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Wednesday, April 22, 2009

Sandisk $SNDK – 1Q:2009 results

Sandisk blew past estimates, reporting revenue 20% higher than street estimates and guiding to a like kind of beat in the following quarter.  Product gross margins of 11.4% were up significantly from the prior quarter’s –62.3% – most had significant losses modeled.  With contract and spot NAND having risen so much intra-quarter, clearly analysts were asleep at the switch on the positive impact of better pricing.  Perception has been that retail markets remain somewhat weak – if so, Sandisk is stuffing the channel as retail and OEM markets were the primary upside to revenue forecasts.

On a concerning note, Sandisk’s royalty income was significantly below the street, clocking in at 71mm vs estimates of ~90mm.  The company attributed this shortfall to a dispute with a licensing customer.  As the Samsung royalty contract is up for renegotiation and resolution has not been achieved as yet, this highlights much of the risk to estimates.  Royalty income is basically 100% profit.  It has a major effect on reported income as there are no costs associated with royalty sales.  Samsung represents a significant portion of the company’s royalty income and could cut the legs out from under the model if they are able to negotiate significantly lower prices.

Sandisk showed 2.4 billion of cash on the balance sheet against 1.2 billion in lease obligations (mostly associated with their portion of the Toshiba JV).  The company made a decision to trade off future capacity to fulfill near-term cash needs.  This may lead them to need to procure more flash from non-captive suppliers.  If I were Samsung, I would be trying to secure a royalty abeyance in favor of a major manufacturing partnership with cost plus accounting or fixed discounts to stated contract prices.  This would give Samsung more manufacturing leverage and significantly reduce Sandisk’s capital spending requirements.   It would also get rid of the overhanging fear of a cash generating secondary from Sandisk – in the prior quarter the company had indicated they could dilute shareholders with an additional 20% equity sale and that cloud hasn’t lifted.

While the quarter and outlook were better than expected, expectations have clearly risen as the stock is up from a low of $5 to its last sale of $15.  Contract prices have been strong and show no near-term sign of abatement.  And yet, I doubt it’s running away here with the royalty issue still squirming beneath the surface.

I have no position in Sandisk.

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