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SanDisk Corporation (NASDAQ:SNDK)

Q4 2013 Earnings Call

January 22, 2014 5:00 AM ET

Executives

Jay Iyer - IR

Sanjay Mehrotra - President and CEO

Judy Bruner - EVP, Administration and CFO

Analysts

Farhan Ahmed - Credit Suisse

Doug Freedman - RBC Capital Markets

Mehdi Hosseini - SIG

James Schneider - Goldman Sachs

Timothy Arcuri - Cowen and Company

Craig Ellis - B. Riley

Mark Newman - Sanford Bernstein

Hans Mosesmann - Raymond James

Vijay Rakesh - Sterne Agee

Monika Garg - Pacific Crest Securities

Operator

Good day everyone and welcome to the SanDisk Corporation's Fourth Quarter 2013 Financial Results Conference Call. Today's conference is being recorded. I would now like to turn the call over to Jay Iyer, Investor Relations. Please go ahead.

Jay Iyer

Thank you, Danielle, 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. In a moment, we will hear remarks from both of them followed by Q&A. 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 also be posted on our website. This guidance is exclusive of any one-time transactions and does not reflect the effect of any acquisitions, divestitures or similar transactions that may be completed after January 22, 2014.

In addition, during our call today, we will make forward-looking statements that refer to expectations, projections or other future events. Please refer to today’s press release and other SEC filing including the most recent 10-Q and 10-K for more information on the risk factors that could cause actual results to differ materially from those expressed in these forward-looking statements. SanDisk assumes no obligation to update these forward-looking statements, which speak as of today.

And finally, I'd like to inform you that we are planning for our First Quarter 2014 Results Conference Call on Wednesday, April 16, 2014. We are also planning for our 2014 Investor Day meeting for May 7, 2014. Please mark your calendars.

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

Sanjay Mehrotra

Thank you, Jay, and good afternoon, everyone. We are very pleased to report outstanding fourth quarter and fiscal 2013 results today. We achieved record fourth quarter and full year revenues and record fourth quarter and full year revenue non-GAAP earnings.

Our business generated record operating and free cash flows for the fourth quarter and for the full year 2013. Consistent with our articulated strategy, solid execution through the year drove a higher mix of SSD and embedded revenues and we strengthened our position in both the client and enterprise SSD markets.

Our 2013 retail revenue has a new annual record with our retail products achieving substantial share gains in key markets globally. We also initiated a comprehensive capital return program demonstrating our confidence in the future of our business. The powerful secular trends for NAND flash adoption among consumers and enterprises combined with our broadening portfolio of solutions and consistent execution translated into outstanding financial results.

Moving to details of our business results, our fourth quarter client and enterprise SSD sales increased sequentially to account for 21% of total revenue. Our enterprise SSDs set a new revenue record in the fourth quarter with strong customer adoption of our lightning-fast drive as well as a full quarter of enterprise SSD revenue from our SMART Storage Systems acquisition. Business momentum for the SMART Storage Systems based solution is rising with SATA and fast SSDs achieving several new design wins and many others in the pipeline at traditional storage and server OEMs and at hyper scale accounts.

Earlier this week, we announced that our UltraDIMM has garnered its first customer acceptance at a Tier 1 storage and server OEM. The UltraDIMM which is an enterprise SSD connected to the server memory bus via DIMM slot is a solution that dramatically improves business application response times. This new product which comes from our SMART Storage Systems acquisition is being implemented in the OEM’s server platforms. We are pleased to see increasing customer interest for this in oriented of high performance, low latency solution. We expect the UltraDIMM revenue ramp to begin later in 2014.

To wrap-up my comments on enterprise SSDs, this young market is evolving along multiple dimensions each with a different set of products performance requirements and varying implementation schemes of flash depending on the customer type, such as storage and server OEM, hyper scale and others. While the resulting business dynamics vary in terms of products requirements pricing and support, the strength of our vertical integration allows us to address these diverse enterprise opportunities.

We feel very good about our position in this market and we expect enterprise storage solutions to be the fastest growing product for us in 2014. Furthermore, we expect our broadening engagement with hyper scale customers to begin bearing fruit in 2014 with meaningful revenue contributions starting later in the year.

In client SSDs, the opportunities for our solutions continue to grow, and we believe we gained substantial share during 2013 with exceptionally strong year-over-year annual revenue growth. The ongoing shift in consumer preference for high performance, slim form factor, long batter life and instant-on capability continues to drive higher attach rates of our solid state storage solutions in notebook PCs and in ultrathin devices.

In addition, growing ranks of Fortune 500 companies are experiencing the benefits of the enterprise-wide deployments of SSD-based PCs, both in terms of increased device performance and in extension of PC lifecycles. We completed our own enterprise-wide deployment of our SSDs in more than 4,500 notebook PCs in 2013, and we are realizing performance and productivity improvements and a deduction in IT-related costs for repair and recovering lost user data.

We see these benefits extending to other enterprises and we are working with our OEM customers to increase penetration of our client SSDs in their corporate PC platform offering. I am extremely pleased with our execution in growing our SSD revenues, and we continue to target achieving 25% of our 2014 revenue from enterprise and end-client SSDs.

In mobile our expanded portfolio of embedded solutions, which include our discrete iNAND, iNAND MCP and custom solutions drove significant growth for us across 2013. In particular, our China market initiative has strengthened our position with the entry in mid-range OEMs, as well as with the emerging companies who are developing premium solutions for both the domestic, China and international markets. We are making good progress in developing our next generation high performance iNAND products, and we expect these to be an important contributor to growth in our embedded revenue in 2014.

In retail, in the fourth quarter, we saw strength in sales of USB flash drive and a rich mix of high performance mobile cards. I am also pleased to note that SanDisk’s product quality, reliability and brand recognition as well as our track-record of meeting customer specifications and product supply requirements have helped us achieve sole supplier status at a leading U.S. retailer for the imaging category. Additionally, we have been selected as one of the top-five suppliers out of more than 6,000 via global retail chain in the general merchandize category.

SanDisk’s vertical integration and broad product portfolio along with our focus and operational excellence and customer centricity have been key enablers of these achievements and we are extremely proud of them. With our market leadership we expect 2014 to be another solid year for our retail products.

In memory technology, our 1Y nanometer technology achieved cost crossover with 19 nanometer in the fourth quarter with big production output exceeding 15% for the quarter. During 2014 we also plan to introduce some X3 based embedded products. We are also making very good progress in developing the 1Z node and we are on-track for starting the production transition to this node towards the end of 2014.

From a wafer fab perspective, the shell for phase two of Fab 5 is on-track to be completed in mid-2014. And as we have previously explained the new clean room space will be primarily used to support 1Y and 1Z technology transition in Fab 3, Fab 4 and phase one of Fab 5. We also plan to use some portion of the new clean room space for pilot production of our 3D NAND in the latter part of 2015. Our expectation for the production ramp of 3D NAND technology in 2016 remains unchanged.

In terms of supply growth, we continue to estimate the industry bit growth in 2014 to be approximately 40% the same as our estimate of the 2013 industry bit growth. SanDisk’s supply bit growth in 2013 was 18% and we estimate our 2014 supply bit growth range to be between 25% and 35% consistent with earlier projections. We remain focused on our strategy of our revenue share outperforming our bit share and we believe we are executing well to this strategy. For the year we continue to expect overall healthy industry fundamentals.

As we look to the future, the rapid proliferation of evermore powerful, smart, connected, consumer and industrial devices will combine to form a much talked about Internet of things. Ultimately, these ubiquitous devices will drive explosive growth in data integration, cloud computing and big data analytics, each of which will have their own requirements for their sponsors and reliable flash solutions.

SanDisk continues a broad focus in mobile computing solutions including, low power small footprint embedded solutions for miniaturized consumer computing devices, as well as in high performance, high reliability SSDs that can be deployed in all tiers of the datacenter leading to a continued differentiation of our portfolio.

We are engaged with key players in this eco-system and we’re excited about the growing value proposition of flash to deliver the best storage solution which will enable these computing trends to realize their full potential. To conclude 2013 was a stellar year for the Company as we executed well on our strategy to grow our mix of high value solutions.

Looking forward to 2014, we believe the secular demand drivers for NAND flash remain healthy and we’re energized to capitalize on the opportunities that lie ahead of us. I would like to thank our employees for all their hard work in 2013 and our investors for their ongoing support.

With that I will turn the call over to Judy for her financial review and outlook.

Judy Bruner

Thank you, Sanjay. By all measures we delivered outstanding results for Q4 and the full year. We are proud to have produced 22% 2013 revenue growth with 22% gigabyte growth and zero change in our average selling price per gigabyte. By increasing our mix of high value solutions while maintaining disciplined capacity management we were able to achieve substantial revenue growth with modest bit supply growth and this was a key factor in our record free cash flow.

Our fourth quarter revenue of 1.73 billion grew 12% year-over-year and was comprised of gigabyte growth of 13% and price decline of 2%. On a sequential basis our gigabyte growth was 12% and our price decline was 6%. The sequential price decline in Q4 reflected in part a seasonally higher mix of retail sales which carry a lower average price per gigabyte.

Our fourth quarter revenue mix by channel was 62% commercial and 38% retail reflecting a sequential increase in retail mix of three percentage points. Our fourth quarter retail revenue grew 16% sequentially and 18% year-over-year. The year-over-year retail growth was driven by mobile cards, USBs and SSDs. While sequentially we also benefited from seasonal growth in imaging cards. For the full year we gained significant global retail share enabling our retail revenue to grow at nearly the same rate as our commercial revenue and maintain a 2013 retail mix of 37% the same as in 2012.

Our fourth quarter commercial revenue grew 1% sequentially and 8% year-over-year. The year-over-year commercial growth was driven by a strong increase in SSD revenue, both client and enterprise partially offset by a decline in mobile revenue. Looking at the mobile revenue from the commercial channel, card sales were down year-over-year due to continued OEM de-bundling and our reduced supply to white label channels. While our sales of mobile cards through the commercial channel were down on a year-over-year basis, we more than made up for this in sales of aftermarket retail mobile cards. And our total Q4 mobile card revenue was up quite nicely year-over-year.

Our fourth quarter mobile embedded revenue was down year-over-year due to lower sales of custom embedded solutions. Within our embedded sales our iNAND and MCP iNAND revenue was up year-over-year, driven by growing demand for entry level and mid-tier mobile devices. Sanjay has discussed our SSD revenue, so I will just point out that SSDs now account for nearly a third of our commercial sales and adding in our retail SSDs, we’re thrilled that SSDs achieved a 21% mix of our total Q4 revenue.

Looking across all channels within our 2013 revenue of 6.17 billion, our embedded revenue grew 37%, removable product revenue declined 2% and SSD revenue grew 170%.

Turning to gross margin, our non-GAAP gross margin of 50.9% was 80 basis points better than our Q3 gross margin and 200 basis points above the midpoint of our previous guidance. There were three primary factors contributing to the stronger than expected gross margin in Q4; first an increased mix of sales utilizing X3 memory; two, receipt of the settlement related to a fab power outage in 2010 ; and three, an increase in license and royalty revenue in Q4, in part from one-time payments.

Our blended cost per gigabyte declined 6% sequentially, the same as price decline with the cost improvement coming primarily from three areas; one, a yen rate in cost of sales of 97 compared to 93 in the third quarter; two, a higher mix of X3 based sales; and three, an increase in fully depreciated fab tools. For the full year 2013, our cost per gigabyte improvement was 20% compared to zero change in our ASP per gigabyte.

Our Q4 non-GAAP operating expenses increased 41 million sequentially to 323 million, slightly higher than our previous forecast of 310 million to 320 million. The sequential increase included certain one-time expenses in R&D of 11 million, seasonal expenses of approximately 6 million and higher bonus expense of 5 million related to our strong 2013 results. The remaining sequential increase relates to a full quarter versus partial quarter of SMART Storage Systems’ expenses, and increased headcount and engineering material.

Our non-GAAP operating expenses for the full year were 18.2% of revenue within our target model of 17% to 19%. Our non-GAAP operating margin was an outstanding 32% for Q4 and 29% for the full year and we set quarterly and annual records for operating income dollars on both a non-GAAP and GAAP basis.

Our diluted share count continued to come down benefiting from a full quarter of our significant Q3 share repurchases, as well as additional share repurchases made in Q4 in conjunction with our convertible offering.

Turning to cash flow, our Q4 cash flow from operations was a record 617 million bringing the full year to a record 1.86 billion. We used 41 million of cash during the quarter for capital investments inclusive of the fab joint ventures bringing free cash flow to 576 million for Q4 and 1.7 billion for the full year. Our 2013 free cash flow was 28% of revenue and over $7 per share.

For 2013, our total fab and non-fab capital investments were 859 million and our total cash investment was 138 million, with the remainder of the investment funded by the joint ventures. Flash ventures did not take out any new equipment leases during 2013, and our off balance sheet fab lease guarantees are now less than 500 million. For 2013 we spent nearly 1.6 billion on share repurchases and 100 million on our quarterly dividend which we instituted in the third quarter. In total our 2013 return of cash to shareholders was 98% of free cash flow.

I will now turn to forward-looking commentary for Q1 and 2014. Let me start with a few comments on supply and pricing, our expected growth in bit supply from the fabs remains consistent with our prior estimates of 25% to 35%. We expect to be able to grow our revenue bits in the upper half of that range as we tighten our inventory levels. For 2014 we expect a healthy balance between industry demand and supply resulting in a modest level of price decline albeit more than what the industry experienced in 2013.

For the first quarter, we expect to experience typical seasonality resulting in lower sequential revenue. Our first quarter revenue estimate is 1.45 billion to 1.525 billion and our full year estimate is 6.4 billion to 6.8 billion.

Turning to gross margins, we expect our 2014 cost reduction to be less than the 20% generated in 2013, likely towards the low-end of the 15% to 25% range previously described. Our primary cost reduction will come from the 1Y transition with an expected positive impact from the yen and a dampening of the cost reduction metric from our continued mix shift towards products which carry higher non-flash content. In addition our gross margin expectations anticipates that a portion of our SMART Storage based sales will use non-captive memory for the majority of the year given various customer qualification schedules.

Relative to the yen, the rate in our Q1 cost of sales is expected to be approximately 99 based on average purchases during Q4. We also placed hedges in Q4 for approximately one-third of our remaining expected 2014 yen requirements at a rate of approximately 99. We currently plan to purchase the remainder of the yen over the course of the year at market rate.

Our non-GAAP gross margin estimate for the first quarter is 47% to 49% which reflects a lower revenue level and a lower mix of high margin retail sales. For the full year 2014, we expect our non-GAAP gross margin to be similar to our full year 2013 results with a non-GAAP gross margin range of 45% to 48%. We expect expenses for 2014 to be in the upper part of our 17% to 19% target range as we continue to invest and expand in our SSD product offerings and building our enterprise go-to-market and support capabilities.

For the full year, we forecast non-GAAP operating expenses of 1.225 billion to 1.25 billion with the first quarter being 300 million to 310 million. We expect our fab capital investments to increase in 2014 driven primarily by the increased capital intensity of the 1Y node which we have previously described, as well as investment in 3D NAND development tools in the fab joint ventures. We expect additions to our wafer capacity inclusive of productivity improvements to be 5% or less.

Our non-fab capital investments are also expected to increase in 2014 and include planned expansion of our assembly and test capacity footprint, as well as equipment and facilities for R&D groups in various parts of the world. Our total capital investment for 2014 is expected to be between 1.5 billion and 1.7 billion with cash requirements being approximately half of this amount. Given the increase in capital spending, we expect a reduced level of free cash flow in 2014 relative to 2013. And we plan to continue our return of capital strategy including share repurchase at approximately 70% of our free cash flow.

Another factor impacting our share count will be that our stock price is now above the upper strike of the call spread placed on our 2017 convertible debt security. The options within this call spread effectively hedge the dilution from the underlying convertible security and the impact of the options is included in our non-GAAP share count. The warrants within the call spread determine the effective strike price of the convertible debt and since the warrants are now in the money we expect to incur non-GAAP share count dilution from the warrants in Q1 in 2014.

Taking into account dilution from the warrants new equity issuances to employees and offsetting share repurchase, our best estimate is that our 2014 non-GAAP diluted share count will be approximately flat to the 229 million shares in Q4.

Finally our non-GAAP tax rate for 2014 is forecasted at 31.5%, slightly higher than in 2014 due to the expiration of the U.S. R&D tax credit. In summary, we delivered outstanding 2013 results with 22% revenue growth, 29% non-GAAP operating margin and $1.7 billion of free cash flow and we returned 98% of that free cash flow to our shareholders.

As we manage our business for 2014 and beyond, our priorities remain focused on further strengthening and broadening our product portfolio, continued disciplined capacity management and investment in future technologies and operational capabilities. We believe this will enable us to deliver another strong year in 2014 with solid revenue growth and excellent operating margins.

We are now happy to answer your questions.

Jay Iyer

Thank you, Judy, thank you, Sanjay. Danielle if you can open the floor for questions. We will do the Q&A session until 3 O’clock.

Question-and-Answer Session

Operator

Absolutely. (Operator Instructions) We will go first to John Pitzer with Credit Suisse.

Farhan Ahmed - Credit Suisse

Hi, this is Farhan Ahmed asking a question on behalf of John. My first question is regarding the X3 products that you talked about in the embedded market. Can you talk about the embedded and client SSD margins today and if you introduce 60, how should that effect the margins and also you talked about revenue increasing, your bit growth this year but if you increase the mix of X3 products, wouldn’t that lead to faster bit growth for you?

Judy Bruner

This is Judy, let me take the question. Let me start with, you were asking about embedded and client margins and how X3 would impact that. Let me start with the margins within our business and then talk about X3. So if you think about our gross margins, obviously some gross margins tend to be below the corporate average and some growth margins tend to be above the corporate average.

Embedded mobile products and client SSD products tend to have gross margins that are somewhat below the corporate average. Enterprise SSD products and retail products tend to have gross margins that are definitely above the corporate average. As you understand everything, can’t be above the corporate average.

As we introduce X3 memory into certain products, like embedded mobile products, we believe that will tend to improve the gross margins in that category. And that’s our expectation for several of the new products that we expect to be introducing in the coming year.

Then you asked about X3 mix in terms of bit growth and our estimate of 25% to 35% supply bit growth for 2014 includes our expectation for technology transitions and our expectation for wafer mix in terms of X2 wafers and X3 wafers. So, that’s already built into our expectation for supply bit growth and revenue bit growth and the reason we think our revenue bit growth can be in the upper half of the range of supply bit growth is that we think we can tighten our inventory levels, our inventory weeks of supply somewhat in 2014.

Farhan Ahmed - Credit Suisse

And then touching on to the retail business, you mentioned that it has very good gross margins. And I just wanted to understand in terms of the retail business, how much of the retail businesses is in emerging markets and how much of it is basically tied to the lower mid end Smartphones? If you can just talk about that, that would be really helpful.

Sanjay Mehrotra

In terms of units, more than half our units sold are in the emerging markets and as we have said before, we are doing very well in the emerging markets. SanDisk brand frankly across the globe is doing very well. And mobile cards in retail certainly are growing opportunity as non iOS phones, they all have pretty much card slots in them and aftermarket card sales for mobile phones continues to do very well for us and in fact growing category and again leveraging SanDisk broad distribution, more than a quarter billion store fronts and SanDisk recognition as a trusted brand really is, defiantly continuing to help us capture bulk of the opportunity in mobile cards in the retail markets.

Jay Iyer

Thank you, Farhan. In interest of time can I ask the callers to limit themselves to one question a brief follow up? Danielle, the next question please.

Operator

Will come from Doug Freedman with RBC Capital Markets.

Doug Freedman - RBC Capital Markets

Great, thanks for taking my question guys and congratulations on the strong results. If you could dig in a little bit on the CapEx number, give us a little bit of color on the linearity of when that CapEx will be spent and when you think that supply comes online. And maybe if you could offer some color on how much of that is really being spent for incremental supply, versus continuing to keep your wafer output flat as you node migrate?

Judy Bruner

Okay. So, the CapEx estimate for 2014 which was $1.5 billion to $1.7 billion, let me just deal with the midpoint of that range for a moment, call it $1.6 billion. Lastly, $1.2 billion of that would be fab related and roughly $400 million of that would be non-fab related.

And then if we look at the fab portion of that, the $1.2 billion, I believe that the spending, first of all, the bulk of it is related to the 1Y transition. And the 1Y transition, we expect is occurring fairly linearly over the course of 2014. So that would cause the majority of that to the spent fairly linearly over the course of the year. There will also be included in that number some development tools related to 3D NAND. I would guestimate that spending is probably more in the middle of the year, but there will be spending over the course of the year there as well.

And then wafer capacity, thank you. Wafer capacity, we expect will increase during 2014 by 5% or less and that is inclusive of productivity improvements. We have not made a decision on any new wafer capacity; however, if we do add new wafer capacity, that new wafer capacity plus productivity improvements we expect would add to the wafer capacity, no more than 5%.

Operator

And we will hear from Mehdi Hosseini with SIG.

Mehdi Hosseini - SIG

Sanjay, I want to go back to your announcement from a week or so ago talking about UltraDIMM and IBM becoming one of the customer. Can you help us understand the market opportunities and if there are more than IBMs out there that you’re working with? And you also mentioned earlier that when it comes to SMART scaling and to that extent UltraDIMM products, how much of a non-captive capacity would you need? And is that already dialed into your revenue guidance?

Sanjay Mehrotra

Regarding UltraDIMM exciting, innovative new product category, actually first of its kind in the marketplace and its main application, as you know is regarding ultra-low latency, targeting applications that require ultra-low latency for highest performance of the application. And also the benefit of UltraDIMM is it goes into the DIMMs slots in the servers, into the memory slots. So the capacity can easily be scaled up with full performance being maintained. So that’s yet another significant benefit of it.

So we think that in very ultra-low latency kind of applications, there will be growing opportunity for UltraDIMM. Keep in mind this is a new product category. New product categories in the industry, in any industry, take a while to evolve.

We are engaged with qualifications with the leading customer that you mentioned and we’re of course engaged with other customers as well. In terms of the revenue opportunity for this, it is too early to really quantify. I would certainly expect it to be multi 100 millions of opportunity and starting from there and growing in the future. But really this is too early to call out. We are engaged in creating the market opportunity here.

And your second question regarding the non-captive memory in UltraDIMMs or other smart products, yes I mean expectations of that are baked into our revenue guidance, as well as in our margin guidance.

Mehdi Hosseini - SIG

Okay great and then if I were just to extend from there and a question for Judy, as your revenue mix diversify, it seems to me just taking bits and ASP is not going to fully capture opportunities for you, especially into process SSD scales? And I have asked this question many times, is there any way you could help us to better model and capture these incremental opportunities above and beyond this year in the longer term?

Judy Bruner

So you’re right, that increasingly providing those statistics of bit growth and ASP change does not adequately describe our revenue opportunity or the changes in our business model. And in fact we believe that our business results are becoming less and less correlated to the component pricing statistics that you see out there in the marketplace. And I think that’s pretty evident in the results that we reported today.

And we also believe that this is resulting in our business model becoming more consistent and more resilient. So in terms of us been able to help you model our business, I think we do breakout for you the percentage of our revenue that is coming from the different broad product categories and form factors and we’ll continue to do that and we will look for other metrics that we can help provide you overtime.

Operator

We’ll hear from James Schneider with Goldman Sachs.

James Schneider - Goldman Sachs

Relative to your comments on the transition to 1Y and 1Z, if you’re starting 1Z starting at the end of 2014, does that imply that the 1Y transition will be potentially complete by the end of 2014?

Judy Bruner

I believe that the 1Y will account for roughly something like two thirds of our bit output by the end of the year. Of course there will always a tail on 1Y just like there is a tail on 19. But yes, it will be definitely more than half and probably roughly two thirds by the end of the year of our output, bit output.

James Schneider - Goldman Sachs

And then as a clarification, you mentioned the vast majority or some portion at least of the phase two of Fab 5 being filled up with equipment needed for process migration and then the initial pilot line for 3D. Can you talk about how much clean room space might be left for potential new capacity adds, now that you’ve decided to do that? But give us a sense of roughly how much clean room space might be left for wafer additions if you do decide to do them at some point?

Sanjay Mehrotra

So the phase two clean room space will be used for technology transitions for 1Y and 1Z in our installed capacity base, primarily 1Z technology transition actually in phase two of the installed capacity of Fab 3, 4 and Fab 5 phase one. Phase two will also be using up some of the clean room space for big 3D NAND related equipment for the pilot lines and some level of production capability of 3D NAND.

And yes beyond that there will be some space available in phase two, which we have not really made any decision on. And it is too soon to quantify how much space will be left. It will be very much depending upon finalization of the process of record for 1Z technology as well as the process of record for the 3D NAND technology. And of course that space will be available for us for any future technology related, whether transition related aspects or any new potential capacity as well.

Jay Iyer

Next question please.

Operator

Will from Timothy Arcuri with Cowen and Company.

Timothy Arcuri - Cowen and Company

Couple of questions. First on your guidance for the full year, you guided revenue down 7% mid-point and you said that your bit supply growth will be between 25% and 35%. So it seems to imply that pricing is going to go down more than roughly 20%, which seems like a good bit. But then you said that pricing would be down only slightly for the year. And I know that you’re really vectoring differently from the market. But when you talked about ASTB down slightly, were you talking more about the overall market?

Judy Bruner

No, I said that we expect overall for 2014 that the industry has a good supply demand balance, a healthy environment. And in a healthy environment we expect that over time industry price decline is probably roughly correlated or similar to industry cost decline. And as a result we expect that industry price decline in 2014 is somewhat more than industry price decline in 2013.

We expect that we can continue to do better in terms of our overall blended price decline than the industry price decline as we continue to execute on our strategy of moving our portfolio, shifting our portfolio, to higher value added solutions. But there is obviously some expectation of price decline in the industry and in our business model as well.

Timothy Arcuri - Cowen and Company

Got it, okay. Thanks for that, and then just a question on CapEx. So the CapEx is doubling with no wafer capacity at year-over-year, which I guess is pretty amazing unto itself. But of the 1.2 billion fab related spending, can you tell us how much of that is related to the development tools for 3D?

Judy Bruner

We’re not really breaking that out but definitely the vast majority of the spending is related to the 1Y transition. And actually I will point out that we did actually show a fair amount of detail in our slides at our May 2013 Investor Day to show the increased capital intensity of the 1Y technology relative to the 19 nanometer technology.

Jay Iyer

Thanks Tim. Next question please.

Operator

Is from Craig Ellis with B. Riley.

Craig Ellis - B. Riley

Judy, can you go into a little bit more detail on some of the puts and takes with cost reduction this year? And specifically with regards to the headwind that the company has and then I think you talked about [indiscernible] Analyst Day with the higher cost mix as it relates to SSDs. How much of the headwind is that in this year’s cost reduction and how does that evolve over time? Is that an even further mix next year if we see enterprise SSDs grow or is it at a point where it might stabilize is an incremental dynamic year-on-year?

Judy Bruner

Okay. So in terms of the puts and takes in 2014 cost improvement, clearly, the biggest improvement will continue to come from the technology transition and in 2014 from 1Y, we have said in the past that the inherent cost reduction capability of 1Y is somewhat less than the cost reduction capability of 19 nanometer, but 1Y will continue to be the biggest driver of cost improvement. We expect to also get cost improvement from the yen rate in our cost of sales in 2014 as we did in 2013. And we would expect to continue to get some benefit from depreciation rolling off from some of our fully depreciated tools, albeit less of that in 2014 than we did in 2013.

In terms of some of the items that will reduce cost improvement, meaning go the other way, headwind, product mix will continue to operate in that way. That does not mean that it is reducing gross margin, but it does mean that as we move to products that have higher non-flash content like enterprise SSDs, it offsets some of the cost improvement on a cost per gigabyte basis. It also dampens the price reduction that we see in our business model. And then one other item that will dampen cost improvement is the non-captive memory that we expect to use for some of the smart based products for the majority of the year.

Craig Ellis - B. Riley

The follow up is what’s the assumption on share buyback for calendar ‘14? Is it at 70% free cash flow target or is it a different number?

Judy Bruner

We’re assuming that we will purchase at 70% of our free cash flow and I will point out that that is the stated program we have talked about for some period of time, that we would spend the greater of what it takes to offset employee equity dilution or 70% of free cash flow and even though we expect our free cash flow to be less in 2014 than it was in 2013 due to the higher CapEx spending, we definitely believe 70% of that free cash flow will still be a larger number than what is required to offset employee equity dilution. That’s why we believe that that share repurchase at 70% of free cash flow can also offset any warrant dilution that we experienced due to the warrants being in the money.

So we think that we’ll continue to have a very sound program in terms of share repurchase and of course following a year in which we had remarkable cash generation and remarkable return of cash.

Jay Iyer

Next question please.

Operator

We’ll hear from Mark Newman with Sanford Bernstein.

Mark Newman - Sanford Bernstein

I have some questions on the technology process migration and how your 1Y transition is going? So as complexity is increasing, the scaling is slowing, we seem to be carrying close to the end of scaling here, you mentioned several times about less benefit on the 1Y nodes. And clearly some issues from other competitors in this industry. So I just wanted to ask you on how the 1Y is going. From what you said on the call, it seems to be quite smooth. But I just wanted to check about, have you come across any difficulties, increased difficulties, impact on yield or quality, relative at this point of your ramp curve, relative to previous nodes?

And also related to that, your control expertise, which is also phenomenal and firm, is that becoming significantly more complicated as I expect it is and could you perhaps talk to those issues?

Sanjay Mehrotra

1Y, as we have said before, really doing very well. 1Y yields are ramping up very nicely. 1Y at this point of the technology development and production ramp is actually doing better than our 90 nanometer did in terms of use at similar times. Of course the reliability of 1Y is solid as well. We have been shipping 1Y products since the Q3 timeframe and of course we’re engaged with qualification of 1Y in embedded and SSD platforms and those will be ramping during the course of the year.

At the end of 2013 for Q4, 15% of our bit output was in 1Y technology note, and as Judy just earlier mentioned that by the end of year we would be expecting to be at a quarterly rate of two-thirds of our output in 1Y. So 1Y will continue to ramp from that 15% level at the end of last year to where two-third of our bit output at the end of the year. 1Y will continue to ramp up gradually during the course of the year.

Controller expertise, firmware management techniques, understanding the customer applications and making sure that our product solutions are robust to meet the requirements in terms of performance, in terms of handling workload, as well as reliability, these are of course key aspects that our controller helps us manage and again this is the differentiation that SanDisk has in this regard and our experience of prior handling, prior generations of memory as well as experience of handling now six generations of X3 memory is really helping in terms of applying this 1Y technology rapidly across various product platforms. So all in all, really 1Y is doing very well for us and I’m very encouraged by the results, initial results on 1Z technology as well.

Mark Newman - Sanford Bernstein

Great, and then just one quick follow up on technology. Could you give an update on 3D NAND, how that is going right now, the status and schedule.

Sanjay Mehrotra

3D NAND, we are making good progress there and as we have said before, the schedule for 3D NAND in terms of starting to ramp up volume production is in 2016, pilot line production, sampling capability in second half of 2015. We are on track for that.

Jay Iyer

Thank you, Mark, next question please.

Operator

We’ll hear from Hans Mosesmann with Raymond James.

Hans Mosesmann - Raymond James

Just a follow on to that question on 3D NAND, what’s your positioning competitively or your approach to 3D NAND versus the competition at this point?

Sanjay Mehrotra

Well, we are not going to get into any technology specifics here of our 3D NAND versus competition, but what I can tell you is that as we have said before, we really believe that as long as you can extend the 2D NAND life, it is in the best interest in terms of ROI and in terms of really applying that technology across a broad range of industry applications, and of course getting full benefit in terms of bit growth, as well as cost aspect.

So we feel very comfortable with our 1Y and 1Z technology nodes serving us very well in 2014 and 2015 timeframe, and in 2016 as I said, we’ll be ramping up production of our 3D NAND technology but I can’t really give you specifics in terms of comparison for confidentiality reasons.

Hans Mosesmann - Raymond James

Okay and then as a follow up, any sense of what bit supply growth for the industry or SanDisk for next year will be?

Sanjay Mehrotra

It’s really too soon to say anything about next year, but really overall, next year means 2015, I assume you’re talking about, and the bit growth rate, I would not expect it to be any higher than the kind of levels that we are already at on a year-over-year basis, because again as we have talked about before, technology complexity is increasing, technology transitions are giving you less bit growth per wafer, given the increasing CapEx, as well as the looming transition from 2D to 3D. CapEx is also -- I mean there are new capacities not being added, prudent capacity management. So all of this -- it really points to continuing, extended stability for bit growth in the industry I believe in the future as well.

And keep in mind that 3D technology in terms of its ramp in the industry will go slow, because this technology first has to be proven, reliable and applicable across various segments of the flash and continue to exist, coexist with 3D in the industry for next several years and all that will ultimately add up I believe to extended stability in the industry environment and to moderate bit growth in the future years as well, but can’t really give you specifics about 2015.

Jay Iyer

Thanks Hans. Next question please.

Operator

We’ll hear from Vijay Rakesh with Sterne Agee.

Vijay Rakesh - Sterne Agee

Just wondering, when you look at your 1Y, when you look at the three bit 1Y how does that ramp and how’s the mix fab going to the end of the year?

Sanjay Mehrotra

1Y X3 going very well. In fact we started shipping 1Y X3 products already. As I mentioned before in third quarter, our removable products use 1Y X3. So both 1Y X2 as well as 1Y X3 ramps are going well and as I mentioned in my script, prepared remarks that we will be having embedded solutions with X3 technology during the course of the year as well. And those will be in 1Y.

Vijay Rakesh - Sterne Agee

And on the 1Z, is that 14 nanometer or 12 nanometer if you can give some color there, and on the enterprise side is it mostly today on 24 nanometer and so is there a cost on curve on the enterprise side as you go through 2014?

Sanjay Mehrotra

So your first question, I’m sorry, [indiscernible], 1Z you’re asking for the specifics of 1Z technology node and for competitive reasons we do not disclose that and we’ll provide you more details as we get closer to having that technology ready for production. And regarding 19 nanometer transition for our enterprise storage products, of course that transition is underway and in our guidance for 2014 our estimations for that have all been baked in.

Vijay Rakesh - Sterne Agee

Right, thanks.

Sanjay Mehrotra

Thanks, Vijay. Danielle, we have time for one last question.

Operator

And that will come from Monika Garg with Pacific Crest Securities.

Monika Garg - Pacific Crest Securities

First question is on the capital intensity, going from 19 to 1Y; it has almost increased 70% to 80%. First of all, you spent less than what you had guided initially in the year for last year. So is it to do with something that adjustment? And then, the question is basically how should we think about capital intensity going to 1Z from 1Y and then going to 3D NAND from pre-NAND?

Judy Bruner

Okay. So, first of all, you are right that we did spend last in CapEx in 2013 than we had originally expected. I believe I have said $1 billion to $1.1 billion and we ended up spending $859 million. There were a couple of reasons for that. Some of the lower spend was outside of the fabs, meaning non-fab equipment, and some of that spending just from a timing perspective will happen in 2014 relative to 2013. So, that is currently contributing to the higher number of non-fab spending in 2014.

And then another factor in why the CapEx came in lower in 2013 was actually that some of this was clearly yen based and we benefited somewhat from our original estimate as the yen weakened. And then even within the fab there is timing in terms of some tools getting accepted just after the first of the year versus just right before the first of the year and falling into the 2014 estimate. Okay, then you asked about the capital intensity of 1Y to 1Z and 1Z will be similar, maybe somewhat less than 1Y. It will be more than 19 -- definitely more than 19 but a little bit less than 1Y in terms of capital intensity.

Monika Garg - Pacific Crest Securities

Judy, there is a follow-up on the margin guidance. Q1 you have guided midpoint 48 points, but for the year midpoint is 46.5. So given that Q1 is actually seasonally slow quarter, so are you expecting ASP declines in the back half of 2014 then?

Judy Bruner

There is a lot of different factors in the gross margin guidance for the full year and we have done our best to take all of those into account. Clearly we have looked at our expectation of the pricing environment over the course of the year. We have looked at our product mix and keep in mind as I mentioned earlier in response to another question, we have a variety of different gross margins across our different product categories. And even within each product category there is a wide range of gross margins depending on the product and/or the channel or customer or geography that we are selling to.

So, we done our best estimate in terms of that annual range of gross margin being 45% to 48%, which I want to point out is really a very strong gross margin range, leading to a very strong operating margin range for the company. And I think in the end, what matters here is can we continue to grow our top line and grow our bottom line dollars over time and we think we can.

Sanjay Mehrotra

Unfortunately that’s all the time we have today. We want to thank everyone for joining us on the call. A reply of today’s call should be available on our website at sandisk.com/ir and thank you and have a good evening.

Operator

And ladies and gentlemen that will conclude today’s conference. Thank you again for your participation. You may now disconnect.

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