SanDisk 1998 Annual Report Download - page 36

SanDisk Corporation
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prices and gross margins than the Company’s FlashDisk
products. This decline was partially offset by cost reductions
related to the Company’s shift to in-house assembly and test.
The Company anticipates that lower capacity products will
continue to represent a significant portion of its sales as
consumer applications such as digital cameras become more
popular. The Company is currently working on many cost
reduction programs to strengthen product gross margins in
1999. There can be no assurance that the Company will be
successful in these efforts. Also, increased competition may
negatively affect gross margins in 1999.
Research and Development. Research and development expenses
consist principally of salaries and payroll related expenses
for design and development engineers, prototype supplies
and contract services. Research and development expenses
increased to $18.2 million in 1998 from $13.6 million in
1997 and $10.2 million in 1996. As a percentage of revenues,
research and development expenses represented 13.4% in
1998, 10.8% in 1997, and 10.4% in 1996. In 1998 and
1997, the increase in research and development expenses
was primarily due to an increase in salaries and payroll-
related expenses associated with additional personnel.
Increased depreciation due to capital equipment additions
and higher project related expenses also contributed to the
growth in research and development expenses in both years.
The Company expects research and development expenses
to continue to increase, in absolute dollars and perhaps as a
percentage of revenue, to support the development of new
generations of flash data storage products.
Sales and M arketing. Sales and marketing expenses include
salaries, sales commissions, benefits and travel expenses for
the Company’s sales, marketing, customer service and appli-
cations engineering personnel. These expenses also include
other selling and marketing expenses, such as independent
manufacturer’s representative commissions, advertising and
tradeshow expenses. Sales and marketing expenses increased
to $16.9 million in 1998 from $12.6 million in 1997 and
$8.8 million in 1996. The increase in 1998 was primarily
due to increased marketing and sales expenses related to the
development of the retail channel. Increased salaries and
payroll related expenses associated with additional personnel
also contributed significantly to the increase in 1998 and
1997. Sales and marketing expenses increased to 12.5% of
total revenues in 1998 compared to 10.0% in 1997 and 9.0%
in 1996 primarily due to increased marketing expenses related
to the development of the retail channel. The Company
expects sales and marketing expenses to increase as sales of
its products grow and as it further develops the retail channel
for its products.
General and Administrative. General and administrative expenses
include the cost of the Company’s finance, information systems,
human resources, shareholder relations, legal and adminis-
trative functions. General and administrative expenses were
$7.5 million in 1998 compared to $7.1 million in 1997 and
$7.4 million in 1996. The increase in 1998 was primarily
due to increased consulting expenses related to the imple-
mentation of the Company’s new management information
system and an increase in bad debt expense. The decrease in
1997 was primarily due to a decrease in legal fees which was
partially offset by increased salaries and payroll related
expenses associated with increased personnel, higher recruit-
ing expenses, increased allowance for doubtful accounts and
higher consulting expenses. General and administrative
expenses represented 5.5% of total revenues in 1998 compared
to 5.7% of revenues in 1997, and 7.6% in 1996. The
Company expects general and administrative expenses to
increase as the general and administrative functions grow to
support the overall growth of the Company. General and
administrative expenses could also increase substantially in
the future if the Company pursues litigation to defend its
patent portfolio. See “Factors That May Affect Future
Results—Risks Associated with Patents, Proprietary Rights
and Related Litigation.”
Interest and Other Income, N et. Interest and other income, net,
was $5.7 million in 1998, $3.7 million in 1997, and $3.2
million in 1996. The increase in 1998 is primarily due to
higher investment balances as a result of the investment of
proceeds from the sale of common stock in the Company’s
November 1997 follow on public offering.
Provision for Income Taxes. The Company’s 1998, 1997, and
1996 effective tax rates were approximately 36.0%, 15.0%,
and 7.3% respectively. The Company’s 1998 tax rate is sub-
stantially higher than its 1997 rate due to the utilization of all
remaining federal and state tax credit carryforwards in 1997.
The Company’s 1997 effective tax rate is substantially higher
than its 1996 rate due to the utilization of all remaining
federal net operating loss carryforwards in 1996.
Liquidity and Capital Resources
As of December 31, 1998, the Company had working capital
of $138.5 million, which included $15.4 million in cash and
cash equivalents and $119.1 million in short-term investments.
The Company has a line of credit facility with a commercial
bank under which it can borrow up to $10.0 million at the
bank’s prime rate. This line of credit facility expires in July
1999. As of December 31, 1998, the Company had $1.0
million committed under the line of credit facility for standby
letters of credit. The facility contains covenants that require
the Company to maintain certain financial ratios and levels
of net worth, and prohibits the payment of cash dividends to
stockholders. The Company is currently in compliance with
all covenants in the line of credit agreement. The Company
intends to either renew its line of credit or negotiate a new
line of credit upon the expiration of its current line.
Operating activities provided $13.4 million of cash in 1998
primarily from net income, a reduction in inventory of
$6.7 million and an increase in other accrued liabilities of
$1.5 million, which were partially offset by a decrease in
accounts payable of $7.2 million and an increase in prepaid
and other assets of $5.3 million. Cash provided by operations
was $26.8 million in 1997 and $13.4 million in 1996.