SanDisk 2013 Annual Report Download - page 114

memory product costs are increasing as a percentage of our overall products costs as we grow our sales mix
of more complex products. If we are unable to reduce the cost of non-flash memory materials and
manufacturing, our gross margin and results of operations would be harmed. In addition, as 2D NAND
technology reaches its limits of cost-effective technology scaling, the development of alternative
technologies, such as the 3D NAND and 3D ReRAM technologies we are working on, is crucial to
continue the cost reductions necessary to maintain adequate gross margin, and our failure to develop these
technologies in a timely or effective manner, or at all, or the failure of these technologies to effectively
compete with those of our competitors, could harm our revenue, gross margin and results of operations.
Our reliance on and investments in captive manufacturing capacity limit our ability to respond to industry
fluctuations in supply and demand. The semiconductor industry, and the NAND flash memory industry in
particular, is highly cyclical and is characterized by constant and rapid technological change, rapid product
obsolescence, price declines, evolving standards, short product life cycles and wide fluctuations in product
supply and demand. We are limited in our ability to react or adjust our cost structure in response to these
cyclical fluctuations. We rely on our significant investments in Flash Ventures as a captive source of
substantially all of our NAND flash memory supply. Growth in our captive memory supply comes from
investments in technology transitions and new capacity at Flash Ventures. These investment decisions
require significant planning and lead-time before an increase in supply can be realized, and are further
determined by factors such as the timing, rate and type of investment by us and Toshiba, our partner in
Flash Ventures, agreement between us and Toshiba as to these matters, our evaluation of the potential
return on investment of the addition of new capacity, particularly in light of the timing, cost and availability
of next generation technology, our profitability, our estimation of market demand and our liquidity
position. A failure to accurately forecast demand for our products or industry capacity could cause us to
over-invest or under-invest in the expansion of captive memory capacity in Flash Ventures.
Over-investment could result in excess supply, which could cause significant decreases in our product
prices, significant excess, obsolete or lower of cost or market inventory write-downs or under-utilization
charges, and the potential impairment of our investments in Flash Ventures. For example, in fiscal year
2008 and the first quarter of fiscal year 2009, we recorded charges for adverse purchase commitments
associated with under-utilization of Flash Ventures’ capacity. On the other hand, if we or Toshiba under-
invest in captive memory capacity or technology transitions, if we grow capacity more slowly than the rest
of the industry, if our technology transitions do not occur on the timeline that we expect or we encounter
unanticipated difficulties in implementing these transitions, or if we implement technology transitions
more slowly than our competitors, we may not have enough captive supply to meet demand on a timely and
cost effective basis and we may lose opportunities for revenue growth and market share as a result, which
would harm our ability to grow revenue. In such cases, we may have only a limited ability to satisfy our
supply needs from non-captive supply sources and may not be able to obtain the right mix of non-captive
product that meets our requirements within an adequate lead time or at a cost that allows us to generate
an adequate gross margin. Furthermore, if our memory supply is limited, we may make strategic decisions
with respect to the allocation of our supply among our products and customers that may preserve our
long-term goals and customer relationships but result in short-term declines in our gross margin or less
favorable gross margin. Our customers also may not allow us to change the memory in the products that
they have already qualified, which can further limit our ability to satisfy our supply needs from other
sources for products that require long and extensive qualification cycles, such as SSDs. Our inability to
obtain sufficient cost-effective non-captive memory that meets our requirements may cause us to lose sales,
market share and profits, which would harm our operating results. In addition, we are contractually
obligated to pay for 50% of the fixed costs of Flash Ventures regardless of whether we purchase any wafers
from Flash Ventures. Furthermore, purchase orders placed under Flash Ventures and the foundry
arrangement with Toshiba for up to three months are binding and cannot be canceled. Therefore, once our
purchase decisions have been made, our production costs are fixed, and we may be unable to reduce costs
to match any subsequent declines in pricing or demand, which would harm our gross margin. Our limited
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