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SNDK > SEC Filings for SNDK > Form 10-Q on 31-Jul-2014All Recent SEC Filings

Show all filings for SANDISK CORP

Form 10-Q for SANDISK CORP


31-Jul-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, firmware and software 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 the 1Z­nanometer technology node. We expect to transition to the 1Z­nanometer node beginning in the second half of fiscal year 2014 and continuing through at least fiscal year 2015. Beyond the 1Z­nanometer node, 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 2D NAND flash memory, while at the same time we are investing in 3­dimensional NAND, or 3D NAND. We believe 2D NAND flash memory will co-exist with 3D NAND for an extended period of time. We are also investing in 3­dimensional resistive RAM, or 3D ReRAM, technology, which we believe may be a viable alternative to NAND flash memory when NAND flash memory can no longer cost-effectively scale at a sufficient rate, or at all.

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, in particular enterprise 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 year-over-year 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 year-over-year 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. We achieved 1Y­nanometer bit-supply mix of 60% in the second quarter of fiscal year 2014, and based upon the profile of our product demand, we expect to maintain this 1Y­nanometer supply mix through the second half of fiscal year 2014, resulting in our captive bit-supply growth for fiscal year 2014 most likely being at the lower end of the 25% to 35% range. We expect our fiscal year 2015 captive bit-supply growth to be between 30% and 40%.

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 per gigabyte reduction 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, reduced Flash Ventures manufacturing costs 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 fiscal year 2014. 1Y­nanometer and subsequent technology nodes have increased manufacturing equipment requirements, which impact the cost reduction benefits obtainable through these technologies. 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 development or volume production of 3D NAND technologies, such as 3D vertical NAND, or 3D VNAND. At this time, these technologies are still emerging and it is unclear how they will compare to our 2D NAND or 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 1Z­nanometer technology node while we work on 3D NAND and 3D ReRAM in parallel.

Dividends

In the six months ended June 29, 2014, we paid cash dividends totaling $0.45 per common share. On July 15, 2014, our Board of Directors declared a dividend of $0.30 per share for holders of record as of August 4, 2014, to be paid on August 25, 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 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. Under this ASR agreement, the financial institution initially delivered to us 14.5 million shares during the third quarter of fiscal year 2013, and we received an additional 0.6 million shares from the financial institution at settlement of the ASR in April 2014, for a total of 15.1 million shares, which resulted in a volume-weighted-average price of $66.07 per share.


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Under our share repurchase program, since the fourth quarter of fiscal year 2011 through June 29, 2014, we spent an aggregate $2.16 billion to repurchase 35.0 million shares. Included in the aggregate repurchase activity are 4.0 million shares that were repurchased for an aggregate amount of $341 million during the six months ended June 29, 2014. In addition to repurchases under our repurchase program, during the six months ended June 29, 2014, we spent $30 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 shares provided to the employees upon vesting.

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 June 30, 2014 and the 1.5% Notes due 2017 are convertible at the holders' option beginning on July 1, 2014 and ending September 30, 2014. As such, the carrying value of the 1.5% Notes due 2017 was classified as a current liability 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 June 29, 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 shares of our common stock with respect to any conversion value greater than the principal amount of the 1.5% Notes due 2017. Based on the closing price of our common stock of $102.74 on June 29, 2014, if all of the 1.5% Notes due 2017 were converted, it would result in 9.6 million shares being distributed to the holders. As of June 29, 2014, no 1.5% Notes due 2017 had been converted.

Acquisitions

On July 23, 2014, we completed the acquisition of Fusion-io, Inc., or Fusion-io, a developer of flash-based PCIe hardware and software storage solutions that enhance application performance in enterprise and hyperscale data centers, pursuant to an Agreement and Plan of Merger dated June 16, 2014, by and among us, Fusion-io and Flight Merger Sub, Inc., or Merger Sub, a wholly-owned subsidiary of SanDisk. The acquisition was effected through a tender offer for all of the outstanding shares of common stock of Fusion-io, par value $0.0002 per share, followed by a merger of Merger Sub with and into Fusion-io, with Fusion-io surviving as a wholly-owned subsidiary of SanDisk. We completed the tender offer and the merger for $11.25 per share for all of the outstanding shares of Fusion-io common stock, and assumed certain unvested, in-the-money options and unvested RSUs, for a total aggregate value of approximately $1.3 billion.

Our third quarter financial results will include the results of Fusion-io from July 23, 2014 through September 28, 2014. We expect to exclusively use non-captive memory for the Fusion-io business for at least the next several quarters. Our financial results will be impacted by:

• transaction, restructuring and integration costs, which are expected to be incurred over several quarters as integration takes place;

• reduction of revenue related to support and maintenance services due to the effects of purchase accounting on Fusion-io's deferred revenue;

• inventory step-up charges related to recording Fusion-io inventory at fair value based on purchase accounting requirements;

• charges for the amortization of acquisition-related intangible assets; and

• stock compensation for the assumption and new issuance of employee equity incentives.


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Results of Operations
                                        Three months ended                                              Six months ended
                     June 29,                       June 30,                        June 29,                       June 30,
                       2014        % of Revenue       2013        % of Revenue        2014        % of Revenue       2013        % of Revenue
                                                                (In millions, except percentages)
Revenue             $ 1,634.0         100.0  %     $ 1,476.3         100.0  %      $ 3,146.0         100.0  %     $ 2,817.0         100.0  %
Cost of revenue         854.6          52.3  %         789.6          53.5  %        1,595.7          50.7 %        1,589.0          56.4 %
Amortization of
acquisition-related
intangible assets        19.7           1.2  %           9.9           0.7  %           39.4           1.3 %           19.7           0.7 %
Total cost of
revenue                 874.3          53.5  %         799.5          54.2  %        1,635.1          52.0 %        1,608.7          57.1 %
Gross profit            759.7          46.5  %         676.8          45.8  %        1,510.9          48.0 %        1,208.3          42.9 %
Operating expenses:
Research and
development             204.1          12.5  %         172.1          11.7  %          402.9          12.8 %          343.2          12.2 %
Sales and marketing      83.4           5.1  %          63.6           4.2  %          160.4           5.1 %          122.7           4.4 %
General and
administrative           54.1           3.3  %          46.9           3.2  %          102.8           3.3 %           92.0           3.3 %
Amortization of
acquisition-related
intangible assets         1.4           0.1  %           1.7           0.1  %            3.0           0.1 %            4.1           0.1 %
Total operating
expenses                343.0          21.0  %         284.3          19.2  %          669.1          21.3 %          562.0          20.0 %
Operating income        416.7          25.5  %         392.5          26.6  %          841.8          26.8 %          646.3          22.9 %
Other income
(expense), net          (13.6 )        (0.8 %)          (9.1 )        (0.6 %)          (29.2 )        (0.9 %)         (29.0 )        (1.0 %)
Income before
income taxes            403.1          24.7  %         383.4          26.0  %          812.6          25.8 %          617.3          21.9 %
Provision for
income taxes            129.2           7.9  %         121.6           8.3  %          269.7           8.6 %          189.3           6.7 %
Net income          $   273.9          16.8  %     $   261.8          17.7  %      $   542.9          17.3 %      $   428.0          15.2 %

Revenue by Channel.
                                       Three months ended                                                        Six months ended
               June 29,                      June 30,                                   June 29,                      June 30,
                 2014       % of Revenue       2013       % of Revenue    % Change        2014       % of Revenue       2013       % of Revenue    % Change
                                                                    (In millions, except percentages)
Commercial    $ 1,099.7           67.3 %    $   960.6           65.1 %       14.5 %    $ 2,078.3           66.1 %    $ 1,789.3           63.5 %       16.2 %
Retail            534.3           32.7 %        515.7           34.9 %        3.6 %      1,067.6           33.9 %      1,027.7           36.5 %        3.9 %
Total revenue $ 1,634.0          100.0 %    $ 1,476.3          100.0 %       10.7 %    $ 3,145.9          100.0 %    $ 2,817.0          100.0 %       11.7 %

The increase in our Commercial revenue for the three months ended June 29, 2014, compared to the three months ended June 30, 2013, was primarily driven by higher sales of client and enterprise SSDs offset by a decline in sales of mobile embedded products, due in part to a major customer shifting its demand from custom embedded solutions to our client SSDs. The increase in Retail revenue for the three months ended June 29, 2014, compared to the three months ended June 30, 2013, was primarily driven by increased sales of mobile cards and USB drives. Overall, gigabytes sold for the three months ended June 29, 2014, compared to the three months ended June 30, 2013, increased 51%, which was offset by a 26% decrease in the average selling price per gigabyte.

The increase in our Commercial revenue for the six months ended June 29, 2014, compared to the six months ended June 30, 2013, was driven by higher sales of client and enterprise SSDs offset by a decline in sales of mobile embedded products, due in part to a major customer shifting its demand from custom embedded solutions to our client SSDs. The increase in Retail revenue for the six months ended June 29, 2014, compared to the six months ended June 30, 2013, was driven primarily by increased sales of mobile cards and USB drives. Overall, gigabytes sold for the six months ended June 29, 2014, compared to the six months ended June 30, 2013, increased 36%, which was offset by an 18% decrease in the average selling price per gigabyte.


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Our ten largest customers represented 47% and 49% of our total revenue in the three months ended June 29, 2014 and June 30, 2013, respectively. One customer exceeded 10% of our total revenue in the three months ended June 29, 2014 and June 30, 2013, representing 17% and 16% of our total revenue, respectively. Our ten largest customers represented 48% and 49% of our total revenue in the six months ended June 29, 2014 and June 30, 2013, respectively. One customer represented 17% of our total revenue in the six months ended June 29, 2014. Two customers represented 18% and 11% of our total revenue in the six months ended June 30, 2013.

Revenue by Category.
                               % of Revenue
                Three months ended        Six months ended
              June 29,     June 30,    June 29,     June 30,
                2014         2013        2014         2013
Embedded          19 %         30 %        20 %          27 %
Removable         40 %         42 %        40 %          43 %
SSD solutions     29 %         16 %        29 %          18 %
Other (1)         12 %         12 %        11 %          12 %
Total revenue    100 %        100 %       100 %         100 %

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

Embedded revenue for the three months ended June 29, 2014 comprised 19% of our revenue mix and was lower year-over-year due primarily to a major customer shifting its demand from custom embedded solutions to our client SSDs. Removable revenue for the three months ended June 29, 2014 comprised 40% of our revenue mix and increased year-over-year due primarily to higher sales of cards and USB drives. SSD solutions achieved 29% of our revenue mix for the three months ended June 29, 2014 with strong year-over-year growth in both client and enterprise SSDs.

Embedded revenue for the six months ended June 29, 2014 comprised 20% of our revenue mix and was lower year-over-year due primarily to a major customer shifting its demand from custom embedded solutions to our client SSDs. Within embedded revenue, sales of our iNAND solutions increased for the six months ended June 29, 2014 compared to the six months ended June 30, 2013. Removable revenue for the six months ended June 29, 2014 comprised 40% of our revenue mix and increased year-over-year due primarily to higher sales of cards and USB drives. SSD solutions achieved 29% of our revenue mix for the six months ended June 29, 2014 with strong growth in both client and enterprise SSDs.

Revenue by Geography.
                                        Three months ended                                                        Six months ended
                June 29,                      June 30,                                   June 29,                      June 30,
                  2014       % of Revenue       2013       % of Revenue    % Change        2014       % of Revenue       2013       % of Revenue    % Change
                                                                     (In millions, except percentages)
United States  $   281.0           17.2 %    $   190.0           12.9 %      47.9  %    $   496.0           15.8 %    $   403.5           14.3 %       22.9 %
Asia-Pacific     1,094.2           67.0 %      1,038.5           70.3 %       5.4  %      2,105.5           66.9 %      1,948.4           69.2 %        8.1 %
Europe, Middle
East and
Africa             189.5           11.6 %        176.6           12.0 %       7.3  %        380.4           12.1 %        350.2           12.4 %        8.6 %
Other foreign
countries           69.3            4.2 %         71.2            4.8 %      (2.4 %)        164.1            5.2 %        114.9            4.1 %       42.8 %
Total revenue  $ 1,634.0          100.0 %    $ 1,476.3          100.0 %      10.7  %    $ 3,146.0          100.0 %    $ 2,817.0          100.0 %       11.7 %

U.S. revenue for the three months ended June 29, 2014, compared to the three months ended June 30, 2013, increased due primarily to higher sales of SSDs and removable products. Asia-Pacific revenue for the three months ended June 29, 2014, compared to the three months ended June 30, 2013, increased due primarily to higher sales of SSDs and removable products, offset by lower sales of embedded products due primarily to decreased sales of custom embedded solutions to a major customer that shifted its demand from custom embedded solutions to our client SSDs. Europe, Middle East and Africa revenue for the three months ended June 29, 2014, compared to the three months ended June 30, 2013, increased due primarily to higher sales of SSDs. Other foreign countries revenue for the three months ended June 29, 2014, compared to the three months ended June 30, 2013, increased due primarily to higher sales of embedded products.


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U.S. revenue for the six months ended June 29, 2014, compared to the six months ended June 30, 2013, increased due primarily to higher sales of SSDs and removable products, partially offset by a reduction in sales of embedded products. Asia-Pacific revenue for the six months ended June 29, 2014, compared to the six months ended June 30, 2013, increased due primarily to higher sales of SSDs and removable products, offset by lower sales of embedded products due primarily to decreased sales of custom embedded solutions to a major customer that shifted its demand from custom embedded solutions to our client SSDs. Europe, Middle East and Africa revenue for the six months ended June 29, 2014, compared to the six months ended June 30, 2013, increased due primarily to higher sales of SSDs. Other foreign countries revenue for the six months ended June 29, 2014, compared to the six months ended June 30, 2013, increased due primarily to higher sales of embedded products.

Our revenue is 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.

Gross Profit and Margin.
                     Three months ended                       Six months ended
              June 29,     June 30,                  June 29,      June 30,
                2014         2013      % Change        2014          2013       % Change
                                  (In millions, except percentages)
Gross profit $  759.6     $  676.8        12.2 %    $ 1,510.9     $ 1,208.3        25.0 %
Gross margin     46.5 %       45.8 %                     48.0 %        42.9 %

Gross margin increased in the three months ended June 29, 2014, compared to the three months ended June 30, 2013, due primarily to a lower mix of custom embedded solutions, partially offset by increased amortization of acquisition-related intangible assets and share-based compensation. On a year-over-year basis, our blended average selling price per gigabyte declined 26%, while our blended cost per gigabyte declined 28%. Cost declines in the second quarter of fiscal year 2014, compared to the second quarter of fiscal year 2013, were derived primarily from reduced Flash Ventures manufacturing cost, increased mix of 1Y­nanometer wafers, a reduced mix of multi-chip package ("MCP") embedded products and the weakening of the Japanese yen relative to the U.S. dollar.

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