May 3 (Bloomberg) -- Creative Technology Ltd., losing in a battle with iPod music players, posted its worst-ever quarterly loss on a drop in prices and costs to reorganize a unit.

The net loss was $114.3 million, or $1.38 an American depositary share, in the third quarter ended March 31, compared with a profit of $15.9 million, or 18 cents, a year earlier, the Singapore-based company said today. Sales dropped 32 percent to $225.7 million.

Creative is turning to higher margin audio products and cutting prices of its Zen and Muvo music players to return to a profit in the second half of 2006. Creative blamed the net loss on an inventory writedown after a drop in prices of NAND flash memory for its players, which contribute more than half of sales.

``Creative is caught in a classic squeeze between Apple, which is a very fashionable brand, and the cheap, low-end players,'' said Jay Moghe, who manages $25 million in hedge funds as chief executive at Stork Capital Asia in Singapore. ``Times are going to continue to be tough for a while.''

Creative shares fell 2 percent to S$9.90 at the 5:05 p.m. close in Singapore, after dropping to S$9.85, the lowest intraday level since Oct. 25, 2001. The shares have tumbled 27 percent this year, the second-worst performer on the 190-member Morgan Stanley Capital International World Information Technology Index.

Product Categories

The company aims to focus heavily on its audio operations, such as X-Fi sound cards targeting the gaming community.

``We had under invested in the marketing efforts of X-Fi as we focused on becoming No. 2 in the MP3 segment,'' Craig McHugh, president of its U.S. unit, Creative Labs Inc., said in a conference call.

Creative is ``exploring strategic options'' to trim operating expenses, which it targets reducing to $65 million a quarter in the second half of 2006, from $108.2 million in the three months ended March.

``This will make us a leaner, more agile operation,'' McHugh said.

Sales of Creative's music players fell 51 percent in the third quarter from the second quarter, McHugh said. The company expects to increase its market share in the second half of 2006, he said, without specifying figures.

IPod Sales Rise

Apple Computer Inc. on April 19 said profit rose 41 percent in the three months ended April 1, boosted by rising sales of iPods. Apple has sold 50.8 million iPods since introducing the device in October 2001, making it the best-selling portable music player in the U.S., said market researcher NPD Group Inc.

Creative wrote down its inventory by 8 percent in the third quarter from three months before, after a decline in prices of NAND flash, used to store songs in its music players. The company had $276 million in inventory at the end of March, compared with $301 million in the second quarter.

Spot prices of the 2-gigabit NAND flash memory chip plunged 69 percent in the three months ended March and are unlikely to rebound in the current quarter, according to Dramexchange.com, Asia's biggest spot market for chips.

Prices of NAND flash, which are expected to remain low, will help Creative ``hit at mass market prices,'' McHugh said. The company is a sponsor of the ``Singapore Idol'' show, a franchise of the U.S. hit television series ``American Idol.''

``No one should underestimate us in the low end of the market,'' he said.

Creative will reduce the number of its MP3 devices and include music players in new products. The company, which makes its own players in factories in China and Malaysia, may also outsource the production, McHugh said.

Players, Sound Cards

Music players contributed 60 percent of sales, down from 68 percent a year ago and 67 percent in the second quarter. Sound cards accounted for 13 percent, unchanged from a year earlier. Speakers contributed 17 percent, up from 12 percent a year earlier and 13 percent in the second quarter.

Creative may divest some units that aren't able to return to profitability, McHugh said.

The operating loss in the third quarter was $118.3 million, the widest in at least five years, compared with an operating profit of $6.4 million a year earlier.

The company incurred a one-time charge of $41.6 million, mostly relating to the restructuring of its Milpitas, California- based unit 3Dlabs Inc. Creative plans to cut 100 positions at 3Dlabs, which is shifting focus to making graphics for hand-held devices, from graphics for personal computers.

Creative had a negative gross margin of 4.5 percent in the third quarter. The figure was calculated by dividing gross loss by sales. It had a gross margin of 23 percent a year earlier.

``The fourth quarter should improve, but it's still not out of the woods,'' Credit Suisse analysts Keng Hock Lim and Kwee Hong Ching wrote in a report today. The analysts upgraded the stock to ``neutral'' from ``underperform,'' citing the recent fall in share price.

To contact the reporter on this story: Andrea Tan in Singapore at atan17@bloomberg.net

Last Updated: May 3, 2006 05:11 EDT