model.
1Q08 Financial Projections
We project total revenues of $827.4M and pro forma EPS of $0.29, estimating $127.1M in royalty revenues and $700.3M in product revenues (Figure 5).
Detailed product modeling includes -13% bit growth (inline with seasonal declines) and 28% price/mb declines. See Figures 6,7 for quarterly product revenue, bit growth, and revenue growth expectations.
While our bit growth estimate (-13%) is near seasonal norms (-10%), the supply-constrained 4Q07 compare is an easy baseline, seemingly embedding a degree of conservatism in our outlook.
On royalties, we model $127M. Every 5% change in contract prices impacts quarterly EPS by $0.02 and annual EPS by $0.075.
We model gross and operating margins down 574 bps q/q to 24.0% and 844 bps to 9.5%, respectively versus 1,400 and 1,500 bps declines in 1Q07 (1Q07 suffered from both a weaker inventory and cost reduction position).
First Call consensus estimates are $1.001B in revenues and $0.42 in EPS, and embed blended gross margins of 33.36% (vs CIR’s new 35.7%). On sensitivities, every 5% change in product revenues impacts quarterly EPS by $0.04, while every 1% change in product gross margins impacts quarterly EPS by $0.02.
2008 Financial Projections
On a full-year basis CIR projects revenues of $4.385B (up 12.5% and below 15-25% guidance) on royalty revenues of $502.7M (up 11.7%) and product revenues of $3.882B (up 12.7%). We model pro forma EPS of $1.90. Product modeling details include 176% bit growth (vs. 207% 3-year averages) and 59% price/mb declines (in line with 3-year averages) (Figure 10).
Our royalty estimates incorporate 125% Samsung bit growth and a 55% price/MB decline with declines each quarter. However, clear precedent exists for increased contract pricing even absent the tough supply challenges facing industry in C2008 For example, from February to September 2007 contract pricing rose 70%+ while in 2006, 4G prices increased 14% over 2 months).
Our royalty estimates exclude revenue from the 25 card/drive companies with which SNDK has brought legal action in the past few months (favorable early settlements with RiTek and PNY Technologies suggest material royalty revenues are possible in 2H08). We estimate annual royalty potential at $40M+ if all are signed.
We do not expect a refresh of the SanDisk/Samsung royalty agreement near- term, which is up for renewal in mid-2009, though we expect SanDisk to address this issue at its February analyst day along with a general discussion on royalties/licensing.
Product-specific revenue expectations are set forth in Figures 8. We expect SSD’s to emerge in 2H08, though primary revenue drivers are handset and imaging cards, as well as USB drives and MP3’s. Take-TV and any related content licensing is not yet incorporated in our model, though could emerge in 2H08.
We model product gross margins of 27% (up 190 bps yoy and 100 bps above the target mid-point) and operating margins of 13.5% (up 49 bps yy and at the low-end of the target range, but with steady improvement through the year (Figure 8)).
Fieldwork points to more gross margin tailwinds than headwinds. Positives are lean retail inventories entering 1Q08, consolidating European market share (from mid 20s to mid 30s), a favorable 300mm mix positions vs Samsung and Hynix, a 43nm node transition on track for mid-2008 and 3 bit per cell launch and commercialization in late 2008 and early 2009, respectively. Partial offsets are Fab 4 ramp up costs and increased second sourcing to 5-10%.
At its 2007 Analyst Day, SanDisk set forth a long term (2008/9) target model
with YoY revenue growth of 25-40%, product gross margins of 24-32%, and
operating margin 15-20% respectively (Figure 8). CIR estimates are below
the mid-point of all SNDK targets excluding operating margin targets.
28 January 2008
6 month price target $38.00
NAND S/D and royalty renegotiation will be key for the stock in ‘08
SanDisk (Buy) reported Q4’07 sales of $1,246mn (+20% qoq), slightly below our $1,270mn (+22% qoq) estimate. We estimate that 4Q’07 proforma EPS was $0.59, $0.04 above our $0.55 estimate (including ESOs) and ~$0.05 above the Street (including ESOs). EPS upside vs. our estimate was driven by a higher than expected gross margin and lower taxes. Bit shipments were +37% qoq, while ASPs were -11% qoq. Q4’07 guidance [probably means Q1 2008] is significantly below the Street, driven by weak bit growth and weak ASP expectations. We are reducing our estimates on lower margins and lower interest income: CY08E to $1.55 from $1.85 and CY09E to $2.40 from $2.65.
We maintain our relative Buy rating as SNDK represents a good long term investment opportunity. In our view, shorter term investors need to wait for a better entry point, which could occur when: (1) we have visibility of NAND supply/demand improving, with Samsung and/or Hynix significantly reducing their 2008 NAND capex budgets. And/Or (2) SanDisk renegotiates its royalty contract with Samsung, which expires in 2009. Remember that all of SanDisk’s current profitability comes from its royalty revenues, as its product business is losing money. Samsung accounts for the vast majority of SanDisk’s royalties, and we view SanDisk’s ability to retain Samsung as a licensee as critical for the stock in 2008. While we expect Samsung to remain a royalty payer in order to gain access to SanDisk’s X3 and X4 technology, investors remain skeptical about SanDisk retaining Samsung. As a result, the resolution of the royalty negotiation would remove a significant overhang from the stock and act as a positive catalyst.
We maintain our 6-month price target at $38 (based on a $24 value of the royalty stream, $7 in net cash/share and $7 for the product business).
Key risk to our price target is losing Samsung as a licensee. SanDisk Corporation (L) S&P 500 (R)
[GS dropped its 2008E from $1.85 to $1.55 and its 2009E from $2.65 to $2.40. 2010E was added at $2.75]
29 January, 2008
Target Price YE ’08 $45.00
Long-Term Growth 14.5%
Navigating Through Oversupply And Macro Demand Concerns
SanDisk reported 4Q non-GAAP EPS of $0.69, above our estimate and consensus of $0.64. Revenues of $1.25B were slightly below our estimate of $1.32B, but this was more than offset by better than expected PGM (driven by better ASP), and lower than expected operating expenses.
While SanDisk management expects the pricing environment in early 2008 to be similar to what we saw in early 2007 given the current oversupply, they expect the market to move into balance as we move through 2008, as industry supply growth should moderate given a more disciplined stance by manufacturers with regards to capex plans. SanDisk anticipates demand from their customers in 2H08 to outstrip their captive supply, and as a result plan to increase their non-captive purchases. SanDisk’s comments support our view that 2H08 fundamentals should improve relative to 2H07.
We are adjusting our 2008 non-GAAP EPS from $2.08 to $1.96, as a result of our 2008 bit growth estimate being lowered from 194% to 180% YoY as well as lower royalty revenues. While we are modeling for ASP to decline 58% YoY, we expect SanDisk to see another strong year of cost reductions which should offset our estimated price declines. SanDisk should also continue to gain share internationally in 2008, allowing it to outpace industry-wide bit growth. We are introducing our 2009 non-GAAP EPS at $2.39.
We believe SanDisk’s current stock price level presents a good opportunity for investors to accumulate the shares, as upside potential significantly outweighs downside risk. Though we expect supply-demand dynamics to remain challenging in the near-term, we believe at these levels, the stock is currently pricing in an overly pessimistic view with regards to the NAND outlook for 2008. We believe the NAND market should be balanced in 2H08, and that a bottoming in spot pricing in late 1Q08 or early 2Q08 should serve as a catalyst for the stock.
Lowering price target to $45 from $50 for YE ’08.
[BS lowered Q1:08 from $0.38 to $0.28; lowered Q2 from $0.35 to $0.21; raised Q3 from $0.50 to $0.55; and raised Q4 from $0.85 to $0.91. Net 2008 now $1.96 down from $2.08. 2009 is estimated at $2.39]