Sandisk Corporation (SNDK) Earnings Call Transcript & Summary

So I would say, first of all, I mean, 1 of the things -- a lot that's happened to us in the last 18, 19 months since we launched the company, right? It's been a great ride. And 1 of the things that's most satisfying is in February of 25, we got up, and we have been working on this technology for quite some time already, and we were trying to decide should we talk about it. And we eventually decided, hey, we're asking people to invest in the company. We should talk about all the interesting things we're working on. And we kind of put this idea out there of high bandwidth flash. And I think everybody looked at us like what are you guys talking about, right? It's like are you talking about HBM because I guess maybe it had HB in the beginning, people thought it was a substitute or something like that. And that's not what we were talking about. What we were saying is we were kind of -- we are kind of shooting for this day of inference where we could bring this very scalable NAND technology to play in AI and specifically in inference. And back in those days, wasn't that long ago where the predominant conversation around AI was all around training. And HBM is spectacular technology, right? It's incredible technology. And our goal is not to -- we're not recreating HBM. That has its place in the world. very, very important. But as we go to scale inference, we thought, hey, these models are going to get very large I think the team did a good job of anticipating some of these problems, we're going to need more density. What does NAND bring? NAND is the most scalable semiconductor technology. It brings a lot of density. And I think some of the insights were, if you're a NAND designer, you even kind of told your whole life, give me more density, right, giving more density. I think in the R&D side of our business, many years ago, people said, "Well, what if we -- we're anticipating this world of inference where bandwidth is going to be more important. And Endurance is going to be more important. So can we take our fundamental NAND design and twist it in a way and make some innovation where we can increase the bandwidth, we can increase the durability and we can really start to play in this world where inference comes along because we know we can deliver the density, right? That's 1 thing HBM has DRAM has a certain density level. It has unbelievable characteristic, but there's always so much density you can get. NAND, we get a lot of density and we have a road map for more density in the future. We talked about at our Analyst Day, like we can produce the bids. It was about getting the other parts right where it played a role in the AI architecture. And so that's the journey we're on with HBF. It's not necessarily a substitute. It's just different. And it gives the providers that are scaling inference a different way to think about, "hey, I could get a whole bunch more density and I could get this bandwidth. And if I can just get the system to work right to internalize that, I can really scale this inference and change the economics in a fundamental way." And that's what it is. So it's not a replacement for anything else. It just provides a different level of innovation to solve this kind of memory wall problem that now is talked about an enormous amount. Again, 18 months ago, we didn't talk about it that much. But we've always kind of believed that AI is essentially a memory-bound problem and how could -- we believe we're very big innovators in memory. How could we apply all of that innovation capability that we have as a company into this inference question, and that's what we're doing with HBO. It's very exciting. We still got some time to go right? We're just taping out the die, and we want to get in a position where we could put samples in customers' hands next year, and then they'll figure out how to integrate it into their system, and then we'll see what the real potential is. But we think it's very, very exciting technology. And again, over the last 18, 19 months of all the things that have happened to us, I think this is 1 of the most exciting for me because it's like pure innovation. You introduce something new that people hadn't thought about, and we're moving the whole market in a way where now people are talking about a lot and they're seeing the potential of it, and that's exciting.

Fair enough. Now we kind of already covered the catalyst for what's changed the market structure and the need for these longer-term agreements at least from some customers. I want to talk some more specifics about that, maybe give Louis a chance to just pick up a little bit but also help us understand, you've talked about the structure of these contracts, multiyear in nature, price ceilings, price floors, how did you kind of conceptualize this? Was it done in conjunction with your customers at a broad level, how should we be thinking about sort of like going forward over the next several years, what are the risks to what you're leaving on the table if pricing continues to go up? And then what protection do you have if pricing goes down in the broader market?

Yes. So if the market was changing, as David explained, our customers were coming to us with very large demand of NAND and we just didn't think there was a way to transact every quarter. David mentioned that as well. So we're trying to see how do we move from a quarterly negotiation or Bazar into a long-term situation where we have predictable demand. And it happens that they were looking for predictable supply because they're making huge commitments. They are buying land, they're making energy contracts and everything, they want to make sure that NAND is arriving at exactly the right time. So we started small, and we started playing with the idea. And over time, we were really a small period of time because it's only 9 months is we signed the first deal. We have 8 very strong partnerships. And I think that number 8 is very important because we've been very selective. We don't want to have a ton of agreements. We want to go and be very strategic for a few of those customers. And they have requirements, which are very meaningful and going all the way to 5 years. And we -- that was the first negotiation. How do we get to an agreement on supply-demand certainty and for how many years and how many exabytes we would spend, I would say, 2/3 of our time agreeing to that foundation because a 5-year agreement, it's actually an agreement with details by year by quarter by month, think about TLC, QLC high cap, low cap. So it's very detailed in terms of the agreement. So we know exactly what they will need and where we need to produce. And then once we have that foundation, we talked about pricing. And we wanted to make sure that pricing was attractive for us and attractive for our customers. And we came up with this construct. There will be a time -- and this is generic because there -- each agreement is different. But think about a time in which prices are fixed. And then there is an ability for us to capture upside if prices go up and an ability for our customers to capture some downside but we wanted to be careful on the downside to make sure that we were protected. So we set that price in a way that was still highly attractive for us. And the final point of the negotiation is, well, how do we make sure that you're going to be there on TBM because I may have to burn some bridges with other customers, and I want to make sure that you're actually going to fulfill your purchase obligations. So we came up with these financial guarantees with third-party financial institutions, which basically will flow those funds to us, if they don't execute their part of the agreement. So we feel very good about the agreement. And as I've mentioned before, just as we signed, we were about to sign 1 of them, 1 meaningful one, and the customer came back and say, "Hey, my engineering team is actually changing the signal, they need a lot more." And we're like, okay, well, let's get this done, let's give your team a little bit more time and not unexpectedly, they came up with more requirements. And so we continue to have these conversations, which I think is very important because we are establishing a relationship, very strategic partnership that we expect will last for many, many years to come.

Yes. And then you've talked about sort of 2/3 of your fiscal '28 bit supply being booked under these NBMs and '29 levels at that rough level or maybe moving higher than that. in the downside, you've talked about looking at 80% gross margin level for the floor pricing on average. Is it correct to think very simply about 2/3 of your business in a downside scenario be 80% gross margin and remaining 1/3 at prevailing prices?

Yes, that's an easy way to think about it. I totally agree.

Okay. Great. Maybe I want to -- well, I do want to ask another couple of technology questions, but maybe just kind of like wanted to talk about your targets because that kind of goes hand in hand with what we just talked about here. For fiscal '28 to '30, back at your Investor Day, you talked about revenue growth in the mid- to high-teens, gross margins of 80%, operating margins of 70% given them out of business covered by your HBMs NBMs during that period, what are some of the overarching assumptions you've made with respect to market supply and floor pricing to sort of get to those targets?

Yes. We didn't start with the market. We started with our relationship with our customers, right? And we have a good idea of how to model our NBM business because we have, again, close relationships. We have expectations and we model a range of scenarios where prices would be higher, prices would be lower, how much we renew, how much we expand, how many MDMs do we have? And then we did the same for the non-NBN business. Under what reality were those -- that part of the business we'd be operating, and we blended the 2 and as I said, we looked at many, many potential outcomes then David and I sat down and we looked at what do we think is the most likely scenarios, right? And we had several potential outcomes, and we came to the conclusion that this is a reasonable expectation, and that's what we shared with you in our Analyst Day. We think it's a great model, right? 80% gross margin all the way down to 50% free cash flow margin on an ongoing basis. That is a model we like, and we wanted to share that with you.

Yes. Let me just make 1 comment on this. And I think Luis and I -- we didn't sit down once we sit down like 5 times a day. But we always knew we had an incredible franchise, right? We -- whether you look at it from a technology point of view or from a business point of view, from a technology point of view, our technology is used in like every interesting device that's built in the world. right, everything, like smartphones, laptops, drones, cars, data centers, it just goes on and on and on. And in many ways, it's kind of an evergreen market. Like there's always something new people are thinking of robotics. So it's always been just fantastic technology. We've been able to produce it at scale. It's highly scalable technology. We talked about at our Investor Day just through the application of what I'll call intellectual capital, new nodal transitions. We can grow at a compounded 27% growth rate, if we look at a 10-year period, that's incredible, like that's not new CapEx. So then you start to transition into the business model. Like we always knew that the dynamics of this business were incredible for free cash flow generation. If you can get the economics right and you can get the cyclicality to settle down. And so when we went into these NBM discussions with our customers, we had a willing partner where it's like, they're going to get a great deal out of this, which is they get predictable supply of incredible technology and they have unbelievable businesses, very enviable businesses. And we're getting out of this predictability of demand that we're feeding into something we know is an incredible economic model. We can scale this technology very efficiently and that allows us to build a really, really attractive financial model for all of us that invest in the company can drive an enormous amount of free cash flow margin. And that's what we were shooting for, and we've been able to kind of land that to the level where we could get up a month ago and say, hey, we have enough confidence in the contracts we've signed and the way we've navigated this business that we can commit to this financial model. And we think that's a great place to be.

Excellent. I wanted to touch on capital for a second because I think you put up an interesting chart at your Investor Day basically showing like per petabyte. The industry has spent about 7x more than you over the recent cycle, which kind of speaks to the level of cost reduction you're able to drive. So how are you thinking about how that plays into sort of your mid-single-digit capital intensity target? And then on the flip side of that, as we think about free cash flow, you've talked about 100% of free cash flow return to shareholders. Talk a little bit about like why buybacks make sense now and what their dividends might ever make them in the future?

Yes. So the first 1 is kind of this thing I was talking about, we knew we had an unbelievable franchise like we had incredible technology that we can produce very efficiently. And like the relationship we have with Keota is a very, very strong relationship. It gives us scale where scale is important. In our business, scale is important in R&D. I think most people think about scale and production. That's important, too. But R&D is really important because if you have the highest share that just means you can invest more engineers, like roughly in technology, big global technology franchises, I'm not talking about the start-up world. I'm talking about big, mature markets you can roughly afford to invest R&D commensurate with your market share, right? And so if you're the biggest player, you should be able to invest more money, which means you should have the best technology. And those -- that chart you just show -- you just talked about, about we can produce bits more capital efficient than anybody else is the output of 25 years of doing that together of like this consistently applying the most R&D very effective with a goal of -- how do I -- not just how do I produce the most bids? Or how do I get the most density? How do I produce the incremental tera-incremental petabyte of supply with the least amount of capital. That's kind of the goal to the R&D team, and they've been doing that for years and years and years, and they've been doing that an intensity that's higher than anybody else because of our market share. And when you do that, you end up with charts like you just described. That gives us like this -- what I was talking about earlier, we always knew we had this incredible foundation if we just get the economics correct around it, that's a big part of it, right? And we got that right, and that's a big advantage for us, and it's going to continue to be a big advantage. And I think 1 of the things you should take away from our Investor Day, we've got line of sight on that road map for BIC technology for years to come. If there's people working way down the horizon on that, which is exactly what you would expect us to do. Now I think your second question was around how are we going to return capital to shareholders?

Yes. David mentioned we need 5 things a day. This is 1 of the other topics we talk about, which is what is the best way to return cash to our shareholders. At the end of the day, your company and we're here to create value for you. We believe that the best way to do it is through a share buyback program. We said we were going to execute that, and we generated $5 billion in cash in Q4 and we bought $4.5 billion of that back. So we're basically executing exactly as we told you we would do. And we continue to do that. We believe -- we continue to believe that's the best way to do it going forward. But we're not -- we're open-minded. If this ever changes, and there is a reason why we should pay a dividend, we'll consider that. We don't think that's the right solution at this point in time, but open-minded.

Yes. And we just got a minute or 2 left, but maybe the way I'd like to close is sort of ask, you've met with a lot of investors since your Investor Day, including at this conference and other venues. Maybe talk about like something you think is still a misperception among investors and how you expect that to change over time?

I don't know if things are a misperception or not. It's just a question of -- some of this is just a question of time horizon, what do you believe? And everybody is afraid to say it's different this time or if you say it's different this time, that's like a code word that you don't know what you're talking about or something like that. But we believe very strongly in the model we put together, like we believed very strongly back in February 25. Like I mean, we better hold careers on this company. We thought this was a tremendously underappreciated asset. Like I said earlier, we look through all of the noise around the way the business had worked in the past, and we said tremendous technology, unbelievable foundation, own the whole stack, right? No margin leakage in technology -- I mean, like we have the most spectacular customers in the world that's like the who's who of everybody and technology uses our product, which is an incredible place to be. It was about just getting -- making a few changes in the way we did business. This huge gap I talked about earlier between we're negotiating pricing quarterly, and we're making investment decisions. We have to live with it for 10 years. We got to close that gap. And then on top of all that, we had this transition going to the data center. And how do we use that transition to make that business model change and really expose the value of this franchise. And I think we're like 2 or 3 quarters into doing that, and there's a belief like, oh, this is so good, it can't be true. It can't last. Well, why can't it last, right? It's just -- this is what we're creating. And I think what we hear from people is just really trying to understand, "Hey, help me really understand these contracts, how does this really work? Why do you have this belief because we've seen this so many different times and it never seemed to work in the past and help me develop conviction that it's going to work this time. And all I can say, I don't know maybe Luis could say it, too, we have a lot of conviction -- we had a lot of conviction back in February of 25, and it's worked out okay. We still have a lot of conviction. In fact, I said when I opened, I think, our Investor Day, I finally feel like I got to the point, after 6.5 years of managing this franchise where the real value creation is going to happen because we've gotten to that point where we're returning cash to shareholders. And we have a model where we can turn revenue into cash, and that cash is going back to the shareholders, and we have a lot of conviction in the durability of that. And it's just everybody is making their own decision of what the durability of that is.

Very good. Well, I think we're out of time, but really appreciate being here with us. David Lewis. Thanks for being here.

Thank you, James. Appreciate it. Thanks for your time.