SanDisk earnings: Watch those margins

July 19, 2007, 7:00 AM UTC

SanDisk (SNDK)

-Average analyst estimate, according to Thomson Financial: profit of $.15 per share on $790 million in revenue

SanDisk (SNDK) has enjoyed a nice little run over the past few months – shares climbed almost 12 percent during the second quarter – but as the flash memory maker’s earnings approach today, there’s reason to feel queasy about the company’s profit margins. And like it or not, profit margins are what Wall Street typically watches most closely when this company reports its results today – more than pure revenues or even raw profit growth.

Milpitas, Calif.-based SanDisk designs NAND flash memory, the sort of tiny, durable storage that holds content for Apple’s (AAPL) iPhone and iPod, and for cell phones and digital cameras. NAND flash has a bright future; it’s increasingly being built into everything from compact camcorders to laptops. The business of designing and manufacturing flash memory has become so competitive that it seems like every chip industry heavyweight has some sort of stake in the business. Intel (INTC) and Micron Technology (MU) are working together on flash, as are SanDisk and Toshiba. Samsung, meanwhile, is the biggest player in the flash space.

With all that competition comes falling prices –great for shoppers, but not so great for profits. Some of the higher capacity flash available in retail stores, the 2-gigabyte cards, can be found for about $20 each – and SanDisk 2 GB cards are selling on for as little as $13.45. (In the past, I’ve found the test to be a decent gauge of how well flash prices are holding up. And these days, the price wars on Amazon are some of the most competitive I’ve seen.)

That alone, though, isn’t enough to cause real worry about flash prices. Intel provided the real cause for concern during its earnings call on Tuesday.

During Intel’s earnings call, CFO Andy Bryant blamed the intense price competition in NOR and NAND flash for the drop in the company’s profit margins. “No one has even asked about the Q2 margin, but if you look under the covers, what you find is the gross margin percentage for the microprocessor business was as expected, and flash took the company down a point,” Bryant said. That little detail suggests it was a very tough quarter for flash memory makers like SanDisk to eke out healthy profits.

Some analysts seem to have shrugged aside those profit hints; JP Morgan upgraded SanDisk on Wednesday on signs that flash prices are beginning to stabilize in the third quarter. But if history is any guide, the pack on Wall Street will get spooked if margins look particularly slim. Traditionally, the masses of SanDisk investors are easily spooked by margin fluctuations.

Long-term, things look good for SanDisk; it has a war chest of valuable flash memory patents and a knack for striking partnerships that allow it to get chips manufactured at a lower cost than most competitors. The trends toward more flash in laptops, phones and camcorders are also encouraging.

Investors who believe in the stock can encourage themselves with those thoughts – but don’t be surprised if other investors prove a bit more fickle if profits were slim in the second quarter.

(Last but not least, a disclaimer: As a technology journalist, I don’t invest in individual tech stocks, so I have no personal financial interest in SanDisk or its competitors.)

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