Form 10-Q/A
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark one)
X Quarterly report pursuant to Section 13 or 15(d) of the
- ------------ Securities Exchange Act of 1934 for the quarterly period ended
March 31, 1998
OR
Transition report pursuant to Section 13 or 15(d) of the Securities
- ------------ Exchange Act of 193 for the transition period from ___ to ___
Commission File Number 0-26734
SanDisk Corporation
(Exact name of registrant as specified in its charter)
Delaware 77-0191793
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
140 Caspian Court, Sunnyvale, California 94089
(Address of principal executive offices) (Zip code)
(408) 542-0500
(Registrant's telephone number, including area code)
N/A
(Former name, former address, and former fiscal year, if
changed since last report.)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of March 31, 1998
Common Stock, $0.001 par value 26,126,629
------------------------------ ----------
Class Number of shares
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SanDisk Corporation
Index
PART I. FINANCIAL INFORMATION
Page No.
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets
March 31, 1998 and December 31, 1997........................ 3
Condensed Consolidated Statements of Income
Three months ended March 31, 1998 and 1997.................. 4
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 1998 and 1997.................. 5
Notes to Condensed Consolidated Financial Statements............ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 24
Item 2. Changes in Securities.......................................... 24
Item 3. Defaults upon Senior Securities................................ 24
Item 4. Submission of Matters to a Vote of Security Holders............ 24
Item 5. Other Information.............................................. 24
Item 6. Exhibits and Reports on Form 8-K............................... 25
Signatures..................................................... 27
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PART I. FINANCIAL INFORMATION
SanDisk Corporation
Condensed Consolidated Balance Sheets
(In thousands)
ASSETS March 31, December 31,
1998 1997*
-------- --------
(unaudited)
Current Assets:
Cash and cash equivalents $ 10,642 $ 20,888
Short-term investments 116,862 114,037
Accounts receivable, net 18,567 19,352
Inventories 20,436 15,648
Deferred tax assets 17,060 17,060
Prepaid expenses and other current assets 882 1,406
-------- --------
Total current assets 184,449 188,391
Property and equipment, net 16,366 15,892
Investment in foundry 40,284 40,284
Deposits and other assets 1,023 900
-------- --------
Total Assets $242,122 $245,467
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 5,318 $ 14,111
Accrued payroll and related expenses 3,527 4,674
Other accrued liabilities 9,415 7,341
Deferred revenue 26,540 27,967
-------- --------
Total current liabilities 44,800 54,093
Stockholders' Equity:
Common stock 183,041 181,921
Retained earnings 14,281 9,453
-------- --------
Total stockholders' equity 197,322 191,374
Total Liabilities and
======== ========
Stockholders' Equity $242,122 $245,467
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements. * Information derived from the audited Consolidated
Financial Statements.
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SanDisk Corporation
Condensed Consolidated Statements of Income
(In thousands, except per share data; unaudited)
Three months ended
March 31,
1998 1997
------- -------
Revenues:
Product $25,426 $18,194
License and royalty 8,676 3,250
------- -------
Total revenues 34,102 21,444
Cost of sales 17,772 12,965
------- -------
Gross profits 16,330 8,479
Operating expenses:
Research and development 4,331 3,001
Sales and marketing 3,951 2,561
General and administrative 2,044 1,377
------- -------
Total operating expenses 10,326 6,939
Operating income 6,004 1,540
Interest and other income, net 1,339 955
------- -------
Income before taxes 7,343 2,495
Provision for income taxes 2,640 370
======= =======
Net income $ 4,703 $ 2,125
======= =======
Net income per share
Basic $ 0.18 $ 0.09
Diluted $ 0.17 $ 0.09
Shares used in computing
net income per share
Basic 26,019 22,398
Diluted 28,022 24,107
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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SanDisk Corporation
Condensed Consolidated Statements of Cash Flows
(In thousands; unaudited)
Three months ended
March 31,
1998 1997
-------- --------
Cash flows used in operating activities:
Net income $ 4,703 $ 2,125
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation 1,351 812
Accounts receivable, net 785 (1,749)
Inventory (4,788) (2,136)
Prepaids and other assets 401 (258)
Accounts payable (8,793) (874)
Accrued payroll and related expenses (1,147) (371)
Other accrued liabilities 2,074 (666)
Deferred revenue (1,427) (1,251)
-------- --------
Total adjustments (11,544) (6,493)
-------- --------
Net cash used in operating activities (6,841) (4,368)
Cash flows used in investing activities:
Purchases of short term investments (48,984) (14,288)
Proceeds from sale of short term investments 46,284 13,766
Acquisition of capital equipment (1,825) (1,184)
-------- --------
Net cash used in investing activities (4,525) (1,706)
Cash flows from financing activities:
Sale of common stock 1,120 626
-------- --------
Net cash provided by financing activities 1,120 626
-------- --------
Net decrease in cash and cash equivalents (10,246) (5,448)
Cash and cash equivalents at beginning of period 20,888 19,323
======== ========
Cash and cash equivalents at end of period $ 10,642 $ 13,875
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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SanDisk Corporation
Notes to Condensed Consolidated Financial Statements
1. These interim condensed consolidated financial statements are unaudited
but reflect, in the opinion of management, all normal recurring
adjustments necessary to present fairly the financial position of SanDisk
Corporation and Subsidiaries (the "Company") as of March 31, 1998, and
the results of operations and cash flows for the three month periods
ended March 31, 1998 and 1997. Because all the disclosures required by
generally accepted accounting principles are not included, these interim
condensed consolidated financial statements should be read in conjunction
with the audited financial statements and notes thereto in the Company's
annual report on Form 10-K as of, and for the year ended December 31,
1997. The condensed consolidated balance sheet data as of December 31,
1997 was derived from the audited financial statements.
The results of operations and cash flows for the three month period ended
March 31, 1998 are not necessarily indicative of results of operations
and cash flows for any future period.
2. The Company's fiscal year ends on the Sunday closest to December 31, and
each fiscal quarter ends on the Sunday closest to March 31, June 30, and
September 30. The first fiscal quarter of 1998 and 1997 ended on March
29, 1998 and March 30, 1997, respectively. Fiscal year 1997 ended on
December 28, 1997. For ease of presentation, the accompanying financial
statements have been shown as ending on the last day of the calendar
month.
3. The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
4. The components of inventory consist of the following:
March 31, December 31,
1998 1997
-------- --------
(In thousands)
Raw materials $ 4,842 $ 3,289
Work-in-process 10,595 10,340
Finished goods 4,999 2,019
-------- --------
$ 20,436 $ 15,648
======== ========
5. In 1997, the Financial Accounting Standards Board issued Statement No.
128, Earnings per Share. Statement 128 replaced the calculation of
primary and fully diluted earnings per share with the basic and diluted
earnings per share. Unlike primary earnings per share, basic earnings per
share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share. Earnings per share amounts
presented have been restated to conform to the Statement 128
requirements.
The following table sets forth the computation of basic and diluted
earnings per share:
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Three months ended
March 31,
1998 1997
------- -------
(In thousands, except
per share amounts)
Numerator:
Numerator for basic and diluted
net income per share - net income $ 4,703 $ 2,125
======= =======
Denominator for basic net income per share:
Weighted average common shares 26,019 22,398
------- -------
Shares used in computing basic net income
per share 26,019 22,398
======= =======
Basic net income per share $ 0.18 $ 0.09
======= =======
Denominator for diluted net income per share:
Weighted average common shares 26,019 22,398
Employee stock options and warrants
to purchase common stock 2,003 1,709
------- -------
Shares used in computing diluted net income
per share 28,022 24,107
======= =======
Diluted net income per share $ 0.17 $ 0.09
======= =======
6. To preserve its intellectual property rights, the Company believes it may
be necessary to initiate litigation with one or more third parties,
including but not limited to those the Company has notified of possible
patent infringement. In addition, one or more of these parties may bring
suit against the Company.
In March 1998, the Company filed a complaint in federal court against
Lexar Media, Inc. ("Lexar") for infringement of a fundamental flashdisk
patent. Lexar has disputed the Company's claim of patent infringement.
The Company intends to vigorously enforce its patents, but there can be
no assurance that these efforts will be successful.
From time to time the Company agrees to indemnify certain of its
suppliers and customers for alleged patent infringement. The scope of
such indemnity varies but may in some instances include indemnification
for damages and expenses, including attorneys fees. The Company may from
time to time be engaged in litigation as a result of such indemnification
obligations. Third party claims for patent infringement are excluded from
coverage under the Company's insurance policies. There can be no
assurance that any future obligation to indemnify the Company's customers
or suppliers, will not have a material adverse effect on the Company's
business, financial condition and results of operations.
Any litigation, whether as a plaintiff or as a defendant, will likely
result in significant expense to the Company and divert the efforts of
the Company's technical and management personnel, whether or not such
litigation is ultimately determined in favor of the Company. In the event
of an adverse result in any such litigation, the Company could be
required to pay substantial damages, cease the
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manufacture, use and sale of infringing products, expend significant
resources to develop non-infringing technology or obtain licenses to the
infringing technology, or discontinue the use of certain processes.
Accordingly, there can be no assurance that any of the foregoing matters,
or any future litigation, will not have a material adverse effect on the
Company's business, financial condition and results of operations.
7. The Company recorded a provision for income taxes at a 36% effective tax
rate for the first three months of 1998 compared to a 15% effective tax
rate for the same period of 1997. The effective tax rate for the first
three months of 1997 was substantially below the federal statutory rate
due to the utilization of federal and state tax credit carryforwards,
Foreign Sales Corporation tax benefits and a reduction in the deferred
tax asset valuation allowance.
8. The Company has a credit agreement (the Agreement) with a bank, which was
renewed in July 1997. Under the provisions of the Agreement, which
expires in July 1998, the Company may borrow up to $10,000,000 on a
revolving line of credit at the bank's prime interest rate. Amounts under
the revolving line of credit can be applied to the issuance of letters of
credit of up to the full amount of the credit line. At March 31, 1998,
$7,200,000 in letters of credit were outstanding. In addition, under the
Agreement, the Company also has a $15,000,000 foreign exchange contract
line under which the Company may enter into foreign exchange contracts.
No amounts were outstanding under the revolving line of credit portion of
the Agreement and the foreign exchange contract portion of the line at
March 31, 1998. The Agreement contains covenants that require the Company
to maintain certain financial ratios and levels of net worth. The
Agreement prohibits the payment of cash dividends to stockholders.
9. As of January 1, 1998, the Company adopted statement of Financial
Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive
Income." SFAS 130 establishes new rules for the reporting and display of
comprehensive income and its components; however, the adoption of this
Statement had no impact on the Company's net income or stockholders'
equity. SFAS 130 requires unrealized gains or losses on the Company's
available-for-sale securities, which prior to adoption were reported
separately in stockholders' equity, to be included in other comprehensive
income.
Three months ended
March 31,
1998 1997
------- -------
(In thousands)
Net income $ 4,703 $ 2,125
Unrealized gain (loss) on
available-for-sale securities 125 (86)
------- -------
Comprehensive income $ 4,828 $ 2,039
======= =======
Accumulated other comprehensive income, which consists of gains (losses)
on available-for-sale securities, was $168,000 and ($80,000) at March 31,
1998 and 1997, respectively.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Certain statements in this discussion and analysis, including in
particular, the second paragraph under the discussion of product revenues and
the paragraph discussing patent license and royalty revenues, are forward
looking statements based on current expectations and entail various risks and
uncertainties that could cause actual results to differ materially from those
expressed in such forward looking statements. Such risks and uncertainties are
discussed below and in the Company's Form 10-K for the year ended December 31,
1997 under the heading "Risk Factors". Readers are cautioned not to place undue
reliance on these forward looking statements, which speak only as of the date
hereof. The Company undertakes no obligation to update these forward looking
statements to reflect events or circumstances occurring after the date hereof.
The following discussion should be read in conjunction with the Company's
consolidated financial statements and the notes thereto.
Overview
The Company was founded in 1988 to develop and market flash data
storage systems. The Company sells its products to the consumer electronics and
industrial/communications markets. During the course of 1997, the percentage of
the Company's product sales attributable to the consumer electronics market,
particularly sales of CompactFlash for use in digital camera applications,
increased substantially. This increase in sales to the consumer market resulted
in a shift to lower capacity products, which typically have lower average
selling prices and gross margins than higher capacity products. In addition,
these products are frequently sold into the retail channel, which usually has
shorter customer order lead-times than the other channels used by the Company,
thereby decreasing the Company's ability to accurately forecast future
production needs. Subject to continued market acceptance of its CompactFlash
products, the Company believes these products will continue to represent a
majority of the Company's sales as the popularity of consumer applications,
including digital cameras, increases. The percentage of sales attributable to
orders received and fulfilled in the same quarter has increased over time and,
in response, the Company is continuing to work to shorten its manufacturing
cycle times.
The Company's operating results are affected by a number of factors
including the volume of product sales, the timing of significant orders,
competitive pricing pressures, the ability of the Company to match supply with
demand, changes in product and customer mix, market acceptance of new or
enhanced versions of the Company's products, changes in the channels through
which the Company's products are distributed, timing of new product
announcements and introductions by the Company and its competitors, the timing
of license and royalty revenues, fluctuations in product costs, availability of
foundry capacity, variations in manufacturing cycle times, fluctuations in
manufacturing yields and manufacturing utilization, increased research and
development expenses and exchange rate fluctuations. In addition, as the
proportion of the Company's products sold for use in consumer electronics
applications increases, the Company's revenues may become subject to seasonal
declines in the first quarter of each year. See "Risk Factors - Fluctuations in
Operating Results" and "- Seasonality."
Beginning in late 1995, the Company adopted a strategy of licensing its
flash technology, including its patent portfolio, to selected third party
manufacturers of flash products. To date, the Company has entered into patent
cross-license agreements with five major companies, and it intends to pursue
opportunities to enter into additional licenses. The Company's current license
agreements provide for the payment of license fees, royalties, or a combination
thereof, to the Company. The timing and amount of these payments can vary
substantially from quarter to quarter, depending on the terms of each agreement
and, in some cases, the timing of sales of products by the other parties. As a
result, license and royalty revenues have fluctuated significantly in the past
and are likely to continue to fluctuate in the future. Given the relatively high
gross margins associated with license and royalty revenues, gross margins and
net income are likely to fluctuate more with changes in license and royalty
revenues than with changes in product revenues.
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SanDisk markets its products using a direct sales organization,
distributors, manufacturers' representatives, private label partners, OEMs and
retailers. The Company expects that sales through the retail channel will
comprise an increasing share of total revenues in the future, and that a
substantial portion of its sales into the retail channel will be made to
participants that will have the right to return unsold products. The Company
recognizes revenues from these sales when the products are sold to the end
customers.
Historically, a majority of the Company's sales have been to a limited
number of customers. The Company expects that sales of its products to a limited
number of customers will continue to account for a substantial portion of its
product revenues for the foreseeable future. The Company has also experienced
significant changes in the composition of its customer base from year to year
and expects this pattern to continue as market demand for such customers'
products fluctuates. The loss of, or significant reduction in purchases by major
customers, could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Risk Factors - Customer
Concentration."
Due to the emerging nature of the Company's markets and certain planned
product transitions, the Company has had difficulty forecasting future inventory
levels required to meet customer demand. As a result of both contractual
obligations and manufacturing cycle time, the Company has been required to order
wafers from its foundries several months in advance of the ultimate shipment of
its products. Under the Company's wafer supply agreements, there are limits on
the number of wafers the Company can order and the Company's ability to change
that quantity is restricted. Accordingly, the Company's ability to react to
significant fluctuations in demand for its products is limited. As a result, the
Company has not been able to match its purchases of wafers to specific customer
orders and therefore the Company has from time to time taken write downs for
potential excess inventory purchased prior to the receipt of customer orders.
These adjustments decrease gross margins in the quarter reported and have
resulted, and could in the future result, in fluctuations in gross margins on a
quarter to quarter basis. See "Risk Factors - Fluctuations in Operating
Results."
Export sales are an important part of the Company's business. While a
majority of the Company's revenues from sales to Asian countries are derived
from OEM customers who plan to export their products to countries outside of
Asia, the Asian economic crisis may adversely effect the Company's revenues to
the extent that demand for the Company's products in Asia declines. Given the
recent economic conditions in Asia and the weakness of many Asian currencies
relative to the United States dollar, the Company's products may be relatively
more expensive in Asia, which could result in a decrease in the Company's sales
in that region. The Company may also experience pressure on its gross margins as
a result of increased price competition from Asian competitors. While most of
the Company's sales are denominated in U.S. Dollars, the Company invoices
certain Japanese customers in Japanese Yen and is subject to exchange rate
fluctuations on these transactions. To date, a portion of the Company's
purchases of wafers, which constitute a significant part of its cost of goods
sold, have been denominated in Japanese Yen. While this percentage has been
decreasing, exchange rate fluctuations can affect the Company's business,
financial condition and results of operations. See "Risk Factors Risks
Associated with International Operations."
For the foreseeable future, the Company expects to realize a
significant portion of its revenues from recently introduced and new products.
Typically new products initially have lower gross margins than more mature
products because the manufacturing yields are lower at the start of
manufacturing each successive product generation. In addition, manufacturing
yields are generally lower at the start of manufacturing any product at a new
foundry, such as USIC and NEC. As a result of these factors, the Company expects
that product gross margins may decline in the near term from the levels
experienced in 1997, and product gross margins are expected to be subject to
fluctuation for the foreseeable future. Moreover, there can be no assurance that
such products or processes will be successfully developed by the Company or that
development of such processes will lower manufacturing costs. In addition, the
Company anticipates that price competition will increase in the future, which
will likely result in decreased average
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selling prices and lower gross margins. See "Risk Factors -Manufacturing Yields"
and "- Declining Average Sales Prices."
The Company is aware of problems associated with computer systems as
the year 2000 approaches. Year 2000 problems are the result of common computer
programming techniques that result in systems that do not function properly when
manipulating dates later than December 31, 1999. The issue is complex and wide
ranging. The problem may affect transaction processing computer applications
used by the Company for accounting, distribution, manufacturing, and planning.
The problem may also affect embedded systems such as building security systems,
machine controllers and production test equipment. Year 2000 problems with these
systems may affect the ability or efficiency with which the company can perform
many significant functions, including but not limited to: order processing,
material planning, product assembly, product test, invoicing, and financial
reporting. In addition, the problem may affect the computer systems of vendors
and customers, disrupting their operations. Year 2000 problems with the
Company's business partners may impact the Company's sources of supply and
demand.
The Company is currently in the process of upgrading its core
management information systems that are known to not be Year 2000 compliant. The
Company believes that these upgrades will be completed before the end of 1998.
These upgrades are intended to address the Year 2000 issues with respect to the
internal budgeting, financial planning, material planning, sales order
processing, accounting, inventory control, shop floor control, and purchasing
business processes. The Company has also initiated a formal Year 2000 Risk
Management program to identify, and mitigate to the best of its ability, any
remaining internal and external risks associated with the Year 2000 problem. The
cost of the Year 2000 project related to upgrading the Company's core management
information system is estimated to be $1.2 million. Of this, the Company
estimates that approximately $400,000 is attributable to the purchase of new
software, which will be capitalized. The costs associated with the other Year
2000 risks have not been quantified.
The costs and time schedule for the Year 2000 problem abatement are
based on management's best estimates for the implementation of its new
management information system. These were derived utilizing numerous
assumptions, including that the most significant Year 2000 risks have already
been identified, that certain resources will continue to be available, that
third party plans will be fulfilled, and other factors. However, there can be no
guarantee that these estimates will be achieved or that the anticipated time
schedule will be met and actual results could differ materially from those
anticipated. Any year 2000 compliance problem of either the Company, or its
suppliers or customers could materially adversely affect the Company's business,
results of operations, financial condition, and prospects. See "Risk Factors
Year 2000 Compliance."
Results of Operations
PRODUCT REVENUES. SanDisk's product revenues were $25.4 million in the
first quarter of 1998, up $7.2 million or 40% from the same period of 1997.
During the three month period ended March 31, 1998, units shipped increased 86%
from the same period of 1997. The largest increase came from sales of
CompactFlash products primarily for use in digital cameras and other consumer
electronics applications. Average selling prices declined 21% in the first
quarter of 1998 compared to the same period in 1997 primarily due to competitive
pricing in the market. The Company anticipates that CompactFlash and other small
form factor products will continue to represent the major portion of its sales
as consumer applications such as digital cameras become more popular. Sales of
these products generally have lower average selling prices and gross margins
than the Company's higher capacity products FlashDisk and FlashDrive products.
The mix of products sold varies from quarter to quarter and may vary in the
future, affecting the Company's overall average selling prices and gross
margins.
The Company entered 1998 with limited bookings visibility, particularly
in Japan. However, bookings strengthened late in the first quarter. Although the
Company has limited visibility as to customer
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orders, the Company expects product revenues to increase in the second quarter
of 1998 relative to the first quarter, if this recent bookings trend continues.
Due to a number of factors described herein and in "Risk Factors," the Company's
ability to adjust its operating expenses is limited in the short term. As a
result, if product revenues are lower than anticipated, the Company's results of
operations will be adversely affected. See "Risk Factors-Fluctuations in
Operating Results" and "Seasonality."
While SanDisk has been successful winning design-ins for many new
applications, it generally takes several quarters for these new customer
products to reach the market. It is difficult to predict the timing of related
new product introductions and future sales volumes from these design-ins as the
success of the customers' products is uncertain. There can be no assurance the
applications will be developed and marketed successfully or at all. As new
markets develop, competition is expected to increase, which will likely cause
average selling prices and gross margins to decline.
Export sales represented 43% of product revenues in the first quarter
of 1998 compared with 40% for the same period of the previous year. The Company
expects international sales to continue to represent a significant portion of
revenues. The Company's top ten customers represented 72% of product revenue in
the first quarter of 1998 compared to 66% for the same period in 1997. The
Company expects that sales to a limited number of customers will continue to
represent a substantial portion of its revenues for the foreseeable future.
LICENSE AND ROYALTY REVENUES. The Company currently earns patent
licenses and royalty revenues under five cross license agreements, with Hitachi,
Intel, Samsung, Sharp and Toshiba. License and royalty revenue from patent cross
license agreements was $8.7 million in the first quarter of 1998, up $5.4
million from $3.3 million in the same period of 1997 primarily due to license
and royalty revenues earned under agreements with Hitachi, Toshiba and Sharp
which were entered into in the second half of 1997. Revenues from patent
licenses and royalties increased to 25% of total revenues in the first quarter
of 1998 from 15% in the same period of the previous year. The Company currently
expects that revenues from patent licenses and royalties will be in the range of
$7.0 to $7.5 million in the second quarter of 1998 due to the timing of revenue
recognition under the various agreements.
GROSS PROFITS. In the first quarter of 1998, gross profits increased to
$16.3 million or 48% of total revenues from $8.5 million or 40% of total
revenues for the same period in the previous year. The growth in overall gross
profits for the first three months of 1998 was primarily due to an increase in
license and royalty revenue. Product gross margins increased slightly to 30% in
the first quarter of 1998 compared to 29% for the same period of 1997. The
increase was due to a mix shift to higher capacity CompactFlash cards and lower
per unit manufacturing costs in the first quarter of 1998. While the Company has
ongoing efforts to reduce manufacturing costs, there can be no assurance that
these cost reductions will be adequate to offset average selling price declines
due to anticipated increased competition.
RESEARCH AND DEVELOPMENT. Research and development expenses consist
principally of salaries and payroll related expenses for design and development
engineers, prototype supplies and contract services. Research and development
expenses increased $1.3 million or 44% in the first quarter of 1998 compared to
the same period in 1997. The increase in research and development expenses was
primarily due to an increase in salaries and payroll related expenses associated
with additional personnel, increased project related expenses and increased
depreciation due to capital equipment additions. Research and development
expenses represented 13% of total revenues for the first quarter of 1998
compared to 14% for the same periods in 1997. The Company expects research and
development expenses to continue to increase in absolute dollars to support the
development of new generations of flash data storage products and the addition
of new foundries to manufacture the Company's products.
SALES AND MARKETING. Sales and marketing expenses include salaries and
payroll related expenses, sales commissions and travel expenses for the
Company's sales, marketing, customer service and applications engineering
personnel. These expenses also include other selling and marketing expenses such
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as independent manufacturer's representative commissions, advertising and
tradeshow expenses. Sales and marketing expenses increased $1.4 million or 54%
in the first quarter of 1998 compared to the same period in 1997. The increase
in sales and marketing expenses for the three month period ended March 31, 1998
was primarily due to increased marketing and sales expenses related to the
development of the retail channel for the Company's products and an increase in
salaries and payroll related expenses associated with additional personnel.
Sales and marketing expenses represented 12% of total revenues in the first
quarter of 1998 and 1997. The Company expects sales and marketing expenses to
increase in absolute dollars as sales of its products grow and it attempts to
develop the retail channel for its products both domestically and
internationally.
GENERAL AND ADMINISTRATIVE. General and administrative expenses include
the cost of the Company's finance, information systems, human resources,
shareholder relations, legal and administrative functions. General and
administrative expenses increased $0.7 million or 48% in the first quarter of
1998 compared to the same period of 1997. The increase was primarily due to
increased salaries and payroll related expenses associated with additional
personnel and higher consulting expenses related to the planned implementation
of the Company's new management information system. General and administrative
expenses represented 6% of total revenues in the three month periods ended March
31, 1998 and 1997. The Company expects general and administrative expenses to
increase in absolute dollars as these functions grow to support the overall
growth of the Company. General and administrative expenses could also increase
substantially in the future in connection with the Company's efforts to defend
its patent portfolio. See "Risk Factors-Patents Proprietary Rights and Related
Litigation."
INTEREST AND OTHER INCOME, NET. Interest and other income, net,
increased $384,000 in the first quarter of 1998 compared to the same period of
1997. This increase was primarily due to higher investment balances as a result
of the investment of proceeds from the sale of common stock in the Company's
November 1997 follow on public offering.
PROVISION FOR INCOME TAXES. The Company recorded a provision for income
taxes at a 36% effective tax rate for the first three months of 1998 compared to
a 15% effective tax rate for the same period of 1997. The effective tax rate for
the first three months of 1997 was substantially below the federal statutory
rate due to the utilization of federal and state tax credit carryforwards,
foreign sales corporation tax benefits and a reduction in the deferred tax asset
valuation allowance. The Company's 1998 effective tax rate is substantially
higher than its 1997 rate due to the utilization of all remaining federal and
state tax credit carryforwards in 1997.
Liquidity and Capital Resources
As of March 31, 1998, the Company had working capital of $139.6
million, which included $10.6 million in cash and cash equivalents and $116.9
million in short term investments. The Company has a line of credit facility
with a commercial bank under which it can borrow up to $10 million at the bank's
prime rate. This line of credit facility expires in July 1998. As of March 31,
1998, the Company had $7.2 million committed under the line of credit facility
for standby letters of credit. The Agreement contains covenants that require the
Company to maintain certain financial ratios and levels of net worth, and
prohibits the payment of cash dividends to stockholders.
Operating activities used $6.8 million of cash during the first three
months of 1998 primarily due to a decline in current liabilities and an increase
in inventories. Investing activities used $4.5 million of cash in the first
three months of 1998 and included net purchases of investments of $2.7 million
and $1.8 million of capital equipment purchases. During the first three months
of 1998, financing activities provided $1.1 million of cash primarily from the
sale of common stock under the SanDisk employee stock purchase and stock option
plans.
Depending on the demand for the Company's products, the Company may
decide to make investments, which could be substantial, in assembly and test
manufacturing equipment or foundry
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capacity to support its business in the future. Management believes the existing
cash and cash equivalents, short term investments and available line of credit,
together with cash flow from operations, will be sufficient to meet the
Company's currently anticipated working capital and capital expenditure
requirements for at least the next twelve months.
Impact of Currency Exchange Rates
The Company currently purchases wafers from Matsushita under purchase
contracts denominated in yen. A portion of the Company's revenues are also
denominated in yen. Foreign exchange exposures arising from the Company's yen
denominated commitments and related accounts payable are offset to the extent
the Company has yen denominated accounts receivable and cash balances. To the
extent such foreign exchange exposures are not offset, the Company enters into
foreign exchange forward contracts to hedge against changes in foreign currency
exchange rates. At March 31, 1998, there were no forward contracts outstanding.
Future exchange rate fluctuations could have a material adverse effect on the
Company's business, financial condition and results of operations.
Risk Factors
FLUCTUATIONS IN OPERATING RESULTS. SanDisk's operating results have
been and are expected to continue to be, subject to quarterly and annual
fluctuations due to a variety of factors. The principal factors that have caused
the Company's operating results to fluctuate in the past several quarters and
may cause the Company's operating results to fluctuate in the future are the
seasonality in sales of products for consumer electronics applications and
unpredictable demand for the Company's products. For example, the Company's
product revenues declined in the first quarter of 1998 and 1997 from the fourth
quarter of the previous years, due to seasonal factors. The Company must order
silicon wafers from its foundries several months prior to the date such wafers
are needed. If the Company overestimates the number of silicon wafers it needs
to fill product orders and as a result builds excess inventories, gross margins
and operating results will be materially adversely affected. If the Company
underestimates the number of silicon wafers required in a particular quarter and
is unable to fulfill customer orders promptly after receipt of an order, the
Company will risk losing potential sales and customers. Since the Company is
selling CompactFlash, its largest volume product, into an emerging consumer
market and is unable to accurately forecast future sales, there will be a
material adverse effect on the Company's operating results if sales fall below
the Company's expectations in a particular quarter and the Company is unable to
reduce its operating expenses. The portion of the Company's quarterly sales
attributable to orders received and fulfilled in the same quarter remains high
and product order backlog fluctuates substantially from quarter to quarter. See
"Seasonality" and "Dependence on Third Party Foundries."
Other factors affecting the Company's operating results and gross
margins include the volume of product sales, competitive pricing pressures, the
ability of the Company to match supply with demand, changes in product and
customer mix, market acceptance of new or enhanced versions of the Company's
products, changes in the channels through which the Company's products are
distributed, timing of new product announcements and introductions by the
Company and its competitors, the timing of license and royalty revenue,
fluctuations in product costs, availability of foundry capacity, variations in
manufacturing cycle time, fluctuations in manufacturing yields and manufacturing
utilization, the ability of the Company to achieve manufacturing efficiencies
with its new and existing products, increased research and development expenses,
exchange rate fluctuations and changes in general economic conditions, including
economic conditions in Asia. All of these factors are difficult to forecast and
these or other factors can materially affect the Company's quarterly or annual
operating results or gross margins.
The Company has increased its expense levels to support its recent
growth, including expenses associated with the expansion of the Company's
in-house assembly and test operations. The Company expects to continue to
increase its operating expenses by hiring additional personnel to support
expected growth, increased marketing efforts and additional research and
development activities. If the Company
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does not achieve increased levels of revenues commensurate with these increased
levels of operating expenses, or if the Company's revenues decrease or do not
meet the Company's expectations for a particular period, the Company's business,
financial condition and results of operations will be materially adversely
affected.
The mix of the Company's products sold varies from quarter to quarter
and will vary in the future, affecting the Company's overall average selling
prices and gross margins. The Company's CompactFlash products, which represent a
significant portion of the Company's product revenues, have lower average
selling prices and gross margins than the Company's higher capacity FlashDisk
and FlashDrive products. The Company expects sales of CompactFlash products will
represent an increasing percentage of product revenues as consumer applications
such as digital cameras become more popular. This shift in product mix, coupled
with lower pricing due to competition, is expected to cause average selling
prices to decline.
The Company has adopted a strategy of cross-licensing its patents to
other manufacturers of flash products. Under such arrangements, the Company
earns license fees and royalties on terms that are individually negotiated. The
timing of recognition of revenues from these payments depends on the terms of
each contract, and, in some cases, on the timing of product shipments by the
third parties. As a result, license and royalty revenue has fluctuated
significantly in the past and is likely to continue to fluctuate in the future.
Given the relatively high gross margins associated with license and royalty
revenue, gross margins and net income are likely to fluctuate more with changes
in license and royalty revenue than with changes in product revenue.
DEPENDENCE ON EMERGING MARKETS AND NEW PRODUCTS. The Company's success
depends to a significant extent upon the development of emerging markets and new
applications for flash data storage systems, as well as on its ability to
introduce commercially attractive and competitively priced products on a timely
basis. The Company believes that continued significant expenditures for research
and development will be required in the future. In particular, the Company
intends to develop new products with increased memory capacity at a lower cost
per megabyte, which the Company believes will be essential to its ability to
remain competitive. In November 1997, the Company introduced a new removable
storage card product family, the MultiMediaCard ("MMC"). MMC is targeted for the
emerging markets for mobile smart phones, advanced pagers and consumer
multimedia devices. MMC will initially be offered in storage capacities of 2MB,
4MB and 8MB. The Company does not expect to generate material revenues from MMC
sales in 1998. There can be no assurance that the Company will successfully
develop any of these new products, that new applications or markets for flash
data storage will develop as expected by the Company, that prospective customers
developing products for any such markets will design the Company's products into
their products and successfully introduce such products, or that products or
technologies developed by others will not render the Company's products or
technologies obsolete or noncompetitive. The failure of new applications or
markets to develop or the failure of the Company's products to be accepted by
the market would have a material adverse effect on the Company's business,
financial condition and results of operations.
INCREASING DEPENDENCE ON CONSUMER PRODUCTS. Product revenues derived
from sales of products for consumer electronics applications, principally
digital cameras, have increased significantly and in 1997 represented the
largest portion of product revenues and units shipped. The Company expects sales
of products for consumer applications to continue to represent the major portion
of product revenues in 1998. There can be no assurance, however, that the
Company will achieve large scale market acceptance for its products in the
consumer electronics market. The Company anticipates that products sold for
consumer applications will generally encounter intense competition and will be
more price sensitive than products sold into its other target markets. In
addition, consumer markets are more likely to experience seasonality of sales,
with potential declines in sales activity during the first quarter of any year.
Because of the large number of OEMs entering the digital camera market, it is
likely that not all of these manufacturers will be successful in achieving
market acceptance of their products. If SanDisk's OEM customers are not
successful in this market, such OEM customers may have excess inventories of
CompactFlash products, which may preclude follow-on orders or result in sales of
their CompactFlash inventories in the open
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market. In addition, if market acceptance of digital cameras is slower than
expected, or if the market for CompactFlash becomes saturated, the Company may
encounter reduced demand for CompactFlash products, declining average selling
prices or product returns, any of which would have an adverse effect on the
Company's results of operations.
The Company anticipates that a greater proportion of its sales to the
consumer electronics market will be made through distributors and to retailers
than is the case with the industrial/communications market. This will be
particularly true if the level of after-market sales of flash memory products
increases. The Company is currently expending significant resources developing a
retail sales channel. The expenditures associated with this development are
likely to precede the realization of significant sales through this channel.
Moreover, the Company has no prior experience in the development or management
of the retail channel or sales through such channel. In addition, a significant
portion of retail sales for consumer applications will be made to distributors
and retail chains, which typically maintain rights to return unsold inventory.
As a result, the Company does not recognize revenues on sales to this channel
until after the products have been sold to end users. If the Company's retail
customers are not successful in this market, there could be substantial product
returns to the Company. The inability to successfully develop and effectively
manage the retail sales channel could have a material adverse effect on the
Company's business, financial condition and results of operations.
SEASONALITY. The Company has experienced and expects to continue to
experience seasonality in its product sales. A significant portion of the
Company's product revenues are derived from the sale of CompactFlash products,
which are sold principally for consumer electronics applications. As a result,
the Company's product sales have been and are expected to be impacted by
seasonal purchasing patterns, with higher sales in the second half of each year
as compared to the first half of each such year. In the past, the Company has
experienced a reduction in order quantities in the first quarter from Japanese
OEM customers, reflecting the fact that most customers in Japan operate on a
fiscal year ending in March and prefer to delay purchases until the beginning of
their next fiscal year. As a result of these factors, product revenues in the
first quarter of 1998 declined 24% from the level in the fourth quarter of 1997.
COMPETITION. The flash data storage markets in which the Company
competes are characterized by intense competition, rapid technological change,
evolving industry standards, declining average selling prices and rapid product
obsolescence. The Company's competitors include many large domestic and
international companies that have greater access to foundry capacity,
substantially greater financial, technical, marketing and other resources,
broader product lines and longer standing relationships with customers than the
Company. The Company's primary competitors include flash chip producers such as
Advanced Micro Devices, Inc. ("AMD"), Hitachi Ltd. ("Hitachi"), Intel
Corporation ("Intel"), Micron Technology, Inc. ("Micron"), Mitsubishi Electronic
Corporation ("Mitsubishi"), Samsung Electronics Company Ltd. ("Samsung"), Sharp
Electronics Corporation ("Sharp") and Toshiba Corporation ("Toshiba"), other
companies using data storage techniques such as socket flash, linear flash and
system flash components, as well as package or card assemblers such as Lexar
Media, Inc. ("Lexar"), M-Systems, Inc. ("M-Systems"), Simple Technology Inc.
("Simple"), SMART Modular Technologies, Inc. ("Smart Modular"), Kingston, TDK,
Matsushita Battery, Inc. ("Matsushita Battery") and Viking Components, Inc. that
combine controllers and flash memory chips developed by others into flash
storage cards. Approximately twenty companies, including Hitachi, Lexar,
Mitsubishi and Micron have been certified by the CompactFlash Association to
manufacture and sell their own brand of CompactFlash, and the Company believes
that other manufacturers will also seek to enter the CompactFlash market in the
future. Competing products promoting industry standards that are different from
SanDisk's CompactFlash product have been announced, including Intel's Miniature
Card, Toshiba's Smart Media (Solid-State Floppy Disk Card), Sony Corporation's
Memory Stick, and Matsushita Battery's recently introduced Mega Storage cards. A
manufacturer of digital cameras that designs-in any one of these alternative
competing standards will eliminate CompactFlash from use in its product, as each
competing standard is mechanically and electronically incompatible with
CompactFlash. In addition, in the third quarter of 1997, Intel announced a
64Mbit flash chip based on its multilevel cell flash. The Company's double
density flash ("D2 flash") and Intel's multilevel cell flash are competing
technological innovations that allow each flash memory cell to
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store two bits of information instead of the traditional single bit stored by
the industry standard flash technology. In November 1997, Iomega Corporation
("Iomega") announced its Clik drive, a miniaturized, mechanical, removable disk
drive that Iomega claims will compete directly with SanDisk's flash card
products.
The Company expects competition to increase in the future from existing
competitors and from other companies that may enter the Company's existing or
future markets with similar or alternative data storage solutions that may be
less costly or provide additional features. Due to the high price sensitivity in
the market for consumer products, aggressive price competition has been
experienced for these applications. Such competition is expected to result in
lower gross margins in the future, if the Company's average selling prices
decrease faster than its costs and could result in lost sales.
The Company has entered into patent cross-license agreements with
Hitachi, Intel, Samsung, Sharp and Toshiba, pursuant to which each party may
manufacture and sell products that incorporate technology covered by the other
party's patents related to flash memory devices. As the Company continues to
license its patents to certain of its competitors, competition will increase. As
a result of the above factors, the Company expects to face substantially more
competition in the future than it has to date. Increased competition could have
a material adverse effect on the Company's business, financial condition and
results of operations. The Company believes that its ability to compete
successfully depends on a number of factors, which include price and quality,
product performance and availability, success in developing new applications for
system flash technology, adequate foundry capacity, efficiency of production,
and timing of new product announcements or introductions by the Company, the
number and nature of the Company's competitors in a given market, successful
protection of intellectual property rights and general market and economic
conditions. There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competitive
pressures faced by the Company will not materially adversely affect its
business, financial condition or results of operations.
DECLINING AVERAGE SALES PRICES. The Company has experienced, and
expects to continue to experience, declining average sales prices for its
products. The flash data storage markets in which the Company competes are
characterized by intense competition. Therefore, the Company expects to incur
increasing pricing pressures from its customers in future periods, which could
result in declining average sales prices for the Company's products. To offset
declining average sales prices, the Company believes that it must continue to
achieve manufacturing cost reductions as well as develop new products that
incorporate advanced features and can be sold at higher average gross margins.
If, however, the Company is unable to achieve such cost reductions, it may not
be able to remain price competitive, resulting in lost sales, and the Company's
gross margins could decline, each of which could have a material adverse effect
on the Company's business, financial condition and results of operations.
CUSTOMER CONCENTRATION. A limited number of customers have historically
accounted for a substantial portion of the Company's revenues and the Company
expects this trend to continue. Sales to the Company's customers are generally
made pursuant to standard purchase orders rather than long-term contracts. The
Company has also experienced significant changes in the composition of its major
customer base from year to year and expects this variability to continue as
certain customers increase or decrease their purchases of the Company's products
as a result of fluctuations in market demand for such customers' products. Under
a joint cooperation agreement signed in January 1993, Seagate has the option to
market the Company's products beginning in 1999 and, if exercised, the Company
will be required to coordinate sales with Seagate so that up to one-third of the
Company's worldwide net revenues could be generated from sales of the Company's
flash products through Seagate.
DEPENDENCE ON THIRD PARTY FOUNDRIES. All of the Company's products
require silicon wafers, which are currently supplied by Matsushita in Japan and
United Microelectronics Corporation ("UMC") in Taiwan. The Company has a
development agreement with NEC in Japan, pursuant to which the Company expects
to receive initial wafer shipments once the products under development complete
internal qualification. In the third quarter of 1997, the Company made an
investment in USIC, a semiconductor
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manufacturing venture headed by UMC in Taiwan, which has a fabrication facility
currently under construction. The Company has arranged to receive foundry wafers
from a separate UMC fabrication facility during the construction of the USIC
plant. The Company completed qualification of these wafers in the first quarter
of 1998. The Company is dependent on its foundries to allocate to the Company a
portion of their foundry capacity sufficient to meet the Company's needs, to
produce wafers of acceptable quality and with acceptable manufacturing yields
and to deliver those wafers to the Company on a timely basis. On occasion, the
Company has experienced difficulties in each of these areas. The loss or
reduction of capacity from any of its foundry suppliers or the inability to
qualify or receive the anticipated level of capacity from any of its
manufacturing partners could have a material adverse effect on the Company's
business, financial condition and results of operations. There can be no
assurance that the NEC fabrication facility will commence shipments on schedule
or that the USIC facility will be completed or will begin production as
scheduled, or that the processes needed to fabricate wafers for the Company will
be qualified at either facility. Moreover, there can be no assurance that any of
the Company's suppliers will be able to maintain acceptable yields or deliver
sufficient quantities of wafers on a timely basis.
Under each of the Company's wafer supply agreements, the Company is
obligated to provide a monthly rolling forecast of anticipated purchase orders.
Except in limited circumstances and subject to acceptance by the foundries, the
estimates for the first three months of each forecast constitute a binding
commitment and the estimates for the remaining months may not increase or
decrease by more than a certain percentage from the previous month's forecast.
These restrictions limit the Company's ability to react to significant
fluctuations in demand for its products. As a result, the Company has not been
able to match its purchases of wafers to specific customer orders and therefore
the Company has taken write downs for potential excess inventory purchased prior
to the receipt of customer orders and may be required to do so in the future.
These adjustments decrease gross margins in the quarter reported and have
resulted, and could in the future result in fluctuations in gross margins on a
quarter to quarter basis. To the extent the Company inaccurately forecasts the
number of wafers required, it may have either a shortage or an excess supply of
wafers, either of which could have a material adverse effect on the Company's
business, financial condition and results of operations. Additionally, if the
Company is unable to obtain scheduled quantities of wafers from any foundry with
acceptable yields, the Company's business, financial condition and results of
operations could be negatively impacted. See "Fluctuations in Operating
Results."
DEPENDENCE ON SOLE SOURCE SUPPLIERS AND THIRD PARTY SUBCONTRACTORS. The
Company purchases several critical components from single or sole source vendors
for which alternative sources are not currently available. Even where
alternative suppliers are available, a significant amount of time would be
required to qualify an additional vendor in the case of certain of the Company's
components. The Company does not maintain long-term supply agreements with any
of these vendors. The inability to develop alternative sources for these single
or sole source components or to obtain sufficient quantities of these components
could result in delays or reductions in product shipments which could adversely
affect the Company's business, financial condition and results of operations.
For example, the Company relies on Motorola, Inc. ("Motorola") as the sole
source of microcontrollers, which are critical components in the Company's
products. The sole source risk associated with microcontrollers from Motorola is
heightened during transitions from one generation of microcontrollers to the
next, given the limited safety stock available during these transitions. In the
event Motorola were to discontinue shipment of microcontrollers for any reason,
the time to design and qualify an alternative source would be approximately nine
to twelve months. The Company's reliance on Motorola as its sole source of
microcontrollers exposes the Company to interruptions of supply that could have
a material adverse effect on the Company's business, financial condition and
results of operations.
The Company uses third-party subcontractors to assemble the memory
components for its products and from time to time uses other subcontractors to
perform certain other assembly and test functions. The Company has no long term
agreements with these subcontractors. As a result of this reliance on third
party subcontractors for assembly of a portion of its products, the Company
cannot directly control product delivery schedules, which can lead to product
shortages or quality assurance problems that could increase manufacturing costs
of the Company's products. Any problems associated with the delivery,
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quality or cost of the Company's products could have a material adverse effect
on the Company's business, financial condition and results of operations.
RISKS ASSOCIATED WITH TRANSITIONING TO NEW PROCESSES AND PRODUCTS.
Successive generations of the Company's products incorporate semiconductor
devices with greater memory capacity per chip. In addition, the Company is
continually involved in joint development with its foundries to produce
semiconductor devices based upon smaller geometry manufacturing processes. Both
the development of higher capacity semiconductor devices and the implementation
of smaller geometry manufacturing processes are important determinants of the
Company's ability to decrease the cost per megabyte of its flash data storage
products. The utilization of semiconductor devices with greater memory capacity
and the design and implementation of new semiconductor manufacturing processes
can entail a number of problems, including lower yields associated with
semiconductor device production, problems associated with design and manufacture
of products to incorporate such devices, and production delays. Because of the
complexity of its products, the Company has periodically experienced significant
delays in the development and volume production ramp up of its products. There
can be no assurance that similar delays will not occur in the future. Any
problems experienced by the Company in its current or future transitions to
higher capacity memory devices or to new semiconductor manufacturing processes
could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company has developed new products based on D2 flash technology, a
new flash system designed to store two bits in each flash memory cell. The
Company began low-volume shipments of its 64Mbit D2 flash products in the third
quarter of 1997. The Company introduced its new 80Mbit D2 flash chip in November
1997 and expects to begin customer shipments of products utilizing this chip in
the second half of 1998. The Company experienced delays in the production ramp
up of the 64Mbit D2 technology and has subsequently shifted its resources to the
qualification and production startup of the second generation 80Mbit D2 design.
Consequently, product revenues from the 64Mbit D2 were not material in 1997. The
Company believes that D2 flash will be important to the Company's ability to
increase the capacity and decrease the cost of certain of its products, maintain
its competitive advantage, broaden its target markets and attract strategic
partners. High density flash memory, such as D2 flash, is a complex technology
requiring tight manufacturing controls and effective test screens. The shift to
volume production for new flash products is particularly prone to problems which
can impact both reliability and yields, thereby increasing manufacturing costs.
There can be no assurance that reliable and cost effective D2 flash products can
be manufactured in commercial volumes and with yields sufficient to result in a
lower cost per megabyte. Furthermore, flash data storage products designed with
80Mbit D2 flash are expected to initially exhibit approximately one-quarter of
the write performance of the Company's existing products when writing data into
memory, potentially limiting their use in certain applications, such as digital
cameras.
MANUFACTURING YIELDS. The fabrication of the Company's products is a
complex and precise process requiring wafers that are produced in a highly
controlled and clean environment. Semiconductor companies supplying the Company
with wafers periodically have experienced problems achieving acceptable wafer
manufacturing yields. Semiconductor manufacturing yields are a function both of
design technology, which is developed by the Company, and process technology,
which is typically proprietary to the foundry. Because low yields may result
from errors in either design or process technology failures, yield problems may
not be effectively determined or improved until an actual product exists that
can be analyzed and tested to recognize process sensitivities in relation to the
design rules that were used. As a result, yield problems may not be identified
until the wafers are well into the production process. This risk is increased
due to the fact that the Company receives its wafers from independent offshore
foundries, increasing the effort and time required to identify, communicate and
resolve manufacturing yield problems. There can be no assurance that the
Company's foundries will achieve or maintain acceptable manufacturing yields in
the future. The inability of the Company to achieve planned yields from its
foundries could have a material adverse effect on the Company's business,
financial condition and results of operations.
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PATENTS, PROPRIETARY RIGHTS AND RELATED LITIGATION. The Company relies
on a combination of patents, trademarks, copyright and trade secret laws,
confidentiality procedures and licensing arrangements to protect its
intellectual property rights. The Company has been notified in the past and the
Company and its foundries may be notified in the future of claims that they may
be infringing patents or other intellectual property rights owned by third
parties. In the past the Company has been involved in significant disputes
regarding its intellectual property rights and believes it may be involved in
similar disputes in the future. There can be no assurance that in the future any
patents held by the Company will not be invalidated, that patents will be issued
for any of the Company's pending applications or that any claims allowed from
existing or pending patents will be of sufficient scope or strength or be issued
in the primary countries where the Company's products can be sold to provide
meaningful protection or any commercial advantage to the Company. Additionally,
competitors of the Company may be able to design around the Company's patents.
To preserve its intellectual property rights, the Company believes it
may be necessary to initiate litigation against one or more third parties,
including but not limited to those the Company has already notified of possible
patent infringement. In addition, one or more of these parties may bring suit
against the Company. In March 1998, the Company filed a complaint in federal
court against Lexar for infringement of a fundamental flashdisk patent. Lexar
has disputed the Company's claim of patent infringement. In the event of an
adverse result in any such litigation, the Company could be required to pay
substantial damages, cease the manufacture, use and sale of infringing products,
expend significant resources to develop non-infringing technology, discontinue
the use of certain processes or obtain licenses to the infringing technology.
Any litigation, whether as a plaintiff or as a defendant, would likely result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel, whether or not such litigation is ultimately
determined in favor of the Company. In addition, the results of any litigation
are inherently uncertain. For example, in 1995, the Company informed Samsung
that the Company believed Samsung infringed certain of its patents. In response,
Samsung filed a complaint accusing the Company of infringing two of its patents.
The Company then filed a complaint against Samsung with the United States
International Trade Commission (the "ITC") alleging that Samsung and its U.S.
sales arm were importing and selling products that infringed two of the
Company's patents. After a hearing on this matter, the ITC issued an order that
both SanDisk patents were valid and that Samsung had infringed such patents, and
prohibited the import, sale, marketing, distribution or advertising of Samsung's
infringing flash memory circuits in the United States. In August 1997, the
Company and Samsung entered into a settlement agreement resolving all aspects of
this dispute, pursuant to which the parties agreed to cross-license certain
patents and Samsung agreed to make license and royalty payments to the Company.
While the Company believes it achieved a favorable result in this matter, the
expense and diversion of management attention in connection with its resolution
were substantial. In addition, the Company has notified several large flash
suppliers that the Company believes certain of their existing or announced
products infringe certain of the Company's patents.
In the event the Company desires to incorporate third party technology
into its products or is found to infringe on others' patents or intellectual
property rights, the Company may be required to license such patents or
intellectual property rights. The Company may also need to license some or all
of its patent portfolio to be able to obtain cross-licenses to the patents of
others. The Company currently has patent cross-license agreements with Hitachi,
Intel, Samsung, Sharp and Toshiba. From time to time, the Company has also
entered into discussions with other companies regarding potential cross-license
agreements for the Company's patents. However, there can be no assurance that
licenses will be offered or that the terms of any offered licenses will be
acceptable to the Company. If the Company obtains licenses from third parties,
it may be required to pay license fees or make royalty payments, which could
have a material adverse effect on the Company's gross margins. The failure to
obtain a license from a third party for technology used by the Company could
cause the Company to incur substantial liabilities and to suspend the
manufacture of products or the use by the Company's foundries of processes
requiring the technology, or to expend substantial resources redesigning its
products to eliminate the infringement. There can be no assurance that the
Company would be successful in redesigning its products or that such licenses
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would be available under reasonable terms. Furthermore, any such development or
license negotiations could require substantial expenditures of time and other
resources by the Company.
As is common in the industry, the Company agrees to indemnify certain
of its suppliers and customers for alleged patent infringement. The scope of
such indemnity varies, but may, in some instances, include indemnification for
damages and expenses, including attorneys' fees. The Company may from time to
time be engaged in litigation as a result of such indemnification obligations.
Third party claims for patent infringement are excluded from coverage under the
Company's insurance policies. There can be no assurance that any future
obligation to indemnify the Company's customers or suppliers, will not have a
material adverse effect on the Company's business, financial condition and
results of operations.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. All of the Company's
wafers are, and for the foreseeable future will be, produced by foundries
located outside the United States. Because the Company currently purchases a
significant portion of its flash wafers in Japanese Yen at set prices, and bills
certain customers in Japanese Yen, fluctuations in currencies could materially
adversely affect the Company's business, financial condition and results of
operations. In addition, gains and losses on the conversion to United States
dollars of accounts receivable, accounts payable and other monetary assets and
liabilities arising from international operations may contribute to fluctuations
in the Company's results of operations. Because sales of the Company's products
have been denominated to date primarily in United States dollars, increases in
the value of the United States dollar could increase the price of the Company's
products so that they become relatively more expensive to customers in the local
currency of a particular country, leading to a reduction in sales and
profitability in that country. Given the recent economic conditions in Asia and
the weakness of many Asian currencies relative to the United States dollar, the
Company's products may be relatively more expensive in Asia, which could result
in a decrease in the Company's sales in that region. Due to its reliance on
export sales and its dependence on foundries outside the United States, the
Company is subject to the risks of conducting business internationally,
including foreign government regulation and general geopolitical risks such as
political and economic instability, potential hostilities and changes in
diplomatic and trade relationships. Manufacturing and sales of the Company's
products may also be materially adversely affected by factors such as unexpected
changes in, or imposition of, regulatory requirements, tariffs, import and
export restrictions and other barriers and restrictions, longer payment cycles,
greater difficulty in accounts receivable collection, potentially adverse tax
consequences, the burdens of complying with a variety of foreign laws and other
factors beyond the Company's control. In addition, the laws of certain foreign
countries in which the Company's products are or may be developed, manufactured
or sold, including various countries in Asia, may not protect the Company's
intellectual property rights to the same extent as do the laws of the United
States and thus make piracy of the Company's products a more likely possibility.
There can be no assurance that these factors will not have a material adverse
effect on the Company's business, financial condition or results of operations.
MANAGEMENT OF GROWTH. The Company has recently experienced and may
continue to experience rapid growth, which has placed, and could continue to
place, a significant strain on the Company's limited personnel and other
resources. To manage such growth effectively, the Company will need to continue
to implement and improve its operational, financial and management information
systems and to hire, train, motivate and manage its employees. In particular,
the Company has recently experienced difficulty in hiring the engineering, sales
and marketing personnel necessary to support the growth of the Company's
business. Competition for such personnel is intense, and there can be no
assurance that the Company will be successful in attracting and retaining such
personnel or that the Company will be able to manage such growth effectively.
The Company's ability to manage its growth will require a significant investment
in and expansion of its existing internal information management systems to
support increased manufacturing, accounting and other management related
functions. The Company is in the process of replacing its existing in-house
information system. The implementation of the new system will impact almost all
phases of the Company's operations (i.e., planning, manufacturing, finance and
accounting). The new system is currently scheduled to become operational in the
second half of 1998. There can be no assurance that the Company will not
experience problems, delays or unanticipated additional costs in implementing
the new
Page 21
<PAGE>
management information system or in the use of its existing system that could
have a material adverse effect on the Company's business, financial condition
and results of operations, particularly in the period in which the new system is
brought online. The failure of the Company to successfully manage any of these
issues would have a material adverse effect on the Company's business,
financial condition and results of operations.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a
significant degree upon the continued contributions of members of its senior
management and other key research and development, sales, marketing and
operations personnel, including, in particular, Dr. Eli Harari, the Company's
founder, President and Chief Executive Officer. The loss of any of such persons
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company does not have an employment
agreement or non-competition agreement with any of its employees.
VOLATILITY OF STOCK PRICE. There has been a history of significant
volatility in the market prices of the Company's Common Stock on the Nasdaq
National Market, and it is likely that the market price of the Company's Common
Stock will continue to be subject to significant fluctuations. For example, in
1997, the Company's stock price fluctuated from a low of $8 7/8 to a high of
$40. The Company believes that future announcements concerning the Company, its
competitors or its principal customers, including technological innovations, new
product introductions, governmental regulations, litigation or changes in
earnings estimated by analysts, may cause the market price of the Common Stock
to fluctuate substantially in the future. Sales of substantial amounts of the
Company's outstanding Common Stock in the public market could materially
adversely affect the market price of the Common Stock. Further, in recent years
the stock market has experienced extreme price and volume fluctuations that have
particularly affected the market prices of equity securities of many high
technology companies and that often have been unrelated to the operating
performance of such companies. These fluctuations as well as general economic,
political and market conditions such as recessions or international currency
fluctuations, may materially adversely affect the market price of the Common
Stock.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. These date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements. Certain of the Company's
internal computer systems are not Year 2000 compliant, and the Company utilizes
third-party equipment and software that may not be Year 2000 compliant. The
Company has commenced actions to correct such internal systems and is in the
early stages of conducting an audit of its third-party suppliers as to Year 2000
compliance of their systems. Failure of the Company's internal computer systems
or of such third-party equipment or software, or of systems maintained by the
Company's suppliers, to operate properly with regard to the Year 2000 and
thereafter could require the Company to incur unanticipated expenses to remedy
any problems, which could have a material adverse effect on the Company's
business, operating results and financial condition. Furthermore, the purchasing
patterns of customers or potential customers may be affected by Year 2000 issues
as companies expend significant resources to correct their current systems for
Year 2000 compliance. These expenditures may result in reduced funds available
to purchase the Company's products, which could have a material adverse effect
on the Company's business, operating results and financial condition.
EFFECT OF ANTI-TAKEOVER PROVISIONS. The Company has taken a number of
actions that could have the effect of discouraging a takeover attempt that might
be beneficial to stockholders who wish to receive a premium for their shares
from a potential bidder. The Company has adopted a Shareholder Rights Plan that
would cause substantial dilution to a person who attempts to acquire the Company
on terms not approved by the Company's Board of Directors. The Shareholder
Rights Plan may therefore have the effect of delaying or preventing any change
in control and deterring any prospective acquisition of the Company. In
addition, the Company's Certificate of Incorporation grants the Board of
Directors the authority to issue up to 4,000,000 shares of Preferred Stock and
to determine the price, rights, preferences and privileges of those shares
without any further vote or action by the Company's stockholders. The rights of
the holders of
Page 22
<PAGE>
Common Stock will be subject to, and may be adversely affected by, the rights of
the holders of any shares of Preferred Stock that may be issued in the future.
While the Company has no present intention to issue shares of Preferred Stock,
such issuance, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could have the effect of making it
more difficult or less attractive for a third party to acquire a majority of the
outstanding voting stock of the Company. Such Preferred Stock may also have
other rights, including economic rights senior to the Common Stock, and, as a
result, the issuance thereof could have a material adverse effect on the market
value of the Common Stock. Furthermore, the Company is subject to the
anti-takeover provisions of Section 203 of the Delaware General Corporation Law
("Section 203"), which prohibits the Company from engaging in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person first becomes an "interested
stockholder," unless the business combination is approved in a prescribed
manner. The application of Section 203 also could have the effect of delaying or
preventing a change of control of the Company.
Page 23
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The information required by this item is set forth in Note 6 of the
Notes to the Condensed Consolidated Financial Statements on pages 7 and 8 and
under "Risk Factors - Patents, Proprietary Rights and Related Litigation" on
pages 19 to 21 of this Form 10-Q for the quarterly period ended March 31, 1998,
and is incorporated herein by reference.
Item 2. Changes in Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
Exhibit
Number Exhibit Title
3.1 Certificate of Incorporation of the Registrant, as amended to
date.3
3.2 Form of Amended and Restated Certificate of Incorporation of
the Registrant./3/
3.3 Bylaws of the Registrant, as amended./3/
3.4 Form of Amended and Restated Bylaws of the Registrant /3/
3.5 Certificate of Designation for the Series A Junior
Participating Preferred Stock, as filed with the Delaware
Secretary of State on April 24, 1997./7/
4.1 Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4./3/
4.3 Amended and Restated Registration Rights Agreement, among the
Registrant and the investors and founders named therein,
dated March 3, 1995./3/
4.4 Amendment No. 1 to the Stock Purchase Agreements among the
Registrant and the holders of Series A, B and D Preferred
Stock, and certain holders of Series E Preferred Stock, dated
January 15, 1993./3/
4.5 Series F Preferred Stock Purchase Agreement between Seagate
Technology, Inc. and the Registrant, dated January 15,1993.
/3/
4.6 Amendment Agreement between Seagate Technology, Inc. and the
Registrant, dated August 23, 1995./3/
4.7 Form of Stock Purchase Agreement between the Registrant and
Seagate Technology, Inc./3/
4.8 Rights Agreement, dated as of April 18, 1997, between the
Company and Harris Trust and Savings Bank./7/
9.1 Amended and Restated Voting Agreement, among the Registrant
and the investors named therein, dated March 3, 1995./3/
10.8 Joint Cooperation Agreement between the Registrant and
Seagate Technology, Inc., dated January 15, 1993.1, /3/
10.9 Amendment and Termination Agreement between the Registrant
and Seagate Technology, Inc., dated October 28, 1994.1, /3/
10.10 License Agreement between the Registrant and Dr. Eli Harari,
dated September 6, 1988./3/
10.13 1989 Stock Benefit Plan./3/
10.14 1995 Stock Option Plan./3/
10.15 Employee Stock Purchase Plan./3/
10.16 1995 Non-Employee Directors Stock Option Plan./3/
10.18 Lease Agreement between the Registrant and G.F. Properties,
dated March 1, 1996./4/
10.19 Business loan agreement between the Registrant and Union Bank
of California, dated July 3, 1996./5/
10.21 Amendment to Lease Agreement between the Registrant and G.F.
Properties, dated April 3, 1997./5/
10.22 First and second amendments to business loan agreement
between the Registrant and Union Bank of California, dated
June 30, 1997./5/
10.23 Foundry Venture Agreement between the Registrant and United
Microelectronics Corporation, dated June 27, 1997.1, /8/
10.24 Written Assurances Re: Foundry Venture Agreement between the
Registrant and United Microelectronics Corporation, dated
September 13, 1995.1, /8/
10.25 Side Letter between Registrant and United Microelectronics
Corporation, dated May 28, 1997./1, 8/
10.26 Third Amendment to the Trade Finance Agreement between the
Registrant and Union Bank of California. /9/
10.27 Clarification letter with regards to Foundry Venture
Agreement between the Registrant and United Microelectronics
Corporation dated October 24, 1997./9/
Page 25
<PAGE>
21.1 Subsidiaries of the Registrant./6/
27.1 Financial Data Schedule for the three months ended March 31,
1998. (In EDGAR format only)
27.2 Restated Financial Data Schedule for the three months ended
March 31, 1997. (In EDGAR format only)
- ----------
1. Confidential treatment granted as to certain portions of these exhibits.
2. Confidential treatment requested as to certain portions of these exhibits.
3. Previously filed as an Exhibit to the Registrant's Registration Statement on
Form S-1 (No. 33-96298).
4. Previously filed as an Exhibit to the Registrant's 1995 Annual Report on Form
10-K.
5. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter
ended June 30, 1996.
6. Previously filed as an Exhibit to the Registrant's 1996 Annual Report on Form
10-K.
7. Previously filed as an Exhibit to the Registrant's Current Report on Form
8-K/A dated April 18, 1997.
8. Previously filed as an Exhibit to the Registrant's Current Report on form 8-K
dated October 16, 1997.
9. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter
ended September 30, 1997.
B. Reports on Form 8-K
The Company filed a current report on Form 8-K dated March 23, 1998,
reporting the filing of a patent infringement claim against Lexar Media, Inc.
Page 26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SanDisk Corporation
(Registrant)
By: /s/ Cindy L. Burgdorf
----------------------------------
Cindy L. Burgdorf
Chief Financial Officer,
Senior Vice President, Finance and
Administration and Secretary
DATED: March 12, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
SanDisk Financial Data Schedule, March 31, 1998
</LEGEND>
<CIK> 0001000180
<NAME> SanDisk Corporation
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<S> <C>
<PERIOD-TYPE> 3-mos
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-END> Jun-30-1998
<CASH> 10,642
<SECURITIES> 116,862
<RECEIVABLES> 18,567
<ALLOWANCES> 0
<INVENTORY> 20,436
<CURRENT-ASSETS> 184,449
<PP&E> 16,366
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<TOTAL-ASSETS> 242,122
<CURRENT-LIABILITIES> 44,800
<BONDS> 0
0
0
<COMMON> 183,041
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<TOTAL-LIABILITY-AND-EQUITY> 242,122
<SALES> 25,426
<TOTAL-REVENUES> 34,102
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<INCOME-PRETAX> 7,343
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<INCOME-CONTINUING> 4,703
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Restated SanDisk Financial Data Schedule, March 31, 1997. Earnings per
share amounts have been restated to comply with Statement of Financial Standards
No. 128, "Earnings Per Share."
</LEGEND>
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<NAME> SanDisk Corporation
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<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> MAR-31-1997
<CASH> 13,875
<SECURITIES> 55,401
<RECEIVABLES> 13,634
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<INVENTORY> 11,766
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<TOTAL-LIABILITY-AND-EQUITY> 107,771
<SALES> 18,194
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