SanDisk 1999 Annual Report Download - page 23

20 Annual Report 1999
MANAGEMENT’S DISCUSSION AND ANALYSIS
Industry-wide demand for semiconductor wafers has increased
significantly due to increased demand in the consumer electronics
and cellular phone markets. Increased demand for advanced tech-
nology silicon wafers is increasing the price of these wafers as
supply becomes constrained. We expect this trend to continue
throughout 2000 which could adversely impact the rate of growth of
our business, either through reduced supply, higher wafer prices or
a combination of the two.
In January 2000, the USIC foundry was merged into UMC. Before
the merger, we owned 10% of USIC, had the right to appoint one of
its directors and were entitled to 12.5% of its total wafer production.
As a result of the merger, we received UMC shares in exchange for
our USIC shares. However, we will not have a right to a seat on the
board of directors of the combined company. We have received
assurances from the senior management of UMC that it intends to
continue to supply us the same wafer capacity at the prices we cur-
rently enjoy under our agreement with USIC. However, there can be
no assurance that we will be able to maintain our current wafer
capacity and competitive pricing arrangement in our future supply
negotiations with UMC.
Under the terms of our wafer supply agreements with UMC, we are
obligated to provide a rolling forecast of anticipated purchase orders
for the next six calendar months. Generally, the estimates for the
first three months of each forecast are binding commitments. The
estimates for the remaining months may only be changed by a cer-
tain percentage from the previous month’s forecast. This limits our
ability to react to fluctuations in demand for our products. For exam-
ple, if customer demand falls below our forecast and we are unable
to reschedule or cancel our wafer orders, we may end up with excess
wafer inventories, which could result in higher operating expenses
and reduced gross margins. Conversely, if customer demand
exceeds our forecasts, we may be unable to obtain an adequate sup-
ply of wafers to fill customer orders, which could result in
dissatisfied customers, lost sales and lower revenues. In addition, in
February 2000, we entered into a capacity and reservation deposit
agreement with UMC. To reserve additional foundry capacity under
this agreement, we paid UMC a reservation deposit. This deposit will
be refunded to us on a quarterly basis over the agreement term, if
we purchase the full wafer capacity reserved for us. We may forfeit
part of our deposit if we are unable to utilize our reserved capacity
within four quarters of the end of the agreement term. If we are
unable to obtain scheduled quantities of wafers with acceptable
price and yields from any foundry, our business, financial condition
and results of operations could be harmed.
The success of our business depends on emerging
markets and new products.
In order for demand for our products to grow, the markets for new
products that use CompactFlash and the MultiMediaCard, such as
portable digital music players and smart phones, must develop and
grow. If sales of these products do not grow, our revenues and profit
margins could level off or decline.
Because we sell our products for use in many new applications, it is
difficult to forecast demand. For example, in 1999, demand for our
32 megabyte capacity MultiMediaCard for use in portable digital
music players grew faster than anticipated and we were unable to
fill all customer orders during the quarter. Although we are increas-
ing production of the MultiMediaCard, if we are unable to fulfill
customer demand for these products in the future, we may lose
sales to our competitors.
SECURE DIGITAL MEMORY CARD PRODUCTS
In the third quarter of 1999, we announced a collaboration under
which we will jointly develop our Secure Digital Memory Card, an
enhanced version of our MultiMediaCard, which will incorporate
advanced security and copyright protection features required by the
emerging markets for the electronic distribution of music, video and
other copyrighted works. We expect to begin shipping our Secure
Digital Memory Cards in 32 and 64 megabyte capacities in the sec-
ond quarter of 2000. The Secure Digital Memory Card is slightly
thicker and uses a different interface than our MultiMediaCard.
Because of these differences, the Secure Digital Memory Card will
not work in current products that include a MultiMediaCard slot. In
order for the market for our Secure Digital Memory Card to develop,
manufacturers of digital audio/video and portable computing prod-
ucts must include a Secure Digital Memory Card compatible slot in
their products and acquire a license to the security algorithms. If
OEMs do not incorporate Secure Digital Memory Card slots in their
products or do not buy our Secure Digital Memory Cards, our busi-
ness, financial condition and results of operations may be harmed.
In addition, consumers may postpone or altogether forego buying
products that utilize our MultiMediaCard and CompactFlash cards
in anticipation of new products that will incorporate the Secure
Digital Memory Card. If this occurs, sales of our MultiMediaCard
and CompactFlash products may be harmed. The main competition
for the Secure Digital Memory Card is expected to come from the
Sony Memory Stick. Sony has substantially greater financial and
other resources than we do and extensive marketing and sales chan-
nels and brand recognition. We cannot assure you that our Secure
Digital Memory Card will be successful in the face of such competition.