2011.04.21 SanDisk Q1 2011 Conference Call

24 April 2011 Q1 2011 SanDisk Conference Call

Sanjay Mehrotra, President and CEO
Judy Bruner, Executive Vice President, and Administration & CFO
Jay Iyer, Director of IR


Jay Iyer, Director of Investor Relations: Thank you and good afternoon. Joining us on the call today are Sanjay Mehrotra, President 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 Sanjay.

Sanjay Mehrotra, President and CEO:

Thank you Jay and good afternoon everyone. Before I provide a review of business results and activities, I would like to spend a few minutes on the recent events in Japan, as I know the topic is of key interest to you. On March 11, Japan suffered a major earthquake and a series of significant follow-on events. Our prayers go to those impacted by these events. Fortunately, for SanDisk, our employees and their families in Japan were unharmed. In addition, our joint-venture wafer fabs in Yokkaichi were relatively unaffected as they were approximately 500 miles from the quake’s epicenter. The earthquake halted normal fab operations for less than a day. The fabs have not been subject to rolling power outages or blackouts. We have been working closely with Toshiba as well as other business partners in Japan to minimize the impact to our NAND flash wafer production.

Based on our current assessment of the entire wafer fab related supply chain, there
are no immediate constraints of key materials, chemicals, gases or other consumables.

Where we have identified potential future shortages, we have been actively working to find, qualify and implement effective solutions, including alternative sources. Judy will provide an estimate for the total costs we incurred in the first quarter from the earthquake as well as from an un-related power outage that occurred in March due to a maintenance issue in Fab 4.

We did suffer a modest loss of supply due to the downtime from the power outage and earthquake. In addition, we expect some earthquake related delays in tool deliveries from certain suppliers in Japan that will affect our expected 2011 captive supply growth. Overall, we project a slight reduction in planned captive bit supply growth from the mid-80% range we estimated previously for 2011. We continue our efforts to maximize captive output and evaluate prudent use of non-captive supply.

Aside from our captive flash memory wafer production in Japan, the rest of the supply chain related to the products we sell is operated out of Taiwan and China through our wafer foundry suppliers for memory controllers, our own Assembly and Test factory in Shanghai, as well as our subcontractor partners outside of Japan. We acted quickly to identify potential shortages and secure and qualify replacement materials. Through collaboration with partners in this supply chain, we currently have no concerns for meeting our future back end production requirements.

I am proud of our entire manufacturing operations team, particularly SanDisk employees at the wafer fabs in Yokkaichi, Japan, as well as our partner Toshiba for promptly assessing and addressing earthquake related production issues. I am thankful for their dedication, around the clock hard work and excellent team spirit to minimize any impact to our business in this difficult period for Japan.

From a captive capacity perspective, we completed the expansion of Fab 4 in the first quarter and that facility is now operating at its full capacity. We expect minimal delay in the timing of the ramp of Fab 5, and the new facility should begin augmenting our overall captive supply in the second half of this year. From a demand standpoint, we have not seen any customer pullbacks in the near term, and we are monitoring order trends very carefully. We have been in close contact with our customers to keep them abreast of earthquake related supply issues and we appreciate their collaboration and support during this period in helping us qualify replacement materials so that we can fulfill their demand.    Based on the strong demand trends that we see in our markets and combined with our supply expectations, we expect to be somewhat supply constrained for the remainder of the year.

Turning to the first quarter, we delivered strong results through solid planning and
execution. OEM demand grew sequentially and the retail channel exhibited normal
seasonality. Total unit sales of our products grew a very strong 11% sequentially, reflecting a robust market environment as well as successful execution of our diversified product and channel strategy.

Our OEM business continued to be propelled by the mobile end market and the products that drove the unit growth were iNAND, other embedded solutions and removable microSD cards. Total unit sales of mobile products grew nearly 40% on a year-over-year basis. The smartphone market remains as vibrant as ever with more than 250 new models expected to launch in 2011 alone, according to industry analysts, and this bodes well for our mobile product line up. Tablet customer activity remains strong for us and we are seeing requests for 16 gigabyte and higher capacities of our embedded solutions for this market. We continue to make good progress on our modular SSDs, with unit shipments increasing nicely driven by the growing ultra- thin portable computer market.

Our retail business posted good revenue growth on a year-over-year basis driven by demand from all key regions except Europe, which continues to be impacted by macroeconomic factors. In BRIC countries our unit sales have grown approximately 75% on a year-over-year basis. This reflects both our market share gains and rapid growth in demand for our products. On the product front, we began shipments of the SanDisk Extreme ProTM SDHC cards that are based on the new SD 3.0 UHS specification. These high-performance cards are geared to support the increasing
adoption of the 1080P full HD resolution video in both cameras and digital camcorders.

We see the full HD video recording feature increasingly moving not only to more attractively priced digital SLR, but point and shoot cameras as well, and that should drive a greater demand for high performance and higher capacity cards. We also started shipping USB flash drive products with the SanDisk SecureAccess software, which protects files against unauthorized access by creating an encrypted, password-protected folder or “vault” on the USB flash drive.

Switching gears to manufacturing, the 24 nanometer technology, utilizing both 2-bits per cell and 3-bits per cell architectures, continues to ramp well and we expect it will account for the majority of our captive output in the second half of this year. We don’t anticipate the recent events in Japan to cause any meaningful changes to the schedule of the ramp of 24 nanometer or 19 nanometer technology, which we announced yesterday.

At our analyst day in February, we presented our floating gate NAND roadmap extending to 1X, which is now 19 nanometer, and then to 1Y nodes. We are also simultaneously exploring further scaling approaches for NAND beyond the 1Y node and other possible future technologies. In the first quarter, we made an incremental strategic technology investment with Toshiba that covers a variety of technologies including a three-dimensional NAND architecture, known as Bit Cost Scalable or BiCS, which Toshiba had been developing independently. We believe that SanDisk and Toshiba joining forces to co-develop BiCS will allow us to further build on our past decade of successful development of multiple generations of NAND flash technologies.

BiCS, if successfully developed and commercialized, can leverage the installed NAND toolsets in the wafers fabs very well, thereby extending the useful life of fab equipment.    We expect BiCS to enable further memory cost reductions beyond the future 1Y or subsequent scaled NAND, until 3-D Read/Write memory, which remains our ultimate goal, is fully ramped into high volume production.

Speaking of 3D Read/Write, joint development work with Toshiba is progressing well, and as also mentioned at the analyst day, we believe it will require extreme ultraviolet (EUV) lithography for future volume production. The extreme ultraviolet lithography equipment and technology are in early stages of development and the timeframe for commercial deployment is yet to be determined. Our three-pronged approach to R&D collaboration with Toshiba in the areas of NAND scaling, BiCS and 3-D Read/Write should position us well for continued technology and cost leadership in the coming decade.

In closing, we are pleased with a strong start for the year. We continue to manage the impact of recent events in Japan, and on taking advantage of the secular growth markets for NAND Flash. Overall, we continue to experience a healthy environment for our business and we are driving hard and executing well on all fronts.
With that, I will turn the call to Judy.

Judy Bruner, Executive Vice President, Administration & CFO: Thank you, Sanjay. We are pleased to report a strong first quarter with revenue up 19% year-over-year, non-GAAP operating margin at a robust 28.5%, and non-GAAP EPS up 8% year-over-year. Our gigabytes sold grew 7% sequentially while ASP per gigabyte declined 8%, and on a year-over-year basis, gigabytes sold increased 78% and ASP per gigabyte declined 32%. Our sequential price decline of 8% was modest for a first quarter and was influenced by mix, with OEM growing to 66% of sales from 59% in Q4, and USB mix increasing seasonally in retail; and both of these mix shifts lead to a somewhat lower ASP per gigabyte. As Sanjay mentioned, our retail business exhibited normal seasonality, down 19% sequentially, and we were pleased with year-over-year growth in retail revenue of 10%. Year-over-year retail sales growth was good in both the Americas and APAC with particularly strong growth in the fast growing regions of China, India, and Latin America, where we also believe we are gaining share. Our EMEA retail sales were down slightly year-over-year, with economic weakness in Europe partially offset by solid growth in the Middle East and Africa. Our OEM sales grew 9% sequentially and 29% year-over-year with the clear driver of growth being our embedded products. We were also pleased with the sequential growth in sales of our modular SSDs and our gaming products.

Our non-GAAP product gross margin for the first quarter was 39% inclusive of a $25
million charge for the combination of a power outage in Fab 4 and the Japan earthquake. A maintenance issue occurred in Fab 4 on March 8th which resulted in a power outage that brought equipment to a stop. Fab 4 was in the process of returning to normal output when the March 11th earthquake occurred, which of course impacted both fabs, and both fabs recovered fully by March 13th. The $25 million charge, or 2 points of product gross margin, includes the cost of scrapped wafers, fixed costs associated with lost wafer output, and costs to bring the fabs back on-line. Q1 product gross margin was also negatively impacted by the Yen to dollar exchange rate, with the sequential impact being about 1.7 percentage points, however unlike the power outage and earthquake, the Yen impact was anticipated in our forecast as the rates experienced in our cost of sales are largely determined by purchases in the previous quarter. Our non-captive memory usage was approximately 5%, similar to the fourth quarter. Our first quarter cost per gigabyte improved sequentially by 8% inclusive of the $25 million charge, the unfavorable Yen movement and our non- captive usage.
First quarter non-GAAP operating expenses were $189 million, less than we had expected primarily because of the timing of certain Fab 5 R&D start-up costs, which we now expect to incur in Q2 instead of Q1. Other Income and Expense was income of $5 million, lower than Q4 by approximately $8 million primarily because Q4 benefited from approximately $5 million in gains on the sale of investments and because of foreign exchange fluctuations. Our non-GAAP tax rate for Q1 was 33% as
expected, and our GAAP tax rate was 32.3%.

On the balance sheet, cash and short- and long-term marketable securities increased sequentially by $164 million bringing gross cash to $5.5 billion and net cash to over $3.3 billion. Our Q1 cash flow from operations was $399 million reflecting strong profitability and positive contribution from both receivables and inventory. Our accounts receivable collections were excellent and our inventory reflects 6 turns measured in dollars and more than 7 turns measured in petabytes. Cash used for capex-related investing included a loan of $214 million to the Fab 4 Flash Alliance venture, a return of capital of $85 million from the Fab 3 Flash Partners venture and non-fab capital investments of $34 million, all adding to a total net capital cash investment of $163 million. Our total capital investments during Q1 were approximately $200 million, with the difference between this and the $163 million cash outlay funded by joint venture working capital. We also invested $115 million in technology and other assets including the investment in technologies that Sanjay described. Our off-balance sheet lease guarantees for fab equipment stood at $739 million at the end of Q1.

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.
For the second quarter, our captive memory supply has been reduced by the fab
downtime in Q1, and we do not believe we can fully make up the shortfall with non-captive supply due to lead-time constraints and mix considerations. Our assessment of demand is that it continues to be strong and we believe we will be somewhat supply constrained for the second quarter. Our estimate of the industry pricing environment for Q2 is stronger than in our original forecasts for the year and this partially offsets the impact of the supply constraint. We forecast Q2 total revenue to be between $1.30 billion and $1.35 billion. The Q1 fab events also lower our full- year estimates of captive supply, however we expect industry price decline for the year to be more moderate than we had originally estimated, and we remain comfortable with the revenue estimate that I provided at our February analyst day, at which time I indicated increased confidence in the upper half of the $5.3 billion to $5.7 billion range provided in January.
We forecast Q2 gross margin percentage to be similar to the first quarter, which is better than our original estimates due to the pricing environment. Compared to Q1, our second quarter gross margin forecast is positively impacted by the expectation that there will be no fab downtime charges, and negatively impacted by our plan to use a higher proportion of non-captive memory in Q2 than in Q1. For the full year, we are raising our non-GAAP product gross margin range to 37% to 40% compared to the previous range of 35% to 38%, and raising the total non-GAAP gross margin range to 41% to 44%, compared to the previous range of 39% to 42%.

Our non-GAAP operating expense forecast for the second quarter is $215 to $225 million with the most significant increases in R&D, largely driven by the impact of Fab 5 startup costs and the new technology investments we began in Q1. Other Income for Q2 is expected to be similar to Q1, and our non-GAAP tax rate forecast remains at 33%.

We remain on track for a 2011 capital investment in fab and non-fab equipment between $1.4 and $1.6 billion. The estimated cash requirement for these investments remains at $800 to $900 million, of which we utilized $163 million in Q1.

In summary, we produced strong results in the first quarter and our outlook for the year is intact or better. We will now open the call for your questions.


Daniel Amir, Lazard Capital Markets: Thanks a lot. Thank you for taking my call. A couple of questions here. First of all, on the captive versus non-captive, can you give us any sort of visibility? How should we look at the non-captive here going forward? It was 5% in Q1, it’s increasing as the year progresses. And what type of visibility could you see of maybe meeting the demand in the market by going to non-captive sources? And then I have one follow-up.

Judy Bruner: Hi Daniel, I’ll take that. At our Analyst Day, I had indicated that we expect to use up to 10% non-captive supply in our mix for 2011. And our estimates for this year remain in that range. We do expect that we will utilize a higher mix of non-captive in the second quarter than in the first quarter where it was 5%, but we remain in the 10% or less range for the full year. And we really make these decisions on non-captive usage on a month-by-month basis as we go and as the year progresses.

Daniel Amir, Lazard Capital Markets:

Okay. My follow-up question is on bigger picture on kind of the industry. I mean, there’s capacity coming onboard in the second half of the year by some of your competitors. I mean, how do you view kind of the rest of the year in terms of the industry side? It seems like SanDisk might be capacity constrained, but in terms of the industry, what’s the view on kind of the next 6 to 9 months in terms of the industry capacity? Thanks.

Sanjay Mehrotra: We feel that the environment for demand is strong in 2011 and beyond. And particularly, when you look at the secular demand trends, the markets for our products in the mobile phone, the tablets and SSD opportunities continuing to emerge as well. So when you look at third-party industry studies, they show that bit growth, even with new capacity coming on from the various suppliers, including ourselves, is in the range of high 70s to high 80s. And in our case, we have indicated that our total supply for the year is somewhat impacted. So all in all, I think we continue to see healthy demand and supply environment in our industry, including in the second half. And really, this is particularly because the demand trends continue to be strong.

Daniel Amir, Lazard Capital Markets: Okay, thanks a lot.

Atif Malik, Morgan Stanley: Hi. Thanks for taking my question. And a good job on the quarter and the guidance, given the limitations that the company was facing with the Japan earthquake. Question on the cost reduction. Judy, at your analyst event, you said cost reduction of 30% for the year, that includes 7 to 9 percentage points of then kind of one-time charges, including the yen. Can you talk about the loading of this cost reduction, 8% cost reduction in 1Q? Should we model it linearly through the year? Or can you just talk about the trajectory of the cost reduction?

Judy Bruner: I would tell you that our 24 nanometer transition, which is the key driver of cost reduction during 2011, is progressing across the year. I can’t give you real specific projections on a quarter-by-quarter basis, but that transition started in the fourth quarter of 2010 and is progressing across 2011. So we should see cost reduction across the year.

Atif Malik, Morgan Stanley: And the 19 nanometer announcement was baked into that 30% cost reduction that you gave at the analyst event.

Judy Bruner: The 19 nanometer is really starting later in the year and is really more a cost-reduction driver for 2012.

Atif Malik, Morgan Stanley: Got it. And second thing, inventory. Can you talk about the inventory at your OEMs? Obviously, there’s a concern that non-Apple tablets might not sell well. I mean, if you can talk about the inventory at OEMs for NAND.

Judy Bruner: We believe that the inventory levels in the channel and held by our customers are fairly normal. We’re not aware of any real issues in terms of inventory out there.

Atif Malik, Morgan Stanley: Thanks.

Kevin Cassidy, Stifel Nicolaus: Thank you for taking my question. As you’re looking out along those lines with the inventory being fairly normal, is there any change in the, I guess, the demand from different sectors? Are you seeing any change from tablets to SSD or more in the [pause] you mentioned the high-performance flash.

Sanjay Mehrotra: In terms of demand, let me just address it between retail and OEM. As we mentioned, on the retail side, we see significant increases in our demand in the emerging markets area, particularly the APAC area. And that’s really due to the growing demand in that region, as well as our market share gains in the region. And Europe, and particularly certain pockets of Europe, do continue to be somewhat weak as we indicated in the prepared remarks. And on the OEM side, the demand driver really is very much from the smartphone market as well as other mobile phones. And the tablet market is certainly picking up nicely. And we are engaged with all the leading players in the smartphone as well as in the tablet market. And that positions us well to ride the opportunity going forward. And of course, the SSD market, there for us, at this point, it’s more in the thin form factor devices, the ultra-thin notebooks. Our very low-profile packages such as our pSSD are doing well in that marketplace. So SSD is certainly still in very early stages, but building up as a nice opportunity for the future.

Kevin Cassidy, Stifel Nicolaus: Okay. How about any change in the demand for 1 bit per cell or 2 bit versus 3 bit?

Sanjay Mehrotra: So all of our production, as you know, is really pretty much between 2 bit per cell and 3 bit per cell memory, and our mix of memory in Q1 was approximately 50% for X3. And this is because the embedded part of the business on the OEM side is growing rapidly. And that part of the business as we had indicated at the Analyst Day, is still more X2-based, although we are making nice progress in continuing to increase quarter-over-quarter in terms of utilizing more X3 bits in that part of the business as well. For the full year, we expect our X3 bits to be more than 50%.

Kevin Cassidy, Stifel Nicolaus: Okay, great. Thank you very much.

Ada Menaker, Auriga USA LLC: This is Ada Menaker for Dan Berenbaum. Could you provide some additional granularity on SSDs? Are you seeing any, from your customers, any request for 2 bit per cell on enterprise SSDs? Or are those also 3 bit per cell?

Sanjay Mehrotra: With respect to our SSD products today, they are really all 2 bit based products. We certainly look at 3 bit based products as an opportunity for us in the future timeframe. Not for 2011, but maybe sometime beyond that. Regarding the enterprise space, there is some SLC utilization in enterprise. But SanDisk is really not a player in the SLC market. But even the enterprise space is converting to 2 bit per cell memory technology.

Ada Menaker, Auriga USA LLC: Thank you. And for my other question, could you maybe provide some detail on your royalty revenue?

Judy Bruner: The license and royalty revenue is down very slightly sequentially from Q4 to Q1, and that’s really a factor of the licensable revenue of our licensees during their fourth quarter, which is translated into our first quarter.

Ada Menaker, Auriga USA LLC: Okay, thank you.

Hendi Susanto, Gabelli & Company: Good evening and thank you for taking my call. Great results. My first question is how much cost advantage does the new 19 nanometer process technology offer? And can you refresh our memory also on the cost advantage of 24 nanometer versus 32 nanometer?

Judy Bruner: So let me just repeat, Hendi, because you cut out a bit. Are you asking for the cost advantage of 19 nanometer versus 24 nanometer?

Hendi Susanto, Gabelli & Company: Yes. And then 24 nanometer versus 32 nanometer?

Sanjay Mehrotra: So regarding the 19 nanometer, as Judy indicated and we have indicated in our prepared remarks as well as the press release, that will go into production in the second half of the year. So we will really provide more detail regarding the cost benefits of 19 nanometer at that time. With respect to 24 nanometer, basically, of course, the cost reduction, purely on wafer level between the 24 nanometer and 32 nanometer. Just doing simply apples-to-apples comparison without taking into consideration any exchange rate effects or any yield effects and assuming mature yields, the benefit there is in the range of 30% to 40%. But that’s just at the memory level. Keep in mind that our ultimate cost reduction has multiple factors in it. Our ultimate cost reduction that we discussed on a year-over-year basis has multiple factors. Those being the ramp-up of 24 nanometer, the exchange rate, the fab related, Fab 5 related start-up costs, as well as non-captive usage. So I just don’t want you to mix the 2 numbers. The technology benefit or in terms of cost versus our overall cost reduction year-over-year.

Hendi Susanto, Gabelli & Company: And what is the split between spot price and contract price in your OEM retail and overall?

Sanjay Mehrotra: I can’t [pause] we really do not supply, not at least directly to the spot market. And the split between spot market prices and contract prices, I mean, to the extent that it is out in the public, you can look at it, it’s quoted on the DRAMeXchange. But that’s really for the industry.

Hendi Susanto, Gabelli & Company: Thank you.

Uche Orji, UBS: Thank you very much. So Judy, let me start by asking since you provided us an update on revenues and margins for the full year, how should we be thinking about costs for the full year? Is it still roughly $850 million?

Judy Bruner: Expenses?

Uche Orji, UBS: Expenses, yes.

Judy Bruner: Right. At this point, we believe that the full year estimate of $850 million for OpEx is still our best estimate.

Uche Orji, UBS: Okay, great. Let me ask you a different question. Sanjay, on the power outages, this is the second quarter in a row where we’ve had a power outage. One in December and one even before the earthquake. What are you doing to make sure that this doesn’t constantly reoccur? I mean, among all the major fab operators, this seems to be more reoccurring with you than others. Secondly, in terms of how we should think about the impact, thanks, Judy, for giving us the cost impact, but when something like this happens, what should go through our minds in terms of what is affected within the factory network within the process, just so that we can calibrate it quickly enough without having to wait until the end of the quarter to be told by Judy?

Sanjay Mehrotra: Okay. So with respect to the power outage in the fab, in the Q4 timeframe of last year as well as Q1 of this year, let me elaborate on that. First of all, the power outage that occurred in Q4 was really an occurrence on the infrastructure, the power infrastructure in the area. Basically, a glitch in power supply in the area generated at the power supply company. And that glitch actually was of a very short duration, slightly above 100 milliseconds, and that impacted some of our equipment in Fab 3, and actually, Fab 4 at that time survived that okay. And Fab 4 is newer construction, and we have actually upgraded some of our equipment with the power structure in the fabs to improve that in that area. So the Q4 power glitch was created by [pause] I mean, the Q4 power outage was created by a glitch on the power company side. In terms of the Q1 glitch, this really occurred only in Fab 4, and this occurred due to an operator error. And basically we have taken actions, corrective actions in terms of process control. So really two very different reasons. The Q4 reason, not in our control, even though we have improved the fab tolerance to any power glitch in the future. And Q1 reason, human operator error, and we have taken corrective actions in terms of training, et cetera, with the fabs.

And let me actually correct myself, the Q4 glitch occurred in both the fabs, Fab 3 as well as Fab 4, and the Q1 glitch, the Q1 power outage was impacted by human error in Fab 4 only.

Uche Orji, UBS: Okay, great. Let me just ask you one last question, please. In the embedded business, you seem to be making some significant progress there. Can you talk about what you see as a potential opportunity for the iNAND and the modular SSD businesses this year? And at least for this year, where are you in terms of monetizing these 200 design wins you had last year? Who is shipping and how much more upside should we expect potentially, even if we didn’t have supply constraints? Just for us to gauge how much is coming from that. And also, what kind of margin should we anticipate going forward with the OEM business? It seems to have been dilutive to gross margins overall. Are we at a point where that should stabilize at least? Thank you.

Sanjay Mehrotra: So with respect to the OEM business and iNAND design wins, the ones we had talked about at the Analyst Day, actually many of those design wins are already getting into production and that’s what is really resulting in strong growth of our OEM business as well as the embedded business in particular. So the embedded business total overall in Q1 was over 40% of the total OEM business. And keep in mind that many of these design wins that we had discussed are also multi-year opportunities for us. So we are really doing well with our iNAND design wins. And you also asked about pSSD. We are doing well there as well. It’s a small part of our revenue in Q1, but we expect it to be growing nicely in the quarters ahead. And I think Judy can comment on the OEM margin question.

Judy Bruner: Right. I mean, keep in mind, as Sanjay just said, that the embedded business was more than 40% of our OEM business in the first quarter and we had strong gross margins in the first quarter. Of course, the iNAND business today is more X2 than it is X3, and we want to continue to improve that X3 mix, and we’re making progress on that. And so that will be positive for margins as we continue to expand the X3 mix within the iNAND business.

Uche Orji, UBS: Thank you.

Arthur Bechhoefler, Private Investor: Thank you for taking my question. I’m looking at the amount of cash that you have and in relationship to the total shareholder equity, and the relationship looks very, very high. Could you explain just a little bit more, give us a little bit better idea of why the cash is so high?

Judy Bruner: Sure. Keep in mind that our cash on a net basis, net of the maturity value of our convertible debt instruments, is between $3.3 billion and $3.4 billion. And as you know, we’re a very capital intensive business. And in fact we have a major fab, Fab 5, that is going to be ramping over the next several years and will require capital investment. So we are comfortable with the amount of cash that we are holding relative to the capital investment that we need to make and ensuring that we continue to have a very strong and a very flexible balance sheet, including flexibility for other investments that we may choose to make over time.

Arthur Bechhoefler, Private Investor: Do you see any possibility of a dividend in the near future?

Judy Bruner: I would say not in the near future. We’ve never paid a dividend. I don’t anticipate that, given the capital investment we have in front of us over the next several years.

Arthur Bechhoefler, Private Investor: Thank you.

Craig Ellis, Caris & Co: Thanks for taking the question. Nice job in the tough environment, guys. Judy, you mentioned that the company’s outlook for pricing had changed and become more favorable. Can you give a little bit more context in terms of when you all felt comfortable starting to take a different view of the market’s pricing? And can you quantify specifically how much the view has changed?

Judy Bruner: Well, we saw a fairly favorable pricing environment across Q1 and into Q2 so far. So I can’t pinpoint an exact time when our view changed, but we have become more comfortable that the pricing, the price decline for the year will be more moderate than we had originally anticipated in our estimates. The expectation for price decline for the year is still a bit higher than our estimate of cost decline because our product gross margin guidance of 37% to 40% is still a bit lower than the product gross margin last year. But we’ve not quantified the specific pricing estimates or the specific cost reduction estimates. And keep in mind that in that cost reduction, we still have the impact of the 3 factors that I spoke about at length at our Analyst Day, namely the yen exchange rate and Fab 5 start-up costs, as well as the non-captive mix.

Craig Ellis, Caris & Co: As well as now the power outage issue in the first quarter, right?

Judy Bruner: Clearly, yes. And that puts, of course, some pressure on the cost reduction for the full year.

Craig Ellis, Caris & Co: Okay. And then just a clarification, you mentioned that there was fab start-up expenses in the quarter, but it sounds like not as much as expected. Can you quantify what the impact was to 1Q and what you’re expecting for 2Q?

Judy Bruner: I’m not going to give a specific breakdown by quarter. But the Fab 5 start-up costs that we’ve incurred so far have been predominantly in R&D. And my estimate of the total R&D Fab 5 start-up costs for the year is still about $50 million in R&D and about $75 million in cost of sales. And that $50 million in R&D is anticipated in Q1 through Q3, with the heaviest period in the second quarter.

Craig Ellis, Caris & Co: Okay, very good. And then lastly, Sanjay, I’m wondering if you can just talk a little bit about the product side of the business from a mix standpoint. This is the first time in a couple of quarters, at least, that I remember the company really talking about SSD. So when do you think the SSD business can become a material percentage of revenue percentage?

Sanjay Mehrotra: I think, again, in the small form factor SSDs, such as pSSD, the business is continuing to grow, although for this year it will remain small. We expect this to become a bigger part of our business next year and going forward, beyond that. Regarding the high-performance SSDs, we plan to have products in the second half of the year. And I would expect that to start becoming a growing opportunity for us next year onward as well. So overall, for 2011, SSD will remain a small revenue contributor, relatively small revenue contributor for us, but it becomes a larger opportunity for us from 2012 onwards.

Craig Ellis, Caris & Co: Good luck. Thanks.

Bob Gujavarty, Deutsche Bank: Great. Thanks. I was curious in this kind of constrained environment, are you in a position to kind of optimize your product mix in terms of just perhaps shifting more Extreme cards at the expense of your blue label cards, those kind of things? Or is that further potential upside in terms of mix and margins?

Sanjay Mehrotra: So in this kind of constrained environment, we definitely do manage the mix of our products. And we take into consideration various factors, such as short-term revenue and profit opportunity, as well as longer-term strategic customers, strategic consideration for our customers as well. But absolutely, I mean, we do have opportunities to mix our products to drive optimally our business forward.

Bob Gujavarty, Deutsche Bank: Great. And just a follow-up, I don’t know if you can speak about Toshiba to this extent. But my understanding is Toshiba is a conglomerate and they do have a nuclear power division. Have you noticed any distraction at Toshiba in their NAND operations relative to some of their other exposure and their other businesses?

Sanjay Mehrotra: Not really. As I said in my prepared remarks, we really are very thankful to Toshiba and certainly, to our people in Yokkaichi as well. I mean, our NAND operations, both in terms of R&D and manufacturing, are really driving full speed ahead.

Bob Gujavarty, Deutsche Bank: Great. Thank you.

Harlan Sur, JP Morgan: Thank you for taking my question. On the 19 nanometer announcement, and congratulations for the execution on that, I think you said previously you’d start to ramp 1x at the end of this year. In your press release, you said second half of this year. And so it seems like the ramp may have gotten pulled forward by a few months. I’m just wondering, do you expect a larger mix of 1x this year versus what you showed at your Analyst Day?

Sanjay Mehrotra: No, we don’t expect larger mix. It will be relatively small. Part of our production output this year. 1x is in qualification stages and development stages, and we plan to begin production in the second half.

Harlan Sur, JP Morgan: Okay. And then on the product side, again at your Analyst Day, the team spent quite a bit of time discussing the opportunities in the enterprise markets. It’s a potentially big opportunity for SanDisk. Wondering when are we going to see the team bring specific products targeting enterprise applications to the markets. Any inputs here would be greatly appreciated.

Sanjay Mehrotra: As we said at the Analyst Day, we really do consider enterprise as a growing and exciting opportunity for the business, for the NAND industry. We are evaluating our participation in that marketplace. There are a couple of different ways to participate in it. One is definitely sell our high-quality flash components for enterprise SSD storage, and of course, other way is to partner and have product offerings in the SSD space as well. So we are currently assessing our options here. It’s an important area for us for the future.

Harlan Sur, JP Morgan: Okay. And just one last question, Sanjay. I know you talked a little bit about managing the materials and chemicals and the disruptions there. But can you specifically address the 12-inch starting wafer [pause] 12-inch wafer supply and your ability to procure those wafers as you look out to the remainder of the year, given some of the disruptions by some of your suppliers?

Sanjay Mehrotra: So regarding the 12-inch wafers for Yokkaichi production, our supply needs are addressed for the next few months through our own inventory, as well as our supply mix from various suppliers of 12-inch wafers to the fabs. We actually have multiple suppliers of 12-inch wafers on the fabs, and as is well known, a certain supplier was in the impacted area. But our teams moved very quickly to secure supply from other suppliers as well. So between our inventory and between somewhat of a shift in mix of the wafers from different suppliers, our needs are met for the next few months. And beyond that, we think we will be fine because these suppliers are expected to come up going forward as well.

Harlan Sur, JP Morgan: Okay. Thank you very much, Sanjay.

Jay Iyer, Investor Relations: We want to thank everyone for joining our call today. A webcast replay of today’s call should be available on our investor relations website shortly. Thank you and have a good evening.


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