2010.04.21 SanDisk Q1 Conference Call

28 January 2010 SanDisk Q4 09 Conference Call

Eli Harari, Chairman of the Board, and CEO
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 and Judy Bruner, Executive Vice President
of Administration and CFO.

[safe harbor]

With that, I will turn the call over to Eli.

Dr. Eli Harari, Chairman and Chief Executive Officer: Thank you, Jay, and good afternoon everyone. First quarter results were considerably better than we had expected.  Our OEM business was the star of the quarter, driven by strong demand from our mobile customers as well as new channels and customers added in 2009.  The OEM business accounted for 63% of total product revenue in Q1 and has been a stabilizing factor compensating for the first quarter seasonality in our retail business, which has yet to recover from the economic downturn in the US and Europe.  Our focus in retail continues to be to maximize profitability, while expanding into new geographies, where we believe we are making steady inroads.

In the mobile end market, we continue to see strong adoption of our iNAND embedded storage solutions, as well as mobile card.  Mobile has now grown to half of our product revenues, compared to virtually nothing five years ago. microSD has become the de-facto standard for cards in mobile phones, and the marketplace has bifurcated into low-capacity 1 and 2 gigabyte microSD cards for low end phones, and high-capacity 4 to 32 gigabyte  microSD card for high end smartphones, and we believe we hold strong leadership positions in both segments.

The mobile market for flash is still in its early days – just to remind you, mobile apps hardly existed, and Smartphones were hardly a household word just two years ago.  The iPad along with other similar products is expected to drive demand for flash memory to 64 GB and higher capacities.  Whether this demand comes in the form of embedded storage or removable cards, we are now well positioned in both categories.

We continue to gain traction with leading OEM’s for our modular SSD solutions, solid state disk, in netbook and tablet computers.  In first quarter, we also entered the retail solid state drive (SSD) market with our G3 product.  At current NAND pricing levels, SSD solutions are still expensive.  However, we believe this market too should drive very substantial consumption of high capacity flash as it becomes much more affordable.  We expect this will occur with the advent of 20x nanometer flash memory technology in mass production next year, and 1x technology in 2012.  We are now executing to our aggressive SSD technology roadmap that should take us to being a top-tier supplier as SSD adoption accelerates in netbook, notebook and tablet PC platforms in the years ahead.

On the operations and technology front, we are very pleased with the ramp of our 32 nanometer technology, as well as the continuing cost benefits that we see from broad implementation of our three-bits per cell (X3) technology into our products, where we believe we are significantly ahead of competition. In first quarter, our cost per gigabyte declined by 14% sequentially, continuing our highly competitive cost structure.

As for the industry environment, demand and supply appears to be in balance for 2010.  For ourselves, we now expect our captive bit output to increase in 2010 over 2009 by approximately 75%, up from approximately 70% estimated previously, with the upside coming late in the year from better productivity and Fab 4 expansion.

Last month, Toshiba announced their intention to commence construction of the shell for a new clean-room at Yokkaichi that will eventually be Fab 5.  We are evaluating the timing of our participation in Fab 5 and we will provide further details as they become available later in the year.

In summary, the first quarter was a very very good start for 2010.  With our leading technology, large scale manufacturing, diversified end markets, broad product portfolio, premium brand, and a strong balance sheet, we have powerful momentum to capitalize on future opportunities and we believe that “in the coming decade, Flash will be bigger than you think.”

I will now turn it over to Judy.

Judy Bruner, Executive Vice-President Administration and Chief Financial Officer: Thank you, Eli.  We delivered our best ever first quarter results, driven by strong OEM demand, minimal price reduction, and continued execution in product cost reduction and expense management.

Our total product revenue was down sequentially by 13%, which was less than we had expected given historical Q1 seasonality and a 14-week fourth quarter.  Our retail business reflected normal seasonality with revenue down 27% sequentially, while our OEM revenue was down only 2% sequentially.  As a result, the Q1 mix of our product revenue was 63% OEM and 37% retail.  Our retail revenue grew 7% year-over-year, and our OEM revenue increased 158%, reflecting strong demand in the mobile market and the new channels we added in 2009.  Looking at our revenue by end market, our first quarter product revenue came 49% from the mobile phone market, up from 38% in the first quarter last year.

Retail demand continued to be soft in Europe and the U.S., while Asia retail sales increased sequentially from Q4 to Q1.  We believe we maintained share in U.S. retail while we may have given up some share in low priced USB products in Europe retail.  In Asia, we benefited from strong consumer demand as well as from our geographic expansion efforts. Our first quarter OEM revenue benefited from strong demand in the mobile market and in general from new customers for mobile embedded solutions, cards, as well as wafers and components.  Our overall ASP per gigabyte declined 7% in the first quarter, much less than in the previous first quarters, reflecting a healthy supply/demand balance.  And some of our 7% decline in ASP per gigabyte reflected the mix of products sold rather than price decreases. Our units sold decreased 3% sequentially and grew 62% year over year.  Average capacity remained fairly steady as the pricing environment has created strong demand for lower capacity units.  Average capacity was down 4% sequentially and up 5% year-over-year.  Our total gigabytes sold declined 7% sequentially and grew 71% year-over-year.

Our license and royalty revenue was slightly stronger than we had forecasted at $93 million and now fully reflects our new license agreement with Samsung.

Our first quarter Non-GAAP total gross margin of 46.5% and Non-GAAP product gross margin of 41.5% benefited from a better than anticipated pricing environment and also from stronger than forecasted OEM sales that resulted in recognizing more of our 32 nanometer, 3-bit per cell production in first quarter results.  Our product gross margin improved sequentially from an underlying product gross margin of 36% in Q409 to 41.5% in Q1, driven by a 14% sequential cost reduction on a per gigabyte basis compared to our 7% decline in price per gigabyte.

Non-GAAP operating expenses of $172 million were down $20 million from the fourth quarter, reflecting a 13-week quarter compared to Q4’s 14 weeks, as well as seasonality in sales and marketing expenses.

Our first quarter non-GAAP operating profit was $334 million or 31% of revenue, and as with the last quarter, more than 70% of this operating profit came from our product business.  Our non-GAAP other income of $23 million included gains of $15 million related to the sale of certain assets and investments.

On the balance sheet, cash and short and long-term marketable securities increased sequentially by $279 million to nearly $3.3 billion.  Our first quarter cash flow from operations was $328 million and our cash flow from investing yielded a positive $1 million, resulting in free-cash-flow of $329 million.  During Q1 we called our $75 million convertible, paying it off with cash, and we reduced our off-balance sheet equipment lease guarantees, ending Q1 with a balance of $931 million.

I’ll now turn to forward-looking commentary.  Please note that non-GAAP to GAAP reconciliation tables for all applicable guidance are posted on our website.

Given our strong results in the first quarter, we are raising our guidance for 2010. Our broad channels and growing demand from the mobile market give us confidence to increase our full year revenue range to $4.5 billion to $4.8 billion.

For the second quarter, we expect total revenue between $1.10 billion and $1.175 billion which reflects tightness in supply for certain low-capacity products.  Within this total Q2 revenue, we expect license and royalty revenue between $80 million and $90 million, slightly down sequentially since our second quarter royalty revenue reflects the seasonal first quarter revenue of our licensees.  For the full year, we are also raising our expectations for license and royalty revenue to a range of $350 million to $375 million.

Turning to gross margin, we expect the sequential improvement in cost to be less in Q2 than in Q1 due to anticipated higher mix of demand for certain products in our portfolio.  We also expect our second quarter sales to reflect more promotional pricing in the retail channel associated with the moms, proms, dads and grads season.  We expect non-GAAP total gross margin for Q2 between 42% and 45% and non-GAAP product gross margin between 37% and 40%.  For the full year 2010, we now anticipate that our cost reduction will be at the high end of the 30% – 40% range we provided in January, and we expect price reduction to be less than our previous estimates.  Partially offsetting these factors, we may utilize some non- captive supply in the second half of the year.

We are raising our full year 2010 forecast for non-GAAP total gross margin to a range of 41% to 44% and for non- GAAP product gross margin to a range of 36% to 39%.  For the 2010 total gross margin, this represents a more than 5 percentage point increase in the mid-point of the range from the previous guidance.

Given our increased top-line expectations for the year, we now expect non-GAAP operating expenses to be at the higher end of the range previously provided, or approximately $750 million. For Q2, we forecast non-GAAP operating expenses of $180 to $190 million.  We now expect non-GAAP other income to be approximately $60 million for the year, and we forecast the non-GAAP tax rate to remain at approximately 37%.  We expect our 2010 capital investments to be at the higher end of the $700 to $900 million range we previously provided, and the estimated cash requirement for 2010 capital investments remains in the range of $300 to $400 million, concentrated later in the year.

In summary, we are pleased with our first quarter performance, and it is looking like 2010 will be a year in which we exceed the operating margin in our Long Term Financial Model.  We’ll now open the call for your questions.

Q&A

Daniel Amir, Lazard Capital Markets: Thanks a lot and congratulations on a great quarter.

Eli Harari: Thank you.

Daniel Amir, Lazard Capital Markets: A couple questions. First of all, can you highlight a bit what the drivers are in the sense that in your OEM business here going forward? And how should we look at kind of the OEM segment as a percentage of your overall sales here in the next two, three quarters?

Eli Harari: Hi. So, the OEM business is growing. I mean, we have said in the past that we believe we are the third largest supplier now and certainly in the top three suppliers of OEM flash. And we believe that we have a tremendous room to grow, and talked about very large, very broad front of design-ins, particularly for embedded products, and we see that as really just starting.

At the Analyst Day, we talked about AFM, that’s the adaptive flash management, which is part of our controller intelligence to allow us to optimize embedded flash to the specific application of the platform, and we’re seeing very significant reception, positive  reception for that.

So I would say that we probably have moved now quite solidly from a model where maybe a year ago or a little bit more than that we were maybe one third OEM and two-thirds retail to just the opposite, one third retail and two-thirds OEM. And I don’t – I expect that this thing is going to be with us for the foreseeable future.

Daniel Amir, Lazard Capital Markets: Great. And the other question is in terms of kind of the e-book and tablet markets and with your commentary that you’re thinking of using some non-captive supply in the second half of the year. I mean how do you see those demand dynamics impacting the flash memory market and then specifically your usage of potentially moving to a little more non-captive?

Eli Harari: So, the non-captive supply is very, very important in the long-term and we’ve always said our model is to have 15 to 20% non-captive. However, it is also the case that with OEM becoming such a much stronger constituent portion of our output, I’ve said many times that OEM really cannot be satisfied through non-captive because you have to quote several quarters out and we really have to have control of our supply, so that really will very likely to the extent that we stay with this two-thirds OEM, one-third retail moving forward, or around that, our ability to employ non-captive will be reduced and we will have to use more captive supply.

Daniel Amir, Lazard Capital Markets: And the tablet e-book question?

Eli Harari: So, can you repeat the question on tablet?

Daniel Amir, Lazard Capital Markets: Yeah, so basically how do you see the tablet e-book market impacting the NAND flash industry here in 2010?

Eli Harari: Tablets to the extent that you defined the iPad as a tablet and its competitors being more or less the same, we view that as a very, very important new platform that drives the demand for flash because it is really designed to be very thin, very long battery life and therefore really relies on attributes of flash for storage.

The iPad is driving 64 gigabyte. We fully expect that the competition will be really driving at the 64 gigabyte and opening up to 128 and 256 gigabyte. This is a very, very positive development for the NAND industry no matter who serves it, and also very important because again the Analyst Day we talked about- thin is in.

What thin means when you have very thin products and you can’t have a fan to cool the environment. You basically are driven to use modular flash which is modular SSD which is SSD functionality but not necessarily in the 1.8 inch or 2.5 inch form factors, and that clearly plays to our strength because we have the ability to customize solid state disk to be basically to fit into very, very thin and any kind of a profile which of course no disk drive can do.

So in that kind of environment people are starting to look at SSD not just is it lower – does it match the cost of hard disk drive but more is it an enabling technology that allows that kind of form factor.

Daniel Amir, Lazard Capital Markets: Excellent.

Kate Kotlarsky, Goldman Sachs: Hi. This is Kate Kotlarsky for Jim Covello. Eli, I had a quick question on the comments you made about supply being tight in general in 2010. I was just curious if you look at the second half versus the first half how much tighter if at all do you think the second half of the year is going to be and kind of tying into that into your comments about evaluating Toshiba, kind of what are the things that you’re going to be looking at as you think about potentially making the investment in fab 5? Thank you.

Eli Harari: Okay, so there is a number of questions in that, so let me try and address those and I’m sure there would be maybe a few other questions on that. So, Judy has indicated we’re raising our guidance for the year from 4 billion to 4.4- to 4.5 to 4.8.

That’s $500 million additional revenues which of course would require very substantial additional gigabytes, petabytes and units that we are forecasting. We will need flash for this year.

So of course the solution to getting that supply is first from captive which is Fab 4, and then non-captive, and then anything we do with Fab 5 will definitely not have any impact. It will not be available until well into 2011 at the earliest.

So, this is what in my remarks I said we’re striving to get our output this year to about 75% more bits this year, later in the year, and this comes from primarily greater efficiency in Fab 4, better yields than we had expected in Fab 4, as much utilization of X3 as we can squeeze out of wafers and that’s going very well and building some additional capacity in Fab 4 in the clean room space.

And there we’re somewhat limited by equipment lead times and of course there is not much space left in there. So all of these in combination give you that 75% or so increase. And that may not be enough and in that case we will explore the non-captive option.

Kate Kotlarsky, Goldman Sachs: Okay. So that 75% implies that you’re primarily using captive supply and not too much non-captive?

Eli Harari: That’s correct, yes.

Judy Bruner: The 75% is the amount by which we believe we can grow our captive output.

Eli Harari: That’s right.

Judy Bruner: In 2010.

Kate Kotlarsky, Goldman Sachs: Okay.

Judy Bruner: Revenue in bits could potentially be more if we purchased non-captive and/or we’re able to increase our inventory turns.

Kate Kotlarsky, Goldman Sachs: Okay. That’s very helpful. Can I just ask one additional question? That 75%, how does that compare to what you would expect for the industry in general. That’s it for me. Thank you.

Eli Harari: So we’ve said in the past that we think from what we see from various independent marketing firms- they’re projecting between 70 and 90% bit increase and we said at the beginning of the year we’re going to be unable – that we’ll be up to 70%. Now, we are more confident that we can be about at 75%, still at the lower end of that industry range.

Kate Kotlarsky, Goldman Sachs: Okay. Thank you so much.

Paul Coster, JPMorgan: Yes, thank you. As you approach the CapEx decision along with your partner Toshiba, can you just talk to us a little bit about what’s going into those discussions and also is there any chance that you may again revise the nature of the joint venture and the share of the JV that you own?

Eli Harari: Well. As you know, Paul, we announced more than two years ago an MOU with Toshiba, a non-binding memorandum of understanding, with Toshiba for the creation of fab 5, and that of course ran into the recession that the whole industry and really was put on hold.

About a month ago, Toshiba announced that they will commence the construction of the shell in Yokkaichi. This is basically a decision to build just a building. And we certainly plan to continue the partnership that we have with Toshiba in fab 5. However, I have also said in the past and we really feel very strongly, that we need to play our part as best we can to maintain health in the industry by not bringing our new capacity – any new capacity that we have from any new sources too soon to the market- that that would be not good for us and of course, we can’t control what our competitors are doing. But basically this for the last, I termed last quarter is curbing our enthusiasm.

That said, we do need to – we do see demand for flash growing at a very strong pace both from the mobile and from other markets including SSD, and therefore we do – again, I have said on February 26, it’s not a question of if we’re going to participate in fab 5 but when, and to what extent and the timing and so on. And all of those have not yet been decided. And we will let you know when the decisions are being made.

Paul Coster, JPMorgan: Do you think that Toshiba shares your philosophy at the moment regarding being cautious about the introduction of new capacity?

Eli Harari: I think you have to ask Toshiba.

Paul Coster, JPMorgan: That’s right, thank you very much.

Eli Harari: Thanks Paul.

Bob Gujavarty,  Deutsche Bank: Thanks, guys, and fantastic job on the margins. I just had a question given how the strong OEM sales have been. Do you get any sense or has this entered in to your discussion in terms of maybe OEMs pre-buying an anticipation of a shortage in the back half of the year? Have you kind of made some assumptions for that as you cleaned your backlog so to speak just to account for any possibility of pull-in of orders?

Eli Harari: 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.

Bob Gujavarty,  Deutsche Bank: Great. Thanks.

Judy Bruner: Bob, this is Judy. I will just add that at the present time we work very closely with our customers, and we monitor both the retail channel inventory and the OEM channel inventory and we believe that both are at normal levels today.

Bob Gujavarty,  Deutsche Bank: Okay, great. And just a quick follow-up. I know we’ve had good positive retail sales data out of the U.S. Is there – are you at all more hopeful maybe now than three months ago or any color on the retail side of the business, not suggesting you give us the December prediction, but is there any inkling of hope there on that side?

Eli Harari: Yeah, I think so. I mean, I think that the U.S. retail and Europe retail depends very much on the recovery in the economy and to the extent that people are beginning to be a lot more optimistic about return of growth, even a slow growth would be very helpful.

Bob Gujavarty,  Deutsche Bank: Great, thanks a lot.

Uche Orji, UBS: Eli, now first of all congratulations on the terrific set of results. Let me just ask you about your confidence of getting access to non-captive supply. Right now demand supply is in balance like you mentioned, but is there any any way you feel for sure that being able to tap non-captive supply and has this already been negotiated prices or will you spending on what the spot market doing in terms of your future dependence on non-captive?

Eli Harari: We have legal agreements that afford us guaranteed access to capacity from several of our licensees. However, it is again, I’ve said in the past that you just can’t turn it off on a switch; you can’t just come and say- okay, next week ship me this. There is a forecasting period. There is lead times and it is not something you can jump in and out of. It’s not that easy.

Uche Orji, UBS: Okay.

Eli Harari: There is a lead time involved.

Uche Orji, UBS: Different question. I mean, you were talking about some low capacity NAND that you said has been popular. Are these in retail or in OEMs and if in OEMs what kind of product are using this lower capacity NAND?

Eli Harari: So I think the main driver for low capacity cards mostly MicroSD one or two gigabyte, amazingly there is a huge number of handsets in – in countries such as China, India, South America and so on, and Africa, where you can get a very good handset for $20 or $25 and those phones used to rely almost entirely on embedded flash, mostly NOR flash or low capacity NAND flash and just in the last several quarters they seem to have switched in very large quantities to a card slot MicroSD in 1 or 2 gigabytes and they can play music and they have an FM radio. So they become now the music player and some of them for 25 bucks you have camera.

So traditionally, we expect that the 1 gigabyte and 2 gigabyte to even kind of disappear but it has come back because of these phenomena. We think it is here to stay, I mean for a long time.

Uche Orji, UBS: I see. And then just particularly the last one, how much of your bit production in Q1 was 24 nanometer and within the 24 nanometer, when will the X3 or X4 be qualified and in full production?

Eli Harari: We have said that 24 nanometer is in development right now.

Uche Orji, UBS: Okay.

Eli Harari: In advanced development and that we expect to start production by late this year.

Uche Orji, UBS: Okay. Is there any cost differential in terms of a CapEx cost to add capacity say 10,000 wafers demand incremental capacity at 24? How does that compare with the previous generation if at all just for us to have a sense of what this means for you from a CapEx and cash flow standpoint? Thank you.

Eli Harari: Every generation of technology migration does require CapEx investments usually to a far lesser degree than starting just wafers from scratch. And, it depends what kind of not that, different companies have different transitions between technologies. In our case, the technology – [coughs]  I am sorry – our 22 nanometer technology and our 24 nanometer technology [Eli probably means 24nm and 32nm] require relatively small equipment changes, so that’s actually very positive.

Uche Orji, UBS: Right. Well. Thank you very much.

Craig Ellis, Caris & Company: Yeah. Thank you, Eli. Congratulations.

Eli Harari: Thank you.

Craig Ellis, Caris & Company: The first question is on just your cost reduction. Can you help us understand the linearity of the cost reduction that you would hope to achieve this year, more front end loaded? relatively balanced? is there anything that would cause it to be lumpy through the year?

Judy Bruner: Craig, I would say that given how much of the cost reduction we were able to pull into the first quarter that in terms of sequential improvement in cost per bit, I expect that Q1 may be a quarter that is difficult to repeat, but relative to the other quarters, I don’t necessarily expect much difference between the Q2, Q3, Q4 in the approximate level of cost decline and as I said, we expect the full year to reach a cost improvement at the high-end of our range of 30 to 40%.

Craig Ellis, Caris & Company: Okay. That makes sense and then Judy, just on the outlook for the year, it looks like there is unusual degree of stability and revenues from the first half to the back half. Does that reflect concern about the strength of the retail business in the back half of the year? Does that reflect concern about supply availability beyond your captive bit growth? How do we interpret the implication for second half growth off of the full year guidance?

Judy Bruner: It does reflect some potential shortage of supply, particularly for the low capacity product that we just discussed a few minutes ago- the 1 and 2 gigabyte memory- and at the moment, as we indicated, the retail business does remain somewhat soft in the U.S. and Europe and we’re optimistic that we’ll begin to see some improvement later in the year, but we haven’t seen that yet.

Craig Ellis, Caris & Company: Okay. Congratulations again and thank you.

Eli Harari: Thank you.

Next question comes from Kevin Cassidy with Thomas Weisel Partners.

Neely (?), Thomas Weisel Partners: Hey, this is Neely (?) for Kevin. I was just hoping you guys could may be tell me what the mix was between 3-bit and 2-bit for the quarter? and what they might be looking like while going forward?

Judy Bruner: We are not going to give a specific mix but our 3-bit-per-cell was above 50% in the first quarter and we expect it to remain approximately 50% or a bit more for the entire year.

Neely (?), Thomas Weisel Partners: Okay. And I also wanted to follow-up on a previous question regarding, I guess some of the cost benefits that you guys might have going from sort of the 34 nanometer 3-bit to sort of 20 nanometer 2-bit, if you could just maybe elaborate little bit on that?

Eli Harari: Actually we are 32 nanometer and some of our competitors are 34 nanometer. Actually it’s funny because people are talking about throwing numbers about what is 2X. Now we have 20 nanometer class which means whatever you want. It has a two in there somewhere in the number. Anyway from 32 nanometer – first of all, 32 nanometer from 43 nanometer is a very substantial cost reduction, and particularly if you stay 3 bits to 3 bits, 43 nanometer X3 to 32 nanometer X3.

As we get to lower geometries, more scaled, I am sure again I’ve said before we expect the difficulty of implementing X3 will increase but we feel that there we are playing to our strength. So we fully expect that when we get to 24 nanometer we will be able to take our X3 with us without in anyway comprising performance.

So from 32 to 24 again pretty substantial cost reduction and basically you’re looking at, we have said NAND is going to start slowing down and we truly believe that, but at the same time the industry and we are moving still at a pretty rapid pace and I would say that the end of scaling of NAND has probably been greatly exaggerated, maybe by us as well. So, actually it’s looking a little bit better all the time and that of course would be very good news for SSD particularly.

Neely (?), Thomas Weisel Partners: Thank you guys.

Daniel Berenbaum, Auriga USA: Hi, good afternoon. Thanks for taking my call. First question, what is the progress on getting 3-bits-per-cell into OEM? I know there has been some reliability concerns as you move to 3-bits-per-cell. How much are you selling into OEM currently and are you going to be able to expand that?

Eli Harari: Initially it has been an uphill battle but it is getting much better now because we have been able to demonstrate through very exhaustive OEM qualifications that the product is very, very good and furthermore through this AFM, adaptable flash memory, we can actually get very very good performance with X3 and everybody understands that- the cost benefits of that. So, I would say that the efforts of the last year are beginning to bear fruit right now, and I think once we’re over the hump that people will wholesale adopt X3.

Daniel Berenbaum, Auriga USA: Okay. I am sorry, I should have said embedded actually.

Eli Harari: Yes, I am talking about embedded.

Daniel Berenbaum, Auriga USA: You’re talking about embedded.

Eli Harari: It is removable cards we have been shipping. We are the ones that qualify X3 and clearly as that moves into production very early.

Daniel Berenbaum, Auriga USA: So then that progress on X3, does that change your long-term view on what you can do for cost per bit reduction? Does that improve that longer term view? Related to that, Judy, you said that you expect operating margins this year to be above the long-term business model. You just had a very strong quarter. Why does this quarter not change your view of what the long-term business model should be? Can you just help me understand why – how you’re thinking about that?

Judy Bruner: Yeah. Let me start with the second part of your question. At our analyst day at the end of February when I laid out the long-term financial model, I described that model as a model that we believe is optional over the long-term in order to balance growth and profit and cash flow. I said that in some years we expect that we will beat the long-term financial model and in some years we will miss it, so it is not my expectation to continue to adjust that long-term financial model, but rather aim for that over time and what I am saying is it looks like this year is a year where we can beat the long-term financial model. And I am sorry. What was the first part of your question?

Daniel Berenbaum, Auriga USA: Just on the good progress on getting 3-bit-per-cell into embedded, does that change your view of the longer term cost reduction? I think you talked about longer term cost reduction as 20% to 30% per bit annually. Does that improved adoption of 3-bits-per-cell into embedded change the view of that?

Eli Harari: No, because we assumed it in the first place. We of course assumed success, not – so we are marching to our plan and we’re doing well against our plan.

Daniel Berenbaum, Auriga USA: Okay, great. Thanks very much.

Hendi Susanto, Gabelli: Hi, all. Thank you for taking my questions. First, I would like to understand more about your plan with regard to non-captive supply. Like, how much confidence do you have in securing 10% to 15% of the coming from the non-captive supply and how much is the maximum like non-captive supply can you get in the second half of 2010 meaning that whether you will be able to secure more than the 10% to 15% that you mentioned before. And could you help us understand and quantify what gross margin impact of using non-captive supply?

Judy Bruner: So, let me clarify. We’ve not given any percentage of non-captive for the second half of this year. And when Eli was describing a 10 or 15%, he was saying that that was sort of the range that we think we might be in – in some periods of time over time. I expect that if we use non-captive in the second half of this year it will probably be modest amounts of non-captive but it is one factor that we are taking into account in our expectations of gross margins for the second half.

Hendi Susanto, Gabelli: Okay.

Eli Harari: And the second margin implications.

Hendi Susanto, Gabelli: Yes. And, then –

Judy Bruner: Yes.

Eli Harari: The margin implications, as we said before of course, that this is a much lower-margin business.

Hendi Susanto, Gabelli: And then you mentioned that for OEM business there is some need of using more captive supply. And how about solid state disk drives, will the choice of non-captive versus captive supply matter in SSD?

Eli Harari: Yes, very much so. Certainly a big part of the SSD market will be OEM, very much so in OEM. There will of course be the retail space in retail it can be non-captive, but I have to say that for SSD we have a very substantial engineering effort and I could tell you that it’s very, very focused on squeezing out the best performance from the flash that we know best which is our own captive flash, so it’s very difficult to get the kind of performance that we feel we can deliver in an SSD environment at a low cost, very high performance, and great reliability. We feel that the best approach there is to use captive for that, even for retail.

Hendi Susanto, Gabelli: Okay. And one last quick question. For the low capacity memory product how is the margin compared to your corporate average margin? Is it lower or is it comparable or higher?

Eli Harari: The margin is very good. And just as an aside, we have said that the new channels that we have today that we didn’t have a year ago really have given us the diversification to allow us to make decisions of how we allocate our supply, how, between these markets based on maximizing profitability.

Hendi Susanto, Gabelli: Thank you.

Caitlin Wolford, Ardent Capital Management: Good afternoon and, wow, great job. Just a quick question and you may have gone over this at the analyst meeting which I missed. Did you say on the call that you were slightly north of 50% on the 3 bit technology?

Judy Bruner: Yes.

Caitlin Wolford, Ardent Capital Management: Okay. And then my question is assuming standard node for each 2 and 3 bit, is the number of die per 12-inch wafer similar?

Eli Harari: Yes. Yes, you just get – yes, very similar, you just get more bits per wafer.

Caitlin Wolford, Ardent Capital Management: Right. Okay. And then –

Eli Harari: per die and therefore per wafer.

Caitlin Wolford, Ardent Capital Management: And then assuming a similar process node, is there a significant difference in terms of how the line is configured or the equipment between the two different technologies?

Eli Harari: No. Essentially identical.

Caitlin Wolford, Ardent Capital Management: So to move, you can move rapidly say within a quarter by moving 2 bit equipment to the 3 bit line?

Eli Harari: Within a day maybe.

Caitlin Wolford, Ardent Capital Management: Within a day? Great, okay. That answered my question. Thanks so much, and wow, great to have you guys doing so well.

Judy Bruner: Thank you.

Betsy Van Hees, Wedbush: Thanks for taking my call and congratulations on a fantastic quarter. Eli, I was wondering if you could help us understand in regards to the new channels of that 626 million in revenue that you did in the OEM, how much of that came from the new channel.

Judy Bruner: Betsy, we’re not going to break out the specific mix of old channels versus new channels, but I will say that our business from new channels and new customers that we added in 2009 did grow sequentially from Q4 to Q1.

Eli Harari: And it is quite substantial.

Betsy Van Hees, Wedbush: And it is quite substantial in terms of the growth or the percent of the overall?

Eli Harari: Both.

Betsy Van Hees, Wedbush: Okay

Eli Harari: Well, the percentage for sure.

Judy Bruner: Percentage, yes, but it did grow. As I said, our OEM revenue in total was down sequentially 2%, although keep in mind that was going from a 14 week quarter to a 13 week quarter. But regardless, the new channels and new customers grew sequentially from Q4 to Q1.

Betsy Van Hees, Wedbush: Thanks, that’s very helpful. So, as we look at the back half of the year and the concerns that you seem to be highlighting about capacity constraints and supply, what’s that going to do to the new channels and your new relationships as you’re looking at trying to allocate the supply that you’re going to have to your various new businesses?

Eli Harari: Well, you know, we are looking at all of these channels as strategic and long-term, and we understand that to do so, if we have to get into allocation we have to do so in a very sensible way and to spread the pain if you will. But our number one priority frankly is to see what we can do on the supply side so that we don’t constrain our customers.

Betsy Van Hees, Wedbush: Thanks so much and once again congratulations on a fantastic quarter.

Eli Harari: Thank you.

Tristan Gerra, Robert Baird: Hi, what were your channel inventories at the end of Q1 for flash cards? I think you were at around five weeks last quarter?

Judy Bruner: Our retail channel inventory on a worldwide basis is at about 7.5 weeks on a backward looking basis at the end of Q1 and that’s very similar to what it was at the end of Q1 last year. It is a very normal range. It tends to be lower at the end of Q4 on a backward looking basis because of the very strong sell through in the December timeframe.

Tristan Gerra, Robert Baird: Great. Thank you.

Atif Malik, Morgan Stanley: Hi, thanks for taking my questions, nice quarter, quick clarification, Judy. The full year gross margin guidance assumes non-captive supply buying in second half this year?

Judy Bruner: It assumes some potentially modest amount in the second half.

Atif Malik, Morgan Stanley: Okay. And then, Eli, the question of supply, if you look at equipment makers in a backlog of very little NAND equipment in their backlogs like asml lithography, there is something different about this time, this year, on NAND spending. You guys and others like Samsung have been very disciplined in placing even on shrink any increment spending.

So my question is there anything fundamentally different in terms of technology, EUV, not ready, in two year’s time that’s giving NAND makers a pause or discipline that we will be in this kind of spending behavior longer and if we do add supply, it will be added in very small increments like you have announced 10% kind of incremental capacity? Is there anything fundamentally different about this time?

Eli Harari: No. And with regards to EUV, EUV still is quite a ways away from mass production and certainly for very high volume production. So I think the assumption is that the demand growth will overwhelm existing capacity and that new fabs that use existing, lithography and existing NAND scaled to as far as it will go, will have to be built in order to meet the demand in the next – I would say really two to five years.

Atif Malik, Morgan Stanley: Okay, thanks.

Eli Harari: Okay. Well, thank you very much. This is great. And as we said, we are looking forward to – this is a very good start and a good 2010. Thank you very much. We’ll see you in a quarter.

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