SanDisk 2005 Annual Report Download - page 93

have enough supply to meet demand and our cost competitiveness, business, financial condition and results of
operations will be harmed.
We depend on our third-party subcontractors and our business could be harmed if our subcontractors do not
perform as planned. We rely on third-party subcontractors for our wafer testing, IC assembly, packaged testing,
product assembly, product testing and order fulfillment. From time to time, our subcontractors have experienced
difficulty in meeting our requirements. If we are unable to increase the capacity of our current sub-contractors or
qualify and engage additional sub-contractors, we may not be able to meet demand for our products. We do not have
long-term contracts with our existing subcontractors nor do we expect to have long-term contracts with any new
subcontract suppliers. We do not have exclusive relationships with any of our subcontractors and therefore cannot
guarantee that they will devote sufficient resources to manufacturing our products. We cannot, and will not, be able
to directly control product delivery schedules. Furthermore, we manufacture on a turnkey basis with some of our
subcontract suppliers. In these arrangements we do not have visibility and control of their inventories of purchased
parts necessary to build our products or of the progress of our products through their assembly line. Any significant
problems that occur at our subcontractors, or their failure to perform at the level we expect, could lead to product
shortages or quality assurance problems, either of which would have adverse effects on our operating results.
In transitioning to new processes, products and silicon sources, we face production and market acceptance
risks that have caused, and may in the future cause significant product delays that could harm our business.
Successive generations of our products have incorporated semiconductors with greater memory capacity per chip.
The transition to new generations of products, such as the 70-nanometer 8 gigabit MLC chip which we began
shipping in the third quarter of 2005, is highly complex and requires new controllers, new test procedures and
modifications of numerous aspects of manufacturing, as well as extensive qualification of the new products by both
us and our OEM customers. In addition, procurement of MLC wafers from non-captive sources requires us to
develop new controller technology and may result in inadequate quality or performance in our products that
integrate these MLC components. Any material delay in a development or qualification schedule could delay
deliveries and adversely impact our operating results. We periodically have experienced 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.
Our products may contain errors or defects, which could result in the rejection of our products, product recalls,
damage to our reputation, lost revenues, diverted development resources and increased service costs and warranty
claims and litigation. Our products are complex, must meet stringent user requirements, may contain errors or
defects and the majority of our products are warrantied for one to five years. Errors or defects in our products may be
caused by, among other things, errors or defects in the memory or controller components, including components we
procure from non-captive sources such as the MLC products we procure from a third-party supplier. These factors
could result in the rejection of our products, damage to our reputation, lost revenues, diverted development
resources, increased customer service and support costs and warranty claims and litigation. We record an allowance
for warranty and similar costs in connection with sales of our product, but actual warranty and similar costs may be
significantly higher than our recorded estimate and result in an adverse effect on our results of operations and
financial condition.
Our new products have from time to time been introduced with design and production errors at a rate higher
than the error rate in our established products. We must estimate warranty and similar costs for new products
without historical information and actual costs may significantly exceed our recorded estimates. Underestimation
of our warranty and similar costs would have an adverse effect on our results of operations and financial condition.
We and Toshiba plan to continue to expand the wafer fabrication capacity of the Flash Partners business
venture and as we do so, we will make substantial capital investments and incur substantial start-up and tool
relocation costs, which could adversely impact our operating results. We and Toshiba are making, and plan to
continue to make, substantial investments in new capital assets to expand the wafer fabrication capacity of our Flash
Partners business venture in Japan. We and Toshiba recently announced our intention to accelerate expansion at Fab
3 to bring wafer capacity to 70,000 wafers per month by March 2007 and in addition, we and Toshiba are
considering a potential new advanced NAND Fab beyond Fab 3. Each time that we and Toshiba add substantial new
wafer fabrication capacity, we will experience significant initial design and development and start-up costs as a
18