The SanDisk Shareholders' Meeting 2000
Sunnyvale, CA on May 11, 2000
The following information is not a solicitation to buy or sell securities in any stock. The information presented is my best recollection. I have strived to make this report accurate, but cannot guarantee there are not some inaccuracies or mistakes. Portions of this document are paraphrased. I have provided this document as a courtesy to SanDisk shareholders who were unable to attend the meeting.
Please visit my photo album for a "Virtual Tour" of the meeting. This is not my best photographic work. I was a bit reluctant to go hog wild with photos. There is a level of security there and I didn't want to be too pushy. Also, I was absorbed by Dr. Harari's presentation. The photo of him is not particularly sharp or flattering, but I felt like I was distracting others by shooting during the presentation.
Also, for those who still have questions about image quality and photorealistic prints, I did bring several photos from my Epson PhotoPC for others to view and attest to the quality. I think Jason Rooks and Jay Dreifus can testify that an 8.0 megapixel camera is overkill.
albums.photopoint.com
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SANDISK SHAREHOLDERS' MEETING FOR 2000
This is the third installation about my experiences at the SanDisk Shareholders' Meeting in Sunnyvale, California on May 11, 2000. The information here is intended to help educate long-term investors about SanDisk. If you will, my intention is to help the individual investor "See the BIG Picture!" for it is my belief that SanDisk will become a major player in the Post-PC era as the technology sector continues to boom world-wide as we sit and discuss SanDisk today. It is only possible to create a stable, educated, dedicated and broad-based shareholder-lead support of SanDisk through due diligence, discourse and mutual discussion of the issues at hand.
I. A Tornado is Coming
Dr. Harari presented the same information he recently gave at a Merrill Lynch investment symposium. The title slide talked about the current tornado, which is being created by the convergence of the consumer electronics, wireless and Internet markets. (NOTE: A "tornado" is a specific technical term employed by Geoffrey Moore in his book The Gorilla Game, which was published a few years back. It has become a bible for the technology investment community. A tornado occurs when an innovative and disruptive technology, in this case flash memory, not only unseats previously established standards of practice, but also enjoys a very rapid and sustained upswing in demand called hypergrowth. The tornado represents a period of rapid proliferation of a company or technology caused by an urge to conform or spontaneously agree on that particular standard.) This type of situation can lead to formation of a mass market, or as Dr. Harari mentioned at the 1999 Shareholders' Meeting, "a megamarket", which creates a severe inversion of the supply and demand dynamics within the market segment. The tornado is the time period when a given innovative solution begins popping up in many diverse applications. The disruptive technology thus represents a final common denominator or a common solution in related or unrelated applications.
Dr. Harari once again pointed out that SanDisk is surrounded by several simultaneous tornados. The three specific areas which he mentioned where flash memory is particularly disruptive included...
a) flash memory leading to the obsolescence of 35 mm emulsion film,
b) replacement of 8mm video cassette tape in camcorders with removable flash, and
c) the adoption of flash memory in place of CD's or Mini-Discs for music storage.
And while flash memory appears to have distinct advantages in the mobile applications that typify the post-PC era, it does not necessarily need to compete with hard disc drive and DRAM that dominate in the desktop environment where power consumption and conservation is not an immediate issue.
The first winds blowing in the flash memory tornado suggest that global demand will increase from about $1.5 billion world-wide to more than $10 billion in the next several years according to market research from independent associations. Solid state flash memory solutions will participate in "design-in and replacement programs" where rotating disc drives now set the standard. In the future up to 4 gigabits of data may be stored on a single chip allowing for a full-length film to be stored with audio.
II. Main Street, USA
Although in Gorilla Game parlance "Main Street" represents a period of mature, robust demand for a product or technology just prior to its gradual replacement by the next disruptive technology, Dr. Harari uses the term to suggest that markets such as digital photography have arrived at places like K-Mart. Thus, digital cameras are becoming available routinely on Main Street, USA. Digital photography is a "killer app" for removable flash memory. Music is the next "killer app" for flash. Thereafter, the cellular phone market should develop. Dr. Harari pointed out that current cell phones utilize a maximum of about 16Mbits of code storage (about 2 megabytes). High density removable storage together with MP3 compatibility is "easy to integrate at little cost" for the cellular handset manufacturers. If you visit my PhotoPoint album you will see the model that Dr. Harari demonstrated for us. Needless to say, he was very enthusiastic about the possibilities for MMC and SDMC in this market given their advantageous form factors.
III. Partnerships
SanDisk recently announced the Joint Venture with Toshiba known as FlashVision, LLC. The lead corporate counsel, Mr. Charles Van Orden, apparently spent countless hours reviewing the final legal documents (reportedly a huge stack of papers) such that Dr. Harari and representatives could participate in the ground breaking ceremonies in Manassas, VA together with the Mayor of the City and the Governor of the State of Virginia. Note that this event occurred several weeks in advance of the previously announced deadline. This partnership will meld the NOR / NAND / Multi-Level Cell (MLC) / controller technology created by both companies into a single entity. The co-licensing of technology will allow for "highly scalable volume production" at UMC, Toshiba's flash fab in Japan, Celestica and Solectron. Dr. Harari mentioned "virtual manufacturing" several times during this segment of the presentation. He also mentioned continued industry support for SanDisk's CF and MMC standards from such heavyweights as Kodak, Nikon, Canon, Nokia, Ericsson and several others. The Toshiba partnership and SanDisk's continued profitability will be based on fundamental patents and licenses of technology.
IV. Growth
Dr. Harari presented a slide of the total terabytes of memory shipped over the past several years. There has been 30-50% growth in production (between quarters?), which has lead to exponential growth in production during this time period. Dr. Harari stated that this growth curve is difficult or almost impossible to sustain given the current production capacity of the company. SanDisk remains on allocation and growth will be blunted until additional capacity is added. The flash market is "supply constrained" for the time being. In order to accommodate the market SanDisk has instituted several engineering goals. These include the shift to 256Mbit MLC (D2) technology and the upcoming shrink from 0.28 to 0.24 micron line widths. IT WAS MADE ABUNDANTLY CLEAR THAT THESE ADVANCES ARE EXTREMELY CHALLENGING FROM AN ENGINEERING PERSPECTIVE. Dr. Harari feels strongly that SanDisk has assembled a talented and dedicated team to tackle this problem. He also charted a time course for innovation on the engineering front...
2000 ====> 1 gigabit chips
2005 ====> 4 gigabit chips
2008 ====> 16 gigabit chips
...and suggested that things could advance at a pace faster than outlined because of the FlashVision, LLC partnership. In this arrangement Toshiba brings its NAND cell technology, lithographic skills to line widths of 0.16 and 0.13 microns, and other manufacturing expertise. SanDisk brings NOR cell technology, MLC / D2, its extensive flash memory IP, marketing and its controller technology. The partners will share the production on a 50-50 basis and also fund the project equally. Dr. Harari mentioned that competition between the companies for the final use of the flash chips do not overlap with Toshiba selling primarily components and SanDisk selling primarily finished cards. Thus, it seems unlikely that the individual companies will compete head-to-head on the open market.
IV. Security, Cryptography and Copyright Protection
Dr. Harari discussed SanDisk's commitment to security issues for content distribution and the SDMC (Secure Digital Memory Card). He stated...
"If you want to attract birds, build a bird house.
If you want to attract great content and E-commerce, build a secure card.
Support for the SDMC Association has been phenomenal. It includes most major manufacturers with the notable exception of Sony.
V. General Comments on "The Numbers"
Dr. Harari revisited the financial data that Mr. Calderoni gave at the time of the last earnings press release and conference call. He spoke about the fact that SanDisk's current licensing revenues fully fund their research efforts. This is a very big advantage over the competition. Similarly, the first quarter of 2000 marked the first quarter that SanDisk was profitable based solely on its operations. He added that there has been significant contributions by the research house in Israel near the Sea of Galilee. The innovations discovered there regarding MMC and SDMC will be represented by $200 million in revenues in 2000 and stated that this group of individuals have made extremely important contributions to SanDisk's advancement in this area.
VI. Market Elasticity and Pricing
On several occasions in the past Dr. Harari has spoken about "market elasticity". In forming the CompactFlash Association SanDisk created an open standard which has endeavored to promote the acceptance and compatibility of CompactFlash products by multiple manufacturers. Second source considerations play an important role in this area. Certainly any efforts to increase competition and reduce cost will not only increase product acceptance, they will also bring great value to the consumer. Dr. Harari suggested that SanDisk's production efficiencies (outlined below) will help lead the way to (voluntary?) reductions in pricing to the consumer, even during this period of high demand. The steps for growth and improvement in gross margins (which have gradually trended upwards during the last few quarters) include...
a) addition of a third fab at UMC,
b) addition of a new non-UMC fab in Taiwan,
c) completion of the migration to 256Mbit / D2 technology,
d) shrinking of line widths from 0.28 to 0.24 microns,
e) new availability of NAND flash products from the JV (Yokkaichi?), and
f) "global virtual manufacturing operations".
VII. Progress
Dr. Harari concluded his presentation by reminding us of SanDisk's current business environment. We have had a record Q1 of 2000, continued robust growth, increasing capacity, all-time record levels of backlog, excellent visibility, a stable pricing environment, strong growth in all segments, increasing production requests from major electronics distributors such as Ingram Micro and Tech Data Corp., exceptionally strong MMC demand (meeting only about 50% of requested product) and improving gross margins.
VIII. Questions & Answers
(paraphrased for simplicity)
Q: How have solutions to capacity and demand imbalances been approached?
A: Demand has become "less cyclical" (read: more predictable), whereas Main Street markets were notoriously difficult to predict in the past. This is afforded by a broader demand for products (read: telecom). The plans for added capacity in the near-term and more distant future were again discussed.
Q: SmartMedia is currently a private labeled product purchased from Toshiba to round out the product line at retail and establish a brand preference. Does the FlashVision JV improve your profitability from the sale of SmartMedia?
A: Yes. The cost structure for the sale of Smart Media will improve as a result of the JV.
Q: Are you concerned about the relations between China and Taiwan? What back-up plans are there.
A: Our wafer production is based in Taiwan and cannot be moved. Assembly of finished cards could be moved relatively easily. If China were to engage Taiwan the entire world-wide semiconductor industry will be adversely impacted, not just SanDisk.
Q: You have kept us in the black by not spending lavishly on advertising. When can we expect to open a magazine and see a SanDisk advertisement? Are any of your partners (read: OEM's) committed to co-marketing products with you?
A: We cannot meet demand now. We have talented staff who are dedicated to developing brand preference and the SanDisk brand name. Currently we wish to stay in the black, as you stated. Sony has probably spent $100 million promoting Memory Stick. We simply don?t have that type of clout or resources to spend.
Q: Why are analysts' estimates projecting such anemic growth for the balance of the year. What guidance have you given?
A: We like to remain conservative in our guidance regarding earnings. (NOTE: It does not appear that the current estimates given actually reflect the guidance given during the last conference call, IMHO.)
Q: How is your venture with KANEB and the PIC card progressing.
A: PIC was renamed P-tag. We remain interested in P-tag, but capacity is constrained and we are concentrating on higher growth, higher margin products currently. We feel the application is worthwhile. (NOTE: They had a P-tag out on display.)
ADDENDUM
VIII. Shareholders' Meeting: Sony and Lexar Media
Sony
Eli stated that he wanted to be on friendly terms with Sony. As he mentioned in a prior interview posted here several weeks ago, SanDisk is essentially working on the challenges it has set forth for itself. It doesn't view competitors as the main competition (not sure how else I can word that) primarily because flash is in such short supply. SanDisk has its work cut out for itself in gearing up its own production. Sony helps the cause of flash memory by incorporating a flash memory solution in their product line with their flagship product, Memory Stick. In doing this Sony pays a licensing fee on the flash wafer indirectly to SanDisk. I do not believe there are any card level patents.
At some point in the future it is plausible that Sony may wish to purchase wafer from the FlashVision JV. I think this will depend on the success of Sony's product launches. Also, Sony is not stupid. They must realize that the synergy of the SanDisk/Toshiba JV will create the lowest cost, highest technology products on the market.
SanDisk and Sony need to stay on friendly terms. Eli has made this clear in his statements and his actions. In the Fall of 1998 I also recall Eli stating, "We'd be happy to wrap our flash chips in (purple) plastic for Sony."
Lexar Media
We did not ask any questions about Lexar Media. This is litigation in progress. It seemed inappropriate to ask questions about ongoing legal proceedings. Some would also consider it ill-advised or inappropriate for management to speculate on the outcome of a lawsuit.
We did everyone a favor by "not going there".
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