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SNDK > SEC Filings for SNDK > Form 10-Q on 1-May-2014All Recent SEC Filings

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Form 10-Q for SANDISK CORP


1-May-2014

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 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 2­dimensional NAND, or 2D NAND, through at least two more technology nodes (1Y­nanometer and 1Z­nanometer), but beyond that there is no certainty that further technology scaling can be achieved cost-effectively with the 2D NAND flash memory architecture. We continue to invest in future generations of 2D NAND flash memory, and we are also pursuing alternative technologies, such as 3­dimensional NAND, or 3D NAND, and 3­dimensional resistive RAM, or 3D ReRAM, technologies, both of which we believe may be viable alternatives to 2D NAND flash memory when 2D NAND flash memory can no longer cost-effectively scale at a sufficient rate, or at all. However, even when 2D NAND flash memory can no longer scale further, we expect 2D NAND flash memory and potential alternative technologies to coexist for an extended period of time.

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 Partners Ltd., Flash Alliance Ltd. and Flash Forward Ltd., collectively referred to as 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, speeds delivery, and ensures continuity and predictability of supply to our customers.

Industry and Company Trends

We operate in an industry characterized by rapid technology transitions, price declines and evolving end-user markets for NAND flash memory. We currently generate revenue from sales of removable products, embedded flash memory and client and enterprise SSDs. Removable products, including cards for mobile and imaging devices and USB drives, provide the largest portion of our revenue. We expect our revenue from removable products to remain constant or decline over the next several years. Our revenue from embedded NAND flash memory products has grown over the past several years, and we expect


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continued revenue growth from embedded products driven by the increasing demand for varying types of smartphones, tablets and other portable devices. Currently and over the next several years, we believe the largest growth area for NAND flash memory will be SSD solutions. We continue to focus on adapting our business to the changing end-market demands for NAND flash memory and aligning our resources accordingly.

We currently expect that industry bit-supply growth for fiscal year 2014 will be approximately 40%, similar to the estimated industry supply growth rate in fiscal year 2013 and significantly lower than in fiscal year 2012. We expect that our captive bit-supply growth for fiscal year 2014 will be between 25% and 35%, compared to 18% in fiscal year 2013 and 86% in fiscal year 2012. In fiscal year 2014, we expect our business to experience a modest decline in our blended average selling price per gigabyte compared to no change in fiscal year 2013. Our revenue for fiscal year 2014 will be influenced primarily by our captive bit-supply growth, industry pricing trends and the mix of our product sales. We expect our fiscal year 2014 cost reduction per gigabyte to be in the range of 15% to 25%. The primary cost reduction drivers in fiscal year 2014 are expected to be the 1Y­nanometer technology transition and expected positive impact of the Japanese yen to U.S. dollar exchange rate for Japanese yen-denominated wafer purchases. The mix of our product sales is having an increasing impact on both our cost per gigabyte and our average selling price per gigabyte. For example, certain of our products include higher non-flash memory content which can offset some of the expected cost improvement from our flash memory transitions, and these same products generally also carry a higher average selling price per gigabyte which impacts our blended average selling price per gigabyte.

As part of our efforts to continuously reduce the cost of NAND flash memory, we are currently focused on transitioning our products to 19­nanometer and 1Y­nanometer technologies and we plan to transition to 1Z­nanometer technology beginning in the second half of 2014. 1Y­nanometer and subsequent technology nodes have increased manufacturing equipment requirements, which will impact the cost reduction benefits obtainable through these technologies. We continue to develop our 3D NAND technology, which we have referred to as BiCS, which we view as a medium-term alternative technology to 2D NAND flash memory, and 3D ReRAM, which we view as a potential long-term successor to NAND technology. As we progress with our 3D NAND development, we are evaluating and modifying certain aspects of our technology architecture to optimize for manufacturability, scalability, cost and product specifications, targeting a broader range of applications. We continue to target pilot production for our 3D NAND in 2015 and volume ramp of our 3D NAND products in 2016. Some of our competitors have announced the launch of 3D NAND technologies, such as 3D vertical NAND, or 3D VNAND, with volume production beginning in 2014. At this time, these technologies are still emerging and it is unclear how these new technologies will compare to our 3D NAND technology and what implications 3D VNAND or other 3D NAND approaches may have for our industry or our business in terms of cost leadership, technology leadership, supply increases and product specifications. We believe that continued 2D NAND scaling is the most efficient method of reducing NAND costs in the near term and addressing the broadest range of market opportunities and therefore continue to focus on scaling 2D NAND flash memory at least through the 1Y­nanometer and 1Z­nanometer technology nodes while we work on alternative technologies, primarily 3D NAND and 3D ReRAM, in parallel.

Dividends

In the first quarter of fiscal year 2014, we paid a cash dividend of $0.225 per common share. On April 15, 2014, our Board of Directors declared a dividend of $0.225 per share for holders of record as of May 5, 2014, to be paid on May 27, 2014. We expect to continue to pay quarterly dividends subject to declaration by our Board of Directors.

Share Repurchases

In the third quarter of fiscal year 2013, under our share repurchase program, we entered into an accelerated share repurchase, or ASR, agreement with a financial institution to purchase $1.0 billion of our common stock. In exchange for an up-front payment of $1.0 billion, the financial institution committed to deliver shares during the ASR's purchase period, which ended on April 8, 2014. During the third quarter of fiscal year 2013, 14.5 million shares were initially delivered to us under this ASR agreement. In April 2014, the ASR was settled and we received an additional 0.6 million shares from the financial institution for a total of 15.1 million shares, which resulted in a variable weighted-average price of $66.07 per share.

Under our share repurchase program, since the fourth quarter of fiscal year 2011 through March 30, 2014, we spent an aggregate $1.91 billion to repurchase 31.7 million shares, and an additional 0.6 million shares were received in April 2014 upon settlement of the ASR. Included in the aggregate repurchase activity are 1.3 million shares that were repurchased for an aggregate amount of $90 million during the three months ended March 30, 2014. In addition to repurchases under our repurchase program, during the three months ended March 30, 2014, we spent $24 million to settle employee tax withholding obligations due upon the vesting of restricted stock units, or RSUs, and withheld an equivalent value of shares from the employees' vesting RSUs.


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Convertible Debt

The conversion provision of the 1.5% Notes due 2017 allows the holders the option to convert their notes during the following calendar quarter if our stock price exceeds 130% of the conversion price of the 1.5% Notes due 2017 for at least 20 trading days during the last 30 consecutive trading days of the current calendar quarter. The conversion threshold was met during the calendar quarter ended March 31, 2014 and the 1.5% Notes due 2017 became convertible at the holders' option beginning on April 1, 2014 and ending June 30, 2014. Accordingly, the carrying value of the notes was reclassified from long-term to short-term debt as of March 30, 2014 and the difference between the principal amount payable in cash upon conversion and the carrying value of the 1.5% Notes due 2017 was reclassified from Stockholders' equity to Convertible short-term debt conversion obligation on our Condensed Consolidated Balance Sheet as of March 30, 2014, and will remain so while the notes are convertible. The determination of whether or not the 1.5% Notes due 2017 are convertible must continue to be performed on a calendar-quarter basis. Consequently, the 1.5% Notes due 2017 may be reclassified as long-term debt if the conversion threshold is not met in future quarters. Upon conversion of any of the 1.5% Notes due 2017, we will deliver cash up to the principal amount of the 1.5% Notes due 2017, and we will deliver shares of our common stock with respect to any conversion value greater than the principal amount of the 1.5% Notes due 2017. As of March 30, 2014, no 1.5% Notes due 2017 had been converted. Based on the closing price of our common stock of $80.61 on March 30, 2014, if all of the 1.5% Notes due 2017 were converted, it would result in 6.9 million shares being distributed to the holders.

Results of Operations
                                                                    Three months ended
                                                 March 30,                      March 31,
                                                   2014        % of Revenue       2013        % of Revenue
                                                             (In millions, except percentages)
Revenue                                         $ 1,511.9         100.0  %     $ 1,340.7         100.0  %
Cost of revenue                                     741.0          49.0  %         799.4          59.6  %
Amortization of acquisition-related intangible
assets                                               19.6           1.3  %           9.8           0.8  %
Total cost of revenue                               760.6          50.3  %         809.2          60.4  %
Gross profit                                        751.3          49.7  %         531.5          39.6  %
Operating expenses:
Research and development                            198.8          13.2  %         171.1          12.8  %
Sales and marketing                                  77.0           5.1  %          59.1           4.3  %
General and administrative                           48.7           3.2  %          45.1           3.4  %
Amortization of acquisition-related intangible
assets                                                1.6           0.1  %           2.4           0.2  %
Total operating expenses                            326.1          21.6  %         277.7          20.7  %
Operating income                                    425.2          28.1  %         253.8          18.9  %
Other income (expense), net                         (15.7 )        (1.0 %)         (19.9 )        (1.4 %)
Income before income taxes                          409.5          27.1  %         233.9          17.5  %
Provision for income taxes                          140.6           9.3  %          67.7           5.1  %
Net income                                      $   268.9          17.8  %     $   166.2          12.4  %

Revenue by Channel.
                                       Three months ended
               March 30,                     March 31,
                 2014       % of Revenue       2013       % of Revenue    % Change
                                (In millions, except percentages)
Commercial    $    978.6          64.7 %    $    828.7          61.8 %       18.1 %
Retail             533.3          35.3 %         512.0          38.2 %        4.1 %
Total revenue $  1,511.9         100.0 %    $  1,340.7         100.0 %       12.8 %

The increase in our Commercial revenue for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, was driven by higher sales of client and enterprise SSDs. The increase in Retail revenue for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, was driven by increased sales of cards and USB drives. Overall, gigabytes sold for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, increased 20%.


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Our ten largest customers represented 49% of our total revenue in each of the three months ended March 30, 2014 and March 31, 2013. We had one customer that exceeded 10% of our total revenue in the three months ended March 30, 2014, representing 17% of our total revenue. 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 revenue.

Revenue by Category.

% of Revenue
for the three months ended
              March 30, 2014      March 31, 2013
Embedded               20 %                23 %
Removable              40 %                45 %
SSD solutions          28 %                20 %
Other (1)              12 %                12 %
Total revenue         100 %               100 %

(1) Other revenue includes license and royalty, wafers and components, and accessories.

SSDs represented our fastest growing revenue category in the first quarter of fiscal year 2014, growing to 28% of our total revenue, driven by strong year-over-year growth in both client and enterprise SSDs. Embedded revenue was flat year-over-year comprising 20% of our revenue mix in our first quarter of fiscal year 2014. Within Embedded revenue, we experienced increased sales of iNAND™ solutions and decreased sales of custom embedded products due to a major customer shifting its demand during the quarter from custom embedded products to our client SSDs. Our Removable revenues, consisting primarily of cards and USB drives, grew slightly year-over-year, comprising 40% of our revenue mix in our first quarter of fiscal year 2014.

Revenue by Geography.
                                                                      Three months ended
                                             March 30,                      March 31,
                                                2014       % of Revenue        2013       % of Revenue    % Change
                                                               (In millions, except percentages)
United States                               $    243.7           16.1 %    $    213.5           15.9 %       14.1 %
Asia-Pacific                                   1,011.4           66.9 %         909.9           67.9 %       11.2 %
Europe, Middle East and Africa                   191.0           12.6 %         173.6           12.9 %       10.0 %
Other foreign countries                           65.8            4.4 %          43.7            3.3 %       50.6 %
Total revenue                               $  1,511.9          100.0 %    $  1,340.7          100.0 %       12.8 %

U.S. revenue for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, increased due primarily to higher sales of SSDs, partially offset by a reduction in sales of removable products. Asia-Pacific revenue for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, increased due primarily to higher sales of SSDs. Europe, Middle East and Africa revenue for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, increased due primarily to higher sales of SSDs and USB drives. The increase in Other foreign countries revenue for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, was due primarily to higher sales of SSDs and USB drives.

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 those regions.


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Gross Profit and Margin.

                         Three months ended
                March 30,       March 31,
                  2014             2013       % Change
                 (In millions, except percentages)
Gross profit $      751.3      $    531.5        41.4 %
Gross margin         49.7 %          39.6 %

Gross margin increased in the three months ended March 30, 2014, compared to the three months ended March 31, 2013, due primarily to a decrease of 7% in our average selling price per gigabyte, while our cost per gigabyte declined by 23%. Cost declines in the first quarter of fiscal year 2014, compared to the first quarter of fiscal year 2013, were derived primarily from the weakening of the Japanese yen relative to the U.S. dollar, reduced Flash Ventures manufacturing cost and our increased mix of 1Y­nanometer wafers, partially offset by increased non-flash memory costs in our SSD and iNAND products. Our average selling price per gigabyte was lower in the three months ended March 30, 2014, compared to the three months ended March 31, 2013, driven by product line price declines, which were partially offset by an increased mix of sales of higher value products, such as SSDs and iNAND products.

Research and Development.
                                     Three months ended
                            March 30,       March 31,
                              2014             2013       % Change
                             (In millions, except percentages)
Research and development $      198.8      $    171.1        16.2 %
% of revenue                     13.2 %          12.8 %

The increase in our research and development expense for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, was due primarily to higher employee-related costs of $25 million, which includes an increase in salary and benefits of $19 million, and an increase in share-based compensation of $4 million, both due primarily to increased head count, and higher facility costs of $2 million.

Sales and Marketing.
                                Three months ended
                       March 30,        March 31,
                         2014             2013       % Change
                        (In millions, except percentages)
Sales and marketing $       77.0       $    59.1        30.3 %
% of revenue                 5.1 %           4.3 %

The increase in our sales and marketing expense for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, was due primarily to higher employee-related costs of $12 million, which includes an increase in salary and benefits of $9 million and an increase in share-based compensation of $3 million, both due primarily to increased head count. In addition, branding and merchandising costs were $5 million higher in the first quarter of fiscal year 2014 compared to the first quarter of fiscal year 2013.

General and Administrative.
                                       Three months ended
                              March 30,        March 31,
                                2014             2013       % Change
                               (In millions, except percentages)
General and administrative $       48.7       $    45.1        8.0 %
% of revenue                        3.2 %           3.4 %

The increase in our general and administrative expense for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, was due primarily to higher employee-related costs of $5 million, which includes an increase in


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salary and benefits of $4 million and an increase in share-based compensation of $1 million, both due primarily to increased head count, partially offset by a reduction in other expenses of $2 million.

Amortization of Acquisition-related Intangible Assets.
                                                                   Three months ended
                                                          March 30,        March 31,
                                                            2014              2013       % Change
                                                            (In millions, except percentages)
Amortization of acquisition-related intangible assets  $        1.6       $      2.4      (33.3 %)
% of revenue                                                    0.1 %            0.2 %

Amortization of acquisition-related intangible assets for the three months ended March 30, 2014, compared to the three months ended March 31, 2013, was lower due primarily to lower amortization of intangible assets from our Pliant acquisition.

Other Income (Expense), net.
                                              Three months ended
                                     March 30,       March 31,
                                       2014             2013       % Change
                                      (In millions, except percentages)
Interest income                   $       13.2      $     12.9         2.3 %
Interest expense                         (27.9 )         (31.0 )      10.0 %
Other income (expense), net               (1.0 )          (1.8 )      45.0 %
Total other income (expense), net $      (15.7 )    $    (19.9 )      21.1 %

"Total other income (expense), net" for the three months ended March 30, 2014 reflected a lower net expense, compared to the three months ended March 31, 2013, due primarily to lower interest expense as a result of a lower interest rate on our 0.5% Notes due 2020 issued in the fourth quarter of fiscal year 2013 compared to our 1.5% Notes due 2013, which matured in the second quarter of fiscal year 2013.

Provision for Income Taxes.
                                       Three months ended
                              March 30,        March 31,
                                2014             2013       % Change
                               (In millions, except percentages)
Provision for income taxes $      140.6       $    67.7       107.7 %
Effective tax rate                 34.3 %          28.9 %

The provision for income taxes for the three months ended March 30, 2014 differs from the U.S. statutory tax rate of 35% due primarily to the tax impact of earnings from foreign operations, state taxes, non-deductibility of certain share-based compensation, and tax-exempt interest income. Earnings and taxes resulting from foreign operations are largely attributable to our Irish, Chinese, Israeli and Japanese entities. Earnings in these countries where tax rates are lower than the U.S. notional rate contributed to the majority of the difference between the rate of our tax provision and the U.S. statutory tax rate. The higher effective tax rate for the three months ended March 30, 2014, compared to the same period in fiscal year 2013, is attributable to the federal R&D tax credit not being extended as of March 30, 2014, while the March 31, 2013 effective tax rate includes both the 2013 federal R&D credit and retroactive inclusion of the 2012 federal R&D tax credit, and changes in the composition of operating income by tax jurisdiction. As of March 30, 2014, 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 . . .

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