SanDisk 1998 Annual Report Download - page 32

SanDisk Corporation
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ITEM 7: MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain statements in this discussion and analysis are forward
looking statements based on current expectations, and entail
various risks and uncertainties that could cause actual results
to differ materially from those expressed in such forward
looking statements. Such risks and uncertainties are set forth
in “Item 1: Business—Factors That May Affect Future Results.”
The following discussion should be read in conjunction with
the Company’s consolidated financial statements and the
notes thereto.
Overview
The Company was founded in 1988 to develop and market
flash data storage systems. The Company sells its products
to the consumer electronics and industrial/communications
markets. During the course of 1998, the percentage of the
Company’s product sales attributable to the consumer elec-
tronics market, particularly sales of CompactFlash for use in
digital camera applications, increased substantially. This
increase in sales to the consumer market resulted in a shift to
lower capacity products, which typically have lower average
selling prices and gross margins than higher capacity products.
In addition, these products are frequently sold into the retail
channel, which usually has shorter customer order lead-times
than the other channels used by the Company, thereby
decreasing the Company’s ability to accurately forecast
future production needs. Subject to market acceptance of its
CompactFlash products, the Company believes these products
will continue to represent a majority of the Company’s sales
as the popularity of consumer applications, including digital
cameras, increases. The percentage of sales attributable to
orders received and fulfilled in the same quarter has increased
over time and, in response, the Company is continuing to
work to shorten its manufacturing cycle times.
The Company’s operating results are affected by a number
of factors including the volume of product sales, the timing
of significant orders, competitive pricing pressures, the ability
of the Company to match supply with demand, changes in
product and customer mix, market acceptance of new or
enhanced versions of the Company’s products, changes in the
channels through which the Company’s products are distributed,
timing of new product announcements and introductions by
the Company and its competitors, the timing of license and
royalty revenues, fluctuations in product costs, availability of
foundry capacity, variations in manufacturing cycle times,
fluctuations in manufacturing yields and manufacturing uti-
lization, increased research and development expenses, and
exchange rate fluctuations. In addition, as the proportion of
the Company’s products sold for use in consumer electronics
applications increases, the Company’s revenues may become
subject to seasonal declines in the first quarter of each year.
See “Item 1: Business—Factors That May Affect Future
Results—Our Operating Results May Fluctuate Significantly”
and “There is Seasonality in Our Business.”
Beginning in late 1995, the Company adopted a strategy of
licensing its flash technology, including its patent portfolio,
to selected third party manufacturers of flash products. To
date, the Company has entered into patent cross-license
agreements with six companies, and it intends to pursue
opportunities to enter into additional licenses. The Company’s
current license agreements provide for the payment of license
fees, royalties, or a combination thereof, to the Company.
The timing and amount of these payments can vary substan-
tially from quarter to quarter, depending on the terms of each
agreement and, in some cases, the timing of sales of products
by the other parties. As a result, license and royalty revenues
have fluctuated significantly in the past and are likely to
continue to fluctuate in the future. Given the relatively high
gross margins associated with license and royalty revenues,
gross margins and net income are likely to fluctuate more
with changes in license and royalty revenues than with
changes in product revenues.
SanDisk markets its products using a direct sales organization,
distributors, manufacturers’ representatives, private label
partners, OEMs and retailers. The Company expects that
sales through the retail channel will comprise an increasing
share of total revenues in the future, and that a substantial
portion of its sales into the retail channel will be made to
participants that will have the right to return unsold products.
The Company does not recognize revenues from these sales
until the products are sold to the end customers. See “Item
1: Business—Sales and Distribution.”
Historically, a majority of the Company’s sales have been to
a limited number of customers. Product sales to the Company’s
top 10 customers accounted for approximately 59% , 67%,
and 71% , respectively, of the Company’s product revenues
for 1998, 1997, and 1996. In addition, revenues from one
customer in 1998 exceeded 10% of total revenues. No single
customer accounted for greater than 10% of revenues in
1997 and in 1996 one customer accounted for 26% of total
revenues. The Company expects that sales of its products to
a limited number of customers will continue to account for a
substantial portion of its product revenues for the foreseeable
future. The Company has also experienced significant changes
in the composition of its customer base from year to year
and expects this pattern to continue as market demand for
such customers’ products fluctuates. The loss of, or significant
reduction in purchases by major customers, could have a
MD&A
MA N AN GEMEN T’S DISCUSSION AN D A N ALYSIS