3 Takeaways From SanDisk's Earnings Results

How did the flash-memory maker stack up against expectations on three key metrics?

Jan 24, 2014 at 10:45AM

SanDisk (NASDAQ:SNDK) reported its fourth-quarter results on Wednesday. In the earnings preview, we looked at three things that investors should pay particular attention to in the report:

  • The effect of the SMART Storage Systems acquisition on the Enterprise SSD business with server companies like IBM (NYSE:IBM)
  • The company's ability to improve its embedded solutions revenue in the face of competition from Micron Technology (NASDAQ:MU)
  • Its ability to control costs

Let's see how it did, and how this impacts long-term investors.

How did the SMART acquisition affect Enterprise SSD?
The SMART acquisition is already starting to pay off. The company set a new revenue record for enterprise SSDs in the fourth quarter. The company has used SMART Storage Systems' solutions to achieve several new design wins, and management says there are more in the pipeline.

Source: SMART Storage Systems

Earlier this week, SanDisk announced that IBM will use its new ULLtraDIMM enterprise SSD in its x3850 and x3950 X6 servers under the brand name eXFlash DIMM. The technology, which SanDisk acquired in the SMART purchase, provides best-in-class latency performance. IBM's early adoption of the technology is interesting, considering Big Blue has under-invested in its server business, and it has agreed to sell the division to Lenovo for $2.3 billion. The server business may be better off in the hands of Lenovo, and Lenovo could do what it did with IBM's PC business with its x86 server business.

Moreover, working with Lenovo may better suit SanDisk. Lenovo has a growing consumer-device business with its IBM-acquired PCs and its mobile devices. A closer relationship with the Chinese manufacturer may allow SanDisk to achieve further design wins.

In the fourth quarter, Enterprise SSD was the fastest-growing business at SanDisk, and the company expects that trend to continue. Currently, SSDs make up nearly a third of the company's commercial sales. With the SMART Storage Systems Guardian technology replacing SanDisk's previous architecture, it believes it will be able to scale better.

Embedded revenue growth
SanDisk's embedded solutions didn't generate as much revenue as they did last year, and the segment fell to just 26% of revenue from 32% in the year-ago quarter. Of course, SSDs more than made up the difference, and surely some of those commercial channel SSDs are in mobile devices.


Source: SanDisk

One bright spot in the segment was SanDisk's iNAND product line, which is targeted at entry-level and mid-range OEMs. iNAND and MCP iNAND revenue was up over the year-ago period, indicating that SanDisk's initiatives in China to gain share on the low end are succeeding. As the high-end mobile-device market saturates, low-end devices ought to return SanDisk's embedded solutions segment to revenue growth in 2014.

SanDisk faces some aggressive competition from Micron in embedded solutions. President Mark Adams indicated on the company's first-quarter conference call that it's going to pursue growing its market share. Last quarter, Micron grew its embedded-systems revenue 31.7% over the prior-year period, to $366 million. That still lags SanDisk's embedded revenue share of $449 million.

Cost reduction
Once again, SanDisk benefited from a weakening yen. The company sources its flash memory from a joint venture it has with Toshiba, Flash Ventures, located in Japan. Thus, as the yen weakens, SanDisk is able to increase its purchasing power via U.S. dollars. The company saw an increase in its yen-per-dollar exchange rate to 97 in the fourth quarter, up from 93 in the quarter prior. The company has hedged an exchange rate of 99 yen per dollar for the upcoming quarter, and expects to take advantage of further weakness throughout 2014.

Long-term investors shouldn't count on a weak yen to improve the cost structure of the company, however. More permanent cost improvements came in the form of SanDisk's transition to 1Y technology from 19 nanometers. Production of the more cost-effective process was higher than the expected 15% of total output in the fourth quarter, indicating that 1Y is ramping well.

Overall, SanDisk's cost per gigabyte declined 6% sequentially, but operating expenses grew more than expected. The SMART acquisition added significant costs, but that was already expected. There were $16 million of one-time expenses, including a $5 million bonus related to the company's excellent 2013 results, which was baked into the company's guidance. In total, one-time and seasonal expenses overshot SanDisk's outlook by $7 million.

Mixed results
SanDisk's stock was like a roller coaster in after-hours trading Wednesday. Great top- and bottom-line results had the stock up initially, but a weak outlook for fiscal 2014 caused the exuberance to die quickly.

The details of SanDisk's fourth-quarter results are somewhat mixed. Enterprise SSDs continue to grow exceptionally well, but the lack of embedded-systems growth isn't great. As the low-end mobile-device segment grows, SanDisk will have to compete with Micron for design wins, particularly in China. The company is doing well controlling costs, but with pricing pressure on flash memory, its operating expenses will need to stay in check.

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