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Executives

Sanjay Mehrotra - Co-Founder, Chief Executive Officer, President, Chief Operating Officer, Director and Member of Secondary Executive Committee

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

Jay Iyer - Director of Investor Relations

Analysts

Atif Malik - Morgan Stanley

Uche Orji - UBS Investment Bank

Kate Kotlarsky - Goldman Sachs

Hans Mosesmann - Raymond James & Associates

Tristan Gerra - Robert W. Baird & Co. Incorporated

Bobby Gujavarty - Deutsche Bank AG

Daniel Amir - Lazard Capital Markets LLC

Daniel Berenbaum - Auriga USA LLC

Hendi Susanto - Gabelli & Company, Inc.

Craig Ellis - Caris & Company

SanDisk (SNDK) Q4 2010 Earnings Call January 27, 2011 5:00 PM ET

Operator

Good day, ladies and gentlemen. Welcome to SanDisk Corporation's Fiscal Fourth Quarter 2010 Financial Results Conference. At this time, I would like to turn the call over to Mr. Jay Iyer, Director of Investor Relations. Please go ahead, sir.

Jay Iyer

Thank you, Lisa, and good afternoon, everyone. Joining us on the call today are Sanjay Mehrotra, President and CEO of SanDisk; and Judy Bruner, Executive Vice President of Administration and CFO.

Before we begin, please note that any non-GAAP financial measures discussed during this call as defined by the SEC in Regulation G will be reconciled to the most directly comparable GAAP financial measure. That reconciliation is now available along with supplemental schedules on our website at sandisk.com/ir. In addition, during our call today, we will make forward-looking statements. Any statement that refers to expectations, projections or other characterizations of future event, including financial projections and future market conditions, is a forward-looking statement. Actual results may differ materially from those expressed in these forward-looking statements. For more information, please refer to the risk factors discussed in the documents we file from time to time with the SEC, including annual report on Form 10-K for fiscal 2009 and our subsequent quarterly reports on Form 10-Q. SanDisk assumes no obligation to update these forward-looking statements which speak as of the date hereof. With that, I will turn the call over to Sanjay.

Sanjay Mehrotra

Thank you, Jay, and good afternoon, everyone. The fourth quarter was another strong period for SanDisk, reflecting solid execution from every growth in the company driving excellent business results. Secular demand drivers from the mobile markets, coupled with our increasing success in diversifying our customer base, helped us achieve year-over-year revenue growth of 35% in 2010. The scale of our business continues to expand at a rapid rate with overall unit volume approaching the $600 million units per year level. Our technology leadership enabled a 46% year-over-year cost decline, well exceeding the price decline rates, and with continued prudent expense management, 2010 was the most profitable year in the company's history.

For our industry, the drivers for NAND flash demand has never been stronger. The increasing adoption of Smartphone with the high-capacity flash storage remains a key demand driver for NAND, and this end market will be the primary growth engine for SanDisk in 2011.

In addition, the anticipated launch of numerous tablet models from several OEMs is establishing an exciting new product category that relies on NAND flash as its storage solution. Furthermore, we believe Apple’s latest Mac Book Air is likely to re-define the concept of mobile computing and the established view of notebook computers. NAND flash memory is a key enabling storage technology for these thin form factor devices which are designed for better responsiveness, high reliability, lightweight and ruggedness, with long battery life. In addition to Smartphones and tablets, consumer devices such as gaming systems and internet-enabled television are in the early stages of embedding NAND flash as part of their system architectures, and we are very pleased to be deeply involved in those ecosystems.

Switching topics to supply, the industry began adding wafer capacity starting in the second half of 2010 to meet the growing demand from multiple end markets anticipated over the next several years. For 2011, given third-party estimates for supply growth and the demand growth drivers I previously described, we expect a healthy balance between demand and supply for the industry in 2011.

For SanDisk, on our third quarter earnings call, we said that we had not made a decision on the timing of Fab 5 startup. Based on our future demand projections, we have now decided to move forward with Fab 5, and we plan to begin ramping the new facility starting in the third quarter of 2011. Regarding Fab 4, the final phase of capacity expansion is progressing well, and the facility will be operating at its full capacity by mid-2011. SanDisk's combined capacity from the three 300-millimeter facilities, Fab 3, 4 and 5, is expected to provide a big supply increase in line with the industry in 2011. The incremental contribution from Fab 5 to our total wafer output is estimated to be less than 5% for 2011. We view our strategic capacity and technology investment as key to our long-term success, and these investments are vital to generate future returns and to enable continued leadership in our markets.

Turning to our fourth quarter results, both our OEM and retail channels grew sequentially with OEM accounting for 59% of the product revenue. Within the OEM channel, our embedded business including iNAND remained on a solid growth trajectory, and it more than doubled on a year-over-year basis accounting for about 40% of OEM revenue in the fourth quarter.

The design win pipeline for our iNAND product line is in excellent shape, and iNAND is not only gaining greater acceptance in Smartphones but in several tablet models as well. To size the opportunity, more than 200 Smartphones and other devices have already designed in our iNAND solution, and this designed-in volume has more than doubled since last year.

Furthermore, the usage mix of our three bits per cell memory in iNAND continues to grow, and we believe we have the distinction of being the only company to be successfully implementing X3 memory in embedded application. With regard to solid state drive, or SSD, we are advancing our product roadmap and have recently strengthened our resources and leadership team in this area. In our retail channel, we are pleased with our overall Q4 results, and we saw a strong sequential growth in North America for the holiday season.

For the year, we made substantial gains in the Asia Pacific region, particularly in India and China, as many of the initiatives we put in place during 2009 began to pay off. Our retail product line continues to evolve and build upon our long history of providing industry-leading products. Just three weeks ago, we announced a 128-gigabyte SanDisk Extreme Pro CompactFlash card which is the world's fastest high-capacity professional imaging card available in the market today.

From a manufacturing standpoint in 2010, our 32-nanometer technology was the production workhorse, and we continued to have high usage of our three bits per cell architecture in a broad array of products. The 46% cost reduction we achieved in 2010 was primarily enabled by these two key technologies, and we believe we have strong cost leadership in the NAND flash memory industry. Looking forward to 2011, our primary cost-reduction driver will be the currently ramping 24-nanometer technology deployed on both 2- and 3-bits-per-cell architectures. Let me quickly update you on our efforts to drive innovation.

If you recall, we have been working with the mobile network operator (MNO) community for some time to develop product solutions that enhance their subscriber's mobile usage experiences. I'm pleased to report that we are now supplying our service discovery cards, or SDC, to MNO. In particular, on December 20, we announced the card-based secured media solution with network -connected flash memory for Cricket Communication to support its differentiated mobile offering called Muve Music.

To summarize, 2010 was an excellent year for SanDisk. Having established a strong foothold, we entered 2011 highly energized, with excellent technology, broad solutions, and deepening customer relationships. Our market share position is growing in OEM and remains #1 in worldwide retail, and you will see us continue to build upon our strong globally-recognized brand.

Our focus in 2011 will be to expand further into the emerging economies, drive higher usage of our X3 memory in embedded applications, and address the emerging SSD market, all supported by a compelling technology and product roadmap. I'm confident that our vision, passion and dedicated team of talented employees will help us achieve our goals. We plan to expand further on many of these topics at our Analyst Day meeting in February, and I look forward to meeting you then.

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

Judy Bruner

Thank you, Sanjay. We are very pleased to report record quarterly and annual revenue. Our fourth quarter revenue of $1.33 billion grew 8% sequentially and 7% year-over-year, and came in at the top of the range we estimated in October, benefiting from solid demand in both our retail and OEM channels. Our fourth quarter non-GAAP operating margin was 29%. And for the full year 2010, we delivered our most profitable year ever, with non-GAAP operating margin of 32% and non-GAAP net income of $1.1 billion, more than 2x the previous high in 2006.

In Q4, our gigabytes sold increased a strong 30% sequentially, with very similar growth in both the retail and OEM channels. Our ASP per gigabyte declined 15% sequentially with a lower decline in the retail channels and a higher decline within OEM, driven by significant growth in OEM average capacity. Our sequential growth in average capacity was 21% and was higher in OEM than in retail.

Our fourth quarter retail revenue was up 17% sequentially with the strongest growth in the U.S. region. On a year-over-year basis, our Q4 retail revenue was flat with strong growth in Asia, modest growth in the U.S. and a decline in Europe. We believe the year-over-year decline in our Europe retail sales reflects both the weak economic environment in Europe, as well as SanDisk pulling back from certain low priced deals in that region.

Our OEM fourth quarter revenue grew 4% sequentially and 16% year-over-year. And as Sanjay pointed out, we had a strong shift in our OEM mix to embedded solutions. Our 2010 revenue of $4.8 billion grew 35% over 2009 and was made up of an increase in gigabytes sold of 74% and a year-over-year price decline of 19%. Our 2010 OEM revenue grew 75% from 2009 and our 2010 retail revenue grew 8%.

OEM revenue represented 62% of our 2010 product revenue. Our revenue mix for 2010 by end market was 50% from the mobile phone market, 22% from imaging, 9% USB, 11% from other end markets and 8% from license and royalty. Our non-GAAP product gross margin for the fourth quarter was 40%, inclusive of an $18 million charge related to a power outage experienced in Fabs 3 and 4 in the fourth quarter. This charge includes the cost of scrapped wafers, the costs to bring the fabs back online and the fixed costs incurred while the fabs were down and not producing wafers. Excluding the impact of the power outage, costs were as expected and included an increase in non-captive memory to approximately 5% of our shipments and an unfavorable sequential movement in the yen to dollar exchange rate embedded in our cost of sales.

Our fourth quarter cost per gigabyte improved sequentially by 3%, including the impact of the power outage, increased non-captive usage and the yen exchange rate. Our full year 2010 underlying cost per gigabyte improvement of 46%, which includes a 7% unfavorable annual movement in exchange rate, as well as power outage and non-captive costs highlights how successful we were this year in our 32-nanometer transition and our consistently high usage of X3 memory.

Our Q4 non-GAAP operating expenses of $195 million were lower than we had forecasted, primarily due to the timing of certain R&D expenses that are now expected in 2011. For the full year 2010, our non-GAAP operating expenses were 15% of revenue, and we achieved non-GAAP operating margin of 32%.

Fourth quarter non-GAAP other income of $13 million included $5.4 million of gains from the sale of certain investments. Our non-GAAP tax rate for Q4 decreased to 22.9%, benefiting from certain onetime favorable adjustments, as well as the reinstatement of the federal R&D tax credit. Our non-GAAP tax rate for the full year 2010 of 32% included slightly more than a one-point benefit from onetime favorable adjustments.

I'm sure you've noticed that our GAAP tax rate for 2010 is approximately 11%. This is due to the Q4 release of the valuation allowance we have been carrying against our deferred tax assets since the fourth quarter of 2008. The release of this allowance reflects both our strong profitability in 2010 and our expectations for continued profitability.

On the balance sheet, cash and short and long term marketable securities increased sequentially by $292 million to more than $5.3 billion. Deducting the maturity value of our convertible debt securities, our net cash stands at $3.2 billion. Our Q4 cash flow from operations was $359 million, and we invested $60 million in the Fab 4 joint venture and $48 million in non-fab capital purchases.

For the full year 2010, we generated over $1.45 billion of cash flow from operations, more than twice the previous high in 2007, and we generated free cash flow of $1.36 billion. For 2010, our non-fab capital investments were $108 million and our share of joint ventures Fab investments was $944 million, for total capital investment of $1.05 billion. Our Fab joint venture investments required zero net cash investment from SanDisk in 2010, due primarily to the use of Fab joint venture working capital. However, there will be some SanDisk cash contributions required in 2011, related to tools installed in the latter part of 2010.

I'll now turn to forward-looking commentary. Please note that non-GAAP to GAAP reconciliation tables for all applicable guidance are posted on our website.

For the first quarter, we expect our retail demand to be lower sequentially due to normal seasonality, and in our OEM channels, demand continues to grow. We expect to be supply constrained for the first quarter, in part due to the fourth quarter power outage. We anticipate that price decline in Q1 will be relatively modest, including the impact of moving to higher average capacity. We forecast our Q1 total revenue to be between $1.20 billion and $1.275 billion, including license and royalty revenue similar to the fourth quarter.

For the full year 2011, we expect our captive gigabyte growth to be in line with industry growth, and we also expect to utilize a modest amount of non-captive supply to meet our customer demand. We are forecasting healthy supply demand balance in the industry in 2011, and we currently expect that that will equate to price decline being somewhat higher in 2011 than in 2010. Our revenue forecast for 2011 is $5.3 billion to $5.7 billion, including license and royalty revenues similar to slightly higher than in 2010.

Turning to gross margin, for the first quarter, we expect our product gross margin percentage to be similar to the fourth quarter, including the impact of utilizing some non-captive supply.

In forecasting our gross margins for Q2 through Q4, the key factors include pricing, the ramp rate of our 24-nanometer technology, the level of non-captive purchases, Fab 5 start up costs, and the yen to the dollar exchange rate. In terms of the yen to dollar exchange rate, we have locked in the yen exchange rate for approximately half of our 2011 wafer purchases. Based on those hedges plus our forecast of future rates, we expect the yen to have an unfavorable impact on our costs in 2011 relative to 2010, thus putting some pressure on our gross margin.

In addition, we will incur Fab 5 start up costs in cost of sales during 2011 with the heaviest period being Q3 and Q4. In terms of non-captive purchases, we plan to continue utilizing these purchases throughout 2011 in order to profitably balance supply to demand, and at the same time, ramp Fab 5 at a prudent rate. We expect this will result in more non-captive purchases in 2011 than in 2010 when we purchased nothing in the first half of the year and very little in the third quarter. Combining these factors, we forecast our non-GAAP product gross margin for the full year 2011 to be in the range of 35% to 38%, which is at the high-end of or above our long-term financial model. Adding in our License and Royalty revenue yields a total non-GAAP gross margin forecast for 2011 of 39% to 42%.

Our primary operating expense investments in 2011 will be in R&D and will include Fab 5 start up costs as well as technology investment in 1X nanometer NAND and beyond. The Fab 5 start up costs in R&D are expected to be heavier in the first half of the year than in the second half, whereas other technology as well as marketing costs are forecasted to be higher in the second half of the year.

We expect that our total non-GAAP operating expenses will be approximately $850 million spread relatively evenly across the year. This puts our 2011 non-GAAP OpEx at the low-end to middle of our long-term financial model of 15% to 17% of revenue, inclusive of the start up costs. We expect our non-GAAP other income for 2011 to be approximately $30 million, spread fairly evenly across the year. This is lower than last year because 2010 benefited from over $30 million of gain from the sale of certain investments, and also because 2011 carries a full year of interest expense on the convertible debt issued in August 2010. We expect our non-GAAP tax rate for 2011 to be 33%.

Relative to our diluted share count for 2011, keep in mind that from an accounting perspective, we will begin to include additional shares in our diluted share count when the stock trades above the $52 strike price of our recent convertible issuance even though we have bond hedges that are expected to offset dilution below $73 per share upon ultimate maturity or conversion.

Our 2011 capital investment forecast for Fab and non-Fab purchases is between $1.4 billion and $1.6 billion, including the remaining expansion of Fab 4 and the initial ramp of Fab 5. These investments will be financed through a combination of leases, joint venture working capital and cash. I will provide further details on our capital spending and our funding plans at our February Analyst Day.

In summary, our fourth quarter and 2010 results were outstanding, and we believe we are well-positioned for a strong 2011. We will now open the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take the first question today from Daniel Amir, Lazard Capital Markets.

Daniel Amir - Lazard Capital Markets LLC

In terms of the guidance, can you give us a little more clarity on the OEM market? It seems like it's reacting much better than seasonal trends. So what are you currently seeing there? I mean, is it in specific end market? Is it more on the embedded side?

Sanjay Mehrotra

In the OEM market, we are seeing a growth in the Smartphone, as well as for 2011 in the tablet category. And of course, the Legacy market of imaging and USB drives, et cetera, continue to be a stronghold as well. In embedded, particularly in the mobile embedded-led opportunities, we are gaining share, and our products are doing very well. As I indicated, that's becoming a larger part of our overall OEM business.

Daniel Amir - Lazard Capital Markets LLC

And then, one follow-up. In terms of the power outage, what type of impact did that have in Q4 and going into Q1 in terms of the impact on margins and potentially on revenues here as you seem like to be somewhat supply constrained?

Judy Bruner

In terms of the impact on the fourth quarter, Daniel, it was really the $18 million charge that I described. It really did not impact revenue in the fourth quarter. In the first quarter, our available supply is reduced by something less than 10% relative to the Power outage. And we're making up for some of that with non-captive purchases. But it is a factor in our available supply in the first quarter.

Operator

Our next is Daniel Berenbaum from Auriga USA.

Daniel Berenbaum - Auriga USA LLC

Just again looking at the guidance, when you talked about Q1 ASP declines being relatively benign and then looking at 2011 being relatively worse than 2010. Can you help us put a little bit more structure around that? Just put some numbers around that?

Judy Bruner

We're not going to put numbers around it, but let me try to give you a little more color. We do believe that the industry in 2011 will be in a healthy supply-demand balance. And we believe that, that translates into a rate of price decline that will be somewhat higher than what the industry experienced in 2010, which was actually a quite benign rate of price decline in 2010. And so we are expecting that it will be higher in 2011. We think it will be a healthy rate of price decline for the industry that will help stimulate further growth in demand and in new applications. And that is all built in to our guidance for revenue growth and for margins for 2011, which we think are very strong.

Daniel Berenbaum - Auriga USA LLC

So then tying into that, I mean, do you imply that -- or it seems that you think that your cost reduction is going to be a little bit less than price declines since it looks like gross margin is going down just a little bit, and I'm sorry, I just haven’t worked through all the math. Is that the right way to think about it? And then you had talked last year, you talked about your long-term cost reduction per byte roadmap being 25% and 35% annually over the course of the next last couple of years. Is that still the right way to think about it?

Judy Bruner

I think you're thinking about it correctly, Daniel. In terms of the all in cost reduction, we believe we'll continue to be a cost leader in 2011 and that we will have very strong cost reduction. But when we factor in all the various moving parts such as the yen exchange rate and the Fab 5 start up costs and some increased usage of non-captive, those all factored into the cost reduction would result in an expectation for cost reduction to be a bit less than price decline, which then is factored into the gross margin guidance that we provided.

Daniel Berenbaum - Auriga USA LLC

So if we were just looking at your -- or if we are excluding those external factors and just looking at your cost reduction, do you think that would be ahead of price declines?

Judy Bruner

You know we're not going to give that kind of specificity, but we do believe that our cost reduction capability is very strong in terms of our underlying cost reduction. And the gross margin that we're arriving at is at the higher end or above our long-term financial model.

Daniel Berenbaum - Auriga USA LLC

And then one last question along those lines, something I didn't understand in the prepared commentary. You talked about ASPs being down partly due to increased shift to OEM or to higher density in OEMs. Could you give a little more clarity around that? I thought OEM was better ASPs, or what didn't I understand there?

Judy Bruner

Really, what I referred to was a higher growth rate in the average capacity of our OEM products. And as you move up in terms of average capacity, ASP per gigabyte does not move up exactly in correlation. It tends to be at a lower rate at the higher capacities. And so that, without an actual price decline, contributes to a somewhat lower ASP per gigabyte.

Operator

Our next question today comes from Craig Ellis, Caris & Company.

Craig Ellis - Caris & Company

Sanjay, can you talk a little bit about the 24-nanometer transition? What some of the key milestones will be in 2011 as you go to that lower number?

Sanjay Mehrotra

We started production of 24-nanometer at the end of last year. During 2011 we will continue to ramp up 24-nanometer, convert from 32-nanometer production to 24-nanometer in our Fabs. By end of this year, we expect to be fully converted, by the December timeframe, to 24-nanometer, except for any 32-nanometer requirement that we still may have related to certain customers.

Craig Ellis - Caris & Company

And then just going back to something that's very topical. On the subject of tablets, can you talk about how meaningful tablets are to the revenue stream now and as you look at the design-in pipeline, when do they begin to become much more meaningful? Is it steadily through the year, or are there any particular step-ups as we think about the next three or four quarters?

Sanjay Mehrotra

So we have a very strong engagement with leading players in the tablets market. We look at tablets as a very strong growth opportunity for us in 2011. You saw at [indiscernible] that scores of models of tablets got announced, and several of these will be heading into production over the course of first half of the year and then probably new product introductions will continue during the course of the year as well. So we really look at this as an opportunity that will be continuing to build up for us during the course of 2011.

Craig Ellis - Caris & Company

And then lastly if I could Judy, you might have mentioned it in the prepared comments. if you did, I did missed it. But could you specify what the range would be for your second sourcing for this year?

Judy Bruner

I'm sorry, you cut out. For our what?

Craig Ellis - Caris & Company

What percent of mix would be second sourced this year?

Judy Bruner

I did not say specifically, but I would tell you that it's probably something around 10% or less.

Operator

Next up, we'll hear from Uche Orji, UBS.

Uche Orji - UBS Investment Bank

Sanjay, you talked about Fab 5 contributing 5% of capacity this year. When it is fully ramped, what will that be in terms of contributions to total capacity for SanDisk?

Sanjay Mehrotra

So what I mentioned was that Fab 5 will contribute less than 5% total wafer output for 2011 on the basis of our existing Fab 3, Fab 4 capacity. So less than 5% of our total output from Fab 3, 4 and 5 in 2011 will be coming from Fab 5. And with respect to the capacity specifically. By the end of this year, we will be reaching at our Fab 5, adding approximately 10% to our total Fab 3, Fab 4, Fab 5 capacity.

Uche Orji - UBS Investment Bank

Just in terms of equipment availability, I know you are going to be ramping into later part of second half of this year. Are there any concerns we may have around your ability to ramp it up by equipment availability or should we just assume this is fully all locked in?

Sanjay Mehrotra

We work very closely with the equipment suppliers. And SanDisk and Toshiba together worked closely with the equipment suppliers, and we believe the equipment is available to meet our capacity NAND's requirement in Fab 5.

Uche Orji - UBS Investment Bank

Judy, in terms of the margin structure within the embedded, as we are seeing more and more of true embedded, I have two questions here. One, is can you just kind of rank order for me the margin contribution across the various product segments? That's one. And then two. Sanjay, if you can just talk about what really -- it looks like iNAND is getting more and more traction. Did I hear you correctly say you had -- how many Smartphone did you mention? I'm not sure I heard it correctly. And if you can just talk what you bring especially into the market space that has allowed you to be ramped in the last, I would say, in the last six months, probably what I've been monitoring. It looks like something to have clicked in terms of your ability to ramp this. So anything can be helpful here.

Judy Bruner

Let me start out. What I would tell you is that in recent periods, the gross margins of our Retail business have outstripped the gross margins of our OEM segment of our business. And that is primarily because we have such high usage of our X3 memory in the retail part of our business. In OEM, usage of X3 to date in the embedded part of our OEM business has been relatively lower, but we are making progress and penetrating the embedded solutions with our extreme memory and we expect to continue to make progress across 2011 in using X3 in embedded solutions. But we really managed our gross margins in terms of the overall blended portfolio, and we're very pleased with the overall gross margin performance for 2010 clearly, as well as with our guidance for 2011.

Sanjay Mehrotra

So regarding your question on Embedded Products and our success and the key factors in that regard. Let me first point out that our Embedded Products include iNAND, as well as other components. And these Embedded Products are certainly going into Smartphone, but categories such as tablets and other mobile devices as well. What I referred to in my prepared remarks was more than 200 models of various mobile devices that our Embedded Products are designed in. Not only Smartphone, but other mobile devices in the ecosystem of consumer devices as well. Regarding iNAND, we have spoken to it for a long time that our systems strength of having really the controller expertise, together with the flash memory, really comes into strong play for embedded opportunities because it helps us understand the user application, the usage models in the end device platforms and tweak, if you will, our iNAND products to really optimize the performance of the storage solution in the end application. We have spoken about Adaptive Flash Management techniques in the past, and basically, those helped us really then several of these designs because we are able to deliver high-performance, as well as high quality and reliability with our solutions. So we believe that eMMC 4.41 in the iNAND product is really a leadership product and best of specifications in the market. And of course, we continue to engage on an ongoing basis with the chipset vendors, as well as the handset providers in the mobile ecosystem and other device manufacturers as well in the ecosystem to continue to look at the next generation opportunities and to continue to advance our product offerings to gain further on these designs and momentum.

Operator

Our next question comes from Tristan Gerra, Robert Baird.

Tristan Gerra - Robert W. Baird & Co. Incorporated

You mentioned that outsourcing will be around 10% or less for the whole year. Is there any quarter where it's going to be above 10%?

Judy Bruner

We're really not going to guide to that on a specific quarterly basis at this point. Our usage of non-captive across the year will depend upon demand trends as they unfold across the year. Our current expectation is that we'll use something up to 10%.

Tristan Gerra - Robert W. Baird & Co. Incorporated

Could you provide a breakdown on the gross margin for yen exchange, fab outage, and long types of usage through the quarter?

Jay Iyer

Tristan, I think you should repeat the question, we didn't catch it.

Tristan Gerra - Robert W. Baird & Co. Incorporated

I may have missed it, but did you provide a breakdown on your gross margin for the quarter as well as yen exchange and all also the fab outage?

Judy Bruner

I did say that the power outage resulted in an $18 million charge to the fourth quarter. So you can calculate that, that is close to a 1.5 point impact on the gross margins. And in terms of the yen exchange rate, I didn't mention that, but I'll tell you that the underlying yen exchange rate in our cost of sales in the fourth quarter moved an unfavorable approximately six percentage points, relative to the third quarter. I'm talking six percentage movement in the yen exchange rate, not in the gross margin percentage.

Tristan Gerra - Robert W. Baird & Co. Incorporated

And are you able to provide the rules of guidance in terms of the iNAND as percentage of your Embedded business? Have you had any kind of high-level target?

Sanjay Mehrotra

INAND is a strong mix of our total Embedded business but we are not going to break out iNAND versus the other components. I did provide you that our Embedded Products contributed 40% of our OEM revenue in the fourth quarter as well as the increased from 30% in the third quarter.

Operator

Next up is Bob Gujavarty, Deutsche Bank.

Bobby Gujavarty - Deutsche Bank AG

I just had a question about the non-captive capacity. Given some tightness and balanced supply and demand, do you anticipate any difficulty in getting as much non-captive as you like or is that already kind of arranged?

Sanjay Mehrotra

We have strong [indiscernible] in place for procuring non-captive supply. Of course, we manage it during the course of the year as we determine our needs, but we are pretty confident that we will be able to procure the non-captive supply to meet the requirements that Judy earlier mentioned.

Bobby Gujavarty - Deutsche Bank AG

And Judy, can you just remind me, isn’t a yen about a 10% move and the dollar yen is about a one percentage point impact to gross margin? Is that the correct ratio, or do I have it wrong?

Judy Bruner

No, the impact is more than that. What we've typically said is that a five percentage move in the yen can cause about a two- to three-point movement in the gross margin percentage.

Operator

Atif Malik, Morgan Stanley has the next question.

Atif Malik - Morgan Stanley

Can you tell us the Toshiba shutdown? How much did it affect your own shipments in Q4?

Judy Bruner

You're talking about the power outage?

Atif Malik - Morgan Stanley

Right.

Judy Bruner

It really did not affect our revenue in the fourth quarter. And as I said, we think that it will have an impact on -- or it does have an impact on, our available supply in the first quarter of something less than 10%.

Atif Malik - Morgan Stanley

And then what would've been the cost-reduction excluding the outage? You said including it was like 3% cost reduction?

Judy Bruner

Yes, it would have been something like around 5% cost reduction. But of course, that is also impacted by the yen exchange rate. So a lot of different moving parts in the cost per gigabyte reduction in the fourth quarter, as well as next year.

Atif Malik - Morgan Stanley

And what was MLC/TLC mix exiting last year?

Sanjay Mehrotra

For 2010, our X3 3-bit per cell mix was more than 50%.

Atif Malik - Morgan Stanley

If I look at your history of cost reduction in the last three years, you have been very strong and you've always up sided your cost reduction targets in the 3-bit per cell or technology migration. But just according to physics, if you scale 32-nanometer wafer to a 24-nanometer, you should be able to get a 45% kind of cost reduction just doing the 24-square over 32-square. And then you have a knob of 3-bit per cell just getting embedded in OEM applications. So I mean why should we believe that the cost reduction should be less than 40% this year?

Sanjay Mehrotra

Let me just provide you some help here. When you look at scaling the technology, it is not only about scaling the flash memory cell, it is also about scaling the periphery transistors, the circuits, inside the chip. And those two tend to scale at somewhat of a different rate. When we look at 32-nanometer to a 24-nanometer, wafer comparison adds mature yields. The 24-nanometer can give you a benefit in the range of 30% to 40%. Again, at the wafer-level, with maturing on both the 32-nanometer wafer as well as 24-nanometer wafer. However, for our yearly cost reduction, as Judy pointed out, there are many factors. One of them is certainly 24-nanometer ramp up. We will be ramping up 24-nanometer during the course of the year. And other factors, of course that play a role in our overall cost reduction are the non-captive supply, as well as Fab 5 related start up costs and impact of exchange rate.

Atif Malik - Morgan Stanley

Should we model a linear kind of a ramp for 24-nanometer for this year?

Sanjay Mehrotra

Yes, the 24-nanometer ramp will be fairly linear during the year.

Atif Malik - Morgan Stanley

And Wi-Fi will start with 24 or 18?

Sanjay Mehrotra

We are not disclosing the plans for Wi-Fi at this point. As I said, the 1x technology will start late this year. Wi-Fi will start in August timeframe with production in the Q3 timeframe.

Operator

Next up is Hendi Susanto, Gabelli & Company.

Hendi Susanto - Gabelli & Company, Inc.

How do you set the non-captive pricing? Like how much influence do Japanese yen and market spot price have on your non-captive purchase? And furthermore, on an apples-to-apples basis or per gigabyte of capacity, how much impact does non-captive purchase have on the gross margin?

Judy Bruner

In terms of non-captive pricing, there are certain formulas available for non-captive pricing for us in our non-captive supply agreements. But I really can't go into how the yen plays into that and of course that plays into any non-captive purchases that we might make from Toshiba, but not necessarily from other suppliers. And I'm sorry, what was the second part of your question?

Hendi Susanto - Gabelli & Company, Inc.

Like on an apples-to-apples basis or on a per gigabyte of capacity, what is the difference in the gross margin between the captive and the non-captive?

Judy Bruner

It can vary quite a bit from period to period, but there is a substantial difference in the cost per gigabyte or the gross margin between our usage of our captive supply and our non-captive. I have said in the past that there can be up to 20 to even 30 percentage points difference between the gross margin for captive versus non-captive.

Hendi Susanto - Gabelli & Company, Inc.

And my last question in the embedded applications, are there new markets that you are planning to pursue in 2011?

Sanjay Mehrotra

Yes. We see emerging markets for IP TV, the connective TVs for gaming devices, and these are new opportunities emerging for embedded flash solutions.

Operator

Next up, we'll hear from Hans Mosesmann, Raymond James.

Hans Mosesmann - Raymond James & Associates

Just an industry comment regarding SLC demand, which looks like it's going to be pretty strong this year on enterprise dynamics. What are the implications of stronger demand in SLC in terms of your business, which is the 2-bits-per-cell and 3-bits-per-cell and then would you consider getting into that business in some way?

Sanjay Mehrotra

So we will continue to focus on MLC and 3-bits-per-cell. That's where we have leadership, especially with solutions related to using the controller. In the enterprise market also, it's an interesting opportunity for us, and we will certainly continue to evaluate it. But a lot of the enterprise market also is starting to use MLC now as well.

Operator

And Kate Kotlarsky, Goldman Sachs, is up next.

Kate Kotlarsky - Goldman Sachs

I wanted to ask about your bit growth expectations for this year. Sanjay, I believe you had mentioned that assuming you only utilize your captive supply, you would be relatively in line with the industry average. Could you share with us what that number is in your mind? Is it something around 80%?

Sanjay Mehrotra

I'll share with you is the number that's available from the third-party sources, and that number points to, for the industry supply growth, in the range of high 70s to high 80s.

Kate Kotlarsky - Goldman Sachs

So we should think of that number as being sort of the minimum of what you expect to grow this year from a bid growth perspective?

Sanjay Mehrotra

We are not providing any specific guidance, but we will be in the range as well.

Kate Kotlarsky - Goldman Sachs

And then can I also ask what your current plans are for 4-bits-per-cell or X4 going forward?

Sanjay Mehrotra

In 24-nanometer, as well as in 32-nanometer, all of our production has been and will be 2-bit per cell and 3-bit per cell technology. We are not producing 4-bits-per-cell in these technology nodes. But of course, a lot of the techniques that we learned from 4-bits-per-cell we are able to apply them to 3-bit-per-cell products, and those are some of the techniques that actually end up giving our 3-bit-per -cell products superior performance and functionality and application compared to others 2-bits-per-cell products.

Kate Kotlarsky - Goldman Sachs

I was wondering if you could tell us what percentage of your OEM business this quarter was white label in the Wafer business? I know that it was a minimal amount in Q3, and I believe that was expected to increase this quarter. So I was just hoping you could share that with us.

Judy Bruner

Kate, no, we're not really going to break out that level of granularity on our OEM business. As we've said, 40% of our OEM business was embedded, and then the rest of it would be Card business as well as some Wafer and Component business.

Operator

Next up is Vijay Rakesh, Sterne Agee.

Kate Kotlarsky - Goldman Sachs

Just wondering if you can give us a little bit more color on the 24-nanometer side. How do you see that ramping here now that it is starting to ramp there?

Sanjay Mehrotra

Regarding 24-nanometer, it could be ramping during the course of the year. And we started it late last year, and it will complete transition by the end of the year. And as I said before, if we complete it by the end of the year except for any 32-nanometer that we will acquire for certain OEMs.

Kate Kotlarsky - Goldman Sachs

So should we assume it's more like a -- between 15%, 20% range in the first quarter and then kind of grow linear into the year?

Sanjay Mehrotra

The transition will occur linearly during the course of the year.

Kate Kotlarsky - Goldman Sachs

On the TLC, on the 3-bits-per-cell, what proportion of your output is on 3-bit now?

Sanjay Mehrotra

In 2010, we had more than 50% of our bit production on 3-bits-per-cell. Similarly in 2011 as well.

Kate Kotlarsky - Goldman Sachs

And on the Toshiba Fab 4, will it be fully subsidized by end of Q2, is that right?

Sanjay Mehrotra

Yes, we have said before that, that Fab 4 will be fully facilitized by mid this year. Yes.

Kate Kotlarsky - Goldman Sachs

And how much capacity does that add in the first half from Fab 4?

Sanjay Mehrotra

What we have said before, it still applies. Which is once Fab 4 is fully facilitized, our total production output from Fab 3 and Fab 4 combined will be at the rate of 2 billion wafers per year.

Operator

There are no further questions in the queue.

Jay Iyer

Thank you. Thank you, Lisa. We want to thank everyone for joining us on the call today. As a reminder, our 2011 Financial Analyst Meeting will be held on February 24, and we hope to see you then. Thank you, and have a good evening.

Operator

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

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