RealMoney Silver - SNDK: Slight Beat, but Outlook Grim

SNDK: Slight Beat, but Outlook Grim
By Bob Faulkner
RealMoney Contributor
1/28/2008 7:07 PM EST

Updated from Jan. 25 with earnings results

San Disk (SNDK) reported its fourth-quarter results Monday, which were a hair light on revenue but better than consensus pro forma EPS expectations. However, the outlook for the March quarter was dismal.

Total revenue in the quarter was $1.26 billion (up 7% year over year; +20% quarter over quarter) and pro forma EPS was 69 cents (GAAP was 45 cents). Product revenue (~90% of total) increased 4% YY and 22% QQ. Pro forma GM on products in the period was 29.7%, down 240 bps YY but up 330 bps versus Q2. Higher volumes and pricing were the contributors to GM improvements. OM was 17.9% down 360 bps from last year's levels and up 220 sequentially.

Cash from operations was about $150M, down about $40M from the prior year's level. The cash and equivalents decreased about $500 after a $200 million share repurchase and a bump up in long-term investments. A/R increased about $20 million, but days sales outstanding fell five days to 33 days. Inventory increased about $10 million, but DOI declined by nine days to 62 days. Channel inventory was said to be about six weeks, flat with the prior year.

Within its two principle business segments, retail (about two-thirds of product revenue) was $727 million,up 2% YY and 20% QQ with megabytes shipped up 37% from Q3 levels This was below the 45%-65% guidance level. OEM revenue was $391M, up 4% from last year and 27% sequentially.

Management's guidance for the first quarter was disappointing. Revenue is expected to be in the $775M-$875M range (down 1% to up 11% YY), with pro forma product gross margins in the 23%-26% range. Pro forma operating expenses should be $215M-$220M, with a tax rate of 34%. At the midpoint of these estimates, it would appear that pro forma EPS should be in the 22 to 24 cents neighborhood. Current Street consensus is $1 billion and 40 cents.

The company's guidance for 2008 is similarly cautious. It expects revenue growth to be 15%-25%, with more modest growth in megabytes shipped. The current consensus revenue estimate for 2008 is up 25%.

As expected, the company did not disclose the reserve against revenue for price protection and promotions, but the suggestion that they were impacted by slowing holiday sales and continued price pressure may indicate it was fairly steep in the period.

SNDK's management was clearly cautious on the conference call given its experience in the latter part of the December quarter. The company characterized the early part of 2008 as being very similar to the start of 2007, i.e., excess capacity and weak prices.

While management anticipates that 2H/08 will see improvement in the industry, it cannot forecast industry capex. All players see the "potential" for solid state storage in a variety of applications. However, many of those applications become attractive only at very low prices/megabyte. Those same low prices must be accompanied by even lower costs/megabytes, and the only way to achieve that is through increased capex.

It's a vicious cycle and one frequently characterized by negative results.

Preview

San Disk is scheduled to report its fourth-quarter 2007 results Monday, Jan. 28, after the close, with a conference call at 5 p.m. EST. Current Street consensus estimates are for revenue of $1.27 billion (up 9% year over year and 22% quarter over quarter) and pro forma EPS of 64 cents.

In the prior quarter, revenue was $1.04 billion (up 38% year over year and 25% quarter over quarter), and pro forma EPS was 38 cents. Product revenue (about 90% of total) increased 36% year over year and 28% quarter over quarter.

The pro forma gross margin on products in the period was 26.4%, down 630 basis points year over year but up 760 basis points vs. second quarter. Higher volumes and normal pricing were the contributors to gross-margin improvements. The operating margin was 25.7%, up 980 basis points from last year's levels and more than 1,000 basis points quarter over quarter. The operating margin benefitted from lower SG&A as well as a credit from the asbestos litigation settlement.

Cash from operations was about $870 million, or double the prior year's level. The cash account increased about $100 million after a dividend increase and the repurchase of 5 million shares. Accounts receivable increased about $80 million, adding one day to days sales outstanding (51 days). Inventory dropped about $10 million, reducing days of inventory by six days (74 days).

Within its two principal business segments, retail (about two-thirds of revenue) was $608 million, up 36% year over year and 25% quarter over quarter. Retail megabytes shipped increased 46% quarter over quarter, with ASPs down 14%. OEM revenue was $311 million, up 37% year over year and 33% quarter over quarter. Megabytes shipped to OEMs increased 82% from second quarter, with ASPs down 26%.

Management guided product revenue in to be in the $1.05 billion to $1.20 billion range, with royalty revenue about flat. The pro forma gross margin was expected to be in the 27% to 30% range, with operating expenses of $240 million to $250 million and a tax rate of 34% to 35%. Back-of-the-envelope math puts EPS at about 63 cents to 64 cents.

There is a little-watched aspect of the company's financials that has just become public during this past year. SanDisk takes a reserve against revenue for price protection and promotions. From the four quarters of available data, that reserve has been at a high of 78% of revenue (first quarter 2007) to a low of 42% of revenue (third quarter 2007).

The extremely high level of reserve suggests that there is an extraordinary level of price and competitive pressure within the market. Given the fact that, at the OEM level, contract prices were down more than 50% sequentially during fourth quarter, will we see that reserve level spike up? That, coupled with the mixed commentary from retailers, may suggest that the anticipated "upside" in fourth-quarter results may be a difficult hurdle.

On the conference calls, here are the keys on which I will be focused:

production growth, megabytes shipped and ASPs;

product margins;

capital spending plans and time frame;

price protection and promotion reserves (in past quarters, the reserve has not been disclosed until the appropriate SEC filings take place);

mobile memory card and USB growth rates; and

outlook for production, ASPs, revenue and margins

While fourth-quarter contract prices certainly contributed to the 56% drop in SanDisk's stock price from early September, there is nothing to suggest that NAND prices will be improving in the next quarter or two either.

SanDisk is one of the many technology and telecommunications stocks that Bob Faulkner monitors and discusses in The Telecom Connection.