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THE DAY AHEAD: How Micron Electronics beat estimates (it wasn&#039t PC sales)

Micron Electronics (Nasdaq: MUEI) handily topped estimates Monday with fourth quarter earnings of 14 cents a share so that must mean its PC business is doing just fine. Well, not quite. Micron's SpecTek memory business is providing the bottom-line boost.

Memory business? No, we don't have the wrong Micron.



Micron Electronics: Will it be a PC contender?



Micron Electronics is a subsidiary of Micron Technology (NYSE: MU), the dynamic random access (DRAM) memory giant, but Micron -- the PC maker -- has a small, yet very profitable memory business in SpecTek.

The SpecTek business is an afterthought, but that's how Micron Electronics delivered a big upside surprise last night. SpecTek takes defective DRAM, refurbishes it, retests it, and then resells it. SpecTek products wind up in digital answering machines and similar products.

Because DRAM prices were stable, SpecTek margins soared in the quarter. SpecTek gross margins improved to 46.1 percent from 38.8 percent in the third quarter. PC margins improved a bit to 17.6 percent, but not nearly enough to double Wall Street estimates.

The PC business was essentially flat and total revenue was down slightly from a year ago to $333 million.

In the PC market, Micron doesn't have the marketing to lure consumers and concentrates on the small business market. And since most folks aren't looking for the hottest PC these days, Micron -- which caters to power users -- is having trouble. The company, which called its consumer business "challenging," is bundling Internet service and recently bought a Web hosting company to diversify its revenue base. Those initiatives helped the bottom line a little.

But if you were picky, you'd find lots to worry about when it comes to Micron's PC business. Unit shipments were up 4.3 percent sequentially in the fourth quarter, but revenue fell 4.6 percent as average selling prices fell 8.3 percent.

Translation: SpecTek's profit hides a lot of flaws.

Is this a Micron conspiracy to boost the bottom line? No. The institutional guys have known about SpecTek all along and admit that the DRAM business has no business being with Micron PC. But it does boost the bottom line.

Louis Mazzucchelli, an analyst with Gerard Klauer Mattison, estimated that more than 70 percent of Micron's profit comes from SpecTek even though the unit doesn't represent the bulk of sales. The fourth quarter numbers (full statement) illustrate the point. Micron's SpecTek division revenue increased 40.9 percent from the third quarter and 108.1 percent year-over-year.

Analysts said if you were to back out the memory business, Micron Electronics wouldn't have doubled estimates.

"We've known about SpecTek and the company breaks it all out, but no one notices it," said Mazzucchelli. "Micron doesn't want you to notice it. They're trying to be a PC company."

Micron, which is trying to evolve into a significant direct PC player, has SpecTek as a vestige of its contract equipment manufacturing business, said James Poyner, an analyst with CIBC World Markets.

Poyner said strategically it would make sense to lump SpecTek with Micron Technology, but the DRAM maker doesn't want it. And a spin-off wouldn't get institutional interest, said Poyner.

Luckily, for Micron Electronics, SpecTek carries its weight -- and the bottom-line.