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Weaker Prices Smack SanDisk

Investors sold shares of the flash-memory producer Wednesday as the company warned of declining margins

SanDisk (SNDK) is losing money as it battles rivals who also want to sell flash memory, the digital data storage medium for devices like cameras or music players. The war for customers is pushing down prices in the market and it's tougher to turn a profit.

Investors sold SanDisk's shares on Jan. 31, after news that the Sunnyvale (Calif.)-based company lost $35 million during the three months ended Dec. 31. SanDisk had earned $134 million during the year-earlier quarter.

To be sure, SanDisk said its recent loss included things like the costs associated with its $1.5 billion acquisition of M-Systems, which closed Nov. 19. Excluding that deal, SanDisk's operating income rose 25.3% year over year to $248 million during the quarter. "The seasonally strong fourth quarter was our first ever billion dollar quarter, completing a year of excellent growth in revenue, standalone SanDisk profit and market share," SanDisk CEO Eli Harari said in the press release late Jan. 30.

SanDisk's acquisition of Israel-based M-Systems, which makes storage devices for computers, did boost sales. Fourth quarter revenue increased 55% on a year-over-year basis to a record $1.164 billion, including $115 million of revenue from msystems.

But that deal came with trade-offs. By making its computer chips under a joint venture with Toshiba (TOSBF), SanDisk has managed to keep its costs down with advanced technology that produces more efficiently. As a result, SanDisk was more profitable than M-Systems. Now SanDisk isn't squeezing out as much profit from its sales as last year. The company's fourth quarter non-GAAP product gross margin was 32.3% including M-Systems and 34.7% for SanDisk on its own, compared to 34.4% in the fourth quarter of 2005.

Meanwhile, rivals are coming on to the scene. For example, Idaho-based Micron Technology (MU), which traditionally makes chips for things like personal computers and servers, recently bought Lexar Media in an effort to boost its exposure to the flash memory market that SanDisk dominates. Lexar's retail distribution network is similar to SanDisk's (see, 8/1/06, "Flash Free-for-All?").

Now SanDisk's prices are falling. Its fourth quarter average price per megabyte sold declined 62% on a year-over-year basis.

It might not get better in the first three months of 2007, either. CEO Harari warned of seasonally lower lower retail sales and a "decline in margins due to the prevailing challenging market pricing for flash memory," according to the press release.

Investors sold the stock 7.5% to $39.62 in early afternoon trading on the Nasdaq.

“SanDisk delivered a solid quarter, but management's outlook was as shaky as we can remember,” Merrill Lynch analyst Sidney Ho wrote in a research note. “Industry oversupply in the first half of the year has limited any visibility into pricing for the year.”

Arik Hesseldahl in New York contributed to this report

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