SanDisk 2006 Annual Report Download - page 64

Our business and the markets we address are subject to significant fluctuations in supply and demand and our
commitments to our ventures with Toshiba may result in periods of significant excess inventory. With the ramp to
volume production at Fab 3 in fiscal 2006, our captive memory supply increased substantially more than in either of
the last two years. Our obligation to purchase 50% of the supply from FlashVision, Flash Partners and Flash
Alliance, the ventures with Toshiba, could harm our business and results of operations if our committed supply
exceeds demand for our products. The adverse effects could include, among other things, significant decreases in
our product prices, significant excess, obsolete or lower of cost or market inventory write-downs and the
impairment of our investments in the ventures with Toshiba. For example, in the fourth quarter of fiscal 2006,
over 90% of our NAND memory wafer purchases were from our ventures with Toshiba. These effects will be
magnified once the Flash Alliance venture commences production. Any future excess supply could have a material
adverse effect on our business, financial condition and results of operations.
We depend on third-party foundries for silicon supply and any shortage or disruption in our supply from these
sources will reduce our revenues, earnings and gross margins. All of our flash memory card products require
silicon supply for the memory and controller components. The substantial majority of our flash memory is currently
supplied by our ventures with Toshiba and by Toshiba pursuant to our foundry agreement, and to a lesser extent by
Samsung and Hynix. Any disruption in supply of flash memory from our captive or non-captive sources would harm
our operating results. We intend to increase production at Fab 3, commence production at Fab 4 and continue to
procure wafers from non-captive sources. If the Fab 3 production ramp does not increase as anticipated, we fail to
commence production at Fab 4 as planned, Fab 4 does not meet anticipated manufacturing output, or our non-
captive sources fail to supply wafers in the amounts and at the times we expect, we may not have sufficient supply to
meet demand and our operating results could be harmed. Currently, our controller wafers are only manufactured by
Tower and UMC, and some of these controllers are sole-sourced at either UMC or Tower. Any disruption in the
manufacturing operations of Tower or UMC would result in delivery delays, would adversely affect our ability to
make timely shipments of our products and would harm our operating results until we could qualify an alternate
source of supply for our controller wafers, which could take three or more quarters to complete. In times of
significant growth in global demand for flash memory, demand from our customers may outstrip the supply of flash
memory and controllers available to us from our current sources. If our silicon vendors are unable to satisfy our
requirements on competitive terms or at all due to lack of capacity, technological difficulties, natural disaster,
financial difficulty, power failure, labor unrest, their refusal to do business with us, their relationships with our
competitors or other causes, we may lose potential sales and our business, financial condition and operating results
may suffer. In addition, these risks are magnified at Toshiba’s Yokkaichi, Japan operations, where the current
ventures are operated, Fab 4 is being constructed, and Toshiba’s foundry capacity is located. Earthquakes and power
outages have resulted in production line stoppage and loss of wafers in Yokkaichi and similar stoppages and losses
may occur in the future. For example, in the first quarter of fiscal 2006, a brief power outage in Fab 3 resulted in a
loss of wafers and significant costs associated with bringing the fab back on line. Also, the Tower fabrication
facility, from which we source controller wafers, is facing financial challenges and is located in Israel, an area of
political and military turmoil. Any disruption or delay in supply from our silicon sources could significantly harm
our business, financial condition and results of operations.
If actual manufacturing yields are lower than our expectations, this may result in increased costs and product
shortages. The fabrication of our products requires wafers to be produced in a highly controlled and ultra clean
environment. Semiconductor manufacturing yields and product reliability are a function of both design technology
and manufacturing process technology and production delays may be caused by equipment malfunctions, fab-
rication facility accidents or human errors. Yield problems may not be identified or improved until an actual product
is made and can be tested. As a result, yield problems may not be identified until the wafers are well into the
production process. We have from time-to-time experienced yields that have adversely affected our business and
results of operations. We have experienced adverse yields on more than one occasion when we have transitioned to
new generations of products. If actual yields are low, we will experience higher costs and reduced product supply,
which could harm our business, financial condition and results of operations. For example, if the production ramp
and/or yield of the 56-nanometer, 300-millimeter Flash Partners’ wafers do not increase as expected, we may not
have enough supply to meet demand and our cost competitiveness, business, financial condition and results of
operations will be harmed.
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