SanDisk 1999 Annual Report Download - page 21

18 Annual Report 1999
MANAGEMENT’S DISCUSSION AND ANALYSIS
DIFFICULTY OF ESTIMATING SILICON WAFER NEEDS
When we order silicon wafers from our foundries, we have to estimate
the number of silicon wafers needed to fill product orders several
months into the future. If we overestimate this number, we will build
excess inventories which could harm our gross margins and operat-
ing results. For example, in the second quarter of 1998, our product
gross margins declined to 12% from 30% in the previous quarter
due in part to a write down of inventory to reflect net realizable
value. If we underestimate the number of silicon wafers needed to
fill product orders, we may be unable to obtain an adequate supply
of wafers which could harm our product revenues. Because our
largest volume product, CompactFlash, is sold into an emerging
consumer market, it has been difficult to accurately forecast future
sales. A substantial majority of our quarterly sales have historically
been from orders received and fulfilled in the same quarter. In addi-
tion, our product order backlog may fluctuate substantially from
quarter to quarter.
ANTICIPATED GROWTH IN EXPENSE LEVELS
We increased our expense levels in 1999 to support our growth. We
expect operating expenses to continue to increase in fiscal 2000 as
a result of the need to hire additional personnel to support expected
growth in sales unit volumes, sales and marketing efforts and
research and development activities, including our proposed collab-
oration with Toshiba providing for the joint development of 512
megabit and 1 gigabit flash memory chips. For example in fiscal
2000, the incremental research and development expenses related
to the proposed Toshiba joint development project are projected to
be in the range of $6 million to $8 million. In addition, we have sig-
nificant fixed costs and we cannot readily reduce these expenses
over the short term. If revenues do not increase proportionately to
operating expenses, or if revenues decrease or do not meet expec-
tations for a particular period, our business, financial condition and
results of operations will be harmed.
VARIABILITY OF AVERAGE SELLING PRICES AND
GROSS MARGIN
Our product mix varies quarterly, which affects our overall average
selling prices and gross margins. Our CompactFlash products, which
currently represent the majority of our product revenues, have lower
average selling prices and gross margins than our higher capacity
FlashDisk and FlashDrive products. We believe that sales of
CompactFlash products will continue to represent a significant per-
centage of our product revenues as consumer applications, such as
digital cameras, become more popular. Dependence on
CompactFlash sales, together with lower pricing caused by
increased competition, caused average unit selling prices to decline
22% during fiscal 1999 compared to a decline of 28% during
fiscal 1998. We expect this trend to continue.
VARIABILITY OF LICENSE FEES AND ROYALTIES
Our intellectual property strategy is to cross-license our patents to
other manufacturers of flash products. Under these arrangements,
we earn license fees and royalties on individually negotiated terms.
The timing of revenue recognition from these payments is depend-
ent on the terms of each contract and on the timing of product
shipments by the third parties. This may cause license and royalty
revenues to fluctuate significantly from quarter to quarter. Because
these revenues have higher gross margins than product revenues,
gross margins and net income fluctuate significantly with changes
in license and royalty revenues.
In transitioning to new processes and products
we face production and market acceptance risks.
GENERAL
Successive generations of our products have incorporated
semiconductor devices with greater memory capacity per chip. Two
important factors that enable us to decrease the costs per megabyte
of our flash data storage products are the development of higher
capacity semiconductor devices and the implementation of smaller
geometry manufacturing processes. A number of challenges exist in
achieving a lower cost per megabyte, including:
•overcoming lower yields often experienced in the early
production of new semiconductor devices;
•problems with design and manufacturing of products
that will incorporate these devices; and
•production delays.
Because our products are complex, we periodically experience
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.
128 MEGABIT TECHNOLOGY
We began shipments of 128 megabit products in the second quarter
of 1999. In the third quarter of 1999, we accelerated the produc-
tion ramp up of our 128 megabit flash memory technology to meet
increased demand. In the third quarter of 1999, during the pro-
duction ramp up of our 128 megabit technology, lower than
anticipated yields contributed to a decline in gross margins. If we
experience unplanned yield problems on our 128Mbit technology in