SanDisk's (SNDK) CEO Sanjay Mehrotra on Q2 2014 Results - Earnings Call Transcript

Jul.17.14 | About: Western Digital (WDC)

SanDisk Corporation (SNDK) Q2 2014 Earnings Conference Call July 16, 2014 5:00 PM ET

Executives

Brendan Lahiff – IR Director

Sanjay Mehrotra – President and CEO

Judy Bruner – EVP of Administration and CFO

Analysts

Steven Chin – UBS

Timothy Arcuri – Cowen & Co.

Steven Fox – Cross Research

Ambrish Srivastava – BMO Capital

C.J. Muse – ISI Group

Doug Friedman – RBC Capital Markets

Vijay Rakesh – Sterne Agee

Craig Ellis – B. Riley

Mehdi Hosseini – SIG

John Pitzer – Credit Suisse

Rajvindra Gill – Needham & Co.

Monika Garg – Pacific Crest Securities

Mark Delaney – Goldman Sachs

Hans Mosesmann – Raymond James

Operator

Good day and welcome to the SanDisk Second Quarter 2014 Financial Results Conference Call.

Today's conference is being recorded.

At this time I would like to turn the conference over to Brendan Lahiff. Please go ahead, sir.

Brendan Lahiff

Thank you, Mellany [ph], and good afternoon everyone. With me on the call are Sanjay Mehrohtra, 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 being discussed during the call, as defined by the SEC in Regulation G, will be reconciled to the most 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 July 16, 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 our SEC filings, including the most recent 10-Q for information on the risk factors that could cause results to differ materially from those expressed in the forward-looking statements. SanDisk assumes no obligation to update these forward-looking statements which speak as of today.

This communication does not constitute an offer to buy or solicitation of an offer to sell any securities. The tender offer to purchase all of the outstanding shares of common stock of Fusion-io, Inc. is being made solely by means of the offer to purchase, the letter of transmittal and related documents, which contain the full terms and conditions of the tender offer and have been mailed to Fusion-io's stockholders and filed with the SEC. Investors and security holders of Fusion-io are urged to read these and other documents filed with the SEC, as well as any amendments or supplements to those documents carefully in their entirety when they become available, because they contain or will contain important information about the proposed transaction.

With that, I'll turn the call over to Sanjay.

Sanjay Mehrotra

Thank you, Brendan, and good afternoon everyone. We are pleased to report record second quarter revenue and net income. Our results highlight ongoing strong execution and further progress in the strategic shift of our revenue mix to SSD solutions. SSDs reached 29% of our second quarter revenue, driven by record revenue in both client and enterprise SSDs, and we are on track to exceed our 2014 revenue mix goal for our SSD solutions.

Our enterprise SSD revenue more than doubled on a year-over-year basis and grew over 30% sequentially, driven by gains in both SaaS and SATA products. Our expanding portfolio of innovative enterprise flash solutions uniquely positions us as a preferred partner to a broad range of customers who are increasingly utilizing flash to optimize their workloads. Our CloudSpeed and other SATA SSD products are now qualified at multiple hyper-scale customers, and we are pleased with the strong traction and revenue ramp achieved in the initial phases of our engagement in this market. In SaaS SSD, we are now in production at a Tier 1 storage OEM for their all-flash array offering, using our recently introduced 2 terabytes Optimus Eco SSD.

In the second quarter we also announced our lightning 12-gigabit SaaS SSD and 4 terabyte Optimus MAX SaaS SSD, extending our leadership in high-performance and high-density SaaS solutions. The new 4 terabyte MAX SaaS SSD has received a lot of customer interest for replacing legacy 15K and even 10K RTM hard-disk drive in mission-critical storage and data center applications. Tier 1 server and storage OEM qualifications of our new SaaS and [indiscernible] products are proceeding well, and we expect them to contribute to our revenue starting in the second half of the year.

In June, we signed a definitive agreement to acquire Fusion-io, a market leader in enterprise PCIe hardware and software solutions. This acquisition will accelerate our transformation into a value-added solutions providers and will further enhance our capabilities with new solutions, channels, customers and go-to market expertise. We have received regulatory clearance for this transaction and look forward to closing this acquisition soon, for the timeline of our tender offer.

In client SSDs, we achieved another record quarterly revenue. Our broad portfolio of SATA and PCIe client SSD solutions continue to serve all leading PC OEMs well, and we are making excellent progress in qualifying our 1Y nanometer client SSDs at many of these OEMs.

During the quarter we introduced the SanDisk Extreme PRO, a high-performance client SSD with up to 1 terabyte class capacity offered with the industry's first ever 10-year warranty. This product has received highly positive reviews, lauding it as the best and most consistently performing client SSD in the market. We are also preparing to commence shipments of X3-based client SSDs in the retail and distribution channels and initiate qualifications with OEM customers in the third quarter. We are excited by the increasing attach rate of SSDs to notebook computers, particularly in corporate PC platforms. Our investments in advancing our product technology, customer engagements and supply chain capabilities position us well to continue to grow our revenue in the client SSD space.

Turning to embedded solutions, overall revenue grew slightly from the prior quarter, with solid growth in sales of custom embedded solutions and the decline in sales of iNAND, primarily stemming from some weakness at certain high-end smartphone customers and the timing of our 1Y product transitions.

Our engagement with China-based mobile device manufacturers is progressing very well, and we are seeing solid revenue growth in this part of the market. We expanded our mobile offerings for mid and entry-level smartphones and tablets with the launch of the iNAND Standard, which is X3-based embedded offering.

Customer qualifications of our X3-based embedded solutions are proceeding as planned, and we expect revenue ramp to begin in the third quarter of 2014, positioning us well for growth in embedded in the second half of the year.

In retail, we delivered record second quarter revenue with a mix of high-performance, ultra and extreme products, contributing through to half of our retail revenue. Key market trends such as ultra-high definition video and high resolution imaging features in various consumer devices also fuel a greater need for high-performance, high-capacity removable storage solutions. This plays to our retail strength, including our valuable brand, excellent performance-based product segmentation and broad global reach. We are well-positioned for strong performance in retail for the upcoming back-to-school and end-of-the-year holiday period.

In terms of fab output in the second quarter, the mix of our 1Y technology was approximately 60% of our total bit output. And we expect to remain at approximately this level for the remainder of 2014.

We continue to have strong demands from our OEM customers for the 19-nanometer technology nodes and we are committed to supporting the long tail of demand for products based on this technology. As we are becoming more successful in OEM and enterprise accounts, this trend of longer product lifecycles on older technology generations is becoming more pronounced as customers rely on us for supply continuity. We expect approximately 5% wafer capacity growth in 2014, and given OEM and enterprise demand for 19-nanometer supply, we expect our supply bit growth to be at the lower end of our previously stated range of 25% to 35%. Our estimate of industry supply bit growth remains at approximately 40%.

We project healthy industry demand supply environment for the remainder of the year. Specifically for SanDisk, we expect to be somewhat supply-constrained during the second half of the year and expect to manage our revenue mix with focus on our strategic priorities and customer relationships.

As we have discussed previously, we will begin installation and qualification of equipment for technology transition in phase two of Fab 5 in the third quarter of 2014. We continue to make very good progress with our 15-nanometer technology development and we expect to begin the production ramp toward the end of this year, with meaningful contribution to product shipments in the Q1 2015 timeframe. Our 3D NAND technology development continues to make good progress, and we expect to be in pilot production in the second half of 2015, with target production in 2016.

To conclude, the second quarter marked another period of significant achievements and developments, putting us on an excellent path to deliver yet another year of record results. The long-term demand drivers remain healthy and SanDisk is increasingly becoming an important partner to our customers as we make progress in delivering a broad array of high-value storage solutions.

We look forward to welcoming the Fusion-io team to the SanDisk family, and we remain focused on delivering the best value to our customers, partners, employees and shareholders.

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

Judy Bruner

Thank you, Sanjay. We are pleased with our Q2 year-over-year growth of 11% in revenue and 16% in non-GAAP earnings per share. Our revenue of $1.63 billion and non-GAAP EPS of $1.41 both represent second quarter records. Our year-over-year revenue growth was 14% in the commercial channel and 4% in the retail channel, resulting in a Q2 mix of 67% commercial and 33% retail.

By product category, the strongest revenue growth was in the SSD solutions which grew 97% year over year and 9% sequentially, reaching 29% of our revenue mix and setting new record levels for both client and enterprise SSD revenue.

Our removable product revenue grew 7% both year over year and sequentially, representing 40% of our Q2 revenue. Within removable products, our strongest growth was in micro SD cards, particularly within emerging markets.

Our embedded revenue was down year over year by 29% and up sequentially by 3%, representing 19% of our total Q2 revenue. Sequentially, our sales of custom embedded solutions increased while sales of iNAND and MCP iNAND products were down due to weakness in sales of certain smartphones and due to the in-progress qualification of our 1Y embedded products with several customers. On a year-over-year basis, the largest decline in embedded revenue resulted from lower custom embedded sales as a large customer shifted demand toward our client SSD solutions.

Within our total revenue, memory petabytes sold increased 31% sequentially and 51% year over year, which was more than the growth in our bit supply, thus reducing inventory.

Our Q2 non-GAAP gross margin was 48%, down 3 points from Q1 as expected, due primarily to an increased mix of custom embedded solutions. The product mix of our sales impacted our blended price per gigabyte and cost per gigabyte, causing the movement in both statistics to be higher than the underlying like-for-like trends. For Q2, our blended price per gigabyte decline was 16% and our blended cost per gigabyte decline was 12%, whereas on a like-for-like basis both numbers were single-digit declines.

The key factors related to product mix that influenced the blended price and cost declines were a higher mix of custom embedded solutions, a lower mix of MCP products, and a higher mix of removable and other sales in emerging markets relative to established markets. The yen rate in Q2 cost of sales was 101 compared to 99 in the first quarter.

Our Q2 non-GAAP operating expenses of $311 million were slightly below our forecasted range, due primarily to a delay in certain hiring and other spending, some of which we consciously slowed down given the planned acquisition of Fusion-io. Our Q2 non-GAAP operating margin was 29% and our non-GAAP tax rate remained at 31.5%.

Our diluted non-GAAP share count increased by 3.3 million shares, even with strong share repurchases, as our Q2 average stock price resulted in our 2017 warrants, adding an incremental 3.6 million to diluted shares.

Our Q2 cash flow from operations was $241 million and cash used for capital investments was $44 million, yielding free cash flow of $197 million. During Q2, our capital return to shareholders totaled $302 million, comprised of $51 million of dividends and $251 million of share buybacks. During Q2 we repurchased 2.7 million shares at an average price of $92.69 per share. On a year-to-date basis, total capital return has been 81% of free cash flow and we have repurchased 4 million shares at an average price of $85.66. Our goal remains to return 100% of 2014 free cash flow to investors through the combination of dividends and stock repurchases.

Our share of joint venture Fab Investments during Q2 was $221 million, and these purchases were funded by joint venture working capital and $64 million of new operating leases. Our off-balance-sheet equipment lease guarantees now stand at $586 million.

I will now turn to forward-looking commentary. We currently expect the Fusion-io acquisition to close in the third quarter, but at this time we will provide our forecast on a standalone basis, with a focus on Q3. For our third quarter we expect the strongest sequential growth to come from our embedded products, including both iNAND and custom embedded solutions. We expect that we will be supply-constrained as we work to complete our modest 2014 capacity expansion and that the industry will be in supply/demand balance.

Our third quarter revenue forecast is $1,675,000,000 to $1,725,000,000. We expect our non-GAAP gross margin to remain similar to the second quarter, with the forecasted range of 47% to 49%. And given our supply constraints as well as expected product mix, we expect our third quarter blended price and cost movements to be muted in comparison to the second quarter. We forecast Q3 non-GAAP operating expenses to be $320 million to $330 million. Q3 non-GAAP other income is forecasted at $5 million, and we expect our non-GAAP tax rate to remain at 31.5%.

In terms of diluted shares, our projection is that the Q3 non-GAAP share count will remain approximately flat to the Q2 level, with share repurchases offsetting new issuances as well as the increasing impact of the 2017 warrant. Note that a schedule is posted on our website showing the impact of the warrants at varying stock prices. And keep in mind that for any given quarter, the impact of the warrants is based on the weighted average stock price for that quarter. For example, the relevant stock price in Q2 was $90.41.

In terms of capital investments, we continue to expect our gross investment for fab equipment and other CapEx to be approximately $1.4 billion in 2014, with cash usage of approximately $600 million, concentrated in the second half of the year given the timing of investments. For the first half of the year, our total gross investment was $540 million, with cash usage of $79 million. And while we expect to use more cash for capital investments in the second half, we also expect higher cash flow from operations in the second half of the year.

As previously indicated, we expect the Fusion-io acquisition to close in our third fiscal quarter. As you can see from their recent quarterly results, Fusion-io has been operating at a loss, and we expect synergies to be modest in the early quarters, with any initial synergies more than offset by one-time restructuring and deal costs. We continue to expect the acquisition to be accretive to our non-GAAP earnings in the second half of our fiscal 2015.

In summary, we are very pleased with our second quarter results. We are growing our revenue with impressive gains in SSD solutions and we are managing our overall product mix and investments to deliver strong profitability, with Q2 achieving a record in net income and EPS. At the same time, we continue to return significant capital to our shareholders. We look forward to delivering a strong second half and another record year.

We'll now open the call for your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]

We will take our first question from Steven Chin with UBS.

Steven Chin – UBS

Hi. Thanks for taking my questions. First thing is on your SSD business. Just get on some of the improvement sentiment on PC demand and just given the recent growth in your SSD business, I was wondering if you are seeing any further acceleration in SSD demand going to the second half and potentially next year, or if you see things sort of holding steady in terms of the penetration rates and whatnot just given what you're hearing from your customers?

Sanjay Mehrotra

We certainly do see our SSDs, in client SSDs, to continue to increase in revenue throughout the year. And we continue to see increases in penetration rate as well, both on the consumer PC side as well as on the corporate PC platform. In fact, on the corporate PC platform, we expect that SSD attach rate will be approximately 30% for 2014 and expecting it to increase to about 60% by 2017 timeframe.

So this attach rate actually, you know, every time you look at this report, this continues to go up. SSD adoption is certainly increasing. And certainly the value proposition of SSD in terms of providing small sleek form factors, you know, with the chrome books, the two-in-one devices, the ultra-thin notebooks, as well as the SSD's value proposition in terms of instant-on capabilities and fast boot-up and high-speed applications, this is all really continuing to drive increasing penetration of SSD. And with our strong portfolio of SATA and PCIe solutions for the PC platform, we definitely continue to see strong advances in our SSD business through this year and continuing next year as well. And of course in enterprise SSD side, as you know, we are growing very nicely as well.

Steven Chin – UBS

Perfect. And just my follow-up is, in terms of the solid state drive controller merchant silicon market, just given some of the consolidation that's going on there with Seagate taking up some assets, and just kind of wondering if you anticipate more competition in the marketplace from them in enterprise in particular. And secondly, just from a bond class perspective, just knowing that merchant silicon from - in SSD/SSE standpoint, that is still relatively stable or at a premium in some cases. I was wondering if you see any impact longer term to SanDisk merchant controller strategy there. Thank you.

Sanjay Mehrotra

Overall in terms of enterprise SSD, really vertical integration is the key for leadership in enterprise space. And as we have seen in the client SSD space, there has been tremendous consolidation in terms of some of the players that were not vertically integrated are not around frankly anymore. So vertical integration is absolutely going to be key in enterprise SSDs as well. Having large volume production capability of flash, high-quality flash, leading-edge technology node, and applying the devices [ph] aspects of that to the controller and the firmware aspects to manage high reliability, high-performance requirements of enterprise workloads, and doing it all really in a very seamless fashion across all aspects of product development and test and understanding of customer applications is key to winning in the enterprise SSD space. So we feel really very good about our continuing position there and continuing advances in this area.

And remember, the key, when it comes to controllers, even if our products use some third-party ESF [ph], in terms of controller, the key really comes, in terms of differentiation, comes from the firmware that is built into the products. And that firmware is built upon many years of experience of flash memory technology, device and system management, data management technique for the flash.

So in terms of controller strategy and in terms of product strategy, we are very well-positioned to continue to do very well in the enterprise storage space.

Steven Chin – UBS

Great. Thank you, Sanjay.

Operator

We'll go next to Timothy Arcuri with Cowen & Company.

Timothy Arcuri – Cowen & Co.

Thanks so much. Sanjay, can you talk a little bit about the royalty profile as the industry moves from planar to 3D? Is it going to impact your royalty stream? It seems like the industry is a little less reliant on your IP at 3D, but I'm not sure if that's right.

Sanjay Mehrotra

As we have said before, our, you know, royalty agreement with our largest licensee provides us royalties on their sales of 2D NAND as well as 3D NAND. In addition, there are certain 3D-specific backend claims that have not been licensed, which means opportunity -- additional opportunity for us in the future. SanDisk has a strong IP position both for 2D memory technology as well as for 3D memory, and our innovation pipeline continues to be strong at the memory level as well as at the system implementation level also.

Timothy Arcuri – Cowen & Co.

Great. Thank you for that. And then Judy, you've been talking about cost reduction targets this year, down 15% to 25% this year. Can you maybe guide us a little bit within that range? It seems like the 1Y mix is sort of flattening off here through the end of the year. So can you guide us within that range? Thanks.

Judy Bruner

Sure. We do expect to be in that range for this year. And at this point I would tell you that most likely we would be around the middle to somewhat higher than the middle of that range.

We've had strong blended cost per gigabyte reduction in the first half of the year on a year-over-year basis, but I think it will be somewhat subdued in the second half of the year given that we will be holding our 1Y mix versus 19-nanometer mix approximately constant across the second half of the year. But overall, cost reduction is in the range that we had anticipated.

Timothy Arcuri – Cowen & Co.

Thank you.

Operator

And we'll go next to Steven Fox with Cross Research.

Steven Fox – Cross Research

Thanks. Good afternoon. Two questions from me. First of all, just on the gross margins going forward. I think you went through the mix impact to the gross margins. But if you were to look at the like-for-like gross margin impact by products, is there any major changes over the next couple of quarters from where the gross margins are on some of the specific products like SSDs, et cetera?

And then secondly, if you look at your own supply constraints for the rest of 2014, can you give us some kind of hint as to where you think you will be more acute in your product sales, where we'll see it most? Thank you.

Judy Bruner

Sure. So in terms of the mix impact on our gross margin as we move forward, the -- as I indicated, we expect the highest amount of revenue growth in the third quarter to come from our embedded products. And as we've said in the past, embedded products as well as client SSD products tend to have gross margins that are somewhat below the corporate average. So that growth in embedded would be somewhat of a headwind to the gross margin going forward.

On the other hand, at the same time, we expect to see gross margin improvements in various parts of the business and in various products. Some of these will come from an increasing usage of captive memory within our enterprise SSD products, and also we expect, as Sanjay indicated, to utilize a higher mix of X3 in several of our products in the second half of the year. So those will be tailwinds and help our gross margins.

But overall in terms of our gross margins, we're anticipating gross margins to remain in a similar range to the second quarter, in the range of 47% to 49%, which is a very strong gross margin and solidly within our target financial model, producing a very strong operating margin for the business.

The second part of your question was about supply constraint --

Steven Fox – Cross Research

Yes, where you would probably see it the most in your sales mix.

Judy Bruner

You know, clearly we work very hard to manage the mix of our business to meet the demand of our strategic customers and to balance the supply mix that we have of the various nodes of memory with the demand that is out there. And so we've been very successful at that, we'll continue to do that. And if there are areas that we need to pull back on, they will tend to be those areas that are less strategic to us going forward.

Sanjay Mehrotra

And certainly profitability considerations will be one of the key factors in helping us manage, and customer relationship.

Steven Fox – Cross Research

Great. Thank you very much.

Operator

We'll go next to Ambrish Srivastava with BMO.

Ambrish Srivastava – BMO Capital

Thank you very much. Judy and Sanjay, just a question on -- just trying to understand the supply constraint situation. How does that improve as you come on to the year?

Judy Bruner

Well, as we indicated, we are working on the capacity expansion that we had planned for this year, both expansion in terms of capacity -- wafer capacity and some productivity improvement that will add to wafer capacity. And that will add about 5% to our wafer capacity this year. We're working on it now and we expect that it will begin to contribute to our revenue supply in the fourth quarter of this year.

At the same time, we are evaluating potential for additional capacity add next year. This is really very similar to what we communicated at our Investor Day. And we expect that our bit supply growth next year will be in line with industry bit supply growth in the range of 30% to 40%.

Ambrish Srivastava – BMO Capital

So the reason you're in this situation is because bit growth was slightly better than what you were anticipating in the first half of the year, is that the right way to think about it?

Judy Bruner

Well, I would say that our bit supply growth this year continues to be in the range that we talked about at the beginning of the year, the 25% to 35% range. Perhaps more towards the lower end and largely influenced by the fact that demand is coming for the 19-nanometer node, and so we are meeting that demand and thereby slowing down the transition to 1Y in order to have enough 19-nanometer to meet the needs of our strategic customers.

Ambrish Srivastava – BMO Capital

Okay, that's very helpful. Thank you very much.

Operator

We'll go next to C.J. Muse with ISI Group.

C.J. Muse – ISI Group

Yes, good afternoon. Thank you for taking my question. I guess first question, curious how you balance your desire to focus on high-cost bits with strategic relationships that demand lower-cost bits in an environment where your capacity adds are coming below industry levels. Would love to hear your thoughts on that and how to think about ASPs prospectively from here.

Sanjay Mehrotra

We basically look at long-term relationships with our customers, and certainly SanDisk has a diversified -- having the most complete portfolio of solutions offerings in the flash industry and I believe the broadest engagement of customer relationships as well. It gives us tremendous opportunity to manage the mix of our business, keeping in mind our top line and bottom line revenue and profit objectives in mind, and that's how we really focus on managing the mix of the business. And again our strategy is to focus on the best combination of revenue, profits and cash flow. And we feel really pleased with the progress that we have made over the course of last few years in diversifying our product portfolio, deepening our customer engagements, broadening the customer engagements. And that just gives us opportunity to manage our mix very effectively.

C.J. Muse – ISI Group

That's helpful. And if I could just ask two clarifications. First, in terms of bit growth next year, up 30% to 40%, does that include additional wafer starts or that's the base case? And then secondly, on the royalty side, can you share whether the rate is the same for 2D and 3D? Thank you.

Sanjay Mehrotra

We are not going to provide specifics on royalty rates for 2D or 3D, although royalty rates are same between the two. Regarding the wafer capacity growth of 30% to 40% for next year, that does include our assumptions for any capacity adds during the year.

C.J. Muse – ISI Group

Thank you.

Operator

We'll go next to Doug Friedman with RBC Capital Markets.

Doug Friedman – RBC Capital Markets

Great. Thanks for taking my question. If you could talk maybe a little bit about struggling with the bit growth numbers that you've communicated being towards the low end on the supply side. Those are talking about just the amount of bits that you're producing. How about the amount of bits that are available for you to ship from inventory, how much higher can that number be on a shipment basis from the work-down of your internal inventories?

Judy Bruner

Sure. We believe that from a revenue perspective we can have a higher growth rate in revenue bits than in supply bits this year. And I would say that the revenue bit growth rate can be more towards the upper end of that range, whereas the supply bits growth more towards the lower end of that range.

And as you saw in our results this quarter, we did bring inventory down. I think we can continue to bring inventory down over the course of the second half of this year, and we expect to do so in order to maximize available petabytes to meet demand.

Doug Friedman – RBC Capital Markets

Okay. I'm also struggling on that bit growth guidance because you did guide wafers to increase I believe about 5%, and we should see a rather material increase in X3. How does X3 play, what percentage of the bit growth is being driven by maybe the X3 conversion? And maybe if you could offer a little bit of a commentary on whether the conditions in the marketplace have changed at all that is contributing to sort of the ASP erosion that you just reported.

Judy Bruner

So in terms of the breakdown of the supply bit growth, we're not going to break it down into all the different pieces. But the lower end of that 25% to 35% range includes growth that's coming from the 1Y transition which we essentially now are not going to transition anymore percentage to 1Y in the second half of the year. And it's coming from an increasing mix of X3, you're right. And in fact, our X3 mix increased in the second quarter relative to the first quarter and we expect it will increase in the second half, and is coming from the 5% increase in wafer capacity. But keep in mind that that wafer capacity is really only starting to contribute in the latter part of the year.

So you have to keep in mind, we had 1Y conversion impacting the first half of the year and not the second half. Then we have wafer capacity starting to impact later in the year but not earlier in the year. And we do have X3 increasing across the year in terms of mix.

And I'm sorry, Doug, what was the second part of your question again?

Doug Friedman – RBC Capital Markets

Just trying to get a sense if you're seeing any change in maybe the marketplace or pricing, the market environment, that is driving the results that you're seeing, most notably sort of the ASP change, even on a like-for-like 12% down in a constrained environment is maybe a little surprising for some.

Judy Bruner

Yeah. So as I indicated, on a like-for-like basis, both our price decline and our cost decline were single-digit numbers relative to the first quarter. But I would tell you that on a like-for-like basis the price decline was somewhat higher than the cost decline. And we did see some pockets of softness in terms of pricing in the second quarter. However, we have seen in recent weeks that pricing firm up and it appears to be moving in the right direction. That combined with our own expectation of supply constraint in the third quarter and we believe a healthier environment across the second half in terms of seasonality and demand, lead us to believe that pricing is going to be very muted in the third quarter.

And so, you know, also keep in mind that as you look at some of these price statistics as well as cost statistics, mix is increasingly influencing those statistics, and any one of them in isolation is really not a good measure of the health of the business. And so I really encourage you to look at our gross margin and our operating margin, both of which I think are leaders in terms of profitability in the industry. And we have worked very hard to diversify our product portfolio and our customer portfolio and manage that mix of products every quarter in order to grow the revenue and produce very strong profitability.

Doug Friedman – RBC Capital Markets

Great. Thank you. I'll leave it there and get back in the queue if there's time.

Operator

And we'll go next to Vijay Rakesh with Sterne Agee.

Vijay Rakesh – Sterne Agee

Yeah, hi guys. You mentioned, you know, as you look at second half, you are keeping the 19-nanometer mix constant. How do you see the 15-nanometer ramping, you know, 1Z ramping next year? Where are you with TLC in the mix today?

Sanjay Mehrotra

With respect to TLC in the mix, in the second quarter it was, you know, 45% to 50% range. And as we have said, in the second half we expect X3 percentage to go higher somewhat. And regarding 1Z nodes, it will be starting production ramp late in the fourth quarter, late this year. And we expect it to be really primarily becoming meaningful starting first quarter in terms of bit mix.

Vijay Rakesh – Sterne Agee

Got it. And when you look at TLC, what portion of your SSDs, obviously SSD is growing faster, what portion of your SSD is on 3-bit today, or when do you expect that to become meaningful?

Sanjay Mehrotra

So as we said, in terms of X3 SSD, we'll be launching it in -- shipping it in retail and commercial channels in the third quarter, the SSD built on 3-bit per cell technology. And we will also be in customer qualifications -- OEM qualifications with that X3 SSD. We expect X3 SSD to start to become more meaningful for us and ramping up nicely in 2015 timeframe.

Vijay Rakesh – Sterne Agee

Got it. Thanks.

Operator

We'll go next to Craig Ellis with B. Riley.

Craig Ellis – B. Riley

Thanks for taking the questions. Judy, I'm sorry if I missed it. Could you please give us an update on the cash CapEx expectation for the full year of calendar 2014?

Judy Bruner

Sure. I said that I expect the cash CapEx for the full year to be approximately $600 million. We've only spent $79 million in the first half of the year, so it's concentrated in the second half of the year. However, at the same time, I expect our cash flow from operations to be stronger in the second half of the year than in the first half of the year.

Craig Ellis – B. Riley

And at Analyst Day you indicated I think that around $400 million of this year's CapEx was for non-wafer-fab, and one of the initiatives was to build your own SSD manufacturing facility in Malaysia. Given the pending Fusion-io acquisition, what's the expectation for the capital intensity of that facility? Does it need to go up given what you may do with that new business?

Judy Bruner

That facility is under construction. We broke ground and it's under construction, and we absolutely are moving as fast as we can on the construction of that Malaysia SSD facility.

Sanjay Mehrotra

And we expect it to be in production in second half of next year.

Craig Ellis – B. Riley

And would it be -- would it be something you could use for Fusion-io product?

Sanjay Mehrotra

We will discuss these post-close, once we firm up our plans.

Craig Ellis – B. Riley

Thank you.

Operator

We'll go next to Mehdi Hosseini with SIG.

Mehdi Hosseini – SIG

Thanks for taking my question. Judy, what will be -- what would have been your guide if you were not bit capacity constrained?

Judy Bruner

You know, I'm not going to provide that number. We have given guidance for revenue growth on both a sequential and year-over-year basis and continuing to execute very well to our plans for this year with very strong profitability. And so we're very happy with how we're executing for this year. And as Sanjay has said, we expect this to be another record year.

Mehdi Hosseini – SIG

Sure, fair. And Sanjay, as we look into next year bit supply growth of 30% to 40%, how should we think about how the Fusion-io is going to consume some of these bits of capacity? And would that have any change on your capacity plan or would you prefer going into the merchant market and just procure from merchant market if you have to? If you remain capacity constrained?

Sanjay Mehrotra

Well, I'm sorry, maybe I didn't let you finish the question. Please say the last sentence again?

Mehdi Hosseini – SIG

Sure. Given the expectation of Fusion-io closing in the September quarter and there the capacity requirement for Fusion-io products, is that changing your capacity planning? And B, if not, would you be willing to procure more from the merchant market?

Sanjay Mehrotra

So regarding the flash memory supply requirements for Fusion-io, as we have seen from our previous acquisitions of Pliant, as well as SmartStorage, it takes several quarters before volume ramp of captive memory supply can really begin in enterprise storage space. So we expect the Fusion-io flash memory requirements to be met for next few quarters from non-captive memory sources. And it will take few quarters before we can start converting it to captive memory based on the timing of the customer qualifications. And besides that, we will be continuing to assess for opportunities to use for part of the portfolio of Fusion-io products requirement non-captive memory.

So we'll have a strategy of converting towards captive memory over the course of few quarters, as well as continuing to leverage non-captive memory for part of that business as well.

Mehdi Hosseini – SIG

Okay. And what was the mix of TLC in the quarter?

Sanjay Mehrotra

As I said, in the range of 45% to 50%.

Mehdi Hosseini – SIG

Thanks much.

Operator

And we'll take our next question from John Pitzer with Credit Suisse.

John Pitzer – Credit Suisse

Yes, thanks guys. Thanks for letting me ask the question. Judy, I'm sorry if I missed this, but given the builds on the handset side this quarter expected from some of your customers, would you expect the embedded mix to kind of peak in the September quarter and go down in the December quarter? And if so, what would the margin kind of consequence be of that? Or can you help me understand that dynamic?

Judy Bruner

We do expect very strong growth in the embedded business in the third quarter, both because of seasonality, as you indicate, as well as due to completing our qualifications of our 1Y iNAND product. So, very strong growth in the third quarter. It's possible that that could ease some in the fourth quarter due to seasonality and in particular as we service our retail channel in the fourth quarter.

But in terms of gross margin, at this point we would anticipate that gross margin would remain in the 47% to 49% range for the second half.

John Pitzer – Credit Suisse

Got it. And then, Sanjay, you answered a question earlier about kind of the parameters around what makes a customer strategic, and I know there's a lot of other puts and takes on that. But I'm kind of curious, how much margin would you be willing to give up to support a strategic customer? Or I guess another way of saying it, at what point would mixing away from a strategic customer be so much more profitable that it would start to make sense for you?

Sanjay Mehrotra

I think if you look at over the course of last few years, I mean we are really continuing -- continue to increase the mix of our solutions toward embedded and SSDs, and we are really doing a very good job in managing that mix I believe.

And in terms of the strategic nature of the customer, the factors that we look at are the long-term stickiness of the business, you know, our relationship with that customer in terms of us being able to deliver value to that customer. We certainly keep in mind the revenue opportunities when we look at the strategic nature of the customers, as well as the profitability consideration. So there are lots of moving parts, when we look at the mix of the business, our customer base really has broadened significantly over the course of last few years. And again, as I said before, I really feel good about having the opportunity to manage this mix on an ongoing basis, with the focus on delivering the top-line growth and delivering strong profits, the net income.

So I really believe that our customer relationship, our technology and product positioning across the broad spectrum of industry applications for flash and our ability to serve the customers as well really performing very well for us.

John Pitzer – Credit Suisse

Thank you.

Operator

And we'll go next to Rajvindra Gill with Needham & Company.

Rajvindra Gill – Needham & Co.

Yes. Thanks for taking my question. I was wondering if you could talk a little bit about the competitive landscape of the SSD space given some of the recent consolidation, and how do you approach the market in terms of your strategy? Thank you.

Sanjay Mehrotra

In terms of strategy for SSD, I mean I'll just comment on client as well as on enterprise. You know, our strategy certainly is to bring leading-edge products, you know, high-performance products with high quality, high support to the customers in terms of supply availability, as well as really making sure that our products really enhance the experience of the customers and devices in the marketplace. So our strategy to our relationship with the customer through bringing value of our technology and products and supply is -- are the key things that we focus on in terms of growing our business.

As you have seen on the client SSD space, we have expanded our solutions offering not only in SATA but on the side of PCIe as well.

And in terms of competition, certainly over the course of last many quarters, SanDisk has really strengthened its market share position. We really are a strong number two player in client SSD market. So we have continued to gain share through our technology, products, supply and quality capabilities.

On the enterprise side, we have focused very much on this as a strategic growth vector for the company, with strong portfolio of solutions, a broad range of solutions, some of which I talked about in my prepared remarks, adjusting both the high-performance as well as the high capacity, and really looking at customer applications, looking at the workloads and bringing solutions, both hardware and software, in terms of accelerating the value proposition of flash and making their application -- customer's applications and services become more resilient and more responsive. And this strategy is working very well for us and we are gaining share in enterprise SSD space as well. And now with the acquisition of Fusion-io, we will instantly [ph] become a leader in the market in PCIe space as well.

So, SanDisk truly is a one-stop shop for entire set of flash storage solutions, and certainly that includes client and the enterprise SSDs. And in all of this, as we have said many times before, vertical integration is the key.

Rajvindra Gill – Needham & Co.

And can you just talk a little bit about the adoption rate of your MCP or just in general the adoption of the trend more to multi-chip package solution in the smartphone industry where OEMs are using both NAND and DRAM?

Sanjay Mehrotra

In the low-end smartphones, certainly multi-chip packages have grown nicely, and certainly SanDisk, we very strategically offer our multi-chip packages that bring in the value of our iNAND solutions, as well as provide the benefit that customers are looking for of flash, iNAND and DRAM in one package.

For the midrange to high-end-range phones, certainly discrete iNAND is primarily the solution in terms of its presence in the marketplace. So there is a strong mix of both multi-chip packages as well as discrete iNAND. Our focus is in providing our customers with their requirements. iNAND -- discrete iNAND is a bigger part of our business. But certainly as you've heard from us before, multi-chip packages have also been substantial offerings from SanDisk for our customers. So we are very pleased with the mix that we are able to provide to our customers in embedded with discrete iNAND, with multi-chip iNAND, as well as with customized solutions. And really there's a broad range of applications of all of these solutions in the marketplace.

Rajvindra Gill – Needham & Co.

Thank you.

Operator

We'll go next to Monika Garg with Pacific Crest Securities.

Monika Garg – Pacific Crest Securities

Hi. Thanks for taking my question. Judy, you kind of didn't provide a yearly guidance, I'm assuming it's because of the Fusion-io kind of close in September, if on the standalone basis could you kind of provide your yearly guidance?

Judy Bruner

You know, you're right, we are not providing a specific quarter four guidance at this point because we will be providing that on a combined basis in October with the Fusion-io business. But I did indicate just a few minutes ago that we do expect the 47% to 49% gross margin range to apply for the second half. And as is typical, we would expect revenue growth from the third quarter to the fourth quarter in terms of seasonality and in terms of growing demand and placement of our products.

But beyond that, I think it makes sense to give specifics in October on a combined business basis.

Monika Garg – Pacific Crest Securities

Thanks a lot. Then just as a follow-up, could you maybe talk about some of the products of Fusion-io like ioControl, ioTurbine? Would, you know, after the merger, would you still like to continue reporting that product or you may think to kind of discontinue them?

Sanjay Mehrotra

Specifically with respect to Fusion-io product roadmap, we will provide you updates after the close in our future quarterly updates.

Monika Garg – Pacific Crest Securities

Okay. Thank you.

Operator

We'll go next to Mark Delaney with Goldman Sachs.

Mark Delaney – Goldman Sachs

Thanks so much for taking the question. I was hoping you could elaborate a little bit more on the enterprise SSD business and if you can talk to us about the range of margins and how they differ between the SaaS and SATA and ULLtraDIMM products, and if all of those are above the corporate average or just some of those types of enterprise SSDs are above the corporate average for margins?

Judy Bruner

Okay. So in terms of the enterprise business, yes, it definitely has a gross margin above the corporate average, when it's using captive memory. And within the enterprise business, I think it's pretty well-understood that SaaS type of products tend to have higher gross margins than SATA products. And of course at this point really ULLtraDIMM is not a part of the revenue equation yet but we are clearly working on that and expect that it will become in the future and that it will have strong gross margins.

Mark Delaney – Goldman Sachs

That's helpful. And the follow-up, on the same topic, Judy, as you -- if you can just talk a little bit more about the mix that you saw this quarter between SATA and SaaS and then what the expectations are for that mix and the organic business as you move through the rest of the year?

Judy Bruner

Both the SATA and the SaaS products grew nicely this quarter, but we're not going to break down the business to that degree.

Mark Delaney – Goldman Sachs

Thank you very much.

Brendan Lahiff

We have time for one more question.

Operator

We will take our last question from Hans Mosesmann with Raymond James.

Hans Mosesmann – Raymond James

Thanks for fitting me in. Most of my questions have been answered, but I'm curious, Sanjay, if you have any comments regarding a competitor's SSD based on the third-generation vNAND or second-generation? It looks like it has gotten pretty good reviews in terms of endurance. What is the -- what's your view on that and what does that do with the competitive dynamic over the next year? Thanks.

Sanjay Mehrotra

In terms of performance, our Extreme PRO SSDs that we announced recently really have got tremendous reviews in the marketplace, as I mentioned in the prepared remarks, in terms of performance and really consistent performance. So we have a strong portfolio of products for our SSDs here.

And regarding the 3D announcements that are out there in the marketplace, we have always talked about in the past that the first few generations of 3D NAND will not really be cost-competitive with the 2D NAND. So I feel really very good about our technology roadmap, with our 1Y production this year, 1Z production this year, 1Z production next year, giving us strong cost leadership with 2D or with any of the 3D NAND technology. And then in 2016 timeframe, to have our 3D NAND.

And using these technologies, we really have a very strong portfolio of SSD offerings to compete with anyone in the marketplace. And ultimately all this demonstrates in the results that we have in terms of the growth of the business and share gains with SSDs.

Hans Mosesmann – Raymond James

Great. Thank you.

Brendan Lahiff

Thanks everyone. We'd like to thank everyone for joining our call today.

A webcast replay of today's call should be available on our Investor Relations website shortly.

Thank you and have a good evening.

Operator

Once again this does conclude the conference. We thank you for your participation.

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

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

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