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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, 1996 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, $.01 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 [ ].
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 February
28, 1997 as reported on the NASDAQ National Market System, was approximately
$297,564,697. 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 February 28, 1997, Registrant had 22,457,713 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting to be held on April 18,
1997 are incorporated by reference into Part III.
SANDISK CORPORATION
1996 FORM 10-K ANNUAL REPORT
Table of Contents
PART I
Page No.
Item 1. Business 1
Item 2. Properties 17
Item 3. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Executive Officers of the Registrant 19
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 20
Item 6. Selected Financial Data 21
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
Item 8. Financial Statements and Supplementary Data 26
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 42
PART III
Item 10. Directors and Executive Officers of the Registrant 43
Item 11. Executive Compensation 43
Item 12. Security Ownership of Certain Beneficial Owners and
Management 43
Item 13. Certain Relationships and Related Transactions 43
PART IV
Item 14. Exhibits, Financial Statements, Schedules, and Reports
on Form 8-K 44
Signatures 47
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 1996 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 Corporation designs, manufactures and markets industry-standard,
solid-state data, image and audio storage products using proprietary high
density flash memory and controller technologies. The Company's products are
designed for a broad range of applications in the four markets targeted by the
Company: industrial, communications, highly portable computing and consumer
electronics. The Company's products include removable FlashDisk cards, embedded
FlashDrives and Chipsets, and removable CompactFlash(TM) products.
The Company's strategy includes focusing on technological innovation in the
development of new generations of flash memory devices and reducing the cost of
its flash data storage products in order to promote broader acceptance of the
Company's products in its target markets. The Company believes that the
widespread acceptance of industry standards is important to the continued
development of the market for flash data storage and as such seeks to promote
and adhere to industry standards.
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
handheld data collection terminals, medical monitors, mobile communication
systems, highly portable computers, digital cameras, cellular telephones,
communications switches, wireless base stations, network computers, pay
telephones, digital audio recorders 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. These markets can be broadly categorized as the
industrial, communications, highly portable computing and consumer electronics
markets.
Memory Technology
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 flash data storage in
applications in the markets described above, although the most common types of
flash memory, "socket flash" and "linear flash," are not well suited for these
purposes.
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.
1
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 (FFS) software. While linear flash cards provide a
low cost mass storage solution, they provide no built-in intelligence, and rely
instead on the host microprocessor and the specialized flash file system (FFS)
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.
In summary, customers in the industrial, communications, highly portable
computing and consumer electronics markets are seeking data storage solutions
which satisfy the requirements that 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.
SanDisk Technology
Since its inception, the Company has focused its research and development
efforts on developing 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 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 developed new
capabilities in flash memory chip design, created a new intelligent controller
and developed an architecture that could leverage advances in flash memory
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 target
markets 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 requires 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 Windows 95, Windows NT, Windows
CE, Macintosh OS System 7.0 and other operating systems.
The Company's proprietary 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 is able to detect bit "wearout," a common problem with flash
memory. 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 operates 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. To date, the Company has received over fifty
patents covering its proprietary flash memory, intelligent controller system and
defect management system.
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
2
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 PC Card and smaller 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 process at Matsushita and at LG Semicon.
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
a competitive cost.
Applications and Markets for Flash Data Storage
The Company is targeting the industrial, communications, highly portable
computing and consumer electronics markets for its flash data storage products.
Industrial 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 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.
Communications Market. 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. High-end
cellular telephones and personal communicators need small form factor storage
that is shock and vibration tolerant and has low power requirements.
Highly Portable Computing Market. Flash data storage products are used in
the highly portable segment of the computer market where the use of traditional
storage devices, such as hard disk drives, is not viable. Certain segments of
the computer market have begun to require new types of data storage,
particularly highly portable handheld computers, electronic organizers and
personal digital assistants. These systems can take advantage of mass storage
with small form factors, shock and vibration tolerance, low power consumption
and compatibility with industry standard computer operating systems.
Consumer Electronics Market. The increasingly digital nature of consumer
electronics goods has created requirements for non-traditional data storage. 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 also have the potential to be used in two-way pagers,
voice/audio recorders, and digital audio samplers. These data storage devices
need to have a very small form factor and be lightweight, shock and vibration
tolerant and interoperable with computer systems and software that can process,
manipulate and print images digitally.
Customers
In 1996, 1995 and 1994, sales to the Company's top ten customers accounted
for approximately 71%, 80% and 81%, respectively, of the Company's product
revenues. During 1996, Epson Hanbai accounted for approximately 26% of the
Company's total revenues. Three of the Company's customers, Epson Hanbai,
Kyocera Corporation ("Kyocera") and Hewlett-Packard Company ("Hewlett-Packard")
accounted for approximately 26%, 14% and 12%
3
of total revenues, respectively, in 1995. Epson Hanbai and Hewlett-Packard
accounted for approximately 20% and 19% of total revenues, respectively, in
1994. 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 "Item 1: Business - Risk Factors
Customer Concentration."
Products
SanDisk's storage products are high capacity, solid-state, non-volatile
flash memory products 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 FlashDisk cards,
embedded FlashDrive products, removable CompactFlasho 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 virtually all of today's computing and communications systems. The Company
also offers several adapters for use with certain of its products. The Company's
products, as of December 31, 1996, are listed in the following table:
- ------------------ --------------------------- ---------------------------------
Uncompressed Capacity
Product Family Form Factor (in megabytes)
- ------------------ --------------------------- ---------------------------------
FlashDisk PC Card Type II 2, 4, 6, 8, 10, 20, 40, 85, 150
--------------------------- ---------------------------------
--------------------------- ---------------------------------
(Removable) PC Card Type III 110, 175, 300
--------------------------- ---------------------------------
- ------------------ --------------------------- ---------------------------------
FlashDrive 1.3 inches 4, 10, 20, 40, 60
--------------------------- ---------------------------------
--------------------------- ---------------------------------
(Embedded) 1.8 inches 4, 10, 20, 40, 80, 140
- ------------------ --------------------------- ---------------------------------
CompactFlash TM 36.4 mm x 42.8 mm x 3.3 mm 2, 4, 6, 8, 10, 15, 20
(Removable)
- ------------------ --------------------------- ---------------------------------
Flash ChipSet 2 chips 2, 4, 10
(Embedded)
- ------------------ --------------------------- ---------------------------------
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 less than 10 percent of the power required by
a rotating disk drive. All of the Company's products are small enough to be
employed in mobile systems while the two smallest, CompactFlash and Flash
ChipSet, are small enough to be used in many of the newer, miniaturized
electronic systems being developed today. The ruggedness levels of the Company's
products range as high as 2,000G's, an operating shock rating equivalent to a
10-foot drop to the floor.
FlashDisk. The Company's FlashDisk products are used in storage, data backup
and data transport applications and are the highest-capacity removable PC Card
ATA cards currently available. FlashDisk products are available in Type II form
factor with capacities ranging from 2MB to 150MB and Type III form factor with
capacities ranging from 110MB to 300MB.
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 140MB for the 1.8 inch product
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 3.3V
features make it ideal for a range of current and next-generation, small form
factor consumer
4
applications such as digital cameras, cellular phones, PDAs, personal
communicators, pagers and audio recorders. CompactFlash products provide
interoperability with systems based upon the PC Card ATA standard by using a
passive Type II adapter. CompactFlash is available in capacities ranging from
2MB to 20MB.
The CompactFlash Association ("CFA") is actively promoting the development
of products using CompactFlash. Founding members of the CFA are Apple Computer,
Inc., Canon Inc., Eastman Kodak Co., Hewlett-Packard Company, LG Semicon,
Matsushita Electric Industrial Co. (Panasonic), Motorola, NEC Corporation
("NEC"), Polaroid Corp., Seagate Technology, Inc. ("Seagate") and Seiko Epson
Corp. During the fourth quarter of 1996, the number of member companies in the
CompactFlash Association reached sixty one. CompactFlash has been designed into
more than seventy new products including digital cameras, handheld PC's, audio
recorders, medical monitors and other industrial products. The Company is
currently working with several leading camera and imaging companies to
facilitate the use of FlashDisk and CompactFlash products in next generation
digital cameras. However, there can be no assurance that the digital cameras
employing these units will become a widely adopted new product category.
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 for the 2MB and 4MB models or
a memory module comprised of multiple flash memory chips for the 10MB product.
It provides full PC Card ATA and IDE disk drive compatibility in a chip set
format.
The majority of the Company's sales in 1996, 1995 and 1994 were of FlashDisk
cards. See "Item 1: Business - Risk Factors - Dependence on Emerging Markets and
New Products."
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,
participate in the development of certain products and assist the Company in the
marketing of its products. This enables the Company to concentrate its resources
on the product design and development areas where the Company believes it has a
competitive advantage and eliminates the high cost of owning and operating a
semiconductor wafer fabrication facility. In this regard, the Company has
developed strategic relationships with Matsushita Electronics Corporation
("Matsushita"), the Company's largest supplier of silicon wafers, LG Semicon,
which purchased an equity interest in the Company in March 1995 and NEC, which
entered into a joint development agreement with the Company in June 1994 for
future generation flash chips and which purchased an equity interest in the
Company in January 1995.
The Company's reliance on third-party manufacturers involves several
material risks, including shortages of manufacturing capacity, reduced control
over delivery schedules, quality assurance, production yields 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 "Item 1: Business
Risk Factors - Dependence on Third Party Foundries, Dependence on Key and Sole
Source Suppliers, and International Operations."
Foundries.
Matsushita. The Company currently purchases most of its wafers from
Matsushita. Matsushita and the Company began cooperation on first generation 0.8
micron flash memory products in 1990. The Company and Matsushita have a joint
cooperation and foundry agreement covering 16Mbit, 32Mbit and 64Mbit
semiconductor devices employing Matsushita's 0.5 micron process technology to
manufacture products designed by the Company. Currently, Matsushita has
qualified two wafer production lines to produce 32Mbit and future generation
devices for the Company. The foundry capacity made available by Matsushita for
the production of 0.5 micron flash wafers during 1996 was sufficient to meet the
Company's requirements. Under the Company's wafer supply agreement with
Matsushita that expires April 17, 2000, the Company is obligated monthly to
provide a six-month rolling forecast of anticipated purchase orders. Except in
limited circumstances and subject to acceptance by Matsushita, the estimates for
the first three months of each forecast constitute a binding commitment and the
estimates for months four through six may not increase or decrease by more than
a certain percentage from the previous month's
5
forecast. This limits the Company's ability to react to any significant
fluctuations in demand for its products. The Company is dependent upon the
foundry to deliver the wafers and to maintain acceptable yields and quality. The
Company generally pays a set price per wafer regardless of yield. The Company is
also engaged in joint development of a 0.4 micron flash process technology with
Matsushita. However, no foundry agreement has been negotiated with Matsushita
for 0.4 micron wafers. The Company expects to commence limited production of 0.4
micron flash wafers at Matsushita in 1997.
LG Semicon. In late 1995, the Company qualified LG Semicon to produce 16Mbit
devices using 0.5 micron process technology. 16Mbit production wafers were
received by the Company and volume shipments began in the fall of 1995. In 1996,
the Company shifted 100% of its production at LG Semicon to 32Mbit devices. LG
Semicon and the Company have a wafer supply agreement which expires November 10,
2000, pursuant to which the Company is obligated monthly to provide a
twelve-month rolling forecast of anticipated purchase orders. Except in limited
circumstances and subject to acceptance by LG Semicon, the estimates for the
first three months of each forecast constitute a binding commitment and the
estimates for months four through twelve may not increase or decrease by more
than a certain percentage from the previous month's forecast. This limits the
Company's ability to react to any significant fluctuations in demand for its
products. LG Semicon was able to meet all of the Company's wafer requirements in
1996. The Company is dependent upon the foundry to deliver the wafers and to
maintain acceptable yields and quality.
NEC. The Company has entered into a joint development agreement with NEC to
develop 0.35 micron flash process technology with products up to 256Mbit
capacity. The Company and NEC intend to demonstrate feasibility of the
technology and, assuming success, to negotiate a foundry agreement to supply a
portion of the Company's future requirements for 256Mbit or other devices of
lower capacity. The Company does not expect to ship products using 256Mbit
technology until 1998 at the earliest.
Given the current glut in the wafer foundry business, the Company believes
that shipments of wafers from Matsushita and LG Semicon will be sufficient to
meet the Company's anticipated requirements for wafers in the next few quarters.
The Company's ability to increase its revenue and net income in 1997 is
dependent on receiving an uninterrupted supply of wafers from both Matsushita
and LG Semicon. See "Item 1: Business - Risk Factors - Dependence on Third Party
Foundries."
Test & Assembly.
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 assembler, Alphatec in Manteca, California.
Monitoring of the assembly process is done by statistical process control and
audits by the Company's personnel. In the event that Alphatec were to stop
assembling the Company's products, it could take at least three to four months
to replace such loss of capacity. During the second half of 1996, the Company
made substantial capital investments and established in-house surface mount
lines for the assembly of the printed circuit boards used in the Company's
FlashDisk and CompactFlash products. See "Item 1: Business - Risk Factors
Dependence on Key and Sole Source Suppliers."
Final Assembly, Systems Test and Configuration.
The Company performs final assembly, testing and configuration of all
products at its headquarters in Sunnyvale, California. 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.
Component Suppliers.
Motorola supplies the microcontroller component for all of the Company's
products. In 1993, Motorola and the Company agreed to customize the Motorola
68000 core microprocessor to integrate the Company's five chip controller into a
single chip. 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. The Company's reliance on Motorola
6
as it 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. See "Item 1: Business - Risk
Factors - Dependence on Key and Sole Source Suppliers."
Quality.
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 also has a strategic relationship with Seagate, which owns
approximately 25% of the Company's Common Stock. In January 1993, Seagate
acquired a 25% ownership interest, calculated on a fully diluted basis, 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,
Seagate's Chairman, President and Chief Executive Officer, serves as Seagate's
nominee to the Company's Board of Directors. See "Item 13: Certain Relationships
and Related Transactions."
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) and 32Mbit (0.5 micron). 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.
In October 1996, the Company announced Double Density Flash, or D2 Flash. D2
is a technological innovation which will allow 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. D2 flash has been under development
by the Company since its inception in 1988. The first commercial products
expected to employ the Company's 64Mbit D2 flash chip, will be undergoing
internal qualifications in the first half of 1997. The D2 flash technology is
highly complex, and the write speed of the first generation 64Mbit 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. There can be no assurances that the Company will achieve successful
qualification of the D2 flash technology, or that the much slower write speed of
D2 flash will be accepted by SanDisk's customers. If SanDisk fails to
successfully introduce its D2 flash products, the Company may be at a
significant cost disadvantage relative to its flash competitors. See "Item 1:
Business - Risk Factors - Dependence on Emerging Markets and New Products."
The Company is also developing with Matsushita and NEC (in separate design
efforts) a new process to design future generation, higher capacity chips
employing 0.35 to 0.4 micron geometries. To date, the Company has not
successfully developed such a process and there can be no assurance that the
Company will be able to successfully develop such a process in the future. The
Company has periodically experienced delays in the development of new
7
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 "Item 1: Business - Risk Factors - Risks Associated with
Transitioning to New Products and Processes."
During 1996, 1995 and 1994, the Company spent approximately $10.2 million,
$8.0 million and $5.9 million, respectively, on research and development
activities. As of December 31, 1996 the Company had 64 full-time employees
engaged in research and development activities.
Sales and Distribution
The Company markets its products using a direct sales organization,
distributors and manufacturers' representatives to serve the multi-faceted
customer base and sales channels into which the Company sells its products. The
Company also sells products to various customers on a private label basis. 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; Sunnyvale, California; 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/Schweber Electronics Inc., Hamilton-Hallmark Inc.
and Bell MicroProducts Inc. into a wide variety of industrial applications and
to OEM customers. In addition, the Company has three independent distributors in
the United States serving various commercial aftermarket sales channels and the
U.S. government; six distributors in Europe; five in Asia; and three in Japan.
Independent Manufacturers' Representatives. In the United States, Canada and
Europe, the Company's direct sales force is supported in its sales effort by 21
independent firms. These companies receive a sales commission and provide sales
support to the direct sales force and the Company's distributors. 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 and Verbatim Corporation to sell the Company's
products on a private label basis. These companies sell directly to OEMs,
superstores, mass merchants, office clubs, retailers and mail order companies to
serve the demand for the Company's products in the various aftermarket sales
channels. In addition, the Company provides private label products for twenty
two OEMs in the United States and eleven OEMs in the Pacific Rim.
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.
8
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, 1996, the Company's
total backlog was $5.8 million, compared to $17.5 million at December 31, 1995.
Bookings visibility declined during 1996 and the Company had to rely on "turns"
business for the majority of its quarterly product sales. 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 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 AMD, Intel, Kingmax, M-Systems, Samsung, Simple, Smart Modular, TDK,
Toshiba and Viking, as well as other manufacturers of products using data
storage techniques such as socket flash, linear flash and system flash
components. Hitachi and Mitsubishi have announced plans to serve as second
source suppliers of CompactFlash. Certain of the Company's competitors,
including Samsung, TDK and Toshiba, have recently introduced flash data storage
cards based upon a system flash approach that the Company believes will be more
competitive than linear flash cards have been in the past. Competing products
promoting industry standards that are different from SanDisk's CompactFlash
product have been announced. 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. Increased
competition could have a material adverse effect on the Company's business,
financial condition and results of operations.
To the extent that the Company determines to license its patents to certain
of its competitors, which may be necessary to gain licenses to their patents, or
to its strategic partners, as the Company eventually expects to do, competition
will also increase. The Company has entered into patent cross-license agreements
with Intel and Sharp Electronics pursuant to which each party may manufacture
and sell products that incorporate technology covered by their respective
patents related to flash memory devices. As a result of the above factors, the
Company expects to face substantially more competition in the future than it has
to date. 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, timing of new
product 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 "Item 1: Business - "Risk Factors - Competition."
Patents and Licenses
The Company's policy is to protect its proprietary technology by filing
patent applications for technology that it considers important for its business.
The Company also pursues a policy of vigorously protecting its intellectual
property rights under patents granted it in the U.S. and foreign countries.
9
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 forty nine US and nine foreign patents granted,
five patent applications allowed and approximately twenty eight 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. 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.
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 addition to litigation, the Company may need to license some or all of
its patent portfolio to be able to obtain cross-licenses to the patents of
others. In October 1995, the Company entered into a patent cross-license
agreement with Intel. In December 1996, the Company entered into a patent
cross-license agreement with Sharp. Under these agreements, the Company and its
licensees each granted to the other a non-exclusive, non-transferable, worldwide
license to make, use, sell and import products that incorporate technology
covered by their respective patents related to flash memory devices. These
licenses apply to certain existing patents and certain additional patents with a
filing date within the periods specified in the agreements. Under the Intel
agreement, the license extends for the life of all covered patents. Pursuant to
these agreements, the Company and its licensees agreed to release each other
from any and all claims or liability for infringement of the subject patents.
These cross-license agreements may increase Intel and Sharp's ability to compete
with the Company. See "Item 1: Business - "Risk Factors - Competition." There
can be no assurance that any other cross-licenses will be available on
commercially reasonable terms, or at all. Moreover, any such cross-licenses,
including the Intel and Sharp licenses, could result in more rapid and intense
competition for the Company's products, by much larger and better financed
competitors. Any such limitations on the Company's ability to market its
products, or delays and costs associated with redesigning its products, or
payments of license fees or licenses of the Company's rights to others could
have a material adverse effect on the Company's business, financial condition
and results of operations.
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 "Item 1: Business "Risk
Factors - Patent, Proprietary Rights and Related Litigation."
Employees
As of December 31, 1996, the Company had 289 regular, full-time employees
and 56 temporary employees, including 64 in research and development, 41 in
sales and marketing, 31 in finance and administration and 209 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 employment 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.
10
Risk Factors
Fluctuations in Operating Results. SanDisk's operating results are
subject to quarterly and annual fluctuations due to a variety of factors. The
Company has very limited visibility with respect to anticipated operating
results for any given quarter, even during the quarter in question.
Factors affecting the Company's operating results include volume of
product orders and sales, availability of foundry capacity, the timing of
significant orders, competitive pricing pressures, the ability of the Company to
match supply with demand or to accurately forecast future inventory levels,
fluctuations in product costs, fluctuation in manufacturing yields,
manufacturing utilization, changes in product and customer mix, 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,
quality of the Company's products, increased research and development expenses
associated with new product introductions, exchange rate fluctuations and
customer qualification and acceptance of new or enhanced versions of the
Company's products. In addition, the Company expects to continue to increase its
operating expenses in connection with the hiring of additional personnel and the
development of new applications. If the Company does not achieve increased
levels of revenues commensurate with these increased levels of operating
expenses, the Company's business, financial condition and results of operations
will be materially adversely affected. All of these factors are difficult to
forecast and these or other factors can materially affect the Company's
quarterly or annual operating results.
In 1996 order visibility weakened. SanDisk's OEM customers in the
emerging consumer markets are still experiencing difficulty gauging the initial
market demand for their new products. The Company is also experiencing a shift
in its customer order profile. The current market situation of ready
availability, coupled with rapidly declining prices of semiconductor memories,
has led customers to expect ever shorter lead-times. Consequently, the turns
component of the Company's quarterly business is increasing. To adapt to these
evolving market conditions, the Company shifted to more in-house manufacturing
in the third quarter of 1996 to reduce costs and manufacturing lead times and to
position itself to respond quickly to changes in customer demand. The current
limited visibility of orders could continue indefinitely.
Late in 1996, the Company also experienced a shift in product mix to
lower capacity (2MB) CompactFlash cards, which 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. 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.
Due to the emerging nature of the Company's markets and certain planned
product transitions, it is difficult for the Company to forecast future
inventory levels required to meet customer demand. As a result of both
contractual obligations and manufacturing cycle time, the Company is required to
order wafers from its foundries as much as six 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 is not able to match its purchases of wafers to specific
customer orders and therefore, the Company may take provisions for potential
excess inventory purchased prior to the receipt of customer orders. These
provisions decrease gross margins in the quarter reported and can result in
significant fluctuations in gross margins on a quarter to quarter basis. As the
Company's manufacturing cycle time has decreased over the past 12 months, the
Company's ability to respond to changes in customer demand has improved.
However, there can be no assurance that future gross margin volatility will not
reoccur as a result of the Company's inability to match supply with demand or
for other reasons.
During 1996, the price of dynamic random access memory (DRAM) decreased
dramatically, in some cases by 75%. All DRAM suppliers were adversely impacted,
including the Company's two flash foundry suppliers, which now have excess
capacity of foundry wafers that can be made available to the Company at reduced
prices. Such reduced wafer prices have helped the Company to accelerate its cost
reduction efforts. However, because SanDisk values its inventory on a lower of
cost or market basis, these cost reductions may have an adverse effect on the
Company's gross margins and results of operations in the future as the Company's
inventory is written down to
11
reflect the lower wafer costs. Due to the highly competitive nature of the DRAM
business, there can be no assurance that wafer costs will remain low or that
increased capacities will remain available.
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 is dependent on Matsushita and LG Semicon to
produce wafers of acceptable quality and with acceptable manufacturing yields,
to deliver those wafers to the Company on a timely basis and to allocate to the
Company a portion of their foundry capacity sufficient to meet the Company's
needs. On occasion, the Company has experienced difficulties in each of these
areas. The loss or reduction of capacity from Matsushita and LG Semicon or the
inability to qualify or receive the anticipated level of capacity from
Matsushita and LG Semicon could have a material adverse effect on the Company's
business, financial condition and results of operations. There can be no
assurance that Matsushita and LG Semicon will be able to maintain acceptable
yields or that they will continue to deliver sufficient quantities of wafers on
a timely basis.
Under the Company's wafer supply agreements with Matsushita and LG
Semicon, the Company is obligated monthly to provide a 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. This limits the Company's ability to react to any
significant fluctuations in demand for its products. 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. The wafer supply agreements with Matsushita and LG Semicon each
include a target number of wafers to be delivered per month that is
substantially higher than the level of supply from either foundry as of December
31, 1996. To the extent the Company is unable to obtain scheduled quantities of
wafers from Matsushita or LG Semicon with planned yields, the Company's
business, financial condition and results of operations could be negatively
impacted.
The Company has entered into a joint development agreement with NEC for
the development of future generations of semiconductor devices to be used in the
manufacture of the Company's products. However, there can be no assurance that
future generations of the semiconductor devices will be successfully developed
or, if developed, that a wafer supply agreement will be entered into with NEC.
Because the lead time to qualify a new foundry is approximately 18 to 24 months,
in the event that the Company and NEC do enter into a wafer supply agreement,
the Company could not expect to receive volume shipments from NEC until 1998 at
the earliest.
Due to the unpredictable nature of the new markets for the Company's
products, the Company may periodically experience shortages in the future.
Because of the lengthy lead times required to qualify a new foundry, there is no
readily available alternative source of supply. The inability of the Company to
obtain expanded foundry capacity, to qualify other wafer manufacturers or to
correctly forecast the number of wafers required from its current suppliers, as
well as any inability to obtain timely and adequate deliveries from the
Company's current or future suppliers or any other circumstance that would
require the Company to seek alternative sources of supply, could delay shipments
of the Company's products and could have a material adverse effect on the
Company's business, financial condition and results of operations.
SanDisk has received recent indications from its foundries that
additional capacity is available. Finished goods inventory levels increased
during 1996 and the Company is now quoting average delivery times of two to six
weeks. Semiconductor supply and demand tend to be cyclical, however, and it is
unlikely that this situation will continue over the long term.
Risks Associated with Transitioning to New Products and Processes.
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
12
associated with design and manufacture of products to incorporate such devices,
and production delays. There can be no assurance that such devices or processes
will be successfully developed by the Company. For example, the Company
discovered and successfully corrected a design flaw in its new flash ChipSet
product in the fourth quarter of 1995. As a result of delays in supplying this
product to a major customer, this customer canceled approximately $500,000 of
product orders that were scheduled for delivery in the fourth quarter of 1995.
The Company shipped the majority of its backlog scheduled for this customer
during the fourth quarter of 1995 and no additional order cancellations were
received. However, there can be no assurance that the Company will not
experience similar problems in the future that could have a material adverse
effect on the Company's business, financial condition and results of operations.
During the first quarter of 1996, the Company began receiving 32Mbit
devices from LG Semicon and began the qualification of this process, which it
completed in October 1996. During the third quarter of 1996, the Company began
production of the 32Mbit devices at LG Semicon. High density flash memory, such
as the 32Mbit, is a complex technology requiring tight manufacturing controls
and effective test screens. The production ramp up period for a flash device at
a new foundry is particularly prone to problems which can impact both
reliability and yields exposing the Company to increased manufacturing costs.
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.
On November 6, 1996, the Company announced its first 64Mbit products
based on double density flash ("D2 flash") technology, a new flash system
designed to store two bits in each flash memory cell. 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. The
Company will not generate significant revenues from sales of 64Mbit products
until at least the second half of 1997. The implementation of D2 flash in a
production environment is currently planned for the second half of 1997 and will
be highly complex. There can be no assurance that reliable and cost effective D2
flash products can be manufactured reliably in commercial volumes and with
yields sufficient to result in a lower cost per megabyte. Furthermore, flash
data storage products designed with D2 flash will initially exhibit
approximately one quarter of the write performance of the Company's existing
products when writing data into memory. This may preclude their use in certain
applications. The failure of the Company to successfully manufacture D2 flash
devices could have a material adverse effect on the Company's business,
financial condition and results of operations.
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 in 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 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
well into the production process and would require cooperation by and
communication between the Company and the foundry for resolution. 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. At the end of the third
quarter of 1996, the Company experienced manufacturing related difficulties at
both of its wafer foundries suppliers, which resulted in reductions in effective
yields of between 5% and 10%. The Company and its foundries identified the
issues and corrective steps have been implemented. 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.
Dependence on Key and Sole Source Suppliers. The majority of the memory
components of the Company's products are assembled by Alphatec in Manteca,
California. In the third quarter of 1996, the Company stopped using GSS Array in
Thailand and Anam in Korea and installed its own surface mount line in its new
Sunnyvale facility. The Company is doing a majority of its assembly on this new
line. A small portion may be done by other third party subcontractors. The
Company also has no long term agreement with Alphatec. As a result of this
reliance on third party subcontractors for assembly of a portion its products,
the Company cannot directly
13
control product delivery schedules, which can lead to product shortages or
quality assurance problems that could increase the costs of manufacture or
assembly 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.
The Company purchases several key components from single or sole source
vendors for which alternative sources are not currently available. Even where
alternative vendors are available, a significant amount of time would be
required to qualify an additional vendor in the case of certain of the Company's
other 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 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 stop 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 is continuing to identify and establish second sources for its key
single and sole source component vendors as sales volumes increase, although
there can be no assurance these efforts will be successful.
Patents, Proprietary Rights and Related Litigation. 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.
From time to time the Company has been notified and its foundries may
in the future be notified, of claims that they may be infringing patents or
other intellectual property rights owned by third parties. If it is necessary or
desirable, the Company may seek licenses under such patents or intellectual
property rights. 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. 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, and any such
development or license could require expenditures by the Company of substantial
time and other resources.
The Company has notified IBM Microelectronics, Samsung Electronics
Company Ltd. ("Samsung") and Toshiba Corporation ("Toshiba") that the Company
believes certain of their existing or announced products infringe certain of the
Company's patents. In addition, from time to time, the Company has entered into
discussions with other companies regarding potential cross-license agreements
for the Company's patents.
In response to the Company's allegations of infringement of five of the
Company's patents, Samsung has filed a complaint in October 1995 accusing the
Company of infringing two of its patents, seeking declaratory relief with
respect to these five Company patents and alleging unspecified damages for
certain other related claims. As written, the complaint potentially implicates
products that comprise substantially all of the Company's revenues for 1995. The
Company has received opinions from its Patent Counsel that, based on information
currently known, the Company's products do not infringe one of these Samsung
patents and that, based on certain assumptions as to how Samsung would claim
infringement, the particular patent claim in the other Samsung patent that
Samsung has accused the Company of infringing is invalid and that the Company's
products do not infringe any of the other
14
claims of such patent. Nonetheless, the Company anticipates that Samsung will
continue to pursue litigation with respect to these claims. SanDisk filed its
answer to Samsung's complaint in March 1996. At that time, SanDisk asserted a
number of counterclaims based on Samsung's alleged infringement of three SanDisk
patents.
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, are importing and selling products that infringe two of the Company's
patents. By its complaint, the Company seeks a judgment by the International
Trade Commission that Samsung is infringing the Company's patents and an order
precluding Samsung from importing those infringing products into the United
States. The U.S. International Trade Commission completed its hearing on this
matter in October 1996. 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. This decision will go to the International Trade Commission which
will decide whether to approve the ruling and enter an exclusion or cease and
desist order barring importation of Samsung flash memory devices. While the
ruling is important, no assurance can be given that the Commission will enter an
exclusion or cease and desist order. A final decision is expected in May, 1997.
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.
If any third party patents are deemed to be valid and infringed by the
Company's products, the Company would be required to obtain a license to the
patents or to redesign its products to eliminate the infringement. Such a
redesign effort, if possible, could result in substantial delays in marketing
its products and in significant costs. There can be no assurance that the
Company could successfully design around the technology in question or that it
could obtain a license to the infringed patents on reasonable terms, or at all.
The Company's inability to design around a valid patent or to obtain a license
on reasonable terms could have a material adverse effect on the Company's
business, financial condition and results of operations.
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, discontinue the use
of certain processes or obtain licenses to the infringing technology.
In addition to litigation, the Company may need to license some or all
of its patent portfolio to be able to obtain cross-licenses to the patents of
others. In October 1995, the Company entered into a cross-license agreement with
Intel Corporation ("Intel"). In December 1996, the Company entered into a
cross-license agreement with Sharp Electronics. There can be no assurance that
any other licenses will be available on commercially reasonable terms, or at
all. Moreover, any such cross-licenses could result in more rapid and intense
competition for the Company's products, by much larger and better financed
competitors. Any such limitations on the Company's ability to market its
products, or delays and costs associated with redesigning its products, or
payments of license fees or licenses of Company rights to others could 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. Legal
fees associated with the Samsung ITC hearings were approximately $2.9 million in
1996. While these expenses are expected to decline in the first half of 1997,
they will remain significant. In addition, the results of any litigation matters
are inherently uncertain. Accordingly, there can be no
15
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.
Competition. 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 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 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. In addition, competition will increase to the extent that
the Company determines to license its patents to certain of its competitors in
order to gain licenses to their patents. For example, in October 1995 and in
December 1996, the Company entered into patent cross-license agreements with
Intel and Sharp, respectively, pursuant to which each party is entitled to
manufacture and sell products that incorporate technology covered by the other
party's patents related to flash memory devices. Increased competition could
have a material adverse effect on the Company's business, financial condition
and results of operations.
The Company settled patent infringement issues relating to features
embodied in M-Systems' TFFS and FTL technology. Subsequent to the M-System's
settlement, the PC Card standards committee adopted FTL technology as part of
the PC Card standard, which enables flash file system software to operate with
linear flash cards. Intel has announced the Miniature Card and Toshiba announced
the Solid-State Floppy Disk Card (SSFDC). Both products are aimed at the mass
storage market for consumer applications, such as digital filmless cameras. The
Company expects these products to compete against its CompactFlash (TM) product.
A manufacturer of digital cameras wishing to design any one of these three
alternatives as removable "digital film" will eliminate the other two from use
in their product, since all three are mechanically and electronically
incompatible with each other. Competition to win the initial design-in is
therefore expected to be fierce. Due to the high price sensitivity in the market
for consumer products, aggressive price competition is expected for these
applications. Such competition may result in lower gross margins in future
quarters, should the relative percentage of sales of CompactFlash(TM) products
increase.
In the third quarter of 1996, the Company began experiencing strong
competition from Toshiba's SSFDC 2 Mbyte product. The Company also believes that
Samsung has begun shipment of competing 32Mbit NAND flash products as well as
samples of its 64Mbit NAND flash products.
Dependence on Emerging Markets and New Products. The Company's success
depends to a significant extent upon the development of emerging and new
applications and markets for flash data storage systems, as well as on its
ability to introduce commercially attractive and competitively priced new
products on a timely basis and to reduce production costs of existing products.
There can be no assurance that new applications or markets for flash data
storage will develop as expected by the Company or that prospective customers
developing products for any such markets will design the Company's products into
their products and successfully introduce such products. In addition, there can
be no assurance that the Company's new products, including its CompactFlash or
Flash ChipSet products, will achieve market acceptance. The failure of new
applications or markets to develop or the failure of new markets to be receptive
to the Company's products could have a material adverse effect on the Company's
business, financial condition and results of operations.
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 lower
prices, which the Company believes will be essential to its ability to remain
competitive. There can be no assurance that these products will be successfully
developed or will achieve market acceptance, or that the Company will be
successful in identifying new product opportunities and develop and bring new
products to market in a timely manner, or that products or technologies
developed by others will not render the Company's products or technologies
obsolete or noncompetitive. The failure of any of the Company's new product
development efforts or lack of market acceptance of such products would have a
material adverse effect on the Company's business, financial condition and
results of operations.
16
Customer Concentration. A limited number of customers historically have
accounted for a substantial portion of the Company's revenues. 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. 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. Under the amended agreement,
beginning in 1999, if Seagate exercises its option to market the Company's
products, the Company and Seagate will coordinate their efforts 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.
International Operations. All of the Company's wafers are, and for the
foreseeable future will be, produced by foreign foundries. Because the Company
currently purchases the majority of its flash wafers in Japanese Yen at a set
price, fluctuations in currencies could materially adversely affect the
Company's business, financial condition and results of operations. Due to its
reliance on export sales and its dependence on foundries outside the United
States, the Company is subject to the risks of conducting business
internationally, including foreign government regulation and general
geopolitical risks such as political and economic instability, potential
hostilities and changes in diplomatic and trade relationships. In addition,
since most of the Company's international sales are denominated in U.S. dollars,
the Company's products may be less competitive in countries with currencies
declining in value against the dollar. 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.
Volatility of Stock Price. To date, the price of the Company's Common
Stock on the NASDAQ National Market has been volatile. 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 or disproportionate to the
operating performance of such companies. These fluctuations as well as general
economic, political and market conditions such as recessions or international
currency fluctuations, may materially adversely affect the market price of the
Common Stock.
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. In December 1996 the
Company exercised its option to lease an adjacent 50,000 square foot building
beginning in 1998. The Company believes that its facilities will be adequate to
meet its near term needs and that additional space will be available as
required.
In addition, the Company leases domestic sales offices in Maitland, Florida,
Dublin, Ohio and Herndon, Virginia, as well as foreign sales offices in Hong
Kong, Hannover, Germany and Yokohama, Japan.
17
ITEM 3. LEGAL PROCEEDINGS
Samsung Electronics Company Ltd. filed a complaint against the Company in
the Northern District of California in October 1995 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. As written, the complaint potentially implicates products that comprised
substantially all of the Company's revenues for 1996 and 1995. The Company has
received opinions from its patent counsel that, based on information currently
known, the Company's products do not infringe one of these Samsung patents and
that, based on certain assumptions as to how Samsung would claim infringement,
the particular patent claim in the other Samsung patent that Samsung has accused
the Company of infringing is invalid and that the Company's products do not
infringe any of the other claims of such patent. Nonetheless, the Company
anticipates that Samsung will continue to pursue litigation with respect to such
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, are importing and selling products that infringe two of the Company's
patents. By its complaint, the Company seeks a judgment by the International
Trade Commission that Samsung is infringing the Company's patents and an order
precluding Samsung from importing those infringing products into the United
States. The U.S. International Trade Commission initiated an investigation based
upon the Company's complaint against Samsung. 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. This decision will go to the International
Trade Commission which will decide whether to approve the ruling and enter an
exclusion or cease and desist order barring importation of Samsung flash memory
devices. While the ruling is important, no assurance can be given that the
Commission will enter an exclusion or cease and desist order. A final decision
is expected in May, 1997.
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, discontinue the use
of certain processes or obtain licenses to the infringing technology.
From time to time the Company agrees to indemnify certain of its suppliers
and customers for alleged patent infringement. The scope of such indemnity
varies but may in some instances include indemnification for damages and
expenses, including attorneys fees. The Company may from time to time be engaged
in litigation as a result of such indemnification obligations. Third party
claims for patent infringement are excluded from coverage under the Company's
insurance policies. There can be no assurance that any future obligation to
indemnify the Company's customers or suppliers, will not have a material adverse
effect on the Company's business, financial condition and results of operations.
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."
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 1996.
18
EXECUTIVE OFFICERS OF THE REGISTRANT
As of December 31, 1996, 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 51 President, Chief Executive Officer and Director
Cindy Burgdorf 49 Chief Financial Officer, Senior Vice President,
Finance and Administration and Secretary
Leon Malmed 59 Senior Vice President, Marketing and Sales
Daniel Auclair 50 Senior Vice President, Operations and Technology
Marianne Jackson 41 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 and as Senior Vice President, Operations and Technology since July 1995.
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.
19
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 since the company's Initial Public Offering.
High Low
Fiscal year 1995
Fourth quarter $31.00 $13.50
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
As of February 28, 1997, there were approximately 273 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.
20
ITEM 6: SANDISK CORPORATION SELECTED FINANCIAL DATA
(In thousands, except per share data)
Year Ended December 31, 1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------
Revenues
Product $ 89,599 $ 61,589 $ 35,378 $ 20,551 $ 22,359
Royalties 8,000 1,250 - - -
- -------------------------------------------------------------------------------------------------------------
Total revenues 97,599 62,839 35,378 20,551 22,359
Cost of revenues 58,707 36,613 28,074 18,941 18,727
- -------------------------------------------------------------------------------------------------------------
Gross profits 38,892 26,226 7,304 1,610 3,632
Operating income (loss) 12,474 7,777 (4,781) (10,243) (6,042)
Net income (loss) 14,485 9,065 (4,287) (9,990) (5,969)
Earnings (loss) per share (pro forma for 1994)
Primary $ 0.60 $ 0.91 $ (0.23)
Fully diluted $ 0.60 $ 0.43 $ (0.23)
Shares used in per share calculations
(pro forma for 1994)
Primary 24,206 9,983 18,872
Fully diluted 24,206 20,856 18,872
At December 31, 1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------
Working capital $ 77,029 $ 68,002 $ 20,971 $ 25,266 $ 5,527
Total assets 108,268 92,147 31,861 32,594 13,522
Long term debt, less current portion - - 93 621 957
Total stockholders' equity 87,810 72,381 23,672 27,862 7,814
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 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.
21
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.
Results of Operations
Product Revenues. SanDisk's product revenues grew 45% in 1996 to $89.6
million from $61.6 million in 1995. The increase of $28.0 million consisted of a
126% increase in units shipped offset by a 36% decline in average selling
prices. The increase in product revenues in 1996 was due to increased sales of
the Company's Chipset, CompactFlash and FlashDisk products. Fiscal year 1995
product revenues of $61.6 million were 74% higher than 1994 due to increased
sales of FlashDisk products.
During the fourth quarter of 1996, the Company experienced a shift in
product mix to lower capacity (2MB) CompactFlash cards which caused average
selling prices to decline 23% from the previous quarter. As a result, product
revenues declined 11% in the fourth quarter even though unit shipments increased
15%. 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 sells products to the industrial, communications, highly
portable computing and consumer markets. The mix of sales to these key markets
varies from quarter to quarter and may vary in the future. While SanDisk has
been successful winning design-ins for many new applications, it generally takes
several quarters for these new products to reach the market. It is difficult to
predict the timing of related new product introductions and future sales volumes
from these design-ins as the success of the products is uncertain. As these
markets develop, competition is expected to increase, which could cause average
selling prices and gross margins to decline. See "Item 1: Business - Risk
Factors - Competition."
Order visibility weakened during the last half of 1996. The Company also
experienced a shift in its customer order profile. The current glut and rapidly
declining average selling prices that have afflicted the DRAM, SRAM and Standard
Flash markets, coupled with the slower than expected growth in demand in the
Company's markets, has brought about an expectation of drop-ship purchasing,
with few or no long term purchase orders. Consequently, the turns component of
the Company's business is increasing. SanDisk's backlog at the end of 1996
shrank to $5.8 million, the lowest level in two years. If the Company is unable
to substantially increase its "turns" business, its results of operations will
be materially adversely affected by this trend. To adapt to these evolving
market conditions, the Company shifted to more in-house manufacturing in the
third quarter of 1996 to reduce costs and lead times and to position itself to
respond quickly to changes in customer demand. The current limited visibility of
orders could continue indefinitely until the new markets addressed by the
Company's products enter a more predictable growth phase and demand begins to
create longer lead times.
Historically, a majority of the Company's sales have been to a limited
number of customers. Sales to the Company's top ten customers accounted for
approximately 71%, 80% and 81%, respectively, of the Company's product revenues
in 1996, 1995 and 1994. 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 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 customer's product introductions. See "Item 1: Business - Risk Factors
- - Customer Concentration."
22
Export sales continue to be an important part of the Company's business
representing 55% and 57% of total revenues in 1996 and 1995, respectively. The
Company invoices certain Japanese customers in yen and is subject to exchange
rate fluctuations on these transactions. The Company expects international sales
to continue to constitute a significant portion of revenues. See "Item 1:
Business - Risk Factors - International Operations."
Royalty Revenues. Royalty revenues from patent cross license agreements
were $8.0 million in 1996 up from $1.3 million in 1995. Total revenues from
patent licenses and royalties increased to 8% of total revenues in 1996, up from
2% in 1995. In December 1996, the Company entered into a patent cross license
agreement with Sharp Corporation. The Company also entered into a patent cross
license agreement with Intel in October 1995. In the future, the Company will
receive royalties under these agreements based on sales of flash products.
Gross Profits. In fiscal 1996, gross profits increased to $38.9 million or
39.8% of revenues from $26.2 million or 41.7% of revenues in 1995, and $7.3
million or 20.6% of revenues in 1994. SanDisk completed its transition from
16Mbit to 32Mbit technology in the third quarter of 1996. For the year ended
December 31, 1996, 32Mbit products represented 70% of the Company's units
shipped up from 6% in the prior year. Product gross margins declined in 1996 to
34.5% of product revenues from 40.6% in 1995 due to the shift in product mix to
lower capacity products where average selling prices declined faster than
product costs. Revenues from patent cross-license royalties partially offset the
lower product gross margins in 1996.
The Company expects price competition to increase in the future, which will
likely result in decreased average selling prices and gross margins. As a
result, the Company expects gross margins to decline in the near term from the
level experienced in 1996, and gross margins are expected to be subject to
fluctuation for the foreseeable future. To remain competitive, the Company will
be 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
0.35 micron manufacturing processes, and utilizing 8 inch instead of 6 inch
wafers. These transitions are expected to occur over the next several quarters.
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 and production delays. There can be no assurance
that such devices or processes will be successfully developed by the Company or
that development of such processes will lower manufacturing costs. See "Item 1:
Business - Risk Factors - Risks Associated with Transitioning to New Products
and Processes."
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 approximately six 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 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."
Currently a significant portion of the Company's wafer purchases are
denominated in Japanese Yen. As a result, exchange rate fluctuations can affect
the Company's business, financial condition and results of operations See "Item
1: Business - Risk Factors - International Operations."
Research and Development. Research and development expenses consist
principally of salaries and benefits for design and development engineers,
patent application costs, prototype supplies and contract services. Research and
development expenditures increased to $10.2 million in 1996 from $8.0 million in
1995 and $5.9 million in 1994. As a percentage of revenues, research and
development costs represented 10.4% in 1996, 12.8% in 1995, and 16.7% in 1994.
Research and development expenses increased in 1996 and 1995 primarily due to
salary and benefit costs associated with additional personnel. In 1996,
increased depreciation due to capital equipment additions during the year and
higher contract service expenses also contributed to the increase in research
and development expenses. In
23
1995, increased patent application related expenses and higher prototype supply
expenses contributed to the increase. The Company expects research and
development expenses to continue to increase in absolute dollars to support the
development of new generations of flash data storage products and the transfer
of the Company's products to new foundries.
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 advertising and tradeshow expenses and independent manufacturer's
representatives commissions. Sales and marketing expenses increased to $8.8
million in 1996 from $6.6 million in 1995 and $4.0 million in 1994. The growth
in sales and marketing expenses in both 1996 and 1995 was primarily due to
higher payroll and benefit related expenses associated with increased headcount
levels, higher outside sales commissions and increased travel expenses.
Increased public relations expenses also contributed to the increase in 1995. As
a percentage of revenues, sales and marketing expenses represented 9.0% in 1996,
10.4% in 1995, and 11.3% in 1994.
General and Administrative. General and administrative expenses include the
cost of the Company's finance, information systems, human resources, shareholder
relations, legal and administrative functions. General and administrative
expenses increased to $7.4 million in 1996 from $3.8 million in 1995 and $2.2
million in 1994. As a percentage of revenues, general and administrative
expenses increased to 7.6% of revenues from 6.1% in 1995 and 1994. The increase
in general and administrative expenses in 1996 and 1995 was primarily due to an
increase in professional and legal fees associated with the defense of the
Company's patents and salary and benefit costs associated with additional
personnel. The Company spent approximately $3.0 million on patent related
litigation in 1996. A substantial portion of these expenses related to SanDisk's
ITC complaint against Samsung Electronics Company. See Note 4 to the Company's
financial statements contained in Item 8 of this report.
Interest and Other Income. Interest and other income was $3,154,000 in 1996,
$1,749,000 in 1995, and $593,000 in 1994. The increase in interest and other
income since 1994 was due to increased cash and investment balances and higher
interest rates.
Interest Expense. Interest expense of $3,000 in 1996, $37,000 in 1995, and
$99,000 in 1994 was related to capital equipment leases which expired at various
times during 1995 and 1996. The Company had no outstanding capital leases at
December 31, 1996.
Provision for Income Taxes. The Company's 1996 and 1995 effective income tax
rates were approximately 7.3% and 4.5%, respectively. The 1996 effective tax
rate is higher than the 1995 rate primarily due to increased foreign withholding
taxes. The effective tax rate is substantially below the federal statutory rate
due to the utilization of federal and state net operating loss and tax credit
carryforwards. The Company had no tax provision in 1994 due to operating losses
incurred. As of December 31, 1996, the Company had federal and state tax credit
carryforwards of approximately $750,000 and $75,000, respectively, which will
expire at various dates beginning in 2008 through 2011.
Liquidity and Capital Resources
As of December 31, 1996, the Company had working capital of $77.0 million,
which included cash and cash equivalents of $19.3 million and short-term
investments of $55.0 million. The Company has a line of credit with a commercial
bank under which it can borrow up to $10 million with a term through July 1997.
The line of credit has restrictions on the payment of cash dividends to
stockholders and requires the Company to maintain certain minimum financial
requirements. At December 31, 1996, the Company had $6.2 million committed under
the line of credit for standby letters of credit. The Company currently is 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.
The Company has experienced positive operating cash flow since the third
quarter of 1994. Cash provided by operations was $13.4 million in 1996, $12.4
million in 1995 and $1.7 million in 1994.
24
Net cash used in investing activities of $22.2 million in 1996 consisted of
net purchases of short term investments of $13.8 million and capital equipment
purchases of $8.4 million. In 1995, $35.4 million of cash was used in investing
activities. This included $31.6 million of net purchases of investments and $3.8
million of capital expenditures. In 1994, investing activities provided net cash
of $3.9 million, reflecting net sales of investments of $5.3 million offset by
capital expenditures of $1.4 million.
During 1996, financing activities provided $0.8 million of cash primarily
from the sale of common stock through the SanDisk stock option and employee
stock purchase plans. Payments against capital leases of $98,000 partially
offset the proceeds from the sale of common stock. Net cash provided by
financing activities for 1995 was $39.1 million, representing sales of common
stock in the Company's initial public offering in November and the sale of
preferred stock earlier in the year. These amounts were offset by principal
payments on capital leases of $0.5 million. Net cash used in financing
activities in 1994 was $0.5 million, representing principal payments on capital
leases offset by sales of common and preferred stock and warrants.
The Company believes that its existing working capital and its available
line of credit will be sufficient to meet the Company's currently anticipated
working capital and capital expenditure requirements through at least 1997. The
Company expects capital expenditures to increase in 1997 to support growth in
operations. Depending on the demand for the Company's products, the Company may
decide to make substantial additional investment in manufacturing capacity to
support its business in the future.
Impact of Currency Exchange Rates
The Company currently purchases wafers from Matsushita under purchase
contracts denominated in yen. A portion of the Company's revenues are also
denominated in yen. Foreign exchange exposures arising from the Company's yen
denominated commitments and related accounts payable are offset to the extent
the Company has yen denominated accounts receivable and cash balances. To the
extent such foreign exchange exposures are not offset, the Company enters into
foreign exchange forward contracts to hedge against changes in foreign currency
exchange rates. At December 31, 1996, there were no forward exchange contracts
outstanding. While the impact of movements in currency exchange rates on foreign
exchange contracts substantially offsets the related impact on the underlying
items hedged, the appreciation of the yen against the U.S. Dollar in 1995
resulted in higher costs to the Company, which were reflected in the Company's
gross margins in the second half of 1995. Future exchange rate fluctuations
could have a material adverse effect on the Company's business, financial
condition and results of operations.
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SANDISK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
Contents
Page
Report of Ernst & Young LLP, Independent Auditors................ 27
Consolidated Balance Sheets...................................... 28
Consolidated Statements of Operations............................ 29
Consolidated Statements of Stockholders' Equity.................. 30
Consolidated Statements of Cash Flows............................ 31
Notes to Consolidated Financial Statements....................... 32
26
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, 1996 and 1995, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1996. 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, 1996 and 1995 and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1996, 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 17, 1997, except for Note 4
for which the date is February 26, 1997
27
SanDisk Corporation
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
Years Ended December 31, 1996 1995
- ----------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 19,323 $ 27,255
Short-term investments 54,965 41,140
Accounts receivable, net of allowance for doubtful
accounts of $593 in 1996 and 1995 11,885 8,428
Inventories 9,630 10,411
Prepaid expenses and other current assets 1,684 534
------------------------------------------------------------------------------
Total current assets 97,487 87,768
Property and equipment, at cost:
Machinery and equipment 17,937 10,900
Leasehold improvements 1,695 354
------------------------------------------------------------------------------
19,632 11,254
Accumulated depreciation and amortization 9,347 7,000
------------------------------------------------------------------------------
10,285 4,254
Deposits and other assets 496 125
- ----------------------------------------------------------------------------------
Total assets $ 108,268 $ 92,147
- ----------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,595 $ 9,053
Accrued payroll and related expenses 2,857 1,946
Other accrued liabilities 4,354 2,862
Deferred income 5,652 5,905
------------------------------------------------------------------------------
Total current liabilities 20,458 19,766
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: 22,326,584 in 1996 and
22,004,820 in 1995 22 22
Capital in excess of par value 98,211 97,272
Accumulated deficit (10,423) (24,913)
------------------------------------------------------------------------------
Total stockholders' equity 87,810 72,381
- ----------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 108,268 $ 92,147
- ----------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
28
SanDisk Corporation
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Years Ended December 31, 1996 1995 1994
- --------------------------------------------------------------------------------------
Revenues
Product $ 89,599 $ 61,589 $ 35,378
Royalties 8,000 1,250 -
- --------------------------------------------------------------------------------------
Total revenues 97,599 62,839 35,378
Cost of revenues 58,707 36,613 28,074
- --------------------------------------------------------------------------------------
Gross profits 38,892 26,226 7,304
Operating expenses
Research and development 10,181 8,043 5,918
Sales and marketing 8,792 6,564 3,996
General and administrative 7,445 3,842 2,171
- --------------------------------------------------------------------------------------
Total operating expenses 26,418 18,449 12,085
- --------------------------------------------------------------------------------------
Operating income (loss) 12,474 7,777 (4,781)
Interest and other income, net 3,154 1,749 593
Interest expense (3) (37) (99)
- --------------------------------------------------------------------------------------
Income (loss) before taxes 15,625 9,489 (4,287)
Provision for income taxes 1,140 424 -
- --------------------------------------------------------------------------------------
Net income (loss) $ 14,485 $ 9,065 $ (4,287)
- ---------------------------------------------------------------------------------------
Net income (loss) per share (pro forma for 1994)
Primary $ 0.60 $ 0.91 $ (0.23)
Fully diluted $ 0.60 $ 0.43 $ (0.23)
- ---------------------------------------------------------------------------------------
Shares used in computing net income
(loss) per share (pro forma for 1994)
Primary 24,206 9,983 18,872
Fully diluted 24,206 20,856 18,872
- ---------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
29
SanDisk Corporation
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
Convertible Capital In Total
Preferred Stock Common Stock Excess of Accumulated Stockholders'
Shares Amount Shares Amount Par Value Deficit Equity
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 1994 14,649 $ 15 2,722 $ 3 $ 57,535 $ (29,691) $ 27,862
Exercise of preferred stock warrants 15 - - - 62 - 62
Exercise of common stock grants
and options for cash, net of
repurchases - - 111 - 35 - 35
Net loss - - - - - (4,287) (4,287)
- -----------------------------------------------------------------------------------------------------------------------------------
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 common stock grants
and 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 common stock grants
and options by employees 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
- -----------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
30
SanDisk Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31, 1996 1995 1994
- ------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $14,485 $ 9,065 $(4,287)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation 2,347 1,625 1,952
Deferred tax (1,000) - -
Changes in assets and liabilities:
Accounts receivable (3,457) (4,311) (1,396)
Inventory 781 (6,337) 325
Prepaid expenses and other current assets (250) (293) 130
Deposits and other assets (271) 581 (161)
Accounts payable (1,458) 4,721 2,167
Accrued payroll and related expenses 911 1,000 422
Other accrued liabilities 1,590 1,031 940
Deferred income (253) 5,348 558
Pledged cash - - 1,000
- ------------------------------------------------------------------------------------------------------
Total adjustments (1,060) 3,365 5,937
- ------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 13,425 12,430 1,650
- ------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of short-term investments (47,977) (40,326) (23,867)
Proceeds from short-term investments 34,157 8,711 29,155
Acquisition of property and equipment (8,378) (3,791) (1,369)
- ------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (22,198) (35,406) 3,919
- ------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Sale of common stock and warrants,
net of repurchases 939 33,429 35
Sale of convertible preferred stock,
net of issuance costs - 6,215 62
Principal payments under capital leases (98) (523) (629)
- ------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 841 39,121 (532)
- ------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (7,932) 16,145 5,037
- ------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of year 27,255 11,110 6,073
- ------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $19,323 $27,255 $11,110
- ------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 3 $ 37 $ 99
Cash paid for income taxes $ 451 $ 219 -
Conversion of preferred stock to common stock $ - $63,683 -
- ------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
31
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, the Far East and Europe. In
August 1995, the Company changed its name from SunDisk Corporation to SanDisk
Corporation.
Supplier and Customer Concentrations
A limited number of customers historically have accounted for a substantial
portion of the Company's revenues. 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. Epson Hanbai, Hewlett Packard and NEC
USA, Inc. accounted for approximately 20%, 19% and 11%, respectively, of total
revenues in 1994. 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. 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.
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 1996 ended on December 29, 1996. Fiscal years 1995 and 1994 ended on
December 31, 1995 and January 1, 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
32
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.
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, U.S. Treasury bills, U.S. government agency obligations,
corporate notes and bonds with high-credit quality institutions 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, 1996 and 1995.
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 and 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, 1996 and
1995 are classified as available-for-sale securities and consist of the
following:
December 31,
1996 1995
---- ----
(In thousands)
Cash equivalents:
Money market fund $ 4,639 $ 1,198
Commercial paper 6,370 -
Corporate notes / bonds 5,894 2,000
-------- --------
Total $ 16,903 $ 3,198
======== ========
Short term investments:
U.S. Treasury bills and
U.S. government agency
obligations $ 4,183 $ 7,515
Corporate notes / bonds 49,782 30,625
Auction rate preferred stock 1,000 3,000
-------- -------
Total 54,965 $41,140
======== =======
Unrealized holding gains and losses on available-for-sale securities at
December 31, 1996 and 1995 and gross realized gains and losses on sales of
available-for-sale securities during the years ended December 31, 1996 and 1995
were immaterial.
Debt securities at December 31, 1996 and 1995, 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,
1996 1995
-------- --------
Short-term investments: (In thousands)
Due in one year or less $ 49,675 $ 24,854
Due after one year through two years 5,290 16,286
-------- --------
Total $ 54,965 $ 41,140
======== ========
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:
33
December 31,
1996 1995
-------- --------
(In thousands)
Raw materials $ 3,858 $ 2,753
Work-in-process 3,475 6,921
Finished goods 2,297 737
-------- --------
$ 9,630 $ 10,411
======== ========
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 financial statements.
Depreciation and Amortization
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, generally two to seven years. Equipment under
capital leases is amortized over the shorter of the estimated useful life of the
asset or the term of the lease.
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, subject to certain rights of return and price protection, is
deferred until the merchandise is sold by the distributors or the rights expire.
The Company earns royalties under certain patent cross license agreements.
Royalty revenue is recognized when earned.
Net Income (Loss) Per Share
Primary net income (loss) per share is computed using the weighted average
number of shares of common stock outstanding. In addition, common equivalent
shares from Series C convertible preferred stock (using the if-converted method)
and from stock options and warrants (using the treasury stock method or modified
treasury stock method where applicable) have been included in the computation
when dilutive. Pursuant to the Securities and Exchange Commission Staff
Accounting Bulletins, common and common equivalent (common stock options and
Series G preferred stock) shares issued by the Company at prices below the
assumed public offering price during the twelve-month period prior to the
offering have been included in the calculation as if they were outstanding for
all periods presented prior to their issuance regardless of whether they are
dilutive (using the treasury stock method and the anticipated initial public
offering price). Pro forma net loss per share is presented for 1994.
Per share information calculated on the above basis is as follows (shares in
thousands):
Years Ended December 31,
1996 1995 1994
---- ---- ----
Primary net income (loss) per share
applicable to common stockholders $0.60 $0.91 $(1.02)
Shares used in computing primary net
income (loss) per share 24,206 9,983 4,208
Fully diluted net income (loss) per share
applicable to common stockholders $0.60 $0.43 $(1.02)
Shares used in computing fully diluted
net income (loss) per share 24,206 20,856 4,208
Fully diluted earnings per share is calculated using net income and the
shares used in the primary calculation, as well as other dilutive preferred
stock (Series A, B, D, E, and F) which is not deemed to be a common stock
equivalent for purposes of the primary earnings per share calculation.
34
Supplemental net income per share for 1995 computed to give effect to the
conversion of redeemable convertible preferred shares as of January 1, 1995
(using the if-converted method) was $ 0.43.
Pro Forma Net Loss Per Share
Pro forma net loss per share has been computed as described above and also
gives effect, even if antidilutive, to common equivalent shares from convertible
preferred stock that automatically converted upon the closing of the Company's
initial public offering (using the if-converted method). All of the convertible
preferred stock outstanding as of the closing date of the offering automatically
converted on a one-for-one basis into shares of common stock, based on the
number of shares of convertible preferred stock outstanding at the date of the
offering.
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 earnings per share are disclosures required by
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation," and are included in Note 5.
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 primarily to
original equipment manufacturers 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,
1996. 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, 1996 and 1995.
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 gains (losses) of approximately $(193,000),
$(20,000) and $109,000 for the years ended December 31, 1996, 1995, and 1994,
respectively. These amounts are included in interest and other income, net in
the statement of operations.
Note 3: Line of Credit
The Company has a credit agreement (the Agreement) with a bank, which
expires in July 1997. 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, 1996). 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, 1996, $6,200,000 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
35
December 31, 1996. 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, 1996, 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, 1996 was approximately $3,800,000.
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, 1996 are as follows:
Year Ending December 31,
1997 $ 1,049,784
1998 1,595,320
1999 1,623,644
2000 1,666,440
2001 1,211,110
Thereafter 573,648
------------
Total $ 7,719,946
============
Rental expense under all operating leases was $1,050,000, $789,000 and $730,000
for the years ended December 31, 1996, 1995 and 1994 respectively.
Contingencies
The Company is party to various legal proceedings. 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. As written, the complaint
potentially implicates products that comprised substantially all of the
Company's revenues for 1996 and 1995. The Company has received opinions from its
patent counsel that, based on information currently known, the Company's
products do not infringe one of these Samsung patents and that, based on certain
assumptions as to how Samsung would claim infringement, the particular patent
claim in the other Samsung patent that Samsung has accused the Company of
infringing is invalid and that the Company's products do not infringe any of the
other claims of such patent. Nonetheless, the Company anticipates that Samsung
will continue to pursue litigation with respect to such 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, are importing and selling products that infringe two of the Company's
patents. By its complaint, the Company seeks a judgment by the International
Trade Commission that Samsung is infringing the Company's patents and an order
precluding Samsung from importing those infringing products into the United
States. The U.S. International Trade Commission initiated an investigation based
upon the Company's complaint against Samsung. 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. This decision will go to the International
Trade Commission which will decide whether to approve the ruling and enter an
exclusion or cease and desist order barring importation of Samsung flash memory
devices. While the ruling is important, no assurance can be given that the
Commission will enter an exclusion or cease and desist order. A final decision
is expected in May, 1997.
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
36
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, discontinue the use of certain
processes or obtain licenses to the infringing technology.
From time to time the Company agrees to indemnify certain of its suppliers
and customers for alleged patent infringement. The scope of such indemnity
varies but may in some instances include indemnification for damages and
expenses, including attorneys fees. The Company may from time to time be engaged
in litigation as a result of such indemnification obligations. Third party
claims for patent infringement are excluded from coverage under the Company's
insurance policies. There can be no assurance that any future obligation to
indemnify the Company's customers or suppliers, will not have a material adverse
effect on the Company's business, financial condition and results of operations.
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 Purchase Agreements
Prior to the adoption of the 1989 Stock Benefit Plan, the Company entered
into stock purchase agreements with certain eligible individuals. Under the
stock purchase agreements, the Company authorized the sale of common stock to
certain employees, directors, and consultants at the fair value on the date of
grant, as determined by the Board of Directors. The shares sold under these
agreements generally vest over four years as determined by the Board of
Directors. Upon the termination of employment, director services, or consultant
services, unvested shares are subject to repurchase by the Company at the
original purchase price.
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, 1996.
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.
37
1995 Non-employee Directors Stock Option Plan
In August 1995, the Company adopted the 1995 Non-employee Directors Stock
Option Plan (the Directors' Plan) and reserved 150,000 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.
The options vest over a four-year period and expire ten years after the date of
grant. At December 31, 1996, a total of 72,000 options had been granted at an
exercise prices of $10.00 and $13.375 per share.
A summary of activity under all stock option plans follows:
Total
Available Weighted
for Future Total Average
Grant/ Issuance Outstanding Exercise Price
(Shares in thousands)
Balance at December 31, 1993 174 1,481 $0.46
Increase in authorized shares 667 -
Granted (715) 715 $1.58
Exercised - (113) $0.31
Canceled 215 (215) $0.46
--------------- -----------
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
=============== ===========
At December 31, 1996, options outstanding were as follows:
Options Outstanding Options Exercisable
------------------- -------------------
Number Weighted Weighted Number
Outstanding Average Average Exercisable Weighted
Range of as of Remaining Exercise as of Average
Exercise Prices December 31, 1996 Contractual life Price December 31, 1996 Exercise Price
- --------------- ----------------- ---------------- ------------ ----------------- ---------------
$0.15 - $ 0.75 1,125,350 6.33 $ 0.5315 1,106,684 $0.54
$2.25 - $ 4.50 466,453 8.04 $ 2.3467 462,153 $2.35
$6.75 - $10.00 663,555 8.61 $ 6.9850 661,555 $6.99
$11.50 - $14.62 886,050 9.87 $12.1884 24,000 $13.38
$17.25 - $20.50 22,000 9.11 $17.3829 224 $20.50
---------------- -------------- ------------ ----------------- ---------------
$ 0.15 - $20.50 3,143,408 8.06 $ 5.4927 2,254,616 $2.94
There were 22,259 shares subject to repurchase under the Stock Benefit Plan
or under stock purchase agreements at December 31, 1996. Approximately 46,359
shares were subject to repurchase at December 31, 1995.
Employee Stock Purchase Plan
In August 1995, the Company adopted the Employee Stock Purchase Plan (the
Purchase Plan) and reserved 433,333 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
38
offering period, whichever is lower. As of December 31, 1996, shares issued
under the Purchase Plan totaled 92,350.
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 6.23% and 6.37% for 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 0.588 and 0.513 for 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 $6.80 and $3.34 for 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 433,333 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 86% of eligible employees have
participated in the plan in 1996 and 1995. Under the Plan, the Company sold
92,350 shares to employees in 1996. 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 1996 and 1995: dividend yield of 0.0%;
and expected life of 6 months; expected volatility factor of 0.588 in 1996 and
0.513 in 1995; and a risk free interest rate ranging from 5.36% to 5.48%. The
weighted average fair value of those purchase rights granted in November 1995,
February 1996 and August 1996 were $2.01, $2.47, and $2.52, 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:
Years ended
December 31,
1996 1995
---- ----
Pro forma net income $13,553,000 $8,915,000
Pro forma earnings per share $0.56 $0.43
39
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.
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, 1996:
Issuance Capital Number of Price Per Expiration
Date Stock Shares Share Date
- --------------- ---------- --------- --------- --------------
May 1990 Common 12,094 $6.615 May 2000
June 1990 Common 66,665 $6.000 None
June 1991 Common 6,666 $6.615 June 1999
November 1991 Common 13,363 $6.615 November 1999
November 1992 Common 7,575 $3.300 June 1998
During 1996, the Company issued 61,744 shares of common stock for no
proceeds in the net issuance of shares upon the exercise of 91,211 warrants with
a weighted average exercise price of $4.17 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, 1996, 1995 and 1994.
Note 7: Income Taxes
The provision for income taxes computed under Statement of Financial
Accounting Standard No. 109 consists of the following:
December 31,
Current: 1996 1995
----------- ---------
Federal $ 1,701,000 $ 312,000
State 42,000 66,000
Foreign 397,000 46,000
----------- ---------
$ 2,140,000 $ 424,000
Deferred:
Federal (1,000,000) -
Provision for income taxes $ 1,140,000 $ 424,000
=========== =========
40
The Company's provision for income taxes differs from the amount computed by
applying the federal statutory rates of 35% for 1996 and 1995 and 34% for 1994
to income before taxes as follows:
December 31,
1996 1995 1994
------ ------ -------
Tax at U.S. statutory rate 35.0% 35.0% (34.0)%
Operating losses (utilized)/not utilized (17.4) (31.4) 34.0
Research credit (5.6) - -
Valuation allowance (8.0) - -
Foreign taxes in excess of U.S. rate 2.1 - -
Other individually immaterial items 1.2 .9 -
------ ------ -------
7.3% 4.5% 0.0%
====== ====== =======
As of December 31, 1996, the Company had federal and state tax credit
carryforwards of approximately $750,000 and $75,000, respectively. The tax
credit carryforwards will expire at various dates beginning in years 2008 though
2011, if not utilized.
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, 1996 and 1995 are as
follows:
December 31,
1996 1995
------- -------
(In thousands)
Deferred tax assets:
Inventory reserves $ 2,500 $ 2,500
Deferred revenue 2,000 2,300
Other 1,500 1,100
Tax credit carryforwards 800 1,400
Fixed assets 350 800
Capitalized research and development 300 500
Net operating loss carryforwards 2,600
------- -------
-
Total deferred tax assets 7,450 11,200
Valuation allowance (6,450) (11,200)
------- -------
Net deferred tax assets $ 1,000 -
======= =======
The valuation allowance decreased by approximately $4,750,000 and $3,000,000
for 1996 and 1995, respectively, and increased $2,600,000 in 1994. Management
has determined, based on the Company's history of prior operating earnings and
its expectations for the future, that a partial valuation allowance for deferred
tax assets should be provided. Approximately $500,000 of the valuation allowance
is attributable to stock option deductions, the benefit of which will be
credited to paid in capital when realized.
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.
Revenues under the agreement were approximately $3,234,000 in 1994. There were
no revenues attributable to this agreement in 1995 and 1996. 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. In addition, under the terms
of the amended agreement, the Stockholder returned approximately $0.8 million of
inventory in November 1994. The Company sold the majority of this returned
inventory in December 1994. Accordingly, the returned inventory did not have a
material impact on the Company's statement of operations for the year ended
December 31, 1994.
41
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, 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)
1996 1995 1994
------- ------- -------
United States $43,999 $27,230 $21,799
Export:
Japan 43,947 24,255 11,300
Far 4,314 8,125 1,689
East
Europe 5,339 3,229 590
------- ------- -------
Total $97,599 $62,839 $35,378
======= ======= =======
Note 10: Major Customers
Customers who accounted for at least 10% of total revenues were as follows:
Years Ended December 31,
1996 1995 1994
---- ---- ----
Epson Hanbai Co., Ltd... 26% 26% 20%
Hewlett-Packard Company * 12% 19%
NEC USA, Inc * * 11%
Kyocera America, Inc.... * 14% *
* Revenues were less than 10%
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
42
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 - 6 of the
Company's definitive Proxy Statement dated March 12, 1997 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.
43
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 27
Consolidated Balance Sheets 28
Consolidated Statement of Operations 29
Consolidated Statements of Stockholders Equity 30
Consolidated Statements of Cash Flows 31
Notes to Consolidated Financial Statements 32-42
2) Financial statement schedules
Index to Financial Statement Schedules
Financial Statement Schedules
II. Valuation and Qualifying Accounts 49
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.
3.2* Form of Amended and Restated Certificate of Incorporation of the Registrant
3.3* Bylaws of the Registrant, as amended.
3.4* Form of Amended and Restated Bylaws of the Registrant
4.1* Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4.
4.3* Amended and Restated Registration Rights Agreement, among the
Registrant and the investors and founders named therein,
dated March 3, 1995.
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.
4.5* Series F Preferred Stock Purchase Agreement between Seagate Technology, Inc. and
the Registrant, dated January 15, 1993.
4.6* Amendment Agreement between Seagate Technology, Inc. and the Registrant, dated
August 23, 1995.
4.7* Form of Stock Purchase Agreement between the Registrant and Seagate Technology, Inc.
9.1* Amended and Restated Voting Agreement, among the Registrant and the investors
named therein, dated March 3, 1995.
10.1* Form of Indemnification Agreement entered into between the Registrant and its
directors and officers.
10.2*+ Foundry Agreement between Matsushita Electronics Corporation, Matsushita
Electronic Industrial Co., Ltd. and the Registrant, dated May 20, 1992.
44
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.
10.4*+ Foundry Agreement between Goldstar Electron Co., Ltd. and the Registrant, dated
October 13, 1993.
10.5*+ Amendment No. 1 to the Foundry Agreement between Goldstar Electron Co., Ltd. and
the Registrant, dated May 10, 1994.
10.6*+ SanDisk/Goldstar Technical Collaboration Agreement between Goldstar Electron
Co., Ltd. and the Registrant, dated March 25, 1994.
10.7*+ Joint Development Agreement between NEC Corporation and the Registrant, dated
June 20, 1994.
10.8*+ Joint Cooperation Agreement between the Registrant and Seagate Technology, Inc.,
dated January 15, 1993.
10.9*+ Amendment and Termination Agreement between the Registrant
and Seagate Technology, Inc., dated October 28, 1994.
10.10* License Agreement between the Registrant and Dr. Eli Harari, dated September 6, 1988
10.13* 1989 Stock Benefit Plan.
10.14* 1995 Stock Option Plan.
10.15* Employee Stock Purchase Plan.
10.16* 1995 Non-Employee Directors Stock Option Plan.
10.17* Patent Cross License Agreement between the Registrant and Intel Corporation,
dated October 12, 1995.
10.18** Lease Agreement between the Registrant and G.F. Properties, dated March 1, 1996.
10.19# Business loan agreement between the Registrant and Union Bank of California, dated July 3,
1996.
10.20++ Patent Cross License Agreement between the Registrant and Sharp Corporation dated December 24,
1996.
11.1 Computation of Earnings (Loss) Per Share.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial Data Schedule for the year ended December 31, 1996. (In EDGAR format only)
- ----------
* Previously filed as an Exhibit to the Registrant's Registration Statement on
Form S-1 (No. 33-96298).
** Previously filed as an Exhibit to the Registrant's 1995 Annual Report on Form
10-K.
# Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter
ended June 30, 1996.
+ Confidential treatment granted as to certain portions of these exhibits.
++ Confidential treatment requested as to certain portions of these exhibits.
46
Consent of Ernst & Young LLP, Independent Auditors
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 33-96298) 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 17, 1997 (except Note 4, as
to which the date is February 26, 1997), 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, 1996.
/s/ Ernst & Young LLP
San Jose, California
March 11, 1997
46
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 12, 1997
47
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,
this Report has been signed below by the following persons in the capacities and
on the dates indicated.
Signature Title Date
By: /s/ Dr. Eli Harari President, Chief Executive Officer March 12, 1997
--------------------------------------
(Dr. Eli Harari) and Director
By: /s/ Irwin Federman Chairman of the Board March 12, 1997
---------------------------
(Irwin Federman)
By: /s/ Cindy L. Burgdorf Chief Financial Officer, March 12, 1997
---------------------------
(Cindy L. Burgdorf) Senior Vice President, Finance and
Administration and Secretary
(Principal Financial Officer)
By: /s/ William V. Campbell Director March 12, 1997
------------------------------
(William V. Campbell)
By: /s/ Catherine P. Lego Director March 12, 1997
---------------------------
(Catherine P. Lego)
By: /s/ Dr. James D. Meindl Director March 12, 1997
-------------------------
(Dr. James D. Meindl)
By: /s/ Joseph Rizzi Director March 12, 1997
--------------------------------------
(Joseph Rizzi)
By: /s/ Alan F. Shugart Director March 12, 1997
--------------------------------------
(Alan F. Shugart)
48
SANDISK CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
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, 1994 $560 $41 $7 $594
Year ended December 31, 1995 $594 -- $1 $593
Year ended December 31, 1996 $593 -- -- $593
* Write offs
49