SanDisk Q4 Earnings Call Transcript

123jump.com Staff
01 Feb, 2010
New York City

Revenues rose 44% to $1.24 billion and net income was $340 million or $1.45 per diluted share. Q4 product gross margin of 44% on a GAAP basis and 45% on a non-GAAP basis was higher than we had anticipated due to less price decline and stronger cost reduction which was 20% per gigabyte.

SanDisk Corp. ((SNDK))
Q4 2009 Earnings Call Transcript
January 28, 2010, 5 p.m. ET

Executives

Jay Iyer - Director, Investor Relations
Eli Harari – Chairman and Chief Executive Officer
Sanjay Mehrotra – President and Chief Operating Officer
Judy Bruner – Executive Vice President, Administration and Chief Financial Officer

Analysts

Daniel Amir - Lazard Capital Markets
James Covello - Goldman Sachs
Tristan Gerra - Robert W. Baird & Co.
Craig Ellis - Caris & Co.
Gary Hsueh - Oppenheimer & Co.
Bob Gujavarty - Deutsche Bank
Jelta Fonner (ph) - Thomas Weisel Partners
Uche Orji - UBS
Daniel Berenbaum - Auriga USA
Hendi Susanto - Gabelli & Co.
Paul Coster – J.P. Morgan

Presentation

Operator

Good day and welcome to the SanDisk Corporation fourth quarter 2009 earnings conference. Today''s call is being recorded. At this time, I would like to turn the conference over to Jay Iyer, Director of Investor Relations.

Jay Iyer

Thank you, Mark. And good afternoon, everyone. Joining us today on the call are Dr. Eli Harari, Chairman and CEO of SanDisk; Sanjay Mehrotra, President and COO and Judy Bruner, Executive Vice President of Administration and CFO.

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 measures. That reconciliation is now available along with our supplemental schedules on our Web site at SanDisk.com/IR.

In addition, during our call today, we will make forward-looking statements. Any statement that refers to expectations, projections or other characterizations of future events including financial projections and future market conditions is a forward-looking statement. Actual results differ materially from those expressed in these forward-looking statements.

For more information, please refer to the risk factors discussed in the documents we file from time to time with the SEC including our Annual Report on Form 10-K/A for fiscal 2008 and our subsequent quarterly reports on Form 10-Q. SanDisk assumes no obligation to update these forward-looking statements which speak as of the date hereof. With that, I would like to turn the call over to Eli.

Eli Harari

Thank you, Jay. And good afternoon. Q4 was our best ever quarter for product revenue, margin and cash flow reflecting a dramatic reversal in our results when compared to the fourth quarter a year ago. Pricing held up well throughout the fourth quarter and product margins benefited from a 20% sequential reduction in cost per gigabyte.

A year ago, the fourth quarter of 2009 marked the bottom of the industry down cycle with all past member (ph) and manufacturers operating at negative margin and reporting heavy losses. By the fourth quarter of 2009, all non supplies including ourselves were reporting vastly improved results partly resulting from production cut backs in the first half of 2009.

Despite the recession, global demand for NAND flash continued to grow and by the second half of 2009 flash manufacturers returned to 100% capacity utilization. This turnaround happened considerably more rapidly than expected demonstrating the remarkable ability of this young industry to self correct.

This is an important factor that we have discussed with you in the past. While we benefited significantly as did others from the general improvement in market conditions that is a rising tide lifts all boats I do believe that our decisive actions at SanDisk contributed much more so to our rapid turnaround amidst the ongoing industry recovery. I would like to reflect on the more important of these SanDisk actions.

In the fourth quarter of 2008, we structured the Company to streamline our organization along retail and OEM businesses which allowed us to reduce our non-GAAP operating expenses by 25% in 2009 compared to 2008.

We opened up major new OEM sales channels and we set our number one priority to return to profitability as evident in our Q3 and Q4 results. In Q1 2009, we sold approximately 20% of our captive capacity to Toshiba and we further cut our captive output by throttling that capacity utilization rate at our Yokkaichi fabs by more than 20% in the first half of 2009. At the same time throughout 2009, we sustained our investments in advanced NAND flash and 3D redrive technologies, 3-bits-per-cell and 4-bits-per-cell NAND architecture, advanced proprietary controller chips and new products for both our retail and OEM businesses.

And in Q2 2009 we renewed our patent cross-license agreement with Samsung Electronics. Looking forward now, with no new NAND fab expected to come on stream in 2010 we expect the NAND industry to continue to experience a healthy balance between demand and supply. Flash storage in mobile handsets is expected to continue to be the primary demand growth engine for the industry in 2010. Exciting new devices such as the iPad launched yesterday are demonstrating the significant new opportunity ahead for flash mass storage.

We see a similar trend in digital camcorders which have abundant optical recording media and have largely embraced flash memory. Today Verizon announced its launch of our slotRadio card in 2,000 Verizon stores for use with their high end cell phones.

Forward state drive, SSD are making well-publicized inroads in enterprise storage and we believe it is only a matter of time before the tipping point is reached for the broader adoption of flash SSD in notebooks and netbook PCs. The iPad as well as Kindle are already past their tipping point as these classes of devices are very thin and are required to deliver long operating time on a battery charge therefore, doing away all together with repeating disk drive or DVD players and relying exclusively on NAND flash for mass storage.

Turning to capacity, current industry forecasts for project a 2010 total NAND industry bit growth in the range of 70% to 90%. For San Disk, we currently project our captive bit output to increase in 2010 by up to 70% compared to our output in 2009 approximately in line with our currently projected bit demand growth in 2010. Our bit output increase will come primarily from completion of the technology transition to 32-nanometer by late 2010 as well as modest incremental wafer capacity utilizing the unused clean-room space in the Yokkaichi Fab 4.

We believe this capacity expansion in Fab 4 will be extremely cost effective and we plan to exercise our option to invest and take up to 50% of that capacity. As for the timing and pace for this final increment of Fab 4 capacity we will proceed with caution to align capacity additions with demand from our customers. Currently, we expect this to add approximately 10% to our monthly captive wafer production in the second half of 2010 the rest coming in 2011.

This is all factored into the 2010 bit growth guidance that I have just provided you. This does mean that our usage of flash memory from non-captive sources will likely be minimal in 2010. Flash industry pricing is expected to reflect a healthy balance between demand and supply in 2010. In the next several years, industry-wide NAND cost reductions are expected to decelerate from the pace of the prior five years due to increasingly more challenging scaling of future NAND technology nodes that we have discussed on previous occasions.

We estimate our own cost reduction in 2010 will be in the range of 30% to 40% compared to 52% in 2009 when we captured the cost benefits of 3-bits-per-cell technology. We expect to start transitioning to 24-nanometer node late in 2010 with cost benefits expected in 2011.

Looking to the future in 2010, with a superb captive manufacturing base, great technology and products and a lean and focused team that is driving our global opportunities. Our strategic actions in 2009 and our uniquely balanced participation in both OEM and retail global markets is working very well for us and will guide our business activity in 2010. I will now turn it over to Sanjay.

Sanjay Mehrotra

Thank you, Eli. Good afternoon, everyone. The strong performance in the fourth quarter was driven by healthy demands for our products from both our retail and OEM customers leading to record unit sales.

We experienced strong lift in seasonal consumer demand and we also benefited from our channel diversification efforts and our strategy to achieve a balanced retail and OEM business focus. Our operational execution was solid with our wafer fab production remaining at high efficiency and the supply chain executing well to meet rising demand levels. Following the record fourth quarter in product sales, channel inventory levels remain healthy and we exited in 2009 maintaining our focus on profitable growth augmented by continued tight control on costs and expenses.

We are exceptionally well positioned now in mobile storage Five our top 10 customers in Q4 2009 were Tier 1 handset manufacturers and in addition we are working closely with the leading mobile network operators and mobile retailers. Sales of our mobile cards and embedded flash cards drove nearly half of the fourth quarter''s record total product revenue. Overall in Q4, we sold 82 million mobile products. Our embedded flash product sales grew very strongly and they accounted for more than 20% of our total mobile OEM business.

Design win momentum for the iNAND continues to be strong. Finally, within OEM revenues from the new channels and customers that we discussed with you in the third quarter grew nicely with strong revenue and profit contribution. Checking our retail business the fourth quarter was seasonally strong with retail sales within all of our end markets posting sequential revenue growth. Our retail market share remains strong in the major geographies and our retail business is growing particularly well in the APAC region.

With regard to new products and markets there is a tremendous of innovation and energy and we will share some of this with you at our investor day meeting on February 26th. In 2009, the combination of a strong ramp of three bits per cell technology along seamless process technology migration enabled SanDisk to reduce product costs per gigabyte by more than 50% for the fifth consecutive year.

Furthermore, our supply chain scaled up efficiently throughout the year to meet a 26% increase in unit volume demand compared to the prior year levels. Our Shanghai Assembly and Test facility significantly ramped upward with strong productivity gains. This in combination with capacity ramp at our contract manufacturers allowed us to flexibly meet the seasonally strong demand in a cost effective fashion.

In Q4, we continued to ramp our 32-nanometer process technology and it accounted for slightly more than 10% of our total bit output. We began shipments of micro SD, SD and Memory Stick PRO Duo cards using our 32 nanometer 3bits per cell technology as planned. To sum it up, we are pleased with our Q4 and 2009 results and we look forward to delivering more in 2010. With that, I will turn the call over to Judy.

Judy Bruner

Thank you, Sanjay. Our fourth quarter results reflected strong growth in both OEM and retail channels with retail revenue up 41% and OEM revenue up 40% sequentially. OEM represented 56% of our fourth quarter product revenue the same proportion as in the third quarter and for the year our product revenue was equally balanced at a 50/50 mix of retail and OEM.

Our fourth quarter, retail revenue was down 6% year-over-year with the decline due primarily to increasing amounts of our mobile business going through mobile network operator stores that we now count as OEM.

Our fourth quarter, OEM revenue was up 215% year-over-year, with the mix from the mobile market increasing to more than 80% of our OEM revenue. Our total fourth quarter product revenue grew 54% year-over-year with units up 55%, ASP per gigabyte down 23% and average capacity up 29%. On a sequential basis, our ASP per gigabyte declined 2% and our total average capacity was up 18% driven primarily by the OEM mobile product mix.

License and royalty revenue of $100 million in the fourth quarter included Samsung royalties based half on the old license agreement and half on the new license agreement. Q4 product gross margin of 44% on a GAAP basis and 45% on a non-GAAP basis was higher than we had anticipated due to less price decline and stronger cost reduction which was 20% per gigabyte.

In addition, we received a higher than expected benefit of $95 million for selling products which carried previously taken reserves. The reserve benefit primarily from lower cost-to-market reserves taken on inventory built in 2008 but also reflected the sale of inventory that had been reserved as excess or obsolete.

Without these inventory reserve benefits, our underlying product gross margin was 36%, a level that generates strong profitability on our product business and a very good return invested capital. Q4 non-GAAP operating expenses of $192 million were in the range we expected and reflected a seasonal lift in sales and marketing a 14-week quarter and an increase in the accrual of incentive compensation related to our 2009 performance.

Comparing the full year of 2009 to 2008, we decreased our non-GAAP expenses by 25%. Our fourth quarter non-GAAP operating income was $417 million or 34% of revenue. Without the benefit received from inventory reserves, the underlying operating income was $322 million or 26% of revenue with more than 70% of this operating profit coming from our product business.

Our non-GAAP other income increased sequentially by $5 million due primarily to certain one-time investment gains and to a lesser extent due to higher invested cash balances. On the balance sheet, cash and short and long-term liquid investments increased sequentially by $432 million to $3.0 billion.

Fourth quarter cash flow from operations was the highest ever in a single quarter at $388 million and free-cash-flow was even higher at $431 million, Cash flow from investing included a $57 million receipt of excess cash from the Flash Partners joint venture, zero outgoing capital payments to the joint ventures and a modest outflow for property and equipment.

For the full year, we generated cash flow from operations of $488 million and free cash flow of $438 million. For 2009, net cash used for capital-related investing was only $49 million. Key elements included $378 million outflow for capital investments in the joint ventures and $60 million outflow for property and equipment with these outflows largely offset by the receipt of $277 million from the joint venture restructuring, $110 million of cash returned from Flash Partners and $13 million received from the wind down of Flash Vision.

We ended 2010 with $1.07 billion of equipment lease obligations down from $2.1 billion at the end of 2008. Our inventory ended 2009 at $596 million, almost the same number as at the end of 2008. However, both the gross level of inventory and the offsetting reserves have been significantly reduced and reserves have returned to normal levels. I will now turn to forward-looking commentary.

I''ll provide guidance for Q1 as well as for the full year 2010. Please note that non-GAAP to GAAP reconciliation tables for all applicable guidance are posted on our Web site. We are expecting a normal level of seasonally reduced demand in the first quarter coupled with the impact of Q1 being a regular 13-week quarter compared to our 14-week Q4.

We are forecasting total revenue for Q1 between 875 million and 950 million which includes license and royalty revenue between 80 million and $90 million fully reflecting the new Samsung license agreement. For the full year 2010, we forecast total revenue between 4.0 billion and 4.4 billion including license and royalty revenue between 320 million and 360 million.

Turning to gross margin, we expect that first quarter cost decline may be a bit less than price decline as we expect more modest cost decline in Q1 than we generated in the previous two consecutive quarters of very strong cost reduction.

For the full year 2010, we expect that the annual cost decline which Eli estimated at 30% to 40% will be greater than the annual price decline allowing product gross margin to expand from our 2009 underlying product gross margin which was in the teens on a full year basis.

We are forecasting a non-GAAP product gross margin for Q1 and for the full year of approximately 31% plus or minus 3 percentage points. We forecast non-GAAP operating expenses in Q1 of 175 million to 185 million and for 2010, of 725 million to 750 million. We forecast non-GAAP other income for 2010 to be approximately $40 million spread relatively evenly across the year.

We forecast a non-GAAP tax rate of approximately 37% up from 36% in 2009 based primarily on certain tax law changes for 2010. On a GAAP basis, we are still in a valuation allowance position and as such, the GAAP tax rate is too difficult to predict.

Turning to the balance sheet and cash flow, we expect our total capital investment in 2010 to be between $700 million and $900 million covering fab technology transitions, incremental wafer capacity in Fab 4, as Eli described and back-end supply chain and other CapEx requirements across the business. We expect to fund this primarily from a combination of cash flow from operations and working capital from the joint ventures and we expect continuing positive free cash flow in 2010.

As in the past, we will provide further color on CapEx and our funding plans at our investor day on February 26. In summary, we are expecting solid performance in 2010 and we look forward to sharing more information with you at our upcoming investor day.

We''ll now open the call for your questions.

Question-and-Answer Session

Operator

Thank you. If you would like to ask a question today, you can do so by pressing the star one on your telephone keypad. Once again star one to ask a question today, if you are using a speaker phone. Please sure ensure that your mute function is off so we can receive your signal. We’ll pause, one moment as we assemble our roster. Our first question today will come from Daniel Amir of Lazard Capital Markets.

Daniel Amir - Lazard Capital Markets

Hi. Congratulations on a great quarter. A couple of questions here. First of all on the price decline you assume that price declines will be less than your cost down which is 30% to 40% which means that pricing, you''re assuming pricing will be somewhat similar like 2009 I guess in the 20, in the mid to high 20s may be? Can you a bit explain kind of your assumptions there why you think the market is going to behave similar like 2009 considering that there is some new capacity coming on board in the expansion of Fab 4 and some shrinkage in the market as well?

Sanjay Mehrotra

This is Sanjay. When we look at the best supply growth in 2009 for the industry it was about 40% and as Eli pointed out when we are looking at 2010 the supply growth is expected to be 70% to 90% for the industry and ours sales is on the low end of that up to 70%. When you look at the demand driver for the industry the demand drivers are strong when you see the handsets, the smartphones, they''re continuing to increase their presence, they''re penetration in the market and with the smartphone''s highest capacity units are continuing to sell both on the (inaudible) side as well as on the dark side and new applications that are coming out are continuing to drive new demands for flash storage as well.

On top of all of this demand is being driven globally. I mean from Asia/Pac, we saw very strong growth in demand on a year-over-year basis and we are continuing to see that from China, India and emerging markets. So all of these factors the applications, the demand growth drivers for particularly the mobile, SSD continuing to increase its penetration during the year, the markets, as well as the regions,we believe will continue to drive the demand. And looking at the bit supply growth we think, that the demand will be the demand and supply will be in good balance during the course of the year. And that cost reduction will be in the 30% to 40% and pricing will hold well during the course of the year.

Daniel Amir - Lazard Capital Markets

Now, if you look at Q1 in terms of seasonality you based on your guidance, you are expecting it to be somewhat similar to maybe previous years'' seasonal trends taking last year aside. I mean what is, what are really the drivers that you are seeing here in Q1? I mean what''s the assumptions really based on this guidance considering that we were exiting the holiday season may be with a bit better inventory than we have previously?

Judy Bruner

Daniel, this is Judy. We are expecting a normal Q1 in terms of down seasonality, down demand in the season. But we are not expecting a normal Q1 or historical Q1 in terms of pricing trends. If you look back at all of our previous Q1s, there''s typically been very significant downward pressure on pricing and this time, we believe that we are entering 2010 with a healthy supply demand balance in the industry because there''s really been no capacity added throughout 2009. So we do expect some movement down in pricing in the first quarter and somewhat more than the essentially no price decline we had in the fourth quarter but definitely less price decline than we have seen in historical Q1s.

Daniel Amir - Lazard Capital Markets

Okay. Great. Thanks.

Jay Iyer

Thanks, Daniel. Next question, Mark?

Operator

Our next question will come from Jim Covello with Goldman Sachs.

James Covello - Goldman Sachs

Great. Good evening. Thank you so much for taking my question. Could I ask, relative to the shifting of the business between retail and OEM what kind of impact do you think that really has in terms of the seasonal patterns that we''ve historically seen?

Sanjay Mehrotra

So if you think that Q1 does have seasonality and that''s baked into the guidance that Judy has provided OEM business may be a little less seasonal than the retail but overall the total business will experience seasonality similar to the year start (ph).

Judy Bruner

I would just add to that Jim, I think we answered this question last quarter as well. But even when our products go through OEM channels ultimately almost all of our products are destined for the consumer. They''re still subject to the seasonal buying patterns of the consumer.

James Covello - Goldman Sachs

That''s exactly what I was trying to figure out. So I appreciate that. And then Eli, you had said relative to the SSDs, I think you said it was only a matter of time for SSDs in the notebook space obviously we are seeing good adoption in the enterprise space. How much time how much is only a matter of time what are we really talking about a year, two years? Less than that?

Eli Harari

I think, if you look again at the iPod, iPod is a very thin product it''s designed absolutely to operate through it''s flash memory. If you are talking about storage, no way that it can support a hard disk drive. And, of course it doesn''t have a DVD. And I think that there''s a whole class of devices like this where consumers will appreciate the other attributes of flash memory in terms of very low power, very responsive and it means possibly small to form factor (ph) to pay the premium.

If you look at the iPod price quote going from 32 GB to 64 GB, $100 incremental cost to the consumer which is not that much that still translates to about $3 per gigabyte. And I would kind of venture to bet my annual salary that there will be a big number of customers that want 64 gigabyte at $3 per gigabyte and yet you hear a lot of people say you need $0.50 per gigabyte in order for SSD to take off. I think when SSD becomes commoditized, yes it will need (ph) to be playing at this price range but we have tremendous opportunities over the next several years. But to answer your question I think, this is an ongoing process of enterprise, of course is ready, willing to pay the additional cost per gigabyte of flash. And I think that by the end of this year and certainly into 2011 you''re going to see more and more notebook computers people asking and being willing to pay a lot more than $0.50 per gigabyte.

And of course within two years we ought to be able to reach the buck per gigabyte and I think that that will be another important, I don''t want to say tipping point but another important milestone for SSD adoption. In the meantime, the SSDs are getting much much better for us as well as for competitors and I think that this is a market that is that is here to stay and it is going to grow and become a very important part. By 2012, I have seen some estimates that this will be that SSDs will consume maybe 15% to 20% of the total non-bit output and I think that''s about I am comfortable with that kind of range of number.

James Covello - Goldman Sachs

You said for 2012, that was?

Eli Harari

2012.

James Covello - Goldman Sachs

Yes.

Eli Harari

I said I have seen some industry projections of 15% to 20%.

James Covello - Goldman Sachs

Yes.

Eli Harari

Of the total non-bit consumption in SSDs and I am saying yes, I think that that sounds about right.

James Covello - Goldman Sachs

Okay. Thank you so much.

Jay Iyer

Thanks, Jim. Mark, next question, please?

Operator

And next is Tristan Gerra with Robert Baird.

Tristan Gerra - Robert W. Baird & Company

Hi, good afternoon. Looking at your cost reduction guidance for 2010 how should we weight this by quarter?

Judy Bruner

Sure, Tristan. I would say that it will be weighted somewhat more to the second half of the year than the first half of the year and that is based on taking into account the timing of the technology transition during the year in production and then taking into account the lag in our business model in terms of when that''s recognized in our P&L.

Tristan Gerra - Robert W. Baird & Company

Okay. And in terms of your previously reserved inventories, anything less that we should expect for Q1 given the amount it was higher than expected in Q4 or is that pretty much it at this point?

Judy Bruner

At this point, really, our inventory is carrying a normal level of reserves and when I say normal I can look back to when our product gross margins used to be back in the 30% range and our reserves now are at a very similar level. So, I do not expect going forward to be talking about underlying product gross margin relative to reported product gross margin really, we should be in a normal territory going forward.

Tristan Gerra - Robert W. Baird & Company

Great. Thank you.

Jay Iyer

Thanks, Tristan. Next question, please?

Operator

Our next question will come from Craig Ellis with Caris & Company.

Craig Ellis - Caris & Company

Thanks. Eli, talked about a lot of good demand drivers but you also mentioned 70% bit growth for the Company which seems pretty low given the demand drivers in place. Can you reconcile the two of those for us?

Eli Harari

Yes. We''ve just gone through the most difficult most challenging and most painful downturn and that memory is very, very, much fresh in our minds. So we had rather be err on the conservative side and build up our business on profitability rather than market share. So the OEM business definitely needs captive supply and as our OEM grows we need to take care of that and we are. But we really do want to be very, very cautious in how we add additional supply. I think it is very important for our health and I think we don''t want to contribute anymore than we have to. We want to contribute to the health of the industry, let''s put it like this.

Craig Ellis - Caris & Company

Okay. And then the follow up would be last year you talked a lot about moving to a second sourcing model that was 20% to 30% of output. Has that thinking changes and as we think about the more fully provisioning of Fab 4 how do we think about the timing with which you add tools there?

Eli Harari

Let me first answer the second question. The provisioning of the remaining space in Fab 4, there''s not that much capacity left in Fab 4 and as you can well imagine filling up what remains of a (inaudible) space is very cost effective because your fixed costs are basically in place already. And, therefore running additional wafers yes, you need new equipment and so on. But the cost of wafer actually is very favorable which is very different from the first tranche of expansion of new capacity in a brand new fab whether it is existing empty shell or a new facility you built from the ground up. The first, let''s say, 50,000, 70,000, 80,000 wafers a month carries a full fixed cost even though I''m not using the full capacity available.

So we think this is the very, very important element for us to take advantage of for our 50/50 option with our partner. And, of course, this does come, this does mean that we delayed the move to greater reliance on non-captive. But in general, our desire continues to be to rely on non-captive supply for around 15% to 25% or so of our future capacity and we do have the agreements in place. These captive capacities, non-captive capacity, could not obviously be turned on an instant. You need to invest in those and qualify it and so on. And at the proper time we plan to absolutely exercise those.

Jay Iyer

Craig, did you have a follow-up?

Craig Ellis - Caris & Company

Well, the follow-up would be just with respect to adding tooling how do we think about the pace at which you will do that through the year and into next year?

Eli Harari

We are not talking about a lot of wafers. We are talking about increasing our captive supply by approximately 10% in the second, starting in the second half of this year. So, in terms of volume, it is not that significant. There is to a certain extent some constraints in terms of lead time, equipment lead time, but overall, I think that, it is not a major thing and it is, I think it is definitely included in the industry projections of 70 to 90 nanometer. When we talk about the additional wafer starts in the remaining clean-room space in Fab 4, that is part of our 70% or under for our own capacity increases.

Craig Ellis - Caris & Company

Got it. Thanks, Eli.

Jay Iyer

Thanks, Craig. Mark, next question, please?

Operator

Gary Hsueh with Oppenheimer and Company.

Gary Hsueh - Oppenheimer & Company

Eli, just off the back of that question, I was wondering if you can help me understand how you plan to meet consistently close to 100% bit growth beyond 2010? I think you talked a little bit about your strategy for non-captive captive in 2010 but beyond 2010, I was wondering if you can kind of list off your options in terms of bit growth outside of just pure technology transitions? And what I am trying to get at is in terms of looking at Toshiba and taking a part of Fab 5, what are some of the considerations when you look at Fab 5 in Yokkaichi whether or not you would participate in some volume option out of that fab?

Eli Harari

So, in terms of steps if you will, to increase our output, the first step as I said, is to take advantage of the low cost structure it remains in the clean room space, Fab 4. After that is to tap into our non-captive supply. Beyond that we would have to figure out how to address future requirements. But we do believe that in 2010 is premature to really start planning a new fab or with regard to Fab 5 as far as our requirements we don''t think that 2010, it''s premature as far as we are concerned.

Gary Hsueh - Oppenheimer & Company

Okay. And second question here for Judy, I understand for a full-year basis cost per bit reduction is going to exceed your expectations for a pricing decline. Can you walk me through the profile of each and whether the declines in terms of pricing and the cost of bit production you plan are those totally coincident or are they going to be gaps here and there in any one quarter?

Judy Bruner

I think it is too difficult for us to give a specific quarterly pattern at this point in particular for a price decline. As I said, in terms of the cost decline of 30% to 40% per bit that will be a little more weighted in the second half of the year than in the first half of the year. And overall, we believe that the price decline for the year will be less than that cost decline. But exactly how it plays out on a quarter-by-quarter basis is a little too difficult, or we wouldn''t want to estimate it at this point. But overall, we are talking about a very healthy level of price decline for the industry and for ourselves in 2010.

Gary Hsueh - Oppenheimer & Company

Okay. Last question, I think this must have been asked but let me just try to ask it again. In terms of the seasonal decline did you say that the OEM decline in Q1 was going to be a little bit less than the retail decline in Q1?

Sanjay Mehrotra

Yes. OEM seasonality would be a little bit less than retail and that is because we are continuing to grow our business in the new channels and with new customers.

Gary Hsueh - Oppenheimer & Company

Can you be specific on what aspect of the OEM business you are growing? Is it the microSD card attachment rate on handsets? Is that in particular what you are seeing?

Sanjay Mehrotra

I think we have said in the last call that we are selling to private label customers as well as to customers from component and to the private label customers we are primarily selling our card products and those card products include mobile products as well as some imaging products. But as Judy pointed out, almost 80% of our OEM revenue is mobile. So it is primarily from the card side.

Gary Hsueh - Oppenheimer & Company

Okay.

Sanjay Mehrotra

But of course, we are continuing to sell components and (inaudible) products as well.

Gary Hsueh - Oppenheimer & Company

Okay. Great. Okay. Thank you.

Jay Iyer

Thanks, Gary. Mark next question, please?

Operator

Next is Bob Gujavarty with Deutsche Bank.

Bob Gujavarty - Deutsche Bank

Thanks for taking my question. I had just a question about 3bit per cell at the moment are you able to use 3 bit per cell across all of the different channels and products you serve or is it primarily aimed at certain, certain product segments?

Sanjay Mehrotra

So we are using 3 bit per cell in all (inaudible) format as well USB flash drive format. And the lowest capacity products do not use 3 bit per cell as well as certain high capacity, high performance products and products such as our PSSDs and SSDs do not use 3 bit per cell.

Bob Gujavarty - Deutsche Bank

Great. How about some of the embedded products? Are those primarily 2 bit per cell right now?

Sanjay Mehrotra

So some of their latest orders (ph) are using 3 bit per cell now.

Bob Gujavarty - Deutsche Bank

Great. And if I could just, one final quick one, you mentioned in the last conference call, given your lead in 3 bit per cell you''re able to kind of sell the lower cost product at the equivalent 2 bit per cell ASP and that''s good for SanDisk. Is that trend continuing for you?

Sanjay Mehrotra

Yes. Basically what we have said was that implementation of 3bitpercell technology in our products is officially seamless from the point of view of the consumer. The consumer cannot really tell the different difference from a 3 bit per cell and 2 bit per cell. And therefore in pricing our products we generally don''t have a difference between 2 bit and 3 bit per cell.

Eli Harari

But I would like to add that we do believe that not all X3 is made equal and that our expertise in systems and controlling and providing the complete solution and the fact that we are now in our third generation X3 technology that makes a difference. And that the fact that our X3 products are transparent to the user is because we have learned how to in effect to design those to have basically equivalent performance to X2. That''s not the case of what we see in the market for some of our competitors and this is very similar to the early days of MLC, 2 bits per cell when our competitors were having some difficulty matching our performance with MLC and therefore, during that transition period portrayed MLC at the time in fact the same applies to X3 as somehow not up to par with 2 bits per cell. We don''t agree with that.

Bob Gujavarty - Deutsche Bank

Great. Thanks for the clarification. And great quarter.

Jay Iyer

Thanks Bob. Mark, next question. Please?

Operator

Kevin Cassidy with Thomas Weisel Partners is next.

Jelta Fonner - Thomas Weisel Partners

Hi. This is Jelta Fonner (ph) for Kevin Cassidy. I just have a quick question on the captive non-captive model. For your non-captive maybe going out to 2011 do you have a target margin range for that?

Eli Harari

We''ve always said in the past when we use non-captive the margin clearly is going to not match, I mean be inferior to the margins that we can get with our captive supply where we of course, have to make the CapEx investment. It is reasonable to expect that our supplier that is supplying us even best terms and conditions does need to make their margins and therefore the way we look at non-captive is it is very important that we are able to generate some contribution dollars even though at reduced margins.

Jelta Fonner - Thomas Weisel Partners

Okay. Great. Thank you very much.

Jay Iyer

Thanks, Gelta. Mark, next question. Please?

Operator

Uche Orji with UBS has our next.

Uche Orji - UBS

Thank you very much. Eli, so let me try to understand what you''re saying on 2bit per cell. How much of your production by the end of the year should be 3 bit per cell and how much is it now?

Sanjay Mehrotra

So for 2009 in total our bit production was slightly above 50% in 3 bit per cell. And in Q4 of 2009 it was better than 50% in 3 bit per cell and for 2010 we are looking at same thing better than 50% for 3 bit per cell. And again, keep in mind that we have a certain mix of the product that uses 3 bit per cell very well and certain products such as the ones I mentioned earlier lower capacity cards and some high performance products and SSDs et cetera, do not use 3 bit per cell. So there''s a mix of the products we have, we believe we are at pretty comfortable levels with 3 bit per cell.

Uche Orji - UBS

Okay.

Eli Harari

Let me just amplify a little bit about what Sanjay said particularly with regards to low capacity cards. You are seeing the market for cards kind of bifurcate you have the 1 gigabyte and 2 gigabyte cards very large unit volume business and then the higher capacity cards more for the smart phones and it is the 1 gigabyte and 2 gigabyte cards where the chips really don''t get the benefit of X3 and are therefore staying on X2.

Uche Orji - UBS

I see. In terms of the acceptance of the 3 bit per cell you cannot, the way you''ve described it, it sounds like there has been no problem in terms of the performance of those cards in the marketplace. When should we expect that this could be good enough to use in things like SSD until X3 cards now? Are X3 products in things like SSD are there any issues why they''re not being used in those kinds of products or just controller-related issues?

Eli Harari

The industry is just basically this year moving from SLC, single bits to MLC, 2 bits per cell. Because the birth pains of this product in a very, very challenging kind of application environment that we have talked about in the past. We believe that it will require very substantial understanding very powerful understanding if you will of system level expertise including not just ECC but all kinds of algorithms that we have developed and perfected over the last few years to make SSD, to make it possible to work from, sorry, 3 bits per cell into SSD and that eventually it could become a very important element of that.

Now that may not apply, let''s say for enterprise drives where SSD drives where performance is very, very important, but as far as handling things like endurance and read and write speed, I think that eventually we will be able to achieve market requirements in SSD with a 3 bit per cell but it is still to be proven. Our first focus this year is really on commercializing our third generation G3, 2 bits per cell MLC and this is really our key focus.

Uche Orji - UBS

Okay. Great. And then just one last question. I did ask you this question also last quarter. It seems like the demand drivers for NAND seem to be so strong that the historical (inaudible) relationship between pricing and demand seems to be broken. How much longer , are there markets that you think will, at what point do you think that relationship gets restored? Are we now in a new power dynamic in terms of demand where ASPs are falling at rates that are not entirely what we''ve seen historically and yet demand continues to ramp. So in terms of how you expect the relationship between product demand and elasticity going forward, can you just give color there to help me? Thanks.

Eli Harari

It is a very complex multi-layered question and answer is equally complex. There are of course markets that are more mature and therefore less elastic. There are numerous new applications that are very price elastic. In general and then of course there is the general economy and consumer confidence and so on things that are outside of our control. I would say that we have always believed that pricing should, it is healthy for the industry and for us to continually cost reduce and share the benefit of that with consumers and that expands and creates new markets. We have not changed our thinking. All we are saying and what I''ve said is that the rate of price reductions that we saw in the last three years which was close to 50% annually was disastrous and would not be supportable by cost reductions. And we are seeing now good stability in the market and it is my hope that we are at the beginning of a long period of health in the industry with continuing price reductions and cost reductions but at a level that makes economic sense.

Uche Orji - UBS

Thank you very much.

Jay Iyer

Thank you, Uche. Mark, next question. Please.

Operator

And next we''ll hear from Daniel Berenbaum with Auriga USA.

Daniel Berenbaum - Auriga USA

Thanks. Judy did you say that you may have covered this did you say that you sold some equipment back in the quarter? I was trying to figure out how free cash flow is higher than cash flow from operations?

Judy Bruner

We didn''t sell equipment. But essentially we received a cash distribution, a cash paydown on our notes receivable from Flash Partners. Our joint ventures actually generate cash and if they generate more cash than is required for capital investment in a given period then they will return that cash to the partners. And since there was no new capacity added within our joint ventures in 2009, the joint ventures generated more cash than was needed.

Daniel Berenbaum - Auriga USA

Okay. And so then moving forward on the CapEx investment, you talked about the $700 million to $900 million total investment. How will that be split out do you think between your CapEx and the investment in the JV?

Judy Bruner

The vast majority of it will be investment in the joint ventures. If you look at this year you see that our non-fab or non-joint venture CapEx was about 60 million for this year. I expect it will be a bit higher than that next year. But still the vast majority of the 700 million to 900 million is fab and therefore joint venture related. But we will give some more detail on that at our investor day.

Daniel Berenbaum - Auriga USA

Okay. And then last question just on an OpEx you guided non-GAAP 725 to 750 what do you think stock-based comp will be across the year just so we can take a stab at the GAAP numbers? And then also on the patterns it looks like, it sort of implied that OpEx would basically be flattish across the year. Am I thinking about that the right way?

Judy Bruner

Okay. First on the stock compensation, we actually have some tables that are on the Web that give the reconciliation of the non-GAAP to the GAAP and what it shows there is that the operating expenses that we would add to the 725 to 750 to get GAAP are about 15 million to 20 million a quarter or about 60 million to $80 million for the year. And then in terms of your second question, we are working very hard to keep expenses tight to manage them carefully. We will have a little bit of growth in expenses as indicated in my guidance. And I would expect, as is typical, there''s seasonality in that it tends to be heavier in the second half of the year than the first half of the year. But there''s not, it is not a hockey stick obviously to get to the 725 to 750.

Daniel Berenbaum - Auriga USA

Okay. Great. Thanks very much.

Jay Iyer

Thanks, Dan. Mark, we have time for two more questions.

Operator

Our next question will come from Hendi Susanto with Gabelli.

Hendi Susanto - Gabelli & Company

Thank you for taking my questions. My first question is about the utilization rate. Judy, you mentioned that the growth in 2010 will be weighted more towards second half. Do you still expect your facilities to run at full capacity like in the first quarter and second quarter of 2010?

Judy Bruner

So I think somewhat two different questions there. What I was saying was slanted more to the second half than the first half is our cost reduction on a per gigabyte basis. The timing of the 30% to 40% reduction in our cost per gigabyte. In terms of utilization, I assume you are asking about fab utilization?

Hendi Susanto - Gabelli & Company

Yes.

Judy Bruner

And absolutely. We are running them at 100% and expect to run them at 100% on a, for all of 2010.

Hendi Susanto - Gabelli & Company

Okay. Then second question, in OEM space what is your market share and then is SanDisk gaining market share from others?

Sanjay Mehrotra

In the OEM space, it is real hard to call out the market share because the OEM customer base is very diverse and the information is not easily deported. But we believe that we are gaining market share in the OEM space as well, particularly as we increase our new customers and new channels through that we are increasing our share on the OEM side as well. And in the retail as well we believe we did very well during the year and held a strong share despite tremendous focus on profitability. And in fact I believe in several of the geographies in retail as well we grew our share during the year.

Hendi Susanto - Gabelli & Company

Thank you.

Eli Harari

But in addition to that, in retail a lot of countries we have high market share. And it is not that easy to dramatically increase that. In OEM, in some accounts which are just starting and we have in other accounts a relatively small market share and we think we are significantly more upside in increasing our share there.

Hendi Susanto - Gabelli & Company

Thank you.

Jay Iyer

Thanks, Hendi. Mark, we will take the last question.

Operator

And the final question will come from Paul Coster of J.P. Morgan.

Paul Coster – J.P. Morgan

Thanks. I just want to go back to the whole issue of price elastic demand and surely one of the reasons it is breaking down is that you''ve got this new product category, smart phones, growing so rapidly and the attach rate to them is 100%. My question is, it is just seems to me, Eli that inevitably as we get close to the end of this year, with the sort of 30% growth for the product category the bottleneck is going to be wafer outs not bit shipments, and the industry is going to have to make some pretty serious decisions just to stay CapEx decisions just to stay up with smart phones let alone SSD. Can you comment upon that?

Eli Harari

You may be right, Paul. We are not at that point at this stage. We would be very, very careful.

We would really try to learn from the mistakes that we and others, I mean, I can''t speak for others but that we''ve made in the past with exuberant, irrational investment that falls in the range of 60% of revenues for us in CapEx in 2007 and 2008. We are not going to return to that.

Paul Coster – J.P. Morgan

No. I get that. So may be the, a supplemental question is if the industry has to start making investments again, what''s the lead time between the point of making the decision and when let''s say, a meaningful wafer out capacity increase can be achieved? Is it six months, a year ?

Eli Harari

For new fab it is definitely longer than that. It''s closer to 18 months. If everybody rushes to the equipment on manufacturing, of course there will be a bottleneck there. There are other considerations of course. NAND is slowing down and the future of NAND beyond, let''s say 20-nanometer is not certain and to cloud the post-NAND technology is not yet in place. And new fabs are very expensive and UV is not yet a proven technology.

There''s just a lot of other considerations that will come into play as far as new mega fabs and I think that right now this is actually a time to kind of pause a little bit at least for us and let the market kind of develop a little bit before we make any further decision on that.

Paul Coster – J.P. Morgan

All right. Thank you.

Jay Iyer

Thanks, Paul. That''s all of the time we have for today. A webcast replay of this conference call will be posted on our Web site at sandisk.com/ir shortly. Have a good evening.

Operator

And that does conclude our conference call. Thank you for your participation.