SanDisk Corp.’s (SNDK) third quarter 2011 adjusted earnings of $1.15 per share surpassed the Zacks Consensus Estimate of $1.02. The adjusted or non-GAAP earnings per share exclude amortization of acquisition-related intangible assets, convertible debt interest and tax gains, but include stock-based compensation expense. Shares surged 2.29% in after market trade.
Revenue
Total revenue for the third quarter was $1.42 billion, up 14.8% on a year-over-year basis. The quarter’s result was on the higher end of the company’s guidance range. Sales of Apple Inc.'s (AAPL) iPad and iPhone as well as smartphones using Google Inc.'s (GOOG) Android platform have been the bright spot. As flash memory is used in these gadgets, the demand for the same is surging. The revenue growth was driven by strong demand for SanDisk’s flash memory products in emerging markets, as well as solid performance by its retail and OEM (original equipment manufacturer) channels, globally.
Segment wise, Product revenue increased 16.2% year over year to $1.32 billion, while License and Royalty revenue was $94.1 million, down 2.1% year over year.
Operating Results
Reported gross margin in the quarter was 43.2% versus 51.8% in the year-ago quarter. The decline is attributable to the 850 basis point year-over-year decrease in the product gross margin.
The margin decline was due to the negative impact of the yen exchange rate, start-up cost for a new fab as well as price declines. All these factors tempered the positive effect of cost control measures.
Operating margin on a GAAP basis was 27.3%, compared with 35.0% in the year-ago quarter. The company’s total operating expenses increased 9.0% on a year-over-year basis. Steeper operating expenses were mainly an outcome of a 21.3% year-over-year increase in research and development (R&D) costs, partially offset by reduction in sales and marketing and general and administrative costs.
Net income on a GAAP basis was $233.3 million, or 96 cents per diluted share, compared with $322.1 million, or $1.34 per share in the year-ago quarter.
Excluding the amortization of acquisition-related intangible assets, convertible debt interest expense and related tax adjustments, but including stock-based compensation expense, non-GAAP net income for the third quarter was $279.6 million, or $1.15 per diluted share, compared with $316.3 million, or $1.31, in the year-ago quarter.
Balance Sheet & Cash Flow
SanDisk generated $176.3 million in cash from operating activities, compared with $269.2 million in the prior quarter. Capital expenditure was $52.9 million. Cash and short-term investments were $2.55 billion versus $2.69 billion in the previous quarter. Huge cash used in investing activities have lowered the cash balance for the reported quarter. Convertible long-term debt for the quarter was $1.58 billion, down from $1.76 billion in the previous quarter. Long-term marketable securities were $2.71 billion.
Fourth Quarter & Fiscal 2011 Outlook
Management expects the current capacity expansion commitment within Phase I of Fab 5 to be completed by the end of January 2012 and future Phase I expansion to begin approximately three months later. With this capacity plan, management expects 2012 captive bit growth rate to be somewhat higher than in 2011, and the key drivers of the 2012 bit growth to be the 19-nanometer technology transition, and the wafer capacity expansion in Fab 5.
SanDisk also expects that growing demand for its products to continue and supply to remain unhindered. Hence, the company forecasts fourth quarter revenue between $1.5 billion and $1.6 billion.
SanDisk expects the fourth quarter gross margin to remain depressed due to Fab 5 start-up costs and currency exchange. The company expects non-GAAP product gross margin of 38% to 40%, and total non-GAAP gross margin including license and royalty of 42% to 44%. Non-GAAP operating expenses are forecast at $225 million to $235 million, with the expected increase coming primarily from growth in the R&D investment level, and a seasonal increase in sales and marketing spending.
Our Take
SanDisk posted decent third quarter 2011 numbers surpassing the Zacks Consensus Estimate. Both OEM and retail sides of the business progressed, enabling solid product revenue. Though revenue guidance was decent, margin guidance was disappointing, as SanDisk continued to see memory price declines and currency headwinds.
In a bid to expand into the fast-growing and high-margin business of sophisticated flash storage for enterprise customers, SanDisk bought solid-state drive maker Pliant Technology for $237 million, earlier this year. With the acquisition, SanDisk made its foray into the booming enterprise flash memory market.
We understand that demand for flash memory could grow in the coming years, backed by the popularity of devices such as smartphones and tablets. But we think that slower cannibalization of PC could hurt the demand for SanDisk’s memory products and rationalize revenue growth, going forward. Also, customer concentration risk, competitive pressure and European weakness are headwinds for the company.
Currently, SanDisk holds a Zacks #4 Rank, implying a short-term Sell rating.
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