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SanDisk Shares Slump Despite Q2 Earnings Beat

Zacks Equity Research

SanDisk Corp. (SNDK) reported second-quarter 2014 adjusted earnings of $1.31 per share, which came ahead of the Zacks Consensus Estimate by a penny. Moreover, earnings per share increased 13.4% from the year-ago quarter. Adjusted earnings per share (on a proportionate tax basis) exclude amortization of acquisition-related intangible assets, convertible debt interest but include stock-based compensation expense.

Nonetheless, shares of SanDisk slumped 9.8% in after-hours trading primarily due to a tepid third quarter revenue guidance.

Revenues

Total revenue increased 10.7% on a year-over-year basis to $1.634 billion, which not only came ahead of management’s guided range of $1.550 billion–$1.625 billion but also beat the Zacks Consensus Estimate of $1.597 billion. The year-over-year revenue growth was primarily attributed to strong demand in both client and enterprise SSDs. Notably, sales from the SSD jumped 97.0% on a year-over-basis and comprised 29.0% of total revenue.

Also, revenues from removable products increased 7.0% on a year-over-basis and comprised 40.0% of total revenue. The increase was primarily driven by growth in microSD cards (part of removable products).

Furthermore, SanDisk revenues from Commercial channels (67.0% of second-quarter revenues) grew 14.0% year over year. However, mobile embedded revenues (part of commercial revenues) were down 29.0% on a year-over-year basis, primarily due to a shift by a customer to client SSD solutions.

Additionally, SanDisk’s revenues from retail channels (33.0% of second-quarter revenues) increased 4.0% year over year attributable to favorable mix of high performance Ultra and Extreme products (SSDs and mobile cards).

During the quarter, SanDisk inked a deal to acquire Fusion-io Inc. (FIO), a provider of flash-based PCIe hardware and software solutions for $1.1 billion in cash. Leveraging Fusion-io’s hardware and software solutions, SanDisk will be able to enhance its existing flash memory storage portfolio.

It is also noteworthy that SanDisk unveiled several new and innovative SSD products to cater to pent-up demand, during the quarter. In a separate development, SanDisk also introduced 15-nanometer 1Z technology, an enhanced version of NAND Extreme embedded flash drive (:EFD).

Operating Results

SanDisk’s adjusted gross profit (including stock-based compensation but excluding other one-time items) for the quarter came in at $779.4 million, up 13.5% form the year-ago quarter. Adjusted gross margin also increased 119 basis points (bps) on a year-over-year basis to 47.7% primarily due to higher revenue base.

SanDisk’s adjusted operating expenses increased 20.9% year over year to $341.5 million. As a percentage of revenues, operating expenses were up 176 basis points (bps) from the year-ago quarter. The increase was primarily due to higher research and development expenses, sales and marketing expenses and general and administrative expenses.

The company reported operating profit (including stock-based compensation but excluding other one-time items) of $437.8 million, up 8.3% from the year-ago quarter. However, operating margin declined 58 bps from the year-ago period, primarily due to higher operating expenses as a percentage of revenues.

Sandisk Corporation - Quarterly EPS (:BNRI) | FindTheBest

Excluding the amortization of acquisition-related intangible assets, convertible debt interest expense and related tax adjustments but including stock-based compensation expense, net income for the second quarter came in at $304.1 million or $1.31 per share compared with $281.7 million or $1.15 per share in the year-ago quarter.

Balance Sheet & Cash Flow

Cash and short-term investments were $2.68 billion versus $2.81 billion in the previous quarter. Long-term marketable securities were $3.57 billion. SanDisk had $1.18 billion of convertible long-term debt in its balance sheet.

SanDisk generated $240.9 million in cash from operating activities compared with $357.6 million in the prior quarter. During the quarter, SanDisk repurchased 2.7 million shares and paid dividends amounting to $51.0 million.

SanDisk also declared a cash dividend of 30 cents per share for the third quarter of fiscal 2014, payable on Aug 25.

Outlook

Management is positive about embedded solutions and enterprise SSD revenue growth, favorable product mix and better supply/demand metrics in 2014. Given, the strong demand from OEM customers and enterprise demand for 19-nanometer technology node, SanDisk expects bit supply to be at a lower end of 25.0% to 35.0%. Also, the company expects to increase its wafer capacity by approximately 5.0%.

SanDisk expects revenues for the third quarter to be between $1.675 billion–$1.725 billion, lower than the Zacks Consensus Estimate of $1.744 billion.

The company expects its third quarter non-GAAP gross margin to be in the range 47.0%–49.0%. SanDisk expects operating expenses in the range of $320.0 million to $330.0 million. The company expects non-GAAP tax rate to be 31.5% in the third quarter.

Our Take

SanDisk posted better-than-expected second-quarter results. Revenues from commercial and retail channels were strong, aided by client and enterprise class SSD sales. Moreover, the strategic acquisition of Fusion-io Inc and SMART Storage Systems is expected to expand SanDisk’s offerings in the Enterprise SSD segment. However, the company provided a tepid third quarter revenue guidance. Also, declining price per gigabyte, primarily due to unfavorable product mix, could impact the company’s results.

Going forward, lackluster PC sales, competition from Micron Technology Inc. (MU) and currency fluctuations remain headwinds. However, we remain positive on management’s commentary of a turnaround in the coming quarters and strong secular demand for its storage products.

It is also worth mentioning that Apple Inc. (AAPL) remains a major customer of SanDisk. Hence, we believe that with price and cost benefits as well as a long-term NAND supply agreements with the likes of Apple will help SanDisk to outperform the NAND market.

Currently, SanDisk has a Zacks Rank #1 (Strong Buy).

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