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SanDisk Corp. (SNDK - Analyst Report) reported fourth quarter 2012 adjusted earnings of 99 cents per share, crushing the Zacks Consensus Estimate of 68 cents. 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. Results fell short of the year-ago numbers by 19.9% but were 135.7% above the prior quarter levels.

The beat was mainly attributable to solid recovery in the mobile embedded and retail businesses, strong geographic contribution and favorable supply/demand metrics.

Revenues

Total revenues for the fourth quarter were $1.54 billion, down 2.2% on a year-over-year basis but up 21.1% from the previous quarter. The quarter’s result came slightly above the Zacks Consensus Estimate of $1.52 billion and within the company’s guidance. The sequential revenue improvement was mainly due to strong performances in both the OEM and Retail verticals.

Within original equipment manufacturer (OEM), mobile embedded business, demand for iNAND products and sales of solid state drives (SSDs) grew decently. Retail products witnessed solid growth due to seasonality and market share gains in most of the geographical regions.

Segment wise, Product revenue decreased 1.9% year over year to $1.44 billion, while License and Royalty revenue came in at $96.8 million, down 6.5% year over year. Both the segments performed well in comparison to the previous quarter.

Operating Results

Reported gross margin in the quarter was 39.1%, down from 42.0% in the year-ago quarter. The year-over-year margin decline was due to higher cost as well as high-level of price declines. But the sequential improvement was due to moderated price declines coupled with cost optimization.

Operating margin was 21.8% versus 26.4% in the year-ago quarter. The company’s total operating expenses increased 8.5% on a year-over-year basis. Higher operating expenses were mainly due to 17.4% and 8.0% year-over-year increases in selling and general expenses and research and development expenses, respectively. But this was slightly offset by lower general and administrative costs.

Net income on a GAAP basis was $213.5 million or 87 cents per share compared with $281.2 million or $1.14 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 fourth quarter was $242.1 million or 99 cents per share compared with $305.1 million or $1.24 in the year-ago quarter.

Balance Sheet & Cash Flow

SanDisk generated $315.6 million in cash from operating activities, compared with $127.9 million in the prior quarter. Capital expenditure was $3.8 million. Cash and short-term investments were $2.88 billion versus $2.60 billion in the previous quarter. Long-term marketable securities were $2.84 billion. Convertible debt for the quarter was $1.70 billion, up from $1.67 billion in the previous quarter.

Outlook

Management is positive about SSD revenue growth and better supply/demand metrics in 2013. The company is planning to focus more on the iNAND technology, as this is going to be a driver for its mobile-embedded products. 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.

The company also expects its total SSD contribution to be roughly 25.0% of total revenue moving into 2014.

SanDisk now expects first quarter revenue to be within $1.23–$1.30 billion, reflecting modest sequential decline due to seasonality. The company also expects a strong fourth quarter 2013 and projects fiscal 2013 revenue in the range of $5.30–$5.60 billion.

The company expects non-GAAP gross margin of 38.0% (+/-2.0%). Non-GAAP operating expenses will be roughly $255.0 million for the first quarter, which reflects continued investments. Non-GAAP other income is expected to be approximately $5.0 million and the tax rate is projected at approximately 28.0% on a non-GAAP basis.

For fiscal 2013, non-GAAP gross margin is expected to be 41.0% (+/- 2.0%). Non-GAAP operating expenses will be roughly $1.05 billion. Non-GAAP operating margin is expected to be within 20.0%-24.0% range. Non-GAAP other income is expected to be approximately $25.0 million and the tax rate is projected at approximately 30.5% on a non-GAAP basis.

The Zacks Consensus Estimate for first quarter and fiscal 2013 are pegged at 59 cents and $3.17 per share, respectively.

Our Take

SanDisk posted solid fourth quarter results with both the bottom and top lines surpassing the Zacks Consensus Estimates. Though the results came below the year-ago levels, the sequential comps were better than expected. Revenues from OEMs and Retail started recovering. Fiscal 2013 guidance was encouraging too.

Though lackluster PC sales, European issues, competition from Micron Technology Inc. (MU - Analyst Report) and currency fluctuations could hurt the fundamentals a bit, we remain overtly positive on management’s commentary of a turnaround story in the coming quarter and beyond and strong secular demand for NAND flash.

Currently, SanDisk holds a Zacks Rank #2 Rank (Buy).

Investors should look out for some other stocks that are slated to report this earnings season with positive Zacks Rank and Expected Surprise Prediction or ESP (Read: Zacks Earnings ESP: A Better Method).

Yahoo Inc. (YHOO - Analyst Report) has a Zacks Rank #1 (Strong Buy) with an ESP of +14.8%. Interdigital Inc. (IDCC - Snapshot Report) has a Zacks Rank #2 (Buy) with an ESP of +350.0%.

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