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SNDK > SEC Filings for SNDK > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for SANDISK CORP


3-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Statements in this report, which are not historical facts, are forward?looking statements within the meaning of the federal securities laws. These statements may contain words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" or other wording indicating future results or expectations. Forward?looking statements are subject to significant risks and uncertainties. Our actual results may differ materially from the results discussed in these forward?looking statements. Factors that could cause our actual results to differ materially include, but are not limited to, those discussed under "Risk Factors" in Part II, Item 1A, and elsewhere in this report. Our business, financial condition or results of operations could be materially harmed by any of these or other factors. We undertake no obligation to revise or update any forward?looking statements to reflect any event or circumstance that arises after the date of this report. References in this report to "SanDisk®," "we," "our," and "us" refer collectively to SanDisk Corporation, a Delaware corporation, and its subsidiaries.

Overview

We are a global leader in flash memory storage solutions. Our goal is to provide simple, reliable and affordable storage solutions for consumer and enterprise use in a wide variety of formats and devices. We sell our products globally to commercial and retail customers.

We design, develop, market and manufacture data storage solutions in a variety of form factors using our flash memory, controller and firmware technologies. Our flash-based products enable businesses and consumers to efficiently and effectively capture, share, use and preserve digital content. Our solutions include solid state drives, or SSDs, removable cards, embedded products, universal serial bus, or USB, drives, digital media players, wafers and components. Our SSD products are used in client computing platforms and enterprise data centers to provide high-speed, high-capacity storage solutions that can be used in lieu of, or in conjunction with, hard disk drives. Our removable cards are used in a wide range of consumer electronics devices such as mobile phones, tablets, digital cameras, gaming devices and PCs. Our embedded flash products are used in mobile phones, tablets, thin-and-light laptops, eReaders, global positioning system, or GPS, devices, gaming systems, imaging devices and computing platforms.

We believe the markets for flash storage are generally price elastic, meaning that a decrease in the price per gigabyte results in increased demand for higher capacities and the emergence of new applications for flash storage. We strive to continuously reduce the cost of NAND flash memory in order to enable us to profitably grow our business, supply a diverse set of customers and channels, and continue to grow our markets. A key component of our ability to reduce the cost of NAND flash memory is our ability to continue to transition our NAND flash memory process technology to smaller nodes. We currently expect to be able to continue to scale our current NAND flash memory architecture, also known as planar NAND, through a few additional generations, but beyond that there is no certainty that further technology scaling can be achieved cost-effectively with the planar NAND flash memory architecture. We continue to invest in future generations of NAND flash memory, and we are also pursuing alternative technologies, such as Bit-cost scaleable 3-Dimensional NAND, or BiCS, and 3-Dimensional resistive RAM, or 3D ReRAM, technologies, both of which we believe may be viable alternatives to NAND flash memory when NAND flash memory can no longer cost-effectively scale at a sufficient rate, or at all. However, even when NAND flash memory can no longer scale further, we expect NAND flash memory and potential alternative technologies to coexist for an extended period of time. Currently, we are focused on transitioning our products to 19-nanometer and 1Y-nanometer technologies and improving manufacturing efficiencies. However, 1Y-nanometer technology will have increased manufacturing equipment requirements, which will impact the cost reduction benefits obtainable through these technologies.

Through our investments in our ventures with Toshiba Corporation, or Toshiba, and our in-house assembly and test facility, we have invested heavily in a vertically integrated business model. We purchase the vast majority of our NAND flash memory supply requirements through Flash Ventures, our significant flash venture relationships with Toshiba, which produce and provide us with leading-edge, low-cost memory wafers. Our manufacturing operations are concentrated in two locations, with Flash Ventures located in Yokkaichi, Japan, and our in-house assembly and test operations located in Shanghai, China. While we do not unilaterally control the operations of Flash Ventures, we believe that our vertically integrated business model helps us to reduce the costs of producing our products, increases our ability to control the quality of our products and speeds delivery to our customers.

We operate in an industry characterized by rapid technology transitions, price declines and evolving end-user markets for NAND flash memory. Historically, removable flash memory cards for imaging devices and USB drives provided the majority of our revenues. With the emergence of the smartphone and tablet markets, our sales of embedded NAND flash memory and cards for mobile phones, tablets, and other mobile devices have increased, and now represent the largest percentage of our revenues. Over the next several years, we believe that the largest growth areas for NAND flash memory will be SSD solutions


in the client computing and enterprise data center markets, whereas the mobile market for NAND flash memory is expected to grow at a slower rate than in the past, and the retail market for NAND flash memory is expected to be approximately constant or declining. We continue to focus on adapting our business to the changing end-markets for NAND flash memory and aligning our resources accordingly.

Beginning in the first quarter of fiscal year 2013, we report only total revenues, which include product revenues and license and royalty revenues. In addition, during the first quarter of fiscal year 2013, we have recast our sales channels to be Retail and Commercial. Retail channel sales are made directly to retail customers and indirectly through distributors to retail customers. The Commercial channel includes original equipment manufacturer, or OEM, business-to-business, and direct enterprise customers as well as licensees. We have adjusted all prior year comparative amounts and explanations within Management's Discussion and Analysis of Financial Condition and Results of Operations to reflect these changes in classification to be consistent for all periods presented.

Convertible Notes

Our 1% Notes due 2013 will mature on May 15, 2013. Upon maturity, we will be
required to pay $928 million in cash to settle the principal amount outstanding
under these notes. We intend to settle these notes using our current cash
resources. In addition, the associated convertible bond hedge transaction and
warrants will either be settled on a net share basis or expire unexercised based
upon the closing stock price at maturity or on their respective expiration
dates.

Results of Operations
                                                                       Three months ended
                                                  March 31,                        April 1,
                                                     2013        % of Revenues       2012        % of Revenues
                                                 (In millions, except percentages)
Revenues                                             $1,340.7        100.0  %        $1,205.6        100.0  %
Cost of revenues                                      799.4           59.6 %          775.3           64.3 %
Amortization of acquisition-related intangible
assets                                                  9.8            0.8 %           13.8            1.1 %
Total cost of revenues                                809.2           60.4 %          789.1           65.4 %
Gross profit                                          531.5           39.6 %          416.5           34.6 %
Operating expenses:
Research and development                              171.1           12.8 %          141.0           11.7 %
Sales and marketing                                    59.1            4.3 %           49.0            4.1 %
General and administrative                             45.1            3.4 %           32.6            2.7 %
Amortization and write-off of
acquisition-related intangible assets                   2.4            0.2 %            2.0            0.2 %
Total operating expenses                              277.7           20.7 %          224.6           18.7 %
Operating income                                      253.8           18.9 %          191.9           15.9 %
Other income (expense), net                           (19.9 )         (1.4 %)         (25.4 )         (2.1 %)
Income before income taxes                            233.9           17.5 %          166.5           13.8 %
Provision for income taxes                             67.7            5.1 %           52.1            4.3 %
Net income                                       $    166.2           12.4 %      $   114.4            9.5 %


Revenues by Channel
                                             Three months ended
                March 31,                       April 1,
                  2013        % of Revenues       2012       % of Revenues     Percent Change
                                      (In millions, except percentages)
Commercial     $    828.7           61.8 %     $   823.5           68.3 %              0.6 %
Retail              512.0           38.2 %         382.1           31.7 %             34.0 %
Total revenues $  1,340.7          100.0 %     $ 1,205.6          100.0 %             11.2 %

The increase in our revenues for the three months ended March 31, 2013, compared to the three months ended April 1, 2012, was due primarily to an increase in gigabytes sold of 36%, partially offset by a decline in average selling price per gigabyte of 18%. Commercial revenues for the three months ended March 31, 2013, compared to the three months ended April 1, 2012, reflect significantly increased sales of SSDs and embedded products for mobile devices, largely offset by a decrease in revenue from OEM cards for the mobile market and wafers. Retail product revenues in the three months ended March 31, 2013 increased compared to the three months ended April 1, 2012 due to higher sales across all major regions and product lines, including imaging cards, mobile cards, USB drives and SSDs.

Our ten largest customers represented approximately 49% and 50% of our total revenues in the three months ended March 31, 2013 and April 1, 2012, respectively. We had two customers that exceeded 10% of our total revenues in the three months ended March 31, 2013, representing 19% and 12% of our total revenues. We had one customer that equaled 10% of our total revenues in the three months ended April 1, 2012.

Geographical Revenues
                                                                         Three months ended
                                           March 31,                        April 1,
                                              2013        % of Revenues       2012        % of Revenues    Percent Change
                                                                 (In millions, except percentages)
United States                             $    213.5            15.9 %     $   170.6            14.1 %           25.1  %
Asia-Pacific                                   909.9            67.9 %         831.6            69.0 %            9.4  %
Europe, Middle East and Africa                 173.6            12.9 %         146.8            12.2 %           18.3  %
Other foreign countries                         43.7             3.3 %          56.6             4.7 %          (22.7 %)
Total revenues                            $  1,340.7           100.0 %     $ 1,205.6           100.0 %           11.2  %

For the three months ended March 31, 2013, compared to the three months ended April 1, 2012, our U.S. revenues increased primarily as a result of increased retail sales of mobile cards and SSDs. The increase in Asia-Pacific revenues was due primarily to increased sales of SSDs, mobile embedded products and retail cards and USB drives, partially offset by a decrease in mobile OEM cards and wafers and components. The increase in revenues in Europe, Middle East and Africa was due primarily to increased retail sales of mobile cards, USB drives and SSDs, partially offset by a decline in commercial sales of embedded products. Our revenues are designated based on the geographic location where the product is delivered, or in the case of license and royalty revenue, the location of the headquarters of the licensee, and therefore may not be indicative of the actual demand in these regions.

Gross Profit and Margin

                          Three months ended
              March 31,      April 1,
                 2013          2012       Percent Change
                  (In millions, except percentages)
Gross profit $    531.5     $  416.5             27.6 %
Gross margin       39.6 %       34.6 %

The increase in gross margin for the three months ended March 31, 2013, compared to the three months ended April 1, 2012, was due primarily to cost reductions of (25%) exceeding average selling price reductions of (18%). Costs per gigabyte improved over the prior year primarily due to wafer production transitioning from 24-nanometer to 19-nanometer, partially offset by an increase in non-flash memory costs as a result of an increased sales mix of SSDs and multi-chip package products, which have higher non-flash memory costs than most of our other products.


Research and Development
                                      Three months ended
                          March 31,      April 1,
                             2013          2012       Percent Change
                              (In millions, except percentages)
Research and development $    171.1     $  141.0             21.3 %
Percent of revenues            12.8 %       11.7 %

The increase in our research and development expense for the three months ended March 31, 2013, compared to the three months ended April 1, 2012, was due primarily to higher employee-related costs of $21 million due primarily to increased headcount and incentive compensation expense and higher third-party engineering costs of $6 million. Incentive compensation expense is higher in the first quarter of fiscal year 2013, compared to the first quarter of fiscal year 2012, due to improved financial performance.

Sales and Marketing
                                 Three months ended
                     March 31,     April 1,
                       2013          2012        Percent Change
                         (In millions, except percentages)
Sales and marketing $    59.1     $    49.0             20.6 %
Percent of revenues       4.3 %         4.1 %

The increase in our sales and marketing expense for the three months ended March 31, 2013, compared to the three months ended April 1, 2012, was due primarily to higher employee-related costs of $9 million due primarily to increased headcount and incentive compensation expense. Incentive compensation expense is higher in the first quarter of fiscal year 2013, compared to the first quarter of fiscal year 2012, due to improved financial performance.

General and Administrative
                                        Three months ended
                            March 31,     April 1,
                              2013          2012        Percent Change
                                (In millions, except percentages)
General and administrative $    45.1     $    32.6             38.3 %
Percent of revenues              3.4 %         2.7 %

The increase in our general and administrative expense for the three months ended March 31, 2013, compared to the three months ended April 1, 2012, was due primarily to one-time insurance recoveries of legal fees of $5 million in the first quarter of fiscal year 2012, increased charitable contributions of $3 million and higher employee-related costs of $2 million due primarily to increased headcount and incentive compensation expense. Incentive compensation expense is higher in the first quarter of fiscal year 2013, compared to the first quarter of fiscal year 2012, due to improved financial performance.


Amortization and Write-off of Acquisition-Related Intangible Assets

                                                                   Three months ended
                                                          March 31,      April 1,      Percent
                                                             2013          2012         Change
                                                            (In millions, except percentages)
Amortization and write-off of acquisition-related
intangible assets                                        $      2.4     $     2.0       20.0 %
Percent of revenues                                             0.2 %         0.2 %

Amortization of acquisition-related intangible assets in the three months ended March 31, 2013, compared to the three months ended April 1, 2012, was higher due to a full quarter of amortization of intangible assets from fiscal year 2012 acquisitions.

Other Income (Expense), net
                                              Three months ended
                                   March 31,      April 1,
                                      2013          2012      Percent Change
                                       (In millions, except percentages)
Interest income                   $     12.9     $   15.0          (14.0 %)
Interest expense                       (31.0 )      (29.3 )          5.8 %
Other income (expense)                  (1.8 )      (11.1 )        (83.8 %)
Total other income (expense), net $    (19.9 )   $  (25.4 )        (21.7 %)

"Total other income (expense), net" for the three months ended March 31, 2013 was a lower net expense compared to the three months ended April 1, 2012 due primarily to a charge incurred by Flash Ventures and losses on non-designated foreign exchange contracts included in "Other income (expense)" in the first quarter of fiscal year 2012 that did not recur in fiscal year 2013.


Provision for Income Taxes
                                        Three months ended
                            March 31,     April 1,
                              2013          2012        Percent Change
                                (In millions, except percentages)
Provision for income taxes $    67.7     $    52.1             29.9 %
Effective tax rate              28.9 %        31.3 %

The provision for income taxes for the three months ended March 31, 2013 differs from the U.S. statutory tax rate primarily due to the tax impact of earnings from foreign operations, state taxes, non-deductibility of certain share-based compensation, federal research and development, or R&D, credit and tax-exempt interest income. Earnings and taxes resulting from foreign operations are largely attributable to our Irish, Chinese, Israeli and Japanese entities. The lower effective tax rate for the three months ended March 31, 2013, compared to the same period in fiscal year 2012, is attributable to a retroactively extended federal R&D tax credit for fiscal year 2012, availability of a federal R&D credit in fiscal year 2013 and changes in the composition of operating income by tax jurisdiction. As of March 31, 2013, we believe that most of our deferred tax assets are more likely than not to be realized, except for certain loss and credit carry forwards in certain U.S. and foreign tax jurisdictions.

Unrecognized tax benefits were $176.2 million and $179.5 million as of March 31, 2013 and December 30, 2012, respectively. Unrecognized tax benefits that would impact the effective tax rate in the future were approximately $83.2 million at March 31, 2013. Income tax expense for the first quarter of fiscal years 2013 and 2012 included interest and penalties of $0.7 million and $0.8 million, respectively.

We are subject to U.S. federal income tax as well as income taxes in multiple state and foreign jurisdictions. In February 2012, the Internal Revenue Service, or IRS, completed its field audit of our federal income tax returns for the years 2005 through 2008 and issued the Revenue Agent's Report. The most significant proposed adjustments are comprised of related party transactions between our U.S. parent company and our foreign subsidiaries. We are contesting these adjustments through the IRS Appeals Office and cannot predict when a resolution will be reached.

We strongly believe the IRS's position regarding the intercompany transactions is inconsistent with applicable tax laws, judicial precedents and existing Treasury regulations, and that our previously reported income tax provisions for the years in question are appropriate. Management believes that an adequate provision has been made for the adjustments from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner that is not consistent with management's expectations, we could be required to adjust our provision for income tax in the period such resolution occurs.

The IRS recently initiated an examination of our federal income tax returns for fiscal years 2009 through 2011. We do not expect a resolution of this audit to be reached during the next twelve months. In addition, we are currently under audit by various state and international tax authorities. We cannot reasonably estimate the outcome of these examinations, or provide assurance that the outcome of these examinations will not materially harm our financial position, results of operations or liquidity.


Non-GAAP Financial Measures

Reconciliation of Net Income.
                                                                         Three months ended
                                                                March 31,                   April 1,
                                                                  2013                        2012
                                                          (In millions except per share and share amounts)
Net income                                               $          166.2            $              114.4
Share-based compensation                                             21.7                            19.1
Amortization of acquisition-related intangible assets                12.2                            15.8
Convertible debt interest                                            23.6                            21.9
Income tax adjustments                                              (16.8 )                         (14.8 )
Non-GAAP net income                                      $          206.9            $              156.4

Diluted net income per share:                            $           0.68            $               0.46
Share-based compensation                                             0.09                            0.08
Amortization of acquisition-related intangible assets                0.05                            0.06
Convertible debt interest                                            0.10                            0.09
Income tax adjustments                                              (0.07 )                         (0.06 )
Non-GAAP diluted net income per share:                   $           0.85            $               0.63

Shares used in computing diluted net income per share
(in thousands):
GAAP                                                              245,577                         247,102
Non-GAAP                                                          245,596                         247,192

We believe these non-GAAP measures provide investors the ability to better assess and understand operating performance, especially when comparing results with previous periods or forecasting performance for future periods, primarily because management typically monitors the business excluding these items. We also use these non-GAAP measures to establish operational goals and for measuring performance for compensation purposes. However, analysis of results on a non-GAAP basis should be used as a complement to, and in conjunction with, and not as a replacement for, data presented in accordance with GAAP.

We believe that the presentation of non-GAAP measures, including non-GAAP net income and non-GAAP diluted net income per share, provides important supplemental information to management and investors about financial and business trends relating to our operating results. We believe that the use of these non-GAAP financial measures also provides consistency and comparability with our past financial reports.

We have historically used these non-GAAP measures when evaluating operating performance because we believe that the inclusion or exclusion of the items described below provides an additional measure of our core operating results and facilitates comparisons of our core operating performance against prior periods and our business model objectives. We have chosen to provide this information to investors to enable them to perform additional analyses of past, present and future operating performance and as a supplemental means to evaluate our ongoing core operations. Externally, we believe that these non-GAAP measures continue to be useful to investors in their assessment of our operating performance and their valuation of our company.

Internally, these non-GAAP measures are significant measures used by us for purposes of:

•evaluating our core operating performance;
•establishing internal budgets;
•setting and determining variable compensation levels;
•calculating return on investment for development programs and growth initiatives;
•comparing performance with internal forecasts and targeted business models;
•strategic planning; and
•benchmarking performance externally against our competitors.


We exclude the following items from our non-GAAP measures:

Share-based Compensation Expense. These expenses consist primarily of expenses for share-based compensation, such as stock options, restricted stock units and our employee stock purchase plan. Although share-based compensation is an important aspect of the compensation of our employees and executives, we exclude share-based compensation expenses from our non-GAAP measures primarily because . . .

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