Full Transcript of SanDisk’s 3Q05 Conference Call — Q&A (SNDK)

Here’s the entire text of the Q&A from SanDisk’s (ticker: SNDK) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Q&A

Operator

Operator Instructions We go first to Paul Coster with JPMorgan. Go ahead, sir.

Q - Paul Coster

Yes, good quarter. A few quick questions. First of all, the 70, 30 split in calendar year '06, do you intend to maintain that, and if so, why?

A - Eli Harari

Yes, we intend to maintain that because we see very strong demand growth in our markets that we will not likely be able to meet across the year, even with a very aggressive ramp. Now, that may fluctuate from one quarter to the next. There may be quarters where we go below if necessary and quarters where we go above. And we will use that as part of our planning schedule.

Q - Paul Coster

Has the philosophy behind it changed at all since you started that strategy?

A - Eli Harari

No. Because, let me say, in next year we're also going to have a lot more availability of MLC from our primary non-captive supplier. And we think that that will be a very advantageous type of capacity use. So, no, I would say, no, it has not changed. I think it's a very good strategy. It has served us very well in the past. And we think it's a very, very, very flexible approach.

Q - Paul Coster

You've been asked this before, but do you think there's any exposure that SanDisk has to the ongoing dispute between Lexar and Toshiba?

A - Eli Harari

No, we don't think we have.

Q - Paul Coster

And what kind of gross margins do you realize on your licensing? I mean, are there any costs associated with it?

A - Eli Harari

We have substantial legal expenses that are not, I guess, not directly counted as part of gross margin, but they're quite substantial.

Q - Paul Coster

Could you hazard a guess on what the gross margin is there, Judy?

A - Judy Bruner

Well, in terms of our published financial statements, there are no costs in costs of sales related to our licensing revenue. As Eli said, there are costs in G&A, legal costs.

Q - Paul Coster

Okay. Got it. Thank you.

A - Eli Harari

Thank you, Paul.

Operator

We go next to Eric Gomberg with Thomas Weisel Partners. Good ahead, sir.

Q - Eric Gomberg

Congratulations on the results and the outlook.

A - Eli Harari

Thank you.

Q - Eric Gomberg

You gave some granularity in terms of bundling in the handset market. Could you give us a sense of what you're hearing from customers, what you may expect in the fourth quarter, and, kind of, what '06 looks like preliminarily in the handset market?

A - Eli Harari

The handset market is moving very strongly, as I've said, to music applications, as well as two megapixel becoming, kind of, the baseline in terms of cameras, TV applications, and so on. So we're seeing, across the board, just about all, like I say, literally the top dozen handset makers are moving very aggressively to have flash storage, 512-megabyte to 2- and 4-gigabytes. In fact, there's a significant move away from on the high end, the Microdrive in handsets towards flash products like the iNAND.

We're also seeing very, a tremendous amount of interest from the mobile network operators to introduce subscription services and also to start selling cards through retail outlets. As I pointed out, the U.S. is a little bit late there, but it's beginning to pick up. Europe is very strong, and, of course, Japan and the Pac-Rim. But I think 2006 is, in my opinion, going to be, really, the year of flash in handsets really picking up. And as I've said in my prepared remarks, by 2007, I would not be surprised if flash in handsets become the dominant application.

Q - Eric Gomberg

Okay. You talk about 40 to 50% bit growth in the fourth quarter. I'm just wondering, if you weren't gated what type of growth do you think you could have this quarter? And to what extent are you either turning OEM customers away or moving the business away from USBs and from MP3s?

A - Eli Harari

We could do a lot better, that's for sure. I think that, I don't have an exact number. You've heard from Samsung and Toshiba that they're not meeting more than about 70% of their customer requirements. On the high-density side, there is no product to be had from any source. And I would say that we are definitely not capturing the opportunity internationally. There are geographies where we have 2, 3, 4% market share where we could easily have 20, 30% if we just had the product. In MP3 players, we certainly don't have enough capacity and in USB Flash Drives, we don't have enough capacity. But, by quite a big margin, I would say.

Q - Eric Gomberg

Could I just ask, on bit growth, my calculation, based on the 50%, you're up something around 170% year-over-year. Would you expect next year to be able to grow your bits at a faster pace?

A - Eli Harari

Yes. If we execute well as currently planned on that accelerated plan in Fab 3, and if Samsung delivers on their MLC transition, I would expect the number to be north of that number.

Q - Eric Gomberg

Just one last quick question. Any impact or what is the impact from the ST commentary on any potential litigation going forward with Hynix or Micron or others?

A - Eli Harari

Well, it's too early say. Of course, we will appeal it and we really do believe that they're infringing. So this is a little bit of clearly disappointment. The same court, with the same patent, with more or less, we believe, the same NAND designs with significantly different outcome. At the very least, the patent is declared valid and enforceable, and we're going to fight on the infringement. We do believe that we're going to prevail over time.

Q - Eric Gomberg

Thanks, very much.

A - Eli Harari

Thank you.

A - Lori Barker Padon

If we could limit this to one question each, that would be helpful. Thank you.

Operator

We go next to Satya Chillara with American Technology Research. Go ahead, please.

Q - Satya Chillara

Great quarter, guys.

A - Eli Harari

Thanks.

Q - Satya Chillara

Can you talk about the OEM growth in Q4, Eli? You've seen big growth in Q3. Is that still continuing in Q4? What kind of growth do you see?

A - Eli Harari

Yes. We expect continued growth in Q4, but we, again, are somewhat limited in our ability to respond frankly to the outside. Primarily there, it is on the high-capacity, very-small form factor card microSD particularly where we could sell a lot more 512-megabyte and, frankly, 1-gigabyte when we introduce that. But we just don't have nobody forecasted this kind of a rapid growth. And we are, frankly, scrambling to put in place the stacking assembly capacity. And that ought to be improving on a weekly basis. But if we could do better there, then it will be even stronger. But it's very strong.

Q - Satya Chillara

Okay. Judy, question for you. Just one follow-up, if you don't mind. In terms of pricing, I heard captive is 39% in Q3 and you're guiding to 45% in Q4.

A - Judy Bruner

No, I said about 35% in Q

Q - Satya Chillara

35? Historically, that put a lid on your gross margins. I know you walked through some of the startup costs and so. How is the Q4 with 35% non-captive still in the range of 33 to 35? Can you give us, walk through the thought process there?

A - Judy Bruner

Well, we had 39% non-captive in the third quarter and reported 37% product gross margins. So we've clearly built the 35% into our 33 to 35% estimate for Q4. But the key factor in the product gross margins for Q4 being down somewhat from the 37% in Q2, excuse me, in Q3, is really that in Q4, we will be selling through a sizable amount of product that was built with the very early 300-millimeter wafers, which due to normal early production and normal early yields, are a bit higher cost wafers than what was built into the products that were sold in Q3.

Q - Satya Chillara

Okay. Thank you.

Operator

Our next questions is from Gurinder Kalra with Bear, Stearns. Go ahead, please.

Q - Gurinder Kalra

Thanks. I just have one clarification and one question. I did some clarification. The gating to your bit growth in Q4, is that due to the front end or more due to the back end?

A - Judy Bruner

It's really due to both. We are faced with capacity constraints at the back-end subcontractors, in terms of getting product out and getting it shipped into retail for the holiday season. But, in addition, our non-captive purchases are coming later in the quarter than we would ideally like. The timing of availability is not as early as we would like. And of course, our own Fab 3 is ramping very rapidly across the fourth quarter.

A - Eli Harari

Yes, October is the iPod nano factor, basically.

Q - Gurinder Kalra

Okay. Great. Just one question. The Matrix acquisition, the 3-D memory and the One-Time Programmable memory, what does it actually replace in terms of applications? What kind of memory will it repace, and in what applications?

A - Eli Harari

Today, it's really, it really replaces, in video games, it replaces, basically, mass programmable. In blank card application, it will replace our shoot-and-store card. And, of course, we're looking to new applications. Once this technology moves down its own technology road map, we think it can become applicable in quite a large number of content distribution, content storage both music and video, in time.

Q - Gurinder Kalra

Okay. Great. Very good quarter. Thank you.

A - Eli Harari

Thank you.

Operator

We get next to Katlin Wolford with Trellis Management. Go ahead, please.

Q - Katlin Wolford

Great. Thank you. Just a quick question. Eli, you had mentioned, I think, previously that you had expected to reach cost parity with 90-nanometer at the 70-nanometer 200-millimeter wafer production in the fourth quarter. Are we still on that schedule?

A - Eli Harari

Yes. We are a little bit ahead of that schedule. We are now, I said in my prepared remarks that the 70-nanometer, 90 sorry.

Q - Katlin Wolford

That's maybe why I

A - Eli Harari

So 70-nanometer 200-millimeter 8-gigabit cost per megabyte, or cost per bit, is now lower already than the more mature 90-nanometer 4-gigabit. We've crossed over.

Q - Katlin Wolford

And what in terms of impact of cost, should be expecting the same kind of cost reductions moving faster than your guided ASP declines?

A - Eli Harari

Yes. The cost structure is, should improve steadily at a hefty rate in the fourth quarter that would still, really, translate to first quarter next year benefits.

A - Judy Bruner

Remember that the majority of our revenue comes from retail, which is recognized based on sell-through. So, for example, in the fourth quarter, we are recognizing revenue from a significant amount of product that was actually built in the third quarter.

Q - Katlin Wolford

Okay. Great job. Thank you, very much.

A - Eli Harari

Thank you.

Operator

We'll go next to Craig Ellis with Citigroup. Go ahead, please.

Q - Craig Ellis

Thank you. And I'd offer my congratulations as well.

A - Eli Harari

Thanks, Craig.

Q - Craig Ellis

You're welcome. Eli, we clearly, in the third quarter were on a much more benign price per megabit decline pace than 50%. When would you expect to see an inflection back towards that 50% trend line?

A - Eli Harari

I think that the fourth quarter is essentially behind us, as far as any pricing. I don't believe there's going to be much change, and it will be benign, and there is, definitely, demand is exceeding supply. On the other hand, you've seen that in retail our average capacity only increased by 4% on a, in retail, and clearly, that is very, very much tied to this benign pricing environment. In 2006 I expect that in the first half you're going to start seeing some catch up on the price reductions in order to stimulate the demand and to move the market faster towards the 1-gigabyte. At that time, I believe we will be very well-positioned to compete in that market because of our cost structure. For the fourth quarter we've said, I think Judy has said, it's 15 to 20% ASP decline. But this is, of course, not the, it's really mostly promos rather than the elastic stimulation that I think you are talking about.

Q - Craig Ellis

Okay. Great. And, then, as a follow-up, you have so much capacity coming on line between the shrink and the 300-millimeter startup. Is it possible that with all that capacity coming online in the first quarter that you can actually grow sequentially from the fourth to the first quarter?

A - Eli Harari

We're so focused on the fourth quarter that honestly, we have some forecasts for the first quarter that actually, I'd rather not comment on the first quarter. But I am very optimistic about 2006. Let's put it that way.

Q - Craig Ellis

Okay. Thanks, Eli.

Operator

We'll go next to Daniel Amir with WR Hambrecht. Go ahead, please.

Q - Daniel Amir

Thanks, a lot. Congratulations on a great quarter.

A - Eli Harari

Thanks.

Q - Daniel Amir

A question, first on the Matrix acquisition, my recall on the 3-D memory, it does have some cost advantages when you're going to higher capacities. Is there a plan to potentially use their technology in your future road map? Or is it pretty much the focus here is on the One-Time Programmable stuff that, basically, the shoot-and-store and et cetera?

A - Eli Harari

Good question. Well, they have terrific engineers and we have terrific engineers. So I expect we are going to put them all into one room, shut the door, throw the key, and have them come up a road map that takes advantage of their strength and our strength. But it's premature, really, to speculate on that.

Q - Daniel Amir

Okay. And in the meantime, if I recall, they used TSMC. So is that pretty much is going to continue, or is anything changing there?

A - Eli Harari

At least for the time being, we're going to leverage their relationship with TSMC and other relationships that they have, as well as with their customers.

Q - Daniel Amir

Okay. Thanks, a lot.

A - Eli Harari

Thank you.

Operator

We go next to Sidney Ho with Merrill Lynch. Go ahead, please.

Q - Sidney Ho

Hi. Let me add my congratulations as well. Question here is following the last question from the Matrix acquisition. With the new technology, do you think the cost reduction curve will continue at the 50% range? Or do you think it's a giant leap, like an MLC? I guess, and another way I can think about it is, How do you compare the cost of One-Time Programmable technology versus, maybe, a future MLC road map?

A - Eli Harari

Yes. MLC OTP, One-Time Programmable, of course, does not have the functionality of NAND/MLC, and, therefore, really is more complementary than competitive. There have been people talk a lot of discussion in technical publications talking about 3-D read/write. And that is a very challenging technology and, certainly, something that everybody is we're going to definitely look at. But I would say for the next several years, really, it's the OTP that's the biggest opportunity.

Q - Sidney Ho

Okay. Should I think of this OPT opportunity, let's say 10% of the total market, something like that?

A - Eli Harari

No. Today it's very, very small.

Q - Sidney Ho

Okay.

A - Eli Harari

I would say, maybe, well, definitely not 10%. However, it could grow into a sizable market for distribution of content. It will take several years. This is definitely a strategic move on our part, and not something that's going to very quickly contribute to, we talked about 60 to $90 million in revenues next year. That's not a big deal next year.

Q - Sidney Ho

Are you seeking royalty revenue going down the road? Or is it too small, too, to go after right now?

A - Eli Harari

There's nobody that's doing 3-D OTP. The market for OTP today is, as I've said, is very small. So they do have pretty fundamental IP, a very strong IP, and you could say this is a revolutionary technology. But I think, as far as challenging NAND and NAND/MLC, I think that, I don't believe that that's the case for the next several years, I think.

Q - Sidney Ho

Okay. Great. Thank you.

A - Eli Harari

If ever, for that matter.

Q - Sidney Ho

Thanks.

Operator

We go next to Steve Chin with UBS. Go ahead, please.

Q - Steve Chin

Thank you. I'm calling on behalf of Alex Gauna. And I want to, first of all, congratulate you on the strong quarter.

A - Eli Harari

Thank you.

Q - Steve Chin

In terms of COGS, given the much publicized polysilicon shortage and how that's driving wafer prices higher this year, and especially into 2006, what are your expectations for cost increases in NAND wafers purchased from your joint ventures?

A - Eli Harari

I don't think it will have a significant impact.

Q - Steve Chin

And, also, I guess do your joint ventures have a pretty adequate supply of ingots or wafers procured for the first half of next year, and, maybe, in the back half of next year also?

A - Eli Harari

Toshiba is, I believe, the largest semiconductor manufacturer in Japan, and they have very, very good, very close relationships with the silicon wafer suppliers. I've not heard about any problem.

Q - Steve Chin

Okay. Great. And, last question, if I may. In terms of microSD, are you currently factoring any royalties from microSD at this time?

A - Eli Harari

MicroSD will be offered, is being offered through the 3C, basically Toshiba, Matshita, and SanDisk to other manufacturers. I do, over time, expect it to begin to generate royalty for us, because I see it really becoming the de facto standard.

Q - Steve Chin

And that would be from vendors beyond the thee you just mentioned?

A - Eli Harari

Yes, of course. This would be from competitors that would supply the market and the license from the SD association.

Q - Steve Chin

Any rough time frame on when that may be expected?

A - Eli Harari

I think we probably could start seeing some of that in 2006.

Q - Steve Chin

Okay. Great. Thank you.

A - Eli Harari

Thank you.

Operator

We go next to Ben Lynch with Deutsche Bank. Go ahead, please.

Q - Ben Lynch

Yes, hi, there. Well done, as well. A couple of questions, please. Just trying to understand the dynamics between your impressive relative ASP performance, some third-party data shows down 20%, Hynix and Samsung were down, sort of, 18, 19% respectively. Could you just, maybe, explain, they had some density changes, MLC, whatever. What contributed to what seemed to be a much better environment for you?

A - Eli Harari

I don't know. I think the dynamic for Samsung and Hynix are very different. Hynix is still at the 2-gigabit chip, which is different than the 4- and 8-gigabit chip. For Samsung, there may be some of the iPod pricing impact. I don't know. But I don't know. You have to ask them. We are vertically integrated, and we do have greater leverage in selling cards rather than components. We've always said there's a diversity in what we do. We sell Ultra, for example, and Extreme have higher margins. Memory Stick PRO Duo has higher margins. MicroSD has higher margins. So we have this ability to retain some of the costs coming down. We don't have to always bring the cost, price down. And, certainly, there's no point in doing so when we can't meet the demand.

Q - Ben Lynch

Do you think there might have been less, just simply less NAND sold into the removable market as a lot of Samsung's incremental capacity was sucked up with the incremental embedded demand and just created a perfect environment for you?

A - Eli Harari

From what I hear, Samsung's customers, other than the ones that are under contract, or under agreements, long-term agreements, definitely are bearing the brunt of the huge iPod, what do you call it?

Q - Ben Lynch

Sucking it up, basically.

A - Eli Harari

Well, big sucking sound, or whatever you call it.

Q - Ben Lynch

Yes, exactly. Yes.

A - Eli Harari

But we're still reporting 35% of our fourth quarter bits are going to be non-captive. So we're okay. But the timing is not good for us either.

Q - Ben Lynch

Yes, okay. And, just, then, the follow-up question I had. Any estimate for the MLC proportion of your non-captive in '06? And when I think about the, if you like, the tradeoff between the royalties you would receive if Samsung is selling to other parties, MLC parts versus, maybe, some implication on the gross margin you can derive from reselling Samsung?

A - Eli Harari

We would be more inclined to take the product if we can sell it, than to collect royalty of somebody else having it. That said, I think we do pretty good either way.

Q - Ben Lynch

Okay. And will it be, just, sorry, this is the last one. Do you think the gross margin on the MLC, all else being the same, obviously, because some prices can be structurally different to what it's historically been for SLC?

A - Eli Harari

I'm sorry. For us or for?

Q - Ben Lynch

For you guys, yes. Just by the nature of the IP you're supplying into it?

A - Eli Harari

Well, we at the 70 nanometer, I, we are practically 100% MLC. We're not wasting too many wafers, maybe one or two, very few percentage on SLC for 70-nanometers. It's just the margin difference is so soft.

Q - Ben Lynch

So you?

A - Eli Harari

Yes.

Q - Ben Lynch

Yes. Okay. Thank you, very much.

A - Lori Barker Padon

And we have time for just one more question. Thank you.

Operator

We'll take our last question from Daniel Gelbtuch with CIBC World Markets. Go ahead, please.

Q - Hugh Cunningham

Guys, congratulations on a great quarter.

A - Eli Harari

Thank you.

Q - Hugh Cunningham

This is Hugh Cunningham for Daniel Gelbtuch. How do you view M-systems, MegaSIM, and Mobile Disk-On-Chip versus your iNAND and microSD?

A - Eli Harari

Very good product. I think they'll do very well. I think that the market, we don't really feel ourselves competing with them. We have iNAND, which is the embedded handset market, is more focused on higher capacities than where they are focused, and, of course, on secure applications. We are also targeting iNAND to non-handset markets as well. We don't really, we think that they'll do very well. With regards to MegaSIM, I think it's early. I think it will depend if it catches on. And, of course, we're trying to convince the market to go with microSD rather than any other solution.

Q - Hugh Cunningham

Okay. Great. Thank you.

Operator

That does conclude today's question-and-answer session. I'll now turn the conference back over to Eli Harari for any closing comments.

Eli Harari, President and CEO

Okay. Well, thank you for joining SanDisk today. We continue to be very excited about our markets and look forward to seeing you all in the coming meetings and at our investor conference. Thank you, very much.

Operator

That does conclude today's conference call. We appreciate your participation, and you may now disconnect.

Related:

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• All Consumer Electronics Stock Blog articles on SanDisk.
• A list of full conference call transcripts available on the Seeking Alpha Network.
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