SanDisk 2007 Annual Report Download - page 62

occur again in the first quarter of fiscal year 2008. We have experienced these conditions in our business in the past
and may experience such downturns in the future.
Our business and the markets we address are subject to significant fluctuations in supply and demand and our
commitments to our flash ventures with Toshiba may result in periods of significant excess inventory. The start of
production at Fab 4 at the end of fiscal year 2007 has further increased our captive supply. Our obligation to
purchase 50% of the supply from the flash 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, and significant excess, obsolete or lower of cost or market inventory
write-downs, which would harm our gross margins and could result in the impairment of our investments in the flash
ventures with Toshiba. These effects could be magnified if the new memory wafer fab with Toshiba is completed
and commences production. For example, product gross margin decreased to 21.8% for the year ended
December 30, 2007 compared to 31.0% for the year ended December 31, 2006, in part due to significant decreases
in our product prices. Any future excess supply or price declines in excess of cost declines 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 disruption or shortage in our supply from these
sources will reduce our revenues, earnings and gross margins. All of our flash memory products require silicon
supply for the memory and controller components. The substantial majority of our flash memory is currently
supplied by the flash ventures with Toshiba and to a lesser extent by Samsung and Hynix. Any disruption or shortage
in supply of flash memory from our captive or non-captive sources would harm our operating results. The risks of
supply disruption are magnified at Toshiba’s Yokkaichi, Japan operations, where the flash ventures with Toshiba are
operated 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 year 2006, a brief power outage occurred at Fab 3, which resulted in a loss of wafers and
significant costs associated with bringing the fab back on line. In addition, the Yokkaichi location is often subject to
earthquakes, which could result in production stoppage, a loss of wafers and the incurrence of significant costs.
Moreover, Toshiba’s employees that produce the flash ventures with Toshiba’s products are covered by collective
bargaining agreements and any strike or other job action by those employees could interrupt our wafer supply for
the flash ventures with Toshiba. Furthermore, if the Fab 4 production ramp is delayed or not completed, we fail to
enter into definitive agreements for the new memory wafer fab with Toshiba, fail to commence production at the
new memory wafer fab as planned, we fail to make timely investments in future capacity additions, 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 manufactured by Tower, UMC, TSMC and SMIC. The Tower fabrication
facility, from which we source controller wafers, is continuing to face financial challenges and is located in Israel,
an area of political and military turmoil. Any disruption in the manufacturing operations of Tower or one of our
other controller wafer vendors would result in delivery delays, adversely affect our ability to make timely shipments
of our products and harm our operating results until we could qualify an alternate source of supply for our controller
wafers, which could take several 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, we
may lose potential sales and our business, financial condition and operating results may suffer. 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
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