SanDisk Looks Beyond Short-Term Pain - TheStreet

SanDisk Looks Beyond Short-Term Pain

Though the flash memory market remains bleak, the company insists it will come out strong.
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For investors seeking a prognosis for when the hemorrhaging flash memory market will heal, the comments by

SanDisk

(SNDK)

CEO Eli Harari were less than reassuring.

"We really don't know how long this thing is going to last," Harari bluntly told analysts gathered in Milpitas, Calif., Monday for SanDisk's annual analyst day briefing.

The glut of flash chips on the market, which drove prices down as much as 58% last year, will eventually correct itself, Harari said. Ideally, pricing is expected to get better in the second half of 2007, as cell phones, video-enabled MP3 players and PCs all make greater use of flash chips, a form of memory that stores data even when an electronic device's power is switched off.

But Harari said that a 2007 recovery may be wishful thinking, and he pegged 2008 as a "worst case" timeframe for flash prices to ameliorate.

In the meantime, SanDisk's financials will take a hit.

Depending on what happens with prices in 2007, SanDisk said 2007 revenue will be anywhere from flat to up 25% from the $3.3 billion in revenue for 2006. Analysts polled by Thomson Financial project revenue of $3.9 billion for 2007.

SanDisk expects its product gross margin will slip to 15% to 25% in 2007 from 31.8% in 2006. The average price per megabit will decline at least 55% in 2007, according to the company.

SanDisk's analyst briefing comes a little more than a week after the company announced it was

slashing its headcount by 10% and freezing salaries in light of the tough market conditions. A week prior to that, SanDisk

reported a $35 million quarterly loss on charges from its acquisition of M-Systems and said it was sidelining M-System's private-label USB business.

Still, Harari insisted Monday that the company is poised to benefit from the current market malaise, notwithstanding the short-term pain on profit margins.

"The longer this down-cycle continues, the stronger we will come out of it," Harari said. He noted that SanDisk was evolving from a semiconductor company to a

consumer electronics company.

Shares of SanDisk closed the regular session down 1%, or 40 cents, at $38.22.

Flashy Goals

The combination of new players in flash memory, including

Intel

(INTC) - Get Report

and

Micron

(MU) - Get Report

, and an increase in manufacturing capacity from existing players has flooded the market with more supply than can be absorbed.

Earlier this month, Micron told analysts that prices for NAND flash would decline 30% to 40% sequentially in the current quarter.

SanDisk is pushing hard to transition to new generations of manufacturing that would allow it to create chips with 56-nanometer circuits in 2007, compared with its current batch of 70-nanometer chips. By moving to smaller circuits, SanDisk can cut its costs and stay one step ahead of the natural price erosion that occurs in flash memory.

But the recent glut of flash chips has thrown this model out of whack. SanDisk projected that prices will decline at least 55% in 2007, but the company expects cost reductions of only 40% to 50% for the year, which will wreak havoc on its profit margins.

CFO Judy Bruner said that product gross margins should come back to 24% to 32% in 2008 and 2009, as the price declines slow down to more-natural levels.

According to SanDisk's management, the company will grow faster than the flash industry in 2007, and executives took turns outlining the various elements of the gameplan.

SanDisk said its weak market share in Europe is largely attributable to the fact that a limited chip supply previously caused it to focus on the U.S. market. Today, of course, supply constraints are not a problem, and SanDisk flagged the European market as a key source of growth going forward.

Unsurprisingly, the company also reiterated its belief that cell phones will provide a big source of demand for flash chips, as handsets offer greater functionality, such as music and video.

Video-enabled MP3 players, such as

Apple's

(AAPL) - Get Report

video iPod, will replace miniature hard drives with flash chips within the next 18 months, SanDisk executives projected, with Harari labeling the switch "inevitable."

The company also is betting that flash chips will replace traditional magnetic hard drives in notebook PCs, and SanDisk said that it would use its presence in 200,000 retail stores, along with its OEM relationships, to spur the adoption of flash hard drives.

As it is, the price of flash, although declining very rapidly, is still too high to be viable in mainstream notebook PCs. But SanDisk suggested that demand for flash PC drives could accelerate in the next 12 months as prices continue to fall.

And SanDisk President Sanjay Mehrotra suggested that flash hard drives could serve another function, by helping the company ride out the volatile price swings in the flash market going forward. Because PC hard drives require large amounts of memory capacity (often 32 gigabytes), flash drives will easily soak up extra flash chips.

Solid-state hard drives will be "a good safety valve in periods of excess capacity," Mehrotra said.

Too bad SanDisk has nothing like that to help it through its current tribulations.