SanDisk 2006 Annual Report Download - page 4

To our Stockholders,
Fiscal 2006 was our best year ever. We delivered impressive financial performance. Our revenue base
continued to diversify and our business model remained strong and consistent. We increased our retail presence in
storefronts worldwide, and our leading market share grew in all major regions. Our investments in new markets,
such as the mobile market, began to pay off and we were well positioned for sourcing as we continued to ramp Fab 3
and as we continued our aggressive cost cutting initiatives, such as the transition to 70 nanometer (nm) lithography.
Strong Financial Results Revenue growth was strong with product revenue growing 42% for the year and we
finished the year with a fourth quarter product revenue growth rate of 58% year-over-year, marking our first billion
dollar quarter! On a SanDisk standalone basis, not including our acquisition of msystems Ltd., our 2006 price per
megabyte declined 58% and our megabytes sold increased 221% — continuing to demonstrate the price elasticity
of demand for our markets. License and royalty revenues increased 38% to $331 million. Even with the aggressive
pricing environment in 2006, our financial results remained within our target model as we reduced our product cost
significantly. Cash provided from operations was $598 million, and we ended the year with cash, short-term
investments and long-term investments of $3.3 billion.
Technology and Manufacturing Leadership In 2006 we exceeded our forecasted ramp of 300 millimeter
production capacity in our Fab 3 manufacturing venture with Toshiba. In addition, we completed the transition to
70nm process technology, which we believe enabled us to deliver the industry’s lowest cost and highest perfor-
mance 8 gigabit Multi Level Cell (MLC) NAND chip. Mid-year, Toshiba and SanDisk broke ground on the second
300 millimeter wafer fab, Fab 4, that is expected to begin operations in the fourth quarter of 2007 to primarily
augment SanDisk’s wafer supply in 2008 and beyond. Economies of large scale manufacturing at the leading edge
are a crucial element of our vertical integration strategy and in 2006, the very cost competitive output from our
captive fabs grew fourfold over the prior year, resulting in a decrease in the percentage of our wafer supply that we
traditionally source from other manufacturers at less favorable costs.
We continue to relentlessly drive technology and product innovations, and we have more than 600 issued
U.S. patents and more than 300 foreign patents. For example, we have systems expertise leadership that we believe
will become ever more important to achieving high performance, reliable Flash memory as we move to finer
geometries in the next several years. Flash scaling is becoming quite challenging, and making the transitions to
three (X3) or four (X4) bits per cell will make it even more challenging for all competitors. We are also continuing to
invest in our 3D technology with a focus on developing read/write capabilities.
msystems Acquisition Accelerates Innovation In November of 2006 we acquired msystems, a Flash pioneer
and an outstanding addition to SanDisk with their shared vision of NAND expansion, complementary products, IP
strength, OEM customers and an excellent team specializing in Flash storage systems engineering and marketing.
Since the acquisition just a few months ago, this team has launched a new solid state Flash drive for notebook
computers and their OEM embedded products nicely complement our mobile card products, providing us with the
industry’s broadest handset storage product lineup. The integration of our two companies is proceeding on track and
we plan to further leverage the legacy msystems team to increase our international growth by creating differentiated
and highly innovative new products, for example, USBTV which is soon to be launched.
Thriving in Challenging Market Conditions In the first quarter of 2007, conditions in our markets dete-
riorated markedly due to industry-wide excess supply of NAND MLC from some of our largest competitors,
coupled with the traditionally slower demand in the first quarter. This has caused pricing of NAND components to
decline at a precipitous rate that exceeds the cost reductions in the same timeframe, thereby adversely impacting
product gross margins. We believe SanDisk’s channel strength, competitive costs and balance sheet position us well
for this difficult cycle and we are focused on emerging from the near-term challenges as a stronger company. We
will continue to invest in rapid technology transitions to drive lower costs and infrastructure to support our projected
long-term growth. In the near-term, however, our margins may remain under pressure throughout 2007. We expect
strong growth in demand later this year, which will help bring back a better balance between demand and supply.
Until the market is in better balance, we have implemented cost cutting measures, including a reduction-in-force, a
salary freeze for employees and salary reductions for executives until conditions improve. We continue to believe
that our industry will be characterized by periods of excess supply as well as supply shortages, and we are well
positioned to traverse these cycles successfully.
Shareholder Letter