Form 10-Q

SECURITIES AND EXCHANGE COMMISSION

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 o

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

Yes x No o

Indicate the number of shares outstanding of each of the issuer’s classes of capital stock as of September 26, 2004.

SanDisk Corporation

Index

2

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

SANDISK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

*Information derived from the audited Consolidated Financial Statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.

3

SANDISK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(unaudited)

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

4

SANDISK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)

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

5

SANDISK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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 September 26, 2004, and the results of operations for the three and nine-month periods ended September 26, 2004 and September 28, 2003 and cash flows for the nine-month periods ended September 26, 2004 and September 28, 2003. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles 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 for the three-month and nine-month periods and cash flows for the nine-month period ended September 26, 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. The second fiscal quarters of 2004 and 2003 ended on June 27, 2004 and June 29, 2003. The third fiscal quarters of 2004 and 2003 ended on September 26, 2004 and September 28, 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 U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The accounting estimates that require management’s most significant judgments include: the assessment of sales returns and allowances, sales incentive programs, allowance for doubtful accounts, warranty cost, valuation of financial instruments including investments in foundries, inventory valuation, and deferred tax assets. The Company’s actual results may differ materially from management’s 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 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 and Flash Partners business ventures.

     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

6

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.

     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 has identified its FlashVision and Flash Partners business ventures as variable interest entities but as the Company is not the primary beneficiary, the Company does not consolidate these entities, but has made the required additional disclosures, see Notes 8 and 10.

     In March 2004, the Financial Accounting Standards Board (FASB) approved the consensus reached on the Emerging Issues Task Force (EITF) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The objective of this Issue is to provide guidance for identifying impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. The accounting provisions of EITF 03-1 are effective for all reporting periods beginning after June 15, 2004, while the disclosure requirements are effective only for annual periods ending after June 15, 2004. The Company has evaluated the impact of the adoption of EITF 03-1 and determined that the impact was not significant to the Company’s overall results of operations or financial position.

3. 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 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 (see also Note 7). For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes option pricing model and amortized ratably to expense over the options’ vesting periods. Because the estimated value is determined as of the date of grant, the actual value ultimately realized by the employee may be significantly different.

7

     The per share weighted-average fair value of options granted during the third quarters of fiscal 2004 and 2003 were $15.70 and $21.43, respectively. The per share weighted-average fair value of options granted during the first nine months of fiscal 2004 and 2003 were $22.80 and $7.86, respectively.

     The value of options granted was estimated on the date of grant using the following weighted-average assumptions:

     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 was estimated on the date of issuance, with the following weighted-average assumptions:

     A summary of activity under all stock option plans follows (shares in thousands):

4. Warranty

     The Company’s warranty activity is as follows:

8

     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 at the time of customer invoice. The Company’s warranty obligation is affected by product failure rates and repair or replacement costs incurred in supporting a product failure. The Company recorded net warranty liability adjustments, totaling approximately ($1.0) million and ($0.6) million, respectively, during the three and nine months ended September 26, 2004 related to revisions to estimates for specific warranty liability requirements recorded in previous periods.

5. Inventories

     Inventories are stated at the lower of cost or market. Cost is computed on a currently adjusted standard 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 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. The Company’s finished goods inventory includes consigned inventory held at certain retail customer locations as well as at third party fulfillment centers and subcontractors. In the third quarter and first nine months of fiscal 2004 and 2003, the Company sold approximately $1.9 million, $6.8 million, $8.4 million and $13.9 million, respectively of inventory that had been fully written off in previous periods.

6. Accumulated Other Comprehensive (Loss) 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 Company’s investments in United Microelectronics, Inc., or UMC, and the short-term portion of the Company’s investment in Tower Semiconductor Ltd., or Tower, net of the related tax effects, for all periods presented.