Q3 2009 Wrap

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.

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2 Responses to Q3 2009 Wrap

  1. Poofypuppy says:

    Thanks, Savo. SanDisk’s share price has done very well since the earnings release/call.

    Regarding Deutshe Bank’s comment “SNDK faces risks on multiple fronts… 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…”, I do believe you covered these back in June in your ‘Monetizing IP- Updated’ post. Maybe the DB analysts should read your blogs first before they publish their reports. 🙂

  2. Hapa says:

    Greetings, Savo.

    I figure you’re taking a little break from Sandisk. So, I would like to share this link with you. I see some relevance to what Sanshiba is doing.

    http://www.economist.com/displayStory.cfm?story_id=14793432&source=hptextfeature

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