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Executives

Jay Iyer - IR

Dr. Eli Harari - Founder, Chairman and CEO

Sanjay Mehrotra - President and COO

Judy Bruner - EVO, Administration and CFO

Analysts

Daniel Amir - Lazard Capital Markets

Jim Covello - Goldman Sachs

Tristan Gerra - Robert Baird

Craig Ellis - Caris & Company

Gary Hsueh - Oppenheimer & Company

Bob Gujavarty - Deutsche Bank

Uche Orji - UBS

Daniel Berenbaum - Ariga U.S.A.

Paul Coster - JPMorgan

Presentation

SanDisk Corp. (SNDK) Q4 2009 Earnings Call January 28, 2009 5:00 PM ET

Operator

Good day and welcome to the SanDisk Corporation fourth quarter 2009 earnings conference. Today's call is being recorded. At this time I would like to turn the call over to Jay Iyer.

Jay Iyer

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

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 web site at sandisk.com/IR.

In addition, during our call today we will make forward-looking statements. Any statement that refers to expectations, projections or other characterizations 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/A for fiscal 2008 and our subsequent quarterly reports on Form 10-Q.

SanDisk assumes no obligation to update these forward-looking statements, which speak as of the date hereof.

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

Dr. Eli Harari

Thank you, Jay and good afternoon. Q4 was our best ever quarter for product revenue, margins and cash flow reflecting a dramatic reversal in our results when compare today the fourth quarter a year ago. Pricing held up well, throughout the fourth quarter and product margins benefited from a 20%, sequential reduction in cost per gigabyte. A year ago the fourth quarter of 2008 marked bottom of the industry down cycle, with all flash memory manufacturers operating at negative margins and reporting heavy losses.

By the fourth quarter of 2009, all NAND suppliers including ourselves were reporting vastly improved results, partly resulting from production cut backs in the first half of 2009. Despite the recession, global demand for NAND flash continued to grow, and by the second half of 2009, flash manufacturers returned to 100% capacity utilization.

This turnaround happened considerably more rapidly than expected, demonstrating the remarkable ability of this young industry to self correct. This is an important factor that we have discussed with you in the past. While we benefited significantly as did others from the general improvement in the market conditions, that is rising tide, lift in the both. I do believe that our decisive actions SanDisk contributed much more so to our rapid turnaround amidst the ongoing industry while recovering. I would like to reflect on the more important of these SanDisk actions.

In the fourth quarter of '08, we structured the company to stream line our organization along retail and OEM business, which allowed us to reduce our non-GAAP operating expenses by 25% in 2009 compared to 2008. We opened major new OEM sales channels, and we set our number one priority to return to profitability as evident in our Q3 and Q4 results.

The Q1 '09 we sold approximately 20% of our captive capacity Toshiba and we further cut our captive by throttling the capacity utilization rate and our finishing fabs by more than 20% in the first half of 2009. At the same time, throughout 2009, we sustained our investment advance NAND flash and 3D read/write, 3-bits-per-sale and 4-bits-per-sale NAND architecture, advanced proprietary controller chips, and new products for both our retail and OEM businesses. And in Q2 '09 we renewed patent cross license agreement, with Samsung electronics.

Looking forward now, with have no new NAND fab expected to come on stream in 2010. We expect the NAND industry to continue to experience a healthy balance between demand and supply. Flash storage in mobile handsets is expected to continue to be the primary demand growth engine for the industry in 2010. Exciting new devices such as the iPad launched yesterday are demonstrating the significant new opportunities ahead for flash mass storage.

We see a similar trend in digital camcorders which have abandoned optical recording media and have largely embraced flash memory. Today Verizon announced its launch of our slotRadio card in 2000 Verizon stores for use with their high end cell phones, and Solid State Drive SSD are making well publicized in-roads in enterprise storage, and we believe it is only a matter of time before the tipping point is reached for the broader adoption of flash SSD in Notebooks and Netbook PC.

The iPad as well as Kindle are already passed their tipping points, as these class of devices are very safe and are required to deliver long operating on a battery charge, therefore doing away all together with rotating disk drives or DVD players and relying exclusively on NAND flash for mass storage.

Turning to capacity current industry forecast project a 2010 total NAND industry bit growth in the range of 70% to 90%. For SanDisk we currently project our captive that offered to increase our 2010 by up to 70% compared to output in 2009, approximately in line with our currently project bit demand growth in 2010 businesses. Our bit output increase will come primarily from completion of the technology transition to 32 nanometer by late 2010, as well as modest incremental wafer capacity, utilizing the unused cleaning space in the Yokkaichi Fab 4.

We believe this capacity at Fab 4 will be extremely cost effective and we plan to exercise our option to invest and take up to 50% of that capacity. Therefore the timing and pace for this final increment of Fab 4 capacity we will proceed with caution to allow in capacity additions with demand from our customers. Frankly we expect this to add approximately 10% to our monthly captive wafer production in the second half of 2010, the rest coming in 2011. This is all factored into the 2010 bit growth guidance that I have just provided you. This does mean that our usage of flash memory for NAND captive sources will likely be minimal in 2010.

Flash industry pricing is expected to reflect a healthy balance between demand and supply in 2010. In the next several years, industry wise NAND cost reduction are expected to decelerate from the pace of the prior five years due to increasingly more challenging scaling of future NAND technology node that we have discussed on previous occasions.

We estimate our own cost reduction in 2010 will be in the 30% 40% compared to 50% in 2009, when we captured the cost benefits of 3-bits-per-cell technology. We expect to start transitioning to 24 nanometer node late in 2010, with cost benefits expected in 2011. Looking to the future, into 2010 with a superb captive manufacturing base, weight technology and products and a lean and focused team that is driving our global opportunities.

Our strategic options in 2009 and our uniquely balanced participation in both OEM and retail global markets is working very well for us, and will guide our business activity in 2010. I will now turn it over to Sanjay.

Sanjay Mehrotra

Thank you, Eli. Good afternoon, everyone. The strong performance in our fourth quarter was driven by healthy demands for our product, from both our retail and OEM customers, leading to record unit sales. We experienced strong lift in seasonal consumer demands, and we also benefited from our channeled diversification efforts, and our strategy to achieve a balanced retail and OEM business focus. Our operational execution was solid, with our wafer fab production remaining at high efficiency and the supply chain executing well to meet rising demand level.

Following the record third quarter in product sales, channel inventory levels remain healthy and we exited 2009, maintaining our focus on profitable growth, augmented by continued tight control, on costs and expenses. We are exceptionally well positioned now in mobile storage. Five of our top ten customers in Q4 '09 were tier-1 handset manufactures and in addition, we are working closely with the leading mobile network operators, and mobile retailers. Face of our mobile cards and embedded flash products drove nearly half of the fourth quarter's record total product revenue. Overall in Q4 we sold 82 million mobile products.

Our embedded flash product sales grew very strongly and that accounted for more than 20% of our total mobile OEM business. Designs and momentum for the iNAND continues to be strong. Finally, within OEMs revenues from the new channels and customers that we discuss with you in the third quarter grew with strong revenue and profit contribution.

Shifting to our retail business, the fourth quarter was seasonally strong. The retail sales, within all of our end market posting sequential revenue growth. Our retail market share remains strong in the major geographies and our retail business is growing particularly well in the APAC region.

In regard to the new products and markets, there is tremendous amount of innovations and energy, and we will share some of this with you at our investor day meeting on February 26th.

In 2009, the combination of a strong brand of 3-bits-per-cell technology, along with seamless process technology migration enables SanDisk to reduce product costs per gigabyte by more than 50% for the fifth consecutive year. Furthermore, our the supply sales scales at efficiently throughout the year, it means a 26% increase in unit volume demands compared to the prior year level. Our Shanghai assembly and test facility significantly ramped upward, with strong productivity gains. This in combination with capacity RAM and our contract manufacturers, allowed us to flexible meet the feasibly strong demand in a cost effective fashion.

In Q4, we continue to ramp our 32-nanometer process technology and as accounted for slightly more than 10% of our total bit output. We began shipments of MicroSD, SD and Memory Stick Pro Duo card, using our 32-nanometer 3-bits-per-cell technology as planned.

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

Judy Bruner

Thank you, Sanjay. Our fourth quarter results reflected strong growth in both OEM and retail channels. With retail revenue up 41%, and OEM revenue up 40% sequentially. OEM represented 56% of our fourth quarter product revenue, the same proportion as in the third quarter, and for the year, our product revenue was equally balanced at a 50/50 mix of retail and OEM.

Our fourth quarter retail revenue was down 6% year-over-year with the decline due primarily to increasing amounts of our mobile business, going through mobile network operators stores that we now count as OEM. Our fourth quarter OEM revenue was up 215% year-over-year, with the mix from the mobile market increasing to more than 80% of our OEM revenue. Our total fourth quarter product revenue grew 54%, year-over-year, with units up 55%, ASP per gigabyte down 23%, and average capacity up 29%. On a sequential basis, our ASP per gigabyte declined 2%, and our total average capacity was up 18% driven primarily by the OEM mobile product mix.

License and royalty revenue of 100 million in the fourth quarter included Samsung royalties based half on the old license agreements and half on the new license agreements. Q4 product gross margin of 44% on a GAAP basis and a 45% on non-GAAP basis was higher than we had anticipated, due to less price decline and stronger cost reductions which was 20% per gigabyte. In addition, we received a higher than expected benefit of 95 million from selling products which carried previously taken reserves. The reserve benefit came primarily from lower of cost or market reserves taken on inventory builds in 2008, but also reflected the sale of inventory that had been reserved as excess or obsolete. Without these inventory reserve benefits, our underlying product gross margin was 36%, a level that generates strong profitability on our product business and a very good return on invested capital.

Q4 non-GAAP operating expenses of 192 million were in the range we expected and reflected a seasonal lift in sales and marketing, a 14 week quarter, and an increase in the accrual of incentive compensation related to our 2009 performance. Comparing the full year of 2009 to 2008, we decreased our non-GAAP expenses by 25%. Our fourth quarter and non-GAAP operating income, was 417 million or 34% of revenue. With half the benefit received from inventory reserves, the underlying operating income was 322 million or 26% of revenue, with more than 70% of this operating profit coming from our product business.

Our non-GAAP other income increased sequentially by 5 million due to certain one-time investment gains exam to a lesser extent due to higher invested cash balances. On the balance sheet, cash and short and long-term liquid investments increased sequentially by 432 million to $3.0 billion. Fourth quarter cash flow from operations was the highest ever in a single quarter at $388 million, and free cash flow was even higher at $431 million.

Cash flow from investing included a $57 million receipt of excess cash from the flash partner's joint venture, zero outgoing capital payments to the joint venture and a modest outflow for property and equipment. For the full year, we generated cash flow from operations of 488 million and free cash flow of 438 million. For 2009, net cash used for capital related investing was only $49 million. Key elements included 378 million outflow for the capital investments in the joint ventures and 60 million outflow for property and equipment. With these outflows largely offset by the receipt of 277 million from the joint venture restructuring, a 110 million of cash returned from flash partners, and 13 million received from the wind down of flash vision.

We ended 2010 with $1.07 billion of equipment lease obligations, down from 2.1 billion at the end of 2008. Our inventory ended 2009, at 596 million, almost the same number as at the end of 2008. However, both the gross level of inventory and the offsetting reserves have been significantly reduced and reserves have returned to normal levels.

I will now turn to forward-looking commentary, I'll provide guidance for Q1, as well as for the full year 2010. Please note that non-GAAP to GAAP reconciliation tables for all applicable guidance are posted on our Web site. We are expecting a normal level of seasonally reduced demand in the first quarter. Coupled with the impact of Q1 being a regular 13 week quarter, compared to our 14 week Q4. We are forecasting total revenue for Q1 between 875 million, and 950 million which includes license and royalty revenue between $80 million and $90 million. Fully reflecting the new Samsung license agreement. For the full year 2010, we forecast total revenue between 4.0 million and 4.4 billion, including license and royalty revenue between 320 million and 360 million.

Turning to gross margin, we expect that first quarter cost decline may be a bit less than price decline as we expect more modest costs decline in Q1 than we generated in the previous two consecutive quarters of very strong cost reductions. For the full year 2010 we expect that the annual cost decline which Eli estimated at 30% to 40% will be greater than the annual price decline allowing product gross margin to expand from our 2009 underlying product gross margins which is on the teens on a full year basis.

We are forecasting a non-GAAP product gross margin for Q1 and for the full year of approximately 31%, plus or minus 3 percentage points. We forecast non-GAAP operating expenses in Q1 of 175 million to 185 million, and for 2010, of 725 million to 750 million. We forecast non-GAAP other income for 2010 to be approximately $40 million spread relatively evenly across the year. We forecast a non-GAAP tax-rate of approximately 37%, up from 36% in 2009, based primarily on certain tax law changes for 2010.

On a GAAP basis, we are still in evaluation allowance position, and as such, the GAAP tax-rate is too difficult to predict. Turning to the balance sheet, and cash flow, we expect our total capital investment in 2010 to be between $700 million $900 million, covering fab technology transitions, incremental wafer capacity and Fab 4 as Eli described and back-end supply chain and other CapEx requirements across the business. We expect fund this primarily from a combination of cash flow from operations, and working capital from the joint ventures, and we expect continuing positive free cash flow in 2010.

As in the past, we will provide further color on CapEx and our funding plans at our investor day on February 26th. In summary, we are expecting solid performance in 2010, and we look forward to sharing more information with you at our upcoming investor day. We will now open the call for your questions.

Question-and-Answer Session

Operator

Thank you. If you would like to ask a question today, (Operator Instructions). We'll pause one moment as we assemble our roster. And our first question today will come from Daniel Amir, Lazard Capital Markets.

Daniel Amir - Lazard Capital Markets

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

Sanjay Mehrotra

This is Sanjay. When we look at the bit supply growth in 2009 for the industry it was about 40% and as Eli pointed when we are looking at 2010, the supply growth is expected to be 70% to 90% and ours is on the low end of that, up to 70%. When you look at the demand drivers, the demand drivers are strong, you know, when you see the handsets, the smart phone, higher capacity units are continuing to sale both on the embedded side as well as on the card side and new applications that are coming out are continuing to drive a new demand for flash storage as well, and on top of all of this the demand is being driven globally I mean from Asia PAC we saw very strong growth in demand on a year-over-year basis and we are continuing to see that from China, India and the emerging market so all of these factors the application, the demand growth drivers particularly the mobile SSD continuing to increase its penetration during the year. The market as well as the regions we believe will continue to drive the demands and looking at the best supply growth we think that the demand will be in good balance during the course of the year and their cost reductions will be in the 30%-40% range and pricing will hold well during the course of the year.

Daniel Amir - Lazard Capital Markets

Now if you look at Q1 in terms of seasonality I mean you based on your guidance you are expecting it to be somewhat similar to may be previous year's seasonal of trend taking last year aside, I mean what are really the drivers that you are seeing here in Q1, I mean was the assumptions really based on this guidance considering that we were exiting the holiday season maybe with a bit better inventory that we have previously.

Judy Bruner

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

Operator

Our next question will come from Jim Covello with Goldman Sachs.

Jim Covello - Goldman Sachs

Can I ask relative to the shifting of the business between retail and OEM what kind of impact do you think that really has in terms of your seasonal pattern that we have historically seen.

Sanjay Mehrotra

So we think that Q1 will have seasonality and that’s based into the guidance that Judy has provided. OEM business may be a little less seasonal than the retail but overall the total business will experience seasonality similar to the year's past.

Judy Bruner

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

Jim Covello - Goldman Sachs

That’s exactly what I was trying to figure out, I appreciate that and then Eli you had said relative to SSD, I think you said it was only a matter of time for SSDs in kind of the notebook space. Obviously we are seeing good adoption in the enterprise base you know how much time, how much is only a matter of time are we really talking about a year, or two years less than that?

Dr. Eli Harari

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

If you look at the iPad price quote going from 32 gigabyte to 64 gigabyte a $100 incremental cost to the consumer which is not that much, that still translate to about $3.00 per gigabyte and I would kind of venture to bet my annual salary that there will be at big numbers, customers that want us to perform 64 gigabyte at $3.00 per gigabyte and yet you hear a lot of people saying need to give $0.50 per gigabyte in order for SSD to take off. I think when necessity becomes commoditized yes we need to do playing at these price range, but we have tremendous opportunities over the next several years.

But to answer your question I think this is an online profit, I've said the enterprise of course is already willing to pay the additional cost per gigabyte of flash and I think that by the end of this year and certainly into 2011, we are going to see more and more notebook computers and people asking and they willing to pay a lot more than $0.50 per gigabyte and of course within two years we have to be able to reach the $1.00 per gigabyte and I think that will be another important I don’t want to say tipping point, but in another important milestone for SSD adoption in the mean time the SSDs these are getting much, much better for us as well as for competitors and I think that this a market that’s interested and its going to go on becoming very important part by 2012, I have seen some estimates that this will be, that SSD will consume maybe 15% to 20% of the total NAND bit output and I think that that’s about I am comfortable with that kind of range number.

Jim Covello - Goldman Sachs

You said for 2012 that was?

Dr. Eli Harari

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

Operator

And next is Tristan Gerra with Robert Baird

Tristan Gerra - Robert Baird

Looking at your cost reduction guidance for 2010 how should we weight this by quarter?

Judy Bruner

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

Tristan Gerra - Robert Baird

And in terms of your previously reserved inventories anything left that we should expect for Q1 given the amount it was higher than expected in Q4 or is that pretty at this point?

Judy Bruner

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

Operator

Your next question will come from Craig Ellis with Caris & Company.

Craig Ellis - Caris & Company

Eli you talked about a lot of good demand drivers but you also mentioned 70% bit growth for the company which seems pretty low given the demand drivers in place. Can you reconcile that two of those for us?

Dr. Eli Harari

Yes, we just gone through the most difficult, the most challenging and most painful downturn and that memory is very, very much fresh in our mind, so we would rather be on the conservative side and it build our business on profitability rather than market share, so the OEM business definitely needs a captive supply and as our OEM grows, we need to take care of that and we are, but we really don't want to be very, very cautious and how we add additional supply, I think it's very important for our health and I think we don't want to contribute anymore then we have to, and we want to contribute to the health of the industry but for like this.

Craig Ellis - Caris & Company

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

Dr. Eli Harari

Let me first answer the second question that provisioning of the remaining space in Fab 4 there is not that very much capacity left in Fab 4 and you can well imagine filling up what remains is cleaning space is very cost effective decline other than fixed cost basically in place already and therefore on running additional wafer yes you need new equipment installing, but the cost of wafer actually very favorable which is very different from the first trends of expansion of new capacity in a brand new Fab, whether it's an existing empty shell or a new facility that you built from the ground up the first, let's say 50,000, 70,000, 80,000 wafers per month carry the full fixed cost even though I am not choosing the full capacity available, so we think that business is very, very important element for us to take advantage of through our 50-50 option with our partner and of course this does come, this doesn't mean that we delayed the move to greater reliance on NAND captive but in general our designers continue to be relying on captive supply for a around at 15% to 25% or so of our future capacity and we do have the agreements in place and these NAND captive capacities that cannot obviously be turned on an instant you need to invest into qualified and someone at the appropriate time we plan to offset exercise those.

Craig Ellis - Caris & Company

Well just the follow would be just with respect to adding and tooling how do we think about the pace which will do that through the year and into next year?

Dr. Eli Harari

We are not talking about a lot of wafers we are talking about increasing our captive supply by approximately 10% starting in the second half of this year so in terms of volume it's not that significant there is to a certain extent some constraints in terms of this lead time, equipment lead times but overall I think that it's not a major thing and I think it's definitely included in the industry projections of 70 to 90 nanometer and when we talk about that additional wafer start in the remaining cleaning space in Fab 4 that is part of our 70% of overall for our own capacity increases.

Operator

Gary Hsueh with Oppenheimer & Company.

Gary Hsueh - Oppenheimer & Company

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

Dr. Eli Harari

So in terms of strategy is to increase our output as soon as I just said, is to take advantage of the local structure that you made in the cleaning space Fab 4, the step after that is to tap into our non-captive supply and beyond that we would have to figure how to address future economies, but we do believe that 2010 is pretty matured to really start planning a the new fab or with regards to fab 5 as far as our requirements we don’t think that fill 2010 is. It's immature so we have sent.

Gary Hsueh - Oppenheimer & Company

Okay and second question is here Judy I understand for a full year basis on the cost per bit reduction is going to exceed your expectations for pricing decline. Can you walk me through the profile of each and whether you know the declines in terms of pricing and the cost per-bit reduction you planned are those totally coincidence or are they going to be gap here and there and anyone anyone caught there?

Judy Bruner

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

Gary Hsueh - Oppenheimer & Company

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

Sanjay Mehrotra

OEM seasonality will be little bit less than retail and that's because we continuing to grow our business in the new channels and new customers.

Gary Hsueh - Oppenheimer & Company

Can you be specific on what aspect of the OEM business you are growing is it microSD card attachment rate on handsets. Is that in particular what you are seeing?

Sanjay Mehrotra

I think we have said in the last call that we are selling to private labels, customers as well as to customers for wafers and component into the private label customers we are primarily selling our card products and those cards are and those card are product include mobile product as well as some imaging products but as Judy pointed that almost 80% of our OEM revenue is mobile so it's primarily from the card side of course we are continuing to sell components and embedded products as well.

Operator

Next is Bob Gujavarty with Deutsche Bank.

Bob Gujavarty - Deutsche Bank

I got just a question about 3-bit-per-cell at the moment are you able to use 3-bit-per-cell across all the different channels and product you serve or is it primarily aiming the certain product segment?

Sanjay Mehrotra

So we are using 3-bit-per-cell in all card format as well as USB flash drive format and the lower capacity product do not use 3-bit-per-cell as well as certain high capacity, high performance products and product such as our pSSD's and SSD's do not use 3-bit-per-cell.

Bob Gujavarty - Deutsche Bank

Great and how about some of the embedded products are those primarily 2-bit-per-cell right now?

Sanjay Mehrotra

No some of the embedded products are using 3-bit-per-cell now.

Bob Gujavarty - Deutsche Bank

Great and if I can just one final quick one you mentioned in the last conference call you are giving your lead in 3-bit-per-cell. You are able to kind of sell the lower cost product at the equivalent 2-bit-per-cell ASP and that’s good for SanDisk. Is that trend continuing for you?

Sanjay Mehrotra

Yes basically what we had said was that implementation of 3-bit-per-cell technology in our products is essentially seamless from the point of view of the consumer. Consumer cannot really tell the difference between a 3-bit-per-cell and 2-bit-per-cell and therefore in pricing our products we generally don’t have a difference between 2-bit and 3-bit-per-cell.

Dr. Eli Harari

But I would like to add that we do believe that not all X3 is made equal and that our X3 insisting in controlling in providing the complete solution and the fact that we are now in our third generation X3 technology, and that will make a difference and that the fact that our products are transformed X3 products are transformed to the user is because we have learned how to manufactured these into to have basically equivalent compare it to X2. That is not the case of what we are seeing in the market for some of our competitor this is very similar to the early days and now it seems 2-bits-per-sell, when our competitors having some difficulty matching our performance with MLC and therefore during their transition period portrayed MLC at the time and in fact that so optimize to X3 today is somehow around with 2-bits-per-cell we don’t agree with that.

Operator

Kevin Cassidy with Thomas Weisel Partners is next.

Unidentified Analyst

Hi this is Gelta in for Kevin Cassidy, I just have a quick question on the captive, non-captive model for your non-captive may be going out to 2011 do you have a target margin range for that?

Dr. Eli Harari

Target we have always said in the past in the years non-captive that the margin clearly is going to not much, be inferior to the margin as we can get with our captive supply where we of course have to make the CapEx investments it's reasonable to expect that our supplier that supplying up even under best terms conditions does need to mix their margins and therefore the way we look at non-captive is very important that we are able to generate some contribution dollars even though it's reduce margin.

Operator

Uche Orji with UBS is our next.

Uche Orji - UBS

Eli, so let me to try to understand what you're saying on 2-bit-per-cell, how much of your production by the end of the year should contribute to set on how much is it now?

Dr. Eli Harari

So for 2009 in quarter our big production was slightly above 15% in 3-bit-per-cell and in Q4 of 2009 it was better than 50% and in 3-bit-per-cell and for 2010 we are looking at same thing better than 50% for 3-bit-per-cell and again keep in mind that we have a certain mix of the product that uses 3-bit-per-cell very well and second for such as the once I mentioned earlier low capacity card and some high performance product etcetera do not use for sale. Mix of the product we have easily we at a pretty comfortable levels that per sale.

Sanjay Mehrotra

Let me just little bit about if it particularly with regards to low capacity we are seeing the market for cards kinds of Bi-focus you have the 1, 2 gigabyte card very large unit volume business and the higher capacity cards more for the smartphones and it is the 1 and 2 gigabyte card that were the chips really don’t get the benefit of X3 and our difference being on X2.

Uche Orji - UBS

Okay and in terms of the acceptance of 3-bit-per-cell, I mean it cannot the way you described it, it sounds like there is been no problem in terms of performance of those cards in the market place when should we expect that this could be put and also use in things like SSD, number of X3 cards now, of X3 products in things like SSD are there any issue why they are not being use in this kind of product as controller related issues?

Dr. Eli Harari

The industry is just basically this year moving from SLC 1-bit to MLC 2-bit-per-cell because the brand stand of these product in a very-very challenging kind of application environment that we have talked about in the past. We believe that it will require very substantial understanding and very powerful understanding if you will of system level expertise including not just ECC but all kinds of algorithm that we have developed and perfected over the last few years.

To make SSD, to make it possible to 3-bit-per-cell into SSD and that eventually it could become a very important element of that. Now that may not apply let say for enterprise drives where SSD drive where performance is very-very important but if science handling things like endurance and read/writes that I think that eventually we will be able to achieve most requirement in SSD with X3 per-cell but that is still to be improving our first focus this year is really on commercializing our 3rd generation 2 G3 2-bit-per-cell MLC and this is really our key focus.

Uche Orji - UBS

Okay great and then just one last question. I did ask you this question also last quarter it seems like the demand drive NAND seem to be so strong that the historical, and lastly few relationship between pricing and demand seems to be broken. How much long, are there market that you think will, at what point do you think that relationship gets restored, are we now a new card in terms of demand where ASP's falling at a rate that are not entirely what is and yet demand continuous to drop. So in terms of how you expect the relationship between product demand than lastly to going forward can you just try to give some color that will be helpful thanks?

Dr. Eli Harari

It’s a very complex and layered question and answer is equally complex there are of course markets are more mature is therefore less elastic they are numerous new application that are very price elastic in general and then of course there's a general economy and consumer confidence some of the things that are outside of our control I would say that we always believed that pricing its healthy for the industry and for us to continually cost reduce and give and share the benefit of that with consumer so that expands and creates new markets, we have not changing our thinking only thing what I've said is that the rate of price reduction that we saw in the last three years which was close to 60% annually was disastrous and would not be supportable by cost reductions and we are seeing now good stability in the market and it is my hope that we are at the beginning of a long period of health in the industry with continuing price reduction and cost reduction. But at a level that makes economic sense

Operator

Daniel Berenbaum with Ariga U.S.A.

Daniel Berenbaum - Ariga U.S.A.

Thanks Judy did you say that you sold some equipment in the quarter I was just trying to figure how free cash flows higher than cash flow from operations?

Judy Bruner

We didn’t sale equipment but essentially we received a cash distribution and cash pay down on our notes receivables from flash partners. Our joint ventures actually generate cash and if they generate more cash than its required for capital investment any given period then they will return that cash to the partners. And since there was no new capacity added within our joint ventures in 2009 the joint ventures generated more cash than what’s needed.

Daniel Berenbaum - Ariga U.S.A

And so then moving forward on the CapEx investment, you talk about 700 million and 900 million total investment, how will that be split out do you think your CapEx and the investment in the JV?

Judy Bruner

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

Daniel Berenbaum - Ariga U.S.A

Okay and then last question is on OPEX you guided non-GAAP 725, 750 what you think stock be comp will be across the year so we can take stab at the GAAP numbers and then also on the patterns I mean it looks like it was sort of imply that OPEX would basically be flattish across the year I am I thinking about that’s the right way?

Judy Bruner

Okay first on stock compensation we actually have some cables that are on the web that gives the reconciliation of the non-GAAP to the GAAP and what it shows there is that the operating expenses that we would add to the 725 to 750 to get GAAP or about 15 to 20 million a quarter or about 60 to 80 million for the year. And then in terms of your second question we are working very hard to keep expenses tight to manage them careful.

We will have a little bit of growth and expenses that as indicated in my guidance and I would expect as, typical there seasonality in that it tends to be heavier in the second half of the year than the first half of the year. But there is not it's not a hockey stick obviously to get to the 725 to 750.

Operator

And our next question will come from (inaudible)

Unidentified Analyst

My first question is about the utilization rate Judy you mention that the growth in 2010 will be waited for second half do you still expect your facilities to run a full capacity right in fourth quarter and second quarter of 2010?

Judy Bruner

So I think somewhat two different questions there when I was saying was slanted more to the second half and the first half is our cost reduction in a per gigabyte basis, the timing of the 30% to 40% reduction in our cost per gigabyte, in terms of utilization I assume you are asking about fab utilization and absolutely we are running them at a 100% and expect to run them at a 100% for all of 2010

Unidentified Analyst

And then second question is in OEM space; what is your market share and is SanDisk gaining market share from others?

Sanjay Mehrotra

In the OEM space it is hard to call out the market share because the OEM customer base is totally diverse and the information is not easily brought in but we believe that we are gaining market shares in the OEM space as well and particularly as we increase our new customers and new channels through that we are increasing our shares on the OEM side as well, and in the retail side as well we believe we did very well during the years and held a strong share despite from industrial personal profitability and in fact I believe in several others geographies, and retail as well we grew our shares during the year.

Unidentified Company Speaker

But in addition to that in retail, in quite a lot of countries we are very high market share and it's not that easy to dramatically increase that, in OEM in some accounts we are just adding in near, relatively small amount of share and we think we have significantly more upside in increasing our share there.

Sanjay Mehrotra

Mark we will take our last question.

Operator

And the final question will come from Paul Coster, JPMorgan.

Paul Coster - JPMorgan

I just want to go back to the whole issue of quiet drastic demand surely one of the reasons is breaking down as you have got this new product category small phones they are growing so rapidly and the attach rate to them is a 100% and my question is it just seems to me, Eli, that in every space we get close to the end of this year. With that with the sort of 30% gross of the product category the bottle neck is going to be way for out not big shipments and the industries is going to have to make some pretty serious decisions just I can say CapEx decision is just to stay up with smaller funds later on SSDs can you comment from that?

Dr. Eli Harari

You may be right Paul? we are not at that point at this stage and we will be very, very careful and we've been trying to learn from mistakes that we and others I mean consist for product, but they are positive so that exuberant irrational investment in the range of 60% of revenues for us CapEx in 2007 - 2008 and we are not going to return to that

Paul Coster - JPMorgan

I get that so maybe the supplemental question is if the industry has to stop making investments then what's the lead time with streamed the point of making the decision and when they say meaningful wafer out capacity increase can be achieved is it sort of 6 months a year?

Dr. Eli Harari

Our new fab is definitely longer than that, it's closer to 18 month if everybody rushes to the equipment manufacture of course there will be a bottle neck there. They are under consideration of course, NAND is slowing down and the future of NAND beyond let's say 20 nanometer is not certain and the portion on technology is not yet in place and new NAND are very expensive and really is not yet up to the technology. There is just a lot of other considerations that will come into play as far as new mega fabs and I think that right now this is actually time to kind of pause a little bit at least for us and let the market kind of develop a little bit before we make any further decision on that.

Sanjay Mehrotra

Thanks Paul that’s all the time we have for today. A webcast replay of this conference call will be posted on our website at sandisk.com/ir shortly. Have a good evening.

Operator

And that does conclude our conference call. Thank you for your participation.

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Source: SanDisk Corp. Q4 2009 Earnings Call Transcript
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