Form 10-Q

Commission File Number 0-26734

SanDisk Corporation

(408) 542-0500

N/A

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [  ]

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes [X] No [  ]

Indicate the number of shares outstanding of each of the issuer’s classes of capital stock as of March 28, 2004.

SanDisk Corporation

Index

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PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

SANDISK CORPORATION

*Information derived from the audited Consolidated Financial Statements.

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SANDISK CORPORATION

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SANDISK CORPORATION

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SANDISK CORPORATION

     1. Basis of Presentation

     These interim condensed consolidated financial statements are unaudited but reflect, in the opinion of management, all adjustments, consisting of normal recurring adjustments and accruals, necessary to present fairly the financial position of SanDisk Corporation and its subsidiaries (the “Company”) as of March 28, 2004, and the results of operations and cash flows for the three-month periods ended March 28, 2004 and March 30, 2003. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted in accordance with the rules and regulations of the Securities and Exchange Commission. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s annual report on Form 10-K as of, and for, the year ended December 28, 2003. Certain prior period amounts have been reclassified to conform to the current period presentation.

     The Company’s results of operations and cash flows for the three-month period ended March 28, 2004 are not necessarily indicative of results that may be expected for the year ended January 2, 2005, or for any future period.

     The Company’s fiscal year ends on the Sunday closest to December 31, and its fiscal quarters end on the Sunday closest to March 31, June 30, and September 30. The first fiscal quarters of 2004 and 2003 ended on March 28, 2004 and March 30, 2003. Fiscal year 2004 is 53 weeks long and ends on January 2, 2005. Fiscal year 2003 was 52 weeks long and ended on December 28, 2003.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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.

     2. Summary of Significant Accounting Policies

     Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

     Foreign Currency Translation. The U.S. dollar is the functional currency for most of the Company’s foreign operations. Gains and losses on the re-measurement into U.S. dollars of the amounts denominated in foreign currencies are included in the net income (loss) for those operations whose functional currency is the U.S. dollar and translation adjustments are included in other comprehensive income and as accumulated other comprehensive income, for those operations whose functional currency is the local currency. The Japanese Yen is the functional currency for the Company’s FlashVision joint venture.

     Warranty Costs. The majority of the Company’s products are warrantied for one to five years. A provision for the estimated future cost related to warranty expense is recorded and included in the cost of revenue when shipment occurs. The Company’s warranty obligation is affected by product failure rates and repair or replacement costs incurred in supporting a product failure. The Company’s warranty obligation can be affected by seasonality as well as changes in product shipment levels. Should actual product failure rates, repair or replacement costs differ from the Company’s estimates, adjustments to its warranty liability would be required.

     The Company’s warranty activity is as follows (in thousands):

     Stock-Based Compensation. The Company accounts for employee stock-based compensation using the intrinsic value method and accordingly, no expense has been recognized for options granted to employees under the plans as the grant

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price is set at the fair market value of the stock on the day of grant. The following table summarizes relevant information as if the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” had been applied to all stock-based awards:

     The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted-average assumptions for grants made as of March 28, 2004 and March 30, 2003:

     The per share weighted-average fair value of options granted during the first quarters of fiscal 2004 and 2003 were $24.68 and $6.58, respectively.

     The pro forma net income and pro forma net income per share amounts listed above include expenses related to our employee stock purchase plans. The fair value of issuances under the employee stock purchase plans is estimated on the date of issuance using the Black-Scholes model, with the following weighted-average assumptions for issuances made as of March 28, 2004 and March 30, 2003, respectively:

     Recent Accounting Pronouncements. In December 2003, the Financial Accounting Standards Board (FASB) issued a revision to Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46R”). FIN 46R clarifies the application of ARB No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support provided by any parties, including the equity holders. FIN 46R requires the consolidation of these entities, known as variable interest entities (“VIEs”), by the primary beneficiary of the entity. The primary beneficiary is the entity, if any, that will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both.

     Among other changes, the revisions of FIN 46R (a) clarified some requirements of the original FIN 46, which had been issued in January 2003, (b) eased some implementation matters, and (c) added new scope exceptions. FIN 46R deferred the effective date of the Interpretation for public companies to the end of the first reporting period ending after March 15, 2004, except that all public companies must at a minimum apply the unmodified provisions of the Interpretation to entities that were previously considered “special-purpose entities” in practice and under the FASB literature prior to the issuance of FIN 46R by the end of the first reporting period ending after December 15, 2003.

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     Among the scope exceptions, companies are not required to apply FIN 46R to an entity that meets the criteria to be considered a “business” as defined in the Interpretation unless one or more of four named conditions exist. FIN 46R applies immediately to a VIE created or acquired after January 31, 2003.

     The Company has reviewed its investment portfolio to determine whether any of its equity investments are considered variable interest entities. The Company did not identify any variable interest entities that must be consolidated as of March 28, 2004, but has made the required additional disclosures.

     3. 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 estimated costs of disposal. Inventories are as follows (in thousands):

     The Company writes down its inventory to a new basis 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.

     In the first three months of fiscal 2004 and 2003, the Company sold approximately $2.2 million and $1.8 million of inventory that had been fully written off in previous periods. The Company may be forced to take additional write-downs for excess or obsolete inventory in future quarters if inventory levels exceed forecasted customer orders. In addition, the Company may record 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 maintain its inventory in line with the near-term forecasted level of business, the Company is obligated to honor existing purchase orders that 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 in times when the demand forecast is reduced.

     4. Accumulated Other Comprehensive Income

     Accumulated other comprehensive income presented in the accompanying balance sheet consists of the accumulated unrealized gains and losses on available-for-sale marketable securities, including the short-term portion of the Company’s investments in United Microelectronics, Inc., or UMC, and Tower, net of the related tax effects, for all periods presented.

     Total accumulated other comprehensive income was $38.9 million and $39.1 million at March 28, 2004 and December 28, 2003, respectively and included gains, net of taxes, on the Company’s investment in (i) UMC of $4.8 million at March 28, 2004 and $4.7 million at December 28, 2002 and (ii) Tower of $33.5 million and $34.0 million at the same dates, respectively. The amount of income tax (benefit) allocated to unrealized gain/loss on investments was ($3.5) million and ($3.2) million as of March 28, 2004 and December 28, 2003, respectively (See also Note 8). The amount of income tax

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expense allocated to unrealized gain on available-for-sale securities was not significant at March 28, 2004 and December 28, 2003, respectively.

     Accumulated other comprehensive income presented in the accompanying condensed consolidated balance sheet consists of the accumulated gains and losses on available-for-sale marketable securities, net of taxes, for all periods presented. Comprehensive income is as follows (in thousands):

     5. Net Income per Share

     The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):

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     Basic net income per share excludes any dilutive effects of options, warrants and convertible securities. Diluted net income per share includes the dilutive effects of stock options, warrants, and convertible securities. For the first quarter of 2004 and 2003, options to purchase 5,164,740 and 8,067,418 shares of common stock, respectively, have been omitted from the diluted net income 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.

     6. Commitments, Litigation, Contingencies and Guarantees

Commitments

     The terms of the FlashVision joint venture, as described in Note 8, contractually obligate the Company to purchase half of FlashVision’s NAND wafer production output. The Company also has the ability to purchase additional capacity under a foundry arrangement with Toshiba. Under the terms of the Company’s foundry agreement with Toshiba, the Company is required to provide Toshiba with a purchase order commitment based on a six-month rolling forecast. The purchase orders placed under this arrangement relating to the first three months of the six-month forecast are binding, are at market prices and cannot be cancelled. At March 28, 2004, approximately $20.1 million of non-cancelable purchase orders for flash memory wafers from Toshiba and FlashVision were outstanding. In addition, as a part of the joint venture agreement with Toshiba, the Company is required to fund certain research and development expenses related to the development of advanced NAND flash memory technologies. As of March 28, 2004, the Company had accrued liabilities related to those expenses of $8.1 million. The common research and development amount is a variable computation with certain payment caps. Future obligations are to be paid in installments using a percentage of the Company’s revenue from NAND flash products built with flash memory supplied by Toshiba or FlashVision. The direct research and development is a pre-determined amount that extends through the third quarter of 2004. Subsequent to the third quarter of 2004, direct research and development liabilities will be computed using a variable percentage of actual research and development expenses incurred.

     Given the current apparent acceleration in global demand for flash memory wafers and assuming that the markets for the Company’s products continue their current growth, new anticipated demand from customers may outstrip the supply of flash memory wafers available to the Company from all its current sources. In that case, the Company may need to secure for itself substantial additional flash memory wafer fabrication capacity at .09 micron and finer line lithography. Accordingly, the Company and Toshiba are currently discussing various fabrication and test capacity expansion plans for the FlashVision operation in Yokkaichi, Japan. Toshiba and the Company plan to substantially expand and increase Yokkaichi’s 200 mm Flash memory wafer output in 2004 and 2005. The capacity expansion will be partially funded through FlashVision internally generated funds, as well as through substantial additional investments by Toshiba and SanDisk. In February 2004, the Company committed to loan FlashVision up to approximately $150.4 million, based upon the exchange rate in effect on that date, to fund additional 200-millimeter fabrication capacity through the first quarter of fiscal 2005. Through March 28, 2004, the Company had funded approximately $22.2 million under this loan arrangement at an interest rate of TIBOR plus 0.35%. This loan is secured by the equipment purchased by FlashVision using the loan proceeds. Additional loans are expected to be made in several tranches through the first quarter of 2006. Because the Company’s funding obligation is denominated in Japanese Yen, the amount of the Company’s obligation on a given date when converted to U.S. dollars will fluctuate based on the exchange rate in effect on that date.

     In December 2003, Toshiba and the Company announced their intention to, and signed a non-binding Memorandum of Understanding, or MOU, in April 2004 with respect to cooperating in the construction of a new 300-millimeter wafer fabrication facility, Fab 3, at Toshiba’s Yokkaichi operations. The Company and Toshiba are currently in discussions regarding the definitive terms of this proposed venture. The non-binding MOU contemplates that, as under the current FlashVision joint venture, the Company would be obligated to purchase half of Fab 3’s NAND wafer production output. Toshiba would construct the Fab 3 building, depreciation of the Fab 3 building would be a component of the cost to each party of wafers produced by Fab 3, and both parties would provide funds for the manufacturing equipment. Toshiba began construction of the building in April 2004. The Company may agree that in the event that the Company and Toshiba do not execute definitive agreements with respect to Fab 3, the Company will reimburse Toshiba for 50% of certain start-up costs and Fab 3 Company formation costs incurred by Toshiba and for cancellation fees due under authorized contractor and vendor invoices for orders placed by Toshiba for certain equipment and construction materials for Fab 3 that Toshiba cannot otherwise use, which amounts would be substantial. The total investment in Fab 3, excluding the cost of building construction which will be borne by Toshiba, is currently estimated at $2.5 billion through the end of 2006, of which the Company’s share is estimated to be approximately $1.3 billion, with initial production currently scheduled for the end of 2005. Fab 3 has available space to

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expand capacity beyond 2006, and further investments to increase such output would be shared equally. If the Company and Toshiba agree upon and execute definitive agreements with respect to Fab 3, the Company will need to raise additional capital for its portion of the investment. In addition to its initial investment in expansion at Yokkaichi and in Fab 3, if definitive agreements for Fab 3 are signed by the Company and Toshiba, for several quarters the Company will incur substantial start-up expenses related to the hiring and training of manufacturing personnel, facilitizing the clean room and installing equipment at the expanded fabrication facility and at Fab 3.

     At March 28, 2004, the Company had approximately $108.4 million of total non-cancelable outstanding purchase orders with its suppliers and subcontractors. The following summarizes the Company’s contractual cash obligations, commitments and off balance sheet arrangements at March 28, 2004, and the effect such obligations are expected to have on its liquidity and cash flow in future periods (in thousands).

Contractual Obligations and Off Balance Sheet Arrangements

(1) FlashVision binding three-month purchase commitments for flash memory wafers are denominated in Japanese Yen, and are subject to fluctuation in exchange rates prior to payment.

(2) Includes a loan to FlashVision entered into in February 2004.

(3) Excludes potential Fab 3 FlashVision agreement, as definitive agreements are not final.