SanDisk 10-Q 2010
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Commission file number: 000-26734
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code
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.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Number of shares outstanding of the issuer’s common stock $0.001 par value, as of October 3, 2010: 234,503,364.
PART I. FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
These interim Condensed Consolidated Financial Statements are unaudited but reflect, in the opinion of management, all adjustments, consisting of normal recurring adjustments and accruals, necessary to present fairly the financial position of SanDisk Corporation and its subsidiaries (the “Company”) as of October 3, 2010, the Condensed Consolidated Statements of Operations for the three and nine months ended October 3, 2010 and September 27, 2009, and the Condensed Consolidated Statements of Cash Flows for the nine months ended October 3, 2010 and September 27, 2009. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been omitted in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). These Condensed Consolidated Financial Statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s most recent Annual Report on Form 10-K for the fiscal year ended January 3, 2010 and filed with the SEC on February 25, 2010. Certain prior period amounts have been reclassified to conform to the current period presentation including certain cash flow line items within investing activities. The results of operations for the three and nine months ended October 3, 2010 are not necessarily indicative of the results to be expected for the entire fiscal year.
Basis of Presentation. >The Company’s fiscal year ends on the Sunday closest to December 31, and its fiscal quarters consist of 13 weeks and generally end on the Sunday closest to March 31, June 30 and September 30, respectively. The third quarter of fiscal years 2010 and 2009 ended on October 3, 2010 and September 27, 2009, respectively. Fiscal year 2010 consists of 52 weeks and fiscal year 2009 consisted of 53 weeks, with the fourth quarter of fiscal year 2009 having 14 weeks, ending on January 3, 2010. For accounting and disclosure purposes, an exchange rate at October 3, 2010 of 83.36 was used to convert Japanese yen to U.S. dollars.
Organization and Nature of Operations. >The Company was incorporated in Delaware on June 1, 1988. The Company designs, develops and markets flash storage products used in a wide variety of consumer electronics products. The Company operates in one segment, flash memory storage products.
Principles of Consolidation. >The Condensed Consolidated Financial Statements include the accounts of the Company and its majority-owned subsidiaries. All intercompany balances and transactions have been eliminated. Non-controlling interest represents the minority shareholders’ proportionate share of the net assets and results of operations of the Company’s majority-owned subsidiaries.
Use of Estimates. >The preparation of Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Condensed Consolidated Financial Statements and accompanying notes. The estimates and judgments affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to customer programs and incentives, intellectual property claims, product returns, bad debts, inventories, investments, long-lived assets, income taxes, warranty obligations, restructuring, contingencies, share-based compensation and litigation. The Company bases estimates on historical experience and on other assumptions that its management believes are reasonable under the circumstances. These estimates form the basis for making judgments about the carrying value of assets and liabilities when those values are not readily apparent from other sources. Actual results could materially differ from these estimates.
Revenue Recognition.> On January 4, 2010, the Company early adopted prospectively new accounting guidance as issued by the Financial Accounting Standards Board (“FASB”) related to revenue recognition of multiple element arrangements and revenue arrangements that include software elements. Multiple element arrangements and arrangements that include software have been immaterial to the Company’s revenue and operating results through October 3, 2010. The Company allocates revenue to each element based on their relative selling price in accordance with the Company’s normal pricing and discounting practices for the specific product or maintenance when sold separately for all multiple element products. In addition, the Company analyzes whether tangible products containing software and non-software components that function together should be excluded from industry-specific software revenue recognition guidance. In terms of the timing and pattern of revenue recognition, the new accounting guidance for revenue recognition is not expected to have a significant effect on the Company’s total net revenues in periods after the initial adoption.
Recent Accounting Pronouncements.> In July 2010, the FASB amended the existing guidance to require an entity to provide a greater level of disaggregated information about the credit quality of its financing receivables and its allowance for credit losses. In addition, the amendments in this update require an entity to disclose credit quality indicators, past due information, and modifications of its financing receivables. This amendment affects the Company’s disclosures as of January 2, 2011, and the Company’s disclosures about activity in annual and interim periods beginning on January 3, 2011. The Company believes that the adoption of this update will not have a significant impact on its disclosures.
The Company measures assets and liabilities at fair value based upon exit price, representing the amount that would be received on the sale of an asset or paid to transfer a liability, as the case may be, in an orderly transaction between market participants. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the assets or liabilities. The Company’s financial assets are measured at fair value on a recurring basis.
Fair Value Hierarchy. >The accounting guidance provides a framework for measuring fair value on either a recurring or nonrecurring basis whereby inputs, used in valuation techniques, are assigned a hierarchical level. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. The three levels of the fair value hierarchy are described as follows:
Instruments that are classified within Level 1 of the fair value hierarchy generally include money market funds, U.S. Treasury securities and equity securities. Level 1 securities represent quoted prices in active markets, and therefore do not require significant management judgment.
Instruments that are classified within Level 2 of the fair value hierarchy primarily include government agency securities, asset-backed securities, mortgage-backed securities, commercial paper, U.S. government-sponsored agency securities, corporate notes and bonds, and municipal obligations. The Company’s Level 2 securities are primarily valued using quoted market prices for similar instruments and nonbinding market prices that are corroborated by observable market data. The Company uses inputs such as actual trade data, benchmark yields, broker/dealer quotes, and other similar data, which are obtained from independent pricing vendors, quoted market prices, or other sources to determine the ultimate fair value of our assets and liabilities. The inputs and fair value are reviewed for reasonableness and may be further validated by comparison to publicly available information or compared to multiple independent valuation sources.
Financial assets and liabilities measured at fair value on a recurring basis as of October 3, 2010 were as follows (in thousands):
Financial assets and liabilities measured at fair value on a recurring basis as of January 3, 2010 were as follows (in thousands):
Financial assets and liabilities measured at fair value on a recurring basis as of October 3, 2010, were presented on the Company’s Condensed Consolidated Balance Sheets as follows (in thousands):
Financial assets and liabilities measured at fair value on a recurring basis as of January 3, 2010, were presented on the Company’s Consolidated Balance Sheets as follows (in thousands):
As of October 3, 2010, the Company did not elect the fair value option for any financial assets and liabilities for which such an election would have been permitted.
Available-for-Sale Investments. >Available-for-sale investments as of October 3, 2010 were as follows (in thousands):
Available-for-sale investments as of January 3, 2010 were as follows (in thousands):
The fair value and gross unrealized losses on the available-for-sale securities that have been in an unrealized loss position, aggregated by type of investment instrument, and the length of time that individual securities have been in a continuous unrealized loss position as of October 3, 2010, are summarized in the following table (in thousands). Available-for-sale securities that were in an unrealized gain position have been excluded from the table.
The gross unrealized gains and losses related to publicly-traded equity investments were due to changes in market prices. The Company has cash flow hedges designated to substantially mitigate risks, both gain and loss, from certain of these equity investments, as discussed in Note 3, “Derivatives and Hedging Activities.” The gross unrealized loss related to U.S. Treasury and government agency securities and corporate and municipal notes and bonds was primarily due to changes in interest rates. The gross unrealized loss on all available-for-sale fixed income securities at October 3, 2010 was considered temporary in nature. Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the investee, and the Company’s intent and ability to hold an investment for a period of time sufficient to allow for any anticipated recovery in market value. For debt security investments, the Company considered additional factors including the Company’s intent to sell the investments or whether it is more likely than not the Company will be required to sell the investments before the recovery of its amortized cost.
The following table shows the gross realized gains and (losses) on sales of available-for-sale securities (in thousands).
Fixed income securities by contractual maturity as of October 3, 2010 are shown below (in thousands). Actual maturities may differ from contractual maturities because issuers of the securities may have the right to prepay obligations.
For certain of the Company’s financial instruments, including accounts receivable, short-term marketable securities and accounts payable, the carrying amounts approximate fair market value due to their short maturities. For those financial instruments where the carrying amounts differ from fair market value, the following table represents the related costs and the estimated fair values, which are based on quoted market prices (in thousands).
The Company uses derivative instruments primarily to manage exposures to foreign currency and equity security price risks. The Company’s primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency and equity security prices. The program is not designated for trading or speculative purposes. The Company’s derivatives expose the Company to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. The Company seeks to mitigate such risk by limiting its counterparties to major financial institutions and by spreading the risk across several major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored on an ongoing basis.
The Company recognizes derivative instruments as either assets or liabilities on its balance sheets at fair value and provides qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. Changes in fair value (i.e., gains or losses) of the derivative instruments are recorded as cost of product revenues, other income (expense), or as accumulated other comprehensive income (“OCI”). The Company does not offset or net the fair value amounts of derivative instruments and separately discloses the fair value amounts of the derivative instruments as either assets or liabilities.
Cash Flow Hedges. >The Company uses a combination of forward contracts and options designated as cash flow hedges to hedge a portion of future forecasted purchases in Japanese yen. The gain or loss on the effective portion of a cash flow hedge is initially reported as a component of accumulated OCI and subsequently reclassified into cost of product revenues in the same period or periods in which the cost of product revenues is recognized, or reclassified into other income (expense) if the hedged transaction becomes probable of not occurring. Any gain or loss after a hedge is no longer designated because it is no longer probable of occurring or it is related to an ineffective portion of a hedge, as well as any amount excluded from the Company’s hedge effectiveness, is recognized as other income or expense immediately, and was immaterial for the three and nine months ended October 3, 2010 and September 27, 2009. As of October 3, 2010, the Company had option contracts in place that hedged future purchases of approximately 3.1 billion Japanese yen, or approximately $37 million based upon the exchange rate as of October 3, 2010, and the net unrealized gain on the effective portion of these cash flow hedges was $2.7 million. The option contracts cover a portion of the Company’s future Japanese yen purchases that are expected to occur during the remainder of fiscal year 2010.
The Company has an outstanding cash flow hedge designated to mitigate equity risk associated with certain available-for-sale investments in equity securities. The gain or loss on the cash flow hedge is reported as a component of accumulated OCI and will be reclassified into other income (expense) in the same period that the equity securities are sold. The securities had a fair value of $70.6 million and $71.8 million as of October 3, 2010 and January 3, 2010, respectively. The cash flow hedge designated to mitigate equity risk of these securities had a fair value of $3.7 million and $0.7 million as of October 3, 2010 and January 3, 2010, respectively.
Other Derivatives. >Other derivatives that are non-designated consist primarily of forward and cross currency swap contracts to minimize the risk associated with the foreign exchange effects of revaluing monetary assets and liabilities. Monetary assets and liabilities denominated in foreign currencies and the associated outstanding forward and cross currency swap contracts were marked-to-market at October 3, 2010 with realized and unrealized gains and losses included in other income (expense). As of October 3, 2010, the Company had foreign currency forward contract hedging exposure in European euro, Japanese yen and British pound. Foreign currency forward contracts were outstanding to buy and (sell) U.S. dollar equivalent of approximately $299.2 million and ($151.8) million in foreign currencies, respectively, based upon each respective country’s exchange rate at October 3, 2010.
The Company has cross currency swap transactions with one counterparty to exchange Japanese yen for U.S. dollars that has a combined notional amount of ($397.1) million and which requires the Company to maintain a minimum liquidity of $1.0 billion. Liquidity is defined as the sum of the Company’s cash and cash equivalents, and short and long-term marketable securities. The Company was in compliance with this covenant as of October 3, 2010. Should the Company fail to comply with this covenant, the Company may be required to settle the unrealized gain or loss on the foreign exchange contracts prior to the original maturity.
The amounts in the tables below include fair value adjustments related to the Company’s own credit risk and counterparty credit risk.
Fair Value of Derivative Contracts. >Fair value of derivative contracts were as follows (in thousands):
Foreign Exchange and Equity Market Risk Contracts Designated as Cash Flow Hedges. >The impact of the effective portion of designated cash flow derivative contracts on the Company’s results of operations was as follows (in thousands):
Foreign exchange contracts designated as cash flow hedges relate primarily to wafer purchases. Gains and losses associated with foreign exchange contracts designated as cash flow hedges are expected to be recorded in cost of product revenues when reclassified out of accumulated OCI. Gains and losses from the equity market risk contract are expected to be recorded in other income (expense) when reclassified out of accumulated OCI. The Company expects to realize the accumulated OCI balance related to foreign exchange contracts within the next twelve months and realize the OCI balance related to the equity market risk contract by the end of fiscal year 2011.
The impact of the ineffective portion and amount excluded from effectiveness testing on designated cash flow derivative contracts on the Company’s results of operations recognized in other income (expense) was as follows (in thousands):
Effect of Non-Designated Derivative Contracts on the Condensed Consolidated Statements of Operations. >The effect of non-designated derivative contracts on the Company’s results of operations recognized in other income (expense) was as follows (in thousands):
Accounts Receivable from Product Revenues, net. >Accounts receivable from product revenues, net, were as follows (in thousands):
Notes Receivable and Investments in the Flash Ventures with Toshiba. >Notes receivable and investments in the flash ventures with Toshiba Corporation (“Toshiba”) were as follows (in thousands):
See Note 11, “Commitments, Contingencies and Guarantees – Flash Partners and Flash Alliance,” regarding equity method investments and Note 12, “Related Parties and Strategic Investments,” for the Company’s maximum loss exposure related to these variable interest entities.
Other Current Accrued Liabilities. >Other current accrued liabilities were as follows (in thousands):
As of October 3, 2010 and January 3, 2010, the total current accrued restructuring liability was primarily comprised of the current portion of the Company’s excess facility lease obligations. The non-current accrued restructuring balance and activity from the prior year end was primarily related to excess lease obligations and cash lease obligation payments. The facility lease obligations extend through the end of the lease term in fiscal year 2016.
Intangible Assets. >Intangible asset balances are presented below (in thousands):
The annual expected amortization expense of intangible assets as of October 3, 2010, is presented below (in thousands):
Liability for warranty expense is included in Other current accrued liabilities and Non-current liabilities in the accompanying Condensed Consolidated Balance Sheets and the activity for the three and nine months ended October 3, 2010 and September 27, 2009 was as follows (in thousands):
The majority of the Company’s products have a warranty of less than three years with a small number of products having a warranty ranging up to ten years. A provision for the estimated future cost related to warranty expense is recorded at the time of customer invoice. The Company’s warranty liability is affected by customer and consumer returns, product failures, number of units sold, and repair or replacement costs incurred. Should actual product failure rates, or repair or replacement costs differ from the Company’s estimates, increases or decreases to its warranty liability would be required.
The following table reflects the carrying value of the Company’s convertible debt as of October 3, 2010 and January 3, 2010 (in millions):
1% Convertible Senior Notes Due 2013. >In May 2006, the Company issued and sold $1.15 billion in aggregate principal amount of 1% Convertible Senior Notes due May 15, 2013 (the “1% Notes due 2013”) at par. The 1% Notes due 2013 may be converted, under certain circumstances, based on an initial conversion rate of 12.1426 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $82.36 per share). The net proceeds to the Company from the sale of the 1% Notes due 2013 were $1.13 billion.
The Company separately accounts for the liability and equity components of the 1% Notes due 2013. The principal amount of the liability component of $753.5 million as of the date of issuance was recognized at the present value of its cash flows using a discount rate of 7.4%, the Company’s borrowing rate at the date of the issuance for a similar debt instrument without the conversion feature. The carrying value of the equity component was $241.9 million as of October 3, 2010 and January 3, 2010. The effective interest rate on the liability component of the 1% Notes due 2013 for each of the three and nine months ended October 3, 2010 and September 27, 2009 was 7.4%.
The following table presents the amount of interest cost recognized for the periods relating to both the contractual interest coupon and amortization of the discount on the liability component of the1% Notes due 2013 (in millions):
The remaining bond discount of $171.8 million as of October 3, 2010 will be amortized over the remaining life of the 1% Notes due 2013, which is approximately 2.6 years.
Concurrent with the issuance of the 1% Notes due 2013, the Company sold warrants to acquire shares of its common stock at an exercise price of $95.03 per share. As of October 3, 2010, the warrants had an expected life of approximately 2.9 years and expire in August 2013. At expiration, the Company may, at its option, elect to settle the warrants on a net share basis. As of October 3, 2010, the warrants had not been exercised and remain outstanding. In addition, counterparties agreed to sell to the Company up to approximately 14.0 million shares of the Company’s common stock, which is the number of shares initially issuable upon conversion of the 1% Notes due 2013 in full, at a price of $82.36 per share. The convertible bond hedge transaction will be settled in net shares and will terminate upon the earlier of the maturity date of the 1% Notes due 2013 or the first day none of the 1% Notes due 2013 remains outstanding due to conversion or otherwise. Settlement of the convertible bond hedge in net shares, based on the number of shares issuable upon conversion of the 1% Notes due 2013, on the expiration date would result in the Company receiving net shares equivalent to the number of shares issuable by the Company upon conversion of the 1% Notes due 2013. As of October 3, 2010, the Company had not purchased any shares under the convertible bond hedge agreement.
1.5% Convertible Senior Notes Due 2017.> In August 2010, the Company issued and sold $1.0 billion in aggregate principal amount of 1.5% Convertible Senior Notes due August 15, 2017 (the “1.5% Notes due 2017”) at par. The 1.5% Notes due 2017 may be converted, under certain circumstances described below, based on an initial conversion rate of 19.0931 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $52.37 per share). The net proceeds to the Company from the sale of the 1.5% Notes due 2017 were $981.0 million.
The Company separately accounts for the liability and equity components of the 1.5% Notes due 2017. The principal amount of the liability component of $706.0 million as of the date of issuance was recognized at the present value of its cash flows using a discount rate of 6.85%, the Company’s borrowing rate at the date of the issuance for a similar debt instrument without the conversion feature. The carrying value of the equity component was $294.0 million as of October 3, 2010. The effective interest rate on the liability component of the 1.5% Notes due 2017 for each of the three and nine months ended October 3, 2010 was 6.85%.
The following table presents the amount of interest cost recognized for the periods relating to both the contractual interest coupon and amortization of the discount on the liability component of the 1.5% Notes due 2017 (in millions):
The remaining bond discount of $290.4 million as of October 3, 2010 will be amortized over the remaining life of the 1.5% Notes due 2017, which is approximately 6.9 years.
The 1.5% Notes due 2017 may be converted prior to the close of business on the scheduled trading day immediately preceding May 15, 2017, in multiples of $1,000 principal amount at the option of the holder under any of the following circumstances: 1) during the five business-day period after any five consecutive trading-day period (the “measurement period”) in which the trading price per note for each day of such measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such day; 2) during any calendar quarter after the calendar quarter ending September 30, 2010, if the last reported sale price of the Company’s common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 130% of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter; or 3) upon the occurrence of specified corporate transactions. On and after May 15, 2017 until the close of business on the second scheduled trading day immediately preceding the maturity date of August 15, 2017, holders may convert their notes at any time, regardless of the foregoing circumstances.
Upon conversion, a holder will receive the conversion value of the 1.5% Notes due 2017 to be converted equal to the conversion rate multiplied by the volume weighted average price of the Company’s common stock during a specified period following the conversion date. The conversion value of each 1.5% Notes due 2017 will be paid in: 1) cash equal to the lesser of the principal amount of the note or the conversion value, as defined, and 2) to the extent the conversion value exceeds the principal amount of the note, a combination of common stock and cash. The conversion price will be subject to adjustment in some events but will not be adjusted for accrued interest. Upon a “fundamental change” at any time, as defined, the Company will in some cases increase the conversion rate for a holder who elects to convert its 1.5% Notes due 2017 in connection with such fundamental change. In addition, the holders may require the Company to repurchase for cash all or a portion of their notes upon a “designated event” at a price equal to 100% of the principal amount of the notes being repurchased plus accrued and unpaid interest, if any.
The Company pays cash interest at an annual rate of 1.5%, payable semi-annually on February 15 and August 15 of each year, beginning February 15, 2011. Debt issuance costs were approximately $19.0 million, of which $5.6 million was allocated to capital in excess of par value and $13.4 million was allocated to deferred issuance costs and is amortized to interest expense over the term of the 1.5% Notes due 2017.
Concurrently with the issuance of the 1.5% Notes due 2017, the Company purchased a convertible bond hedge and sold warrants. The convertible bond hedge transaction is structured to reduce the potential future economic dilution associated with the conversion of the 1.5% Notes due 2017 and, combined with the warrants, to increase the initial conversion price to $73.33 per share. Each of these components is discussed separately below:
1% Convertible Notes Due 2035. >On February 11, 2010, the Company notified the holders of its 1% Convertible Notes due 2035 that it would exercise its option to redeem the $75.0 million principal amount outstanding on March 15, 2010 for a redemption price of $1,000 per $1,000 principal amount of the notes, plus accrued interest. On March 15, 2010, the Company completed the redemption of the 1% Convertible Notes due 2035 through an all-cash transaction of $75.0 million plus accrued interest of $0.4 million. As of the date of the completion of the redemption, the Company had no further obligations related to the 1% Convertible Notes due 2035.
Accumulated other comprehensive income, net of tax, presented in the accompanying Condensed Consolidated Balance Sheets consists of the accumulated unrealized gains and losses on available-for-sale investments, including the Company’s investments in equity securities, as well as currency translation adjustments relating to local currency-denominated subsidiaries and equity investees, and the accumulated unrealized gains and losses related to derivative instruments accounted for under hedge accounting (in thousands).
Comprehensive income is presented below (in thousands):