Lexar Media Holds The Right Cards

Amid a desolated tech landscape, the digital camera business is turning out to be a bright spot. According to market researcher IDC, U.S. sales will climb by more than 18% this year to 12.8 million units. And almost all those cameras need flash memory cards.

It's just the moment that Lexar Media was created for. Launched in 1996 as a spinoff from chipmaker Cirrus Logic, Lexar's sales have exploded, reaching $175 million in fiscal 2002, and they have been growing at an average annualized rate of 125% over the past five years. That's good enough to place it in the fourth place on our first list of the 25 Fastest-Growing Tech Companies in the U.S.

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And after years of losses, Lexar is finally profitable, earning 5 cents a share last year. That compares to an 82-cent per share loss in fiscal 2001. Analysts surveyed by First Call Thomson Financial are bullish, expecting a 30-cent per share profit for 2003.

There is still plenty of room to grow revenue. Semico Research, a chip industry research firm in Scottsdale, Ariz., reckons that $2 billion worth of the little cards were sold worldwide last year, and that sales should reach $3.3 billion this year and $12 billion by 2006. The majority of those cards are being sold for use with digital cameras.

The market could get even bigger as flash memory use expands beyond the camera market. Slots for flash cards are appearing in PDAs and music players. Palm in the last year has adopted a type of flash memory card--Secure Digital cards--as a standard. Microsoft is also using SD cards, though not exclusively. Some PC makers, including Dell, have laid out plans to phase out floppy disk drives in favor of flash memory card slots on their notebooks. And in the coming year, cards will start appearing in some mobile phones.

Historically, the flash memory market has been divided between SanDisk of Sunnyvale, Calif., and Japan's Toshiba. The two companies developed their own proprietary format. SanDisk invented the CompactFlash card, which is about the size of a small box of matches. Toshiba favored its SmartMedia, which looks like a floppy disk that was shrunk in a washing machine. Together they sold most of the 1.7 million units of removable flash sold in 1997.

Before breaking away from Cirrus Logic, Lexar developed controller parts for SanDisk and had Toshiba in its stable of investors. Its first CompactFlash cards, introduced late in 1997, were faster and held more data--up to 32 megabytes--than others on the market. But it also doubled the capacity on its SmartMedia-compatible cards when it introduced a 16-MB card in mid-1998.

Chief Executive EricStangEric Stang says the secret to Lexar's success is its controllers, the brains of the card. "The controllers have allowed us to bring out cards that do things that our competitors can't do," Stang says.

It wasn't long before Epson and Eastman Kodak were offering the cards bundled with their digital cameras. Low-capacity cards would sell inside the box with the camera in hopes that buyers would run out and buy cards with more capacity. The strategy worked, and similar deals followed. Lexar Media is now the exclusive supplier of flash cards for Nikon's Coolpix line of digital cameras.

Lexar was founded to be format-agnostic. It manufactures two types of cards: CompactFlash cards and Memory Stick cards under license from Sony. It doesn't own its own factory but has its cards manufactured under contract by Taiwan's United Microelectronics. Other formats it resells under its own brand name, including Toshiba's Secure Digital card and the new xD Picture card produced by Olympus, another Lexar investor.

Stang's strategy is to develop Lexar as a retail brand. Its cards are available at major retailers, including Wal-Mart Stores, Target, CompUSA and Circuit City. He also expects to increase licensing revenue, which last year amounted to $17 million, or about 10% of revenue.

The image quality on digital images is improving every day. But better pictures mean more data to record, which slows cameras down between shots. Stang says Lexar's cards are designed to be faster than those of its competitors, though rival SanDisk has recently been speeding up its own cards.

Another trend in flash memory bears watching: Card capacities continue to increase, and prices continue to fall. A study by IDC pegged the price per megabyte at 45 cents last year and forecast it would drop to 10 cents per megabyte by 2006.

Analyst Paul Coster of J.P. Morgan says that in the short run Lexar can stand the hit by making up the difference on volume. He is forecasting 100% growth in total megabyte shipments this year, and that will be offset by a decline in the per-megabyte price of about 30% to 40%. "We can live with that," he says.