SanDisk (SNDK) Earnings Report: Q Conference Call Transcript

Transcription

1 SanDisk (SNDK) Earnings Report: Q Conference Transcript The following SanDisk conference call took place on October 16, 2014, 05:00 PM ET. This is a transcript of that earnings call: Company Participants Jay Iyer; SanDisk (NASDAQ:SNDK); Senior Director, Investor Relations Sanjay Mehrotra; SanDisk (NASDAQ:SNDK); Co-Founder, CEO, President and Director Judy Bruner; SanDisk (NASDAQ:SNDK); CFO and EVP of Administration Other Participants Mehdi Hosseini; Susquehanna Financial Group; Analyst Doug Freedman; RBC Capital Markets; Analyst Timothy Arcuri; Cowen and Company; Analyst Craig Ellis; B. Riley Caris; Analyst Gabriel Ho; BMO Capital Markets Canada; Analyst Mark Newman; Sanford C. Bernstein; Analyst Mark Delaney; Goldman Sachs Group; Analyst John Pitzer; Credit Suisse; Analyst Christopher Muse; ISI Group; Analyst Joseph Moore; Morgan Stanley; Analyst MANAGEMENT DISCUSSION SECTION Good day, and welcome to the SanDisk Third Quarter 2014 Financial Results Conference. Today's conference is being recorded. At this time, I would like to turn the conference over to Jay Iyer. Please go ahead, sir. Jay Iyer (Senior Director, Investor Relations): Thank you, [Camille], and good afternoon, everyone. With me on the call today are Sanjay Mehrotra, President and CEO of SanDisk ; and Judy Bruner, Executive Vice President of Administration and CFO. In a moment, we will hear remarks from both of them, followed by Q&A. Before we begin, please note that any non-gaap financial measures discussed during this call, as defined by the SEC in Regulation G, will be reconciled to the most directly comparable GAAP financial measure. That reconciliation is now available along with supplemental schedules on our website at sandisk.com/ir. Please note that non-gaap to GAAP reconciliation tables for all applicable guidance will also be posted on our website. This guidance is exclusive of any onetime transactions and does not reflect the effect of any acquisitions, divestitures or similar transactions that may be completed after October 16, In addition, during our call today, we will make forward-looking statements that refer to expectations, projections or other future events. Please refer to today's press release and our SEC filings, including the most recent 10-Q, for more information on the risk factors that could cause actual results to differ materially 2014 TheStreet, Inc. All Rights Reserved Page 1 of 15

2 from those expressed in these forward-looking statements. SanDisk assumes no obligation to update these forward-looking statements which speak as of today. With that, I will turn the call over to Sanjay. Thank you, Jay, and good afternoon, everyone. We are very pleased to report record revenue, strong earnings and cash flow, and to have returned more than $0.5 billion of capital to shareholders during the quarter. With the acquisition of Fusion-io, SanDisk now has the most comprehensive enterprise portfolio in the industry. Our solutions range from the highest-performance, lowest-latency products that enable application acceleration and disrupt traditional IT architectures, to products that have a compelling value proposition to replace hard drives in a variety of applications. This portfolio, coupled with our broad and expanding customer reach and well-established vertical integration capabilities, positions us well to accelerate our momentum in the fast-growing market for enterprise flash. We expect our enterprise SSD revenue to surpass $1 billion in 2015, a year ahead of our previously stated time line. Our enterprise SSD revenue grew strongly on a year-over-year basis during the third quarter, driven by our SAS leadership position and growing presence in enterprise SATA, and it was further bolstered by a partial quarter of revenues from Fusion-io solutions. We have now converted the vast majority of SMART Storage products to captive NAND flash, and this provides us with an important advantage as we pursue several large opportunities with hyperscale customers. We are delighted to report first revenue shipment of ULLtraDIMM, our high-performance, lowlatency SSDs, to leading server in storage OEMs. Design traction for ULLtraDIMM SSDs continues to grow with successful qualifications at Super Micro Computer and Huawei achieved in the third quarter. The Fusion-io business performed in line with our expectations post-acquisition. On the product front, multiple OEMs have now qualified and are offering our next-generation Fusion-io PCIe product. Our plan is to continue supporting the majority of Fusion-io products on non-captive NAND in In addition to the growth of the enterprise SSD portfolio, we are pleased that Dell will begin incorporating SanDisk DAS Cache software into certain Dell PowerEdge servers as part of the base configuration. This flash soft server-side caching software that allows customers to benefit from server-attached SSDs in the cache for an application's most frequently accessed data. Following the completion of the Fusion-io acquisition in late July, we have made excellent progress in integrating Fusion-io into SanDisk. To best realize the capabilities, talent and scale of the two teams, we have decided to accelerate the combination of the legacy SanDisk Enterprise Storage Solutions group and the newly added Fusion-io team by forming one enterprise storage organization under John Scaramuzzo. As planned at the time of the acquisition of Fusion-io, the sales team has been integrated under the leadership of Henri Richard. Lance Smith has decided to leave SanDisk to pursue other opportunities. In client SSDs, we saw healthy year-over-year revenue growth as attach rate of SSDs to PCs continues to increase and our overall market share position remains strong. During the quarter, we had a successful launch of our X3-based SanDisk Ultra II SSD for retail, and the product has garnered several awards from top reviewers. We also began shipment of our 1Y nanometer X2 SSDs and qualification efforts for our 1Y nanometer X3 SSDs are underway with multiple OEM customers. Our combined sales from enterprise and client SSDs drove 27% of our third quarter revenue TheStreet, Inc. All Rights Reserved Page 2 of 15

3 Turning to mobile embedded. The launch of several new smartphones containing our embedded solutions enabled healthy sequential revenue growth, with particular strength from sales growth of custom embedded solutions. We believe that Apple's decision to increase the embedded storage in their mid-tier and top tier iphone, the 64-gigabyte and 128-gigabyte respectively, is indicative of pent-up consumer demand for higher storage capacities. We expect other OEMs to follow suit by increasing the embedded storage capacities in their respective offerings, and this bodes well for the prospects for our inand portfolio as well as the overall demand for file of flash. We are pleased with the broadening customer traction of our embedded X3 solutions. Our X3 flash and systems technology capabilities allow our customers to increase overall mobile device capacities at competitive cost structures while still delivering outstanding application experience. In retail, revenue increased slightly from the previous quarter, but declined modestly on a year-over-year basis, with growth in microsd cards offset by decline in SD cards. Our overall global retail presence remains solid, backed by our valuable brand and consumer recognition of our high-quality products. We are positioned well as we head into the seasonally strong period of the year. Turning to industry demand, we continue to see multiple strong growth drivers for flash, and the demand outlook remains robust. Even as mobile market shares shift among different OEMs, overall smartphone shipments remain on a strong trajectory, and we are very pleased to see the average capacity growth in these devices drive strong demand for flash. In client computing, I'm sure you will agree with me that once we have become used to a SSD-powered laptop, there is no going back. Consequently, the increasing penetration rate of flash in corporate laptops will spill into the consumer space and drive significant growth in flash penetration in the PC platforms in the years ahead. Finally, enterprise and hyperscale customers continue to work with market leaders like SanDisk to find new ways to use flash in an ever-increasing number of applications and workloads, as flash technology is a critical foundation of the modern-day responsive enterprise. To summarize, we believe that near term and secular demand drivers for flash remain strong and we continue to be confident in the future prospects for the industry. Turning to Fab operations and technology. We completed the planned 5% wafer capacity expansion in Fab 5 Phase 1, bringing SanDisk's annualized wafer capacity to approximately 2.8 million wafers. We also recently celebrated the opening of Fab 5 Phase 2, and we have started moving equipment into the new clean room to support our 15-nanometer node ramp. We are on track to begin product shipment of 15- nanometer this quarter with meaningful production in Q1 of We believe our 15-nanometer technology nodes, using both X2 and X3 architectures, will be the lowest cost memory technology in the industry in 2015, with capability to serve all product applications ranging from consumer to enterprise. As we discussed last quarter, our mix of 1Y nanometer production is relatively consistent to the second half of 2014 at 60%, while we maintain a long scale of 19-nanometer production for strategic customers and begin our 15-nanometer production ramp in Q4. Our estimate of industry supply bit growth for 2014 is slightly below 40%, and SanDisk's captive bit supply will be slightly below 25% given the long tail of 19-nanometer production. For 2015, both 19-nanometer and 1Y production will continue even as we ramp 15-nanometer. We continue to prudently manage our capacity expansion to ensure appropriate ROI given the future transition to 3D. With this in mind, we are planning an approximate 5% capacity expansion in This capacity expansion, along with our technology transition, results in expected captive supply bit growth in the range of 30% to 40% TheStreet, Inc. All Rights Reserved Page 3 of 15

4 For the industry, our estimates for 2015 supply bit growth are also the range of 30% to 40%, and we continue to expect a healthy industry supply/demand environment in Our 3D NAND technology development continues to make good progress, and we expect to be in pilot production in the second half of 2015 with target volume production in I would now like to take a moment to recognize and congratulate my dear friend, Dr. Eli Harari, Founder and retired Chairman and CEO of SanDisk, who was recently honored by President Obama with the National Medal of Technology and Innovation. This award is the highest honor the United States can bestow to recognize Eli's leadership in advancing the field of science and technology. Eli's contributions have had immeasurable impact on our lives and society. We're incredibly proud and honored to have been a part of the journey that Eli pioneered over 2.5 decades ago. Congratulations, Eli, on this well-deserved and prestigious award. To conclude, we are pleased with our third quarter results. We are driving hard in innovation and execution in a vibrant industry with strong secular demand drivers. SanDisk has an industry-leading solutions portfolio and road map, and our deep ecosystem and customer engagement are second to none. Our outstanding technology, systems engineering, supply chain capabilities, and our ability to attract key talent are key competitive advantages for us. And we believe we have what it takes to create new, differentiated opportunities for our business and continue to be a leader in our market. We look forward to completing a record 2014 and to executing on our plan for another strong year in With that, I will turn over the call to Judy for the financial review and outlook. Thank you, Sanjay. Q3 was another strong quarter for SanDisk, with revenue growing 7% year-over-year to an all-time record of $1.75 billion. We delivered excellent gross margins, very strong free cash flow and non- GAAP operating margin of 28%, even with restructuring charges and the inclusion of the Fusion-io business. With rapid progress on our integration initiatives, we are well on our way to meeting our goal of Fusion-io being accretive to earnings in the second half of On a year-over-year basis, our commercial channel revenue grew 13%, while retail revenue was down 2%. The primary source of our growth in the commercial channel was SSD, both enterprise and client solutions. Within the retail channel, sales of SD cards decreased due to the declining camera market, partially offset by growth in demand for microsd cards. Sequentially, our commercial revenue grew 8% driven by embedded growth, and our retail revenue grew 5% driven by back-to-school USB sales and mobile cards. Sales in the retail channel comprised 32% of our Q3 revenue mix compared to 35% in the year ago quarter. Our total petabytes sold increased 9% sequentially and 43% year-over-year. Our captive bit sales grew faster than our captive bit supply, resulting in further reduction to our captive inventory level. Our overall inventory increased sequentially because of the non-captive inventory acquired in the Fusion-io transaction. Looking at revenue by product category, our SSD revenue grew 48% year-over-year, with the strongest growth coming from enterprise SSDs. Sequentially, our SSD revenue grew 1%, with growth in enterprise SSD revenue offset by a decline from client SSD. The sequential decline in client SSD revenue reflected demand timing from certain customers as well as our own supply allocation decisions. Our embedded revenue was down 16% year-over-year and up 30% sequentially. The sequential increase in embedded revenue came from both custom embedded and inand solutions. Our removable products revenue, which include sales in both retail and commercial channels, was flat year-over-year and up 1% sequentially. Our Q3 non-gaap gross margin increased sequentially to 49%, benefiting from a stronger mix of product 2014 TheStreet, Inc. All Rights Reserved Page 4 of 15

5 sales and a higher usage of X3 memory, which made up more than 50% of our revenue bit. Our blended price per gigabyte and cost per gigabyte both came down 3% sequentially, inclusive of the impact of product mix and average capacity growth. 1Y nanometer technology comprised approximately 2/3 of our petabytes sold. And the yen rate in our cost of sales was JPY101, consistent with the rate in the second quarter. Our Q3 non-gaap operating expenses increased $63 million sequentially, with $25 million of the increase reflecting restructuring charges and the remainder of the growth driven by 10 weeks of Fusion-io operating expenses. Without the impact of Fusion-io, SanDisk's standalone expenses were approximately flat from the second quarter, less than originally forecasted, primarily due to the timing of certain R&D expenditures. Restructuring expenses were $10 million less than originally forecasted, largely due to lower charges for IT integration and employee severance. Related to the Fusion-io acquisition, our GAAP costs and expenses also include $11 million of stock compensation charges related to acceleration of Fusion-io equity awards held by certain former Fusion-io employees, $17 million related to amortization of acquisition-related intangible assets and $5 million of inventory step-up charges. Our non-gaap Q3 diluted share count declined sequentially by 1.9 million shares, as share repurchases more than offset dilution from the 2017 warrants and employee shares. Our non-gaap tax rate came down slightly, and our non-gaap EPS was $1.45, inclusive of restructuring charges. Q3 cash flow from operations was a robust $588 million, and cash used for capital investments was $116 million, yielding free cash flow of $471 million. During Q3, our capital return was $525 million, including $458 million spent on share buyback and $67 million delivered to shareholders in cash dividends. On a year-to-date basis, total capital return stands at 95% of free cash flow, and we have repurchased 8.75 million shares. Our share of joint venture fab investments during Q3 was $243 million and non-fab capital purchases were $87 million, bringing total year-to-date gross capital purchases to approximately $870 million. Our Q3 fab capital investments were funded by joint venture working capital, $60 million of operating leases and a net $29 million contribution from SanDisk. Our cash flow statement also reflects $1.07 billion spent on the Fusionio acquisition, which is net of $190 million of cash acquired. On the balance sheet, our inventory dollars grew by $30 million sequentially, inclusive of $77 million of noncaptive inventory received in the Fusion-io acquisition. Our captive inventory has fallen two quarters in a row. And while we entered the year expecting to draw down inventory, we now have pockets of supply constraints exacerbated by the lower 2014 supply bit growth, resulting from the long tail of 19-nanometer production for strategic customers. I will now turn to forward-looking commentary. For the fourth quarter, we have strong demand signals from our customers in all key product categories. We expect to further reduce our captive inventory levels in Q4 to fulfill demand. However, we expect to be in supply allocation, and this will constrain our growth in some areas in Q4. We will prioritize our business according to our strategic priorities and customer relationships. Our fourth quarter revenue forecast is $1.8 billion to $1.85 billion. As we look to 2015, we plan to increase our supply bit growth from less than 25% this year to a range of 30% to 40%. Given the lean level of inventory we will have at the end of 2014, our 2015 revenue bit growth will likely need to be at the low end of that range. For Q4, we expect our non-gaap gross margin to be between 47% and 49%. Our yen rate in the fourth quarter is determined primarily by third quarter purchases, which includes some 2014 TheStreet, Inc. All Rights Reserved Page 5 of 15

6 hedges placed approximately one year ago, yielding an expected fourth quarter yen rate in cost of sales similar to the rate in the last two quarters. Our Q4 '14 wafer purchases, which will impact Q1 '15 cost of sales, will be based approximately on 2/3 market rate purchases in Q4 and 1/3 on hedges placed a year ago at approximately JPY99. With current yendenominated content in our cost of sales, a 10% move in the yen rate found in our cost of sales generates approximately a 200-basis point change in our gross margin. To date, we have not placed any hedges for So if market rates stay comparable to today, this will be a benefit to 2015 costs. We expect Q4 non-gaap operating expenses of $380 million to $390 million, reflecting a full quarter of Fusionio-related expenses and inclusive of restructuring expenses of approximately $15 million. Q4 non-gaap other income is forecasted at approximately $3 million, and we expect our non-gaap tax rate to be equal to the Q3 rate of 31.2%. We expect our Q4 non-gaap diluted share count to come down to approximately 228 million, reflecting continued share repurchases. We are refining our estimate of 2014 capital investments from $1.4 billion to $1.3 billion, with Q4 gross investments expected to be approximately $400 million, inclusive of both joint venture and non-fab investments. The fourth quarter cash usage for capital investments is expected to be approximately $150 million, bringing the total full year cash usage for capital investments to approximately $350 million, for the combination of joint venture and non-fab investment. In summary, we expect that 2014 will be another record year in both revenue and earnings. With the broadest portfolio of enterprise and consumer flash solutions in the industry, SanDisk is uniquely positioned to capitalize on the opportunities ahead. We are investing for the future while also generating strong free cash flow and executing a market-leading capital return program. We will now open the call for your questions. QUESTIONS & ANSWERS Jay Iyer (Senior Director, Investor Relations): Thank you, Judy. Thank you, Sanjay. Camille, can I ask you to poll the floor for questions? (Operator Instructions) Camille? (Operator Instructions) We do have our first question from Mehdi Hosseini from SIG. Mehdi Ho sseini (Analyst - Susquehanna Financial Group): Judy, a quick follow-up on your guide. What would be the pro forma gross margin excluding FIO's restructuring? The restructuring expenses are included on a separate line in our P&L in expense -- operating expenses. And so the restructuring expenses are not impacting gross margin. So my guide for the Q4 gross margin is 47% to 49% on a non-gaap basis, and that's not impacted by restructuring. Mehdi Ho sseini (Analyst - Susquehanna Financial Group): Sure. And then, one follow-up for Sanjay. As you started ramping the 15-nanometer, how should we think about the impact on your cost structure since different competitors have a different die size? So can you, either qualitatively or quantitatively, talk about the decline in the die size, how it would impact your cost structure 2014 TheStreet, Inc. All Rights Reserved Page 6 of 15

7 per bit? Because when I look at on the surface, 1Y to 15-nanometer doesn't seem huge. But I'm just wondering if your die is different than competitors, and how it would impact the cost per bit? So we believe we have the smaller die in production. We will have smaller die in production with our 1Z nanometer, which we are starting to ramp this quarter. And our 1Z, we believe, will continue to give us lowestcost die in X2 as well as with X3 memory. And remember, at the product level, the total cost is the cost of the flash memory as well as cost of all the non-flash memory components that go into our overall product cost structure. And with respect to 1Z at the memory level itself, in terms of cost reduction capability, 1Z technology, transition from 1Z to 1Y will give us more cost reduction than the transition from 19-nanometer to 1Y. But our cost leadership in the industry will continue with our 1Z, again, the smallest die and the lowest-cost die in production at the memory level of the industry. Mehdi Ho sseini (Analyst - Susquehanna Financial Group): So the takeaway here is the 1Y to 1Z. The more cost reduction than 19 to 1Y, correct? That's correct at the memory level. Our next question is from Doug Freedman with RBC Capital Markets. Do ug Freedman (Analyst - RBC Capital Markets): So Judy, one of the things I'm struggling with. It looks like your reported inventory actually went up, but it sounds like it's a mix-related issue. And you're telling us, if I heard correctly, that we should expect some pockets of demand that go unserviced in the fourth quarter. What do you think will happen to that demand? Will you be able to service that in Q1 of '15? So just to clarify first on the inventory. The inventory dollars in total did go up, but that was driven by the noncaptive inventory that we acquired as part of the Fusion-io acquisition. Our captive inventory, which we need for servicing the vast majority of our demand, actually went down for a second quarter in a row. And the noncaptive inventory is earmarked for the Fusion-io-related products and business. We will work hard in the fourth quarter to meet the needs of our customers and service the demand out there. But we do, as I said, expect to have pockets of supply constraint. And we will be implementing another capacity expansion, as Sanjay described, in 2015, in order to build some capacity. And in terms of overall demand, we believe our strategic customers, we will work very closely with them, and that demand will not go away for SanDisk. Do ug Freedman (Analyst - RBC Capital Markets): Great. And if I could, for my follow-up, you talked in the past about introducing more 3 bit per cell SSD products. Can you give us an update on how that is going? And if you wouldn't mind maybe in answering that, giving us an idea of how much bit growth moving from MLC output to TLC will contribute? 2014 TheStreet, Inc. All Rights Reserved Page 7 of 15

8 So in terms of client SSD with X3, we are making very good progress there. And these products with X3 are in qualification stages with customers. We look at it more as a 2015 X3 revenue opportunity in client SSD for us that will continue to ramp up primarily from Q1 onwards timeframe. In terms of X3 mix in our total product sales, X3 mix will increase next year compared to this year. But it's all baked in our bit growth guidance that we have provided today. Next, we have a question from Timothy Arcuri with Cowen and Company. Timothy Arcuri (Analyst - Cowen and Company): First of all, Judy, can you break out the FIO portion of revenue and cost to sort of help us see where results would have been [ex]-fusion-io? We're not going to break out the specific Fusion-io-related revenue and costs. But I will tell you that the Fusion-io revenue was down sequentially from the prior run rate of the Fusion business, and that was our expectation. So the revenue level met our expectation. We expected that it would be down sequentially, of course, due to the fact that it only included 10 weeks versus 13 weeks, but also due to the integration of the business and the sales force. They had a fairly large sales force, and we needed to integrate that into SanDisk, determine account ownership, territory leadership, commission plans, et cetera. So overall, we're very pleased with how that integration is going, and we believe that the Fusion-io revenue will grow from this point forward. Also, I will tell you that the Fusion-io gross margins, even using non-captive memory, is accretive to the SanDisk gross margin, meaning the Fusion-io product gross margin is higher than the corporate average of the SanDisk gross margin. Timothy Arcuri (Analyst - Cowen and Company): Great. And then, Sanjay, I wanted to get your perspective on this news that XMC is partnering with Spansion to develop 3D NAND, and they're claiming that they're going to be producing it in I just wanted to get your view on that, whether that's plausible and whether that's something that you're thinking about. My view is that NAND is a highly complex device technology. The device structure, the manufacturing process technology -- we ve really -- are absolutely leading-edge in the entire semiconductor industry. And to build experience in this and to be successful in this really requires many generations of technology transition capability under your belt, just like the flash suppliers in the industry today have. So I believe that it is very hard for a new entrant to catch up at the leading-edge technology node with building a flash memory that has the reliability, that has the overall cost structure and overall specifications that are required to meet the broad range of market applications. And not only technology complexity. Of course, in order to be a successful player in this, you require scale of operation as well. So I look at this as really, at this point, given the barriers to entry with respect to technology learning curve, manufacturing learning curve as well as the scale of production and all the IT considerations that go into building a leading-edge flash memory technology road map, I see this, really, as a very uphill task. And I don't see this as something for a new entrant to become successful or for us to worry about, frankly. And of course, systems expertise is also required. Today, flash is not just about making a NAND flash 2014 TheStreet, Inc. All Rights Reserved Page 8 of 15

9 memory chip. It is about controller, firmware, all the product solutions are really all about system-level expertise as well. We have a question from Craig Ellis with B. Riley and Company. Craig Ellis (Analyst - B. Riley Caris): I wanted to go back to the comments that the company would see 30% to 40% bit supply growth next year. Can you help us understand, Sanjay or Judy, what the parameters are that would differentiate the company coming in closer to the low end of that range versus the company coming in closer to the high end of that range? Sure. So first of all, the 30% to 40% bit supply growth bakes into it, the approximately 5% capacity expansion that Sanjay described, also bakes in the technology transition with 1Z ramping across the year, and bakes in a higher X3 mix in our revenue next year than in our revenue this year. So those three areas as well would be the key areas where we could be higher or lower across the year. It will depend on the time -- on the yield ramp of our 1Z technology and also on the demand that we see for our X3-based products, and of course, on the fab productivity. We are always looking for ways to get more wafer output through fab productivity investments such as installing bottleneck tools, and those will also be areas of focus in Craig Ellis (Analyst - B. Riley Caris): That's helpful, Judy. And then, as a follow-up, I think in the past when the company has gone through a manufacturing transition, there's generally, once it starts rolling, about a 10% to 15% per quarter mix towards that new node. Is that the right framework to look at for the 15-nanometer ramp? And if so, when would the company expect to see the current tightness that you're seeing in the business alleviate somewhat so you are able to capture all of them -- the demand that you see out there? The 1Z technology nodes will be primarily becoming meaningful starting from Q1 of next year and will continue to ramp up into production throughout the course of 2015 timeframe. And as Judy pointed out, it is also about qualifying various products with our customers using that 1Z technology node. I would expect the ramp of production of 1Z technology nodes at the end of next year to achieve a similar percentage in terms of bit output mix as 1Y has now. That means 1Z technology mix at the end of next year to be around 60%. And as we said, it is starting -- production ramp is starting this quarter, becoming meaningful from Q1 and continuing to ramp during the course of the year. And again, that is all baked into our revenue bit as well as the supply bit guidance. Craig Ellis (Analyst - B. Riley Caris): And when would current tightness be alleviated with that ramp, Sanjay? We look at -- we see strong demand in all product categories for our business in 2015 timeframe, and SanDisk's focus will continue to be to have the best mix in terms of high-value solutions in our revenue. And I believe we are really executing very well in that strategy. I mean, when you look at 2014 timeframe, we have outgrown the industry in terms of revenue. That means our revenue growth is higher. It's on track, I believe, to be higher in 2014 than the industry revenue growth TheStreet, Inc. All Rights Reserved Page 9 of 15

10 In 2015, I see that our revenue dollar share will continue to outperform our revenue bit share. And with all the strong demand drivers that we see in 2015, it is likely that certain pockets of weakness with supply constraint may exist during the course of the year. But this is something we have become very good at managing in terms of the overall mix of the business to achieve the best combination of revenue, profit and cash flow as well as really address the key considerations for our strategic customers and continue to drive long-term growth of the company. Our next question is from Ambrish Srivastava from BMO. Gabriel Ho (Analyst - BMO Capital Markets Canada): This is Gabriel Ho calling in for Ambrish. I think a quick follow-up on Fusion-io, on what percentage of the bits sold or the 9% was due to Fusion-io? The Fusion-io bit used are actually a pretty small number of bits. These are all non-captive. And I would tell you that non-captive memory usage for us is a low-single-digit percentage of our overall bits. Gabriel Ho (Analyst - BMO Capital Markets Canada): Okay. Thank you. And the second one is, your largest customer was 70% of total in the first half. And what is it in Q3? And what's your expectation in Q4? For Q3, we have a customer that is 20% of our revenue. But we don't have -- we're not providing a guidance for Q4. From Mark Newman, Bernstein. Mark Newman (Analyst - Sanford C. Bernstein): I wanted to ask questions specifically on longer-term supply and demand. I'm very encouraged to hear the comments of the supply constraint you're seeing in the market, especially in light of the increasing content per box from iphone recently. I guess my question though is, there's a lot of concerns out there right now that demand in the market, overall, not just specifically to NAND flash, may slow down. There's just this general concern out there. And so just in light of -- if there is any kind of shock or surprise, global recession, or any kind of event that would reduce your demand growth expectations. I wonder if you could share with us how you would think about that. How you would alleviate that concern, thinking about your current plans of 5% capacity growth next year, looking at your inventory levels you have, which you said excluding the Fusion-io impact are actually getting leaner. If you could explain to us, like, what kind of flexibility you have to offset any kind of short-term demand or slowing down, and how you would -- and what the impact would be to SanDisk. Sure, Mark, I'll take that. I think that, as one thinks about potential macroeconomic risks out there, that is one good reason to manage capacity prudently, which we are absolutely doing. And of course, another good reason is to be focused, as we always are, on the ROI of capacity expansion and thinking ahead to the 2014 TheStreet, Inc. All Rights Reserved Page 10 of 15

11 transition ahead to 3D memory from 2D memory. But we are conscious of thinking about macroeconomic risks. We believe that the capacity expansion we have is very prudent. And we believe, most likely, we will have pockets of supply constraint in various times in We grew nicely in the fourth quarter. We do believe there were probably some macroeconomic factors impacting us -- sorry, I meant third quarter -- in the third quarter, such as within our retail business. We did see less revenue than we had expected in certain emerging markets in the third quarter such as Latin America, Russia and Middle East and Africa. So we are conscious of that, we're monitoring it very closely, but I feel very comfortable with our capacity plans for We absolutely need that 5% capacity that we are planning to add. And Mark, I'll just add that in addition to our disciplined capacity strategy, taking into consideration the kind of things that you referred to, what is important is that SanDisk, really, in our markets, is uniquely positioned. There's a broad engagement with customers, diversified set of customers in all markets, all channels, all end market applications. And we, as Judy has said, I mean, we have the broadest portfolio of solutions as well. So this really positions us very well in terms of managing the mix of the business regardless of the considerations that may occur in one market segment versus another segment or one region versus another region, our unique position with our broad portfolio and diverse set of customers and deep ecosystem engagement, and really tremendous sales and customer support reach, I believe, is huge advantage in us continuing to drive the business, taking into considerations all the possible factors, whether macroeconomic or geopolitical in nature. Mark Newman (Analyst - Sanford C. Bernstein): Would you specifically consider if demand was substantially lower than expected to delay capacity expansion? Or possibly reduce -- I guess another thing you can do is reduce your non-captive bit mix. Our non-captive bit mix is primarily for Fusion-io in 2015 timeframe, and I feel very good about our capacity plans. It's a very modest addition of our capacity in 2015 with supply bit growth in the 30% to 40%. And as Judy mentioned, we need to build up some of our inventory position to service our customers well, and that puts our revenue bit growth towards the lower end of that 30% to 40% range. So I feel very good about the demand trends that you see in our markets. I mean, when you look at smartphones, the average capacities that continue to increase in smartphones, certainly, you look at notebook computers, the flash attach rates to notebooks absolutely continuing to increase. And on the enterprise side, it is just early innings. And this market will continue to evolve very nicely. So I feel pretty confident about our capacity strategy here. Mark, I'll just add that we really expect to have a quite tight supply/demand balance within our business across And we are focused on keeping it that way, in part, in order to continue to consistently produce the world-class operating margins that we produce consistently within our target financial model of 25% to 30%. Our next question comes from Mark Delaney with Goldman Sachs TheStreet, Inc. All Rights Reserved Page 11 of 15

12 Mark Delaney (Analyst - Goldman Sachs Group): Can you help me understand what your expectations for ASPs are in the fourth quarter? And then, if you're able to improve your ASP through either mix or like-for-like price increases given the supply/demand situation is that you've articulated? For the fourth quarter, we expect a very healthy supply/demand environment in the industry. So we would expect price movement to be modest in the fourth quarter. Mark Delaney (Analyst - Goldman Sachs Group): Okay. I appreciate that. And then, there's been a fair amount of M&A in the SSD market, both at industry - - both at SanDisk, but also the industry more broadly. And I'm hoping you can help me understand if the competitive landscape has changed at all, either in terms of the competitors that you're seeing, the quality of the products that SanDisk is matching up against, or how challenging the pricing is in the SSD market specifically. In the SSD market, there is the client market as well as enterprise. And SanDisk, with our vertical integration capabilities and particularly in enterprise side with the recent acquisition of Fusion-io and in the past starting with client and then SMART Storage and adding capabilities in software area, I believe we have the best capabilities that are out there in terms of driving the enterprise SSD growth. And on the client side as well, we have really, as you have seen, we have grown revenue, I think, brilliantly well over the course of last couple of years in client SSD. So SanDisk, really, on client SSD as well as on the enterprise SSD side, has what it takes to continue to build its market leadership position. I don't think there's a competitor out there that can match up to the breadth of the SSD product line that we have, particularly in enterprise with our SAS products, our SATA products, PCIe, DDR software on top of that. We really do have the most complete portfolio. Our next question, from John Pitzer from Credit Suisse. John Pitz er (Analyst - Credit Suisse): Sanjay, I guess my first question is I'd like to better understand how you view your relationship with strategic customers. Because clearly, I think one of the investor frustrations out there is, given how tight supply is now, you're just not really moving the dial on ASP or margin. And then, I'm just kind of curious. How do you define strategic customer? What kind of return do you need to see on that customer to make it worth your while, to kind of give up some near-term gains of moving mix or margin? And even with strategic customers, given how tight the environment is, why not raise pricing even with the strategic customers? If the relationship is that important, it should be a two-way street, not just a one-way street. I think our relationship with the broad spectrum of strategic customers is excellent and only continues to get deeper and broader as we go -- as we expand our solutions offerings from embedded solutions to SSD solutions to enterprise solutions. So I feel very good about our SanDisk strategic relationships. And when you look at our results, I believe SanDisk is able to certainly deliver value to our customers and also get our 2014 TheStreet, Inc. All Rights Reserved Page 12 of 15

13 customers to give value to SanDisk. Because when you look at our operating margins, in our industry, I believe they are the best. In our -- when you look at, by any measure, in the semiconductor industry, our operating margins are among the very best. And in terms of our price decline, if you look at it on a year-over-year basis, I believe we are on track to have our price decline to be less than the industry price decline in 2014 timeframe. All of this is because of SanDisk's capability to really have a strong portfolio of solutions, a strong value proposition for our customers, and to continue to drive a strong mix of our business as well. And of course, we focus on strategic areas. And in terms of strategic areas, things that are important for us are areas where we can drive innovation, where our customers are driving innovation, where SanDisk is able to bring value to the customers as well as get value from the customers. That's very important. And I think we have made tremendous progress in this regard over the course of last several quarters. John Pitz er (Analyst - Credit Suisse): That's helpful, Sanjay. And then as a follow-up to Judy, just quickly two quick things. First, am I doing the math right, if I exclude files from December guide, is the core business about flat year-over-year? And on the margin guidance being the same this quarter as you gave for the September quarter, I would have thought that maybe with more Fusion-io, probably a richer mix of branded retail around the holidays and maybe some more X3 that there might have been some more gross margin upside. Just kind of curious what else is going on within the mix of business, September to December, that would be kind of depressing margins a bit? First, the legacy, so-called legacy SanDisk business, is growing quarter-over-quarter and year-over-year even if you exclude the Fusion-io business. And in terms of the gross margins for the fourth quarter, the range of 47% to 49%, that is a similar range to what we have experienced over the last two quarters. And I will point out that in the fourth quarter, we expect to see a higher proportion, of course, of retail promotional activity. That's always the case in terms of holiday promotions for the retail business, so that has some impact on margin. And we do expect to see growth in our overall embedded solutions revenue. And embedded is one area that has gross margins that are somewhat less than the corporate average. But overall, 47% to 49% gross margin and an operating margin within our target financial model is really worldclass performance. And we feel very good about being able to grow the revenue and produce that level of competitive operating margin and do it consistently. C.J. Muse with ISI Group. Christopher Muse (Analyst - ISI Group): Yes. Thank you for taking my question. I guess, Sanjay, a bigger-picture question for you. If you think about [3D NAND] bits and [reluctancy] to add planar in the industry, given the obsolescence factor and the eventual move to 3D, coupled with 3D likely taking longer given the yield challenges there, I guess I'm curious, do you think we'll see a change here where pricing trends, similar to John's earlier question, can start to move up. Do you start to look to sign longer contracts, a la, in the DRAM side seeing three-plus-month type contracts? I think the question or where I'd love to hear your thoughts is the fact that it's getting harder and harder to add bits. It's more and more capital-intensive. Why would you not ask to get paid more for them? So I think we have been discussing this for a couple of years that the technology complexity in the NAND 2014 TheStreet, Inc. All Rights Reserved Page 13 of 15

14 industry is increasing tremendously. It's taking longer to develop new technology nodes. The gain coming from each sector, say, 2D NAND generation is smaller compared to what it was in the past. And of course, as we all know, 2D NAND is approaching the end of its life and 3D NAND in the future years will start ramping into production. So we have always said that these technology complexities do definitely bring a stabilizing effect to the industry in terms of the supply bit growth and, certainly, in terms of the pricing environment as well because the demand trend for flash are secular in nature in multiple mega markets for flash. So certainly, it has already been playing out that the increasing technology complexity, the greater capital investment that is required, the upcoming transition from 2D to 3D and therefore considerations of ROI on any new capacity, all of this is playing a role in reduced levels of supply bit growth compared to the years past, while the demand trends really continue to be solid, if anything, continue to pick up momentum in the marketplace. So these trends are translating into an industry environment that is significantly more healthy, more robust than any time in the past. And SanDisk certainly is very much focused on making sure that we are really driving our supply toward the best mix of solutions. And as part of that, we absolutely manage our pricing consideration with our customers very closely. As I said, we want to make sure that for our variable bits that we produce and for the tremendous technology investment that we have, that we are getting the recognition of that from our customers in terms of pricing as well. I believe we are doing a good job, and we stay focused on continuing to improve the mix and allocate our supply, with considerations of pricing and margin from our variety of customers and end markets, keeping that in mind. Our final question comes from Joe Moore with Morgan Stanley. Joseph Moore (Analyst - Morgan Stanley): For the last couple of quarters, you've had this inventory drawdown and yet revenues have been kind of in the middle of expectations. Has this been kind of your plan going into the quarter to draw down the inventory? Or did something happen over the course of the quarter that had that ended up coming down? And if you didn't expect to draw down, then why didn't it drive some revenue upside? We have been planning to draw down inventory this year. In fact, I believe at the beginning of the year, I indicated that our revenue bit growth in 2014 could be greater than our supply bit growth because we did expect to draw down inventory. And we have drawn it down. And credit goes also to the efficiency of our supply chain organization which has made a number of improvements that have allowed us to draw down the inventory [weeks] of supply even as the mix of our business has moved more towards SSDs which tend to have longer cycle times and hub requirements and so on. So yes, we've always planned, over the course of this year, to draw down inventory and at -- but at this point, we're operating at very lean levels of inventory, and that's what's creating pockets of supply constraint. Joseph Moore (Analyst - Morgan Stanley): Okay, great. And then if I go back a few years ago, you guys used to buy a decent amount of non-captive products because you have a lot of value-added segments and you were able to get pretty good margin on that. As you see these constraints, have you entertained the idea of doing that again more broadly? 2014 TheStreet, Inc. All Rights Reserved Page 14 of 15

15 Well, we are, as we mentioned earlier, planning for 2015 to largely use non-captive for the Fusion-io-based business. So clearly, we're trying to use non-captive there. Relative to the other commercial parts of our business, it's difficult to use non-captive once you have worked with your customers to qualify the products on your own captive solution. You can't just suddenly switch over to a different product with them once you've gone through qualification. So it's very difficult in our commercial business. In our retail business, there, our business is particularly well-suited for the leading-edge X3 memory that we're producing in our own fabs. So it is difficult to use non-captive outside of areas where we, for example, have done an acquisition and it's already on non-captive and then we can keep it there. Jay Iyer (Senior Director, Investor Relations): Thank you, Joe. Thank you, Sanjay. Thank you, Judy, and thank you, everyone, for joining our call today. A webcast replay should be available on our IR website shortly. Thank you, and have a good evening. Once again, that does conclude today's call. We appreciate your participation. All rights reserved (c) 2014 TheStreet, Inc. Please feel free to quote up to 200 words per transcript. Any quote should be accompanied by "Provided by TheStreet" and a link to the complete transcript and Any other use or method of distribution is strictly prohibited. THE INFORMATION CONTAINED IN EACH WRITTEN OR AUDIO TRANSCRIPT (the "TRANSCRIPT") IS A REPRODUCTION OF A PARTICULAR COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION. THE TRANSCRIPTS ARE PROVIDED "AS IS" AND "AS AVAILABLE" AND THESTREET IS NOT RESPONSIBLE IN ANY WAY NOR DOES IT MAKE ANY REPRESENTATION OR WARRANTY REGARDING THE ACCURACY OR COMPLETENESS OF THE TRANSCRIPTS AS PRODUCED, NOR THE SUBSTANCE OF A PARTICULAR COMPANY'S INFORMATION. THE TRANSCRIPTS ARE PROVIDED FOR INFORMATIONAL PURPOSES ONLY. THESTREET IS NOT PROVIDING ANY INVESTMENT ADVICE OR ENDORSING ANY PARTICULAR COMPANY TheStreet, Inc. All Rights Reserved Page 15 of 15