-----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, U068cmtUDRPlNzX53RSXijT34OZbAsKWAyzeqihJ1WuJUMjr8hOyiG6IAubJyozq uOLbLwWB0OEbsNi/OWfTcQ== 0001000180-98-000010.txt : 19981113 0001000180-98-000010.hdr.sgml : 19981113 ACCESSION NUMBER: 0001000180-98-000010 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981112 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: 98744497 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 SEPTEMBER 30, 1998 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 September 30, 1998 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 September 30, 1998 Common Stock, $0.001 par value 26,588,350 ------------------------------ ---------- Class Number of shares SanDisk Corporation Index PART I. FINANCIAL INFORMATION Page No. Item 1. Condensed Consolidated Financial Statements: Condensed Consolidated Balance Sheets September 30, 1998 and December 31, 1997.................... 3 Condensed Consolidated Statements of Income Three and nine months ended September 30, 1998 and 1997..... 4 Condensed Consolidated Statements of Cash Flows Nine months ended September 30, 1998 and 1997............... 5 Notes to Condensed Consolidated Financial Statements............ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................. 10 PART II. OTHER INFORMATION Item 1. Legal Proceedings.............................................. 26 Item 2. Changes in Securities.......................................... 26 Item 3. Defaults upon Senior Securities................................ 26 Item 4. Submission of Matters to a Vote of Security Holders............ 26 Item 5. Other Information.............................................. 26 Item 6. Exhibits and Reports on Form 8-K............................... 27 Signatures..................................................... 29 Page 2 PART I. FINANCIAL INFORMATION SanDisk Corporation Condensed Consolidated Balance Sheets (In thousands) ASSETS September 30, December 31, 1998 1997* ------------ ----------- (unaudited) Current Assets: Cash and cash equivalents $ 13,880 $ 20,888 Short-term investments 112,972 114,037 Accounts receivable, net 17,738 19,352 Inventories 18,205 15,648 Deferred tax assets 17,110 17,060 Prepaid expenses and other current assets 1,105 1,406 ------------- ------------ Total current assets 181,010 188,391 Property and equipment, net 16,018 15,892 Investment in foundry 51,209 40,284 Deposits and other assets 1,141 900 ------------- ------------ Total Assets $249,378 $245,467 ============= ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 5,994 $ 14,111 Accrued payroll and related expenses 3,481 4,674 Other accrued liabilities 5,909 7,341 Deferred revenue 31,722 27,967 ------------- ------------ Total current liabilities 47,106 54,093 Stockholders' Equity: Common stock 184,210 181,921 Retained earnings 18,062 9,453 ------------- ------------ Total stockholders' equity 202,272 191,374 Total Liabilities and ============= ============ Stockholders' Equity $249,378 $245,467 ============= ============ 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 Nine months ended September 30, September 30, 1998 1997 1998 1997 ---------- ---------- ---------- ----------- Revenues: Product $ 24,143 $ 30,219 $ 73,049 $ 72,335 License and royalty 7,935 5,925 24,492 12,600 ---------- ---------- ---------- ----------- Total revenues 32,078 36,144 97,541 84,935 Cost of sales 18,840 20,135 57,172 49,476 ---------- ---------- ---------- ----------- Gross profits 13,238 16,009 40,369 35,459 Operating expenses: Research and development 4,805 3,550 13,610 9,634 Sales and marketing 3,964 3,197 12,163 8,728 General and administrative 1,836 2,029 5,589 4,933 ---------- ---------- ---------- ----------- Total operating expenses 10,605 8,776 31,362 23,295 Operating income 2,633 7,233 9,007 12,164 Interest and other income, net 1,283 771 3,900 2,680 ---------- ---------- ---------- ----------- Income before taxes 3,916 8,004 12,907 14,844 Provision for income taxes 1,410 1,202 4,645 2,227 ========== ========== ========== =========== Net income $ 2,506 $ 6,802 $ 8,262 $ 12,617 ========== ========== ========== =========== Net income per share Basic $ 0.09 $ 0.30 $ 0.32 $ 0.56 Diluted $ 0.09 $ 0.27 $ 0.30 $ 0.52 Shares used in computing net income per share Basic 26,411 22,568 26,200 22,480 Diluted 27,392 24,957 27,749 24,492 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) Nine months ended September 30, 1998 1997 --------- --------- Cash flows from operating activities: Net income $ 8,262 $12,617 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 4,674 2,839 Accounts receivable, net 1,614 (10,796) Inventory (2,557) (1,690) Deferred tax assets (50) - Prepaid expenses and other assets 60 (2,800) Accounts payable (8,117) 3,570 Accrued payroll and related expenses (1,193) 1,383 Other accrued liabilities (1,432) (960) Deferred revenue 3,755 26,342 --------- --------- Total adjustments (3,246) 17,888 --------- --------- Net cash provided by operating activities 5,016 30,505 Cash flows from investing activities: Purchases of short term investments (114,556) (41,393) Proceeds from sale of short term investments 115,968 54,367 Investment in foundry (10,925) (40,231) Acquisition of capital equipment (4,800) (5,838) --------- --------- Net cash used in investing activities (14,313) (33,095) Cash flows from financing activities: Sale of common stock 2,289 1,604 --------- --------- Net cash provided by financing activities 2,289 1,604 --------- --------- Net decrease in cash and cash equivalents (7,008) (986) Cash and cash equivalents at beginning of period 20,888 19,323 ========= ========= Cash and cash equivalents at end of period $13,880 $18,337 ========= ========= 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 Subsidiaries (the "Company") as of September 30, 1998, and the results of operations and cash flows for the three and nine month periods ended September 30, 1998 and 1997. 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, 1997. The condensed consolidated balance sheet data as of December 31, 1997 was derived from the audited financial statements. The results of operations and cash flows for the three and nine month periods ended September 30, 1998 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 third fiscal quarter of 1998 and 1997 ended on September 27, 1998 and September 28, 1997, respectively. Fiscal year 1997 ended on December 28, 1997. 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: September 30, December 31, 1998 1997 -------- -------- (In thousands) Raw materials $ 2,919 $ 3,289 Work-in-process 10,493 10,340 Finished goods 4,793 2,019 -------- -------- $ 18,205 $ 15,648 ======== ======== Page 6 5. The following table sets forth the computation of basic and diluted earnings per share: Three months ended Nine months ended September 30, September 30, 1998 1997 1998 1997 ------ ------ ------ ------ (In thousands, except per share amounts) Numerator: Numerator for basic and diluted net income per share - net income $ 2,506 $ 6,802 $ 8,262 $12,617 ======= ======= ======= ======= Denominator for basic net income per share: Weighted average common shares 26,411 22,568 26,200 22,480 ------ ------ ------ ------ Shares used in computing basic net income per share 26,411 22,568 26,200 22,480 ====== ====== ====== ====== Basic net income per share $ 0.09 $ 0.30 $ 0.32 $ 0.56 ====== ====== ====== ====== Denominator for diluted net income per share: Weighted average common shares 26,411 22,568 26,200 22,480 Employee stock options and warrants to purchase common stock 981 2,389 1,549 2,012 ------ ------ ------ ------ Shares used in computing diluted net income per share 27,392 24,957 27,749 24,492 ====== ====== ====== ====== Diluted net income per share $ 0.09 $ 0.27 $ 0.30 $ 0.52 ====== ====== ====== ====== 6. 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, or others, may bring suit against the Company. In March 1998, the Company filed a complaint in federal court against Lexar Media, Inc. ("Lexar") for infringement of a fundamental flashdisk patent. Lexar has disputed the Company's claim of patent infringement, claimed SanDisk's patent is invalid or unenforceable and asserted various counterclaims including unfair competition, violation of the Lanham Act, patent misuse, interference with prospective economic advantage, trade defamation and fraud. SanDisk has denied each of Lexar's counterclaims. In July 1998, the federal district court denied Lexar's request to have the case dismissed on the grounds the Company failed to perform an adequate prefiling investigation. Discovery in the Lexar suit commenced in August 1998. The Company intends to vigorously enforce its patents, but there can be no assurance that these efforts will be successful. 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 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 Page 7 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. Any litigation, whether as a plaintiff or as a defendant, will likely result in significant expense to the Company and divert the efforts of the Company's technical and management personnel, whether or not such litigation is ultimately determined in favor of the Company. 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. 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. The Company recorded a provision for income taxes at a 36% effective tax rate for the first nine months of 1998 compared to a 15% effective tax rate for the same period of 1997. The effective tax rate for the first nine months of 1997 was substantially below the federal statutory rate due to the utilization of federal and state tax credit carryforwards, Foreign Sales Corporation tax benefits and a reduction in the deferred tax asset valuation allowance. 8. The Company has a credit agreement (the Agreement) with a bank, which was renewed in July 1998. Under the provisions of the Agreement, which expires in July 1999, the Company may borrow up to $10.0 million on a revolving line of credit at the bank's prime interest rate. Amounts under the revolving line of credit can be applied to the issuance of letters of credit up to the full amount of the credit line. At September 30, 1998, $1.0 million of letters of credit were outstanding. In addition, under the Agreement, the Company also has a $15.0 million foreign exchange contract line under which the Company may enter into foreign exchange contracts. As of September 30, 1998, $2.8 million was outstanding under the foreign exchange contract portion of the line. The Agreement contains covenants that require the Company to maintain certain financial ratios and levels of net worth. The Agreement prohibits the payment of cash dividends to stockholders. 9. On August 21, 1998, the Company implemented an option cancellation/regrant program. Under the cancellation/regrant program, employees could elect to exchange their stock options with exercise prices in excess of $12.00 per share for new options priced at $10.00 per share, the market price of the Company's common stock on August 21, 1998. Under the new options, shares become exercisable six to twelve months later than under the old higher-priced options. The new options have a maximum term of ten years from the August 21, 1998, grant date. Officers and directors of the Company were not eligible for participation in the option cancellation/regrant program. Options covering a total of approximately 903,425 shares were canceled and regranted in connection with the program. 10. As of January 1, 1998, the Company adopted statement of Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive Income." SFAS 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this Statement had no impact on the Company's net income or stockholders' equity. SFAS 130 requires unrealized gains or losses on the Company's available-for-sale securities, which prior to adoption were reported separately in stockholders' equity, to be included in other comprehensive income. Page 8 Statements of Comprehensive Income Three months ended Nine months ended September 30, September 30, 1998 1997 1998 1997 -------- -------- -------- -------- (In thousands) Net income $ 2,506 $ 6,802 $ 8,262 $ 12,617 Unrealized gain (loss) on available-for-sale securities 203 5 347 (5) -------- -------- -------- -------- Comprehensive income $ 2,709 $ 6,807 $ 8,609 $ 12,612 ======== ======== ======== ======== Accumulated other comprehensive income, which consists of gains (losses) on available-for-sale securities, was $390,000 and $1,000 at September 30, 1998 and 1997, respectively. 11. In June 1998, the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is required to be adopted in years beginning after June 15, 1999. Because of the Company's minimal use of derivatives, management does not anticipate that the adoption of the new statement will have a significant effect on earnings or the financial position of the Company. Page 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Certain statements in this discussion and analysis, including in particular, the paragraph discussing patent license and royalty revenues, 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 the Company's Form 10-K for the year ended December 31, 1997 under the heading "Risk Factors". Readers are cautioned not to place undue reliance on these forward looking statements, which speak only as of the date hereof. The Company undertakes 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 the Company's consolidated financial statements and the notes thereto. Overview The Company was founded in 1988 to develop and market flash data storage systems. The Company sells its products to the consumer electronics and industrial/communications markets. The percentage of the Company's product sales attributable to the consumer electronics market has increased substantially and in 1998 represents approximately 60% of product revenues. This increase in sales to the consumer market resulted in a shift to CompactFlash products, which typically have lower average selling prices and gross margins than higher capacity products. In addition, these products are frequently sold into the retail channel, which usually has shorter customer order lead-times than the other channels used by the Company, thereby decreasing the Company's ability to accurately forecast future production needs. Subject to continued market acceptance of its CompactFlash products, the Company believes these products will continue to represent a majority of the Company's sales as the popularity of consumer applications, including digital cameras, increases. The percentage of sales attributable to orders received and fulfilled in the same quarter has increased over time and, in response, the Company is continuing to work to shorten its manufacturing cycle times. Beginning in late 1995, the Company adopted a strategy of licensing its flash technology, including portions of its patent portfolio, to selected third party manufacturers of flash products. To date, the Company has entered into patent cross-license agreements with six companies, and it intends to pursue opportunities to enter into additional licenses. The Company's current license agreements provide for the payment of license fees, royalties, or a combination thereof, to the Company. 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. SanDisk markets its products using a direct sales organization, distributors, manufacturers' representatives, private label partners, OEMs and retailers. The Company expects that sales through the retail channel will comprise an increasing share of total revenues in the future, and that a substantial portion of its sales into the retail channel will be made to participants that will have the right to return unsold products. The Company recognizes revenues from sales to the retail channel and distributors when the products are sold to the end customers. Historically, a majority of the Company's sales have been to a limited number of customers. The Company expects that sales of its products to a limited number of customers will continue to account for a substantial portion of its product revenues for the foreseeable future. The Company has also experienced significant changes in the composition of its customer base from year to year and expects this pattern to continue as market demand for such customers' products fluctuates. The loss of, or significant reduction in purchases by major customers, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors - Customer Concentration." Page 10 Export sales are an important part of the Company's business. While a majority of the Company's revenues from sales to Asian countries are derived from OEM customers who plan to export a portion of their products to countries outside of Asia, the Asian economic crisis has and may continue to adversely effect the Company's revenues to the extent that demand for the Company's products in Asia declines. Given the recent economic conditions in Asia and the weakness of many Asian currencies relative to the United States dollar, the Company's products are and may continue to be relatively more expensive in Asia, which could result in a decrease in the Company's sales in that region. The Company has and may continue to experience pressure on its gross margins as a result of increased price competition from Asian competitors. While most of the Company's sales are denominated in U.S. Dollars, the Company invoices certain Japanese customers in Japanese Yen and is subject to exchange rate fluctuations on these transactions. To date, a portion of the Company's purchases of wafers have been denominated in Japanese Yen. While this percentage has been decreasing, exchange rate fluctuations can affect the Company's business, financial condition and results of operations. See "Risk Factors Risks Associated with International Operations." The Company's operating results are affected by a number of factors including the volume of product sales, the timing of significant orders, competitive pricing pressures, the ability of the Company to match supply with demand, changes in product and customer mix, market acceptance of new or enhanced versions of the Company's products, changes in the channels through which the Company's products are distributed, timing of new product announcements and introductions by the Company and its competitors, the timing of license and royalty revenues, fluctuations in product costs, the ability of the Company to achieve manufacturing efficiencies with its new and existing products, availability of foundry capacity, variations in manufacturing cycle times, fluctuations in manufacturing yields and manufacturing utilization, increased research and development expenses and exchange rate fluctuations. In addition, as the proportion of the Company's products sold for use in consumer electronics applications increases, the Company's revenues may become subject to seasonal declines in the first quarter of each year. See "Risk Factors - Fluctuations in Operating Results", "- Increasing Dependence on Consumer Products" and "- Seasonality." Year 2000 Readiness Disclosure The Company is aware of problems associated with computer systems as the year 2000 approaches. Year 2000 problems are the result of common computer programming techniques that result in systems that do not function properly when manipulating dates later than December 31, 1999. The issue is complex and wide ranging. The problem may affect transaction processing computer applications used by the Company for accounting, distribution, manufacturing, planning and communications. The problem may also affect embedded systems such as building security systems, machine controllers and production test equipment. Year 2000 problems with these systems may affect the ability or efficiency with which the Company can perform many significant functions, including but not limited to: order processing and fulfillment, material planning, product assembly, product test, invoicing and financial reporting. In addition, the problem may affect the computer systems of the Company's suppliers and customers, potentially disrupting their operations. Year 2000 problems with the Company's business partners may impact the Company's sources of supply and demand. Year 2000 Readiness. The Company has established a Year 2000 Risk Management program to assess the impact of the Year 2000 issue on SanDisk, and to coordinate remediation activities. The Company completed the evaluation of its products for Year 2000 compliance in the third quarter of 1998. The Company's FlashDisk, FlashDrive, Flash Chipset, CompactFlash, MultiMediaCard, and ImageMate product lines do not perform date related processing, do not contain real time clock circuitry and therefore are Year 2000 ready. Sandisk storage and connectivity products are used as components in a variety of host systems. The firmware, operating system, and application software of these host systems are designed and manufactured by others. SanDisk makes no claim with regard to the Year 2000 readiness of host Page 11 systems designed by others in which SanDisk's products are used. Independent system designers make derivative works from the SanDisk Host Developer's Toolkit ("Toolkit") source code product. Sample date related subroutines and data structures are included in the Toolkit for use by system designers. Designers modify the sample routines in order to fit the specific requirements of their host operating system. The designer is responsible for the formatting and processing logic associated with the date values that pass through the Toolkit subsystem and for the Year 2000 readiness of the systems in which the Toolkit is used. SanDisk makes no claims with regard to the Year 2000 readiness of host firmware and operating systems designed by others that contain derivative works of the Host Developer's Toolkit. The Year 2000 compliance assessment of the Company's management information system is complete, and remediation is well underway. The Company expects to complete the implementation of a new, Year 2000 compliant management information system in the fourth quarter of 1998. The new system is a commercially available fully integrated MRP II (Materials Requirement Planning and Accounting system) software application. This system will be used for Accounting, Order Processing, Planning, Inventory Control, Shop Floor Control and Distribution. Problems or delays in the implementation of the Company's Year 2000 compliant management information system could result in a disruption of the Company's operations. The assessment and remediation of Year 2000 problems in tertiary business information systems is on-going. Well over 90% of the company's investment in desktop PC hardware is known to be Year 2000 compliant. The majority of the software used on these systems and network servers are recent versions of vendor supported, commercially available products. Upgrading these applications as Year 2000 compliant patches are released by the respective vendors has not been a significant burden on the Company and is expected to be completed before the end of 1999. The assessment and remediation of Year 2000 problems in computer systems used for facilities control, machine control, and manufacturing testing is on-going. The most significant Year 2000 issue in this area has been found to be related to older wafer test equipment. This equipment is not expected to be in use in the year 2000. The Company is phasing in new Year 2000 compliant wafer test equipment in conjunction with the introduction of new generations of flash memory. The Company has begun its assessment of Year 2000 risks related to suppliers, customers and other third parties. Inquiries will be made of all critical suppliers and an assessment made of their Year 2000 readiness. SanDisk will also contact its significant customers regarding their Year 2000 readiness in order to understand the potential for any disruptions in their ordering patterns. Completion of this review will depend on the responsiveness of the Company's vendors and customers, over which the Company has no control. Year 2000 Risk Management Program Costs. The cost of the Year 2000 project related to upgrading the Company's core management information system is approximately $1.0 million. The Company has capitalized approximately $400,000 for the cost of purchased software and hardware. The Company would have incurred the majority of these costs, in spite of Year 2000 issues, due to the need to upgrade its management information system to support the Company's growth. The additional expenses related to the management of the Year 2000 compliance program and completing the assessment of the Company's internal and external risks are not expected to be material to the Company's quarterly operating results. The costs and time schedule for the Year 2000 problem abatement are based on management's best estimates for the implementation of its new management information system and Year 2000 problems uncovered to date. These estimates were derived utilizing numerous assumptions, including that the most significant Year 2000 risks have already been identified, that certain resources will continue to be available, that third party plans will be fulfilled, and other factors. However, there can be no guarantee that these estimates will be achieved or that the anticipated time schedule will be met and actual results could differ materially from those anticipated. Page 12 Contingency Plans. Specific contingency plans for systems that pose significant risk to on-going operations are being developed under the auspices of the Company's Year 2000 Risk Management program. If the Company is unable to complete the replacement of its core management information system in a timely manner, an alternative plan has been developed. This plan consists of applying available vendor supplied software patches to the existing system. The costs and time involved to complete this alternative are expected to be minimal. Should previously undetected Year 2000 problems be found in other systems, these systems will either be upgraded, replaced, turned off, or operated in place with manual procedures to compensate for their deficiencies. While the Company believes that these alternative plans would be adequate to meet the Company's needs without materially impacting its operations, there can be no assurance that such alternatives would be successful or that the Company's results of operations would not be materially adversely affected by the delays and inefficiencies inherent in conducting operations in this manner. Risks Related to Year 2000 Readiness. Success of the Company's Year 2000 compliance efforts depend, in part, on the success of its key suppliers and customers in dealing with their Year 2000 issues. The Company does not have any control over the remediation efforts of its key suppliers and customers and is not aware of the extent to which they have resolved their Year 2000 compliance issues. The Company currently purchases several critical components from single or sole source vendors. Disruptions in the supply of components from any of these sole source suppliers due to Year 2000 issues, could cause delays in the Company's fulfillment of customer orders which could result in reduced or lost revenues. Furthermore, the Company's sales have historically been to a limited number of customers. Any disruption in the purchasing patterns of these customers or potential customers due to Year 2000 issues could cause a decline in the Company's revenues. There can be no assurance that the Company and its key suppliers and customers will identify and remediate all significant Year 2000 problems on a timely basis. Furthermore, there can be no assurance that the Company's insurance will cover losses from business interruptions arising from Year 2000 problems of the Company or its suppliers. Year 2000 compliance problems of the Company's key suppliers and customers could adversely affect the Company's, business, financial condition and results of operations. The foregoing statements regarding the Company's Year 2000 readiness are based upon management's best estimates at the present time, which were derived utilizing assumptions regarding future events, including the continued availability of certain resources, third party modification plans and other factors. There can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, the nature and amount of programming required to upgrade or replace each of the affected programs, the rate and magnitude of related labor and consulting costs and the success of the Company's external customers and suppliers in addressing the Year 2000 issue. The Company's evaluation is on-going and it expects that new and different information will become available to it as the evaluation continues. Consequently, there is no guarantee that all material elements will be Year 2000 ready in time. Results of Operations Product Revenues. SanDisk's product revenues were $24.1 million in the third quarter of 1998, down $6.1 million or 20% from the third quarter of 1997. Product revenues for the nine months ended September 30, 1998 were $73.0 million, up $0.7 million or 1% from the same period in 1997. During the three and nine month periods ended September 30, 1998, units shipped increased 29% and 36%, respectively, from the same periods of 1997. These increases were offset by decreases in average selling prices of 39% for the third quarter of 1998 and 26% for the first nine months of 1998 compared to the same periods of 1997. Page 13 Due to the economic recession in Japan, sales to this region declined $5.8 million in the third quarter of 1998 compared to the same period in 1997, representing essentially all of the year to year decline in product revenues. The Company continues to experience limited bookings visibility, particularly in Japan. More than one half of the Company's anticipated quarterly revenues continue to be turns business, orders received and fulfilled in the same quarter, with customers demanding short lead times and quick delivery schedules, thus capitalizing on the current market conditions and aggressive pricing environment. Due to a number of factors described herein and in "Risk Factors," the Company's ability to adjust its operating expenses is limited in the short term. As a result, if product revenues are lower than anticipated, the Company's results of operations will be adversely affected. See "Risk Factors-Fluctuations in Operating Results", "- Risks Associated with International Operations" and "Seasonality." Export sales represented 47% and 46%, respectively,of product revenues for the three and nine month periods ended September 30, 1998 compared with 60% and 53%, respectively, for the same periods of the previous year. The Company expects international sales to continue to represent a significant portion of its product revenues. The Company's top ten customers represented 65% of product revenue in the third quarter of 1998 compared to 67% for the same period in 1997. The Company expects that sales to a limited number of customers will continue to represent a substantial portion of its revenues for the foreseeable future. License and Royalty Revenues. The Company currently earns patent licenses and royalty revenues under six cross license agreements, with Hitachi, Intel, Samsung, Sharp, Silicon Storage Technology, Inc. ("SST") and Toshiba. License and royalty revenue from patent cross license agreements was $7.9 million in the third quarter of 1998, up $2.0 million from $5.9 million in the same period of 1997 primarily due to the timing of revenue recognition under the various agreements. In the first nine months of 1998, revenue from patent license and royalties was $24.5 million, up $11.9 million from the same period of 1997. Revenues from patent licenses and royalties increased to 25% of total revenues in the three and nine month periods ended September 30, 1998 from 16% and 15% respectively, for the same periods of the previous year. The Company currently expects that revenues from patent licenses and royalties will be in the range of $7.5 to $8.0 million per quarter for the next several quarters. Gross Profits. In the third quarter of 1998, gross profits were $13.2 million or 41% of total revenues, down from $16.0 million or 44% of total revenues for the same period of 1997. Gross profits for the first nine months of 1998 were $40.4 million or 41% of total revenues compared to $35.5 million or 42% of total revenues for the same period in the previous year. The growth in overall gross profits for the first nine months of 1998 was due to an increase in license and royalty revenue. Product gross margins decreased to 22% in the third quarter of 1998 compared to 33% for the same period of 1997. The decrease was primarily due to the decline in average selling prices. During the third quarter, the Company completed the transition from 32Mbit, 0.4 micron technology to the more cost effective 64Mbit, 0.35 micron technology. While the Company has ongoing efforts to reduce manufacturing costs, there can be no assurance that these cost reductions will be adequate to offset future average selling price declines due to increased competition. 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 increased $1.3 million or 35% in the third quarter of 1998 compared to the third quarter of 1997. In the first nine months of 1998 research and development expenses increased $4.0 million compared to the same period in 1997. These increases were primarily due to an increase in salaries and payroll related expenses associated with additional personnel, increased project related expenses and increased depreciation due to capital equipment additions. Research and development expenses represented 15% of total revenues for the third quarter of 1998 compared to 10% for the same period in 1997. The Company expects research and development expenses to continue to increase in absolute dollars to support the development of new generations of flash data storage products. Page 14 Sales and Marketing. Sales and marketing expenses include salaries and payroll related expenses, sales commissions and travel expenses for the Company's 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 increased $0.8 million or 24% in the third quarter of 1998 compared to the third quarter of 1997. In the first nine months of 1998, sales and marketing expenses increased $3.4 million compared same period in 1997. These increases were primarily due to increased marketing and sales expenses related to the development of the retail channel for the Company's products and an increase in salaries and payroll related expenses associated with additional personnel. Sales and marketing expenses represented 12% of total revenues in the third quarter of 1998 compared to 9% for the same period of 1997. The Company expects sales and marketing expenses to increase in absolute dollars as sales of its products grow and it continues to develop the retail channel for its products both domestically and internationally. General and Administrative. General and administrative expenses include the cost of the Company's finance, information systems, human resources, shareholder relations, legal and administrative functions. General and administrative expenses decreased $0.2 million or 10% in the third quarter of 1998 compared to the third quarter of 1997. In the first nine months of 1998, general and administrative expenses increased $0.7 million or 13% compared to the same period of 1997. The decrease in the third quarter of 1998 was primarily due to a decrease in bad debt expense. The increase in the first nine months of 1998 was primarily due to increased salaries and payroll related expenses associated with additional personnel and higher consulting expenses related to the implementation of the Company's new management information system. General and administrative expenses represented 6% of total revenues in the third quarters of 1998 and 1997. The Company expects general and administrative expenses to increase in absolute dollars as these functions grow to support the overall growth of the Company. General and administrative expenses could also increase substantially in the future in connection with the Company's efforts to defend its patent portfolio. See "Risk Factors-Patents Proprietary Rights and Related Litigation." Interest and Other Income, Net. Interest and other income, net, increased $0.5 million in the third quarter of 1998 compared to the same period of 1997. This increase was primarily due to higher investment balances as a result of the investment of proceeds from the sale of common stock in the Company's November 1997 follow on public offering. Provision for Income Taxes. The Company recorded a provision for income taxes at a 36% effective tax rate for the first nine months of 1998 compared to a 15% effective tax rate for the same period of 1997. The effective tax rate for the first nine months of 1997 was substantially below the federal statutory rate due to the utilization of federal and state tax credit carryforwards, foreign sales corporation tax benefits and a reduction in the deferred tax asset valuation allowance. The Company's 1998 effective tax rate is substantially higher than its 1997 rate due to the utilization of all remaining federal and state tax credit carryforwards in 1997. Liquidity and Capital Resources As of September 30, 1998, the Company had working capital of $133.9 million, which included $13.9 million in cash and cash equivalents and $113.0 million in short term investments. The Company has a line of credit facility with a commercial bank under which it can borrow up to $10 million at the bank's prime rate. This line of credit facility expires in July 1999. As of September 30, 1998, the Company had $2.8 million committed under the foreign exchange facility of the line of credit for Yen forward exchange contracts that mature in November 1998. The Agreement contains covenants that require the Company to maintain certain financial ratios and levels of net worth, and prohibits the payment of cash dividends to stockholders. Operating activities provided $5.0 million of cash during the first nine months of 1998 primarily from net income, an increase in deferred revenue and a decrease in accounts receivable which were Page 15 partially offset by a decline in accounts payable and an increase in inventory. Investing activities used $14.3 million of cash in the first nine months of 1998 and included an additional investment of $10.9 million in the USIC foundry and capital equipment purchases of $4.8 million, which were partially offset by net proceeds from investments of $1.4 million. During the first nine months of 1998, financing activities provided $2.3 million of cash primarily from the sale of common stock under the SanDisk employee stock purchase and stock option plans. Depending on the demand for the Company's products, the Company may decide to make investments, which could be substantial, in assembly and test manufacturing equipment or foundry capacity to support its business in the future. Management believes the existing cash and cash equivalents, short term investments and available line of credit, together with cash flow from operations, will be sufficient to meet the Company's currently anticipated working capital and capital expenditure requirements for at least the next twelve months. Impact of Currency Exchange Rates The Company currently purchases wafers from Matsushita under purchase contracts denominated in yen. A portion of the Company's revenues are also denominated in yen. Foreign exchange exposures arising from the Company's yen denominated commitments and related accounts payable are offset to the extent the Company has yen denominated accounts receivable and cash balances. To the extent such foreign exchange exposures are not offset, the Company enters into foreign exchange forward contracts to hedge against changes in foreign currency exchange rates. At September 30, 1998, there were $2.8 million in Yen forward contracts outstanding. Future exchange rate fluctuations could have a material adverse effect on the Company's business, financial condition and results of operations. Risk Factors Fluctuations in Operating Results. SanDisk's operating results have been and are expected to continue to be, subject to quarterly and annual fluctuations due to a variety of factors. The principal factors that have caused the Company's operating results to fluctuate in the past several quarters and may cause the Company's operating results to fluctuate in the future are unpredictable demand for the Company's products, declining average selling prices, the economic recession in Japan and the seasonality in sales of products for consumer electronics applications. For example, the Company's product revenues declined in the first and second quarters of 1998 and were relatively flat in the third quarter, due to lower average selling prices, a decline in sales to Japan and seasonal factors. The Company must order silicon wafers from its foundries several months prior to the date such wafers are needed. If the Company overestimates the number of silicon wafers it needs to fill product orders and as a result builds excess inventories, gross margins and operating results will be materially adversely affected. For example, in the second quarter of 1998 product gross margins declined to 12% from 30% in the previous quarter partially due to a lower of cost or market write down of inventory. Because the Company is selling CompactFlash, its largest volume product, into an emerging consumer market and is unable to accurately forecast future sales, there will be a material adverse effect on the Company's operating results if sales fall below the Company's expectations in a particular quarter and the Company is unable to reduce its operating expenses. The portion of the Company's quarterly sales attributable to orders received and fulfilled in the same quarter ("turns business") remains higher than 50% and product order backlog may fluctuate substantially from quarter to quarter. See "Seasonality" and "Dependence on Third Party Foundries." Other factors affecting the Company's operating results and gross margins include the volume of product sales, competitive pricing pressures, the ability of the Company to match supply with demand, changes in product and customer mix, market acceptance of new or enhanced versions of the Company's products, changes in the channels through which the Company's products are distributed, timing of new product announcements and introductions by the Company and its competitors, the timing of Page 16 license and royalty revenue, fluctuations in product costs, availability of foundry capacity, variations in manufacturing cycle time, fluctuations in manufacturing yields and manufacturing utilization, the ability of the Company to achieve manufacturing efficiencies with its new and existing products, increased research and development expenses, exchange rate fluctuations and changes in general economic conditions, including economic conditions in Asia. All of these factors are difficult to forecast and these or other factors can materially affect the Company's quarterly or annual operating results or gross margins. The Company has increased its expense levels to support its anticipated growth, including expenses associated with the expansion of the Company's in-house assembly and test operations. The Company expects to continue to increase its operating expenses by hiring additional personnel to support expected growth in sales unit volumes, increased marketing and sales efforts and accelerated research and development activities. If the Company does not achieve increased levels of revenues commensurate with these increased levels of operating expenses, or if the Company's revenues decrease or do not meet the Company's expectations for a particular period, the Company's business, financial condition and results of operations will be materially adversely affected. The mix of the Company's products sold varies from quarter to quarter and will vary in the future, affecting the Company's overall average selling prices and gross margins. The Company's CompactFlash products, which currently represent a significant portion of the Company's product revenues, have lower average selling prices and gross margins than the Company's higher capacity FlashDisk and FlashDrive products. The Company expects that sales of CompactFlash products will represent a significant percentage of product revenues as consumer applications such as digital cameras become more popular. This dependence on CompactFlash sales, coupled with lower pricing due to competition, has caused and is expected to continue to cause average selling prices to decline, sometimes at a faster rate than cost reductions implemented by the Company. The Company has adopted a strategy of cross-licensing its patents to other manufacturers of flash products. Under such arrangements, the Company earns license fees and royalties on terms that are individually negotiated. The timing of recognition of revenues from these payments depends on the terms of each contract, and, in some cases, on the timing of product shipments by the third parties. As a result, license and royalty revenue has fluctuated significantly in the past and may fluctuate in the future. Given the relatively high gross margins associated with license and royalty revenue, gross margins and net income are likely to fluctuate more with changes in license and royalty revenue than with changes in product revenue. Dependence on Emerging Markets and New Products. The Company's success depends to a significant extent upon the development of emerging markets and new applications for flash data storage systems, as well as on its ability to introduce commercially attractive and competitively priced products on a timely basis. The Company believes that continued significant expenditures for research and development will be required in the future. In particular, the Company intends to develop new products with increased memory capacity at a lower cost per megabyte, which the Company believes will be essential to its ability to remain competitive. In November 1997, the Company introduced a new removable storage card product family, the MultiMediaCard. MultiMediaCard is targeted for the emerging markets for mobile smart phones, advanced pagers and consumer multimedia devices. MultiMediaCard will initially be offered in storage capacities of 4MB and 8MB. The Company does not expect to generate material revenues from MultiMediaCard sales in 1998. There can be no assurance that the Company will successfully develop any of these new products, that new applications or markets for flash data storage will develop as expected by the Company, that prospective customers developing products for any such markets will design the Company's products into their products and successfully introduce such products, or that products or technologies developed by others will not render the Company's products or technologies obsolete or noncompetitive. The failure of new applications or markets to develop or the failure of the Company's products to be accepted by the market would have a material adverse effect on the Company's business, financial condition and results of operations. Page 17 Increasing Dependence on Consumer Products. Product revenues derived from sales of products for consumer electronics applications, principally digital cameras, have increased significantly and in 1998 represent the largest portion of product revenues and units shipped. There can be no assurance, however, that the Company will achieve large scale market acceptance for its products in the consumer electronics market. The Company anticipates that products sold for consumer applications will generally encounter intense competition and will be more price sensitive than products sold into its other target markets. In addition, consumer markets require larger expenditures for marketing and promotion to establish brand name recognition and preference. Consumer markets are more likely to experience seasonality of sales, with potential declines in sales activity during the first quarter of any year. Because of the large number of OEMs entering the digital camera market, it is likely that not all of these manufacturers will be successful in achieving market acceptance of their products. If SanDisk's OEM customers are not successful in this market, such OEM customers may have excess inventories of CompactFlash products, which may preclude follow-on orders or result in sales of their CompactFlash inventories in the open market. The market acceptance of digital cameras that use CompactFlash has been slower than expected and the number of companies supplying CompactFlash has increased, causing average selling prices and product gross margins to decline at a rapid rate. If market acceptance of digital cameras that use CompactFlash continues to be slower than expected, or if the market for CompactFlash becomes saturated, the Company may encounter reduced demand for CompactFlash products, declining average selling prices or product returns, any of which would have an adverse effect on the Company's results of operations. The Company anticipates that a greater proportion of its sales to the consumer electronics market will be made through distributors and to retailers than is the case with the industrial/communications market. This will be particularly true if the level of after-market sales of flash memory products increases. The Company is currently expending significant resources developing a retail sales channel. The expenditures associated with this development are likely to precede the realization of significant sales through this channel. Moreover, the Company has no prior experience in the development or management of the retail channel or sales through such channel. In addition, a significant portion of retail sales for consumer applications will be made to distributors and retail chains, which typically maintain rights to return unsold inventory. As a result, the Company does not recognize revenues on sales to this channel until after the products have been sold to end users. If the Company's retail customers are not successful in this market, there could be substantial product returns to the Company. The inability to successfully develop and effectively manage the retail sales channel could have a material adverse effect on the Company's business, financial condition and results of operations. Seasonality. The Company has experienced and expects to continue to experience seasonality in its product sales. A significant portion of the Company's product revenues are derived from the sale of CompactFlash products, which are sold principally for consumer electronics applications. As a result, the Company's product sales have been and are expected to be impacted by seasonal purchasing patterns, with higher sales in the second half of each year as compared to the first half of each such year. In the past, the Company has experienced a reduction in order quantities in the first quarter from Japanese OEM customers, reflecting the fact that 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. In the first quarter of 1998, product revenues declined 24% from the level in the fourth quarter of 1997 due in part to these seasonal factors and the Asian economic crisis. Competition. The flash data storage markets in which the Company competes are characterized by intense competition, rapid technological change, evolving industry standards, declining average selling prices and rapid product obsolescence. The Company's competitors include many large domestic and international companies that have greater access to foundry capacity, substantially greater financial, technical, marketing and other resources, broader product lines and longer standing relationships with customers than the Company. The Company's primary competitors include flash chip producers such as Advanced Micro Devices, Inc. ("AMD"), Atmel Corporation ("Atmel"), Hitachi Ltd. ("Hitachi"), Intel Page 18 Corporation ("Intel"), Micron Technology, Inc. ("Micron"), Mitsubishi Electronic Corporation ("Mitsubishi"), Samsung Electronics Company Ltd. ("Samsung"), Sharp Electronics Corporation ("Sharp") and Toshiba Corporation ("Toshiba"), other companies using data storage techniques such as socket flash, linear flash and system flash components, as well as package or card assemblers such as Lexar Media, Inc. ("Lexar"), M-Systems, Inc. ("M-Systems"), Simple Technology Inc. ("Simple"), SMART Modular Technologies, Inc. ("Smart Modular"), Sony Corporation ("Sony"), Kingston Technology Company ("Kingston"), TDK Corporation ("TDK"), Matsushita Battery, Inc. ("Matsushita Battery") and Viking Components, Inc. ("Viking") that combine controllers and flash memory chips developed by others into flash storage cards. Several companies, including Hitachi, Lexar, Mitsubishi and Micron have been certified by the CompactFlash Association to manufacture and sell their own brand of CompactFlash, and the Company believes that other manufacturers will enter the CompactFlash market in the future. Competing products promoting industry standards that are different from SanDisk's CompactFlash product have been announced, including Intel's Miniature Card, Toshiba's Smart Media (Solid-State Floppy Disk Card), Sony Corporation's Memory Stick, Matsushita Battery's recently introduced Mega Storage cards and M-Systems' Diskonchip(TM) for embedded storage applications. A manufacturer of digital cameras that designs-in any one of these alternative competing standards will eliminate CompactFlash from use in its product, as each competing standard is mechanically and electronically incompatible with CompactFlash. In addition, in the third quarter of 1997, Intel announced a 64Mbit flash chip based on its multilevel cell flash. The Company's double density flash ("D2 flash") and Intel's multilevel cell flash are competing technological innovations that allow each flash memory cell to store two bits of information instead of the traditional single bit stored by the industry standard flash technology. In November 1997, Iomega Corporation ("Iomega") announced its Clik drive, a miniaturized, mechanical, removable disk drive that Iomega claims will compete directly with SanDisk's flash card products. In September 1998, IBM introduced the microdrive, a rotating disk drive in a type II CompactFlash format. This product will initially compete directly with the Company's type II CompactFlash memory cards for use in high end professional digital cameras. In October 1998, M-Systems introduced their Diskonchip 2000 product which is expected to compete against the Company's Chipset products in embedded storage applications. In the first and second quarters of 1998, Sony's Mavica digital camera captured approximately 40% of the US market for digital cameras according to independent industry analysts. The Mavica uses a standard floppy disk to store digital images and therefore uses no CompactFlash (or any other flash) cards. If other manufacturers adopt the Mavica format and it becomes the new "defacto standard", this will significantly reduce the Company's sales prospects for CompactFlash cards. The Company's MultiMediaCard products are expected to face stiff competition from Toshiba's SmartMedia flash cards and Sony's flash Memory Stick. Although the Memory Stick is proprietary to Sony, its possible adoption and widespread use in future products may adversely impact future sales of the Company's MultiMediaCard and CompactFlash products. The Company expects competition to increase in the future from existing competitors and from other companies that may enter the Company's existing or future markets with similar or alternative data storage solutions that may be less costly or provide additional features. Due to the high price sensitivity in the market for consumer products, aggressive price competition has been experienced for these applications. Such competition is expected to result in lower gross margins in the future, if the Company's average selling prices decrease faster than its costs and could result in lost sales. The Company has entered into patent cross-license agreements with Hitachi, Intel, Samsung, Sharp, SST and Toshiba pursuant to which each party may manufacture and sell products that incorporate technology covered by the other party's patents related to flash memory devices. As the Company continues to license its patents to certain of its competitors, competition will increase. As a result of the above factors, the Company expects to face substantially more competition in the future than it has to date. Increased competition could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that its ability to compete successfully depends on a number of factors, which include price and quality, product performance and availability, success in developing new applications for system flash technology, adequate foundry capacity, efficiency of Page 19 production, timing of new product announcements or introductions by the Company, the number and nature of the Company's competitors in a given market, successful protection of intellectual property rights and general market and economic conditions. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, financial condition or results of operations. Declining Average Sales Prices. The Company has experienced, and expects to continue to experience, declining average sales prices for its products. For example in the third quarter of 1998 average selling prices declined 29% compared to the third quarter of 1997. The flash data storage markets in which the Company competes are characterized by intense competition. Therefore, the Company expects to incur increasing pricing pressures from its customers in future periods, which will likely result in a further decline in average sales prices for the Company's products. To offset declining average sales prices, the Company believes that it must continue to achieve manufacturing cost reductions as well as develop new products that incorporate advanced features and can be sold at higher average gross margins. If, however, the Company is unable to achieve such cost reductions, it may not be able to remain price competitive, resulting in lost sales, and the Company's gross margins could decline, each of which could have a material adverse effect on the Company's business, financial condition and results of operations. During the third quarter of 1998, the semiconductor industry as a whole continued to experience significant production over capacity. This "buyers market" continued to put margin pressures on all flash memory suppliers. The Company believes that the current semiconductor down cycle may continue for the next few quarters, putting continued pressure on average selling prices and product gross margins. Risks Associated with International Operations. Sales of the Company's products have been denominated to date primarily in United States dollars. Increases in the value of the United States dollar could increase the price of the Company's products so that they become relatively more expensive to customers in the local currency of a particular country, leading to a reduction in sales and profitability in that country. Given the recent economic conditions in Asia and the weakness of many Asian currencies relative to the United States dollar, the Company's products are relatively more expensive in Asia, which has resulted and may continue to result in a decrease in the Company's sales in that region. In the third quarter of 1998, product sales to the Japan declined to 30% of total product sales, primarily as a result of the Japanese economic crisis and market recession. If the current market conditions in Japan do not improve, or further decline, results of operations may be adversely affected. All of the Company's wafers are, and for the foreseeable future will be, produced by foundries located outside the United States. Because the Company currently bills certain customers in Japanese Yen, fluctuations in currencies could materially adversely affect the Company's business, financial condition and results of operations. In addition, gains and losses on the conversion to United States dollars of accounts receivable, accounts payable and other monetary assets and liabilities arising from international operations may contribute to fluctuations in the Company's results of operations. Due to its reliance on export sales and its dependence on foundries outside the United States, the Company is subject to the risks of conducting business internationally, including foreign government regulation and general geopolitical risks such as political and economic instability, potential hostilities and changes in diplomatic and trade relationships. Manufacturing and sales of the Company's products may also be materially adversely affected by factors such as unexpected changes in, or imposition of, regulatory requirements, tariffs, import and export restrictions and other barriers and restrictions, longer payment cycles, greater difficulty in accounts receivable collection, potentially adverse tax consequences, the burdens of complying with a variety of foreign laws and other factors beyond the Company's control. In addition, the laws of certain foreign countries in which the Company's products are or may be developed, manufactured or sold, including various countries in Asia, may not protect the Company's intellectual property rights to the same extent as do the laws of the United States and thus make piracy of the Company's products a more likely possibility. There can be no assurance that these factors will not have a material adverse effect on the Company's business, financial condition or results of operations. Page 20 Customer Concentration. A limited number of customers have historically accounted for a substantial portion of the Company's revenues and the Company expects this trend to continue. Sales to the Company's customers are generally made pursuant to standard purchase orders rather than long-term contracts. The Company has also experienced significant changes in the composition of its major customer base from year to year and expects this variability to continue as certain customers increase or decrease their purchases of the Company's products as a result of fluctuations in market demand for such customers' products. Dependence on Third Party Foundries. All of the Company's products require silicon wafers, the majority of which are currently supplied by United Silicon Corporation ("USC") and USIC in Taiwan and Matsushita Electronic Corporation in Japan. The Company is dependent on its foundries to allocate to the Company a portion of their foundry capacity sufficient to meet the Company's needs, to produce wafers of acceptable quality and with acceptable manufacturing yields and to deliver those wafers to the Company on a timely basis. On occasion, the Company has experienced difficulties in each of these areas. The loss or reduction of capacity from any of its foundry suppliers or the inability to qualify or receive the anticipated level of capacity from any of its manufacturing partners could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that any of the Company's suppliers will be able to maintain acceptable yields or deliver sufficient quantities of wafers on a timely basis. Under each of the Company's wafer supply agreements, the Company is obligated to provide a monthly rolling forecast of anticipated purchase orders. Except in limited circumstances and subject to acceptance by the foundries, the estimates for the first three months of each forecast constitute a binding commitment and the estimates for the remaining months may not increase or decrease by more than a certain percentage from the previous month's forecast. These restrictions limit the Company's ability to react to significant fluctuations in demand for its products. As a result, the Company has not been able to match its purchases of wafers to specific customer orders and therefore the Company has from time to time taken write downs for potential excess inventory purchased prior to the receipt of customer orders and may be required to do so in the future. 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. To the extent the Company inaccurately forecasts the number of wafers required, it may have either a shortage or an excess supply of wafers, either of which could have a material adverse effect on the Company's business, financial condition and results of operations. Additionally, if the Company is unable to obtain scheduled quantities of wafers from any foundry with acceptable yields, the Company's business, financial condition and results of operations could be negatively impacted. See "Fluctuations in Operating Results." Dependence on Sole Source Suppliers and Third Party Subcontractors. The Company purchases several critical components from single or sole source vendors for which alternative sources are not currently available. Even where alternative suppliers are available, a significant amount of time would be required to qualify an additional vendor in the case of certain of the Company's components. The Company does not maintain long-term supply agreements with any of these vendors. The inability to develop alternative sources for these single or sole source components or to obtain sufficient quantities of these components could result in delays or reductions in product shipments which could adversely affect the Company's business, financial condition and results of operations. For example, the Company relies on Motorola, Inc. ("Motorola") as the sole source of certain designs of microcontrollers, which are critical components in the Company's products. The sole source risk associated with microcontrollers from Motorola is heightened during transitions from one generation of microcontrollers to the next, given the limited safety stock available during these transitions. In the event Motorola were to discontinue shipment of microcontrollers for any reason, the time to design and qualify an alternative source would be approximately nine to twelve months. The Company's reliance on Motorola as its sole source of certain microcontrollers exposes the Company to interruptions of supply that could have a material adverse effect on the Company's business, financial condition and results of operations. Page 21 The Company uses third-party subcontractors to assemble the memory components for its products and from time to time uses other subcontractors to perform certain other assembly and test functions. The Company has no long term agreements with these subcontractors. As a result of this reliance on third party subcontractors for assembly of a portion of its products, the Company cannot directly control product delivery schedules, which can lead to product shortages or quality assurance problems that could increase manufacturing costs of the Company's products. Any problems associated with the delivery, quality or cost of the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. Risks Associated with Transitioning to New Processes and Products. Successive generations of the Company's products incorporate semiconductor devices with greater memory capacity per chip. In addition, the Company is continually involved in joint development with its foundries to produce semiconductor devices based upon smaller geometry manufacturing processes. Both the development of higher capacity semiconductor devices and the implementation of smaller geometry manufacturing processes are important determinants of the Company's ability to decrease the cost per megabyte of its flash data storage products. The utilization of semiconductor devices with greater memory capacity and the design and implementation of new semiconductor manufacturing processes can entail a number of problems, including lower yields associated with semiconductor device production, problems associated with design and manufacture of products to incorporate such devices, and production delays. Because of the complexity of its products, the Company has periodically experienced significant delays in the development and volume production ramp up of its products. There can be no assurance that similar delays will not occur in the future. Any problems experienced by the Company in its current or future transitions to higher capacity memory devices or to new semiconductor manufacturing processes could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has developed new products based on D2 (Double Density) flash technology, a new flash architecture designed to store two bits in each flash memory cell. The Company introduced its new 80Mbit D2 flash chip in November 1997 and began customer shipments in the third quarter of 1998, but expects production volumes to be limited, primarily because of more advanced flash memory designs currently planned for production in 1999, which are expected to have faster write speed than the 80Mbit D2 flash. The Company believes that D2 flash will be important to the Company's ability to increase the capacity and decrease the cost of certain of its products, maintain its competitive advantage, broaden its target markets and attract strategic partners. High density flash memory, such as D2 flash, is a complex technology requiring tight manufacturing controls and effective test screens. The shift to volume production for new flash products is particularly prone to problems which can impact both reliability and yields, thereby increasing manufacturing costs. There can be no assurance that reliable and cost effective D2 flash products can be manufactured in commercial volumes and with yields sufficient to result in a lower cost per megabyte. Furthermore, D2 flash technology needs to be designed to significantly improve its write speed so that it can be usefully applied to market applications such as digital cameras, where write speed is an important parameter. There can be no assurance that the Company will be able to achieve the requisite write speed in its future D2 products. Manufacturing Yields. The fabrication of the Company's products is a complex and precise process requiring wafers that are produced in a highly controlled and clean environment. Semiconductor companies supplying the Company with wafers periodically have experienced problems achieving acceptable wafer manufacturing yields. Semiconductor manufacturing yields are a function both of design technology, which is developed by the Company, and manufacturing process technology, which is typically proprietary to the foundry. Because low yields may result from errors in either design or manufacturing failures, yield problems may not be effectively determined or improved until an actual product exists that can be analyzed and tested to recognize process sensitivities in relation to the design rules that were used. As a result, yield problems may not be identified until the wafers are well into the production process. This risk is increased due to the fact that the Company receives its wafers from independent offshore foundries, increasing the effort and time required to identify, communicate and resolve manufacturing yield problems. There can be no assurance that the Company's foundries will Page 22 achieve or maintain acceptable manufacturing yields in the future. The inability of the Company to achieve planned yields from its foundries could have a material adverse effect on the Company's business, financial condition and results of operations. Patents, Proprietary Rights and Related Litigation. 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. The Company has been notified in the past and the Company and its foundries may be notified in the future of claims that they may be infringing patents or other intellectual property rights owned by third parties. In the past the Company has been involved in significant disputes regarding its intellectual property rights and believes it may be involved in similar disputes in the future. There can be no assurance that in the future 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 against one or more third parties, including but not limited to those the Company has already notified of possible patent infringement. In addition, one or more of these parties may bring suit against the Company. In March 1998, the Company filed a complaint in federal court against Lexar for infringement of a fundamental flash disk patent. Lexar has disputed the Company's claim of patent infringement, claimed SanDisk's patent is invalid or unenforceable and asserted various counterclaims including unfair competition, violation of the Lanham Act, patent misuse, interference with prospective economic advantage, trade defamation and fraud. SanDisk has denied each of Lexar's counterclaims. In July 1998, the federal district court denied Lexar's request to have the case dismissed on the grounds the Company failed to perform an adequate prefiling investigation. Discovery in the Lexar suit commenced in August 1998. The Company intends to vigorously enforce its patents, but there can be no assurance that these efforts will be successful. 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, discontinue the use of certain processes or obtain licenses to the infringing technology. Any litigation, whether as a plaintiff or as a defendant, would likely result in significant expense to the Company and divert the efforts of the Company's technical and management personnel, whether or not such litigation is ultimately determined in favor of the Company. In addition, the results of any litigation are inherently uncertain. In the event the Company desires to incorporate third party technology into its products or is found to infringe on others' patents or intellectual property rights, the Company may be required to license such patents or intellectual property rights. The Company may also need to license some or all of its patent portfolio to be able to obtain cross-licenses to the patents of others. The Company currently has patent cross-license agreements with Hitachi, Intel, Samsung, Sharp, SST and Toshiba. From time to time, the Company has also entered into discussions with other companies regarding potential cross-license agreements for the Company's patents. However, there can be no assurance that licenses will be offered or that the terms of any offered licenses will be acceptable to the Company. If the Company obtains licenses from third parties, it may be required to pay license fees or make royalty payments, which could have a material adverse effect on the Company's gross margins. The failure to obtain a license from a third party for technology used by the Company could cause the Company to incur substantial liabilities and to suspend the manufacture of products or the use by the Company's foundries of processes requiring the technology, or to expend substantial resources redesigning its products to eliminate the infringement. There can be no assurance that the Company would be successful in redesigning its products or that such licenses would be available under reasonable terms. Furthermore, any such development or license negotiations could require substantial expenditures of time and other resources by the Company. Page 23 As is common in the industry, 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 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. Management of Growth. The Company has experienced and may in the future experience rapid growth, which has placed, and could continue to place, a significant strain on the Company's limited personnel and other resources. To manage such growth effectively, the Company will need to continue to implement and improve its operational, financial and management information systems and to hire, train, motivate and manage its employees. In particular, the Company has on occasion experienced difficulty in hiring the engineering, sales and marketing personnel necessary to support the growth of the Company's business. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel or that the Company will be able to manage such growth effectively. The Company's ability to manage its growth has required, and is expected to continue to require, a significant investment in and expansion of its existing internal information management systems to support increased manufacturing, accounting and other management related functions. The Company is in the process of replacing its existing in-house information system. The implementation of the new system will impact almost all phases of the Company's operations (i.e., planning, manufacturing, finance and accounting). The new system is currently scheduled to become operational in the fourth quarter of 1998. There can be no assurance that the Company will not experience problems, delays or unanticipated additional costs in implementing the new management information system or in the use of its existing system that could have a material adverse effect on the Company's business, financial condition and results of operations, particularly in the period in which the new system is brought online. The failure of the Company to successfully manage any of these issues would have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Key Personnel. The Company's success depends to a significant degree upon the continued contributions of members of its senior management and other key research and development, sales, marketing and operations personnel, including, in particular, Dr. Eli Harari, the Company's founder, President and Chief Executive Officer. The loss of any of such persons could have a material adverse effect on the Company's business, financial condition and results of operations. The Company does not have an employment agreement or non-competition agreement with any of its employees. Volatility of Stock Price. There has been a history of significant volatility in the market prices of the Company's Common Stock on the Nasdaq National Market, and it is likely that the market price of the Company's Common Stock will continue to be subject to significant fluctuations. For example, in the twelve month period ending September 30, 1998, the Company's stock price fluctuated from a low of $7.50 to a high of $40.00. The Company believes that future announcements concerning the Company, its competitors or its principal customers, including technological innovations, new product introductions, governmental regulations, litigation or changes in earnings estimated by analysts, may cause the market price of the Common Stock to fluctuate substantially in the future. Sales of substantial amounts of the Company's outstanding Common Stock in the public market could materially adversely affect the market price of the Common Stock. Further, in recent years the stock market has experienced extreme price and volume fluctuations that have particularly affected the market prices of equity securities of many high technology companies and that often have been unrelated to the operating performance of such companies. These fluctuations as well as general economic, political and market conditions such as recessions or international currency fluctuations, may materially adversely affect the market price of the Common Stock. Year 2000 Compliance. The Company is aware of problems associated with computer systems as the year 2000 approaches. Year 2000 problems are the result of common computer programming Page 24 techniques that result in systems that do not function properly when manipulating dates later than December 31, 1999. The Company has established a Year 2000 Risk Management program to assess the impact of the Year 2000 issue on SanDisk, and to coordinate remediation activities. Based on the Company's assessment to date, all of the Company's flash memory and connectivity products are Year 2000 compliant. Other Year 2000 issues facing the Company include, but are not limited to the following: remediation of the Company's management information system, the assessment and the remediation of the tertiary business information systems, the assessment and remediation of the computer systems used for facilities control, machine control, and manufacturing testing and Year 2000 compliance problems of the Company's key suppliers and customers. The total cost of Year 2000 compliance issues, based on management's estimates, has not been and is not anticipated to be, material to the Company's business, financial condition and results of operations. However, the Company does not have any control over the remediation efforts of its key suppliers an customers and is not aware of the extent to which they have resolved their Year 2000 compliance issues. There can be no assurance that the Company and its key suppliers and customers will identify and remediate all significant Year 2000 risks on a timely basis, that remediation efforts will not involve significant time and expense, or that unremediated problems will not have a material adverse effect on the Company's business, financial condition and results of operations. See "Managements Discussion and Analysis of Financial Condition and Results of Operations - Year 2000 Readiness Disclosure." Effect of Anti-Takeover Provisions. The Company has taken a number of actions that could have the effect of discouraging a takeover attempt that might be beneficial to stockholders who wish to receive a premium for their shares from a potential bidder. The Company has adopted a Shareholder Rights Plan that would cause substantial dilution to a person who attempts to acquire the Company on terms not approved by the Company's Board of Directors. The Shareholder Rights Plan may therefore have the effect of delaying or preventing any change in control and deterring any prospective acquisition of the Company. In addition, the Company's Certificate of Incorporation grants the Board of Directors the authority to issue up to 4,000,000 shares of Preferred Stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the Company's stockholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any shares of Preferred Stock that may be issued in the future. While the Company has no present intention to issue shares of Preferred Stock, such issuance, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult or less attractive for a third party to acquire a majority of the outstanding voting stock of the Company. Such Preferred Stock may also have other rights, including economic rights senior to the Common Stock, and, as a result, the issuance thereof could have a material adverse effect on the market value of the Common Stock. Furthermore, the Company is subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law ("Section 203"), which prohibits the Company from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person first becomes an "interested stockholder," unless the business combination is approved in a prescribed manner. The application of Section 203 also could have the effect of delaying or preventing a change of control of the Company. Page 25 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 "Risk Factors - Patents, Proprietary Rights and Related Litigation" on pages 23 to 24 of this Form 10-Q for the quarterly period ended September 30, 1998, 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 Page 26 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./3/ 3.2 Form of Amended and Restated Certificate of Incorporation of the Registrant./3/ 3.3 Bylaws of the Registrant, as amended./3/ 3.4 Form of Amended and Restated Bylaws of the Registrant /3/ 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./7/ 4.1 Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4./3/ 4.3 Amended and Restated Registration Rights Agreement, among the Registrant and the investors and founders named therein, dated March 3, 1995./3/ 4.4 Amendment No. 1 to the Stock Purchase Agreements among the Registrant and the holders of Series A, B and D Preferred Stock, and certain holders of Series E Preferred Stock, dated January 15, 1993./3/ 4.5 Series F Preferred Stock Purchase Agreement between Seagate Technology, Inc. and the Registrant, dated January 15, 1993./3/ 4.6 Amendment Agreement between Seagate Technology, Inc. and the Registrant, dated August 23, 1995./3/ 4.7 Form of Stock Purchase Agreement between the Registrant and Seagate Technology, Inc./3/ 4.8 Rights Agreement, dated as of April 18, 1997, between the Company and Harris Trust and Savings Bank./7/ 9.1 Amended and Restated Voting Agreement, among the Registrant and the investors named therein, dated March 3, 1995./3/ 10.10 License Agreement between the Registrant and Dr. Eli Harari, dated September 6, 1988.3 10.13 1989 Stock Benefit Plan./3/ 10.14 1995 Stock Option Plan./3/ 10.15 Employee Stock Purchase Plan./3/ 10.16 1995 Non-Employee Directors Stock Option Plan./3/ 10.18 Lease Agreement between the Registrant and G.F. Properties, dated March 1, 1996./4/ 10.19 Business loan agreement between the Registrant and Union Bank of California, dated July 3, 1996./5/ 10.21 Amendment to Lease Agreement between the Registrant and G.F. Properties, dated April 3, 1997./5/ 10.22 First and second amendments to business loan agreement between the Registrant and Union Bank of California, dated June 30, 1997./5/ 10.23 Foundry Venture Agreement between the Registrant and United Microelectronics Corporation, dated June 27, 1997./1,8/ 10.24 Written Assurances Re: Foundry Venture Agreement between the Registrant and United Microelectronics Corporation, dated September 13, 1995.1, 8 10.25 Side Letter between Registrant and United Microelectronics Corporation, dated May 28, 1997./1,8/ 10.26 Third Amendment to the Trade Finance Agreement between the Registrant and Union Bank of California./9/ 10.27 Clarification letter with regards to Foundry Venture Agreement between the Registrant and United Microelectronics Corporation dated October 24, 1997./9/ 10.28 Lease Agreement between the Registrant and G.F. Properties, dated June 10, 1998./11/ 10.29 Trade Finance Agreement between the Registrant and Union Bank of California, dated July 15, 1998. 21.1 Subsidiaries of the Registrant./10/ Page 27 27.1 Financial Data Schedule for the three months ended September 30, 1998. (In EDGAR format only) - ---------- 1. Confidential treatment granted as to certain portions of these exhibits. 2. Confidential treatment requested as to certain portions of these exhibits. 3. Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-1 (No. 33-96298). 4. Previously filed as an Exhibit to the Registrant's 1995 Annual Report on Form 10-K. 5. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1996. 6. Previously filed as an Exhibit to the Registrant's 1996 Annual Report on Form 10-K. 7. Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K/A dated April 18, 1997. 8. Previously filed as an Exhibit to the Registrant's Current Report on form 8-K dated October 16, 1997. 9 Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended September 30, 1997. 10. Previously filed as an Exhibit to the Registrant's 1997 Annual Report on Form 10-K. 11. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1998.
B. Reports on Form 8-K No reports on form 8-K were filed during the quarter ended September 30, 1998. Page 28 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/ Cindy L. Burgdorf ---------------------------------- Cindy L. Burgdorf Chief Financial Officer, Senior Vice President, Finance and Administration and Secretary DATED: November 10, 1998 Page 29 EX-10.29 2 TRADE FINANCE AGREEMENT TRADE FINANCE AGREEMENT THIS AMENDED AND RESTATED TRADE FINANCE AGREEMENT ('Agreement') is made and entered into as of July 15, 1998 by and between SanDisk Corporation, a Delaware Corporation ('Borrower') and UNION BANK OF CALIFORNIA, N.A. ('Bank'). This Agreement amends and restates in its entirety that certain Trade Finance Agreement dated July 1, 1996, as amended from time to time, between Bank and Borrower. SECTION 1. THE LOAN 1.1 The Trade Finance Credit Facility. Bank will extend to Borrower a Trade Finance Credit Facility in an amount not to exceed Ten Million Dollars ($10,000,000); (the 'Trade Finance Credit Facility') to expire on July 15, 1999. The Trade Finance Credit Facility shall be subject to the following sublimits: a. The Clean Advance Line in an amount not to exceed Ten Million Dollars ($10,000,000); b. The Standby L/C Line in an amount not to exceed Ten Million Dollars ($10,000,000); 1.1.1 Clean Advance Line. Bank will also make available an amount that will not exceed the amount listed above (the 'Clean Advance Line') for Borrower's working capital purposes. All advances under the Clean Advance Line must be made on or before July 15, 1999, at which time all unpaid principal and interest under the Clean Advance Line shall be due and payable. Borrower may borrow, repay and reborrow all or part of the Clean Advance Line in accordance with the terms of the Clean Advance Note. The Clean Advance Line shall be evidenced by a Promissory Note (the 'Clean Advance Note') on the standard form used by Bank for commercial loans. Bank shall enter each amount borrowed and repaid in Bank's records and such entry shall be deemed to be the amount of the Clean Advance Line outstanding. Omission by Bank to make any such entries shall not discharge Borrower of its obligation to repay amounts borrowed in full with interest. 1.1.2 The Standby L/C Sublimit. Bank shall issue, for the account of Borrower, one or more irrevocable, standby letters of credit (individually, a "Standby L/C' and collectively, the 'Standby L/Cs'). All such Standby L/Cs shall be drawn on such terms and conditions as are acceptable to Bank and shall be governed by the terms of (and Borrower agrees to execute) Bank's standard form of Standby UC application and reimbursement agreement. The aggregate amount available to be drawn under all outstanding Standby L/Cs and the aggregate amount of unpaid reimbursement obligations under drawn Standby L/Cs shall not exceed Ten Million Dollars ($10,000,000). No Standby L/C shall expire after July 15, 1999. 1.1.3 Trade Finance Revolving Lines and Limits. The aggregate amount available to be drawn under each sublimit listed above shall be reduced, dollar for dollar, by the aggregate amount of unpaid principal obligations under the respective sublimit. The aggregate of all unpaid advances and reimbursement obligations shall reduce, dollar for dollar, the maximum amount available under the Trade Finance Credit Facility. Borrower may reborrow or obtain new extensions of credit under each such sublimit until the expiration date of the Trade Finance Credit Facility, to the extent that Borrower has paid or otherwise satisfied prior borrowings or extensions of credit, subject to all terms and conditions in the Loan Documents. 1.2 Terminology. As used herein the word 'Loan' shall mean, collectively, all the credit facilities described above. As used herein the word 'Note' shall mean, collectively, all the promissory notes described above. As used herein, the words 'Loan Documents' shall mean all documents executed in connection with this Agreement. As used herein, the word 'L/C' shall mean all Commercial L/Cs and Standby L/Cs described above. 1.3 Purpose of Loan. The proceeds of the Trade Finance Credit Facility shall be used to finance Borrower's customary trade cycle. Proceeds of the Clean Advance Line shall be used for general working capital purposes. 1.4 Interest. The unpaid principal balance of the Clean Advance Line shall bear interest at the rate of zero percent (0%) per annum in excess of the Reference Rate as more specifically provided in the Clean Advance Note. 1.5 Trade Finance Fees. All fees in connection with the Trade Finance Credit Facility will be in accordance with Bank's standard schedule of fees as published from time to time, except as follows: Standby L/C Issuance Fee shall be at Four-Tenth's of One Percent (0.40%) per annum. 1.6 Balances. Borrower shall maintain its major depository accounts, excluding its broker accounts, with Bank until the Note and all sums payable pursuant to this Agreement have been paid in full. 1.7 Disbursement. Upon execution hereof, Bank shall disburse the proceeds of the Loan as provided in Bank's standard form Authorization executed by Borrower. 1.8 Controlling Document. In the event of any inconsistency between the terms of this Agreement and any Note or any of the other Loan Documents, the terms of such Note or other Loan Documents will prevail over the terms of this Agreement. SECTION 2. CONDITIONS PRECEDENT Bank shall not be obligated to disburse all or any portion of the proceeds of the Loan unless at or prior to the time for the making of such disbursement, the following conditions have been fulfilled to Bank's satisfaction: 2.1 Compliance. Borrower shall have performed and complied with all terms and conditions required by this Agreement to be performed or complied with by it prior to or at the date of the making of such disbursement and shall have executed and delivered to Bank the Note and other documents deemed necessary by Bank. 2.2 Borrowing Resolution. Borrower shall have provided Bank with certified copies of resolutions duly adopted by the Board of Directors of Borrower, authorizing this Agreement and the Loan Documents. Such resolutions shall also designate the persons who are authorized to act on Borrower's behalf in connection with this Agreement and to do the things required of Borrower pursuant to this Agreement. 2.3 Continuing Compliance. At the time any UC is to be issued, there shall not exist any event, condition or act which constitutes an event of default under Section 6 hereof or any event, condition or act which with notice, lapse of time or both would constitute such event of default; nor shall there be any such event, condition, or act immediately after the disbursement were it to be made. SECTION 3. REPRESENTATIONS AND WARRANTIES Borrower represents and warrants that: 3.1 Business Activity. The principal business of Borrower is the manufacturing of flash storage products. 3.2 Affiliates and Subsidiaries. Borrower's affiliates and subsidiaries (those entities in which Borrower has either a controlling interest or at least a 25% ownership interest) and their addresses, and the names of Borrower's principal shareholders, are as provided on a schedule delivered to Bank on or before the date of this Agreement. 3.3 Authority to Borrow. The execution, delivery and performance of this Agreement, the Note and all other agreements and instruments required by Bank in connection with the Loan are not in contravention of any of the terms of any indenture, agreement or undertaking to which Borrower is a party or by which it or any of its property is bound or affected. 3.4 Financial Statements. The financial statements of Borrower, including both a balance sheet at March 31, 1998 together with supporting schedules, and an income statement for the three (3) months ended March 31, 1998, have heretofore been furnished to Bank, and are true and complete and fairly represent the financial condition of Borrower during the period covered thereby. Since March 31, 1998, there has been no material adverse change in the financial condition or operations of Borrower. 3.5 Title. Except for assets which may have been disposed of in the ordinary course of business, Borrower has good and marketable title to all of the property reflected in its financial statements delivered to Bank and to all property acquired by Borrower since the date of said financial statements, free and clear of all liens, encumbrances, security interests and adverse claims except those specifically referred to in said financial statements. 3.6 Litigation. There is no litigation or proceeding pending or threatened against Borrower or any of its property which is reasonably likely to affect the financial condition, property or business of Borrower in a materially adverse manner or result in liability in excess of Borrower's insurance coverage. 3.7 Default. Borrower is not now in default in the payment of any of its material obligations, and there exists no event, condition or act which constitutes an event of default under Section 6 hereof and no condition, event or act which with notice or lapse of time, or both, would constitute an event of default. 3.8 Organization. Borrower is duly organized and existing under the laws of the state of its organization, and has the power and authority to carry on the business in which it is engaged and/or proposes to engage. 3.9 Power. Borrower has the power and authority to enter into this Agreement and to execute and deliver the Note and all of the other Loan Documents. 3.10 Authorization. This Agreement and all things required by this Agreement have been duly authorized by all requisite action of Borrower. 3.11 Qualification. Borrower is duly qualified and in good standing in any jurisdiction where such qualification is required. 3.12 Compliance With Laws. Borrower is not in violation with respect to any applicable laws, rules, ordinances or regulations which materially affect the operations or financial condition of Borrower. 3.13 ERISA. Any defined benefit pension plans as defined in the Employee Retirement Income Security Act of 1974, as amended ('ERISA'), of Borrower meet, as of the date hereof, the minimum funding standards of Section 302 of ERISA, and no Reportable Event or Prohibited Transaction as defined in ERISA has occurred with respect to any such plan. 3.14 Regulation U. No action has been taken or is currently planned by Borrower, or any agent acting on its behalf, which would cause this Agreement or the Note to violate Regulation U or any other regulation of the Board of Governors of the Federal Reserve System or to violate the Securities and Exchange Act of 1934, in each case as in effect now or as the same may hereafter be in effect. Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock as one of its important activities and none of the proceeds of the Loan will be used directly or indirectly for such purpose. 3.15 Continuing Representations. These representations shall be considered to have been made again at and as of the date each L/C is issued and of each disbursement of the Loan and shall be true and correct as of such date or dates. SECTION 4. AFFIRMATIVE COVENANTS Until the Note and all sums payable pursuant to this Agreement or any other of the Loan Documents have been paid in full, unless Bank waives compliance in writing, Borrower agrees that: 4.1 Use of Proceeds. Borrower will use the proceeds of the Loan only as provided in subsection 1.3 above. 4.2 Payment of Obligations. Borrower will pay and discharge promptly all taxes, assessments and other governmental charges and claims levied or imposed upon it or its property, or any part thereof, provided, however, that Borrower shall have the right in good faith to contest any such taxes, assessments, charges or claims and, pending the outcome of such contest, to delay or refuse payment thereof provided that adequately funded reserves are established by it to pay and discharge any such taxes, assessments, charges and claims. 4.3 Maintenance of Existence. Borrower will maintain and preserve its existence and assets and all rights, franchises, licenses and other authority necessary for the conduct of its business and will maintain and preserve its property, equipment and facilities in good order, condition and repair. Bank may, at reasonable times, visit and inspect any of the properties of Borrower. 4.4 Records. Borrower will keep and maintain full and accurate accounts and records of its operations according to generally accepted accounting principles and will permit Bank to have access thereto, to make examination and photocopies thereof, and to make audits during regular business hours. Costs for such audits shall be paid by Borrower. 4.5 Information Furnished. Borrower will furnish to Bank: (a) Within forty five (45) days after the close of each fiscal quarter, except for the final quarter of each fiscal year, its unaudited balance sheet as of the close of such fiscal quarter, its unaudited income and expense statement with supportive schedules and statement of retained earnings for that fiscal quarter, prepared in accordance with generally accepted accounting principles; (b)Within one hundred twenty (1 20) days after the close of each fiscal year, a copy of its statement of financial condition including at least its balance sheet as of the close of such fiscal year, its income and expense statement and retained earnings statement for such fiscal year, examined and prepared on an audited basis by independent certified public accountants selected by Borrower and reasonably satisfactory to Bank, in accordance with generally accepted accounting principles applied on a basis consistent with that of the previous year; (c) Such other financial statements and information as Bank may reasonably request from time to time; (d) In connection with each financial statement provided hereunder, a statement executed by chief financial officer of Borrower, certifying that no default has occurred and no event exists which with notice or the lapse of time or both, would result in a default hereunder, (e)Prompt written notice to Son-k of all events of default under any of the terms or p of this Agreement or of any other agreement, contract, document or instrument entered, or to be entered into with Bank, and of any litigation which, if decided adversely to Borrower, would have a material adverse effect on Borrower's financial condition, and of any other matter which has resulted in, or is likely to result in, a material adverse change in its financial condition or operations, and (f) Prior written notice to Bank of any changes in Borrower's officers and other senior management; Borrower's name; and location of Borrower's assets, principal place of business or chief executive office. 4.6 Quick Ratio. Borrower shall maintain at all times a ratio of cash, accounts receivable and marketable securities to current liabilities of not less than 2.25:1.0, as such terms are defined by generally accepted accounting principals. Bank Line and Deferred Revenues shall be included in current liabilities. 4.7 Tangible Net Worth. Borrower will at all times maintain Tangible Net Worth of not less than One Hundred Seventy Million Dollars ($170,000,000) plus 50% of Net Profit after Taxes. "Tangible Net Worth" shall mean net worth increased by indebtedness of Borrower subordinated to Bank and decreased by patents, licenses, trademarks, trade names, goodwill and other similar intangible assets, organizational expenses, and monies due from affiliates (including officers, shareholders and directors). 4.8 Debt To Tangible Net Worth. Borrower will at all times maintain a ratio of total liabilities to tangible net worth of not grater than 0.5:1.0. "Tangible Net Worth" shall mean net worth increased by indebtedness of Borrower subordinated to Bank and decreased by patents, licenses, trademarks, trade names, goodwill and other similar intangible assets, organizational expenses, and monies due from affiliates (including officers, shareholders and directors). 4.9 Profitability. Borrower will maintain a net profit, after provision for income taxes, of any positive amount, for any two consecutive fiscal quarters, as reported at the end of each such fiscal quarter. Net profit after tax for any fiscal quarter will not reflect a loss greater than five percent (5%) of Tangible Net Worth as of the last day of the immediately preceding fiscal quarter. 4.10 Insurance. Borrower will keep all of its insurable property, real, personal or mixed, insured by good and responsible companies against fire and such other risks as are customarily insured against by companies conducting similar business with respect to like properties. Borrower will maintain adequate worker's compensation insurance and adequate insurance against liability for damages to persons and property. 4.11 Additional Requirements. Borrower will promptly, upon demand by Bank, take such further action and execute all such additional documents and instruments in connection with this Agreement as Bank in its reasonable discretion deems necessary, and promptly supply Bank with such other information concerning its affairs as Bank may request from time to time. 4.12 Litigation and Attorneys' Fees. Borrower will pay promptly to Bank upon demand, reasonable attorneys' fees (including but not limited to the reasonable estimate of the allocated costs and expenses of in-house legal counsel and legal staff) and all costs and other expenses paid or incurred by Bank in collecting, modifying or compromising the Loan or in enforcing or exercising its rights or remedies created by, connected with or provided for in this Agreement or any of the Loan Documents, whether or not an arbitration, judicial action or other proceeding is commenced. If such proceeding is commenced, only the prevailing party shall be entitled to attorneys' fees and court costs. 4.13 Bank Expenses. Borrower will pay or reimburse Bank for all costs, expenses and fees incurred by Bank in preparing and documenting this Agreement and the loan, and all amendments and modifications thereof, including but not limited to all filing and recording fees, costs of appraisals, insurance and attorneys' fees, including the reasonable estimate of the allocated costs and expenses of in-house legal counsel and legal staff. 4.14 Reports Under Pension Plans. Borrower will furnish to Bank, as soon as possible and in any event within 15 days after Borrower knows or has reason to know that any event or condition with respect to any defined benefit pension plans of Borrower described in Section 3 above has occurred, a statement of an authorized officer of Borrower describing such event or condition and the action, if any, which Borrower proposes to take with respect thereto. SECTION 5. NEGATIVE COVENANTS Until the Note and all other sums payable pursuant to this Agreement or any other of the Loan Documents have been paid in full, unless Bank waives compliance in writing, Borrower agrees that: 5.1 Encumbrances and Liens. Borrower will not create, assume or suffer to exist any mortgage, pledge, security interest, encumbrance, or lien (other than for taxes not delinquent and for taxes and other items being contested in good faith) on property of any kind, whether real, personal or mixed, now owned or hereafter acquired, or upon the income or profits thereof, except to Bank and except for minor encumbrances and easements on real property which do not affect its market value, and except for existing liens on Borrower's personal property and future purchase money security interests encumbering only the personal property purchased. 5.2 Borrowings. Borrower will not sell, discount or otherwise transfer any account receivable or any note, draft or other evidence of indebtedness, except to Bank or except to a financial institution at face value for deposit or collection purposes only and without any fee other than fees normally charged by the financial institution for deposit or collection services. Borrower will not borrow any money, become contingently liable to borrow money, nor enter any agreement to directly or indirectly obtain borrowed money, except pursuant to agreements made with Bank. 5.3 Sale of Assets, Liquidation or Merger. Borrower will neither liquidate nor dissolve nor enter into any consolidation, merger, partnership or other combination, nor convey, nor sell, nor lease all or the greater part of its assets or business, nor purchase or lease all or the greater part of the assets or business of another. 5.4 Loans, Advances and Guaranties. Borrower will not, except in the ordinary course of business as currently conducted, make any loans or advances, become a guarantor or surety, pledge its credit or properties in any manner or extend credit. 5.5 Investments. Borrower will not purchase the debt or equity of another person or entity except for savings accounts and certificates of deposit of Bank, direct U.S. Government obligations and commercial paper issued by corporations with the top ratings of Moody's or Standard & Poor's, and those eligible instruments outlined in Borrower's investment policy provided to Bank, provided all such permitted investments shall mature with in 30 months of purchase. An additional cash investment in USI, a semiconductor manufacturing venture headed by UMC is permitted, provided the investment does not exceed Twenty Million Dollars ($20,000,000) in fiscal year 1998. 5.6 Payment of Dividends. Borrower will not declare or pay any dividends, other than a dividend payable in its own common stock, or authorize or make any other distribution with respect to any of its stock now or hereafter outstanding. 5.7 Retirement of Stock. Borrower will not acquire or retire any share of its capital stock for value. 5.8 Parent and Subsidiary Property. Borrower will not transfer any property to its parent or any affiliate of its parent, except for value received in the normal course of business as business would be conducted with an unrelated or unaffiliated entity. In no event shall management fees or fees for services be paid by Borrower to any such direct or indirect affiliate without Bank's prior written approval. 5.9 Capital Expenditures. Borrower will not make capital expenditures in excess of Fifteen Million Dollars ($15,000,000) in any fiscal year; and shall only make such expenditures as are necessary for Borrower in the conduct of its ordinary course of business. Each said expenditure shall be needed by Borrower in the ordinary course of its business. Expenditures as used in this subsection shall include the current expense portion of all leases whether or not capitalized and shall also include the current portion of any debt used to finance capital expenditures. SECTION 6. EVENTS OF DEFAULT The occurrence of any of the following events ('Events of Default') shall terminate any obligation on the part of Bank to make or continue the Loan and automatically, unless otherwise provided under the Note, shall make all sums of interest and principal and any other amounts owing under the Loan immediately due and payable, without notice of default, presentment or demand for payment, protest or notice of nonpayment or dishonor, or any other notices or demands: 6.1 Borrower shall default in the due and punctual payment of the principal of or the interest on the Note or any of the other Loan Documents; or 6.2 Any default shall occur under the Note; or 6.3 Borrower shall default in the due performance or observance of any covenant or condition of the Loan Documents; 6.4 Any guaranty or subordination agreement required hereunder is breached or becomes ineffective, or any Guarantor or subordinating creditor dies, disavows or attempts to revoke or terminate such guaranty or subordination agreement; or 6.5 There is a change in ownership or control of ten percent (1 0%) or more of the issued and outstanding stock of Borrower. SECTION 7. MISCELLANEOUS PROVISIONS 7.1 Additional Remedies. The rights, powers and remedies given to Bank hereunder shall be cumulative and not alternative and shall be in addition to all rights, powers and remedies given to Bank by law against Borrower or any other person, including but not limited to Bank's rights of setoff or banker's lion. 7.2 Non waiver. Any forbearance or failure or delay by Bank in exercising any right, power or remedy hereunder shall not be deemed a waiver thereof and any single or partial exercise of any right, power or remedy shall not precede the further exercise thereof. No waiver shall be effective unless it is in writing and signed by an officer of Bank. 7.3 Inurement. The benefits of this Agreement shall inure to the successors and assigns of Bank and the permitted successors and assignees of Borrower, and any assignment of Borrower without Bank's consent shall be null and void. 7.4 Applicable Law. This Agreement and all other agreements and instruments required by Bank in connection therewith shall be governed by and construed according to the laws of the State of California. 7.5 Severability. Should any one or more provisions of this Agreement be determined to be illegal or unenforceable, all other provisions nevertheless shall be effective. 7.6 Integration Clause. Except for documents and instruments specifically referenced herein, this Agreement constitutes the entire agreement between Bank and Borrower regarding the Loan and all prior communications verbal or written between Borrower and Bank shall be of no further effect or evidentiary value. 7.7 Construction. The section and subsection headings herein are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. 7.8 Amendments. This Agreement may be amended only in writing signed by all parties hereto. 7.9 Counterparts. Borrower and Bank may execute one or more counterparts to this Agreement, each of which shall be deemed an original. SECTION 8. SERVICE OF NOTICES 8.1 Any notices or other communications provided for or allowed hereunder shall be effective only when given by one of the following methods and addressed to the respective party at its address given with the signatures at the end of this Agreement and shall be considered to have been validly given: (a) upon delivery, if delivered personally; (b) upon receipt, if mailed, first class postage prepaid, with the United States Postal Service; (c) on the next business day, if sent by overnight courier service of recognized standing; and (d) upon telephoned confirmation of receipt, if telecopied. 8.2 The addresses to which notices or demands are to be given may be changed from time to time by notice delivered as provided above. THIS AGREEMENT is executed on behalf of the parties by duly authorized officers as of the date first above written. UNION BANK OF CALIFORNIA, N.A. SANDISK CORPORATION, A DELAWARE DELAWARE CORPORATION - ------------------------------------ ----------------------------------- John Noble Eli Harari Vice President President & CEO - ------------------------------------ ----------------------------------- JamesGoudy Cindy Burgdorf Vice President SVP & CFO UNION BANK OF CALIFORNIA PROMISSORY NOTE (BASE RATE) Borrower Name: SANDISK CORPORATION Borrower Address: 140 CASPIAN COURT, SUNNYVALE, CA. 94089 Office: 64561 Loan Number: 8159632704 0080000000 Maturity Date: JULY 15, 1999 Amount: $10,000,000.00 $10,000,000.00 Date JULY 15, 1998 FOR VALUE RECEIVED, on JULY 15, 1999, the undersigned ("Debtor") promises to pay to the order of UNION BANK OF CALIFORNIA, N.A. ("Bank'), as indicated below, the principal sum of TEN MILLION AND NO/1 00 Dollars ($1 0,000,000,00), or so much thereof as is disbursed, together with interest on the balance of such principal from time to time outstanding, at the per annum rate or rates and at the times set forth below. 1. INTEREST PAYMENTS. Debtor shall pay interest on the 1 5TH day of each QUARTER (commencing OCTOBER 15, 1998). Should interest not be paid when due, it shall become part of the principal and bear interest as herein provided. All computations of interest under this note shall be made on the basis of a year of 360 days, for actual days elapsed. a. BASE INTEREST RATE. At Debtor's option, amounts outstanding hereunder in minimum amounts of at least $1 00,000.00 shall bear interest at a rate, based on an index selected by Debtor, which is 1.00% per annum in excess of Bank's LIBOR-Rate for the Interest Period selected by Debtor, acceptable to Bank. No Base Interest Rate may be changed, altered or otherwise modified until the expiration of the Interest Period selected by Debtor. The exercise of interest rate options by Debtor shall be as recorded in Bank's records, which records shall be prima facie evidence of the amount borrowed under either interest option and the interest rate; provided, however, that failure of Bank to make any such notation in its records shall not discharge Debtor from its obligations to repay in full with interest all amounts borrowed. In no event shall any Interest Period extend beyond the maturity date of this note. To exercise this option, Debtor may, from time to time with respect to principal outstanding on which a Base Interest Rate is not accruing, and on the expiration of any Interest Period with respect to principal outstanding on which a Base Interest Rate has been accruing, select an index offered by Bank for a Base Interest Rate Loan and an Interest Period by telephoning an authorized lending officer of Bank located at the banking office identified below prior to 1 0:00 a.m., Pacific time, on any Business Day and advising that officer of the selected index, the Interest Period and the Origination Date selected (which Origination Date, for a Base Interest Rate Loan based on the LIBOR-Rate, shall follow the date of such selection by no more than two (2) Business Days). Bank will mail a written confirmation of the terms of the selection to Debtor promptly after the selection is made. Failure to send such confirmation shall not affect Bank's rights to collect interest at the rate selected. If, on the date of the selection, the index selected is unavailable for any reason, the selection shall be void. Bank reserves the right to fund the principal from any source of funds notwithstanding any Base Interest Rate selected by Debtor. b. VARIABLE INTEREST RATE. All principal outstanding hereunder which is not bearing interest at a Base Interest Rate shall bear interest at a rate per annum equal to the Reference Rate, which rate shall vary as and when the Reference Rate changes. At any time prior to the maturity of this note, subject to the provisions of paragraph 4, below, of this note, Debtor may borrow, repay and reborrow hereon so long as the total outstanding at any one time does not exceed the principal amount of this note. Debtor shall pay all amounts due under this note in lawful money of the United States at Bank's SANTA CLARA VALLEY CBO Office, or such other office as may be designated by Bank, from time to time. -1- 2. LATE PAYMENTS. If any payment required by the terms of this note shall remain unpaid ten days after same is due, at the option of Bank, Debtor shall pay a fee of $100 to Bank. 3. INTEREST RATE FOLLOWING DEFAULT. In the event of default, at the option of Bank, and, to the extent permitted by law, interest shall be payable on the outstanding principal under this note at a per annum rate equal to five percent (5%) in excess of the interest rate specified in paragraph l..b, above, calculated from the date of default until all amounts payable under this note are paid in full. 4. PREPAYMENT. a. Amounts outstanding under this note bearing interest at a rate based on the Reference Rate may be prepaid in whole or in part at any time, without penalty or premium. Debtor may prepay amounts outstanding under this note bearing interest at a Base Interest Rate in whom or in part provided Debtor has given Bank not less than five (5) Business Days prior written notice of Debtor's intention to make such prepayment and pays to Bank the liquidated damages due as a result. Liquidated Damages shall also be paid, if Bank, for any other reason, including acceleration or foreclosure, receives all or any portion of principal bearing interest at a Base Interest Rate prior to its scheduled payment date. Liquidated Damages shall be an amount equal to the present value of the product of: (i) the difference (but not less than zero) between (a) the Base Interest Rate applicable to the principal amount which is being prepaid, and lb) the return which Bank could obtain if it used the amount of such prepayment of principal to purchase at bid price regularly quoted securities issued by the United States having a maturity date most closely coinciding with the relevant Base Rate Maturity Date and such securities were hold by Bank until the relevant Base Rate Maturity Date ("Yield Rate"); (ii) a fraction, the numerator of which is the number of days in the period between the date of prepayment and the relevant Base Rate Maturity Date and the denominator of which is 360; and (iii) the amount of the principal so prepaid (except in the event that principal payments are required and have been made as scheduled under the terms of the Base Interest Rate Loan being prepaid, then an amount equal to the lesser of (A) the amount prepaid or (B) 50% of the sum of (1) the amount prepaid and (2) the amount of principal scheduled under the terms of the Base Interest Rate Loan being prepaid to be outstanding at the relevant Base Rate Maturity Date). Present value under this note is determined by discounting the above product to present value using the Yield Rate as the annual discount factor. b. In no event shall Bank be obligated to make any payment or refund to Debtor, nor shall Debtor be entitled to any setoff or other claim against Bank, should the return which Bank could obtain under this prepayment formula exceed the interest that Bank would have received if no prepayment had occurred. All prepayments shall include payment of accrued interest on the principal amount so prepaid and shall be applied to payment of interest before application to principal. A determination by Bank as to the prepayment fee amount, if any, shag be conclusive. c. Bank shall provide Debtor a statement of the amount payable on account of prepayment. Debtor acknowledges that (1) Bank establishes a Base Interest Rate upon the understanding that it apply to the Base Interest Rate Loan for the entire Interest Period, and (ii) any prepayment may result in Bank incurring additional costs, expenses or liabilities; and Debtor agrees to pay these liquidated damages as a reasonable estimate of the costs, expenses and liabilities of Bank associated with such prepayment. 5. DEFAULT AND ACCELERATION OF TIME FOR PAYMENT. Default shall include, but not be limited to, any of the following: (a) the failure of Debtor to make any payment required under this note when due; (b) any breach, misrepresentation or other default by Debtor, any guarantor, co-maker. endorser, or any person or entity other than Debtor providing security for this note (hereinafter individually and collectively referred to as the "Obligor") under any security agreement, guaranty or other agreement between Bank and any Obligor; (c) the insolvency of any Obligor or the failure of any Obligor generally to pay such Obligor's debts as such debts become due; (d) the commencement as to any Obligor of any voluntary or involuntary proceeding under any laws relating to bankruptcy, insolvency, reorganization, arrangement, debt adjustment or debtor relief; (e) the assignment by any Obligor for the benefit of such Obligor's creditors; (f) the appointment, or commencement of any proceeding for the appointment of a receiver, trustee, custodian or similar official for all or substantially all of any Obligor's property; (g) the commencement of any proceeding for the dissolution or liquidation of any Obligor; (h) the termination of existence or death of any Obligor; (i) the revocation of any guaranty or subordination agreement given in connection with this note; (j) the failure of any Obligor to comply with any order, judgment, injunction, decree. writ or demand of any court or other public authority; (k) the filing or recording against any Obligor, or the property of any Obligor, of any notice of levy, notice to withhold, or other legal process for taxes other than property taxes; (1) the default by any Obligor personally liable for amounts owed hereunder on any obligation concerning the borrowing of money; (m) the issuance against any Obligor, or the property of any Obligor, of any writ of attachment, execution, or other judicial lien; or (n) the deterioration of the financial condition of any Obligor which results in Bank deeming itself, in good faith, insecure. Upon the occurrence of any such default, Bank, in its discretion, may cease to advance funds hereunder and may declare all obligations under this note immediately due and payable; however, upon the occurrence of an event of default under d, e, f, or g, all principal and interest shall automatically become immediately due and payable. 6. ADDITIONAL AGREEMENTS OF DEBTOR. If any amounts owing under this note are not paid when due, Debtor promises to pay all costs and expenses, including reasonable attorneys' fees, incurred by Bank in the collection or enforcement of this note. Debtor and any endorsers of this note. for the maximum period of time and the full extent permitted by law, (a) waive diligence, presentment, demand, notice of nonpayment, protest, notice of protest, and notice of every kind; (b) waive the right to assert the defense of any statute of limitations to any debt or obligation hereunder; and (c) consent to renewals and extensions of time for the payment of any amounts due under this note. The receipt of any check or other item of payment by Bank, at its option, shall not be considered a payment on account until such check or other item of payment is honored when presented for payment at the drawee bank. Bank may delay the credit of such payment based upon Bank's schedule of funds availability, and interest under this note shall accrue until the funds are deemed collected. In any action brought under or arising out of this note, Debtor and any Obligor, including their successors and assigns, hereby consent to the jurisdiction of any competent court within the State of -2- California, as provided in any alternative dispute resolution agreement executed between Debtor and Bank, and consent to service of process by any means authorized by said state's law. The term "Bank' includes, without limitation, any holder of this note. This note shall be construed in accordance with and governed by the laws of the State of California. 7. DEFINITIONS. As used herein, the following terms shall have the meanings respectively set forth below: 'Base Interest Rate' means a rate of interest based on the LIBOR-Rate. "Base Interest Rate Loan" means amounts outstanding under this note that bear interest at a Base Interest Rate. 'Base Rate Maturity Date" means the last day of the Interest Period with respect to principal outstanding under a Base Interest Rate Loan. 'Business Day' means a day on which Bank is open for business for the funding of corporate loans, and, with respect to the rate of interest based on the LIBOR Rate, on which dealings in U.S. dollar deposits outside of the United States may be carried on by Bank. "Interest Period' means with respect to funds bearing interest at a rate based on the LIBOR Rate, any calendar period of [one, two or three weeks or one, two, three, four, five, six, nine or twelve months]. In determining an Interest Period, a month means a period that starts on one Business Day in a month and ends on and includes the day preceding the numerically corresponding day in the next month. For any month in which there is no such numerically corresponding day, then as to that month, such day shall be deemed to be the last calendar day of such month. Any Interest Period which would otherwise and on a non-Business Day shall end on the next succeeding Business Day unless that is the first day of a month, in which event such Interest Period shall end on the next preceding Business Day. "LIBOR Rate" means a per annum rate of interest (rounded upward, if necessary, to the nearest I /1 00 of 1%) at which dollar deposits, in immediately available funds and in lawful money of the United States would be offered to Bank, outside of the United States, for a term coinciding with the Interest Period selected by Debtor and for an amount equal to the amount of principal covered by Debtor's interest rate selection, plus Bank's costs, including the costs, if any, of reserve requirements. 'Origination Date' means the first day of the interest Period. "Reference Rate" means the rate announced by Bank from time to time at its corporate headquarters as its Reference Rate. The Reference Rate is an index rate determined by Bank from time to time as a means of pricing certain extensions of credit and is neither directly tied to any external rate of interest or index nor necessarily the lowest rate of interest charged by Bank at any given time. SANDISK CORPORATION By ----------------------------------------------- Eli Harari, President & CEO By ----------------------------------------------- Cindy L. Burgdorf, SVP & CFO -3- EX-27 3 FINANCIAL DATA SCHEDULE
5 SanDisk Financial Data Schedule, September 30, 1998 0001000180 SanDisk Corporation 1,000 3-mos Dec-31-1998 Sep-30-1998 13,880 112,972 17,738 0 18,205 181,010 16,018 0 249,378 47,106 0 0 0 184,210 0 249,378 24,143 32,078 18,840 0 10,605 0 0 3,916 1,410 2,506 0 0 0 2,506 0.09 0.09
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