2010.01.28 SanDisk Q4 Conference Call

28 January 2010 SanDisk Q4 09 Conference Call

Eli Harari, Chairman of the Board, and CEO
Sanjay Mehrotra, President, and COO
Judy Bruner, Executive Vice President, and Administration & CFO
Jay Iyer, Director of IR

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Jay Iyer, Director of Investor Relations

Thank you and good afternoon everyone. Joining us on the call today are Dr. Eli Harari, Chairman and CEO of SanDisk, Sanjay Mehrotra, President and COO, and Judy Bruner, Executive Vice President of Administration and CFO.

[safe harbor]

With that, I would like to turn the call over to Eli.

Dr. Eli Harari, Chairman and Chief Executive Officer: Thank you, Jay, and good afternoon. Q4 was our best-ever quarter for product revenue, margins, and cash flow, reflecting a dramatic reversal in our results when compared to the fourth quarter a year ago. Pricing held up well throughout the fourth quarter, and product margins benefitted from a 20% sequential reduction in cost per gigabyte.

A year ago, the fourth quarter of 2008 marked the bottom of the industry down-cycle with all flash memory manufacturers operating at negative margins and reporting heavy losses. By the fourth quarter of 2009, all NAND suppliers, including ourselves, were reporting vastly improved results, partly resulting from production cutbacks in the first half of 2009. Despite the recession, global demand for NAND flash continued to grow, and by the second half of 2009 flash manufacturers returned to 100% capacity utilization. This turnaround happened considerably more rapidly than expected, demonstrating the remarkable ability of this young industry to self-correct: that is an important factor that we have discussed with you in the past.

While we benefited significantly, as did others, from the general improvement in market conditions, that is, “a rising tide lifts all boats”, I believe that our decisive actions at SanDisk contributed much more so to our rapid turn-around amidst the ongoing industry-wide recovery. I would like to reflect on the more important of these SanDisk actions: In Q4 08, we restructured the company to streamline our organization along Retail and OEM businesses, which allowed us to reduce our non-GAAP operating expenses by 25% in 2009 compared to 2008. We opened up major new OEM sales channels and we set our #1 priority to return to profitability, as evident in our Q3 and Q4 results. In Q1 09, we sold approximately 20% of our captive capacity to Toshiba and we further cut our captive output by throttling back capacity utilization rates at our Yokkaichi fabs by more than 20% in the first half of 2009. At the same time, throughout 2009, we sustained our investments in advanced NAND Flash and 3D R/W technologies, three bits per cell and four bits per cell NAND architectures, advanced proprietary controller chips and new products for both our retail and OEM businesses. And, in Q2 09 we renewed our patent cross license agreement with Samsung Electronics.

Looking forward now, with no new NAND fabs expected to come on stream in 2010, we expect the NAND industry to continue to experience a healthy balance between demand and supply. Flash storage in mobile handsets is expected to continue to be the primary demand growth engine for the industry in 2010. Exciting new devices such as the iPAD launched yesterday, are demonstrating the significant new opportunities ahead for Flash mass storage. We see a similar trend in digital camcorders which have abandoned optical recording media and have largely embraced flash memory. Today Verizon announced its launch of our slotRadio cards in 2000 Verizon stores, for use with their high-end cell phones. Solid-state drives (SSD) are making well publicized inroads in enterprise storage and we believe it is only a matter of time before the tipping point is reached for the broader adoption of Flash SSD in notebook and netbook PC’s. The iPAD, as well as the Kindle, are already past that tipping point, as these class of devices are very thin and are required to deliver long operating time on a battery charge, therefore doing away altogether with rotating disk drives or DVD players, and relying exclusively on NAND flash for mass storage.

Turning to capacity, current industry forecasts project a 2010 total NAND industry bit growth in the range of 70%-90%. For SanDisk, we currently project our captive bit output to increase in 2010 by up to 70% compared to our output in 2009, approximately in line with our currently projected bit demand growth in 2010. Our bit output increase will come primarily from completion of the technology transition to 32 nanometer by late 2010, as well as modest incremental wafer capacity, utilizing the unused clean-room space in Yokkaichi Fab 4. We believe this capacity expansion at Fab 4 will be extremely cost effective, and we plan to exercise our option to invest and take up to 50% of that capacity. As for the timing and pace for this final increment of Fab 4 capacity, we will proceed with caution to align capacity additions with demand from our customers. Currently we expect this to add approximately 10% to our monthly captive wafer production in the second half of 2010, the rest coming in 2011. This is all factored into the 2010 bit growth guidance that I have just provided you. This does mean that our usage of flash memory from non captive sources will likely be minimal in 2010.

Flash industry pricing is expected to reflect a healthy balance between demand and supply in 2010. In the next several years industry-wide NAND cost reductions are expected to decelerate from the pace of the prior five years, due to increasingly more challenging scaling of future NAND technology nodes that we have discussed on previous occasions. We estimate our own cost reductions in 2010 will be in the range of 30%-40%, compared to 52% in 2009 when we captured the cost benefits of three bits per cell technology. We expect to start transitioning to 24 nanometer node late in 2010 with cost benefits expected in 2011.

Looking to the future, we enter 2010 with a superb captive manufacturing base, great technology and products, and a lean and focused team that is driving our global opportunities. Our strategic actions in 2009 and our uniquely balanced participation in both OEM and Retail global markets is working very well for us, and will guide our business activities in 2010.

I will now turn it over to Sanjay.

Sanjay Mehrotra, President and Chief Operating Officer: Thank you, Eli. Good afternoon everyone.

The strong performance in our fourth quarter was driven by healthy demand for our products from both our retail and OEM customers, leading to record unit sales. We experienced strong lift in seasonal consumer demand and we also benefited from our channel diversification efforts and our strategy to achieve a balanced retail and OEM business focus. Our operational execution was solid with our wafer fab production remaining at high efficiencies and the supply chain executing well to meet rising demand levels. Following a record fourth quarter in product sales, channel inventory levels remain healthy and we exited 2009 maintaining our focus on profitable growth augmented by continued tight control on costs and expenses.

We are exceptionally well positioned now in mobile storage: five of our top ten customers in Q4 09 were Tier 1 handset manufacturers and, in addition, we are working closely with the leading mobile network operators and mobile retailers. Sales of our mobile card and embedded flash products drove nearly half of the fourth quarter’s record total product revenue. Overall in Q4, we sold 82 million mobile products. Our embedded flash product sales grew very strongly and that accounted for more than 20% of our total mobile OEM business. Design win momentum for the iNAND™ continues to be strong. Finally, within OEM, revenues from the new channels and customers that we discussed with you in the third quarter grew nicely with strong revenue and profit contribution.

Shifting to our retail business, the fourth quarter was seasonally strong with retail sales within all of our end markets posting sequential revenue growth. Our retail market share remains strong in the major geographies, and our retail business is growing particularly well in the APAC region. With regard to new products and markets, there is a tremendous amount of innovation and energy and we will share some of this with you at our Investor Day meeting on February 26.

In 2009, the combination of a strong ramp of three bits per cell technology along with seamless process technology migrations enabled SanDisk to reduce product cost per gigabyte by more than 50% for the fifth consecutive year. Furthermore, our supply chain scaled up efficiently throughout the year to meet a 26% increase in unit volume demand compared to the prior year levels. Our Shanghai Assembly and Test facility significantly ramped output with strong productivity gains. This, in combination with capacity ramp at our contract manufacturers, allowed us to flexibly meet the seasonally strong demand in a cost effective manner. In Q4, we continued to ramp our 32-nanometer process technology and it accounted for slightly more than 10% of our total bit output. We began shipments of micro SD, SD and Memory Stick PRO Duo cards using our 32 nanometer 3 bits per cell technology as planned.

To summarize, we are pleased with our Q4 and 2009 results and we look forward to delivering more in 2010. With that, I will turn the call over to Judy.

Judy Bruner, Executive Vice-President Administration and Chief Financial Officer: Thank you, Sanjay. Our fourth quarter results reflected strong growth in both OEM and retail channels, with retail revenue up 41% and OEM revenue up 40% sequentially. OEM represented 56% of our fourth quarter product revenue, the same proportion as in the third quarter, and for the year, our product revenue was equally balanced at a 50/50 mix of retail and OEM.

Our fourth quarter retail revenue was down 6% year-over-year, with the decline due primarily to increasing amounts of our mobile business going through mobile network operator stores that we now count as OEM. Our fourth quarter OEM revenue was up 215% year-over-year, with the mix from the mobile market increasing to more than 80% of our OEM revenue.

Our total fourth quarter product revenue grew 54% year-over-year with units up 55%, ASP per gigabyte down 23% and average capacity up 29%. On a sequential basis, our ASP per gigabyte declined 2%, and our total average capacity was up 18%, driven primarily by the OEM mobile product mix.

License and Royalty revenue of $100 million in the fourth quarter included Samsung royalties based half on the old license agreement and half on the new license agreement.

Q4 Product gross margin of 44% on a GAAP basis and 45% on a non-GAAP basis was higher than we had anticipated due to less price decline and stronger cost reduction, which was 20% per gigabyte. In addition, we received a higher than expected benefit of $95 million from selling products which carried previously taken reserves. The reserve benefit came primarily from lower-of-cost-or-market reserves taken on inventory built in 2008, but also reflected the sale of inventory that had been reserved as excess or obsolete. Without these inventory reserve benefits, our underlying product gross margin was 36%, a level that generates strong profitability on our product business and a very good return on invested capital.

Q4 Non-GAAP operating expenses of $192 million were in the range we expected, and reflected a seasonal lift in sales & marketing, a 14-week quarter, and an increase in the accrual of incentive compensation related to our 2009 performance. Comparing the full year of 2009 to 2008, we decreased our non-GAAP expenses by 25%.

Our fourth quarter non-GAAP operating income was $417 million or 34% of revenue. Without the benefit received from inventory reserves, the underlying operating income was $322 million, or 26% of revenue, with more than 70% of this operating profit coming from our product business. Our non-GAAP other income increased sequentially by $5 million due primarily to certain one-time investment gains and to a lesser extent due to higher invested cash balances.

On the balance sheet, cash and short and long-term liquid investments increased sequentially by $432 million to $3.0 billion. Fourth quarter cash flow from operations was the highest ever in a single quarter at $388 million, and free-cash-flow was even higher at $431 million. Cash flow from investing included a $57 million receipt of excess cash from the Flash Partners joint venture, zero outgoing capital payments to the joint ventures and a modest outflow for property & equipment. For the full year, we generated cash flow from operations of $488 million and free-cash-flow of $438 million. For 2009, net cash used for capital-related investing, was only $49 million. Key elements included $378 million outflow for capital investments in the joint ventures and $60 million outflow for property & equipment, with these outflows largely offset by the receipt of $277 million from the joint venture restructuring, $110 million of cash returned from Flash Partners, and $13 million from the wind-down of Flash Vision. We ended 2009 with $1.07 billion of equipment lease obligations, down from $2.1 billion at the end of 2008. Our inventory ended 2009 at $596 million, almost the same number as at the end of 2008, however, both the gross level of inventory and the offsetting reserves have been significantly reduced, and reserves have returned to normal levels.

I’ll now turn to forward-looking commentary. I’ll provide guidance for Q1 as well as for the full year 2010. Please note that non-GAAP to GAAP reconciliation tables for all applicable guidance are posted on our website.

We are expecting a normal level of seasonally reduced demand in the first quarter, coupled with the impact of Q1 being a regular 13-week quarter compared to our 14-week Q4. We are forecasting total revenue for Q1 between $875 million and $950 million, which includes license and royalty revenue between $80 and $90 million, fully reflecting the new Samsung license agreement. For the full year 2010, we forecast total revenue between $4.0 and $4.4 billion, including license and royalty revenue between $320 and $360 million.

Turning to gross margin, we expect that first quarter cost decline may be a bit less than price decline as we expect more modest cost decline in Q1 than we generated in the previous two consecutive quarters of very strong cost reduction. For the full year 2010, we expect that the annual cost decline which Eli estimated at 30% to 40% will be greater than the annual price decline, allowing product gross margin to expand from our 2009 underlying product gross margin which was in the teens on a full year basis. We are forecasting a non-GAAP product gross margin for Q1 and for the full year of approximately 31%, plus or minus 3 percentage points.

We forecast non-GAAP operating expenses in Q1 of $175 to $185 million, and for 2010 of $725 to $750 million. We forecast non-GAAP other income for 2010 to be approximately $40 million, spread relatively evenly across the year. We forecast a non-GAAP tax rate of approximately 37%, up from 36% in 2009, based primarily on certain tax law changes for 2010. On a GAAP basis, we are still in a valuation allowance position, and as such the GAAP tax rate is too difficult to predict.

Turning to the balance sheet and cash flow, we expect our total capital investment in 2010 to be between $700 and $900 million, covering fab technology transitions, incremental wafer capacity in Fab 4 as Eli described, and back-end supply chain and other capex requirements across the business. We expect to fund this primarily from a combination of cash flow from operations and working capital from the joint ventures, and we expect continuing positive free cash flow in 2010. As in the past, we will provide further color on capex and our funding plans at our Investor Day on February 26.

In summary, we are expecting solid performance in 2010, and we look forward to sharing more information with you at our upcoming Investor Day. We’ll now open the call for your questions.

Q&A

Daniel Amir, Lazard Capital Markets: Congratulations on a great quarter. A couple of questions here. First of all on the price decline, you assume that price declines will be less than your cost downs, which is 30% to 40%. Which means that pricing you’re assuming pricing will be somewhat similar like ’09 I guess in the 20s, in the mid to high 20s, maybe. Can you a bit explain kind of your assumptions there, why you think the market is going to behave similar like ’09 considering that, you know, there is some new capacity coming on board, and the expansion of Fab 4, and some shrinkage in the market as well?

Sanjay Mehrotra: This is Sanjay. When we look at the bit supply growth in 2009, for the industry it was about 40% and as Eli pointed out, when we are looking at 2010, the supply growth is expected to be 70% to 90% for the industry and ours is on the low end of that, up to 70%. When you look at the demand drivers in the industry, the demand drivers are strong, you know, where when you see the handsets, the smart phones, they are continuing to increase their presence, their penetration in the market and with the smartphone”s highest capacity units are continuing to sell both on the embedded side as well as on the card side and new applications that are coming out are continuing to drive new demand for flash storage as well.

On top of all of this the demand is being driven globally. I mean from Asia/Pac, we saw very strong growth in demand on a year-over-year basis and we are continuing to see that from China, India and the emerging markets. So all of these factors- the applications, the demand growth drivers for particularly the mobile, SSD continuing to increase its penetration during the year, the markets, as well as the regions, we believe will continue to drive the demand. And looking at the bit supply growth we think, that the demand will be [pause] demand and supply will be in good balance during the course of the year. And that cost reduction will be in the 30% to 40% range and pricing will hold well during the course of the year.

Daniel Amir, Lazard Capital Markets: Now if you look at Q1 in terms of seasonality I mean you [pause] based on your guidance you are expecting it to be somewhat similar to maybe previous year’s seasonal trends, taking last year aside, I mean what are really the drivers that you are seeing here in Q1, I mean what is the assumptions really based on this guidance, considering that we were exiting the holiday season maybe with a bit better inventory that we have previously.

Judy Bruner: Daniel this is Judy. We are expecting a normal Q1 in terms of down demand in the season but we are not expecting a normal Q1 or historical Q1 in terms of pricing trends, if you look back at all of our previous Q1s there has typically been very significant downward pressure on pricing, and this time we believe that we entering 2010 with a healthy supply demand balance in the industry because there is really been no capacity added throughout 2009. So we do expect some movement down in pricing in the first quarter and somewhat more than the essentially no price decline we had in the fourth quarter, but definitely less price decline than we have seen in historical Q1s.

Daniel Amir, Lazard Capital Markets: Ok. Great. Thanks.

Jim Covello, Goldman Sachs: Great. Good evening. Thank you so much for taking my question. Could I ask relative to the shifting of the business between retail and OEM what kind of impact do you think that really has in terms of your seasonal pattern that we have historically seen?

Sanjay Mehrotra: So we say that Q1 will have seasonality and that’s baked into the guidance that Judy has provided. OEM business may be a little less seasonal than the retail but overall the total business will experience seasonality similar to the years past.

Judy Bruner: I would just add to that Jim, I think we answered this question last quarter as well, that even when our products go through OEM channels, ultimately almost all of our products are destined for the consumer and so they are still subject to the seasonal buying patterns of the consumers.

Jim Covello, Goldman Sachs: That’s exactly what I was trying to figure out, so I appreciate that.

And then Eli you had said relative to SSDs, I think you said it was only a matter of time for SSDs in kind of the notebook space. Obviously we are seeing good adoption in the enterprise space. How much time, how much is only a matter of time? What are we really talking about? A year, or two years? Less than that?

Eli Harari: I think if you look again at the iPad, iPad is a very thin product. It’s designed absolutely to operate with flash memory. 64 gigabyte storage, no way that it can support a hard disk drive and of course doesn’t have a DVD and I think that there is a whole class of devices like this, where consumers will appreciate the other attributes of flash memory in terms of very low power, it’s very responsive, you know tremendous responsiveness, and small form factor to pay the premium.

If you look at the iPad price quote going from 32 gigabyte to 64 gigabyte- a $100 incremental cost to the consumer, which is not that much, that still translates to about $3.00 per gigabyte and I would kind of venture to bet my annual salary that there will be a big number of customers that want 64 gigabyte at $3.00 per gigabyte- and yet you hear a lot of people saying need $0.50 per gigabyte in order for SSD to take off.

I think when SSD becomes commoditized- yes it will need to be playing at these price ranges, but we have tremendous opportunities over the next several years.

But to answer your question I think this is an ongoing process, I’ve said the enterprise of course is already willing to pay the additional cost per gigabyte of flash. And I think that by the end of this year and certainly into 2011, we are going to see more and more notebook computers and people asking and being willing to pay a lot more than $0.50 per gigabyte.

And of course within two years we ought to be able to reach the $1.00 per gigabyte and I think that will be another important, I don’t want to say tipping point, but another important milestone for SSD adoption. In the mean time the SSDs are getting much, much better for us as well as for competitors and I think that this is a market that’s here to stay and its going to go on becoming very important part. By 2012, I have seen some estimates that this will be, that SSDs will consume maybe 15% to 20% of the total NAND bit output and I think that that’s about [pause] I am comfortable with that kind of range of numbers.

Jim Covello, Goldman Sachs: You said for 2012 that was?

Eli Harari: 2012, I said I have seen some industry projections of 15% to 20% of the total NAND bit consumption in SSDs and I am saying yes I think that sounds about right.

Jim Covello, Goldman Sachs: Ok. Thank you so much.

Tristan Gerra, Robert W. Baird: Hi, good afternoon. Looking at your cost reduction guidance for 2010 how should we weight this by quarter?

Judy Bruner: Sure Tristan. I would say that it will be weighted somewhat more to the second half the year than the first half of the year and that’s based on taking into account the timing of the technology transition during the year in production and then taking into account the lag in our business model in terms of when that’s recognized in our P&L.

Tristan Gerra, Robert W. Baird: Ok.  And in terms of your previously reserved inventories anything left that we should expect for Q1 given the amount it was higher than expected in Q4 or is that pretty much it, this point?

Judy Bruner: At this point really our inventory is carrying a normal level of reserves and when I say normal I can look back to when our product gross margins used to be back in the 30% range and our reserves now are at a very similar level. So I do not expect going forward to be talking about underlying product gross margin relative to reported product gross margin. Really we should be in a normal territory going forward.

Tristan Gerra, Robert W. Baird: Great. Thank you.

Craig Ellis, Caris & Company: Thanks. Eli you talked about a lot of good demand drivers but you also mentioned 70% bit growth for the company which seems pretty low given the demand drivers in place. Can you reconcile the two of those for us?

Eli Harari: Yes. We’ve just gone through the most difficult, most challenging, most painful downturn and that memory is very, very much fresh in our mind, so we would rather err on the conservative side and build-up our business on profitability rather than market share, so the OEM business definitely needs a captive supply and as our OEM grows, we need to take care of that and we are, but we really do want to be very, very cautious in how we add additional supply. I think it’s very important for our health and I think we don’t want to contribute anymore than we have to, [pause]. We want to contribute to the health of the industry [several inaudible words].

Craig Ellis, Caris & Company: Okay and then the follow would be- last year you talked a lot about moving to a second sourcing model that was 28% to 30% of output. Has that thinking changed? And as we think about the more fully provisioning of Fab 4, how do we think about the timing with which you add tools there?

Eli Harari: Let me first answer the second question that provisioning of the remaining space in Fab 4. There is not that very much capacity left in Fab 4 and as you can well imagine, filling up what remains of the clean-room space is very cost effective because your fixed costs are basically in place already. And therefore running additional wafers- yes you need new equipment and so on, but the cost of wafer actually is very favorable which is very different from the first tranche of expansion of new capacity in a brand new fab, whether it’s an existing empty shell or a new facility that you built from the ground up- the first, let’s say 50,000, 70,000, 80,000 wafers per month carry the full fixed cost even though I am not using the full capacity available.

So we think that this is a very, very important element for us to take advantage of, through our 50-50 option with our partner and of course this does come, this does mean that we delay the move to greater reliance on noncaptive, but in general, our desire continues to be to rely on noncaptive supply for around 15% to 25% for our future capacity and we do have the agreements in place and these noncaptive capacities cannot obviously be turned on in an instant. You need to invest in those and qualify it and so on. And at the appropriate time we plan to absolutely epedite those.

Craig Ellis, Caris & Company: Well, the follow-up would be just with respect to adding tooling how do we think about the pace at which you will do that through the year and into next year?

Eli Harari: We are not talking about a lot of wafers. We are talking about increasing our captive supply by approximately 10% starting in the second half of this year. So in terms of volume it’s not that significant. There is to a certain extent some constraints in terms of this lead time, equipment lead time, but overall I think that it’s not a major thing. I think it’s definitely included in the industry projections of 70 to 90 nanometer [he means bit growth] and when we talk about that additional wafer starts in the remaining clean-room space in Fab 4, that is part of our 70% or under for our own capacity increases.

Craig Ellis, Caris & Company: Alright. Thanks Eli.

Gary Hsueh, Oppenheimer & Co.: Eli just off the back of that question, I was wondering if you could help me understand how you plan to meet consistently close to 100% bit growth beyond 2010? I think you talked a little bit about your strategy for non-captive/ captive in 2010, but beyond 2010, I was wondering if you could kind of list off your options in terms of bit growth outside of just pure technology transitions? And what I am trying to get at is, in terms of looking at Toshiba and taking part of Fab 5, what are some of the considerations when you start to look at Fab 5 in Yokkaichi, whether or not you participate in some volume option out of that fab?

Eli Harari: So, in terms of steps, if you will, to increase our output, the first step, as I said, is to take advantage of the low cost structure that remains in the clean room space, Fab 4. After that is to tap into our non-captive supply. Beyond that we would have to figure out how to address future requirements. But we do believe that 2010 is premature to really start planning a new fab or with regard to Fab 5. As far as our requirements we don’t think that 2010, it’s premature as far as we are concerned.

Gary Hsueh, Oppenheimer & Co.: Okay. And second question here for Judy, I understand for a full-year basis, cost per bit reduction is going to exceed your expectations for pricing decline. Can you walk me through the profile of each and whether the declines in terms of pricing and the cost of bit production you plan, are those totally coincident or are there going to be gaps here and there in any one quarter?

Judy Bruner: I think it is too difficult for us to give a specific quarterly pattern at this point in particular for a price decline. As I said, in terms of the cost decline of 30% to 40% per bit, that will be a little more weighted in the second half of the year than in the first half of the year. And overall, we believe that the price decline for the year will be less than that cost decline. But exactly how it plays out on a quarter-by-quarter basis is a little too difficult, or we wouldn’t want to estimate it at this point. But overall, we are talking about a very healthy level of price decline for the industry and for ourselves in 2010.

Gary Hsueh, Oppenheimer & Co.: Okay and last question I think this must have been asked but let me just try and ask it again, in terms of the seasonal decline did you say that the OEM decline in Q1 was going to be a little bit less than the retail decline in Q1?

Sanjay Mehrotra: Yes. OEM seasonality will be little bit less than retail and that’s because we continuing to grow our business in the new channels and with new customers.

Gary Hsueh, Oppenheimer & Co.: Can you be specific on what aspect of the OEM business you are growing? Is it the microSD card attachment rate on handsets? Is that in particular what you are seeing?

Sanjay Mehrotra: I think we have said in the last call that we are selling to private label customers as well as to customers for wafers  and components and to the private label customers we are primarily selling our card products and those card products include mobile products as well as some imaging products. But as Judy pointed out, almost 80% of our OEM revenue is mobile. So it is primarily from the card side.

So we are continuing to sell components and the embedded products as well.

Gary Hsueh, Oppenheimer & Co.: Ok. Great. Ok. Thank you.

Bob Gujavarty, Deutsche Bank Securities: Thanks for taking my question. I had just a question about 3 bit per cell- at the moment are you able to use 3 bit per cell across all of the different channels and products you serve? or is it primarily aimed at certain, certain product segments?

Sanjay Mehrotra: So we are using 3 bit per cell in all card formats as well USB flash drive formats. And the lowest capacity products do not use 3 bit per cell as well as certain high capacity, high performance products and products such as our pSSDs and SSDs do not use 3 bit per cell.

Bob Gujavarty, Deutsche Bank Securities: Great. How about some of the embedded products? Are those primarily 2 bit per cell right now?

Sanjay Mehrotra: So some of the embedded products are using 3 bit per cell now.

Bob Gujavarty, Deutsche Bank Securities: Great. And if I could just, one final quick one, you mentioned in the last conference call, given your lead in 3 bit per cell, you’re able to kind of sell the lower cost product at the equivalent 2 bit per cell ASP and that’s good for SanDisk. Is that trend continuing for you?

Sanjay Mehrotra: Yes. Basically what we have said was that implementation of 3 bit per cell technology in our products is officially seamless from the point of view of the consumer. The consumer cannot really tell the different difference between a 3 bit per cell and 2 bit per cell. And therefore in pricing our products we generally don”t have a difference between 2 bit and 3 bit per cell.

Eli Harari: But I would like to add that we do believe that not all X3 is made equal and that our expertise in systems and controllers and providing the complete solution and the fact that we are now in our third generation X3 technology that makes a difference. And that the fact that our X3 products are transparent to the user is because we have learned how to manufacture these to design those to have basically equivalent performance to X2.

That’s not the case of what we see in the market for some of our competitors and this is very similar to the early days of MLC, 2 bits per cell, when our competitors were having some difficulty matching our performance with MLC, and therefore, during that transition period portrayed MLC at the time, in fact the same applies to X3 today, as somehow not up to par with 2 bits per cell. We don’t agree with that.

Bob Gujavarty, Deutsche Bank Securities: Great. Thanks for the clarification. And great quarter.

Jelta Fonner, Thomas Weisel Partners: Hi this is Jelta Fonner for Kevin Cassidy, I just have a quick question on the captive/ non-captive model. For your non-captive may be going out to 2011, do you have a target margin range for that?

Eli Harari: We’ve always said in the past, when we use non-captive, that the margin clearly is going to not match, I mean be inferior to the margins that we can get with our captive supply, where we, of course, have to make the CapEx investment. It is reasonable to expect that our supplier that is supplying us even under best terms and conditions does need to make their margins and therefore the way we look at non-captive is- it is very important that we are able to generate some contribution dollars even though at reduced margins.

Jelta Fonner, Thomas Weisel Partners: Ok. Great. Thank you very much.

Uche Orji, UBS: Thank you very much. Eli, so let me try to understand what you’re saying on 3 bit per cell. How much of your production by the end of the year should be 3 bit per cell and how much is it now?

Sanjay Mehrotra: So for 2009 in total, our bit production was slightly above 50% in 3 bit per cell. And in Q4 of 2009 it was better than 50% in 3 bit per cell and for 2010 we are looking at same thing- better than 50% for 3 bit per cell. And again, keep in mind that we have a certain mix of the product that uses 3 bit per cell very well and certain products such as the ones I mentioned earlier- lower capacity cards and some high performance products and SSDs et cetera, do not use 3 bit per cell. So with the mix of the products we have, we believe we are at pretty comfortable levels with 3 bit per cell.

Uche Orji, UBS: Ok.

Eli Harari: Let me just amplify a little bit about what Sanjay said particularly with regards to low capacity cards. You are seeing the market for cards kind of bifurcate- you have the 1 gigabyte and 2 gigabyte cards- very large unit volume business; and then the higher capacity cards more for the smart phones. And it is the 1 gigabyte and 2 gigabyte cards where the chips really don’t get the benefit of X3 and are therefore staying on X2, MLC.

Uche Orji, UBS: I see. In terms of the acceptance of the 3 bit per cell you cannot, the way you”ve described it, it sounds like there has been no problem in terms of the performance of those cards in the marketplace. When should we expect that this could be good enough to use in things like SSD like X3 cards now? X3 products in things like SSD. Are there any issues why they’re not being used in those kinds of products or just controller-related issues?

Eli Harari: The industry is just basically this year moving from SLC, single bit to MLC, 2 bits per cell. Because the birth pains of this product in a very, very challenging kind of application environment that we have talked about in the past. We believe that it will require very substantial understanding, very powerful understanding if you will, of system level expertise including not just ECC but all kinds of algorithms that we have developed and perfected over the last few years to make SSD, to make it possible to work from, sorry, 3 bits per cell into SSD and that eventually it could become a very important element of that.

Now that may not apply, let’s say for enterprise drives where SSD drives where performance is very, very important, but as far as handling things like endurance and read and write speed, I think that eventually we will be able to achieve market requirements in SSD with a 3 bit per cell but it is still to be proven. Our first focus this year is really on commercializing our third generation, G3, 2 bits per cell MLC and this is really our key focus.

Uche Orji, UBS: Ok. Great. And then just one last question. I did ask you this question also last quarter. It seems like the demand drivers for NAND seem to be so strong that the historical elasticity relationship between pricing and demand seems to be broken. How much longer [pause], are there markets that you think will, [pause] at what point do you think that relationship gets restored? Are we now in a new part of the dynamic in terms of demand where ASPs probably not great, but are not entirely what we have seen historically, and yet demand continues to ramp. So in terms of how you expect the relationship between product demand and elasticity going forward, can you just give color there to help me? Thanks.

Eli Harari: It is a very complex, multi-layered question and the answer is equally complex. There are of course markets that are more mature and therefore less elastic. There are numerous new applications that are very price elastic. In general and then of course there is the general economy and consumer confidence and so on things that are outside of our control. I would say that we have always believed that pricing should, it is healthy for the industry and for us to continually cost reduce and share the benefit of that with consumers and that expands and creates new markets. We have not changed our thinking. All we are saying and what I’ve said is that the rate of price reductions that we saw in the last three years, which was close to 60% annually, was disastrous and would not be supportable by cost reductions. And we are seeing now good stability in the market and it is my hope that we are at the beginning of a long period of health in the industry with continuing price reductions and cost reductions, but at a level that makes economic sense.

Uche Orji, UBS: Thank you very much.

Daniel Berenbaum, Auriga USA: Thanks. Judy did you say that, you may have covered this, did you say that you sold some equipment back in the quarter? I was trying to figure out how free cash flow is higher than cash flow from operations?

Judy Bruner: We didn’t sell equipment. But essentially we received a cash distribution, a cash pay-down on our notes receivable from Flash Partners. Our joint ventures actually generate cash and if they generate more cash than is required for capital investment in a given period then they will return that cash to the partners. And since there was no new capacity added within our joint ventures in 2009, the joint ventures generated more cash than was needed.

Daniel Berenbaum, Auriga USA: Okay. And so then moving forward on the CapEx investment, you talked about the $700 million to $900 million total investment. How will that be split out do you think between your CapEx and the investment in the JV?

Judy Bruner: The vast majority of it will be investment in the joint ventures. If you look at this year, you see that our non-fab or non-joint venture CapEx was about 60 million for this year. I expect it will be a bit higher than that next year. But still the vast majority of the 700 million to 900 million is fab and therefore joint venture related. But we will give some more detail on that at our investor day.

Daniel Berenbaum, Auriga USA: Ok. And then last question just on an OpEx, you guided non-GAAP 725 to 750 what do you think stock-based comp will be across the year just so we can take a stab at the GAAP numbers? And then also on the patterns it looks like, it sort of implied that OpEx would basically be flattish across the year. Am I thinking about that the right way?

Judy Bruner: Okay. First on the stock compensation, we actually have some tables that are on the Web that give the reconciliation of the non-GAAP to the GAAP and what it shows there is that the operating expenses that we would add to the 725 to 750 to get GAAP are about 15 million to 20 million a quarter or about 60 million to 80 million for the year.

And then in terms of your second question, we are working very hard to keep expenses tight, to manage them carefully. We will have a little bit of growth in expenses as indicated in my guidance. And I would expect, as is typical, there’s seasonality in that it tends to be heavier in the second half of the year than the first half of the year. But there’s not, it is not a hockey stick obviously to get to the 725 to 750.

Daniel Berenbaum, Auriga USA: Ok. Great. Thanks very much.

Hendi Susanto, Gabelli & Company: Thank you for taking my questions. My first question is about the utilization rate. Judy, you mentioned that the growth in 2010 will be weighted more towards second half. Do you still expect your facilities to run at full capacity like in the first quarter and second quarter of 2010?

Judy Bruner: So I think somewhat two different questions there. What I was saying was slanted more to the second half than the first half is our cost reduction on a per gigabyte basis. The timing of the 30% to 40% reduction in our cost per gigabyte. In terms of utilization, I assume you are asking about fab utilization?

Hendi Susanto, Gabelli & Company: Yes.

Judy Bruner: And absolutely. We are running them at 100% and expect to run them at 100% on a, for all of 2010.

Hendi Susanto, Gabelli & Company: Okay. Then second question, in the OEM space what is your market share? and then is SanDisk gaining market share from others?

Sanjay Mehrotra: In the OEM space, it is real hard to call out the market share because the OEM customer base is very diverse and the information is not easily reported. But we believe that we are gaining market share in the OEM space as well, particularly as we increase our new customers and new channels through that we are increasing our share on the OEM side as well. And in the retail side as well we believe we did very well during the year and held a strong share despite tremendous focus on profitability. And in fact I believe in several of the geographies in retail as well, we grew our share during the year.

Hendi Susanto, Gabelli & Company: Thank you.

Eli Harari: But in addition to that, in retail, in a lot of countries we have high market share. And it is not that easy to dramatically increase that. In OEM, in some accounts which are just starting and we have in other accounts a relatively small market share and we think we have significantly more upside in increasing our share there.

Hendi Susanto, Gabelli & Company: Thank you.

Paul Coster, JP Morgan: Thanks. I just want to go back to the whole issue of price elastic demand and surely one of the reasons it is breaking down is that you’ve got this new product category, smart phones, that are growing so rapidly and the attach rate to them is 100%. My question is, it is just seems to me, Eli, that inevitably as we get close to the end of this year, with the sort of 30% growth for the product category the bottleneck is going to be wafer outs not bit shipments, and the industry is going to have to make some pretty serious decisions just to stay, CapEx decisions just to stay up with smart phones, let alone SSDs. Can you comment upon that?

Eli Harari: You may be right, Paul. We are not at that point at this stage. We would be very, very careful.

We would really try to learn from the mistakes that we and others, I mean, I can’t speak for others but that we’ve made in the past with exuberant, irrational investment that was in the range of 60% of revenues for us in CapEx in 2007 and 2008. We are not going to return to that.

Paul Coster, JP Morgan: I get that. So may be the, a supplemental question is- if the industry has to start making investments again, what’s the lead time between the point of making the decision and when let’s say, a meaningful wafer out capacity increase can be achieved? Is it six months, a year?

Eli Harari: For new fab it is definitely longer than that. It’s closer to 18 months. If everybody rushes to the equipment manufacturers, of course there will be a bottleneck there. There are other considerations of course. NAND is slowing down and the future of NAND beyond, let’s say 20-nanometer is not certain and to cloud- the post-NAND technology is not yet in place. And new fabs are very expensive and UV is not yet a proven technology.

There’s just a lot of other considerations that will come into play as far as new mega fabs and I think that right now this is actually a time to kind of pause a little bit, at least for us, and let the market kind of develop a little bit before we make any further decision on that.

Paul Coster, JP Morgan: Alright, Thank you.

Jay Iyer, Investor Relations: Thanks, Paul. That’s all of the time we have for today. A webcast replay of this conference call will be posted on our web site at sandisk.com/ir shortly. Have a good evening.

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