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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
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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 mi