Updated from Oct. 20SanDisk ( SNDK) on Thursday almost doubled third-quarter earnings compared with a year ago on a 45% jump in sales, blowing past analysts' estimates. Sunnyvale, Calif.-based SanDisk said stronger-than-expected sales into the handset market drove its 20-cent upside surprise. Shares jumped early Friday on the news; the stock was recently up $6.87, or 14.8%, to $53.25. The company forecast a sequential increase in license and royalty revenue and a more than 40% sequential jump in megabytes sold, but that will be offset by higher operating expenses and price declines. Separately, SanDisk also announced Thursday that it would acquire privately held Matrix Semiconductor in a combination stock-cash deal valued at $250 million. The flash memory maker earned $107.5 million, or 55 cents a share in the quarter ended Oct. 2, nearly double the $54.1 million, or 29 cents a share, in the same period last year. The company's revenue, meanwhile, rose 45% to $589.6 million. SanDisk's guidance for the typically weak summer quarter called for flat sales and lower margins compared with the previous quarter, when the company brought in 32 cents a share on $515 million in sales. But many analysts viewed that outlook as conservative and were modeling stronger results, which SanDisk still managed to shoot past. The consensus estimate gathered by Thomson First Call was most recently forecasting that SanDisk would earn 35 cents a share on $523.8 million in sales. The company's gross margin improved considerably to 44% in the third quarter from 36% in the year-ago quarter and 42% in the previous quarter. The operating margin during the quarter climbed to 26.9% from 20.5% in the same period a year ago. "Demand for NAND flash continues to grow globally and is currently outstripping industrywide supply," SanDisk CEO Eli Harari said in a statement. In particular he cited strong adoption of music-enabled mobile phones that require high-capacity cards. In a conference call late Thursday, Harari said SanDisk sold more than 5 million cards into the handset market, up from 3 million the previous quarter. Combined sales to handset makers and in retail outlets made up more than 15% of the company's $529.7 million in product sales in the quarter and surpassed sales of USB flash drives for the first time, he said. In my opinion, 2006 "is going to be the year of flash in handsets really picking up," Harari said. "By 2007, I would not be surprised if flash in handsets becomes the dominant application." SanDisk's product sales set a new record and represented an increase of 45% year over year and 17% sequentially. Revenue from licenses and royalties totaled $59.9 million, up 40% year over year but down 2% sequentially. The company did not provide specific earnings and revenue guidance for the fourth quarter or 2006. But CFO Judy Bruner said the company expects fourth-quarter license and royalty revenue -- which SanDisk draws as a result of a broad portfolio of patents on NAND flash technology -- to range from $64 million to $67 million. SanDisk expects megabytes sold to increase 40% to 50% sequentially -- up from a 23% sequential increase registered in the third quarter. Conversely, the average selling price per megabyte is expected to decline 15% to 20% due to holiday promotions, in contrast to a benign 5% sequential decline in the third quarter. Operating expenses are expected to increase to $115 million in the fourth quarter from $98.2 million in the third quarter primarily due to holiday branding and merchandising. All of that should translate into a gross margin in the company's product business of 33% to 35% in the fourth quarter, down from 44% in the third quarter, Bruner said. Wall Street has forecast earnings of 45 cents a share in the current quarter on sales of $621.9 million. Separately, SanDisk said after the bell that it would acquire Matrix for $238 million in stock and $12 million in cash. The deal is expected to close by the end of the year. Bruner said SanDisk expects Santa Clara, Calif.-based Matrix to generate $60 million to $90 million in sales in 2006 while adding operating expenses of $30 million to $40 million. She forecast that the acquisition will result in total dilution of 20 cents to 30 cents in 2006, with 10 cents to 20 cents coming from amortization of intangible assets and stock-based compensation. Matrix has developed three-dimensional integrated circuit technology that is not rewritable and consequently cheaper than flash memory, which is rewritable. Matrix 3-D memory is used for storage applications such as video games, music and other content, as well as for archiving. In a press release, Harari said SanDisk hopes to extend Matrix technology beyond video games into SanDisk's recently launched cards for secure music distribution and other preloaded content in handsets. Last month Apple's ( AAPL) unveiling of a new iPod music player -- the nano -- using NAND flash memory highlighted the potential of the technology. Apple has cornered a substantial piece of Samsung's flash supply for the nano, which affects SanDisk in a few different ways. Apple's move will keep supply tight and thus prevent prices from falling as much as they would otherwise; and SanDisk stands to receive a royalty from Samsung on its flash product because of SanDisk's copyrights on production technology.
At the same time, however, SanDisk relies on Samsung for some NAND flash because SanDisk can't produce enough itself to meet demand. But because of the wildly popular nano, SanDisk is receiving inventory from Samsung for the holiday season later than SanDisk would like, Bruner said. SanDisk trails far behind Apple as the second-largest maker of digital music players. If given the choice, SanDisk would rather take product from Samsung and sell it than receive a royalty from Samsung on NAND flash product it sells to someone else. "That said, we do pretty good either way," Harari said.