Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

SanDisk (NASDAQ:SNDK)

Q4 2012 Earnings Call

January 23, 2013 5:00 pm ET

Executives

Jay Iyer

Sanjay Mehrotra - Co-Founder, Chief Executive Officer, President, Director and Member of Special Option Committee

Judy Bruner - Chief Financial Officer, Executive Vice President of Administration and Member of Secondary Executive Committee

Analysts

James Schneider - Goldman Sachs Group Inc., Research Division

Vijay R. Rakesh - Sterne Agee & Leach Inc., Research Division

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

John W. Pitzer - Crédit Suisse AG, Research Division

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Joseph Moore - Morgan Stanley, Research Division

Mark C. Newman - Sanford C. Bernstein & Co., LLC., Research Division

Dean Grumlose - Stifel, Nicolaus & Co., Inc., Research Division

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Bobby Gujavarty - Deutsche Bank AG, Research Division

Doug Freedman - RBC Capital Markets, LLC, Research Division

Operator

Good day, everyone, and welcome to the SanDisk Corporation's Fourth Quarter and Fiscal Year End 2012 Financial Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jay Iyer with Investor Relations. Please go ahead, sir.

Jay Iyer

Thank you, Elizabeth and good afternoon, everyone. With me on the call are Sanjay Mehrotra, President and CEO of SanDisk; and Judy Bruner, Executive Vice President of Administration and CFO.

Before we begin, please note that any non-GAAP financial measures discussed during this call as defined by the SEC in Regulation G will be reconciled to the most directly comparable GAAP financial measure. That reconciliation is now available along with supplemental schedules on our website at sandisk.com/IR. Please note that non-GAAP to GAAP reconciliation tables for all applicable guidance will be posted on our website This guidance is exclusive of any onetime transactions and does not reflect the effect of any acquisitions, divestitures or similar transactions that may be completed after January 23, 2013.

In addition, during our call today, we will make forward-looking statements. Any statement that refers to expectations, projections or other categorizations of future events, including financial projections and future market conditions, is a forward-looking statement. Actual results may differ materially from those expressed in these forward-looking statements. For more information, please refer to the risk factors discussed in the documents we file from time to time with the SEC, including our annual report on Form 10-K for fiscal 2011 and our subsequent quarterly reports on Form 10-Q. SanDisk assumes no obligation to update these forward-looking statements which speak as of their respective dates.

I'd like to take this opportunity to let you know that we plan to hold our First Quarter Results Conference Call on Wednesday, April 17, 2013. With that, I will turn the call over to Sanjay.

Sanjay Mehrotra

Thank you, Jay, and good afternoon, everyone. We are pleased with our strong performance in the second half of 2012. Specifically, we began supplying a broader range of embedded products to mobile OEMs, drove strong growth in the computing end market and gained market share in retail across both developed and emerging markets. Our solid execution in light of changing market dynamics allowed us to rebound and drive significant growth in the second half of the year, offsetting a difficult first half of 2012, which was impacted by weak pricing, card debundling among handset OEMs and embedded product transitions with mobile OEMs.

From a technology standpoint, we executed well on our 19-nanometer transition, and this provides us with an industry-leading flash cost structure. Overall, I'm encouraged with our robust recovery in the second half of 2012, and the company is strongly positioned for continued gains on multiple fronts in 2013.

In the second half of 2012, we expanded our embedded product portfolio, and we now offer customized embedded solutions and a broad range of iNAND discrete and iNAND MCP, which is our iNAND package with mobile DRAM. In Q4, revenue from our iNAND products alone increased 60% sequentially with the strongest growth stemming from our new iNAND MCP product line. Combined with a very strong revenue increase in the customized embedded solution, our overall embedded sales set a record, growing 45% sequentially, accounting for about 1/3 of our total revenue.

In solid state drives, I'm pleased to report solid sequential revenue growth from both our client and enterprise products. Total SSD sales were 10% of our fourth quarter revenue. On a year-over-year basis, our full-year SSD sales almost tripled and represented 9% of our 2012 revenue. We expect to grow our SSD revenue sequentially in Q1 2013 both in dollar terms and as a percentage of our overall revenue and we remain on track to drive 25% of our company revenue from SSDs in 2014.

In the fourth quarter, we began revenue shipments of our SAS SSDs to a fourth storage OEM, and we are working closely with other OEMs to drive adoption of our enterprise SSDs. Of particular note, we have begun shipping what we believe to be the industry's highest capacity 1.6 terabyte SAS drives. In addition, our robust and high-performance SAS drives are seeing increasing adoption through our OEMs by social media and Web 2.0 customers among others.

We achieved good progress on the software front with the adoption of our FlashSoft offerings by large storage OEM for distribution and future bundling with their servers. As a reminder, we view our enterprise and client SSD software offerings as a key differentiator in terms of the value add that SanDisk brings to our customers.

Looking ahead, we are working on ways to leverage software to drive industry-leading flash solutions that dramatically accelerate application performance and reduce total cost of ownership of flash-based storage. We look forward to introducing some exciting products to our customers in 2013.

Our client SSDs continue to garner new design wins, and we are excited about the production ramp of new computing platforms supported by our SATA-based caching and standalone SSD offerings. Two weeks ago, at the Consumer Electronics Show, we launched the SanDisk Ultra Plus SSD for the retail channel and the SanDisk X110 SSD for OEM customers. These new products, manufactured on our leading edge 19-nanometer MLC technology provide performance upgrade over our earlier offerings and should help us to strengthen further our market position. We also began revenue shipments of a new client SSD to an additional major OEM customer and SanDisk now supplies client SSDs to 10 leading PC OEMs.

To drive further growth in SSDs, we launched a new initiative to offer a broad range of OEM-grade client and enterprise Solutions to value-added resellers, system integrators and direct market resellers. This new distribution channel delivers SanDisk SSD technology to small and medium-sized businesses, which is a growing market for us. Additionally, direct engagement with our cloud customers is progressing well and we are adding resources in these new channels to support their development.

Retail performance in the fourth quarter was driven by seasonality as well as strong execution that resulted in continued share gain in most regions. Our broad global footprint, diversified product portfolio and brand strength continue to differentiate our retail offerings. In fact, during the fourth quarter, our unit sales of USB flash drives in the retail channel set a new record for us. Furthermore, on a year-over-year basis, the unit mix of our higher-margin SanDisk Ultra and SanDisk Extreme imaging cards increased substantially, reflecting consumer preference for our high-performance products.

From a manufacturing standpoint, 19-nanometer technology accounted for the vast majority of the production output for the fourth quarter, and we anticipate continued transition to 19-nanometer technology throughout 2013. We also expect a long tail of 24-nanometer technology in 2013 in order to support our OEM customer requirements. We expect to begin the 1Y-nanometer transition in the second half of this year.

Turning to supply. In 2013, industry supply growth is estimated to be in the 30% to 40% range, and we expect a healthy demand and supply balance and a significantly improved pricing environment. We continue to take a prudent approach to managing wafer capacity expansion in our fabs. We expect continued improvements in fab productivity, providing increases in wafer output during 2013, allowing us to defer the addition of new wafer capacity. We have not yet made a decision about adding new capacity and we are still evaluating the timing and extent of any new capacity addition in 2013.

Our captive bit supply growth in 2012 was significantly higher than the industry average growth. And in 2013, our planned bit supply growth will be below estimated industry range.

While our supply growth plan for 2013 may somewhat limit our annual revenue growth, we believe it paves the way for healthier business fundamentals for us and provides us with the flexibility to focus on improving the mix of our product sales and enhancing our profitability.

Switching to demand drivers, in 2013, we expect the client and enterprise SSD markets to fuel additional demand for NAND flash as an increasing proportion of PCs sold will include solid-state storage and the prevalence of cloud-based services continues to drive flash accelerated data centers. In addition, we expect the mobile market to remain a strong growth engine for the NAND flash industry in 2013 with the launch of many new smartphones and tablet models keeping the mobile market vibrant.

According to industry analysts, for the first time, unit shipments of smartphones are expected to exceed those of feature phones in 2013. Key drivers for this expected milestone event are growth of low-cost smartphones and market expansion in China and other emerging regions. Further, the availability of the touch functionality in ultra-thin devices and the convergence of smartphones and tablets are giving rise to new product categories represented, for example, by the Samsung Galaxy Note II and LG Optimus, that inherently require high capacity data storage solutions. These trends portend significant growth opportunity for flash memory storage. In addition, we see an increasing number of high definition TV models shipping with not just embedded flash storage, but even with higher capacity SSDs to enable set-top box and media center functionalities.

At the recently concluded CES, several new models of 4K TV with higher capacities of built-in storage were launched, and all these trends indicate the growing appeal and applications for NAND flash memory beyond smartphones, tablets and PCs. Our broad presence in the consumer, mobile and computing ecosystems, combined with our partnerships with processor and chipset vendors, close collaborative engagement with operating systems and software developers and our heritage of technology and system expertise positions us favorably to contribute to and benefit from these evolving market trends. Our participation in retail OEM and now, in newer channels and direct customer engagement should enable us to expand our market reach over time.

To conclude, we exited 2012 in a position of increased competitive and financial strength. Our markets remain healthy, growth drivers are diverse and strong and we remain focused on driving profitable growth for our business. I would like to thank you for your support during 2012, and I look forward to your continued interest in SanDisk. With that, I will turn the call over to Judy for her financial review and outlook.

Judy Bruner

Thank you, Sanjay. We are pleased to close 2012 with fourth quarter revenue near the record level of last Q4, and with strong profits and cash flow. Our fourth quarter margins benefited from our improving product mix, a healthy industry environment and continued strong execution on cost reduction.

Our fourth quarter bits sold increased 13% sequentially and 56% year-over-year, bringing the full year 2012 revenue bit growth to 62%. Our ASP per gigabyte increased 7% sequentially, driven by an increased mix of mobile embedded and SSD sales as well as a strong supply-demand balance within our business. Our fourth quarter ASP per gigabyte represented a year-over-year decline of 37%, and our full-year average price was 45% lower than in 2011.

The mix of our product revenue was 61% OEM and 39% retail for both the fourth quarter and the full year.

In the retail channel, our fourth quarter revenue grew 15% sequentially and 3% year-over-year. Our retail sequential growth rate was similar across major regions and on a product basis, was strongest for mobile cards. Our retail year-over-year growth represented solid growth in Asia and emerging markets, partially offset by decline in the U.S. and Europe.

On a product basis, our retail sales grew nicely year-over-year in mobile cards and SSDs, partially offset by a reduction in imaging card revenue as that market continues to experience a shift to mobile phones.

Within our imaging revenue, the mix shift to higher performance cards has been a positive for gross margin. Our fourth quarter OEM sales grew 27% sequentially and were down 5% year-over-year. We are regaining share in the mobile embedded market and growing our share in the SSD market while managing the secular decline in the bundled card market. Our sales of private label cards and wafers were also down year-over-year as we prioritized supply for our retail, mobile-embedded and SSD products. Our fourth quarter embedded revenue achieved a record $500 million, up 33% year-over-year, and our fourth quarter SSD revenue through the OEM channel grew approximately 95% on a year-over-year basis.

Our Q4 license and royalty revenue grew $6 million sequentially, primarily reflecting certain onetime royalty payments, bringing our 2012 license and royalty revenue to $374 million, the same level as in 2011.

Our non-GAAP gross margin increased from 31% in Q3 to 40% in Q4, driven by a sequential blended cost improvement of 7%, coupled with our sequential price increase of 7%. The primary contributors to our Q4 cost improvement were a further increase in 19-nanometer mix and a higher usage of captive memory in our enterprise SSDs. Our overall cost improvement in 2012 was 36%, 5 points higher than we achieved in 2011. Noncaptive petabytes were less than 1% of our sales in Q4, and the yen rate in our cost of sales was approximately JPY 79, similar to both Q3 and the year-ago quarter. The yen began weakening versus the dollar in the second half of Q4, impacting wafer purchases late in Q4 and those wafers will translate into cost of sales with about a 3-month lag. More on this subject when I get to our 2013 forecast.

Our Q4 non-GAAP operating expenses were $247 million, reflecting sequential growth in R&D and sales and marketing. The Q4 sequential R&D growth came primarily from headcount-related expenses and prototype expenditures, and the marketing growth was driven primarily by headcount, branding and other marketing spend.

Our Q4 non-GAAP operating margin was 24%, reflecting a strong recovery in profitability. Our Q4 non-GAAP tax rate was 32%, and our diluted share count remained flat sequentially.

In 2012, we reduced our shares outstanding by approximately 1.1 million shares, as our share repurchase program more than offset issuances under our employee incentive programs.

On the balance sheet, gross cash and marketable securities increased in Q4 by approximately $300 million to $5.7 billion, and net cash increased to almost $3.8 billion. Our inventory balance decreased in Q4 by $100 million, reflecting strong sales and improved fab cycle time.

Cash flow from operations in Q4 was $316 million, and we also received $153 million of repayments from the joint ventures. We spent $105 million on CapEx during Q4, primarily for test equipment and facilities outfitting, and we spent $39 million on share repurchases. For the full year, we spent $230 million on share repurchases, retiring over 5.6 million shares.

In terms of capital spending for the full year 2012, our share of fab-related investments was approximately $500 million, which was funded by joint venture, working capital and equipment leases. And the joint ventures also provided a net return of cash of $319 million to SanDisk, which helped to fund our $488 million in non-fab related capital investments.

In summary, our cash balance increased by approximately $100 million over the course of 2012, after making total capital investments of approximately $1 billion, and spending approximately $300 million on share repurchases and acquisitions. I'll now turn to forward-looking commentary.

We expect our 2013 supply growth to reflect minimal growth in wafer capacity, a 1Y transition beginning in the second half and a year-over-year increase in our mix of X2 memory. This will lead to a much lower level of bit growth in 2013 than we experienced in 2012. At the same time, we anticipate a favorable industry supply-demand environment to result in a more moderate rate of industry price decline than in 2012, and we expect our improving product mix to further moderate our price decline. Overall, our estimate for 2013 revenue is $5.3 billion to $5.6 billion. We expect to experience typical seasonality with a soft first quarter and a strong fourth quarter, and our first quarter revenue estimate is $1.225 billion to $1.3 billion.

We expect to generate strong gross margins in 2013, given our expectation of a healthy supply-demand environment, our evolving product mix and a weaker yen. In terms of the yen, I'll give you some color on how this will likely impact our results across the year. Our Q1 costs are largely determined based on wafer purchases made in Q4, and the majority of those purchases were made before the yen weakened significantly, giving us an average rate for Q1 of approximately 81. Our Q2 cost of sales will be largely based on Q1 wafer purchases and we made a decision at the end of 2012 to fix the cost of those purchases at a rate of about 86. After which, the yen weakened further. So if the yen were to stay where it has recently been trading, the benefit to our gross margins will be the greatest in the second half of 2013.

Given our estimates for costs, pricing and product mix, we forecast a non-GAAP gross margin for Q1 of 38% plus or minus 2 points, and for the full year of 2013, we forecast 41% plus or minus 2 points.

Non-GAAP operating expenses for 2013 are forecasted to be approximately $1.05 billion, with approximately $255 million in the first quarter. The primary expense increases will be in memory technology development and in SSD R&D and go-to-market capabilities and we also expect to incur higher incentive compensation expense in 2013 relative to a reduced level in 2012.

We expect non-GAAP other income of approximately $5 million per quarter or $20 million for the year. Our tax rate will reflect a discrete benefit in Q1 due to the passage of the retroactive 2012 R&D tax credit. We expect a non-GAAP tax rate of approximately 28% in Q1 and approximately 31% for the rest of the year, yielding a non-GAAP rate of approximately 30.5% for the full year. Based on our 2013 forecast for revenue, gross margin and operating expenses, we expect non-GAAP operating margins to be in our long-term financial model of 20% to 24% in 2013, up from the 16% we achieved in 2012.

Turning to a few items related to the balance sheet and use of cash. Our 2013 capital investments are expected to be approximately $1.2 billion to $1.3 billion, assuming no new wafer capacity beyond productivity improvements, with the increase from 2012, primarily reflecting increased capital intensity for the 1Y-nanometer transition. We expect the fab portion of this capital investment, which is estimated at $850 million to $950 million to be funded by a combination of joint venture cash flow and equipment leases and the nonfab capital investments of approximately $350 million to be a use of cash during 2013. We expect to generate strong growth in free cash flow in 2013, and we plan to continue to utilize our stock repurchase plan with an objective to, at a minimum, offset the share dilution from our employee equity programs.

Next, I'd like to describe a couple of changes that we will make in our reporting in 2013. First, because license and royalty revenue has been less than 10% of our total revenue for 3 years now, we will no longer show a separate line item for this revenue on our P&L. Going forward, we will report total revenue on the P&L, and we will provide supplementary schedules at the time of our earnings call as to the mix of our revenue by major categories including license and royalty. We have added these supplementary revenue schedules to the metrics we publish on our website beginning this quarter. These schedules provide revenue by major end market and by form factor. Another change will be how we refer to our channels in our earnings releases and in our SEC reports beginning for fiscal year 2013. As we are moving into the B2B channel and direct engagement with enterprise customers, we will recast our OEM channel as the commercial channel, which will include OEM, B2B and direct enterprise customers as well as licensees. Thus, the channel breakdown of our total revenue will include the retail and the commercial channels.

In closing, we are pleased with the improvements we have achieved in the second half of 2012 in our product offerings, our customer engagement and our revenue, profits and cash flow. As we look forward to 2013, we expect to continue gaining competitive strength, and we are focused on delivering solid year-over-year revenue growth with strong profitability and free cash flow. We will now open the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go to the first caller, Jim Schneider with Goldman Sachs.

James Schneider - Goldman Sachs Group Inc., Research Division

First of all, I want to ask about your expectations for supply growth for the year of the 30% to 40%. Does that assume that any -- you or any of your competitors add any wafer capacity in the back half of the year? And if your competitors were to do so, what do you think the upper bound of that range might be or might change to?

Judy Bruner

In terms of our assumptions, the 30% to 40% bit supply growth is an assumption for the overall industry. As Sanjay said, we expect our supply bit growth to be somewhat less than that range. In terms of the assumptions relative to ourselves, we've assumed that we do not add new capacity in 2012 -- sorry, 2013 beyond productivity improvements. But we will get some increase in wafer capacity from our productivity improvements, which are very cost-effective. In terms of the rest of the industry, we have made some assumptions for some additional wafer capacity growth from competitors in the second half of the year, yes.

James Schneider - Goldman Sachs Group Inc., Research Division

Okay. And then as a follow-on, can you share with us your expectation for this year in terms of the -- if you strip out the yen, what the apples for apples cost decline will be for 2013? And then can you comment on any yen hedging activity you've performed so far this year and what your plans are?

Judy Bruner

Okay. So we're not going to give a specific cost reduction forecast or range for 2013 but I will say that the cost reduction that we expect to achieve in 2013 is quite a bit less than the 36% cost reduction that we achieved in 2012. And that is inclusive of the benefit that we will get from the yen. I'm going to come back to cost reduction a minute -- in a minute but to answer your question on the yen, we have largely fixed the rate of the yen for the first half of 2013. If I assume that the yen stays about where it is for the rest of the year and that, that is what we achieve in our second half of the year, then the overall year should benefit by roughly about 3 percentage points in terms of cost improvement on a year-over-year basis. But that 3 percentage point improvement is embedded within our expectation that cost improvement will be less in 2013 than in 2012. Mentioned several reasons why that is the case. If you think about our cost improvement in 2013, first, we will get less improvement from 1Y than we did from 19-nanometer, which was the major cost reduction driver in 2012. Second, the timing of the 1Y transition will also lead to less cost reduction. Let me come back to that in a minute. Third, we expect that our product demand requirements will lead us to have a lower mix of X3 wafers in 2013 relative to 2012. And even our product mix itself is evolving towards products that have a higher non-memory content and also tend to stay on the older nodes somewhat longer because of OEM requirements. So that also leads to a lower year-over-year cost per gigabyte improvement. Now the yen goes the other way and partially offset some of these factors but all in all, we still believe that our cost reduction will be quite a bit less than the 36%. And just -- I said I wanted to come back to the 1Y timing. We said that the 1Y transition will essentially begin in the third quarter. And if you compare that to last year, our 19-nanometer transition actually began in the fourth quarter of 2011. So we benefited all during 2012 from the 19-nanometer transition. And 24-nanometer will continue to stay alive during 2013 as well. I know that's a long answer but I hope that answered your question.

Operator

[Operator Instructions] We'll go next to Vijay Rakesh with Sterne Agee.

Vijay R. Rakesh - Sterne Agee & Leach Inc., Research Division

Guys, I'm just wondering, when you look at your 20-nanometer, 19-nanometer, what is the mix now, what is the mix by the end of the year between 24 and 19?

Sanjay Mehrotra

So in Q4, more than 2/3 of our bit production was in 19-nanometer. And as we look at 2013, we will be ramping up 19-nanometer throughout the course of the year and 24-nanometer long tail of production will continue during 2013 as well, due to certain OEM requirements for certain products. And as Judy pointed out and as I mentioned in my prepared remarks as well, 1Y transition will begin in the third quarter.

Vijay R. Rakesh - Sterne Agee & Leach Inc., Research Division

Got it. And then on the SSD side, you guys have been doing very well. You mentioned you added a fourth OEM customer on the storage side. What is giving you -- how -- when you look at your products, what is the edge you have over the competition? How do you see you gaining more share in 2013, if you can lay out the roadmap there?

Sanjay Mehrotra

So in 2013, the share gain opportunities are of course, continuing penetration of the SAS drives with our leading-edge solution and the edge that we get is the full benefit of vertical integration, the flash memory technology, flash memory capacity and supply for the customers. But on top of all of that, the controller, which is the home developed ASIC. As that -- the appliance team, part of SanDisk now has developed. And all the firmware algorithms to really manage the reliability and the performance and the endurance of these SAS drives so that ultimately, the customer gets predictable performance. And this is a key differentiator for us in our products, giving customers predictable performance over a variety of workloads that they may be running over these SAS drives. So we look at gaining share in SAS drives. Our share in PCIe has been small. We only launched that product in 2012. As we bring out our next-generation PCIe products, we expect to be gaining share in the PCIe segment as well. So we're excited about the opportunities in enterprise SSD space for us, both on the side of SAS drives as well as PCIe, as well as continue to engage with customers for SATA enterprise drives as well. And again, the benefit of vertical integration, owning the memory technology, knowing the roadmap of memory technology and all the intricacies involved for the future and being able to implement the features in the controller to give high reliability, high performance solutions to our customers is an edge. And I might as well add here that software too, which is something we acquired FlashSoft and Schooner, give us strong competencies to be able to differentiate our SSD offerings with our customers in the future.

Vijay R. Rakesh - Sterne Agee & Leach Inc., Research Division

Got it. Great. And as you on the OEM side, does it mean that your focus on retail, you're focusing less there and so does that imply better margins and less cyclicality in the core business?

Sanjay Mehrotra

We are certainly focused on continuing to strengthen the mix of our business and in that regard, absolutely driving for strong growth in SSD, both on the client and enterprise SSD. And then in the mobile space, our embedded business is growing nicely but I'll point out that retail is a very important part of our business. Retail is higher margins than corporate averages and we have a strong brand recognition, #1 global shares. SanDisk is really very well-positioned on retail and our strategy is to continue to drive for strong mix of our business and strong opportunities in retail, as well as in enterprise SSDs and embedded. So pedal to the metal on OEM and retail opportunities with a focus on driving a strong combination of revenue, profits and cash flow.

Operator

We'll take the next question from Daniel Amir with Lazard.

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

Can you expand a little about in terms of your gross margin guidance, how should we look at the overall cost decline, how should we look at the [indiscernible] year and what type of price assumptions should we be looking at first half versus second half? So just a little more clarity around kind of your annual gross margin guidance. And then I have one follow-up.

Judy Bruner

Okay. So Daniel, as I said a few minutes ago, we expect that the cost decline in 2013 will be quite a bit less than it was in 2012, and I enumerated the reasons why. We would expect that cost decline can -- is really going down for everyone in the industry. The physics are the same here. There are factors in our improving product mix in terms of the mix of our business that may cause our cost decline year-over-year to go down by a somewhat higher percentage. But we achieved a very strong cost improvement in 2012. We have, in the past, talked about a range of a 25% to 35% cost reduction per year, and I believe that as we move to the remaining nodes on NAND that, that cost reduction capability is coming down towards the lower end, if not below the low end of that range. You cut out for a minute when you were asking your question. You were asking about price as well. But did you mention something else? Was it yen?

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

Yes, I mean, the pricing and then the X2, X3 mix?

Judy Bruner

Oh, X2, X3 mix. In terms of the X2, X3 mix, our X3 mix was about 50% in 2012, and we would estimate that it would go to something like about 40% in 2013 given the product demand requirements that we see from our customers. And then in terms of price, we are expecting a very favorable supply-demand environment in 2013, and that we expect that will cause a much shallower level of price decline in 2013 than in 2012. And we expect that our product mix will impact our price decline to be even shallower just as it is impacting our cost reduction to be shallower. And so overall for 2013, we expect price decline to be less than cost decline and that is why we're able to give gross margin guidance at the midpoint of 41%, up from the 34% that we achieved in 2012.

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

Great. And my follow-up, maybe to Sanjay, is on the SSD side, you're expecting a big growth this year on the SSD front. I mean, if you had upside, where would the upside come from on the SSD front? Would it be from the PC side or the enterprise side?

Sanjay Mehrotra

We plan to be driving strong growth both on the client side as well as the enterprise side. And certainly, on the client side the ultra-thin devices are driving increasing adoption of SSDs, both caching solutions and standalone solutions. And our penetration in the standalone SSD space is continuing to increase nicely. And on the enterprise side, as we bring forward during the course of the year our next edition products on SAS as well as PCIe, we look forward to driving strong gains there as well. So we will really continue to look at our opportunities on both fronts and as we have said, we'll continue to focus on managing the mix of the business with our objective of managing revenue growth, balanced with profit growth as well. And of course, we'll keep in mind long term strategic considerations with respect to customer engagement in mind as well. So I think the market is growing very nicely for the client SSDs in terms of industry term [ph] as well as for the enterprise SSDs.

Operator

We'll take our next question from Jagadish Iyer with Piper Jaffray.

[Technical Difficulty]

And hearing no response, we'll go to the next caller, John Pitzer with Crédit Suisse.

John W. Pitzer - Crédit Suisse AG, Research Division

I guess my first question, guys, just relative to the lead times on litho tools, how late in the year can you go before having to make a decision on adding wafer start capacity for this year? And Judy, if you were to make the decision to move ahead with Fab 5, how do we think of CapEx?

Sanjay Mehrotra

So I will comment on the litho tools. As we've said before, we work closely with the fab tools at vendors in terms of managing our expectation and their delivery for tools. We have said that generally the lead times are in the neighborhood of 4 months, around 4 months. So as you can see if we were to add any capacity in the second half of the year, we still have time to make that decision. But again, we've not really made any decision regarding any additional capacity in the second half yet.

Judy Bruner

And relative to the CapEx, the guidance I provided of $1.2 billion to $1.3 billion does not include any new wafer capacity in Fab 5. And so if we were to begin to add wafer capacity later in 2013, that number would go up. But since we haven't made a decision, I really can't give you what that range would be.

John W. Pitzer - Crédit Suisse AG, Research Division

And then guys as my follow-up, just quickly, any 10% customers in the December quarter, and would you expect there to be any 10% customers coming up in March relative to your guidance?

Judy Bruner

We did have a 10% customer in Q4 and a 10% customer for the year. We will be reporting that customer in our 10-K since it was above the 10% for the year. So I'll give it to you now and that customer was Apple, and the total percentage for 2012 was a bit below 13%. And we continue to have strong diversity of our customers. I will mention that our top 2 customers in 2012 were 22% of our revenue and that, that compared to 19% in 2011.

Operator

[Operator Instructions] We'll go next to Raji Gill with Needham & Company.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Just on the top line guidance, if I understood it correctly, it was $5.3 billion to $5.6 billion, which basically implies something like 8% year-over-year growth. Given kind of a more favorable environment in terms of the demand drivers, the significant demand drivers in smartphones as well as the retail in USB, expecting why that growth -- that year-over-year growth might have not been a bit higher, could you maybe talk a little bit about the growth drivers for the year by product segment and along those lines, any commentary on the bundled -- the attach rates for bundled cards in your core business segments?

Judy Bruner

Okay. Let me start out here. So first of all, I want to point out that we do expect to have limited bit growth in our revenue in 2013. It will be quite a bit less than it was in 2012. As we indicated, we expect our supply bit growth to be less than the industry range of 30% to 40%. Now that doesn't necessarily translate straight into revenue bit growth because we could have changes in our inventory. We could potentially purchase some noncaptive, although I expect that noncaptive usage in a tight supply demand environment would be limited. So we have somewhat -- we have limited bit growth but we then expect to also have quite shallow price decline. And that is what allows us to achieve the revenue growth that we're achieving. I will say that we do expect to be somewhat supply constrained in 2013, but I believe we manage our business best when we are somewhat supply constrained. And that allows us to prioritize our supply to the best product mix and to really take into account gross margins as well as strategic considerations in how we allocate that supply. In terms of the product categories, Sanjay I think has sort of already discussed this but I'll repeat that we believe the highest growth area for us in 2013 will be the SSD segments, both the client and the enterprise. And then next, I would point to mobile embedded as the next highest growth area. We do expect that there will be continuing trend in card debundling, and that there can be a reduction in the revenue that comes from those removable products. And we will, as Sanjay said, continue to allocate and prioritize supply to retail as much as possible because that is another very important part of our business that generates strong margins and strong brand recognition. So overall, we feel very good about the model for 2013. We think that it's good revenue growth and that it gives the best combination of growth and profitability and cash flow.

Sanjay Mehrotra

And regarding your question on the slot-in [ph] rate, based on the third-party reports that are available, that in terms of all feature phones now, maybe about 3/4 of the -- not feature phones -- in terms of all mobile phones, about 3/4 of all mobile phones today have slots in them and this large percentage rate is expected to decline over the course of next 3 to 4 years, maybe by 2015, 2016 time frame as a percentage of all mobile phones, this number getting into the 60s. And particularly in smartphones, about 3/4 of the smartphones again today have card slots in them. And that number over the course of next 3 to 4 years is expected to decline to something in the 50 to 60 range. And of course, this is a comment on the card slot, embedded storage within the smartphones continuing -- within the smartphones as well as budget smartphones and overall in the mobile phone category really continues to increase strongly and SanDisk is well-positioned to address both card as well as embedded opportunities with a broad line of our products there. So overall, the unit time for flash continues to expand nicely in the industry, particularly on the embedded side.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

I appreciate that, Sanjay. Just one last question on the SSD, you're committing to the 25% of revenue. If I just kind of do the quick calculation on the math, it seems like it's something at least $1.4 billion of -- or over, of SSD revenue. I'm just wondering how you're able to kind of bridge that gap from exiting last year -- entering this year to that number and a year from now.

Sanjay Mehrotra

So we're really not providing any specific guidance in terms of 2014 revenue. But 2014 in terms of SSD our strategy is to continue to focus on driving growth to get to 25% plus in 2014 of our total revenue to be the contribution from SSDs. And in 2013, I would expect our SSD contribution for the full-year to be above 15%.

Operator

Your next question is from Joe Moore with Morgan Stanley.

Joseph Moore - Morgan Stanley, Research Division

Can you talk about the use of 3-bit-per-cell product within OEM markets and within SSDs? I know your primary competitor has been talking about using TLC more broadly in those markets, how do you see that now?

Sanjay Mehrotra

So in SSD space, we're very much focused on driving the growth of our business and gaining share in the mainstream section of the SSD market. And the mainstream section of the SSD market, using leading-edge flash memory technology really requires high-performance and high reliability as well. And those in the industry we believe are best supplied with X2 memory. So our focus, as we focus on -- our focus as we try to drive for greater share on the client SSD is to supply the mainstream of the market and mainstream of the market is really needing X2 memory. So in 2013, we plan to be supplying our client SSD demand, as well as our enterprise SSD demand with X2 memory. Of course, we constantly assess X3 memory application for the SSDs but it's not in our 2013 roadmap.

Joseph Moore - Morgan Stanley, Research Division

And within OEMs, smartphone or tablet, is that also similarly still primarily X2 this year?

Sanjay Mehrotra

The increasing performance requirements, particularly when you look at smartphones and tablets with their high resolution capabilities, bigger displays, and now even using quad core in these devices, they really expect a strong performance from flash memory and the quad core kind of applications with all the imaging and video processing capabilities can even require a strong random performance, strong flash memory and all of that really positions X2 as the best candidate to really provide the flash solutions for these markets.

So in the mobile segment, mobile embedded segment, we will continue to support that with X2. Although there is some element of X3 memory, particularly in our iNAND products, that will continue to do well as well. And of course, on the card side, our cards are built with X3 memory. So Judy said that X3 as a total percentage of our business will be around 40% in 2013, will be coming down from 50% to 40% due to the growth in embedded and SSDs. But we believe that we will have a very strong lead over the rest of the competition in 2013 with our X3 memory.

Operator

The next question comes from Mark Newman with Sanford Bernstein.

Mark C. Newman - Sanford C. Bernstein & Co., LLC., Research Division

I have a quick question. I think we're simply poised to set up a very, very good 2013 due to supply discipline. And I just wanted to see maybe if you could talk to, a little bit, about how you think about adding capacity and how you think the industry thinks about adding capacity, so that it gives us a little bit more comfort that the industry is not going to add capacity. For example, at what kind of gross margin or cost of capital will you consider to actually add capacity? And due to technological risk in the industry, has that changed from before?

Sanjay Mehrotra

So when we look at making decisions on adding capacity, the factors that we look at are certainly, our demand-supply expectations, our expectations regarding total output from our production in the fabs, including any productivity gains that we are planning on in the fabs. And our technology roadmap such as 1Y technology this year that will be introduced in the Q3 time frame. The progress of that technology roadmap. And we certainly keep an eye on the future technologies as well and potential requirements of those future technologies. Because it's very important that any new investments that we make in capacity, we feel good about ROI on that capacity for the future. So these are really some of the factors and of course, we're always assessing for our own decisions the demand from our customers in terms of determining the timing of our -- any capacity additions. So what -- really multiple factor that we are look at. And we look at it all within the framework of our strategy of driving for revenue, profit and cash flow.

Mark C. Newman - Sanford C. Bernstein & Co., LLC., Research Division

So is there any numbers you can provide behind that in terms of gross margin or return on capital -- return on investment calculation?

Judy Bruner

There's not a specific benchmark or threshold number that we are looking for that would best cause us to add capacity. But we clearly are looking at all the factors that Sanjay described, including gross margin and return on investment. And we do return on investment analyses quite frequently when we're analyzing adding capacity. And of course, as Sanjay described, the future technology roadmap and the equipment set for that roadmap is one of the key factors that we analyze when we take a look at that; as is the supply-demand environment for our business. But not a specific threshold.

Operator

We'll go next to Kevin Cassidy with Stifel, Nicolaus.

Dean Grumlose - Stifel, Nicolaus & Co., Inc., Research Division

This is Dean Grumlose calling in for Kevin. As you look out at your forecast for the full year, could you characterize the assumptions that you make -- be making about the content in PCs and tablets as far as the increased content on a per platform basis?

Sanjay Mehrotra

So in terms of the PCs, by average capacities, we would expect them to continue to increase. The full SSD average capacity, third-party reports are available that show continuing increases of these average capacities. And on the caching side, the average capacities will remain in high 20s to low 30s on an average basis. The full client SSD in terms of enterprise -- in terms of full SSDs plus caching, will continue to increase in capacity. In terms of tablets, there is quite a bit of segmentation in various categories of tablets. There are certain tablets that are toward the low end, other tablets that are toward the high end. The high-end tablets we would expect that over time, the average capacities would increase. But overall for tablets, if you look at third-party report, because of the growth in the tablet and particularly a lot of the growth in the lower end tablet categories, as this market segment supply becomes bigger, the average capacity for tablet actually I think somewhat declines. But keep in mind that average capacity in tablets are 3x to 4x higher than the average capacities in smartphones.

Operator

We'll go next to Mehdi Hosseini with Susquehanna International.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Sanjay, as you look at into -- have a more profitable revenue stream, how do you prioritize customers especially now that you have, I think, your largest customer 2012 is a new large customer and you also mentioned the penetration into the SSD but there's -- but given how limited capacity you're building into the assumptions, I imagine it's going to be a way to think about prioritization and any color you can provide on that, I would appreciate and I have a follow-up.

Judy Bruner

Let me start out here. Sanjay may want to add on. But clearly, there are a number of factors that play into our prioritization of supply and gross margin is clearly one of them, as is the strategic importance of the products and the customers. And we really look at maintaining diversity of our customer base and our product portfolio. And I think we did a very good job of that in 2012 and especially in Q4. And so I think we have demonstrated that we are able to allocate our supply between the client SSDs, the enterprise SSDs, the mobile embedded as well as our retail and other removable products.

Sanjay Mehrotra

Yes, I don't really have much more to add other than just saying that we definitely look at increasing our opportunities with the customer base that has long-term stickiness for our customer as well. So strategic considerations play an important role as well as of course, driving for our objective of revenue and profit growth as well. And within that framework, we feel very comfortable with 2013 capacity plans that we have. We believe it will give us the opportunity to drive growth in the embedded SSD as well as the retail segment. And yes, we -- the white label channels or other component channels will become somewhat smaller mix of our total revenue. But even there, we do like to be a supplier in those channels because we do believe in diversified -- being a strong supplier with a diversified set of products to a diversified set of customers and channels.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

And the follow-up is, if the industry as a whole has become more disciplined and focused on profitability, do you think there's going to be a structural change in the mix of the contract or the length of the contract versus spot transactions?

Sanjay Mehrotra

Mix of the contract or length of the contract, you mean in terms of the OEM customers? Certain customers work on a month-to-month basis. Some of them we have discussions around surrounding key business metrics on a quarterly basis. And so this is really a whole mix of considerations that vary from customer to customer. And of course, as the industry conditions change, it is possible that there may be some change from certain customers in some direction here but really nothing noticeable to report here.

Operator

And we'll take the next question from Bob Gujavarty with Deutsche Bank.

Bobby Gujavarty - Deutsche Bank AG, Research Division

I think one of the interesting trends is it sounds like the SSD business is going to grow Q-on-Q and that sounds a lot better than typical seasonality. Can you talk a little bit about the trends? Is that broad-based both client and enterprise? Just kind of what you're seeing there.

Judy Bruner

Sure. I'll take that, Bob. I would say as we look into Q1 here in the SSD business, we are gaining share in that business, both client and enterprise in a very fast-growing part of the market. And so therefore, you're right. It bucks the seasonality trend that we see in the traditional parts of our business. And yes, we expect to be able to grow overall and in both parts of that business.

Bobby Gujavarty - Deutsche Bank AG, Research Division

Okay. Maybe a quick follow-up to that. Is there any anecdotal evidence that suggests maybe we've reached a tipping point here? Maybe the mix of the cache versus the all SSD solution that OEMs are looking? Curious if you can even offer some kind of maybe tipping point, anecdotal evidence on the SSD side?

Judy Bruner

I'd say in terms of anecdotal, we are seeing in particular, strength in the client side of the SSD business. So that in particular is where we expect to see growth as we move into Q1.

Operator

And our last question will come from Doug Freedman with RBC Capital Markets.

Doug Freedman - RBC Capital Markets, LLC, Research Division

If you could talk about, Judy, if I look at the JV, it sounds like you had some positive cash flow there. Are you expecting to see positive cash flow out of the JV in 2013?

Judy Bruner

Not necessarily cash onto our balance sheet in 2013 because we do expect somewhat higher capital expenditures by the JV in 2013. I mentioned that in 2012, the joint venture capital expenditures on our behalf was about $500 million, and that in 2013, I expect it to be in the range of $850 million to $950 million, assuming that we don't do any new wafer capacity. So that increase from $500 million to $850 million to $950 million probably means that the JV can fund that expenditure in 2013 but not return cash to the SanDisk balance sheet like it did in 2012, that number being $319 million in 2012.

Doug Freedman - RBC Capital Markets, LLC, Research Division

Okay. And then as my follow-up, can you give us an update on where you stand with your royalty agreements with your licensees? It looks like 3-bit in one of your competitors is ramping and has ramped. I believe that, that has a higher royalty to you. Can you give us some update on how that will flow through your numbers?

Judy Bruner

We don't go into the specific elements of the license agreements that we have with our licensees. We expect that our license and royalty revenue will be strong in 2013, but I would tell you that I expect our product revenue to grow as a mix percentage of the total revenue.

Jay Iyer

Thank you, Doug. Thank you, Judy. Thank you, Sanjay. Elizabeth, that's all the time we have for today. We want to thank everyone for joining us. A webcast replay of today's call should be available on our Investor Relations website shortly. Thank you and have a good evening.

Operator

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: SanDisk Management Discusses Q4 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts