SanDisk 2005 Annual Report Download - page 108

Licensing and Royalties. The timing and amount of royalty revenues and the recognition of license fees can
vary substantially from quarter to quarter depending on the terms of our license agreements and the timing and
volume of sales of products by our licensees. Gross margins and operating income fluctuate more with changes in
license and royalty revenues than with changes in product revenues since license and royalty revenues have
immaterial variable costs of sale.
Retail Sales. Our arrangements with retailers often involve complex terms. These terms include providing
the retailer with a right to return unsold product, market development funds, cooperative advertising funds, price
protection, volume incentive rebates and other promotions. In some cases, we consign inventory to our customers.
These consignment activities involve administrative costs to track and account for our inventory. We defer
recognition of revenue on sales to retailers and distributors until they sell-through the product they have purchased
from us to their customers. Our retail business is seasonal, with the fourth quarter being the strongest due to holiday
sales in North America.
Memory Market Dynamics. Semiconductor memory markets have generally been characterized by cycles of
undersupply and oversupply. In an oversupply environment, price reductions occur and the value of our inventory
may decrease resulting in a lower of cost or market price adjustment if pricing pressure results in a net realizable
value that is lower than our cost. In 2001, for example, we recorded approximately $85.0 million of charges related
to inventory revaluation. We may be forced to reduce the carrying value of our inventory if market demand for our
products deteriorates and our inventory levels exceed customer orders.
Our business is characterized by constant focus on cost reduction. NAND flash memory cost reduction is
achieved by transitioning to new generations of technology, by producing larger wafer sizes and by improving
yields. Manufacturing yields are lower at the start of manufacturing each successive product generation. 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. In the next two to three years, we expect to make substantial
new investments in additional fabrication capacity in the ventures with Toshiba.
Matrix Acquisition. On January 13, 2006, we acquired Matrix Semiconductor, Inc. Matrix is a pioneer in the
design and development of three-dimensional (3-D) integrated circuits. Matrix 3-D memory is used for one-time
programmable storage applications where low cost is the paramount consideration, such as video games, music and
archiving.
Critical Accounting Policies & Estimates
Our discussion and analysis of our financial condition and results of operations is 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, among others, those related to customer programs and
incentives, product returns, bad debts, inventories and related reserves, investments, income taxes, warranty
obligations, stock compensation, contingencies and litigation. We base our estimates on historical experience and
on other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for
our judgments about the carrying values of assets and liabilities when those values are not readily apparent from
other sources. Estimates have historically approximated actual results. However, future results will differ from these
estimates under different assumptions and conditions.
Revenue Recognition, Sales Returns and Allowances and Sales Incentive Programs. We recognize 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 reasonable assurance of realization. Sales made to distributors and
retailers are generally under agreements allowing price protection and/or right of return and, therefore, the sales and
related costs of these transactions are deferred until the retailers or distributors sell the merchandise to their end
customer, or the rights of return expire. At January 1, 2006 and January 2, 2005, deferred income, from sales to
distributors and retailers was $139.9 million and $82.0 million, respectively. Estimated sales returns are provided
for as a reduction to product revenue and deferred revenue and were not material for any period presented in our
consolidated financial statements.
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Annual Report