SanDisk Not Flashy Enough

It beats estimates, but shares drop more than 12% after hours.
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Updated from 4:51 p.m. EST

SanDisk

(SNDK)

surpassed Wall Street expectations Thursday, boosting its sales 37% as consumers continued to snap up the company's flash memory products.

But the company's plans to aggressively cut prices may have given some investors the jitters. Shares of SanDisk plunged 12.2%, or $8.63, to $62.05 in extended trading.

The Sunnyvale, Calif., company earned $134 million or 68 cents a share, on $751 million in sales for the quarter ending Jan. 1. SanDisk had sales of $549 million in the year-ago period.

The gain was larger than the average analyst expectation, which called for 62 cents EPS on $727 million in sales, according to Thomson First Call.

The total megabytes sold in the fourth quarter increased 49% sequentially, at the high end of the company's guidance of a 40% to 50% increase. The average price per megabyte declined 13% because of holiday promotions, less than the 15% to 20% decline the company had forecast.

SanDisk signaled that it intended to drastically slash prices in 2006, beginning in the first quarter, when the average price per megabyte would decline 25% to 30%.

The idea, said CEO Eli Harari, is to stimulate demand for the higher-capacity flash chips being produced at SanDisk's factories.

The news comes a day after Israel-based flash memory maker

M-Systems

(FLSH)

reportedly warned analysts during its earnings conference call that it expects margins in the current quarter to deteriorate as retail prices sink by as much as 30%.

Shares of M-Systems were down 12.5% on Wednesday.

Flash memory makers such SanDisk and M-Systems are facing increased competition.

Intel

(INTC) - Get Report

, the world's largest chipmaker, recently announced that it was starting a flash memory joint venture with

Micron Technology

(MU) - Get Report

.

But some analysts said that SanDisk's pricing cuts were standard practice in the flash business.

"There's nothing that's illogical about that," said Polestar Investments analyst Raj Sharma, who owns SanDisk shares. "They've always talked about pricing declines in this industry to create more demand. That's been the whole story."

Indeed, SanDisk's projected 2006 price-per-megabyte decline of 50% to 55%, is in the same range of the 52% pricing decline it experienced in 2005.

Although the first quarter is seasonally slower than the fourth quarter, SanDisk projected that the price cuts would result in total megabytes sales that are flat to up 10% sequentially. For 2006, the company expects total megabytes sold to increase between 180% and 190%.

Harari acknowledged that SanDisk was concerned about DRAM memory manufacturers converting their chipmaking facilities to NAND flash memory production. But he maintained that SanDisk's lead in production technology gave it a cost advantage over the DRAM companies.

"We will definitely use our cost advantage to drive demand to our benefit," Harari said.

Still, the company's margin forecast suggested that its aggressive price-cutting could take a toll on the bottom line. SanDisk pegged its non-GAAP product gross margin for 2006 between 32% and 35%, compared to the 35.5% level in 2005.

CFO Judy Bruner said that as lower-margin MP3 players comprise an increasingly large part of SanDisk's product mix, the company's overall gross margin levels would be affected.

According to the company, MP3 players accounted for 6% of total revenue in 2005, up from 1% the year before.

Sales of SanDisk's MP3 players quadrupled in the fourth quarter, and have the No. 2 rank in market share behind

Apple's

(AAPL) - Get Report

iPod, according to Harari.

SanDisk shipped 11 million units of flash chips for cell phones in the fourth quarter, compared with 3 million units in the second quarter. The handset business accounted for 13% of total revenue in 2005.

Revenue from licensing and royalties was $67 million in the fourth quarter, up 63% year over year. The company expects its intellectual property portfolio to generate $78 to $84 million in the first quarter, and $350 million in 2006.

For the full year 2005, SanDisk posted $2.3 billion in sales, up 30% from 2004's $1.8 billion revenue. Fully diluted earnings per share for 2005 was $2, compared with $1.44 in 2004.