SanDisk 2006 Annual Report Download - page 61

• increased purchases of flash memory products from our non-captive sources, which typically cost more than
products from our captive sources;
• difficulty in forecasting and managing inventory levels, particularly due to noncancelable contractual
obligations to purchase materials such as flash memory and controllers, and the need to build finished
product in advance of customer purchase orders;
• errors or defects in our products caused by, among other things, errors or defects in the memory or controller
components, including memory and non-memory components we procure from third-party suppliers;
• write-downs of our investments in fabrication capacity, equity investments and other assets;
• estimates used in calculating share-based compensation expense; and
• the other factors described under “Risk Factors” and elsewhere in this report.
Our average selling prices, net of promotions, may decline faster than cost reductions due to industry or
SanDisk excess supply, competitive pricing pressures or strategic price reductions initiated by us or our compet-
itors. The market for NAND flash products is competitive and characterized by rapid price declines. Price
declines may be influenced by, among other factors, supply in excess of demand, technology transitions, including
adoption of MLC technology by other competitors, new technologies or other strategic actions by competitors to
gain market share. If our technology transitions take longer or are more costly than anticipated to complete, our cost
reductions fail to keep pace with the rate of price declines or our price decreases fail to generate sufficient additional
demand, our gross margin and operating results will be negatively impacted which could generate quarterly or
annual net losses.
Sales to a small number of customers represent a significant portion of our revenues and, if we were to lose one
of our major licensees or customers or experience any material reduction in orders from any of our customers, our
revenues and operating results would suffer. Sales to our top 10 customers and licensees accounted for more than
52%, 50%, and 55% of our total revenues during the fiscal years 2006, 2005 and 2004, respectively. No customer
exceeded 10% of total revenues in any of these periods except Best Buy, which accounted for 11% of our total
revenues in fiscal 2005. If we were to lose one of our major licensees or customers or experience any material
reduction in orders from any of our customers or in sales of licensed products by our licensees, our revenues and
operating results would suffer. Additionally, our license and royalty revenues may decline significantly in the future
as our existing license agreements expire. Our sales are generally made from standard purchase orders rather than
long-term contracts. Accordingly, our customers may generally terminate or reduce their purchases from us at any
time without notice or penalty. In addition, the composition of our major customer base changes from year-to-year
as we enter new markets making our revenues from several customers somewhat less predictable from year-to-year.
Our business depends significantly upon sales of products in the highly competitive consumer market, a
significant portion of which are made to retailers and through distributors, and if our distributors, and, retailers are
not successful in this market, we could experience substantial product returns, which would negatively impact our
business, financial condition and results of operations. A significant portion of our sales are made through
retailers, either directly or through distributors. Sales through these channels typically include rights to return
unsold inventory and protection against price declines. As a result, we do not recognize revenue until after the
product has been sold through to the end user, in the case of sales to retailers, or to our distributors’ customers, in the
case of sales to distributors. If our distributors and retailers are not successful, we could experience reduced sales as
well as substantial product returns or price protection claims, which would harm our business, financial condition
and results of operations. Availability of sell-through data varies throughout the retail channel, which makes it
difficult for us to forecast retail product revenues. Our arrangements with our customers also provide them price
protection against declines in our recommended selling prices, which has the effect of reducing our deferred
revenue and eventually our revenue. Except in limited circumstances, we do not have exclusive relationships with
our retailers or distributors, and therefore, must rely on them to effectively sell our products over those of our
competitors.
Our revenue depends in part on the success of products sold by our OEM customers. An increasing portion of
our sales are to OEMs, which can either bundle or embed our flash memory products with their products, such as
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