Sandisk Corporation (SNDK) Earnings Call Transcript & Summary

[indiscernible] Citi's Tech Conference. Welcome, everyone. Asiya Merchant. I'm here. I lead Citi's tech hardware and supply chain on the research side. Really excited to have Luis Visoso here, CFO of Sandisk. I'm sure this is one of the -- one of the more exciting sessions here at Citi's Tech Conference. So I'm going to start off here with a few questions. Any safe harbor or something?

Really quickly.

All right.

We'll be making forward-looking statements in today's discussion based on management's current assumptions and expectations, including with respect to our technology and product portfolio, our business plans and performance, market trends and opportunities and our future financial results. These forward-looking statements are subject to risks and uncertainties. We assume no obligations to update these statements. Please refer to our annual report on Form 10-K and other filings with the SEC for more information on the risks and uncertainties that could cause actual results to materially differ from expectations. We will also be making reference to non-GAAP financials and a reconciliation of GAAP to non-GAAP financials can be found on our website.

Great. Thank you. All right. I'm going to kick it off here with a few questions. I'm going to leave some opportunity for investors to ask a few. Please do raise your hand so we can bring the mic to you. All right. Thank you again for being here.

Thank you. [indiscernible] to be here.

Of course, you guys -- I'm going to have to credit David and yourself, Luis here for these NBMs that've taken investors' interest by quite unexpectedly. I know you guys have been talking about it, but when actually people did see it in your results, and it's been 2 quarters, plus you had an Investor Day as well, where you talked about it. So I'm going to start it off with that because that seems to be on top of everybody's mind. Just to recap, you expect NBMs from a bit perspective to be 50% of your bits this year, and you're talking about 2/3 into fiscal '28. Just where do we end up with the steady state? Are you thinking about this being like a 70%, 80% through your -- I think at the Investor Day, you talked about it through fiscal '30, sort of your long-term target overall when you read that out. But in terms of NBM bits, like what do you think could be the steady state going on after fiscal '28?

Yes. I love the question and just what we're trying to do here. And you really take a step back because when we started, we were ne transacting every quarter, right? And it was tough because you started the quarter and you did not know what our customers wanted. You got an idea of what they wanted, but not necessarily agreement on price. And it was very tricky to manage and to guide a forecast. I remember one of our first Board member meetings, one of our Board members asked, what's your backlog? I'm like, what do you mean backlog? That doesn't exist in this industry. So it was not kind of profitability was really challenging. So starting this journey, on building the new business models, I think, was the right thing to do. And we started talking about that maybe 3 quarters ago, and it was an idea and we were working on it. We had several customers engaged. And we signed our first NBM, I think, was in January. We were taking small steps and really warming up and learning on how to do this. And it was a shorter one, and it was with a strategic customer, obviously. But we then fast forward to where we are today. And I think the relationship with these customers has dramatically changed. I think as you and I have talked, we've been very selective. We didn't want 20 or whatever. We wanted to focus on those few customers that we thought are going to win in the market that are very, very strategic for us. And those customers that are going to continue to take more bids as we go along the journey. So I don't know what the magic number is of where we want to be, right? We keep on learning. We have these conversations with customers and they tell us their needs. We work on financials. Again, we're working on an attractive business that's durable. That is the single most important thing to do, and we do both. Doing one or the other doesn't make sense. We want an attractive business that's durable. And therefore, as we negotiate with customers, we are constantly redefining where do we want that 50 2/3 to evolve into the future.

And then just within that framework right now, you have 50%, you're the 2/3 fiscal '27, fiscal '28. What about the one that's left over? Should investors think about that as any kind of upside above sort of whatever the pricing is within these NBMs? Is that sort of upside relative and it could be a function of the spot price or the contract -- broader contract price that's going on the market?

Yes. I think there are some customers which some of them just are never going to embrace the new business model, and we will sell bids that we have for them in the market at market prices. There is also a small percentage of our business that goes to very strategic customers that are just relatively small. And they just -- the new business model may never be a good solution for them. So we think there will be a proportion of our business that will stay in the non-NBM business, and that will be based on spot prices.

Okay. And then just a little bit on margins. So obviously, investors are captivated by your current margins. And you've said that even at these floor levels, which are within these NBMs, there's a floor and a ceiling. But even at floor levels, you're hovering around 80% gross margins, which is very, very attractive. When you talk about economic sharing mechanism at these, like just help investors understand what happens on the upside, right, because there's a ceiling, but then there is what happens on the downside. And then how do we think about the transactional part of that, which are non-NBMs?

Yes. So when we started to work with our customers and started to lengthen the time of these new business models, we thought, well, a fixed price is going to be tricky. -- because one of us is not going to be happy. If prices go up, we wouldn't be happy because we wouldn't capture it. If prices go lower, our customers would be uncompetitive versus what others would be paying in their markets. So we said, well, there would be a mechanism, this floor and ceiling around that fixed pricing. So think about it kind of parallel to the fixed pricing and kind of some upside protection and some downside protection. And the good thing is, as you've mentioned, we feel good about margins even at the low case scenario. The non-MBM business will continue to price at spot prices. Well, whatever we think -- the value we offer to our customers and what we can negotiate with them -- and even if you are an NBM customer and you want upside, obviously, we're going to see what is the right price for that business.

Okay. Which reminds -- brings us back to the fact that you've had a couple of customers come back to you after those initial NBMs. I think you've talked about that in your last call. So when we think about these customers who are coming back, are these more hyperscalers? Are these non-hyperscalers but still in the data centers? Are they edge customers? And then how should we think about these NBMs when you renegotiate them? Are they just incrementally higher price now? Is it the entire agreement that got redone? Is it part of that agreement that was just the upside? Just maybe help investors under.

Yes. So there are 2 contracts that we changed, but there are many NBM customers that have come back to us. And some of them have just bought business outside of the NBM, which is great. Now we're strengthening this relationship, which moves us from being a tactical vendor to a very strategic partner. And I think that has many implications, including if they ever had to make choices, we are closer to them, and that will give us a preferential treatment. We expect that will give us a different treatment. But to your question, yes, 2 customers have come back. One of them extended the duration and the other one just added a ton of volume to the NBM that we had initially signed. This was a very interesting contract because they all take time. Somebody was asking me, why do they take so much time? Well, because they are pretty big, right? It takes longer to buy a house than to buy something small, I guess. But these are big commitments and customers take them very seriously. And even when we were signing the first version, they started to talk about upside and they said, well, engineering is coming up with these numbers based on these models, inference usage models and the numbers are just too big, and we need more time to get them. Why don't we sign version 1? And then we'll see what happens over time. And not surprisingly, they came back and said, "Hey, we actually do need more. We are ready to commit, and we changed that. So the contract is not super long, but these are robust contracts with a lot of different clauses that protect around supply and demand certainty, right? So there is a few things. The only things that changed in the new contract were quantities, and we did adjust price to the prices that we thought were attractive for them and attractive for us.

Okay. All right. Just while we're on the topic of data centers, and I know there's a lot of questions on data centers. But remind us, 38%, I think, exiting fiscal '26, which was your last quarter. What -- how do you think about the business overall? Do you think 40%, 50% is kind of where you think sort of end state where data centers and obviously, you have your retail business and then you have your edge business?

Yes. So we started late with data center, right? We -- when the financials were a little tougher, we had to make choices and we prioritize edge versus data center and just didn't have the right products. And all of that changed when we had BiCS8, which is an amazing technology. And then we brought these products into market with we call Carrera for our compute product and Stargate for QLC, right, so for storage. So now we have the right products, which are amazing in terms of performance, density and energy consumption. So we're very happy. We reported $3 billion in revenue from these businesses in the last quarter. But as you said, we're only 38% of our business going to data center and the market is very soon going to be 50%. We're still -- in my view, we're still a little bit underrepresented in data center. We expect this will continue to evolve. But we believe in a portfolio. We believe in having presence across markets. We think that's the right thing to maximize value over term -- over time. And just like we're committed to our consumer business. It's -- well, some people talk about consumer at edge. We talk about consumer really what you and I would buy in an Amazon.com or Best Buy or those type of stores. And we believe in that portfolio, it's very important.

Yes. All right. If I can, just before I switch off from the -- when you're talking about QLC technology, you talk about data lakes, you talked about at your Analyst Day, you had some very interesting projections as well on how big this data center could become in terms of exabyte consumption for the overall industry. you do have -- and you're also talking about a cost structure that you're -- with your BiCS8, BiCS10, BiCS11. You do have Chinese competition, YMCC. They're very, very aggressive. They have been aggressive for the last few years. Are they also gaining a lot of hyperscaler attention? Like how do you think about that competition from hyperscalers, which is where a lot of the growth that you've talked about for the industry?

Yes. So I -- it's difficult for me to talk about their business because I don't know -- I mean, I know as much as you can read externally, there is some information through the IPO process, which seems to indicate to me or at least my understanding is they are more of a component selling a lot of components. So I don't know how much they are developing their ESSDs. What I can tell you is our relationship with hyperscalers is very strong and robust and growing. So we feel about our competitive position in the market despite of...

Yes. And just talk a little bit -- I know you guys don't like to talk about cost per se. But just as you think about your migration, BiCS8, BiCS10, BiCS11, how are you thinking about your moats? Cost obviously should be attractive for your hyperscaler customers. But broadly speaking, how are you thinking about your moats as you're transitioning on that technology road map from current BiCS8,iCS10, BiCS. And I know you talked about BiCS9 at the Investor Day.

Yes. So we don't think it's a good strategy to talk about our cost downs, particularly our negotiating prices with customers. Having said that, we do see some benefit in cost as we continue to innovate in our portfolio. As we drive new nodes, we continue to improve yield. And our single most important advantage is how much CapEx is required to spend to generate new nodes. Alper has this -- isn't it amazing when your R&D leader talk about CapEx efficiency, right? That's what you want. So he has this beautiful chart that proves that over time, we've been consistently spending less CapEx per additional bed, which makes us very competitive because then that flows through obviously lower depreciation, lower unit cost. So we think that, that's a competitive advantage, which goes back to our ability to continue to drive scaling. So we're very focused on driving cost as a competitive advantage. We think it's very important. You could argue a little bit less critical right now because margins are better, but we are very focused on driving cost down. There are -- within our cost, as you track our unit cost over time, there will be mix impacts, right? As you move more of your business to data center, those products are more costly per unit. So the gross margins are still very interesting and attractive, but the unit cost could be higher because there is more components, more DRAM, more components in general. So there will be a mix element of that and DRAM and just as a few other components have increasing costs. So the -- what we call non-memory cost keeps on going up.

Great. And then you also have your CMOS, which is your bonding technology, direct bonding technology. Just help us understand, when you think about your mid- to high-teens bit growth kind of how you're thinking about overall. How much of that is a function of just the mix towards more of the bonded arrays? How much of that is sort of just wafer migration towards these higher nodes, stacking, et cetera?

Yes. So I would say it's 100% driven by node transition. So if you look at our history, we've been producing fewer wafers over the years from where we were all the way to a point where we started under utilizing the fabs, whatever, 18 months ago, maybe a little bit less. And then we've been ramping back up. But going forward, we don't expect that we'll need any wafer additions to supply the market. So all of this is driven by more efficient, more productive wafers where you can fit in more bits. -- there was this picture we showed at Analyst Day where you saw one on top of the other, and you can clearly visible see it's just more efficient from a space point of view, right? So just every wafer can produce a lot more bits. So that's our single driver. It's not -- your bonding is very interesting because now you can be more productive in your R&D because now you can innovate on the array or on the CMOS. You can do one or both. So it just gives you a lot more flexibility back to your BiCS9 comment. But that's not how we drive productivity on the wafer. It's the array itself.

Okay. And then when you talk about BiCS10, I know you talked a lot about what was interesting from that with it was bandwidth, it was power efficiency. Like any one particular thing that hyperscalers are more focused on as you -- is it bandwidth? Is it power efficiency? Maybe if it's density, it's TCO? Like where do you think your technology? Is it all of the above where it's like.

I think it's 3 of them really. But if I had to say one that's increasing in importance is energy efficiency, right? And we know the reasons for that. But they are -- it's difficult to see them sacrificing one over the other. They want it to be an end. But if there is one increasing, it's that one.

Okay. And if I can just maybe switch a little bit towards the non-hyperscale or the non-data center customers, I think I should say. If you think about the edge, that's still a very important part of your business. You've talked about it, smartphones, PCs. Just as you think about maybe some return to growth here in calendar '27 in the back half of from a unit perspective. And when you think also on top of that content growth, we obviously have iPhones launching here, the new iPhones, foldables, et cetera. How are you thinking about that end market? And what are these customers telling you about from a -- whether it's a return to growth on units or content overall for the market?

Yes. So first, I would say their financial results seems to be good, right, or very good, if I will say. Some of them reported last week and some have been reporting over the last several weeks. And I -- it seems like their revenue, their margins, their free cash flow seems to be pretty robust. So I think that the edge customers are adjusting to the fact that memory was subsidized and now it's no longer being subsidized. I think what's happening is that the low-end models, right, they are just not viable anymore, and they are really shifting towards the higher performing -- medium to higher performing models, which makes more sense. So if your business model was built around very cheap NAND to subsidize your business model, that just doesn't make any sense. I don't think you want us to subsidize those business models. So we're not -- and so what gives us confidence that this will grow in the future? So again, once you eliminate the lower-end models, we believe that next year, we should expect to see medium -- low single-digit unit growth and maybe a little bit more on content growth, just particularly focused on the models that will remain, which are the medium and the higher end.

Okay. And do you see, I don't know, AI at the edge, maybe driving a little bit of that content growth? Is it too early? Or how are you thinking about that -- or your customer conversations at least that they're driven -- content growth is driven by AI on the edge there?

Yes, I wouldn't say we're seeing too much of that. AI could be a driver of replacement of all PCs, for example, but not a major factor. so far, I would see it more on the data center.

Okay. And then the mid- to high teens kind of bit growth that you guys have talked about, like when you think about the industry, and I know you have a market intelligence team that kind of runs through all these numbers. Just if the demand is stronger than expected, we obviously heard from NeoClouds, -- we have our own AI model here at Citi. We've upped numbers there more recently. If demand is stronger and all your competitors alongside SanDisk are kind of looking at this, I think investors always worrisome about overbuilding over capacity, what if they're building for 35% bit growth or 25% bit growth versus mid- to high teens bit growth. What gives you the confidence that we're not going to repeat what probably we've seen in past cycles?

Yes. So I don't know what others will do, right? We track them as much as we can. There is a lot of external press related to that. What I can speak to is what we're doing. And we've been consistent over the last 24 months. We believe that the market will sustainably grow mid- to high teens, and that's what we're executing to. I think you can easily make the argument that you should invest for more. And then a minute later, you would find out that that's probably not a good thing to do. So we think that, that's sustainable over the long term. As you know, there is very little or nothing we can do to change supply over the short term. So really, you're looking at a 10- to 15-year horizon, right? And am I making a bet to increase our CapEx? And I don't think that makes sense for us at this point in time.

Yes. And investors also -- just to your point exactly that about demand, like why couldn't demand be higher than that mid- to high teens? Just I know you guys have been very consistent. I've heard David, even when he was back at Western Dig talk about NAND bit growth kind of in that range. What -- and since then, we've seen AI adoption, right? What gives you confidence on that long-term mid- to high teens bit growth? Why couldn't it be stronger?

It could be stronger. But then you are subsidizing business models that don't make sense, right? So it depends on -- everything is going to be balanced at the end of the day, they cannot be more demand than supply, right, by definition. So you're selling at a price that makes sense for your customers and for us, and we believe that we're achieving that now, which was not the case in the...

A little bit on HBF. You guys talked about it. That's interesting. Obviously, it solves a need or a business case is there for it. You've talked about it. You introduced it a couple of years ago, then at your last analyst event, you talked about more developments in it. Just remind investors again, where are we? When should we start to see this as really in your model, in the business model itself?