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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
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Exchange Act of 1934 for the fiscal year ended December 31, 2001 or *
_______ Transition report pursuant to Section 13 or 15(d) of the Securities Act
of 1934
Commission File No. 0-26734
SANDISK CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 77-0191793
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
140 Caspian Court, Sunnyvale, California 94089
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (408) 542-0500
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- -------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value;
Rights to Purchase Series A, Junior Participating Preferred Stock
(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 _______
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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 March 1,
2002 as reported on the Nasdaq National Market System, was approximately
$902,017,880. Shares of Common Stock held by each officer and director and by
each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
As of March 1, 2002, Registrant had 68,637,117 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the 2002 Annual Meeting of
Stockholders to be held on May 22, 2002 are incorporated by reference into Part
III of this Form 10-K.
*For purposes of this Form 10-K the Registrant has indicated its fiscal year as
ending on December 31/st/. The Registrant operates on a fifty-two-fifty-three
week fiscal year cycle ending on the Sunday closest to December 31/st/.
SANDISK CORPORATION
Table of Contents
PART I
Page No.
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Item 1. Business 4
Item 2. Properties 18
Item 3. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 19
Executive Officers of the Registrant 20
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 21
Item 6. Selected Financial Data 22
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 24
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 49
Item 8. Financial Statements and Supplementary Data 51
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 79
PART III
Item 10. Directors and Executive Officers of the Registrant 80
Item 11. Executive Compensation 80
Item 12. Security Ownership of Certain Beneficial Owners and
Management 80
Item 13. Certain Relationships and Related Transactions 80
PART IV
Item 14. Exhibits, Financial Statements, Schedules, and Reports
on Form 8-K 81
Signatures 85
PART I
ITEM 1. BUSINESS
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Statements in this report which are not historical facts are forward-looking
statements within the meaning of the federal securities laws. These statements
may contain words such as "expects," "anticipates," "intends," "plans,"
"believes," "estimates," or other wording indicating future results.
Forward-looking statements are subject to risks and uncertainties. Actual
results may differ materially from the results discussed in forward-looking
statements. Factors that could cause actual results to differ materially
include, but are not limited to, those discussed under "Factors That May Affect
Future Results" under Item 7 below, and elsewhere in this report. We undertake
no obligation to revise or update any forward-looking statements to reflect any
event or circumstance that may arise after the date of this report.
OVERVIEW
We design, manufacture and market flash memory storage products that are used
in a wide variety of electronic systems. We have designed our flash memory
storage solutions to address the storage requirements of emerging applications
in the consumer electronics and industrial/communications markets. Our products
are used in a number of rapidly growing consumer electronics applications, such
as digital cameras, personal digital assistants, or PDAs, portable digital music
players, digital video recorders and smart phones, as well as in industrial and
communications applications, such as communications routers and switches and
wireless communications base stations. In fiscal 2001, we shipped approximately
11 million flash memory cards and flash chip sets. Our products include
removable CompactFlash cards, SmartMedia cards, FlashDisk cards,
MultiMediaCards, Secure Digital cards, Memory Stick, and Ultra CompactFlash
cards and embedded Flash ChipSets, NAND Flash Components and FlashDrives with
storage capacities ranging from 8 megabytes to 2 gigabytes. During 2001, we
completed a technology transition from NOR flash manufactured for us by UMC in
Taiwan to NAND flash manufactured for us under our FlashVision joint venture
with Toshiba. In fiscal 2001, our customers included Arrow Electronics, Inc.,
Avnet Electronics, Bell Microproducts, Inc., Best Buy Company, Inc., Canon,
Inc., Circuit City Stores, Inc., Costco Wholesale Corporation, Eastman Kodak
Company, Ericsson, Hewlett-Packard Company, Ingram Micro, Inc., Matsushita
Electric Industrial Co., Ltd., Mitsubishi Plastic Co. Ltd., Nikon Corporation,
Office Depot, Inc., Siemens AG, Staples, Inc., Thomson Multimedia, Inc., and
Wynit, Inc., among others. In addition, we currently license our technologies to
several companies including Hitachi Ltd., Intel Corporation, Lexar Media,
Incorporated, Matsushita Electronics Corporation, Samsung Electronics Company
Ltd., Sharp Electronics Corporation, SmartDisk Corporation, Silicon Storage
Technologies, Incorporated, Sony Corporation, TDK Corporation and Toshiba
Corporation.
In September 2001, we signed an agreement with Sony Corporation, or Sony,
involving their Memory Stick card format. Under the agreement, Sony will supply
us a portion of their Memory Stick output for resale under the SanDisk brand
name. Sony has also agreed to purchase a portion of their NAND flash memory
requirements from us provided that we meet market competitive pricing for these
components. In addition, we and Sony agreed to co-develop and co-own the
specifications for the next generation Memory Stick.
In 2000, we entered into a joint venture agreement with Toshiba Corporation,
or Toshiba, under which we formed FlashVision, L.L.C., or FlashVision, to
produce advanced flash memory, utilizing fabrication space at Dominion
Semiconductor, L.L.C., or Dominion, in Manassas, Virginia. Production commenced
in the second half of 2001 and Toshiba and SanDisk each receive 50% of
Dominion's flash memory output. In December 2001, we and Toshiba signed a
binding memorandum of understanding, or MOU, under which we and Toshiba agreed
to restructure our FlashVision joint venture by consolidating our FlashVision
advanced NAND wafer fabrication manufacturing operations with Toshiba's memory
fabrication facility at Yokkaichi, Japan. The Yokkaichi fabrication facility, or
Yokkaichi, is Toshiba's most advanced memory fabrication facility and has
approximately twice the wafer fabrication capacity of Dominion. Through this
consolidation, we expect Yokkaichi to provide more cost-competitive NAND flash
wafers than is possible at Dominion. Under the terms of the MOU, Toshiba will
transfer the FlashVision owned and leased NAND production tool-set from Dominion
to Yokkaichi and has agreed to bear substantially all the costs associated with
the equipment transfers. Toshiba will continue to supply our NAND flash
requirements out of its existing production at Yokkaichi during the transfer. We
intend to terminate all
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manufacturing operations at Virginia in the first quarter of 2002 and transfer
substantially all the FlashVision equipment to Yokkaichi in 2002. Once the
consolidation is completed, we expect that Yokkaichi's total NAND wafer output
will match the combined prior NAND capacity of Yokkaichi and Dominion. We and
Toshiba contemplate that the FlashVision operation at Yokkaichi will continue
essentially the same 50-50 joint venture and on essentially the same terms as we
have had at Dominion in Virginia. In March 2002, FlashVision notified ABN AMRO
that it was exercising its right of early termination under the lease facility
and will repay all amounts outstanding thereunder in April 2002. We and Toshiba
are currently seeking other sources of financing to replace the ABN AMRO lease
facility.
Recent Developments
On February 22, 2002, we announced that Michael Gray, Vice President,
Finance, would assume responsibility for our financial and accounting functions
until we hire a successor to Frank A. Calderoni, Senior Vice President, Finance
and Administration and Chief Financial Officer, who resigned in February 2002.
On December 24, 2001, we completed a private placement of $125 million of 4
1/2% Convertible Subordinated Notes due 2006, or Notes, and on January 10, 2002,
we sold an additional $25.0 million of the Notes pursuant to the exercise by the
initial purchasers of their option.
References in this annual report on Form 10-K to "SanDisk," "we," "our," and
"us" collectively refer to SanDisk Corporation, a Delaware corporation, its
subsidiaries and SunDisk Corporation, its predecessor. Our principal executive
offices are located at 140 Caspian Court, Sunnyvale, California 94089 and our
telephone number is (408) 542-0500.
Industry Background
In recent years, digital computing and processing have expanded beyond the
boundaries of desktop computer systems to include a broader array of consumer
electronic, industrial and communications products. These new devices include
digital cameras, PDAs, highly portable computers, portable music players,
digital video recorders, wireless base stations, network computers,
communication routers and switches, cellular telephones, mobile communication
systems, handheld data collection terminals, medical monitors 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 can meet these requirements, these devices and systems represent
market opportunities for flash storage systems.
The SanDisk Solution
Our flash memory storage solution, known as system flash or data storage
flash, addresses the needs of many emerging applications in the consumer
electronics and industrial/communications markets. Since our inception, we have
been actively involved in all aspects of flash memory process development, chip
design, controller development and system-level integration, as well as the
creation and promotion of new flash card industry standards, to ensure the
creation of fully-integrated, broadly interoperable products that are compatible
with both existing and new system platforms. We believe our core technical
competencies are in high-density flash memory process and design, controller
design, system-level integration, compact packaging and low-cost system testing.
To achieve compatibility among various electronic platforms, regardless of the
host processor or operating system used, we have developed new capabilities in
flash memory chip design and created intelligent controllers. We have also
developed an architecture that can leverage advances in flash memory process
technology to ensure a scaleable, high-yield, cost-effective and highly reliable
manufacturing process. Our CompactFlash, MultiMediaCard, Secure Digital card and
FlashDisk products are portable, have an on-board controller and use file
formats that are forward- and backward-compatible. All of our flash data storage
products can store almost any type of digital information, including voice,
e-mail, music, video clips and digital images.
SanDisk's products offer the following features:
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Small form factor. Our CompactFlash products weigh about one-half ounce and
are approximately the size of a matchbook. Our MultiMediaCard and Secure Digital
Card products are approximately the size of a quarter coin and weigh less than
two grams. Our FlashDisk cards are small and lightweight with a length of 85.6
mm, width of 54.0 mm, thickness of 5.0 mm or 10.5 mm and weight of less than 2.0
ounces.
Non-volatility. Our products store information in non-volatile memory cells
that do not require power to retain information.
High degree of ruggedness. Our devices have an operating shock rating of
2,000 Gs for CompactFlash and 1,000 Gs for all other products (equivalent to
being able to withstand ten foot and eight foot drops onto concrete,
respectively). Our products are also designed to tolerate extensive fluctuations
in temperatures and humidity.
Low power consumption. During read and write operations, our products use
less power than the rotating disk drives found in many portable computers. At
all other times during system operation, our products require virtually no
power. Depending upon the end product making use of our flash data storage, this
translates into longer battery life.
High reliability. Our products utilize sophisticated error detection and
correction algorithms and dynamic defect management techniques to provide high
data reliability and endurance.
High performance. We believe that the read and write data rates of our
products meet or exceed the read and write data rates required today by the
majority of consumer and industrial/communications applications.
The flash process and flash memory chip designs developed by us in
cooperation with our partners make our products scaleable over several
generations of semiconductor fabrication processes. This feature has allowed us
to significantly reduce our cost per megabyte of capacity with each new
generation of our products. By maintaining the same basic design parameters,
each generation of our flash memory products maintains full compatibility with
prior generations. This chip architecture has allowed us to significantly reduce
cell size and thereby chip size. This has allowed us to increase storage
capacity and lower the cost of our flash memory products.
We have developed core competencies in low-cost micropackaging technology as
well as low-cost batch testing, both of which are important elements in building
high-capacity, high-reliability flash cards at a competitive cost and in high
volumes.
Applications and Markets for Flash Data Storage
We target the consumer electronics and the industrial/communications markets
for our flash data storage products.
Our products are used in a number of rapidly growing consumer electronics
applications, such as digital cameras, PDAs, portable music players, digital
video recorders and smart phones, as well as in industrial and communications
applications, such as communications routers and switches and wireless
communications base stations.
Consumer Electronics. The increasing trend towards the use of digital
technology in consumer electronics devices has created requirements for new data
storage products. For example, a number of major camera and imaging companies
have introduced digital cameras that we believe 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. In addition, flash data
storage products, such as our removable CompactFlash, SmartMedia, FlashDisk,
MultiMediaCard, Secure Digital, Memory Stick, and Ultra CompactFlash products
and embedded Flash ChipSet, NAND Flash Components and FlashDrive products are
used in PDAs, highly portable computers, digital audio players, network
computers, cellular telephones, next-generation smart telephones and other
devices.
Industrial/Communications Market. The communications market has applications
that require new types of data storage. For example, communications switches and
cellular base stations require data storage in environments that
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are subject to shock and vibration and a wide range of temperature and humidity
conditions. As the storage capacity of our cards grows, we are increasingly able
to displace disk drives in routers and switches manufactured by
telecommunications companies such as Cisco, Nortel and Lucent.
In the fiscal years ended December 30, 2001, 2000, and 1999, product sales to
our top 10 customers accounted for approximately 49%, 48%, and 57% of our
product revenues, respectively. In 2001 and 2000, no single customer accounted
for greater than 10% of our total revenues. In 1999, revenues from one customer
exceeded 10% of total revenues. We expect that sales of our products to a
limited number of customers will continue to account for a substantial portion
of our revenues for the foreseeable future. We have also experienced significant
changes in the composition of our major customer base from year to year and
expect this pattern to continue as certain customers increase or decrease their
purchases of our products as a result of fluctuations in market demand for their
products. Sales to our customers are generally made pursuant to standard
purchase orders rather than long-term contracts. The loss of, or significant
reduction in, purchases by any of our major customers, could harm our business,
financial condition and results of operations.
SanDisk's Products
Our storage products are high capacity, solid-state, non-volatile flash
memory devices that comply with industry standards, including the PC Card ATA
and/or IDE, MultiMediaCard, Secure Digital and Memory Stick standards. We offer
a broad line of flash data storage products in terms of capacities, form
factors, operating voltage and temperature ranges. Our current product families
include removable CompactFlash cards, SmartMedia cards, FlashDisk cards,
MultiMediaCards, Secure Digital Cards, Memory Stick, and Ultra CompactFlash
cards, and embedded Flash ChipSets, NAND Flash Components, FlashDrives and
TriFlash. Our products are compatible with the majority of today's computing and
communications systems that are based on industry standards. Our principal
products, as of December 31, 2001, are listed in the following table:
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Uncompressed
Product Family Form Factor Capacity
CompactFlash (Removable) 36.4 mm x 42.8 mm x 3.3 mm 8 megabytes to 1 gigabyte
Ultra CompactFlash (Removable) 36.4 mm x 42.8 mm x 3.3 mm 128 to 512 megabytes
SmartMedia (Removable) Flash Card (45 mm x 37.0 mm x 0.76 mm) 8 to 128 megabytes
Secure Digital (Removable) 32.0 mm x 24.0 mm x 2.1 mm 8 to 256 megabytes
Memory Stick (Removable) 50.0mm x 21.45mm x 2.8mm 16 to 128 megabytes
MultiMediaCard (Removable) 32.0 mm x 24.0 mm x 1.4 mm 8 to 64 megabytes
FlashDisk (Removable) PC Card Type II (54.0 mm x 85.6 mm x 5.0 mm) 16 megabytes to 2 gigabytes
Flash ChipSet (Embedded) ATA controller and flash memory chip 128 megabit to 1 gigabit
NAND Flash Components TSOP (thin small outline package) 64 megabit to 1 gigabit
FlashDrive (Embedded) 2.5 & 3.5 inches 32 megabytes to 2 gigabytes
- -----------------------------------------------------------------------------------------------------------
CompactFlash. Our CompactFlash products provide full PC Card ATA
functionality but are only one-fourth the size of a standard PC Card.
CompactFlash's compact size, ruggedness, low-power requirements and its ability
to operate at either 3.3V or 5V make it well-suited for a range of current and
next-generation, small form factor consumer applications such as digital
cameras, PDAs, personal communicators and audio recorders. CompactFlash products
provide interoperability with systems based upon the PC Card ATA standard by
using a low-cost passive Type II adapter. CompactFlash cards are available in
capacities ranging from 8 megabytes to 1 gigabyte in Type I form factor.
Ultra CompactFlash. Ultra CompactFlash is a line of high-speed CompactFlash
cards specifically designed for use in the rapidly growing market for
high-performance digital cameras. Ultra CompactFlash cards are targeted at
advanced photographers who require high-speed cards to quickly shoot many
high-resolution images. Ultra CompactFlash cards have more than twice the
sustained write speed of our standard CompactFlash Products. Capacities range
from 128 megabytes to 512 megabytes. We introduced our Ultra CompactFlash cards
in the fourth quarter of 2001. We cannot assure you that our Ultra CompactFlash
cards will receive substantial market
7
acceptance. Any failure by our customers to accept our Ultra CompactFlash
products could harm our business, financial condition and results of operations.
SmartMedia Cards. Our SmartMedia card is a removable flash memory card that
can be used in several different types of digital devices including digital
cameras, digital music players and digital voice recorders. Our SanDisk brand
SmartMedia Cards are available in capacities ranging from 8 to 128 megabytes.
Secure Digital Card. The Secure Digital Card measures 32.0 mm by 24.0 mm by
2.1 mm. The Secure Digital Card is an enhanced version of our MultiMediaCard
that incorporates advanced security and copyright protection features for the
emerging markets for the electronic distribution of music, video and other
copyrighted works. Our Secure Digital Card is available in storage capacities of
8 to 256 megabytes. We began shipping the Secure Digital Card in the first
quarter of 2001.
The Secure Digital Card incorporates a number of new features, including
Secure Digital Music Initiative, or SDMI, compliant security and copy
protection, a mechanical write protect switch and a high data transfer rate. The
Secure Digital Card is slightly thicker (2.1mm) than our MultiMediaCard and uses
a nine-pin interface instead of the seven-pin interface of the MultiMediaCard.
Because of these differences, the Secure Digital Card will not work in current
products that include a MultiMediaCard slot. However, our MultiMediaCard
products are forward compatible and will work in Secure Digital Card slots.
Broad acceptance of our Secure Digital Card by consumers may reduce demand for
our MultiMediaCard and other flash memory card products. The Secure Digital Card
relies on the copy protection features that have been developed for the DVD
standard and therefore may be more likely to be endorsed by the leading content
providers. We cannot assure you that our Secure Digital Card will receive
substantial market acceptance. Any failure by our customers to accept our Secure
Digital Card products could harm our business, financial condition and results
of operations.
Memory Stick. The SanDisk Memory Stick, introduced in the fourth quarter of
2001, is a popular, small-size flash memory card targeted at a wide variety of
electronic products. It is sold in capacities ranging between 16 and 128MB and
is used primarily in consumer electronics products sold under the Sony brand
name. During 2001, we entered into an agreement with Sony under which they will
supply us Memory Stick products under the SanDisk brand. Sony has also agreed to
purchase a portion of their NAND flash chip requirements from us provided that
we meet market competitive pricing for these components. Sony and SanDisk also
agreed to co-develop and co-own the specifications for the next generation
Memory Stick. We do not expect to generate revenues from the second generation
Memory Stick before 2003.
MultiMediaCard. Our MultiMediaCard measures 32.0 mm by 24.0 mm by 1.4 mm,
about the size of a quarter coin, and weighs less than two grams. MultiMediaCard
is targeted at the emerging markets for mobile smart phones, consumer multimedia
devices, digital audio recorders, digital video recorders, portable music
players and other products that need removable data storage in a small form
factor. Our MultiMediaCard is available in storage capacities of 8, 16, 32 and
64 megabytes.
FlashDisk. Our FlashDisk products are used in data storage, data backup and
data transport applications. Our FlashDisk products are available in the PC Card
Type II form factor with capacities ranging from 16 megabytes to 2 gigabytes.
Flash ChipSet. Our Flash ChipSet products provide a very small footprint,
solid-state ATA mass storage system. Our Flash ChipSet products consist of a
single chip ATA controller and a flash memory chip, and are available in
capacities of 128 megabit to 1 gigabit. We provide full PC Card, ATA and IDE
disk drive compatibility in a chip set format.
NAND Flash Components. NAND is a widely-used type of flash memory for high
capacity data storage applications. NAND flash memory has much lower power
dissipation, lower cost per bit and higher capacity than the standard NOR flash
commonly used for code store applications. NAND flash has gained wide acceptance
in embedded storage consumer electronics applications. Our NAND Flash Components
are sold as TSOP (thin small outline package) chips. Available capacities range
from 64 megabit to 1 gigabit.
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FlashDrive. Our FlashDrives come in 2.5 and 3.5 inch form factors and 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 our FlashDrive products range from 32 megabytes to 2 gigabytes.
TriFlash. Our TriFlash is a high capacity, small size embedded flash memory
device. TriFlash is ideal for storing audio, video, data and images on small
portable systems. These products are targeted at Internet music players and cell
phones. TriFlash will give product manufacturers the option of either using
TriFlash and/or removable flash memory cards in their consumer electronics
products. TriFlash is available in 16, 32 and 64 megabyte capacities. We expect
to begin shipping our TriFlash products in second quarter of 2002. We cannot
assure you that our TriFlash products will receive substantial market
acceptance. Any failure by our customers to accept our TriFlash products could
harm our business, financial condition and results of operations.
Other SanDisk products. We also sell ImageMate external memory card readers
and PC Card adapters under the SanDisk brand name. Our ImageMate external memory
card readers offer a fast, convenient way to transfer data between our memory
card products and a personal computer through a USB connection. The ImageMates
are available in CompactFlash, MultiMediaCard, Secure Digital and SmartMedia
Card versions. Our PC Card adapters allow the user to transfer data between our
memory card products and a laptop through the laptop's PC Card (PCMCIA) slot.
The PC Card adapters are available in CompactFlash, MultiMediaCard, Secure
Digital and SmartMedia Card versions.
In January 2002, we introduced our Cruzer product. The Cruzer is a portable,
pocket-size storage device that uses our MultiMediaCards or Secure Digital cards
for the easy storage and transport of personal computer data files, image files,
video and audio files. The Cruzer plugs into the industry-standard USB port that
is built into desktop PCs, notebook computers and other devices. We expect to
begin shipping our Cruzer product in the second quarter of 2002, in 32, 64, 128
and 256 megabyte capacities. We cannot assure you that our Cruzer products will
receive substantial market acceptance. Any failure by our customers to accept
our Cruzer products could harm our business, financial condition and results of
operations.
Our Personal Tag, or P-Tag, is a wearable, matchbook size, memory card that
can be used to store critical data such as medical records and other personal
information. The target markets for these cards include military agencies,
government departments, insurance and health care companies worldwide for
healthcare and security applications. The product evaluation process of these
types of customers is lengthy. We also believe that the current generation P-Tag
may not provide sufficient security for stored data, and that to make it a more
attractive product we will have to improve its on-board security for data
protection. We do not expect to generate meaningful revenue from the P-Tag until
2003 or 2004 at the earliest. We cannot assure you that our P-Tag products will
receive substantial market acceptance. Any failure by our customers to accept
our P-Tag products could harm our business, financial condition and results of
operations.
Technology
Since our inception, we have focused our research, development and
standardization efforts on developing highly reliable, high-performance and
cost-effective flash memory storage products to address a variety of emerging
markets needs. We have 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 newly developed system platforms. In 2000, we entered into a long
term strategic partnership with Toshiba to jointly develop and manufacture
advanced NAND flash memory components to be used in all our products. We believe
our core technical competencies are in high-density flash memory process and
design, controller design, system-level integration, compact packaging and
low-cost system testing. We have also initiated, defined and developed new
standards such as CompactFlash, MultiMediaCard & Secure Digital card to meet new
market needs and to promote wide acceptance of the standards through
interoperability and ease of use.
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To achieve compatibility with various electronic platforms regardless of the
host processors or operating systems used, we developed new capabilities in
flash memory chip design and created intelligent controllers. We also developed
an architecture that can leverage advances in process technology to ensure a
scaleable, high-yielding, cost-effective and highly reliable manufacturing
process. We believe that these technical competencies and our system design
approach have enabled us to introduce flash data storage products that are
better suited for our target markets than linear flash cards based on socket
flash chips. We design our products to be compatible with industry-standard IDE,
ATA, MultiMediaCard, Secure Digital and Memory Stick interfaces used in all
standard operating (OS) systems such as Windows and Apple compatible personal
computers, and operating systems used in cell phones, PDAs, and other consumer
and industrial products.
Our patented intelligent controller with its advanced defect management
system permits our products to achieve a high level of reliability and
longevity. Latent bit failure can occur several years into the life of a flash
card product and can be difficult to detect with traditional flash technology.
Our system allows the automatic substitution of entire sectors or major blocks
of the memory chip in case of any latent flash memory failures. Additionally,
our controller generates an error correcting code that is stored simultaneously
with the data and is used to detect and dynamically correct any errors when the
data is read. This design permits our products to maintain error-free operation
for hundreds of thousands of erase and write cycles and reduces manufacturing
costs by allowing us to incorporate partial die with less than 100% of the
physical bits on each chip into the products without loss of functionality.
Strategic Manufacturing Relationships
An important element of our strategy has been to establish strategic
relationships with leading technology companies that can provide us with access
to leading edge semiconductor manufacturing capacity and participate in the
development of some of our products. This enables us to concentrate our
resources on the product design and development areas where we believe we have
competitive advantages. We have developed strategic relationships with United
Microelectronics, Inc., or UMC, in Taiwan, and Toshiba with whom we have a joint
venture, FlashVision, which manufactures our NAND flash memory. We may establish
relationships with other foundries in the future.
All of our products require silicon wafers that are currently supplied by
Toshiba's wafer facility at Yokkaichi, Japan, under our joint venture agreement,
as well as UMC in Taiwan. All of our memory wafers are currently manufactured
using NAND process technology primarily in 0.16 micron feature sizes. UMC and
other ASIC suppliers currently manufacture our controller wafers. In the past,
we have experienced periods of supply constraints or excesses, each of which can
have a significant impact on our gross margins and supplier relationships. Any
delays in wafer availability or uncompetitive wafer pricing could limit our
revenue growth and harm our business, financial condition and results of
operations.
In December 2001, we signed a binding memorandum of understanding, or MOU,
with Toshiba under which we and Toshiba agreed to restructure our FlashVision
business by consolidating our FlashVision advanced NAND wafer fabrication
manufacturing operations with Toshiba's memory fabrication facility at
Yokkaichi, Japan. The Yokkaichi fabrication facility is Toshiba's most advanced
memory fabrication facility and has approximately twice the wafer fabrication
capacity of Dominion. Through this consolidation, we expect Yokkaichi to provide
more cost-competitive NAND flash wafers than is possible at Dominion. Under the
terms of the MOU, Toshiba will transfer the FlashVision owned and leased NAND
production tool-set from Dominion to Yokkaichi and has agreed to bear
substantially all the costs associated with the equipment transfers, which are
expected to be completed in 2002. Once the consolidation is completed,
Yokkaichi's total NAND wafer output will match the combined prior NAND capacity
of Yokkaichi and Dominion. We and Toshiba contemplate that the FlashVision
operation at Yokkaichi will continue essentially the same 50-50 joint venture
and on essentially the same terms as we have had at Dominion in Virginia. In
March 2002, FlashVision notified ABN AMRO that it was exercising its right of
early termination under the lease facility and will repay all amounts
outstanding thereunder in April 2002. We and Toshiba are currently seeking other
sources of financing to replace the ABN AMRO lease facility. The transfer and
qualification of the advanced fabrication equipment from Dominion Virginia to
Yokkaichi Japan is a highly complex operation. It is quite possible that we may
encounter difficulties and delays. Although the additional costs associated with
such potential delays will generally be borne by Toshiba, our results of
operations may suffer if this equipment transfer is
10
not completed on time and production does not commence at Yokkaichi as planned,
thereby reducing the total NAND production capacity available to us.
Under the terms of our wafer supply agreements with UMC, we are obligated to
provide a rolling forecast of anticipated purchase orders for the next six
calendar months. Except in limited circumstances and subject to acceptance by
UMC, the estimates for a portion of the forecast, generally three months,
constitute a binding commitment and the estimates for the remaining months may
not increase or decrease by more than a certain percentage from the previous
month's forecast. We have similar forecast requirements and binding commitments
under our supply agreement with Toshiba for wafers from their current Yokkaichi
foundry and we are obligated to purchase 50% of the NAND flash wafer output from
the FlashVision Yokkaichi facility or bear the costs of unused capacity if we
choose not to purchase our share of the available wafers. These requirements
limit our ability to react to any significant fluctuations in demand for our
products. When the demand for our products experiences an unexpected, sudden and
sharp decline, and we are unable to reschedule or cancel our wafer orders, we
end up with excess wafer inventories, which result in higher costs and reduced
gross margins. Furthermore, if a significant drop in demand is also accompanied
by a rapid decline in market prices for our products, we may have to reduce the
value of our inventory to market, resulting in lower gross margins. Conversely,
if customer demand exceeds our forecasts, we may be unable to obtain an adequate
supply of wafers to fill customer orders, which could result in lost sales and
the loss of customers to competitors who are able to meet the customer
requirements. We are dependent upon our foundry partners to deliver wafers and
to maintain acceptable yields and quality.
On July 4, 2000, we entered into a share purchase agreement to make a $75.0
million investment in Tower Semiconductor, or Tower, in Israel, representing
approximately 10% ownership of Tower. The investment is subject to the
completion of certain milestones. During 2001, Tower satisfied the closing
conditions of the share purchase agreement and completed the first two
milestones. Under the terms of the agreement, as of December 31, 2001, we had
invested $42.5 million to purchase 1,599,931 ordinary shares and obtain wafer
credits of $21.4 million. In September 2001, we agreed to convert 75% of our
wafer credits to equity at a price of $12.75 per share and received an
additional 1,284,007 ordinary shares.
Due to the continued weakness in the semiconductor industry, the value of our
Tower investment and remaining wafer credits had declined to $16.6 million at
December 31, 2001. It was determined that this decline was other than temporary,
as defined by generally accepted accounting principles and a loss of $20.6
million was recorded in the second half of 2001. In addition, we recognized a
loss of $5.5 million on our exchange of 75% of our Tower wafer credits for
ordinary shares. These losses, totaling $26.1 million, or $15.8 million net of
tax benefit, were recorded as loss on foundry investment in 2001. If the fair
value of the Tower investment declines further, it may be necessary to record
additional losses.
Under our original agreement, additional contributions by us will take the
form of mandatory warrant exercises for ordinary shares at an exercise price of
$30.00 per share if other milestones are met by Tower. The warrants will expire
five years from the date of grant, and in the event the key milestones are not
achieved, the exercise of these warrants will not be mandatory. However, in
March of 2002, we modified our share purchase agreement with Tower by agreeing
to advance the payments for the third and fourth milestones to April 5, 2002 and
October 1, 2002, respectively. We will make these payments whether or not Tower
actually achieves its previously agreed upon milestone obligations. In exchange
for this and as part of the modification to the share purchase agreement, Tower
has agreed that of the aggregate payment of $22.0 million represented by the
third and fourth milestone payments, (i) 60% of this amount, or $13.2 million,
will be applied to the issuance of additional ordinary Tower shares based on the
average closing price of Tower shares on the NASDAQ in the thirty consecutive
trading days preceding each payment date (but not to exceed $12.50 per share)
and (ii) 40% of this amount, or $8.8 million, will be credited to our pre-paid
wafer account, to be applied against orders placed with Tower's new fabrication
facility, when completed. Currently, we expect Tower to supply us a portion of
the ASIC controller chips used in our flash cards. We currently expect first
wafer production to commence at the new fabrication facility in late 2002.
Tower's completion of the wafer foundry facility is dependent on its ability
to obtain additional financing for the foundry construction from equity and
other sources and the release of grants and approvals for changes in grant
programs from the Israel government's Investment Center. If Tower is unable to
obtain additional financing, complete foundry construction in a timely manner or
successfully complete the development and transfer of advanced CMOS process
technologies and ramp-up of production, the value of our investment in Tower
will decline significantly or possibly become worthless and we may be unable to
obtain the wafers needed to manufacture our products, which would harm our
results of operations. In addition, the value of our investment in Tower may be
adversely affected by a further deterioration of conditions in the market for
foundry manufacturing services and the market for semiconductor products
generally.
We believe additional foundry capacity will be necessary to meet future
demand for our products. Our ability to increase our revenues and net income in
future periods is dependent on establishing additional wafer supply
relationships and on receiving an uninterrupted supply of wafers from our
manufacturing partners.
11
Our reliance on third-party wafer manufacturers involves several material
risks, including shortages of manufacturing capacity, reduced control over
delivery schedules, quality assurance, production yields and costs. This
reliance could significantly harm our business, financial condition and results
of operations. In addition, as a result of our dependence on foreign wafer
manufacturers, we are subject to the risks of conducting business
internationally, including political risks and exchange rate fluctuations.
Assembly and Testing
We test our wafers at Toshiba in Yokkaichi, Japan, and at the UMC facility
and United Test Center, Inc. in Taiwan. Substantially all of the tested wafers
are then shipped to our third party memory assembly subcontractors: Silicon
Precision Industries Co., Ltd. in Taiwan and Mitsui & Co., Ltd. in Japan.
A substantial portion of our packaged memory final test, card assembly and
card test is performed at Silicon Precision Industries and United Test Center,
Inc. in Taiwan, and Celestica, Inc. in China. We completed the transfer of our
testing and assembly operations to these subcontractors in the second half of
2001. In fiscal 2002, these subcontractors will assemble and test the vast
majority of our products. We expect our reliance on subcontractors will continue
to reduce the cost of our operations and give us access to increased production
capacity. Any significant problems that occur at our subcontractors, or their
failure to perform at the level we expect, could result in a disruption of
production and a shortage of products to meet customer demand.
Our customers have demanding requirements for quality and reliability. To
maximize quality and reliability, we monitor electrical and inspection data from
our wafer foundries and assembly and test subcontractors. We monitor wafer
foundry production for consistent overall quality, reliability, yield and defect
levels. Most of our major component suppliers and subcontractors are ISO 9001 or
9002 certified.
Research and Development
We believe that our 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. In fiscal
2001, the majority of our production output shifted from the 256 megabit, 0.24
micron D2 technology to the 512 megabyte, 0.16 micron NAND flash memory supplied
by FlashVision LLC, our joint venture with Toshiba. In December 2001, SanDisk
received the first production output of the next generation of 1 gigabit, 0.16
micron NAND MLC (Multi Level Cell, which is the same as our D2) flash memory. We
expect we will begin production of 1 gigabit NAND flash memory that employs 0.13
micron process feature size through our joint venture with Toshiba late in the
second half of 2002. We do not expect the 0.13 micron NAND flash memory wafers
to contribute substantially to revenues until 2003.
Our research and development expenses were $58.9 million, $46.1 million, and
$26.9 million for the fiscal years ended December 31, 2001, 2000, and 1999,
respectively. As of December 31, 2001, we had 160 full-time equivalent employees
engaged in research and development activities, including 20 in our Israel
design center. In fiscal 2002 and beyond, we expect to significantly increase
our spending on process and design research and development to support the
development and introduction of new generations of flash data storage products,
including our 1gigabit and 2 gigabit NAND MLC flash memory co-development and
manufacturing joint venture with Toshiba.
Sales and Distribution
We market our products using a direct sales organization, distributors and
manufacturers' representatives. We also sell products to various customers on a
private label basis and under the SanDisk brand in the retail channel. Our sales
efforts are organized as follows:
Direct Sales Force. Our direct sales offices are located in Maitland,
Florida; Herndon, Virginia; Nashua, New Hampshire; Sunnyvale and Irvine,
California; Hannover, Munich and Rantingen, Germany; Kista, Sweden; Hong Kong,
China; and Yokohama and Osaka, Japan. These offices support our major OEM
customers and our
12
distribution and manufacturers' representative partners. Our retail sales
offices are located in Trabuco Canyon, California; Avon, Ohio; Bedford, Texas;
Hetfordshire, England; Haarlem, the Netherlands; and Osaka, Japan.
Distributors. In the United States, our products are sold through Arrow
Electronics Inc., Avnet Inc. and Bell MicroProducts Inc. to OEM customers for a
wide variety of industrial applications. In addition, we have distributors in
various regions of the world including Europe, Japan, Australia, New Zealand,
Taiwan, Korea, Singapore and Hong Kong.
Independent Manufacturers' Representatives. In the United States, Canada and
Europe, our direct sales force is supported in its sales efforts by more than 40
independent firms. These domestic and international firms receive a commission
for providing support to our direct sales force and distributors in the
industrial distribution, OEM and retail channels. The manufacturers'
representative companies sell our products as well as products from other
manufacturers.
OEMs. We provide private label products to OEMs in the United States, Europe
and the Pacific Rim.
Retail. We ship SanDisk brand name products directly to consumer electronics
stores, office superstores, photo retailers, mass merchants, catalog and mail
order companies, Internet and e-commerce retailers and selected retail
distributors. Our retail distributors include Ingram Micro, Inc., Tech Data
Corporation, Laguna Corporation and Wynit, Inc. in the United States, in
addition to international distributors. Our products are available in more than
38,000 retail stores worldwide. Fourteen independent manufacturers'
representative firms are supporting our sales efforts in the retail channel. In
addition, we sell our products on the Internet through third parties such as
Amazon.com.
Customer Service and Technical Support
We provide customers with comprehensive product service and support. We
provide technical support through our applications engineering group located in
the United States, Japan and Hong Kong. We work closely with our customers to
monitor the performance of our product designs, to provide application design
support and assistance, and to gain insight into our customers' needs to help in
the design of future products.
Our support package is generally offered with product sales and includes
technical documentation and application design assistance. In some cases, we
offer additional support which includes training, system-level design,
implementation and integration support and failure analysis. We believe that
tailoring the technical support level to our customers' needs is essential for
the success of product introductions and to achieve a high level of satisfaction
among our customers. We generally provide a one-year warranty on our products.
Patents and Licenses
We rely on a combination of patents, trademarks, copyright and trade secret
laws, confidentiality procedures and licensing arrangements to protect our
intellectual property rights. We vigorously protect and defend our intellectual
property rights. In the past, we have been involved in significant disputes
regarding our intellectual property rights and we believe we may be involved in
similar disputes in the future.
In 1988, we 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 us. We currently own or have exclusive
rights to 174 United States and 37 foreign issued patents, and 109 patent
applications pending in the United States, as well as 56 pending in foreign
patent offices. We intend to seek additional international and United States
patents on our technology. We believe some of our patents are fundamental to the
implementation of flash data storage systems, as well as the implementation of
MLC flash, independent of the flash technology used. However, we cannot assure
you that any patents held by us will not be invalidated, that patents will be
issued for any of our 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 our products can be sold to provide meaningful
protection or any commercial advantage to us. Additionally, our competitors may
be able to design their products around our patents.
13
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights or positions, which has resulted in
significant and often protracted and expensive litigation. To preserve our
intellectual property rights, we believe it may be necessary to initiate
litigation against one or more third parties, including but not limited to those
we have already notified of possible patent infringement. In addition, one or
more of these parties may bring suit against us.
For example, on or about August 3, 2001, the Lemelson Medical, Education &
Research Foundation, or Lemelson Foundation, filed a complaint for patent
infringement against us and four other defendants. The suit, captioned Lemelson
Medical, Education, & Research Foundation, Limited Partnership vs. Broadcom
Corporation, et al., Civil Case No. CIV01 1440PHX HRH, was filed in the United
States District Court, District of Arizona. On November 13, 2001, the Lemelson
Foundation filed an Amended Complaint, which made the same substantive
allegations against us but named more than twenty-five additional defendants.
The Amended Complaint alleges that we, and the other defendants, have infringed
certain patents held by the Lemelson Foundation pertaining to bar code scanning
technology. By its complaint, the Lemelson Foundation requests that we be
enjoined from our allegedly infringing activities and seeks unspecified damages.
On February 4, 2002, we filed an answer to the amended complaint, wherein we
alleged that we do not infringe the asserted patents, and further contend that
the patents are not valid or enforceable.
On October 15, 2001, we filed a complaint for patent infringement in the
United States District Court for the Northern District of California against
Micron Technology, Inc., or Micron. In the suit, captioned SanDisk Corp. v.
Micron Technology, Inc., Civil No. CV 01-3855 CW, the complaint seeks damages
and an injunction against Micron for making, selling, importing or using flash
memory cards that infringe our U.S. Patent No. 6,149,316. On February 15, 2002,
Micron answered the complaint, denied liability, and counterclaimed seeking a
declaration that the patent in suit is not infringed, is invalid, and is
unenforceable.
On October 31, 2001, we filed a complaint for patent infringement in the
United States District Court for the Northern District of California against
Memorex Products, Inc., Pretec Electronics Corporation, Ritek Corporation and
Power Quotient International Co., Ltd. In the suit, captioned SanDisk Corp. v.
Memorex Products, Inc., et. al., Civil No. CV 01-4063 VRW, we seek damages and
injunctions against these companies from making, selling, importing or using
flash memory cards that infringe our U.S. patent No. 5,602,987, or the `987
Patent. Defendants Memorex, Pretec and Ritek have filed answers denying the
allegations. We have filed a motion for a preliminary injunction in the suit to
enjoin Memorex, Pretec and Ritek from making, selling, importing or using flash
memory cards that infringe our `987 Patent prior to the trial on the merits.
This preliminary injunction motion is scheduled for hearing on April 11, 2002.
On November 30, 2001, we filed a complaint for patent infringement in the
United States District Court for the Northern District of California against
Power Quotient International - USA Inc, or PQI-USA. In the suit, captioned
SanDisk Corp. v. Power Quotient International - USA Inc., Civil No. C 01-21111,
we seek damages and an injunction against PQI-USA from making, selling,
importing or using flash memory cards that infringe our U.S. patent No.
5,602,987. The PQI-USA complaint and litigation are related to the October 31,
2001 litigation referred to above. The products at issue in the PQI-USA case are
identical to those charged with infringement in the October 31, 2001 litigation.
On December 21, 2001, PQI-USA filed an answer to the complaint denying the
allegations, which included a counter claim for a declaratory judgment of
non-infringement and invalidity of our `987 Patent. We have motioned for a
preliminary injunction in the suit to enjoin PQI-USA from making, selling,
importing or using flash memory cards that infringe our `987 Patent prior to the
trial on the merits. This preliminary injunction motion is scheduled for hearing
on April 8, 2002.
On or about March 5, 2002, Samsung Electronics Co., Ltd., or Samsung, filed a
patent infringement lawsuit against us in the United States District Court for
the Eastern District of Texas. The lawsuit alleges that we infringe four Samsung
United States patents, Nos. 5,473,563; 5,514,889; 5,546,341 and 5,642,309, and
seeks a preliminary and permanent injunction against unnamed products of ours,
as well as damages, attorneys' fees and cost of the lawsuit.
14
From time to time, we have been contacted by various other parties who have
alleged that certain of our products infringe on patents that these parties
claim to hold. To date, no legal actions have been filed in connection with any
such infringement, other than as discussed above.
In the event of an adverse result in any such litigation, we could be
required to pay substantial damages, cease the manufacture, use and sale of
infringing products, expend significant resources to develop non-infringing
technology, discontinue the use of certain processes or obtain licenses to the
infringing technology. Any litigation, whether as a plaintiff or as a defendant,
would likely result in significant expense to us and divert the efforts of our
technical and management personnel, whether or not such litigation is ultimately
determined in our favor. In addition, the results of any litigation are
inherently uncertain.
If we decide to incorporate third party technology into our products or our
products are found to infringe on others' patents or intellectual property
rights, we may be required to license such patents or intellectual property
rights. We may also need to license some or all of our patent portfolio to be
able to obtain cross-licenses to the patents of others. We currently have patent
cross-license agreements with several companies including Hitachi, Intel, Lexar,
Samsung, Sharp, SST, SmartDisk, TDK, Sony, Matsushita and Toshiba. From time to
time, we have also entered into discussions with other companies regarding
potential cross-license agreements for our patents. We cannot assure you that
licenses will be offered or that the terms of any offered licenses will be
acceptable to us. If we obtain licenses from third parties, we may be required
to pay license fees or make royalty payments, which could reduce our gross
margins. If we are unable to obtain a license from a third party for technology,
we could incur substantial liabilities or be required to expend substantial
resources redesigning our products to eliminate the infringement. In addition,
we might be required to suspend the manufacture of products or the use by our
foundries of processes requiring the technology. We cannot assure you that we
would be successful in redesigning our products or that we could obtain licenses
under reasonable terms. Furthermore, any development or license negotiations
could require substantial expenditures of time and other resources by us.
As is common in the industry, we agree to indemnify certain of our 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. We may from time to time be engaged in
litigation as a result of these indemnification obligations.
In our efforts to maintain the confidentiality and ownership of our trade
secrets and other confidential information, we require all regular and temporary
employees, consultants, foundry partners, certain customers, suppliers and
partners to execute confidentiality and invention assignment agreements upon
commencement of a relationship with us and extending for a period of time beyond
termination of the relationship. We cannot assure you that these agreements will
provide meaningful protection for our trade secrets or other confidential
information in the event of unauthorized use or disclosure of such information.
Backlog
We manufacture and market primarily standard products. Sales are generally
made pursuant to standard purchase orders. We include in our backlog only those
customer orders for which we have accepted purchase orders and assigned shipment
dates within the upcoming twelve months. Since orders constituting our current
backlog are subject to changes in delivery schedules or cancellations, backlog
is not necessarily an indication of future revenue. As of December 31, 2001, our
backlog was $19.5 million, compared to $63.3 million at December 31, 2000. The
decline in backlog in 2001 was primarily due to a reduction in orders from our
OEM customers and a significant reduction in order lead times due to
industry-wide overcapacity. Because of the deterioration in market conditions
throughout most of 2001, our quarterly turns business, the business we book and
ship in the same quarter, reached approximately 80% of product shipments in the
third and fourth quarters of 2001. In 2001, sales to our OEM customers declined
to 34% of our product revenues from 57% in 2000. Retail sales, which are
typically booked and shipped in the same quarter, increased to 54% of our
product revenues from 28% in 2000. We expect sales to the retail channel to
continue to represent a significant portion of our revenue in 2002.
15
Competition
We compete in an industry characterized by intense competition, rapid
technological changes, evolving industry standards, declining average selling
prices and rapid product obsolescence. Our competitors include many large
domestic and international companies that have greater access to advanced wafer
foundry capacity, substantially greater financial, technical, marketing and
other resources, broader product lines and longer standing relationships with
customers.
Our primary competitors include companies that develop and manufacture
storage flash chips, such as Hitachi, Samsung, Micron Technology and Toshiba. In
addition, we compete with companies that manufacture other forms of flash memory
and companies that purchase flash memory components and assemble memory cards.
Companies that manufacture socket flash, linear flash and components include
Advanced Micro Devices, Atmel, Fujitsu, Intel, Macronix, Mitsubishi, Sharp
Electronics and ST Microelectronics. Companies that combine controllers and
flash memory chips developed by others into flash storage cards include
Dane-Elec Manufacturing, Delkin Devices, Inc., Feiya Technology Corporation,
Fuji, Hagiwara, I/O Data, Ingentix, Kingston Technology, Lexar Media, M-Systems,
Matsushita Battery, Matsushita Panasonic, Memorex, PNY, Pretec, Silicon Storage
Technology, Silicon Tek, Simple Technology, Sony Corporation, TDK Corporation,
Toshiba, and Viking Components.
In addition, many companies have been certified by the CompactFlash
Association to manufacture and sell their own brand of CompactFlash. We believe
additional manufacturers will enter the CompactFlash market in the future.
We have entered into an agreement with Matsushita and Toshiba, forming the
Secure Digital Association, or SD Association, to jointly develop and promote a
next generation flash memory card called the Secure Digital card. Under this
agreement, royalty-bearing Secure Digital card licenses will be available to
other flash memory card manufacturers, which will increase the competition for
our Secure Digital card and other products. In addition, Matsushita and Toshiba
have commenced selling Secure Digital cards that will compete directly with our
products. While other flash card manufacturers will be required to pay the SD
Association license fees and royalties, which will be shared among Matsushita,
Toshiba and us, there will be no royalties or license fees payable among the
three companies for their respective sales of the Secure Digital card. Thus, we
will forfeit potential royalty income from Secure Digital card sales by
Matsushita and Toshiba.
In addition, we and Toshiba will each separately market and sell any 512
megabit and 1 gigabit flash memory chips developed and manufactured by our joint
venture, FlashVision. Accordingly, we will compete directly with Toshiba for
sales of these advanced chips.
We have entered into patent cross-license agreements with several of our
leading competitors including Hitachi, Intel, Lexar, Matsushita, SST, Samsung,
Sharp, Smartdisk, Sony, TDK and Toshiba. Under these agreements, each party may
manufacture and sell products that incorporate technology covered by the other
party's patent or patents related to flash memory devices. As we continue to
license our patents to certain of our competitors, competition will increase and
may harm our business, financial condition and results of operations. Currently,
we are engaged in licensing discussions with several of our competitors. There
can be no assurance that we will be successful in concluding licensing
agreements under terms which are favorable to us, or at all.
Competing products have been introduced that promote industry standards that
are different from our products including Sony's standard floppy disk used for
digital storage in its Mavica digital cameras; Panasonic's Mega Storage cards;
Iomega's Clik drive, a miniaturized, mechanical, removable disk drive;
M-Systems' DiskOnKey, a USB-based memory device; and the Secure MultiMediaCard
from Hitachi and Infineon. Each competing standard may not be mechanically and
electronically compatible with our products. If a manufacturer of digital
cameras or other consumer electronic devices designs in one of these alternative
competing standards, our products will be eliminated from use in that product.
In addition, other companies, such as Sanyo, DataPlay and Matrix Semiconductor
have announced products or technologies that may potentially compete with our
products.
IBM's Microdrive, a rotating disk drive in a Type II CompactFlash format
competes directly with our larger capacity memory cards. M-Systems' DiskOnChip
2000 Millennium product competes against our NAND Flash Component products in
embedded storage applications such as set top boxes and networking appliances.
16
Sony has licensed its proprietary Memory Stick to us and other companies and
Sony has agreed to supply us a portion of their Memory Stick output for resale
under our brand name. If consumer electronics products using the Memory Stick
achieve widespread use, sales of our MultiMediaCard, Secure Digital card,
SmartMedia card and CompactFlash products may decline. Our MultiMediaCard
products also have faced significant competition from Toshiba's SmartMedia flash
cards.
We also face competition from products based on multilevel cell flash
technology from Intel and Hitachi. These products currently compete with our
NAND multilevel cell products. Multilevel cell flash is a technological
innovation that allows each flash memory cell to store two bits of information
instead of the traditional single bit stored by conventional flash technology.
Furthermore, we expect to face competition both from existing competitors and
from other companies that may enter our existing or future markets that have
similar or alternative data storage solutions, which may be less costly or
provide additional features. For example, Infineon has formed a joint venture
with Saifun, an Israeli startup company, called Ingentix, to develop a
proprietary flash memory technology which will be targeted at low cost data
storage applications. Price is an important competitive factor in the market for
consumer products. Increased price competition could lower gross margins if our
average selling prices decrease faster than our costs and could also result in
lost sales.
We believe that our ability to compete successfully depends on a number of
factors, including:
. price, quality, and on-time delivery to our customers;
. product performance and availability;
. success in developing new applications for system flash technology;
. adequate foundry capacity;
. efficiency of production;
. timing of new product announcements or introductions by us, our customers
and our competitors;
. the ability of our competitors to incorporate their flash data storage
systems into their customers' products;
. the number and nature of our competitors in a given market;
. successful protection of intellectual property rights; and
. general market and economic conditions.
We believe that we compete reasonably favorably with other companies with
respect to these factors. We cannot assure you that we will be able to compete
successfully against current and future competitors or that competitive
pressures faced by us will not materially adversely affect our business,
financial condition or results of operations.
Employees
As of December 31, 2001, we had 565 full-time employees and 15 temporary
employees, including 160 in research and development, 115 in sales and
marketing, 111 in general and administration and 194 in operations. Our success
is dependent on our retention of key technical, sales and marketing employees
and members of senior management. Additionally, our success is contingent on our
ability to attract and recruit skilled employees in a very competitive market.
None of our employees are represented by a collective bargaining agreement and
we have never experienced any work stoppage. We believe that our employee
relations are good.
17
ITEM 2. PROPERTIES
----------
Our principal facilities are located in Sunnyvale, California. We lease two
adjacent buildings, a 104,000 square foot building that is dedicated to research
and development and operations activities and a 63,000 square foot building
which houses our administrative, sales and marketing functions. We occupy this
space under lease agreements that expire in July 2006. Under these agreements,
we have the option to renew the leases on both buildings for one additional
five-year term ending on June 30, 2011. We believe that our facilities will be
adequate to meet our near term needs and that additional space will be available
as required. We also lease sales offices in the United States of America, Japan,
Germany, the Netherlands, Hong Kong and Sweden, an operations support office in
Taichung, Taiwan and a design center in Tefen, Israel.
ITEM 3. LEGAL PROCEEDINGS
-----------------
On or about August 3, 2001, the Lemelson Medical, Education & Research
Foundation, or Lemelson Foundation, filed a complaint for patent infringement
against us and four other defendants. The suit, captioned Lemelson Medical,
Education, & Research Foundation, Limited Partnership vs. Broadcom Corporation,
et al., Civil Case No. CIV01 1440PHX HRH, was filed in the United States
District Court, District of Arizona. On November 13, 2001, the Lemelson
Foundation filed an Amended Complaint, which made the same substantive
allegations against us but named more than twenty-five additional defendants.
The Amended Complaint alleges that we, and the other defendants, have infringed
certain patents held by the Lemelson Foundation pertaining to bar code scanning
technology. By its complaint, the Lemelson Foundation requests that we be
enjoined from our allegedly infringing activities and seeks unspecified damages.
On February 4, 2002, we filed an answer to the amended complaint, wherein we
alleged that we do not infringe the asserted patents, and further contend that
the patents are not valid or enforceable.
On October 15, 2001, we filed a complaint for patent infringement in the
United States District Court for the Northern District of California against
Micron Technology, Inc., or Micron. In the suit, captioned SanDisk Corp. v.
Micron Technology, Inc., Civil No. CV 01-3855 CW, the complaint seeks damages
and an injunction against Micron for making, selling, importing or using flash
memory cards that infringe our U.S. Patent No. 6,149,316. On February 15, 2002,
Micron answered the complaint, denied liability, and counterclaimed seeking a
declaration that the patent in suit is not infringed, is invalid, and is
unenforceable.
On October 31, 2001, we filed a complaint for patent infringement in the
United States District Court for the Northern District of California against
Memorex Products, Inc., Pretec Electronics Corporation, Ritek Corporation and
Power Quotient International Co., Ltd. In the suit, captioned SanDisk Corp. v.
Memorex Products, Inc., et. al., Civil No. CV 01-4063 VRW, we seek damages and
injunctions against these companies from making, selling, importing or using
flash memory cards that infringe our U.S. patent No. 5,602,987, or the `987
Patent. Defendants Memorex, Pretec and Ritek have filed answers denying the
allegations. We filed a motion for a preliminary injunction in the suit to
enjoin Memorex, Pretec and Ritek from making, selling, importing or using flash
memory cards that infringe our `987 Patent prior to the trial on the merits.
This preliminary injunction motion is scheduled for hearing on April 11, 2002.
On November 30, 2001, we filed a complaint for patent infringement in the
United States District Court for the Northern District of California against
Power Quotient International - USA Inc, or PQI-USA. In the suit, captioned
SanDisk Corp. v. Power Quotient International - USA Inc., Civil No. C 01-21111,
we seek damages and an injunction against PQI-USA from making, selling,
importing or using flash memory cards that infringe our U.S. patent No.
5,602,987. The PQI-USA complaint and litigation are related to the October 31,
2001 litigation referred to above. The products at issue in the PQI-USA case are
identical to those charged with infringement in the October 31, 2001 litigation.
On December 21, 2001, PQI-USA filed an answer to the complaint denying the
allegations, which included a counter claim for a declaratory judgment of
non-infringement and invalidity of our `987 Patent. We have motioned for a
preliminary injunction in the suit to enjoin PQI-USA from making, selling,
importing or using flash memory cards that infringe our `987 Patent prior to the
trial on the merits. This preliminary injunction motion is scheduled for hearing
on April 8, 2002.
18
On or about March 5, 2002, Samsung Electronics Co., Ltd., or Samsung, filed a
patent infringement lawsuit against us in the United States District Court for
the Eastern District of Texas. The lawsuit alleges that we infringe four Samsung
United States patents, Nos. 5,473,563; 5,514,889; 5,546,341 and 5,642,309, and
seeks a preliminary and permanent injunction against unnamed products of ours,
as well as damages, attorneys' fees and cost of the lawsuit.
Litigation is subject to inherent risks and uncertainties that may cause
actual results to differ materially from our expectations. Factors that could
cause litigation results to differ include, but are not limited to, the
discovery of previously unknown facts, changes in the law or in the
interpretation of laws, and uncertainties associated with the judicial
decision-making process.
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 the fiscal year covered by this report.
19
EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------
Our executive officers, who are elected by and serve at the discretion of the
Board of Directors, are as follows (all ages are as of March 1, 2002):
Name Age Position
---- --- --------
Dr. Eli Harari 56 President, Chief Executive Officer and Director
Sanjay Mehrotra 43 Executive Vice President and Chief Operating Officer
Nelson Chan 40 Senior Vice President and General Manager, Retail Business Unit
Jocelyn Scarborough 57 Vice President, Human Resources
Dr. Eli Harari, the founder of SanDisk, has served as President and Chief
Executive Officer and as a director of SanDisk 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 Corporation
and Hughes Aircraft Microelectronics. Dr. Harari holds a Ph.D. in Solid State
Sciences from Princeton University and has more than 70 patents issued in the
field of non-volatile memories and storage systems. Dr. Harari is a board member
of Tower Semiconductor, a public company in which SanDisk holds a minority
investment and Digital Portal, Inc. a joint venture firm created by SanDisk and
Photo-Me International.
Mr. Sanjay Mehrotra co-founded SanDisk in 1988 and has served as SanDisk's
vice president of engineering, vice president of product development, director
of memory design, and product engineering. He is currently Executive Vice
President and Chief Operating Officer. He has more than 21 years of experience
in the non-volatile semiconductor memory industry including engineering and
engineering management positions at Intel Corporation, Seeq Technology,
Integrated Device Technology and Atmel Corporation. Mr. Mehrotra earned a B.S.
and M.S. degrees in electrical engineering and computer sciences from the
University of California, Berkeley. He also holds several patents and has
published articles in the area of non-volatile memory design and flash memory
systems. Mr. Mehrotra is a board member of Divio, a privately held semiconductor
start-up company, in which SanDisk has a 10% ownership interest.
Mr. Nelson Chan brings more than 17 years of high-technology marketing and
engineering experience and has served as SanDisk's Vice President of Marketing
and Senior Vice President of Sales and Marketing. He is currently Senior Vice
President and General Manager, Retail Business Unit. Prior to joining SanDisk in
1992, Mr. Chan held marketing and engineering positions at Chips and
Technologies, Signetics, and Delco Electronics. Mr. Chan was one of the
principal organizers of the CompactFlash Association (CFA) and the
MultiMediaCard Association (MMCA). He is an officer and board member of the CFA
and a board member of the MMCA. Mr. Chan is also a board member of Digital
Portal Inc., a joint venture firm created by SanDisk and Photo-Me International.
He holds a B.S. in Electrical and Computer Engineering from the University of
California at Santa Barbara and an M.B.A. from Santa Clara University.
Ms. Jocelyn Scarborough joined SanDisk as Vice President of Human Resources
in March 1999. She was previously Principal of Scarborough and Associates from
1997 to 1999 and Vice President of Human Resources for the California State
Automobile Association from 1994 to 1997. From 1973 to 1993, Ms. Scarborough
held various professional and management positions in Human Resources and
Marketing at Digital Equipment Corporation, including Marketing Manager,
Director of Human Resources and Director of Management & Organization
Development. Ms. Scarborough holds a B.S. in Psychology from Gordon College.
20
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
---------------------------------------------
RELATED STOCKHOLDER MATTERS
---------------------------
Market Price of Common Stock
- ----------------------------
Our Common Stock is traded on the Nasdaq National Market under the symbol
"SNDK". Our initial public offering of stock occurred on November 8, 1995 at a
post-split price to the public of $5.00 per share. On January 26, 2000, our
board of directors approved a 2-for-1 stock split, in the form of a 100% stock
dividend, payable to stockholders of record as of February 8, 2000. The dividend
was paid and the split was effected on February 22, 2000. Shares, share price,
per share amounts, common stock at par value and capital in excess of par value
have been restated to reflect the stock split for all periods presented. The
following table lists the high and low sales prices for each quarter during the
last two fiscal years.
High Low
---- ---
Fiscal year 2000
First quarter $169.625 $37.469
Second quarter $126.500 $41.250
Third quarter $ 94.500 $51.125
Fourth quarter $ 74.750 $27.500
Fiscal year 2001
First quarter $ 48.688 $18.625
Second quarter $ 30.000 $17.250
Third quarter $ 27.940 $ 8.610
Fourth quarter $ 18.290 $ 9.050
As of March 1, 2002, we had approximately 361 stockholders of record. We have
never declared or paid any cash dividends on our Common Stock and do not expect
to pay cash dividends on our Common Stock in the foreseeable future. We
currently intend to retain our earnings, if any, for use in our business.
On December 24, 2001, we sold to two qualified institutional buyers, Morgan
Stanley & Co. Incorporated and ABN AMRO Rothschild LLC, $125.0 million principal
amount of 4 1/2% Convertible Subordinated Notes due 2006, or Notes, and on
January 10, 2002, we sold an additional $25.0 million of the Notes pursuant to
the exercise by the initial purchasers of their option. These initial purchasers
received a commission from the sale of the Notes of an aggregate of $3.8
million. The Notes were resold by the initial purchasers to "qualified
institutional buyers" pursuant to Rule 144A of the Securities Act of 1933, as
amended and were not, when issued, of the same class as securities listed on a
national securities exchange or quoted on Nasdaq. The Notes are convertible at
the option of the holders into our common stock at a conversion rate which is
equivalent to a conversion price of approximately $18.43 per share, which is
equal to a conversion rate of approximately 54.2535 shares of common stock per
$1,000 principal amount of Notes. The Notes are redeemable by us at any time on
or after November 17, 2004 at specified prices. While the Notes are outstanding,
we will have debt service obligations on the Notes of approximately $6.8 million
per year in interest payments. We expect to use the net proceeds of the offering
for general corporate purposes, including the development of new technologies
and fabrication facilities, general working capital and capital expenditures. We
may also use a portion of the net proceeds to fund acquisitions of products,
technologies or complementary businesses. However, we currently have no
commitments or agreements for any specific acquisitions.
21
ITEM 6: SANDISK CORPORATION SELECTED FINANCIAL DATA
(In thousands, except per share data)
Year Ended December 31, 2001/(1)/ 2000/(2)/ 1999 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
Revenues
Product $ 316,867 $ 526,359 $ 205,770 $ 103,190 $ 105,675
License and royalty 49,434 75,453 41,220 32,571 19,578
- --------------------------------------------------------------------------------------------------------------------------
Total revenues 366,301 601,812 246,990 135,761 125,253
Cost of revenues 392,293 357,017 152,143 80,311 72,280
- --------------------------------------------------------------------------------------------------------------------------
Gross profits (losses) (25,992) 244,795 94,847 55,450 52,973
Operating income (loss) (152,990) 124,666 30,085 12,810 19,680
Net income (loss) $ (297,944) $ 298,672 $ 26,550 $ 11,836 $ 19,839
Net income (loss) per share
Basic $ (4.37) $ 4.47 $ 0.48 $ 0.23 $ 0.43
Diluted $ (4.37) $ 4.11 $ 0.43 $ 0.21 $ 0.40
Shares used in per share calculations
Basic 68,148 66,861 55,834 52,596 45,760
Diluted 68,148 72,651 61,433 55,344 49,940
At December 31, 2001 2000 1999 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
Working capital $ 415,096 $ 525,950 $ 482,793 $ 138,471 $ 134,298
Total assets 932,348 1,107,907 657,724 255,741 245,467
Long-term obligations 129,908 73,492 - - -
Total stockholders' equity 675,379 863,058 572,127 207,838 191,374
See the Consolidated Financial Statements and Management's Discussion and
Analysis of Financial Condition and Results of Operations.
(1) Includes other-than-temporary impairment charges of $302.3 million, or
$188.1 million net of tax and restructuring charges of $8.5 million or $6.7
million net of tax.
(2) Includes gain on investment in UMC of $344.2 million, or $203.9 million net
of tax.
22
SanDisk Corporation
SUPPLEMENTARY QUARTERLY DATA
(Unaudited. In thousands, except per share data)
Quarterly/2001 1st 2nd 3rd 4th
- ----------------------------------------------------------------------------------------------------------
Revenues
Product $ 88,083 $ 88,115 $ 57,305 $ 83,364
License and royalty 13,244 19,033 8,582 8,575
- ----------------------------------------------------------------------------------------------------------
Total revenues 101,327 107,148 65,887 91,939
Gross profits (losses) (17,453) 396 (23,539) 14,604
Operating income (loss) (48,303) (28,650) (61,373) (14,664)
Net income (loss)* (143,102) (9,994) (170,476) 25,628
Net income (loss) per share
Basic+ $ (2.11) $ (0.15) $ (2.50) $ 0.37
Diluted+ $ (2.11) $ (0.15) $ (2.50) $ 0.36
Quarterly/2000 1st 2nd 3rd 4th
- ---------------------------------------------------------------------------------------------------------
Revenues
Product $ 97,249 $122,572 $ 151,817 $ 154,721
License and royalty 12,120 21,377 19,022 22,934
- ---------------------------------------------------------------------------------------------------------
Total revenues 109,369 143,949 170,839 177,655
Gross profits 41,611 59,435 68,965 74,784
Operating income 17,551 30,852 35,535 40,728
Net income** 219,271 24,269 25,602 29,530
Net income per share
Basic+ $ 3.32 $ 0.36 $ 0.38 $ 0.44
Diluted+ $ 3.00 $ 0.33 $ 0.35 $ 0.41
* In the first and third quarters of 2001, we recognized losses of $179.9
million and $116.4 million, respectively, on the other-than-temporary
decline in the market value of our foundry investments in UMC and Tower
Semiconductor.
** On January 3, 2000, the USIC foundry was merged into the UMC parent
company. We had invested $51.2 million in USIC. In exchange for our USIC
shares, we received 111 million UMC shares. These shares were valued at
approximately $396 million at the time of the merger, resulting in a pretax
gain of $344.2 million in the first quarter of 2000.
+ Quarterly earnings per share figures may not total to yearly earnings per
share, due to rounding and the fluctuations in the number of options
included or omitted from diluted calculations based on the stock price or
option strike prices.
See the Consolidated Financial Statements and Management's Discussion and
Analysis of Financial Condition and Results of Operations.
23
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-----------------------------------------------------------------------
OF OPERATIONS
- -------------
Statements in this report which are not historical facts are forward-looking
statements within the meaning of the federal securities laws. These statements
may contain words such as "expects," "anticipates," "intends," "plans,"
"believes", "estimates," or other wording indicating future results or
expectations. Forward-looking statements are subject to risks and uncertainties.
Our actual results may differ materially from the results discussed in
forward-looking statements. Factors that could cause our actual results to
differ materially include, but are not limited to, those discussed under
"Factors That May Affect Future Results" below, and elsewhere in this report.
The following discussion should be read in conjunction with our consolidated
financial statements and the notes thereto. We undertake no obligation to revise
or update any forward-looking statements to reflect any event or circumstance
that may arise after the date of this report.
Overview
SanDisk was founded in 1988 to develop and market flash data storage systems.
We sell our products to the consumer electronics and industrial/communications
markets. In fiscal 2001, approximately 78% of our product sales were
attributable to the consumer electronics market, particularly sales of
CompactFlash and SmartMedia card products for use in digital camera
applications. Our CompactFlash products have lower average selling prices and
gross margins than our higher capacity FlashDisk and FlashDrive products. In
addition, a substantial portion of our products are sold into the retail
channel, which usually has shorter customer order lead-times than our other
channels. A majority of our sales to the retail channel are turns business, with
orders received and fulfilled in the same quarter, thereby decreasing our
ability to accurately forecast future production needs. We believe sales to the
consumer market will continue to represent a substantial majority of our sales,
and may increase as a percentage of sales in future years, as the popularity of
consumer applications, including digital cameras, increases.
Our operating results are affected by a number of factors including the
volume of product sales, competitive pricing pressures, availability of foundry
capacity, variations in manufacturing cycle times, fluctuations in manufacturing
yields and manufacturing utilization, the timing of significant orders, our
ability to match supply with demand, changes in product and customer mix, market
acceptance of new or enhanced versions of our products, changes in the channels
through which our products are distributed, timing of new product announcements
and introductions by us and our competitors, the timing of license and royalty
revenues, fluctuations in product costs, increased research and development
expenses, and exchange rate fluctuations. We have experienced seasonality in the
past. As the proportion of our products sold for use in consumer electronics
applications increases, our revenues may become increasingly subject to seasonal
increases in the fourth quarter of each year and declines in the first quarter
of the following year. See "Factors That May Affect Future Results--Our
Operating Results May Fluctuate Significantly Which May Adversely Affect Our
Stock Price" and "--There is Seasonality in Our Business."
Beginning in late 1995, we adopted a strategy of licensing our flash
technology, including our patent portfolio, to third party manufacturers of
flash products. To date, we have entered into patent cross-license agreements
with several companies, and intend to pursue opportunities to enter into
additional licenses. Under our current license agreements, licensees pay license
fees, royalties, or a combination thereof. In some cases, the compensation to us
may be partially in the form of guaranteed access to flash memory manufacturing
capacity from the licensee company. The timing and amount of royalty payments
and the recognition of license fees can vary substantially from quarter to
quarter depending on the terms of each agreement and, in some cases, the timing
of sales of products by the other parties. As a result, license and royalty
revenues have fluctuated significantly in the past and are likely to continue to
fluctuate in the future. Given the relatively high gross margins associated with
license and royalty revenues, gross margins and net income are likely to
fluctuate more with changes in license and royalty revenues than with changes in
product revenues.
We market our products using a direct sales organization, distributors,
manufacturers' representatives, private label partners, OEMs and retailers. In
2001, retail sales accounted for 54% of total product revenues, compared to 28%
in 2000. We expect that sales through the retail channel will comprise an
increasing share of our product revenues in the future, and that a substantial
portion of our sales into the retail channel will be made to participants
24
that will have the right to return unsold products. Our policy is to defer
recognition of revenues from these sales until the products are sold to the end
customers.
Historically, a majority of our sales have been to a limited number of
customers. Sales to our top 10 customers accounted for approximately 49%, 48%,
and 57%, respectively, of our product revenues for 2001, 2000, and 1999. In 2001
and 2000, no single customer accounted for greater than 10% of our total
revenues. In 1999, revenues from one customer exceeded 10% of our total
revenues. We expect that sales of our products to a limited number of customers
will continue to account for a substantial portion of our product revenues for
the foreseeable future. We have also experienced significant changes in the
composition of our customer base from year to year and expect this pattern to
continue as market demand for our customers' products fluctuates. The loss of,
or a significant reduction in purchases by any of our major customers, could
harm our business, financial condition and results of operations. See "Factors
That May Affect Future Results--Sales to a Small Number of Customers Represent a
Significant Portion of Our Revenues".
All of our products require silicon wafers, the majority of which are
currently manufactured for us by Toshiba's wafer facility at Yokkaichi, Japan,
under our joint venture agreement, as well as UMC in Taiwan. Industry-wide
demand for semiconductors decreased significantly in 2001, due to decreased
demand in the cellular phone markets and the broad, general economic downturn
leading to a US recession. Semiconductor manufacturers, including some of our
suppliers and competitors, added new advanced wafer fab capacity prior to the
downturn. This additional capacity, along with slowing economic conditions,
resulted in excess supply and led to intense pricing pressure. From the fourth
quarter of 2000 to the fourth quarter of 2001, the average sales price per
megabyte we sold decreased by 68%, far in excess of our ability to reduce our
cost per megabyte. Consequently we saw a dramatic reduction in our product gross
margins, which resulted in substantial operating losses in 2001. If
industry-wide demand for our products continues to be below the industry-wide
available supply, our product prices could decrease further causing our
operating losses to continue in 2002.
Under our wafer supply agreements, there are limits on the number of wafers
we can order and our ability to change that quantity, either up or down, is
restricted. Accordingly, our ability to react to significant fluctuations in
demand for our products is limited. If customer demand falls below our forecast
and we are unable to reschedule or cancel our orders for wafers or other long
lead-time items such as controller chips or printed circuit boards, we may end
up with excess inventories, which could result in higher operating expenses and
reduced gross margins. If customer demand exceeds our forecasts, we may be
unable to obtain an adequate supply of wafers to fill customer orders, which
could result in lost sales and lower revenues. If we are unable to obtain
adequate quantities of flash memory wafers with acceptable prices and yields
from our current and future wafer foundries, our business, financial condition
and results of operations could be harmed.
We have from time to time taken write-downs for excess or obsolete
inventories and lower of cost or market price adjustments. In 2001, such
write-downs and lower of cost or market adjustments were approximately $85.0
million. We may be forced to take additional write-downs for excess or obsolete
inventory in future quarters if the current deterioration in market demand for
our products continues and our inventory levels continue to exceed customer
orders. In addition, we may record additional lower of cost or market price
adjustments to our inventories if continued pricing pressure results in a net
realizable value that is lower than our cost. Although we continuously try to
reduce our inventory in line with the current level of business, we are
obligated to honor existing purchase orders, which we have placed with our
suppliers. In the case of FlashVision manufacturing, both we and Toshiba are
obligated to purchase their share of the production output, which makes it more
difficult for us to reduce our inventory.
Excess inventory not only ties up our cash, but also can result in
substantial losses if such inventory, or large portions thereof, has to be
revalued due to lower market pricing or product obsolescence. These inventory
adjustments decrease gross margins and in 2001 resulted in, and could in the
future result in, fluctuations in gross margins and net earnings in the quarter
in which they occur. See "Factors That May Affect Future Results--Our Operating
Results May Fluctuate Significantly."
Export sales are an important part of our business, representing 55%, 57% and
53% of our total revenues in 2001, 2000, and 1999, respectively. Our sales may
be impacted by changes in economic conditions in our international markets.
Economic conditions in our international markets, including Japan, Asia and the
European Union, may adversely affect our revenues to the extent that demand for
our products in these regions declines. While most of our
25
sales are denominated in U.S. Dollars, we invoice certain Japanese customers in
Japanese Yen and are subject to exchange rate fluctuations on these transactions
which could affect our business, financial condition and results of operations.
See "Factors That May Affect Future Results--Our international operations make
us vulnerable to changing conditions and currency fluctuations."
For the foreseeable future, we expect to realize a significant portion of our
revenues from recently introduced and new products. Typically, new products
initially have lower gross margins than more mature products because the
manufacturing yields are lower at the start of manufacturing each successive
product generation. In addition, manufacturing yields are generally lower at the
start of manufacturing any product at a new foundry. In 2001, we experienced
start-up costs of approximately $22.0 million associated with ramping up NAND
wafer production at FlashVision . During the start-up phase, the fabrication
equipment and operating expenses are applied to a relatively small output of
production wafers, making this output very expensive.
To remain competitive, we are focusing on a number of programs to lower
manufacturing costs, including development of future generations of NAND flash
memory. There can be no assurance that we will successfully develop such
products or processes or that development of such processes will lower
manufacturing costs. If the current industry-wide and worldwide economic
slowdown continues throughout fiscal 2002, we may be unable to efficiently
utilize the NAND flash wafer production from FlashVision, which would force us
to amortize the fixed costs of the fabrication facility over a reduced wafer
output, making these wafers significantly more expensive. See "Factors That May
Affect Future Results--We must achieve acceptable manufacturing yields."
Critical Accounting Policies & Estimates
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent liabilities. On an
on-going basis, we evaluate our estimates, including those related to customer
programs and incentives, product returns, bad debts, inventories, investments,
income taxes, warranty obligations, restructuring, and contingencies and
litigation. We base our estimates on historical experience and on various other
assumptions that we believe to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
Revenue recognition. We recognizes net revenues when the earnings process is
-------------------
complete, as evidenced by an agreement with the customer, transfer of title and
acceptance if applicable, fixed pricing and probable collectibility. Because of
frequent sales price reductions and rapid technology obsolescence in the
industry, sales made to distributors and retailers under agreements allowing
price protection and/or right of return are deferred until the retailers or
distributors sell the merchandise.
Customer Incentives, Returns and Allowances. We record estimated reductions
-------------------------------------------
to revenue for customer programs and incentive offerings including promotions
and other volume-based incentives, particularly for our retail customers, which
represented 75% of our product revenues in fourth quarter of 2001. If market
conditions were to decline, we may take actions to increase customer incentive
offerings to our retail customers, possibly resulting in an incremental
reduction of revenue at the time the incentive is offered. In addition, we
record a provision for estimated sales returns and allowances on product sales
in the same period as the related revenues are recorded. These estimates are
based on historical sales returns, analysis of credit memo data and other known
factors. If the historical data we use to calculate these estimates do not
properly reflect future returns, revenue could be overstated.
Allowance for Doubtful Accounts -Methodology. We evaluate the collectibility
--------------------------------------------
of our accounts receivable based on a combination of factors. In circumstances
where we are aware of a specific customer's inability to meet its financial
obligations to us (e.g., bankruptcy filings, substantial down-grading of credit
ratings), we record a specific reserve for bad debts against amounts due to
reduce the net recognized receivable to the amount we reasonably believe will be
collected. For all other customers, we recognize reserves for bad debts based on
the length of time the receivables are past due based on our historical
experience. If circumstances change (i.e., higher than expected
26
defaults or an unexpected material adverse change in a major customer's ability
to meet its financial obligations to us), our estimates of the recoverability of
amounts due us could be reduced by a material amount.
Warranty Costs. We provide for the estimated cost of product warranties at
--------------
the time revenue is recognized. While we engage in product quality programs and
processes, our warranty obligation is affected by product failure rates and
repair or replacement costs incurred in correcting a product failure. Should
actual product failure rates, repair or replacement costs differ from our
estimates, increases to our warranty liability would be required.
Valuation of Financial Instruments. Our short-term investments include
----------------------------------
investments in marketable equity and debt securities. We also have equity
investments in semiconductor wafer manufacturing companies, UMC of $194.9
million and Tower of $16.6 million, as of December 31, 2001. In determining if
and when a decline in market value below amortized cost of these investments is
other-than-temporary, we evaluate the market conditions, offering prices, trends
of earnings, price multiples, and other key measures for our investments in
marketable equity securities and debt instruments. When such a decline in value
is deemed to be other-than-temporary, we recognize an impairment loss in the
current period operating results to the extent of the decline. Due to the
slowdown in the semiconductor industry and economic recession in 2001, the
market value of our UMC and Tower investments declined significantly. These
declines were deemed to be other-than-temporary and losses totaling $302.3 were
recognized. If the slowdown in the semiconductor industry continues in 2002, we
may recognize additional losses on these investments.
Inventories - Slow Moving and Obsolescence. We write down our inventory for
------------------------------------------
estimated obsolescence or unmarketable inventory equal to the difference between
the cost of the inventory and the estimated market value based upon assumptions
about future demand and market conditions, including assumptions about changes
in average selling prices. If actual market conditions are less favorable than
those projected by management, additional inventory write-downs may be required.
Use of Estimates. The preparation of financial statements in conformity with
----------------
generally accepted accounting principles requires us to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from our estimates
Deferred Tax Assets. As of December 31, 2001, we had a net deferred tax asset
-------------------
of approximately $36 million that has been fully offset by a valuation
allowance. Due to our current losses, we have not used projections of future
taxable income in determining the amount of the valuation allowance required.
Results of Operations
We operate in one business segment, flash memory products. Our products are
sold throughout the world. In the United States and foreign countries our
products are sold through direct, OEM, reseller, and distributor channels. Our
chief decision-maker, the President and Chief Executive Officer, evaluate our
performance based on total our results. Revenue is evaluated based on geographic
region and product category. Separate financial information is not available by
product category in regards to asset allocation, expense allocation, or
profitability.
Product Revenues. In 2001, our product revenues were $316.9 million, a
decrease of 40% from $526.4 million in 2000. The decrease was primarily due to
the downturn in the worldwide economy, industry-wide excess supply of flash
memory, and reduced demand from OEM customers who were liquidating existing
inventories throughout most of 2001. All of these factors reduced the demand for
our products and resulted in intense pricing pressures causing the average
selling price of our products to decline significantly. In 2001, the largest
decline in revenues came from MultiMediaCards, due to the slowdown in the market
for digital music players and CompactFlash, due to the decline in average
selling price. In 2001, our flash memory product unit sales declined 19% and our
average selling price per megabyte of flash memory shipped declined 50% compared
to 2000. However, the decline in average selling price per megabyte was even
more severe, at 68%, when comparing the fourth quarter of 2001 to the same
period in 2000.
27
In 2000, our product revenues increased 156% to $526.4 million from $205.8
million in 1999. The increase consisted of an increase of 173% in unit sales,
which was partially offset by a 7% decline in average selling prices per unit.
In 2000, the largest increase in unit volume came from sales of CompactFlash
products that represented 47% of product revenues and MultiMediaCard products
that represented 21% of product revenues. The continuing move towards higher
capacity cards in 2000 partially offset a decline in the average selling price
per megabyte of capacity shipped. In 2000, the average megabyte capacity per
unit shipped increased 17% while the average selling price per megabyte of flash
memory shipped declined 22% compared to the prior year.
Our backlog as of December 31, 2001 was $19.5 million compared to $63.3
million in 2000 and $157.2 million in 1999. The decrease in 2001 was primarily
due to a reduction in orders from our OEM customers and a significant reduction
in order lead times due to industry-wide overcapacity. Because of the
deterioration in market conditions throughout most of 2001, our quarterly turns
business, the business we book and ship in the same quarter, reached
approximately 80% of our product shipments in the third and fourth quarters of
2001. In 2001, OEM sales decreased to 34% of product revenues in 2001, compared
to 57% in 2000. Retail sales, which are typically booked and shipped in the same
quarter, increased to 54% of our product revenues, compared to 28% in 2000. In
the fourth quarter of 2001, sales through our retail channels accounted for
approximately 75% of product revenues. We expect sales to the retail channel to
continue to be a significant portion of our revenue in 2002. See "Factors That
May Affect Future Results - Our Operating Results May Fluctuate Significantly"
and "-There is Seasonality in Our Business." Since orders constituting our
current backlog are subject to changes in delivery schedules or cancellations,
backlog is not necessarily an indication of future revenue.
License and Royalty Revenues. We currently earn patent license fees and
royalties under several cross-license agreements, including agreements with
Hitachi, Intel, Lexar, Sharp, Samsung, SmartDisk, Sony, SST, TDK and Toshiba.
License and royalty revenues from patent cross-license agreements were $49.4
million in 2001, compared to $75.5 million in 2000 and $41.2 million in 1999.
The decrease in license and royalty revenues in 2001 was primarily due to lower
patent royalties from lower royalty bearing sales by some of our licensees
resulting in decreased patent license revenues recognized. The increase in
license and royalty revenues in 2000 was primarily due to patent royalties from
increased sales by certain of our licensees, and $4.7 million of revenue
recognized in conjunction with the settlement of the Lexar litigation. Revenues
from licenses and royalties were 13% of total revenues in 2001 and 2000, and 17%
in 1999.
Our income from patent licenses and royalties can fluctuate significantly
from quarter to quarter. A substantial portion of this income comes from
royalties based on the actual sales by our licensees. Given the current market
outlook for 2002, sales of licensed flash products by our licensees may be lower
than the corresponding sales in recent quarters, which may cause a drop in our
royalty revenues.
Gross Profits (Losses). In fiscal 2001, gross profits declined to negative
$26.0 million, or negative 7% of total revenues from $244.8 million, or 41% of
total revenues in 2000 and $94.8 million, or 38% of total revenues in 1999.
Product gross margins decreased to negative 24% in 2001, from positive 32% in
2000 and positive 26% in 1999. The decline in gross margins in 2001 was
primarily due to lower sales volume, severely reduced average selling prices,
inventory write downs of approximately $85.0 million and start-up costs
associated with our FlashVision foundry joint venture of approximately $22.0
million. The increases in gross margins in 2000 were primarily due to the lower
cost per megabyte of our 256 megabit flash memory products, which represented
the majority of our product sales in 2000.
Due to weak economic conditions, excess supply in the markets for our
products and lower demand from customers as they continued to reduce their
inventories, we experienced intense pricing pressures in 2001. We expect our
average selling prices per megabyte to decline significantly in 2002 and
possibly beyond, until market supply and demand for our products returns to
equilibrium. Although we are taking significant steps to lower our product
costs, given the current market conditions, we cannot guarantee that our product
cost will decline as quickly as our average selling prices. If our average
selling prices decline faster than our costs, our gross margin will be
negatively impacted in 2002.
Research and Development. Research and development expenses consist
principally of salaries and payroll-related expenses for design and development
engineers, prototype supplies and contract services. Research and
28
development expenses increased to $58.9 million in 2001 from $46.1 million in
2000 and $26.9 million in 1999. As a percentage of revenues, research and
development expenses were 16% in 2001, 8% in 2000 and 11% in 1999. In 2001 and
2000, the increase in research and development expenses was primarily due to an
increase in salaries and payroll-related expenses associated with additional
personnel and higher project-related expenses. The additional project expenses
in 2001 were to support the development of new generations of NAND flash data
storage products. We expect our research and development expenses to continue to
increase in future quarters to support the development and introduction of new
generations of flash data storage products, including our joint venture with
Toshiba, our co-development agreement with Sony and our development of advanced
controller chips.
Sales and Marketing. Sales and marketing expenses include salaries, sales
commissions, benefits and travel expenses for our sales, marketing, customer
service and applications engineering personnel. These expenses also include
other selling and marketing expenses such as independent manufacturer's
representative commissions, advertising and tradeshow expenses. Sales and
marketing expenses decreased to $42.6 million in 2001 from $49.3 million in 2000
and $25.3 million in 1999. The decrease in 2001 was primarily due to decreased
commission expenses due to lower product revenues, reduction in travel expenses
and a decrease in marketing expenses. The increase in 2000 was primarily due to
increased salaries and payroll-related expense and increased commission expenses
due to higher product revenues and increased marketing expenses. Sales and
marketing expenses represented 12% of total revenues in 2001 compared to 8% in
2000 and 10% in 1999. We expect sales and marketing expenses to increase as
sales of our products grow and as we continue to develop the retail channel and
brand awareness for our products.
General and Administrative. General and administrative expenses include the
cost of our finance, information systems, human resources, shareholder
relations, legal and administrative functions. General and administrative
expenses were $17.0 million in 2001 compared to $24.8 million in 2000 and $12.6
million in 1999. The decrease in 2001 was primarily due to decreased legal fees
and lower salaries and expenses associated with reduced headcount. General and
administrative expenses represented 5% of total revenues in 2001 compared to 4%
in 2000 and 5% in 1999. General and administrative expenses could increase in
the future if we pursue litigation to defend our patent portfolio and grow our
infrastructure to support our growth. See "Factors That May Affect Future
Results - Risks Associated with Patents, Proprietary Rights and Related
Litigation."
Restructuring Charges. In the third quarter of 2001, we adopted a plan to
transfer all of our card assembly and test manufacturing operations from our
Sunnyvale location to offshore subcontractors. As a result we recorded a
restructuring charge of $8.5 million. The charge included $1.1 million of
severance and employee related costs for a reduction in workforce of
approximately 193 personnel, equipment write-off charges of $6.4 million and
lease commitments of $1.0 million on a vacated warehouse facility. See Note 10
of Notes to Condensed Consolidated Financial Statements.
As a part of our plan to transfer all card assembly and test manufacturing
operations to offshore subcontractors, we abandoned excess equipment and
recorded a charge of $6.4 million in the third quarter of fiscal 2001.
We are attempting to sublease one warehouse building in San Jose, California.
Given the current real estate market conditions in the San Jose area, we do not
expect to be able to sublease this building before the end of 2003 and as a
result, we recorded a charge of $1.0 million in the third quarter of 2001.
Of the $8.5 million restructuring charge, cash payments of $0.8 million were
paid in 2001. After writing off certain non-cash charges, accruals of $1.7
million remain as of December 31, 2001, primarily related to severance and
benefits to be paid out during fiscal 2002 and excess facility charges, which
will be paid over the respective lease terms. We believe that the savings
resulting from the restructuring activity will contribute to a reduction in
manufacturing and operating expense levels of approximately $11.8 million in
fiscal 2002.
Equity in Income of Joint Venture. In 2001, equity in income of joint
ventures of $2.1 million included our share of net income from our FlashVision
joint venture and losses from our DPI joint venture.
Interest Income/Expense. Interest income was $12.3 million in 2001 compared
to $22.8 million in 2000 and $8.3 million in 1999. The decrease in 2001 was
primarily due to a reduction in cash and investment balances resulting
29
from cash used by operations and strategic investments in Tower Semiconductor
and FlashVision. In addition, overall market interest rates were lower in 2001
due to reductions in the Federal funds rate. We expect interest income to
decline and interest expense to increase in 2002 relative to 2001 due to
interest expense payable on the convertible notes issued in late 2001 and early
2002 and the continuing impact of the reduction in the Federal funds rate in the
fourth quarter of 2001.
Loss on investment in foundries. The market value of our investments in UMC
and Tower Semiconductor have declined significantly due to the downturn in the
economy and excess supply in the semiconductor industry. The value of our
investment in UMC had declined to $194.9 million at December 31, 2001. It was
determined that the decline in the market value of the investment in UMC was
other than temporary, as defined by generally accepted accounting principles. We
recorded a loss of $275.8 million on our UMC investment in 2001, or $166.9
million net of taxes, in accordance with Statement of Financial Accounting
Standards Number 115. If the fair value of our UMC investment declines further,
it may be necessary to record additional losses. In addition, in future periods,
if our UMC shares are sold, there may be a gain or loss, due to fluctuations in
the market value of UMC's stock.
The value of our Tower investment and wafer credits had declined to $16.6
million at December 31, 2001. It was determined that this decline was other than
temporary, as defined by generally accepted accounting principles, and a loss of
$20.6 million was recognized. In addition, we recorded a loss of $5.5 million on
our exchange of 75% of our Tower wafer credits for 1,284,007 ordinary shares at
$12.75 per share. These losses totaling $26.1 million, or $15.8 million net of
tax benefit, were recorded in loss on foundry investment in 2001. If the fair
value of our Tower investment declines further, it may be necessary to record
additional losses.
Other Income (Loss), Net. Other Income (Loss), net was a loss of $1.0 million
in 2001 compared to income of $572,000 in 2000 and income of $1.3 million in
1999. The loss in 2001 was primarily due to foreign currency transaction losses
on our Yen denominated assets. Other income in 2000 and 1999 came primarily from
foreign currency transaction gains.
Provision for (Benefit from) Income Taxes. Our 2001 effective tax benefit
rate was approximately 33%, while our 2000 and 1999 effective tax rates were
approximately 39% and 33%, respectively. Our 2001 tax benefit was generated
primarily from our ability to benefit from the 2001 net operating loss using
carryback capacity along with the unrealized gain on our investment in UMC
shares. The 2001 tax benefit is limited to the amount of tax refund that we will
receive from our loss carryback and the amount available to offset unrealized
tax gains related to the UMC investment. As of December 31, 2001, we had
recorded the maximum carryback benefit available and therefore future losses may
not give rise to a current tax benefit.
Our assessment of the amount of valuation allowance required will be
influenced by the amount of unrealized tax gains on investments. Any increase in
the mark to market value of the investments may result in the recognition of
some portion of the valuation allowance. This may cause the interim tax rate to
fluctuate significantly.
Liquidity and Capital Resources
At December 31, 2001, we had working capital of $415.1 million, which
included $189.4 million in unrestricted cash and unrestricted cash equivalents
and $105.5 million in unrestricted short-term investments, excluding our
investment in UMC. Under the terms of the FlashVision lease agreement, we as
guarantor are required to pledge cash and equity securities up to the full value
of the outstanding lease commitments guaranteed by us. As of December 31, 2001,
we had guaranteed $129.5 million of FlashVision's lease commitments and pledged
$64.7 million of cash and cash equivalents and $64.7 million of our UMC equity
securities. This pledged cash and cash equivalents and marketable equity
securities are included in "Restricted cash and cash equivalents" and
"Restricted investment in UMC" on our balance sheet.
Operating activities used $72.1 million of cash in 2001 primarily due to our
net loss, an increase in deferred tax assets of $134.5 million, a decrease in
accounts payable of $39.2 million, and a decrease in deferred revenue of $34.9
million. These were partially offset by cash provided by a decline in accounts
receivable of $51.2 million a reduction in inventories of $40.6 million and an
increase in other current liabilities, related party of $31.3 million. Cash
provided by operations was $84.9 million 2000 and $17.0 million in 1999.
30
Net cash provided by investing activities was $25.1 million in 2001. Proceeds
from net sales of investments of $155.5 million were partially offset by $15.0
million invested in FlashVision, our foundry joint venture with Toshiba, $42.5
million invested in Tower, $2.0 million invested in DPI, our joint venture with
Photo-Me International and $26.2 million of capital equipment purchases. Net
cash used in investing activities was $137.9 million in 2000 and $214.4 million
in 1999.
Net cash provided by financing activities was $130.2 million in 2001, which
included the $121.5 million net proceeds from the issuance of long-term
convertible subordinated notes in the fourth quarter of 2001, and $8.6 million
from the sale of common stock through our stock option and employee stock
purchase plans. In 2000, financing activities provided $13.2 million and $328.2
million in 1999.
On December 24, 2001, we completed a private placement of $125.0 million of 4
1/2% Convertible Subordinated Notes due 2006, or Notes, and on January 10, 2002,
the initial purchasers completed the exercise of their option to purchase an
additional $25.0 million of Notes, for which we received net proceeds of
approximately $145.9 million. Based on the aggregate principal amount at
maturity of $150.0 million, the Notes provide for semi-annual interest payments
of $3.4 million each on May 15 and November 15. The Notes are convertible into
shares of our common stock at any time prior to the close of business on the
maturity date, unless previously redeemed or repurchased, at a conversion rate
of 54.2535 shares per $1,000 principal amount of the Notes, subject to
adjustment in certain events. At anytime on or after November 17, 2004, we may
redeem the notes in whole or in part at a specified percentage of the principal
amount plus accrued interest. The debt issuance costs are being amortized over
the term of the Notes using the interest method. We intend to fulfill our debt
service obligations from cash generated by our operations, if any, and from our
existing cash and investments. If necessary, among other alternatives, we may
add lease lines of credit to finance capital expenditures and obtain other
long-term debt and lines of credit. We may incur substantial additional
indebtedness in the future. There can be no assurance that we will be able to
meet our debt service obligations, including our obligations under the Notes.
In January 2000, the USIC foundry was merged into the UMC parent company. In
exchange for our USIC shares, we received 111 million UMC shares. These shares
were valued at approximately $396 million at the time of the merger, resulting
in a pretax gain of $344.2 million ($203.9 million after-tax) in the first
quarter of 2000. All of the UMC shares we received as a result of the merger
were subject to trading restrictions imposed by UMC and the Taiwan Stock
Exchange. As of December 31, 2001, the trading restrictions had expired on 66.7
million shares. The remaining 44.4 million shares will become available for sale
over a two-year period beginning in January 2002. We also received 20.0 million
and 22.2 million shares as stock dividends from UMC in 2001 and 2000. Due to the
decline in UMC stock price from the weakness in the semiconductor industry, the
value of the Company's investment in UMC had declined to $194.9 at December 31,
2001. In 2001, it was determined that the decline in the market value of the
investment was other than temporary, as defined by generally accepted accounting
principles and a loss of $275.8 million, or $166.9 million net of taxes was
recorded in accordance with Statement of Financial Accounting Standards Number
115. The loss was included in loss on investment in foundry. If the fair value
of the UMC investment declines further, it may be necessary to record additional
losses. In addition, in future periods, there may be a gain or loss due to
fluctuations in the market value of UMC stock or if UMC shares are sold.
On June 30, 2000, we closed a transaction with Toshiba providing for the
joint development and manufacture of 512 megabit and 1 gigabit flash memory
chips and Secure Digital Card controllers. As part of this transaction, SanDisk
and Toshiba formed FlashVision, a joint venture to equip and operate a silicon
wafer manufacturing line at Dominion Semiconductor in Virginia. In January 2001,
we invested the final $15.0 million of our $150.0 million cash commitment in
FlashVision. We are obligated to guarantee one-half of all FlashVision lease
amounts up to a maximum guarantee of $175.0 million. As of December 31, 2001, we
had guarantee obligations in the amount of $129.5 million, with ABN AMRO Bank,
N.V. as agent for a syndicate of financial institutions, on the equipment lease
lines to equip FlashVision's manufacturing clean room with advanced wafer
processing equipment. Although FlashVision recently terminated the ABN AMRO
lease facility, as further discussed below, under the terms of the FlashVision
lease agreements, we as guarantor remain at this time subject to certain
financial covenants. We obtained a compliance waiver for the third quarter of
2001 and negotiated an amendment to the lease agreement which includes a
modification of the covenant requirements and requires us to pledge cash and
equity securities up to the full value of the outstanding guaranteed lease
commitments. As of December 31, 2001, we had pledged cash of
31
$64.7 million and UMC equity securities of $64.7 million. While these assets are
pledged, they are not available to us to be used to fund operations.
In December 2001, we signed a binding memorandum of understanding, or MOU,
with Toshiba under which we and Toshiba agreed to restructure our FlashVision
business by consolidating our FlashVision advanced NAND wafer fabrication
manufacturing operations at Toshiba's memory fabrication facility at Yokkaichi,
Japan. The Yokkaichi fabrication facility, or Yokkaichi, is Toshiba's most
advanced memory fabrication facility and has approximately twice the wafer
fabrication capacity of Dominion. Through this consolidation, we expect
Yokkaichi to provide more cost-competitive NAND flash wafers than is possible at
Dominion. Under the terms of the MOU, Toshiba will transfer the FlashVision
- -owned and leased NAND production tool-set from Dominion to Yokkaichi and has
agreed to bear substantially all of the costs associated with the equipment
transfers, which are expected to be completed in 2002. Once the consolidation is
completed, Yokkaichi's total NAND wafer output will match the combined prior
NAND capacity of Yokkaichi and Dominion. We and Toshiba contemplate that the
FlashVision operation at Yokkaichi will continue essentially the same 50-50
joint venture and on essentially the same terms as we have had at Dominion in
Virginia. Under our joint venture agreement, we are contractually obligated, and
expect to continue to be obligated after the restructuring of our FlashVision
joint venture, to purchase half of FlashVision's NAND wafer production output.
In March 2002, FlashVision notified ABN AMRO that it was exercising its right of
early termination under the lease facility and will repay all amounts
outstanding thereunder in April 2002. We and Toshiba are currently seeking other
sources of financing to replace the ABN AMRO lease facility. The transfer and
qualification of the advanced fabrication equipment from Dominion, Virginia to
Yokkaichi, Japan is a highly complex operation. It is quite possible that we may
encounter difficulties and delays. Although the additional costs associated with
these potential delays will generally be borne by Toshiba, our results of
operations may suffer if this equipment transfer is not completed on time and
production does not commence at Yokkaichi as planned, thereby reducing the total
NAND production capacity available to us.
On July 4, 2000, we entered into a share purchase agreement to make a $75.0
million investment in Tower, in Israel, representing approximately 10% ownership
of Tower. The investment is subject to the completion of certain milestones.
During 2001, Tower satisfied the closing conditions of the share purchase
agreement and completed the first two milestones. Under the terms of the
agreement, we invested $42.5 million to purchase 1,599,931 ordinary shares and
obtain wafer credits of $21.4 million. In September 2001, we agreed to convert
75% of our wafer credits to equity at a price of $12.75 per share and received
an additional 1,284,007 ordinary shares. Due to the continued weakness in the
semiconductor industry, the value of our Tower investment and remaining wafer
credits had declined to $16.6 million at December 31, 2001. It was determined
that this decline was other than temporary, as defined by generally accepted
accounting principles and a loss of $20.6 million was recorded in the second
half of 2001. In addition we recognized a loss of $5.5 million on the exchange
of 75% of our Tower wafer credits for 1,284,007 ordinary shares at $12.75 per
share. These losses totaling $26.1 million, or $15.8 million net of tax benefit
were recorded in loss on foundry investment in 2001.
Under our original agreement, additional contributions by us will take the
form of mandatory warrant exercises for ordinary shares at an exercise price of
$30.00 per share if other milestones are met by Tower. The warrants will expire
five years from the date of grant, and in the event the key milestones are not
achieved, the exercise of these warrants will not be mandatory. However, in
March of 2002, we modified our share purchase agreement with Tower by agreeing
to advance the payments for the third and fourth milestones to April 5, 2002 and
October 1, 2002, respectively. We will make these payments whether or not Tower
actually achieves its previously agreed upon milestone obligations. In exchange
for this and as part of the modification to the share purchase agreement, Tower
has agreed that of the aggregate payment of $22.0 million represented by the
third and fourth milestone payments, (i) 60% of this amount, or $13.2 million,
will be applied to the issuance of additional ordinary Tower shares based on the
average closing price of Tower shares on the NASDAQ in the thirty consecutive
trading days preceding each payment date (but not to exceed $12.50 per share)
and (ii) 40% of this amount, or $8.8 million, will be credited to our pre-paid
wafer account, to be applied against orders placed with Tower's new fabrication
facility, when completed. Currently, we expect Tower to supply us a portion of
the ASIC controller chips used in our flash cards. We expect first wafer
production to commence at the new fabrication facility in late 2002.
Tower's completion of the wafer foundry facility is dependent on its ability
to obtain additional financing for the foundry construction from equity and
other sources and the release of grants and approvals for changes in grant
programs from the Israel government's Investment Center. If Tower is unable to
obtain additional financing, complete foundry construction in a timely manner or
successfully complete the development and transfer of advanced CMOS process
technologies and ramp-up of production, the value of our investment in Tower
will decline significantly or possibly become worthless and we may be unable to
obtain the wafers needed to manufacture our products, which would harm our
results of operations. In addition, the value of our investment in Tower may be
adversely affected by a further deterioration of conditions in the market for
foundry manufacturing services and the market for semiconductor products
generally. If the fair value of the Tower investment declines further, it may be
necessary to record additional losses.
32
On August 9, 2000, we entered into a joint venture, DPI, with PMI for the
manufacture, installation, marketing, and maintenance of self-service, digital
photo printing labs, or kiosks, bearing the SanDisk brand name in locations in
the U.S. and Canada. Under the agreement, we and PMI will each make an initial
investment of $4.0 million and secure lease financing for the purchase of the
kiosks. During 2001, we invested $2.0 million in DPI. Recently, DPI has changed
its business plan from 100% leasing the kiosks to customers and sharing in the
photo printing revenues generated, to a mix of leasing and selling the kiosks
outright. While this plan may reduce the long-term cumulative income from each
kiosk, it is expected to reduce substantially DPI's requirements for lease
financing. Therefore, we expect based on the current business plan that the
total value of our lease guarantees to be below $5.0 million in 2002. PMI will
manufacture the kiosks for the joint venture and will install and maintain the
kiosks under contract with the joint venture. The first 30 kiosks are currently
deployed in pilot programs in select retail stores in the United States, and we
expect to gather actual consumer usage information to guide our future continued
involvement in the DPI joint venture. DPI has experienced delays in its U.S.
market rollout of the kiosks, due primarily to modifications to improve the
kiosk's operation as a standalone, reliable, user-friendly photo printing
device. These delays have provided opportunities for several competitors to
enter the digital photo printing market with alternative products, which may
offer more attractive features or lower costs than the DPI kiosks. We cannot
assure you that these kiosks, if and when they are introduced, will function
reliably as intended, or that they will receive favorable acceptance from
consumers. If DPI is unsuccessful, our investment may become worthless,
requiring us to record a loss equal to the total amount invested. We account for
this investment under the equity method, and recorded a loss of $1.4 million as
our share of the equity in loss of joint venture in 2001.
On November 2, 2000, we made a strategic investment of $7.2 million in Divio,
Inc., or Divio. Divio is a privately-held manufacturer of digital imaging
compression technology and products for future digital camcorders that will be
capable of using our flash memory cards to store home video movies, replacing
the magnetic tape currently used in these systems. Under the agreement, we own
approximately 10% of Divio and are entitled to one board seat. A number of
companies are developing compression chip products that may be superior to, or
may be offered at a lower cost than the Divio chips. These competing products
may render Divio's products uncompetitive and thereby significantly reduce the
value of our investment in Divio.
The following summarizes our contractual obligations at December 31, 2001,
and the effect such obligations are expected to have on our liquidity and cash
flow in future periods (in thousands).
Less Than After 5
Total 1 Year 1 - 3 Years 4 - 5 Years Years
----- ------ ----------- ----------- -----
CONTRACTUAL OBLIGATIONS:
Convertible subordinated notes payable (See Note 4.) $ 125,000/(1)/ $ - $ - $ 125,000 $ -
Operating leases 10,754 2,623 4,838 3,293 -
Purchase commitments for flash memory wafers 32,500 32,500 - - -
---------- ---------- ----------- ----------- ----------
Total contractual cash obligations $ 168,254 $ 35,123 $ 4,838 $ 128,293 $ -
========== ========== =========== =========== ==========
(1) On January 10, 2002, we sold an additional $25.0 million of the Notes
pursuant to the exercise by the initial purchasers of their option.
Depending on the demand for our products, we may decide to make additional
investments, which could be substantial, in assembly and test manufacturing
equipment or foundry capacity to support our business in the future. We may also
invest in or acquire other companies' product lines or assets. Our operating
expenses may increase as a result of the need to hire additional personnel to
support our sales and marketing efforts and research and development activities,
including our collaboration with Toshiba for the joint development of 512
megabit and 1 gigabit flash memory chips and Sony for the joint development of
the next generation Memory Stick. We believe our existing cash and cash
equivalents and short-term investments will be sufficient to meet our currently
anticipated working capital and capital expenditure requirements for the next
twelve months.
33
Impact of Currency Exchange Rates
A portion of our revenues is denominated in Japanese Yen. We enter into
foreign exchange forward contracts to hedge against changes in foreign currency
exchange rates. At December 31, 2001, one forward contract with a notional
amount of $9.8 million was outstanding. No forward contacts were outstanding at
December 31, 2000. Future exchange rate fluctuations could have a material
adverse effect on our business, financial condition and results of operations.
Impact of Recently Issued Accounting Standards
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141
supersedes Accounting Principles Board ("APB") Opinion 16 "Business
Combinations" and SFAS No. 38 "Accounting for Pre-acquisition Contingencies,"
and eliminates the pooling-of-interests method of accounting for business
combinations except for qualifying business combinations that were initiated
prior to July 1, 2001. SFAS No. 141 also includes new criteria to recognize
intangible assets separately from goodwill. The requirements of SFAS 141 are
effective for any business combination accounted for by the purchase method that
is completed after June 30, 2001 (i.e., the acquisition date is July 1, 2001 or
after). We did not engage in any merger or acquisition activity during the year
and therefore, application of SFAS 141 is not expected to have a material impact
on results of operation and financial position in 2002.
SFAS No. 142, supersedes APB Opinion No. 17, "Intangible Assets," and states
that goodwill and intangible assets with indefinite lives are no longer
amortized but are reviewed for impairment annually, or more frequently if
impairment indicators arise. Separable intangible assets that are not deemed to
have an indefinite life will continue to be amortized over their useful lives.
The discontinuing of amortization provisions under SFAS No. 142 of goodwill and
indefinite lived intangible assets apply to assets acquired after June 30, 2001.
In addition, the impairment provisions of SFAS 142 apply to assets acquired
prior to July 1, 2001 upon adoption of SFAS 142. Application of the
non-amortization provisions and changes in estimated useful lives of intangibles
of FAS 142 for goodwill is not expected to have a material impact on results of
operation and financial position in 2002.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets ("SFAS No. 144"), which supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be disposed of." The primary objective of SFAS No. 144 is to develop
one accounting model based on the framework established in SFAS No. 121 for
long-lived assets to be disposed of by sale, and to address significant
implementation issues. The provisions of this statement are effective for fiscal
years beginning after December 15, 2001, and interim periods within those fiscal
years, with early application encouraged. We are evaluating the impact of SFAS
No. 144 on our financial position and results of operations.
Factors That May Affect Future Results
- --------------------------------------
Our operating results may fluctuate significantly, which may adversely
affect our stock price.
Our quarterly and annual operating results have fluctuated
significantly in the past and we expect that they will continue to fluctuate in
the future. This fluctuation is a result of a variety of factors, including the
following:
. unpredictable or declining demand for our products;
. decline in the average selling prices of our products due to
competitive pricing pressures;
. seasonality in sales of our products;
. natural disasters affecting the countries in which we conduct our
business, particularly o &Japan, where our sole source of NAND flash
memory wafer capacity will be located and, to a lesser extent, Taiwan,
China and the United States;
. excess capacity of flash memory from our competitors and our own flash
wafer capacity, which
34
may cause an acceleration in the decline in our average selling
prices;
. difficulty of forecasting and management of inventory levels; in
particular, building a large o &inventory of unsold product due to
non-cancelable contractual obligations to purchase materials such as
flash wafers, controllers, printed circuit boards and discrete
components;
. expenses related to obsolescence or devaluation of unsold inventory;
. adverse changes in product and customer mix;
. slower than anticipated market acceptance of new or enhanced versions of
our products;
. competing flash memory card standards, which displace the standards used
in our products;
. changes in our distribution channels;
. fluctuations in our license and royalty revenue;
. fluctuations in product costs, particularly due to fluctuations in
manufacturing yields and utilization;
. availability of sufficient silicon wafer foundry capacity to meet
customer demand;
. shortages of components such as capacitors and printed circuit boards
required for the &manufacturing of our products;
. significant yield losses, which could affect our ability to fulfill
customer orders and could &increase our costs;
. manufacturing flaws affecting the reliability, functionality or
performance of our products, o &which could increase our product costs,
reduce demand for our products or require product recalls;
. increased research and development expenses;
. exchange rate fluctuations, particularly the U.S. Dollar to Japanese Yen
exchange rate;
. changes in general economic conditions, particularly in Japan and the
European Union; and
. reduced sales to our retail customers if consumer confidence declines or
economic conditions worsen..
Difficulty of estimating silicon wafer needs. When we order silicon wafers
from our foundries, we have to estimate the number of silicon wafers needed to
fill product orders several months into the future. If we overestimate this
number, we will build excess inventories, which could harm our gross margins and
operating results. On the other hand, if we underestimate the number of silicon
wafers needed to fill product orders, we may be unable to obtain an adequate
supply of wafers, which could harm our product revenues. Because the majority of
our CompactFlash, SmartMedia card, MultiMediaCard and Secure Digital card, are
sold into emerging consumer markets, it has been difficult to accurately
forecast future sales. In addition, bookings visibility remains low due to the
current economic uncertainty in our markets. A substantial majority of our
quarterly sales are currently, and have historically been, from orders received
and fulfilled in the same quarter, which makes accurate forecasting very
difficult. Our product order backlog may fluctuate substantially from quarter to
quarter.
Variability of expense levels. Despite the significant actions we took in
2001 to align expense levels with decreased revenues, we may need to hire
additional personnel in certain business areas or otherwise increase our
operating expenses in the future to support our sales and marketing efforts and
research and development activities. We have significant fixed costs and we
cannot readily reduce these expenses over the short term. If our revenues do not
increase proportionately to our operating expenses, or if revenues decrease or
do not meet expectations for a particular period, our business, financial
condition and results of operations will be harmed.
35
Variability of average selling prices and gross margins. Our product mix
varies quarterly, which affects our overall average selling prices and gross
margins. Our CompactFlash, SmartMedia card, MultiMediaCard and Secure Digital
card products, which currently represent the majority of our product revenues,
have lower average selling prices and gross margins than our higher capacity
FlashDisk and FlashDrive products. We believe that sales of CompactFlash,
SmartMedia card, MultiMediaCard and Secure Digital card products will continue
to represent a significant percentage of our product revenues as consumer
applications, such as digital cameras and digital music players, become more
popular. Flash data storage markets are intensely competitive, and price
reductions for our products are necessary to meet consumer price points. Due to
continued oversupply in flash memory foundry capacity throughout 2001 and the
economic slow-down in 2001, the decline in our average selling price per
megabyte of 50% was much more severe than the 22% decrease we experienced in
2000 and we expect that price declines for our products in the next several
quarters could be significant. If we cannot reduce our product manufacturing
costs in future periods to offset further price reductions, our gross margins
and net profitability will suffer.
In the fourth quarter of 2001, we commenced retail sales of Memory Stick
cards supplied to us under an OEM supply and purchase agreement with Sony. We
cannot assure you that the gross margins on the sale of Memory Stick products
will be comparable to the gross margins from the sale of our other products.
Variability of license fees and royalties. Our intellectual property
strategy consists of cross-licensing our patents to other manufacturers of flash
products. Under these arrangements, we earn license fees and royalties on
individually negotiated terms. The timing of revenue recognition from these
payments is dependent on the terms of each contract and on the timing of product
shipments by the third parties. Our income from patent licenses and royalties
can fluctuate significantly from quarter to quarter. A substantial portion of
this income comes from royalties based on the actual sales by our licensees.
Given the current market outlook for the first quarter of 2002 and beyond, sales
of licensed flash products by our licensees may be substantially lower than the
corresponding sales in recent quarters, which may cause a substantial drop in
our royalty revenues. Because these revenues have higher gross margins than our
product revenues, our overall gross margins and net income fluctuate
significantly with changes in license and royalty revenues. We cannot assure you
that our existing licensees will renew their licenses upon expiration, or that
we will be successful in signing new licensees in the future.
Our selling prices may be affected by excess capacity in the market for
flash memory products
Throughout 2001, worldwide flash memory supply exceeded customer demand,
causing excess supply in the markets for our products and significant declines
in average selling prices. If this situation continues in 2002, price declines
for our products could continue to be significant. If we cannot reduce our
product manufacturing costs to offset these reduced prices, our gross margins
and net profitability will be adversely impacted.
Our business depends significantly upon consumer products
In 2001, we continued to receive more product revenue and ship more units
of products for consumer electronics applications, including digital cameras and
PDAs, compared to other applications. In the fourth quarter of 2001, we shipped
a record number of units to the consumer market. The consumer market is
intensely competitive and is more price sensitive than our other target markets.
In addition, we must spend more on marketing and promotion in consumer markets
to establish brand name recognition and drive demand.
A significant portion of our sales to the consumer electronics market are
made to retailers and through distributors. Sales through these channels
typically include rights to return unsold inventory. As a result, we do not
recognize revenue until after the product has been sold through to the end user.
If our distributors and retailers are not successful in this market, there could
be substantial product returns, which would harm our business, financial
condition and results of operations.
There is seasonality in our business
Sales of our products in the consumer electronics market may be subject to
seasonality. As a result, product sales may be impacted by seasonal purchasing
patterns with higher sales generally occurring in the fourth quarter of each
year followed by declines in the first quarter of the following year. In
addition, in the past we have experienced a decrease in orders in the first
quarter from our Japanese OEM customers primarily because most customers in
36
Japan operate on a fiscal year ending in March and prefer to delay purchases
until the beginning of their next fiscal year.
In transitioning to new processes and products, we face production and
market acceptance risks
General. Successive generations of our products have incorporated
semiconductor devices with greater memory capacity per chip. Two important
factors have enabled us to decrease the cost per megabyte of our flash data
storage products: the development of higher capacity semiconductor devices and
the implementation of smaller geometry manufacturing processes. A number of
challenges exist in achieving a lower cost per megabyte, including:
. lower yields often experienced in the early production of new
semiconductor devices;
. manufacturing flaws with new processes including manufacturing
processes at our subcontractors which may be extremely complex;
. problems with design and manufacturing of products that will
incorporate these devices, which &may result in delays or product
recalls; and
. production delays.
Because our products are complex, we periodically experience significant
delays in the development and volume production ramp up of our products. Similar
delays could occur in the future and could harm our business, financial
condition and results of operations.
NAND MLC flash technology. We have developed new products based on NAND MLC
(Multi Level Cell) flash technology, a flash architecture designed to store two
bits in each flash memory cell. High density flash memory, such as NAND MLC
flash, is a complex technology that requires strict manufacturing controls and
effective test screens. Problems encountered in the shift to volume production
for new flash products could impact both reliability and yields, and result in
increased manufacturing costs and reduced product availability. NAND MLC
technology is highly complex and has not previously been successfully
commercialized. We may not be able to manufacture future generations of NAND MLC
products with yields sufficient to result in lower costs per megabyte. If we are
unable to bring future generations of high density flash memory into full
production as quickly as planned or if we experience unplanned yield or
reliability problems, our revenues and gross margins will decline.
Secure Digital card products. SanDisk, along with Matsushita and Toshiba,
jointly developed and jointly promote the Secure Digital card. The Secure
Digital card incorporates advanced security and copyright protection features
required by the emerging markets for the electronic distribution of music, video
and other copyrighted works. Although the Secure Digital card is designed
specifically to address the copy protection rights of the content providers,
there can be no assurance that these content providers will find these measures
sufficient or will agree to support them. Furthermore, despite numerous design
wins, the Secure Digital card standard has been slow to develop as a major new
standard and we cannot assure you that consumers will widely adopt the Secure
Digital card. Conversely, broad acceptance of our Secure Digital card by
consumers will likely reduce demand for our MultiMediaCard and CompactFlash card
products. During 2001, we experienced a substantial decline in sales of
MultiMediaCards which was not matched by a corresponding increase in sales of
Secure Digital cards. See "--The success of our business depends on emerging
markets and new products."
Memory Stick products. In September 2001, we signed an agreement with Sony
involving their Memory Stick card format. Under the agreement, Sony will supply
us a portion of their Memory Stick output for us to resell under our brand name.
Sony has also agreed to purchase a portion of their NAND memory chip
requirements from us provided that we meet market competitive pricing for these
components. In addition, we and Sony agreed to co-develop and co-own the
specifications for the next generation Memory Stick. Each of us will have all
rights to manufacture and sell this new generation Memory Stick. We cannot
assure you that this new business will generate substantial revenues or gross
margin contributions for us. Consumers may prefer to purchase the Sony brand
Memory Stick over our SanDisk brand Memory Stick. Furthermore, the second
generation Memory Stick is still in the early stages of development and is not
expected to generate significant sales before 2003. We cannot assure you that
the second generation Memory Stick will achieve commercial success in the
marketplace when it is introduced.
37
We are transitioning our technology to NAND-based products. The transition
to NAND-based products is very complex, and requires good execution from our
manufacturing, technology, quality, marketing, and sales and customer support
staffs. If the current soft market conditions continue throughout 2002 and
beyond, or if we are unable for any reason to achieve customer acceptance of our
card products built with these NAND flash chips, we will experience a
significant increase in our inventory, as we are contractually obligated, and
expect to continue to be obligated after the restructuring of our FlashVision
business, to purchase half of FlashVision's NAND wafer production output. This
may result in inventory write offs and have a material adverse effect on our
business, results of operations and financial condition.
In the third quarter of 2001, we began to purchase controller wafers from
UMC and are continuing development of advanced flash memory technology utilizing
the 0.15 micron technology design rules at UMC.
We depend on third party foundries for silicon wafers
All of our flash memory card products require silicon wafers, the majority
of which are currently supplied by Toshiba's wafer facility at Yokkaichi, Japan,
as well as UMC in Taiwan. After the restructuring of our FlashVision business,
all of our NAND flash memory wafers will be supplied by Toshiba's Yokkaichi
wafer facilities. If Toshiba, FlashVision and UMC are uncompetitive or are
unable to satisfy these requirements, our business, financial condition and
operating results may suffer. Any disruption in supply from these sources due to
natural disaster, power failure, labor unrest or other causes could
significantly harm our business, financial condition and results of operations.
Under the terms of our wafer supply agreements with Toshiba, FlashVision
and UMC, we are obligated to provide a rolling forecast of anticipated purchase
orders for the next six calendar months. Generally, the estimates for the first
three months of each forecast are binding commitments. The estimates for the
remaining months may only be changed by a certain percentage from the previous
month's forecast. This limits our ability to react to fluctuations in demand for
our products. For example, if customer demand falls below our forecast and we
are unable to reschedule or cancel our wafer orders, we may end up with excess
wafer inventories, which could result in higher operating expenses and reduced
gross margins. Conversely, if customer demand exceeds our forecasts, we may be
unable to obtain an adequate supply of wafers to fill customer orders, which
could result in dissatisfied customers, lost sales and lower revenues. If we are
unable to obtain scheduled quantities of wafers with acceptable price and yields
from any foundry, our business, financial condition and results of operations
could be harmed.
Our investment in new flash memory wafer production may result in increased
expenses and fluctuations in operating results
FlashVision, L.L.C. On June 30, 2000, we closed a transaction with Toshiba
providing for the joint development and manufacture of 512 megabit and 1 gigabit
flash memory chips and Secure Digital card controllers. As a part of this
transaction, we and Toshiba formed and contributed initial funding to
FlashVision, a joint venture to equip and operate a silicon wafer manufacturing
line at Dominion Semiconductor in Virginia. In January 2001, we invested the
final $15.0 million of our $150.0 million cash commitment. As of December 31,
2001 we had guaranteed $129.5 million in equipment lease lines to equip
Toshiba's Dominion Semiconductor manufacturing clean room with advanced wafer
processing equipment. We are obligated to guarantee a total of up to $175.0
million in equipment lease lines.
In December 2001, we and Toshiba agreed to restructure our FlashVision
business and to transfer its operations to Toshiba's Yokkaichi fabrication
facility in Japan. Under the terms of the MOU, Toshiba will transfer the
FlashVision owned and leased NAND production tool-set from Dominion to Yokkaichi
and has agreed to bear substantially all of the costs associated with the
equipment transfers, which are expected to be completed in 2002. The transfer
and qualification of the advanced fabrication equipment from Dominion, Virginia
to Yokkaichi, Japan is a highly complex operation. It is quite possible that we
may encounter difficulties and delays. Although the additional costs associated
with potential delays will be borne by Toshiba, our results of operations may
suffer if this equipment transfer is not completed on-time and production does
not commence at Yokkaichi as planned, thereby reducing the total NAND production
capacity available to us.
38
We were using the new production capacity at Dominion to manufacture NAND
flash memory wafers with minimum lithographic feature size of 0.16 micron . Late
in 2002, we expect to start shifting a portion of our production output at
Yokkaichi to 0.13 micron NAND. Such minimum feature sizes are considered today
to be among the most advanced for mass production of silicon wafers. Therefore,
it is difficult to predict how long it will take to achieve adequate yields,
reliable operation, and economically attractive product costs based on our new
designs. Introduction of new feature sizes and technologies will be subject to
the same risks and uncertainties after the restructuring of our FlashVision
business. We currently rely and will continue to rely on Toshiba to address
these challenges. With our investments in the Dominion facility and in Toshiba's
Yokkaichi facility after the restructuring of our FlashVision business, we are
now and will continue to be exposed to the adverse financial impact of any
delays or manufacturing problems associated with wafer production lines. Any
problems or delays in volume production at the Yokkaichi fabrication facility
could adversely impact our operating results in 2002 and beyond.
We incurred substantial start up expenses related to the hiring and
training of manufacturing personnel, facilitizing the clean room and installing
equipment at the Dominion fabrication facility. Although as a part of our
agreement with Toshiba to restructure our FlashVision business we will recapture
substantially all of the Dominion start-up expenses. We will incur similar
start-up expenses in connection with the new Yokkaichi fabrication facility. In
addition, we may not achieve the expected cost benefits of this transition until
the second half of 2002, if at all. Until the transition of the Dominion
tool-set is completed, we will rely solely on the current Yokkaichi fabrication
facility for our NAND wafers. If we experience increased demand during this
transition period, we may not be able to procure a sufficient number of wafers
from Toshiba to meet this demand, which would harm our business and operating
results. Under our agreement with Toshiba, we are committed to purchase 50% of
the output from the Dominion fabrication facility prior to the FlashVision
restructuring and from the Yokkaichi fabrication facility after the
restructuring. Apart from our commitment to purchase our share of the
FlashVision wafer output from Yokkaichi after the restructuring, we will also
purchase NAND wafers from Toshiba's current Yokkaichi fabrication facility on a
foundry relationship basis. This foundry relationship will be conducted under a
firm purchase order commitment over rolling three-month periods. NAND wafers are
ordered under purchase orders at market prices and cannot be cancelled. If we
place purchase orders with Toshiba and our business condition deteriorates, we
may end up with excess inventories of NAND wafers, which could harm our business
and financial condition. We will incur start-up costs and pay our share of
ongoing operating activities even if we do not utilize our full share of the new
Yokkaichi output. Should customer demand for NAND flash products be less than
our available supply, we may suffer from reduced revenues and increased
expenses, and increased inventory of unsold NAND flash wafers, which could
adversely affect our operating results. In order for us to sell NAND based
CompactFlash, MultiMediaCards and Secure Digital cards, we have been developing
new controllers, printed circuit boards and test algorithms because the
architecture of NAND flash is significantly different from our prior NOR flash
designs. Any technical difficulties or delays in the development of these
elements could prevent us from taking advantage of the available NAND output and
could adversely affect our results of operations.
Tower Semiconductor. On July 4, 2000, we entered into a share purchase
agreement to make a $75.0 million investment in Tower Semiconductor, or Tower,
in Israel, representing approximately 10% ownership of Tower. The investment is
subject to the completion of certain milestones relative to the construction of
a new wafer fabrication facility by Tower. During 2001, Tower satisfied the
closing conditions of the share purchase agreement and completed the first two
milestones. Under the terms of the agreement, we invested $42.5 million to
purchase 1,599,931 ordinary shares and obtain wafer credits of $21.4 million. In
September 2001, we agreed to convert 75% of our wafer credits to equity at a
price of $12.75 per share and received an additional 1,284,007 ordinary shares.
We expect first wafer production to commence at the new fabrication facility in
late 2002. Due to the continued weakness in the semiconductor industry, the
value of our Tower investment and remaining wafer credits had declined to $16.6
million on December 31, 2001. It was determined that this decline was other than
temporary, as defined by generally accepted accounting principles and a loss of
$20.6 million was recorded in the second half of 2001. In addition, we
recognized a loss of $5.5 million on our exchange of 75% of our Tower wafer
credits for ordinary shares. These losses totaling $26.1 million, or $15.8
million net of tax benefit, were recorded in loss on investment in foundry in
2001. In March of 2002, we modified our share purchase agreement with Tower by
agreeing to advance the payments for the third and fourth milestones to April 5,
2002 and October 1, 2002, respectively. We will make these payments whether or
not Tower actually achieves its previously agreed upon milestone obligations. In
exchange for this and as part of the modification to the share purchase
agreement, Tower has agreed that of the aggregate payment of $22.0 million
represented by the third and fourth milestone payments, (i) 60% of this amount,
or $13.2 million, will be applied to the issuance of additional ordinary Tower
shares based on the average closing price of Tower shares on the NASDAQ in the
thirty consecutive trading days preceding each payment date (but not to exceed
$12.50 per share) and (ii) 40% of this amount, or $8.8 million, will be credited
to our pre-paid wafer account, to be applied against orders placed with Tower's
new fabrication facility, when completed.
Tower's completion of the wafer foundry facility is dependent on its
ability to obtain additional financing for the foundry construction from equity
and other sources and the release of grants and approvals for changes in grant
programs from the Israel government's Investment Center. If Tower is unable to
obtain additional financing, complete foundry construction in a timely manner or
is unable to successfully complete the development and transfer
39
of advanced CMOS process technologies and ramp-up of production, the value of
our investment in Tower will decline significantly or possibly become worthless
and we may be unable to obtain the wafers needed to manufacture our products,
which would harm our results of operations. In addition, the value of our
investment in Tower may be adversely affected by a further deterioration of
conditions in the market for foundry manufacturing services and the market for
semiconductor products generally. If the fair value of the Tower investment
declines further, we may record additional losses.
The success of our business depends on emerging markets and new products
In order for demand for our products to grow, the markets for new products
that use CompactFlash, the MultiMediaCard, and Secure Digital card such as
digital cameras, portable digital music players and cellular phones must develop
and grow. If sales of these products do not grow, our revenues and profit
margins could be adversely impacted.
In 2001, we experienced a substantial drop in demand from our
MultiMediaCard customers, which we believe is attributable to the switch by
these customers to the Secure Digital card, as well as the generally soft market
conditions.
The success of our new product strategy will depend upon, among other
things, the following:
. our ability to successfully develop new products with higher memory
capacities and enhanced features at a lower cost per megabyte;
. the development of new applications or markets for our flash data
storage products;
. the adoption by the major content providers of the copy protection
features offered by our Secure Digital card products;
. the extent to which prospective customers design our products into
their products and successfully introduce their products; and
. the extent to which our products or technologies become obsolete or
noncompetitive due to products or technologies developed by others.
512 megabit and 1 gigabit flash memory card products. On June 30, 2000, we
closed a transaction with Toshiba providing for the joint development of 512
megabit and 1 gigabit flash memory chips and the manufacture of Secure Digital
card controllers. As part of this venture, we and Toshiba plan to employ
Toshiba's 0.16 micron and future 0.13 micron NAND flash integrated circuit
manufacturing technology and SanDisk's multilevel cell flash and controller
system technology. During the third quarter of 2000, we announced with Toshiba
the completion of the joint development of the 512 megabit NAND flash chip
employing Toshiba's 0.16 micron manufacturing process technology. We began
employing the 512 megabit technology in the second half of 2001, and expect to
commence shipments of cards employing the 1 gigabit technology in the first half
of 2002. The development of the next generation .13 micron, 1 gigabit and 2
gigabit NAND flash memory chips is highly complex. We cannot assure you that we
and Toshiba will successfully develop and bring into full production with
acceptable yields and reliability these new products or the underlying
technology, or that any development or production ramp will be completed in a
timely or cost-effective manner. If we are not successful in any of the above,
or if our cost structure is not competitive, our business, financial condition
and results of operations could suffer.
We may be unable to maintain market share
During periods of excess supply in the market for our flash memory
products, such as we experienced in 2001 and continue to experience, we may lose
market share to competitors who aggressively lower their prices. Conversely,
under conditions of tight flash memory supply, we may be unable to increase our
production volumes at a sufficiently rapid rate so as to maintain our market
share. Ultimately, our growth rate depends on our ability to obtain sufficient
flash memory wafers and other components to meet demand. If we are unable to do
so in a timely manner, we may lose market share to our competitors. Currently,
we are experiencing severe price competition for our products which is adversely
impacting our product gross margins and overall profitability.
40
Our international operations make us vulnerable to changing conditions and
currency fluctuations
Political risks. Currently, the majority of our flash memory and controller
wafers are produced by Toshiba in Japan and UMC in Taiwan. After the
restructuring of our FlashVision business, all of our flash memory and
controller wafers will be produced overseas by Toshiba and UMC. We also use
third-party subcontractors in Taiwan and China for the assembly and testing of
some of our card and component products. We may therefore be affected by the
political, economic and military conditions in Taiwan. Taiwan is currently
engaged in various political disputes with China and in the past both countries
have conducted military exercises in or near the other's territorial waters and
airspace. The Taiwanese and Chinese governments may escalate these disputes,
resulting in an economic embargo, a disruption in shipping routes or even
military hostilities. This could harm our business by interrupting or delaying
the production or shipment of flash memory wafers or card products by our
Taiwanese foundry and subcontractors. See "--We depend on our suppliers and
third party subcontractors."
We use a third-party subcontractor in China for the assembly and testing of
our CompactFlash products. As a result, our business could be harmed by the
effect of political, economic, legal and other uncertainties in China. Under its
current leadership, the Chinese government has been pursuing economic reform
policies, including the encouragement of foreign trade and investment and
greater economic decentralization. The Chinese government may not continue to
pursue these policies and, even if it does continue, these policies may not be
successful. The Chinese government may also significantly alter these policies
from time to time. In addition, China does not currently have a comprehensive
and highly developed legal system, particularly with respect to the protection
of intellectual property rights. As a result, enforcement of existing and future
laws and contracts is uncertain, and the implementation and interpretation of
such laws may be inconsistent. Such inconsistency could lead to piracy and
degradation of our intellectual property protection.
Although we do not believe the current political unrest and escalation of
violence in Israel represent a major security problem for Tower since Migdal
Haemek, Israel is in a relatively secure geographic location, the unrest may
expand and even if it remains at current levels, could cause scheduling delays,
as well as economic uncertainty, which could cause potential foundry customers
to go elsewhere for their foundry business. Moreover, if U.S. military actions
in Afghanistan, or elsewhere, result in retaliation against Israel, Tower's
fabrication facility and our engineering design center in Israel may be
adversely impacted. We cannot assure you that the Tower facility will be
completed or will begin production as scheduled, or that the processes needed to
fabricate our wafers will be qualified at the new facility. Moreover, we cannot
assure you that this new facility will be able to achieve acceptable yields or
deliver sufficient quantities of wafers on a timely basis at a competitive
price. Furthermore, if the current depressed business conditions for
semiconductor wafers persists in 2002 and beyond, Tower may be unable to operate
their new fabrication facility at an optimum capacity utilization, which would
cause them to operate at a loss. In addition, while the political unrest has not
yet posed a direct security risk to our engineering design center in Israel, it
may cause unforeseen delays in the development of our products and may in the
future pose such a direct security risk.
Economic risks. We price our products primarily in U.S. Dollars. Given the
recent economic conditions in Asia and the European Union and the weakness of
the Euro, Yen and other currencies relative to the U.S. Dollar, our products may
be relatively more expensive in these regions, which could result in a decrease
in our sales. While most of our sales are denominated in U.S. Dollars, we
invoice certain Japanese customers in Japanese Yen and are subject to exchange
rate fluctuations on these transactions, which could harm our business,
financial condition and results of operations.
General risks. Our international business activities could also be limited
or disrupted by any of the following factors:
. the need to comply with foreign government regulation;
. general geopolitical risks such as political and economic instability,
potential hostilities and changes in diplomatic and trade
relationships;
. natural disasters affecting the countries in which we conduct our
business, particularly Japan, such as the earthquakes experienced in
Taiwan in 1999 and in Japan and China in previous years;
41
. imposition of regulatory requirements, tariffs, import and export
restrictions and other barriers and restrictions;
. longer payment cycles and greater difficulty in accounts receivable
collection, particularly as we increase our sales through the retail
distribution channel, and general business conditions deteriorate;
. adverse tax rules and regulations;
. weak protection of our intellectual property rights; and
. delays in product shipments due to local customs restrictions.
We depend on our suppliers and third-party subcontractors
We rely on our vendors, some of which are sole source suppliers, for
several of our critical components. We do not have long-term supply agreements
with some of these vendors. Our business, financial condition and operating
results could be significantly harmed by delays or reductions in shipments if we
are unable to develop alternative sources or obtain sufficient quantities of
these components. For example, after the restructuring of our FlashVision
business, we will rely on Toshiba's Yokkaichi fabrication facility for all of
our flash memory wafers. Any disruption in the supply of wafers from the
Yokkaichi fabrication facility would severely adversely impact our business.
Until the transition of the Dominion tool-set is completed, we will rely solely
on the current Yokkaichi fabrication facility for our NAND wafers. If we
experience increased demand during this transition period, we may not be able to
procure a sufficient number of wafers from Toshiba to meet this demand, which
would harm our business and operating results.
We also rely on third-party subcontractors for a substantial portion of
wafer testing, packaged memory final testing, card assembly and card testing,
including Silicon Precision Industries Co., Ltd. in Taiwan and Celestica, Inc.
in China. These subcontractors will also be assembling and testing a majority of
our mature, high-volume products. In the fourth quarter of 2001, we completed
the transfer of all of our card assembly and test manufacturing operations from
our Sunnyvale location to these offshore subcontractors. We have no long-term
contracts with these subcontractors and cannot directly control product delivery
schedules. Any significant problems that occur at our subcontractors, or their
failure to perform at the level we expect could lead to product shortages or
quality assurance problems, which could increase the manufacturing costs of our
products and have adverse effects on our operating results. Furthermore, we are
moving to turnkey manufacturing with some of our subcontract suppliers, which
may reduce our visibility and control of their inventories of purchased parts
necessary to build our products.
Our markets are highly competitive
Flash memory manufacturers and memory card assemblers. We compete in an
industry characterized by intense competition, rapid technological changes,
evolving industry standards, declining average selling prices and rapid product
obsolescence. Our competitors include many large domestic and international
companies that have greater access to advanced wafer foundry capacity,
substantially greater financial, technical, marketing and other resources,
broader product lines and longer standing relationships with customers.
Our primary competitors include companies that develop and manufacture
storage flash chips, such as Hitachi, Samsung, Micron Technology and Toshiba. In
addition, we compete with companies that manufacture other forms of flash memory
and companies that purchase flash memory components and assemble memory cards.
Companies that manufacture socket flash, linear flash and components include
Advanced Micro Devices, Atmel, Fujitsu, Intel, Macronix, Mitsubishi, Sharp
Electronics and ST Microelectronics. Companies that combine controllers and
flash memory chips developed by others into flash storage cards include
Dane-Elec Manufacturing, Delkin Devices, Inc., Feiya Technology Corporation,
Fuji, Hagiwara, I/O Data, Ingentix, Kingston Technology, Lexar Media, M-Systems,
Matsushita Battery, Matsushita Panasonic, Memorex, PNY, Pretec, Silicon Storage
Technology, Silicon Tek, Simple Technology, Sony Corporation, TDK Corporation,
Toshiba and Viking Components.
42
In addition, many companies have been certified by the CompactFlash
Association to manufacture and sell their own brand of CompactFlash. We believe
additional manufacturers will enter the CompactFlash market in the future.
We have entered into an agreement with Matsushita and Toshiba, forming the
Secure Digital Association, or SD Association, to jointly develop and promote a
next generation flash memory card called the Secure Digital card. Under this
agreement, royalty-bearing Secure Digital card licenses will be available to
other flash memory card manufacturers, which will increase the competition for
our Secure Digital card and other products. In addition, Matsushita and Toshiba
have commenced selling Secure Digital cards that will compete directly with our
products. While other flash card manufacturers will be required to pay the SD
Association license fees and royalties, which will be shared among Matsushita,
Toshiba and us, there will be no royalties or license fees payable among the
three companies for their respective sales of the Secure Digital card. Thus, we
will forfeit potential royalty income from Secure Digital card sales by
Matsushita and Toshiba.
In addition, we and Toshiba will each separately market and sell any 512
megabit and 1 gigabit flash memory chips developed and manufactured by our joint
venture, FlashVision. Accordingly, we will compete directly with Toshiba for
sales of these advanced chips.
We have entered into patent cross-license agreements with several of our
leading competitors including Hitachi, Intel, Lexar, Matsushita, SST, Samsung,
Sharp, Sony, Toshiba and TDK. Under these agreements, each party may manufacture
and sell products that incorporate technology covered by the other party's
patent or patents related to flash memory devices. As we continue to license our
patents to certain of our competitors, competition will increase and may harm
our business, financial condition and results of operations. Currently, we are
engaged in licensing discussions with several of our competitors. There can be
no assurance that we will be successful in concluding licensing agreements under
terms which are favorable to us, or at all.
Alternative storage media. Competing products have been introduced that
promote industry standards that are different from our products including Sony's
standard floppy disk used for digital storage in its Mavica digital cameras,
Panasonic's Mega Storage cards, Iomega's Clik drive, a miniaturized, mechanical,
removable disk drive, M-Systems' DiskOnKey, a USB-based memory device, and the
Secure MultiMediaCard from Hitachi and Infineon. Each competing standard may not
be mechanically and electronically compatible with our products. If a
manufacturer of digital cameras or other consumer electronic devices designs in
one of these alternative competing standards, our products will be eliminated
from use in that product. In addition, other companies, such as Sanyo, DataPlay
and Matrix Semiconductor have announced products or technologies that may
potentially compete with our products.
IBM's Microdrive, a rotating disk drive in a Type II CompactFlash format
competes directly with our larger capacity memory cards. M-Systems' DiskOnChip
2000 Millennium product competes against our NAND Flash Components in embedded
storage applications such as set top boxes and networking appliances.
Sony has licensed its proprietary Memory Stick to us and other companies
and Sony has agreed to supply us a portion of their Memory Stick output for
resale under our brand name. If consumer electronics products using the Memory
Stick achieve widespread use, sales of our MultiMediaCard, Secure Digital card,
SmartMedia card and CompactFlash products may decline. Our MultiMediaCard
products also have faced significant competition from Toshiba's SmartMedia flash
cards.
Alternative flash technologies. We also face competition from products
based on multilevel cell flash technology from Intel and Hitachi. These products
currently compete with our NAND MLC products. Multilevel cell flash is a
technological innovation that allows each flash memory cell to store two bits of
information instead of the traditional single bit stored by conventional flash
technology.
Furthermore, we expect to face competition both from existing competitors
and from other companies that may enter our existing or future markets that have
similar or alternative data storage solutions, which may be less costly or
provide additional features. For example, Infineon has formed a joint venture
with Saifun, an Israeli startup company, to develop a proprietary flash memory
technology which will be targeted at low cost data storage applications. Price
is an important competitive factor in the market for consumer products.
Increased price
43
competition could lower gross margins if our average selling prices decrease
faster than our costs and could also result in lost sales.
Sales to a small number of customers represent a significant portion of our
revenues.
Approximately one-half of our revenues come from a small number of
customers. For example, sales to our top 10 customers accounted for
approximately 49%, 48%, and 57%, respectively, of our product revenues for 2001,
2000, and 1999. In 2001 and 2000, no single customer accounted for greater than
10% of our total revenues. In 1999, revenues from one customer exceeded 10% of
our total revenues. If we were to lose one of our major customers or experience
any material reduction in orders from any of these customers, our revenues and
operating results would suffer. Our sales are generally made by standard
purchase orders rather than long-term contracts. In addition, the composition of
our major customer base changes from year to year as the market demand for our
customers' products changes.
Our multiple sales channels may compete for a limited number of customer
sales
Web-based sales of our products today represent a small but growing portion
of our overall sales. Sales on the Internet tend to undercut traditional
distribution channels and may dramatically change the way our consumer products
are purchased in future years. We cannot assure you that we will successfully
develop the Internet sales channel or successfully manage the inherent conflict
between the Internet and our traditional sales channels.
We must achieve acceptable wafer manufacturing yields
The fabrication of our products requires wafers to be produced in a highly
controlled and ultra clean environment. Semiconductor companies that supply our
wafers sometimes have experienced problems achieving acceptable wafer
manufacturing yields. Semiconductor manufacturing yields are a function of both
our design technology and the foundry's manufacturing process technology. Low
yields may result from design errors or manufacturing failures. Yield problems
may not be determined or improved until an actual product is made and can be
tested. As a result, yield problems may not be identified until the wafers are
well into the production process. The risks associated with yields are even
greater because we rely exclusively on independent offshore foundries for our
wafers which increases the effort and time required to identify, communicate and
resolve manufacturing yield problems. If the foundries cannot achieve planned
yields, we will experience higher costs and reduced product availability, which
could harm our business, financial condition and results of operations.
In addition, we cannot assure you that the Yokkaichi fabrication facilities
will produce satisfactory quantities of wafers with acceptable prices,
reliability and yields. Any failure in this regard could materially harm our
business, financial condition and results of operations. During the transition
from the Dominion fabrication facility to the new Yokkaichi fabrication
facility, when we will be solely reliant on the current Yokkaichi fabrication
facility for our NAND wafers, any such failure will be particularly harmful to
us as we will not have an alternate source of supply. In addition, we have no
experience in operating a wafer manufacturing line and we intend to rely on the
existing manufacturing organizations at the Yokkaichi fabrication facilities.
The new Yokkaichi fabrication facility will be tasked to "copy exactly" the same
manufacturing flow employed by Toshiba in its existing Yokkaichi fabrication
facility but we cannot assure you that they will be successful in manufacturing
these advanced NAND flash products on a cost-effective basis or at all.
Risks associated with patents, proprietary rights and related litigation
General. We rely on a combination of patents, trademarks, copyright and
trade secret laws, confidentiality procedures and licensing arrangements to
protect our intellectual property rights. In the past, we have been involved in
significant disputes regarding our intellectual property rights and claims that
we may be infringing third parties' intellectual property rights. We expect that
we may be involved in similar disputes in the future. We cannot assure you that:
. any of our existing patents will not be invalidated;
. patents will be issued for any of our pending applications;
44
. any claims allowed from existing or pending patents will have
sufficient scope or strength;
. our patents will be issued in the primary countries where our products
are sold in order to protect our rights and potential commercial
advantage; or
. any of our products do not infringe on the patents of other companies.
In addition, our competitors may be able to design their products around
our patents.
We intend to vigorously enforce our patents but we cannot be sure that our
efforts will be successful. If we were to have an adverse result in any
litigation, we could be required to pay substantial damages, cease the
manufacture, use and sale of infringing products, expend significant resources
to develop non-infringing technology, discontinue the use of certain processes
or obtain licenses to the infringing technology. Any litigation is likely to
result in significant expense to us, as well as divert the efforts of our
technical and management personnel.
Cross-licenses and indemnification obligations. If we decide to incorporate
third party technology into our products or if we are found to infringe on
others' intellectual property, we could be required to license intellectual
property from a third party. We may also need to license some of our
intellectual property to others in order to enable us to obtain cross-licenses
to third party patents. Currently, we have patent cross-license agreements with
several companies, including Hitachi, Intel, Lexar, Matsushita, SST, Samsung,
Sharp, Smartdisk, Sony, TDK and Toshiba and we are in discussions with other
companies regarding potential cross-license agreements. We cannot be certain
that licenses will be offered when we need them, or that the terms offered will
be acceptable. If we do obtain licenses from third parties, we may be required
to pay license fees or royalty payments. In addition, if we are unable to obtain
a license that is necessary to the manufacture of our products, we could be
required to suspend the manufacture of products or stop our wafer suppliers from
using processes that may infringe the rights of third parties. We cannot assure
you that we would be successful in redesigning our products or that the
necessary licenses will be available under reasonable terms, or that our
existing licensees will renew their licenses upon expiration, or that we will be
successful in signing new licensees in the future.
We have historically agreed to indemnify various 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
attorney's fees. We may periodically engage in litigation as a result of these
indemnification obligations. We are not currently engaged in any such
indemnification proceedings. Our insurance policies exclude coverage for third
party claims for patent infringement. Any future obligation to indemnify our
customers or suppliers could harm our business, financial condition or results
of operations.
Litigation risks associated with our intellectual property. Litigation is
subject to inherent risks and uncertainties that may cause actual results to
differ materially from our expectations. Factors that could cause litigation
results to differ include, but are not limited to, the discovery of previously
unknown facts, changes in the law or in the interpretation of laws, and
uncertainties associated with the judicial decision-making process. Furthermore,
parties that we have sued and that we may sue for patent infringement may
countersue us for infringing their patents.
On or about August 3, 2001, the Lemelson Medical, Education & Research
Foundation, or Lemelson Foundation, filed a complaint for patent infringement
against us and four other defendants. The suit, captioned Lemelson Medical,
Education, & Research Foundation, Limited Partnership vs. Broadcom Corporation,
et al., Civil Case No. CIV01 1440PHX HRH, was filed in the United States
District Court, District of Arizona. On November 13, 2001, the Lemelson
Foundation filed an Amended Complaint, which made the same substantive
allegations against us but named more than twenty-five additional defendants.
The Amended Complaint alleges that we, and the other defendants, have infringed
certain patents held by the Lemelson Foundation pertaining to bar code scanning
technology. By its complaint, the Lemelson Foundation requests that we be
enjoined from our allegedly infringing activities and seeks unspecified damages.
On February 4, 2002, we filed an answer to the amended complaint, wherein we
alleged that we do not infringe the asserted patents, and further contend that
the patents are not valid or enforceable.
On October 15, 2001, we filed a complaint for patent infringement in the
United States District Court for the Northern District of California against
Micron Technology, Inc., or Micron. In the suit, captioned SanDisk Corp.
45
v. Micron Technology, Inc., Civil No. CV 01-3855 CW, the complaint seeks damages
and an injunction against Micron for making, selling, importing or using flash
memory cards that infringe our U.S. Patent No. 6,149,316. On February 15, 2002,
Micron answered the complaint, denied liability, and counterclaimed seeking a
declaration that the patent in suit is not infringed, is invalid, and is
unenforceable.
On October 31, 2001, we filed a complaint for patent infringement in the
United States District Court for the Northern District of California against
Memorex Products, Inc., Pretec Electronics Corporation, Ritek Corporation and
Power Quotient International Co., Ltd. In the suit, captioned SanDisk Corp. v.
Memorex Products, Inc., et. al., Civil No. CV 01-4063 VRW, we seek damages and
injunctions against these companies from making, selling, importing or using
flash memory cards that infringe our U.S. patent No. 5,602,987 or the `987
Patent. Defendants Memorex, Pretec and Ritek have filed answers denying the
allegations. We filed a motion for a preliminary injunction in the suit to
enjoin Memorex, Pretec and Ritek from making, selling, importing or using flash
memory cards that infringe our `987 Patent prior to the trial on the merits.
This preliminary injunction motion is scheduled for hearing on April 11, 2002.
On November 30, 2001, we filed a complaint for patent infringement in the
United States District Court for the Northern District of California against
Power Quotient International - USA Inc, or PQI-USA. In the suit, captioned
SanDisk Corp. v. Power Quotient International - USA Inc., Civil No. C 01-21111,
we seek damages and an injunction against PQI-USA from making, selling,
importing or using flash memory cards that infringe our U.S. patent No.
5,602,987. The PQI-USA complaint and litigation are related to the October 31,
2001 litigation referred to above. The products at issue in the PQI-USA case are
identical to those charged with infringement in the October 31, 2001 litigation.
On December 21, 2001, PQI-USA filed an answer to the complaint denying the
allegations, which included a counter claim for a declaratory judgment of
non-infringement and invalidity of our `987 Patent. We have motioned for a
preliminary injunction in the suit to enjoin PQI-USA from making, selling,
importing or using flash memory cards that infringe our `987 Patent prior to the
trial on the merits. This preliminary injunction motion is scheduled for hearing
on April 8, 2002.
On or about March 5, 2002, Samsung Electronics Co., Ltd., or Samsung, filed
a patent infringement lawsuit against us in the United States District Court for
the Eastern District of Texas. The lawsuit alleges that we infringe four Samsung
United States patents, Nos. 5,473,563; 5,514,889; 5,546,341 and 5,642,309, and
seeks a preliminary and permanent injunction against unnamed products of ours,
as well as damages, attorneys' fees and cost of the lawsuit.
Rapid growth may strain our operations
Despite actions we took in 2001 to align expense levels with decreased
revenues, we must continue to hire, train, motivate and manage our employees to
accommodate future growth. In the past, we have experienced difficulty hiring
the necessary engineering, sales and marketing personnel to support our growth.
In addition, we must make a significant investment in our existing internal
information management systems to support increased manufacturing, as well as
accounting and other management related functions. Our systems, procedures and
controls may not be adequate to support rapid growth, which could in turn harm
our business, financial condition and results of operations.
Terrorist attacks and threats, and government responses thereto, may
negatively impact all aspects of our operations, revenues, costs and stock price
The recent terrorist attacks in the United States, the U.S. retaliation for
these attacks and the related decline in consumer confidence and continued
economic weakness have had a substantial adverse impact on our retail sales. If
consumer confidence does not recover, our revenues and results of operations may
be adversely impacted in the first quarter of 2002 and beyond.
In addition, any similar future events may disrupt our operations or those
of our customers and suppliers and may affect the availability of materials
needed to manufacture our products or the means to transport those materials to
manufacturing facilities and finished products to customers. In addition, these
events have had and may continue to have an adverse impact on the U.S. and world
economy in general and consumer confidence and spending in particular, which
could harm our sales. Any of these events could increase volatility in the U.S.
and world financial
46
markets which could harm our stock price and may limit the capital resources
available to us and our customers or suppliers. This could have a significant
impact on our operating results, revenues and costs and may result in increased
volatility in the market price of our common stock.
Our success depends on key personnel, including our executive officers, the
loss of whom could disrupt our business
Our success greatly depends on the continued contributions of our senior
management and other key research and development, sales, marketing and
operations personnel, including Dr. Eli Harari, our founder, President and Chief
Executive Officer. Our success will also depend on our ability to recruit
additional highly skilled personnel. We cannot assure you that we will be
successful in hiring or retaining such key personnel, or that any of our key
personnel will remain employed with us.
Anti-takeover provisions in our charter documents, stockholder rights plan
and in Delaware law could prevent or delay a change in control and, as a result,
negatively impact our stockholders
We have taken a number of actions that could have the effect of
discouraging a takeover attempt. For example, we have adopted a stockholder
rights plan that would cause substantial dilution to a stockholder, and
substantially increase the cost paid by a stockholder, who attempts to acquire
us on terms not approved by our board of directors. This could prevent us from
being acquired. In addition, our certificate of incorporation grants the board
of directors the authority to fix the rights, preferences and privileges of and
issue up to 4,000,000 shares of preferred stock without stockholder action.
Although we have no present intention to issue shares of preferred stock, such
an issuance could have the effect of making it more difficult and less
attractive for a third party to acquire a majority of our outstanding voting
stock. Preferred stock may also have other rights, including economic rights
senior to our common stock that could have a material adverse effect on the
market value of our common stock. In addition, we are subject to the
anti-takeover provisions of Section 203 of the Delaware General Corporation Law.
This section provides that except in certain limited circumstances a corporation
shall not engage in any business combination with any interested stockholder
during the three-year period following the time that such stockholder becomes an
interested stockholder. This provision could have the effect of delaying or
preventing a change of control of SanDisk.
Our stock price has been, and may continue to be, volatile
The market price of our stock has fluctuated significantly in the past and
is likely to continue to fluctuate in the future. For example, in the 12 months
ending December 31, 2001, our stock price fluctuated significantly from a low of
$8.61 to a high of $48.69. We believe that such fluctuations will continue as a
result of future announcements concerning us, our competitors or principal
customers regarding technological innovations, new product introductions,
governmental regulations, litigation or changes in earnings estimates by
analysts. In addition, in recent years the stock market has experienced
significant price and volume fluctuations and the market prices of the
securities of high technology and semiconductor companies have been especially
volatile, often for reasons outside the control of the particular companies.
These fluctuations as well as general economic, political and market conditions
may have an adverse affect on the market price of our common stock.
Our Digital Portal Inc., or DPI, joint venture has an unproven product and
an untested market
DPI has experienced delays in its U.S. market rollout of its photo printing
kiosks, due primarily to modifications to improve the kiosk's operation as a
standalone, reliable, user-friendly photo printing device. We cannot assure you
that these kiosks, if and when they are introduced will function reliably as
intended, or that they will receive favorable acceptance from consumers in a
reasonable period of time. If DPI is unsuccessful, our financial results may be
harmed.
We have substantially increased our indebtedness.
On December 24, 2001, we completed a private placement of $125.0 million of
4 1/2% Convertible Subordinated Notes due 2006, or Notes, and on January 10,
2002, we sold an additional $25.0 million of the Notes pursuant to the exercise
by the initial purchasers of their option. As a result, we incurred $150.0
million aggregate
47
principal amount of additional indebtedness, substantially increasing our ratio
of debt to total capitalization. While the notes are outstanding, we will have
debt service obligations on the notes of approximately $6.8 million per year in
interest payments. If we are unable to generate sufficient cash to meet these
obligations and must instead use our existing cash or investments, we may have
to reduce, curtail or terminate other activities of our business.
We intend to fulfill our debt service obligations from cash generated by
our operations, if any, and from our existing cash and investments. If
necessary, among other alternatives, we may add lease lines of credit to finance
capital expenditures and obtain other long-term debt and lines of credit. We may
incur substantial additional indebtedness in the future. The level of our
indebtedness, among other things, could:
. require the dedication of a substantial portion of any cash flow from
our operations to service our indebtedness, thereby reducing the amount
of cash flow available for other purposes, including working capital,
capital expenditures and general corporate purposes;
. make it difficult for us to obtain any necessary future financing for
working capital, capital expenditures, debt service requirements or
other purposes;
. cause us to use a significant portion of our cash and cash equivalents
or possibly liquidate other assets to repay the total principal amount
due under the Notes and our other indebtedness if we were to default
under the Notes or our other indebtedness;
. limit our flexibility in planning for, or reacting to changes in, our
business and the industries in which we complete;
. place us at a possible competitive disadvantage with respect to less
leveraged competitors and competitors that have better access to
capital resources; and
. make us more vulnerable in the event of a further downturn in our
business.
There can be no assurance that we will be able to meet our debt service
obligations, including our obligations under the Notes.
In 2000, we entered into a joint venture agreement with Toshiba, under
which we formed FlashVision. We agreed to guarantee one-half of all FlashVision
lease amounts up to a maximum guarantee of $175.0 million. As of December 31,
2001, we had guarantee obligations in the amount of $129.5 million in favor of
ABN AMRO Bank N.V., as agent for a syndicate of financial institutions on the
equipment lease lines to equip FlashVision. This guarantee constitutes senior
indebtedness under the Notes. In March 2002, FlashVision notified ABN AMRO that
it was exercising its right of early termination under the lease facility and
will repay all amounts outstanding thereunder in April 2002. We and Toshiba are
currently seeking other sources of financing to replace the ABN AMRO lease
facility.
However, under the terms of the FlashVision lease agreements, we as guarantor
remain at this time subject to certain financial covenants. We obtained a
compliance waiver for the third quarter of 2001 and negotiated an amendment to
the lease agreement which includes a modification of the covenant requirements
and required us to pledge cash and equity securities up to the full value of the
outstanding guaranteed lease commitments beginning in the fourth quarter of
2001. As of December 31, 2001, we had guaranteed $129.5 million of FlashVision's
lease commitments and pledged $64.7 million of cash and cash equivalents and
$64.7 million of our UMC equity securities.
If, in connection with the restructuring of our FlashVision business and the
early termination of the ABN AMRO lease facility, we and Toshiba are unable to
refinance the existing ABN AMRO lease facility, we may use a portion of the
proceeds from the Notes to repay these obligations. This would result in the
diversion of resources from other important areas of our business and could
significantly harm our business, financial condition and results of operations.
We cannot assure you that we will be successful in replacing FlashVision's lease
facility.
We may not be able to satisfy a fundamental change offer under the
indenture governing the Notes.
The indenture governing the Notes contains provisions that apply to a
fundamental change. A fundamental change as defined in the indenture would occur
if we were to be acquired for consideration other than cash or
48
securities traded on a major U.S. securities market. If someone triggers a
fundamental change, we may be required to offer to purchase the Notes with cash.
This would result in the diversion of resources from other important areas of
our business and could significantly harm our business, financial condition and
results of operations.
If we have to make a fundamental change offer, we cannot be sure that we
will have enough funds to pay for all the Notes that the holders could tender.
Our failure to redeem tendered notes upon a fundamental change would constitute
a default under the indenture, which would constitute a default under the ABN
AMRO Bank N.V. guarantee and might constitute a default under the terms of our
other indebtedness, which would significantly harm our business and financial
condition.
We may not be able to pay our debt and other obligations.
If our cash flow is inadequate to meet our obligations, we could face
substantial liquidity problems. If we are unable to generate sufficient cash
flow or otherwise obtain funds necessary to make required payments on the Notes
or our other indebtedness, we would be in default under the terms thereof, which
would permit the holders of the Notes to accelerate the maturity of the Notes
and also could cause defaults under our other indebtedness. Any such default
would harm our business, prospects, financial condition and operating results.
In addition, we cannot assure you that we would be able to repay amounts due in
respect of the Notes if payment of the Notes were to be accelerated following
the occurrence of any other event of default as defined in the indenture
governing the Notes. Moreover, we cannot assure that we will have sufficient
funds or will be able to arrange for financing to pay the principal amount due
on the Notes at maturity.
We may need additional financing, which could be difficult to obtain.
We currently expect that our existing cash and investment balances, cash
generated from operations and the proceeds from the sale of the Notes will be
sufficient to meet our cash requirements to fund operations and expected capital
expenditures at least through 2002. However, in the event we need to raise
additional funds during that time period or in future periods, we cannot be
certain that we will be able to obtain additional financing on favorable terms,
if at all. From time to time, we may decide to raise additional funds through
public or private debt or equity financings to fund our activities. If we issue
additional equity securities, our stockholders will experience additional
dilution and the new equity securities may have rights, preferences or
privileges senior to those of existing holders of common stock or debt
securities. In addition, if we raise funds through debt financing, we will have
to pay interest and may be subject to restrictive covenants, which could harm
our business. If we cannot raise funds on acceptable terms, if and when needed,
we may not be able to develop or enhance our products, take advantage of future
opportunities, grow our business or respond to competitive pressures or
unanticipated industry changes, any of which could have a negative impact on our
business.
The Notes and other indebtedness have rights senior to those of our current
stockholders.
In the event of our bankruptcy, liquidation or reorganization or upon
acceleration of the Notes due to an event of default under the indenture and in
certain other events, our assets will be available for distribution to our
current stockholders only after all senior indebtedness, including the amount we
have guaranteed on behalf of FlashVision and obligations under the Notes, have
been paid in full. As a result, there may not be sufficient assets remaining to
make any distributions to our stockholders.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
We are exposed to financial market risks, including changes in interest
rates, foreign currency exchange rates and marketable equity security prices. To
mitigate some of these risks, we utilize currency forward contracts. We do not
use derivative financial instruments for speculative or trading purposes, and no
significant derivative financial instruments were outstanding at December 31,
2001.
Interest Rate Risk. Our exposure to market risk for changes in interest
rates relates primarily to our investment portfolio. The primary objective of
our investment activities is to preserve principal while maximizing yields
without significantly increasing risk. This is accomplished by investing in
widely diversified short-term investments, consisting primarily of investment
grade securities, substantially all of which either mature within the next
twelve
49
months or have characteristics of short-term investments. A hypothetical 50
basis point increase in interest rates would result in an approximate $429,000
decline (less than 0.5%) in the fair value of our available-for-sale debt
securities.
Foreign Currency Risk. A substantial majority of our revenue, expense and
capital purchasing activity are transacted in U.S. dollars. However, we do enter
into transactions in other currencies, primarily the Japanese Yen. To protect
against reductions in value and the volatility of future cash flows caused by
changes in foreign exchange rates, we have established a hedging program.
Currency forward contracts are utilized in this hedging program. Our hedging
program reduces, but does not always entirely eliminate the impact of foreign
currency exchange rate movements. An adverse change of 10% in exchange rates
would result in a decline in income before taxes in 2001 of approximately
$256,000.
Market Risk. We also hold available-for-sale equity securities in our
short-term investment portfolio and equity investments in semiconductor wafer
manufacturing companies. A reduction in prices of 10% of these marketable equity
securities would result in a decrease in the fair value of our investments in
marketable equity securities of approximately $17.0 million. As of December 31,
2001, we had net unrealized gains on short-term equity securities totaling $96.8
million which were included in other comprehensive income. These unrealized
gains include an unrealized gain of $95.8 million on the appreciation in value
of our investment in UMC. The market value of our investment in UMC has
fluctuated significantly in the past and may decline in the future due to
downturns in the semiconductor industry, declines in demand for UMC's products
or unfavorable economic conditions. If we sell UMC shares in future periods, we
may recognize a gain or loss due to fluctuations in the market value of our UMC
stock.
All of the potential changes noted above are based on sensitivity analysis
performed on our financial position at December 31, 2001. Actual results may
differ materially.
50
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SANDISK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
Contents
Page
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Report of Ernst & Young LLP, Independent Auditors ................................... 52
Consolidated Balance Sheets ......................................................... 53
Consolidated Statements of Operations ............................................... 54
Consolidated Statements of Stockholders' Equity ..................................... 55
Consolidated Statements of Cash Flows ............................................... 56
Notes to Consolidated Financial Statements .......................................... 57
51
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, 2001 and 2000, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 2001. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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, 2001 and 2000 and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 2001, in conformity with accounting principles generally
accepted in the United States.
/s/ Ernst & Young LLP
San Jose, California
January 21, 2002, except for Note 3,
as to which the date is March 5, 2002.
52
SanDisk Corporation
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
December 31, 2001 2000
- ----------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 189,499 $ 106,277
Short-term investments 105,501 260,462
Investment in foundries 105,364 112,854
Accounts receivable, net of allowance for doubtful accounts of
$4,919 in 2001 and $5,010 in 2000 45,223 96,405
Inventories 55,968 96,600
Tax refund receivable 28,473 -
Prepaid expenses and other current assets 12,129 17,709
------------------------------------------------------------------------------------------------------------
Total current assets 542,157 690,307
Restricted cash and cash equivalents 64,734 -
Property and equipment, net 33,730 41,095
Investment in foundries 41,380 197,688
Restricted investment in UMC 64,734 -
Investment in FlashVision 153,168 134,730
Deferred tax asset 18,842 -
Deposits and other non-current assets 13,603 37,087
- ----------------------------------------------------------------------------------------------------------------
Total assets $ 932,348 $1,100,907
================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 19,938 $ 59,179
Accounts payable to related parties 24,008 7,933
Accrued payroll and related expenses 5,279 16,215
Income taxes payable 7,361 16,427
Deferred tax liability 18,842 -
Research & development liability, related party 15,256 -
Other accrued liabilities 20,571 13,863
Deferred revenue 15,806 50,740
------------------------------------------------------------------------------------------------------------
Total current liabilities 127,061 164,357
Convertible subordinated notes payable 125,000 -
Long-term liabilities, related parties 4,908 3,492
Deferred taxes and other liabilities - 70,000
------------------------------------------------------------------------------------------------------------
Total liabilities 256,969 237,849
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value
Authorized shares: 4,000,000
Issued: none - -
Common stock, $0.001 par value
Authorized shares: 125,000,000
Issued and outstanding: 68,464,000 in 2001 and
67,464,000 in 2000 68 67
Capital in excess of par value 580,363 566,934
Retained earnings 48,525 346,469
Accumulated other comprehensive income (loss) 46,423 (50,412)
------------------------------------------------------------------------------------------------------------
Total stockholders' equity 675,379 863,058
- ----------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 932,348 $1,100,907
================================================================================================================
See accompanying notes.
53
SanDisk Corporation
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Years Ended December 31, 2001 2000 1999
- ------------------------------------------------------------------------------------------------
Revenues
Product $ 316,867 $ 526,359 $ 205,770
License and royalty 49,434 75,453 41,220
- ------------------------------------------------------------------------------------------------
Total revenues 366,301 601,812 246,990
Cost of revenues 392,293 357,017 152,143
- ------------------------------------------------------------------------------------------------
Gross profits (losses) (25,992) 244,795 94,847
Operating expenses
Research and development 58,931 46,057 26,883
Sales and marketing 42,576 49,286 25,294
General and administrative 16,981 24,786 12,585
Restructuring 8,510 - -
- ------------------------------------------------------------------------------------------------
Total operating expenses 126,998 120,129 64,762
- ------------------------------------------------------------------------------------------------
Operating income (loss) (152,990) 124,666 30,085
Equity in income of joint venture 2,082 - -
Interest income/expense 12,266 22,786 8,280
Gain (loss) on investment in foundry (302,293) 344,168 -
Other income (loss), net (1,009) 572 1,261
- -----------------------------------------------------------------------------------------------
Income (loss) before taxes (441,944) 492,192 39,626
Provision for (benefit from) income taxes (144,000) 193,520 13,076
- ------------------------------------------------------------------------------------------------
Net income (loss) $ (297,944) $ 298,672 $ 26,550
================================================================================================
Net income (loss) per share
Basic $ (4.37) $ 4.47 $ 0.48
Diluted $ (4.37) $ 4.11 $ 0.43
================================================================================================
Shares used in computing net income per share
Basic 68,148 66,861 55,834
Diluted 68,148 72,651 61,433
================================================================================================
See accompanying notes.
54
SanDisk Corporation
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
Accumulated
Common Capital In Other Total
Stock Excess of Retained Comprehensive Stockholders'
Shares Amount Par Value Earnings Income (Loss) Equity
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 53,256 $ 54 $ 186,066 $ 21,247 $ 471 $ 207,838
Net income - - - 26,550 - 26,550
Unrealized loss on available for
sale securities - - - - (272) (272)
-------------
Comprehensive income 26,278
-------------
Exercise of stock options for cash 1,766 2 6,107 - - 6,109
Issuance of stock pursuant to
employee stock purchase plan 268 - 1,807 - - 1,807
Net exercise of common stock warrants 58 - - - - -
Sale of common stock, net of
issuance costs 9,900 9 320,277 - - 320,286
Income tax benefit from stock
options exercised - - 9,809 - - 9,809
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 65,248 65 524,066 47,797 199 572,127
Net income - - - 298,672 - 298,672
Unrealized loss on available for
sale securities - - - - (343) (343)
Unrealized loss on investments - - - - (50,268) (50,268)
-------------
Comprehensive income 248,061
-------------
Exercise of stock options for cash 2,147 2 10,370 - - 10,372
Issuance of stock pursuant to
employee stock purchase plan 69 2,815 - - 2,815
Sale of common stock, net of
issuance costs - - 425 - - 425
Income tax benefit from stock
options exercised - - 29,258 - - 29,258
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 67,464 67 566,934 346,469 (50,412) 863,058
Net loss - - - (297,944) (297,944)
Unrealized gain on available for
sale securities - - - - 908 908
Unrealized gain on investments 95,927 95,927
-------------
Comprehensive loss (201,109)
-------------
Exercise of stock options for cash 831 1 4,766 - - 4,767
Issuance of stock pursuant to
employee stock purchase plan 169 - 3,863 3,863
Income tax benefit from stock
options exercised - - 4,800 - - 4,800
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 68,464 $ 68 $ 580,363 $ 48,525 $ 46,423 $ 675,379
=============================================================================================================================
See accompanying notes.
55
SanDisk Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except per share data)
Years Ended December 31, 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) (297,944) $ 298,672 $ 26,550
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Deferred taxes (134,483) 114,501 (1,100)
(Gain) loss on investment in foundry 302,293 (344,168)
Depreciation 20,548 15,928 7,145
Equity in net income of joint ventures (2,082) - -
Non-cash portion of restructuring charge 6,383 - -
Loss on disposal of equipment 7,013 1,013
Compensation related to modification of stock option terms - 425 -
Changes in assets and liabilities:
Accounts receivable 51,182 (47,477) (31,221)
Income tax refund receivable (28,473) - -
Inventories 40,632 (60,921) (26,757)
Prepaid expenses and other current assets 6,179 (4,531) 2,931
Deposits and other assets 6,964 (3,545) (5,721)
Accounts payable (39,241) 36,378 23,796
Accrued payroll and related expenses (10,936) 7,956 4,491
Income taxes payable (4,266) 39,842 10,984
Other current liabilities, related party 31,331 - -
Other accrued liabilities 6,352 5,937 3,934
Deferred revenue (34,934) 21,357 1,931
Other non-current liabilities, related party 1,416 3,485 -
- ----------------------------------------------------------------------------------------------------------------------------
Total adjustments 225,878 (213,820) (9,587)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in ) operating activities (72,066) 84,852 16,963
- ----------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of short-term investments (224,659) (593,146) (332,379)
Proceeds from short-term investments 380,207 643,734 139,391
Acquisition of property and equipment (26,223) (26,586) (21,391)
Investment in FlashVision (14,970) (134,730) -
Investment in equity securities (44,498) (7,200) -
Deposit in escrow account for investment in equity securities 20,004 (20,004) -
Restricted cash (64,734) - -
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 25,127 (137,932) (214,379)
- ----------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net proceeds from issuance of convertible subordinated notes 121,531 - -
Sale of common stock and warrants 8,630 13,187 328,202
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 130,161 13,187 328,202
- ----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 83,222 (39,893) 130,786
- ----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of year 106,277 146,170 15,384
- ----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 189,499 $ 106,277 $ 146,170
============================================================================================================================
Supplemental disclosure of cash flow information:
Cash paid for income taxes 13,962 37,260 4,306
- ----------------------------------------------------------------------------------------------------------------------------
See accompanying notes.
56
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 operates in one segment and serves customers in the consumer
electronics, industrial, communications and highly portable computing markets.
Principal geographic markets for the Company's products include the United
States, Japan, Europe and the Far East.
Supplier and Customer Concentrations
A limited number of customers historically have accounted for a substantial
portion of the Company's revenues. Sales to our top 10 customers accounted for
approximately 49%, 48%, and 57%, respectively, of our product revenues for the
fiscal years ended December 31, 2001, 2000, and 1999. In 2001 and 2000, no
single customer accounted for more than 10% of total revenues. In 1999, revenues
from one customer exceeded 10% of total revenues. Sales of the Company's
products will vary as a result of fluctuations in market demand. 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. All of the Company's
products require silicon wafers. The majority of the Company's flash memory
wafers are currently supplied by the Company's FlashVision joint venture with
Toshiba. After the restructuring of the FlashVision joint venture, all of the
Company's NAND flash memory wafers will be supplied by Toshiba's wafer facility
in Yokkaichi, Japan. In the third quarter of 2001, the Company began to purchase
controller wafers from UMC and is continuing development of advanced flash
memory technology utilizing the 0.15 micron technology design rules at UMC. The
Company is dependent on its foundries to allocate to the Company a portion of
their foundry capacity sufficient to meet the Company's needs, to produce wafers
of acceptable quality and with acceptable manufacturing yields and to deliver
those wafers to the Company on a timely basis. On occasion, the Company has
experienced difficulties in each of these areas. Under the Company's joint
venture agreement with Toshiba, the Company is committed to purchase 50% of
FlashVision's wafer output from the Dominion, Virginia fabrication facility
prior to the FlashVision restructuring and from the Yokkaichi fabrication
facility after the restructuring.
Under the terms of the Company's wafer supply agreements, the Company is
obligated to provide a monthly rolling forecast of anticipated purchase orders.
Except in limited circumstances and subject to acceptance by the foundries, the
estimates for the first three months of each forecast constitute a binding
commitment and the estimates for the remaining months may not increase or
decrease by more than a certain percentage from the previous month's forecast.
These restrictions limit the Company's ability to react to significant
fluctuations in demand for its products. As a result, the Company has not been
able to match its purchases of wafers to specific customer orders, and therefore
the Company has taken write downs for potential excess inventory purchased prior
to the receipt of customer orders and may be required to do so in the future.
These adjustments decrease gross margins in the quarter reported and have
resulted, and could in the future result in fluctuations in gross margins on a
quarter to quarter basis. To the extent the Company inaccurately forecasts the
number of wafers required, it may have either a shortage or an excess supply of
wafers, either of which could have a material adverse effect on the Company's
business, financial condition and results of operations. Additionally, if the
Company is unable to obtain scheduled quantities of wafers from any foundry with
acceptable yields, the Company's business, financial condition and results of
operations could be negatively impacted.
In addition, certain key components are purchased from single source vendors
for which alternative sources are currently not available. Shortages could occur
in these essential materials due to an 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
57
operations. We also rely on third-party subcontractors to assemble and test the
memory components for our products. We have no long-term contracts with these
subcontractors and cannot directly control product delivery schedules. This
could lead to product shortages or quality assurance problems that could
increase the manufacturing costs of our products and have adverse effects on our
operating results.
Basis of Presentation
The Company's fiscal year ends on the Sunday closest to December 31. Fiscal
year 2001 ended on December 30, 2001 and was 52 weeks in length. Fiscal year
2000 ended on December 31, 2000 and was 52 weeks in length. Fiscal year 1999
ended on January 2, 2000 and was 53 weeks in length. 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.
Critical Accounting Policies & Estimates
The Company's consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires the Company to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent liabilities. On an
on-going basis, the Company evaluates its estimates, including those related to
customer programs and incentives, product returns, bad debts, inventories,
investments, income taxes, warranty obligations, restructuring, and
contingencies and litigation. The Company bases its estimates on historical
experience and on various other assumptions that it believes to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
Revenue recognition. The company recognizes net revenues when the earnings
-------------------
process is complete, as evidenced by an agreement with the customer, transfer of
title and acceptance if applicable, fixed pricing and probable collectibility.
Because of frequent sales price reductions and rapid technology obsolescence in
the industry, sales made to distributors and retailers under agreements allowing
price protection and/or right of return are deferred until the retailers or
distributors sell the merchandise.
Customer Incentives, Returns and Allowances. The Company records estimated
-------------------------------------------
reductions to revenue for customer programs and incentive offerings including
promotions and other volume-based incentives, particularly for its retail
customers, which represented 75% of our product revenues in fourth quarter of
2001. If market conditions were to decline, the Company may take actions to
increase customer incentive offerings to its retail customers, possibly
resulting in an incremental reduction of revenue at the time the incentive is
offered. In addition, the Company records a provision for estimated sales
returns and allowances on product sales in the same period as the related
revenues are recorded. These estimates are based on historical sales returns,
analysis of credit memo data and other known factors. If the historical data the
Company uses to calculate these estimates do not properly reflect future
returns, revenue could be overstated.
Allowance for Doubtful Accounts-Methodology. The Company evaluates the
-------------------------------------------
collectibility of its accounts receivable based on a combination of factors. In
circumstances where the Company is aware of a specific customer's inability to
meet its financial obligations to the Company (e.g., bankruptcy filings,
substantial down-grading of credit ratings), the Company records a specific
reserve for bad debts against amounts due to reduce the net recognized
receivable to the amount it reasonably believe will be collected. For all other
customers, the Company recognizes reserves for bad debts based on the length of
time the receivables are past due based on its historical experience. If
circumstances change (i.e., higher than expected defaults or an unexpected
material adverse change in a major customer's ability to meet its financial
obligations to us), the Company's estimates of the recoverability of amounts due
it could be reduced by a material amount.
58
Warranty Costs. The Company provides for the estimated cost of product
--------------
warranties at the time revenue is recognized. While the Company engages in
product quality programs and processes, its warranty obligation is affected by
product failure rates and repair or replacement costs incurred in correcting a
product failure. Should actual product failure rates, repair or replacement
costs differ from the Company's estimates, increases to its warranty liability
would be required.
Valuation of Financial Instruments. The Company's short-term investments
----------------------------------
include investments in marketable equity and debt securities. The Company also
has equity investments in semiconductor wafer manufacturing companies, UMC of
$194.9 million and Tower of $16.6 million, as of December 31, 2001. In
determining if and when a decline in market value below cost of these
investments is other-than-temporary, the Company evaluates the market
conditions, offering prices, trends of earnings, price multiples, and other key
measures for our investments in marketable equity securities and debt
instruments. When such a decline in value is deemed to be other-than-temporary,
the Company recognizes an impairment loss in the current period operating
results to the extent of the decline. Due to the slowdown in the semiconductor
industry and economic recession in 2001, the market value of the Company's UMC
and Tower investments declined significantly. These declines were deemed to be
other-than-temporary and losses totaling $302.3 million were recognized. If the
slowdown in the semiconductor industry continues in 2002, the Company may
recognize additional losses on these investments.
Inventories - Slow Moving and Obsolescence. The Company writes down its
------------------------------------------
inventory for estimated obsolescence or unmarketable inventory equal to the
difference between the cost of the inventory and the estimated market value
based upon assumptions about future demand and market conditions, including
assumptions about changes in average selling prices. If actual market conditions
are less favorable than those projected by management, additional inventory
write-downs may be required.
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.
Deferred Tax Assets. As of December 31, 2001, the Company has a net deferred
tax asset of approximately $36 million that has been fully offset by a valuation
allowance. Due to its current losses, the Company has not used projections of
future taxable income in determining the amount of the valuation allowance
required.
Foreign Currency Transactions
Foreign operations are measured using the U.S. dollar as the functional
currency. Accordingly, monetary accounts (principally cash, accounts receivable
and liabilities) are remeasured using the foreign exchange rate at the balance
sheet date. Operations accounts and nonmonetary balance sheet accounts are
remeasured at the rate in effect at the date of transaction. The effects of
foreign currency remeasurement are reported in current operations.
Reclassification
Certain reclassifications have been made to prior year's amounts to conform
to the current year's presentation.
Cash Equivalents and Short-Term Investments
Cash equivalents consist of short-term, highly liquid financial instruments
with insignificant interest rate risk that are readily convertible to cash and
have maturities of three months or less from the date of purchase. Cash
equivalents and short-term investments consist of money market funds, taxable
commercial paper, U.S. government agency obligations, corporate / municipal
notes and bonds with high-credit quality, money market preferred stock and
auction rate preferred stock. Short-term investments also include the
unrestricted portion of the Company's investment in foundries for which trading
restrictions expire within one year. The fair market value, based on quoted
59
market prices, of cash equivalents and short-term investments is substantially
equal to their carrying value at December 31, 2001 and 2000.
Under FAS 115, management classifies investments as available-for-sale at the
time of purchase and periodically reevaluates such designation. Debt securities
classified as available-for-sale are reported at fair value. Unrecognized gains
or losses on available-for-sale securities are included 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 other income
(expense). The cost of securities sold is based on the specific identification
method.
Under the terms of the FlashVision lease agreements, the Company as guarantor
is required to pledge cash and equity securities up to the full value of the
outstanding guaranteed lease commitments. As of December 31, 2001, the Company
had guaranteed $129.5 million of FlashVision lease commitments and pledged $64.7
million of cash and cash equivalents and $64.7 million of its UMC equity
securities. This pledged cash and cash equivalents and marketable equity
securities are included in "Restricted cash and cash equivalents" and
"Restricted investment in UMC" on the Company's balance sheet.
The Company's investments as of December 31, 2001 and 2000 are as follows (in
thousands):
December 31, 2001 December 31, 2000
-----------------
Unrestricted Restricted Total Unrestricted Total
------------ ---------- ----- ------------ -----
Cash equivalents:
Money market fund $108,311 $ 64,734 $173,045 $ 2,921 $ 2,921
Commercial paper 79,379 0 79,379 60,505 $ 60,505
Corporate notes / bonds 0 0 0 12,492 12,492
-------- -------- -------- -------- --------
Total 187,690 64,734 252,424 $ 75,918 $ 75,918
======== ======== ======== ======== ========
Short term investments:
- -----------------------
U.S. government agency obligations $3,000 $ 0 $3,000 $ 10,004 $ 10,004
Municipal notes / bonds 70,739 0 70,739 136,580 $136,580
Corporate notes / bonds 13,061 0 13,061 47,795 $ 47,795
Commercial paper 7,958 0 7,958 6,115 $ 6,115
Auction rate preferred stock 10,700 0 10,700 59,967 $ 59,967
Marketable equity securities * 105,407 64,734 170,141 112,855 112,855
-------- -------- ------- -------- --------
Total $210,865 $ 64,734 $275,599 $373,316 $373,316
======== ======== ======== ======== ========
Total cash equivalents and short
term investments $398,555 $129,468 $528,023 $449,234 $449,234
======== ======== ======== ======== ========
* Includes Investment in Foundries, short-term.
The unrealized gain on available-for-sale securities at December 31, 2001 was
$46.4 million. At December 31, 2000, the unrealized loss on available-for-sale
securities was $50.4 million. The unrealized gain includes $95.8 million of
unrealized gain on the Company's investment in UMC in the fourth quarter of 2001
(see "Investment in Foundry" below). Fair value of available-for-sale securities
is based upon quoted market prices. Gross realized gains and losses on sales of
available-for-sale securities during the years ended December 31, 2001 and 2000
were immaterial.
Debt securities at December 31, 2001 and 2000, by contractual maturity, are
shown below. Actual maturities may differ from contractual maturities because
issuers of the securities may have the right to prepay obligations.
60
December 31,
2001 2000
---- ----
Short term investments (In thousands)
Due in one year or less $ 64,079 $ 94,554
Due after one year through two years/(1)/ 41,422 165,907
---------- ----------
Total $ 105,501 $ 260,462
========== ==========
(1) Includes $5.3M of investments maturing in greater than 2 years.
Long-Term Investments
The Company holds minority equity investments in companies having operations
or technology in areas within SanDisk's strategic focus. Certain of the
investments carry restrictions on immediate disposition. Investments in public
companies with restrictions of less than one year are classified as
available-for-sale and are adjusted to their fair market value with unrealized
gains and losses recorded as a component of accumulated other comprehensive
income. Investments in non-public companies are reviewed on a quarterly basis to
determine if their value has been impaired and adjustments are recorded as
necessary. Upon disposition of these investments, the specific identification
method is used to determine the cost basis in computing realized gains or
losses. Declines in value that are judged to be other than temporary are
reported in other income and expense.
Accounts Receivable
Accounts receivable include amounts owed by geographically dispersed
distributors, retailers, and OEM customers. No collateral is required.
Provisions are provided for sales returns, product exchanges and bad debts.
The activity in the allowance for doubtful accounts is as follows (in
thousands):
Additions
Balance at Charged to Balance at
For the year ended Beginning Costs and Deductions End
----------
December 31, of Period Expenses (Write-offs) of Period
------------ --------- -------- ------------ ---------
1999 $ 1,069 $ 945 $ 143 $ 1,871
2000 $ 1,871 $ 3,991 $ 852 $ 5,010
2001 $ 5,010 $ 829 $ 920 $ 4,919
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 (in
thousands):
61
December 31,
2001 2000
---- ----
Raw materials $ 6,325 $ 33,092
Work-in-process 18,850 53,921
Finished goods 30,793 9,587
-------- ---------
$ 55,968 $ 96,600
======== =========
In 2001, the Company recorded write-downs for excess or obsolete inventories
and lower of cost or market price adjustments of approximately $85 million. The
Company may be forced to take additional write-downs for excess or obsolete
inventory in future quarters if the current deterioration in market demand for
its products continues and its inventory levels continue to exceed customer
orders. In addition, the Company may record additional lower of cost or market
price adjustments to its inventories if continued pricing pressure results in a
net realizable value that is lower than its manufacturing cost. Although the
Company continuously tries to reduce its inventory in line with the current
level of business, the Company is obligated to honor existing purchase orders,
which have been placed with its suppliers. In the case of its FlashVision joint
venture, the Company is obligated to purchase 50% of the production output,
which makes it more difficult for the Company to reduce its inventory.
Property and Equipment
Property, plant and equipment are carried at cost less accumulated
depreciation and amortization. Depreciation and amortization expense related to
plant and equipment totaled $20.5 million, $15.9 million, and $7.1 million, in
fiscal 2001, 2000, and 1999, respectively. Depreciation and amortization is
computed using the straight-line method over the estimated useful lives of the
assets or the remaining lease term, whichever is shorter, generally two to seven
years.
Property and equipment consist of the following (in thousands):
December 31,
2001 2000
---- ----
Machinery and equipment $ 62,656 $ 62,310
Software 8,481 7,435
Furniture and fixtures 2,076 2,103
Leasehold improvements 6,227 5,842
-------- --------
Property and equipment, at cost 79,440 77,690
Accumulated depreciation and amortization (45,710) (36,595)
-------- --------
Property and equipment, net $ 33,730 $ 41,095
======== ========
Investment in Foundries
The Company has made equity investments in semiconductor wafer
manufacturing companies to obtain access to advanced wafer manufacturing
capacity. The current portion of "Investment in Foundries" includes the
unrestricted available-for-sale portion of the Company's investments in UMC and
Tower. The non-current portion of "Investment in Foundries" includes the portion
of the Company's investments in UMC and Tower that will not be
available-for-sale within one year due to trading restrictions. As of December
31, 2001, the Company's total investment in UMC was valued at $194.9 million and
its total investment in Tower was valued at $16.6 million. The Company accounts
for these investments on a cost basis. See Note 8.
62
Investment in Joint Venture
On June 30, 2000, the Company closed a transaction with Toshiba providing
for the joint development and manufacture of 512 megabit and 1 gigabit flash
memory chips and Secure Digital Card controllers. As part of this transaction,
SanDisk and Toshiba formed FlashVision, a joint venture to equip and operate a
silicon wafer manufacturing line at Dominion Semiconductor in Virginia. As of
December 31, 2001, the Company invested the final $15.0 million of its $150
million commitment in FlashVision for 49.9% ownership and guaranteed FlashVision
lease obligations of $129.5 million. The Company accounts for its investment in
FlashVision using the equity method. See Note 8.
Revenue Recognition
The Company recognizes revenue in accordance with Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements" (SAB 101), which requires
that revenue from product sales and patent license fees be recognized when
persuasive evidence of an agreement exists, delivery of the product has
occurred, the fee is fixed or determinable and collection is probable.
Product revenue, less a provision for estimated sales returns, is recognized
when title passes which is generally at the time of shipment. However, revenue
on shipments to distributors and retailers, subject to certain rights of return
and price protection, is deferred until the merchandise is sold by the
distributors or retailers, or the rights expire.
The Company earns patent license and royalty revenue under patent
cross-license agreements with several companies including Hitachi Ltd., Intel
Corporation, Lexar Media, Inc., Samsung Electronics Company Ltd., Sharp
Electronics Corporation, Silicon Storage Technology, Inc., SmartDisk
Corporation, Sony Corporation, TDK and Toshiba Corporation. The Company's
current license agreements provide for the payment of license fees, royalties,
or a combination thereof, to the Company. The timing and amount of these
payments can vary substantially from quarter to quarter, depending on the terms
of each agreement and, in some cases, the timing of sales of products by the
other parties.
Patent license and royalty revenue is recognized when earned. In 2001, 2000
and 1999, the Company received payments under these cross-license agreements,
portions of which were recognized as revenue and portions of which are deferred
revenue. The Company receives royalty revenue reports from certain of its
licensees and records all revenues one quarter in arrears. Recognition of
deferred revenue is expected to occur in future periods over the life of the
agreements, as the Company meets certain obligations as provided in the various
agreements.
Advertising Expense
The cost of advertising is expensed as incurred. Advertising costs were $8.8
million, $8.2 million, and $3.6 million in 2001, 2000, and 1999, respectively.
Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net
income per share (in thousands, except per share amounts):
63
2001 2000 1999
---- ---- ----
Numerator:
Numerator for basic and diluted
net income (loss) per share - net income (loss) $(297,944) $ 298,672 $ 26,550
========== ========== ==========
Denominator for basic net income (loss) per share:
Weighted average common shares 68,148 66,861 55,834
---------- ---------- ----------
Basic net income (loss) per share $ (4.37) $ 4.47 $ 0.48
========== ========== ==========
Denominator for diluted net income (loss) per share:
Weighted average common shares 68,148 66,861 55,834
Incremental common shares attributable to
exercise of outstanding employee stock options
and warrants (assuming proceeds would be used to
purchase common stock) 0 5,790 5,599
---------- ---------- ----------
Shares used in computing diluted net income (loss)
per share 68,148 72,651 61,433
========== ========== ==========
Diluted net income (loss) per share $ (4.37) $ 4.11 $ 0.43
========== ========== ==========
Basic earnings (loss) per share excludes any dilutive effects of options,
warrants, and convertible securities. Diluted earnings (loss) per share includes
the dilutive effects of stock options, warrants, and convertible securities.
Options and warrants to purchase 4,892,912; 907,380 and 190,807 shares of common
stock were outstanding during 2001, 2000 and 1999, respectively, but have been
omitted from the diluted earnings per share calculation because the options'
exercise price was greater than the average market price of the common shares
and, therefore the effect would be antidilutive. Incremental common shares
attributable to the assumed conversion of the Company's convertible subordinated
debentures were not included in the per share computation as the effect would be
antidilutive for fiscal year 2001.
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 (loss) and net income (loss) per share disclosures are
required by Statement of Financial Accounting Standards No. 123, "Accounting for
Stock Based Compensation," and are included in Note 4.
Issued Accounting Standards
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141
supersedes Accounting Principles Board ("APB") Opinion 16 "Business
Combinations" and SFAS No. 38 "Accounting for Pre-acquisition Contingencies,"
and eliminates the pooling-of-interests method of accounting for business
combinations except for qualifying business combinations that were initiated
prior to July 1, 2001. SFAS No. 141 also includes new criteria to recognize
intangible assets separately from goodwill. The requirements of SFAS 141 are
effective for any business combination accounted for by the purchase method that
is completed after June 30, 2001 (i.e., the acquisition date is July 1, 2001 or
after). The Company did not engage in any merger or acquisition activity during
the year and therefore, application of SFAS 141 is not expected to have a
material impact on results of operation and financial position in 2002.
64
SFAS No. 142, supersedes APB Opinion No. 17, "Intangible Assets," and states
that goodwill and intangible assets with indefinite lives are no longer
amortized but are reviewed for impairment annually, or more frequently if
impairment indicators arise. Separable intangible assets that are not deemed to
have an indefinite life will continue to be amortized over their useful lives.
The discontinuing of amortization provisions under SFAS No. 142 of goodwill and
indefinite lived intangible assets apply to assets acquired after June 30, 2001.
In addition, the impairment provisions of SFAS 142 apply to assets acquired
prior to July 1, 2001 upon adoption of SFAS 142. Application of the
non-amortization provisions and changes in estimated useful lives of intangibles
of FAS 142 for goodwill is not expected to have a material impact on results of
operation and financial position in 2002.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets ("SFAS No. 144"), which supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be disposed of." The primary objective of SFAS No. 144 is to develop
one accounting model based on the framework established in SFAS No. 121 for
long-lived assets to be disposed of by sale, and to address significant
implementation issues. The provisions of this statement are effective for fiscal
years beginning after December 15, 2001, and interim periods within those fiscal
years, with early application encouraged. Sandisk is evaluating the impact of
SFAS No. 144 on its financial position and results of operations.
Note 2: Financial Instruments
Concentration of Credit Risk
The Company's concentration of credit risk consists principally of cash, cash
equivalents, short-term investments and trade receivables. The Company's
investment policy restricts investments to high-credit quality investments and
limits the amounts invested with any one issuer. The Company sells to original
equipment manufacturers, retailers and distributors in the United States, Japan,
Europe and the Far East, 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
Under our FlashVision joint venture agreement with Toshiba (see Note 8), we
are obligated to guarantee one-half of all FlashVision lease amounts up to a
maximum guarantee of $175.0 million. As of December 31, 2001, we had guarantee
obligations in the amount of $129.5 million, with ABN AMRO Bank, N.V. as agent
for a syndicate of financial institutions, on the equipment lease lines to equip
FlashVision's manufacturing clean room with advanced wafer processing equipment.
Under the terms of the FlashVision lease agreements, we as guarantor are subject
to certain financial covenants. We obtained a compliance waiver for the third
quarter of 2001 and negotiated an amendment to the lease agreement which
includes a modification of the covenant requirements and requires us to pledge
cash and equity securities up to the full value of the outstanding guaranteed
lease commitments. As of December 31, 2001, we had pledged cash of $64.7 million
and UMC equity securities of $64.7 million and was in compliance with the
covenant requirements.
Note 3: Commitments and Contingencies
Commitments
The Company is obligated to guarantee one-half of all FlashVision lease
amounts up to a maximum guarantee of $175.0 million. As of December 31, 2001,
the Company had guarantee obligations in the amount of $129.5 million, with ABN
AMRO Bank, N.V. as agent for a syndicate of financial institutions, on the
equipment lease lines to equip FlashVision's manufacturing clean room with
advanced wafer processing equipment. In March 2002, FlashVision notified ABN
AMRO that it was exercising its right of early termination under the lease
facility and will repay all amounts outstanding thereunder in April 2002. The
Company and Toshiba are currently seeking other sources of financing to replace
the ABN AMRO lease facility. However, under the terms of the FlashVision lease
agreements, the Company as guarantor remains at this time subject to certain
financial covenants, including calculations of leverage, tangible net worth,
fixed charge coverage and current assets to current liabilities. The Company
obtained a
65
compliance waiver for the third quarter of 2001 and negotiated an amendment to
the lease agreement which includes a modification of the covenant requirements
and requires it to pledge cash and equity securities up to the full value of the
outstanding guaranteed lease commitments. As of December 31, 2001, the Company
had pledged cash of $64.7 million and UMC equity securities of $64.7 million as
collateral against the lease balance of $129.5 million. While these assets are
pledged, they are not available to the Company to be used to fund operations.
In December 2001, the Company signed a binding memorandum of understanding,
or MOU, with Toshiba under which the Company and Toshiba agreed to restructure
our FlashVision business by consolidating our FlashVision advanced NAND wafer
fabrication manufacturing operations at Toshiba's memory fabrication facility at
Yokkaichi, Japan. The Company and Toshiba contemplate that the FlashVision
operation at Yokkaichi will continue essentially the same 50-50 joint venture
and on essentially the same terms as it had at Dominion in Virginia. Under the
joint venture agreement, the Company is contractually obligated, and expects to
continue to be obligated after the restructuring of its FlashVision joint
venture, to purchase half of FlashVision's NAND wafer production output.
Apart from its commitment to purchase 50% of the FlashVision wafer output
from Yokkaichi after the restructuring, the Company will also purchase NAND
wafers from Toshiba's current Yokkaichi fabrication facility on a foundry
relationship basis. This foundry relationship will be conducted under a firm
purchase order commitment over rolling three-month periods. NAND wafers are
ordered under purchase orders at market prices and cannot be cancelled. At
December 31, 2001, approximately $32.5 million of non-cancelable purchase orders
for flash memory wafers from FlashVison were outstanding. If the Company places
purchase orders with Toshiba and its business condition deteriorates, it may end
up with excess inventories of NAND wafers, which could harm its business and
financial condition. The Company will incur start-up costs and pay its share of
ongoing operating activities even if we do not utilize our full share of the new
Yokkaichi output.
As part of their joint venture agreement, the Company and Toshiba also agreed
to share certain research and development expenses related to the development of
advanced NAND flash memory technologies. As of December 31, 2001, the Company
had accrued current liabilities related to these expenses of $15.3 million and
long-term liabilities of $4.9 million. These obligation will be paid in
installments throughout 2002 and 2003. In addition, beginning in 2002, the
Company will make quarterly payments to Toshiba for the Company's portion of the
research and development expenses associated with the continued development of
advanced NAND flash memory technologies. The amount of these payments will be
calculated as a percentage of the Company's revenues from NAND flash memory
products.
On July 4, 2000, the Company entered into a share purchase agreement to
make a $75.0 million investment in Tower, in Israel, representing approximately
10% ownership of Tower. The investment is subject to the completion of certain
milestones. During 2001, Tower satisfied the closing conditions of the share
purchase agreement and completed the first two milestones. Under the terms of
the agreement, the Company invested $42.5 million. Under the original agreement,
additional contributions by the Company will take the form of mandatory warrant
exercises for ordinary shares at an exercise price of $30.00 per share if other
milestones are met by Tower. The warrants will expire five years from the date
of grant, and in the event the key milestones are not achieved, the exercise of
these warrants will not be mandatory. However, in March of 2002, we modified our
share purchase agreement with Tower by agreeing to advance the payments for the
third and fourth milestones to April 5, 2002 and October 1, 2002, respectively.
We will make these payments whether or not Tower actually achieves its
previously agreed upon milestone obligations. In exchange for this and as part
of the modification to the share purchase agreement, Tower has agreed that of
the aggregate payment of $22.0 million represented by the third and fourth
milestone payments, (i) 60% of this amount, or $13.2 million, will be applied to
the issuance of additional ordinary Tower shares based on the average closing
price of Tower shares on the NASDAQ in the thirty consecutive trading days
preceding each payment date (but not to exceed $12.50 per share) and (ii) 40% of
this amount, or $8.8 million, will be credited to our pre-paid wafer account, to
be applied against orders placed with Tower's new fabrication facility, when
completed.
The Company leases its headquarters and sales offices under operating leases
that expire at various dates through 2006. Future minimum lease payments under
operating leases at December 31, 2000 are as follows (in thousands):
66
Year Ending December 31,
- ------------------------
2002 $ 2,623
2003 2,408
2004 2,430
2005 2,264
2006 1,029
Total $ 10,754
=========
Rental expense under all operating leases was $3.6 million, $2.5 million, and
$2.1 million for the years ended December 31, 2001, 2000, and 1999,
respectively.
The Company had foreign exchange contract lines in the amount of $65.1
million at December 31, 2001. Under these lines, the Company may enter into
forward exchange contracts that require the Company to sell or purchase foreign
currencies. One forward exchange contract in the notional amount of $9.8 million
was outstanding at December 31, 2001.
Contingencies
The Company relies on a combination of patents, trademarks, copyright and
trade secret laws, confidentiality procedures and licensing arrangements to
protect its intellectual property rights. There can be no assurance that there
will not be any disputes regarding the Company's intellectual property rights.
Specifically, there can be no assurance that any patents held by the Company
will not be invalidated, that patents will be issued for any of the Company's
pending applications or that any claims allowed from existing or pending patents
will be of sufficient scope or strength or be issued in the primary countries
where the Company's products can be sold to provide meaningful protection or any
commercial advantage to the Company. Additionally, competitors of the Company
may be able to design around the Company's patents.
To preserve its intellectual property rights, the Company believes it may be
necessary to initiate litigation with one or more third parties, including but
not limited to those the Company has notified of possible patent infringement.
In addition, one or more of these parties may bring suit against the Company.
Any litigation, whether as a plaintiff or as a defendant, would likely result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel, whether or not such litigation is ultimately
determined in favor of the Company.
On or about August 3, 2001, the Lemelson Medical, Education & Research
Foundation, or Lemelson Foundation, filed a complaint for patent infringement
against the Company and four other defendants. The suit, captioned Lemelson
Medical, Education, & Research Foundation, Limited Partnership vs. Broadcom
Corporation, et al., Civil Case No. CIV01 1440PHX HRH, was filed in the United
States District Court, District of Arizona. On November 13, 2001, the Lemelson
Foundation filed an Amended Complaint, which made the same substantive
allegations against the Company but named more than twenty-five additional
defendants. The Amended Complaint alleges that the Company, and the other
defendants, have infringed certain patents held by the Lemelson Foundation
pertaining to bar code scanning technology. By its complaint, the Lemelson
Foundation requests that the Company be enjoined from its allegedly infringing
activities and seeks unspecified damages. On February 4, 2002, the Company filed
an answer to the amended complaint, wherein the Company alleged that it does not
infringe the asserted patents, and further contend that the patents are not
valid or enforceable.
On October 15, 2001, the Company filed a complaint for patent infringement
in the United States District Court for the Northern District of California
against Micron Technology, Inc., or Micron. In the suit, captioned SanDisk Corp.
v. Micron Technology, Inc., Civil No. CV 01-3855 CW, the complaint seeks damages
and an injunction against Micron for making, selling, importing or using flash
memory cards that infringe the Company's U.S. Patent No. 6,149,316. On February
15, 2002, Micron answered the complaint, denied liability, and counterclaimed
seeking a declaration that the patent in suit is not infringed, is invalid, and
is unenforceable.
67
On October 31, 2001, the Company filed a complaint for patent infringement
in the United States District Court for the Northern District of California
against Memorex Products, Inc., Pretec Electronics Corporation, Ritek
Corporation and Power Quotient International Co., Ltd. In the suit, captioned
SanDisk Corp. v. Memorex Products, Inc., et. al., Civil No. CV 01-4063 VRW, the
complaint seeks damages and injunctions against these companies from making,
selling, importing or using flash memory cards that infringe the Company's U.S.
patent No. 5,602,987, or the `987 Patent. Defendants Memorex, Pretec and Ritek
have filed answers denying the allegations. The Company has filed a motion for a
preliminary injunction in the suit to enjoin Memorex, Pretec and Ritek from
making, selling, importing or using flash memory cards that infringe our `987
Patent prior to the trial on the merits. This preliminary injunction motion is
scheduled for hearing on April 11, 2002.
On November 30, 2001, the Company filed a complaint for patent infringement
in the United States District Court for the Northern District of California
against Power Quotient International - USA Inc, or PQI-USA. In the suit,
captioned SanDisk Corp. v. Power Quotient International - USA Inc., Civil No. C
01-21111, the complaint seeks damages and an injunction against PQI-USA from
making, selling, importing or using flash memory cards that infringe our U.S.
patent No. 5,602,987. The PQI-USA complaint and litigation are related to the
October 31, 2001 litigation referred to above. The products at issue in the
PQI-USA case are identical to those charged with infringement in the October 31,
2001 litigation. On December 21, 2001, PQI-USA filed an answer to the complaint
denying the allegations, which included a counter claim for a declaratory
judgment of non-infringement and invalidity of our `987 Patent. The Company has
motioned for a preliminary injunction in the suit to enjoin PQI-USA from making,
selling, importing or using flash memory cards that infringe our `987 Patent
prior to the trial on the merits. This preliminary injunction motion is
scheduled for hearing on April 8, 2002.
On or about March 5, 2002, Samsung Electronics Co., Ltd., or Samsung, filed a
patent infringement lawsuit against the Company in the United States District
Court for the Eastern District of Texas. The lawsuit alleges that the Company
infringes four Samsung United States patents, Nos. 5,473,563; 5,514,889;
5,546,341 and 5,642,309, and seeks a preliminary and permanent injunction
against unnamed products of the Company, as well as damages, attorneys' fees and
cost of the lawsuit.
On March 21, 2000, Mitsubishi Denki Co. Ltd. (Mitsubishi Electric) filed a
complaint in Tokyo District Court against SanDisk K.K., SanDisk's wholly owned
subsidiary in Japan. The complaint alleges that SanDisk K.K., based in Yokohama,
Japan, infringes on three Mitsubishi Japanese patents, which are related
primarily to the mechanical construction of memory cards. In the complaint,
Mitsubishi asked the court for a preliminary injunction halting the sale of
SanDisk CompactFlash and flash ATA memory cards in Japan. Mitsubishi dropped two
of the patents from the suit. During the second quarter, we won a favorable
ruling, dismissing the complaint on the third patent and thereby concluding the
Mitsubishi lawsuit.
In Chile, Compaq Corporation is opposing our attempt to register CompactFlash
as a trademark. We do not believe that our failure to obtain registration for
the CompactFlash mark in any country will materially harm our business. SanDisk
successfully obtained the United States trademark registration for the mark
"CompactFlash".
In the event of an adverse result in any such litigation, the Company could
be required to pay substantial damages, cease the manufacture, use and sale of
infringing products, expend significant resources to develop non-infringing
technology or obtain licenses to the infringing technology, or discontinue the
use of certain processes.
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.
68
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.
Note 4: Convertible Subordinated Notes Payable
On December 24, 2001, the Company completed a private placement of $125.0
million of 4 1/2% Convertible Subordinated Notes due 2006, or Notes, and on
January 10, 2002 the initial purchasers completed the exercise of their option
to purchase an additional $25.0 million of Notes, for which the Company received
net proceeds of approximately $145.9 million. Based on the aggregate principal
amount at maturity of $150.0 million, the Notes provide for semi-annual interest
payments of $3.4 million each on May 15 and November 15. The Notes are
convertible into shares of our common stock at any time prior to the close of
business on the maturity date, unless previously redeemed or repurchased, at a
conversion rate of 54.2535 shares per $1,000 principal amount of the Notes,
subject to adjustment in certain events. At anytime on or after November 17,
2004, the Company may redeem the notes in whole or in part at a specified
percentage of the principal amount plus accrued interest. The debt issuance
costs are being amortized over the term of the Notes using the interest method.
Note 5: Stockholders' Equity
Stock Benefit Plan
The 1989 Stock Benefit Plan, in effect through August 1995, comprised two
separate programs, the Stock Issuance Program and the Option Grant Program. The
Stock Issuance Program allowed eligible individuals to immediately purchase the
Company's common stock at a fair value as determined by the Board of Directors.
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 the 1989 Stock Benefit Plan at December
31, 2001.
1995 Stock Benefit Plan
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.
In May 1999, the stockholders increased the shares available for future
issuance under the 1995 Stock Benefit Plan by 7,000,000 shares and approved an
automatic share increase feature pursuant to which the number of shares
available for issuance under the plan will automatically increase on the first
trading day in January each calendar year, beginning with calendar year 2002 and
continuing over the remaining term of the plan, by an amount equal to
approximately 4% of the total number of shares outstanding on the last trading
day in December in the immediately preceding calendar year, but in no event will
any such annual increase exceed 4,000,000 shares.
1995 Non-employee Directors Stock Option Plan
In August 1995, the Company adopted the 1995 Non-employee Directors Stock
Option Plan (the Directors' Plan). Under this plan, automatic option grants are
made at periodic intervals to eligible non-employee members of the Board of
Directors. Initial option grants vest over a four-year period. Subsequent annual
grants vest one year after date of grant. All options granted under the
Non-employee Directors Stock Option Plan expire ten years after the date of
grant. In May 1999, the stockholders increased the shares available for future
issuance under the 1995 Non-Employee Directors Stock Option Plan by 400,000 and
approved an automatic share increase feature pursuant to which the number of
shares available for issuance under the plan will automatically increase on the
first trading day in January each calendar year, beginning with calendar year
2002 and continuing over the remaining term of the plan, by an amount equal to
0.2% of the total number of shares outstanding on the last trading day in
December in
69
the immediately preceding calendar year, but in no event will any such annual
increase exceed 200,000 shares. At December 31, 2001, the Company had reserved
800,000 shares for issuance under the Directors' Plan and a total of 528,000
options had been granted at exercise prices ranging from $5.00 to $70.063 per
share.
A summary of activity under all stock option plans follows (shares in
thousands):
Total
Available Weighted
for Future Total Average
Grant/ Issuance Outstanding Exercise Price
---------------- ----------- --------------
Balance at December 31, 1998 1,804 8,252 $ 4.75
---------------- --------------
Increase in authorized shares 7,400 -
Granted (3,000) 3,000 $31.00
Exercised - (1,766) $ 3.47
Canceled 308 (308) $ 9.69
---------------- --------------
Balance at December 31, 1999 6,512 9,178 $ 9.50
---------------- --------------
Granted (2,290) 2,290 $53.57
Exercised - (2,147) $ 4.85
Canceled 469 (469) $ 9.69
---------------- --------------
Balance at December 31, 2000 4,691 8,852 $25.29
---------------- --------------
Granted (1,272) 1,272 $19.39
Exercised - (831) $ 5.73
Canceled 674 (674) $32.10
---------------- --------------
Balance at December 31, 2001 4,093 8,619 $25.77
================ ==============
At December 31, 2001, options outstanding were as follows:
Options Outstanding Options Exercisable
------------------- -------------------
Number Weighted Number
Outstanding Average Weighted Exercisable Weighted
Range of as of Remaining Average as of Average
Exercise Prices December 31, 2001 Contractual Life Exercise Price December 31, 2001 Exercise Price
--------------- ----------------- ---------------- -------------- ----------------- --------------
$ 0.375 - $ 6.000 1,688,083 5.49 $ 4.650 1,458,117 $ 4.634
$6.0625 - $ 10.82 1,693,066 7.43 $7.8299 971,610 $ 7.134
$11.450 - $ 30.000 1,531,510 8.55 $22.257 618,995 $22.073
$31.188 - $ 34.375 1,207,391 8.89 $34.159 306,609 $34.064
$35.813 - $ 35.813 1,444,346 7.95 $35.813 724,880 $35.813
$36.125 - $139.500 1,054,996 8.33 $70.100 468,042 $69.763
------------------ ----------------- ---------------- -------------- ----------------- --------------
$ 0.375 - $139.500 8,619,392 7.65 $25.769 4,548,253 $21.197
Employee Stock Purchase Plan
In August 1995, the Company adopted the Employee Stock Purchase Plan (the
Purchase Plan). In May 1999, the stockholders increased the shares available for
future issuance under the Employee Stock Purchase Plan by 600,000 and approved
an automatic share increase feature pursuant to which the number of shares
available for issuance under the plan will automatically increase on the first
trading day in January each calendar year, beginning with calendar year 2002 and
continuing over the remaining term of the plan, by an amount equal to
forty-three hundredths of one percent (0.43%) of the total number of shares
outstanding on the last trading day in December in the immediately preceding
calendar year, but in no event will any such annual increase exceed 400,000
shares. Under the Purchase Plan, qualified employees are entitled to purchase
shares through payroll deductions at 85% of the fair market value at the
beginning or end of the offering period, whichever is lower. As of December 31,
2001, the Company had reserved 2,366,666 shares of common stock for issuance
under the Purchase Plan and a total of 1,203,337 shares had been issued.
70
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 under the fair value method
of this Statement. The fair value for the options granted 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 4.68%, 6.16%
and 5.52% for 2001, 2000 and 1999, respectively; a dividend yield of 0.0%, a
volatility factor of the expected market price of the Company's common stock of
0.955, 0.951 and 0.888 for 2001, 2000 and 1999 respectively; and a
weighted-average expected life of the option of approximately 5 years. The
weighted average fair value of those options granted were $14.47, $39.82 and
$22.38 for 2001, 2000 and 1999, respectively.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that 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, participating 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 53% of eligible employees participated in the plan in 2001 and 78%
and 79% in 2000 and 1999, respectively. Under the Plan, the Company sold
169,044, 69,423 and 269,092 shares to employees in 2001, 2000 and 1999,
respectively. Pursuant to APB 25 and related interpretations, the Company does
not recognize compensation cost related to employee purchase rights under the
Plan. To comply with the pro forma reporting requirements of SFAS 123,
compensation cost is estimated for the fair value of the employees' purchase
rights using the Black-Scholes model with the following assumptions for those
rights granted in 2001, 2000 and 1999: dividend yield of 0.0%; and expected life
of 6 months; expected volatility factor of .80 and .94 in 2001, 1.56 and 1.18 in
2000 and .98 and 1.16 in 1999; and a risk free interest rate ranging from 4.38%
to 6.43%. The weighted average fair value of those purchase rights granted in
February 1999, August 1999, February 2000, August 2000, February 2001 and August
2001 were $6.01, $17.72, $38.69, $29.24, $11.67 and $10.15, 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 (loss)
and earnings (loss) per share would have been changed to the pro forma amounts
indicated below (in thousands, except per share amounts):
Years ended December 31,
2001 2000 1999
---- ---- ----
Pro forma net income (loss) $ (331,676) $ 276,421 $ 19,625
Pro forma net income (loss) per share
Basic $ (4.87) $ 4.13 $ 0.35
Diluted $ (4.87) $ 3.80 $ 0.32
Shareholder Rights Plan
71
On April 21, 1997, the Company adopted a shareholder rights plan (the Rights
Agreement). Under the Rights Agreement, rights were distributed as a dividend at
the rate of one right for each share of common stock of the Company held by
stockholders of record as of the close of business on April 28, 1997. The rights
will expire on April 28, 2007 unless redeemed or exchanged. Under the Rights
Agreement, each right will initially entitle the registered holder to buy one
one-hundredth of a share of Series A Junior Participating Preferred Stock for
$500.00. The rights will become exercisable only if a person or group acquires
beneficial ownership of 15 percent or more of the Company's common stock or
commences a tender offer or exchange offer upon consummation of which such
person or group would beneficially own 15 percent or more of the Company's
common stock.
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. The Company contributed $1.1 million and $105,000 for
the plan years ended December 31, 2001 and 1999, respectively. No contributions
were made by the Company for the year ended December 31, 2000.
Note 7: Income Taxes
The provision for (benefit from) income taxes consists of the following (in
thousands):
December 31,
2001 2000 1999
---- ---- ----
Current:
Federal ($ 28,455) $ 53,683 $ 10,354
State 38 13,296 2,117
Foreign 6,845 10,211 4,105
----------- ---------- -----------
(21,572) 77,190 16,576
Deferred:
Federal (97,388) 94,147 (2,600)
State (25,040) 21,683 (400)
Foreign - 500 (500)
----------- ---------- -----------
(122,428) 116,330 (3,500)
Provision for (benefit from)
income taxes ($ 144,000) $ 193,520 $ 13,076
============ ========== ===========
The tax benefits associated with stock options increased taxes receivable by
$4.8 million in 2001 and reduced taxes payable by $29.3 million and $9.8 million
in 2000 and 1999, respectively. Such benefits are credited to capital in excess
of par when realized.
The Company's provision for (benefit from) income taxes differs from the
amount computed by applying the federal statutory rates to income (loss) before
taxes as follows:
72
December 31,
2001 2000 1999
---- ---- ----
Federal statutory rate (35.0%) 35.0% 35.0%
State taxes, net of federal benefit (5.6) 4.6 2.8
Research credit (0.6) (0.2) (1.7)
Tax exempt interest income (0.5) (0.8) (3.9)
Valuation allowance 8.2 - -
Other individually immaterial items 0.9 0.7 0.8
----- ----- -----
(32.6%) 39.3% 33.0%
===== ===== =====
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, 2001 and 2000 are as
follows (in thousands):
December 31,
2001 2000
---- ----
Deferred tax assets:
Inventory reserves $ 35,900 $ 13,000
Deferred revenue 6,500 17,100
Accruals and other reserves 8,500 11,400
Credit carryforwards 27,900 -
NOL carryforward 6,400 -
Unrealized loss on investment write down 8,400 -
Other 3,300 1,200
--------- ----------
Subtotal: Deferred tax assets 97,200 42,700
Less: Valuation allowance (36,100) -
--------- ----------
Total: Deferred tax assets $ 61,100 $ 42,700
--------- ----------
Deferred tax liabilities:
Unrealized gain on exchange of Foundry
shares (61,100) (105,600)
--------- ----------
Total: Deferred tax liabilities (61,100) (105,600)
--------- ----------
Total net deferred tax assets/ (liabilities) $ - $ (62,900)
========= ==========
The Company provided a full valuation allowance against the net deferred tax
assets, as it is more likely than not that the deferred tax assets will not be
realized. The valuation allowance increased by $36.1million in 2001.
Approximately $4.8 million of the valuation allowance shown above relates to tax
benefits from stock option deductions that will be credited to equity when
realized.
The Company has a federal net operating loss carryforward of approximately
$11 million that will expire in 2021 and state net operating losses of
approximately $36 million that will begin to expire at various dates beginning
in 2006 through 2021. The Company has various federal and state tax credits that
will begin to expire at various dates beginning in 2004 through 2021. Federal
alternative minimum tax credits and certain stated credits do not expire.
Utilization of the Company's net operating loss and tax credit carry
forwards may be subject to a substantial annual limitation due to the ownership
change limitations provided by the Internal Revenue Code and similar state
provisions.
73
Note 8: Joint Venture, Strategic Manufacturing Relationships and Investments
On June 30, 2000, the Company closed a transaction with Toshiba providing for
the joint development and manufacture of 512 megabit and 1 gigabit flash memory
chips and Secure Digital Card controllers. As part of this transaction, SanDisk
and Toshiba formed FlashVision, a joint venture to equip and operate a silicon
wafer manufacturing line at Dominion Semiconductor in Virginia. In January 2001,
the Company invested the final $15.0 million of its $150.0 million cash
commitment in FlashVision. The Company agreed to guarantee one-half of all
FlashVision lease amounts up to a maximum guarantee of $175.0 million. As of
December 31, 2001, the Company had guarantee obligations in the amount of $129.5
million, with ABN AMRO Bank, N.V. as agent for a syndicate of financial
institutions, on the equipment lease lines to equip FlashVision's manufacturing
clean room with advanced wafer processing equipment. Although FlashVision
recently terminated the ABN AMRO lease facility, as further discussed below,
under the terms of the FlashVision lease agreements, the Company as guarantor
remains at this time subject to certain financial covenants. The Company
obtained a compliance waiver for the third quarter of 2001 and negotiated an
amendment to the lease agreement. which includes a modification of the covenant
requirements and requires the Company to pledge cash and equity securities up to
the full value of the outstanding guaranteed lease commitments. As of December
31, 2001, we had pledged cash of $64.7 million and UMC equity securities of
$64.7 million. While these assets are pledged, they are not available to the
Company to be used to fund operations.
In December 2001, the Company signed a binding memorandum of understanding,
or MOU, with Toshiba under which the Company and Toshiba agreed to restructure
their FlashVision business by consolidating FlashVision's advanced NAND wafer
fabrication manufacturing operations at Toshiba's memory fabrication facility at
Yokkaichi, Japan. The Yokkaichi fabrication facility, or Yokkaichi, is Toshiba's
most advanced memory fabrication facility and has approximately twice the wafer
fabrication capacity of Dominion. Through this consolidation, the Company
expects Yokkaichi to provide more cost-competitive NAND flash wafers than is
possible at Dominion. Under the terms of the MOU, Toshiba will transfer the
FlashVision owned and leased NAND production tool-set from Dominion to Yokkaichi
and has agreed to undertake full responsibility for the transition, which is
expected to be completed in 2002. Once the consolidation is completed,
Yokkaichi's total NAND wafer output will match the combined prior NAND capacity
of Yokkaichi and Dominion. The Company and Toshiba contemplate that the
FlashVision operation at Yokkaichi will continue essentially the same 50-50
joint venture and on essentially the same terms as it has had at Dominion in
Virginia. In March 2002, FlashVision notified ABN AMRO that it was exercising
its right of early termination under the lease facility and will repay all
amounts outstanding thereunder in April 2002. The Company and Toshiba are
currently seeking other sources of financing to replace the ABN AMRO lease
facility.
The Company invested $51.2 million in United Silicon, Inc., ("USIC") a
semiconductor manufacturing subsidiary of United Microelectronics Corporation in
Taiwan ("UMC"). In January 2000, the USIC foundry was merged into the UMC parent
company. In exchange for its USIC shares, the Company received 111 million UMC
shares. These shares were valued at approximately $396 million at the time of
the merger, resulting in a pretax gain of $344.2 million ($203.9 million
after-tax) in the first quarter of 2000. All of the UMC shares the Company
received as a result of the merger were subject to trading restrictions imposed
by UMC and the Taiwan Stock Exchange. As of December 31, 2001, the trading
restrictions had expired on 66.7 million shares. The remaining 44.4 million
shares will become available for sale over a two-year period beginning in
January 2002. In July of 2001, the Company received a stock dividends from UMC
of 20.0 million and 22.2 million shares in 2001 and 2000, respectively.
Due to the decline in the UMC stock price from the weakness in the
semiconductor industry, the value of the Company's investment in UMC had
declined to $194.9 at December 31, 2001. It was determined that the decline in
the market value of the investment was other than temporary, as defined by
generally accepted accounting principles and a loss of $275.8 million, or $166.9
million net of taxes was recorded in accordance with Statement of Financial
Accounting Standards Number 115. The loss was included in loss on investment in
foundry. If the fair value of the UMC investment declines further, it may be
necessary to record additional losses. In addition, in future periods, there may
be a gain or loss due to fluctuations in the market value of UMC stock or if UMC
shares are sold.
74
On July 4, 2000, the Company entered into a share purchase agreement to
make a $75.0 million investment in Tower Semiconductor, ("Tower"), in Israel,
representing approximately 10% ownership of Tower. The investment is subject to
the completion of certain milestones relative to the construction of a new wafer
fabrication facility by Tower. During 2001, Tower satisfied the closing
conditions of the share purchase agreement and completed the first two
milestones. Under the terms of the agreement, the Company has invested $42.5
million to purchase 1,599,931 ordinary shares and obtain wafer credits of $21.4
million. In September 2001, the Company agreed to convert 75% of its wafer
credits to equity at a price of $12.75 per share and received an additional
1,284,007 ordinary shares. The Company expects first wafer production to
commence at the new fabrication facility in late 2002. Due to the continued
weakness in the semiconductor industry, the value of the Company's Tower
investment and remaining wafer credits had declined to $16.6 million on December
31, 2001. It was determined that this decline was other than temporary, as
defined by generally accepted accounting principles and a loss of $20.6 million
was recorded in the second half of 2001. In addition, the Company recognized a
loss of $5.5 million on the exchange of 75% of its Tower wafer credits for 1,
284,007 ordinary shares at $12.75 per share. These losses totaling $26.1
million, or $15.8 million net of tax benefit, were recorded in loss on
investment in foundry in 2001. The Company accounts for its investment in Tower
on a cost basis. In March of 2002, the Company modified its share purchase
agreement with Tower by agreeing to advance the payments of the third and fourth
milestone payment dates to April 5, 2002 and October 1, 2002, respectively, and
to make these payments whether or not Tower actually achieves its previously
agreed upon milestone obligations. In exchange for this and as part of the
modification to the share purchase agreement, Tower has agreed that of the
aggregate payment of $22.0 million represented by the third and fourth milestone
payments, (i) 60% of this amount, or $13.2 million, will be applied to the
issuance of additional ordinary Tower shares based on the average closing price
of Tower shares on the NASDAQ in the thirty consecutive trading days preceding
each payment date (but not to exceed $12.50 per share) and (ii) 40% of this
amount, or $8.8 million, will be credited to the Company's pre-paid wafer
account, to be applied against orders placed with Tower's new fabrication
facility, when completed.
In September 2001, the Company signed an agreement with Sony involving
their Memory Stick card format. Under the agreement, Sony will supply the
Company a portion of their Memory Stick output for the Company to resell under
the SanDisk brand name. Sony has also agreed to purchase a portion of its NAND
memory chip requirements from the Company provided that it meets market
competitive pricing for these components. In addition, the two companies agreed
to co-develop and co-own the specifications for the next generation Memory
Stick. Each company will have all rights to manufacture and sell this new
generation Memory Stick.
On August 9, 2000, SanDisk entered into a joint venture, Digital Portal,
Inc. ("DPI"), with Photo-Me International ("PMI") for the manufacture,
installation, marketing, and maintenance of self-service, digital photo printing
labs, or kiosks, bearing the SanDisk brand name in locations in the U.S. and
Canada. Under the agreement, the Company and PMI will each make an initial
investment of $4.0 million for 50% ownership and secure lease financing for the
purchase of the kiosks. During 2001, the Company invested $2.0 million in DPI.
Recently, DPI has changed its business plan from 100% leasing the kiosks to
customers and sharing in the photo printing revenues generated, to a mix of
leasing and selling the kiosks outright. While this plan may reduce the
long-term cumulative income from each kiosk, it is expected to substantially
reduce DPI's requirements for lease financing. Therefore, the Company expects
based on the current business plan that the total value of its lease guarantees
will be below $5.0 million in 2002. PMI will manufacture the kiosks for the
joint venture and will install and maintain the kiosks under contract with the
joint venture. The Company accounts for this investment under the equity method,
and recorded a loss of $1.4 million as its share of the equity in loss of joint
venture in 2001.
On November 2, 2000, the Company made a strategic investment of $7.2
million in Divio, Inc. Divio is a privately-held manufacturer of digital imaging
compression technology and products for future digital camcorders that will be
capable of using our flash memory cards to store home video movies, replacing
the magnetic tape currently used in these systems. Under the agreement, the
Company owns approximately 10% of Divio and is entitled to one board seat. The
Company accounts for the investment under the cost method.
Note 9: Derivatives
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." The standard requires that all derivatives be recorded on the
balance sheet at fair value and establishes criteria for designation and
effectiveness of hedging relationships. The cumulative effect of adopting SFAS
133 as of January 1, 2001 was not material to the Company's consolidated
financial statements.
The Company is exposed to foreign currency exchange rate risk inherent in
forecasted sales, cost of sales, and assets and liabilities denominated in
currencies other than the U.S. dollar. The Company is also exposed to interest
rate risk inherent in its debt and investment portfolios. The Company's risk
management strategy provides for the use of derivative financial instruments,
including foreign exchange forward contracts, to hedge certain foreign currency
exposures. The Company's intent is to offset gains and losses that occur on the
underlying exposures, with gains and losses on the derivative contracts hedging
these exposures. The Company does not enter into any speculative
75
positions with regard to derivative instruments. The Company enters into foreign
exchange contracts to hedge against exposure to changes in foreign currency
exchange rates, only when natural offsets cannot be achieved. Such contracts are
designated at inception to the related foreign currency exposures being hedged,
which include sales by subsidiaries, and assets and liabilities that are
denominated in currencies other than the U.S. dollar. The Company's foreign
currency hedges generally mature within six months.
All derivatives are recorded at fair market value on the balance sheet,
classified in other assets. For derivative instruments that are designated and
qualify as cash flow hedges, the effective portion of the gain or loss on the
derivative instrument is recorded in accumulated other comprehensive income as a
separate component of stockholders' equity and reclassified into earnings in the
period during which the hedged transaction affects earnings. For derivative
instruments that are designated and qualify as fair value hedges, the gain or
loss on the derivative instrument, as well as the offsetting gain or loss on the
hedged item attributable to the hedged risk, are recognized in earnings in the
current period. For derivative instruments not designated as hedging
instruments, changes in their fair values are recognized in earnings in the
current period.
For foreign currency forward contracts, hedge effectiveness is measured by
comparing the cumulative change in the hedged contract with the cumulative
change in the hedged item, both of which are based on forward rates. To the
extent that the critical terms of the hedged item and the derivative are not
identical, hedge ineffectiveness is reported in earnings immediately. The
Company estimates the fair values on derivatives based on quoted market prices
or pricing models using current market rates.
The Company reports hedge ineffectiveness from foreign currency derivatives
for both options and forward contracts in other income or expense. Hedge
ineffectiveness was not material in fiscal 2001. The effective portion of all
derivatives is reported in the same financial statement line item as the changes
in the hedged item.
The Company had foreign exchange contract lines in the amount of $65.1 million
at December 31, 2001. Under these lines, the Company may enter into forward
exchange contracts that require the Company to sell or purchase foreign
currencies.
At December 31, 2001, the Company had $23.6 million in Japanese
Yen-denominated accounts payable and open purchase orders designated as cash
flow hedges or fair value hedges against Japanese Yen-denominated cash holdings
and accounts receivable. At December 31, 2001, the Company had one forward
contract to sell Yen in the amount of $9.8 million. Foreign currency translation
gains of $291,000 were deferred at December 31, 2001 in connection with this
contract as the contract has been identified as a hedging contract. One forward
exchange contract in the notional amount of $9.8 million was outstanding at
December 31, 2001. The Company estimates the fair values of derivatives based on
quoted market prices or pricing models using current market rates. There was no
unrealized loss on derivative instruments as of December 31, 2001.
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
($894,000), $428,000, and $1,467,000 for the years ended December 31, 2001,
2000, and 1999, respectively. These amounts are included in other income (loss),
net, in the statement of operations.
Note 10: Restructuring Charge and Related Activities
In the third quarter of 2001, the Company adopted a plan to transfer all of
its card assembly and test manufacturing operations from its Sunnyvale location
to offshore subcontractors. As a result, the Company recorded a restructuring
charge of $8.5 million. The charge included $1.1 million of severance and
employee related costs for a reduction in workforce of approximately 193
personnel, equipment write-off charges of $6.4 million and lease commitments of
$1.0 million on a vacated warehouse facility.
Workforce Reduction: In the third quarter of 2001, the Company adopted a
plan to reduce its workforce by a total of 193 employees through involuntary
employee separations from October 2001 through April 2002. The Company recorded
a charge of $1.1 million for employee separations in the third quarter of 2001.
As of December 31, 2001, the Company had made severance and benefit payments
related to the planned reduction in force totaling
76
$805,000.
Abandonment of Excess Equipment: As a part of its plan to transfer all card
assembly and test manufacturing operations to offshore subcontractors, the
Company abandoned excess equipment and recorded a charge of $6.4 million in the
third quarter of fiscal 2001.
Abandonment of Excess Leased Facilities: The Company is attempting to
sublease one warehouse building in San Jose, California. Given the current real
estate market condition in the San Jose area, the Company does not expect to be
able to sublease this building before the end of 2003 and as a result, the
Company has recorded a charge of $1.0 million in the third quarter of 2001.
Remaining Payout: Remaining cash expenditures related to the workforce
reduction will be paid by April 2002. Amounts related to the abandonment of
excess leased facilities will be paid as the lease payments are due in 2002 and
2003.
Savings: The Company believes that the savings resulting from the
restructuring activity will contribute to a reduction in manufacturing and
operating expense levels by approximately $11.8 million in fiscal 2002.
The following table reflects the total restructuring charge:
Workforce Lease
--------- -----
Equipment Reduction Commitments Total
----------- --------- ----------- -----
(in thousands)
Restructuring Charge $ 6,383 $ 1,094 $ 1,033 $ 8,510
Write offs and write downs (6,027) - - (6,027)
Cash charges - (805) - (805)
----------- --------- ----------- ----------
Reserve balance, December 31, 2001 $ 356 $ 289 $ 1,033 $ 1,678
=========== ========= =========== ==========
Note 11: Segment Information
During fiscal 2001, 2000 and 1999, the Company operated in one segment, flash
memory products. The Company markets and sells its products in the United States
and in foreign countries through its sales personnel, dealers, distributors,
retailers and its subsidiaries. The Company's chief decision maker, the Chief
Executive Officer, evaluates performance of the Company based on total Company
results. Revenue is evaluated based on geographic region and product category.
Separate financial information is not available by product category in regards
to asset allocation, expense allocation, or profitability.
Geographic Information:
Sales outside the U.S. are comprised of sales to international customers in
Europe, Canada, and Asia Pacific. Other than sales in U.S., Japan and Europe,
international sales were not material individually in any other international
location. Intercompany sales between geographic areas are accounted for at
prices representative of unaffiliated party transactions.
Information regarding geographic areas for the years ended December 31, 2001,
2000, and 1999 are as follows (in thousands):
Years Ended December 31,
2001 2000 1999
---- ---- ----
Revenues:
United States $163,516 $258,715 $ 116,922
77
Japan 105,056 178,564 62,176
Europe 57,386 99,352 22,674
Other foreign countries 40,343 65,181 45,218
-------- -------- --------
Total $366,301 $601,812 $246,990
Long Lived Assets:
United States $186,167 $174,685 $ 25,442
Japan 388 520 261
Europe 23 55 20
Other foreign countries 41,700 198,253 57,273
-------- -------- --------
Total $228,278 $373,513 $ 82,996
======== ======== ========
Revenues are attributed to countries based on the location of the customers.
Long lived assets in other foreign countries includes the long-term investment
in UMC of $25.9 in 2001, $197.7 in 2000 and $51.2 million in 1999 and long-term
investment in Tower of $15.4 in 2001. Long lived assets in the United States
includes the investment in FlashVision of $153.2 and Divio of $7.2 in 2001.
Major Customers
In 2001 and 2000, there were no customers who accounted for more than 10% of
total revenue. In 1999, revenues from one customer represented approximately
$28.0 million or 11%, of consolidated revenues.
Note 12: Accumulated Other Comprehensive Income
Accumulated other comprehensive income presented in the accompanying balance
sheet consists of the accumulated unrealized gains and loses on
available-for-sale marketable securities for all periods presented (in
thousands).
2001 2000 1999
---- ---- ----
Accumulated other comprehensive income (loss) at beginning of year $ (50,412) $ 199 $ 471
Change of accumulated other comprehensive income during the year
Unrealized gain (loss) on investments $ 95,927 $ (50,268) -
Unrealized gain (loss) on available-for-sale securities $ 908 $ (343) $ (272)
--------- ---------- ----------
Accumulated other comprehensive income (loss) at year end $ 46,423 $ (50,412) $ 199
========= ========== ==========
The 2001 unrealized gain on investments included a tax expense of
approximately $29.8 million and the 2000 unrealized loss on investments included
a tax benefit of $34.6 million. The tax effects for other comprehensive income
were immaterial in 1999.
Note 13: Related Parties
The Company has entered into a joint venture agreement with Toshiba, under
which they formed FlashVision, to produce advanced NAND flash memory wafers. In
addition, the Company and Toshiba will jointly develop and share the research
and development expenses of future generations of advanced NAND flash memory
products. The Company also purchases NAND flash memory card products from
Toshiba. In 2001, the Company purchased NAND flash memory wafers and card
products from FlashVision and Toshiba and made payments for shared research and
development expenses totaling approximately $132.3 million in 2001 and $22.0
million in 2000. The Company had accounts payable balances due to FlashVision
and Toshiba of $24.0 million at December 31, 2001 and $7.9 million. The Company
had accrued current liabilities due to Toshiba for joint research and
development expenses of $15.3 million at December 31, 2001 and long-term
liabilities of $4.9 million and $3.5 million as of December 31, 2001 and 2000,
respectively.
78
Note 14: Investment in Joint Venture
The following summarized the financial information for FlashVision at
December 31, 2001 (in thousands). In fiscal 2000, the investment in FlashVision
did not meet the significant subsidiary threshold and therefore, summary
financial information for prior years have been excluded.
December 31, 2001
-----------------
(unaudited)
Current Assets $ 61,601
Property, plant and
equipment and other assets 312,183
Current Liabilities 67,438
The following summarizes financial information for FlashVision for the nine
months ended December 31, 2001 (in thousands).
Nine Months Ended
-----------------
December 31, 2001
-----------------
(unaudited)
Net sales $ 110,706
Gross profit 4,351
Net income 5,160
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
---------------------
Not applicable.
79
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------
Reference is made to the information regarding directors and nominees and
disclosure relating to compliance with Section 16A of the Securities Exchange
Act of 1934 appearing under the captions "Election of Directors" and "Compliance
with Section 16A of the Securities Exchange Act of 1934" in our Proxy Statement
for our Annual Meeting of Stockholders to be held on May 22, 2002, which
information is incorporated in this Form 10-K by reference. Information
regarding executive officers is set forth under the caption "Executive Officers
of the Registrant" in Part I of this Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
----------------------
The information required by this item is set forth under "Executive
Compensation and Related Information" in our Proxy Statement for the 2002 Annual
Meeting of Stockholders, and 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 the caption
"Security Ownership of Certain Beneficial Owners and Management" in our Proxy
Statement for the 2002 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
The information required by this item is set forth under the caption
"Compensation Committee Interlocks and Insider Participation" and "Certain
Transactions" in our Proxy Statement for the 2002 Annual Meeting of
Stockholders, and is incorporated herein by reference.
80
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 52
Consolidated Balance Sheets 53
Consolidated Statements of Operations 54
Consolidated Statements of Stockholders' Equity 55
Consolidated Statements of Cash Flows 56
Notes to Consolidated Financial Statements 57-79
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.
2) Exhibits required by Item 601 of Regulation S-K
A. Exhibits
Exhibit
Number Exhibit Title
------ -------------
3.1 Restated Certificate of Incorporation of the Registrant.(2)
3.2 Certificate of Amendment of the Restated Certificate of
Incorporation of the Registrant.(12)
3.3 Restated Bylaws of the Registrant, as amended to date.
3.4 Certificate of Designation for the Series A Junior
Participating Preferred Stock, as filed with the Delaware
Secretary of State on April 24, 1997.(4)
4.1 Reference is made to Exhibits 3.1, 3.2 and 3.3.(2), (12)
4.2 Amended and Restated Registration Rights Agreement, among the
Registrant and the investors and founders named therein, dated
March 3, 1995.(2)
4.3 Series F Preferred Stock Purchase Agreement between Seagate
Technology, Inc. and the Registrant dated January 15, 1993.(2)
4.4 Rights Agreement, dated as of April 18, 1997, between the
Company and Harris Trust and Savings Bank.(4)
4.5 First Amendment to Rights Agreement dated October 22, 1999,
between Harris Trust and the Registrant.(9)
4.6 Second Amendment to Rights Agreement dated December 17, 1999,
between Harris Trust and the Registrant. (10)
4.7 Indenture, dated as of December 24, 2001, between the
Registrant and The Bank of New York, as Trustee, including the
form of note set forth in Section 2.2 thereof.
4.8 Registration Rights Agreement, dated as of December 24, 2001,
among the Registrant, as Issuer and Morgan Stanley & Co.
Incorporated and ABN AMRO Rothschild LLC, as Initial
Purchasers.
9.1 Amended and Restated Voting Agreement, among the Registrant and
the investors named therein, dated March 3, 1995.(2)
10.1 License Agreement between the Registrant and Dr. Eli Harari,
dated September 6, 1988.(2)
10.2 1989 Stock Benefit Plan.(2), (*)
10.3 Employee Stock Purchase Plan.(2), (*)
81
Exhibit
Number Exhibit Title
------ -------------
10.4 1995 Non-Employee Directors Stock Option Plan.(2), (*)
10.5 Lease Agreement between the Registrant and G.F. Properties,
dated March 1, 1996.(3)
10.6 Amendment to Lease Agreement between the Registrant and G.F.
Properties, dated April 3, 1997.(5)
10.7 Foundry Venture Agreement between the Registrant and United
Microelectronics Corporation, dated June 27, 1997.(1),(6)
10.8 Written Assurances Re: Foundry Venture Agreement between the
Registrant and United Microelectronics Corporation, dated
September 13, 1995.(1), (6)
10.9 Side Letter between Registrant and United Microelectronics
Corporation, dated May 28, 1997.(1), (6)
10.10 Clarification letter with regards to Foundry Venture Agreement
between the Registrant and United Microelectronics Corporation
dated October 24, 1997.(7)
10.11 Lease Agreement between the Registrant and G.F. Properties,
dated June 10, 1998.(8)
10.12 1995 Stock Option Plan Amended and Restated as of December 17,
1998.(10), (*)
10.13 1995 Non-Employee Directors Stock Option Plan Amended and
Restated as of December 17, 1998.(10), (*)
10.14 1995 Employee Stock Purchase Plan Amended and Restated as of
December 17, 1998. (10), (*)
10.15 Master Agreement, dated as of May 9, 2000, by and among the
Registrant, Toshiba Corporation and Semiconductor North
America, Inc.(12),(+)
10.16 Operating Agreement dated as of May 9, 2000, by and between the
Registrant and Semiconductor North America, Inc.(12)
10.17 Common R&D and Participation Agreement, dated as of May 9,
2000, by and between the Registrant and Toshiba
Corporation.(12),(+)
10.18 Product Development Agreement, dated as of May 9, 2000, by and
between the Registrant and Toshiba Corporation.(12),(+)
10.19 Share Purchase Agreement, dated as of July 4, 2000, by and
between the Registrant and Tower Semiconductor Ltd.(13)
10.20 Escrow Agreement, dated as of August 14, 2000, by and
between the Registrant, Tower Semiconductor Ltd. and Union bank
of California, N.A.(13)
10.21 Additional Purchase Obligation Agreement, dated as of July 4,
2000, by and between the Registrant and Tower Semiconductor
Ltd.(13)
10.22 Shareholders Agreement, dated as of July 4, 2000, by and
between the Registrant and the Israel Corporation.(13)
10.23 Definitive Agreement to Form Vending Business, dated August 7,
2000, by and between the Registrant and Photo-Me International,
Plc.(13),(+)
10.24 Non-Solicitation Agreement, dated August 7, 2000, by and
between the Registrant, DigitalPortal Inc. and Photo-Me
International, Plc.(13),(+)
10.25 Exclusive Product Purchase Agreement, dated as of August 7,
2000, by and between Photo-Me, International Plc., and
DigitalPortal Inc. (13),(+)
10.26 Stockholders' Agreement, dated as of August 7, 2000, by and
among the Registrant, DigitalPortal Inc. and Photo-Me,
International, Plc.(13),(+)
10.27 Bylaws of DigitalPortal Inc.(13),(+)
10.28 Registration Rights Agreement, dated as of January 18, 2001, by
and between Registrant, The Israel Corporation, Alliance
Semiconductor Ltd., Macronix International Co., Ltd. and Quick
Logic Corporation (14)
10.29 Consolidated Shareholders Agreement, dated as of January 18,
2001, by and among Registrant, The Israel Corporation, Alliance
Semiconductor Ltd. And Macronix International Co., Ltd. (14)
10.30 Appendix 1 to FlashVision L.L.C. 2000 lease financing agreement
between FlashVision L.L.C. Corporation to ABN AMRO Bank N.V.
(15), (+)
82
Exhibit
Number Exhibit Title
------ -------------
10.31 Master Lease agreement between FlashVision L.L.C. Corporation
to ABN AMRO Bank N.V. (15), (+)
10.32 Guarantee, dated as of December 27, 2000 from SanDisk
Corporation to ABN AMRO Bank N.V., related to FlashVision
L.L.C. 2000 lease financing. (15), (+)
10.33 Memorandum of Understanding, dated as of December 17, 2001 by
and between the Registrant and Toshiba Corporation. (++)
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors
______________
* Indicates management contract or compensatory plan or arrangement.
+ Confidential treatment has been granted for certain portions thereof.
++ Confidential treatment has been requested for certain portions thereof.
1. Confidential treatment granted as to certain portions of these exhibits.
2. Previously filed as an Exhibit to the Registrant's Registration Statement
on Form S-1 (No. 33-96298).
3. Previously filed as an Exhibit to the Registrant's 1995 Annual Report on
Form 10-K.
4. Previously filed as an Exhibit to the Registrant's Current Report on
Form 8-K/A dated April 18, 1997.
5. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended June 30, 1997.
6. Previously filed as an Exhibit to the Registrant's Current Report on form
8-K dated October 16, 1997.
7. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended September 30, 1997.
8. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended June 30, 1998.
9. Previously filed as an Exhibit to the Registrant's Current Report on Form
8-K dated January 1, 1999.
10. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended March 31, 1999.
11. Previously filed as an Exhibit to the Registrant's 1999 Annual Report on
Form 10-K.
12. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended June 30, 2000.
13. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended September 30, 2000.
14. Previously filed as an Exhibit to the Registrant's Schedule 13(d) dated
January 26, 2001.
15. Previously filed as an Exhibit to the Registrant's 2000 Annual Report on
Form 10-K.
B. Reports on Form 8-K
On December 19, 2001, the Registrant filed a Current Report on Form 8-K
reporting under Item 5 the signing of the Memorandum of Understanding with
Toshiba Corporation and the Offering of Convertible Subordinated Notes by the
Registrant.
83
Consent of Ernst & Young LLP, Independent Auditors
We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 33-96298, No. 333-32039, No. 333-63076 and No. 333-83193)
pertaining to the 1995 Stock Option Plan, 1995 Non-Employee Directors Stock
Option Plan, Employee Stock Purchase Plan and Special Stock Option Plan (as
amended and restated February 23, 2000) of SanDisk Corporation of our report
dated January 21, 2002 (except for Note 3, as to which the date is March 5,
2002) with respect to the consolidated financial statements of SanDisk
Corporation included in this Annual Report (Form 10-K) for the year ended
December 31, 2001.
/s/ Ernst & Young LLP
San Jose, California
March 26, 2002
84
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/ Michael Gray
---------------------------------
Michael Gray
Principal Financial and Accounting
Officer, Vice President, Finance
(on behalf of the Registrant)
DATED: March 26, 2002
--------------
85
POWER OF ATTORNEY
KNOW ALL PEOPLE BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Dr. Eli Harari and Michael Gray, jointly and
severally, his or her attorneys in fact, each with the power of substitution,
for him or her in any and all capacities, to sign any amendments to this Report
on Form 10-K, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys in fact, or his or her
substitute or substitutes, may do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, this Report has been signed below by the following persons in the
capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
By: /s/ Dr. Eli Harari President, Chief Executive Officer March 27, 2002
---------------------------- and Director
(Dr. Eli Harari)
By: /s/ Irwin Federman Chairman of the Board, Director March 27, 2002
----------------------------
(Irwin Federman)
By: /s/ Michael Gray March 27, 2002
----------------------------
(Michael Gray) Vice President, Finance
And Principal Financial
and Accounting Officer
By: /s/ William V. Campbell
----------------------------
(William V. Campbell) Director March 27, 2002
By: /s/ Catherine P. Lego Director March 27, 2002
----------------------------
(Catherine P. Lego)
By: /s/ Dr. James D. Meindl Director March 27, 2002
----------------------------
(Dr. James D. Meindl)
By: /s/ Alan F. Shugart Director March 27, 2002
------------------------------
(Alan F. Shugart)
86
INDEX TO EXHIBITS
Exhibit
Number Exhibit Title
- ------ -------------
3.1 Restated Certificate of Incorporation of the Registrant.(2)
3.2 Certificate of Amendment of the Restated Certificate of
Incorporation of the Registrant.(12)
3.3 Restated Bylaws of the Registrant, as amended to date.
3.4 Certificate of Designation for the Series A Junior Participating
Preferred Stock, as filed with the Delaware Secretary of State on
April 24, 1997.(4)
4.1 Reference is made to Exhibits 3.1, 3.2 and 3.3.(2), (12)
4.2 Amended and Restated Registration Rights Agreement, among the
Registrant and the investors and founders named therein, dated March
3, 1995.(2)
4.3 Series F Preferred Stock Purchase Agreement between Seagate
Technology, Inc. and the Registrant dated January 15, 1993.(2)
4.4 Rights Agreement, dated as of April 18, 1997, between the Company
and Harris Trust and Savings Bank.(4)
4.5 First Amendment to Rights Agreement dated October 22, 1999, between
Harris Trust and the Registrant.(9)
4.6 Second Amendment to Rights Agreement dated December 17, 1999,
between Harris Trust and the Registrant.(10)
4.7 Indenture, dated as of December 24, 2001, between the Registrant and
The Bank of New York, as Trustee, including the form of note set
forth in Section 2.2 thereof.
4.8 Registration Rights Agreement, dated as of December 24, 2001, among
the Registrant, as Issuer and Morgan Stanley & Co. Incorporated and
ABN AMRO Rothschild LLC, as Initial Purchasers.
9.1 Amended and Restated Voting Agreement, among the Registrant and the
investors named therein, dated March 3, 1995.(2)
10.1 License Agreement between the Registrant and Dr. Eli Harari, dated
September 6, 1988.(2)
10.2 1989 Stock Benefit Plan.(2), (*)
10.3 Employee Stock Purchase Plan.(2), (*)
10.4 1995 Non-Employee Directors Stock Option Plan.(2), (*)
10.5 Lease Agreement between the Registrant and G.F. Properties, dated
March 1, 1996.(3)
10.6 Amendment to Lease Agreement between the Registrant and G.F.
Properties, dated April 3, 1997.(5)
10.7 Foundry Venture Agreement between the Registrant and United
Microelectronics Corporation, dated June 27, 1997.(1),(6)
10.8 Written Assurances Re: Foundry Venture Agreement between the
Registrant and United Microelectronics Corporation, dated September
13, 1995.(1), (6)
10.9 Side Letter between Registrant and United Microelectronics
Corporation, dated May 28, 1997.(1), (6)
10.10 Clarification letter with regards to Foundry Venture Agreement
between the Registrant and United Microelectronics Corporation
dated October 24, 1997.(7)
10.11 Lease Agreement between the Registrant and G.F. Properties, dated
June 10, 1998.(8)
10.12 1995 Stock Option Plan Amended and Restated as of December 17,
1998.(10), (*)
10.13 1995 Non-Employee Directors Stock Option Plan Amended and Restated
as of December 17, 1998.(10), (*)
10.14 1995 Employee Stock Purchase Plan Amended and Restated as of
December 17, 1998. (10), (*)
10.15 Master Agreement, dated as of May 9, 2000, by and among the
Registrant, Toshiba Corporation and Semiconductor North America,
Inc.(12),(+)
10.16 Operating Agreement dated as of May 9, 2000, by and between the
Registrant and Semiconductor North America, Inc.(12)
10.17 Common R&D and Participation Agreement, dated as of May 9, 2000, by
and between the Registrant and Toshiba Corporation.(12),(+)
10.18 Product Development Agreement, dated as of May 9, 2000, by and
between the Registrant and
Exhibit
Number Exhibit Title
- ------ -------------
Toshiba Corporation.(12),(+)
10.19 Share Purchase Agreement, dated as of July 4, 2000, by and between
the Registrant and Tower Semiconductor Ltd.(13)
10.20 Escrow Agreement, dated as of August 14, 2000, by and between the
Registrant, Tower Semiconductor Ltd. and Union bank of California,
N.A.(13)
10.21 Additional Purchase Obligation Agreement, dated as of July 4, 2000,
by and between the Registrant and Tower Semiconductor Ltd.(13)
10.22 Shareholders Agreement, dated as of July 4, 2000, by and between the
Registrant and the Israel Corporation.(13)
10.23 Definitive Agreement to Form Vending Business, dated August 7, 2000,
by and between the Registrant and Photo-Me International,
Plc.(13),(+)
10.24 Non-Solicitation Agreement, dated August 7, 2000, by and between the
Registrant, DigitalPortal Inc. and Photo-Me International,
Plc.(13),(+)
10.25 Exclusive Product Purchase Agreement, dated as of August 7, 2000, by
and between Photo-Me, International Plc., and DigitalPortal Inc.
(13),(+)
10.26 Stockholders' Agreement, dated as of August 7, 2000, by and among
the Registrant, DigitalPortal Inc. and Photo-Me, International, Plc.
(13),(+)
10.27 Bylaws of DigitalPortal Inc.(13),(+)
10.28 Registration Rights Agreement, dated as of January 18, 2001, by and
between Registrant, The Israel Corporation, Alliance Semiconductor
Ltd., Macronix International Co., Ltd. and Quick Logic Corporation
(14)
10.29 Consolidated Shareholders Agreement, dated as of January 18, 2001,
by and among Registrant, The Israel Corporation, Alliance
Semiconductor Ltd. And Macronix International Co., Ltd. (14)
10.30 Appendix 1 to FlashVision L.L.C. 2000 lease financing agreement
between FlashVision L.L.C. Corporation to ABN AMRO Bank N.V. (15),
(+)
10.31 Master Lease agreement between FlashVision L.L.C. Corporation to ABN
AMRO Bank N.V. (15), (+)
10.32 Guarantee, dated as of December 27, 2000 from SanDisk Corporation to
ABN AMRO Bank N.V., related to FlashVision L.L.C. 2000 lease
financing. (15), (+)
10.33 Memorandum of Understanding, dated as of December 17, 2001 by and
between the Registrant and Toshiba Corporation. (++)
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors
______________
* Indicates management contract or compensatory plan or arrangement.
+ Confidential treatment has been granted for certain portions thereof.
++ Confidential treatment has been requested for certain portions thereof.
1. Confidential treatment granted as to certain portions of these exhibits.
2. Previously filed as an Exhibit to the Registrant's Registration Statement
on Form S-1 (No. 33-96298).
3. Previously filed as an Exhibit to the Registrant's 1995 Annual Report on
Form 10-K.
4. Previously filed as an Exhibit to the Registrant's Current Report on
Form 8-K/A dated April 18, 1997.
5. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended June 30, 1997.
6. Previously filed as an Exhibit to the Registrant's Current Report on form
8-K dated October 16, 1997.
7. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended September 30, 1997.
8. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended June 30, 1998.
9. Previously filed as an Exhibit to the Registrant's Current Report on Form
8-K dated January 1, 1999.
10. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended March 31, 1999.
11. Previously filed as an Exhibit to the Registrant's 1999 Annual Report on
Form 10-K.
12. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended June 30, 2000.
13. Previously filed as an Exhibit to the Registrant's Form 10-Q for the
quarter ended September 30, 2000.
14. Previously filed as an Exhibit to the Registrant's Schedule 13(d) dated
January 26, 2001.
15. Previously filed as an Exhibit to the Registrant's 2000 Annual Report on
Form 10-K.