SanDisk (SNDK) Shares Slump Despite Q3 Earnings Beat

SanDisk Corp. (SNDK) reported third-quarter 2014 adjusted earnings of $1.31 per share, which came ahead of the Zacks Consensus Estimate of $1.20 per share. However, earnings per share decreased 13% from the year-ago quarter. Adjusted earnings per share (on a proportionate tax basis) exclude amortization of acquisition-related intangible assets, inventory related expenses and convertible debt interest but include stock-based compensation expense.

Also, shares of SanDisk slumped 5.1% in after-hours trading primarily due to lower-than-expected third-quarter revenue and a tepid fourth quarter revenue guidance. Also, lower operating profit and higher expenses as a result of increased restructuring and acquisition related expenses for Fusion-io impacted share prices.

Revenues

Total revenue increased 7.5% on a year-over-year basis to $1.746 billion, which came ahead of management’s guided range of $1.675 billion–$1.725 billion. However, reported revenues lagged the Zacks Consensus Estimate of $1.760 billion.

The year-over-year revenue growth was primarily attributed to strong demand in both client and enterprise SSDs. Also, the acquisition of Fusion-io contributed to the year-over-year increase. Notably, sales from SSD jumped 48% on a year-over-basis, primarily due to better-than-expected sales from enterprise SSDs.

Furthermore, revenues from Commercial channels (68% of third-quarter revenues) increased 13% year over year, primarily attributed to better-than-expect demand in both enterprise and client SSDs. However, embedded revenues (part of commercial revenues) were down 16% on a year-over-year basis, primarily due to a shift by a customer to client SSD solutions.

Additionally, SanDisk’s revenues from retail channels (32% of third-quarter revenues) decreased 2% year over year due to lower demand of SD cards. Revenues from removable products were flat on a year-over-year basis.

During the quarter, SanDisk completed the acquisition of Fusion-io, a provider of flash-based PCIe hardware and software solutions for $1.1 billion in cash.

It is also noteworthy that SanDisk unveiled several new and innovative SSD products to cater to pent-up demand during the quarter.

In a separate development, SanDisk along with Toshiba Corporation announced the opening of Phase 2 of Fab 5 and beginning of construction work for Fab 2 at Toshiba's Yokkaichi Operations in Mie Prefecture, Japan.

Operating Results

SanDisk’s adjusted gross profit (including stock-based compensation but excluding other one-time items) for the quarter came in at $850.6 million, up 4.7% form the year-ago quarter. The year-over-year increase was primarily due to favorable product mix. Adjusted gross margin however decreased 128 basis points (bps) on a year-over-year basis to 48.7% primarily due to higher cost of sale. Also, both price per gigabyte and cost per gigabyte decreased 3% sequentially.

SanDisk’s adjusted operating expenses increased 37.5% year over year to $419.7 million. As a percentage of revenues, operating expenses were up 525 basis points (bps) from the year-ago quarter. The increase was primarily due to the Fusion-io acquisition, higher research and development expenses, sales and marketing expenses and general and administrative expenses.

This in turn impacted operating performance. The company reported operating profit (including stock-based compensation but excluding other one-time items) of $430.8 million, down 15% from the year-ago quarter. Moreover, operating margin declined 653 bps from the year-ago period and came in at 24.7%.

Excluding the amortization of acquisition-related intangible assets, inventory related expenses, convertible debt interest expense and related tax adjustments but including stock-based compensation expense, net income for the third quarter came in at $303.6 million or $1.31 per share compared with $352.6 million or $1.51 per share in the year-ago quarter.

Sandisk Corporation - Quarterly Earnings Per Share | FindTheBest

Balance Sheet & Cash Flow

Cash and short-term investments were $2.30 billion versus $2.68 billion in the previous quarter. Long-term marketable securities were $2.84 billion. SanDisk had $1.19 billion of convertible long-term debt in its balance sheet.

SanDisk generated $587.7 million in cash from operating activities compared with $240.9 million in the prior quarter. During the quarter, SanDisk repurchased stocks worth $466.6 million and paid dividends amounting to $67.0 million.

SanDisk also declared a cash dividend of 30 cents per share for the fourth quarter of fiscal 2014, payable on Nov 24.

Outlook

Management remains positive on embedded solutions and enterprise SSD revenue growth, favorable product mix and better supply/demand metrics in 2014 and 2015. Given, the strong demand from OEM customers and enterprise demand for 19-nanometer technology node, SanDisk expects bit supply to be at the lower end of the range of 30% to 40%. The company also expects revenues from enterprise SSD to surpass $1 billion in 2015.

SanDisk expects revenues for the fourth quarter to be between $1.800 billion–$1.850 billion, lower than the Zacks Consensus Estimate of $1.908 billion.

The company expects its fourth quarter non-GAAP gross margin to be in the range 47%–49%. SanDisk expects operating expenses in the range of $380 million to $390 million, reflecting expenses related to the Fusion-io acquisition and restructuring expenses. The company expects non-GAAP tax rate to be 31.2% in the fourth quarter.

Our Take

SanDisk posted mixed third-quarter 2014 results, with the top line missing the Zacks Consensus Estimate, while the bottom line beat the same. Revenues from Commercial channels were strong, aided by client and enterprise class SSD sales. Moreover, the strategic acquisitions of Fusion-io Inc and SMART Storage Systems are expected to expand SanDisk’s offerings in the Enterprise SSD segment. However, the company provided a tepid fourth quarter revenue guidance. Also, declining price per gigabyte, primarily due to unfavorable product mix, could impact the company’s results.

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

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

Currently, SanDisk has a Zacks Rank #3 (Hold).

A better-ranked stock in the technology sector worth considering is Rambus Inc. (RMBS), which sports a Zacks Rank #1 (Strong Buy).

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