-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EKCeDXE85cnrJYNUSIM6NWFD/n3JU01n7kVHfswOhspKDS6lS86QyK8DB7XSomS8 kPEhBlBD5lsiLy8pEKOIPA== 0001000180-00-000005.txt : 20000518 0001000180-00-000005.hdr.sgml : 20000518 ACCESSION NUMBER: 0001000180-00-000005 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000331 FILED AS OF DATE: 20000517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SANDISK CORP CENTRAL INDEX KEY: 0001000180 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER STORAGE DEVICES [3572] IRS NUMBER: 770191793 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-26734 FILM NUMBER: 638905 BUSINESS ADDRESS: STREET 1: 140 CASPIAN COURT CITY: SUNNYVALE STATE: CA ZIP: 94089 BUSINESS PHONE: 4085620500 MAIL ADDRESS: STREET 1: 140 CASPIAN COURT CITY: SUNNYVALE STATE: CA ZIP: 94089 10-Q 1 FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2000 Form 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark one) X Quarterly report pursuant to Section 13 or 15(d) of the Securities - --------- Exchange Act of 1934 For the quarterly period ended March 31, 2000 OR Transition report pursuant to Section 13 or 15(d) of the Securities - --------- Exchange Act of 1934 For the transition period from to ----- ----- Commission File Number 0-26734 SanDisk Corporation (Exact name of registrant as specified in its charter) Delaware 77-0191793 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 140 Caspian Court, Sunnyvale, California 94089 (Address of principal executive offices) (Zip code) (408) 542-0500 (Registrant's telephone number, including area code) N/A (Former name, former address, and former fiscal year, if changed since last report.) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock as of March 31, 2000 Common Stock, $0.001 par value 66,558,905 ------------------------------ ---------- Class Number of shares SanDisk Corporation Index PART I. FINANCIAL INFORMATION Page No. Item 1. Condensed Consolidated Financial Statements: Condensed Consolidated Balance Sheets March 31, 2000 and December 31, 1999.......................... 3 Condensed Consolidated Statements of Income Three months ended March 31, 2000 and 1999.................... 4 Condensed Consolidated Statements of Cash Flows Three months ended March 31, 2000 and 1999.................... 5 Notes to Condensed Consolidated Financial Statements.............. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................... 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk........29 PART II. OTHER INFORMATION Item 1. Legal Proceedings................................................ 30 Item 2. Changes in Securities............................................ 30 Item 3. Defaults upon Senior Securities.................................. 30 Item 4. Submission of Matters to a Vote of Security Holders.............. 30 Item 5. Other Information................................................ 30 Item 6. Exhibits and Reports on Form 8-K................................. 31 Signatures....................................................... 33 Page 2 PART I. FINANCIAL INFORMATION SanDisk Corporation Condensed Consolidated Balance Sheets (In thousands) ASSETS March 31, 2000 December 31, 1999* ---------------- ------------------ (unaudited) Current Assets: Cash and cash equivalents $ 107,558 $ 146,170 Short-term investments 353,145 312,278 Investment in UMC 214,760 - Accounts receivable, net 78,884 52,434 Inventories 35,231 35,679 Deferred tax assets - 17,000 Prepaid expenses and other current assets 5,266 4,829 ---------------- ----------------- Total current assets 794,844 568,390 Property and equipment, net 31,919 31,788 Investment in UMC 197,688 - Investment in foundry - 51,208 Deposits and other assets 9,460 6,338 ---------------- ----------------- Total Assets $ 1,033,911 $ 657,724 ================ ================= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 31,347 $ 30,734 Accrued payroll and related expenses 6,908 8,259 Income taxes payable 11,715 5,843 Other accrued liabilities 15,331 11,378 Deferred tax liability 60,074 - Deferred revenue 32,941 29,383 ---------------- ----------------- Total current liabilities 158,316 85,597 Deferred tax liability 68,317 - ---------------- ----------------- Total Liabilities 226,633 85,597 ---------------- ----------------- Stockholders' Equity: Common stock 530,204 524,131 Retained earnings 277,074 47,996 ---------------- ----------------- Total stockholders' equity 807,278 572,127 Total Liabilities and ================ ================= Stockholders' Equity $ 1,033,911 $ 657,724 ================ =================
The accompanying notes are an integral part of these condensed consolidated financial statements. * Information derived from the audited Consolidated Financial Statements. Page 3 SanDisk Corporation Condensed Consolidated Statements of Income (In thousands, except per share data; unaudited) Three months ended March 31, 2000 1999 --------------- ---------------- Revenues: Product $ 97,249 $ 35,926 License and royalty 12,120 8,210 --------------- --------------- Total revenues 109,369 44,136 Cost of sales 67,758 26,509 --------------- --------------- Gross profits 41,611 17,627 Operating expenses: Research and development 8,769 5,212 Sales and marketing 10,544 5,173 General and administrative 4,747 2,394 --------------- --------------- Total operating expenses 24,060 12,779 Operating income 17,551 4,848 Interest income 5,618 1,397 Gain on investment in foundry 344,168 - Other income, net 434 207 --------------- --------------- Income before taxes 367,771 6,452 Provision for income taxes 148,500 2,129 --------------- --------------- Net income $ 219,271 $ 4,323 =============== =============== Net income per share Basic $ 3.32 $ 0.08 Diluted $ 3.00 $ 0.07 Shares used in computing net income per share Basic 66,095 53,534 Diluted 73,015 58,628 The accompanying notes are an integral part of these condensed consolidated financial statements. Page 4 SanDisk Corporation Condensed Consolidated Statements of Cash Flows (In thousands; unaudited)
Three months ended March 31, 2000 1999 --------------- ---------------- Cash flows from operating activities: Net income $ 219,271 $ 4,323 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 3,546 1,657 Deferred taxes 138,437 - Gain on investment in foundry (344,168) - Changes in operating assets and liabilities: Accounts receivable, net (26,451) (3,109) Inventories 448 856 Prepaid expenses and other assets (3,559) 3,320 Accounts payable 613 8,583 Accrued payroll and related expenses (1,351) 1,004 Income taxes payable 5,873 2,089 Other accrued liabilities 3,952 42 Deferred revenue 3,558 (6,418) --------------- ---------------- Total adjustments (219,102) 8,024 --------------- ---------------- Net cash provided by operating activities 169 12,347 Cash flows from investing activities: Purchases of short term investments (114,631) (45,127) Proceeds from sale of short term investments 73,453 34,387 Acquisition of capital equipment (3,676) (3,036) --------------- ---------------- Net cash used in investing activities (44,854) (13,776) Cash flows from financing activities: Sale of common stock 6,073 1,475 --------------- ---------------- Net cash provided by financing activities 6,073 1,475 --------------- ---------------- Net increase (decrease) in cash and cash equivalents (38,612) 46 Cash and cash equivalents at beginning of period 146,170 15,384 =============== ================ Cash and cash equivalents at end of period $ 107,558 $ 15,430 =============== ================
The accompanying notes are an integral part of these condensed consolidated financial statements. Page 5 SanDisk Corporation Notes to Condensed Consolidated Financial Statements 1. These interim condensed consolidated financial statements are unaudited but reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly the financial position of SanDisk Corporation and its subsidiaries (the "Company") as of March 31, 2000, and the results of operations and cash flows for the three month periods ended March 31, 2000 and 1999. Because all the disclosures required by generally accepted accounting principles are not included, these interim condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto in the Company's annual report on Form 10-K as of, and for, the year ended December 31, 1999. The condensed consolidated balance sheet data as of December 31, 1999 was derived from the audited financial statements. The results of operations and cash flows for the three month periods ended March 31, 2000 are not necessarily indicative of results of operations and cash flows for any future period. 2. The Company's fiscal year ends on the Sunday closest to December 31, and each fiscal quarter ends on the Sunday closest to March 31, June 30, and September 30. The first fiscal quarter of 2000 and 1999 ended on April 2, 2000 and March 28, 1999, respectively. Fiscal year 2000 is 52 weeks long and ends on December 31, 2000. Fiscal year 1999 was 53 weeks long and ended on January 2, 2000. For ease of presentation, the accompanying financial statements have been shown as ending on the last day of the calendar month. 3. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. 4. The components of inventory consist of the following: March 31, December 31, 2000 1999 ---------- ---------- (In thousands) Raw materials $ 10,040 $ 10,387 Work-in-process 15,489 20,708 Finished goods 9,702 4,584 ---------- ---------- $ 35,231 $ 35,679 ========== ========== Page 6 5. The following table sets forth the computation of basic and diluted earnings per share:
Three months ended March 31, 2000 1999 --------- ------- (In thousands, except per share amounts) Numerator: Numerator for basic and diluted net income per share - net income $ 219,271 $ 4,323 ========= ======= Denominator for basic net income per share: Weighted average common shares 66,095 53,534 --------- ------- Shares used in computing basic net incomen per share 66,095 53,534 ========= ======= Basic net income per share $ 3.32 $ 0.08 ========= ======= Denominator for diluted net income per share: Weighted average common shares 66,095 53,534 Employee stock options and warrants to purchase common stock 6,920 5,094 --------- ------- Shares used in computing diluted net income per share 73,015 58,628 ========= ======= Diluted net income per share $ 3.00 $ 0.07 ========= =======
For the three month periods ended March 31, 2000 and 1999, options to purchase 81,564 and 21,506 shares of common stock, respectively have been excluded from the earnings per share calculation, as their effect is antidilutive. 6. The Company relies on a combination of patents, trademarks, copyright and trade secret laws, confidentiality procedures and licensing arrangements to protect its intellectual property rights. There can be no assurance that there will not be any disputes regarding the Company's intellectual property rights. Specifically, there can be no assurance that any patents held by the Company will not be invalidated, that patents will be issued for any of the Company's pending applications or that any claims allowed from existing or pending patents will be of sufficient scope or strength or be issued in the primary countries where the Company's products can be sold to provide meaningful protection or any commercial advantage to the Company. Additionally, competitors of the Company may be able to design around the Company's patents. To preserve its intellectual property rights, the Company believes it may be necessary to initiate litigation with one or more third parties, including but not limited to those the Company has notified of possible patent infringement. In addition, one or more of these parties may bring suit against the Company. In March 1998, we filed a complaint in federal court against Lexar for infringement of a fundamental flash memory card patent. Lexar disputed this claim and asserted that our patent was invalid or unenforceable, as well as asserted various counterclaims including unfair competition, violation of the Lanham Act, patent misuse, interference with prospective economic advantage, trade defamation and fraud. We have denied all of these counterclaims. In July 1998, the court Page 7 denied Lexar's request to have the case dismissed. Discovery in this suit began in August 1998. On February 22, 1999, the court considered arguments and papers submitted by the parties regarding the scope and proper interpretation of the asserted claims in our patent at issue in the Lexar suit. On March 4, 1999, the court issued its ruling on the proper construction of the claim terms in our patent. On July 30, 1999, we filed a motion for partial summary judgment that Lexar CompactFlash and PC Cards contributorily infringe our patent. In December 1999, Lexar filed a counter motion for partial summary judgment for invalidity of our patent. Both motions were heard by the court on March 17, 2000 and on March 28, 2000 the court found that the accused Lexar flash cards contributarily infringed SanDisk's patent and granted SanDisk's motion for partial summary judgement. Additionally, the court denied Lexar's summary judgement motion for non-infringement and invalidity. In May 1999, Lexar filed a complaint against us in federal court for claims of unfair competition, false advertising, trade libel and intentional and negligent interference with prospective business advantage. In Lexar's complaint, Lexar alleged that statements by us regarding the comparative performance of our products and Lexar's in digital cameras were false, and further alleged that we had interfered with the certification of certain Lexar products by the CompactFlash Association. On July 1, 1999, we filed a motion to dismiss the Lexar complaint. Also, in July 1999, Lexar filed a motion for preliminary injunction seeking to stop certain advertising practices that Lexar alleges were misleading. On August 26, 1999, the parties executed and filed with the court a joint stipulation withdrawing our motion to dismiss and granting Lexar permission to amend its complaint. Lexar has amended its complaint to remove any allegations and causes of action based on our alleged interference in certification by the CompactFlash Association. On September 17, 1999, the court conducted a hearing on Lexar's motion for preliminary injunction. On September 24, 1999, the court issued an order granting a limited preliminary injunction which enjoins us from using or implying certain terminology in advertising regarding the comparative performance of our memory products in digital cameras. On October 1, 1999, we filed counterclaims against Lexar asserting causes of action including unfair competition and false advertising under both federal and California law. Although we cannot predict the ultimate outcome of the case, we believe that Lexar's claims are without merit and that we have meritorious counterclaims against Lexar. A trial date has been set for both of these matters in October 2000. Although we cannot predict the ultimate outcome of the cases, we believe that Lexar's claims are without merit and that SanDisk's counterclaims are meritorious. On March 21, 2000, Mitsubishi Denki Co. Ltd. (Mitsubishi Electric) filed a complaint in Tokyo District Court against SanDisk K.K., SanDisk's wholly-owned subsidiary in Japan. The complaint alleges that SanDisk K.K., based in Yokohama, Japan, infringes on three Mitsubishi Japanese patents. The Mitsubishi patents in question are #JP2099342, #JP2129071 and # JP2138047. Based on preliminary information, SanDisk believes that these patents are related primarily to the mechanical construction of memory cards built with a separate connector. In the complaint, Mitsubishi asked the court for a preliminary injunction halting the sale of SanDisk CompactFlash and flash ATA memory cards in Japan. Although the Company cannot predict the ultimate outcome of the case, it believes that Mitsubishi's claims are without merit. The Company and SanDisk K.K. will vigorously defend itself against Mitsubishi's claims. From time to time, the Company has been contacted by various parties who have alleged that certain of the Company's products infringe on patents that such parties claim to hold. To date no legal actions have been filed in connection with any such infringement, other than as discussed above. In the event of an adverse result in any such litigation, the Company could be required to pay substantial damages, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to the infringing technology, or discontinue the use of certain processes. From time to time the Company agrees to indemnify certain of its suppliers and customers for alleged patent infringement. The scope of such indemnity varies but may in some instances include Page 8 indemnification for damages and expenses, including attorneys fees. The Company may from time to time be engaged in litigation as a result of such indemnification obligations. Third party claims for patent infringement are excluded from coverage under the Company's insurance policies. There can be no assurance that any future obligation to indemnify the Company's customers or suppliers, will not have a material adverse effect on the Company's business, financial condition and results of operations. Compaq Corporation has opposed in several countries, including the United States, our attempting to register CompactFlash as a trademark. We do not believe that our failure to obtain registration for the CompactFlash mark will materially harm our business. Litigation frequently involves substantial expenditures and can require significant management attention, even if the Company ultimately prevails. In addition, the results of any litigation matters are inherently uncertain. Accordingly, there can be no assurance that any of the foregoing matters, or any future litigation, will not have a material adverse effect on the Company's business, financial condition and results of operations. 7. Certain of the Company's balance sheet accounts and purchase commitments are denominated in Japanese Yen. The Company enters into foreign exchange contracts to hedge against changes in foreign currency exchange rates. The effects of movements in currency exchange rates on these instruments are recognized when the related operating revenues and expenses are recognized. The impact of movements in currency exchange rates on foreign exchange contracts substantially mitigates the related impact on the underlying items hedged. At March 31, 2000, forward contracts with a notional amount of $16.2 million were outstanding. In the first quarter of 2000, the Company had a net foreign currency transaction gain of $0.5 million, primarily due to transaction gains on its Japanese yen based assets. 8. Accumulated other comprehensive income presented in the accompanying balance sheet consists of the accumulated unrealized gains and loses on available-for-sale marketable securities, net of the related tax effects, for all periods presented. Three months ended March 31, 2000 1999 -------- -------- (In thousands) Net income $219,271 $ 4,323 Unrealized gain (loss) on available-for-sale securities 9,807 (252) -------- -------- Comprehensive income $229,078 $ 4,071 ======== ======== Accumulated other comprehensive income was $10.0 million and $0.2 million at March 31, 2000 and December 31, 1999, respectively. 9. On May 9, 2000, the Company signed a definitive agreement with Toshiba providing for the joint development and manufacturing of 512 megabit and 1 gigabit flash memory chips and Secure Digital Memory Card controllers. Further, the Company and Toshiba will form and fund a joint venture, FlashVision LLC, to equip and operate a silicon wafer manufacturing line in Virginia. The cost of equipping the Virginia wafer manufacturing line is estimated at between $700 million and $800 million. The Company, as part of its 50% ownership of the joint venture, expects to invest up to $150 million in cash and, if necessary, guarantee equipment lease lines for an additional $250 million. The Company does not expect any material revenues from the 512 megabit technology for at least one year and from the 1 gigabit technology for at least two years. The agreement is expected Page 9 to close no later than June 30, 2000, pending satisfactory completion of due diligence by SanDisk and Toshiba. 10. On January 3, 2000, the USIC foundry was merged into UMC. The Company had invested $51.2 million in USIC. In exchange for its USIC shares, the Company received 111 million UMC shares. These shares were valued at approximately $396 million at the time of the merger, resulting in a pretax gain of $344.2 million ($203.9 million after-tax). All of the UMC shares received by the Company are subject to trading restrictions imposed by UMC and the Taiwan Stock Exchange. The trading restrictions will expire on one-half of the shares on July 3, 2000. The remaining shares will become available for sale over a two year period beginning in January 2002. When the shares are ultimately sold, it is likely that the Company will report additional gains or losses. The 50% of the shares that will become unrestricted in 2000 will be treated as available-for-sale securities under FASB 115 at March 31, 2000. At March 31, 2000, these shares were adjusted to market value and the resulting unrealized net gain of $10.1 million dollars was included in other comprehensive income. The remaining 50% of the shares, that will be restricted from sale until 2002, will be accounted for at their historical cost. In April 2000, UMC announced a stock dividend of 200 shares for every 1000 shares of UMC owned, resulting in our ownership of 22 million shares additional shares of UMC. Page 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Certain statements in this discussion and analysis are forward looking statements based on current expectations, and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward looking statements. Such risks and uncertainties are discussed below and in our Form 10-K for the year ended December 31, 1999 under the heading "Factors That May Affect Future Results." Readers are cautioned not to place undue reliance on these forward looking statements, which speak only as of the date hereof. We undertake no obligation to update these forward looking statements to reflect events or circumstances occurring after the date hereof. The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto. Overview SanDisk was founded in 1988 to develop and market flash data storage systems. We sell our products to the consumer electronics and industrial/communications markets. In the first quarter of fiscal 2000, approximately 70%of our product sales were attributable to the consumer electronics market, particularly sales of CompactFlash for use in digital camera applications. Our CompactFlash products have lower average selling prices and gross margins than our higher capacity FlashDisk and FlashDrive products. In addition, a substantial portion of our CompactFlash products are sold into the retail channel, which usually has shorter customer order lead-times than our other channels. A majority of our sales to the retail channel are turns business, with orders received and fulfilled in the same quarter, thereby decreasing our ability to accurately forecast future production needs. We believe sales to the consumer market will continue to represent a majority of our sales as the popularity of consumer applications, including digital cameras, increases. Our operating results are affected by a number of factors including the volume of product sales, availability of foundry capacity, variations in manufacturing cycle times, fluctuations in manufacturing yields and manufacturing utilization, the timing of significant orders, competitive pricing pressures, our ability to match supply with demand, changes in product and customer mix, market acceptance of new or enhanced versions of our products, changes in the channels through which our products are distributed, timing of new product announcements and introductions by us and our competitors, the timing of license and royalty revenues, fluctuations in product costs, increased research and development expenses, and exchange rate fluctuations. In addition, as the proportion of our products sold for use in consumer electronics applications increases, our revenues may become subject to seasonal declines in the first quarter of each year. See "Factors That May Affect Future Results - Our Operating Results May Fluctuate Significantly Which May Adversely Affect Our Stock Price" and "-There is Seasonality in Our Business." Beginning in late 1995, we adopted a strategy of licensing our flash technology, including our patent portfolio, to selected third party manufacturers of flash products. To date, we have entered into patent cross-license agreements with several companies, and intend to pursue opportunities to enter into additional licenses. Our current license agreements provide for the payment of license fees, royalties, or a combination thereof. The timing and amount of these payments can vary substantially from quarter to quarter depending on the terms of each agreement and, in some cases, the timing of sales of products by the other parties. As a result, license and royalty revenues have fluctuated significantly in the past and are likely to continue to fluctuate in the future. Given the relatively high gross margins associated with license and royalty revenues, gross margins and net income are likely to fluctuate more with changes in license and royalty revenues than with changes in product revenues. We market our products using a direct sales organization, distributors, manufacturers' representatives, private label partners, OEMs and retailers. We expect that sales through the retail channel will comprise an increasing share of total revenues in the future, and that a substantial portion of our sales into the retail channel will be made to participants that will have the right to return unsold products. We do not recognize revenues from these sales until the products are sold to the end customers. Page 11 Historically, a majority of our sales have been to a limited number of customers. We expect that sales of our products to a limited number of customers will continue to account for a substantial portion of our product revenues for the foreseeable future. We have also experienced significant changes in the composition of our customer base from year to year and expect this pattern to continue as market demand for our customers' products fluctuates. The loss of, or significant reduction in purchases by major customers, could have a material adverse effect on our business, financial condition and results of operations. See "Factors That May Affect Future Results - Sales to a Small Number of Customers Represent a Significant Portion of Our Revenues" and "Business - Sales and Distribution." All of our products require silicon wafers, which are currently manufactured by UMC in Taiwan. Industry-wide demand for semiconductors increased significantly in 1999 and the first quarter of 2000, due to increased demand in the consumer electronics and cellular phone markets. This increased demand is expected to continue in 2000 causing supply to become constrained and prices to increase. Under our wafer supply agreements, there are limits on the number of wafers we can order and our ability to change that quantity is restricted. Accordingly, our ability to react to significant fluctuations in demand for our products is limited. If customer demand exceeds our forecasts, we may be unable to obtain an adequate supply of wafers to fill customer orders, which could result in lost sales and lower revenues. If we are unable to obtain adequate quantities of flash memory wafers with acceptable prices and yields from our current and future wafer foundries, our business, financial condition and results of operations could be harmed. 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. We have from time to time taken write downs for excess inventories. For example, in the second quarter of 1998, our product gross margins were negatively impacted by such an inventory write down. These adjustments decrease gross margins in the quarter reported and have resulted, and could in the future result, in fluctuations in gross margins on a quarter to quarter basis. See "Factors That May Affect Future Results - Our Operating Results May Fluctuate Significantly." Export sales are an important part of our business. Our sales may be impacted by changes in economic conditions in our international markets. For example, in 1998, product sales to Japan declined 19% from the prior year, due in part to the Asian economic crisis. While a majority of our revenues from sales to Japan and other Asian countries are derived from OEM customers who plan to export a portion of their products to countries outside of Asia, economic conditions in Asia may continue to adversely effect our revenues to the extent that demand for our products in Asia declines. Given the recent economic conditions in Asia and the weakness of many Asian currencies relative to the United States dollar, our products may be relatively more expensive in Asia, which could result in a decrease of our sales in that region. We may also experience pressure on our gross margins as a result of increased price competition from Asian competitors. While most of our sales are denominated in U.S. Dollars, we invoice certain Japanese customers in Japanese Yen and are subject to exchange rate fluctuations on these transactions which could affect our business, financial condition and results of operations. See "Factors That May Affect Future Results - Our international operations make us vulnerable to changing conditions and currency fluctuations." For the foreseeable future, we expect to realize a significant portion of our revenues from recently introduced and new products. Typically, new products initially have lower gross margins than more mature products because the manufacturing yields are lower at the start of manufacturing each successive product generation. In addition, manufacturing yields are generally lower at the start of manufacturing any product at a new foundry. To remain competitive, we are focusing on a number of programs to lower manufacturing costs, including development of future generations of D2 flash and advanced technology wafers. There can be no assurance that we will successfully develop such products or processes or that development of such processes will lower manufacturing costs. In addition, if the industry wide supply of flash memory products grows faster than customer demand, we could experience increased price competition in the future, which could result in decreased average selling prices and lower gross margins. See "Factors That May Affect Future Results -We Must Achieve Acceptable Manufacturing Yields." Page 12 Results of Operations Product Revenues. Our product revenues were $97.2 million in the first quarter of 2000, up $61.3 million or 171% from the first quarter of 1999. During the three month period ended March 31, 2000, flash memory product unit shipments increased 168% over the same period in 1999. The largest increase came from sales of CompactFlash which represented 50% of product revenues, and MultiMediaCards which represented 15% of product revenues for the three month period ended March 31, 2000. Average selling prices were relatively unchanged in the first quarter of 2000 compared to the same period in 1999. A shift in product mix to higher capacity cards offset a decline in the average selling price per megabyte of capacity shipped. Sales to the consumer market represented approximately 70% of product revenues and sales to the telecommunications/industrial market accounted for the remaining 30% during the three month periods ended March 31, 2000 and 1999. Sales to the retail channel represented 26% of product revenues in the first quarter of 2000, up from 20% for the same period of the previous year. The mix of products sold varies from quarter to quarter and will continue to vary in the future, affecting our overall average selling prices and gross margins. Export sales represented 50% of our product revenues for the three month period ended March 31, 2000 compared to 42% for the same period of the previous year. We expect international sales to continue to represent a significant portion of our product revenues. For the three month period ended March 31, 2000, our top ten customers represented approximately 52% of our product revenues compared to 61% for the same period in 1999. In the first three months of fiscal 2000, one customer accounted for more than 10% of product sales. Two customers each accounted for more than 10% of product sales in the first three months of 1999. We expect that sales to a limited number of customers will continue to represent a substantial portion of our revenues for the foreseeable future. License and Royalty Revenues. We currently earn patent license fees and royalties under several cross-license agreements. License and royalty revenues from patent cross-license agreements were $12.1 million in the first quarter of 2000, up from $8.2 million in the same period of the previous year, due primarily to an increase in royalty revenues. Revenues from licenses and royalties decreased to 11% of total revenues in the first quarter of 2000 from 19% in the first quarter of 1999. Gross Profits. In the first quarter of 2000, gross profits were $41.6 million, or 38% of total revenues compared to $17.6 million, or 40% of total revenues in the same period of 1999. Product gross margin increased to 30% of product revenues in the first quarter of 2000 from 26% in the first quarter of 1999, primarily due to a lower cost per megabyte of our 128Mbit and 256Mbit flash memory products. We plan to decrease production of our 128Mbit products in the second quarter of 2000 as we ramp up production of our 256Mbit products. The 256Mbit flash chip has a lower manufacturing cost per megabyte and we currently expect it to contribute to improved product gross margins in the second quarter. The initial production period of each new generation of flash technology is subject to many risks and uncertainties as described in "Factors That May Affect Future Results - In transitioning to new processes and products we face production and market acceptance risks." Research and Development. Research and development expenses consist principally of salaries and payroll related expenses for design and development engineers, prototype supplies and contract services. Research and development expenses were $8.8 million in the first quarter of 2000, up $3.6 million or 68% from $5.2 million in the same period of 1999. This increase was primarily due to increased salary and related expenses and increased depreciation expense. Research and development expenses represented 8% of total revenues in the first quarter of 2000 compared to 12% in the first quarter of 1999. We expect our research and development expenses to continue to increase in absolute dollars to support the development and introduction of new generations of flash data storage products, including the 512Mbit and 1 Gigabit flash memory co-development and manufacturing joint venture with Toshiba. We expect the incremental research and development expenses related to the Toshiba joint development project to be in the range of $6.0 million to $8.0 million in fiscal 2000. Page 13 Sales and Marketing. Sales and marketing expenses include salaries, sales commissions, benefits and travel expenses for our sales, marketing, customer service and applications engineering personnel. These expenses also include other selling and marketing expenses, such as independent manufacturer's representative commissions, advertising and tradeshow expenses. Sales and marketing expenses were $10.5 million in the first quarter of 2000, up $5.4 million or 104% from $5.2 million in the first quarter of 1999. The increase was primarily due to higher commission expenses due to increased product revenues, increased salary and related expenses and higher marketing expenses. Sales and marketing expenses represented approximately 10% of total revenues in the first quarter of 2000 compared to 12% in the first quarter of 1999. We expect sales and marketing expenses to increase as sales of our products grow and as we continue to develop the retail channel for our products. General and Administrative. General and administrative expenses include the cost of our finance, information systems, human resources, shareholder relations, legal and administrative functions. General and administrative expenses were $4.7 million in the first quarter of 2000, up $2.4 million or 98% from $2.4 million in the first quarter of 1999. The increase was primarily due to increased salary and related expenses, an increase in the allowance for doubtful accounts and increased legal expenses. For the three month period ended March 31, 2000, general and administrative expenses represented 4% of total revenues compared to 5% for the same period in 1999. We expect general and administrative expenses to increase as our general and administrative functions grow to support our overall growth. General and administrative expenses could also increase substantially in the future if we continue to pursue litigation to defend our patent portfolio. See "Factors That May Affect Future Results - Risks Associated with Patents, Proprietary Rights and Related Litigation." Interest Income. Interest income was $5.6 million in the first quarter of 2000 compared to $1.4 million in the first quarter of 1999. The increase in 2000 was due primarily to higher interest income due to the investment of the proceeds from the sale of common stock in our November 1999 follow-on public offering. Gain on Investment in Foundry. In the first quarter of 2000, we recognized a gain of $344.2 million as a result of the merger of United Silicon, Inc. ("USIC") and United Microelectronics Corporation ("UMC"). We had invested $51.2 million in USIC. We received 111 million shares of UMC in exchange for our USIC shares. These shares were valued at $396 million at the time of the merger. All of the UMC shares are subject to trading restrictions imposed by UMC and the Taiwan Stock Exchange. The trading restrictions will expire on one-half of the shares on July 3, 2000. The remaining shares will become available for sale over a two year period beginning in January 2002. When the shares are ultimately sold, it is likely that we will report additional gains or losses. In April 2000, UMC announced a stock dividend of 200 shares for every 1000 shares of UMC owned, resulting in our ownership of 22 million additional UMC shares. Other Income, net. Other income, net was $0.4 million in the first quarter of 2000 compared to $0.2 million for the same period of the prior year. The increase was primarily due to increased foreign currency transaction gains in the first quarter of 2000. Provision for Income Taxes. We recorded a provision for income taxes of $8.3 million, or a 35% effective tax rate for the three month period ending March 31, 2000. We recorded an additional tax provision of $140.2 million, or an approximate tax rate of 41% on the gain in foundry investment. The effective tax rate in 1999 was 33%. The lower effective tax rate in 1999 reflects greater benefits from federal and state tax credits. Liquidity and Capital Resources As of March 31, 2000, we had working capital of $636.5 million, which included $107.6 million in cash and cash equivalents and $353.1 million in short-term investments. Operating activities provided $0.2 million of cash in the first quarter of 2000 primarily from net income and an increase in current liabilities of $12.6 million, which were partially offset by an increase in accounts receivable of $26.5 million. Page 14 Net cash used in investing activities of $44.9 million in the first quarter of 2000 consisted of net purchases of investments of $41.2 million and capital equipment purchases of $3.7 million. In the first quarter of 2000, cash provided by financing activities of $6.1 million came primarily from the sale of common stock through our stock option and employee stock purchase plans. In May 2000, we signed a definitive agreement with Toshiba providing for the joint development and manufacturing of 512 megabit and 1 gigabit flash memory chips and Secure Digital Memory Card controllers. Further, we and Toshiba will form and fund a joint venture, FlashVision LLC, to equip and operate a silicon wafer manufacturing line in Virginia. The cost of equipping the Virginia wafer manufacturing line is estimated at between $700 million and $800 million. We, as part of our 50% ownership of the joint venture, expect to invest up to $150 million in cash, and, if necessary, guarantee equipment lease lines for an additional $250 million. The agreement is expected to close no later than June 30, 2000, pending satisfactory completion of due diligence by SanDisk and Toshiba. Depending on the future demand for our products, we may decide to make additional investments, which could be substantial, in assembly and test manufacturing equipment or foundry capacity to support our business in the future. On January 3, 2000, the USIC foundry was merged into UMC. We previously invested $51.2 million in USIC. In exchange for our USIC shares, we received 111 million UMC shares. These shares were valued at approximately $396 million at the time of the merger, resulting in a pretax gain of $344 million ($204 million after-tax). All the UMC shares we received as a result of the merger are subject to trading restrictions imposed by UMC and the Taiwan Stock Exchange. The trading restrictions will expire on one-half of the shares on July 3, 2000. The remaining shares will become available for sale over a two year period beginning in January 2002. When the shares are ultimately sold, it is likely that we will report additional gains or losses. To the extent we can liquidate the UMC shares, we will plan to use such funds to support our operations and capital expenditures. Impact of Currency Exchange Rates A portion of our revenues are denominated in Japanese yen. We enter into foreign exchange forward contracts to hedge against changes in foreign currency exchange rates. At March 31, 2000, forward contracts with a notional amount of $16.2 million were outstanding. Future exchange rate fluctuations could have a material adverse effect on our business, financial condition and results of operations. Factors That May Affect Future Results Our operating results may fluctuate significantly which may adversely affect our stock price. Our quarterly and annual operating results have fluctuated significantly in the past and we expect that they will continue to fluctuate in the future. This fluctuation is a result of a variety of factors, including the following: o unpredictable demand for our products; o decline in the average selling prices of our products due to competitive pricing pressures; o seasonality in sales of our products; o adverse changes in product and customer mix; o slower than anticipated market acceptance of new or enhanced versions of our products; o competing flash memory card standards which displace the standards used in our products; Page 15 o changes in our distribution channels; o timing of license and royalty revenue; o fluctuations in product costs, particularly due to fluctuations in manufacturing yields and utilization; o availability of sufficient silicon wafer foundry capacity to meet customer demand; o excess capacity of flash memory from our competitors and our own new flash wafer capacity; o significant yield losses which could affect our ability to fulfill customer orders and could increase our costs; o lengthening in manufacturing cycle times due to our suppliers operating at peak capacity; o increased research and development expenses; o exchange rate fluctuations, particularly the U.S. dollar to Japanese yen exchange rate; o changes in general economic conditions, in particular the economic recession in Japan; o natural disasters affecting the countries in which we conduct our business, particularly Taiwan, Japan and the United States; o difficulty of forecasting and management of inventory levels; and o expenses related to obsolescence of unsold inventory. o 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 operating 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 addition, our product order backlog may fluctuate substantially from quarter to quarter. Anticipated growth in expense levels We increased our expense levels in 1999 and the first quarter of fiscal 2000 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 collaboration 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 Toshiba joint development project are expected to be in the range of $6 million to $8 million. In addition, we have significant 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 expectations for a particular period, our business, financial condition and results of operations will be harmed. Page 16 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 and MultiMediaCard 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 and MultiMediaCard products will continue to represent a significant percentage of our product revenues as consumer applications, such as digital cameras and Internet music players, 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. In addition, average unit selling prices declined in the first quarter of 2000 compared to the fourth quarter of 1999 and 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 dependent 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: o overcoming lower yields often experienced in the early production of new semiconductor devices; o problems with design and manufacturing of products that will incorporate these devices; and o 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 production ramp up of our 128 megabit flash memory technology to meet increased demand. In the third quarter of 1999, during the production 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 128 megabit technology in the future, we may be unable to meet our customers' demand for high capacity MultiMediaCard and CompactFlash products which could result in lost sales and reduced revenues. In addition, our gross margins may be harmed by any problems we encounter in the production of our 128 megabit flash memory. We plan to decrease production of our 128 megabit products in the second quarter of 2000 as we ramp up production of our 256 megabit products. Page 17 D2 flash technology We have developed new products based on D2 flash technology, a new flash architecture designed to store two bits in each flash memory cell. High density flash memory, such as D2 flash, is a complex technology that requires strict manufacturing controls and effective test screens. Problems encountered in the shift to volume production for new flash products could impact both reliability and yields, and result in increased manufacturing costs and reduced product availability. We may not be able to manufacture future generations of our D2 products with yields sufficient to result in lower costs per megabyte. In fiscal 2000, we expect to increase production of our 256 megabit flash memory technology, which has a lower cost per megabyte than the 128 megabit technology. If we are unable to bring future generations of our 256 megabit flash memory into full production as quickly as planned or if we experience unplanned yield problems, we will not be able to meet our customers' forecasted demand, which would result in lost sales, reduced revenues and reduced margins. MultiMediaCard products The MultiMediaCard presents new challenges in assembly and testing. In the third quarter of 1999, during the MultiMediaCard production startup phase, we experienced fluctuations in yields which reduced MultiMediaCard product availability, increased manufacturing costs and reduced product margins for this product family. We are currently unable to meet all customer demand for MultiMediaCard products. Future yield problems with our MultiMediaCard products could result in lost sales and reduced revenues. In addition, our gross margins may be harmed by any problems we encounter in the production of our MultiMediaCard products. Secure Digital Memory Card products In the third quarter of 1999, we announced a memorandum of understanding under which we, along with Matsushita and Toshiba, will jointly develop and promote the Secure Digital Memory Card. The Secure Digital Memory Card is an enhanced version of our MultiMediaCard that 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 Card products in the second quarter of 2000. Negotiations for a definitive agreement concerning this collaboration are underway, and are expected to be concluded in the second quarter. The Secure Digital Memory Card will incorporate a number of new features, including SDMI compliant security and copy protection, a mechanical write protect switch and a high data transfer rate. We have never built products incorporating these features. Any problems or delays in establishing production capabilities or ramping up production volumes of our Secure Digital Memory Card products could result in lost sales or increased manufacturing costs in 2000. In addition, we cannot be sure that manufacturers of consumer electronic products will develop new products that use the Secure Digital Memory Card or that content providers such as music studios will agree to distribute their copyrighted content for storage on Secure Digital Memory Cards. Furthermore, there is no assurance that consumers will widely adopt Secure Digital Memory Cards because of the requirement to purchase copyrighted content. Conversely, broad acceptance of our Secure Digital Memory Card by consumers may reduce demand for our MultiMediaCard and CompactFlash card products. See "--The success of our business depends on emerging markets and new products." We depend on third party foundries for silicon wafers. All of our products require silicon wafers. We rely on UMC in Taiwan to supply all of our silicon wafers. We depend on UMC to allocate a portion of its capacity to our needs, produce acceptable quality wafers with acceptable manufacturing yields and deliver our wafers on a timely basis at a competitive price. If UMC is unable to satisfy these requirements, our business, financial condition and operating results may suffer. For example, in September 1999, both UMC foundries producing our flash memory wafers were damaged and temporarily shut down by an earthquake in Taiwan. Future earthquakes, aftershocks or other Page 18 natural disasters in Taiwan could preclude us from obtaining an adequate supply of wafers to fill customer orders, and could significantly harm our business, financial condition and results of operations. 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 technology silicon wafers is increasing the price of these wafers as supply becomes constrained. We expect this trend to continue throughout 2000 and possibly through 2001, 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 do 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 currently 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 certain percentage from the previous month's forecast. This limits our ability to react to fluctuations in demand for our products. For example, 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 supply 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 year. Although we are increasing 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 the 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 customer samples of our Secure Digital Memory Cards in 32 and 64 megabyte capacities in the second quarter of 2000. The Secure Digital Memory Card is slightly thicker and uses a different interface than our MultiMediaCard. Page 19 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 products 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 business, 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 channels and brand recognition. We cannot assure you that our Secure Digital Memory Card will be successful in the face of such competition. In addition, the market for portable digital music players is very new and it is uncertain how quickly consumer demand for these players will grow. If this market does not grow as quickly as anticipated or our customers are not successful in selling their portable digital music players to consumers, our revenues could be adversely affected. In addition, it is often the case with new consumer markets that after an initial period of new market formation and initial acceptance by early adopters, the market enters a period of slow growth as standards emerge and infrastructure develops. In the event that this occurs in the portable digital music player market or other emerging markets, sales of our products would be harmed. The success of our new product strategy will depend upon, among other things, the following: o our ability to successfully develop new products with higher memory capacities and enhanced features at a lower cost per megabyte; o the development of new applications or markets for our flash data storage products; o the extent to which prospective customers design our products into their products and successfully introduce their products; and o the extent to which our products or technologies become obsolete or noncompetitive due to products or technologies developed by others. 512 megabit and 1 gigabit scale flash memory card products In May 2000, we signed a definitive agreement with Toshiba providing for the joint development and manufacture of 512 megabit and 1 gigabit flash memory chips and Secure Digital Memory Card controllers. As part of this collaboration, we and Toshiba plan to employ Toshiba's future 0.16 micron and 0.13 micron NAND flash integrated circuit manufacturing technology and SanDisk's multilevel cell flash and controller system technology. The development of 512 megabit and 1 gigabit flash memory chips and Secure Digital Memory Card controllers is expected to be complex and incorporates SanDisk and Toshiba technology that is still under development. We cannot assure you that we and Toshiba will successfully develop these new products or the underlying technology, or that any development will be completed in a timely or cost-effective manner. If we are not successful in any of the above, our business, financial condition and results of operations could suffer. We may be unable to maintain market share. We may be unable to increase our production volumes at a sufficiently rapid rate so as to maintain our market share. Ultimately, our growth rate depends on our ability to obtain sufficient flash memory wafers and other components to meet demand. If we are unable to do so in a timely manner, we may lose market Page 20 share to our competitors. Currently, our supply constraints are forcing some of our largest customers to seek alternate sources of supply to meet their growing flash memory product needs. Our selling prices may be affected by future excess capacity in the market for flash memory products. Currently industry wide demand for flash memory products far exceeds the available supply. This is primarily driven by an explosion in the growth of cellular phones and internet appliances and the accelerating shift in consumer electronics from analog to digital devices. This strong demand had manifested itself in improved bookings visibility and a more stable pricing environment. All major flash memory suppliers, including SanDisk, are responding to this strong demand by significantly increasing investments in new advanced flash memory production capacity due to the broadly held assumption that our industry is entering a prolonged growth phase which will be able to absorb the new flash production output. If this assumption should prove to be erroneous, or if one or several of our target markets experience delays in anticipated growth, there may be excess supply in market for our products. This excess capacity, even if temporary in nature, could cause average selling prices to drop significantly, thereby adversely impacting our product gross margins and operating results in future quarters. Our international operations make us vulnerable to changing conditions and currency fluctuations. Political risks Currently, all of our flash memory wafers are produced by two UMC foundries in Taiwan. We also use a third-party subcontractor in Taiwan for the assembly and testing of our MultiMediaCard products. We may therefore be affected by the political, economic and military conditions in Taiwan. Taiwan is currently engaged in various political disputes with China and in the past both countries have conducted military exercises in or near the other's territorial waters and airspace. The Taiwanese and Chinese governments may escalate these disputes, resulting in an economic embargo, a disruption in shipping routes or even military hostilities. This could harm our business by interrupting or delaying the production or shipment of flash memory wafers or MultiMediaCard products by our Taiwanese foundries and subcontractor. See "-- We depend on our suppliers and third party subcontractors." In addition, in the second quarter of 1999, we began using a third-party subcontractor in China for the assembly and testing of our CompactFlash products. As a result, our business could be harmed by the effect of political, economic, legal and other uncertainties in China. Under its current leadership, the Chinese government has been pursuing economic reform policies, including the encouragement of foreign trade and investment and greater economic decentralization. The Chinese government may not continue to pursue these policies and, even if it does continue, these policies may not be successful. The Chinese government may also significantly alter these policies from time to time. In addition, China does not currently have a comprehensive and highly developed legal system, particularly with respect to the protection of intellectual property rights. As a result, enforcement of existing and future laws and contracts is uncertain, and the implementation and interpretation of such laws may be inconsistent. Such inconsistency could lead to piracy and degradation of our intellectual property protection. Economic risks We price our products primarily in U.S. dollars. As a result, if the value of the U.S. dollar increases relative to foreign currencies, our products could become less competitive in international markets. For example, our products are relatively more expensive in Asia because of the weakness of many Asian currencies relative to the US dollar. In addition, we currently invoice some of our customers in Japanese yen. Therefore, fluctuations in the Japanese yen against the U.S. dollar could harm our business, financial condition and results of operations. Similarly, the weakness of the Euro may make our products less competitive in Europe relative to Japanese flash memory suppliers. Page 21 Our sales are also highly dependent upon global economic conditions. In fiscal 1998, sales to Japan declined to 31.6% of total product sales from 38.1% in 1997. In 1999, sales to Japan represented 22.4% of product revenue. We believe these declines were primarily due to the Japanese recession. General risks Our international business activities could also be limited or disrupted by any of the following factors: o the need to comply with foreign government regulation; o general geopolitical risks such as political and economic instability, potential hostilities and changes in diplomatic and trade relationships; o natural disasters affecting the countries in which we conduct our business, particularly Taiwan and Japan; o imposition of regulatory requirements, tariffs, import and export restrictions and other barriers and restrictions, particularly in China; o longer payment cycles and greater difficulty in accounts receivable collection, particularly as we increase our sales through the retail distribution channel; o potentially adverse tax consequences; o less protection of our intellectual property rights; and o delays in product shipments due to local customs restrictions. We depend on our suppliers and third party subcontractors. We rely on our vendors, some of which are sole source suppliers, for several of our critical components. We do not have long-term supply agreements with some of these vendors. Our business, financial condition and operating results could be harmed by delays or reductions in shipments if we are unable to develop alternative sources or obtain sufficient quantities of these components. For example, we rely on UMC for all of our flash memory wafers and NEC to supply certain designs of microcontrollers. In September 1999, both UMC foundries producing our flash memory wafers were damaged and temporarily shut down by an earthquake in Taiwan. In addition, due to industry-wide increasing demand for semiconductors, we have recently experienced resistance to price reductions from some of our important suppliers. See "--We depend on third party foundries for silicon wafers." We have begun to experience longer order lead times on standard components due to high industry demand. Shortages of any of these standard components could result in higher manufacturing costs or lower revenues due to production delays or reduced product shipments. Additionally, where possible, we are building buffer inventories of critical components. If we accumulate excess inventories or these buffer inventories become obsolete, we will have to write down inventories which will adversely affect our gross margins and results of operations. We also rely on third-party subcontractors to assemble and test the memory components for our products. We have no long-term contracts with these subcontractors and cannot directly control product delivery schedules. This could lead to product shortages or quality assurance problems which could increase the manufacturing costs of our products and have adverse effects on our operating results. During the second half of 1999, we transferred a substantial portion of wafer testing, packaged memory final testing, card assembly and card testing to Silicon Precision Industries Co., Ltd. in Taiwan and Celestica, Inc. in China. In the second quarter of 2000, we will begin using an additional subcontractor in Page 22 the Philippines for card assembly and testing. In fiscal 2000, we expect that they will be assembling and testing a majority of our mature, high-volume products. This increased reliance on subcontractors is expected to reduce manufacturing costs and give us access to increased production capacity. During the transition period, we will continue full operations at our Sunnyvale production facility while simultaneously transferring test equipment and training personnel of our subcontractors. However, we do not have sufficient duplicative production testing equipment at Sunnyvale and at our subcontractors. Therefore, any significant problems in this complex transfer of operations may result in a disruption of production and a shortage of product to meet customer demand in the first half of 2000 and beyond. Continuing declines in our average sales prices may result in declines in our gross margins. In 1999, the average unit selling prices of our products declined 22% compared to 1998. In 1999, the average price per megabyte shipped declined 52% compared to 1998. Because flash data storage markets are characterized by intense competition and price reductions for our products are necessary to meet consumer price points, we expect that market-driven pricing pressures will continue. This will likely result in a further decline in average sales prices for our products. We believe that we can offset declining average sales prices by achieving manufacturing cost reductions and developing new products that incorporate more advanced technology, include more advanced features and can be sold at stable average gross margins despite continued declines in average selling price per megabyte. However, if we are unable to achieve such cost reductions and technological advances, this could result in lost sales and declining gross margins, and as a result, our business, financial condition and results of operations could suffer. The semiconductor industry is cyclical and we believe it is currently in a recovery from one of its most severe down cycles. During most of 1997 and 1998, the semiconductor industry experienced significant production over capacity, which reduced margins for substantially all flash memory suppliers. Currently, the markets for our products are supply constrained and our selling prices have stayed relatively stable. There can be no assurance that this trend will continue throughout 2000. Our markets are highly competitive. Flash memory manufacturers and memory card assemblers We compete in an industry characterized by intense competition, rapid technological changes, evolving industry standards, declining average selling prices and rapid product obsolescence. Our competitors include many large domestic and international companies that have greater access to advanced wafer foundry capacity, substantially greater financial, technical, marketing and other resources, broader product lines and longer standing relationships with customers. Our primary competitors include: o storage flash chip producers, such as Hitachi Ltd., Samsung Electronics Company Ltd. and Toshiba Corporation; o socket flash, linear flash and component manufacturers, such as Advanced Micro Devices, Inc., Atmel Corporation, Intel Corporation, Macronix International Co., Ltd., Micron Technology, Inc., Mitsubishi Electronic Corporation, Sharp Electronics Corporation and STMicroelectronics NV; and o module or card assemblers, such as Lexar Media, Inc., M-Systems, Inc., Pretec Electronics Corp., Simple Technology Inc., Sony Corporation, Kingston Technology Company, Panasonic Consumer Electronic Company, Silicon Storage Technology, Inc., TDK Corporation, Matsushita Battery, Inc. Delkin Devices, Inc., Silicon Tek and Viking Components, Inc., who combine controllers and flash memory chips developed by others into flash storage cards. In addition, over 25 companies have been certified by the CompactFlash Association to manufacture and sell their own brand of CompactFlash. We believe additional manufacturers will enter the CompactFlash market in the future. Page 23 We have announced a memorandum of understanding under which we, Matsushita and Toshiba will jointly develop and promote a next generation flash memory card called the Secure Digital Memory Card. Under this agreement, Secure Digital Memory Card licenses will be granted to other flash memory card manufacturers, which will increase the competition for our Secure Digital Memory Card, CompactFlash and MultiMediaCard products. In addition, Matsushita and Toshiba will sell Secure Digital Memory Cards that will compete directly with our products. While other flash card manufacturers will be required to pay the SD Association license fees and royalties which will be shared between Matsushita, Toshiba and SanDisk, there will be no royalties or license fees payable among the three companies for their respective sales of the Secure Digital Memory Card. Thus, we will forfeit potential royalty income from Secure Digital Memory Card sales by Matsushita and Toshiba. In May 2000, we signed a definitive agreement with Toshiba providing for the joint development and manufacture of 512 megabit and 1 gigabit flash memory chips and Secure Digital Memory Card controllers. We and Toshiba will each separately market and sell any products developed and manufactured under this relationship. Accordingly, we will compete directly with Toshiba for sales of these advanced chips and controllers. We have entered into patent cross-license agreements with several of our leading competitors including, Hitachi, Samsung, Toshiba, Intel, SST and Sharp. Under these agreements, each party may manufacture and sell products that incorporate technology covered by the other party's patents related to flash memory devices. As we continue to license our patents to certain of our competitors, competition will increase and may harm our business, financial condition and results of operations. Currently, we are engaged in licensing discussions with several of our competitors. There can be no assurance that we will be successful in concluding licensing agreements under terms which are favorable to us. Alternative storage media Competing products have been introduced that promote industry standards that are different from our CompactFlash and MultiMediaCard products, including Toshiba's SmartMedia, Sony Corporation's Memory Stick, Sony's standard floppy disk used for digital storage in its Mavica digital cameras, Panasonic's Mega Storage cards, Iomega's Clik drive, a miniaturized, mechanical, removable disk drive and M-Systems' Diskonchip for embedded storage applications and the Secure MultiMediaCard from Hitachi and Infineon. Each competing standard is mechanically and electronically incompatible with CompactFlash and MultiMediaCard. If a manufacturer of digital cameras or other consumer electronic devices designs in one of these alternative competing standards, CompactFlash or MultiMediaCard will be eliminated from use in that product. In September 1998, IBM introduced the microdrive, a rotating disk drive in a Type II CompactFlash format. This product competes directly with our Type II CompactFlash memory cards, for use in high-end professional digital cameras. In October 1998, M-Systems introduced their Diskonchip 2000 Millennium product which competes against our Flash ChipSet products in embedded storage applications such as set top boxes and networking appliances. According to independent industry analysts, Sony's Mavica digital camera captured a considerable portion of the United States market for digital cameras in 1998 and 1999. The Mavica uses a standard floppy disk to store digital images and therefore uses no CompactFlash, or any other flash cards. Our sales prospects for CompactFlash cards have been adversely impacted by the success of the Mavica. Recently, Sony has shifted its focus to the use of its flash Memory Stick in its latest digital camera models. Our MultiMediaCard products also have faced significant competition from Toshiba's SmartMedia flash cards and we expect to face similarly significant competition from Sony's Memory Stick. Sony has licensed its proprietary memory stick to other companies. If it is adopted and achieves widespread use in future products, sales of our MultiMediaCard and CompactFlash products may decline. Recently, Hitachi, Infineon, Sanyo and Fujitsu have proposed their Secure MultiMediaCard which provides the copy Page 24 protection function that is included in our Secure Digital Memory Card. Should this initiative gain industry wide acceptance, it may reduce the widespread adoption of the Secure Digital Memory Card. In the first quarter of 2000, Sanyo announced that it is developing a miniature magneto-optical storage device for use in future digital cameras, music players and camcorders. There can be no assurance that this device will not be adopted by some of our OEM customers. Alternative flash technologies We also face competition from products based on multilevel cell flash technology such as Intel's 64 megabit and 128 megabit StrataFlash chips and Hitachi's 256 megabit multilevel cell flash chip. These products compete with our D2 multilevel cell flash technology. Multilevel cell flash is a technological innovation that allows each flash memory cell to store two bits of information instead of the traditional single bit stored by the industry standard flash technology. In the second quarter of 1999, Intel announced their new 128 megabit multilevel cell chip and Hitachi is currently shipping CompactFlash and MultiMediaCard products employing their multilevel cell 256 megabit flash chip. In addition, Toshiba has begun customer shipments of 32 and 64 megabyte SmartMedia cards employing their new 256 megabit flash chip. Although Toshiba has not incorporated multilevel cell flash technology in their 256 megabit flash chip, their use of more advanced lithographic design rules may allow them to achieve a more competitive cost structure than that of our 256 megabit D2 flash chip. Furthermore, we expect to face competition from existing competitors and from other companies that may enter our existing or future markets that have similar or alternative data storage solutions which may be less costly or provide additional features. Price is an important competitive factor in the market for consumer products. Increased price competition could lower gross margins if our average selling prices decrease faster than our costs and could also result in lost sales. Our business depends upon consumer products. In 1999 and the first quarter of 2000, we received more product revenue and shipped more units of products destined for consumer electronics applications, principally digital cameras, than for any other application. We believe that these products will encounter intense competition and be more price sensitive than products sold into our other target markets. In addition, we must spend more on marketing and promotion in consumer markets to establish brand name recognition and preference. A significant portion of sales to the consumer electronics market is made through distributors and to retailers. Sales through these channels typically include rights to return unsold inventory. As a result, we do not recognize revenue until after the product has been sold to the end user. If our distributors and retailers are not successful in this market, there could be substantial product returns, which would harm our business, financial condition and results of operations. Sales to a small number of customers represent a significant portion of our revenues. More than half of our revenues come from a small number of customers. For example in the first quarter of 2000, sales to our top 10 customers accounted for approximately 52% of our product revenues and in 1999 sales to our top 10 customers represented 61% of our product revenues . In the first quarter of 2000 and in fiscal year 1999, one customer accounted for more than 10% of product sales. If we were to lose any of these customers or experience any material reduction in orders from these customers, our revenues and operating results would suffer. Our sales are generally made by standard purchase orders rather than long-term contracts. In addition, the composition of our major customer base changes from year to year as the market demand for our customers' products change. Page 25 Our multiple sales channels may compete for a limited number of customer sales. Web based sales of our products today represent a small but growing portion of our overall sales. Sales on the Internet tend to undercut the traditional distribution channels and may dramatically change the way our consumer products are purchased in future years. We cannot assure you that we will successfully manage the inherent channel conflicts between our retail channel customers and customers that wish to purchase directly on the Internet. There may be seasonality in our business. Sales of our products, in particular the sale of CompactFlash products, in the consumer electronics applications market may be subject to seasonality. As a result, product sales may be impacted by seasonal purchasing patterns with higher sales generally occurring in the second half of each year. In addition, in the past we have experienced a decrease in orders in the first quarter from our Japanese OEM customers primarily because most customers in Japan operate on a fiscal year ending in March and prefer to delay purchases until the beginning of their next fiscal year. For example, our product revenues were 24% lower in the first quarter of 1998 than in the fourth quarter of 1997, mostly due to these seasonal factors.. Although we did not experience this seasonality in the first quarter of 2000 and are not able to fulfill all demand from our customers, we cannot assure you that we will not experience seasonality in the future. We must achieve acceptable wafer manufacturing yields. The fabrication of our products requires wafers to be produced in a highly controlled and ultra clean environment. Semiconductor companies that supply our wafers sometimes have experienced problems achieving acceptable wafer manufacturing yields. Semiconductor manufacturing yields are a function of both our design technology and the foundry's manufacturing process technology. Low yields may result from design errors or manufacturing failures. Yield problems may not be determined or improved until an actual product is made and can be tested. As a result, yield problems may not be identified until the wafers are well into the production process. The risks associated with yields are even greater because we rely on independent offshore foundries for our wafers which increases the effort and time required to identify, communicate and resolve manufacturing yield problems. If the foundries cannot achieve the planned yields, this will result in higher costs and reduced product availability, and could harm our business, financial condition and results of operations. Under the terms of our definitive agreement with Toshiba, we and Toshiba will jointly form and fund a joint venture which will equip and operate a silicon wafer manufacturing line in Virginia (the Dominion facility) to manufacture 512 megabit and 1 gigabit flash memory chips. However, we cannot assure you that this manufacturing line will produce satisfactory quantities of wafers with acceptable prices and yields. Any failure in this regard could materially harm our business, financial condition and results of operations. In addition, the construction improvements and operation of this line will cause us to incur significant expense and may result in the diversion of resources from other important areas of business. We cannot assure you that we or Toshiba will be able to secure sufficient funding to support this manufacturing line. In addition, we have no experience in operating a wafer manufacturing line and we intend to rely on the existing manufacturing organization at the Dominion facility. This organization will be trained in Nand flash manufacturing by Toshiba, but we cannot assure you that they will be successful in manufacturing these advanced Nand flash products on a cost-effective basis or at all. We are committed to purchase 50% of the Nand flash output from the Dominion facility, and therefore, should the customer demand for Nand flash products be below our available supply, our results of operations could be adversely affected. Furthermore, in order for us to sell Nand based CompactFlash, MultiMediaCards and SD Cards, we will have to develop new controllers, printed circuit boards and test algorithms because the architecture of Nand flash is significantly different from our current Nor flash designs. Any delays in the development of these elements could prevent us from taking advantage of the available Nand output and could adversely affect our results of operations. Page 26 Risks associated with patents, proprietary rights and related litigation. General We rely on a combination of patents, trademarks, copyright and trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. In the past, we have been involved in significant disputes regarding our intellectual property rights and claims that we may be infringing third parties' intellectual property rights. We expect that we may be involved in similar disputes in the future. We cannot assure you that: o any of our existing patents will not be invalidated; o patents will be issued for any of our pending applications; o any claims allowed from existing or pending patents will have sufficient scope or strength; o our patents will be issued in the primary countries where our products are sold in order to protect our rights and potential commercial advantage; or o any of our products may infringe on the patents of other companies. In addition, our competitors may be able to design their products around our patents. We intend to vigorously enforce our patents but we cannot be sure that our efforts will be successful. If we were to have an adverse result in any litigation, we could be required to pay substantial damages, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology, discontinue the use of certain processes or obtain licenses to the infringing technology. Any litigation is likely to result in significant expense to us, as well as divert the efforts of our technical and management personnel. For example, the Lexar litigation described below has resulted in cumulative litigation expenses of approximately $1.7 million. Cross-licenses and indemnification obligations If we decide to incorporate third party technology into our products or if we are found to infringe on others' intellectual property, we could be required to license intellectual property from a third party. We may also need to license some of our intellectual property to others in order to enable us to obtain cross-licenses to third party patents. Currently, we have patent cross-license agreements with several companies, including Hitachi, Intel, Samsung, Sharp, SST, SmartDisk and Toshiba and we are in discussions with other companies regarding potential cross-license agreements. We cannot be certain that licenses will be offered when we need them, or that the terms offered will be acceptable. If we do obtain licenses from third parties, we may be required to pay license fees or royalty payments. In addition, if we are unable to obtain a license that is necessary to the manufacture of our products, we could be required to suspend the manufacture of products or stop our wafer suppliers from using processes that may infringe the rights of third parties. We cannot assure you that we would be successful in redesigning our products or that the necessary licenses will be available under reasonable terms. We have historically agreed to indemnify various suppliers and customers for alleged patent infringement. The scope of such indemnity varies, but may, in some instances, include indemnification for damages and expenses, including attorney's fees. We may periodically engage in litigation as a result of these indemnification obligations. We are not currently engaged in any such indemnification proceedings. Our insurance policies exclude coverage for third party claims for patent infringement. Any future obligation to indemnify our customers or suppliers could harm our business, financial condition or results of operations. Page 27 Litigation risks associated with our intellectual property From time to time, it may be necessary to initiate litigation against third parties to preserve our intellectual property rights. These parties could in turn bring suit against us. For example, in March 1998 we filed a complaint in federal court against Lexar Media, Inc. for infringement of one of our flash card patents. Lexar disputed this claim and asserted that our patent was invalid or unenforceable, as well as asserting various counterclaims including unfair competition, violation of the Lanham Act, patent misuse, interference with prospective economic advantage, trade defamation and fraud. We have denied all of these counterclaims. In July 1998, the court denied Lexar's request to have the case dismissed. Discovery in this suit began in August 1998. On February 22, 1999, the court considered arguments and papers submitted by the parties regarding the scope and proper interpretation of the asserted claims in our patent at issue in the Lexar suit. On March 4, 1999, the court issued its ruling on the proper construction of the claim terms in our patent. On July 30, 1999, we filed a motion for partial summary judgment that Lexar CompactFlash and PC Cards contributorily infringe our patent. Lexar filed a motion for summary judgement that our patent is invalid in view of prior art. A hearing on both of these motions was held on March 17, 2000 and on March 28, 2000 the court found that the accused Lexar flash cards contributarily infringed SanDisk's patent and granted SanDisk's motion for partial summary judgement. Additionally, the court denied Lexar's summary judgement motion for non-infringement and invalidity. A trial date has been set this matter in October 2000. On March 21, 2000, Mitsubishi Denki Co. Ltd. (Mitsubishi Electric) filed a complaint in Tokyo District Court against SanDisk K.K., SanDisk's wholly-owned subsidiary in Japan. The complaint alleges that SanDisk K.K., based in Yokohama, Japan, infringes on three Mitsubishi Japanese patents. The Mitsubishi patents in question are #JP2099342, #JP2129071 and # JP2138047. Based on preliminary information, we believe that these patents are related primarily to the mechanical construction of memory cards built with a separate connector. In the complaint, Mitsubishi asked the court for a preliminary injunction halting the sale of our CompactFlash and flash ATA memory cards in Japan. SanDisk and SanDisk K.K. will vigorously defend itself against Mitsubishi's claims. From time to time, we have been contacted by various parties who have alleged that certain of our products infringe on patents that such parties claim to hold. To date no legal actions have been filed in connection with any such infringement, other than as discussed above. In the event of an adverse result in any such litigation, we could be required to pay substantial damages, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to the infringing technology, or discontinue the use of certain processes. Litigation frequently involves substantial expenditures and can require significant management attention, even if we ultimately prevail. In addition, the results of any litigation matters are inherently uncertain. Accordingly, there can be no assurance that any of the foregoing matters, or any future litigation, will not have a material adverse effect on our business, financial condition and results of operations. Our rapid growth may strain our operations. We are currently experiencing rapid growth, which has placed, and continues to place, a significant strain on our personnel and other resources. To accommodate this growth, we must continue to hire, train, motivate and manage our employees. We are having difficulty hiring the necessary engineering, sales and marketing personnel to support our growth. In addition, we must make a significant investment in our existing internal information management systems to support increased manufacturing, as well as accounting and other management related functions. Our systems, procedures and controls may not be adequate to support our rapid growth, which could in turn harm our business, financial condition and results of operations. Our success depends on key personnel, including our executive officers, the loss of whom could disrupt our business. Our success greatly depends on the continued contributions of our senior management and other key research and development, sales, marketing and operations personnel, including Dr. Eli Harari, our founder, Page 28 President and Chief Executive Officer. Our success will also depend on our ability to recruit additional highly skilled personnel. We cannot assure you that we will be successful in hiring or retaining such key personnel, or that any of our key personnel will remain employed with us. Anti-takeover provisions in our charter documents, stockholder rights plan and in Delaware law could prevent or delay a change in control and, as a result, negatively impact our stockholders. We have taken a number of actions that could have the effect of discouraging a takeover attempt. For example, we have adopted a stockholder rights plan that would cause substantial dilution to a stockholder who attempts to acquire us on terms not approved by our board of directors. In addition, our certificate of incorporation grants the board of directors the authority to fix the rights, preferences and privileges of and issue up to 4,000,000 shares of preferred stock without stockholder action. Although we have no present intention to issue shares of preferred stock, such an issuance could have the effect of making it more difficult and less attractive for a third party to acquire a majority of our outstanding voting stock. Preferred stock may also have other rights, including economic rights senior to the common stock that could have a material adverse effect on the market value of the common stock. In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law. This section provides that a corporation shall not engage in any business combination with any interested stockholder during the three-year period following the time that such stockholder becomes an interested stockholder. This provision could have the effect of delaying or preventing a change of control of SanDisk. Our stock price has been, and may continue to be, volatile. The market price of our stock has fluctuated significantly in the past and is likely to continue to fluctuate in the future. For example in the twelve month period ending March 31, 2000 our stock price has fluctuated from a low of $8.50 to a high of $169.625. We believe that such fluctuations will continue as a result of future announcements concerning us, our competitors or principal customers regarding technological innovations, new product introductions, governmental regulations, litigation or changes in earnings estimates by analysts. In addition, in recent years the stock market has experienced significant price and volume fluctuations and the market prices of the securities of high technology companies have been especially volatile, often for reasons outside the control of the particular companies. These fluctuations as well as general economic, political and market conditions may have an adverse affect on the market price of our common stock. Item 3. Quantitative and Qualitative Disclosures About Market Risk Please refer to the Company's Form 10-K for the year ended December 31, 1999. Page 29 PART II. OTHER INFORMATION Item 1. Legal Proceedings The information required by this item is set forth in Note 6 of the Notes to the Condensed Consolidated Financial Statements on pages 7 and 8 and under "Factors That May Affect Future Results - Risks Associated with Patents, Proprietary Rights and Related Litigation" on pages 26 to 28 of this Form 10-Q for the quarterly period ended March 31, 2000, and is incorporated herein by reference. Item 2. Changes in Securities None Item 3. Defaults upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K A. Exhibits Exhibit Number Exhibit Title 3.1 Certificate of Incorporation of the Registrant, as amended to date.2 3.2 Form of Amended and Restated Certificate of Incorporation of the Registrant.2 3.3 Bylaws of the Registrant, as amended.2 3.4 Form of Amended and Restated Bylaws of the Registrant 2 3.5 Certificate of Designation for the Series A Junior Participating Preferred Stock, as filed with the Delaware Secretary of State on April 24, 1997.4 4.1 Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4.2 4.3 Amended and Restated Registration Rights Agreement, among the Registrant and the investors and founders named therein, dated March 3, 1995.2 4.5 Series F Preferred Stock Purchase Agreement between Seagate Technology, Inc. and the Registrant, dated January 15, 1993.2 4.8 Rights Agreement, dated as of April 18, 1997, between the Company and Harris Trust and Savings Bank.4 4.9 First Amendment to Rights Agreement dated October 22, 1999, between Harris Trust and the Registrant.11 9.1 Amended and Restated Voting Agreement, among the Registrant and the investors named therein, dated March 3, 1995.2 10.10 License Agreement between the Registrant and Dr. Eli Harari, dated September 6, 1988.2 10.13 1989 Stock Benefit Plan.2 10.14 1995 Stock Option Plan.2 10.15 Employee Stock Purchase Plan.2 10.16 1995 Non-Employee Directors Stock Option Plan.2 10.18 Lease Agreement between the Registrant and G.F. Properties, dated March 1, 1996.3 10.21 Amendment to Lease Agreement between the Registrant and G.F. Properties, dated April 3, 1997.5 10.23 Foundry Venture Agreement between the Registrant and United Microelectronics Corporation, dated June 27, 1997.1, 6 10.24 Written Assurances Re: Foundry Venture Agreement between the Registrant and United Microelectronics Corporation, dated September 13, 1995.1, 6 10.25 Side Letter between Registrant and United Microelectronics Corporation, dated May 28, 1997.1, 6 10.27 Clarification letter with regards to Foundry Venture Agreement between the Registrant and United Microelectronics Corporation dated October 24, 1997.7 10.28 Lease Agreement between the Registrant and G.F. Properties, dated June 10, 1998.8 10.29 Trade Finance Agreement between the Registrant and Union Bank of California, dated July 15, 1998.9 10.30 1995 Stock Option Plan Amended and Restated as of December 17, 1998.12 10.31 1995 Non-Employee Directors Stock Option Plan Amended and Restated as of December 17, 1998.12 10.32 1995 Employee Stock Purchase Plan Amended and Restated as of December 17, 1998.12 21.1 Subsidiaries of the Registrant.10 27.1 Financial Data Schedule for the quarter ended March 31, 2000. (In EDGAR format only) - ---------- 1. Confidential treatment granted as to certain portions of these exhibits. 2. Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-1 (No. 33-96298). 3. Previously filed as an Exhibit to the Registrant's 1995 Annual Report on Form 10-K. Page 31 4. Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K/A dated April 18, 1997. 5. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1997. 6. Previously filed as an Exhibit to the Registrant's Current Report on form 8-K dated October 16, 1997. 7. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended September 30, 1997. 8. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1998. 9. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended September 30, 1998. 10. Previously filed as an Exhibit to the Registrant's Annual Report on Form 10-K. 11. Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated January 1, 1999. 12. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended March 31, 1999. B. Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended March 31, 2000. Page 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. SanDisk Corporation (Registrant) By: /s/ Frank Calderoni ----------------------- Frank Calderoni Chief Financial Officer, Senior Vice President, Finance and Administration (On behalf of the Registrant and as Principal Financial Officer.) DATED: May 15, 2000 EX-27 2 FINANCIAL DATA SCHEDULE
5 SanDisk Financial Data Schedule, March 31, 2000 0001000180 SanDisk Corporation 1,000 3-MOS Dec-31-2000 Mar-31-2000 107,558 567,905 78,884 0 35,231 794,844 31,919 0 1,033,911 158,316 0 0 0 530,204 277,074 1,033,911 97,249 109,369 67,758 0 24,060 0 0 367,771 148,500 219,271 0 0 0 219,271 3.32 3.00
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