SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
X Annual report pursuant to Section 13 or 15(d) of the Securities
- ---------- Exchange Act of 1934 for the fiscal year ended December 31, 1997 or
Transition report pursuant to Section 13 or 15(d) of the Securities
- ---------- Act of 1934
Commission File No. 0-26734
SANDISK CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 77-0191793
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
140 Caspian Court, Sunnyvale, California 94089
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (408) 542-0500
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ X ].
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of the Common Stock on March 2,
1998 as reported on the NASDAQ National Market System, was approximately
$416,264,216. Shares of Common Stock held by each officer and director and by
each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
As of March 2, 1998, Registrant had 26,125,986 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting to be held on April 30,
1998 are incorporated by reference into Part III.
<PAGE>
SANDISK CORPORATION
1997 FORM 10-K ANNUAL REPORT
Table of Contents
PART I
Page No.
Item 1. Business 1
Item 2. Properties 22
Item 3. Legal Proceedings 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Executive Officers of the Registrant 24
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 25
Item 6. Selected Financial Data 26
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 28
Item 8. Financial Statements and Supplementary Data 34
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 53
PART III
Item 10. Directors and Executive Officers of the Registrant 54
Item 11. Executive Compensation 54
Item 12. Security Ownership of Certain Beneficial Owners and
Management 54
Item 13. Certain Relationships and Related Transactions 54
PART IV
Item 14. Exhibits, Financial Statements, Schedules, and Reports
on Form 8-K 55
Signatures 58
<PAGE>
PART I
ITEM 1. BUSINESS
Certain statements in this discussion of the Company's business and
elsewhere in this Annual Report on Form 10-K for 1997 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
set forth below under "Risk Factors".
SanDisk designs, manufactures and markets flash memory data storage
products used in a wide variety of electronic systems. The Company has optimized
its flash memory storage solution, known as "system flash," to address the needs
of many emerging applications in the consumer electronics and
industrial/communications markets. Since its inception, the Company has been
actively involved in all aspects of flash memory process development, chip
design, controller development and system-level integration to ensure the
creation of fully-integrated, broadly interoperable products that are compatible
with both existing and new system platforms. The Company believes its core
technical competencies are in high-density flash memory process and design,
controller design, system-level integration, compact packaging and low-cost
system test. The Company's products include removable CompactFlash(TM) products,
FlashDisk cards and MultiMediaCard ("MMC") products, and embedded FlashDrives
and Flash ChipSet products. SanDisk has applied its technology to the markets
for digital cameras and other consumer electronics devices such as PDAs. The
Company offers products in the PCMCIA format, the CompactFlash format and the
MultiMediaCard format which was introduced in November 1997. The Company's
customers in 1997 included Boeing Defense & Space Co., ("Boeing"), Canon Inc.
("Canon"), Casio Manufacturing Corporation ("Casio"), Eastman Kodak Company
("Kodak"), Epson Hanbai Co., Ltd. ("Epson Hanbai"), Fujitsu Limited ("Fujitsu"),
Hewlett-Pakard Company ("Hewlett- Packard"), Kyocera America, Inc. ("Kyocera"),
Lucent Technologies, Inc. ("Lucent"), Matsushita Electric Industrial Co., Ltd.
("MEI"), NEC USA Inc. ("NEC USA"), Norand Corporation ("Norand"), Pentax
Corporation ("Pentax"), Psion Computers PLC ("Psion") and Telxon Corporation
("Telxon"). The Company currently has patent cross-license agreements with
Hitachi Ltd. ("Hitachi"), Intel Corporation ("Intel"), Samsung Electronics
Company Ltd. ("Samsung"), Sharp Electronics Corporation ("Sharp") and Toshiba
Corporation ("Toshiba").
Industry Background
The traditional data storage market encompasses several types of memory
and storage devices designed primarily for specific components of computer
systems. Dynamic random access memory ("DRAM") provides main system memory;
static random access memory ("SRAM") provides specialized and high speed memory;
hard disk drives provide high capacity data storage; and floppy disk drives
permit low capacity removable data storage. In recent years, digital computing
and processing have expanded beyond the boundaries of desktop computer systems
to include a broader array of electronic systems. These new devices include
digital cameras, personal digital assistants, highly portable computers, digital
audio recorders, wireless base stations, network computers, communication
switches, cellular telephones, mobile communication systems, handheld data
collection terminals, medical monitors, pay telephones and other electronic
systems. These emerging applications have storage requirements that are not well
addressed by traditional storage solutions. These requirements include small
form factor size, high reliability, low power consumption and the capability to
withstand high levels of shock and vibration and extreme temperature
fluctuations. Because storage products based on flash semiconductor technology
meet those requirements, these devices and systems represent new market
opportunities for flash storage systems.
In the late 1980s, a new memory technology, known as flash memory, was
developed as an extension of ultraviolet erasable programmable read-only memory
("EPROM"). Flash memory is non-volatile, unlike DRAM and SRAM, requiring no
power to retain data and is electrically reprogrammable, unlike EPROM. Flash
memory has the potential to satisfy the requirements for a variety of data
storage applications although the most common types of flash memory, "socket
flash" and "linear flash," are not well suited for many purposes.
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Socket flash is being used as a replacement for EPROMs in applications
such as embedded firmware or microcode storage in computer systems. Typical chip
densities for socket flash range from 1Mbit to 16Mbit. Socket flash is well
suited for read often/write infrequently applications, as the erase times are
relatively slow (typically one second per block or sector). In addition, socket
flash has not been optimized for defect management. With frequent erase/write
operations, bits in flash storage media deteriorate over time. As a result, the
longevity and durability of socket flash chips in frequent erase/write
applications is limited. Also, socket flash chips, because they are optimized
for fast read access rather than low cost, are relatively large and expensive
memory chips.
More recently, technology known as linear flash has been developed that
permits socket flash chips to be used in data storage applications with the use
of separate flash file system software. While linear flash cards provide a
low-cost mass storage solution, they provide limited built-in intelligence, and
rely instead on the host microprocessor and specialized software to manage the
socket flash chips as a mass data storage device. This limits the portability of
linear flash cards between different systems, as well as their ability to be
upgraded for use in future generation products. A linear flash card used for
data storage in one system may not be usable in other systems because of
potential incompatibilities in the host processors, as well as the operating
system software used in the two systems. Furthermore, because of differences in
the socket flash of various suppliers, linear flash cards from one manufacturer
may not function properly with flash file system software designed for linear
flash cards from other manufacturers.
Customers in the consumer electronics and industrial/communications
markets are seeking data storage solutions that satisfy requirements such as
small form factor, high reliability, low power consumption and the capability to
withstand high levels of shock and vibration and extreme temperature
fluctuations, which are not well addressed by traditional storage solutions such
as hard disk drives and DRAM, or by linear flash cards based on socket flash
memory chips.
The SanDisk Solution
The Company has optimized its flash memory storage solution known as
"system flash," to address the needs of many emerging applications in the
consumer electronics and industrial/communications markets. Since its inception,
the Company has been actively involved in all aspects of flash memory process
development, chip design, controller development and system-level integration to
ensure the creation of fully-integrated, broadly interoperable products that are
compatible with both existing and new system platforms. The Company believes its
core technical competencies are in high-density flash memory process and design,
controller design, system-level integration, compact packaging and low-cost
system test. To achieve compatibility among various electronic platforms
regardless of the host processor or operating system used, the Company has
developed new capabilities in flash memory chip design, created a new
intelligent controller and developed an architecture that can leverage advances
in flash memory process technology to ensure a scaleable, high-yielding,
cost-effective and highly reliable manufacturing process.
The Company's products offer the following features:
Small form factor. The Company's FlashDisk cards are small and
lightweight with a length of 85.6 mm, width of 54.0 mm, thickness of
5.0 mm (PCMCIA Type II) or 10.5 mm (PCMCIA Type III) and weight of less
than 2.0 ounces. The Company's CompactFlash products weigh about
one-half ounce and are approximately the size of a matchbook (36.4 mm x
42.8 mm x 3.3 mm). The Company's MMC products are approximately the
size of a quarter coin (32 mm x 24 mm x 1.4 mm) and weigh less than two
grams.
Non-volatility. SanDisk products store information in non-volatile
memory cells that do not require power to retain information.
High degree of ruggedness. SanDisk's devices have an operating
shock rating of 2,000 Gs for CompactFlash and 1,000 Gs for all other
products (equivalent to being able to withstand ten foot and eight
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foot drops onto concrete, respectively). The Company's products are
also designed to tolerate extreme temperatures and humidity.
Low power consumption. During read/write operations, SanDisk's
products use less power than the 1.8 inch and 2.5 inch rotating disk
drives found in many portable computers. At all other times during
system operation, the Company's products require virtually no power.
Depending upon the end product making use of the Company's flash data
storage, this can translate into longer battery life.
High reliability. SanDisk's products utilize sophisticated error
detection and correction algorithms and dynamic defect management
techniques to provide high data reliability and endurance.
High performance. The Company believes that the access times of
the Company's products meet or exceed the read and write data rates of
the majority of consumer and industrial/communication applications.
The flash process and flash memory chip designs developed by the
Company in cooperation with its development partners make the Company's products
scaleable over several generations of semiconductor fabrication processes. This
feature has allowed the Company to significantly reduce its cost per megabyte of
capacity as each new process generation is qualified. By maintaining the same
basic design parameters, each generation of the Company's products maintains
full compatibility with prior generations. This chip architecture has allowed
the Company to significantly reduce cell size and thereby chip size. This has
permitted increased storage capacity in PC Card, CompactFlash and MMC platforms.
The Company's proprietary flash process requires some modifications to the
typical CMOS semiconductor fabrication process, but can be implemented on
existing advanced fabrication lines without the need for special materials or
equipment. The Company has successfully implemented its processes at Matsushita
Electronics Corporation ("Matsushita") and at LG Semicon ("LG Semicon"), and is
currently implementing its processes at NEC Corporation ("NEC") and United
Silicon, Inc. ("USIC") a subsidiary of United Microelectronics Corporation
("UMC").
The Company also has developed core competencies in low-cost
micropackaging technology as well as low-cost batch testing, both of which are
important elements in building high capacity, high reliability flash cards at a
competitive cost.
SanDisk's Business Strategy
The Company is pursuing the following strategies:
Enable New Products in Large and Emerging Markets; Develop and Promote
Industry Standards. The Company develops products that it believes will have
applications in large, emerging markets such as the markets for digital cameras,
PDAs and smart phones. The Company believes that the widespread acceptance of
universal industry standards is important to the development of the market for
flash data storage. The Company designs its products to be compatible with
existing industry standards and, where appropriate, develops and promotes new
standards. The Company was one of the founding members of PCMCIA, where it has
worked to establish the ATA standard interface which is globally supported by
all PCMCIA card slots. The Company developed the CompactFlash format and was one
of the founding members of the CompactFlash Association ("CFA"), an organization
established in October 1995 to promote CompactFlash as a small form factor flash
data storage standard. The Company believes that this format is becoming the de
facto industry standard storage platform for digital cameras, where it is used
instead of traditional film. The Company's CompactFlash, FlashDisk, FlashDrive
and Flash Chipset products are compatible with IDE and ATA standard interfaces
used in all IBM compatible PCs and are compatible with Windows 95, Windows NT,
Windows CE, Macintosh System 8.0 and other operating systems. The
interoperability afforded by adherence to these industry standards enables users
of flash data storage cards to transfer data quickly and easily from one device
to another, such as from a digital camera to a desktop computer system equipped
with a PCMCIA or CompactFlash slot.
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In November 1997, the Company along with Siemens AG introduced the MMC
format which was designed to meet the requirements of the mobile communications
industry for a small form factor storage card with a simple high performance
serial interface. The Company is committed to making MMC a broadly supported
industry standard. The Company believes that working with industry groups to
develop widely-adhered-to standards will lead to the acceptance of the Company's
products in large markets.
Maintain Technology Leadership. The Company believes that it was the
first to develop and introduce removable flash data storage cards and that it
has led the industry with several technological innovations. The Company
believes that its technological expertise in flash memory design and process
engineering, intelligent controllers and system-level integration, in
conjunction with its relationships with its semiconductor manufacturing
partners, provides it with a competitive advantage. The Company is actively
developing advanced flash data storage technologies designed to enable it to
continue to meet evolving customer requirements for flash data storage system
products. The Company has developed D2 flash, which is a technological
innovation that allows each flash memory cell to store two bits of information
instead of the traditional single bit per cell, effectively doubling the amount
of storage capacity on approximately the same size chip. The Company plans to
use this technology to achieve a significant reduction in the cost per megabyte
of flash data storage. The Company began low-volume shipments of flash card
products employing 64 Mbit D2 flash in the third quarter of 1997. In November
1997, the Company announced its 80 Mbit D2 flash chip.
Reduce Cost Per Megabyte of Flash Data Storage. The Company is focused
on reducing the cost per megabyte of its products in order to increase the
number of applications for these products and to enhance the Company's ability
to address new markets. The Company has designed its patented flash memory
technology and integrated intelligent controller to increase the amount of
usable flash storage per wafer. The Company works closely with its manufacturing
partners to increase the amount of storage capacity per wafer by utilizing very
small flash memory cells, to realize high yields through the built-in ability to
utilize partial die and to facilitate the migration to smaller geometry
manufacturing processes through several generations of flash technology.
Virtually all of the Company's products utilize its 32Mbit flash devices.
Leverage Intellectual Property. The Company has cross-licensed its
flash technology, including its patent portfolio, to selected third parties. The
Company believes that permitting other flash memory providers to use its
technology will facilitate the development of its target markets, will provide a
second source of supply of CompactFlash, which is required by many OEM
customers, and can serve as a significant source of license fees and royalty
revenues for the Company. To date, the Company has entered into patent
cross-license agreements with Hitachi, Intel, Samsung, Sharp and Toshiba, and
intends to pursue opportunities to enter into additional licenses.
Applications and Markets for Flash Data Storage
The Company is targeting the consumer electronics and the industrial
communications markets for its flash data storage products.
Consumer Electronics. The increasing trend towards the use of digital
technology in consumer electronics devices has created requirements for new data
storage products. For example, a number of major camera and imaging companies
have introduced digital cameras that the Company believes will enable
professionals and consumers to eliminate the need for standard 35mm photographic
film by replacing it with re-usable compact digital data storage devices.
Removable and embedded flash data storage products such as the Company's Chipset
and MMC products, can also be potentially used in PDAs, highly portable
computers, digital audio recorders, network computers, cellular telephones,
two-way pagers, next-generation smart telephones, digital audio samplers and
other devices. These data storage devices need to have a very small form factor,
must be lightweight, shock and vibration tolerant, non-volatile and
interoperable with computer systems and software that can process, manipulate
and print images digitally.
Industrial/Communications Market. Emerging applications in the
industrial market encompass a wide variety of electronic systems used by
personnel such as inventory controllers, service technicians, route salesmen,
delivery crews, meter readers, car-rental service employees, physicians, real
estate agents, insurance agents and
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public safety officers. The systems used by these workers are often
subjected to rough handling, used in a variety of temperature and humidity
conditions and required to operate for extended periods of time without external
power sources or frequent battery changes. The information collected by these
individuals is critical to the successful operation of their business or agency
and hence must be stored reliably regardless of the operating environment. In
addition, the information is frequently processed at some point (typically the
end of the work day or night) by a computer system and must therefore be easily
transferable.
The communications market has applications that are beginning to
require new types of data storage. For example, communications switches and
cellular base stations require data storage in environments such as subway
stations or outdoor telephone booths that are subject to shock and vibration and
a wide range of temperature and humidity conditions.
The Company's products are used in consumer electronics applications
such as digital cameras, PDAs, highly portable computers, audio recorders, video
and electronic games, and digital audio samplers, and in
industrial/communications applications such as POS terminals, transportation,
medical instrumentation, automation, telecommunications switches, PHS base
stations, cellular base stations and routers. In 1997, the Company's customers
included Boeing, Canon, Casio, Kodak, Epson Hanbai, Fujitsu, Hewlett-Packard,
Kyocera, Lucent, MEI, NEC USA, Norand, Pentax, Psion and Telxon.
In the fiscal years ended December 31, 1997, 1996 and 1995, product
sales to the Company's top 10 customers accounted for approximately 67%, 71% and
80%, respectively, of the Company's product revenues. In 1997, no single
customer accounted for greater than 10% of total revenues. During 1996, Epson
Hanbai accounted for approximately 26% of the Company's total revenues. Three of
the Company's customers, Epson Hanbai, Kyocera and Hewlett-Packard, accounted
for approximately 26%, 14% and 12% of the Company's total revenues,
respectively, in 1995. The Company expects that sales of its products to a
limited number of customers will continue to account for a substantial portion
of its revenues for the foreseeable future. The Company has also experienced
significant changes in the composition of its major customer base from year to
year and expects this pattern 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. Sales to the Company's customers
are generally made pursuant to standard purchase orders rather than long-term
contracts. The loss of, or significant reduction in purchases by the Company's
major customers, could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Risk Factors - Customer
Concentration."
Products
SanDisk's storage products are high capacity, solid-state, non-volatile
flash memory devices which comply with PC Card ATA and/or IDE industry
standards. The Company offers a broad line of flash data storage system products
in terms of capacities, form factors, operating voltage and temperature ranges.
The Company's current product families include removable CompactFlash, FlashDisk
and MMC cards, embedded FlashDrive products and Flash ChipSets. All products use
the Company's proprietary 512 byte sector erase flash memory chips and
intelligent controller. The Company's products are compatible with the majority
of today's computing and communications systems that are based on industry
standards. The Company's products, as of December 31, 1997, are listed in the
following table:
<TABLE>
<S> <C> <C>
- ------------------------- ------------------------------- ---------------------------------------------------
Product Family Form Factor Uncompressed Capacity (in million bytes)
- ------------------------- ------------------------------- ---------------------------------------------------
CompactFlash 36.4 mm x 42.8 mm x 3.3 mm 2, 4, 6, 8, 10, 15, 20, 24, 30, 40, 48
(Removable)
- ------------------------- ------------------------------- ---------------------------------------------------
FlashDisk PC Card Type II 2, 4, 6, 8, 10, 20, 40, 60, 85
(Removable) ------------------------------- ---------------------------------------------------
PC Card Type III 110,175,220
- ------------------------- ------------------------------- ---------------------------------------------------
Flash Chipset 2 chips 2, 4, 8
(Embedded)
- ------------------------- ------------------------------- ---------------------------------------------------
FlashDrive 1.3 inches 4, 10, 20, 40, 60
(Embedded) ------------------------------- ---------------------------------------------------
1.8 inches 4, 10, 20, 40, 80, 140
- ------------------------- ------------------------------- ---------------------------------------------------
</TABLE>
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Unlike rotating disk drives, the Company's flash products are
solid-state devices. The Company's products are very reliable. They have no
moving parts that are subject to mechanical failure. The Company's products are
non-volatile, meaning that no on-going source of power is required in order for
the products to retain data, images or audio indefinitely. Flash is noiseless,
considerably lighter, more rugged and consumes substantially less power than a
rotating disk drive. The Company's products are small enough to be employed in
mobile systems while the three smallest, CompactFlash, MMC and Flash ChipSet,
are small enough to be used in many of the newer, miniaturized electronic
systems being developed today. In November 1997, the Company announced its 80
Mbit D2 flash chip. The Company plans to begin shipments of products utilizing
the 80 Mbit D2 flash chip by mid-year 1998.
CompactFlash. The Company's CompactFlash products provide full PC Card
ATA functionality but are only one-fourth the size of a standard Type II PC
card. CompactFlash's compact size, ruggedness and low-power requirements and its
ability to operate at either 3.3V or 5V make it well-suited for a range of
current and next-generation, small form factor consumer applications such as
digital cameras, PDAs, personal communicators, pagers and audio recorders.
CompactFlash products provide interoperability with systems based upon the PC
Card ATA standard by using a low-cost passive Type II adapter. CompactFlash
cards are available in capacities ranging from 2MB to 48MB.
FlashDisk. The Company's FlashDisk products are used in storage, data
backup and data transport applications. FlashDisk products are available in Type
II form factor with capacities ranging from 2MB to 85MB and Type III form factor
with capacities ranging from 110MB to 220MB.
Flash ChipSet. The Flash ChipSet product provides a very small
footprint solid-state ATA mass storage system. The Flash ChipSet product
consists of a single chip ATA controller and a flash memory chip and is
available in 2MB, 4MB and 8MB capacities. It provides full PC Card, ATA and IDE
disk drive compatibility in a chip set format.
FlashDrive. The Company's FlashDrives in 1.3 inch and 1.8 inch form
factors are targeted at applications that require embedded data storage devices.
FlashDrives offer rugged, portable, low-power data storage and are "plug and
play" replacements for rotating IDE drives making them ideal for mobile
computers, communication devices and other systems that require embedded
storage. Capacities of the Company's FlashDrive products range between 4MB and
60MB for the 1.3 inch product and between 4MB and 220MB for the 1.8 inch
product.
MMC. In November 1997, the Company introduced a new removable storage
card product family, the MultiMediaCard ("MMC"). MMC measures 32 millimeters
("mm") by 24 mm by 1.4 mm and weighs less than two grams. MMC is targeted at the
emerging markets for mobile smart phones, advanced pagers, consumer multimedia
devices, digital audio recorders and other products that need removable data
storage in a small form factor. MMC will initially be offered in storage
capacities of 2MB, 4MB and 8MB . The Company does not expect to generate
significant revenues from MMC sales in 1998. There can be no assurance that MMC
will be commercially available on schedule or that it will receive substantial
market acceptance. Any failure by SanDisk's customers to accept the Company's
MMC products could cause a material adverse effect on the Company's business,
financial condition and results of operations. See "Risk Factors - Dependence on
Emerging Markets and New Products."
Technology
Since its inception, the Company has focused its research and
development efforts on developing highly reliable and cost-effective flash
memory storage products to address a number of emerging markets. The Company has
been actively involved in all aspects of this development, including flash
memory process development, chip design, controller development and system-level
integration, to ensure the creation of fully-integrated, broadly interoperable
products that are compatible with both older and newly developed system
platforms. The Company believes its core technical competencies are in high
density flash memory process and design, controller design, system-level
integration, compact packaging and low-cost system test.
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To achieve compatibility among various electronic platforms regardless
of the host processors or operating systems used, the Company developed new
capabilities in flash memory chip design, created a new intelligent controller
and developed an architecture that could leverage advances in process technology
to ensure a scaleable, high-yielding, cost-effective and highly reliable
manufacturing process. The Company believes that these technical competencies
and the Company's system design approach have enabled it to introduce flash data
storage products that are better suited for its targeted market than linear
flash cards based on socket flash chips.
The Company designs its products to be compatible with
industry-standard IDE and ATA interfaces used in all IBM compatible PCs. To
achieve this design, the Company uses a 512 byte memory sector size that
required a departure from the typical socket flash chip design. By decreasing
the sector size to be the same as the sector size of all 3.5 inch, 2.5 inch and
1.8 inch hard disk drives, the Company was able to achieve compatibility with
DOS and Windows.
The Company's patented intelligent controller coupled with the
intelligent controller's advanced defect management system permits the Company's
products to achieve a high level of reliability and longevity. This defect
management system, which currently resides on a single proprietary controller
chip, is able to detect bit "wearout," a common problem with flash memory, both
immediately following manufacture and late in the product's life. Late bit
failure can occur several years into the life of a product and can be difficult
to detect with traditional flash technology. The Company's defect management
system automatically detects bits that have failed or are likely to fail due to
the number of erase/write cycles such bits have undergone and switches memory to
spare good bits incorporated into the design. The system also allows the
automatic substitution of entire sectors or major blocks of the memory chip.
Additionally, the controller generates an error correcting code which is stored
simultaneously with the data and is used to detect and correct any errors when
the data is read. This design permits the Company's products to maintain
error-free operation for hundreds of thousands of erase/write cycles and reduces
manufacturing costs by allowing the Company to incorporate partial die with less
than 100% of the physical bits on each chip into the products without loss of
functionality. Currently, all of the Company's controller chips are manufactured
by Motorola using a Motorola CPU core processor.
The flash process and flash memory chip designs developed by the
Company in cooperation with its development partners make the Company's products
scaleable over several generations of semiconductor fabrication processes. This
feature has allowed the Company to significantly reduce its cost per megabyte of
capacity as each new process generation is qualified. By maintaining the same
basic design parameters, each generation of the Company's products maintains
full compatibility with prior generations. This chip architecture, which
incorporates three polysilicon layers and one metal layer, as well as a virtual
ground array and a split gate transistor cell, has allowed the Company to
significantly reduce cell size and thereby chip size. This has permitted
increased storage capacity in PCMCIA, CompactFlash and MMC card platforms. The
Company's patented flash process requires some modifications to the typical CMOS
semiconductor fabrication process, but can be implemented on existing advanced
fabrication lines without the need for special materials or equipment. The
Company has successfully implemented its 0.4 micron process at Matsushita and
has ramped down production of the .5 micron process at Matsushita and LG
Semicon. The Company is currently qualifying its 0.35 micron process at UMC. The
Company is also in the advanced stages of development of its 0.35 micron process
at NEC.
In the third quarter of 1997, the Company commenced shipment of
production units of its 64 Mbit D2 flash and in November 1997 announced its 80
Mbit D2 flash chip. D2 is a technological innovation which allows each flash
memory cell to store two bits of information instead of the traditional single
bit per cell employed by the industry standard flash technology. The D2 flash
technology is highly complex, and the write speed of the first generation 64Mbit
and 80Mbit D2 flash is significantly slower than the Company's current flash
products. In addition, D2 flash involves several techniques never proven in a
high volume production environment. 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. There can be no assurance that the much slower write speed of
D2 flash will be accepted by SanDisk's customers. Any failure by SanDisk's
customers to accept the Company's D2 flash products, or any failure to
successfully establish volume production of the D2 flash product,
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could cause a material adverse affect on the Company's business, financial
condition and results of operations. See "Risk Factors - Dependence on Emerging
Markets and New Products."
The Company also has developed core competencies in low-cost
micropackaging technology as well as low-cost batch testing, both of which are
important elements in building high capacity flash cards to high reliability
standards at competitive cost.
Strategic Manufacturing Relationships
An important element of the Company's strategy has been to establish
strategic relationships with leading technology companies that can provide the
Company with access to leading edge semiconductor manufacturing capacity and
participate in the development of certain products. This enables the Company to
concentrate its resources on the product design and development areas where the
Company believes it has competitive advantages and eliminates the high cost of
owning and operating a semiconductor wafer fabrication facility. The Company has
developed strategic relationships with Matsushita, LG Semicon and NEC. In the
third quarter of 1997, the Company invested in USIC, a semiconductor
manufacturing facility founded by UMC in Taiwan.
All of the Company's products require silicon wafers which are
currently supplied by Matsushita and LG Semicon. Most of the Company's wafers
are currently manufactured using 0.4 micron process technology. The Company is
currently ramping down production of 0.5 micron wafers at Matsushita and LG
Semicon and expects to complete the transition from 0.5 micron wafers by
mid-year 1998. The Company currently has a joint development agreement and a
foundry agreement for 0.35 micron wafers with NEC. The Company expects to
receive its first production wafer shipments from NEC in 1998. However, there
can be no assurance that Matsushita, LG Semicon or NEC will be able to produce
the required quantities of the Company's wafers at competitive prices. Any
delays in wafer availability or uncompetitive wafer pricing would have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company invested approximately $40.3 million in USIC, which
represents an ownership interest of approximately 10% in the venture and
guarantees the Company access to approximately 12.5% of the facility's wafer
output. The USIC facility is currently under construction at the Science Based
Industrial Park in Hsin Chu City, Taiwan. The facility is scheduled to start
producing limited wafer quantities in mid 1998 and is scheduled to reach full
monthly production of approximately 20,000 eight inch wafers in 1999. The
Company has arranged to receive foundry wafers from a separate UMC fabrication
facility during the construction of the USIC plant. The Company expects to begin
receiving these wafers in the first half of 1998. There can be no assurance that
the USIC facility will be completed on schedule or that the USIC and UMC
facilities will begin production as scheduled, or that the processes needed to
fabricate wafers for the Company will be qualified at either facility.
Substantial delays in the construction of the USIC facility or the production of
wafers from UMC or USIC could have a material adverse effect on the Company's
business, financial condition and results of operations.
Under the general terms of the Company's wafer supply agreements with
its foundry partners, 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 a portion of the
forecast, generally three months, 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 months forecast. These requirements limit
the Company's ability to react to any significant fluctuations in demand for its
products. The Company is dependent upon its foundry partners to deliver wafers
and to maintain acceptable yields and quality.
The Company believes that shipments of wafers from its foundry partners
will be sufficient to meet the Company's anticipated requirements for wafers for
the foreseeable future. The Company's ability to increase its revenue and net
income in future periods is dependent on receiving an uninterrupted supply of
wafers from its manufacturing partnerships.
The Company's reliance on third-party wafer manufacturers involves
several material risks, including shortages of manufacturing capacity, reduced
control over delivery schedules, quality assurance, production yields
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and costs. In addition, as a result of the Company's dependence on foreign wafer
manufacturers, the Company is subject to the risks of conducting business
internationally, including exchange rate fluctuations. See "Risk Factors -
Dependence on Third Party Foundries."
The Company has also developed a strategic manufacturing relationship
with Motorola, the supplier of the microcontroller for all of the Company's
products. The small form factor of this single chip integrated controller is
necessary to produce the Company's CompactFlash products as well as its flash
ChipSet products. To reduce its reliance on Motorola as its sole source of
microcontrollers, the Company has undertaken a design effort to bring up an
alternate source of controller chips. The Company expects to have the second
source in production before the end of 1998. There can be no assurance that the
second source vendor will be able to successfully produce the required
quantities of controller chips. Any interruption of supply of the Company's
controller chips from Motorola before the alternate source reaches full
production could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Risk Factors - Dependence on
Sole Source Suppliers and Third Party Subcontractors."
The Company is continuing to identify and establish second sources for
its key single and sole source component vendors and subcontractors as sales
volumes increase, although there can be no assurance these efforts will be
successful. During the next several quarters, if the demand for the Company's
products exceeds its suppliers ability to deliver needed components or
subassemblies, the Company may be unable to meet customer demand.
Assembly and Test
The Company tests the majority of its wafers at its headquarters in
Sunnyvale, California. Substantially all of the tested wafers are then shipped
to the Company's third party memory assembly subcontractors: ISE in Manteca,
California, Integrated Packaging Assembly Corporation in San Jose, California
and Mitsui in Japan. Monitoring of the assembly process is done by statistical
process control and audits by the Company's personnel.
The Company performs final assembly, testing and configuration of all
products at its headquarters in Sunnyvale, California. The Company has made
substantial capital investments and has established in-house surface mount lines
for the assembly of the printed circuit boards used in the Company's
CompactFlash and FlashDisk products. In July 1996, the Company moved its
corporate headquarters from two leased facilities totaling 54,000 square feet in
Santa Clara to a leased, 104,000 square foot building in Sunnyvale. The move
allowed the Company to substantially expand its manufacturing facility and to
move some production work in-house from off-site sub-contractors. The Company
currently anticipates that it will continue to make substantial capital
investments to further enhance its assembly capabilities. See "Risk Factors -
Dependence on Sole Source Suppliers and Third Party Subcontractors."
The Company's customers have demanding requirements for quality and
reliability. To maximize quality and reliability, the Company monitors
electrical and inspection data from its wafer foundries and assembly
subcontractors. The Company monitors wafer foundry production for consistent
overall quality, reliability and yield levels. Most of the Company's major
component suppliers and subcontractors have ISO 9001 or 9002 certification.
Seagate Relationship
The Company has a strategic relationship with Seagate. In January 1993,
Seagate acquired a 25% ownership interest in the Company and entered into a
joint cooperation agreement that provides for a strategic alliance between the
parties. Seagate has the option to market the Company's products commencing in
January 1999 and at that time may be established as a distributor for the
Company's products. If the option is exercised, the Company and Seagate will
coordinate their efforts so that up to one-third of the Company's worldwide net
revenues from all flash products could be generated from sales of the Company's
flash products through Seagate. The joint cooperation agreement also provides
that each party will have the exclusive right to market to certain customers.
The joint cooperation agreement will terminate if, among other things, Seagate's
ownership interest in the Company falls below 10% or, on or after January 15,
2000, upon at least one year's advance written notice by the Company to Seagate.
Seagate has the right to nominate one director to the Company's Board of
Directors. Alan F.
Shugart,
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Seagate's Chairman and Chief Executive Officer, serves as Seagate's
nominee to the Company's Board of Directors. The Shareholder Rights Plan,
adopted by the Board of Directors on April 21, 1997, permits Seagate to continue
to hold its ownership interest in the Company without triggering the provisions
of the plan. At December 31, 1997, Seagate had an ownership interest of
approximately 24% in the Company.
Research and Development
The Company believes that its future success will depend on the
continued development and introduction of new generations of flash memory chips,
controllers and products designed specifically for the flash data storage
market. To date, the Company has developed and put into production flash data
storage products utilizing semiconductor devices with the following memory
capacity and geometries: 4Mbit (0.9 micron), 8Mbit (0.8 micron), 16Mbit (0.5
micron), 32Mbit (0.5 0.4 and 0.35 micron) and 64Mbit D2 flash (0.5 micron). In
November 1997, the Company announced its 80 Mbit (0.4 and 0.35 micron) D2 flash
chip and plans to begin customer shipments of 80 Mbit D2 flash products by
mid-year 1998. In addition, the Company has developed several generations of
controllers for these flash memory chips. Currently, a majority of the Company's
products utilize the 32Mbit device. 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.
The Company, along with its current foundry partners (in separate
design efforts), is developing a new process to manufacture future generation,
higher capacity chips employing 0.35 to 0.4 micron geometries. To date, the
Company has not successfully completed the qualification of such a process at LG
Semicon and USIC, and there can be no assurance that the Company will be able to
successfully commence volume production with such a process at these foundries
in the future. The Company has periodically experienced delays in the
development of new processes at its foundry partners and such delays may occur
again in the future. The Company's foundry partners may also experience delays
in establishing development capabilities for new processes and these delays may
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Risk Factors - Risks Associated with
Transitioning to New Products and Processes."
In the fourth quarter of 1996, the Company established a design center
in Tefen, Israel to conduct research on product design improvements and new
product development. As of December 31, 1997, the center had nine full- time
employees engaged in research and development activities.
During the fiscal years ended December 31, 1997, 1996 and 1995, the
Company spent $13.6 million, $10.2 million and $8.0 million, respectively, on
research and development activities. As of December 31, 1997, the Company had 82
full-time employees engaged in research and development activities, including
those in its Israel design center.
Sales and Distribution
The Company markets its products using a direct sales organization,
distributors and manufacturers' representatives. The Company also sells products
to various customers on a private label basis and under the SanDisk brand in the
retail channel. The Company's sales efforts are organized as follows:
Direct Sales Force. The Company's direct sales force is located in
Maitland, Florida; Herndon, Virginia; Dublin, Ohio; Irvine, California;
Sunnyvale, California; Branford, Connecticut; Hannover, Germany; Hong Kong; and
Yokohama, Japan. This organization supports major OEM customers and the
Company's distribution and manufacturers' representative partners.
Distributors. In the United States, the Company's products are sold
through Anthem Electronics Inc., Arrow Electronics Inc., Hamilton-Hallmark Inc.
and Bell MicroProducts Inc. to OEM customers for a wide variety of industrial
applications. In addition, the Company has distributors in various regions of
the world including Europe, Japan, Australia, New Zealand, Taiwan, Korea and
Hong Kong.
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Independent Manufacturers' Representatives. In the United States,
Canada and Europe, the Company's direct sales force is supported in its sales
efforts by more than 30 independent firms. These domestic and international
firms receive a commission for providing support to the Company's direct sales
force and distributors in the industrial distribution, OEM and retail channels.
The manufacturers' representative companies sell the Company's products as well
as products from other manufacturers.
Private Label Partners and OEMs. The Company has contractual
distribution agreements with Epson Hanbai to sell the Company's products on a
private label basis. Epson Hanbai sells directly to OEMs, as well as
superstores, mass merchants, office clubs, retailers and mail order companies in
Japan. In addition, the Company provides private label products to OEMs in the
United States and the Pacific Rim.
Retail. The Company entered the retail channel in 1997 and is shipping
SanDisk brand name product directly to retail superstores, office clubs and
selected retail distributors. Eleven independent manufacturers' representative
firms are supporting the Company's sales efforts in the retail channel.
Customer Service and Technical Support
The Company provides customers with comprehensive product service and
support. The Company provides technical support through its application
engineering group located in the United States and Japan. The Company works
closely with its customers to monitor the performance of its product designs, to
provide application design support and assistance and to gain insight into
customer's needs to help in the definition of subsequent generations of
products.
The Company's support package is generally offered with product sales
and includes technical documentation and application design assistance. During
an OEM's production phase, the Company provides failure analysis and replacement
of defective components. In some cases, the Company offers additional support
which includes training, system-level design, implementation and integration
support. The Company believes that tailoring the technical support level to its
customers' needs is essential for the success of product introductions and to
achieve a high level of satisfaction among its customers.
The Company generally provides a one-year warranty on its products.
Patents and Licenses
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 vigorously protects and
defends its intellectual property rights and in the past has been involved in
significant disputes regarding its intellectual property rights and believes it
may be involved in similar disputes in the future.
In 1988, the Company developed the concept of emulation of a hard disk
drive with flash solid-state memory. The first related patents were filed in
1988 by Dr. Eli Harari and exclusively licensed to the Company. The Company
currently owns or has exclusive rights to sixty two United States and thirteen
foreign issued patents, and over thirty patent applications pending in the
United States, as well as twenty pending in foreign patent offices. The Company
intends to seek additional international and United States patents on its
technology. The Company believes some of its patents are fundamental to the
implementation of flash data storage systems, as well as the implementation of
D2 flash, independent of the flash technology used. However, there can be no
assurance that 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.
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights or positions, which have resulted in
significant and often protracted and expensive litigation. To preserve its
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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
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 matter 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 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
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.
In its efforts to maintain the confidentiality and ownership of trade
secrets and other confidential information, the Company requires all employees
(regular and temporary), consultants, foundry partners, certain customers,
suppliers and partners to execute confidentiality and invention assignment
agreements upon commencement of a relationship with the Company and extending
for a period of time beyond termination of the relationship. There can be no
assurance that these agreements will provide meaningful protection for the
Company's trade secrets or other confidential information in the event of
unauthorized use or disclosure of such information. See "Risk Factors -
Fluctuations in Operating Results."
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Backlog
The Company manufactures and markets primarily standard products. Sales
are generally made pursuant to standard purchase orders. The Company includes in
its backlog only those customer orders for which it has accepted purchase orders
and assigned shipment dates within the following twelve months. Since orders
constituting the Company's current backlog are subject to changes in delivery
schedules, backlog is not necessarily an indication of future revenue. In
addition, there can be no assurance that the current backlog will necessarily
lead to revenues in any future period. As of December 31, 1997, the Company's
total backlog was $18.6 million compared to $5.8 million at December 31, 1996.
Bookings visibility continues to be limited. The Company believes that the
current situation will continue until the new markets addressed by the Company's
products enter a more predictable growth phase and demand begins to create
longer lead times. See "Item 1: Business Risk Factors - Fluctuations in
Operating Results."
Competition
The flash data storage markets in which the Company competes are
characterized by intense competition, rapid technological change, evolving
industry standards, rapidly declining average selling prices and rapid product
obsolescence. The Company's competitors include many large domestic and
international companies that have greater access to wafer fab 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, Intel, Micron Technology, Inc.
("Micron"), Mitsubishi Electronic Corporation ("Mitsubishi"), Samsung, Sharp and
Toshiba, other companies using data storage techniques such as socket flash,
linear flash and system flash components, as well as package assemblers such as
Lexar Media, Inc. ("Lexar"), M-Systems, Inc. ("M-Systems"), Simple Technology
Inc. ("Simple"), SMART Modular Technologies, Inc. ("SMART Modular") and Viking
Components, Inc. ("Viking") that combine controllers and flash memory chips
developed by others into flash data storage cards. Approximately twenty
companies, including Hitachi, Lexar, Mitsubishi and Micron have been certified
by the CompactFlash Association ("CFA") 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
Panasonic's recently introduced Mega Storage cards. In addition, in 1997 Sony
introduced a digital camera that has no flash memory and instead uses a standard
floppy disk for storing pictures. 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 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 may 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, as 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 each
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
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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, timing of new product announcements or introductions
by the Company, its customers and its competitors, the ability of the Company's
competitors to incorporate their flash data storage systems into their
customers' products, 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. The Company believes that it competes favorably
with other companies with respect to these factors. 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. See "Risk Factors - Competition."
Employees
As of December 31, 1997, the Company had 445 regular, full-time
employees and 128 temporary employees, including 82 in research and development,
62 in sales and marketing, 49 in finance and administration and 382 in
operations. The Company's success is dependent on its retention of key
technical, sales and marketing employees and members of senior management.
Additionally, the Company's success is contingent on its ability to attract and
recruit skilled employees in a very competitive market. None of the Company's
employees are represented by a collective bargaining agreement and the Company
has never experienced any work stoppage. The Company believes that its employee
relations are good.
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. For example, the Company's product
revenues increased each quarter for the first three quarters of 1996 and then
decreased in both the last quarter of 1996 and the first quarter of 1997 before
increasing in each of the last three quarters of 1997. 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 unpredictable demand for the Company's products and
seasonality in sales of products for consumer electronics applications. 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, a significant increase in the Company's effective
tax rate in 1998 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.
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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 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. In 1997, the Company experienced a shift in product
mix to CompactFlash cards that generally have lower average selling prices and
lower gross margins than higher capacity FlashDisk and FlashDrive products. This
shift in product mix, coupled with lower pricing due to competition, caused
average selling prices to decline. The Company anticipates that lower capacity
products will continue to represent a significant portion of its sales as
consumer applications such as digital cameras become more popular.
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. In 1997, the portion of the
Company's product revenues derived from sales of products for consumer
electronics applications, principally digital cameras, increased significantly
and over this period represented the largest portion of product revenues and
units shipped. 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 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
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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 expect to 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. In 1997, the Company's product mix
shifted towards CompactFlash products, which are sold principally for consumer
electronics applications. The Company anticipates that this trend will continue.
As a result, the Company expects that its product sales will be increasingly
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, the Company
anticipates that revenue in the first quarter of 1998 will decline from the
level in the fourth quarter of 1997. The Company expects that its operating
expenses may continue to increase over this time period. Accordingly, a decrease
in revenues in any quarter would adversely impact the Company's results of
operations in that period.
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
AMD, Hitachi, Intel, Micron, Mitsubishi, Samsung, Sharp and 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,
M-Systems, Simple, SMART Modular and Viking 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 Panasonic'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 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 may 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
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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. The Company's 10 largest customers accounted for
67%, 71% and 80% of product revenues in 1997, 1996 and 1995, respectively. 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
LG Semicon in Korea. The Company has also entered into a wafer supply agreement
with NEC in Japan, pursuant to which the Company expects to receive initial
wafer shipments in 1998. In the third quarter of 1997, the Company made an
investment in USIC, a semiconductor 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 expects to begin
receiving these wafers in the first half 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
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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. With the significant increases in unit
shipments in 1997, the Company from time to time experienced capacity
constraints in the memory assembly area. 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, 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
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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.
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 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
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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
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. See "Item 1: Business - Patents and Licenses."
Risks Associated with International Operations. In 1997, export sales
accounted for approximately 57% of the Company's total revenues. 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 the majority 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
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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 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. In addition, the Company recently brought in-house
certain assembly operations that were previously performed by outside vendors.
The Company has limited experience in performing these functions and there can
be no assurance it will be able successfully integrate these operations into its
manufacturing process. In addition, if the Company experiences problems with
these in-house operations, it may be difficult to quickly substitute outside
vendors. 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. See "Item 1:
Business - Employees" and "Management."
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
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economic, political and market conditions such as recessions or international
currency fluctuations, may materially adversely affect the market price of the
Common Stock. See "Price Range of 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. See
"Industry Background."
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 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.
ITEM 2. PROPERTIES
The Company's principal facilities are presently located in a 104,000
square foot building in Sunnyvale, California. Approximately one half of the
space is dedicated to production activities. The remaining space is used for
administrative, marketing and development activities. The Company occupies this
space under a lease agreement that expires in July 2001. The Company has also
entered into a lease agreement for an adjacent 50,000 square foot building. The
lease on this additional space will commence in July 1998 and expire in July
2001. The Company believes that its facilities will be adequate to meet its near
term needs and that additional space will be available as required. The Company
also leases domestic sales offices in Herndon, Virginia; Irvine, California;
Branford, Connecticut; Dublin, Ohio and Maitland, Florida, as well as foreign
sales offices in Hannover, Germany; Yokohama, Japan; Hong Kong and a design
center in Tefen, Israel.
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ITEM 3. LEGAL PROCEEDINGS
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 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 or obtain licenses to the infringing technology, or
discontinue the use of certain processes. 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
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. See "Business - Patents and Licenses."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1997.
23
<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT
As of December 31, 1997, the executive officers of the Company, who are
elected by and serve at the discretion of the Board of Directors, are as
follows:
Name Age Position
Dr. Eli Harari 52 President, Chief Executive Officer and Director
Cindy Burgdorf 50 Chief Financial Officer, Senior Vice President,
Finance and Administration and Secretary
Leon Malmed 60 Senior Vice President, Marketing and Sales
Daniel Auclair 51 Senior Vice President, Business Development and
Intellectual Property
Marianne Jackson 42 Vice President, Human Resources
Dr. Harari, the founder of the Company, has served as President and Chief
Executive Officer and as a director of the Company since June 1988. Dr. Harari
founded Wafer Scale Integration, a privately held semiconductor company, in 1983
and was its President and Chief Executive Officer from 1983 to 1986, and
Chairman and Chief Technical Officer from 1986 to 1988. From 1973 to 1983, Dr.
Harari held various management positions with Honeywell Inc., Intel and Hughes
Aircraft Microelectronics. Dr. Harari holds a Ph.D. degree in Solid State
Sciences from Princeton University.
Ms. Burgdorf joined the Company as Chief Financial Officer, Vice President,
Finance and Secretary in June 1994 and has served as Senior Vice President,
Finance and Administration since July 1995. From 1992 to 1994, Ms. Burgdorf was
Vice President of Operations Administration and Vice President of Materials and
Planning at Maxtor Corp. ("Maxtor"). From 1978 to 1992, Ms. Burgdorf held
various financial management positions including Corporate Controller, Group
Controller of the Components Group and director of the worldwide customer
satisfaction program at Intel. Ms. Burgdorf is a Certified Public Accountant and
holds a B.S. degree in Business Administration from San Jose State University.
Mr. Malmed joined the Company as Vice President, Worldwide Marketing and
Sales in December 1992 and has served as Senior Vice President, Marketing and
Sales since July 1995. From 1991 to 1992, Mr. Malmed was Executive Vice
President of Marketing/Sales at SyQuest Technology, Inc., a manufacturer of
removable-cartridge disk drives. From 1990 to 1991, Mr. Malmed was Senior Vice
President, Sales and Marketing at Prairetek, Inc., a manufacturer of disk
drives. From 1983 to 1990, Mr. Malmed held various management positions at
Maxtor. Mr. Malmed holds a B.S. degree in Mechanical Engineering from the
University of Paris.
Mr. Auclair has served as Vice President, Systems Engineering from 1990 to
June 1993, Vice President, Engineering and Technology from June 1993 to July
1995, Senior Vice President, Operations and Technology July 1995 to January 1998
and has served as Senior Vice President Business Development and Intellectual
Property since January 1998. From 1988 to 1990, Mr. Auclair was Vice President
of Engineering at Anamartic, a company that utilizes wafer scale technology to
build DRAM mass storage systems. From 1984 to 1988, Mr. Auclair was Vice
President and General Manager of the OMTI division of Scientific Micro Systems,
a supplier of disk controllers and disk controller chips to the disk drive
industry. Mr. Auclair holds a B.S. degree in Engineering Physics from the
University of Maine and an M.S. degree in Computer Science from the University
of Santa Clara.
Ms. Jackson has served as Vice President of Human Resources since April
1995. From September 1994 to March 1995, Ms. Jackson was President of M.F.
Jackson and Associates, a consulting firm that provided human resource and
organizational development consulting services. From 1993 to 1994, Ms. Jackson
served as Vice President of Worldwide Human Resources at Logitech, Inc., a
leading manufacturer of computer accessories and software products. Prior to
1993, Ms. Jackson was Director of Human Resources at Silicon Graphics, Inc. and
Sun Microsystems, Inc. Ms. Jackson holds B.A. degrees in Psychology and
Sociology from the University of California at Santa Barbara.
24
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
Market Price of Common Stock
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol SNDK. SanDisk's initial public offering of stock was November 8, 1995 at
$10.00 per share. The following table lists the high and low sales price for
each quarter during the last two years.
High Low
Fiscal year 1996
First quarter $21.75 $12.00
Second quarter $17.00 $10.625
Third quarter $16.25 $9.625
Fourth quarter $16.125 $11.25
Fiscal year 1997
First quarter $13.875 $8.875
Second quarter $14.875 $9.625
Third quarter $36.625 $14.75
Fourth quarter $40.00 $15.75
As of March 2, 1998, there were approximately 251 stockholders of record.
The Company has never declared or paid any cash dividends on its Common Stock
and does not expect to pay cash dividends on its Common Stock in the foreseeable
future. In addition, the Company's existing line of credit agreement currently
prohibits the payment of cash dividends without the bank's consent. The Company
currently intends to retain its earnings, if any, for use in its business.
25
<PAGE>
ITEM 6: SANDISK CORPORATION SELECTED FINANCIAL DATA
(In thousands, except per share data)
<TABLE>
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
Revenues
Product $105,675 $ 89,599 $ 61,589 $ 35,378 $ 20,551
License and royalty 19,578 8,000 1,250 -- --
-------- -------- -------- -------- --------
Total revenues 125,253 97,599 62,839 35,378 20,551
Cost of revenues 72,280 58,707 36,613 28,074 18,941
-------- -------- -------- -------- --------
Gross profits 52,973 38,892 26,226 7,304 1,610
Operating income (loss) 19,680 12,474 7,777 (4,781) (10,243)
Net income (loss) 19,839 14,485 9,065 (4,287) (9,990)
Net income (loss) per share
(pro forma for 1995 and 1994)
Basic $0.87 $0.65 $0.48 ($0.25)
Diluted $0.79 $0.60 $0.45 ($0.25)
Shares used in per share calculations
(pro forma for 1995 and 1994)
Basic 22,880 22,162 18,747 17,463
Diluted 24,970 24,206 20,328 17,463
At December 31, 1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
Working capital $134,298 $ 77,029 $ 68,002 $ 20,971 $ 25,266
Total assets 245,467 108,268 92,147 31,861 32,594
Long term debt, less current portion -- -- -- 93 621
Total stockholders' equity 191,374 87,810 72,381 23,672 27,862
<FN>
The Company is restricted in paying cash dividends under the terms of its line
of credit agreement and paid no cash dividends during the five-year period. (See
Note 3 of the Notes to the Consolidated Financial Statements)
The net income (loss) per share amounts prior to 1997 have been restated to
comply with Statement of Financial Standards No. 128, Earnings Per Share. For
further discussion of earnings per share and the impact of Statement No. 128,
see Note 1 of the Notes to the Consolidated Financial Statements.
Statements of operations for years prior to 1994 exclude historical loss per
share as it was not presented in the initial public registration statement.
See Notes to the Consolidated Financial Statements and Management's Discussion
and Analysis of Financial Condition and Results of Operations.
</FN>
</TABLE>
26
<PAGE>
SanDisk Corporation
SUPPLEMENTARY QUARTERLY DATA
Quarterly/1997
(Unaudited. In thousands except per share data)
1st 2nd 3rd 4th
------- ------- ------- -------
Revenues
Product $18,194 $23,922 $30,219 $33,340
License and royalty 3,250 3,425 5,925 6,978
------- ------- ------- -------
Total revenues 21,444 27,347 36,144 40,318
Gross profits 8,479 10,972 16,009 17,513
Operating income 1,540 3,391 7,233 7,516
Net income 2,125 3,690 6,802 7,222
Net income per share
Basic $0.09 $0.16 $0.30 $0.30
Diluted $0.09 $0.15 $0.27 $0.27
Quarterly/1996
Unaudited. (In thousands except per share data)
1st 2nd 3rd 4th
------- ------- ------- -------
Revenues
Product $19,489 $23,312 $24,798 $22,000
License and royalty 1,250 1,250 1,250 4,250
------- ------- ------- -------
Total revenues 20,739 24,562 26,048 26,250
Gross profits 8,017 9,505 10,289 11,081
Operating income 2,498 2,872 3,114 3,990
Net income 3,054 3,405 3,643 4,383
Net income per share
Basic $0.14 $0.15 $0.16 $0.20
Diluted $0.13 $0.14 $0.15 $0.18
27
<PAGE>
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements in this discussion and analysis 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
set forth in "Item 1: Business - Risk Factors." 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 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, exchange rate fluctuations, and an expected significant
increase in the Company's effective tax rate in 1998. 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 "Item 1: Business - 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.
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
does not expect to recognize revenues from these sales until the products are
sold to the end customers. See "Item 1: Business - Sales and Distribution."
28
<PAGE>
Historically, a majority of the Company's sales have been to a limited
number of customers. Product sales to the Company's top 10 customers accounted
for approximately 67%, 71% and 80%, respectively, of the Company's product
revenues for 1997, 1996 and 1995. 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. For example, during the fourth quarter of 1996,
the volume of large OEM orders decreased due to the timing of customers' product
introductions. 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 "Item 1: Business - Risk
Factors - Customer Concentration" and "Business - Sales and Distribution."
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 "Item 1: Business - Risk Factors - Fluctuations in
Operating Results."
Export sales are an important part of the Company's business, constituting
57%, 55% and 57% of the Company's total revenues in 1997, 1996 and 1995,
respectively. In 1997, 38% of the Company's product revenues came from sales to
Japan and 4% from other Asian countries. 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 significant 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 "Item 1: Business - Risk Factors - 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 NEC and USIC. To
remain competitive, the Company is focusing on a number of programs to lower its
manufacturing costs. These include transitioning from single to double density
flash designs, from 0.5 to 0.4 micron manufacturing processes, and from six inch
to eight inch wafers. These transitions are expected to occur over the next
several quarters. 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 selling prices and lower gross margins. See
"Item 1: Business Risk Factors -Manufacturing Yields" and "- Declining Average
Sales Prices."
29
<PAGE>
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 the 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.
Results of Operations
Product Revenues. SanDisk's product revenues increased 18% to $105.7 million
in 1997 from $89.6 million 1996. The increase of $16.1 million consisted of a
146% increase in units shipped offset by a 51% decline in average selling
prices. Fiscal year 1996 revenues of $89.6 million were 45% higher than 1995 due
to increased sales of the Chipset, CompactFlash and FlashDisk products.
In 1997, the largest increase in unit volume came from sales of
CompactFlash products, primarily for use in digital cameras and other consumer
electronics applications. In 1997, sales of CompactFlash products exceeded sales
of PCMCIA flash cards for the first time. CompactFlash products represented
approximately 73% of all units shipped and 49% of product revenues in 1997. This
shift in product mix from PCMCIA flash cards to CompactFlash cards, which have
lower capacities, contributed the decline in average selling prices in 1997. The
Company anticipates that lower capacity products will continue to represent a
significant portion of its sales as consumer applications such as digital
cameras become more popular. Sales of these lower capacity products generally
have lower average selling prices and gross margins than higher capacity
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 has experienced and expects to continue to experience
seasonality in its product sales. Due to the shift in product mix towards
CompactFlash products which are sold primarily for consumer electronics
applications, the Company expects that its product sales will be increasingly
impacted by seasonal purchasing patterns, with
30
<PAGE>
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. Although the
Company has limited visibility as to customer orders, the Company expects
product revenues in the first quarter of 1998 to decline relative to the fourth
quarter of 1997 due to these seasonal factors. In addition, the effects of the
Asian economic crisis on the Company's revenues is uncertain. The Company's
ability to adjust its operating expenses is limited in the short term due to a
number of factors described herein and in "Risk Factors." As a result, if
product revenues are lower than anticipated, the Company's results of operations
will be adversely affected. SanDisk's backlog at the end of 1997 was $18.6
million compared to $5.8 million in 1996. See "Risk Factors - Fluctuations in
Operating Results" and " - Seasonality."
License and Royalty Revenues. The Company currently earns patent license
fees and royalties under five cross-license agreements, of which agreements with
Hitachi, Toshiba and Samsung were entered into in the third quarter of 1997.
SanDisk also has cross-license agreements with Intel and Sharp. License and
royalty revenue from patent cross-license agreements was $19.6 million in 1997,
up from $8.0 million in 1996 and $1.3 million in 1995. Revenues from licenses
and royalties increased to 16% of total revenues in 1997 from 8% in 1996 and 2%
in 1995.
Gross Profits. In fiscal 1997, gross profits increased to $53.0 million or
42.3% of total revenues from $38.9 million or 39.8% of total revenues in 1996
and $26.2 million or 41.7% of total revenues in 1995. In 1997, the growth in
overall gross profits resulted from an increase in license and royalty revenues,
which was partially offset by a decline in gross profit from product sales.
Product gross profits declined as a percentage of product revenues to 31.6% in
1997 compared to 34.5% in 1996 and 40.6% in 1995. This decline was primarily due
to the shift in product mix to lower capacity CompactFlash products that have
lower average selling prices and gross margins. This decline in gross margins
was partially offset by cost reductions related to the Company's shift to
in-house assembly and test. The Company anticipates that lower capacity products
will continue to represent a significant portion of its sales as consumer
applications such as digital cameras become more popular. The Company expects
product gross margins may continue to decrease in 1998 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 to $13.6 million in 1997 from $10.2 million in 1996 and $8.0
million in 1995. As a percentage of revenues, research and development expenses
represented 10.8% in 1997, 10.4% in 1996 and 12.8% in 1995. In 1997 and 1996,
the increase in research and development expenses was primarily due to an
increase in salaries and payroll-related expenses associated with additional
personnel. Increased depreciation due to capital equipment additions and higher
project related expenses also contributed to the growth in research and
development expenses in both years. The Company expects research and development
expenses to continue to increase 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, sales
commissions, benefits 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 as independent manufacturer's
representative commissions, advertising and tradeshow expenses. Sales and
marketing expenses increased to $12.6 million in 1997 from $8.8 million in 1996
and $6.6 million in 1995. The increase in sales and marketing expenses in 1997
and 1996 was primarily due to an increase in salaries and payroll related
expenses associated with additional personnel. Higher marketing, travel and
selling expenses also contributed to this increase in both years. Sales and
marketing expenses increased to 10.0% of total revenues in 1997 compared to 9.0%
in 1996 primarily due to increased marketing expenses related to the development
of the retail channel. In 1995, sales and marketing expenses were 10.4% of
revenues. The Company expects sales and marketing expenses to increase as sales
of its products grow and as it develops the retail channel for its products.
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 were to $7.1 million in 1997 compared to $7.4 million in 1996 and $3.8
million in 1995.
31
<PAGE>
The decrease in 1997 was primarily due to a decrease in legal fees which was
partially offset by increased salaries and payroll related expenses associated
with increased personnel, higher recruiting expenses, increased allowance for
doubtful accounts and higher consulting expenses related to the Company's
management information system. In 1996, the increase in general and
administrative expenses was primarily due to an increase in legal fees
associated with the Samsung litigation and an increase in salary and benefit
expenses. General and administrative expenses represented 5.7% of revenues in
1997, 7.6% in 1996 and 6.1% in 1995. The Company expects general and
administrative expenses to increase as the general and administrative functions
grow to support the overall growth of the Company. General and administrative
expenses could also increase substantially in the future if the Company pursues
litigation to defend its patent portfolio. See "Risk Factors - Patents,
Proprietary Rights and Related Litigation."
Interest and Other Income, Net. Interest and other income, net, was $3.7
million in 1997, $3.2 million in 1996 and $1.7 million in 1995. The increase in
interest and other income since 1995 is primarily due to increased cash and
investment balances and higher interest rates.
Provision for Income Taxes. The Company's 1997, 1996 and 1995 effective tax
rates were approximately 15.0%, 7.3% and 4.5% respectively. The Company's 1997
effective tax rate is substantially higher than its 1996 rate due to the
utilization of all remaining federal net operating loss carryforwards in 1996.
The 1996 effective tax rate was substantially higher than the 1995 rate as net
operating loss carryforwards were available to offset essentially all of the
1995 taxable income.
Due to increased license and royalty revenues and growth in the Company's
net income in 1997, the Company utilized the remainder of its tax credit
carryforwards during the 1997 fiscal year. The Company's effective tax rate is
expected to increase significantly in 1998 and is expected to be near the
statutory tax rate.
Liquidity and Capital Resources
As of December 31, 1997, the Company had working capital of $134.3 million,
which included $20.9 million in cash and cash equivalents and $114.0 million in
short-term investments. The Company has a line of credit facility with a
commercial bank under which it can borrow up to $10.0 million at the bank's
prime rate. This line of credit facility expires in July 1998. As of December
31, 1997, the Company had $7.2 million committed under the line of credit
facility for standby letters of credit. The facility 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. The Company
is currently in compliance with all covenants in the line of credit agreement.
The Company intends to either renew its line of credit or negotiate a new line
of credit upon the expiration of its current line.
Operating activities provided $26.8 million of cash in 1997. In addition to
net income, sources of cash included increased deferred revenue of $22.3
million, primarily from the receipt of funds under license and royalty
agreements. Cash provided by operations was $13.4 million in 1996 and $12.4
million in 1995.
Net cash used in investing activities of $108.9 million in 1997 consisted of
net purchases of investments of $59.0 million, an investment of $40.3 in the
USIC foundry and $9.6 million of capital equipment purchases. In 1996 and 1995,
cash used in investing activities was $22.2 million and $35.4 million,
respectively. In 1996, cash used for investing purposes included net purchases
of short term investments of $13.8 million and capital equipment purchases of
$8.4 million. In 1995, cash used in investing activities included $31.6 million
net purchases of short term investments and $3.8 million of capital equipment
purchases.
During 1997, cash provided by financing activities of $83.7 million was
primarily from the sale of common stock in the Company's November 1997 follow on
public offering. Financing activities provided $0.8 million in 1996 primarily
from the sale of common stock through the SanDisk stock option and employee
stock purchase plans and $39.1 million in 1995 primarily from the sale of common
stock in the Company's initial public offering and the sale of preferred stock.
32
<PAGE>
Depending on the demand for the Company's products, the Company may decide
to make additional investments, which could be substantial, in assembly and test
manufacturing equipment to support its business in the future. Management
believes the existing cash and cash equivalents, short-term investments and
available line of credit will be sufficient to meet the Company's currently
anticipated working capital and capital expenditure requirements for the next 12
months.
Impact of Currency Exchange Rates
The Company currently purchases wafers from Matsushita under purchase
contracts denominated in Japanese Yen. A portion of the Company's revenues are
also denominated in Japanese Yen. Foreign exchange exposures arising from the
Company's Japanese Yen denominated commitments and related accounts payable are
offset to the extent the Company has Japanese 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 December 31, 1997, 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.
33
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SANDISK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
Contents
Page
Report of Ernst & Young LLP, Independent Auditors 35
Consolidated Balance Sheets 36
Consolidated Statements of Income 37
Consolidated Statements of Stockholders' Equity 38
Consolidated Statements of Cash Flows 39
Notes to Consolidated Financial Statements 40
34
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
SanDisk Corporation
We have audited the accompanying consolidated balance sheets of SanDisk
Corporation as of December 31, 1997 and 1996, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1997. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
SanDisk Corporation at December 31, 1997 and 1996 and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
---------------------
Ernst & Young LLP
San Jose, California
January 16, 1998
35
<PAGE>
SanDisk Corporation
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
December 31, 1997 1996
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 20,888 $ 19,323
Short-term investments 114,037 54,965
Accounts receivable, net of allowance for doubtful
accounts of $756 in 1997 and $593 in 1996 19,352 11,885
Inventories 15,648 9,630
Deferred tax assets 17,060 900
Prepaid expenses and other current assets 1,406 784
--------- ---------
Total current assets 188,391 97,487
Property and equipment, at cost:
Machinery and equipment 27,244 17,937
Leasehold improvements 1,981 1,695
--------- ---------
29,225 19,632
Accumulated depreciation and amortization 13,333 9,347
--------- ---------
15,892 10,285
Investment in foundry 40,284 -
Deposits and other assets 900 496
--------- ---------
Total assets $ 245,467 $ 108,268
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 14,111 $ 7,595
Accrued payroll and related expenses 4,674 2,857
Other accrued liabilities 7,341 4,354
Deferred revenue 27,967 5,652
--------- ---------
Total current liabilities 54,093 20,458
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value
Authorized shares: 4,000,000
Issued and outstanding: none -- --
Common stock, $0.001 par value
Authorized shares: 40,000,000
Issued and outstanding: 25,865,229 in 1997 and
22,326,584 in 1996 26 22
Capital in excess of par value 181,895 98,211
Retained earnings (accumulated deficit) 9,453 (10,423)
--------- ---------
Total stockholders' equity 191,374 87,810
--------- ---------
Total liabilities and stockholders' equity $ 245,467 $ 108,268
========= =========
The accompanying notes are an integral part of these consolidated financial
statements
36
<PAGE>
SanDisk Corporation
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Years Ended December 31, 1997 1996 1995
--------- -------- --------
Revenues
Product $ 105,675 $ 89,599 $ 61,589
License and royalty 19,578 8,000 1,250
--------- -------- --------
Total revenues 125,253 97,599 62,839
Cost of revenues 72,280 58,707 36,613
--------- -------- --------
Gross profits 52,973 38,892 26,226
Operating expenses
Research and development 13,577 10,181 8,043
Sales and marketing 12,568 8,792 6,564
General and administrative 7,148 7,445 3,842
--------- -------- --------
Total operating expenses 33,293 26,418 18,449
--------- -------- --------
Operating income 19,680 12,474 7,777
Interest and other income, net 3,660 3,154 1,749
Interest expense - (3) (37)
--------- -------- --------
Income before taxes 23,340 15,625 9,489
Provision for income taxes 3,501 1,140 424
--------- -------- --------
Net income $ 19,839 $ 14,485 $ 9,065
========= ======== ========
Net income per share (pro forma for 1995)
Basic $ 0.87 $ 0.65 $ 0.48
Diluted $ 0.79 $ 0.60 $ 0.45
Shares used in computing net income
per share
Basic 22,880 22,162 18,747
Diluted 24,970 24,206 20,328
The accompanying notes are an integral part of these consolidated financial
statements
37
<PAGE>
SanDisk Corporation
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Convertible Capital In Total
Preferred Stock Common Stock Excess of Retained Stockholders'
Shares Amount Shares Amount Par Value Earnings Equity
<S> <C> <C> <C> <C> <C> <C> <C>
-------- -------- -------- -------- ---------- --------- -------------
Balance at December 31, 1994 $ 14,664 $ 15 2,833 $ 3 $ 57,632 $ (33,978) $ 23,672
Sale of preferred stock, net of
issuance costs 665 - - - 6,215 - 6,215
Conversion of preferred stock into
common stock at IPO (15,329) (15) 15,329 15 - - -
Initial Public Offering, net of
issuance costs - - 3,701 4 33,336 - 33,340
Exercise of stock options for cash
net of repurchases - - 142 - 89 - 89
Net income - - - - - 9,065 9,065
-------- -------- -------- -------- ---------- --------- -------------
Balance at December 31, 1995 - - 22,005 22 97,272 (24,913) 72,381
Exercise of stock options for cash - - 168 - 95 - 95
Issuance of stock pursuant to
employee stock purchase plan - - 92 - 783 - 783
Exercise of common stock warrants - - 62 - - - -
Income tax benefit from stock
options exercised - - - - 61 - 61
Unrealized gain on available for
sale securities - - - - - 5 5
Net income - - - - - 14,485 14,485
-------- -------- -------- -------- ---------- --------- -------------
Balance at December 31, 1996 - - 22,327 22 98,211 (10,423) 87,810
Exercise of stock options for cash - - 357 1 583 - 584
Issuance of stock pursuant to
employee stock purchase plan - - 126 - 1,189 - 1,189
Exercise of common stock warrants - - 55 - - - -
Sale of common stock, net of
issuance costs - - 3,000 3 79,414 - 79,417
Income tax benefit from stock
options exercised - - - - 2,498 - 2,498
Unrealized gain on available for
sale securities - - - - - 37 37
Net income - - - - - 19,839 19,839
-------- -------- -------- -------- ---------- --------- -------------
Balance at December 31, 1997 - $ - 25,865 $ 26 $ 181,895 $ 9,453 $ 191,374
======== ======== ======== ======== ========== ========= =============
<FN>
The accompanying notes are an integral part of these consolidated financial statements
</FN>
</TABLE>
38
<PAGE>
SanDisk Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<S> <C> <C> <C>
Years Ended December 31, 1997 1996 1995
--------- -------- --------
Cash flows from operating activities:
Net income $ 19,839 $ 14,485 $ 9,065
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 3,985 2,347 1,625
Deferred tax (16,055) (1,000) -
Changes in assets and liabilities:
Accounts receivable (7,467) (3,457) (4,311)
Inventory (6,018) 781 (6,337)
Prepaid expenses and other current assets (1,122) (250) (293)
Deposits and other assets (9) (271) 581
Accounts payable 6,516 (1,458) 4,721
Accrued payroll and related expenses 1,817 911 1,000
Other accrued liabilities 2,987 1,590 1,031
Deferred revenue 22,315 (253) 5,348
--------- -------- --------
Total adjustments 6,949 (1,060) 3,365
--------- -------- --------
Net cash provided by operating activities 26,788 13,425 12,430
--------- -------- --------
Cash flows from investing activities:
Purchases of short-term investments (148,954) (47,977) (40,326)
Proceeds from short-term investments 89,919 34,157 8,711
Acquisition of property and equipment (9,592) (8,378) (3,791)
Investment in foundry (40,284) - -
--------- -------- --------
Net cash used in investing activities (108,911) (22,198) (35,406)
--------- -------- --------
Cash flows from financing activities:
Sale of common stock and warrants,
net of repurchases 83,688 939 33,429
Sale of convertible preferred stock,
net of issuance costs - - 6,215
Principal payments under capital leases - (98) (523)
--------- -------- --------
Net cash provided by financing activities 83,688 841 39,121
--------- -------- --------
Net increase (decrease) in cash and cash equivalents 1,565 (7,932) 16,145
--------- -------- --------
Cash and cash equivalents at beginning of year 19,323 27,255 11,110
--------- -------- --------
Cash and cash equivalents at end of year $ 20,888 $ 19,323 $ 27,255
========= ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ - $ 3 $ 37
Cash paid for income taxes $ 15,172 $ 451 $ 219
Conversion of preferred stock to common stock $ - $ - $ 63,683
<FN>
The accompanying notes are an integral part of these consolidated financial
statements
</FN>
</TABLE>
39
<PAGE>
Notes to Consolidated Financial Statements
Note 1: Organization and Summary of Significant Accounting Policies
Organization and Nature of Operations
SanDisk Corporation (the Company) was incorporated in Delaware on June 1,
1988, to design, manufacture, and market industry-standard, solid-state mass
storage products using proprietary, high-density flash memory technology. The
Company serves customers in the industrial, communications, highly portable
computing and consumer electronics markets. Principal geographic markets for the
Company's products include the United States, Japan, Europe and the Far East.
Supplier and Customer Concentrations
A limited number of customers historically have accounted for a substantial
portion of the Company's revenues. In 1997, no customer accounted for more than
10% of total revenue. Epson Hanbai accounted for approximately 26% of total
revenues in 1996. Three of the Company's customers, Epson Hanbai, Kyocera and
Hewlett Packard accounted for approximately 26%, 14% and 12%, respectively, of
total revenues in 1995. No other distributor or OEM customer constituted 10% or
more of revenues in the periods presented. Sales of the Company's products will
vary as a result of fluctuations in market demand for such customers' products.
Further, the flash data storage markets in which the Company competes are
characterized by rapid technological change, evolving industry standards,
declining average selling prices and rapid technological obsolescence.
Certain of the raw materials used by the Company in the manufacture of its
products are available from a limited number of suppliers. For example, all of
the Company's products require silicon wafers which are currently supplied by
two foundries, Matsushita in Japan and LG Semicon in Korea. 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. 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.
As well, certain key components such as controllers, are purchased from
single source vendors for which alternative sources are currently not available.
Shortages could occur in these essential materials due to the interruption of
supply or increased demand in the industry. If the Company were unable to
procure certain of such materials, it would be required to reduce its
manufacturing operations which could have a material adverse effect upon its
results of operations.
40
<PAGE>
Use of Estimates
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.
Basis of Presentation
The Company's fiscal year ends on the Sunday closest to December 31. Fiscal
year 1997 ended on December 28, 1997. Fiscal years 1996 and 1995 ended on
December 29, 1996 and December 31, 1995, respectively. For ease of presentation,
the accompanying financial statements have been shown as ending on the last day
of the calendar month.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.
Foreign Currency Transactions
Foreign operations are measured using the U.S. dollar as the functional
currency. Accordingly, monetary accounts (principally cash, receivables and
liabilities) are remeasured using the foreign exchange rate at the balance sheet
date. Operations accounts and nonmonetary balance sheet accounts are remeasured
at the rate in effect at the date of transaction. The effects of foreign
currency remeasurement are reported in current operations and have not been
material in the periods presented.
Reclassifications
Certain reclassifications, none of which affected net income, have been made
to prior year's amounts to conform to the current year's presentation.
Cash Equivalents and Short-Term Investments
Cash equivalents consist of short-term, highly liquid financial instruments
with insignificant interest rate risk that are readily convertible to cash and
have maturities of three months or less from the date of purchase. Cash
equivalents and short-term investments consist of money market funds, taxable
commercial paper, certificates of deposit, U.S. government agency obligations,
corporate / municipal notes and bonds with high-credit quality, money market
preferred stock and auction rate preferred stock. The fair market value, based
on quoted market prices, of cash equivalents and short-term investments is
substantially equal to their carrying value at December 31, 1997 and 1996.
Under FAS 115, management classifies investments as available-for-sale at
the time of purchase and periodically reevaluates such designation. Debt
securities classified as available-for-sale are reported at fair value.
Unrecognized gains or losses on available-for-sale securities are included, net
of tax, in equity until their disposition. Realized gains and losses and
declines in value judged to be other than temporary on available-for-sale
securities are included in interest income. The cost of securities sold is based
on the specific identification method.
All cash equivalents and short-term investments as of December 31, 1997 and
1996 are classified as available-for-sale securities and consist of the
following:
41
<PAGE>
December 31,
1997 1996
-------- --------
(In thousands)
Cash equivalents:
Money market fund $ 115 $ 4,639
Commercial paper 2,000 6,370
Municipal notes 5,800 -
U.S. government agency obligations 694 -
Corporate notes / bonds 1,650 5,894
-------- --------
Total $ 10,259 $ 16,903
======== ========
Short term investments:
U.S. government agency obligations $ 7,463 $ 4,183
Municipal notes / bonds 54,059 -
Corporate notes / bonds 24,429 49,782
Money market preferred stock 4,000 -
Certificates of deposit 4,036 -
Auction rate preferred stock 20,050 1,000
--------- --------
Total $ 114,037 $ 54,965
========= ========
Unrealized holding gains and losses on available-for-sale securities at
December 31, 1997 and 1996 and gross realized gains and losses on sales of
available-for-sale securities during the years ended December 31, 1997 and 1996
were immaterial.
Debt securities at December 31, 1997 and 1996, by contractual maturity, are
shown below. Expected maturities may differ from contractual maturities because
issuers of the securities may have the right to prepay obligations.
December 31,
1997 1996
--------- --------
Short-term investments: (In thousands)
Due in one year or less $ 68,937 $ 49,675
Due after one year through two years 45,100 5,290
--------- --------
Total $ 114,037 $ 54,965
========= ========
Inventories
Inventories are stated at the lower of cost or market. Cost is computed on a
currently adjusted standard basis (which approximates actual costs on a
first-in, first-out basis). Market value is based upon an estimated average
selling price reduced by normal gross margins. Inventories are as follows:
December 31,
1997 1996
-------- -------
(In thousands)
Raw materials $ 3,289 $ 3,858
Work-in-process 10,340 3,475
Finished goods 2,019 2,297
-------- -------
$ 15,648 $ 9,630
======== =======
42
<PAGE>
Given the volatility of the market, the Company makes inventory provisions
for potentially excess and obsolete inventory based on backlog and forecasted
demand. However, backlog is subject to revisions, cancellations and
rescheduling. Actual demand may differ from forecasted demand and such
differences may have a material effect on the Company's financial position and
results of operations.
Depreciation and Amortization
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, generally two to seven years.
Investment in Foundry
In the third quarter of 1997, the Company invested $40.3 million in United
Silicon, Inc., ("USIC") a semiconductor manufacturing subsidiary of United
Microelectronics Corporation in Taiwan. The transaction gives the Company an
equity stake of approximately 10% in the facility (which will be accounted for
on the cost basis) and guarantees access to approximately 12.5% of the wafer
output from the facility.
Revenue Recognition
Product revenue is generally recognized at the time of shipment, less a
provision for estimated sales returns. However, revenue on shipments to
distributors and retailers, subject to certain rights of return and price
protection, is deferred until the merchandise is sold by the distributors or
retailers or the rights expire.
The Company earns royalties under certain patent cross license agreements.
Royalty revenue is recognized when earned. In 1997, the Company received
payments under these cross license agreements, portions of which were recognized
as revenue and portions of which are deferred revenue. Recognition of deferred
revenue is expected to occur in future periods as the Company meets certain
obligations as provided in the various agreements.
Net Income Per Share
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. In addition, in February 1998, the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 98, Earnings per Share. Staff Accounting
Bulletin No. 98 effected the treatment of certain stock and warrants ("cheap
stock") issued within a one-year period prior to an initial public offering.
Upon the adoption of Statement 128, the Staff generally does not continue to
believe that such stock and warrants should be treated as outstanding for all
reporting periods. Earnings per share amounts presented have been restated to
conform to the Statement 128 and Staff Accounting Bulletin No. 98 requirements.
The following table sets forth the computation of basic and diluted earnings
per share:
43
<PAGE>
<TABLE>
<S> <C> <C> <C>
1997 1996 1995
-------- -------- -------
Numerator:
Numerator for basic and diluted
net income per share - net income $ 19,839 $ 14,485 $ 9,065
======== ======== =======
Denominator for basic net income per share:
Weighted average common shares 22,880 22,162 7,361
Convertible preferred stock (pro forma 1995) - - 11,386
-------- -------- ------
Shares used in computing basic net income
per share 22,880 22,162 18,747
======== ======== =======
Basic net income per share (pro forma 1995) $ 0.87 $ 0.65 $ 0.48
======== ======== =======
Denominator for diluted net income per share:
Weighted average common shares 22,880 22,162 7,361
Convertible preferred stock (pro forma 1995) - - 11,386
Employee stock options and warrants
to purchase common stock 2,090 2,044 1,581
-------- -------- -------
Shares used in computing diluted net income
per share 24,970 24,206 20,328
======== ======== =======
Diluted net income per share (pro forma 1995) $ 0.79 $ 0.60 $ 0.45
======== ======== =======
</TABLE>
Stock Based Compensation
The Company accounts for employee stock based compensation under APB Opinion
No. 25, "Accounting for Stock Issued to Employees" and related interpretations.
Pro forma net income and net income per share are disclosures required by
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation," and are included in Note 5.
Impact of Recently Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income". This statement requires that all items
that are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. This statement is effective
for fiscal years beginning after December 15, 1997, and will be adopted by the
Company for the year ended December 31, 1998.
In addition, during June 1997, the Financial Accounting Standards Board
issued Statement No. 131, "Disclosures About Segments of an Enterprise and
Related Information". This statement replaces Statement No. 14 and changes the
way public companies report segment information. This statement is effective for
fiscal years beginning after December 15, 1997 and will be adopted by the
Company for the year ended December 31, 1998.
Adoption of these pronouncements is not expected to have a material impact
on the Company's financial statements.
44
<PAGE>
Note 2: Financial Instruments
Concentration of Credit Risk
The Company's concentration of credit risk consists principally of cash,
cash equivalents, short-term investments and trade receivables. The Company's
investment policy restricts investments to high-credit quality investments and
limits the amounts invested with any one issuer. The Company sells to original
equipment manufacturers, retailers and distributors in the United States and
Japan, performs ongoing credit evaluations of its customers' financial
condition, and generally requires no collateral. Reserves are maintained for
potential credit losses.
Off Balance Sheet Risk
In connection with the credit agreement discussed in Note 3, the Company has
a foreign exchange contract line in the amount of $15,000,000 at December 31,
1997. Under this line, the Company may enter into forward exchange contracts
which require the Company to sell or purchase foreign currencies. There were no
forward exchange contracts outstanding at December 31, 1997 and 1996.
Certain of the Company's purchase commitments and balance sheet accounts are
denominated in yen. Foreign exchange exposures arising from the Company's yen
denominated purchase commitments and related accounts payable are mitigated to
the extent the Company has yen denominated current assets. To the extent such
foreign exchange exposures are not mitigated, the Company enters into foreign
exchange contracts to hedge against changes in foreign currency exchange rates.
The effects of movements in currency exchange rates on these instruments are
recognized when the related operating revenues and expenses are recognized. The
impact of movements in currency exchange rates on foreign exchange contracts
substantially mitigates the related impact on the underlying items hedged. The
Company had net transaction losses of approximately $7,000, $193,000, and
$20,000 for the years ended December 31, 1997, 1996, and 1995, respectively.
These amounts are included in interest and other income, net, in the statement
of income.
Note 3: Line of Credit
The Company has a credit agreement (the Agreement) with a bank, which
expires in July 1998. Under the provisions of the Agreement, the Company may
borrow up to $10,000,000 on a revolving line of credit at the bank's prime
interest rate (8.25% at December 31, 1997). Amounts under the revolving line of
credit can be applied to the issuance of letters of credit of up to $10,000,000.
At December 31, 1997, $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 (see Note 2) under which the Company may enter into
forward 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 December 31, 1997. The Agreement contains covenants that require the
Company to maintain certain financial ratios and levels of net worth. The
agreement also does not permit the payment of cash dividends to stockholders. As
of December 31, 1997, the Company was in compliance with the covenants. Based on
available collateral and outstanding letters of credit, the amount available
under the Agreement at December 31, 1997 was approximately $2,800,000.
Note 4: Commitments and Contingencies
Commitments
The Company leases its headquarters and sales offices under operating leases
that expire at various dates through 2002. Future minimum lease payments under
operating leases at December 31, 1997 are as follows:
45
<PAGE>
Year Ending December 31,
(in thousands)
1998 $ 1,521
1999 1,796
2000 1,682
2001 1,211
2002 574
Thereafter 287
-------
Total $ 7,071
=======
Rental expense under all operating leases was $1,253,000, $1,050,000, and
$789,000 for the years ended December 31, 1997, 1996 and 1995 respectively.
Contingencies
The Company relies on a combination of patents, mask work protection,
trademarks, copyright and trade secret laws, confidentiality procedures and
licensing arrangements to protect its intellectual property rights. There can be
no assurance that there will not be any disputes regarding the Company's
intellectual property rights. Specifically, there can be no assurance that 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 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.
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 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 or obtain licenses to the
infringing technology, or discontinue the use of certain processes.
In October 1995, Samsung Electronics Company Ltd. Filed a complaint against
the Company in the Northern District of California accusing the Company of
infringing two Samsung patents, seeking declaratory relief with respect to five
Company patents and alleging unspecified damages for certain other related
claims. On January 11, 1996, the Company filed a complaint against Samsung with
the United States International Trade Commission alleging that Samsung and its
U.S. sales arm, were importing and selling products that infringe two of the
Company's patents. On February 26, 1997, the Administrative Law Judge assigned
to the case issued an Initial Determination finding both SanDisk patents valid
and infringed and further finding a violation of Section 337 of the Trade Act.
On June 2, 1997, the Commission issued a limited exclusion order prohibiting the
unlicensed entry of infringing flash memory circuits, and carriers and circuit
boards containing such circuits, that are manufactured by or on behalf of
Samsung. On August 14, 1997, in connection with the settlement of all disputes
between them, the Company and Samsung announced the signing of a patent cross
license agreement for flash memory related patents. Under the agreement, the
Company and Samsung have licensed each others patents covering the design and
manufacture of flash memory products.
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
46
<PAGE>
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.
Litigation frequently involves substantial expenditures and can require
significant management attention, even if the Company ultimately prevails. In
addition, the results of any litigation matters are inherently uncertain.
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. See "Item 1: Business -
Risk Factors - Patents, Proprietary Rights and Related Litigation."
Note 5: Stockholders' Equity
Stock Benefit Plan
The 1989 Stock Benefit Plan, in effect through August 1995, comprised two
separate programs, the Stock Issuance Program and the Option Grant Program. The
Stock Issuance Program allowed eligible individuals to immediately purchase the
Company's common stock at a fair value as determined by the Board of Directors.
Such shares may be fully vested when issued or may vest over time as determined
by the Board of Directors. Under the Option Grant Program, eligible individuals
were granted options to purchase shares of the Company's common stock at a fair
value, as determined by the Board of Directors, of such shares on the date of
grant. The options generally vest over a four-year period, expiring no later
than ten years from the date of grant. Unexercised options are canceled upon the
termination of employment or services. Options that are canceled under this plan
will be available for future grants under the 1995 Stock Option Plan. There were
no shares available for option grants under this plan at December 31, 1997.
The 1995 Stock Option Plan provides for the issuance of incentive stock
options and nonqualified stock options. Under this plan, the vesting and
exercise provisions of option grants are determined by the Board of Directors.
The options generally vest over a four-year period, expiring no later than ten
years from the date of grant.
1995 Non-employee Directors Stock Option Plan
In August 1995, the Company adopted the 1995 Non-employee Directors Stock
Option Plan (the Directors' Plan). The Company reserved 200,000 shares of common
stock for issuance thereunder. Under this plan, automatic option grants are made
at periodic intervals to eligible non-employee members of the Board of
Directors. Initial option grants vest over a four-year period. Subsequent annual
grants vest one year after date of grant. All options granted under the
Non-employee Directors Stock Option Plan expire ten years after the date of
grant. At December 31, 1997, a total of 96,000 options had been granted at
exercise prices ranging from $10.00 to $13.375 per share.
A summary of activity under all stock option plans follows:
47
<PAGE>
<TABLE>
<S> <C> <C> <C>
Total
Available Weighted
for Future Total Average
Grant/ Issuance Outstanding Exercise Price
---------------- --------------
(Shares in thousands)
Balance at December 31, 1994 341 1,868 $0.89
Increase in authorized shares 1,566 -
Granted (790) 790 $6.41
Exercised - (141) $0.64
Canceled 59 (59) $1.35
---------------- --------------
Balance at December 31, 1995 1,176 2,458 $2.67
Granted (922) 922 $12.35
Exercised - (168) $0.57
Canceled 68 (68) $8.46
---------------- --------------
Balance at December 31, 1996 322 3,144 $5.49
Increase in authorized shares 2,550 -
Granted (912) 912 $20.59
Exercised - (358) $1.63
Canceled 145 (145) $9.83
---------------- --------------
Balance at December 31, 1997 2,105 3,553 $9.58
================ ==============
</TABLE>
At December 31, 1997, options outstanding were as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------- ----------------------------------
<S> <C> <C> <C> <C> <C>
Number Weighted Number Weighted
Outstanding Average Weighted Exercisable Weighted
Range of as of Remaining Average as of Average
Excercise prices December 31, 1997 Contractual life exercise price December 31, 1997 Exercise Price
- ---------------- ----------------- ---------------- -------------- ----------------- --------------
$ 0.15 - $ 0.75 821,802 5.55 $ 0.5677 821,802 $ 0.5677
$ 2.25 - $ 6.75 998,470 7.35 $ 4.8813 998,470 $ 4.8813
$ 9.37 - $12.00 772,163 8.90 $ 11.8021 240,057 $ 11.4838
$12.13 - $19.75 771,270 9.68 $ 18.4194 55,994 $ 13.8670
$20.50 - $38.25 189,450 9.79 $ 28.3990 2,348 $ 21.1388
- ---------------- ----------------- ---------------- -------------- ----------------- --------------
$ 0.15 - $38.25 3,553,155 7.91 $ 9.5802 2,118,671 $ 4.2117
</TABLE>
There were 8,177 shares subject to repurchase under the Stock Benefit Plan
at December 31, 1997. Approximately 22,259 shares were subject to repurchase at
December 31, 1996.
Employee Stock Purchase Plan
In August 1995, the Company adopted the Employee Stock Purchase Plan (the
Purchase Plan). The Company has reserved 883,333 shares of common stock for
issuance thereunder. Under the Purchase Plan, qualified employees are entitled
to purchase shares through payroll deductions at 85% of the fair market value at
the beginning or end of the offering period, whichever is lower. As of December
31, 1997, shares issued under the Purchase Plan totaled 218,147.
In addition, the stockholders (i) increased the shares available for future
issuance under the 1995 Stock Benefit Plan by 2,500,000 shares, (ii) increased
the shares available for future issuance under the 1995 Non-Employee Directors
Stock Option Plan by 50,000 and (iii) increased the shares available for future
issuance under the Employee Stock Purchase Plan by 450,000 in April 1997.
48
<PAGE>
Accounting for Stock Based Compensation
The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under SFAS 123 "Accounting for
Stock-Based Compensation," requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB 25, because the
exercise price of the Company's stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, which also requires that the information be determined as
if the Company has accounted for its employee stock options granted subsequent
to December 31, 1994 under the fair value method of this Statement. For all
grants subsequent to December 31, 1994 that were granted prior to the Company's
initial public offering in November 1995, the fair value of these options was
determined using the minimum value method with a weighted average risk free
interest rate of 6.32% and an expected life of 5 years. The fair value for the
options granted subsequent to the Company's initial public offering in November
1995 was estimated at the date of grant using a Black-Scholes single option
pricing model with the following weighted average assumptions: risk-free
interest rates of 6.24%, 6.23% and 6.37% for 1997, 1996 and 1995, respectively;
a dividend yield of 0.0%, a volatility factor of the expected market price of
the Company's common stock of 0.655, 0.588 and 0.513 for 1997, 1996 and 1995,
respectively; and a weighted-average expected life of the option of 5 years. The
weighted average fair value of those options granted were $12.45, $6.98 and
$3.34 for 1997, 1996 and 1995, respectively.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Under the 1995 Employee Stock Purchase Plan, the Company is authorized to
issue up to 883,333 shares of common stock to participating employees. Under the
terms of the Plan, employees can choose to have up to 10% of their annual base
earnings withheld to purchase the Company's common stock. The purchase price of
the stock is 85% of the lower of the subscription date fair market value and the
purchase date fair market value. Approximately 75% of eligible employees have
participated in the plan in 1997 and 86% in 1996 and 1995. Under the Plan, the
Company sold 125,797 and 92,350 shares to employees in 1997 and 1996,
respectively. Pursuant to APB 25 and related interpretations, the Company does
not recognize compensation cost related to employee purchase rights under the
Plan. To comply with the pro forma reporting requirements of SFAS 123,
compensation cost is estimated for the fair value of the employees' purchase
rights using the Black-Scholes model with the following assumptions for those
rights granted in 1997, 1996 and 1995: dividend yield of 0.0%; and expected life
of 6 months; expected volatility factor of 0.63 and 0.89 in 1997, 0.588 in 1996
and 0.513 in 1995; and a risk free interest rate ranging from 5.36% to 6.08%.
The weighted average fair value of those purchase rights granted in November
1995, February 1996, August 1996, February 1997 and August 1997 were $2.01,
$2.47, $2.52, $3.42 and $4.69, respectively.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of SFAS 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
49
<PAGE>
Years ended December 31,
1997 1996 1995
------- -------- -------
(in thousands, except per share amounts)
Pro forma net income $ 17,156 $ 13,553 $ 8,915
Pro forma net income per share
Basic $ 0.75 $ 0.61 $ 0.48
Diluted $ 0.69 $ 0.56 $ 0.44
Because SFAS 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1999.
Shareholder Rights Plan
On April 21, 1997, the Company adopted a shareholder rights plan (the Rights
Agreement). Under the Rights Agreement, rights were distributed as a dividend at
the rate of one right for each share of common stock of the Company held by
stockholders of record as of the close of business on April 28, 1997. The rights
will expire on April 28, 2007 unless redeemed or exchanged. Under the Rights
Agreement, each right will initially entitle the registered holder to buy one
one-hundredth of a share of Series A Junior Participating Preferred Stock for
$65.00. The rights will become exercisable only if a person or group (other than
Seagate Corporation, which is permitted to maintain its 25 percent stake in the
Company) acquires beneficial ownership of 15 percent or more of the Company's
common stock or commences a tender offer or exchange offer upon consummation of
which such person or group would beneficially own 15 percent or more of the
Company's common stock.
Warrants
The Company has periodically granted warrants in connection with the sale of
its stock and certain lease and bank agreements. The Company has the following
warrants outstanding to purchase capital stock at December 31, 1997:
Issuance Capital Number of Price Per Expiration
Date Stock Shares Share Date
- ---------------- ------------ ------------ ------------ ------------------
May 1990 Common 12,094 $6.615 May 2000
June 1991 Common 6,666 $6.615 June 1999
November 1991 Common 13,363 $6.615 November 1999
November 1992 Common 3,788 $3.300 June 1998
During 1997, the Company issued 55,125 shares of common stock for no
proceeds in the net issuance of shares upon the exercise of 70,453 warrants with
a weighted average exercise price of $5.86 per share.
Note 6: Retirement Plan
Effective January 1, 1992, the Company adopted a tax-deferred savings plan,
the SanDisk 401(k) Plan, for the benefit of qualified employees. The plan is
designed to provide employees with an accumulation of funds at retirement.
Qualified employees may elect to make contributions to the plan on a monthly
basis. The Company may make annual contributions to the plan at the discretion
of the Board of Directors. No contributions were made by the Company for the
years ended December 31, 1997, 1996 and 1995.
50
<PAGE>
Note 7: Income Taxes
The provision for income taxes consists of the following:
December 31,
1997 1996 1995
-------- ------- -----
(in thousands)
Current:
Federal $ 12,131 $ 1,701 $ 312
State 2,662 42 66
Foreign 5,263 397 46
-------- ------- -----
20,056 2,140 424
Deferred:
Federal (13,205) (1,000) -
State (3,350) - -
-------- ------- -----
(16,555) (1,000) -
Provision for income taxes $ 3,501 $ 1,140 $ 424
======== ======= =====
The tax benefits associated with stock options reduces taxes currently
payable as shown above by $2,498,000 and $61,000 in 1997 and 1996, respectively.
Such benefits are credited to capital in excess of par when realized.
The Company's provision for income taxes differs from the amount computed by
applying the federal statutory rates to income before taxes as follows:
December 31,
1997 1996 1995
------ ------- -------
Tax at U.S. statutory rate 35.0% 35.0% 35.0%
State taxes, net of federal benefit (1.9) - -
Operating losses utilized - (17.4) (31.4)
Research credit (3.8) (5.6) -
Valuation allowance (14.9) (8.0) -
Foreign taxes in excess of U.S. rate 0.4 2.1 -
Other individually immaterial items 0.2 1.2 0.9
------- ------- -------
15.0% 7.3% 4.5%
======= ======= =======
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. Significant components of
the Company's deferred tax assets as of December 31, 1997 and 1996 are as
follows:
51
<PAGE>
December 31,
1997 1996
------- -------
(In thousands)
Deferred tax assets:
Inventory reserves $ 3,338 $ 2,500
Deferred revenue 9,913 2,000
Accruals and reserves 3,970 1,500
Tax credit carryforwards - 800
Other 334 650
------- -------
Total deferred tax assets 17,555 7,450
Valuation allowance - (6,450)
------- --------
Net deferred tax assets $17,555 $ 1,000
======= =======
The valuation allowance decreased by approximately $6,450,000, $4,750,000
and $3,000,000 for 1997, 1996 and 1995, respectively. Management has determined,
based on the Company's history of prior operating earnings and its expectations
for the future, that no valuation allowance for deferred tax assets should be
provided as of December 31, 1997.
Note 8: Related Party Transactions
In January 1993, the Company entered into a joint cooperation agreement with a
stockholder. Under the terms of the agreement, the stockholder had a
nonexclusive right to distribute flash memory products produced by the Company.
There were no revenues attributable to this agreement in 1997, 1996 and 1995.
The agreement was amended in October 1994. Under the terms of the amended
agreement, the stockholder relinquished its right to distribute flash memory
products but has the option to reinstate this right in January 1999.
Note 9: Industry and Geographic Information
The Company markets its products in the United States and in foreign
countries through its sales personnel, dealers, distributors, retailers, and its
subsidiaries. Export sales account for a significant portion of the Company's
revenues. Geographic revenue information is as follows:
Years Ended December 31,
(In thousands)
1997 1996 1995
-------- -------- --------
United States $ 53,820 $ 43,999 $ 27,230
Export:
Japan 51,677 43,947 24,255
Europe 10,774 5,339 3,229
Far East 8,982 4,314 8,125
-------- -------- --------
Total $125,253 $ 97,599 $ 62,839
======== ======== ========
Note 10: Major Customers
In 1997, there were no customers who accounted for more than 10% of total
revenue. Customers who accounted for at least 10% of total revenues in 1996 and
1995 were as follows:
52
<PAGE>
Years Ended December 31,
1997 1996 1995
---- ---- ----
Epson Hanbai Co., Ltd... * 26% 26%
Hewlett-Packard Company * * 12%
NEC USA, Inc * * *
Kyocera America, Inc.... * * 14%
* Revenues were less than 10%
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
53
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors. Reference is made to the information regarding directors
appearing under the caption "Election of Directors" on pages 3 - 5 of the
Company's definitive Proxy Statement dated March 23, 1998 for its Annual Meeting
of Stockholders (the Proxy Statement), which information is incorporated in this
Form 10-K by reference. Information regarding executive officers is set forth
under "Executive Officers of the Registrant" in Part I of this
10-K.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth under "Executive
Compensation and Related Information" in the Company's Proxy Statement for the
Annual Meeting of Stockholders which is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The information required by this item is set forth under "Security Ownership
of Certain Beneficial Owners and Management" in the Company's Proxy Statement
for the Annual Meeting of Stockholders which is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth under "Compensation
Committee Interlocks and Insider Participation" and "Certain Transactions" in
the Company's Proxy Statement for the Annual Meeting of Stockholders which is
incorporated herein by reference.
54
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report
1) All financial statements
Index to Financial Statements Page
----
Report of Ernst & Young LLP, Independent Auditors 35
Consolidated Balance Sheets 36
Consolidated Statements of Income 37
Consolidated Statements of Stockholders Equity 38
Consolidated Statements of Cash Flows 39
Notes to Consolidated Financial Statements 40-53
2) Financial statement schedules
Index to Financial Statement Schedules
Financial Statement Schedules
II. Valuation and Qualifying Accounts 60
All other schedules have been omitted because the required information is not
present or not present in amounts sufficient to require submission of the
schedules, or because the information required is included in the consolidated
financial statements or notes thereto.
3) Exhibits required by Item 601 of Regulation S-K
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 Registrant3
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
55
<PAGE>
10.1 Form of Indemnification Agreement entered into between the
Registrant and its directors and officers.3
10.2 Foundry Agreement between Matsushita Electronics Corporation,
Matsushita Electronic Industrial Co., Ltd. and the Registrant,
dated May 20, 1992.1, 3
10.3 Amendment No. 1 to MEC/SunDisk Foundry Agreement, between
Matsushita Electronics Corporation, Matsushita Electronic
Industrial Co., Ltd. and the Registrant, dated April 17, 1995.1,
3
10.4 Foundry Agreement between Goldstar Electron Co., Ltd. and the
Registrant, dated October 13, 1993.1, 3
10.5 Amendment No. 1 to the Foundry Agreement between Goldstar
Electron Co., Ltd. And the Registrant, dated May 10, 1994.1, 3
10.6 SanDisk/Goldstar Technical Collaboration Agreement between
Goldstar Electron Co., Ltd. and the Registrant, dated March 25,
1994.1, 3
10.7 Joint Development Agreement between NEC Corporation and the
Registrant, dated June 20, 1994.1, 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
10.17 Patent Cross License Agreement between the Registrant and Intel
Corporation, dated October 12, 1995.3
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
10.20 Patent Cross License Agreement between the Registrant and Sharp
Corporation dated December 24, 1996.2, 6
10.21 Amendment to Lease Agreement between the Registrant and G.F.
Properties, dated April 3, 1997.
10.22 First and second amendments to business loan agreement between
the Registrant and Union Bank of California, dated June 30, 1997.
21.1 Subsidiaries of the Registrant.6
27.1 Financial Data Schedule for the year ended December 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.
56
<PAGE>
Consent of Ernst & Young LLP, Independent Auditors
We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 33-96298 and No. 333-32039) pertaining to the SanDisk Corporation
1995 Stock Option Plan, 1995 Non-Employee Directors Stock Option Plan and
Employee Stock Purchase Plan of SanDisk Corporation of our report dated January
16, 1998, with respect to the consolidated financial statements and schedule of
SanDisk Corporation included in this Annual Report (Form 10-K) for the year
ended December 31, 1997.
/s/ Ernst & Young LLP
San Jose, California
March 19, 1998
57
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
By: /s/ Cindy L. Burgdorf
---------------------
Cindy L. Burgdorf
Chief Financial Officer, Senior Vice President,
Finance and Administration and Secretary
DATED: March 19, 1998
58
<PAGE>
POWER OF ATTORNEY
KNOW ALL PEOPLE BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Dr. Eli Harari and Cindy L. Burgdorf,
jointly and severally, his or her attorneys in fact, each with the power of
substitution, for him or her in any and all capacities, to sign any amendments
to this Report on Form 10-K, and to file the same, with exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of said attorneys in
fact, or his or her substitute or substitutes, may do or cause to be done by
virtue thereof.
Pursuant to the requirements of the Securities and Exchange Act of 1934,
as amended, this Report has been signed below by the following persons in the
capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
Signature Title Date
By: President, Chief Executive Officer March 19, 1998
----------------------------
(Dr. Eli Harari) and Director
By: Chairman of the Board March 19, 1998
----------------------------
(Irwin Federman)
By: Chief Financial Officer, March 19, 1998
----------------------------
(Cindy L. Burgdorf) Senior Vice President, Finance and
Administration and Secretary
(Principal Financial and
Accounting Officer)
By: March 19, 1998
----------------------------
(William V. Campbell) Director
By: Director March 19, 1998
----------------------------
(Catherine P. Lego)
By: Director March 19, 1998
-------------------------------
(Dr. James D. Meindl)
By: Director March 19, 1998
-------------------------------
(Joseph Rizzi)
By: Director March 19, 1998
------------------------------
(Alan F. Shugart)
</TABLE>
59
<PAGE>
SANDISK CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
<TABLE>
<S> <C> <C> <C> <C>
Additions
Balance at Charged to Balance at
Beginning Costs and * End
Description Of Period Expenses Deductions Of Period
---------------------------------- ---------- ---------- ---------- ----------
Allowance for doubtful accounts:
Year ended December 31, 1995 $ 594 - $ 1 $ 593
Year ended December 31, 1996 $ 593 - - $ 593
Year ended December 31, 1997 $ 593 $ 204 $ 41 $ 756
</TABLE>
*Write offs
60
FRONT COVER
SanDisk 1997 Annual Report
More Memory. More Possibilities.
(with photographs of SanDisk's CompactFlash, MultiMediaCard and FlashDisk
products and various devices they are used in.)
<PAGE>
INSIDE FRONT COVER
Corporate Profile
SanDisk Corporation designs, manufactures and markets flash memory data storage
products used in wide variety of electronic systems. The Company has optimized
its flash memory storage solution, known as "system flash", to address the needs
of many emerging applications in the consumer electronics and
industrial/communications markets. The Company believes its core technical
competencies are in high-density flash memory process and design, controller
design, system-level integration, compact packaging and low-cost system test.
The Company's products include removable CompactFlash and FlashDisk memory
cards, MultiMediaCard and embedded FlashDrive and Flash ChipSet products.
SanDisk has successfully applied its technology to the rapidly growing markets
for digital cameras and other consumer electronics devices such as mobile phones
and handheld PCs.
(bar graphs w/ the following data)
1994 1995 1996 1997
(in thousands)
Revenues $35,378 $62,839 $97,599 $125,253
Working Capital $20,971 $68,002 $77,029 $134,298
Operating Income (Loss) ($4,781) $7,777 $12,474 $ 19,680
Net Income (Loss) ($4,287) $9,065 $14,485 $ 19,839
<PAGE>
To Our Stockholders:
Fiscal 1997 was another good year for SanDisk. The Company recorded its third
consecutive profitable year with net income of $19.8 million and revenues of
$125.3 million. This represented an increase of 28% over revenues of $97.6
million in the previous year. Product revenues grew 18% in fiscal 1997. Year
over year unit shipments increased 146%, exceeding 1.4 million units. Average
selling prices declined 51% due in part to a mix shift to lower capacity
CompactFlash cards. Net income increased by 37%, due in large part to increased
patent licenses and royalties. SanDisk ended 1997 with a strong balance sheet
with $134.9 million in cash and short term investments, and no debt.
CompactFlash emerged as the de facto global standard for small form factor
digital storage cards in the face of competing products during 1997.
CompactFlash has been designed into more than 140 products, including digital
cameras, hand held computers, audio recorders and medical monitors. SanDisk
worked with many of the leading camera and imaging companies to facilitate the
use of our CompactFlash products in next generation digital cameras as a
removable storage medium. There are currently more than two dozen digital
cameras offered by companies such as Kodak, Canon, Casio, Panasonic, NEC,
Konica, Polaroid, Epson, Vivitar, Umax, Nikon and Hewlett Packard that employ
CompactFlash to store digital images.
The demand for higher capacity CompactFlash cards was fueled by the rapid growth
of the digital camera after-market. Consumers are showing a preference for
digital cameras having higher resolution at a given price point. These higher
resolution cameras require increased storage capacities, driving the market to
higher capacity CompactFlash cards. New higher resolution digital camera models
are expected to be introduced in 1998. We are very pleased with SanDisk's
leadership position in the emerging digital film market. Additionally, our
CompactFlash cards have been designed into the majority of PDA's (personal
digital assistants) including the H.P. 320LX and Psion Series 5. Microsoft's
Palm PC and Auto PC reference designs which employ the Windows CE operating
system specify CompactFlash as the removable Flash memory card.
SanDisk demonstrated its ability to move into volume production during the year
while maintaining product quality and good product margins. Over one million
CompactFlash units were shipped during 1997 representing approximately 49% of
product revenues and an increase of 400% over 1996 CompactFlash revenues.
SanDisk also announced the signing of key retail distribution agreements with
major consumer electronics and office product chains to sell CompactFlash under
the SanDisk brand name. CompUSA, Circuit City, Office Depot, Staples, Computer
City, Best Buy, Micro Center and Fry's Electronics, as well as Ritz Camera, Wolf
Camera and Kits Camera chains, now all carry SanDisk labeled CompactFlash
storage cards. These agreements give SanDisk a high-profile presence in retail
outlets throughout the United States and Canada, and are evidence of our intent
to expand the retail portion of our business in the future. In the third and
fourth quarters of 1997, sales to the retail channel represented approximately
15% of product revenue. We are pleased with the growth in retail sales during
the year.
During 1997, SanDisk concluded additional flash patent cross-licensing
agreements with Hitachi, Toshiba and Samsung, bringing the total of such patent
license agreements to five. These cross-licensing agreements further confirm the
strength and depth of our patent portfolio in Flash memory cards and flash data
storage systems. The license fees and royalties flowing from these agreements
have allowed SanDisk to fund accelerated product and technology development, in
addition to improving our overall gross margins.
In July, SanDisk announced plans to invest in United Silicon, Inc. (USIC), a
semiconductor facility headed by United Microelectronics Corporation (UMC) in
Taiwan. The USIC investment amount totaled $40.3 million and was paid in full
during the third quarter. This transaction gives SanDisk a 10% equity stake in
USIC with guaranteed access to 12.5% of the wafer output from this $1 billion
new fab designed to process eight inch wafers at the leading edge technology of
0.35 and 0.25 micron process geometries. With the addition of the USIC facility
to SanDisk's existing foundry supply arrangements, SanDisk should have access to
sufficient advanced wafer production capacity to meet the Company's anticipated
needs for the next several years.
In early November, SanDisk and Siemens made a major new product announcement,
introducing the MultiMediaCard (MMC), which is the world's smallest solid state
flash storage device. We expect the MMC will emerge as the portable storage de
facto standard for mobile phones, advanced pagers and other consumer electronics
hand held products. The MMC product announcement is a furthering of SanDisk's
overall strategy to establish and provide products that become industry
standards, are targeted to mass markets and are supported by the major industry
players. MMC has received the support and endorsement of leading
telecommunication companies including Ericsson, Motorola, Nokia, QUALCOM and
Siemens Private Communication Systems. First customer
<PAGE>
shipments of MMC are projected for mid-1998, but revenues attributable to MMC
are not expected to be material before fiscal year 1999.
We successfully completed a secondary offering of common stock in late November
which provided SanDisk with approximately $79.4 million of additional capital to
help fund anticipated future growth.
SanDisk's primary challenge in 1998 is to continue to aggressively pursue cost
reductions and rapid introductions of new technology and exciting products. The
manufacturing transition from six inch to eight inch wafers and from 0.50 micron
to 0.35 micron Flash memory technology, which began in the second half of 1997
is expected to be completed in the first half of 1998. Delays in introducing the
first generation 64 megabit Double Density (D2) technology resulted in
disappointing revenues from this design in 1997. We have now shifted our efforts
to the second generation 80 megabit D2, which is expected to begin customer
shipments at mid-year 1998. We believe these activities are important to
maintaining our leadership position in the rapidly developing markets we are
addressing and we have considerable engineering resources dedicated to
accomplishing this task.
As expected, the Company entered 1998 with limited bookings visibility,
particularly in Japan. Despite ongoing weakness in the Japanese market and
considerable pricing pressures from Asian competitors, we are experiencing
strong design-in activity for our CompactFlash, ChipSets and MultiMediaCard
products in numerous consumer, industrial and communications applications. We
expect business to pick up as exciting new models of digital cameras and other
consumer hand held devices currently under development hit the market.
The current uncertainty in Asia does not alter our view of SanDisk's strong
business fundamentals. SanDisk's market leading products, strong OEM
relationships, low cost flash technology, high volume economies of scale,
continued royalty income flow and extremely strong balance sheet, position us
well in our emerging mass markets. The pace of innovation in consumer
electronics and mobile communications is fast and furious, and many of these new
appliances are enabled by SanDisk's storage solutions. We are highly focused on
accelerating development of our next generation Flash technology, reducing
manufacturing costs, expanding global sales channels and implementing the
requisite infrastructure to support the introduction of exciting new storage
products to sustain our long term growth. We continue to enjoy good strategic
relationships with our corporate partners, and with Seagate, our largest
shareholder. As a result, we remain optimistic about the opportunities ahead.
We appreciate your continued support of our strategy as we move forward to 1998.
/s/ Eli Harari
Eli Harari
President and Chief Executive Officer
<PAGE>
INSIDE BACK COVER
CORPORATE INFORMATION
At December 31, 1997, there were 573 people employed at SanDisk Corporation.
REGISTRAR AND TRANSFER AGENT
Harris Trust and Savings Bank, Chicago, Illinois
INDEPENDENT PUBLIC AUDITORS
Ernst & Young LLP, San Jose, California
INVESTOR / SHAREHOLDER RELATIONS
Cindy Burgdorf, Chief Financial Officer,
Senior Vice President, Finance and Administration
Sharon, Spehar, Shareholder Relations
LEGAL COUNSEL
Brobeck, Phleger & Harrison LLP, Palo Alto, California
BOARD OF DIRECTORS
William V. Campell(2), Intuit, President and Chief Executive Officer
Irwin Federman(1), Chairman of the Board, U.S. Venture Partners, General Partner
Eli Harari, SanDisk Corporation, President and Chief Executive Officer
Catherine P. Lego(1), Lego Ventures
Dr. James D. Meindl, Georgia Institute of Technology
Joseph D. Rizzi(1), Matrix Partners, General Partner
Alan F. Shugart(2), Seagate Technology, Chief Executive Officer
(1) Audit Committee
(2) Compensation Committee
EXECUTIVE OFFICERS
Daniel Auclair, Senior Vice President, Business Development and
Intellectual Property
Cindy Burgdorf, Chief Financial Officer,
Senior Vice President, Finance and Administration
Dr. Eli Harari, President and Chief Executive Officer
Marianne Jackson, Vice President, Human Resources
Leon Malmed, Senior Vice President, Marketing and Sales
<PAGE>
OUTSIDE BACK COVER
WORLDWIDE LOCATIONS
SANDISK
CORPORATE HEADQUARTERS
140 Caspian court
Sunnyvale, CA 94089-9820
Phone: 408-542-0500
Fax: 408-542-0503
http://www.sandisk.com
SANDISK SALES OFFICES
Northwestern Region USA
140 Caspian Court
Sunnyvale, CA 94089
Phone: 408-542-0500
Fax: 408-542-0403
Western Region USA
8 Corporate Park, Suite 300
Irvine, CA 92606
Phone: 714-442-8370
Fax: 714-442-8371
Central Region USA
4900 Blazer Parkway
Dublin, OH 43017
Phone: 614-760-3700
Fax: 614-760-3701
New England & Canada
175 North Main St.
Branford, CT 06405
Phone: 203-483-4390
Fax: 203-483-4399
Mid-Atlantic Region USA
620 Herndon Parkway, Suite 200
Herndon, VA 22070
Phone: 703-481-9828
Fax: 703-437-9215
Southern Region USA, Latin & South America
101 Southhall Lane, Suite 400
Maitland, FL 32751
Phone: 407-667-4880
Fax: 407-667-4834
European Sales Office
SanDisk GmbH
Karlsruher Str. 2C
D-30519 Hannover, Germany
Phone: 49-511-8759185
Fax: 49-511-8759187
Japan Sales Office
SanDisk Ltd., Japan
8F Nisso Bldg. 15
2-17-19 Shin-Yokohama, Kohoku-ku
Yokohama 222-0033
Phone: 81-45-474-0181
Fax: 81-45-474-0371
Asia / Pacific Rim Sales Office
Flat B, 3/F, Harrison Court (V)
8 Man Wan Road
Waterloo Hill, Kowloon
Hong Kong
Phone: 852-2712-0501
Fax: 852-2712-9385
SanDisk (logo)
SanDisk and CompactFlash are trademarks of SanDisk Corporation. All
other trademarks are property of their respective owners.
Copyright 1997 SanDisk Corporation.
SUBSIDIARIES OF THE REGISTRANT
1) SanDisk KK
2) SanDisk GMBH
3) SanDisk Israel
Consent of Ernst & Young LLP, Independent Auditors
We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 33-96298 and No. 333-32039) pertaining to the SanDisk Corporation
1995 Stock Option Plan, 1995 Non-Employee Directors Stock Option Plan and
Employee Stock Purchase Plan of SanDisk Corporation of our report dated January
16, 1998, with respect to the consolidated financial statements and schedule of
SanDisk Corporation included in this Annual Report (Form 10-K) for the year
ended December 31, 1997.
/s/ Ernst & Young LLP
San Jose, California
March 19, 1998
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<LEGEND>
SanDisk Financial Data Schedule, December 31, 1997
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