SanDisk 2006 Annual Report Download - page 65

We depend on our third-party subcontractors and our business could be harmed if our subcontractors do not
perform as planned. We rely on third-party subcontractors for our wafer testing, IC assembly, packaged testing,
product assembly, product testing and order fulfillment. From time-to-time, our subcontractors have experienced
difficulty in meeting our requirements. If we are unable to increase the capacity of our current subcontractors or
qualify and engage additional subcontractors, we may not be able to meet demand for our products. We do not have
long-term contracts with our existing subcontractors nor do we expect to have long-term contracts with any new
subcontract suppliers. We do not have exclusive relationships with any of our subcontractors, and therefore, cannot
guarantee that they will devote sufficient resources to manufacturing our products. We are not able to directly
control product delivery schedules. Furthermore, we manufacture on a turnkey basis with some of our subcontract
suppliers. In these arrangements, we do not have visibility and control of their inventories of purchased parts
necessary to build our products or of the progress of our products through their assembly line. Any significant
problems that occur at our subcontractors, or their failure to perform at the level we expect, could lead to product
shortages or quality assurance problems, either of which would have adverse effects on our operating results.
We are constructing a captive assembly and test manufacturing facility in China. The Chinese government
recently approved a 50-year lease by us of a piece of land to construct and equip a captive assembly and test
manufacturing facility in the Zizhu Science-Based Park near Shanghai, China. Our anticipated expenditure for this
project is approximately $170 million, of which approximately $150 million is expected to be paid in fiscal 2007.
Any delays in the construction and equipping of the facility would harm our results of operations and financial
condition. Once constructed, this facility is only intended to replace a portion of our test and assembly needs and
therefore, we will continue to depend on our third-party subcontractors for a majority of our test and assembly
needs.
In transitioning to new processes, products and silicon sources, we face production and market acceptance
risks that have caused, and may in the future continue to cause significant product delays that could harm our
business. Successive generations of our products have incorporated semiconductors with greater memory
capacity per chip. The transition to new generations of products, such as the 56-nanometer 8 and 16 gigabit
MLC chip, which we expect to begin shipping in volume in fiscal 2007, is highly complex and requires new
controllers, new test procedures and modifications of numerous aspects of manufacturing, as well as extensive
qualification of the new products by both us and our OEM customers. In addition, Flash Partners is currently
ramping the 56-nanometer 8 gigabit MLC chip in the Yokkaichi, Japan 300-millimeter fab and this transition is
subject to yield, quality and output risk. Furthermore, procurement of MLC wafers from non-captive sources
requires us to develop new controller technologies and may result in inadequate quality or performance in our
products that integrate these MLC components. Any material delay in a development or qualification schedule
could delay deliveries and adversely impact our operating results. We periodically have experienced significant
delays in the development and volume production ramp-up of our products. Similar delays could occur in the future
and could harm our business, financial condition and results of operations.
Our products may contain errors or defects, which could result in the rejection of our products, product recalls,
damage to our reputation, lost revenues, diverted development resources and increased service costs and warranty
claims and litigation. Our products are complex, must meet stringent user requirements, may contain errors or
defects and the majority of our products are warrantied for one to five years. Errors or defects in our products may be
caused by, among other things, errors or defects in the memory or controller components, including components we
procure from non-captive sources such as the MLC products we procure from a third-party supplier. In addition, in
the fourth quarter of fiscal year 2006, over 90% of our NAND memory purchases were from our captive ventures
with Toshiba and if the wafers contain errors or defects, our overall supply could be adversely affected. These
factors could result in the rejection of our products, damage to our reputation, lost revenues, diverted development
resources, increased customer service and support costs and warranty claims and litigation. We record an allowance
for warranty and similar costs in connection with sales of our product, but actual warranty and similar costs may be
significantly higher than our recorded estimate and result in an adverse effect on our results of operations and
financial condition.
Our new products have from time-to-time been introduced with design and production errors at a rate higher
than the error rate in our established products. We must estimate warranty and similar costs for new products
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