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SanDisk Corp. (SNDK - Analyst Report) reported first-quarter 2013 adjusted earnings of 78 cents per share, surpassing the Zacks Consensus Estimate of 70 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 also came 35.5% higher than the year-ago period but were 21.3% below the prior quarter level.

The beat was mainly attributable to strong solid state drive (SSD) sales and strength in retail businesses and favorable supply/demand metrics. Share price tumbled 3.08% in the day’s trade but was up 1.31% in after-hours trading.

Revenues

Total revenue for the first quarter was $1.34 billion, up 11.2% on a year-over-year basis but down 13.0% from the previous quarter. The quarter’s result surpassed both the company's guidance as well as the Zacks Consensus Estimate of $1.32 billion. The year-over-year revenue improvement was mainly due to strong performances in both the OEM (original equipment manufacturer) and Retail verticals. Petabytes sales were up 36.0%, partially offset by lower pricing. Sequential decline in revenues was mainly due to seasonality, which was at par with management’s outlook provided during fourth quarter 2012.

Within OEM, sales of SSD grew 200.0%, while sales of mobile embedded solutions improved by double digits. Sales from Retail vertical witnessed 4.0% year-over-year growth.

During the quarter, SanDisk started shipment of 19-nanometer (nm) SSDs to its retail customers. The company plans to ship the 19 nm SSDs to its OEM customers shortly.

Operating Results

Reported gross margin in the quarter was 39.6%, up from 34.5% in the year-ago quarter. The year-over-year margin growth was due to lower bit cost partially offset by price declines.

Operating margin was 18.9% versus 15.9% in the year-ago quarter. The company’s total operating expenses increased 23.6% on a year-over-year basis. Higher operating expenses were mainly due to 21.4%, 20.6% and 38.4% year-over-year increases in research and development expenses, selling and general expenses and general and administrative expenses, respectively.

Net income on a GAAP basis was $166.2 million or 68 cents per share compared with $114.4 million or 46 cents 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 first quarter was $191.5 million or 78 cents per share compared with $142.2 million or 58 cents in the year-ago quarter.

Balance Sheet & Cash Flow

SanDisk generated $473.7 million in cash from operating activities compared with $315.6 million in the prior quarter. Capital expenditure was $3.8 million. Cash and short-term investments were $3.31 billion versus $2.88 billion in the previous quarter. Long-term marketable securities were $2.88 billion. Convertible debt for the quarter was $1.72 billion, up from $1.70 billion in the previous quarter.

SanDisk repurchased 1.76 million of common stock for $50.97 each, amounting to $90.0 million.

Outlook

Management is positive about SSD revenue growth, favorable product mix (retail and OEM) and better supply/demand metrics in 2013. The company also stated that it will cap wafer capacity addition to keep the supply level restricted. This will boost pricing. SanDisk also expects a ramp in the demand for its latest 19-nm technology.

Apart from this, SanDisk is planning to focus more on 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 second quarter revenues to be within $1.35–$1.40 billion. Management stated that the revenue guidance is conservative, reflecting modest sequential decline in SSD revenues due to seasonality. For fiscal 2013, SanDisk expects revenues in the range of $5.60–$5.75 billion (previously $5.30–$5.60 billion).

For the second quarter, the company expects non-GAAP gross margin of 41.0%–43.0%. Non-GAAP operating expenses will be roughly $260.0 million for the second quarter, which reflects continued investments. The tax rate is projected at approximately 32.0% on a non-GAAP basis.

For fiscal 2013, non-GAAP gross margin is expected to be 42.0%–44.0% (previously 39.0%–43.0%). Gross margin expansion reflects decent pricing environment and a weaker yen during the second half. Non-GAAP operating expenses will be roughly $1.05 billion (reiterated). The tax rate is projected at approximately 32.0% (previously 30.5%) on a non-GAAP basis.

The Zacks Consensus Estimate for second quarter and fiscal 2013 are pegged at 83 cents and $3.52 per share, respectively.

Our Take

SanDisk posted solid first-quarter results with both its top and bottom lines surpassing the Zacks Consensus Estimates. Though the results came below the prior quarter levels, the year-over-year comps were better than expected. Revenues from OEMs and Retail were strong, aided by higher mobile embedded and SSD sales. Fiscal 2013 guidance was encouraging too, citing restricted price declines.

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 #1 (Strong Buy). Apart from SanDisk, we also expect earnings beat from the following stocks.

Lattice Semiconductor Corp. (LSCC - Snapshot Report), Earnings ESP of +100.0% and a Zacks Rank #1 (Strong Buy).

LinkedIn Corp. (LNKD - Analyst Report), Earnings ESP of +300.0% and a Zacks Rank #3 (Hold).

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