Lexar Hoping to Reverse Losses Through ‘Major Changes’

Lexar said Q4 sales rose 6% to $188.5 million. But the firm posted a $63.3 million loss (-80 cents per share) vs. a $18.9 million profit (21 cents) a year ago. For the year, Lexar said, revenue soared 65% to $681.7 million; however, Lexar posted a loss of $75.5 million (-96 cents) vs. a $39.9 million profit (49 cents) in 2003. In one of the firm’s few financial positives for the quarter, CFO Brian McGee said revenue from a new line of Kodak-branded Lexar memory products soared 120% from the 3rd quarter.

But Lexar’s main positive news came as it won more than $380 million in damages from Toshiba after a 6-week trial in Cal. Superior Court, San Jose. The jury found Toshiba liable for breach of fiduciary duty and theft of flash-related trade secrets. The court found Toshiba’s actions “oppressive, fraudulent or malicious, which supports an award of punitive damages,” Lexar said. After the conference call, Lexar said the jury ruled that Toshiba should pay Lexar $84 million more in punitive damages, boosting the total award to $465.4 million, which Lexar said was “believed to be the largest IP verdict in California history and the 3rd largest IP verdict in the United States.”

Stang called the initial verdict a “first step,” noting that a Lexar case for patent infringement against Toshiba on more than 10 of its patents remained pending. But he called the San Jose ruling a “big” first step and “a huge victory for Lexar in our battle to stop others from using our proprietary technology.” Stang said “we also believe it is a harbinger of what will come as our federal patent case against Toshiba, Fuji and others proceeds to trial.” Lexar expects that trial to start next year.

On Fri., Toshiba vowed to fight, saying the jury’s decision was made “in error.” The firm said “we plan to pursue all available legal avenues to correct it” and “at this time, [it] does not plan to revise projections” for fiscal 2004 because of the issue.

Weaker Lexar earnings performance were blamed partly on the firm’s previously announced decision to record revenue from all retail customers on a sellthrough basis rather than from certain retail customers on a sell-to basis, effective Oct. 1. Stang told analysts some $9 million of the company’s Q4 loss came from additional revenue deferral.

But Stang said Lexar also was hurt by “challenging market dynamics at retail” in Q4. Those dynamics “resulted in greater than anticipated price reductions, promotional activities and price protection obligations, as well as write-downs to our inventory and higher than anticipated operating expenses.” Stang told analysts “upwards of $40 million of our loss” in Q4 “can be attributed to” price cuts and price protection. On that front, he said, the company had a “higher sales mix of high capacity [memory] cards in the quarter” and its “margins were lower on these cards.” Lexar also “saw higher levels of rebate redemptions than we planned on these products,” he said, adding, “in hindsight, we believe we underpriced the market on these products in Q4.”

Also hurting Lexar were “cost declines that we expected later in the quarter Q4 and also into Q1 which did not materialize,” Stang said. He also said Lexar was hurt by “unexpected price declines generally -- especially on our lower capacity cards.” Stang noted that “a little over 65% of our price protection in Q4 was for cards 256 megabytes or less.” Lexar also “got off track internationally” -- especially in Japan but also in Europe, which saw “pretty poor growth,” he said.

Stang said the company had begun to address the problems and expected to make “major developments in our action plan this quarter.” Those steps, he said, included “streamlining our logistics to improve inventory management, adjusting our marketing and sales strategies to emphasize profitability [over growth], reducing costs in both manufacturing and operating expenses, manufacturing additional form factors and strengthening our internal processes and controls.”

Lexar is launching its own Memory Stick Pro products this quarter. Stang said this line “comes with a much lower cost structure.” He said the company is “focusing our product mix to emphasize more [of its] premium products.”

Stang said there are “not enough” flash memory supplies “to go around today” -- a problem he traced to Lexar’s and other firms’ failure to anticipate stronger demand. Demand outpaced expectations thanks to the popularity of digital music players such as Apple’s iPod and handheld game devices such as Sony’s PlayStation Portable (PSP), he said. The flash shortage will ease as Samsung introduces new products and starts a new production line devoted to flash memory “probably by the end of Q3,” Stang said. New entrants in the flash memory arena also should help, he said. But he predicted Samsung and Toshiba will remain the flash market leaders, at least this year.

Lexar “adjusted the management structure within the company to improve our execution and better serve our customers,” he said. Lexar hired Colin Kavanagh, ex- ModusLink, as vp-worldwide operations, and named Sandy Duncan, ex-Microsoft, vp-managing dir.-Europe, Middle East and Africa, a new position. Duncan managed Microsoft’s European retail division and helped launch the Xbox videogame console there.

Stang said Lexar expected to report sales of “at least $200 million” and a 14-18 cents loss per diluted share for the first quarter including costs associated with legal wrangles and a 2-6 cents loss excluding those legal costs. But Stang declined to give a fiscal year earnings estimate “due to the rapidly changing market conditions.”

Lexar plans to file its 10-K with the SEC by March 31, after an extension, McGee said, adding that the company’s head count increased to 274 at the end of Q4 from 232 in Q3. Lexar shares were up 99.31% at $6.32 in late afternoon trading Fri.