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SanDisk Faces Solid Problems

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Flash-memory maker SanDisk (Nasdaq: SNDK  ) saw its third-quarter earnings fall by a disastrous 28% even though revenue was in line with analyst expectations. So what happened?

The numbers
While the company's net income fell drastically, revenue increased by 15% to $1.4 billion. Gross profits also took a haircut of 3% from the year-ago quarter to $625.6 million. The fall in profits was from a 37% decline in the average selling price per gigabyte of storage. Moreover, even though product sales had effectively increased, the decline in license and royalty income pulled net earnings down further.

On the margins front, SanDisk disappointed with gross margin crashing down to 44.2% from loftier 52% levels. This fall was due to a combination of unfavorable yen exchange rates, product price declines, increased noncaptive usage, and start-up costs.

Net income margin also went down drastically from 26% to just 16.5% due to increased income tax expenditure and higher research and development expenses. What's even worse is that this declining trend has been consistent since the third quarter of last year.

Solid business
In May 2011, SanDisk acquired solid-state-drive maker Pliant Technology for $327 million in order to further expand into the high-margin, high-growth business of enterprise-class SSD flash storage. Subsequently, the company has been successful in this space and has seen its enterprise SSDs qualify in three out of seven Tier 1 storage OEMs. This in turn has contributed strongly to the company's revenue.

From a demand standpoint, the future of NAND flash memory looks very bright. NAND is a type of solid-state memory that is primarily used in USB flash drives, memory cards, and solid-state drives. But the key growth driver here is the fact that NAND-based memory cards are used in mobile devices such as smartphones, tablets, and ultrabooks. They're even used on an enterprise scale for servers and storage systems.

For SanDisk, mobile revenues grew well from the previous year's quarter due to increased sales of embedded products. This was on the back of growth in the mobile market, which includes tablets and phones such as those of Apple (Nasdaq: AAPL  ) .

The tablet market did witness a considerable shakeout during the quarter, but nevertheless retail and OEM mobile segments managed to deliver a strong 25% growth in revenue from the same period last year.

The company's retail sales also grew continuously since the first quarter of 2010, backed by strong demand from emerging markets.

However, the party-pooper here is the economy, which seems to be slipping further into despair.

Economic woes
SanDisk is not the only flash-storage device maker that's trapped in the throes of an economic slowdown. High-performance solid-state drive and storage memory maker OCZ (Nasdaq: OCZ  ) also reported solid revenue in its latest quarter, but failed to deliver on the bottom line. And then there is the infamous "c" word. That's right: competition.

Solid state of competition
SanDisk is not the only one producing solid-state memory products. It also faces competition from other small and large players. These include STEC (Nasdaq: STEC  ) manufacturer of enterprise SSDs, chip giant Intel (Nasdaq: INTC  ) and OCZ.

In addition, let's not forget traditional hard disk manufacturers like Western Digital (NYSE: WDC  ) and Seagate (Nasdaq: STX  ) , who are making faster traditional and hybrid hard disk drives at much cheaper rates.

The Foolish bottom line
Despite the slowdown in the economy, flash memory will probably continue to be in demand because of the widespread use of tablets and smartphones. And then there is the demand for solid-state drives which, according to Gartner, is set to grow as much as 70% to 90% in the next five years. So from a long-term perspective, SanDisk does look like a good bet. However, it has to deal with a lot of competition in the days ahead. Fools should consider tracking SanDisk for the long term.

Fool contributor Keki Fatakia does not own shares in any of the companies mentioned in this article. The Motley Fool owns shares of Intel, Apple, and Western Digital. The Fool owns shares of and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Intel and Apple. Motley Fool newsletter services have also recommended creating bull call spread positions in Apple and Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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