This post started as a Q1 2010 Wrap. After a bit of reflection I decided just to focus on OEM, “the star of the quarter” as Eli put it.

Given the recent market meltdown, SanDisk’s OEM success is all the more relevant.

Far better to be strong in the remarkably resilient OEM smart phone market, than weak in the soft retail market.

As SanDisk’s last 10Q put it:

“ OEM revenue in the three months ended April 4, 2010 grew 158% compared to the three months ended March 29, 2009, due to increased sales of cards, embedded solutions, non-branded products, wafers and components, primarily to the mobile market and to new channels that we added in the second half of fiscal 2009…  We expect OEM revenue to continue to grow faster than retail revenue and to represent more than half of our revenues in fiscal year 2010.”

Also far better to be thriving in the Asia-Pacific market, than stagnating in the US or Europe.

For Q1, SanDisk’s geographical product revenues:

United States:                                    16.7%
Europe, Middle East and Africa:            16.3%
Asia-Pacific:                                        64.7%

Q1 2010

Q1 was a blow-out. Street estimates were $928M and $0.58. SanDisk delivered $1087M and $0.95, thanks in large part to strength in OEM sales to mobile customers.

OEM sales generated 63% of revenues, up from 50% last quarter. OEM sales in Q1 were a stabilizing factor compensating for the first quarter seasonality in SanDisk’s retail business.

Most interestingly, according to Eli, this roughly 2/3 OEM and 1/3 retail split appears to be here to stay- at least for a while.

Gross margins (GMs) were remarkably strong. SanDisk’s Q1 non-GAAP total gross margin was 46.5% and non-GAAP product gross margin was 41.5%.

GMs benefited from a stable pricing environment and also from strong OEM sales that resulted in recognizing significant 32 nanometer, 3-bit per cell production in first quarter results.

Strategic Shift

To use Sanjay’s words from this year’s Investor Day (ID), 2009 was a transformational year for SanDisk. SanJay used the slide below to illustrate the point.

In 2008 SanDisk was a retail products company. Retail accounted for 64% of the product business while OEM was 36%. By the end of 2009, this had changed- Retail was down to 50% and OEM was up to 50%.

Now at the end of Q1 2010, OEM accounted for almost 2/3 of product revenues. SanDisk has become an OEM products company.

A strategic shift indeed. Its not like retail is dead, it grew YoY. OEM is just busting out of its britches.

Q1 2010 was SanDisk’s first billion dollar March quarter, thanks to OEM.

OEM Revenue Mix

The slide below is another most informative slide from SanDisk’s 2010 Investor Day. Yoram Cedar, Executive VP of OEM and Corporate Engineering, used it as a lead-in to his presentation on SanDisk’s OEM business.

SanDisk divides its OEM business into five product segments. These segments with revenue mix for 2009: Mobile Handset Vendors 52%, Mobile Network Operators 18%, Private Label Cards and Components 13%, Imaging and Gaming 12% and Computing 5%.

A few of things jump out.

Mobile is really really big- especially considering that the top two segments are really both mobile. Another way of putting this is that Mobile accounted for 70% of SanDisk’s OEM revenues in 2009.

Remarkably Private Label Cards & Components accounted for 13% of SanDisk’s OEM revenues in 2009. It generated more revenue than SanDisk’s legacy business of Imaging and Gaming. This business segment, Private Label Cards & Components, didn’t even exist in 2008. Listening to SanDisk describe this segment its hard not to conclude that this is all about China.

Computing, at 5% of revenues, is the sleeping SSD giant- the next looming mega-market after Mobile.

Adaptive Flash Management (AFM)

SanDisk’s success in OEM can be attributed to strength in Mobile. While cards are great, the strongest Mobile growth has been in OEM embedded. To hear SanDisk tell it, this strength in embedded can be directly attributed to Adaptive Flash Management (AFM).

AFM deserves its own post and hopefully I’ll get to it in the not too distant future. Basically AFM is a term SanDisk is now using to describe its flash system expertise.

The slide below, also from this year’s Investor Day, illustrates how AFM is able to transform raw NAND’s poor performance to meet target OEM application specifications.

Basically, on one flash die SanDisk can manage different areas differently and can do it dynamically in real time, based on what is happening in the handset, in the OS and in the chip set.

For example using X3 NAND with lowest cost per bit, thanks to AFM, SanDisk says it can bring X3’s poor random read/write, sequential read/write, endurance and data retention up to target OEM specifications for embedded applications.

One portion of the X3 die can be configured to perform as SLC- meeting code endurance requirements, another as a scratch pad for smart caching- improving endurance and Random R/W requirements. Issues with sequential R/W are addressed with a high performance mode.

Today SanDisk is one of the top three suppliers of OEM flash. To hear SanDisk tell it, this is only the beginning of its OEM success. How far this could go is anyone’s guess.

Mobile is shaping up to the monster most of us hoped for. SSDs look to be the next great thing. SanDisk looks nicely positioned to ride both these OEM waves, but lots could go wrong.

On the plus side, I suspect one of the next big OEM NAND stories will be allocation. As Eli put it in the Q1 conference call when asked about OEM customer’s “pre-buying” in anticipation of a shortage in the second half of 2010:

“ Let me answer it without, indirectly. We do feel that you’ve heard me say or us saying that in the next decade we think that flash will be bigger than you think and that’s really based on the mobile and the way it’s going as well as the SSDs.

Two major new markets that are very, very early, so the industry will need to build additional capacity that doesn’t exist. I think we all know that. And you know the key is really the timing of those because the return on investment by itself is tied to the timing.

Now, what that leads me to say is over the next several years there will be periods, I believe, of shortages of flash memory, and there will be times where people will understand, OEMs, particularly large OEMs, that flash is becoming very strategic to their business. You can view it as a commodity, but when you can’t get it at any price because it is just not there because your demand far exceeds the available capacity of the industry, and the cumulative demand of all customers, then of course people will start wanting to secure for themselves some of that capacity, so I do expect some of that may happen.

Of course we don’t know for a fact, but I would not be surprised if the strategic nature in the next few years is going to start becoming effective. It’s no secret flash is a very, very tough technology. There are very few companies that can really deliver leading-edge technology, very high volume, both from the technology and the manufacturing and the balance sheet. So the answer to your question is yes. I think there is going to be some of that but there are some OEMs will start taking steps to assure themselves of supply.”

As flash swings from commodity to a strategic material this could get interesting. If OEM customers end up pre-buying this year, as I expect they will, SanDisk should be in the driver’s seat. This could be sweet timing given Fab 5’s looming capital requirements.

Managed and negotiated properly, I would think, OEM pre-buying could provide a big chunk of the capital needed to fund SanDisk’s share of Fab 5.


One Response to OEM

  1. Poofypuppy says:

    Thanks, Savo. I think we intuitively knew/know that SanDisk’s revenue mix has shifted from retail sales (SD cards, U3, etc.) towards smartphone embedded flash, and the slides above really drive the point home. But the Adaptive Flash Management is something that I did not know about (until now). AFD almost sounds like SanDisk has built the “Transformers” of the NAND world.


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