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SanDisk Misses EPS, but Shares Rise

SNDK MU

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SanDisk Corp.’s (SNDK - Analyst Report) second quarter 2012 adjusted earnings of 15 cents per share missed the Zacks Consensus Estimate of 17 cents. 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. The weakness was mainly due to lower demand for its mobile cards at some OEMs (original equipment manufacturers) and weak pricing.

Despite the miss, the company’s shares surged 11.17% in after-market trade reflecting positive investor sentiment on the back of strong second half guidance.

Revenue

Total revenue for the second quarter was $1.03 billion, down 24.9% on a year-over-year basis. The quarter’s result came slightly above the Zacks Consensus Estimate of $1.02 billion. The revenue deceleration was due to weak performances in the OEM vertical, partially offset by strength in Retail.

Segment wise, Product revenue decreased 26.3% year over year to $945.2 million, while License and Royalty revenue came in at $87.1 million, down 6.4% year over year.

Sales of SSDs (solid state drives) grew sequentially due to the ramp up of enterprise SSD solution offerings. Management believes that the product will continue to perform better with support from the acquisition of enterprise Storage Software Maker Schooner Information Technology in June.

Operating Results

Reported gross margin in the quarter was 27.2%, down from 44.6% in the year-ago quarter. The margin decline was due to higher cost as well as price declines. Cost per gigabyte improved 35% year over year. The negative impact from Yen conversion also affected the gross margin.

Operating margin was 3.5% versus 27.6% in the year-ago quarter. The company’s total operating expenses increased 4.3% on a year-over-year basis. Higher operating expenses were mainly due to 4.9% and 8.4% year-over-year increases in research and development and selling and general expenses, respectively. But this was partially offset by lower general and administrative costs.

Net income on a GAAP basis was $13.0 million or 5 cents per diluted share compared with $248.4 million or $1.02 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 second quarter was $36.8 million or 15 cents per diluted share compared with $269.0 million or $1.14, in the year-ago quarter.

Balance Sheet & Cash Flow

SanDisk generated $19.1 million in cash from operating activities, compared with $209.6 million in the prior quarter. Capital expenditure was $96.1 million. Cash and short-term investments were $2.54 billion versus $2.67 billion in the previous quarter. Long-term marketable securities were $2.72 billion. Convertible debt for the quarter was $1.65 billion, up from $1.63 billion in the previous quarter.

Outlook

Management has provided an upbeat outlook for the second half of fiscal 2012. It believes that price declines could moderate in the second half. Management also expects higher demand for its mobile and SSD solutions, which will likely boost its revenue growth in the third and fourth quarters.

The company expects a host of new launches by the coming quarters that will expand its portfolio as well as strengthen fundamentals. Specifically, SanDisk forecasts a growth in mobile embedded revenue as well as SSD sales.

The company also mentioned some market dynamics that would be catalysts for SanDisk during the second half. It expects the launch of several new smartphones and tablets, Ultrabooks and other end-client PCs, running on SSDs. This will boost demand for NAND Flash gadgets aka SSD.

Also, the flash-drive maker anticipates a cut in the supply as the industry is reducing its capacity. Constrained supply coupled with growing demand for SSDs due to continuous launch of next-gen technologies would create an encouraging pricing environment.

Anticipating the changing market scenario, SanDisk now expects third quarter revenue in the range of $1.20 billion, plus or minus $50 million.

The company expects non-GAAP gross margin to remain flat sequentially at approximately 28% (+/- 2.0%). The company expects price declines to get balanced with cost decline, allowing gross margins to stabilize. Non-GAAP operating expenses will be roughly $235 million for the third quarter. Non-GAAP other income is expected to be approximately $5 million, and the tax rate is projected at approximately 30% on a non-GAAP basis.

For the fourth quarter, the company expects to benefit from continued sequential growth in sales of the mobile embedded products and SSDs, as well as retail seasonality. Gross margin will keep on improving in the fourth quarter with a continued favorable supply-demand environment and an increasing mix of higher value-added product sales.

For fiscal 2012, non-GAAP operating expenses are expected to be $910 million, down from the previously expected $920 million. The company also expects total capital investment of approximately $1.2 billion, including about $700.0 million at the fab joint ventures and about $500 million of capital expenditure.

Zacks Consensus Estimate for third quarter and 2012 are pegged at 37 cents and $1.63 per share, respectively.

Our Take

SanDisk posted a weak second quarter with the bottom line missing the Zacks Consensus Estimate. Revenues from OEMs continued to lack luster, somewhat offset by strength in retails. Second half guidance was encouraging, which was enough to turn on the mood of the investors.

Though lackluster PC sales, European issues, competition from Micron Technology Inc. (MU - Snapshot Report) and currency fluctuations are headwinds, we remain positive on management’s commentary of a turnaround story in the second half of the year and strong secular demand for NAND flash.

Currently, SanDisk holds a Zacks #3 Rank, implying a short-term “Hold” rating.

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