-----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, BsGkCXMle+fvs2fPciKvJ10xy06gNbH1jo/Q9djV7NqrJTbba2cNP1E6+ysqoRex t7kGd1lR+0msx3clnm/ycQ== 0001012870-01-001444.txt : 20010409 0001012870-01-001444.hdr.sgml : 20010409 ACCESSION NUMBER: 0001012870-01-001444 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 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-K405 SEC ACT: SEC FILE NUMBER: 000-26734 FILM NUMBER: 1588946 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-K405 1 0001.txt FORM 10-K405 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K X Annual report pursuant to Section 13 or 15(d) of the Securities Exchange - ----- Act of 1934 for the fiscal year ended December 31, 2000 or * Transition report pursuant to Section 13 or 15(d) of the Securities Act of - ----- 1934 Commission File No. 0-26734 SANDISK CORPORATION (Exact name of Registrant as specified in its charter) Delaware 77-0191793 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 140 Caspian Court, Sunnyvale, California 94089 (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code: (408) 542-0500 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- ------------------- None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value; Rights to Purchase Series A, Junior Participating Preferred Stock ----------------------------------------------------------------- (Title of Class) 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 No X ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ X ]. The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing sale price of the Common Stock on March 8, 2001 as reported on the NASDAQ National Market System, was approximately $1,396,929,000. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of March 8, 2001, Registrant had 67,957,788 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement for the 2001 Annual Meeting of Stockholders to be held on June 5, 2001 are incorporated by reference into Part III of this Form 10-K. *For purposes of this Form 10-K the Registrant has indicated its fiscal year as ending on December 31st. The Registrant operates on a fifty-two-fifty-three week fiscal year cycle ending on the Sunday closest to December 31/st/. SANDISK CORPORATION 2000 FORM 10-K ANNUAL REPORT Table of Contents
PART I Page No. -------- Item 1. Business 1 Item 2. Properties 14 Item 3. Legal Proceedings 15 Item 4. Submission of Matters to a Vote of Security Holders 15 Executive Officers of the Registrant 15 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 17 Item 6. Selected Financial Data 18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 8. Financial Statements and Supplementary Data 43 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 67 PART III Item 10. Directors and Executive Officers of the Registrant 67 Item 11. Executive Compensation 67 Item 12. Security Ownership of Certain Beneficial Owners and Management 67 Item 13. Certain Relationships and Related Transactions 67 PART IV Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K 68 Signatures 71
PART I ITEM 1. BUSINESS -------- BUSINESS We design, manufacture and market flash memory storage products that are used in a wide variety of electronic systems. We have designed our flash memory storage solutions to address the storage requirements of emerging applications in the consumer electronics and industrial/communications markets. Our products are used in a number of rapidly growing consumer electronics applications, such as digital cameras, personal digital assistants, portable digital music players, digital video recorders and smart phones, as well as in industrial and communications applications, such as communications routers and switches and wireless communications base stations. In fiscal 2000, we shipped over 13 million flash memory cards and flash chip sets. Our products include removable CompactFlash cards, MultiMediaCards, FlashDisk cards and Secure Digital Cards and embedded FlashDrives and Flash ChipSets with storage capacities ranging from 8 megabytes to 1.2 gigabytes. In fiscal 2000, our customers included Arrow Electronics, Inc., Avnet Electronics, Bell Microproducts, Inc., Best Buy Company, Inc., Canon, Inc., Cisco Systems, Inc., Eastman Kodak Company, Ericsson, Hewlett-Packard Company, Lucent Technologies Inc., Matsushita Electric Industrial Co., Ltd., Mitsubishi Plastic Co. Ltd., NEC America, Inc., Nikon Corporation, Nokia Corporation, Siemens, Tech Data Corporation, Thomson, and Wynit, Inc. In addition, we currently license our technologies to several companies including Hitachi Ltd., Intel Corporation, Lexar Media, Incorporated, Samsung Electronics Company Ltd., Sharp Electronics Corporation, SmartDisk Corporation, Silicon Storage Technologies, Incorporated, TDK Corporation and Toshiba Corporation. In 2000, we entered into a joint venture agreement with Toshiba Corporation, under which we formed FlashVision, LLC to produce advanced flash memory, utilizing fabrication space at Dominion Semiconductor in Manassas, Virginia. Toshiba and SanDisk will each get 50 percent of Dominion's flash memory output with production expected to commence in the second half of 2001. Industry Background In recent years, digital computing and processing have expanded beyond the boundaries of desktop computer systems to include a broader array of consumer electronic, industrial and communications products. These new devices include digital cameras, personal digital assistants, or PDAs, highly portable computers, portable music players, digital video recorders, wireless base stations, network computers, communication routers and switches, cellular telephones, mobile communication systems, handheld data collection terminals, medical monitors and other electronic systems. These emerging applications have storage requirements that are not well addressed by traditional storage solutions. These requirements include small form factor size, high reliability, low power consumption and the capability to withstand high levels of shock and vibration and extreme temperature fluctuations. Because storage products based on flash semiconductor technology can meet these requirements, these devices and systems represent market opportunities for flash storage systems. The SanDisk Solution We have optimized our flash memory storage solution, known as system flash or data storage flash, to address the needs of many emerging applications in the consumer electronics and industrial/communications markets. Since our inception, we have been actively involved in all aspects of flash memory process development, chip design, controller development and system-level integration to ensure the creation of fully-integrated, broadly interoperable products that are compatible with both existing and new system platforms. We believe our core technical competencies are in high-density flash memory process and design, controller design, system-level integration, compact packaging and low-cost system testing. To achieve compatibility among various electronic platforms, regardless of the host processor or operating system used, we have developed new capabilities in flash memory chip design and created intelligent controllers. We also developed an architecture that can leverage advances in flash memory process technology to ensure a scaleable, high-yield, cost-effective and highly reliable manufacturing process. Our CompactFlash, MultiMediaCard, Secure Digital Card, and FlashDisk products are portable, have an on-board controller and use file formats that are forward and backward compatible. All of our flash data storage products can store almost any type of digital information, including voice mail, e-mail, music, video clips and digital images. SanDisk's products offer the following features: Small form factor. Our CompactFlash products weigh about one-half ounce and are approximately the size of a matchbook. Our MultiMediaCard and Secure Digital Card products are approximately the size of a quarter coin and weigh less than two grams. Our FlashDisk cards are small and lightweight with a length of 85.6 mm, width of 54.0 mm, thickness of 5.0 mm or 10.5 mm and weight of less than 2.0 ounces. Non-volatility. Our products store information in non-volatile memory cells that do not require power to retain information. High degree of ruggedness. Our devices have an operating shock rating of 2,000 Gs for CompactFlash and 1,000 Gs for all other products (equivalent to being able to withstand ten foot and eight foot drops onto concrete, respectively). Our products are also designed to tolerate extensive fluctuations in temperatures and humidity. Low power consumption. During read and write operations, our products use less power than the rotating disk drives found in many portable computers. At all other times during system operation, our products require virtually no power. Depending upon the end product making use of our flash data storage, this translates into longer battery life. High reliability. Our products utilize sophisticated error detection and correction algorithms and dynamic defect management techniques to provide high data reliability and endurance. High performance. We believe that the read and write data rates of our products meet or exceed the read and write data rates required today by the majority of consumer and industrial/communications applications. The flash process and flash memory chip designs developed by us in cooperation with our partners make our products scaleable over several generations of semiconductor fabrication processes. This feature has allowed us to significantly reduce our cost per megabyte of capacity with each new generation of our products. By maintaining the same basic design parameters, each generation of our products maintains full compatibility with prior generations. This chip architecture has allowed us to significantly reduce cell size and thereby chip size. This has allowed us to increase storage capacity and lower the cost of our PC Card, CompactFlash and MultiMediaCard products. We have developed core competencies in low-cost micropackaging technology as well as low-cost batch testing, both of which are important elements in building high-capacity, high-reliability flash cards at a competitive cost and in high volumes. Applications and Markets for Flash Data Storage We are targeting the consumer electronics and the industrial/communications markets for our flash data storage products. Our products are used in a number of rapidly growing consumer electronics applications, such as digital cameras, personal digital assistants, portable music players, digital video recorders and smart phones, as well as in industrial and communications applications, such as communications routers and switches and wireless communications base stations. 2 Consumer Electronics. The increasing trend towards the use of digital technology in consumer electronics devices has created requirements for new data storage products. For example, a number of major camera and imaging companies have introduced digital cameras that we believe will enable professionals and consumers to eliminate the need for standard 35mm photographic film by replacing it with re-usable compact digital data storage devices. Removable and embedded flash data storage products, such as our CompactFlash, MultiMediaCard, Secure Digital Card and Flash ChipSet products, are used in personal digital assistants, highly portable computers, digital audio players, network computers, cellular telephones, next-generation smart telephones and other devices. Industrial/Communications Market. The communications market has applications that are beginning to require new types of data storage. For example, communications switches and cellular base stations require data storage in environments that are subject to shock and vibration and a wide range of temperature and humidity conditions. As the storage capacity of our cards grows, we are increasingly able to displace disk drives in routers and switches manufactured by telecommunications companies such as Cisco, Nortel and Lucent. In the fiscal years ended December 31, 2000, 1999, and 1998, product sales to our top 10 customers accounted for approximately 48%, 57%, and 59% of our product revenues, respectively. In 2000, no single customer accounted for greater than 10% of our total revenues. In 1999 and 1998, revenues from one customer exceeded 10% of total revenues. We expect that sales of our products to a limited number of customers will continue to account for a substantial portion of our revenues for the foreseeable future. We have also experienced significant changes in the composition of our major customer base from year to year and expect this pattern to continue as certain customers increase or decrease their purchases of our products as a result of fluctuations in market demand for their products. Sales to our customers are generally made pursuant to standard purchase orders rather than long-term contracts. The loss of, or significant reduction in, purchases by any of our major customers, could harm our business, financial condition and results of operations. SanDisk's Products Our storage products are high capacity, solid-state, non-volatile flash memory devices that comply with PC Card ATA and/or IDE industry standards. We offer a broad line of flash data storage products in terms of capacities, form factors, operating voltage and temperature ranges. Our current product families include removable CompactFlash, MultiMediaCard, FlashDisk and Secure Digital Card products, embedded FlashDrive products and Flash ChipSets. Our products are compatible with the majority of today's computing and communications systems that are based on industry standards. Our products, as of December 31, 2000, are listed in the following table:
- ---------------------------------------------------------------------------------------------------------------------- Uncompressed Product Family Form Factor Capacity CompactFlash (Removable) Type I (36.4 mm x 42.8 mm x 3.3 mm) 8 to 512 megabytes Type II (36.4 mm x 42.8 mm x 5.3 mm) 256 and 300 megabytes MultiMediaCard (Removable) 32 mm x 24 mm x 1.4 mm 8 to 64 megabytes FlashDisk (Removable) PC Card Type II (54.0 mm x 85.6 mm x 5.0 mm) 8 megabytes to 1.2 gigabytes Flash ChipSet (Embedded) 2 chips 8 to 64 megabytes FlashDrive (Embedded) 2.5 & 3.5 inches 32 megabytes to 1.2 gigabytes SmartMedia (Removable) Flash Card (45 mm x 37 mm x 0.76 mm) 8 to 64 megabytes - ----------------------------------------------------------------------------------------------------------------------
CompactFlash. Our CompactFlash products provide full PC Card ATA functionality but are only one-fourth the size of a standard PC Card. CompactFlash's compact size, ruggedness, low-power requirements and its ability to 3 operate at either 3.3V or 5V make it well-suited for a range of current and next-generation, small form factor consumer applications such as digital cameras, PDAs, personal communicators and audio recorders. CompactFlash products provide interoperability with systems based upon the PC Card ATA standard by using a low-cost passive Type II adapter. CompactFlash cards are available in capacities ranging from 8 megabytes to 512 megabytes in Type I form factor and in capacities of 256 and 300 megabytes in Type II form factor. MultiMediaCard. Our MultiMediaCard measures 32.0 mm by 24.0 mm by 1.4 mm, about the size of a quarter coin, and weighs less than two grams. MultiMediaCard is targeted at the emerging markets for mobile smart phones, consumer multimedia devices, digital audio recorders, digital video recorders, portable music players and other products that need removable data storage in a small form factor. Our MultiMediaCard is available in storage capacities of 8, 16, 32 and 64 megabytes. FlashDisk. Our FlashDisk products are used in storage, data backup and data transport applications. Our FlashDisk products are available in the PC Card Type II form factor with capacities ranging from 8 megabytes to 1.2 gigabytes. Flash ChipSet. Our Flash ChipSet products provide a very small footprint, solid-state ATA mass storage system. Our Flash ChipSet products consist of a single chip ATA controller and a flash memory chip, and are available in capacities of 8, 16, 32 and 64 megabytes. We provide full PC Card, ATA and IDE disk drive compatibility in a chip set format. FlashDrive. Our FlashDrives come in 2.5 and 3.5 inch form factors and are targeted at applications that require embedded data storage devices. FlashDrives offer rugged, portable, low-power data storage and are plug and play replacements for rotating IDE drives making them ideal for mobile computers, communication devices and other systems that require embedded storage. Capacities of our FlashDrive products range between 32 megabytes and 1.2 gigabytes. Other SanDisk products. We also sell SmartMedia Cards, ImageMate external drives and FlashPath adapters under the SanDisk brand name. Our SanDisk brand SmartMedia Cards are available in capacities ranging from 8 to 64 megabytes. Our ImageMate external drives offer a fast, convenient way to transfer data between our memory card products and a personal computer through a USB or parallel port connection. The ImageMate is available in CompactFlash, MultiMediaCard and SmartMedia Card versions. FlashPath adapters are floppy disk-shaped adapters that allow users to transfer data to and from their MultiMediaCard or SmartMedia Cards and their computer using a floppy disk drive. We also sell TriFlash embedded chips with capacities of 16 to 64 megabytes and NAND Flash embedded chips with a capacity of 32 megabytes. Our Personal Tag, or P-Tag, is a wearable, matchbook size, memory card that can be used to store critical data such as medical records and other personal information. The target markets for these cards include military agencies, government departments, insurance and health care companies worldwide. Secure Digital Card. The Secure Digital Card measures 32.0 mm by 24.0 mm by 2.1 mm. The Secure Digital Card is an enhanced version of our MultiMediaCard that incorporates advanced security and copyright protection features required by the emerging markets for the electronic distribution of music, video and other copyrighted works. Our Secure Digital Card is available in storage capacities of 8, 16, 32 and 64 megabytes. We began shipping the Secure Digital Card in the first quarter of 2001. The Secure Digital Card incorporates a number of new features, including SDMI compliant security and copy protection, a mechanical write protect switch and a high data transfer rate. The Secure Digital Card is slightly thicker (2.1mm) than our MultiMediaCard and uses a nine-pin interface instead of the seven-pin interface of the MultiMediaCard. Because of these differences, the Secure Digital Card will not work in current products that include a MultiMediaCard slot. However, our MultiMediaCard products are forward compatible and will work in Secure Digital Card slots. Conversely, broad acceptance of our Secure Digital Card by consumers may reduce demand for our MultiMediaCard and CompactFlash card products. The Secure Digital Card 4 relies on the copy protection features that have been developed for the DVD standard and therefore may be more likely to be endorsed by the leading content providers. The Secure Digital Card will face significant competition from the Sony Memory Stick and the Secure MultiMediaCard from Hitachi and Infineon. The Secure Digital Card Association currently numbers 225 members, however, some of these members are also participating in associations for competing standards. We cannot assure you that our Secure Digital Card will receive substantial market acceptance. Any failure by our customers to accept our Secure Digital Card products could harm our business, financial condition and results of operations. Technology Since our inception, we have focused our research and development efforts on developing highly reliable and cost-effective flash memory storage products to address a number of emerging markets. We have been actively involved in all aspects of this development, including flash memory process development, chip design, controller development and system-level integration to ensure the creation of fully-integrated, broadly interoperable products that are compatible with both existing and newly developed system platforms. We believe our core technical competencies are in high-density flash memory process and design, controller design, system-level integration, compact packaging and low-cost system testing. To achieve compatibility with various electronic platforms regardless of the host processors or operating systems used, we developed new capabilities in flash memory chip design and created intelligent controllers. We also developed an architecture that can leverage advances in process technology to ensure a scaleable, high-yielding, cost-effective and highly reliable manufacturing process. We believe that these technical competencies and our system design approach have enabled us to introduce flash data storage products that are better suited for our target markets than linear flash cards based on socket flash chips or SmartMedia flash cards, which do not contain an intelligent controller. We design our products to be compatible with industry-standard IDE and ATA interfaces used in all Windows and Apple compatible personal computers. Our patented intelligent controller with its advanced defect management system permits our products to achieve a high level of reliability and longevity. Latent bit failure can occur several years into the life of a flash card product and can be difficult to detect with traditional flash technology. The system allows the automatic substitution of entire sectors or major blocks of the memory chip in case of any latent flash memory failures. Additionally, the controller generates an error correcting code that is stored simultaneously with the data and is used to detect and dynamically correct any errors when the data is read. This design permits our products to maintain error-free operation for hundreds of thousands of erase and write cycles and reduces manufacturing costs by allowing us to incorporate partial die with less than 100% of the physical bits on each chip into the products without loss of functionality. Strategic Manufacturing Relationships An important element of our strategy has been to establish strategic relationships with leading technology companies that can provide us with access to leading edge semiconductor manufacturing capacity and participate in the development of some of our products. This enables us to concentrate our resources on the product design and 5 development areas where we believe we have competitive advantages. We have developed strategic relationships with UMC in Taiwan, Toshiba with whom we have a joint venture, FlashVision LLC, which will manufacture NAND flash memory and Tower Semiconductor in Israel. We may establish relationships with other foundries in the future. On June 30, 2000, we closed a transaction with Toshiba providing for the joint development and manufacture of 512 megabit and 1 gigabit flash memory chips and Secure Digital Card controllers. As a part of this transaction, SanDisk and Toshiba formed and contributed initial funding to FlashVision LLC, a joint venture to equip and operate a silicon wafer manufacturing line at Dominion Semiconductor in Virginia. The cost of equipping the Virginia wafer manufacturing line is estimated at between $700 million and $800 million. As part of our 50% ownership of the joint venture we had invested $134.7 million as of December 31, 2000, and in January 2001, we invested the remaining $15.3 million. We have also guaranteed up to $215 million in equipment lease lines to equip Toshiba's Dominion Semiconductor manufacturing clean room with advanced wafer processing equipment. As of January 26, 2001, $20 million was guaranteed. In addition, we will share certain research and development costs. We expect to begin shipping products based on the 512 megabit technology during the second half of 2001, and from the 1 gigabit technology during 2002. All of our products require silicon wafers that are currently supplied by UMC and Toshiba, under our joint venture agreement. Most of our wafers are currently manufactured using 0.24 micron process technology, and the wafers that will be made in our FlashVision Joint Venture employ a 0.16 micron process technology. In the past, we have experienced periods of supply constraints or excesses, each of which can have a significant impact on our gross margins and supplier relationships. Any delays in wafer availability or uncompetitive wafer pricing could limit our revenue growth and harm our business, financial condition and results of operations. Under the terms of our wafer supply agreements with UMC, we are obligated to provide a rolling forecast of anticipated purchase orders for the next six calendar months. Except in limited circumstances and subject to acceptance by UMC, the estimates for a portion of the forecast, generally three months, 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. We have similar forecast requirements and binding commitments under our supply agreement with Toshiba for wafers from their Yokkaichi foundry and will be obligated to purchase 50% of the NAND flash wafer output from the Dominion fab or bear the costs of unused capacity if we choose to not purchase our share of the available wafers. These requirements limit our ability to react to any significant fluctuations in demand for our products. When the demand for our products experiences an unexpected, sudden and sharp decline, as occurred late in the fourth quarter of fiscal 2000 and the first quarter of 2001, and we are unable to reschedule or cancel our wafer orders, we end up with excess wafer inventories, which result in higher costs and reduced gross margins. Furthermore, if a significant drop in demand is also accompanied by a rapid decline in market prices for our products we may have to reduce the value of our inventory to market, resulting in lower gross margins. Conversely, if customer demand exceeds our forecasts, we may be unable to obtain an adequate supply of wafers to fill customer orders, which could result in lost sales and the loss of customers to competitors who are able to meet the customer requirements. In addition, in February 2000, we entered into a capacity and reservation deposit agreement with UMC. To reserve additional foundry capacity under this agreement, we paid UMC a reservation deposit. This deposit will be refunded to us on a quarterly basis over the agreement term if we purchase the full wafer capacity reserved for us. We may forfeit part of our deposit if we are unable to utilize our reserved capacity within four quarters of the end of the agreement term. We are dependent upon our foundry partners to deliver wafers and to maintain acceptable yields and quality. In 2000, 1999, and 1998, we purchased wafers from UMC, a foundry in which we have ownership, totaling approximately $161.6 million, $22.8 million and $11.6 million, respectively. On July 4, 2000, SanDisk entered into a share purchase agreement to make a $75 million investment in Tower Semiconductor, or Tower, in Israel, representing approximately 10% ownership of Tower. In exchange for our investment, we received one seat on the board of directors of Tower and a guaranteed portion of the wafer output from the advanced fabrication facility Tower has started to build in Migdal Haemek, Israel. 6 Under the terms of the agreement, we will make our investment over a period of approximately 18 months if key milestones related to the construction, equipping and wafer production at the new wafer fabrication facility are met. On January 26, 2001, Tower satisfied the closing conditions of the share purchase agreement, and we transferred the first $20 million of our investment from an escrow account to purchase 866,551 ordinary shares and obtain $8.8 million in pre-paid wafer credits. On March 1, 2001, we paid Tower $11 million upon its completion of milestone one, to purchase 366,690 ordinary shares and obtain additional prepaid wafer credits. Additional contributions will take the form of mandatory warrant exercises for ordinary shares at an exercise price of $30.00 per share if other milestones are met. The warrants expire five years from the date of grant and in the event the key milestones are not achieved, the exercise of these warrants will not be mandatory. We expect first wafer production to commence at the new fabrication facility in late 2002. We also have a manufacturing relationship with NEC, under which NEC supplies microcontrollers for our products. NEC is currently a sole-source supplier for these controller chips. Any interruption in supply from NEC may harm our business. We believe additional foundry capacity will be necessary to meet future demand for our products. Our ability to increase our revenues and net income in future periods is dependent on establishing additional wafer supply relationships and on receiving an uninterrupted supply of wafers from our manufacturing partners. Our reliance on third-party wafer manufacturers involves several material risks, including shortages of manufacturing capacity, reduced control over delivery schedules, quality assurance, production yields and costs. This reliance could significantly harm our business, financial condition and results of operations. In addition, as a result of our dependence on foreign wafer manufacturers, we are subject to the risks of conducting business internationally, including political risks and exchange rate fluctuations. Assembly and Testing We test wafers at our headquarters in Sunnyvale, California, at the UMC facility in Taiwan, at Silicon Precision Industries in Taiwan, and at Celestica, Inc. in China. Substantially all of the tested wafers are then shipped to our third party memory assembly subcontractors: Silicon Precision Industries Co., Ltd. in Taiwan and Mitsui & Co., Ltd. in Japan. A substantial portion of packaged memory final test, card assembly and card test is performed at Silicon Precision Industries in Taiwan and Celestica, Inc. in China. In fiscal 2001, these subcontractors will assemble and test a majority of our mature, high-volume products. We expect our reliance on subcontractors will continue to reduce the cost of our operations and give us access to increased production capacity. We began transferring portions of our testing and assembly operations to these subcontractors in the second half of 1999 and are still continuing this transition. We will continue operations at our Sunnyvale production facility for new products and special customer requirements. Any significant problems that occur at our subcontractors, or their failure to perform at the level we expect, could result in a disruption of production and a shortage of products to meet customer demand in the first half of 2001 and beyond. Our customers have demanding requirements for quality and reliability. To maximize quality and reliability, we monitor electrical and inspection data from our wafer foundries and assembly subcontractors. We monitor wafer foundry production for consistent overall quality, reliability and yield levels. Most of our major component suppliers and subcontractors are ISO 9001 or 9002 certified. Research and Development We believe that our future success will depend on the continued development and introduction of new generations of flash memory chips, controllers and products designed specifically for the flash data storage market. In fiscal 2000, the majority of our production output shifted to the 256 megabit, .24 micron D2 technology. In our 7 joint venture with Toshiba, FlashVision LLC, we will begin production of 512 megabit NAND flash memory that employs 0.16 micron process feature size by mid- year 2001. We do not expect to generate revenues from this 512 megabit technology until the second half of 2001. The next generation of 1 gigabit NAND flash that is under joint development is not expected to contribute to revenues before 2002. Our research and development expenses were $46.1 million, $26.9 million and $18.2 million for the fiscal years ended December 31, 2000, 1999, and 1998, respectively. As of December 31, 2000, we had 177 full-time equivalent employees engaged in research and development activities, including 25 in our Israel design center. In fiscal 2001 and beyond, we expect to significantly increase our spending on process and design research and development to support the development and introduction of new generations of flash data storage products, including our 512 megabit and 1 gigabit NAND flash memory co-development and manufacturing joint venture with Toshiba. 8 Sales and Distribution We market our products using a direct sales organization, distributors and manufacturers' representatives. We also sell products to various customers on a private label basis and under the SanDisk brand in the retail channel. Our sales efforts are organized as follows: Direct Sales Force. Our direct sales offices are located in Maitland, Florida; Herndon, Virginia; Dublin and Avon, Ohio; Nashua, New Hampshire; Sunnyvale, Irvine, and Trabuco Canyon, California; Bedford, Texas; Hannover and Rantingen, Germany; Amsterdam, the Netherlands; Paris, France; Hertfordshire, England; Hong Kong, China; and Yokohama and Osaka, Japan. These offices support our major OEM customers and our distribution and manufacturers' representative partners. Distributors. In the United States, our products are sold through Arrow Electronics Inc., Avnet Inc. and Bell MicroProducts Inc. to OEM customers for a wide variety of industrial applications. In addition, we have distributors in various regions of the world including Europe, Japan, Australia, New Zealand, Taiwan, Korea, Singapore and Hong Kong. Independent Manufacturers' Representatives. In the United States, Canada and Europe, our direct sales force is supported in its sales efforts by more than 39 independent firms. These domestic and international firms receive a commission for providing support to our direct sales force and distributors in the industrial distribution, OEM and retail channels. The manufacturers' representative companies sell our products as well as products from other manufacturers. OEMs. We provide private label products to OEMs in the United States, Europe and the Pacific Rim. Retail. We ship SanDisk brand name products directly to consumer electronics stores, office superstores, photo retailers, mass merchants, catalog and mail order companies, Internet and e-commerce retailers and selected retail distributors. Our distributors include Ingram Micro, Inc., Tech Data Corporation, Laguna Corporation and Wynit, Inc. in the United States, in addition to international distributors. Our products are available in more than 20,000 retail stores worldwide. Fourteen independent manufacturers' representative firms are supporting our sales efforts in the retail channel. In addition, we sell our products on the Internet through third parties such as Amazon.com. Strategic Investments On August 9, 2000, we entered into a joint venture, Digital Portal Inc., or DPI, with Photo-Me International, or PMI, for the manufacture, installation, marketing and service of self-service, digital photo printing labs, or kiosks, bearing the SanDisk brand name in locations in the U.S. and Canada. These kiosks employ high-quality, low-cost, silver halide photo processing technology developed by PMI. Under the agreement, we and PMI will each make an initial investment of $4.0 million and secure lease financing for the purchase of the kiosks. The total value of the lease financing will depend on the number of kiosks deployed by the joint venture. We estimate that we will guarantee equipment lease arrangements of approximately $40 million over the first two years of the agreement. PMI will manufacture the kiosks for the joint venture and will install and maintain the kiosks under contract with the joint venture. We expect the first kiosks to be deployed in pilot programs in selected retail stores in the United States starting in the first half of 2001. On November 2, 2000, we made a strategic investment of $7.2 million in Divio, Inc. Divio is a privately-held manufacturer of digital imaging compression technology and products for future digital camcorders that will be capable of using our flash memory cards to store home video movies, replacing the magnetic tape currently used in these systems. Under the agreement, we own approximately 10% of Divio and are entitled to one board seat. Customer Service and Technical Support 9 We provide customers with comprehensive product service and support. We provide technical support through our application engineering group located in the United States, Japan and Hong Kong. We work closely with our customers to monitor the performance of our product designs, to provide application design support and assistance, and to gain insight into our customers' needs to help in the design of future products. Our support package is generally offered with product sales and includes technical documentation and application design assistance. In some cases, we offer additional support which includes training, system-level design, implementation and integration support and failure analysis. We believe that tailoring the technical support level to our customers' needs is essential for the success of product introductions and to achieve a high level of satisfaction among our customers. We generally provide a one-year warranty on our products. Patents and Licenses We rely on a combination of patents, trademarks, copyright and trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. We vigorously protect and defend our intellectual property rights. In the past, we have been involved in significant disputes regarding our intellectual property rights and we believe we may be involved in similar disputes in the future. In 1988, we developed the concept of emulation of a hard disk drive with flash solid-state memory. The first related patents were filed in 1988 by Dr. Eli Harari and exclusively licensed to us. We currently own or have exclusive rights to 138 United States and 37 foreign issued patents, and over 75 patent applications pending in the United States, as well as 40 pending in foreign patent offices. We intend to seek additional international and United States patents on our technology. We believe some of our patents are fundamental to the implementation of flash data storage systems, as well as the implementation of D2 flash, independent of the flash technology used. However, we cannot assure you that any patents held by us will not be invalidated, that patents will be issued for any of our 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 our products can be sold to provide meaningful protection or any commercial advantage to us. Additionally, our competitors may be able to design their products around our patents. The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights or positions, which has resulted in significant and often protracted and expensive litigation. To preserve our intellectual property rights, we believe it may be necessary to initiate litigation against one or more third parties, including but not limited to those we have already notified of possible patent infringement. In addition, one or more of these parties may bring suit against us. For example, in March 1998, we sued Lexar in the Northern District of California alleging that Lexar's CompactFlash and PC Cards infringe our U.S. Patent No. 5,602,987 ("'987 Patent"). Lexar disputed this claim and asserted various counter claims, including unfair competition, violation of the Lanham Act, patent misuse, interference with prospective economic advantage, trade defamation, unenforceability and fraud. On November 14, 2000, in resolution of these actions, Lexar stipulated that our '987 Patent is valid and infringed by Lexar's current CompactFlash and PC Cards. Lexar made a lump sum payment of $8.0 million for royalties due on the '987 Patent, through March 31, 2001. Subject to Lexar's representations and warranties relating to Lexar's newly designed CompactFlash and PC Cards, we have stipulated that these designs do not infringe our '987 Patent. Lexar entered into a 4% royalty-bearing license agreement for certain Lexar products that may use the '987 Patent beyond March 31, 2001. We and Lexar have agreed to dismiss with prejudice all pending claims of patent infringement and counterclaims involving claims of false advertising, unfair competition and patent misuse. In September 2000, Lexar sued us in the District Court of Delaware alleging that our SmartMedia products infringe Lexar's United States Patent No. 5,479,638 ("'638 Patent"). In resolution of this action, we paid Lexar a lump sum payment of $2.0 million for a fully-paid up license for use of the '638 Patent in SmartMedia products. Under the settlement, Lexar has provided us with an option for a royalty bearing license to its patents for use in certain future products. 10 We and Lexar have agreed to resolve any future disputes relating to the use by Lexar of the '987 Patent through binding arbitration. We have also agreed that for a period of seven years, neither we nor Lexar shall seek injunctive relief against the other in any patent lawsuit. However, at all times, we retain the right to seek injunctive relief to enforce the payment of royalties pursuant to an arbitrator's ruling. On March 21, 2000, Mitsubishi Denki Co. Ltd. (Mitsubishi Electric) filed a complaint in Tokyo District Court against SanDisk K.K., our wholly-owned subsidiary. The complaint alleges that SanDisk K.K., based in Yokohama, Japan, infringes on three Mitsubishi Japanese patents. The Mitsubishi patents in question are #JP2099342, #JP2129071 and #JP2138047, which are related primarily to the mechanical construction of memory cards. In the complaint, Mitsubishi asked the court for a preliminary injunction halting the sale of our CompactFlash and flash ATA memory cards in Japan. Mitsubishi has since dropped patents #JP2129071 and #JP2138047 from the suit. We are vigorously defending against Mitsubishi's remaining claims. From time to time, we have been contacted by various other parties who have alleged that certain of our products infringe on patents that these parties claim to hold. To date no legal actions have been filed in connection with any such infringement, other than as discussed above. In the event of an adverse result in any such litigation, we could be required to pay substantial damages, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology, 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 us and divert the efforts of our technical and management personnel, whether or not such litigation is ultimately determined in our favor. In addition, the results of any litigation are inherently uncertain. In the event we desire to incorporate third party technology into our products or our products are found to infringe on others' patents or intellectual property rights, we may be required to license such patents or intellectual property rights. We may also need to license some or all of our patent portfolio to be able to obtain cross-licenses to the patents of others. We currently have patent cross-license agreements with several companies including Hitachi, Intel, Lexar, Samsung, Sharp, SST, SmartDisk, TDK and Toshiba. From time to time, we have also entered into discussions with other companies regarding potential cross-license agreements for our patents. However, we cannot assure you that licenses will be offered or that the terms of any offered licenses will be acceptable to us. If we obtain licenses from third parties, we may be required to pay license fees or make royalty payments, which could reduce our gross margins. If we are unable to obtain a license from a third party for technology, we could incur substantial liabilities or be required to expend substantial resources redesigning our products to eliminate the infringement. In addition, we might be required to suspend the manufacture of products or the use by our foundries of processes requiring the technology. We cannot assure you that we would be successful in redesigning our products or that we could obtain licenses under reasonable terms. Furthermore, any development or license negotiations could require substantial expenditures of time and other resources by us. As is common in the industry, we agree to indemnify certain of our 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. We may from time to time be engaged in litigation as a result of these indemnification obligations. In our efforts to maintain the confidentiality and ownership of our trade secrets and other confidential information, we require all regular and temporary employees, consultants, foundry partners, certain customers, suppliers and partners to execute confidentiality and invention assignment agreements upon commencement of a relationship with us and extending for a period of time beyond termination of the relationship. We cannot assure you that these agreements will provide meaningful protection for our trade secrets or other confidential information in the event of unauthorized use or disclosure of such information. 11 Backlog We manufacture and market primarily standard products. Sales are generally made pursuant to standard purchase orders. We include in our backlog only those customer orders for which we have accepted purchase orders and assigned shipment dates within the upcoming twelve months. Since orders constituting our current backlog are subject to changes in delivery schedules or cancellations, backlog is not necessarily an indication of future revenue. As of December 31, 2000, our backlog was $63.3 million, compared to $157.2 million at December 31, 1999. Retail sales are typically booked and shipped in the same quarter. Competition We compete in an industry characterized by intense competition, rapid technological changes, evolving industry standards, declining average selling prices and rapid product obsolescence. Our competitors include many large domestic and international companies that have greater access to advanced wafer foundry capacity, substantially greater financial, technical, marketing and other resources, broader product lines and longer standing relationships with customers. Our primary competitors include companies that develop and manufacture storage flash chips , such as Hitachi, Samsung, Micron Technology and Toshiba. In addition, we compete with companies that manufacture other forms of flash memory and companies that purchase flash memory components and assemble memory cards. Companies that manufacture socket flash, linear flash and components include Advanced Micro Devices, Atmel, Intel, Macronix, Mitsubishi, Fujitsu, Sharp Electronics and ST Microelectronics. Companies that combine controllers and flash memory chips developed by others into flash storage cards include Lexar Media, M-Systems, Pretec, Simple Technology, Sony Corporation, Kingston Technology, Panasonic, Silicon Storage Technology, TDK Corporation, Matsushita Battery, Delkin Devices, Inc., Feiya Technology Corporation, Dane-Elec Manufacturing, Silicon Tek, Infineon Technologies and Viking Components. We have entered into patent cross-license agreements with several of our leading competitors including Hitachi, Intel, Lexar, Sharp, Samsung, SST, TDK and Toshiba. Under these agreements, each party may manufacture and sell products that incorporate technology covered by each party's patents related to flash memory devices. As we continue to license our patents to certain of our competitors, competition will increase and may harm our business, financial condition and results of operations. In addition, over 40 companies have been certified by the CompactFlash Association to manufacture and sell their own brand of CompactFlash. We believe additional manufacturers will enter the CompactFlash market in the future. We have announced a memorandum of understanding under which we, Matsushita and Toshiba are jointly developing and promoting a next generation flash memory card called the Secure Digital Card. Under this agreement, Secure Digital Card licenses will be granted to other flash memory card manufacturers, which will increase the competition for our Secure Digital Card, CompactFlash and MultiMediaCard products. In addition, Matsushita and Toshiba are selling Secure Digital Cards that will compete directly with our MultiMediaCard and Secure Digital Card products. While other flash card manufacturers will be required to pay the SD Association license fees and royalties, there will be no royalties or license fees payable among the three companies for their respective sales of the Secure Digital Card. On June 30, 2000, we closed a transaction with Toshiba providing for the joint development and manufacture of 512 megabit and 1 gigabit flash memory chips and Secure Digital Card controllers. 12 We expect to begin shipping products based on the 512 megabit technology during the second half of 2001, and from the 1 gigabit technology during 2002. As we and Toshiba will each separately market and sell any products developed and manufactured under this relationship, we will compete directly with Toshiba for sales of these advanced chips and controllers. Competing products have been introduced that promote industry standards that are different from our CompactFlash, MultiMediaCard and Secure Digital Card products, including Toshiba's SmartMedia, Sony Corporation's Memory Stick, Sony's standard floppy disk used for digital storage in their Mavica digital cameras, Panasonic's Mega Storage cards, Iomega's Clik drive, a miniaturized mechanical, removable disk drive, DataPlay's miniature optical storage drive and the Secure MultiMediaCard from Hitachi and Infineon. Each competing standard is mechanically and electronically incompatible with CompactFlash, MultiMediaCard and Secure Digital Card. If a manufacturer of products such as digital cameras designs in one of these alternative competing standards, CompactFlash, MultiMediaCard and Secure Digital Card will be eliminated from use in that product. The IBM microdrive, a rotating disk drive in a Type II CompactFlash competes directly with our Type II CompactFlash memory cards for use in high-end professional digital cameras. M-Systems' Diskonchip 2000 Millennium product competes against our Flash ChipSet and NAND flash memory component products in embedded storage applications such as set top boxes and networking appliances. According to independent industry analysts, Sony's Mavica digital camera captured a considerable portion of the United States market for digital cameras from 1998 to 2000. The Mavica uses a standard floppy disk to store digital images and therefore uses no CompactFlash, or any other flash cards. Our sales prospects for CompactFlash cards have been adversely impacted by the success of the Mavica. Recently, Sony has shifted its focus to the use of its flash Memory Stick in its latest digital camera models, and we may face significant competition from this product. Sony has licensed its proprietary Memory Stick to other companies. If it is adopted and achieves widespread use in future products, sales of our MultiMediaCard and CompactFlash products may decline. Our MultiMediaCard products have also faced significant competition from Toshiba's SmartMedia flash cards. We also sell SmartMedia cards to our retail customers who prefer to buy all their flash memory cards from one supplier. Hitachi, Infineon, Sanyo and Fujitsu have proposed their Secure MultiMediaCard, which provides the copy protection function that is included on our Secure Digital Card. Should this initiative gain industry acceptance, it may reduce the widespread adoption of the Secure Digital Card. We also face competition from products based on multilevel cell flash technology from Intel and Hitachi. These products compete with our D2 multilevel cell flash technology. Multilevel cell flash is a technological innovation 13 that allows each flash memory cell to store two bits of information instead of the traditional single bit stored by the industry standard flash technology. Furthermore, we expect to face competition from existing competitors and from other companies that may enter our existing or future markets that have similar or alternative data storage solutions which may be less costly or provide additional features. Price is an important competitive factor in the market for consumer products. Increased price competition could lower gross margins if our average selling prices decrease faster than our costs, and could also result in lost sales. We believe that our ability to compete successfully depends on a number of factors, which include: . price, quality, and on-time delivery to our customers; . product performance and availability; . success in developing new applications for system flash technology; . adequate foundry capacity; . efficiency of production; . timing of new product announcements or introductions by us, our customers and our competitors; . the ability of our competitors to incorporate their flash data storage systems into their customers' products; . the number and nature of our competitors in a given market; . successful protection of intellectual property rights; and . general market and economic conditions. We believe that we compete reasonably favorably with other companies with respect to these factors. We cannot assure you that we will be able to compete successfully against current and future competitors or that competitive pressures faced by us will not materially adversely affect our business, financial condition or results of operations. Employees As of December 31, 2000, we had 720 full-time employees and 283 temporary employees, including 177 in research and development, 132 in sales and marketing, 114 in finance and administration and 580 in operations. Our success is dependent on our retention of key technical, sales and marketing employees and members of senior management. Additionally, our success is contingent on our ability to attract and recruit skilled employees in a very competitive market. None of our employees are represented by a collective bargaining agreement and we have never experienced any work stoppage. We believe that our employee relations are good. ITEM 2. PROPERTIES ---------- Our principal facilities are presently located in Sunnyvale, California. We lease two adjacent buildings, a 104,000 square foot building that is dedicated to production and research and development activities and a 50,000 square foot building which houses our administrative and sales and marketing functions. We occupy this space under lease agreements that expire in July 2006. Under these agreements, we have the option to renew the leases on both buildings for one additional five-year term ending on June 30, 2011. In addition, we lease warehouse space in San Jose, California. This 40,000 square foot building is leased through July 2005. We believe that our facilities will be adequate to meet our near term needs and that additional space will be available as required. We also lease domestic sales offices in Herndon, Virginia; Irvine and Trabuco Canyon, California; Dublin and Avon, Ohio; Nashua, New Hampshire; Bedford, Texas and Maitland, Florida, as well as foreign sales offices in Paris, France; Hannover and Ratingen, Germany; Amsterdam, the Netherlands; Yokohama and Osaka, Japan; Hong Kong, China and Hertfordshire, England, a technical support office in Taichung, Taiwan and a design center in Tefen, Israel. 14 ITEM 3. LEGAL PROCEEDINGS ----------------- In March 1998, we sued Lexar in the Northern District of California alleging that Lexar's CompactFlash and PC Cards infringe our U.S. Patent No. 5,602,987 ("'987 Patent"). Lexar disputed this claim and asserted various counter claims, including unfair competition, violation of the Lanham Act, patent misuse, interference with prospective economic advantage, trade defamation, unenforceability and fraud. On November 14, 2000, in resolution of these actions, Lexar stipulated that SanDisk's '987 Patent is valid and infringed by Lexar's current CompactFlash and PC Cards. Lexar made a lump sum payment of $8.0 million in December 2000 for royalties due on the '987 Patent, through March 31, 2001. Subject to Lexar's representations and warranties relating to Lexar's newly designed CompactFlash and PC Cards, SanDisk has stipulated that these designs do not infringe SanDisk's '987 Patent. Lexar entered into a 4% royalty-bearing license agreement for certain Lexar products that may use the '987 Patent beyond March 31, 2001. SanDisk and Lexar have agreed to dismiss with prejudice all pending claims of patent infringement and counterclaims involving claims of false advertising, unfair competition and patent misuse. In September 2000, Lexar sued SanDisk in the District of Delaware alleging that our SmartMedia products infringe Lexar's United States Patent No. 5,479,638 ("'638 Patent"). In resolution of this action, we paid Lexar a lump sum payment of $2.0 million for a fully-paid up license for use of the '638 Patent in SmartMedia products. Under the settlement, Lexar has provided us with an option for a royalty bearing license to its patents for use in certain future products. SanDisk and Lexar have agreed to resolve any future disputes relating to the use by Lexar of the '987 Patent through binding arbitration. We have also agreed that for a period of seven years, neither SanDisk nor Lexar shall seek injunctive relief against the other in any patent lawsuit. However, at all times, we retain the right to seek injunctive relief to enforce the payment of royalties pursuant to an arbitrator's ruling. On March 21, 2000, Mitsubishi Denki Co. Ltd. (Mitsubishi Electric) filed a complaint in Tokyo District Court against SanDisk K.K., SanDisk's wholly owned subsidiary. The complaint alleges that SanDisk K.K., based in Yokohama, Japan, infringes on three Mitsubishi Japanese patents. The Mitsubishi patents in question are #JP2099342, #JP2129071 and #JP2138047, which are related primarily to the mechanical construction of memory cards. In the complaint, Mitsubishi asked the court for a preliminary injunction halting the sale of SanDisk CompactFlash and flash ATA memory cards in Japan. Mitsubishi has since dropped patents #JP2129071 and #JP2138047 from the suit. SanDisk and SanDisk K.K. are vigorously defending against Mitsubishi's remaining claims. Compaq Corporation has opposed in several countries, including the United States, our attempting to register CompactFlash as a trademark. We do not believe that our failure to obtain registration for the CompactFlash mark will materially harm our business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- None EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------- Our executive officers, who are elected by and serve at the discretion of the Board of Directors, are as follows (all ages are as of March 8, 2001): Name Age Position ---- --- -------- Dr. Eli Harari 55 President, Chief Executive Officer and Director Frank Calderoni 43 Chief Financial Officer, Senior Vice President, Finance and Administration Ralph Hudson 56 Senior Vice President, Worldwide Operations Sanjay Mehrotra 42 Senior Vice President, Engineering Nelson Chan 39 Senior Vice President, Sales and Marketing Jocelyn Scarborough 56 Vice President, Human Resources Dr. Eli Harari, the founder of SanDisk, has served as President and Chief Executive Officer and as a director of SanDisk since June 1988. Dr. Harari founded Wafer Scale Integration, a privately held semiconductor company, in 1983 and was its President and Chief Executive Officer from 1983 to 1986, and Chairman and Chief Technical Officer from 1986 to 1988. From 1973 to 1983, Dr. Harari held various management positions with Honeywell Inc., Intel Corporation and Hughes Aircraft Microelectronics. Dr. Harari holds a Ph.D. in Solid State Sciences from Princeton University. Mr. Frank Calderoni joined SanDisk in February 2000 as its Chief Financial Officer and Senior Vice President, Finance and Administration. He was previously Vice President, Finance and Operations, Global Small Business at International Business Machines Corporation. From 1979 to 1999, Mr. Calderoni held various management 15 positions, including controller Storage Systems Division, Server Group Controller and System 390 division director of finance and planning at IBM. Mr. Calderoni holds a B.S. in Finance/Accounting from Fordham University and an M.B.A. from Pace University. Mr. Ralph Hudson joined SanDisk as Senior Vice President of World Wide Operations in August 1998. He was previously President of RJ Hudson Consulting from 1997 to 1998, Vice President of Operations for USRobotics/3Com's Network Work Systems Division from 1996 to 1997, Senior Vice President and General Manager for Bell and Howell from 1993 to 1996 and held various senior management positions with Data General from 1977 to 1993 where he was Vice President of World Wide Operations from 1989 to 1993. Prior to this, he held various management and senior management positions with NCR Corporation from 1967 to 1977. Mr. Hudson holds a B.S. in Industrial Engineering from Allied Institute of Technology. Mr. Sanjay Mehrotra is a co-founder of SanDisk, has served as Director of Memory Design and Product Engineering from November 1988 to June 1995; Vice President of Product Development from July 1995 to July 1999; and as Senior Vice President, Engineering since July 1999. From January 1980 until November 1988, Mr. Mehrotra worked at Intel, Seeq Technology, Integrated Device Technology and Atmel Corporation in the area of design engineering and engineering management, mostly in EPROM and EEPROM product development. Mr. Mehrotra holds a B.S. and an M.S. in Electrical Engineering and Computer Science from the University of California at Berkeley. Mr. Nelson Chan joined SanDisk as Vice President, Marketing in September 1992, and he became Senior Vice President, Marketing in December 1999 and has served as Senior Vice President, Sales and Marketing Since July 2000. From 1986 to 1992, Mr. Chan was Marketing Manager for the Integrated Systems Products Division at Chips and Technologies. From 1983 to 1986, Mr. Chan held marketing and engineering positions at Signetics and Delco Electronics. Mr. Chan holds a B.S. in Electrical and Computer Engineering from the University of California at Santa Barbara and an M.B.A. from Santa Clara University. Ms. Jocelyn Scarborough joined SanDisk as Vice President of Human Resources in March 1999. She was previously Principal of Scarborough and Associates from 1997 to 1999 and Vice President of Human Resources for the California State Automobile Association from 1994 to 1997. From 1973 to 1993, Ms. Scarborough held various management positions, including Director of Human Resources and Organization Development, at Digital Equipment Corporation. Ms. Scarborough holds a B.S. in Psychology from Gordon College. 16 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND ---------------------------------------------- RELATED STOCKHOLDER MATTERS --------------------------- Market Price of Common Stock - ---------------------------- Our Common Stock is traded on the Nasdaq National Market under the symbol SNDK. Our initial public offering of stock occurred on November 8, 1995 at a post- split price to the public of $5.00 per share. On January 26, 2000, our board of directors approved a 2-for-1 stock split, in the form of a 100% stock dividend, payable to stockholders of record as of February 8, 2000. The dividend was paid and the split was effected on February 22, 2000. Shares, per share amounts, common stock at par value and capital in excess of par value have been restated to reflect the stock split for all periods presented. The following table lists the high and low sales prices for each quarter during the last two years.
High Low ---- --- Fiscal year 1999 First quarter $ 18.813 $ 6.250 Second quarter $ 22.344 $ 8.500 Third quarter $ 47.875 $19.750 Fourth quarter $ 50.313 $18.875 Fiscal year 2000 First quarter $169.625 $37.469 Second quarter $126.500 $41.250 Third quarter $ 94.500 $51.125 Fourth quarter $ 74.750 $27.500
As of March 8, 2001, we had approximately 325 stockholders of record. We have never declared or paid any cash dividends on our Common Stock and do not expect to pay cash dividends on our Common Stock in the foreseeable future. We currently intend to retain our earnings, if any, for use in our business. 17 ITEM 6: SANDISK CORPORATION SELECTED FINANCIAL DATA (In thousands, except per share data)
Year Ended December 31, 2000 1999 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- Revenues Product $ 526,359 $205,770 $103,190 $105,675 $ 89,599 License and royalty 75,453 41,220 32,571 19,578 8,000 - ----------------------------------------------------------------------------------------------------------------------------- Total revenues 601,812 246,990 135,761 125,253 97,599 Cost of revenues 357,017 152,143 80,311 72,280 58,707 - ----------------------------------------------------------------------------------------------------------------------------- Gross profits 244,795 94,847 55,450 52,973 38,892 Operating income 124,666 30,085 12,810 19,680 12,474 Net income $ 298,672 $ 26,550 $ 11,836 $ 19,839 $ 14,485 Net income per share Basic $4.47 $0.48 $0.23 $0.43 $0.33 Diluted $4.11 $0.43 $0.21 $0.40 $0.30 Shares used in per share calculations Basic 66,861 55,834 52,596 45,760 44,324 Diluted 72,651 61,433 55,344 49,940 48,412 At December 31, 2000 1999 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- Working capital $ 525,950 $482,793 $138,471 $134,298 $ 77,029 Total assets 1,107,907 657,724 255,741 245,467 108,268 Total stockholders' equity 863,058 572,127 207,838 191,374 87,810
See Notes to the Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations. 18 SanDisk Corporation SUPPLEMENTARY QUARTERLY DATA (Unaudited. In thousands except per share data)
Quarterly/2000 1st 2nd 3rd 4th - ----------------------------------------------------------------------------------------------------------------- Revenues Product $ 97,249 $122,572 $151,817 $154,721 License and royalty 12,120 21,377 19,022 22,934 - ----------------------------------------------------------------------------------------------------------------- Total revenues 109,369 143,949 170,839 177,655 Gross profits 41,611 59,435 68,965 74,784 Operating income 17,551 30,852 35,535 40,728 Net income* 219,271 24,269 25,602 29,530 Net income per share Basic $ 3.32 $ 0.36 $ 0.38 $ 0.44 Diluted** $ 3.00 $ 0.33 $ 0.35 $ 0.41 Quarterly/1999 1st 2nd 3rd 4th - ----------------------------------------------------------------------------------------------------------------- Revenues Product $ 35,926 $ 42,300 $ 57,624 $ 69,920 License and royalty 8,210 10,249 9,910 12,851 - ----------------------------------------------------------------------------------------------------------------- Total revenues 44,136 52,549 67,534 82,771 Gross profits 17,627 21,691 23,637 31,892 Operating income 4,848 7,033 6,956 11,248 Net income 4,323 5,694 6,505 10,028 Net income per share Basic $ 0.08 $ 0.11 $ 0.12 $ 0.17 Diluted $ 0.07 $ 0.10 $ 0.11 $ 0.15
* On January 3, 2000, the USIC foundry was merged into the UMC parent company. We had invested $51.2 million in USIC. In exchange for our USIC shares, we received 111 million UMC shares. These shares were valued at approximately $396 million at the time of the merger, resulting in a pretax gain of $394.2 million ($203.9 million after tax) in the first quarter of 2000. ** Quarterly earnings per share figures may not total to yearly earnings per share, due to rounding and the fluctuations in the number of options included or omitted from diluted calculations based on the stock price or option strike prices. See Notes to the Consolidated Financial Statement and Management's Discussion and Analysis of Financial Condition and Results of Operations. 19 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- Certain statements in this discussion and analysis are forward looking statements based on current expectations, and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward looking statements. Such risks and uncertainties are set forth in "Factors That May Affect Future Results" and elsewhere in this report. The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto. Overview SanDisk was founded in 1988 to develop and market flash data storage systems. We sell our products to the consumer electronics and industrial/communications markets. In fiscal 2000, approximately 58% of our product sales were attributable to the consumer electronics market, particularly sales of CompactFlash and MultiMediaCard products for use in digital camera applications. Our CompactFlash products have lower average selling prices and gross margins than our higher capacity FlashDisk and FlashDrive products. In addition, a substantial portion of our CompactFlash and MultiMediaCard products are sold into the retail channel, which usually has shorter customer order lead-times than our other channels. A majority of our sales to the retail channel are turns business, with orders received and fulfilled in the same quarter, thereby decreasing our ability to accurately forecast future production needs. We believe sales to the consumer market will continue to represent a majority of our sales, and increase as a percentage of sales in future years, as the popularity of consumer applications, including digital cameras, increases. Our operating results are affected by a number of factors including the volume of product sales, competitive pricing pressures, availability of foundry capacity, variations in manufacturing cycle times, fluctuations in manufacturing yields and manufacturing utilization, the timing of significant orders, our ability to match supply with demand, changes in product and customer mix, market acceptance of new or enhanced versions of our products, changes in the channels through which our products are distributed, timing of new product announcements and introductions by us and our competitors, the timing of license and royalty revenues, fluctuations in product costs, increased research and development expenses, and exchange rate fluctuations. We have experienced seasonality in the past. As the proportion of our products sold for use in consumer electronics applications increases, our revenues may become subject to seasonal declines in the first quarter of each year. See "Factors That May Affect Future Results--Our Operating Results May Fluctuate Significantly Which May Adversely Affect Our Stock Price" and "--There is Seasonality in Our Business." Beginning in late 1995, we adopted a strategy of licensing our flash technology, including our patent portfolio, to third party manufacturers of flash products. To date, we have entered into patent cross-license agreements with several companies, and intend to pursue opportunities to enter into additional licenses. Under our current license agreements, licensees pay license fees, royalties, or a combination thereof. In some cases, the compensation to us may be partially in the form of guaranteed access to flash memory manufacturing capacity from the licensee company. The timing and amount of royalty payments and the recognition of license fees can vary substantially from quarter to quarter depending on the terms of each agreement and, in some cases, the timing of sales of products by the other parties. As a result, license and royalty revenues have fluctuated significantly in the past and are likely to continue to fluctuate in the future. Given the relatively high gross margins associated with license and royalty revenues, gross margins and net income are likely to fluctuate more with changes in license and royalty revenues than with changes in product revenues. We market our products using a direct sales organization, distributors, manufacturers' representatives, private label partners, OEMs and retailers. We expect that sales through the retail channel will comprise an increasing share of our product revenues in the future, and that a substantial portion of our sales into the retail channel will be made to participants that will have the right to return unsold products. Our policy is to defer recognition of revenues from these sales until the products are sold to the end customers. Historically, a majority of our sales have been to a limited number of customers. Sales to our top 10 customers accounted for approximately 48%, 57%, and 59%, respectively, of our product revenues for 2000, 1999, and 1998. In 2000, no single customer accounted for greater than 10% of our total revenues. In 1999 and 1998, 20 revenues from one customer exceeded 10% of total revenues. We expect that sales of our products to a limited number of customers will continue to account for a substantial portion of our product revenues for the foreseeable future. We have also experienced significant changes in the composition of our customer base from year to year and expect this pattern to continue as market demand for our customers' products fluctuates. The loss of, or a significant reduction in purchases by any of our major customers, could harm our business, financial condition and results of operations. See "Factors That May Affect Future Results--Sales to a Small Number of Customers Represent a Significant Portion of Our Revenues". All of our products require silicon wafers, the majority of which are currently manufactured for us by UMC in Taiwan. Industry-wide demand for semiconductors increased significantly in 1999 and the first nine months of 2000, due to increased demand in the consumer electronics and cellular phone markets. This increased demand caused supply constraints for most of 2000. However, semiconductor manufacturers, including UMC and Toshiba have been adding new advanced wafer fab capacity. This additional capacity, along with slowing economic conditions experienced late in the fourth quarter of 2000 and into 2001, has resulted in excess supply and intense pricing pressure. If industry-wide demand for our products continues to be below the industry-wide available supply, our product prices could decrease further causing our revenues and profits to decline significantly. Under our wafer supply agreements, there are limits on the number of wafers we can order and our ability to change that quantity, either up or down, is restricted. Accordingly, our ability to react to significant fluctuations in demand for our products is limited. If customer demand falls below our forecast and we are unable to reschedule or cancel our orders for wafers or other long lead- time items such as controller chips or printed circuit boards, we may end up with excess wafer inventories, which could result in higher operating expenses and reduced gross margins. If customer demand exceeds our forecasts, we may be unable to obtain an adequate supply of wafers to fill customer orders, which could result in lost sales and lower revenues. If we are unable to obtain adequate quantities of flash memory wafers with acceptable prices and yields from our current and future wafer foundries, our business, financial condition and results of operations could be harmed. We have from time to time taken write-downs for excess inventories, and may be forced to do so again if the current deterioration in market demand for our products continues and our inventory levels exceed customer orders. In addition, we may have to write-down our inventories if continued pricing pressure results in a net realizable value that is lower than our cost, or if part of the inventory becomes obsolete. Due to the current market demand for our products changing so rapidly, we ended the fourth quarter with significant amounts of excess inventory. Although we are working to reduce this inventory in line with the current level of business, we are obligated to honor existing purchase orders, which we have placed with our suppliers. Furthermore, to assure favorable future business relations with our major suppliers, we may choose not to shut down their production of our products. In the case of FlashVision manufacturing at Dominion in Virginia, both Toshiba and SanDisk are obligated to purchase their share of the production output, which may make it more difficult for us to reduce our inventory. Excess inventory not only ties up our cash, but also can result in substantial losses if such inventory, or large portions thereof, has to be revalued due to lower market pricing or product obsolescence. These inventory adjustments decrease gross margins and have resulted, and could in the future result in, fluctuations in gross margins and net earnings in the quarter in which they occur. See "Factors That May Affect Future Results--Our Operating Results May Fluctuate Significantly." Export sales are an important part of our business, representing 57%, 53% and 56% of our total revenues in 2000, 1999, and 1998, respectively. Our sales may be impacted by changes in economic conditions in our international markets. Economic conditions in our international markets, including Asia and the European Union, may adversely affect our revenues to the extent that demand for our products in these regions declines. Given the recent economic conditions in Asia and the European Union and the weakness of the Euro, Yen and other currencies relative to the United States dollar, our products may be relatively more expensive in these regions, which could result in a decrease of our sales in these regions. While most of our sales are denominated in U.S. Dollars, we invoice certain Japanese customers in Japanese Yen and are subject to exchange rate fluctuations on these transactions which could affect our business, financial condition and results of operations. See "Factors That May Affect Future Results--Our international operations make us vulnerable to changing conditions and currency fluctuations." 21 For the foreseeable future, we expect to realize a significant portion of our revenues from recently introduced and new products. Typically, new products initially have lower gross margins than more mature products because the manufacturing yields are lower at the start of manufacturing each successive product generation. In addition, manufacturing yields are generally lower at the start of manufacturing any product at a new foundry. To remain competitive, we are focusing on a number of programs to lower manufacturing costs, including development of future generations of D2 flash and advanced technology wafers. There can be no assurance that we will successfully develop such products or processes or that development of such processes will lower manufacturing costs. If the current industry-wide and worldwide economic slowdown continues for the rest of fiscal 2001, we may be unable to efficiently utilize the NAND flash wafer production from FlashVision, which would force us to amortize the fixed costs of the fabrication facility over a reduced wafer output, making these wafers significantly more expensive. See "Factors That May Affect Future Results--We must achieve acceptable manufacturing yields." Results of Operations Product Revenues. In 2000, our product revenues increased 156% to $526.4 million from $205.8 million in 1999. The increase consisted of an increase of 173% in unit sales, which was partially offset by a 7% decline in average selling prices per unit. In 2000, the largest increase in unit volume came from sales of CompactFlash Products that represented 47% of product revenues and MultiMediaCard products that represented 21% of product revenues. The continuing move towards higher capacity cards in 2000 partially offset a decline in the average selling price per megabyte of capacity shipped. In 2000, the average megabyte capacity per unit shipped increased 17% while the average selling price per megabyte of flash memory shipped declined 22% compared to the prior year. The mix of products sold varies from quarter to quarter and may vary in the future, affecting our overall average selling prices and gross margins. In 1999, our product revenues were $205.8 million, an increase of 99% from $103.2 million in 1998. In 1999 the largest increase in unit volume came from sales of CompactFlash which represented 61% of product revenues, and MultiMediaCard products which represented 7% of product revenues. A shift in product mix to higher capacity cards in 1999 partially offset a decline in the average selling price per megabyte of capacity shipped. In 1999, the average megabyte capacity per unit shipped increased 65% while the average selling price per megabyte of flash memory shipped declined 52% compared to the prior year. Our backlog as of December 31, 2000 was $63.3 million compared to $157.2 million in 1999 and $13.4 million in 1998. See "Factors That May Affect Future Results - Our Operating Results May Fluctuate Significantly" and "-There is Seasonality in Our Business." Bookings visibility declined significantly late in the fourth quarter of 2000, and we experienced material order cancellations and rescheduling of existing purchase orders from some of our customers. Visibility remains low in the first quarter of 2001 due to the current economic uncertainty in our markets. Since orders constituting our current backlog are subject to changes in delivery schedules or cancellations, backlog is not necessarily an indication of future revenue. Retail sales are typically booked and shipped in the same quarter. In the first quarter of 2001, demand from our major OEM customers has been substantially below forecast, as these customers continue to try to reduce their inventories. In addition, retail channel orders have been lower than the levels we experienced in the fourth quarter of 2000. Due to this continuing weakness of economic conditions and ongoing customer inventory corrections, we expect first quarter 2001 revenues to be significantly below our revenues in the fourth quarter of 2000. License and Royalty Revenues. We currently earn patent license fees and royalties under nine cross-license agreements with Hitachi, Intel, Lexar, Sharp, Samsung, SmartDisk, SST, TDK and Toshiba. License and royalty revenues from patent cross-license agreements was $75.5 million in 2000, up from $41.2 million in 1999 and $32.6 million in 1998. The increase in license and royalty revenues in 2000 was primarily due to patent royalties from 22 increased sales by certain of our licensees, and the revenue of $4.7 million recognized in conjunction with the settlement of the Lexar litigation. The increase in license and royalty revenues in 1999, as compared to 1998, was primarily due to an increase in patent royalty revenues. Revenues from licenses and royalties were 13% of total revenues in 2000, 17% in 1999 and 24% in 1998. Our income from patent licenses and royalties can fluctuate significantly from quarter to quarter. A substantial portion of this income comes from royalties based on the actual sales by our licensees. Given the current market outlook for 2001, sales of licensed flash products by our licensees may be substantially lower than the corresponding sales in recent quarters, which may cause a substantial drop in our royalty revenues. Gross Profits. In fiscal 2000, gross profits increased to $244.8 million, or 41% of total revenues from $94.8 million, or 38% of total revenues in 1999 and $55.5 million, or 41% of total revenues in 1998. Product gross margins increased to 32% in 2000 from 26% in 1999 and 22% in 1998. The increases in 2000 were primarily due to the lower cost per megabyte of our 256 megabit flash memory products, which represented the majority of our product sales in 2000. The increases in 1999 were due to the lower cost per megabyte of our 256 megabit and 128 megabit flash memory products, which began shipping in volume in the second half of 1999. Due to weak economic conditions, excess supply in the markets for our products, and lower demand from customers as they continue to reduce their inventories, we are experiencing intense pricing pressures. Due to these factors, we expect our average selling prices per megabyte to decline significantly in the first quarter of 2001 and in future quarters throughout 2001 and possibly beyond, until market supply and demand for our products returns to equilibrium. Although we are taking significant steps to lower our product costs, given the current market conditions, we expect our selling prices to decline more quickly than our product cost, resulting in a decline in our product gross margins in 2001. 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 to $46.1 million in 2000 from $26.9 million in 1999 and $18.2 million in 1998. As a percentage of revenues, research and development expenses were 8% in 2000, 11% in 1999 and 13% in 1998. In 2000 and 1999, the increase in research and development expenses was primarily due to an increase in salaries and payroll-related expenses associated with additional personnel and higher project related expenses. Increased depreciation due to capital equipment additions also contributed to the growth in research and development expenses in both years. The additional project expenses in 2000 were to support the development of new generations of flash data storage products including the 512 megabit and 1 gigabit flash memory co-development with Toshiba. We expect our research and development expenses to continue to increase in future quarters to support the development and introduction of new generations of flash data storage products, including the joint venture with Toshiba and the development of advanced controller chips. Sales and Marketing. Sales and marketing expenses include salaries, sales commissions, benefits and travel expenses for our sales, marketing, customer service and applications engineering personnel. These expenses also include other selling and marketing expenses, such as independent manufacturer's representative commissions, advertising and tradeshow expenses. Sales and marketing expenses increased to $49.3 million in 2000 from $25.3 million in 1999 and $16.9 million in 1998. The increases in both 2000 and 1999 were primarily due to increased salaries and payroll-related expenses and increased commission expenses due to higher product revenues and increased marketing expenses. Sales and marketing expenses represented 8% of total revenues in 2000 compared to 10% in 1999 and 12% in 1998. We expect sales and marketing expenses to continue to increase as sales of our products grow, as we continue to develop the retail channel and brand awareness for our products and as we increase our marketing activities for our Secure Digital Card products. 23 General and Administrative. General and administrative expenses include the cost of our finance, information systems, human resources, shareholder relations, legal and administrative functions. General and administrative expenses were $24.8 million in 2000 compared to $12.6 million in 1999 and $7.5 million in 1998. The increases for both 2000 and 1999 were primarily due to increased salary and related expenses associated with additional personnel, increased legal fees and an increase in the allowance for doubtful accounts related to higher trade accounts receivable balances from increased revenues. General and administrative expenses represented 4% of total revenues in 2000 compared to 5% in 1999 and 6% in 1998. We expect general and administrative expenses to increase as we expand and develop our infrastructure to support our anticipated future growth. General and administrative expenses could also increase substantially in the future if we pursue additional litigation to defend our patent portfolio. See "Factors That May Affect Future Results - Risks Associated with Patents, Proprietary Rights and Related Litigation." Given the current market conditions and expected decline in product revenues in the first quarter of 2001, we have instituted strict expense control measures. These measures in the first quarter of 2001 included a reduction in our work force and significant cuts in discretionary spending. However, we are continuing to invest in research and development of advanced technologies and future products. Interest Income. Interest income was $22.8 million in 2000 compared to $8.3 million in 1999 and $5.3 million in 1998. The increase in 2000 is primarily due to a full year of higher interest income resulting from the investment of the proceeds from the sale of common stock in our November 1999 follow-on public offering, as well as increased cash flows as a result of the increase in revenue and operating margin. The increase in 1999 is primarily due to higher interest income in the fourth quarter due to the investment of the proceeds from the sale of common stock in our November 1999 follow-on public offering. We expect interest income to decline in 2001 relative to 2000 due to lower cash and investment balances resulting from our investments in FlashVision and Tower, combined with the drop in risk-free interest rates due to recent actions taken by the U.S. Federal Reserve Board. Gain on investment in foundry. In the first quarter of 2000, we recognized a gain of $344.2 million as a result of the exchange of our investment of $51.2 million in United Silicon, Inc., or USIC, for an investment in United Microelectronics Corporation, or UMC. We received 111 million shares of UMC in exchange for our USIC shares. These shares were valued at $396 million at the time of the exchange and were subject to trading restrictions imposed by UMC and the Taiwan Stock Exchange. The trading restrictions expired on one-half of the shares on July 3, 2000. The remaining shares will become available for sale over a two-year period beginning in January 2002. When the shares are ultimately sold, it is likely that we will recognize additional gains or losses. In May 2000, we received a stock dividend of 200 UMC shares for every 1,000 shares of UMC owned, resulting in our ownership of 22 million additional UMC shares. At December 31, 2001, the market value of both our short-term and long-term investment in UMC had declined $201.9 million below its carrying basis. It was determined that this decline was related to the downturn in the semiconductor industry as a whole and was temporary in nature due to the historically cyclical nature of the industry. The available-for-sale portion of our investment was marked-to-market through other comprehensive income as required by SFAS 115. As of March 22, 2001, the market value of our investment in UMC remained significantly below our cost. The downturn in the semiconductor industry and the economy in general appears to be more severe than previously anticipated. There is a great deal of uncertainty regarding when the semiconductor industry will recover from this down cycle. Because of the continued downturn in the economy, we believe that the decline in the market value of our investment in UMC at March 22, 2001 is other than temporary, and we will report a loss in other income and expense in the first quarter of 2001. This loss will be based upon the fair market value of the investment at the end of the first quarter of fiscal 2001, as compared to the investment's cost basis. 24 Other Income, Net. Other income, net was $572,000 in 2000 compared to $1.3 million in 1999 and $374,000 in 1998. The fluctuations largely relate to foreign currency transaction gains. In 2000, 1999, and 1998 we had net foreign currency transaction gains of $428,000, $1.1 million and $412,000, respectively. Provision for Income Taxes. Our 2000, 1999 and 1998 effective tax rates were approximately 39%, 33% and 36%, respectively. Our 2000 effective tax rate was higher than our 1999 rate due primarily to effects of state income taxes on significantly increased income and a reduced proportional rate benefit from federal and state credits and tax exempt interest income due to the significant increase in taxable income over 1999. Our 1999 effective tax rate was lower than our 1998 rate due to the proportional rate benefits from federal and state tax credits. Liquidity and Capital Resources As of December 31, 2000, we had working capital of $526.0 million, which included $106.3 million in cash and cash equivalents and $373.3 million in short-term investments. Operating activities provided $84.9 million of cash in 2000 primarily from net income, increases in deferred taxes of $114.5 million largely due to the gain on UMC, income taxes payable of $39.8 million as a result of higher taxable income than in 1999, accounts payable of $36.4 million primarily from increased inventories, and deferred revenue of $21.4 million related to license fees, which were partially offset by an increase in inventory of $60.9 million and an increase in accounts receivable of $52.2 million associated with higher revenues. Cash provided by operations was $17.0 million in 1999 and $15.1 million in 1998. Net cash used in investing activities of $137.9 million in 2000 included $134.7 million invested in FlashVision LLC, our foundry joint venture with Toshiba, $26.6 million of capital equipment purchases, a $20.0 million deposit in an escrow account for our investment in Tower Semiconductor, and our $7.2 million investment in Divio, partially offset by proceeds from net sales of investments of $51.5 million. In 1999, net cash used in investing activities of $214.4 million consisted $21.4 million of capital equipment purchases and net purchases of investments of $193.0 million. In 1998, net cash used in investing activities of $23.0 million consisted of a second investment in the USIC foundry of $10.9 million, $7.5 million of capital equipment purchases and net purchases of investments of $4.6 million. In 2000, financing activities provided $13.6 million, primarily from the sale of common stock through the our stock option and employee stock purchase plans. During 1999, cash provided by financing activities of $328.2 million was primarily from $320.3 million from the net proceeds of the sale of common stock in our November 1999 follow-on stock offering and $7.9 million from the sale of common stock through the SanDisk stock option and employee stock purchase plans. During 1998, cash provided by financing activities of $2.4 million was primarily from the sale of common stock through the SanDisk stock option and employee stock purchase plans. On June 30, 2000, we closed a transaction with Toshiba providing for the joint development and manufacture of 512 megabit and 1 gigabit flash memory chips and Secure Digital Card controllers. As part of this transaction, SanDisk and Toshiba formed FlashVision LLC, a joint venture to equip and operate a silicon wafer manufacturing line at Dominion Semiconductor in Virginia. The cost of equipping the Virginia wafer manufacturing line is estimated at between $700 million and $800 million. As part of our 50% ownership of the joint venture we had invested $134.7 million as of December 31, 2000, and in January 2001 we invested the remaining $15.3 million. We have also guaranteed up to $215 million in equipment lease lines to equip Toshiba's Dominion Semiconductor manufacturing clean room with advanced wafer processing equipment. As of January 26, 2001, $20 million of this amount had been borrowed by FlashVision. On July 4, 2000, we entered into a share purchase agreement to make a $75 million investment in Tower Semiconductor, or Tower, in Israel, representing approximately 10% ownership of Tower. In exchange for our investment, we received one seat on the board of directors of Tower and a guaranteed portion of the wafer output from the advanced fabrication facility Tower has started to build in Migdal Haemek, Israel. Under the terms of the agreement, we will make our investment over a period of approximately 18 months if key milestones related to the construction, equipping and wafer production at the new wafer fabrication facility are met. 25 On January 26, 2001, Tower satisfied the closing conditions of the share purchase agreement, and we transferred the first $20 million of our investment from an escrow account to purchase 866,551 ordinary shares and obtain $8.8 million in pre-paid wafer credits. On March 1, 2001, we paid Tower $11 million upon its completion of milestone one, to purchase 366,690 ordinary shares and obtain additional prepaid wafer credits. Additional contributions will take the form of mandatory warrant exercises for ordinary shares at an exercise price of $30.00 per share if other milestones are met. The warrants will expire five years from the date of grant, and in the event the key milestones are not achieved, the exercise of these warrants will not be mandatory. We expect first wafer production to commence at the new fabrication facility in late 2002. On August 9, 2000, we entered into a joint venture, DigitalPortal Inc , or DPI, with Photo-Me International, or PMI, for the manufacture, installation, marketing and service of self-service, digital photo printing labs, or kiosks, bearing the SanDisk brand name in locations in the U.S. and Canada. These kiosks employ high-quality, low-cost, silver halide photo processing technology developed by PMI. Under the agreement, SanDisk and PMI will each make an initial investment of $4 million in the DPI joint venture, and secure lease financing for the purchase of the kiosks. The total value of the lease financing will depend on the number of kiosks deployed by the joint venture. We estimate that we will guarantee equipment lease arrangements of approximately $40 million over the first two years of the agreement. PMI will manufacture the kiosks for the joint venture and will install and maintain the kiosks under contract with the joint venture. We expect to deploy the first kiosks in pilot programs in selected retail stores in the United States starting in the first half of 2001. On November 2, 2000, we made a strategic investment of $7.2 million in Divio, Inc. Divio is a privately-held manufacturer of digital imaging compression technology and products for future digital camcorders that will be capable of using our flash memory cards to store home video movies, replacing the magnetic tape currently used in these systems. Under the agreement, we own approximately 10% of Divio and are entitled to one board seat. Depending on the demand for our products, we may decide to make additional investments, which could be substantial, in assembly and test manufacturing equipment or foundry capacity to support our business in the future. Our operating expenses may increase as a result of the need to hire additional personnel to support our sales and marketing efforts and research and development activities, including our proposed collaboration with Toshiba for the joint development of 512 megabit and 1 gigabit flash memory chips. We believe the existing cash and cash equivalents and short-term investments will be sufficient to meet our currently anticipated working capital and capital expenditure requirements for the next twelve months. In January 2000, the USIC foundry was merged into the UMC parent company. In exchange for our USIC shares, we received 111 million UMC shares. These shares were valued at approximately $396 million at the time of the merger, resulting in a pretax gain of $344.2 million ($203.9 million after-tax) in the first quarter of 2000. All of the UMC shares we received as a result of the merger were subject to trading restrictions imposed by UMC and the Taiwan Stock Exchange. The trading restrictions expired on one-half of the shares six months after the date of the merger, on July 3, 2000. The remaining shares will become available for sale over a two-year period beginning in January 2002. When the shares are ultimately sold, it is likely that we will recognize additional gains or losses due to fluctuations in the price of the UMC shares. While we do not anticipate the need for such funds in the current year, we may liquidate a portion of the UMC shares that are available for sale, and use the proceeds to support our operations and capital expenditures. Impact of Currency Exchange Rates A portion of our revenues are denominated in Japanese Yen. We enter into foreign exchange forward contracts to hedge against changes in foreign currency exchange rates. No forward contracts were outstanding at December 31, 2000. At December 31, 1999, two forward contracts with notional amounts of $8.2 million were outstanding. 26 Future exchange rate fluctuations could have a material adverse effect on our business, financial condition and results of operations. Impact of Recently Issued Accounting Standards In June 1998, the Financial Accounting Standards Board issued Statement 133, Accounting for Derivative Instruments and Hedging Activities, which we are required to adopt in fiscal 2001. Historically, we have had a minimal use of derivatives and do not anticipate that the adoption of the new Statement will have a significant effect on our earnings or financial position. In December 1999, The Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements". SAB 101 provides guidance on the recognition, presentation and disclosure of revenue in financial statements. All registrants are expected to apply the accounting and disclosures described in SAB 101. Our implementation of SAB 101 did not have a material impact on our consolidated results of operations, financial position and cash flows. In March 2000, the Financial Accounting Standards Board issued FASB Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation-an Interpretation of APB Opinion No. 25." FIN 44 clarifies the application of APB Opinion 25 and, among other issues clarifies the following: the definition of an employee for the purposes of applying APB Opinion No. 25; the criteria for determining whether a plan qualifies as a noncompensatory plan; the accounting consequences of various modifications to the terms for the previously fixed stock options or awards; and the accounting for an exchange of stock compensation awards in a business combination. FIN 44 became effective July 1, 2000 and did not have a material impact on our consolidated results of operations, financial position, and cash flows. 27 Factors That May Affect Future Results - -------------------------------------- Our operating results may fluctuate significantly, which may adversely affect our stock price. Our quarterly and annual operating results have fluctuated significantly in the past and we expect that they will continue to fluctuate in the future. This fluctuation is a result of a variety of factors, including the following: . unpredictable demand for our products; . decline in the average selling prices of our products due to competitive pricing pressures; . seasonality in sales of our products; . excess capacity of flash memory from our competitors and our own new flash wafer capacity; . difficulty of forecasting and management of inventory levels; and in particular, building a large inventory of unsold product due to non- cancelable contractual obligations to purchase materials such as flash wafers, controllers, printed circuit boards and discrete components; and . expenses related to obsolescence or devaluation of unsold inventory, or reserves necessary to protect us against future write offs of such unsold inventory. . adverse changes in product and customer mix; . slower than anticipated market acceptance of new or enhanced versions of our products; . competing flash memory card standards which displace the standards used in our products; . changes in our distribution channels; . timing of license and royalty revenue; . fluctuations in product costs, particularly due to fluctuations in manufacturing yields and utilization; . availability of sufficient silicon wafer foundry capacity to meet customer demand; . shortages of components such as capacitors and printed circuit boards required for the manufacturing of our products; . significant yield losses which could affect our ability to fulfill customer orders and could increase our costs; . manufacturing flaws affecting the reliability, functionality or performance of our products which could increase our product costs, reduce demand for our products or require product recalls; . lengthening in manufacturing cycle times due to our suppliers operating at peak capacity; . increased research and development expenses; . exchange rate fluctuations, particularly the U.S. dollar to Japanese yen exchange rate; . changes in general economic conditions, particularly in Japan and the European Union; . natural disasters affecting the countries in which we conduct our business, particularly Taiwan, Japan and the United States; Difficulty of estimating silicon wafer needs When we order silicon wafers from our foundries, we have to estimate the number of silicon wafers needed to fill product orders several months into the future. If we overestimate this number, we will build excess inventories, which could harm our gross margins and operating results. Bookings visibility declined significantly late in the fourth quarter of 2000, and remains low in 2001 due to the current economic uncertainty in our markets. On the 28 other hand, if we underestimate the number of silicon wafers needed to fill product orders, we may be unable to obtain an adequate supply of wafers, which could harm our product revenues. Because our largest volume products, CompactFlash and MultiMediaCard, are sold into emerging consumer markets, it has been difficult to accurately forecast future sales. A substantial majority of our quarterly sales have historically been from orders received and fulfilled in the same quarter, which makes accurate forecasting very difficult. In addition, our product order backlog may fluctuate substantially from quarter to quarter. Anticipated growth in expense levels We significantly increased our expense levels in 2000 to support our growth. We may need to hire additional personnel or increase our operating expenses in 2001 to support our sales and marketing efforts and research and development activities, including our joint venture with Toshiba providing for the development of 512 megabit and 1 gigabit flash memory chips. We have significant fixed costs and we cannot readily reduce these expenses over the short term. If our revenues do not increase proportionately to our operating expenses, or if revenues decrease or do not meet expectations for a particular period, such as we are forecasting for the first quarter of 2001, our business, financial condition and results of operations will be harmed. Variability of average selling prices and gross margin Our product mix varies quarterly, which affects our overall average selling prices and gross margins. Our CompactFlash and MultiMediaCard products, which currently represent the majority of our product revenues, have lower average selling prices and gross margins than our higher capacity FlashDisk and FlashDrive products. We believe that sales of CompactFlash and MultiMediaCard products will continue to represent a significant percentage of our product revenues as consumer applications, such as digital cameras and digital music players, become more popular. In fiscal 2000, average selling prices per megabyte decreased 22% compared to fiscal 1999, reflecting the Flash memory supply shortages that prevailed during the first nine months of the year, which helped to keep selling prices in 2000 more stable than in 1999. Average selling prices per megabyte declined 52% in 1999 compared to 1998. Due to recent increases in flash memory foundry capacity and the economic slow-down in the first quarter of 2001, we expect that the decline in our average selling prices in 2001 will be more severe than in 2000. If we cannot reduce our product manufacturing costs in 2001 to offset these reduced prices, our gross margins and net profitability will suffer. Variability of license fees and royalties Our intellectual property strategy consists of cross-licensing our patents to other manufacturers of flash products. Under these arrangements, we earn license fees and royalties on individually negotiated terms. The timing of revenue recognition from these payments is dependent on the terms of each contract and on the timing of product shipments by the third parties. Our income from patent licenses and royalties can fluctuate significantly from quarter to quarter. A substantial portion of this income comes from royalties based on the actual sales by our licensees. Given the current market outlook for 2001, sales of licensed flash products by our licensees may be substantially lower than the corresponding sales in recent quarters, which may cause a substantial drop in our royalty revenues. Because these revenues have higher gross margins than product revenues, gross margins and net income fluctuate significantly with changes in license and royalty revenues. Continuing declines in our average sales prices may result in declines in our gross margins. In 2000, the average price per megabyte shipped declined 22% compared to 1999. Flash data storage markets are intensely competitive and accordingly, price reductions for our products are necessary to meet consumer price points. Due to recent increases in flash memory foundry capacity and the worldwide economic slow-down in the first quarter of 2001, we expect that price declines for our products could be significant on an annualized basis. If we cannot reduce our product manufacturing costs in 2001 to offset these reduced prices, our gross margins and net profitability will suffer. 29 Our selling prices may be affected by excess capacity in the market for flash memory products. In the first nine months of 2000, industry-wide demand for flash memory products exceeded the available supply, driven by an explosion in the growth of cellular phones and the accelerating shift in consumer electronics from analog to digital devices. Flash memory suppliers, including SanDisk, responded to this strong demand by significantly increasing investments in new advanced flash memory production capacity. This has led to a significant increase in worldwide flash memory supply at a time when customer demand has decreased significantly, causing excess supply in the markets for our products and significant declines in average selling prices. If this situation continues throughout 2001, we expect that price declines for our products could be significant on an annualized basis. If we cannot reduce our product manufacturing costs in 2001 to offset these reduced prices, our gross margins and net profitability will suffer. Our business depends upon consumer products. In 2000, we continued to receive more product revenue and ship more units of products for consumer electronics applications, principally digital cameras, compared to other applications. The consumer market is intensely competitive and is more price sensitive than our other target markets. In addition, we must spend more on marketing and promotion in consumer markets to establish brand name recognition and drive demand. A significant portion of our sales to the consumer electronics market is made through distributors and to retailers. Sales through these channels typically include rights to return unsold inventory. As a result, we do not recognize revenue until after the product has been sold through to the end user. If our distributors and retailers are not successful in this market, there could be substantial product returns, which would harm our business, financial condition and results of operations. There is seasonality in our business. Sales of our products, in particular the sale of CompactFlash and MultiMediaCard products, in the consumer electronics market may be subject to seasonality. As a result, product sales may be impacted by seasonal purchasing patterns with higher sales generally occurring in the second half of each year. In addition, in the past we have experienced a decrease in orders in the first quarter from our Japanese OEM customers primarily because most customers in Japan operate on a fiscal year ending in March and prefer to delay purchases until the beginning of their next fiscal year. Although we did not experience seasonality in 2000, we cannot assure you that we will not experience seasonality in 2001 or future years. In transitioning to new processes and products, we face production and market acceptance risks. General Successive generations of our products have incorporated semiconductor devices with greater memory capacity per chip. Two important factors have enabled us to decrease the cost per megabyte of our flash data storage products: the development of higher capacity semiconductor devices and the implementation of smaller geometry manufacturing processes. A number of challenges exist in achieving a lower cost per megabyte, including: . lower yields often experienced in the early production of new semiconductor devices; . manufacturing flaws with new processes including manufacturing processes at our subcontractors which may be extremely complex; . problems with design and manufacturing of products that will incorporate these devices; and . production delays. 30 Because our products are complex, we periodically experience significant delays in the development and volume production ramp up of our products. Similar delays could occur in the future and could harm our business, financial condition and results of operations. D2 flash technology We have developed new products based on D2 flash technology, a flash architecture designed to store two bits in each flash memory cell. High density flash memory, such as D2 flash, is a complex technology that requires strict manufacturing controls and effective test screens. Problems encountered in the shift to volume production for new flash products could impact both reliability and yields, and result in increased manufacturing costs and reduced product availability. We may not be able to manufacture future generations of our D2 products with yields sufficient to result in lower costs per megabyte. If we are unable to bring future generations of our 256 and 512 megabit flash memory into full production as quickly as planned or if we experience unplanned yield or reliability problems, our revenues and gross margins will decline. Secure Digital Card products SanDisk, along with Matsushita and Toshiba, jointly developed and will promote the Secure Digital Card. The Secure Digital Card is an enhanced version of our MultiMediaCard that incorporates advanced security and copyright protection features required by the emerging markets for the electronic distribution of music, video and other copyrighted works. We began shipping our Secure Digital Card products in the first quarter of 2001, and expect to begin high-volume production in the first half of 2001. The Secure Digital Card incorporates a number of new features, including SDMI compliant security and copy protection, a mechanical write protect switch and a high data transfer rate. We have never before built products incorporating these features. Any problems or delays in establishing production capabilities or ramping up production volumes of our Secure Digital Card products could result in lost sales or increased manufacturing costs in 2001 and beyond. In addition, we cannot be sure that manufacturers of consumer electronic products will develop new products that use the Secure Digital Card or that content providers such as music studios will agree to distribute their copyrighted content for storage on Secure Digital Cards. For example, in 2000 the major U.S. based content providers have had significant success in U.S. courts in their litigation with Napster.Com and MP3.Com, and this may have slowed down the widespread distribution of digital music on the internet. Although the Secure Digital Card is designed specifically to address the copy protection rights of the content providers, there can be no assurance that these content providers will find these measures sufficient or will agree to support them. Furthermore, there is no assurance that consumers will widely adopt Secure Digital Cards, as they only operate with copyrighted content. Conversely, broad acceptance of our Secure Digital Card by consumers may reduce demand for our MultiMediaCard and CompactFlash card products. See "--The success of our business depends on emerging markets and new products." We depend on third party foundries for silicon wafers. All of our products require silicon wafers. We rely on UMC in Taiwan and Toshiba in Yokkaichi, Japan to supply the majority of our silicon wafers. We depend on UMC to allocate a portion of its capacity to meet our needs, produce acceptable quality wafers with acceptable manufacturing yields and deliver our wafers on a timely basis at a competitive price. If UMC is unable to satisfy these requirements, our business, financial condition and operating results may suffer. Any disruption in supply from UMC due to natural disaster, power failure or other causes could significantly harm our business, financial condition and results of operations. Under the terms of our wafer supply agreements with UMC, we are obligated to provide a rolling forecast of anticipated purchase orders for the next six calendar months. Generally, the estimates for the first three months of each forecast are binding commitments. The estimates for the remaining months may only be changed by a certain percentage from the previous month's forecast. This limits our ability to react to fluctuations in demand for our products. For example, if customer demand falls below our forecast and we are unable to reschedule or cancel our wafer orders, we may end up with excess wafer inventories, which could result in higher operating expenses and 31 reduced gross margins. Conversely, if customer demand exceeds our forecasts, we may be unable to obtain an adequate supply of wafers to fill customer orders, which could result in dissatisfied customers, lost sales and lower revenues. In addition, in February 2000, we entered into a capacity and reservation deposit agreement with UMC. To reserve additional foundry capacity under this agreement, we paid UMC a reservation deposit. This deposit will be refunded to us on a quarterly basis, over the agreement term, if we purchase the full wafer capacity reserved for us. We may forfeit part of our deposit if we are unable to utilize our reserved capacity within four quarters of the end of the agreement term. If we are unable to obtain scheduled quantities of wafers with acceptable price and yields from any foundry, our business, financial condition and results of operations could be harmed. In 2000, 1999, and 1998, we purchased wafers from UMC, a foundry in which we have ownership, totaling approximately $161.6 million, $22.8 million and $11.6 million, respectively. In the third quarter of 2000, we completed qualifications and began volume production of the 256 megabit D2 0.24 micron technology in two UMC fabs. We now have three UMC fabs producing our 0.24 micron wafers. The yields on these wafers vary from fab to fab due to the relative stage of start-up or production ramp. The third UMC fab to begin production is a new UMC fab and we have been experiencing lower yields than the two other fabs. There can be no assurances that we will not experience delays in wafer availability, low yields, or undetected manufacturing flaws which may adversely impact the reliable operation of our products. Any such difficulties may adversely impact our product supply and gross margins. Our investment in new flash memory wafer production may result in increased expenses and fluctuations in operating results. On June 30, 2000, we closed a transaction with Toshiba providing for the joint development and manufacture of 512 megabit and 1 gigabit flash memory chips and Secure Digital Card controllers. Under this agreement, we had invested $134.7 million as of December 31, 2000 and in January 2001 invested the remaining $15.3 million. We have also guaranteed up to $215 million in equipment lease lines entered into by FlashVision LLC, which is jointly owned by us and Toshiba, to equip Toshiba's Dominion Semiconductor manufacturing clean room with advanced wafer processing equipment. As of January 26, 2001, $20 million of this amount had been borrowed by FlashVision. Toshiba is obligated to invest and guarantee an equal amount and each of us will equally share the startup expenses and the wafer output. We will use the new production capacity at Dominion to manufacture primarily NAND flash memory wafers with minimum lithographic feature size of 0.16 micron initially, moving to 0.13 micron in the future. Such minimum feature sizes are considered today to be among the most advanced for mass production of silicon wafers and have never been used for the high volume manufacture of flash memory chips. Therefore, it is difficult to predict how long it will take to equip and commence production at the new facility and achieve adequate yields, reliable operation, and economically attractive product costs based on our new designs. We have not operated our own wafer fabrication facility in the past and therefore we rely on Toshiba to address these challenges. With our investments in the Dominion facility, we are now exposed to the adverse financial impact of any delays or manufacturing problems associated with the wafer production line. Any problems or delays in commencing production at the new Dominion facility could adversely impact our operating results in 2001 and beyond. We expect to incur substantial start up expenses related to the hiring and training of manufacturing personnel, facilitizing the clean room and installing equipment. During the ramp-up period, currently expected to begin in the middle of 2001, equipment depreciation begins and line operating expenses increase substantially. While the wafer output is still relatively low, the cost of wafers from the Dominion facility is expected to be significantly higher than the cost of wafers from our other suppliers. This may negatively impact our overall product gross margins until flash wafer output from Dominion reaches an optimum level, which may never occur. Under our agreement with Toshiba, we are committed to purchase 50% of the output from the Dominion facility. We will incur startup costs and pay our share of ongoing operating activities even if we do not utilize our full share of the Dominion output. Should customer demand for NAND flash products be less than our available supply, we may suffer from reduced revenues and increased expenses, and increased inventory of unsold NAND flash wafers, which could adversely affect our operating results. We cannot assure you that we or Toshiba will be able to secure sufficient 32 funding to support this manufacturing line. Furthermore, in order for us to sell NAND based CompactFlash, MultiMediaCards and Secure Digital Cards, we will have to develop new controllers, printed circuit boards and test algorithms because the architecture of NAND flash is significantly different from our current NOR flash designs. Any technical difficulties or delays in the development of these elements could prevent us from taking advantage of the available NAND output and could adversely affect our results of operations. On July 4, 2000, SanDisk entered into a share purchase agreement to make a $75 million investment in Tower Semiconductor, or Tower, in Israel, representing approximately 10% ownership of Tower. In exchange for our investment, we received one seat on the board of directors of Tower and a guaranteed portion of the wafer output from the advanced fabrication facility Tower is starting to build in Migdal Haemek, Israel. Under the terms of the agreement, we will make our investment over a period of approximately 18 months if key milestones related to the construction, equipping and wafer production at the new wafer fabrication facility are met. On January 26, 2001, Tower satisfied the closing conditions of the share purchase agreement, and we transferred the first $20 million of our investment from an escrow account to Tower in exchange for 866,551 ordinary shares and obtain $8.8 million in pre-paid wafer credits. On March 1, 2001, we paid Tower $11 million upon its completion of milestone one, to purchase 366,690 ordinary shares and obtain additional prepaid wafer credits. Additional contributions will take the form of mandatory warrant exercises for ordinary shares at an exercise price of $30.00 per share if other milestones are met. The warrants will expire five years from the date of grant, and in the event the key milestones are not achieved, the exercise of these warrants will not be mandatory. We expect first wafer production to commence at the new fabrication facility in late 2002. Although we do not believe the current political unrest in Israel represents a major security problem for Tower, in which we recently invested, since Migdal Haemek, Israel is in a secure geographic location, the unrest may nevertheless cause scheduling delays. We cannot assure you that the Tower facility will be completed or will begin production as scheduled, or that the processes needed to fabricate our wafers will be qualified at the new facility. Moreover, we cannot assure you that this new facility will be able to achieve acceptable yields or deliver sufficient quantities of wafers on a timely basis at a competitive price. The success of our business depends on emerging markets and new products. In order for demand for our products to grow, the markets for new products that use CompactFlash, the MultiMediaCard, and Secure Digital Card such as portable digital music players and smart phones, must develop and grow. If sales of these products do not grow, our revenues and profit margins could level off or decline. Because we sell our products for use in many new applications, it is difficult to forecast demand. During the third quarter of 2000, the U.S. Courts ruled against Napster.Com and MP3.Com in two cases involving unlicensed distribution of copyrighted digital music over the Internet. This action is being carefully studied by the original equipment manufacturers, or OEMs, who have been developing MP3 players using Flash memory cards such as our MultiMediaCards for storage of music. If these OEMs reduce their production of digital music players in response to these recent court decisions or other factors, demand for our products will decrease. In addition, we believe that these OEMs may redesign their platforms to work with our Secure Digital Card, which we began shipping in the first quarter of 2001. Accordingly, we may experience a drop in demand from our MultiMediaCard customers before the new anticipated demand for our Secure Digital Card materializes. Secure Digital Card products As part of our June 2000 joint venture with Toshiba, we will jointly develop the Secure Digital Card, an enhanced version of our MultiMediaCard, which will incorporate advanced security and copyright protection features required by the emerging markets for the electronic distribution of music, video and other copyrighted works. We began shipping our Secure Digital Card products in 32 and 64 megabyte capacities in the first quarter of 2001. The Secure Digital Card is slightly thicker and uses a different interface than our MultiMediaCard. Because of 33 these differences, the Secure Digital Card will not work in current products that include a MultiMediaCard slot. In order for the market for our Secure Digital Card to develop, manufacturers of digital audio/video and portable computing products must include a Secure Digital Card compatible slot in their products and acquire a license to the security algorithms. If OEMs do not incorporate Secure Digital Card slots in their products or do not buy our Secure Digital Cards, our business, financial condition and results of operations may be harmed. In addition, consumers may postpone or altogether forego buying products that utilize our MultiMediaCard in anticipation of new products such as MP3 players and digital camcorders that will incorporate the Secure Digital Card. If this occurs, sales of our MultiMediaCard products may be harmed. The main competition for the Secure Digital Card is expected to come from the Sony Memory Stick. Sony has substantially greater financial and other resources than we do and extensive marketing and sales channels and brand recognition. We cannot assure you that our Secure Digital Card will be successful in the face of such competition. In addition, the market for portable digital music players is very new and it is uncertain how quickly consumer demand for these players will grow. If this market does not grow as quickly as anticipated or our customers are not successful in selling their portable digital music players to consumers, our revenues could be adversely affected. In addition, it is often the case with new consumer markets that after an initial period of new market formation and initial acceptance by early adopters, the market enters a period of slow growth as standards emerge and infrastructure develops. In the event that this occurs in the portable digital music player market or other emerging markets, sales of our products would be harmed. The success of our new product strategy will depend upon, among other things, the following: . our ability to successfully develop new products with higher memory capacities and enhanced features at a lower cost per megabyte; . the development of new applications or markets for our flash data storage products; . the adoption by the major content providers of the copy protection features offered by our Secure Digital Card products; . the extent to which prospective customers design our products into their products and successfully introduce their products; and . the extent to which our products or technologies become obsolete or noncompetitive due to products or technologies developed by others. 512 megabit and 1 gigabit flash memory card products On June 30, 2000, we closed a transaction with Toshiba providing for the joint development and manufacture of 512 megabit and 1 gigabit flash memory chips and Secure Digital Card controllers. As part of this collaboration, we and Toshiba plan to employ Toshiba's 0.16 micron and future 0.13 micron NAND flash integrated circuit manufacturing technology and SanDisk's multilevel cell flash and controller system technology. During the third quarter of 2000, we announced with Toshiba the completion of the joint development of the 512 Megabit NAND flash chip employing Toshiba's .16 micron manufacturing process technology. We expect cards employing the 512 megabit technology to be shipped in significant quantities in the second half of 2001, and cards employing the 1 gigabit technology to be shipped in 2002. The development of 512 megabit and 1 gigabit flash memory chips and Secure Digital Card controllers is expected to be complex and incorporates SanDisk and Toshiba technology that is still under development. We cannot assure you that we and Toshiba will successfully develop and bring into full production with acceptable yields and reliability these new products or the underlying technology, or that any development or production ramp will be completed in a timely or cost-effective manner. If we are not successful in any of the above, our business, financial condition and results of operations could suffer. We may be unable to maintain market share. During periods of excess supply in the market for our flash memory products, such as we are experiencing in the first half of 2001, we may lose market share to competitors who aggressively lower their prices. Conversely, under conditions of tight flash memory supply, we may be unable to increase our production volumes at a sufficiently 34 rapid rate so as to maintain our market share. Ultimately, our growth rate depends on our ability to obtain sufficient flash memory wafers and other components to meet demand. If we are unable to do so in a timely manner, we may lose market share to our competitors. Our international operations make us vulnerable to changing conditions and currency fluctuations. Political risks Currently, the majority of our flash memory wafers are produced by three UMC foundries in Taiwan. We also use a third-party subcontractor in Taiwan for the assembly and testing of our MultiMediaCard products. We may therefore be affected by the political, economic and military conditions in Taiwan. Taiwan is currently engaged in various political disputes with China and in the past both countries have conducted military exercises in or near the other's territorial waters and airspace. The Taiwanese and Chinese governments may escalate these disputes, resulting in an economic embargo, a disruption in shipping routes or even military hostilities. This could harm our business by interrupting or delaying the production or shipment of flash memory wafers or MultiMediaCard products by our Taiwanese foundries and subcontractor. See "-- We depend on our suppliers and third party subcontractors." We use a third-party subcontractor in China for the assembly and testing of our CompactFlash products. As a result, our business could be harmed by the effect of political, economic, legal and other uncertainties in China. Under its current leadership, the Chinese government has been pursuing economic reform policies, including the encouragement of foreign trade and investment and greater economic decentralization. The Chinese government may not continue to pursue these policies and, even if it does continue, these policies may not be successful. The Chinese government may also significantly alter these policies from time to time. In addition, China does not currently have a comprehensive and highly developed legal system, particularly with respect to the protection of intellectual property rights. As a result, enforcement of existing and future laws and contracts is uncertain, and the implementation and interpretation of such laws may be inconsistent. Such inconsistency could lead to piracy and degradation of our intellectual property protection. In addition, while the political unrest in Israel has not yet posed a direct security risk to our engineering design center or our foundry investment in Tower Semiconductor due to their geographic location, it may nevertheless cause unforeseen delays in the development of our products or the construction of the Tower wafer foundry. Economic risks We price our products primarily in U.S. dollars. Given the recent economic conditions in Asia and the European Union and the weakness of the Euro, Yen and other currencies relative to the United States dollar, our products may be relatively more expensive in these regions, which could result in a decrease in our sales. While most of our sales are denominated in U.S. Dollars, we invoice certain Japanese customers in Japanese Yen and are subject to exchange rate fluctuations on these transactions which could harm our business, financial condition and results of operations. Our sales are also highly dependent upon global economic conditions. An example of this is our sales to Japan, which declined to 21% of product revenue in 2000, from 22% of product revenue in 1999. In 1998 our sales to Japan were 32% of total product revenue, down from 38% in 1997. We believe these declines were primarily due to the ongoing Japanese recession. General risks Our international business activities could also be limited or disrupted by any of the following factors: . the need to comply with foreign government regulation; 35 . general geopolitical risks such as political and economic instability, potential hostilities and changes in diplomatic and trade relationships; . natural disasters affecting the countries in which we conduct our business, such as the earthquake experienced in Taiwan in 1999; . imposition of regulatory requirements, tariffs, import and export restrictions and other barriers and restrictions, particularly in China; . longer payment cycles and greater difficulty in accounts receivable collection, particularly as we increase our sales through the retail distribution channel; . Adverse tax rules and regulations; . weak protection of our intellectual property rights; and . delays in product shipments due to local customs restrictions. We depend on our suppliers and third party subcontractors. We rely on our vendors, some of which are sole source suppliers, for several of our critical components. We do not have long-term supply agreements with some of these vendors. Our business, financial condition and operating results could be significantly harmed by delays or reductions in shipments if we are unable to develop alternative sources or obtain sufficient quantities of these components. For example, we rely on UMC for the majority of our flash memory wafers and NEC to supply 100% of certain designs of microcontrollers. We also rely on third-party subcontractors for a substantial portion of wafer testing, packaged memory final testing, card assembly and card testing, including Silicon Precision Industries Co., Ltd. in Taiwan, Celestica, Inc. in China, and Amkor, in the Philippines. These three subcontractors will also be assembling and testing a majority of our mature, high-volume products. We began transferring portions of our testing and assembly operations to these subcontractors in the second half of 1999 and are still continuing this transition. We will continue operations at our Sunnyvale production facility for new products and special customer requirements. However, we do not have sufficient duplicative production testing equipment at Sunnyvale and at our subcontractors. Any problems in this complex transition may result in a disruption of production and a shortage of product to meet customer demand. We have no long-term contracts with these subcontractors and cannot directly control product delivery schedules. Any significant problems that occur at our subcontractors, or their failure to perform at the level we expect could lead to product shortages or quality assurance problems, which could increase the manufacturing costs of our products and have adverse effects on our operating results. Furthermore, we are moving to turnkey manufacturing with some of our subcontract suppliers, which may reduce our visibility and control of their inventories of purchased parts necessary to build our products. Our markets are highly competitive. Flash memory manufacturers and memory card assemblers We compete in an industry characterized by intense competition, rapid technological changes, evolving industry standards, declining average selling prices and rapid product obsolescence. Our competitors include many large domestic and international companies that have greater access to advanced wafer foundry capacity, substantially greater financial, technical, marketing and other resources, broader product lines and longer standing relationships with customers. 36 Our primary competitors include companies that develop and manufacture storage flash chips , such as Hitachi, Samsung, Micron Technology and Toshiba. In addition, we compete with companies that manufacture other forms of flash memory and companies that purchase flash memory components and assemble memory cards. Companies that manufacture socket flash, linear flash and components include Advanced Micro Devices, Atmel, Intel, Macronix, Mitsubishi, Fujitsu, Sharp Electronics and ST Microelectronics. Companies that combine controllers and flash memory chips developed by others into flash storage cards include Lexar Media, M-Systems, Pretec, Simple Technology, Sony Corporation, Kingston Technology, Panasonic, Silicon Storage Technology, TDK Corporation, Matsushita Battery, Delkin Devices, Inc., Feiya Technology Corporation, Dane-Elec Manufacturing, Silicon Tek, Infineon Technologies and Viking Components.. In addition, many companies have been certified by the CompactFlash Association to manufacture and sell their own brand of CompactFlash. We believe additional manufacturers will enter the CompactFlash market in the future. We have announced an agreement with Matsushita and Toshiba to jointly develop and promote a next generation flash memory card called the Secure Digital Card. Under this agreement, Secure Digital Card royalty-bearing licenses will be granted to other flash memory card manufacturers, which will increase the competition for our Secure Digital Card, CompactFlash and MultiMediaCard products. In addition, Matsushita and Toshiba have commenced selling Secure Digital Cards that will compete directly with our products. While other flash card manufacturers will be required to pay the SD Association license fees and royalties which will be shared between Matsushita, Toshiba and SanDisk, there will be no royalties or license fees payable among the three companies for their respective sales of the Secure Digital Card. Thus, we will forfeit potential royalty income from Secure Digital Card sales by Matsushita and Toshiba. In addition, we and Toshiba will each separately market and sell any 512 megabit and 1 gigabit flash memory chips and Secure Digital Card controllers developed and manufactured under our relationship. Accordingly, we will compete directly with Toshiba for sales of these advanced chips and controllers. We have entered into patent cross-license agreements with several of our leading competitors including Hitachi, Lexar, Samsung, Toshiba, Intel, SST, Sharp, SmartDisk and TDK. Under these agreements, each party may manufacture and sell products that incorporate technology covered by the other party's patents related to flash memory devices. As we continue to license our patents to certain of our competitors, competition will increase and may harm our business, financial condition and results of operations. Currently, we are engaged in licensing discussions with several of our competitors. There can be no assurance that we will be successful in concluding licensing agreements under terms, which are favorable to us. Alternative storage media 37 Competing products have been introduced that promote industry standards that are different from our CompactFlash and MultiMediaCard products including Toshiba's SmartMedia, Sony Corporation's Memory Stick, Sony's standard floppy disk used for digital storage in its Mavica digital cameras, Panasonic's Mega Storage cards, Iomega's Clik drive, a miniaturized, mechanical, removable disk drive, and M-Systems' Diskonchip for embedded storage applications and the Secure MultiMediaCard from Hitachi and Infineon. Each competing standard is mechanically and electronically incompatible with CompactFlash and MultiMediaCard. If a manufacturer of digital cameras or other consumer electronic devices designs in one of these alternative competing standards, CompactFlash or MultiMediaCard will be eliminated from use in that product. IBM's microdrive, a rotating disk drive in a Type II CompactFlash format competes directly with our Type II CompactFlash memory cards for use in high-end professional digital cameras. M-Systems' Diskonchip 2000 Millennium product competes against our Flash ChipSet products in embedded storage applications such as set top boxes and networking appliances. According to independent industry analysts, Sony's Mavica digital camera captured a considerable portion of the U.S. market for digital cameras from 1998 to 2000. The Mavica uses a standard floppy disk to store digital images and therefore uses no CompactFlash, or any other flash cards. Our sales prospects for CompactFlash cards have been adversely impacted by the success of the Mavica. Recently, Sony has shifted its focus to the use of its flash Memory Stick in its latest digital camera models. Our MultiMediaCard products also have faced significant competition from Toshiba's SmartMedia flash cards and we expect to face similarly significant competition from Sony's Memory Stick. Sony has licensed its proprietary Memory Stick to other companies. If it is adopted and achieves widespread use in future products, sales of our MultiMediaCard and CompactFlash products may decline. Recently, Hitachi, Infineon, Sanyo and Fujitsu have proposed their Secure MultiMediaCard which provides the copy protection function that is included in our Secure Digital Card. Should this initiative gain industry wide acceptance, it may reduce the widespread adoption of the Secure Digital Card. In the first quarter of 2000, Sanyo announced that it is developing a miniature magneto-optical storage device for use in future digital cameras, music players and camcorders. There can be no assurance that this device will not be adopted by some of our OEM customers. Alternative flash technologies We also face competition from products based on multilevel cell flash technology from Intel and Hitachi. These products compete with our D2 multilevel cell flash technology. Multilevel cell flash is a technological innovation that allows each flash memory cell to store two bits of information instead of the traditional single bit stored by the industry standard flash technology. Furthermore, we expect to face competition from existing competitors and from other companies that may enter our existing or future markets that have similar or alternative data storage solutions which may be less costly or provide additional features. Price is an important competitive factor in the market for consumer products. Increased price competition could lower gross margins if our average selling prices decrease faster than our costs and could also result in lost sales. Sales to a small number of customers represent a significant portion of our revenues. Approximated one-half of our revenues come from a small number of customers. For example, sales to our top 10 customers accounted for approximately 48%, 57%, and 59%, respectively, of our product revenues for 2000, 1999, 38 and 1998. In 2000, no single customer accounted for greater than 10% of our total revenues. In 1999 and 1998, revenues from one customer exceeded 10% of our total revenues. If we were to lose one of our major customers or experience any material reduction in orders from any of these customers, our revenues and operating results would suffer. Our sales are generally made by standard purchase orders rather than long-term contracts. In addition, the composition of our major customer base changes from year to year as the market demand for our customers' products changes. Our multiple sales channels may compete for a limited number of customer sales. Web based sales of our products today represent a small but growing portion of our overall sales. Sales on the Internet tend to undercut traditional distribution channels and may dramatically change the way our consumer products are purchased in future years. We cannot assure you that we will successfully develop the Internet sales channel or successfully manage the inherent conflict between the Internet and our traditional sales channels. We must achieve acceptable wafer manufacturing yields. The fabrication of our products requires wafers to be produced in a highly controlled and ultra clean environment. Semiconductor companies that supply our wafers sometimes have experienced problems achieving acceptable wafer manufacturing yields. Semiconductor manufacturing yields are a function of both our design technology and the foundry's manufacturing process technology. Low yields may result from design errors or manufacturing failures. Yield problems may not be determined or improved until an actual product is made and can be tested. As a result, yield problems may not be identified until the wafers are well into the production process. The risks associated with yields are even greater because we rely exclusively on independent offshore foundries for our wafers which increases the effort and time required to identify, communicate and resolve manufacturing yield problems. If the foundries cannot achieve planned yields, we will experience higher costs and reduced product availability, which could harm our business, financial condition and results of operations. In addition, we cannot assure you that the Dominion fabrication facility we are co-developing with Toshiba, will produce satisfactory quantities of wafers with acceptable prices, reliability and yields. Any failure in this regard could materially harm our business, financial condition and results of operations. In addition, the construction and operation of this line will cause us to incur significant expense and may result in the diversion of resources from other important areas of our business. In addition, we have no experience in operating a wafer manufacturing line and we intend to rely on the existing manufacturing organization at the Dominion facility. This organization will be trained in NAND flash manufacturing by Toshiba, but we cannot assure you that they will be successful in manufacturing these advanced NAND flash products on a cost- effective basis or at all. Risks associated with patents, proprietary rights and related litigation. General We rely on a combination of patents, trademarks, copyright and trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. In the past, we have been involved in significant disputes regarding our intellectual property rights and claims that we may be infringing third parties' intellectual property rights. We expect that we may be involved in similar disputes in the future. We cannot assure you that: . any of our existing patents will not be invalidated; . patents will be issued for any of our pending applications; . any claims allowed from existing or pending patents will have sufficient scope or strength; . our patents will be issued in the primary countries where our products are sold in order to protect our rights and potential commercial advantage; or 39 . any of our products may infringe on the patents of other companies. In addition, our competitors may be able to design their products around our patents. We intend to vigorously enforce our patents but we cannot be sure that our efforts will be successful. If we were to have an adverse result in any litigation, we could be required to pay substantial damages, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology, discontinue the use of certain processes or obtain licenses to the infringing technology. Any litigation is likely to result in significant expense to us, as well as divert the efforts of our technical and management personnel. For example, our recent Litigation with Lexar lasted for two and one-half years and resulted in cumulative litigation expenses of approximately $6.0 million. Cross-licenses and indemnification obligations If we decide to incorporate third party technology into our products or if we are found to infringe on others' intellectual property, we could be required to license intellectual property from a third party. We may also need to license some of our intellectual property to others in order to enable us to obtain cross-licenses to third party patents. Currently, we have patent cross-license agreements with several companies, including Hitachi, Intel, Lexar, Samsung, Sharp, SST, SmartDisk, TDK and Toshiba and we are in discussions with other companies regarding potential cross-license agreements. We cannot be certain that licenses will be offered when we need them, or that the terms offered will be acceptable. If we do obtain licenses from third parties, we may be required to pay license fees or royalty payments. In addition, if we are unable to obtain a license that is necessary to the manufacture of our products, we could be required to suspend the manufacture of products or stop our wafer suppliers from using processes that may infringe the rights of third parties. We cannot assure you that we would be successful in redesigning our products or that the necessary licenses will be available under reasonable terms. We have historically agreed to indemnify various suppliers and customers for alleged patent infringement. The scope of such indemnity varies, but may, in some instances, include indemnification for damages and expenses, including attorney's fees. We may periodically engage in litigation as a result of these indemnification obligations. We are not currently engaged in any such indemnification proceedings. Our insurance policies exclude coverage for third party claims for patent infringement. Any future obligation to indemnify our customers or suppliers could harm our business, financial condition or results of operations. Litigation risks associated with our intellectual property From time to time, it may be necessary to initiate litigation against third parties to preserve our intellectual property rights. These parties could in turn bring suit against us. On March 21, 2000, Mitsubishi Denki Co. Ltd. (Mitsubishi Electric) filed a complaint in Tokyo District Court against SanDisk K.K., our wholly owned subsidiary in Japan. The complaint alleges that SanDisk K.K., based in Yokohama, Japan, infringes on three Mitsubishi Japanese patents. The Mitsubishi patents in question are #JP2099342, #JP2129071 and #JP2138047, which are related primarily to the mechanical construction of memory cards. In the complaint, Mitsubishi asked the court for a preliminary injunction halting the sale of SanDisk CompactFlash and flash ATA memory cards in Japan. Mitsubishi has since dropped patents #JP2129071 and #JP2138047 from the suit. We and SanDisk K.K. are vigorously defending against Mitsubishi's remaining claims. Our rapid growth may strain our operations. We have experienced rapid growth, which has placed a significant strain on our personnel and other resources. To accommodate future growth, we must continue to hire, train, motivate and manage our employees. We have 40 experienced difficulty hiring the necessary engineering, sales and marketing personnel to support our growth. In addition, we must make a significant investment in our existing internal information management systems to support increased manufacturing, as well as accounting and other management related functions. Our systems, procedures and controls may not be adequate to support rapid growth, which could in turn harm our business, financial condition and results of operations. California energy crisis In recent months, California has been experiencing a shortage of energy supply. This shortage is expected to continue throughout 2001 and possibly into future years. Although the majority of our product assembly and testing is done outside of California, we may experience some hardship due to rolling blackouts and the need for reduced power consumption, as well as increased power costs. Our success depends on key personnel, including our executive officers, the loss of whom could disrupt our business. Our success greatly depends on the continued contributions of our senior management and other key research and development, sales, marketing and operations personnel, including Dr. Eli Harari, our founder, President and Chief Executive Officer. Our success will also depend on our ability to recruit additional highly skilled personnel. We cannot assure you that we will be successful in hiring or retaining such key personnel, or that any of our key personnel will remain employed with us. Anti-takeover provisions in our charter documents, stockholder rights plan and in Delaware law could prevent or delay a change in control and, as a result, negatively impact our stockholders. We have taken a number of actions that could have the effect of discouraging a takeover attempt. For example, we have adopted a stockholder rights plan that would cause substantial dilution to a stockholder, and substantially increase the cost paid by a stockholder, who attempts to acquire us on terms not approved by our board of directors. This could prevent us from being acquired. In addition, our certificate of incorporation grants the board of directors the authority to fix the rights, preferences and privileges of and issue up to 4,000,000 shares of preferred stock without stockholder action. Although we have no present intention to issue shares of preferred stock, such an issuance could have the effect of making it more difficult and less attractive for a third party to acquire a majority of our outstanding voting stock. Preferred stock may also have other rights, including economic rights senior to our common stock that could have a material adverse effect on the market value of our common stock. In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law. This section provides that a corporation shall not engage in any business combination with any interested stockholder during the three-year period following the time that such stockholder becomes an interested stockholder. This provision could have the effect of delaying or preventing a change of control of SanDisk. Our stock price has been, and may continue to be, volatile. The market price of our stock has fluctuated significantly in the past and is likely to continue to fluctuate in the future. For example, in 2000 our stock price fluctuated significantly from a low of $27.50 to a high of $169.63, and has recently traded as low as $18.63. We believe that such fluctuations will continue as a result of future announcements concerning us, our competitors or principal customers regarding technological innovations, new product introductions, governmental regulations, litigation or changes in earnings estimates by analysts. In addition, in recent years the stock market has experienced significant price and volume fluctuations and the market prices of the securities of high technology companies have been especially volatile, often for reasons outside the control of the particular companies. These fluctuations as well as general economic, political and market conditions may have an adverse affect on the market price of our common stock. 41 Item 7a. Market Risk Disclosure Information - --------------------------------------------- Interest Rate Risk. Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This is accomplished by investing in widely diversified short-term investments, consisting primarily of investment grade securities, substantially all of which either mature within the next twelve months or have characteristics of short-term investments. A hypothetical 50 basis point increase in interest rates would result in an approximate $731,000 decline (less than 0.28%) in the fair value of our available-for-sale debt securities. Foreign Currency Risk. A substantial majority of our revenue, expense and capital purchasing activity are transacted in U.S. dollars. However, we do enter into transactions in other currencies, primarily the Japanese Yen. To protect against reductions in value and the volatility of future cash flows caused by changes in foreign exchange rates, we have established a hedging program. Currency forward contracts are utilized in these hedging programs. Our hedging programs reduce, but do not always entirely eliminate, the impact of foreign currency exchange rate movements. An adverse change of 10% in exchange rates would result in a decline in income before taxes of approximately $294,000. All of the potential changes noted above are based on sensitivity analyses performed on our financial positions at December 31, 2000. 42 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA SANDISK CORPORATION CONSOLIDATED FINANCIAL STATEMENTS Contents
Page ---- Report of Ernst & Young LLP, Independent Auditors................. 44 Consolidated Balance Sheets....................................... 45 Consolidated Statements of Income................................. 46 Consolidated Statements of Stockholders' Equity................... 47 Consolidated Statements of Cash Flows............................. 48 Notes to Consolidated Financial Statements........................ 49
43 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders SanDisk Corporation We have audited the accompanying consolidated balance sheets of SanDisk Corporation as of December 31, 2000 and 1999, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SanDisk Corporation at December 31, 2000 and 1999 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP San Jose, California January 23, 2001 44 SanDisk Corporation CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts)
December 31, 2000 1999 - ------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 106,277 $ 146,170 Short-term investments 373,316 311,049 Accounts receivable, net of allowance for doubtful accounts of $5,010 in 2000 and $1,871 in 1999 104,617 52,434 Inventories 96,600 35,679 Deferred tax assets 7,066 17,000 Prepaid expenses and other current assets 9,431 6,058 ------------------------------------------------------------------------------- Total current assets 697,307 568,390 Property and equipment, net 41,095 31,788 Investment in foundry 197,688 51,208 Investment in joint venture 134,730 -- Deposits and other non-current assets 37,087 6,338 - ------------------------------------------------------------------------------------- Total assets $ 1,107,907 $ 657,724 - ------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 67,112 $ 30,734 Accrued payroll and related expenses 16,215 8,259 Income taxes payable 16,427 5,843 Other accrued liabilities 20,863 11,378 Deferred revenue 50,740 29,383 ------------------------------------------------------------------------------- Total current liabilities 171,357 85,597 Deferred taxes and other liabilities 73,492 -- ------------------------------------------------------------------------------- Total liabilities 244,849 85,597 Stockholders' equity: Preferred stock, $0.001 par value Authorized shares: 4,000,000 Issued: none -- - Common stock, $0.001 par value Authorized shares: 125,000,000 Issued and outstanding: 67,464,000 in 2000 and 65,248,000 in 1999 67 65 Capital in excess of par value 566,934 524,066 Retained earnings 346,469 47,797 Accumulated other comprehensive income (loss) (50,412) 199 ------------------------------------------------------------------------------- Total stockholders' equity 863,058 572,127 - ------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 1,107,907 $ 657,724 - -------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements 45 SanDisk Corporation CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)
Years Ended December 31, 2000 1999 1998 - ------------------------------------------------------------------------------------------------- Revenues Product $ 526,359 $ 205,770 $ 103,190 License and royalty 75,453 41,220 32,571 - ------------------------------------------------------------------------------------------------- Total revenues 601,812 246,990 135,761 Cost of revenues 357,017 152,143 80,311 - ------------------------------------------------------------------------------------------------- Gross profits 244,795 94,847 55,450 Operating expenses Research and development 46,057 26,883 18,174 Sales and marketing 49,286 25,294 16,933 General and administrative 24,786 12,585 7,533 - ------------------------------------------------------------------------------------------------- Total operating expenses 120,129 64,762 42,640 - ------------------------------------------------------------------------------------------------- Operating income 124,666 30,085 12,810 Interest income 22,786 8,280 5,307 Gain on investment in foundry 344,168 - - Other income, net 572 1,261 374 - ------------------------------------------------------------------------------------------------- Income before taxes 492,192 39,626 18,491 Provision for income taxes 193,520 13,076 6,655 - ------------------------------------------------------------------------------------------------- Net income $ 298,672 $ 26,550 $ 11,836 - ------------------------------------------------------------------------------------------------- Net income per share Basic $ 4.47 $ 0.48 $ 0.23 Diluted $ 4.11 $ 0.43 $ 0.21 - ------------------------------------------------------------------------------------------------- Shares used in computing net income per share Basic 66,861 55,834 52,596 Diluted 72,651 61,433 55,344 - -------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements 46 SanDisk Corporation CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands)
Accumulated Capital In Other Total Common Excess of Retained Comprehensive Stockholders' Stock Shares Amount Par Value Earnings Income Equity - ----------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1997 51,730 $ 52 $ 181,869 $ 9,411 $ 42 $ 191,374 Net income - - - 11,836 - 11,836 Unrealized gain on available for sale securities - - - - 429 429 -------- Comprehensive income 12,265 -------- Exercise of stock options for cash 1,260 1 929 - - 930 Issuance of stock pursuant to employee stock purchase plan 260 1 1,474 - - 1,475 Net exercise of common stock warrants 6 - - - - - Income tax benefit from stock options exercised - - 1,761 - - 1,761 Compensation expense related to modification of stock options - - 33 - - 33 - ----------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1998 53,256 54 186,066 21,247 471 207,838 Net income - - - 26,550 - 26,550 Unrealized loss on available for sale securities - - - - (272) (272) -------- Comprehensive income 26,278 -------- Exercise of stock options for cash 1,766 2 6,107 - - 6,109 Issuance of stock pursuant to employee stock purchase plan 268 - 1,807 - - 1,807 Net exercise of common stock warrants 58 - - - - - Sale of common stock, net of issuance costs 9,900 9 320,277 - - 320,286 Income tax benefit from stock options exercised - - 9,809 - - 9,809 - ----------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1999 65,248 65 524,066 47,797 199 572,127 Net income - - - 298,672 - 298,672 Unrealized loss on available for sale securities - - - - (343) (343) Unrealized loss on investments - - - - (50,268) (50,268) -------- Comprehensive income 248,061 -------- Exercise of stock options for cash 2,147 2 10,370 - - 10,372 Issuance of stock pursuant to employee stock purchase plan 69 - 2,815 - - 2,815 Compensation expense related to modification of stock options - - 425 - - 425 Sale of common stock, net of issuance costs - - - - - - Income tax benefit from stock options exercised 29,258 29,258 - ----------------------------------------------------------------------------------------------------------------------- Balance at December 31, 2000 67,464 $ 67 $ 566,934 $ 346,469 $ 50,412 $ 863,058 - -----------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements 47 SanDisk Corporation CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Years Ended December 31, 2000 1999 1998 - -------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 298,672 $ 26,550 $ 11,836 Adjustments to reconcile net income to net cash provided by operating activities: Deferred taxes 114,501 (1,100) 1,160 Gain on investment in foundry (344,168) Depreciation 15,928 7,145 5,839 Loss on disposal of equipment 1,013 Compensation related to modification of stock option terms 425 - 33 Changes in assets and liabilities: Accounts receivable (52,183) (33,616) (247) Inventories (60,921) (26,757) 6,726 Prepaid expenses and other current assets (3,373) 2,959 (6,089) Deposits and other assets (3,545) (5,721) 283 Accounts payable 36,378 23,796 (7,174) Accrued payroll and related expenses 7,956 4,491 (906) Income taxes payable 39,842 10,984 2,617 Other accrued liabilities 9,485 6,301 1,548 Deferred revenue 21,357 1,931 (515) Other non-current liabilities 3,485 - - - -------------------------------------------------------------------------------------------------------------- Total adjustments (213,820) (9,587) 3,275 - -------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 84,852 16,963 15,111 - -------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Purchases of short-term investments (593,146) (332,379) (137,822) Proceeds from short-term investments 643,734 139,391 133,214 Acquisition of property and equipment (26,586) (21,391) (7,489) Investment in joint venture (134,730) 0 0 Investment in equity securities (7,200) 0 0 Deposit in escrow account for investment in equity (20,004) 0 (10,923) securities - -------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (137,932) (214,379) (23,020) - -------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Sale of common stock and warrants 13,187 328,202 2,405 - -------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 13,187 328,202 2,405 - -------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (39,893) 130,786 (5,504) - -------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at beginning of year 146,170 15,384 20,888 - -------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 106,277 $ 146,170 $ 15,384 - -------------------------------------------------------------------------------------------------------------- Supplemental disclosure of cash flow information: Cash paid for income taxes $ 37,260 $ 4,306 $ 8,277 - --------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements 48 Notes to Consolidated Financial Statements - ------------------------------------------ Note 1: Organization and Summary of Significant Accounting Policies Organization and Nature of Operations SanDisk Corporation (the Company) was incorporated in Delaware on June 1, 1988, to design, manufacture, and market industry-standard, solid-state mass storage products using proprietary, high-density flash memory technology. The Company operates in one segment and serves customers in the consumer electronics, industrial, communications and highly portable computing markets. Principal geographic markets for the Company's products include the United States, Japan, Europe and the Far East. Supplier and Customer Concentrations A limited number of customers historically have accounted for a substantial portion of the Company's revenues. In 2000, no single customer accounted for more than 10% of total revenues. In 1999 and 1998, revenues from one customer exceeded 10% of total revenues. Sales of the Company's products will vary as a result of fluctuations in market demand. Further, the flash data storage markets in which the Company competes are characterized by rapid technological change, evolving industry standards, declining average selling prices and rapid technological obsolescence. Certain of the raw materials used by the Company in the manufacture of its products are available from a limited number of suppliers. For example, all of the Company's products require silicon wafers, the majority of which are currently supplied by United Microelectronics Corporation ("UMC') in Taiwan and Toshiba, through its Yokaaichi facility 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. 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 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. In addition, certain key components are purchased from single source vendors for which alternative sources are currently not available. Shortages could occur in these essential materials due to an interruption of supply or increased demand in the industry. If the Company were unable to procure certain of such materials, it would be required to reduce its manufacturing operations that could have a material adverse effect upon its results of operations. We also rely on third-party subcontractors to assemble and test the memory components for our products. We have no long-term contracts with these subcontractors and cannot directly control product delivery schedules. This could lead to product shortages or quality assurance problems that could increase the manufacturing costs of our products and have adverse effects on our operating results. 49 Use of Estimates 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. Basis of Presentation The Company's fiscal year ends on the Sunday closest to December 31. Fiscal year 2000 ended on December 31, 2000 and was 52 weeks in length. Fiscal year 1999 ended on January 2, 2000 and was 53 weeks in length. Fiscal year 1998 ended on December 27, 1998 and was 52 weeks in length. For ease of presentation, the accompanying financial statements have been shown as ending on the last day of the calendar month. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Foreign Currency Transactions Foreign operations are measured using the U.S. dollar as the functional currency. Accordingly, monetary accounts (principally cash, accounts receivable and liabilities) are remeasured using the foreign exchange rate at the balance sheet date. Operations accounts and nonmonetary balance sheet accounts are remeasured at the rate in effect at the date of transaction. The effects of foreign currency remeasurement are reported in current operations. See Note 2. Cash Equivalents and Short-Term Investments Cash equivalents consist of short-term, highly liquid financial instruments with insignificant interest rate risk that are readily convertible to cash and have maturities of three months or less from the date of purchase. Cash equivalents and short-term investments consist of money market funds, taxable commercial paper, U.S. government agency obligations, corporate / municipal notes and bonds with high-credit quality, money market preferred stock and auction rate preferred stock. Short-term investments also include 50% of the UMC shares referred to below ("Investment in Foundry"). The fair market value, based on quoted market prices, of cash equivalents and short-term investments is substantially equal to their carrying value at December 31, 2000 and 1999. Under FAS 115, management classifies investments as available-for-sale at the time of purchase and periodically reevaluates such designation. Debt securities classified as available-for-sale are reported at fair value. Unrecognized gains or losses on available-for-sale securities are included, in equity until their disposition. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are included in other income (expense). The cost of securities sold is based on the specific identification method. All cash equivalents and short-term investments as of December 31, 2000 and 1999 are classified as available-for-sale securities and consist of the following (in thousands): 50
December 31 2000 1999 -------- -------- Cash equivalents: Money market fund $ 2,921 $ 21,853 Commercial paper 60,505 117,769 Corporate notes / bonds 12,492 - -------- -------- Total $ 75,918 $139,622 ======== ======== Short term investments: U.S. government agency obligations $ 10,004 $ 2,969 Municipal notes / bonds 136,580 133,462 Corporate notes / bonds 47,795 58,969 Commercial paper 6,115 4,009 Auction rate preferred stock 59,967 111,640 Marketable equity securities * 112,855 - -------- -------- Total $373,316 $311,049 ======== ========
* Investment in UMC. No such amounts were recorded in fiscal 1999. Unrealized gain and losses on available-for-sale securities at December 31, 2000 and 1999 were ($50.4 million) and $199,000, respectively. The unrealized loss as of December 31, 2000 includes $50.3 million of unrealized loss on the current portion of the Company's investment in UMC (see "Investment in Foundry" below). Fair value of available-for-sale securities is based upon quoted market prices. Gross realized gains and losses on sales of available-for-sale securities during the years ended December 31, 2000 and 1999 were immaterial. Debt securities at December 31, 2000 and 1999, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because issuers of the securities may have the right to prepay obligations.
December 31, 2000 1999 -------- -------- Short-term investments: (In thousands) Due in one year or less $ 94,554 $170,097 Due after one year through two years 165,907 140,952 -------- -------- Total $260,461 $311,049 ======== ========
Long-Term Investments The Company holds minority equity investments in companies having operations or technology in areas within SanDisk's strategic focus. Certain of the investments carry restrictions on immediate disposition. Investments in public companies with restrictions of less than one year are classified as available- for-sale and are adjusted to their fair market value with unrealized gains and losses recorded as a component of accumulated other comprehensive income. Upon disposition of these investments, the specific identification method is used to determine the cost basis in computing realized gains or losses. Declines in value that are judged to be other than temporary are reported in other income and expense. 51 Accounts Receivable The activity in the allowance for doubtful accounts is as follows (in thousands):
Additions Balance at Charged to Balance at For the year ended Beginning Costs and Deductions End December 31, of Period Expenses (Write-offs) of Period ----------- --------- -------- ---------- --------- 1998 $ 756 $ 345 $ 32 $1,069 1999 $1,069 $ 945 $143 $1,871 2000 $1,871 $3,991 $852 $5,010
Inventories Inventories are stated at the lower of cost or market. Cost is computed on a currently adjusted standard basis (which approximates actual costs on a first- in, first-out basis). Market value is based upon an estimated average selling price reduced by normal gross margins. Inventories are as follows (in thousands):
December 31 2000 1999 -------- -------- Raw materials $ 33,092 $ 10,387 Work-in-process 53,921 20,708 Finished goods 9,587 4,584 -------- -------- $ 96,600 $ 35,679 ======== ===-====
Given the volatility of the market, the Company writes down inventories to net realizable value based on backlog and forecasted demand. However, backlog is subject to revisions, cancellations and rescheduling. Actual demand may differ from forecasted demand and such differences may have a material effect on the Company's financial position and results of operations. Property and Equipment Property and equipment consist of the following (in thousands):
December 31, 2000 1999 -------- -------- Machinery and equipment $ 62,310 $ 47,004 Software 7,435 5,994 Furniture and fixtures 2,103 1,335 Leasehold improvements 5,842 3,772 -------- -------- Property and equipment, at cost 77,690 58,105 Accumulated depreciation and amortization (36,595) (26,317) -------- -------- Property and equipment, net $ 41,095 $ 31,788 ======== ========
Depreciation and Amortization Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter, generally two to seven years. Investment in Foundry In 1997, the Company invested $40.3 million in United Silicon, Inc., ("USIC") a semiconductor manufacturing subsidiary of United Microelectronics Corporation in Taiwan ("UMC"). The transaction gave the Company an equity stake of approximately 10% in the facility (which was accounted for on the cost basis) and guaranteed access to approximately 12.5% of the wafer output from the facility. In 1998, the Company increased its investment by $10.9 million to retain its 10% ownership interest. No changes were made to the production agreement. In January 2000, the USIC foundry was merged into the UMC parent company. The Company received UMC shares in exchange for its USIC shares. The Company does not have a right to a seat on the board of directors of the combined company. 52 In exchange for USIC shares, we received 111 million UMC shares. These shares were valued at approximately $396 million at the time of the merger, resulting in a pretax gain of $344.2 million ($203.9 million after-tax) in the first quarter of 2000. All of the UMC shares received by the Company as a result of the merger were subject to trading restrictions imposed by UMC and the Taiwan Stock Exchange. The trading restrictions expired on one-half of the shares on July 3, 2000. The remaining shares will become available for sale over a two- year period beginning in January 2002. When the shares are ultimately sold, it is likely that the Company will recognize additional gains or losses due to fluctuations in the price of the UMC shares. In May 2000, the Company received a stock dividend from UMC of 200 shares for every 1,000 shares of UMC owned, resulting in its ownership of 22 million additional shares of UMC. The shares received as a stock dividend and the 50% of the shares received as a result of the merger that became unrestricted in July 2000 are treated as available-for-sale securities under Statement of Financial Accounting Standards 115, "Accounting for Certain Investments in Debt and Equity Securities", at December 31, 2000 and are included in short-term investments. These shares were adjusted to market value and the resulting unrealized loss of $50.3 million in fiscal 2000 is included in accumulated other comprehensive income. In addition, on September 18, 2000, UMC completed its American Depositary Shares ("ADRs") offering. In connection with this offering, SanDisk signed a lock-up agreement that prohibits the sale of all but 5 million of these unrestricted UMC shares for a period of 90 days following the completion of the offering. The remaining 50% of the shares received as a result of the merger, that will be restricted from sale until 2002, are accounted for at their historical cost beginning in the first quarter of 2001. These securities will be marked to market through other comprehensive income when the when the related restrictions lapse Revenue Recognition Product revenue, less a provision for estimated sales returns, is recognized when title passes which is generally at the time of shipment. However, revenue on shipments to distributors and retailers, subject to certain rights of return and price protection, is deferred until the merchandise is sold by the distributors or retailers, or the rights expire. The Company earns patent license and royalty revenue under patent cross- license agreements with Hitachi Ltd., Intel Corporation, Lexar, Samsung Electronics Company Ltd., Sharp Electronics Corporation, Silicon Storage Technology, Inc., SmartDisk Corporation, TDK and Toshiba Corporation. 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. 53 Patent license and royalty revenue is recognized when earned. In 2000, 1999 and 1998, the Company received payments under these cross-license agreements, portions of which were recognized as revenue and portions of which are deferred revenue. Recognition of deferred revenue is expected to occur in future periods over the life of the agreements, as the Company meets certain obligations as provided in the various agreements. Advertising Expense The cost of advertising is expensed as incurred. Advertising costs were $8.2 million, $3.6 million, and $2.0 million in 2000, 1999, and 1998, respectively. 54 Net Income Per Share The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
2000 1999 1998 ---- ---- ---- Numerator: Numerator for basic and diluted net income per share - net income $298,672 $ 26,550 $ 11,836 ======== ======== ======== Denominator for basic net income per share: Weighted average common shares 66,861 55,834 52,596 -------- -------- -------- Basic net income per share $ 4.47 $ 0.48 $ 0.23 ======== ======== ======== Denominator for diluted net income per share: Weighted average common shares 66,861 55,834 52,596 Incremental common shares attributable to exercise of outstanding employee stock options and warrants (assuming proceeds would be used to purchase common stock) 5,790 5,599 2,748 -------- -------- -------- Shares used in computing diluted net income per share 72,651 61,433 55,344 ======== ======== ======== Diluted net income per share $ 4.11 $ 0.43 $ 0.21 ======== ======== ========
Options and warrants to purchase 907,380, 190,807, and 1,802,886 shares of common stock were outstanding during 2000, 1999 and 1998, respectively, but have been omitted from the diluted earnings per share calculation because the options' exercise price was greater than the average market price of the common shares and, therefore the effect would be antidilutive. Stock Based Compensation The Company accounts for employee stock based compensation under APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Pro forma net income and net income per share disclosures are required by Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation," and are included in Note 4. Impact of Recently Issued Accounting Standards In June 1998, the Financial Accounting Standards Board issued Statement 133, Accounting for Derivative Instruments and Hedging Activities, which is required to be adopted by the Company beginning January 1, 2001. Historically, the Company has had a minimal use of derivatives and do not anticipate that the adoption of the new Statement will have a significant effect on our earnings or financial position; however, we have studied the actual impact, and have determined that it will be immaterial to our financial position or earnings. In December 1999, The Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements". SAB 101 provides guidance on the recognition, presentation and disclosure of revenue in financial statements. All registrants are expected to apply the accounting and disclosures described in SAB 101. The Company's implementation of SAB 101 did not have a material impact on consolidated results of operations, financial position and cash flows. 55 In March 2000, the Financial Accounting Standards Board issued FASB Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation-an Interpretation of APB Opinion No. 25." FIN 44 clarifies the application of APB Opinion 25 and, among other issues clarifies the following: the definition of an employee for the purposes of applying APB Opinion No. 25; the criteria for determining whether a plan qualifies as a noncompensatory plan; the accounting consequences of various modifications to the terms for the previously fixed stock options or awards; and the accounting for an exchange of stock compensation awards in a business combination. FIN 44 became effective July 1, 2000 and did not have a material impact on the Company's consolidated results of operations, financial position, and cash flows. Note 2: Financial Instruments Concentration of Credit Risk The Company's concentration of credit risk consists principally of cash, cash equivalents, short-term investments and trade receivables. The Company's investment policy restricts investments to high-credit quality investments and limits the amounts invested with any one issuer. The Company sells to original equipment manufacturers, retailers and distributors in the United States, Japan, Europe and the Far East, performs ongoing credit evaluations of its customers' financial condition, and generally requires no collateral. Reserves are maintained for potential credit losses. Off Balance Sheet Risk Certain of the Company's balance sheet accounts are denominated in Japanese Yen. The Company enters into foreign exchange contracts to hedge against changes in foreign currency exchange rates. The effects of movements in currency exchange rates on these instruments are recognized when the related operating revenues and expenses are recognized. The Company has a foreign exchange contract line in the amount of $15.0 million at December 31, 1999. Under this line, the Company may enter into forward exchange contracts that require the Company to sell or purchase foreign currencies. Two forward exchange contracts in the notional amount of $8.2 million were outstanding at December 31, 1999. Foreign currency translation gains of $122,000 were deferred at December 31, 1999 in connection with these contracts as the contracts have been identified as hedging contracts. One forward exchange contract in the amount of $4.3 million was outstanding at December 31, 1998. Foreign currency translation losses of $34,000 were deferred at December 31, 1998 in connection with this forward contract. The impact of movements in currency exchange rates on foreign exchange contracts substantially mitigates the related impact on the underlying items hedged. The Company had net transaction gains of approximately $428,000, $1,467,000 and $412,000 for the years ended December 31, 2000, 1999 and 1998, respectively. These amounts are included in other income (loss), net, in the statement of income. 56 Note 3: Commitments and Contingencies Commitments The Company leases its headquarters and sales offices under operating leases that expire at various dates through 2006. Future minimum lease payments under operating leases at December 31, 2000 are as follows (in thousands): Year Ending December 31, - ------------------------ 2001 $ 2,685 2002 2,411 2003 2,370 2004 2,416 2005 2,251 2006 1,024 ------- Total $13,157 ======= Rental expense under all operating leases was $2.5 million, $2.1 million and $1.7 million for the years ended December 31, 2000, 1999 and 1998, respectively. Contingencies The Company relies on a combination of patents, trademarks, copyright and trade secret laws, confidentiality procedures and licensing arrangements to protect its intellectual property rights. There can be no assurance that there will not be any disputes regarding the Company's intellectual property rights. Specifically, there can be no assurance that any patents held by the Company will not be invalidated, that patents will be issued for any of the Company's pending applications or that any claims allowed from existing or pending patents will be of sufficient scope or strength or be issued in the primary countries where the Company's products can be sold to provide meaningful protection or any commercial advantage to the Company. Additionally, competitors of the Company may be able to design around the Company's patents. To preserve its intellectual property rights, the Company believes it may be necessary to initiate litigation with one or more third parties, including but not limited to those the Company has notified of possible patent infringement. In addition, one or more of these parties may bring suit against the Company. 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. For example, in March 1998, the Company sued Lexar in the Northern District of California alleging that Lexar's CompactFlash and PC Cards infringe our U.S. Patent No. 5,602,987 ("'987 Patent"). Lexar disputed this claim and asserted various counter claims, including unfair competition, violation of the Lanham Act, patent misuse, interference with prospective economic advantage, trade defamation, unenforceability and fraud. On November 14, 2000, in resolution of these actions, Lexar stipulated that SanDisk's '987 Patent is valid and infringed by Lexar's current CompactFlash and PC Cards. Lexar made a lump sum payment of $8.0 million in December 2000 for royalties due on the '987 Patent, through March 31, 2001. Subject to Lexar's representations and warranties relating to Lexar's newly designed CompactFlash and PC Cards, SanDisk has stipulated that these designs do not infringe SanDisk's '987 Patent. Lexar entered into a 4% royalty-bearing license agreement for certain Lexar products that may use the '987 Patent beyond March 31, 2001. SanDisk and Lexar have agreed to dismiss with prejudice all pending claims of patent infringement and counterclaims involving claims of false advertising, unfair competition and patent misuse. In September 2000, Lexar sued SanDisk in the District of Delaware alleging that our SmartMedia products infringe Lexar's United States Patent No. 5,479,638 ("'638 Patent"). In resolution of this action, the Company paid 57 Lexar a lump sum payment of $2.0 million for a fully-paid up license for use of the '638 Patent in SmartMedia products. Under the settlement, Lexar has provided the Company with an option for a royalty bearing license to its patents for use in certain future products. SanDisk and Lexar have agreed to resolve any future disputes relating to the use by Lexar of the '987 Patent through binding arbitration. We have also agreed that for a period of seven years, neither SanDisk nor Lexar shall seek injunctive relief against the other in any patent lawsuit. However, at all times, we retain the right to seek injunctive relief to enforce the payment of royalties pursuant to an arbitrator's ruling. On March 21, 2000, Mitsubishi Denki Co. Ltd. (Mitsubishi Electric) filed a complaint in Tokyo District Court against SanDisk K.K., SanDisk's wholly owned subsidiary in Japan. The complaint alleges that SanDisk K.K., based in Yokohama, Japan, infringes on three Mitsubishi Japanese patents. The Mitsubishi patents in question are #JP2099342, #JP2129071 and #JP2138047, which are related primarily to the mechanical construction of memory cards. In the complaint, Mitsubishi asked the court for a preliminary injunction halting the sale of SanDisk CompactFlash and flash ATA memory cards in Japan. Mitsubishi has since dropped patents #JP2129071 and #JP2138047 from the suit. The Company and SanDisk K.K. are vigorously defending against Mitsubishi's remaining claims. Compaq Corporation has opposed in several countries, including the United States, our attempting to register CompactFlash as a trademark. We do not believe that our failure to obtain registration for the CompactFlash mark will materially harm our business. In the event of an adverse result in any such litigation, the Company could be required to pay substantial damages, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to the infringing technology, or discontinue the use of certain processes. From time to time the Company agrees to indemnify certain of its suppliers and customers for alleged patent infringement. The scope of such indemnity varies but may in some instances include 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. Litigation frequently involves substantial expenditures and can require significant management attention, even if the Company ultimately prevails. In addition, the results of any litigation matters are inherently uncertain. Accordingly, there can be no assurance that any of the foregoing matters, or any future litigation, will not have a material adverse effect on the Company's business, financial condition and results of operations. Note 4: Stockholders' Equity Stock Benefit Plan The 1989 Stock Benefit Plan, in effect through August 1995, comprised two separate programs, the Stock Issuance Program and the Option Grant Program. The Stock Issuance Program allowed eligible individuals to immediately purchase the Company's common stock at a fair value as determined by the Board of Directors. Under the Option Grant Program, eligible individuals were granted options to purchase shares of the Company's common stock at a fair value, as determined by the Board of Directors, of such shares on the date of grant. The options generally vest over a four-year period, expiring no later than ten years from the date of grant. Unexercised options are canceled upon the termination of employment or services. Options that are canceled under this plan will be available for future grants under the 1995 Stock Option Plan. There were no shares available for option grants under the 1989 Stock Benefit Plan at December 31, 2000. 58 1995 Stock Benefit Plan The 1995 Stock Option Plan provides for the issuance of incentive stock options and nonqualified stock options. Under this plan, the vesting and exercise provisions of option grants are determined by the Board of Directors. The options generally vest over a four-year period, expiring no later than ten years from the date of grant. On July 17, 1998, the Board of Directors approved an option cancellation/regrant program. Under the cancellation/regrant program, employees could elect to exchange their stock options with exercise prices in excess of $6.00 per share for new options priced at $5.00 per share, the market price of the Company's common stock on the date of implementation, 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 1,806,846 shares were canceled and regranted in connection with the program. The number of options shown as granted and canceled in the table below reflect this exchange of options. Such options had a weighted average exercise price before repricing of $10.331, and the new options were granted at an exercise price of $5.00. In May 1999, the stockholders increased the shares available for future issuance under the 1995 Stock Benefit Plan by 7,000,000 shares and approved an automatic share increase feature pursuant to which the number of shares available for issuance under the plan will automatically increase on the first trading day in January each calendar year, beginning with calendar year 2002 and continuing over the remaining term of the plan, by an amount equal to approximately 4% of the total number of shares outstanding on the last trading day in December in the immediately preceding calendar year, but in no event will any such annual increase exceed 4,000,000 shares. 1995 Non-employee Directors Stock Option Plan In August 1995, the Company adopted the 1995 Non-employee Directors Stock Option Plan (the Directors' Plan. Under this plan, automatic option grants are made at periodic intervals to eligible non-employee members of the Board of Directors. Initial option grants vest over a four-year period. Subsequent annual grants vest one year after date of grant. All options granted under the Non- employee Directors Stock Option Plan expire ten years after the date of grant. In May 1999, the stockholders increased the shares available for future issuance under the 1995 Non-Employee Directors Stock Option Plan by 400,000 and approved an automatic share increase feature pursuant to which the number of shares available for issuance under the plan will automatically increase on the first trading day in January each calendar year, beginning with calendar year 2002 and continuing over the remaining term of the plan, by an amount equal to 0.2% of the total number of shares outstanding on the last trading day in December in the immediately preceding calendar year, but in no event will any such annual increase exceed 200,000 shares. At December 31, 2000, the Company had reserved 800,000 shares for issuance under the Directors' Plan and a total of 448,000 options had been granted at exercise prices ranging from $5.00 to $70.063 per share. 59 A summary of activity under all stock option plans follows (shares in thousands):
Total Available Weighted for Future Total Average Grant/ Issuance Outstanding Exercise Price ----------------- ----------- -------------- Balance at December 31, 1997 4,210 7,106 $ 4.79 ---------------- ------------ Granted (4,444) 4,444 $ 5.97 Exercised - (1,260) $ 0.74 Canceled 2,038 (2,038) $10.04 ---------------- ------------ Balance at December 31, 1998 1,804 8,252 $ 4.75 ---------------- ------------ Increase in authorized shares 7,400 - Granted (3,000) 3,000 $31.00 Exercised - (1,766) $ 3.47 Canceled 308 (308) $ 9.69 ---------------- ------------ Balance at December 31, 1999 6,512 9,178 $ 9.50 ----------------- ------------ Granted (2,290) 2,290 $53.57 Exercised - (2,147) $ 4.85 Canceled 469 (469) $ 9.69 ---------------- ------------ Balance at December 31, 2000 4,691 8,852 $25.29 ================ ============
At December 31, 2000, options outstanding were as follows:
Options Outstanding Options Exercisable ------------------- ------------------- Number Weighted Number Outstanding Average Weighted Exercisable Weighted Range of as of Remaining Average as of Average Exercise Prices December 31, 1999 Contractual Life Exercise Price December 31, 1999 Exercise Price - -------------------- --------------------- ------------------ ---------------- --------------------- ---------------- $ 0.188 - $ 5.000 1,752,233 6.77 $ 4.270 1,088,408 $ 3.963 $ 5.094 - $ 6.250 1,801,785 7.27 $ 6.122 1,119,848 $ 6.078 $ 6.438 - $ 15.219 526,006 7.52 $10.304 316,648 $10.563 $16.750 - $ 29.919 647,778 8.59 $23.517 172,426 $23.340 $30.000 - $ 41.031 3,119,537 9.32 $35.144 485,486 $34.778 $43.438 - $139.500 1,004,515 9.40 $74.707 90,000 $69.167 - ------------------- --------- ---- ------- --------- ------- $ 0.188 - $139.500 8,851,854 8.25 $25.288 3,330,457 $12.858
Employee Stock Purchase Plan In August 1995, the Company adopted the Employee Stock Purchase Plan (the Purchase Plan). In May 1999, the stockholders increased the shares available for future issuance under the Employee Stock Purchase Plan by 600,000 and approved an automatic share increase feature pursuant to which the number of shares available for issuance under the plan will automatically increase on the first trading day in January each calendar year, beginning with calendar year 2002 and continuing over the remaining term of the plan, by an amount equal to forty- three hundredths of one percent (0.43%) of the total number of shares outstanding on the last trading day in December in the immediately preceding calendar year, but in no event will any such annual increase exceed 400,000 shares. Under the Purchase Plan, qualified employees are entitled to purchase shares through payroll deductions at 85% of the fair market value at the beginning or end of the offering period, whichever is lower. As of December 31, 2000, the Company had reserved 2,366,666 shares of common stock for issuance under the Purchase Plan and a total of 1,034,293 shares had been issued. 60 Accounting for Stock Based Compensation The Company has elected to follow APB 25 and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS 123 "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information regarding net income and earnings per share is required by SFAS 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of this Statement. For all grants subsequent to December 31, 1994 that were granted prior to the Company's initial public offering in November 1995, the fair value of these options was determined using the minimum value method with a weighted average risk free interest rate of 6.32% and an expected life of 5 years. The fair value for the options granted subsequent to the Company's initial public offering in November 1995 was estimated at the date of grant using a Black-Scholes single option pricing model with the following weighted average assumptions: risk-free interest rates of 6.16%, 5.52% and 4.84% for 2000, 1999 and 1998, respectively; a dividend yield of 0.0%, a volatility factor of the expected market price of the Company's common stock of 0.951, 0.888 and 0.600 for 2000, 1999 and 1998 respectively; and a weighted-average expected life of the option of approximately 5 years. The weighted average fair value of those options granted were $39.82, $22.38 and $3.325 for 2000, 1999 and 1998, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. Under the 1995 Employee Stock Purchase Plan participating employees can choose to have up to 10% of their annual base earnings withheld to purchase the Company's common stock. The purchase price of the stock is 85% of the lower of the subscription date fair market value and the purchase date fair market value. Approximately 78% of eligible employees participated in the plan in 2000 and 79% and 65% in 1999 and 1998, respectively. Under the Plan, the Company sold 69,423, 269,092 and 259,484 shares to employees in 2000, 1999 and 1998, respectively. Pursuant to APB 25 and related interpretations, the Company does not recognize compensation cost related to employee purchase rights under the Plan. To comply with the pro forma reporting requirements of SFAS 123, compensation cost is estimated for the fair value of the employees' purchase rights using the Black- Scholes model with the following assumptions for those rights granted in 2000, 1999 and 1998: dividend yield of 0.0%; and expected life of 6 months; expected volatility factor of 1.56 and 1.18 in 2000, .98 and 1.16 in 1999, and .65 and 1.02 in 1998; and a risk free interest rate ranging from 5.35% to 6.43%. The weighted average fair value of those purchase rights granted in February 1998, August 1998, February 1999, August 1999, February 2000 and August 2000 were $3.50, $2.25, $6.01, $17.72, $38.69 and $29.24, respectively. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share amounts):
Years ended December 31, 2000 1999 1998 -------- ------- ------ Pro forma net income $276,421 $19,625 $7,575 Pro forma net income per share Basic $ 4.13 $ 0.35 $ 0.14
61 Diluted $ 3.80 $ 0.32 $ 0.14
Because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect was not fully reflected until 1999. Shareholder Rights Plan On April 21, 1997, the Company adopted a shareholder rights plan (the Rights Agreement). Under the Rights Agreement, rights were distributed as a dividend at the rate of one right for each share of common stock of the Company held by stockholders of record as of the close of business on April 28, 1997. The rights will expire on April 28, 2007 unless redeemed or exchanged. Under the Rights Agreement, each right will initially entitle the registered holder to buy one one-fiftieth of a share of Series A Junior Participating Preferred Stock for $250.00. The rights will become exercisable only if a person or group acquires beneficial ownership of 15 percent or more of the Company's common stock or commences a tender offer or exchange offer upon consummation of which such person or group would beneficially own 15 percent or more of the Company's common stock. Stock Split On January 26, 2000, the Company's board of directors approved a 2-for-1 stock split, in the form of a 100% stock dividend, payable to stockholders of record as of February 8, 2000. The dividend was paid and the split was effected on February 22, 2000. Shares, per share amounts, common stock at par value and capital in excess of par value have been restated to reflect the stock split for all periods presented. Note 5: Retirement Plan Effective January 1, 1992, the Company adopted a tax-deferred savings plan, the SanDisk 401(k) Plan, for the benefit of qualified employees. The plan is designed to provide employees with an accumulation of funds at retirement. Qualified employees may elect to make contributions to the plan on a monthly basis. The Company may make annual contributions to the plan at the discretion of the Board of Directors. The Company contributed $105,000 for the plan year ended December 31, 1999. No contributions were made by the Company for the years ended December 31, 2000 and 1998. Note 6: Income Taxes The provision for income taxes consists of the following (in thousands):
December 31, 2000 1999 1998 -------- ------- ------ Current: Federal $ 53,683 $10,354 $1,413 State 13,296 2,117 651 Foreign 10,211 4,105 2,936 -------- ------- ------ 77,190 16,576 5,000 Deferred: Federal 94,147 (2,600) 1,305 State 21,683 (400) 350 Foreign 500 (500) - -------- ------- ------ 116,330 (3,500) 1,655 Provision for income taxes $193,520 $ 13,076 $ 6,655 ======== ======== =======
62 The tax benefits associated with stock options reduces taxes currently payable as shown above by $29,258,000, $9,809,000, and $1,761,000 in 2000, 1999 and 1998, respectively. Such benefits are credited to capital in excess of par when realized. The Company's provision for income taxes differs from the amount computed by applying the federal statutory rates to income before taxes as follows:
December 31, 2000 1999 1998 ---- ---- ---- Federal statutory rate 35.0% 35.0% 35.0% State taxes, net of federal benefit 4.6 2.8 3.5 Research credit (0.2) (1.7) (1.9) Tax exempt interest income (0.8) (3.9) (6.1) Other individually immaterial items 0.7 0.8 5.5 ---- ---- ---- 39.3% 33.0% 36.0% ==== ==== ====
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. Significant components of the Company's deferred tax assets as of December 31, 2000 and 1999 are as follows (in thousands):
December 31, 2000 1999 --------- ------- Deferred tax assets: Inventory writedown reserves $ 13,000 $ 3,400 Deferred revenue 17,100 10,600 Accruals and other reserves 11,400 4,000 Other 1,200 800 --------- ------- Total deferred tax assets $ 42,700 $18,800 --------- ------- Deferred tax liabilities: Unrealized gain on exchange of UMC shares (105,600) - --------- ------- Total deferred tax assets/(liabilities) $ (62,900) $18,800 ========= =======
Note 7: Joint Venture, Strategic Manufacturing Relationships and Investments On June 30, 2000, the Company and Toshiba closed a transaction providing for the joint development and manufacture of 512 megabit and 1 gigabit flash memory chips and Secure Digital Card controllers. As a part of this transaction, the Company and Toshiba formed and contributed initial funding to FlashVision LLC, a joint venture to equip and operate a silicon wafer manufacturing line at Dominion Semiconductor in Virginia. The cost of equipping the Virginia wafer manufacturing line is estimated at between $700 million and $800 million. As part of the Company's 50% ownership of the joint venture it had invested $134.7 million as of December 31, 2000, and in January 2001, we invested the remaining $15.3 million. The Company has also guaranteed 63 up to $215 million in equipment lease lines to equip Toshiba's Dominion Semiconductor manufacturing clean room with advanced wafer processing equipment. As of January 26, 2001, $20 million was guaranteed. In addition, the Company will share certain research and development costs. The Company expects to generate revenues from the sale of products using 512 megabit technology during the second half of 2001, and from the 1 gigabit technology during 2002. The Company accounts for this investment under the equity method, and the Company's of losses on this joint venture through December 31, 2000 are not material. On July 4, 2000, SanDisk entered into a share purchase agreement to make a $75 million investment in Tower Semiconductor, or Tower, in Israel, representing approximately 10% ownership of Tower. In exchange for its investment, the Company will receive one seat on the board of directors of Tower and a guaranteed portion of the wafer output from the advanced fabrication facility Tower is starting to build in Migdal Haemek, Israel. Under the terms of the agreement, the Company will make our investment over a period of approximately 18 months if key milestones related to the construction, equipping and wafer production at the new wafer fabrication facility are met. On January 26, 2001, Tower satisfied the closing conditions of the share purchase agreement, and the Company transferred the first $20 million of its investment from an escrow account to purchase 866,551 shares ordinary shares and obtain $8.8 million in pre-paid wafer credits. On March 1, 2001, the Company paid Tower $11 million upon its completion of milestone one, to purchase 366,690 ordinary shares and obtain additional prepaid wafer credits. Additional contributions will take the form of mandatory warrant exercises for ordinary shares at an exercise price of $30.00 per share if other milestones are met. The warrants will expire five years from the date of grant, and in the event the key milestones are not achieved, the exercise of these warrants will not be mandatory. We expect first wafer production to commence at the new fabrication facility in late 2002. The Company accounts for this investment under the cost method. On August 9, 2000, SanDisk entered into a joint venture, DigitalPortal Inc., or DPI, with Photo-Me International, or PMI, for the manufacture, installation, marketing and service of self-service, digital photo printing labs, or kiosks, bearing the SanDisk brand name in locations in the U.S. and Canada. These kiosks employ high-quality, low-cost, silver halide photo processing technology developed by PMI. Under the agreement, SanDisk and PMI will each make an initial investment of $4 million and secure lease financing for the purchase of the kiosks. The total value of the lease financing will depend on the number of kiosks deployed by the joint venture. The Company estimates that it will guarantee equipment lease arrangements of approximately $40 million over the first two years of the agreement. PMI will manufacture the kiosks for the joint venture and will install and maintain the kiosks under contract with the joint venture. The Company expects the first kiosks to be deployed in pilot programs in select retail stores in the United States starting in the first half of 2001. The Company accounts for this investment under the equity method, and the Company's of losses on this joint venture through December 31, 2000 are not material. On November 2, 2000, SanDisk made a strategic investment of $7.2 million in Divio, Inc. Divio is a privately-held manufacturer of digital imaging compression technology and products for future digital camcorders that will be capable of using our flash memory cards to store home video movies, replacing the magnetic tape currently used in these systems. Under the agreement, SanDisk owns approximately 10% of Divio and is entitled to one board seat. The Company accounts for this investment under the cost method. In 2000, 1999, and 1998, the Company purchased wafers from USIC/UMC, a foundry in which the Company has ownership, totaling approximately $161.6 million, $22.8 million and $11.6 million, respectively. Note 8: Segment Information The Company applied SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or group, in deciding how to allocate resources and in assessing performance. 64 The Company operates in one segment, flash memory products. The Company markets its products in the United States and in foreign countries through its sales personnel, dealers, distributors, retailers and its subsidiaries. The Chief Executive Officer has been identified as the Chief Operating Decision Maker ("CODM") because he has final authority over resource allocation decisions and performance assessment. The CODM does not receive discrete financial information about individual components of the market. 65 Geographic Information: Information regarding geographic areas for the years ended December 31, 2000, 1999, and 1998 are as follows (in thousands):
Years Ended December 31, 2000 1999 1998 -------- -------- -------- Revenues: United States $258,715 $116,922 $ 60,113 Japan 178,564 62,176 46,276 Europe 99,352 22,674 9,810 Other foreign countries 65,181 45,218 19,562 -------- -------- -------- Total $601,812 $246,990 $135,761 Long Lived Assets: United States $174,685 $ 25,442 $ 16,779 Japan 520 261 445 Europe 55 20 9 Other foreign countries 198,253 57,273 51,517 -------- -------- -------- Total $373,517 $ 82,996 $ 68,750 ======== ======== ========
Revenues are attributed to countries based on the location of the customers. Long lived assets in other foreign countries includes the long-term investment in UMC of $197.7 in 2000 and $51.2 million in 1999 and 1998. Long lived assets in the United States includes the investment in FlashVision of $134.7 in 2000. Major Customers In 2000, there were no customers who accounted for more than 10% of total revenue. In 1999 and 1998, revenues from one customer represented approximately $28.0 million and $14.0 million, respectively, of consolidated revenues. Note 9: Accumulated Other Comprehensive Income Financial Accounting Standards Board Statement No. 130, "Reporting Comprehensive Income", requires unrealized gains or losses on the Company's available-for-sale securities to be included in other comprehensive income. Comprehensive income consists of net income and other comprehensive income. 66 Accumulated other comprehensive income presented in the accompanying balance sheet consists of the accumulated unrealized gains and loses on available-for- sale marketable securities for all periods presented. The tax effects for other comprehensive income were immaterial for all periods presented (in thousands). 2000 1999 1998 --------- ----- ----- Accumulated other comprehensive income at beginning of year $ 199 $ 471 $ 42 Change of accumulated other comprehensive income during the year Unrealized loss on investments $ (50,268) - - --------- ----- ----- Unrealized gain (loss) on available-for-sale securities $ (343) $(272) $ 429 --------- ----- ----- Accumulated other comprehensive income at year end $ (50,412) $ 199 $ 471 ========= ===== =====
The unrealized loss on investments includes a tax benefit of approximately $34.6 million. Note 10: Subsequent Event (unaudited) At December 31, 2000, the market value of both our short-term and long-term investment in UMC had declined $201.9 million below its carrying basis. It was determined that this decline was related to the downturn in the semiconductor industry as a whole and was temporary in nature due to the historically cyclical nature of the industry. The available-for-sale portion of our investment was marked-to-market through other comprehensive income as required by SFAS 115. As of March 22, 2001, the market value of our investment in UMC remained significantly below our cost. The downturn in the semiconductor industry and the economy in general appears to be more severe than previously anticipated. There is a great deal of uncertainty regarding when the semiconductor industry will recover from this down cycle. Because of the continued downturn in the economy, we believe that the decline in the market value of our investment in UMC at March 22, 2001 is other than temporary, and we will report a loss in other income and expense in the first quarter of 2001. This loss will be based upon the fair market value of the investment at the end of the first quarter in fiscal 2001, as compared to the investment's cost basis. Item 9. Changes in and Disagreements With Accountants on Accounting and --------------------------------------------------------------- Financial Disclosure -------------------- Not applicable. PART III Item 10. Directors and Executive Officers of the REGISTRANT -------------------------------------------------- Directors. Reference is made to the information regarding directors appearing under the caption "Election of Directors" in our Proxy Statement for our Annual Meeting of Stockholders to be held on June 5, 2001, which information is incorporated in this Form 10-K by reference. Information regarding executive officers is set forth under the caption "Executive Officers" in Part I of this Form 10-K. Item 11. Executive Compensation ----------------------- The information required by this item is set forth under "Executive Compensation and Related Information" in our Proxy Statement for the 2001 Annual Meeting of Stockholders, and is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management -------------------------------------------------------------- The information required by this item is set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in our Proxy Statement for the 2001 Annual Meeting of Stockholders, and is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions ---------------------------------------------- The information required by this item is set forth under the caption "Compensation Committee Interlocks and Insider Participation" and "Certain Transactions" in our Proxy Statement for the Annual Meeting of Stockholders, and is incorporated herein by reference. 67 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Documents filed as part of this report 1) All financial statements
Index to Financial Statements Page ----- Report of Ernst & Young LLP, Independent Auditors 44 Consolidated Balance Sheets 45 Consolidated Statements of Income 46 Consolidated Statements of Stockholders' Equity 47 Consolidated Statements of Cash Flows 48 Notes to Consolidated Financial Statements 49-66 2) Financial statement schedules Index to Financial Statement Schedules Financial Statement Schedules II. Valuation and Qualifying Accounts 79
All other schedules have been omitted because the required information is not present or not present in amounts sufficient to require submission of the schedules, or because the information required is included in the consolidated financial statements or notes thereto. 3) Exhibits required by Item 601 of Regulation S-K A. Exhibits 68
Exhibit Number Exhibit Title - ------ ------------- 3.1 Certificate of Incorporation of the Registrant, as amended to date.(2),(13) 3.2 Form of Amended and Restated Certificate of Incorporation of the Registrant.(2) 3.3 Bylaws of the Registrant, as amended.(2) 3.4 Form of Amended and Restated Bylaws of the Registrant.(2) 3.5 Certificate of Designation for the Series A Junior Participating Preferred Stock, as filed with the Delaware Secretary of State on April 24, 1997.(4) 4.1 Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4.(2) 4.3 Amended and Restated Registration Rights Agreement, among the Registrant and the investors and founders named therein, dated March 3, 1995.(2) 4.5 Series F Preferred Stock Purchase Agreement between Seagate Technology, Inc. and the Registrant dated January 15, 1993.(2) 4.8 Rights Agreement, dated as of April 18, 1997, between the Company and Harris Trust and Savings Bank.(4) 4.9 First Amendment to Rights Agreement dated October 22, 1999, between Harris Trust and the Registrant.(11) 9.1 Amended and Restated Voting Agreement, among the Registrant and the investors named therein, dated March 3, 1995.(2) 10.10 License Agreement between the Registrant and Dr. Eli Harari, dated September 6, 1988.(2) 10.13 1989 Stock Benefit Plan.(2) 10.15 Employee Stock Purchase Plan.(2) 10.16 1995 Non-Employee Directors Stock Option Plan.(2) 10.18 Lease Agreement between the Registrant and G.F. Properties, dated March 1, 1996.(3) 10.21 Amendment to Lease Agreement between the Registrant and G.F. Properties, dated April 3, 1997.(5) 10.23 Foundry Venture Agreement between the Registrant and United Microelectronics Corporation, dated June 27, 1997.(1),(6) 10.24 Written Assurances Re: Foundry Venture Agreement between the Registrant and United Microelectronics Corporation, dated September 13, 1995.(1), (6) 10.25 Side Letter between Registrant and United Microelectronics Corporation, dated May 28, 1997.(1), (6) 10.27 Clarification letter with regards to Foundry Venture Agreement between the Registrant and United Microelectronics Corporation dated October 24, 1997.(7) 10.28 Lease Agreement between the Registrant and G.F. Properties, dated June 10, 1998.(8) 10.29 Trade Finance Agreement between the Registrant and Union Bank of California, dated July 15, 1998.(9) 10.30 1995 Stock Option Plan Amended and Restated as of December 17, 1998.(12) 10.31 1995 Non-Employee Directors Stock Option Plan Amended and Restated as of December 17, 1998.(12) 10.32 1995 Employee Stock Purchase Plan Amended and Restated as of December 17, 1998. (12) 10.33 Master Agreement, dated as of May 9, 2000, by and among the Registrant, Toshiba Corporation and Semiconductor North America, Inc.(13),(+) 10.34 Operating Agreement dated as of May 9, 2000, by and between the Registrant and Semiconductor North America, Inc.(13) 10.35 Common R&D and Participation Agreement, dated as of May 9, 2000, by and between the Registrant and Toshiba Corporation.(13),(+) 10.36 Product Development Agreement, dated as of May 9, 2000, by and between the Registrant and Toshiba Corporation.(13),(+) 10.37 Share Purchase Agreement, dated as of July 4, 2000, by and between the Registrant and Tower Semiconductor Ltd.(14) 10.38 Escrow Agreement, dated as of August 14, 2000, by and between the Registrant, Tower Semiconductor Ltd. and Union bank of California, N.A.(14)
69 10.39 Additional Purchase Obligation Agreement, dated as of July 4, 2000, by and between the Registrant and Tower Semiconductor Ltd.(14) 10.40 Shareholders Agreement, dated as of July 4, 2000, by and between the Registrant and the Israel Corporation.(14) 10.41 Definitive Agreement to Form Vending Business, dated August 7, 2000, by and between the Registrant and Photo-Me International, Plc.(14),(+) 10.42 Non-Solicitation Agreement, dated August 7, 2000, by and between the Registrant, DigitalPortal Inc. and Photo-Me International, Plc.(14),(+) 10.43 Exclusive Product Purchase Agreement, dated as of August 7, 2000, by and between Photo-Me, International Plc., and DigitalPortal Inc. (14),(+) 10.44 Stockholders' Agreement, dated as of August 7, 2000, by and among the Registrant, DigitalPortal Inc. and Photo-Me, International, Plc.(14),(+) 10.45 Bylaws of DigitalPortal Inc.(14),(+) 10.46 Registration Rights Agreement, dated as of January 18, 2001, by and between Registrant, The Israel Corporation, Alliance Semiconductor Ltd., Macronix International Co., Ltd. and Quick Logic Corporation. (15) 10.47 Consolidated Shareholders Agreement, dated as of January 18, 2001 by and among Registrant, the Israel Corporation, Alliance Semiconductor, Ltd. and Macronix International Co., Ltd. (15) 10.48 Appendix 1 to Participation Agreement, dated as of December 27, 2000, by and among FlashVision L.L.C., ABN AMRO Bank N.V., Keybank National Association, Union Bank of California, N.A. and other participants. (*), (++) 10.49 Master Lease Intended as Security, dated as of December 27, 2000, by and between Flashvision, L.L.C. and ABN Ammo Bank N.V. (*), (++). 10.50 Guarantee, dated as of December 27, 2000 by the Registrant to ABN AMRO Bank N.V. (*), (++) 21.1 Subsidiaries of the Registrant. (10) 23.1 Consent of Ernst & Young LLP, Independent Auditors (*)
______________ * Filed herewith. + Confidential treatment has been granted for certain portions thereof. ++ Confidential treatment has been requested for certain portions thereof. 1. Confidential treatment granted as to certain portions of these exhibits. 2. Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-1 (No. 33-96298). 3. Previously filed as an Exhibit to the Registrant's 1995 Annual Report on Form 10-K. 4. Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K/A dated April 18, 1997. 5. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1997. 6. Previously filed as an Exhibit to the Registrant's Current Report on form 8-K dated October 16, 1997. 7. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended September 30, 1997. 8. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1998. 9. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended September 30, 1998. 10. Previously filed as an Exhibit to the Registrant's Annual Report on Form 10-K. 11. Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated January 1, 1999. 12. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended March 31, 1999. 13. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 2000, 14. Previously filed as an Exhibit to the Registrant's Form 10-Q for the quarter ended September 30, 2000, 15. Previously filed as an Exhibit to the Registrant's Schedule 13(d) dated January 26, 2001. B. Reports on Form 8-K None 70 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 By: /s/ Frank Calderoni ------------------------------------- Frank Calderoni Chief Financial Officer, Senior Vice President, Finance and Administration (on behalf of the Registrant) DATED: March 29, 2001 -------------- 71 POWER OF ATTORNEY KNOW ALL PEOPLE BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dr. Eli Harari and Frank Calderoni, jointly and severally, his or her attorneys in fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys in fact, or his or her substitute or substitutes, may do or cause to be done by virtue thereof. Pursuant to the requirements of the Securities and Exchange Act of 1934, as amended, this Report has been signed below by the following persons in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- By: /s/ Dr. Eli Harari President, Chief Executive Officer March 29, 2001 ---------------------------- (Dr. Eli Harari) and Director By: /s/ Irwin Federman Chairman of the Board, Director March 29, 2001 ---------------------------- (Irwin Federman) By: /s/ Frank Calderoni Chief Financial Officer, March 29, 2001 ---------------------------- (Frank Calderoni) Senior Vice President, Finance and Administration (Principal Financial and Accounting Officer) By: /s/ William V. Campbell Director March 29, 2001 ---------------------------- (William V. Campbell) By: /s/ Catherine P. Lego Director March 29, 2001 ---------------------------- (Catherine P. Lego) By: /s/ Dr. James D. Meindl Director March 29, 2001 ---------------------------- (Dr. James D. Meindl) By: /s/ Alan F. Shugart Director March 29, 2001 ------------------------------ (Alan F. Shugart)
72 EX-10.48 2 0002.txt APPENDIX I TO PARTICIPATION AGREEMENT Exhibit 10.48 - -------------------------------------------------------------------------------- APPENDIX 1 To Participation Agreement FlashVision/SanDisk Tranche Lease Financing DEFINITIONS AND INTERPRETATION - -------------------------------------------------------------------------------- A. Interpretation. In each Operative Document, unless a clear contrary intention appears: (i) the singular number includes the plural number and vice versa; (ii) reference to any Person includes such Person's successors and assigns but, if applicable, only if such successors and assigns are permitted by the Operative Documents, and reference to a Person in a particular capacity excludes such Person in any other capacity or individually; (iii) reference to any gender includes the other gender; (iv) reference to any agreement (including any Operative Document), document or instrument means such agreement, document or instrument as amended, restated, supplemented or otherwise modified and in effect from time to time in accordance with the terms thereof and, if applicable, the terms of the other Operative Documents; (v) reference to any Applicable Laws means such Applicable Laws as amended, modified, codified, replaced or reenacted, in whole or in part, and in effect from time to time, including rules and regulations promulgated thereunder and reference to any section or other provision of any Applicable Laws means that provision of such Applicable Laws from time to time in effect and constituting the substantive amendment, modifications, codification, replacement or reenactment of such section or other provision; (vi) reference in any Operative Document to any Article, Section, Appendix, Schedule or Exhibit means such Article or Section thereof or Appendix, Schedule or Exhibit thereto; (vii) "hereunder", "hereof", "hereto" and words of similar import shall be deemed references to an Operative Document as a whole and not to any particular Article, Section or other provision thereof; CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION PURSUANT TO RULE 24B-2. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. Appendix 1-1 (viii) "including" (and with correlative meaning "include") means including without limiting the generality of any description preceding such term; and (ix) relative to the determination of any period of time, "from" means "from and including" and "to" means "to but excluding". B. Accounting Terms. In each Operative Document, unless expressly otherwise provided, accounting terms shall be construed and interpreted, and accounting determinations and computations shall be made, in accordance with GAAP. C. Conflict in Operative Documents. If there is any conflict between any Operative Documents, such Operative Document shall be interpreted and construed, if possible, so as to avoid or minimize such conflict, but, to the extent (and only to the extent) of such conflict, the Participation Agreement shall prevail and control. D. Legal Representation of the Parties. The Operative Documents were negotiated by the parties with the benefit of legal representation and any rule of construction or interpretation that any ambiguity in the Operative Documents is to be construed or interpreted against the drafting party shall not apply to any construction or interpretation hereof or thereof. E. Defined Terms. Unless a clear contrary intention appears, terms defined herein have the respective indicated meanings when used in each Operative Document. "ABN AMRO" means ABN AMRO Bank N.V. "Accepted" means, with respect to any Item of Equipment, that Lessee has inspected and tested such Item of Equipment after the date such Item of Equipment was delivered and Installed at the Facility and that Lessee has accepted such Item of Equipment from the manufacturer or vendor thereof. "Acquisition Agreement" shall mean, with respect to any Equipment, the purchase agreement or purchase order with the manufacturer or vendor of such Equipment pursuant to which Lessee has agreed to purchase such Equipment. "Additional Costs" means amounts payable to any Participant pursuant to Article XIII or Article XV of the Participation Agreement. "Advance" means an advance by Lessor to Lessee pursuant to Article III of the Participation Agreement. "Affiliate" means, with respect to any Person, any other Person (i) directly or indirectly controlling or controlled by or under direct or indirect common control with such Person or (ii) directly or indirectly owning or holding five percent (5%) or more of the equity interest in such Person. For purposes of this definition, "control", when used with respect to any Person, means the power to direct the management and policies of such Person, directly or indirectly, whether Appendix 1-2 through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. "Affiliate Sublease" is defined in Section 5.2 of the Lease. "After Tax Basis" means, with respect to any payment to be received, the amount of such payment increased so that, after deduction of the amount of all Taxes (including any Taxes otherwise excluded by the definition of "Impositions", and assuming for this purpose that the recipient of such payment is subject to taxation at the highest marginal Federal rate generally applicable to Persons of the same type as the recipient and the highest marginal state and local rates generally applicable to Persons of the same type as the recipient in the jurisdiction in which such recipient has its principal place of business) required to be paid by the recipient (less any tax savings realized as a result of the payment of the indemnified amount) with respect to the receipt by the recipient of such amounts, such increased payment (as so reduced) is equal to the payment otherwise required to be made. "Agent" means ABN AMRO or any successor pursuant to the terms of the Operative Documents when acting in its capacity as agent for the Participants. "Aggregate Commitment Amount" means Two Hundred and Fifteen Million Dollars ($215,000,000). "Aggregate Purchase Price" means, at any time, (a) with respect to any Lease Supplement, the sum of the Purchase Prices for all related Lease Supplement Equipment, and (b) with respect to all Equipment, the sum of the Purchase Prices for all Equipment subject to the Lease at such time. "Allocation Fraction" means, with respect to any Item of Equipment, a fraction, the numerator of which is the Purchase Price of such Item of Equipment and the denominator of which is the Aggregate Purchase Price of all Equipment then subject to the applicable Lease Supplement, including such Item of Equipment. "Annual Appraisal" means an update (which update shall be a desktop appraisal) of the Initial Appraisal from an Appraiser received pursuant to the terms of the Lease on each annual anniversary of the Document Closing Date, setting forth as of such annual anniversary the Fair Market Value of each Item of Equipment then subject to the Lease, in form and substance reasonably satisfactory to Agent and the Required Participants and using appraisal methods consistent with the methods used in the Initial Appraisal. Each such appraisal shall be prepared at the sole cost and expense of Lessee. "Applicable Laws" at any time means all then existing applicable laws, rules, regulations (including Environmental Laws), statutes, treaties, codes, ordinances, Permits, certificates, orders and licenses of and interpretations by any Governmental Authority, and applicable judgments, decrees, injunctions, writs, orders or like action of any court, arbitrator or other administrative, judicial or quasi-judicial tribunal or agency of competent jurisdiction (including those pertaining to health, safety or the environment and those pertaining to the construction, installation or use of the Equipment. Appendix 1-3 "Applicable Lending Office" means, for each Participant, the office of such Participant set forth as the Applicable Lending Office for such Participant on Schedule II to the Participation Agreement, or such other office of such Participant (or of an Affiliate of such Participant) as such Participant may from time to time specify to Agent and Lessee by written notice as the office from which its Participation Interests are made available and maintained. "Applicable Margin" means with respect to the Participation Interests purchased by the Participants while interest or yield is accruing thereon by reference to the LIBO Rate, the respective margin percentage that shall be subject to adjustment (upwards or downwards, as appropriate) based on the existence of the applicable Level I, II, III, IV or V as at the end of any fiscal quarter as set forth below. The Leverage Ratio of the Guarantor shall be determined from the then most recent quarterly or annual financial statements and the Compliance Certificate in respect thereof delivered by the Guarantor pursuant to the Guarantee. The adjustment, if any, to the Applicable Margin shall be effective commencing on the third Business Day after the delivery of such financial statements and Compliance Certificate. If the Guarantor shall at any time fail to timely furnish to the Participants the financial statements and Compliance Certificate required to be delivered pursuant to the Guarantee, then, during the period commencing on the date such financial statements and Compliance Certificate were required to be delivered pursuant to the Guarantee until the date on which such financial statements and Compliance Certificate are delivered by the Guarantor (but only during such period), Level V shall be deemed to exist and no retroactive adjustments shall be made for such period. Notwithstanding the foregoing, during the period from the Document Closing Date through the date which is three Business Days after the date on which the Guarantor delivers the first quarterly or annual financial statements and Compliance Certificate pursuant to the Guarantee for the period ended June 30, 2001, Level IV shall be deemed to exist. --------------------------------------------------------------------------- Applicable Margin Table --------------------------------------------------------------------------- Applicable Margin for Applicable Margin for Tranche A and Tranche B Tranche C Level Advances Advances --------------------------------------------------------------------------- Level V [*] [*] --------------------------------------------------------------------------- Level IV [*] [*] --------------------------------------------------------------------------- Level III [*] [*] --------------------------------------------------------------------------- Level II [*] [*] --------------------------------------------------------------------------- Level I [*] [*] --------------------------------------------------------------------------- "Appraisal" means any of the Initial Appraisal, any Annual Appraisal, any Supplemental Appraisal or any Lease Term Appraisal. "Appraiser" means American Appraisal Associates or such other independent qualified Person as may be selected by Agent and reasonably satisfactory to Lessee. "Arrangement Fee" means the arrangement fee described in the Fee Letter. [*] INDICATES THAT CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION PURSUANT TO RULE 24B-2. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. Appendix 1-4 "Arranger" means ABN AMRO in its capacity as arranger of the lease facility provided under the Operative Documents. "Assignment Agreement" means an Assignment Agreement substantially in the form of Exhibit F to the Participation Agreement. "Available Commitment" means as to any Participant at any time an amount equal to the excess, if any, of (A) the amount of such Participant's Commitment, over (B) the aggregate amount of its Participation Interest in all Advances then outstanding. "Bank" means ABN AMRO in its individual capacity. "Bankruptcy Code" means Title 11 of United States Code entitled "Bankruptcy," as now or hereafter in effect. "Base Term" means, with respect to any Lease Supplement, the period beginning on the applicable Lease Supplement Closing Date and ending on the first anniversary of such Lease Supplement Closing Date. "Basic Rent" means, with respect to any Lease Supplement, all installments of Fixed Rent and Variable Rent in respect of the relevant Lease Supplement Balance due and payable by Lessee on each Payment Date during the Base Term or Renewal Term, if any, applicable thereto. "Bill of Sale" means a bill of sale substantially in the form of Exhibit C to the Participation Agreement to be delivered to Lessor pursuant to the Participation Agreement. "Break Costs" means an amount equal to the amount, if any, required to compensate any Participant for any losses (including, without limitation, any loss, cost or expense incurred by reason of the liquidation or reemployment of deposits or funds acquired by any Participant to fund its obligations under the Operative Documents) it may reasonably incur as a result of (x) Lessee's payment of any Basic Rent other than on a Payment Date therefor, (y) any Advance not being made on the date specified therefor in the applicable Lease Supplement Closing Date Notice (other than as a result of a breach by such Participant of its obligation under Section 3.1 of the Participation Agreement to fund its Participation Interest in such Advance) as set forth in Section 3.4 of the Participation Agreement, or (z) any conversion of the LIBO Rate other than pursuant to and in accordance with the Operative Documents. A statement as to the amount of such loss, cost or expense, prepared in good faith and in reasonable detail and submitted by any Participant to Agent and by Agent to Lessee, shall be presumed correct absent demonstrable error. "Business Day" means (i) each Monday, Tuesday, Wednesday, Thursday and Friday which is not a day on which banks in New York, New York, Chicago, Illinois, Manassas, Virginia or Sunnyvale, California are generally authorized or obligated, by law or executive order, to close and (ii) relative to any determination of the LIBO Rate, any day which is a Business Day under clause (i) and is also a day on which dealings in Dollars are carried on in the London interbank eurodollar market. Appendix 1-5 "Capital Asset" shall mean with respect to any Person, any tangible fixed or capital asset owned or leased (in the case of a Capitalized Lease) by such Person, or any expense incurred by such Person that is required by GAAP to be reported as a non-current asset on such Person's balance sheet. "Capital Expenditures" means with respect to any Person and its Subsidiaries on a consolidated basis, all expenses accrued for the acquisition of Capital Assets which, in accordance with GAAP, would be classified as capital expenditures (including all Capitalized Lease Obligations). "Capitalized Lease" means with respect to any Person and its Subsidiaries on a consolidated basis, any lease of property, real, personal or mixed, the obligations under which are capitalized on the consolidated balance sheet of such Person and its Subsidiaries in accordance with GAAP. "Capitalized Lease Obligations" means with respect to any Person and its Subsidiaries on a consolidated basis, the capitalized amount of monetary obligations of such Person and its Subsidiaries to pay rent or other amounts under or in respect of Capitalized Leases. "Cash Equivalents" means, as at any date of determination: (a) Direct obligations of, or obligations the principal and interest on which are unconditionally guaranteed by, the United States of America or obligations of any agency of the United States of America to the extent such obligations are backed by the full faith and credit of the United States of America, in each case maturing within one year from the date of acquisition thereof; (b) Certificates of deposit maturing within one year from the date of acquisition thereof issued by a commercial bank or trust company organized under the laws of the United States of America or a state thereof or that is a Participant, provided that (A) such deposits are denominated in Dollars, (B) such bank or trust company has capital, surplus and undivided profits of not less than $1,000,000,000 and (C) such bank or trust company has certificates of deposit or other debt obligations that were rated, as of the date such Cash Equivalents were acquired, at least A-1 (or its equivalent) by S&P or P-1 (or its equivalent) by Moody's; (c) Open market commercial paper maturing within 270 days from the date of acquisition thereof issued by a corporation organized under the laws of the United States of America or a state thereof, provided such commercial paper was rated, as of the date such Cash Equivalents were acquired, at least A-1 (or its equivalent) by S&P or P-1 (or its equivalent) by Moody's; and (d) Any repurchase agreement entered into with a commercial bank or trust company organized under the laws of the United States of America or a state thereof or that is a Participant, provided that (A) such bank or trust company has capital, surplus and undivided profits of not less than $1,000,000,000, (B) such bank or trust company has certificates of deposit or other debt obligations that were rated, as of the date such Cash Equivalents were acquired, at least A-1 (or its equivalent) by Appendix 1-6 S&P or P-1 (or its equivalent) by Moody's, (C) the repurchase obligations of such bank or trust company under such repurchase agreement are fully secured by a perfected security interest in a security or instrument of the type described in clause (a), (b) or (c) above and (D) such security or instrument so securing the repurchase obligations has fair market value at the time such repurchase agreement is entered into of not less than 100% of such repurchase obligations. "Casualty" is defined in Section 6.1 of the Lease. "Casualty Amount" means, with respect to any Item of Equipment as of any date specified for payment thereof, an amount equal to the greater of (a) the Purchase Price for such Item of Equipment and (b) the product obtained by multiplying (i) the outstanding Lease Supplement Balance for the Lease Supplement to which such Equipment is subject plus all Variable Rent accrued and unpaid on such Lease Supplement Balance by (ii) the Allocation Fraction of such Item of Equipment. "Casualty Notice" is defined in Section 6.1 of the Lease. "Casualty Recoveries" is defined in Section 6.1 of the Lease. "Casualty Settlement Date" is defined in Section 6.1(a) of the Lease. "CERCLA" means the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, 42 U.S.C. ss.ss.9601 et seq., as amended. "Change in Control" shall mean a change in control of Guarantor of a nature that would be required to be reported (assuming such event has not been "previously reported") in response to Item 1(a) of the Current Report on Form 8-K, pursuant to Section 13 or 15(d) of the Exchange Act; provided that, without limitation, a Change in Control shall be deemed to have occurred at such time as (i) any "person" including a "group" (within the meaning of Sections 13(d) and 14(d) of the Exchange Act) (x) is or has become the "beneficial owner", as defined in Rule 13d-3 under the Exchange Act, directly or indirectly, of [*] or more of the combined voting power of the outstanding securities of Guarantor ordinarily having the right to vote at the election of directors, (y) acquires all or substantially all of the assets of Guarantor, or (ii) individuals who constituted the Board of Directors of Guarantor on the Document Closing Date (the "Incumbent Board") have ceased for any reason to constitute at least a majority thereof; provided further that any person becoming a director subsequent to the Document Closing Date whose election, or nomination for election by Guarantor's shareholders, was approved by a vote of at least three-quarters (3/4) of the directors comprising the Incumbent Board (either by a specific vote or by approval of the proxy statement of Guarantor in which such person is named as a nominee for director without objection to such nomination) shall be, for purposes of this definition, considered as though such person were a member of the Incumbent Board. "Claims" means any and all obligations, liabilities, losses, actions, suits, judgments, penalties, fines, claims, demands, settlements, costs and expenses (including, without limitation, reasonable legal fees and expenses) of any nature whatsoever. [*] INDICATES THAT CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION PURSUANT TO RULE 24B-2 CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. Appendix 1-7 "Code" means the Internal Revenue Code of 1986, as amended from time to time, or any successor statute thereto. "Collateral" means each of the following: (i) the Equipment (including all Parts thereof, accessions thereto and replacements (including any Replacement Equipment) and substitutions therefor); (ii) the Sublease and any Affiliate Sublease; (iii) all Related Property to the extent assignable; (iv) all products, accessions, rents, issues, profits, returns, income and proceeds of and from any and all of the foregoing Collateral (including proceeds which constitute property of the types described in clauses (i), (ii) and (iii) above and, to the extent not otherwise included, all payments under insurance (whether or not Agent or Lessor is the loss payee thereof, or any indemnity, warranty or guaranty, payable by reason of loss or damage to or otherwise with respect to any of the foregoing Collateral). "Collateral Assignment" means (i) a Collateral Assignment of Sublease (FlashVision/SanDisk Tranche) to be entered into on or prior to the initial Lease Supplement Closing Date, executed by Lessee and acknowledged by DSC, and (ii) if any Affiliate Sublease is entered into by Lessee, a Collateral Assignment of Sublease (FlashVision/SanDisk Tranche) in the form of the Collateral Assignment of Sublease (FlashVision/SanDisk Tranche) entered into on or prior to the initial Lease Supplement Closing Date, executed by Lessee and acknowledged by the applicable Affiliate Sublessee but with such changes as are necessary to reflect the different parties and the different terms of the sublease. "Commitment" means (i) as to any Participant, the obligation of such Participant to purchase a Participation Interest in Advances to be made by Lessor under the Participation Agreement, in an aggregate amount at any one time outstanding not to exceed the amount set forth opposite such Participant's name on Schedule I to the Participation Agreement, and (ii) as to Lessor, the obligation of Lessor to make Advances from amounts received from the Participants pursuant to the purchase of Participation Interests under the Participation Agreement. "Commitment Fee Payment Date" means each quarterly Payment Date in respect of Fixed Rent occurring during the Installation Period and the last day of the Installation Period. "Commitment Fee Rate" means with respect to the Available Commitment of each Participant, the per annum percentage that shall be subject to adjustment (upwards or downwards, as appropriate) based on the existence of the applicable Level I, II, III, IV or V as at the end of any fiscal quarter as set forth below. The Leverage Ratio of the Guarantor shall be determined from the then most recent quarterly or annual financial statements and the Compliance Certificate in respect thereof delivered by the Guarantor pursuant to the Guarantee. The adjustment, if any, to the Commitment Fee Rate shall be effective commencing on the third Business Day after the delivery of such financial statements and Compliance Certificate. If the Guarantor shall at any time fail to timely furnish to the Participants the financial statements and Appendix 1-8 Compliance Certificate required to be delivered pursuant to the Guarantee, then, during the period commencing on the date such financial statements and Compliance Certificate were required to be delivered pursuant to the Guarantee until the date on which such financial statements and Compliance Certificate are delivered by the Guarantor (but only during such period), Level V shall be deemed to exist and no retroactive adjustments shall be made for such period. Notwithstanding the foregoing, during the period from the Document Closing Date through the date which is three Business Days after the date on which the Guarantor delivers the first quarterly or annual financial statements and Compliance Certificate pursuant to the Guarantee for the period ended June 30, 2001, Level IV shall be deemed to exist. [*] "Commitment Fees" is defined in Section 4.1 of the Participation Agreement. "Commitment Percentage" means, as to any Participant, such Participant's Tranche A Participation Interest Commitment Percentage, Tranche B Participation Interest Commitment Percentage or Tranche C Equity Interest Commitment Percentage, as the case may be (or, at any time after the Commitments of the Participants shall have expired or terminated, the percentage which the aggregate amount of such Participant's purchases of Participation Interests then outstanding constitutes of the aggregate amount of the purchases of Participation Interests then outstanding). "Compliance Certificate" means a certificate of a Responsible Officer of Guarantor delivered pursuant to Section 10(a)(iv)(A) or 10(a)(iv)(B) of the Guarantee. "Consolidated Total Debt" means with respect to Guarantor and its Subsidiaries on a consolidated basis as of any date of determination, the outstanding principal balance of all Indebtedness of such Persons, including all Guaranty Obligations (including those of Guarantor in respect of the Obligations of Lessee under the Operative Documents). "Debt Service Coverage Ratio" means, as of any date of determination, the ratio of (a)Lessee EBITDAR for the Fiscal Quarter ending on such date to (b) the sum of all Interest Expense of Lessee and its Subsidiaries plus all rental expense of Lessee and its Subsidiaries on a consolidated basis for such period. "Debt to Equity Ratio" means, as of any date of determination, the ratio of (a) Indebtedness of Lessee and its Subsidiaries on a consolidated basis as of such date, to (b) Members' original capital in Lessee plus retained earnings less distributions made to Members in respect of capital as of such date. "Default" means any Event of Default or any condition, occurrence or event which, after notice or lapse of time or both, would constitute an Event of Default. "Defaulted Amount" is defined in Section 3.4(a) of the Participation Agreement. "Defaulting Participant" is defined in Section 3.4(a) of the Participation Agreement. [*] INDICATES THAT CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION PURSUANT TO RULE 24B-2. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. Appendix 1-9 "Document Closing Date" is defined in Section 2 of the Participation Agreement. "Dollars" and "$" mean dollars in lawful currency of the United States of America. "DSC" means Dominion Semiconductor Company, L.L.C., a Virginia limited liability company and a wholly-owned Subsidiary of Toshiba. "DSC Foundry Agreement" means the Foundry Agreement to be entered into between DSC and Lessee and referred to in Section 8.1(w) of the Participation Agreement. "DSC Services Agreement" means the Services Agreement dated as of April 1, 2000 between Lessee and DSC. "Early Termination Option" is defined in Section 10.1 of the Lease. "Eligible Institution" means (i) a commercial bank organized under the laws of the United States, or any State thereof; (ii) a commercial bank organized under the laws of any other country that is a member of the OECD or has concluded special lending arrangements with the International Monetary Fund associated with its General Arrangements to Borrow, or a political subdivision of any such country, provided that such bank is acting through a branch or agency located in the United States; (iii) a finance company, insurance company or other financial institution or fund (whether a corporation, partnership or other entity) engaged generally in making, purchasing or otherwise investing in commercial loans in the ordinary course of its business; (iv) the central bank of any country that is a member of the OECD; (v) any Participant; or (vi) in the case of an assignment or transfer by Bank Leumi USA of the Participation Interests held by it, the ultimate parent of such Participant; provided, however, that (A) any such Person described in clause (i), (ii), (iii), (iv) or (vi) above or a parent entity of any such Person shall also have combined capital and surplus (as established in its most recent report of condition to its primary regulator) of not less than $250,000,000 (or its equivalent in foreign currency), and (B) any Person described in clause (ii), (iii), (iv) or (vi) above shall, on the date on which it is to become a Participant hereunder, be entitled to receive payments hereunder without deduction or withholding of any United States Federal income taxes. "Employee Benefit Plan" means any "employee benefit plan" as defined in Section 3(3) of ERISA which is or was maintained or contributed to by Lessee or any of its ERISA Affiliates. "Environmental Claim" means any investigation, notice, notice of violation, claim, action, suit, proceeding, demand, abatement order or other order or directive (conditional or otherwise), by any Governmental Authority or any other Person, arising (i) pursuant to or in connection with any actual or alleged violation of any Environmental Law; (ii) in connection with any Hazardous Substance or any actual or alleged Hazardous Activity; or (iii) in connection with any actual or alleged damage, injury, threat or harm to health, safety, natural resources or the environment. "Environmental Indemnity Agreement" means the Environmental Indemnity Agreement dated as of May 9, 2000 between Guarantor, Toshiba and DSC. Appendix 1-10 "Environmental Law" at any time, means any applicable Federal, state, county or local law, statute, ordinance, rule, regulation, license, permit, authorization, approval, covenant, criteria having the effect of law, guideline having the effect of law, administrative or court order, judgment, decree, injunction, code or requirement or any agreement with a Governmental Authority theretofore enacted or promulgated: (x) relating to pollution (or the cleanup, removal, remediation or encapsulation thereof, or any other response thereto), or the regulation or protection of human health, safety or the environment, including air, water, vapor, surface water, groundwater, drinking water, land (including surface or subsurface), plant, aquatic and animal life, or (y) concerning exposure to, or the use, manufacture, containment, storage, recycling, treatment, generation, discharge, emission, Release or threatened Release, transportation, processing, handling, labeling, containment, production, distribution, disposal or remediation of, any Hazardous Substance or Hazardous Activity, in each case as amended and as then in effect, and any common law or equitable doctrine (including, without limitation, injunctive relief and tort doctrines such as negligence, nuisance, trespass and strict liability) that may impose liability or obligations for injuries (whether personal or to property) or damages due to or threatened as a result of the presence of, exposure to, or ingestion of, any Hazardous Substance. At any time, Environmental Laws include, but are not limited to, CERCLA; the Resource Conservation and Recovery Act of 1976, 42 U.S.C. ss.6901 et seq.; the Federal Water Pollution Control Act, 33 U.S.C. ss.1251 et seq.; the Clean Air Act, 42 U.S.C. ss.ss.7401 et seq.; the National Environmental Policy Act, 42 U.S.C. ss.4321; the Refuse Act, 33 U.S.C. ss.ss.401 et seq.; the Hazardous Materials Transportation Act of 197S, 49 U.S.C. ss.ss.1801-1812; the Toxic Substances Control Act, 15 U.S.C. ss.ss.2601 et seq.; the Federal Insecticide, Fungicide, and Rodenticide Act, 7 U.S.C. ss.ss.136 et seq.; the Safe Drinking Water Act, 42 U.S.C. ss.ss. 300f et seq., each as amended and as then in effect, and their state and local counterparts or equivalents, including any regulations promulgated thereunder. "Equipment" means collectively all Items of Equipment. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended, and any successor statute thereto, as interpreted by the rules and regulations thereunder, all as the same may be in effect from time to time. "ERISA Affiliate" means, as applied to any Person, (i) any corporation which is a member of a controlled group of corporations within the meaning of Section 414(b) of the Code of which that Person is a member; (ii) any trade or business (whether or not incorporated) which is a member of a group of trades or businesses under common control within the meaning of Section 414(c) of the Code of which that Person is a member; and (iii) any member of an affiliated service group within the meaning of Section 414(m) or (o) of the Code of which that Person, any corporation described in clause (i) above or any trade or business described in clause (ii) above is a member. Any former ERISA Affiliate of Lessee shall continue to be considered an ERISA Affiliate of Lessee within the meaning of this definition with respect to the Appendix 1-11 period such entity was an ERISA Affiliate of Lessee and with respect to liabilities arising after such period for which Lessee could be liable under the Code or ERISA. "ERISA Event" means (i) the assertion of a claim (other than routine claims for benefits) against any Employee Benefit Plan or the assets thereof, or against Lessee or any of its ERISA Affiliates in connection with any Employee Benefit Plan which is reasonably likely to have a Material Adverse Effect; or (ii) receipt from the Internal Revenue Service of notice of the failure of any Pension Plan (or any other Employee Benefit Plan intended to be qualified under Section 401(a) of the Code) to qualify under Section 401(a) of the Code, or the failure of any trust forming part of any Pension Plan to qualify for exemption from taxation under Section 501(a) of the Code. "Escrow Account" is defined in Section 3.1(c) of the Participation Agreement. "Event of Default" is defined in Section 8.1 of the Lease. "Excepted Payments" means (a) all indemnity payments (including indemnity payments made pursuant to Section 12 of the Participation Agreement) to which Lessor, or any of its Affiliates, agents, officers, directors or employees is entitled; (b) any amounts (other than Basic Rent, any Renewal Payment or amounts payable by Lessee pursuant to Section 6.1 or Articles VIII or X of the Lease) payable under any Operative Document to reimburse Lessor or any of its respective Affiliates (including the reasonable expenses of Lessor incurred in connection with any such payment) for performing or complying with any of the obligations of Lessee under and as permitted by any Operative Document, except to the extent that one or more Participants have indemnified Lessor with respect thereto pursuant to the Participation Agreement; (c) any amount payable to Lessor by any Participant or transferee permitted under the Operative Documents of the interest of Lessor as the purchase price of such purchasing Participant's Participation Interest; (d) any insurance proceeds (or payments with respect to risks self-insured or policy deductibles) to which Lessor is entitled under liability policies other than such proceeds or payments payable to Agent; (e) any insurance proceeds under policies maintained by Lessor, excluding insurance proceeds under policies required to be maintained by Lessee under the Lease; (f) Transaction Expenses or other amounts or expenses paid or payable to or for the benefit of Lessor; and (g) any payments in respect of interest to the extent attributable to payments referred to in clauses (a) through (f) above. Appendix 1-12 "Expiration Date" means with respect to any Lease Supplement the last day of the Base Term applicable thereto or, if a Renewal Term has been granted with respect thereto, the last day of the then current Renewal Term applicable thereto. "Facility" means the "Module II" facility of DSC located at Manassas, Virginia. "Fair Market Value" means, with respect to any Item of Equipment as of any date, the price at which a purchaser would purchase such Item of Equipment in an arm's-length transaction between a willing buyer and a willing seller none of which is affiliated with Lessee, Guarantor, Agent or any Participant, and neither of them being under any compulsion to buy or sell. In making any determination of Fair Market Value, the Appraiser may assume such Item of Equipment has been maintained in accordance with the requirements of the Lease and that such Item of Equipment is in the condition in which it is required to be under the Lease as of the date for which such determination is made (unless such Fair Market Value is being determined for purposes of Section 12.2 of the Participation Agreement or a Lease Term Appraisal, in which case the foregoing assumptions shall not be made and the Appraiser shall determine the Fair Market Value based on the actual condition of such Item of Equipment). "Federal Funds Effective Rate" means for any day the greater of (i) average of the rates per annum as determined by ABN AMRO at which overnight Federal funds are offered to ABN AMRO for such day by major banks in the interbank market, and (ii) if ABN AMRO is borrowing overnight funds from a Federal Reserve Bank on that day, the rate per annum at which such overnight borrowings are made on that day. Each determination of the Federal Funds Effective Rate by ABN AMRO shall be conclusive and binding on Lessee except in the case of manifest errors. "Fee Letter" means the commitment and fee letter, dated December 5, 2000, between Lessee and ABN AMRO. "Fees" is defined in Section 4.1 of the Participation Agreement. "Final Expiration Date" means the last Expiration Date to occur with respect to all of the Lease Supplements. "Fiscal Quarter" means any reported quarter of a Fiscal Year. "Fiscal Year" means any period of twelve consecutive calendar months ending on March 31; references to a Fiscal Year with a number corresponding to any calendar year (e.g., the "2000 Fiscal Year") refer to the Fiscal Year ending on March 31st of such calendar year. "Fixed Charges" means, for any period for which a determination is made pursuant to the applicable terms of the Participation Agreement, the sum, without duplication, determined in respect of Lessee and its Subsidiaries on a consolidated basis, of (a) Interest Expense of Lessee and its Subsidiaries for such period plus (b) current maturities of long term Funded Indebtedness of Lessee and its Subsidiaries plus current maturities of long term Funded Indebtedness of any other Person to the extent Lessee or any of its Subsidiaries is liable in respect of any Guaranty Obligations of such Funded Indebtedness of such other Person, plus (c) all rental expenses of Lessee and its Subsidiaries for such period, plus (d) Capital Expenditures of Lessee and its Appendix 1-13 Subsidiaries during such period, plus (e) Restricted Payments, as described in clause (i) of the definition of such term, made by Lessee and its Subsidiaries (other than to Lessee) during such period. "Fixed Charge Coverage Ratio" means for any period for which a determination is made pursuant to the applicable terms of the Participation Agreement, with respect to Lessee and its Subsidiaries on a consolidated basis, the ratio of (a) Lessee EBITDAR for such period to (b) Fixed Charges for such period. "Fixed Rent" shall mean, for each Lease Supplement and each Payment Date therefor, that portion of the installment of Basic Rent payable on such Payment Date representing amortization of the relevant Lease Supplement Balance, all as set forth on Schedule A to the Lease, as amended from time to time pursuant to Section 4.1(a) of the Lease. "FlashVision/Toshiba Tranche Operative Documents" means the Participation Agreement (FlashVision/Toshiba Tranche) dated as of December 27, 2000 among FlashVision, L.L.C., as lessee, ABN AMRO, as agent, lessor and a participant, the Conduit Group Agents and the other "Participants" from time to time party thereto, the Guarantee of even date therewith executed by Toshiba, as guarantor, and the other "Operative Documents" as defined in Appendix 1 to such Participation Agreement. "F.R.S. Board" means the Board of Governors of the Federal Reserve System or any successor thereto. "Funded Indebtedness" of any Person means, without duplication: (a) All obligations of such Person evidenced by notes, bonds, debentures or other similar instruments and all other obligations of such Person for borrowed money (including obligations to repurchase receivables and other assets sold with recourse); (b) All non-contingent obligations of such Person for the deferred purchase price of property or services (including obligations under letters of credit and other credit facilities which secure or finance such purchase price), other than trade payables incurred by such Person in the ordinary course of its business on ordinary terms and overdue; (c) All obligations of such Person under conditional sale or other title retention agreements with respect to property acquired by such Person (to the extent of the value of such property if the rights and remedies of the seller or lender under such agreement in the event of default are limited solely to repossession or sale of such property), including the interest and yield components of rent under Synthetic Leases and, without duplication, the principal balance of Synthetic Leases; (d) All obligations of such Person as lessee under or with respect to Capitalized Lease Obligations; and (e) any Guaranty Obligations of such Person in respect of obligations described in clauses (a) through (d) above of another Person. Appendix 1-14 "Fund," "Funded" or "Funding" means each funding by a Participant of its Participation Interest in any Advance as described in Article III of the Participation Agreement. "GAAP" means United States generally accepted accounting principles (including principles of consolidation), in effect from time to time. "GAAS" means United States generally accepted auditing standards as in effect from time to time. "Governmental Action" means all permits, authorizations, registrations, consents, approvals, waivers, exceptions, variances, orders, judgments, written interpretations, decrees, licenses, exemptions, publications, filings, notices to and declarations of or with, or required by, any Governmental Authority, or required by any Applicable Laws, and shall include, without limitation, all environmental and operating permits and licenses that are required by Applicable Laws or any Governmental Authority for the use and operation of the Equipment as contemplated by the Lease. "Governmental Authority" means any nation or government, any state or other political subdivision thereof and any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. "Grossed-Up Basis" is defined in Section 12.4(d) of the Participation Agreement. "Guarantee" means that certain Guarantee dated as of December 27, 2000 executed and delivered by the Guarantor in favor of the Agent, Lessor and the Participants. "Guarantee Event of Default" is defined in Section 11.1 of the Guarantee. "Guarantor" means SanDisk Corporation, a Delaware corporation. "Guarantor EBITDAR" means, with respect to Guarantor and its Subsidiaries on a consolidated basis for any period for which a determination is made pursuant to the Operative Documents, the sum of the following: (a) The net income of Guarantor and its Subsidiaries for such period; plus (b) The sum (to the extent deducted in calculating net income in clause (a) above) of (i) all Interest Expenses (net of all interest income of Guarantor and its Subsidiaries during such period), (ii) all depreciation and amortization expenses, (iii) all rental expenses, and (iv) all tax expense based on or measured by income. "Guaranty Obligation" means, with respect to any Person, any direct or indirect liability of that Person with respect to any indebtedness, lease, dividend, letter of credit or other obligation, including a Synthetic Lease (the "primary obligations") of another Person (the "primary obligor"), including any obligation of that Person, whether or not contingent, (a) to purchase, repurchase or otherwise acquire such primary obligation or any property constituting Appendix 1-15 direct or indirect security therefor, or (b) to advance or provide funds (i) for the payment or discharge of any such primary obligation, or (ii) to maintain working capital or equity capital of the primary obligor or otherwise to maintain the net worth or solvency or any balance sheet item, level of income or financial condition of the primary obligor, or (c) to purchase property, securities or services primarily for the purpose of assuring the owner of any such primary obligation of the ability of the primary obligor to make payment of such primary obligation, or (d) otherwise to assure or hold harmless the holder of any such primary obligation against loss in respect thereof. The amount of any Guaranty Obligation shall be deemed equal to the stated or determinable amount of the primary obligation in respect of which such Guaranty Obligation is made or, if not stated or if indeterminable, the maximum reasonably anticipated liability in respect thereof. "Hazardous Activity" means any activity, process, procedure or undertaking that directly or indirectly (i) produces, generates or creates any Hazardous Substance; (ii) causes or results in (or threatens to cause or result in) the Release of any Hazardous Substance into the environment (including air, water vapor, surface water, groundwater, drinking water, land (including surface or subsurface), plant, aquatic and animal life); (iii) involves the containment or storage of any Hazardous Substance; or (iv) would be regulated as hazardous waste treatment, storage or disposal within the meaning of any Environmental Law. "Hazardous Substance" or "Hazardous Material" means any substance, waste or material which is toxic, explosive, corrosive, flammable, infectious, radioactive, carcinogenic, mutagenic or otherwise hazardous by listing characteristic or definition under any Environmental Law, including petroleum, crude oil or any fraction thereof, petroleum derivatives, by-products and other hydrocarbons and is or becomes regulated by any Governmental Authority, including any agency, department, commission, board or instrumentality of the United States or any political subdivision of the foregoing and also including asbestos, urea formaldehyde foam insulation, polychlorinated biphenyls ("PCBs") and radon gas. "Highest Lawful Rate" is defined in Section 4.3(b) of the Participation Agreement. "Holdback Amount" is defined in Section 3.1(c) of the Participation Agreement. "Impositions" means, except to the extent described in the following sentence, any and all liabilities, losses, expenses, costs, charges and Liens of any kind whatsoever for fees, taxes, levies, imposts, duties, charges, assessments or withholdings of any nature whatsoever ("Taxes") (including (i) personal property or ad valorem taxes; (ii) sales taxes, use taxes and other similar taxes (including rent taxes and intangibles taxes); (iii) any excise taxes; (iv) transfer taxes, conveyance taxes, mortgage taxes, intangible taxes, stamp taxes and documentary recording taxes and fees; (v) taxes that are or are in the nature of franchise, income, value added, gross receipts, privilege and doing business taxes, license and registration fees; and (vi) assessments on any Equipment or any Part thereof); and in each case all interest, additions to tax and penalties thereon, which at any time may be levied, assessed or imposed by any Governmental Authority upon or with respect to (a) any Indemnitee, any Equipment or any Part thereof or interest therein, or Lessee or any sublessee or user of any Equipment; (b) the leasing, financing, refinancing, demolition, construction, installation, substitution, subleasing, acquisition, acceptance, inspection, assignment, control, condition, servicing, maintenance, repair, ownership, possession, Appendix 1-16 sale, purchase, rental, lease, activity conducted on, delivery, insuring, use, operation, improvement, transfer, return or other disposition of any Equipment or any Part thereof or interest therein; (c) the Participation Interests or other indebtedness with respect to any Equipment or any Part thereof or interest therein or transfer thereof; (d) the rentals, receipts or earnings arising from any Equipment or any Part thereof or interest therein; (e) the Operative Documents, the performance thereof or any payment made or accrued pursuant thereto; (f) the income or other proceeds received with respect to any Equipment or any Part thereof or interest therein upon the sale or disposition thereof; (g) any contract relating to the manufacture, acquisition or delivery of any Equipment or any Part thereof or interest therein; or (h) otherwise in connection with the Overall Transaction or the enforcement thereof. Notwithstanding anything in the first paragraph of this definition (except as provided in the final paragraph of this definition) the term "Imposition" shall not mean or include: (i) Taxes and impositions (other than Taxes that are, or are in the nature of, sales, use, value added, rental, transfer, property or ad valorem taxes) that are imposed by any Governmental Authority and that are based upon or measured by net income (including any taxes based on capital gains and minimum taxes); provided that this clause (i) shall not limit or expand Lessee's obligations under Sections 12.4(e) or 13.3 of the Participation Agreement; (ii) any Tax or imposition to the extent, but only to such extent, that it relates to any act, event or omission that first occurs, or relates to a period, after the termination of the Lease, return of the Equipment as required under the Lease and payment in full of all amounts due under the Lease (but not any Tax or imposition that relates to any period prior to such termination, return and payment in full with respect to the Equipment to which such Tax or Imposition relates); (iii) any Tax or imposition for so long as, but only for so long as, it is being contested in accordance with the provisions of Section 12.4(b) of the Participation Agreement, provided that the foregoing shall not limit Lessee's obligation under Section 12.4(b) of the Participation Agreement to advance to such Indemnitee amounts with respect to Taxes or impositions that are being contested in accordance with Section 12.4(b) of the Participation Agreement or any expenses incurred by such Indemnitee in connection with such contest; (iv) any Taxes imposed against or payable by an Indemnitee resulting from, or that would not have been imposed but for, the actual (as opposed to imputed) gross negligence or actual (as opposed to imputed) willful misconduct of such Indemnitee; (v) any Taxes imposed upon an Indemnitee with respect to any voluntary transfer, sale, finance or other voluntary disposition of any interest in the Equipment or any part thereof or interest therein, or any interest or obligation under the Operative Documents or any Participation Interest, or from any sale, assignment, transfer or other disposition of any interest in an Indemnitee (other than any transfer in connection with (1) the exercise by the Lessee of an termination option or Purchase Option with respect to Appendix 1-17 the Equipment, (2) the exercise by Lessee of the Sale Option, (3) an Event of Default or (4) a Casualty or Condemnation affecting the Equipment); (vi) Taxes imposed on or payable by an Indemnitee to the extent such Taxes would not have been imposed but for a breach by the Indemnitee or an Affiliate thereof of any representations, warranties or covenants in the Operative Documents (unless such breach is caused by Lessee's breach of any of its representations, warranties or covenants in the Operative Documents); (vii) Taxes to the extent resulting from an Indemnitee's failure to comply with the provisions of Section 12.4(b) of the Participation Agreement, which failure materially adversely affects the ability of Lessee to contest such Taxes (unless such failure is caused by Lessee's breach of any of its representations, warranties, or covenants in the Operative Documents; or (viii) any Taxes imposed on an Indemnitee as a result of the failure of such Indemnitee to file any return or report timely and in the form prescribed by law or to pay any Tax (unless such failure is caused by Lessee's breach of any of its representations, warranties or covenants in the Operative Documents). Notwithstanding the foregoing, the exclusions from the definition of Impositions set forth in clauses (i), (ii) and (viii) above shall not apply (but the other exclusions shall apply) to any Taxes or increase in Taxes (net of any corresponding decrease in Taxes realized by an Indemnitee) imposed by a taxing authority of a State in which the Equipment is located on an Indemnitee, to the extent such increase or imposition would not have occurred if on each Lease Supplement Closing Date the Participants had advanced funds to Lessee in the form of a loan secured by the Equipment in an amount equal to the amounts funded on such Lease Supplement Closing Date, with debt service for such loan equal to the Basic Rent payable and a principal balance on the maturity of such loan in an amount equal to the then outstanding amount of the Lease Supplement Balance at the end of the Lease Term with respect to such Equipment. "Indebtedness" of any Person shall mean, without duplication, (i) all indebtedness of such Person for borrowed money or for the deferred purchase price (or a portion thereof) of property or services, including obligations under Synthetic Leases (other than trade payables incurred in the ordinary course of business of such Person), (ii) all indebtedness of such Person evidenced by a note, bond, debenture or similar instrument, (iii) the principal component of all Capitalized Lease Obligations of such Person and all obligations of such Person under any other lease to the extent that the then present value of the minimum rental commitment thereunder should, in accordance with GAAP, be capitalized on a balance sheet of such Person, (iv) the face amount of all letters of credit issued for the account of such Person and, without duplication, all unreimbursed amounts drawn thereunder, (v) all indebtedness of any other Person secured by any Lien on any property owned by such Person, whether or not such indebtedness has been assumed, (vi) payment obligations under any interest rate protection agreements (including without limitation, any interest rate swaps, caps, floors, collars and similar agreements) and currency swaps and similar agreements, and (vii) any indebtedness of any other Person of the character referred to in clauses (i) through (vi) with respect to which such Person has become Appendix 1-18 liable by way of any guarantee, similar contingent obligation or other arrangement which has the effect of assuring payment. "Indemnitee" means each Participant, Agent (in its individual capacity and as agent), Lessor (in its individual capacity and as lessor), any additional, separate or co-agent appointed in accordance with the terms of the Participation Agreement, and the respective Affiliates, successors, permitted assigns, permitted transferees, contractors, employees, officers, directors, shareholders, partners, Sub-Participants, representatives and agents of each of the foregoing Persons; provided, however, that in no event shall Guarantor, Lessee or any of their respective Affiliates be an Indemnitee. "Initial Appraisal" means the appraisal of all of the Equipment delivered pursuant to Appendix 2 to the Participation Agreement on the Document Closing Date, setting forth the Fair Market Value of each Item of Equipment which as of the initial Lease Supplement Closing Date or any subsequent Lease Supplement Closing Date is to become subject to the Lease, in form and substance, and using appraisal methods, reasonably satisfactory to Agent and the Required Participants. Such appraisal shall be prepared at the sole cost and expense of Lessee. "Installation Expenses" means all fees, costs and expenses incurred or payable by Lessee with respect to the Installation of any Equipment. "Installation Period" means the period commencing on the Document Closing Date and ending on the earliest of (i) the eighteenth (18th) monthly anniversary of the Document Closing Date, (ii) the termination of the Lease as to all Lease Supplements pursuant to Section 10.1(a) of the Lease, (iii) the date Lessee gives notice or is deemed to have given notice of its election of the Purchase Option or Sale Option pursuant to Section 11.1(b) or 11.1(c) of the Lease, to the extent such notice relates to all of the Equipment then subject to the Lease, or (iv) upon the occurrence of an Event of Default as described in Section 8.1(e) of the Lease or upon notice by Agent, at the direction of the Required Participants, following the occurrence of any other Event of Default, that the Commitments are terminated. "Installed" means, with respect to any Equipment, that such Equipment has been installed at the Facility and is fully operational and fit for its intended purposes, and "Installation" shall refer to the process of causing any such Equipment to be so Installed. "Insurance Requirements" means all terms and conditions of any insurance policy required by the Lease to be maintained by Lessee and all requirements of the issuer of such policy with respect to such policy. "Interest Expense" means, with respect to any Person (and its Subsidiaries) on a consolidated basis for any period, the sum determined on a consolidated basis in accordance with GAAP, of (a) all interest accruing on the Indebtedness of such Person during such period (including, without limitation, interest attributable to Capitalized Lease Obligations) plus (b) all fees in respect of outstanding letters of credit payable by such Person and accruing during such period. "Interest Period" means (a) with respect to any interest or yield in respect of any portion of the Participation Interests determined by reference to the Prime Rate, all or any portion of the Appendix 1-19 period from and including a Payment Date (or, in the case of the initial Interest Period in respect thereof, from and including the date on which such Participation Interests were Funded at such rate or were converted into a Funding of such Type, in either case in accordance with the Operative Documents) in respect of such portion of Variable Rent representing such interest or yield, to but excluding the next succeeding Payment Date in respect of such portion of Variable Rent during which such interest or yield is determined by reference to such rate, or (b) with respect to any interest or yield on any portion of any Participation Interests determined by reference to the LIBO Rate, the LIBO Rate Period therefor then in effect as of the determination date. "Item of Equipment" means any item of equipment used or to be used in the manufacture of NAND flash memory integrated circuits at the Facility and which is or will be purchased by Lessor pursuant to the Operative Documents and described on Schedule I to the relevant Lease Supplement but only if included in the Initial Appraisal, together with any accessories, additions, improvements, modifications, Parts and replacements from time to time incorporated or installed in any such item of equipment which are or become property of Lessor pursuant to the terms of the Lease. "Investment Company Act" means the Investment Company Act of 1940, as amended, together with the rules and regulations promulgated thereunder. "Lease" means the Master Lease Intended as Security FlashVision/SanDisk Tranche, dated as of December 27, 2000, between Lessor and Lessee, together with all Lease Supplements. "Lease Balance" means, as of any determination date, the sum of the outstanding amount of the Lease Supplement Balances. "Lease Extension" is defined in Section 14.18 of the Participation Agreement. "Lease Supplement" means a Lease Supplement substantially in the form of Exhibit A to the Lease, together with all attachments and schedules thereto, as any such Lease Supplement may be amended from time to time pursuant to the Operative Documents. "Lease Supplement Balance" means, with respect to any Lease Supplement as any date of determination, the sum of (i) the amount set forth in Section 7 of such Lease Supplement, less (ii) the amount of all Fixed Rent, Renewal Payments and Casualty Amounts paid by Lessee pursuant to such Lease Supplement and the Lease. "Lease Supplement Closing Date" means any Business Day on which an Advance is made under the Participation Agreement in accordance with Section 3.3 thereof, Lessor purchases any Equipment, a Lease Supplement in respect of such Equipment is executed and delivered in accordance with the Operative Documents and the conditions precedent set forth in Article VI of the Participation Agreement have been satisfied or waived in respect of such Lease Supplement. "Lease Supplement Closing Date Notice" is defined in Section 3.3 of the Participation Agreement. Appendix 1-20 "Lease Supplement Equipment" means, with respect to any Lease Supplement, all Equipment listed on Attachment A to such Lease Supplement. "Lease Term" with respect to any Lease Supplement is defined in Section 3.1 of the Lease. "Lease Term Appraisal" means any appraisal required to be delivered pursuant to Section 11.4 of the Lease. "Lessee" means FlashVision, L.L.C., a Virginia limited liability company. "Lessee Articles" means the Articles of Organization of Lessee as filed with the State Corporation Commission of the Commonwealth of Virginia on May 16, 2000. "Lessee EBITDAR" means, with respect to Lessee and its Subsidiaries on a consolidated basis for any period for which a determination is made pursuant to the Operative Documents, the sum of the following: (a) The net income of Lessee and its Subsidiaries for such period; plus (b) The sum (to the extent deducted in calculating net income in clause (a) above) of (i) all Interest Expenses (net of all interest income of Lessee and its Subsidiaries during such period), (ii) all depreciation and amortization expenses, (iii) all rental expenses, and (iv) all tax expense based on or measured by income. "Lessor" means ABN AMRO in its capacity as lessor under the Operative Documents. "Lessor Lien" means Liens on or against any Equipment (a) which result from any act of, or any Claim against, Lessor or any Participant in any case unrelated to the Overall Transaction or (b) which result from any Tax owed by any such Person, except any Tax for which Lessee is obligated to indemnify. "Level I" means at any time that the Guarantor's Leverage Ratio at the end of the applicable Fiscal Quarter for the trailing four Fiscal Quarters then ended is less than 1.50 to 1.0. "Level II" means at any time that the Guarantor's Leverage Ratio at the end of the applicable Fiscal Quarter for the trailing four Fiscal Quarters then ended is greater than or equal to 1.50 to 1.0 but is less than 2.00 to 1.0. "Level III" means at any time that the Guarantor's Leverage Ratio at the end of the applicable Fiscal Quarter for the trailing four Fiscal Quarters then ended is greater than or equal to 2.00 to 1.0 but is less than 2.50 to 1.0. "Level IV" means at any time that the Guarantor's Leverage Ratio at the end of the applicable Fiscal Quarter for the trailing four Fiscal Quarters then ended is greater than or equal to 2.50 to 1.0 but is less than 2.75 to 1.0. Appendix 1-21 "Level V" means at any time that the Guarantor's Leverage Ratio at the end of the applicable Fiscal Quarter for the trailing four Fiscal Quarters then ended is equal to or greater than 2.75 to 1.0. "Leverage Ratio" means as of any date of determination, for Guarantor and its Subsidiaries on a consolidated basis, the ratio of (i) Consolidated Total Debt as of such date to (ii) Guarantor EBITDAR for the four-Fiscal Quarter period then ended, in each case as set forth in the most recent Compliance Certificate delivered by the Guarantor pursuant to the Guarantee. "LIBO Rate" means for any LIBO Rate Period at any time, the applicable London interbank offered rate for deposits in U.S. dollars appearing on Telerate Page 3750 as of 11:00 a.m. (London time) two (2) Business Days prior to the first day of the LIBO Rate Period chosen by Lessee or otherwise in effect pursuant to Section 10.1 of the Participation Agreement, and having a maturity approximately equal to such LIBO Rate Period; or if no London interbank offered rate of such maturity then appears on Telerate Page 3750, then the rate equal to the London interbank offered rate for deposits in U.S. dollars maturing immediately before or immediately after such maturity, whichever is higher, as determined by Agent from Telerate Page 3750; or if Telerate Page 3750 is not available, the applicable LIBO Rate for the relevant LIBO Rate Period shall be the rate determined by Agent to be the arithmetic average of the rates at which ABN AMRO offers to place deposits in U.S. dollars with first-class banks in the London interbank market at approximately 11:00 a.m. (London time) two (2) Business Days prior to the first day of such LIBO Rate Period, in the approximate amount of the aggregate outstanding Lease Balance to which such LIBO Rate is to apply having a maturity approximately equal to such LIBO Rate Period. "LIBO Rate Funding" means, with respect to any Participation Interest, the portion of such Participation Interest which is accruing interest or yield by reference to the LIBO Rate (Reserve Adjusted). "LIBO Rate Period" means, with respect to any LIBO Rate Funding: (a) (i) initially the period commencing on the applicable Lease Supplement Closing Date, so long as three (3) Business Days prior written notice of such Lease Supplement Closing Date has been given in accordance with Section 3.3 of the Participation Agreement and ending one, two, three or six months thereafter, as selected by Lessee in the relevant Lease Supplement Closing Date Notice; or (ii) with respect to any conversion of any portion of any Participation Interests into a LIBO Rate Funding from a Prime Rate Funding, the period commencing on the day on which such Prime Rate Funding is so converted pursuant to an irrevocable notice of conversion given to Agent by Lessee pursuant to Section 3.2(g) of the Participation Agreement and ending one, two, three or six months thereafter, as selected by Lessee in such notice of conversion; and (b) thereafter, each period commencing on the last day of the next preceding LIBO Rate Period applicable to such Participation Interests and ending one, two, three or six months thereafter, as selected by Lessee by irrevocable notice to Lessor and the Agent Appendix 1-22 not less than three Business Days prior to the last day of the then current LIBO Rate Period with respect thereto; provided that, the foregoing provisions relating to LIBO Rate Periods are subject to the following: (i) if any LIBO Rate Period would otherwise end on a day that is not a Business Day, such LIBO Rate Period shall be extended to the next succeeding Business Day unless the result of such extension would be to carry such LIBO Rate Period into another calendar month, in which event such LIBO Rate Period shall end on the immediately preceding Business Day; (ii) any LIBO Rate Period in respect of Participation Interests relating to any Lease Supplement that would otherwise extend beyond the Expiration Date in respect of such Lease Supplement shall end on such Expiration Date; (iii) any LIBO Rate Period that begins on a day for which there is no numerically corresponding day in the calendar month at the end of such LIBO Rate Period shall end on the last Business Day of such last calendar month of such LIBO Rate Period; (iv) Lessee shall select LIBO Rate Periods so as not to require a payment or prepayment of any Participation Interests during a LIBO Rate Period for such Participation Interests; and (v) if Lessee shall fail to specify the length of any LIBO Rate Period for any Participation Interests, such Participation Interests shall have a LIBO Rate Period of one month. Interest and yield computations in respect of LIBO Rate Fundings shall be made including the first day, but excluding the last day, occurring in each LIBO Rate Period. "LIBO Rate (Reserve Adjusted)" means, relative to any Advance for any LIBO Rate Period, a rate per annum (rounded upwards, if necessary, to the nearest 1/16 of 1%) determined pursuant to the following formula: LIBO RATE LIBO RATE (Reserve Adjusted) = -------------------------------- 1.00 - LIBOR Reserve Percentage The LIBO Rate (Reserve Adjusted) for any LIBO Rate Period will be determined by Agent, on the basis of the LIBOR Reserve Percentage in effect on, and the applicable LIBO Rate obtained by Agent, two Business Days before the first day of such LIBO Rate Period. "LIBOR Reserve Percentage" means, relative to any LIBO Rate Period, the reserve percentage (expressed as a decimal) equal to the maximum aggregate reserve requirements (including all basic, emergency, supplemental, marginal and other reserves and taking into account any transitional adjustments or other scheduled changes in reserve requirements) specified under regulations issued from time to time by the F.R.S. Board and then applicable to Appendix 1-23 assets or liabilities consisting of and including "Eurocurrency Liabilities", as currently defined in Regulation D of the F.R.S. Board, having a term approximately equal or comparable to such LIBO Rate Period. "Lien" means any mortgage, deed of trust, pledge, security interest, encumbrance, lien, easement, declaration or servitude of any kind, including, without limitation, any irrevocable license, conditional sale or other title retention agreement or any financing lease having substantially the same economic effect as the foregoing. "Management Committee" is defined in the Master Agreement. "Master Agreement" means that certain Master Agreement dated as of May 9, 2000 among Toshiba, SENA and Guarantor, together with all Schedules, Exhibits and Appendices thereto, as the same may be amended, restated, supplemented or otherwise modified from time to time to the extent permitted by the Operative Documents. "Master Agreement Documents" means the Master Agreement, the Operating Agreement, the Lessee Articles, the Environmental Indemnity Agreement, the DSC Services Agreement and when effective, the Sublease, the Purchase and Supply Agreements, the DSC Foundry Agreement and any Affiliate Sublease, as any such document may be amended, restated, supplemented or otherwise modified from time to time to the extent permitted by the Operative Documents. "Master Agreement Event of Default" means a breach or default by any applicable Person under any of the Specified Master Agreement Document Provisions. "Material Adverse Effect" means any change or changes, effect or effects or condition or conditions that individually or in the aggregate are or would reasonably be expected to be materially adverse to (i) the business operations or financial condition of Lessee or of Guarantor and its Subsidiaries on a consolidated basis, (ii) the Overall Transaction, (iii) the ability of Lessee or Guarantor to perform their respective obligations under the Operative Documents, (iv) the validity or enforceability of any of the Operative Documents, or (v) the useful life or Fair Market Value of the Equipment then subject to the Lease, on any date of determination. "Materials of Environmental Concern" shall mean and include chemicals, pollutants, contaminants, wastes, toxic substances, petroleum and petroleum products. "Members" means the members of Lessee which, as of the Document Closing Date, are the Guarantor and SENA. "Membership Interest" means a Member's aggregate rights in Lessee, including such Member's right to a share of the profits and losses of Lessee, the right to receive distributions from Lessee and the right to vote and participate in the management of Lessee. "Modifications" is defined in Section 5.4 of the Lease. "Moody's" means Moody's Investors Service, Inc. or any successor agency thereto. Appendix 1-24 "Multiemployer Plan" means any Employee Benefit Plan which is a "multiemployer plan" as defined in Section 3(37) of ERISA. "Non-Consenting Participant" means any Participant that has not consented to (a) any amendment or waiver requested pursuant to the Operative Documents, or (b) any Lease Extension pursuant to Section 14.18 of the Participation Agreement. "Non-Defaulting Participant" is defined in Section 3.4(b) of the Participation Agreement. "Obligations" means all obligations (monetary or otherwise) of Lessee arising under or in connection with any of the Operative Documents. "Operating Agreement" means the Operating Agreement dated as of May 9, 2000 between the Guarantor and SENA with respect to the formation and governance of Lessee, as the same may be amended, restated, supplemented or otherwise modified from time to time to the extent permitted by the Operative Documents. "Operating Committee" is defined in the Operating Agreement. "Operative Documents" means the following: (a) the Participation Agreement; (b) the Lease; (c) the Lease Supplements; (d) the Security Documents; (e) the Bills of Sale; (f) the Guarantee; and (g) the Fee Letter. "Option Exercise Amount" means, as of any date of determination with respect to any Lease Supplement, the sum of the relevant Lease Supplement Balance plus all accrued but unpaid Rent thereon plus all other sums then due and payable with respect thereto under the Operative Documents by Lessee or any of its Affiliates. "Original Part" is defined in Section 5.4 of the Lease. "Overall Transaction" means all the transactions and activities referred to in or contemplated by the Operative Documents. "Overdue Rate" means the Prime Rate plus 2.0% per annum. "Part" means all appliances, parts, instruments, appurtenances, accessories, furnishings and other equipment of whatever nature that may from time to time be incorporated or installed in or attached to any Item of Equipment. "Participant Balance" means (a) with respect to any Lease Supplement for each Participant, the sum of its Tranche A Participant Balance related thereto, its Tranche B Participant Balance related thereto and its Tranche C Participant Balance related thereto, and (b) Appendix 1-25 with respect to the Lease Balance for each Participant, the sum of its Tranche A Participant Balance, its Tranche B Participant Balance and its Tranche C Participant Balance. "Participants" means, collectively, the Tranche A Participants, the Tranche B Participants, and the Tranche C Participants. "Participation Agreement" means the Participation Agreement (FlashVision/SanDisk Tranche), dated as of December 27, 2000, among Lessee, Agent, Lessor and the Participants. "Participation Interest" means, as to each Tranche A Participant and Tranche B Participant, a participation interest or, as to each Tranche C Participant, an equity interest, in the Advances Funded by it and the Lease and the right to receive its applicable portion of the following payments actually received by Lessor from or on behalf of Lessee with respect to any Lease Supplement or any other Operative Document, pursuant to the provisions of Section 5.3 of the Participation Agreement: (i) Basic Rent, (ii) Supplemental Rent, (iii) Option Exercise Amount, (iv) Proceeds, (v) Residual Value Guarantee Amount, (vi) the Lease Balance or any Lease Supplement Balance, and (vii) other payments in respect of indemnities or pursuant to the Guarantee or the exercise of remedies under the Operative Documents, but excluding, however, (x) any Excepted Payments and (y) as to a particular Participant, any payments on account of any Advances and interest or yield thereon for which Lessor has not received payment from such Participant of such Participant's Commitment Percentage thereof. "Payment Date" means, with respect to the Base Term and each Renewal Term in respect of any Lease Supplement, (a) as to any Variable Rent accruing based on a LIBO Rate, the last day of each LIBO Rate Period therefor then in effect (or, if any such LIBO Rate Period is longer than three months, the three month calendar anniversary of the first day of such LIBO Rate Period and the last day of such LIBO Rate Period), (b) as to any other Variable Rent, the fifteenth (15th) day of each month or if such fifteenth (15th) day is not a Business Day, the next succeeding Business Day, and (c) as to any Fixed Rent payable with respect thereto, each Business Day specified on Schedule A to the Lease as a "Payment Date" in respect of Fixed Rent thereon. "Payment Default" means an Event of Default contemplated by Section 8.1(a) of the Lease. "PBGC" means the Pension Benefit Guaranty Corporation or any entity succeeding to any or all of its functions under ERISA. "Pension Plan" means any Employee Benefit Plan, other than a Multiemployer Plan, which is subject to Section 412 of the Code or Section 302 of ERISA. "Permitted Contest" means actions taken by a Person to contest in good faith, by appropriate proceedings initiated timely and diligently prosecuted, the legality, validity or applicability to any Equipment or other Collateral or any interest in any thereof of any Person of (a) any law, regulation, rule, judgment, order or other legal provision or judicial or administrative requirements; (b) any term or condition of, or any revocation or amendment of, or other proceeding relating to, any authorization or other consent, approval or other action by any Governmental Authority or any Governmental Action; (c) any manufacturer's guidelines or Appendix 1-26 standards or any Insurance Requirements, or (d) any Lien or Tax; provided that the initiation and prosecution of such contest would not: (i) result in, or increase the risk of the imposition of, any criminal liability on any Indemnitee; (ii) materially and adversely affect the security interests created by the Operative Documents or the right, title or interest of Agent, Lessor or any Participant in or to any of the Equipment or any Part thereof or other Collateral or the right of Agent, Lessor or any Participant to receive all or any portion of the Rent, Lease Balance, or any other amount payable under the Operative Documents; (iii) permit, or pose a material risk of, the sale or forfeiture of, or foreclosure on, any Equipment or any Part thereof or other Collateral; or (iv) materially and adversely affect the fair market value, utility or remaining useful life of any Equipment or other Collateral or any interest therein or the continued economic operation thereof; and provided further that in any event adequate reserves in accordance with GAAP are maintained against any adverse determination of such contest. "Permitted Liens" means (a) any rights in favor of Agent, Lessor and/or the Participants pursuant to the Lease and the other Operative Documents; (b) materialmen's, mechanics', workers', artisan's, repairmen's, employees' or other like Liens securing payment of the price of goods or services (but excluding any Installation Expenses) rendered in the ordinary course of business for amounts the payment of which is not overdue or is being contested pursuant to a Permitted Contest; (c) any Lessor Lien; (d) Liens for current Taxes which are not delinquent or the validity of which is being contested pursuant to a Permitted Contest; (e) Liens of any of the types referred to in clause (b) above that have been bonded for not less than the full amount in dispute (or as to which other security arrangements reasonably satisfactory to Lessor have been made), which bonding (or arrangements) shall comply with applicable Requirements of Law, and has effectively stayed any execution or enforcement of such Liens; (f) Liens arising out of judgments or awards with respect to which appeals or other proceedings for review are being prosecuted in good faith and for the payment of which adequate reserves have been provided as required by GAAP or other appropriate provisions have been made, so long as such proceedings have the effect of staying the execution of such judgments or awards and satisfy the conditions for the continuation of proceedings to contest set forth in Section 5.7 of the Lease; (g) Liens attaching to property or assets (other than the Equipment or other Collateral) and created with the consent of the Required Participants; (h) Liens (other than Liens created or imposed under ERISA or Liens on or in any way affecting the Equipment) incurred or deposits made by Lessee in the ordinary course of business in connection with workers' compensation, unemployment insurance and other types of social security, or to secure the performance of tenders, statutory obligations, bids, leases, government contracts, performance and return-of-money bonds and other similar obligations (exclusive of obligations for the payment of borrowed money); (i) the respective rights and interests of the parties under the Sublease or any Affiliate Sublease; provided (i) such rights and interests under such Sublease or Affiliate Sublease remain at all times subject and subordinate to the rights of Agent and the Participants and the Liens granted to Lessor and/or Agent under the Operative Documents and (ii) such Sublease or Affiliate Sublease shall not create, grant or provide for any Lien against any Equipment; and (j) Liens in favor of manufacturers of equipment that is to become Equipment but only so long as such Liens terminate on or prior to such equipment being purchased by Lessor pursuant to the Participation Agreement, other than with respect to the Equipment subject to the final Lease Supplement for which a Holdback Amount has been established; provided that such Liens terminate upon release of the Holdback Amount. Appendix 1-27 "Permitted Modification" is defined in Section 5.4 of the Lease. "Person" means any individual, corporation, partnership, joint venture, limited liability company, association, joint-stock company, trust, unincorporated organization, Governmental Authority or any other entity. "Prime Rate" means, on any date on which the Prime Rate is used with respect to any Variable Rent, a fluctuating rate of interest per annum equal to the greater of (i) the rate of interest most recently announced by ABN AMRO as its prime rate and (ii) the Federal Funds Effective Rate most recently determined by Agent, plus 50 basis points per annum. If the Federal Funds Effective Rate or the rate of interest announced by ABN AMRO as its prime rate, as applicable, changes from time to time after the Document Closing Date, the Prime Rate shall be automatically increased or decreased, if appropriate and as the case may be, without notice to Lessee or Lessor, as of the effective time of each change. "Prime Rate Funding" means, with respect to any Participation Interest, the portion of such Participation Interest which is accruing interest or yield by reference to the Prime Rate. "Proceeds" means all amounts received by Agent or Lessor in connection with any Casualty or any sale of the Equipment pursuant to Lessor's exercise of remedies under Section 8.2 of the Lease or Lessee's exercise of the Sale Option under Section 11.1(c) of the Lease, and all interest earned thereon, less, solely in the case of a sale pursuant to Section 8.2 of the Lease, the reasonable expense of claiming and collecting such amounts, including all reasonable costs and expenses in connection therewith for which Agent, Lessor or any Participant is entitled to be reimbursed pursuant to the Lease. "Purchase and Supply Agreements" means each Purchase and Supply Agreement to be entered into between Lessee and each of SENA and SanDisk, respectively, and referred to in Section 8.1(w) of the Participation Agreement. "Purchase Option" is defined in Section 11.1(b) of the Lease. "Purchase Price" for any Equipment means an amount equal to the lesser of (a) the purchase price paid by Lessee to the manufacturer or vendor of such Equipment pursuant to the applicable Acquisition Agreement, including any other amounts payable to the manufacturer or vendor of such Equipment and referred to in the invoice for such Equipment, to the extent included in the applicable Appraisal referred to in clause (b) below, and (b) the Fair Market Value of such Equipment as of the Lease Supplement Closing Date therefor indicated in (i) the Initial Appraisal, or (ii) in the case of any Equipment acquired by Lessor as of any Lease Supplement Closing Date occurring after the first anniversary of the Document Closing Date, the most recent Annual Appraisal delivered as of such Lease Supplement Closing Date, provided that in the event a Supplemental Appraisal of any Equipment is required to be delivered pursuant to Section 6.2(b) of the Participation Agreement, the Fair Market Value of such Equipment shall be as indicated in such Supplemental Appraisal. "Regulated Activity" shall mean the use, Release, generation, treatment, storage, recycling, transportation or disposal of Hazardous Substance to the extent such activities are regulated by any Governmental Authority. Appendix 1-28 "Regulation T, U, or X" means Regulation T, U or X, respectively, of the F.R.S. Board as from time to time in effect and any successor to all or a portion thereof. "Related Agreements" shall mean all agreements or contracts now or hereafter necessary for the use, operation or maintenance of any Equipment or otherwise relating to any Equipment, including each Acquisition Agreement, but excluding the Master Agreement Documents. "Related Goods" shall mean (a) all operation manuals, service manuals, maintenance manuals and other materials regarding the operation, service or maintenance of the Equipment provided by the vendors or manufacturers of the Equipment or others and (b) all books and records relating to the Equipment in any and all tangible forms, except to the extent the same constitutes confidential business information or processes of Lessee. "Related Intangibles" shall mean all general intangibles now or hereafter necessary for the use, operation or maintenance of any Equipment or otherwise relating to any Equipment, including all records, files, insurance policies, guarantees and warranties relating to such Equipment, and all computer software and intellectual property, guaranties and warranties and documents relating to such Equipment to the extent provided by the manufacturer or vendor of the Equipment, except to the extent the same constitutes proprietary business information or processes of Lessee, in each case to the extent assignable. "Related Permits" shall mean all licenses, authorizations, certificates, consents, approvals and other permits, now or hereafter necessary for the use, operation or maintenance of the Equipment or otherwise relating to the Equipment. "Related Property" means, with respect to any Lease Supplement, all Related Agreements, Related Goods, Related Intangibles and Related Permits applicable thereto. "Release" means the release, deposit, disposal or leak of any Hazardous Substance into or upon or under any land or water or air, or otherwise into the environment, including, without limitation, by means of burial, disposal, discharge, emission, injection, spillage, leakage, seepage, leaching, dumping, pumping, pouring, escaping, emptying, placement and the like. "Removable Part" is defined in Section 5.4 of the Lease. "Renewal Payment" means, with respect to any Lease Supplement, the payment required to be made pursuant to Section 4.1(b) of the Lease on the last day of the relevant Base Term or Renewal Term, as applicable, which payment shall be applied to reduce the applicable outstanding Lease Supplement Balance as of such date (after applying any Fixed Rent or Casualty Amount payable or to be paid on such date with respect to such Lease Supplement) to an amount not in excess of the aggregate Fair Market Value of the relevant Lease Supplement Equipment as of such date, but in each case only to the extent, if any, that such Lease Supplement Balance exceeds the Fair Market Value of such Equipment. "Renewal Option" is defined in Section 11.1(a) of the Lease. "Renewal Term" is defined in Section 11.1(a) of the Lease. Appendix 1-29 "Rent" means, collectively, the Basic Rent and the Supplemental Rent, in each case payable under the Lease. "Replaced Equipment" is defined in Section 6.4 of the Lease. "Replacement Notice" is defined in Section 6.4 of the Lease. "Replacement Participant" is defined in Section 10.1(b) of the Participation Agreement. "Replacement Equipment" means (x) a new Item of Equipment of identical manufacture and model as the Item of Equipment comprising the Replaced Equipment or (y) an Item of Equipment which shall have a utility, Fair Market Value, and an economic useful life at least equal to that of the Replaced Equipment immediately prior to such substitution assuming the Replaced Equipment was in the condition and repair required to be maintained by the terms of the Lease, and Lessee shall have provided to Agent and Lessor at Lessee's expense, an appraisal satisfactory to Agent and Lessor with respect to the determination of such utility, Fair Market Value and economic useful life or (z) such Replacement Equipment as shall otherwise be acceptable to each of the Participants in its respective sole and absolute discretion. "Required Alteration" is defined in Section 5.4 of the Lease. "Required Participants" means, as of any date of the determination, Participants the Commitment Percentages of which aggregate at least 51% of the aggregate Commitment Percentages of all Participants. "Requirements of Law" means all Federal, state, county, municipal and other governmental statutes, laws, rules, orders, regulations, ordinances, judgments, decrees and injunctions, affecting the Equipment or other Collateral, or the demolition, manufacture, installation, use or alteration thereof, whether now or hereafter enacted and in force, including any that require repairs, modifications or alterations in or to the Equipment or other Collateral or in any way limit the use and enjoyment thereof and any that may relate to environmental requirements (including all Environmental Laws), and all permits, licenses, authorizations and regulations relating thereto. "Residual Value Guarantee Amount" means, with respect to any Lease Supplement as of any date of determination, an amount equal to the percentage, as specified in Schedule B to the Lease in respect of the Base Term or Renewal Term then in effect, with respect to such Lease Supplement of the applicable Lease Supplement Balance as of the first day of the Base Term or Renewal Term then in effect with respect to such Lease Supplement, less Fixed Rent and Casualty Amounts applied to the Tranche A Participant Balance paid by Lessee in respect thereof or any other amount paid in reduction of the applicable Lease Supplement Balance and applied to the Tranche A Participant Balance during the Base Term or Renewal Term then in effect, but in no event less than the aggregate outstanding Participation Interests of the Tranche A Participants in respect of such Lease Supplement on the applicable Expiration Date. "Responsible Officer" means (i) in the case of Lessee, the President, the Chief Executive Officer or Executive Vice President, and (ii) in the case of Guarantor, the Chief Financial Officer. Appendix 1-30 "Responsible Officer's Certificate" means a certificate signed by any Responsible Officer, which certificate shall certify as true and correct the subject matter being certified to in such certificate. "Restricted Payment" means (i) any dividend or other payment or distribution, direct or indirect, on account of any Membership Interests of Lessee now or hereafter outstanding (including without limitation any payment in connection with any dissolution, merger, consolidation or disposition involving Lessee), or to the Members, in their capacity as such, in respect of any Membership Interests of Lessee, now or hereafter outstanding, (ii) any redemption, retirement, sinking fund or similar payment, purchase or other acquisition for value, direct or indirect, of any Membership Interests of Lessee, now or hereafter outstanding and (iii) any payment made to retire, or to obtain the surrender of, any outstanding warrants, options or other rights to acquire Membership Interests of Lessee now or hereafter outstanding. "S&P" means Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc., or any successor agency thereto. "Sale Option" is defined in Section 11.1(c) of the Lease. "Scheduled Lease Supplement Closing Date" is defined in Section 3.4 of the Participation Agreement. "SEC" means the Securities and Exchange Commission. "Securities Act" means the Securities Act of 1933, as amended, together with the rules and regulations promulgated thereunder. "Security Agreement " means that certain Security Agreement to be entered into as of the initial Lease Supplement Closing Date between Lessor and Agent, for the benefit of the Participants. "Security Documents" means the Security Agreement, the Collateral Assignment and all UCC financing statements executed, delivered and filed or required to be executed, delivered and filed pursuant to the Operative Documents. "SENA" means Semiconductor North America, Inc. a Delaware corporation and a wholly-owned Subsidiary of Toshiba. "Specified Master Agreement Document Provisions" means the provisions of the Master Agreement Documents specified on Schedule 8.1(s) to the Participation Agreement, as amended from time to time in accordance with Section 8.1(w) of the Participation Agreement. "Sublease" means that certain Master Lease Agreement (FlashVision/SanDisk Tranche) to be entered into on or prior to the initial Lease Supplement Closing Date between Lessee, as lessor, and DSC, as lessee, relating to the Equipment. "Subsidiary" shall mean, with respect to any Person, any corporation or other entity of which securities or other ownership interests having ordinary voting power to elect a majority of Appendix 1-31 the board of directors or other Persons performing similar functions are at the time directly or indirectly owned by such Person. "Sub-Participant" is defined in Section 11.2 of the Participation Agreement. "Supplemental Appraisal" means any update (which update shall be a desktop appraisal) of the Initial Appraisal or then most recent Annual Appraisal, as applicable, from an Appraiser received pursuant to Section 6.2(b) of the Participation Agreement on a Lease Supplement Closing Date, setting forth as of such date the Fair Market Value of each Item of Equipment then required to be appraised pursuant to said Section 6.2(b) of the Participation Agreement, any of which appraisal updates shall be in form and substance reasonably satisfactory to Agent and the Required Participants and shall use appraisal methods consistent with the methods used in the Initial Appraisal. Each such appraisal shall be prepared at the sole cost and expense of Lessee. "Supplemental Rent" means any and all amounts, liabilities and obligations other than Basic Rent which Lessee assumes or agrees or is otherwise obligated to pay under the Lease or any other Operative Document (whether or not designated as Supplemental Rent) to Agent, Lessor, any Participant or any other Person, including without limitation, Fees, Break Costs, any Residual Value Guarantee Amount, any Lease Balance, any Lease Supplement Balance, any Renewal Payment and any Additional Costs. "Synthetic Lease" means a lease intended to qualify as an operating lease under Financial Accounting Standards Board Statement No. 13 where the lessee retains beneficial ownership of the leased property for federal income tax purposes. "Taxes" is defined in the definition of Impositions. "Toshiba" means Toshiba Corporation, a Japanese corporation. "Toshiba Lease" means the Master Lease Intended as Security between ABN AMRO, in its capacity as lessor, and Lessee relating to the FlashVision/Toshiba Tranche Operative Documents. "Tranche" with respect to the Participation Interests means the Tranche A Participation Interests, the Tranche B Participation Interests or the Tranche C Equity Interests. "Tranche A Participant" means a Person named as a Tranche A Participant on Schedule I to the Participation Agreement. "Tranche A Participant Balance" means (a) with respect to any Lease Supplement Balance for each Tranche A Participant as of any date of determination an amount equal to such Participant's Tranche A Participation Interest as of such date in the outstanding amount of the Advance made in respect of such Lease Supplement, and (b) with respect to the Lease Balance means for each Tranche A Participant as of any date of determination an amount equal to the sum of such Participant's Tranche A Participation Interest as of such date in all outstanding Advances. Appendix 1-32 "Tranche A Participation Interest" means, as to each Tranche A Participant as of any date of determination and with respect to any Lease Supplement, such Tranche A Participant's Tranche A Participation Interest Commitment Percentage multiplied by the outstanding amount of the Advance with respect to such Lease Supplement as to which such Participant has Funded its Tranche A Participation Interest Commitment Percentage under Article III of the Participation Agreement. "Tranche A Participation Interest Commitment" is defined in Section 3.2(a) of the Participation Agreement. "Tranche A Participation Interest Commitment Percentage" means with respect to each Tranche A Participant and each Lease Supplement, the percentage of the Aggregate Commitment Amount set forth after such Participant's Tranche A Participation Interest Commitment in Schedule I to the Participation Agreement. "Tranche B Participant" means a Person named as a Tranche B Participant on Schedule I to the Participation Agreement. "Tranche B Participant Balance" means (a) with respect to any Lease Supplement Balance for each Tranche B Participant as of any date of determination an amount equal to the sum of such Participant's Tranche B Participation Interest as of such date in the outstanding amount of the Advance made in respect of such Lease Supplement, and (b) with respect to the Lease Balance means for each Tranche B Participant as of any date of determination an amount equal to the sum of such Participant's Tranche B Participation Interest as of such date in all outstanding Advances. "Tranche B Participation Interest" means, as to each Tranche B Participant as of any date of determination and with respect to any Lease Supplement, such Tranche B Participant's Tranche A Participation Interest Commitment Percentage in respect of such Lease Supplement multiplied by the outstanding amount of the Advance with respect to such Lease Supplement as to which such Participant has funded its Tranche B Participation Interest Commitment Percentage under Article III of the Participation Agreement. "Tranche B Participation Interest Commitment" is defined in Section 3.2(a) of the Participation Agreement. "Tranche B Participation Interest Commitment Percentage" means with respect to each Tranche B Participant and each Lease Supplement, the percentage of the Aggregate Commitment Amount set forth after such Participant's Tranche B Participation Interest Commitment in Schedule I to the Participation Agreement. "Tranche C Equity Interest" means, as to each Tranche C Participant as of any date of determination and with respect to any Lease Supplement, such Tranche C Participant's Tranche C Equity Interest Commitment Percentage multiplied by the outstanding amount of the Advance with respect to such Lease Supplement as to which such Participant has funded its Tranche C Equity Interest Commitment Percentage under Article III of the Participation Agreement. Appendix 1-33 "Tranche C Equity Interest Commitment" is defined in Section 3.2(a) of the Participation Agreement. "Tranche C Equity Interest Commitment Percentage" means with respect to each Tranche C Participant and each Lease Supplement, the percentage of the Aggregate Commitment Amount set forth after such Participant's Tranche C Equity Interest Commitment in Schedule I to the Participation Agreement. "Tranche C Participant" means the Person named as a Tranche C Participant on Schedule I to the Participation Agreement. "Tranche C Participant Balance" means (a) with respect to any Lease Supplement Balance for each Tranche C Participant as of any date of determination an amount equal to the sum of such Participant's Tranche C Equity Interest as of such date in the outstanding amount of the Advance made in respect of such Lease Supplement, and (b) with respect to the Lease Balance means for each Tranche C Participant as of any date of determination an amount equal to the sum of such Participant's Tranche C Equity Interest as of such date in all outstanding Advances. "Transaction Expenses" means all reasonable costs and expenses incurred in connection with the preparation, execution and delivery of the Operative Documents and the transactions contemplated by the Operative Documents including without limitation: (a) the reasonable fees and expenses of McGuireWoods LLP, special counsel to Agent and Lessor and document counsel to the Participants (it being understood that Lessee will not be obligated to pay legal fees and expenses for any additional counsel for any Participant except as otherwise provided in Section 14.15(c) of the Participation Agreement); (b) the initial and ongoing fees and reasonable expenses of Agent and Lessor; (c) all applicable appraisal fees and reasonable expenses; (d) search fees, recording fees and filing fees incurred in connection with Lien searches and the filing of UCC financing statements; (e) any other reasonable out-of-pocket expenses of any party to the Operative Documents incurred in connection with the consummation of the Overall Transaction on the Document Closing Date; and (f) the reasonable fees and expenses of Mayer, Brown & Platt, special counsel to Lessee and Guarantor. "Transferee" is defined in Section 11.3(a) of the Participation Agreement. "Type" means, with respect to any Funding as of any date of determination, its nature as a LIBO Rate Funding or a Prime Rate Funding as of such date. Appendix 1-34 "Uniform Commercial Code" and "UCC" means the Uniform Commercial Code as in effect in any applicable jurisdiction. "Variable Rent" means with respect to each Interest Period occurring during the Base Term and any Renewal Term with respect to any Lease Supplement, an amount equal to the interest and yield accrued on the Participation Interests made in respect of such Lease Supplement outstanding during such period at the applicable per annum rate determined in accordance with Section 3.2(b) of the Participation Agreement. Appendix 1-35 EX-10.49 3 0003.txt MASTER LEASE INTENDED AS SECURITY Exhibit 10.49 EXECUTION COPY ================================================================================ MASTER LEASE INTENDED AS SECURITY (FLASHVISION/SANDISK TRANCHE) Dated as of December 27, 2000 between FLASHVISION, L.L.C., as Lessee, and ABN AMRO BANK N.V., not in its individual capacity, but solely as Lessor ================================================================================ THIS LEASE HAS BEEN EXECUTED IN 10 MANUALLY EXECUTED SERIALLY NUMBERED COUNTERPARTS OF WHICH THIS IS COUNTERPART NUMBER ___. TO THE EXTENT, IF ANY, THAT THIS LEASE CONSTITUTES CHATTEL PAPER (AS SUCH TERM IS DEFINED IN THE UNIFORM COMMERCIAL CODE AS IN EFFECT IN ANY APPLICABLE JURISDICTION) NO SECURITY INTEREST IN THIS LEASE MAY BE CREATED THROUGH THE TRANSFER OR POSSESSION OF ANY COUNTERPART HEREOF OTHER THAN COUNTERPART "NUMBER 1", WHICH SHALL BE IDENTIFIED AS THE COUNTERPART CONTAINING THE RECEIPT THEREFOR EXECUTED BY AGENT ON OR FOLLOWING THE SIGNATURE PAGE THEREOF. EXECUTION COPY TABLE OF CONTENTS Page ARTICLE I DEFINITIONS; LESSEE LIABILITY........................................1 ARTICLE II DELIVERY AND ACCEPTANCE.............................................1 Section 2.1 Acceptance and Lease of Equipment............................1 Section 2.2 Acceptance Procedure.........................................1 ARTICLE III LEASE TERM.........................................................2 Section 3.1 Lease Term...................................................2 ARTICLE IV RENT; OTHER ECONOMIC PROVISIONS.....................................2 Section 4.1 Basic Rent and Renewal Payments; Residual Value Guarantee Amount. .....................................................2 Section 4.2 Supplemental Rent............................................3 Section 4.3 Place and Manner of Payment..................................3 Section 4.4 Net Obligations..............................................3 Section 4.5 Overdue Amounts..............................................4 ARTICLE V POSSESSION, ASSIGNMENT, USE AND MAINTENANCE OF EQUIPMENT.............4 Section 5.1 Possession and Use of the Equipment; Compliance with Law.....4 Section 5.2 Subleases and Assignments....................................5 Section 5.3 Maintenance..................................................5 Section 5.4 Alterations, Modifications, etc..............................6 Section 5.5 Liens........................................................7 Section 5.6 Inspection...................................................7 Section 5.7 Permitted Contests...........................................8 Section 5.8 Annual Appraisals............................................8 ARTICLE VI RISK OF LOSS; INSURANCE; REPLACEMENTS OF EQUIPMENT..................8 Section 6.1 Casualty.....................................................8 Section 6.2 Insurance Coverages.........................................10 Section 6.3 Delivery of Insurance Certificates..........................11 Section 6.4 Replacement and Substitution................................11 ARTICLE VII WARRANTIES........................................................12 ARTICLE VIII EVENTS OF DEFAULT; REMEDIES......................................13 Section 8.1 Events of Default...........................................13 Section 8.2 Remedies....................................................15 Section 8.3 Sale of Collateral..........................................16 Section 8.4 Application of Proceeds.....................................16 Section 8.5 Right to Perform Obligations................................16 Section 8.6 Power of Attorney...........................................17 i EXECUTION COPY Section 8.7 Lessee Purchase Following Event of Default..................17 ARTICLE IX RETURN OF EQUIPMENT................................................17 Section 9.1 Return of Equipment.........................................17 ARTICLE X EARLY TERMINATION...................................................19 Section 10.1 Early Termination .........................................19 Section 10.2 Required Termination ......................................19 ARTICLE XI LEASE TERMINATION..................................................20 Section 11.1 Lessee's Options ..........................................20 Section 11.2 Election of Options .......................................21 Section 11.3 Sale Option Procedures ....................................21 Section 11.4 Appraisals ................................................22 ARTICLE XII OWNERSHIP, GRANT OF SECURITY INTEREST AND FURTHER ASSURANCES......22 Section 12.1 Grant of Security Interest ................................22 Section 12.2 Retention of Proceeds .....................................23 ARTICLE XIII MISCELLANEOUS....................................................23 Section 13.1 Effect of Waiver ..........................................23 Section 13.2 Applicable Law ............................................23 Section 13.3 Effect and Modification of Lease ..........................23 Section 13.4 Notices ...................................................23 Section 13.5 Counterparts ..............................................23 Section 13.6 Severability ..............................................24 Section 13.7 Successors and Assigns; Merger ............................24 Section 13.8 Section Headings; Table of Contents .......................24 Section 13.9 Final Agreement ...........................................24 Section 13.10 Timeliness of Performance ................................24 Section 13.11 FINANCE LEASE ............................................24 Schedule A Fixed Rent Schedule B Residual Value Guarantee Amount ii EXECUTION COPY MASTER LEASE INTENDED AS SECURITY This MASTER LEASE INTENDED AS SECURITY (FLASHVISION/SANDISK TRANCHE) (as amended and supplemented from time to time, including each Lease Supplement entered into pursuant hereto, this "Lease") is entered into as of December 27, 2000 between FLASHVISION, L.L.C., a Virginia limited liability company ("Lessee"), with its principal office at 9600 Godwin Drive, Manassas, Virginia 20110, and ABN AMRO BANK N.V., a bank organized under the laws of the Netherlands, not in its individual capacity, but solely in its capacity as Lessor ("Lessor"). W I T N E S S E T H: NOW THEREFORE, in consideration of the mutual terms and conditions herein contained, the parties hereto agree as follows: ARTICLE I DEFINITIONS; LESSEE LIABILITY For all purposes hereof, the capitalized terms used herein and not otherwise defined shall have the meanings assigned thereto in Appendix 1 to that certain Participation Agreement (FlashVision/SanDisk Tranche) dated as of December 27, 2000, among Lessee, Lessor, the Participants party thereto from time to time and ABN AMRO BANK N.V., not in its individual capacity but solely in its capacity as Agent for the Participants ("Agent") (the "Participation Agreement"). All obligations imposed on Lessee in this Lease shall be the full recourse liability of Lessee. ARTICLE II DELIVERY AND ACCEPTANCE Section 2.1 Acceptance and Lease of Equipment. On each Lease Supplement Closing Date, subject to the satisfaction or waiver of the conditions set forth in Article VI of the Participation Agreement and its receipt of Funds from the Participants, (a) Lessor hereby agrees to accept delivery on such Lease Supplement Closing Date of the interest in the Equipment to be delivered pursuant to the terms of the Participation Agreement and simultaneously to lease such Equipment to Lessee under this Lease, and (b) Lessee hereby agrees, expressly for the direct benefit of Lessor, Agent and the Participants, to lease from Lessor hereunder, for the applicable Lease Term, the Equipment to be delivered on such Lease Supplement Closing Date. Section 2.2 Acceptance Procedure. Lessor hereby authorizes one or more employees of Lessee, to be designated by Lessee, as the authorized representative or representatives of Lessor to accept delivery under this Lease of the Equipment identified on Schedule I to each CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION PURSUANT TO RULE 24B-2. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. EXECUTION COPY Lease Supplement executed by Lessee on the related Lease Supplement Closing Date. Lessee hereby agrees that such acceptance of delivery by such authorized representative or representatives and the execution and delivery by Lessee of a Lease Supplement on such Lease Supplement Closing Date shall, without further act, constitute the irrevocable acceptance by Lessee under this Lease of the Equipment which is the subject thereof for all purposes of this Lease and the other Operative Documents on the terms set forth therein and herein. ARTICLE III LEASE TERM Section 3.1 Lease Term. Unless earlier terminated, the term of this Lease with respect to any Lease Supplement (with respect to any Lease Supplement, the "Lease Term") shall consist of the Base Term in respect of such Lease Supplement and the Renewal Terms in respect of such Lease Supplement, if any, provided that in no event shall the Expiration Date of any Renewal Term in respect of any Lease Supplement extend beyond the fifth (5th) anniversary of the Document Closing Date without the prior written consent of Lessor and each Participant pursuant to Section 14.18 of the Participation Agreement. ARTICLE IV RENT; OTHER ECONOMIC PROVISIONS Section 4.1 Basic Rent and Renewal Payments; Residual Value Guarantee Amount. (a) With respect to each Lease Supplement, Lessee shall pay to Lessor Basic Rent for the relevant Lease Supplement Equipment (i) on each Payment Date, (ii) on the date required under Section 11.1(c) in connection with Lessee's exercise of the Sale Option with respect to such Lease Supplement Equipment, and (iii) on any date on which this Lease terminates or upon demand following an Event of Default, as provided in Section 8.2. Fixed Rent in respect of each Lease Supplement shall be payable on the dates and in the amounts set forth on Schedule A hereto, which schedule shall be amended (i) on each Lease Supplement Closing Date to reflect the Fixed Rent payable with respect to such Lease Supplement which may be necessary based on the Lease Supplement Equipment delivered as of such date and (ii) following the delivery of each Annual Appraisal pursuant to Section 5.8, if necessary to reflect the Fair Market Value of the Equipment as of the next succeeding Expiration Date for each Lease Supplement and the last day of each Renewal Term for each Lease Supplement (but not beyond the fifth anniversary of the Document Closing Date) permitted hereunder. (b) If a Renewal Term has been elected by Lessee with respect to any Lease Supplement pursuant to Section 11.1(a), then Lessee shall as a condition precedent to the effectiveness of such election, on the last Business Day of the Base Term or the Renewal Term in effect prior to giving effect to such election, as applicable, in respect of such Lease Supplement, pay to Lessor as Supplemental Rent an amount (a "Renewal Payment") sufficient, 2 2 EXECUTION COPY when applied to the outstanding Lease Supplement Balance in respect of such Lease Supplement pursuant to Section 5.3 of the Participation Agreement, to reduce such Lease Supplement Balance by the amount, if any, that such Lease Supplement Balance exceeds the Fair Market Value of such Lease Supplement Equipment as of such date, as determined pursuant to the most recent Annual Appraisal therefor delivered pursuant to Section 5.8. (c) Schedule B hereto sets forth the percentage referred to in the definition of "Residual Value Guarantee Amount," for the Base Term and each Renewal Term for all Lease Supplements. Section 4.2 Supplemental Rent. Lessee shall pay to Lessor (or the other applicable Person entitled thereto pursuant to the Operative Documents) any and all Supplemental Rent promptly as the same shall become due and payable and in the event of any failure on the part of Lessee to pay any Supplemental Rent when due and payable (subject to the applicable notice or grace periods, to the extent applicable, set forth in Section 8.1(a)), Lessor, and Agent and the Participants, acting through Lessor, shall have all rights, powers and remedies provided for herein or by law or in equity or otherwise in the case of nonpayment of Basic Rent. Lessee hereby reaffirms that its obligation to pay Supplemental Rent shall include the payment of any and all Additional Costs. The expiration or other termination of Lessee's obligation to pay Basic Rent hereunder shall not limit or modify the obligation of Lessee with respect to Supplemental Rent. Section 4.3 Place and Manner of Payment. Payments of Rent shall be paid in immediately available funds at the office of Agent specified on Schedule II to the Participation Agreement, or at such other office of Agent as Agent may from time to time specify to Lessee in a notice pursuant to Section 14.3 of the Participation Agreement. All payments of Basic Rent, Lease Balance, Lease Supplement Balance, Option Exercise Amount and Casualty Amount shall be received by Agent not later than 12:00 noon, Chicago, Illinois time, on the date due; funds received after such time shall for all purposes under the Operative Documents be deemed to have been received by Agent on the next succeeding Business Day. All payments of Supplemental Rent paid to Agent shall be distributed by Agent in accordance with Section 5.3 of the Participation Agreement. Section 4.4 Net Obligations. This Lease is a net lease and Lessee's obligation to pay all indemnities and other amounts payable under the Operative Documents in accordance with their terms shall be absolute and unconditional under any and all circumstances and, without limiting the generality of the foregoing, Lessee shall not be entitled to any abatement or reduction of payments or any setoff against Rent, indemnity or other amounts, whether arising by reason of any past, present or future claims of any nature by Lessee against Agent, Lessor or any Participant, or otherwise. Except as otherwise expressly provided herein, this Lease shall not terminate, nor shall the obligations of Lessee be otherwise affected: (a) by reason of any defect in, damage to, or loss of possession or use, obsolescence or destruction, of any or all of the Equipment, however caused; or (b) by the taking or requisitioning of any or all of the Equipment by condemnation or otherwise; or (c) by the invalidity or unenforceability or lack of due authorization by Agent, Lessor, any Participant or Lessee or other infirmity of this Lease or any other Operative Document; or (d) by the attachment of any Lien of any third party to any Equipment; or (e) by any prohibition or restriction of or interference with Lessee's use or quiet 3 3 EXECUTION COPY enjoyment of any or all of the Equipment by any Person; or (f) by the insolvency of or the commencement by or against Agent, Lessor or any Participant of any bankruptcy, reorganization or similar proceeding; or (g) by the failure of Lessee to achieve the characterization of the transaction intended as set forth in Section 5.1 of the Participation Agreement; or (h) by any other cause, whether similar or dissimilar to the foregoing, any present or future law to the contrary notwithstanding. It is the intention of the parties that all Rent, indemnities and other amounts payable by Lessee under the Operative Documents shall be payable in all events in the manner and at the times herein provided unless Lessee's obligations in respect thereof have been terminated or modified pursuant to the express provisions of this Lease or any other Operative Document. To the extent permitted by Applicable Laws, Lessee hereby waives any and all rights which it may now have or which may at any time be conferred upon it, by statute or otherwise, to terminate, cancel, quit or surrender this Lease, in whole or in part, except strictly in accordance with the express terms hereof and any other Operative Document. Each rental, indemnity or other payment made by Lessee hereunder shall be final, and Lessee shall not seek to recover (except as expressly provided in this Lease) all or any part of such payment from Agent, Lessor or any Participant for any reason whatsoever. In the event that Lessee believes Lessor or Lessee has made a miscalculation or Lessee has made an overpayment of any amount due and payable hereunder, Lessee may submit to Lessor a statement showing the calculation of the correct amount that was due and payable and request a repayment of any amount Lessee believes to be an excess payment and Lessor shall reasonably consider such request; provided, that any such statement shall not be deemed conclusive. Without affecting Lessee's obligation to pay Rent or other amounts payable under the Operative Documents, Lessee may seek damages for a breach by Agent, Lessor or any Participant of its obligations or the inaccuracy of its representations and warranties under this Lease or the Participation Agreement or any other Operative Documents. Section 4.5 Overdue Amounts. If any Rent shall not be paid when due, Lessee shall pay to Lessor, for its own account or , if payable to the Agent, any Participant or any other Person for the account of such Person, as applicable, in each case as Supplemental Rent, interest at the Overdue Rate on such overdue amount from and including the due date thereof (without regard to any applicable grace period) to but excluding the Business Day of payment thereof. ARTICLE V POSSESSION, ASSIGNMENT, USE AND MAINTENANCE OF EQUIPMENT Section 5.1 Possession and Use of the Equipment; Compliance with Law. Lessee agrees that the use of the Equipment will be limited to the fabrication, assembly and testing of semiconductor wafers and will be used, operated, maintained and stored in compliance with any and all Applicable Laws, including all Environmental Laws, where the failure to so comply would have a Material Adverse Effect, and all Insurance Requirements, except where the failure to comply would not reasonably be expected to cause the relevant insurance to lapse, to be cancelled or to be reduced (as to amount or scope of coverage). Lessee shall procure and maintain in effect all licenses, registrations, certificates, permits, approvals and consents required by Applicable Laws or any Governmental Authority, where the failure to so comply would have a Material Adverse Effect, or any Insurance Requirements, except where the failure to comply would not reasonably be expected to cause the relevant insurance to lapse, to be cancelled or to 4 4 EXECUTION COPY be reduced (as to amount or scope of coverage) in connection with the ownership, delivery, installation, use and operation of any or all of the Equipment. The Equipment will at all times be and remain in the possession and control of Lessee at the Facility, subject, however, to the terms of Section 5.2 and to the removal of Items of Equipment from the Facility for customary periods for repair and maintenance in accordance with customary maintenance and overhaul procedures or for repair or restoration following a casualty. Subject to Lessor's rights under Section 8.2, 8.3, 8.5, and 8.6 if an Event of Default has occurred and is continuing, Lessor covenants that it will not interfere in Lessee's use or possession of the Equipment during the Lease Term. Section 5.2 Subleases and Assignments. LESSEE SHALL NOT, WITHOUT THE PRIOR WRITTEN CONSENT OF AGENT AND LESSOR, SUBLEASE OR OTHERWISE RELINQUISH POSSESSION OF ANY EQUIPMENT OR OTHER COLLATERAL, OR ASSIGN, TRANSFER OR ENCUMBER ITS RIGHTS, INTERESTS OR OBLIGATIONS HEREUNDER AND ANY ATTEMPTED SUBLEASE, RELINQUISHMENT, ASSIGNMENT, TRANSFER OR ENCUMBERING BY LESSEE SHALL BE NULL AND VOID, except, subject to the terms and conditions set forth in this Section 5.2, in connection with the Sublease or an Affiliate Sublease as specifically contemplated by this Section 5.2. Lessee shall be entitled to enter into the Sublease of the Equipment with DSC or a sublease with any other Affiliate of Toshiba that is controlled by Toshiba in form substantially similar to the Sublease (an "Affiliate Sublease"); provided, however, that such Sublease or Affiliate Sublease and with respect to which such Affiliate has executed and delivered an acknowledgement to Agent and Lessor substantially similar to the acknowledgement executed by DSC in respect of the Collateral Assignment in respect of any Lease Supplement Equipment shall not extend beyond the then remaining Lease Term applicable thereto, and provided, further, that (i) Lessee shall at all times remain primarily liable hereunder with respect to all Lease Supplement Equipment so subleased to the same extent as if such Sublease or Affiliate Sublease had not occurred; (ii) DSC or any sublessee under an Affiliate Sublease shall not engage in activities with the Equipment in contravention of Section 5.1 without prior written consent of Agent and Lessor; and (iii) each sublease permitted hereby shall contain a provision requiring the sublessee to give prompt notice of any Casualty to the Equipment to Lessee within the time period specified herein. Lessee agrees that (i) the Sublease and any Affiliate Sublease are subject and subordinate to this Lease and the rights and interests of Agent, Lessor and the Participants and (ii) that the Sublease and any Affiliate Sublease shall (a) expressly state that it is subject and subordinate to all of the provisions of this Lease and the other Operative Documents and the rights and interests of Agent, Lessor and the Participants under this Lease and the other Operative Documents in respect of the Equipment covered by the Sublease and any Affiliate Sublease upon the occurrence of an Event of Default, but in all cases such sublessee shall have the right and Lessor shall be subject to the same obligation under the applicable sublease as set forth in the final sentence of Section 5.1, (b) expressly require possession of the Equipment subject thereto to be returned as directed by Agent or Lessor upon notice to DSC or any Affiliate sublessee that an Event of Default shall have occurred and be continuing if Lessor is exercising a remedy to regain possession of the Equipment pursuant to Article VIII, and (c) expressly prohibit any further sublease or assignment of the Equipment subject thereto or the granting of any Lien on the Equipment (other than the Lien of the Sublease and any Affiliate Sublease) or other Collateral subject thereto. Section 5.3 Maintenance. At all times during the term of this Lease, Lessee shall, at its own cost and expense, keep, repair, maintain and preserve all of the Equipment in at least as 5 5 EXECUTION COPY good order and operating and mechanical condition, repair and appearance as when originally Accepted and Installed, ordinary wear and tear excepted, in accordance with prudent industry practice and in a manner consistent with that relating to similar Equipment owned or operated by Lessee and the terms of all contracts (including, without limitation, service contracts and insurance contracts) at the time applicable thereto, and subject to Lessee's rights under Section 5.7 regarding Permitted Contests, in compliance with all Applicable Laws in all material respects and Insurance Requirements, except where the failure to comply would not reasonably be expected to cause the relevant insurance to lapse, to be cancelled or to be reduced (as to amount or scope of coverage), and, subject to Lessee's rights under Section 5.7 regarding Permitted Contests, in the event that Applicable Laws or Insurance Requirements require any alteration, replacement or addition of or to any Part of any Equipment, Lessee will conform therewith at its own expense where the failure to comply would have a Material Adverse Effect or cause the relevant insurance to lapse, to be cancelled or to be reduced (as to amount or scope of coverage). In no event shall Lessee discriminate as to the use or maintenance of any Equipment (including the periodicity of maintenance or recordkeeping in respect of such Equipment) as compared to equipment of a similar nature which Lessee owns or leases. To the extent not prohibited by Applicable Laws, Lessee shall prepare and deliver to Agent within a reasonable time prior to the required date of filing (or, to the extent permissible, file on behalf of Agent, Lessor and the Participants) any and all reports (other than income tax returns) to be filed by Agent, Lessor or any Participant with any Governmental Authority or other Person by reason of the ownership by Lessor of the Equipment or the leasing thereof to Lessee. Lessor agrees to promptly inform Lessee of any request for such reports received by it. Lessee shall maintain all records, logs and other materials required by any Governmental Authority having jurisdiction over the Equipment or Lessee to be maintained in respect of the Equipment where the failure to so maintain would reasonably cause a Material Adverse Effect. Lessee hereby waives any right now or hereafter conferred by Applicable Laws to make repairs on any of the Equipment at the expense of Agent, Lessor or any Participant. Section 5.4 Alterations, Modifications, etc. In case any Item of Equipment or any Part is required to be altered, added to, replaced or modified in order to comply with any Applicable Laws in all material respects or Insurance Requirements where the failure to so comply would reasonably be expected to cause the relevant insurance to lapse, to be cancelled or to be reduced (as to amount of scope of coverage) (a "Required Alteration") pursuant to Sections 5.1 or 5.3 hereof, subject to the provisions of Section 5.7 regarding Permitted Contests, Lessee agrees to make such Required Alteration at its own expense. Lessee shall have the right to make any modification, alteration or improvement to any Item of Equipment (herein referred to as a "Permitted Modification"), or to remove any Parts which have become worn out, broken or obsolete, provided in each case that Lessee continues to be in compliance with Sections 5.1 and 5.3 hereof and that such action (a) will not decrease the economic value of such Item of Equipment or impair its originally intended use or function or decrease its useful life in any material respect and (b) will not cause such Item of Equipment to become suitable for use only by Lessee unless in the case of this clause (b) such modification is readily removable without damage to such Item of Equipment. In the event any Permitted Modification (i) is readily removable without in any material respect impairing the value or useful life which the Item of Equipment would have had at such time had such Part not been affixed or placed to or on such Item of Equipment (or if not readily removable without in any material respect so impairing the value or useful life of 6 6 EXECUTION COPY such Item of Equipment, Lessee actually restores the value or useful life of such Item of Equipment in all material respects to the value or useful life which the Item of Equipment would have had at such time had such Part not been affixed or placed to or on such Item of Equipment) (a "Removable Part"), (ii) is not a Required Alteration and (iii) is not a Part which replaces any Part originally incorporated or installed in or attached to such Item of Equipment on the date on which such Item of Equipment became subject to this Lease or any Part in replacement of or substitution for any such original Part (each an "Original Part"), any such Permitted Modification or Original Part so removed and replaced shall be and remain the property of Lessee. To the extent such Permitted Modification is not a Removable Part, or is a Required Alteration or an Original Part, the same shall immediately and automatically be and become the property of Lessor and subject to the terms of this Lease. Any Required Alterations and any Parts installed or replacements made by Lessee upon any Item of Equipment pursuant to its obligation to maintain and keep the Equipment in good order, operating condition and repair under Section 5.3 shall be considered, in each case, accessions to such Item of Equipment and title thereto and a security interest therein shall be immediately and automatically vested in Lessor. Section 5.5 Liens. Subject to the final sentence of this Section 5.5, Lessee will not directly or indirectly create, incur, assume or suffer to exist any Lien (other than Permitted Liens) on or with respect to (i) any Item of Equipment or any Part thereof or any other Collateral, Lessor's title thereto, or any interest therein or (ii) this Lease or any of Agent's, Lessor's or any Participant's interests hereunder. Lessee, at its own expense, will promptly pay, satisfy and otherwise take such actions as may be necessary to keep this Lease, each Item of Equipment and all other Collateral free and clear of, and to duly discharge or eliminate or bond in a manner satisfactory to Agent and Lessor, any such Lien not excepted above if the same shall arise at any time. Lessee will notify Agent and Lessor in writing promptly upon becoming aware of any Lien (other than any Lien excepted above) that attaches to the Equipment or any Item of Equipment or any other Collateral, and a description of the full particulars thereof. Without limiting the foregoing, Lessee shall not assign or pledge any of its rights under the Sublease or any Affiliate Sublease to any Person other than to Agent. Lessee, on its own or on Lessor's behalf but at Lessee's sole cost and expense, may contest, by appropriate administrative or judicial proceedings conducted in good faith and with due diligence, the amount, validity or application, in whole or in part, of any Lien on any Item of the Equipment or other Collateral, and Lessor agrees not to pay, settle or otherwise compromise any such Lien, so long as such contest constitutes a Permitted Contest. Section 5.6 Inspection. Upon three (or, upon the occurrence and during the continuance of an Event of Default, one) Business Day's prior written notice by Agent or Lessor, Lessee shall make the Equipment and all other Collateral available to Agent and Lessor and their representatives (the "Inspecting Parties") for inspection at reasonable times at the Facility and, if requested in such notice, shall also make Lessee's records pertaining to the Equipment and all other Collateral available for inspection. All such inspections shall be during Lessee's normal business hours, shall be subject to Lessee's customary safety and security provisions and shall be at the expense and risk of the Inspecting Parties, except that if an Event of Default has occurred and is continuing, Lessee shall reimburse the Inspecting Parties for the reasonable costs of such inspections. No inspection shall unreasonably interfere with Lessee's or any sublessee's operations. None of the Inspecting Parties shall incur any liability or obligation by reason of making any such inspection or inquiry unless and to the extent such Inspecting Party causes 7 7 EXECUTION COPY damage to any Person or to the Equipment or any property of Lessee or any other Person during the course of such inspection. Provided that an Event of Default has not occurred and is continuing, neither Lessor nor Agent shall conduct such inspection more frequently than once in any calendar year. Section 5.7 Permitted Contests. If, to the extent and for so long as a Permitted Contest in respect of any Applicable Laws, Governmental Action, manufacturer's guidelines or standards or Insurance Requirements relating to the Equipment, any part thereof or any other Collateral or the obligation to comply therewith shall be prosecuted diligently and in good faith in appropriate proceedings by the Lessee or its Affiliates, Lessee shall not be required to comply with such Applicable Laws, Governmental Action, manufacturer's guidelines or standards or Insurance Requirements, as the case may be. At Lessee's request, Lessor will join in any proceedings pursuant to this Section 5.7 if and so long as the Lessee agrees in writing to pay, and pays, all related reasonable out of pocket expenses of Lessor and Lessee agrees that any such claim against Lessor, Agent or any Participant relating thereto will be subject to the indemnification provisions of Section 12.1 of the Participation Agreement. Section 5.8 Annual Appraisals. On or prior to each annual anniversary of the Document Closing Date, Lessee shall deliver to Agent, Lessor and the Participants an Annual Appraisal covering all Equipment then subject to this Lease as to which Lessee has not theretofore exercised the Purchase Option, the Sale Option or the Early Termination Option. ARTICLE VI RISK OF LOSS; INSURANCE; REPLACEMENTS OF EQUIPMENT Section 6.1 Casualty. If (A) any Item of Equipment shall be or become (i) lost, stolen, destroyed, irreparably damaged from any cause whatsoever, damaged beyond economic repair, or rendered permanently unfit for normal use for any reason whatsoever (other than obsolescence), including by reason of any defect in design or manufacture, in each such case in Lessee's reasonable determination, which determination shall be made promptly after any such event or Lessee's discovery thereof (including notification by any sublessee, as applicable), or (ii) damaged so as to result in an insurance settlement on the basis of a total loss or a constructive or compromised total loss, or (iii) captured, confiscated or requisitioned by condemnation or otherwise and the loss shall have resulted in loss of possession of such Item of Equipment by Lessee for a period of more than 180 consecutive days, or (B) as a result of any rule, regulation, order or other action of any Governmental Authority having jurisdiction, the use in normal operation of such Item of Equipment shall have been prohibited for a period extending beyond the Lease Term applicable to such Item of Equipment (any such occurrence being hereinafter called a "Casualty"), prior to or during the term of this Lease, Lessee shall give Agent and Lessor notice thereof (a "Casualty Notice") not later than thirty (30) days (or, with respect to a Casualty referred to in clause (ii) of the definition of such term, such longer period as Lessee may request, not to exceed one hundred nineteen (119) days), following a Responsible Officer of Lessee becoming aware of the occurrence of such Casualty. The Casualty Notice shall specify whether Lessee will: 8 8 EXECUTION COPY (a) pay the Casualty Amount of the Item of Equipment suffering such Casualty, which payment shall be made no later than ninety (90) days (unless Lessee has delivered a Casualty Notice with respect to a Casualty referred to in clause (ii) of the definition of such term after the expiration of such thirty (30) day period, no later than the date which is one hundred twenty (120) days following a Responsible Officer of Lessee becoming aware of the occurrence of such Casualty) following the date of such Casualty Notice (the "Casualty Settlement Date"), provided that in any event the Casualty Settlement Date shall be no later than the last day of the Lease Term applicable to such Equipment; and the Casualty Amount shall be applied by Agent to reduce the relevant Lease Supplement Balance as indicated below; or (b) replace the Item of Equipment with respect to which the Casualty has occurred pursuant to the following provisions of this Section 6.1 and Section 6.4, provided that upon the occurrence and during the continuance of an Event of Default, Lessee shall be obligated, at the option of the Required Participants, to make the payments referred to in clause (a) above and shall not be entitled to exercise any right or election of replacement as set forth in this clause (b).(c) If Lessee has elected, or is required, to pay the Casualty Amount pursuant to clause (a) above, Lessee shall continue to make all payments of Basic Rent due under this Lease without reduction for the Item of Equipment suffering such Casualty until such Casualty Amount is paid, upon which event Lessee's obligation to pay Basic Rent for the Item of Equipment suffering such Casualty shall cease. Upon payment of the Casualty Amount in respect of any Item of Equipment suffering a Casualty, the amount of the Lease Supplement Balance shall be reduced by an amount equal to the product of the remaining relevant Lease Supplement Balance (determined prior to the receipt of such Casualty Amount), multiplied by the Allocation Fraction of the Item of Equipment suffering such Casualty. If Lessee has given notice that it intends to replace the Item of Equipment suffering such Casualty, and such replacement is permitted under the foregoing clause (b), Lessee may, not more than ninety (90) days after the date of such Casualty Notice, replace the Item of Equipment suffering the Casualty with Replacement Equipment pursuant to the requirements of Section 6.4. If Lessee has paid the amount payable with respect to the Casualty as set forth in clause (a) above and all other amounts due hereunder and no Event of Default has occurred and is continuing, Lessee shall be entitled to receive, and Lessor shall direct the applicable insurance carrier to pay, or if received by Lessor shall pay, to Lessee the proceeds of any recovery in respect of such Item of Equipment from insurance or otherwise ("Casualty Recoveries"), and Lessor, subject to the rights of any insurer insuring such Item of Equipment as provided herein, shall execute and deliver to Lessee, or to its assignee or nominee, a quitclaim bill of sale (without representations or warranties except that such Item of Equipment is free and clear of all Lessor Liens) for such Item of Equipment, and such other documents as may be required to release the Equipment from the terms of this Lease, in such form as may reasonably be requested by Lessee. All fees, costs and expenses relating to a substitution as described herein shall be borne by Lessee. Any payments (including, without limitation, insurance proceeds) received at any time by Agent, Lessor or Lessee from any Governmental Authority or other party with respect to any loss 9 9 EXECUTION COPY or damage to any Item of Equipment not constituting a Casualty will be paid to Lessee to be applied directly in payment of repairs or for replacement of property in accordance with the provisions of Sections 5.1 and 5.3, if not already paid by Lessee, or if already paid by Lessee and no Event of Default shall have occurred and be continuing, shall be applied to reimburse Lessee for such payment, and any balance remaining after compliance with said Sections with respect to such loss or damage shall be retained by Lessee. During the existence of a Default, or any Event of Default, any payments received by Agent or Lessor with respect to any loss or damage to any item of Equipment (whether or not constituting a Casualty) shall be held by Agent as security for the obligations of Lessee under this Lease, and at such time as there shall not be continuing any such Event of Default or Default, such amount (unless theretofore otherwise applied to the obligations of Lessee hereunder in accordance with Section 8.4) shall be applied to pay the Casualty Amount of the applicable Item of Equipment if Lessee has elected, or is required, to pay such Casualty Amount or paid over to Lessee. Any such payments received by Lessor in excess of the costs of repair or replacement of the applicable Item of Equipment not required to be held by Agent pursuant to the preceding sentence or if so held when released shall be and remain the property of Lessee. LESSEE HEREBY ASSUMES ALL RISK OF LOSS, DAMAGE, THEFT, TAKING, DESTRUCTION, CONFISCATION, REQUISITION, COMMANDEERING, TAKING BY EMINENT DOMAIN OR CONDEMNATION, PARTIAL OR COMPLETE, OF OR TO ANY OF THE EQUIPMENT, HOWEVER CAUSED OR OCCASIONED, SUCH RISK TO BE BORNE BY LESSEE WITH RESPECT TO EACH ITEM OF EQUIPMENT FROM THE DATE OF THIS LEASE, AND CONTINUING UNTIL SUCH ITEM OF EQUIPMENT HAS BEEN RETURNED TO LESSOR IN ACCORDANCE WITH THE PROVISIONS OF ARTICLE IX. LESSEE AGREES THAT NO OCCURRENCE SPECIFIED IN THE PRECEDING SENTENCE SHALL IMPAIR, IN WHOLE OR IN PART, ANY OBLIGATION OF LESSEE UNDER THIS LEASE, INCLUDING, WITHOUT LIMITATION, THE OBLIGATION TO MAKE PAYMENTS. Section 6.2 Insurance Coverages. Lessee shall at all times, at its expense, cause to be carried and maintained (a) commercial general liability insurance with respect to the Equipment against third party personal injury and property damage in an amount as of each Lease Supplement Closing Date and at all times thereafter of not less than $50,000,000 per occurrence, including fire, flood and environmental insurance, (b) property insurance in respect of the Equipment at the time leased hereunder, said property insurance to be in amounts at least equal at all times to the replacement cost of the Equipment then subject to this Lease, and (c) such other insurance, including worker's compensation and business interruption insurance, in each case, as is consistent with prudent industry practice and as generally carried by corporations of established reputation engaged in the same or similar business as Lessee. Such insurance shall be written by reputable insurance companies that are financially sound and solvent and otherwise reasonably appropriate considering the amount and type of insurance being provided by such companies. Any insurance company selected by Lessee and writing such required insurance shall be rated in A.M. Best's Insurance Guide or any successor thereto (or if there be none, an organization having a similar national reputation) and shall have a general financial rating of "A" (or comparable rating for a rating by an organization other than A.M. Best) and a financial rating of at least "X" (or comparable rating for a rating by an 10 10 EXECUTION COPY organization other than A.M. Best) or be otherwise acceptable to Agent and Lessor. In the case of liability insurance maintained by Lessee, it shall name Agent and Lessor (in each case, in its individual capacity and as Agent or Lessor, as applicable) and each of the Participants as additional insureds and, in the case of property insurance maintained by Lessee, it shall name Agent and Lessor as loss payees to the extent of their and the Participants' interests in the Equipment. Each policy referred to in this Section 6.2 shall provide that: (i) it will not be cancelled, materially modified or its limits reduced, or allowed to lapse without renewal, except after not less than (x) 10 days' prior written notice to Agent and Lessor, in the case of a cancellation or non-renewal due to non-payment, or (y) 30 days' prior written notice to Agent and Lessor, in all other cases; (ii) the interests of Agent and Lessor and any Participant shall not be invalidated by any act or negligence of or breach of warranty or representation by Lessee or any Person having an interest in the Equipment; (iii) such insurance is primary with respect to any other insurance carried by or available to Agent and Lessor or any Participant; (iv) the insurer shall waive any right of subrogation, setoff, counterclaim, or other deduction, whether by attachment or otherwise, against Agent and Lessor and the Participants; and (v) such policy shall contain a cross-liability clause providing for coverage of Agent and Lessor and each Participant, as if separate policies had been issued to each of them. Lessee will notify Agent and Lessor promptly of any policy cancellation, expiration, reduction in policy limits, modification or amendment. Lessee hereby waives, releases and discharges Agent, Lessor and each Participant and their agents and employees from all claims whatsoever arising out of loss, claim, expense or damage to or destruction covered or coverable by insurance required under this Article VI notwithstanding that such loss, claim, expense or damage may have been caused by Agent, Lessor or any Participant or any of their agents or employees, and Lessee agrees to look solely to the insurance coverage in the event of such loss. Section 6.3 Delivery of Insurance Certificates. On or before the initial Lease Supplement Closing Date and each subsequent Lease Supplement Closing Date, Lessee shall deliver to Agent and Lessor certificates of insurance satisfactory to Agent and Lessor evidencing the existence of all insurance required to be maintained hereunder and setting forth the respective coverages, limits of liability, carrier, policy number and period of coverage. Thereafter, throughout the Lease Terms, at the time each of Lessee's insurance policies is renewed or replaced (but in no event less frequently than once each year and in all cases not less than fifteen (15) days prior to the expiration date of any policy) or upon written request by Agent or Lessor following and during the continuance of an Event of Default, Lessee shall deliver to Agent and Lessor certificates of insurance evidencing that all insurance then required by Section 6.2 to be maintained by Lessee is in effect. The insurance coverage herein required may be subject to deductibles or self-insured retentions up to an amount not in excess of (i) $1,000,000 in respect of property insurance, (ii) $100,000 in respect of liability insurance, (iii) $200,000 per individual and $800,000 maximum for workers' compensation insurance and (iv) damage arising from 48 hours of cessation of operations in respect of business interruption insurance. Such coverage may be provided in a combination of umbrella and excess liability policies. Section 6.4 Replacement and Substitution. During the applicable Lease Term and provided that no Event of Default exists and Lessee has not elected or is not deemed to have elected an option under Section 10.1, 10.2 or Section 11.1(b) or (c) with respect to the Item of 11 11 EXECUTION COPY Equipment to be replaced or substituted, Lessee may replace or substitute such Item of Equipment ("Replaced Equipment") with Replacement Equipment subject to Lessee's satisfaction of each of the following conditions: (a) Lessee shall have delivered to Agent and Lessor a written notice (the "Replacement Notice") indicating the date such replacement or substitution is to take place (which date shall be (i) in respect of a voluntary replacement or substitution, not more than 90 days following the date of the Replacement Notice or (ii) in the case of a replacement or substitution on account of a Casualty, not later than the date provided for in the applicable Casualty Notice, which Casualty Notice shall serve as the Replacement Notice with respect to such Casualty, which shall identify the Replacement Equipment, the Purchase Price for the Replacement Equipment, and the Replaced Equipment; (b) Lessee shall have delivered to Agent and Lessor evidence satisfactory to Agent and Lessor (i) of Lessee's compliance with the insurance provisions of Section 6.2 with respect to the Replacement Equipment, (ii) of Lessee's payment in full of the Purchase Price and all Installation Expenses of the Replacement Equipment, and (iii) that the Item of Equipment to serve as the Replacement Equipment satisfies the requirements set forth in the definition of "Replacement Equipment"; (c) Lessee shall cause a Bill of Sale and an amendment to the relevant Lease Supplement and UCC financing statements as detailed on Schedule 6.1(f) of the Participation Agreement to be executed and delivered to Lessor in order to subject such Replacement Equipment to this Lease; and (d) Such Replacement Equipment shall be the same make, model and year of manufacture as the Replaced Equipment or Lessee shall have delivered to Agent and Lessor an Appraisal of the Replacement Equipment showing both (i) the then-current Fair Market Value thereof, and (ii) the Fair Market Value thereof as of the then-current Expiration Date with respect to the Replaced Equipment and on each date on which a Renewal Term with respect thereto would expire, in each case greater than or equal to such values at such dates for the Replaced Equipment. Upon the satisfaction by Lessee of the foregoing conditions, Lessor shall, subject to the rights of any insurer insuring Replaced Equipment suffering a casualty, if applicable, execute and deliver to Lessee, or to its assigns or a nominee, a quitclaim bill of sale (without representations or warranties, except that the Replaced Equipment is free and clear of all Lessor Liens) for the Replaced Equipment and such other documents as may be required to release the Replaced Equipment from the terms of this Lease and the Security Documents, in such form as may reasonably be requested by Lessee. ARTICLE VII WARRANTIES LESSEE ACKNOWLEDGES AND AGREES THAT: (a) ALL OF THE EQUIPMENT IS LEASED AS-IS AND WHERE-IS; (b) ALL OF THE EQUIPMENT LEASED BY IT IS OF 12 12 EXECUTION COPY A SIZE, DESIGN, SPECIFICATION AND MANUFACTURE SELECTED BY LESSEE; (c) LESSEE IS SATISFIED THAT THE SAME IS SUITABLE FOR ITS PURPOSES; (d) LESSOR IS NOT A MANUFACTURER THEREOF OR A DEALER IN PROPERTY OF SUCH KIND; AND (e) LESSOR HAS NOT MADE NOR SHALL IT BE DEEMED TO HAVE MADE: (i) ANY REPRESENTATION OR WARRANTY OR COVENANT WITH RESPECT TO THE TITLE, MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, CONDITION, QUALITY, DESCRIPTION, DURABILITY OR SUITABILITY OF ANY OF THE EQUIPMENT IN ANY RESPECT OR IN CONNECTION WITH OR FOR THE PURPOSES AND USES OF LESSEE; OR (ii) ANY OTHER REPRESENTATION OR WARRANTY WHATSOEVER, EXPRESS OR IMPLIED, WITH RESPECT TO ANY OF THE EQUIPMENT. ARTICLE VIII EVENTS OF DEFAULT; REMEDIES Section 8.1 Events of Default. The occurrence of any of the following shall constitute an event of default (each an "Event of Default") hereunder (whether any such event shall be voluntary or involuntary or come about or be effected by operation of law or pursuant to or in compliance with any judgment, decree or order of any court or any order, rule or regulation of any Governmental Authority): (a) (i) any payment of Rent, Lease Supplement Balance or Lease Balance (other than a Renewal Payment or other payment due on an Expiration Date) payable by Lessee shall not be paid when due, and, such payment shall be overdue for a period of five (5) Business Days, (ii) any payment payable by Lessee on an Expiration Date, including any Renewal Payment or any payment described at Section 10.2 or Article XI hereof or Section 12.2 of the Participation Agreement, shall not be paid when due or (iii) Lessee shall fail to make payment of any Supplemental Rent (other than Supplemental Rent referred to in clause (i) or (ii) of this Section 8.1(a)) due and payable within ten (10) Business Days after receipt of written notice thereof; or (b) Any representation or warranty of Lessee contained in any Operative Document, or in any certificate, report, financial statement or in other document required to be furnished or delivered pursuant to any Operative Documents by Lessee or on Lessee's behalf to any Participant or Agent or Lessor is false or misleading in any material respect when made or reaffirmed, as the case may be and, if capable of being cured, remains uncured for thirty (30) days after the earlier of (i) receipt by Lessee of notice thereof and (ii) a Responsible Officer of Lessee obtaining knowledge thereof; or (c) Lessee shall default in the performance or observance of any term, covenant, condition or agreement on its part to be performed or observed under Sections 8.1(d), (j) or (n) of the Participation Agreement; or (d) Lessee shall default in any material respect in the performance or observance of (i) any term, covenant, condition or agreement on its part to be performed or 13 13 EXECUTION COPY observed under Sections 8.1(k), (l), (m), (o), (p), (q) or (t) of the Participation Agreement or (ii) any other term, covenant, condition or agreement on its part to be performed or observed hereunder or under any other Operative Document (and not constituting an Event of Default under any other clause of this Section 8.1), and such default, in the case of either clause (i) or clause (ii) above, if capable of being remedied, shall continue unremedied for a period of thirty (30) days after the earlier to occur of (x) written notice thereof by Agent or Lessor to Lessee or (y) a Responsible Officer of Lessee obtaining knowledge thereof (provided that, upon notice from Lessee to Lessor, if such failure referred to in clause (ii) of this Section 8.1(d) is not reasonably capable of being cured during such 30-day period, such period shall be extended for a total period of 180 days so long as (i) such failure is subject to cure during such 180-day period and (ii) Lessee is diligently and continuously proceeding to cure or cause to be cured such failure); or (e) (i) Lessee shall commence a voluntary case concerning itself under the Bankruptcy Code; or (ii) an involuntary case is commenced against Lessee and the petition remains unstayed and in effect for more than sixty (60) days, or is not dismissed within sixty (60) days, after commencement of the case; or (iii) a custodian (as defined in the Bankruptcy Code) is appointed for, or takes charge of, all or substantially all of the property of Lessee or Lessee commences any other proceedings under any reorganization, arrangement, adjustment of debt, relief of debtors, dissolution, insolvency or liquidation or similar law of any jurisdiction whether now or hereafter in effect relating to Lessee or there is commenced against Lessee any such proceeding which remains undismissed for a period of sixty (60) days; or (iv) any order of relief is entered in any such case or proceeding; or (v) Lessee is adjudicated insolvent or bankrupt or (vi) Lessee suffers any appointment of any custodian or the like for it or any substantial part of its property to continue undischarged or unstayed for a period of sixty (60) days; or (vii) Lessee makes a general assignment for the benefit of creditors; or (viii) Lessee shall fail to pay, or shall state that it is unable to pay its debts generally as they become due; or (ix) Lessee shall consent to, or approve in writing any of the foregoing; or (x) any limited liability company action is taken by Lessee for the purpose of effecting any of the foregoing; or (f) (i) Lessee shall default in the payment when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) of any amount owing in respect of any Indebtedness in the principal amount of [*] or more; or Lessee shall default in the performance or observance of any obligation or condition with respect to any Indebtedness or any other event shall occur or condition exist, if the effect of such default, event or condition is to accelerate the maturity of any such Indebtedness or to permit the holder or holders thereof, or any trustee or agent for such holders, to accelerate the maturity of any such Indebtedness, or any such Indebtedness shall become or be declared to be due and payable prior to its stated maturity other than as a result of a regularly scheduled payment, and the principal amount of such Indebtedness is [*] or more, but excluding, except as described in clause (ii) below, any breach or default under the FlashVision/Toshiba Tranche Operative Documents; or (ii) any Event of Default shall occur under the Flash Vision/Toshiba Tranche Operative Documents, other than a Guarantee Event of Default (as defined therein); or (g) any ERISA Event which constitutes grounds for the termination of any Pension Plan by the PBGC or for the appointment of a trustee by the PBGC to administer any [*] INDICATES THAT CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION PURSUANT TO RULE 24B-2. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. 14 EXECUTION COPY Pension Plan shall occur, or any Pension Plan shall be terminated within the meaning of Title IV of ERISA or a trustee shall be appointed by the PBGC to administer any Pension Plan; (h) One or more judgments or decrees in an aggregate amount of $20,000,000 or more, to the extent not paid by insurance or coverage thereof has not been acknowledged in writing by the applicable insurer, shall be entered by a court against Lessee and any such judgments or decrees shall not be stayed, discharged, paid, bonded or vacated within 30 days; or (i) Lessee fails to maintain the insurance coverages required under Section 6.2; or (j) any Guarantee Event of Default shall occur and be continuing; or (k) Lessee shall have elected the Sale Option with respect to any Lease Supplement and shall have failed to comply with the return conditions set forth in Section 11.3; or (l) any Master Agreement Event of Default shall have occurred and such event of default, if capable of being remedied, shall continue unremedied for a period of thirty (30) days after the earlier to occur of (i) written notice thereof by Agent or Lessor to Lessee and Guarantor, or (ii) a Responsible Officer of Guarantor obtaining knowledge thereof; or (m) (i) Lessee shall have been dissolved (x) voluntarily by the Members pursuant to Section 11.01(b) of the Operating Agreement or (y) as a result of a default by a Member pursuant to Section 11.01(c) of the Operating Agreement, or (z) as a result of a "Deadlock" pursuant to Section 11.01(d) of the Operating Agreement; (ii) Guarantor shall sell, transfer or convey any of its equity interest in Lessee to any Person, other than to an Affiliate of Guarantor that is controlled by Guarantor; (iii) upon the occurrence of the Termination Date (as defined in Section 11.04 of the Operating Agreement), in the event Guarantor elects the Unilateral Option under Section 11.04 (Dissolution by Unilateral Option) of the Operating Agreement, unless prior to such Termination Date (A) Toshiba restructures the Operative Documents to take into consideration Toshiba's assumption of Guarantor's obligations under the Guarantee, which may include a repricing of the transaction covered thereby, (B) Toshiba provides a guarantee of Lessee's obligations under the Operative Documents in form substantially similar to the Guarantee (in which case the Guarantee shall be deemed released) and (C) Lessee or its designee under the Operative Documents exercises its Early Termination Option under Section 10.1 of the Lease with respect to all of the Equipment subject to the Lease and pays in full the amounts due under such Section 10.1 of the Lease; or (n) (i) Guarantor shall fail to own and control at least 49.9% of the Membership Interests in Lessee unless such failure is due to a circumstance not constituting an Event of Default under Section 8.1(m); or (ii) Toshiba shall fail to own and control at least 50% of the Membership Interests in Lessee unless such failure is due to a circumstance not constituting an Event of Default under, or otherwise is permitted pursuant to the terms of, Section 8.1(m) or Section 8.1(m) of the Toshiba Lease. Section 8.2 Remedies. If any Event of Default exists, Lessor shall have the rights, options and remedies of a secured party under the UCC (regardless of whether the UCC or a law 15 15 EXECUTION COPY similar thereto has been enacted in a jurisdiction wherein the rights or remedies are asserted) and all other Applicable Laws, and, without limiting the foregoing, Lessor also may exercise in any order one or more or all of the following remedies (it being understood that no remedy herein conferred is intended to be exclusive of any other remedy or remedies, but each and every remedy shall be cumulative and shall be in addition to every other remedy given herein or now or hereafter existing at law or in equity or by statute): (i) terminate this Lease by notice in writing to Lessee, but Lessee shall remain liable as hereinafter provided; (ii) declare the entire outstanding Lease Balance to be due and payable, together with accrued unpaid Rent and any other amounts payable under the Operative Documents; (iii) enforce the security interest given hereunder pursuant to the UCC or any other law; (iv) enter upon the premises where any of the Collateral may be and take possession of all or any of such Collateral; (v) proceed by appropriate court action or actions either at law or in equity, to enforce performance by Lessee of the applicable covenants of this Lease or to recover damages for the breach thereof; and (vi) require Lessee to assemble and return the Equipment and other Collateral as provided in Section 9.1. Notwithstanding the foregoing, Lessor's rights under this Section 8.2 and 8.3 shall be subject to Lessee's rights to purchase all of the Equipment pursuant to Section 10.1, but in any such case within the time periods provided for in Section 8.7, to the extent applicable. Notwithstanding the foregoing, if any Event of Default described in Section 8.1(e) shall have occurred and be continuing, then the entire outstanding Lease Balance and all accrued Rent and other amounts payable under the Operative Documents shall automatically and immediately become due and payable, without presentment, demand, notice, declaration, protest or other requirements of any kind, all of which are hereby expressly waived and, upon payment of such amounts, Lessor and Agent shall transfer title to the Equipment to Lessee free and clear of Lessor Liens or any Liens described in clause (a) of the definition of Permitted Liens in the manner required under Section 10.1. Section 8.3 Sale of Collateral. Subject to Section 8.7, in addition to the remedies set forth in Section 8.2 and to the extent permitted by Applicable Laws, if any Event of Default shall occur, Lessor may, but is not required to, sell the Collateral in one or more sales. Any Participant, Agent or Lessor may purchase all or any part of the Collateral at such sale. Lessee acknowledges that sales for cash or on credit to a wholesaler, retailer or user of such Collateral, or at public or private auction, are all commercially reasonable. Any notice required by law of intended disposition by Lessor shall be deemed reasonably and properly given if given at least ten (10) days before such disposition. Section 8.4 Application of Proceeds. The proceeds of such sale or exercise of other remedies shall be applied in the manner set forth in Section 5.3 of the Participation Agreement. Section 8.5 Right to Perform Obligations. If an Event of Default exists, Lessor may, but shall not be obligated to, on ten (10) Business Days' notice to Lessee (or at least one (1) Business Day's, notice, if, in the reasonable judgment of Lessor an emergency exists or at least three (3) Business Days' notice, if in the reasonable judgment of Lessor there exists a condition which Lessee has failed to address pursuant to the terms of the Lease which if not remedied would have a Material Adverse Effect), remedy such condition, and the fees and expenses incurred by Lessor in connection with such performance together with interest thereon shall be payable by Lessee within ten (10) days of written demand. Interest on fees and expenses so 16 16 EXECUTION COPY incurred by Lessor shall accrue at the Overdue Rate as provided in Section 4.5 from the date payment by Lessee for such fees and expenses is due hereunder until paid in full. Section 8.6 Power of Attorney. Lessee unconditionally and irrevocably appoints Lessor as its true and lawful attorney-in-fact, with full power of substitution, to the extent permitted by Applicable Laws, in its name and stead and on its behalf, for the purpose of effectuating any sale, assignment, transfer or delivery hereunder, if an Event of Default exists, whether pursuant to foreclosure or power of sale or otherwise, and in connection therewith to execute and deliver all such deeds, bills of sale, assignments, releases (including releases of this Lease on the records of any Governmental Authority) and other proper instruments as Lessor may reasonably consider necessary or appropriate. Lessee ratifies and confirms all that such attorney or any substitute shall lawfully do by virtue hereof in accordance with the terms hereof. If requested by Lessor or any purchaser, Lessee shall ratify and confirm any such lawful sale, assignment, transfer or delivery by executing and delivering to Lessor or such purchaser, all deeds, bills of sale, assignments, releases and other proper instruments to effect such ratification and confirmation as may be designated in any such request. Section 8.7 Lessee Purchase Following Event of Default. (a) At any time after the occurrence and during the continuance of an Event of Default Lessor may give Lessee notice that Lessee's Purchase Option or Early Termination Option shall terminate unless exercised and consummated within thirty (30) days of the date of such notice is given. Lessee may exercise (which exercise shall be irrevocable) and consummate the purchase of all, but not less than all, of the Equipment during such thirty (30) day period by paying the amounts required under Sections 10.1 or 11.1(b), together with (without duplication) all other amounts then due and payable by Lessee pursuant to this Lease and the other Operative Documents. (b) Guarantor and/or Toshiba may exercise directly the right to purchase the Equipment under Section 10.1 upon such conditions and at such times as set forth in a written notice to Lessor and Agent executed by each of Lessee, Guarantor and Toshiba. ARTICLE IX RETURN OF EQUIPMENT Section 9.1 Return of Equipment. (a) If Lessor has terminated this Lease pursuant to Article VIII, and Lessee has not purchased the Equipment pursuant to Section 10.2, or if Lessee has exercised the Sale Option with respect to any Equipment, Lessee shall (i) for a period of up to one year after the applicable Expiration Date or the date of such termination, as the case may be, maintain (or cause to be maintained) the applicable Equipment in the condition required by Section 5.3, store such Equipment without cost to Lessor, Agent or any Participant, and keep all of such Equipment insured in accordance with Article VI, and (ii) upon Lessor's or Agent's request following the applicable Expiration Date or such termination forthwith deliver exclusive 17 17 EXECUTION COPY possession of such Equipment to Lessor or a purchaser of the Equipment at a location designated by Lessor within the continental United States, together with a copy of an inventory list of such Equipment, all operating, maintenance and repair manuals relating to such Equipment and subject to applicable confidentiality requirements, if any, that have been received or prepared by Lessee (in condition to be placed in immediate service), and, at Lessee's cost and expense, remove any Permitted Modifications if permitted by clause (b) of Section 5.4. (b) In connection with the delivery of any Equipment required to be made to Lessor or any purchaser under Section 9.1(a)(ii), Lessee shall, at its sole cost and expense: (i) properly remove all markings on such Equipment made by Lessee which are not necessary for the operation, maintenance or repair of such Equipment or required by the manufacturer, Applicable Law or Insurance Requirements; (ii) at least ninety (90) days prior to the Expiration Date of the Lease Supplement to which such Equipment is subject, or, in the case of a termination of this Lease pursuant to Article VIII, promptly after such termination, cause a supplier's representative or qualified maintenance provider reasonably acceptable to Agent to perform a comprehensive inspection, examination and test of such Equipment and provide a comprehensive report which certifies that such Equipment is operating within the applicable supplier's specifications or if during such inspection, examination and test, the authorized inspector finds such Equipment not operating within the supplier's specifications, then Lessee shall repair or replace such defective Equipment in accordance with this Lease and, after corrective measures are completed, Lessee will provide for a follow-up inspection and report of such Equipment by the authorized inspector; (iii) if such Equipment is not to be operated in place pursuant to the Sublease or an Affiliate Sublease, provide for such Equipment to be completely de-installed and severed from the Facility or any other real property to which attached by a supplier's representative or maintenance provider reasonably acceptable to Agent in accordance with the supplier's recommendations and repair any and all damage caused to such Equipment by such severance; (iv) if such Equipment is not to be operated in place pursuant to the Sublease or an Affiliate Sublease, pack such Equipment properly for shipment and arrange for the shipment thereof to any location within the continental United States specified by Lessor (or any purchaser) in a manner consistent with the supplier's recommendations; and (v) if requested by Lessor or Agent (or any purchaser), such delivery shall include the assignment by Lessee to Lessor (or any purchaser) of any Related Agreements subject to applicable contract provisions and applicable confidentiality requirements, if any and, to the extent permitted by Applicable Law and otherwise transferable, any Related Permits necessary for the use, operation or maintenance of such Equipment. 18 18 EXECUTION COPY (c) This Article IX shall survive termination of this Lease. ARTICLE X EARLY TERMINATION Section 10.1 Early Termination. If Lessee has not previously elected the Sale Option with respect to any Lease Supplement, Lessee may, at its option, upon at least thirty (30) days' advance written notice to Agent and Lessor, purchase all, but not less than all, of the Equipment and Related Property subject to this Lease ("Early Termination Option") for the sum of (i) all accrued and unpaid Rent payable through the date of such purchase, (ii) the outstanding Lease Balance after giving effect to any payment under clause (i), and (iii) all other fees and expenses and other amounts then due and payable pursuant to this Lease and the other Operative Documents (including any Break Costs to the extent such payment is not made on a scheduled Payment Date). Upon the indefeasible payment of such sums by Lessee in accordance with the provisions of the preceding sentence, the obligation of Lessee to pay Rent hereunder (other than Rent expressly surviving the termination of this Lease, including payments pursuant to Article XII of the Participation Agreement) shall cease, the term of this Lease with respect to all Lease Supplements shall end on the date of such payment and Lessor and Agent, on behalf of the Participants, shall as promptly as practicable execute and deliver to Lessee such documents as may be reasonably required to release the Equipment and Related Property and other Collateral from the terms and scope of this Lease and the other Operative Documents (without representations or warranties, except that the Collateral is free and clear of Lessor Liens), including quitclaim bills of sale, UCC termination statements, lease termination agreements and an assignment of any right of Lessor to any Related Property, if any, or the benefits thereof, in such form as may be reasonably requested by Lessee, all at Lessee's sole cost and expense. Section 10.2 Required Termination. In the event that (a) any Operative Document to which Lessee or Guarantor is a party or the security interest granted under this Lease or any other Operative Document shall (except in accordance with its or their terms), in whole or in part, terminate, cease to be effective or cease to be the legally valid, binding and enforceable obligation of Lessee or Guarantor, as applicable, (b) Lessee or any of its Affiliates shall, directly or indirectly, contest in any manner in any court the effectiveness, validity, binding nature or enforceability of any Operative Document, (c) the security interest in the Collateral securing Lessee's or Guarantor's obligations shall, in whole or in part, cease to be a perfected first priority security interest (subject to Permitted Liens), (d) there exists an Event of Default, (e) Lessee shall have abandoned or constructively abandoned all or any material portion of the Equipment for a period of 30 consecutive days which results in the Equipment not being properly maintained in accordance with the terms of this Lease or (f) Equipment with a Fair Market Value in excess of thirty percent (30%) of the Aggregate Purchase Price of all of the Equipment then subject to this Lease shall have suffered and shall be subject at such time to a Casualty, Lessee shall, upon notice from Agent, Lessor or the Required Participants (except in the case of an Event of Default set forth in Section 8.1(e), in which case no notice shall be required and such purchase shall be made promptly upon such Event of Default, and except in the case of an event described in clause (c) that occurs as a result of Lessor's or Agent's acts or omissions, in which case Lessee shall have a thirty (30) day period from the receipt of notice from Lessor or Agent of 19 19 EXECUTION COPY such occurrence to cure such lapsed perfection), repurchase all of the Equipment and Related Property by paying to Agent, for the benefit of Lessor and the Participants, all amounts that would have been payable on the date of such repurchase if Lessee had purchased all of the Equipment and Related Property on such date pursuant to Section 10.1, such payment to be made not later than thirty (30) days following such notice or Event of Default, or in the case of a Casualty described in clause (f), within the period provided for in Section 6.1(a). ARTICLE XI LEASE TERMINATION Section 11.1 Lessee's Options. Not later than 180 days prior to the Expiration Date then in effect with respect to any Lease Supplement, Lessee shall, by delivery of written notice to Agent and Lessor, exercise one of the following options, subject to the requirements and limitations of Section 11.2: (a) elect to renew this Lease with respect to all, but not less than all, of the Lease Supplement Equipment then subject to such Lease Supplement (the "Renewal Option") with respect to the applicable Base Term or applicable Renewal Term then in effect, for a renewal term commencing on the last day of the applicable Base Term or applicable Renewal Term then in effect and expiring on the one year anniversary thereof (each, a "Renewal Term") provided, that (i) such option shall be exercised only with respect to the applicable Base Term or applicable Renewal Term then in effect with respect to such Lease Supplement, (ii) in connection with the exercise of the Renewal Option with respect to a Lease Supplement, Lessee shall have theretofore provided Agent, Lessor and the Participants with an Annual Appraisal required pursuant to Section 5.8 of this Lease as of the most recent anniversary of the Document Closing Date and (iii) notwithstanding the foregoing, in no event shall any Renewal Term in respect of any Lease Supplement extend beyond the date which is five (5) years following the Document Closing Date unless such additional Renewal Term has been approved pursuant to Section 14.18 of the Participation Agreement; or (b) purchase all, but not less than all, of such Lease Supplement Equipment for cash for the Option Exercise Amount on such Expiration Date (such option being referred to as the "Purchase Option"); or (c) sell on such Expiration Date all, but not less than all, of such Lease Supplement Equipment on behalf of the Participants for cash to a purchaser or purchasers not in any way affiliated with Lessee (the "Sale Option"). Simultaneously with a sale pursuant to a Sale Option, Lessee shall pay or cause to be paid to Lessor on the last day of the applicable Lease Term (i) all accrued Basic Rent and any Supplemental Rent then due and payable with respect to such Lease Supplement and the Casualty Amount of any Item of such Lease Supplement Equipment theretofore suffering a Casualty as to which the Casualty Amount was not paid under Section 6.1, (ii) as Supplemental Rent for the benefit of the Participants, an amount equal to the Residual Value Guarantee Amount then in effect with respect to such Lease Supplement, determined after giving effect to the payment of any amount required under clause (i) and (iii) all of the Proceeds of such sale. Lessor shall refund to Lessee the portion of the 20 20 EXECUTION COPY Proceeds in excess of the relevant Lease Supplement Balance (as determined following the application of such Residual Value Guarantee Amount paid by Lessee and all amounts paid pursuant to clause (i) above), if any, as promptly as practicable following the receipt by Lessor of the foregoing payments. Lessee agrees, however, that the amount payable pursuant to this Section 11.1(c) shall in no event be construed to limit any obligation of Lessee under Article XII of the Participation Agreement and Sections 11.3 and 11.4 of this Lease. The obligation of Lessee to pay the amounts determined pursuant to clauses (i) and (ii) of this Section 11.1(c) and Sections 11.3 and 11.4 shall be recourse obligations of Lessee and shall be payable on the applicable Expiration Date. All amounts paid to Lessor pursuant to this Section 11.1(c) and any Proceeds to be retained by Lessor shall be distributed to the Participants in accordance with Section 5.3 of the Participation Agreement. Section 11.2 Election of Options. Lessee's election of a Purchase Option will be irrevocable at the time made, but if Lessee fails to make a timely election under Section 11.1, Lessee will be deemed to have irrevocably elected the Renewal Option, and if the Renewal Option is not available, Lessee shall be deemed to have irrevocably elected the Purchase Option. Lessee shall be deemed to have elected the Purchase Option with respect to a Lease Supplement if it fails to sell all of the applicable Lease Supplement Equipment on the applicable Expiration Date in accordance with the terms and conditions herein relating to the Sale Option. Furthermore, a Sale Option shall automatically be revoked if there exists a Default or Event of Default at any time after such Sale Option is properly elected, and, if an Event of Default exists, Lessor shall be entitled to exercise all rights and remedies provided in Article VIII. Lessee may not elect a Sale Option if there exists on the date the election is made an Event of Default or a Default. Section 11.3 Sale Option Procedures. If Lessee elects a Sale Option with respect to any Lease Supplement, Lessee shall use its best commercial efforts to obtain the highest all cash purchase price for all of the Lease Supplement Equipment then subject to such Lease Supplement, and Lessee shall comply with Section 9.1 hereof. All costs related to such sale and delivery, including the reasonable cost of sales agents, removal of the Equipment, delivery of documents and the Equipment to any location designated by a buyer within the continental United States, certification, installation and testing of the Equipment in any location chosen by the buyer or prospective buyer, reasonable legal costs, reasonable costs of notices, any advertisement or other similar costs or other information and of any parts shall be borne entirely by Lessee, without regard to whether such costs were incurred by Agent, Lessor, Lessee or any potentially qualified buyer, and shall in no event be paid from any of the Proceeds. Neither Agent, Lessor nor any Participant shall have any responsibility for procuring any purchaser. If, nevertheless, Lessor, at the direction of the Required Participants, undertakes any sales efforts, Lessee shall promptly reimburse Agent, Lessor and/or any such Participant for any reasonable charges, costs and expenses incurred in such effort, including any allocated reasonable time charges, costs and expenses of internal counsel or other reasonable attorneys' fees. Upon a sale of any Lease Supplement Equipment pursuant to the Sale Option, such Lease Supplement Equipment shall be in the condition required by Section 5.3 and Liens for Taxes not yet due and payable (which shall be the responsibility of Lessee for the period prior to the sale) and shall be free and clear of all Liens (including Permitted Liens, other than Lessor Liens), and Lessee shall cause all such Lease Supplement Equipment to be delivered to such location or locations designated by the buyer thereof. Lessor (A) at the direction of the Required Participants, shall 21 21 EXECUTION COPY determine whether to accept the highest all cash offer for such Lease Supplement Equipment which determination shall be made by the Required Participants, and (B) if accepted by the Required Participants, Lessee shall sell such Lease Supplement Equipment in accordance with the terms of such offer to the buyer submitting such offer; provided that Lessor shall not be entitled to reject the highest all cash offer for such Lease Supplement Equipment if the Proceeds from the sale of such Lease Supplement Equipment pursuant to such offer would be sufficient, together with the sum of the amounts referred to in clauses (i) and (ii) of Section 11.1(c), to reduce such Lease Supplement Balance to $0. If, within 45 days prior to the relevant Expiration Date relating to a Sale Option with respect to any Lease Supplement, Lessee has not obtained an all cash purchase price for the relevant Lease Supplement Equipment that would provide Proceeds sufficient, together with such amounts referred to in clauses (i) and (ii) of Section 11.1(c), to reduce such Lease Supplement Balance to $0, then any Participant may request the Lease Term Appraisal with respect to such Lease Supplement Equipment described in Section 11.4 and, if such Lease Term Appraisal is requested, receipt of such Lease Term Appraisal at least ten (10) Business Days prior to the relevant Expiration Date relating to such Sale Option shall be a condition to the consummation of the sale of such Lease Supplement Equipment on such Expiration Date. Any purchaser or purchasers of any Equipment shall not in any way be affiliated with Lessee. Section 11.4 Appraisals. If Lessee exercises a Sale Option with respect to any Lease Supplement and the sum of the anticipated Proceeds from the sale of the relevant Lease Supplement Equipment and Related Property plus the Residual Value Guarantee Amount then in effect with respect to such Lease Supplement is less than the applicable outstanding Lease Supplement Balance, Lessor (upon direction from any Participant) shall, as provided in Section 11.3, engage an appraiser of nationally recognized standing reasonably acceptable to Lessee, at Lessee's expense, to prepare a Lease Term Appraisal with respect to such Lease Supplement Equipment to determine (by appraisal methods satisfactory to the Participants) the Fair Market Value of such Lease Supplement Equipment as of the relevant Expiration Date. If the Fair Market Value of such Lease Supplement Equipment as of such Expiration Date set forth in such Lease Term Appraisal is in excess of the aggregate Proceeds, Lessee shall, to the extent required by Section 12.2 of the Participation Agreement, promptly pay to Lessor, as Supplemental Rent, for the benefit of Lessor and the Participants, an amount, not to exceed the lesser of the amount required by Section 12.2 of the Participation Agreement and the amount of such excess, as necessary to repay the relevant outstanding Lease Supplement Balance determined immediately prior to the application of the foregoing amounts. ARTICLE XII OWNERSHIP, GRANT OF SECURITY INTEREST AND FURTHER ASSURANCES Section 12.1 Grant of Security Interest. Title to the Equipment shall remain in Lessor as security for the obligations of Lessee hereunder and under the other Operative Documents to which it is a party until Lessee has fulfilled all of its obligations hereunder and thereunder (which security shall be assigned by Lessor to Agent, for the benefit of the Participants, pursuant to the relevant Security Documents). Lessee hereby assigns, hypothecates, transfers and pledges to 22 22 EXECUTION COPY Lessor, and grants to Lessor a continuing security interest in, the Equipment and other Collateral, to secure the payment of all sums due hereunder and under the related documents to which it is a party and the performance of all other obligations hereunder and under the other Operative Documents to which it is a party. Section 12.2 Retention of Proceeds. If Lessee would be entitled to any amount (including any Casualty Recoveries) or title to any Equipment hereunder but for the existence of any Event of Default or Default, Lessor shall hold such amount or Equipment as part of the Collateral and, while such Event of Default exists, shall be entitled to apply such amounts against any amounts due hereunder; provided, that Lessor shall (or shall cause Agent to) distribute such amount or transfer such Equipment in accordance with the other terms of this Lease if and when no Event of Default or Default exists or Lessee purchases the Equipment pursuant to this Lease. ARTICLE XIII MISCELLANEOUS Section 13.1 Effect of Waiver. No delay or omission to exercise any right, power or remedy inuring to Lessor, or Agent or any Participant through Lessor, upon any breach or default of Lessee hereunder shall impair any such right, power or remedy nor shall it be construed to be a waiver of any such breach or default, or an acquiescence therein or thereof or in any similar breach or default thereafter occurring, nor shall any single or partial exercise of any right, power or remedy preclude any other or further exercise thereof, or the exercise of any other right, power or remedy, nor shall any waiver of any single breach or default be deemed a waiver of any other breach or default theretofore or thereafter occurring. Any waiver, permit, consent or approval of any kind or character on the part of Agent, Lessor or the Participants of any breach or default under this Lease must be specifically set forth in writing and must satisfy the applicable requirements set forth in Section 14.5 of the Participation Agreement. Section 13.2 Applicable Law. THIS LEASE SHALL BE GOVERNED BY AND CONSTRUED UNDER THE INTERNAL LAWS OF THE STATE OF CALIFORNIA WITHOUT REGARD TO CONFLICT OF LAW PRINCIPLES. Section 13.3 Effect and Modification of Lease. No variation, modification, amendment or waiver of this Lease shall be valid unless entered into in accordance with Section 14.5 of the Participation Agreement. Section 13.4 Notices. All demands, notices and other communications hereunder shall be in writing and shall be deemed to have been duly given if given as provided from Section 14.3 of the Participation Agreement. Section 13.5 Counterparts. This Lease may be executed in any number of counterparts, each of which shall be an original, but all of which shall together constitute one and the same instrument. This Lease has been executed in several counterparts. One counterpart has been prominently marked "Counterpart No. 1 ". Only the counterpart marked "Counterpart No. 23 23 EXECUTION COPY 1 " shall evidence a monetary obligation of Lessee or shall be deemed to be an original or to be chattel paper for purposes of the Uniform Commercial Code, and such copy shall be held by Agent. Section 13.6 Severability. Whenever possible, each provision of this Lease shall be interpreted in such manner as to be effective and valid under Applicable Laws; but if any provision of this Lease shall be prohibited by or invalid under Applicable Laws, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Lease. Section 13.7 Successors and Assigns; Merger. This Lease shall be binding upon the parties hereto and their respective successors and assigns and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns. Section 13.8 Section Headings; Table of Contents. Section headings and the table of contents used in this Lease (including the schedule) are for convenience of reference only and shall not affect the construction of this Lease. Section 13.9 Final Agreement. THIS LEASE, TOGETHER WITH THE OTHER OPERATIVE DOCUMENTS, REPRESENTS THE ENTIRE FINAL AGREEMENT BETWEEN THE PARTIES WITH RESPECT TO THE TRANSACTIONS CONTEMPLATED BY THE LEASE AND THE OTHER OPERATIVE DOCUMENTS. THIS LEASE CANNOT BE MODIFIED, SUPPLEMENTED, AMENDED, RESCINDED OR CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES, EXCEPT BY AN INSTRUMENT IN WRITING SIGNED BY THE PARTIES HERETO IN ACCORDANCE WITH THE TERMS OF THE PARTICIPATION AGREEMENT. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. Section 13.10 Timeliness of Performance. The provisions of Articles VIII and XI pertaining to the delivery of notice and the performance of certain events on dates required by Articles VIII and XI are to be strictly adhered to by the parties hereto. Section 13.11 FINANCE LEASE. THE PARTIES INTEND THAT THIS LEASE BE A FINANCE LEASE UNDER ARTICLE 2A OF THE UNIFORM COMMERCIAL CODE AS IN EFFECT IN THE STATE OF CALIFORNIA. [remainder of page intentionally left blank] 24 EXECUTION COPY IN WITNESS WHEREOF, the parties hereto have caused this Lease to be executed and delivered as of the date first above written. FLASHVISION, L.L.C. By: ------------------------------------ Name Printed: -------------------------- Title: --------------------------------- ABN AMRO BANK N.V., not individually but solely as Lessor By: ------------------------------------ Name Printed: -------------------------- Title: --------------------------------- By: ------------------------------------ Name Printed: -------------------------- Title: --------------------------------- 25 EXECUTION COPY THIS COUNTERPART IS THE ORIGINAL EXECUTED COUNTERPART. Receipt of this original counterpart of the foregoing Lease is hereby acknowledged as of the date hereof. ABN AMRO BANK N.V., not individually but solely as Agent for the Participants By: ------------------------------------ Name Printed: -------------------------- Title: --------------------------------- By: ------------------------------------ Name Printed: -------------------------- Title: --------------------------------- 26 SCHEDULE A TO LEASE Fixed Rent Fixed Rent will be set on each Lease Supplement Closing Date in respect of the Lease Supplement Equipment financed on such date, based on the Fair Market Value of each Item of Equipment so financed on such date (as set forth in the most recent Initial Appraisal, Annual Appraisal or Supplemental Appraisal then delivered in respect thereof). This Schedule A will be replaced on the initial Lease Supplement Closing Date with a mutually acceptable Schedule A reflecting the Fixed Rent payable with respect to the Items of Equipment made subject to the Lease on such date. Schedule A - 1 27 EXECUTION COPY SCHEDULE B TO LEASE Percentage Applicable to Calculation of Residual Value Guarantee Amount Base Term of any Lease Supplement: 86% Renewal Term #1 of any Lease Supplement: 88% Renewal Term #2 of any Lease Supplement: 88% Renewal Term #3 of any Lease Supplement: 88% Renewal Term #4 of any Lease Supplement: 88% Schedule B - 1 28 EXECUTION COPY EXHIBIT A TO LEASE LEASE SUPPLEMENT NO. ____ COUNTERPART NO. ____ OF SERIALLY NUMBERED MANUALLY EXECUTED COUNTERPARTS. TO THE EXTENT THAT THIS DOCUMENT CONSTITUTES CHATTEL PAPER UNDER THE UNIFORM COMMERCIAL CODE, NO SECURITY INTEREST IN THIS DOCUMENT MAY BE CREATED THROUGH THE TRANSFER AND POSSESSION OF ANY COUNTERPART OTHER THAN COUNTERPART NO. 1. Lease Supplement No. ___ dated _____________, _____ (this "Lease Supplement") between FLASHVISION, L.L.C., a Virginia limited liability company ("Lessee"), and ABN AMRO BANK N.V. ("Lessor"), not in its individual capacity, but solely in its capacity as Lessor. W I T N E S S E T H: WHEREAS, Lessee and Lessor have heretofore entered into that certain Master Lease Intended as Security (FlashVision/SanDisk Tranche) dated as of December 27, 2000 (as from time to time amended, restated, supplemented or otherwise modified, the "Lease"; unless otherwise defined herein, capitalized terms used herein shall have the meanings specified in the Lease); and WHEREAS, the Lease provides for the execution and delivery of a separate Lease Supplement on each Lease Supplement Closing Date for the Equipment to be acquired on such Lease Supplement Closing Date for the purpose of confirming the acceptance and lease of such Equipment, specifying the purchase prices and descriptions applicable to such Equipment and setting forth certain other matters, all as required pursuant to the Lease and the other Operative Documents; NOW, THEREFORE, in consideration of the premises and other good and sufficient consideration, Lessor and Lessee hereby agree as follows: (1) Inspection and Approval. Lessee hereby acknowledges and confirms that it has inspected, received and approved the Equipment set forth on Schedule I hereto for all purposes of the Lease and the other Operative Documents and, as among Agent, Lessor, the Participants and Lessee, such Equipment complies in all material respects with the specifications for such Equipment, is in good working order, repair, condition and appearance and has been Installed and Accepted at the Facility and is otherwise acceptable to Lessee. Lessee hereby certifies that it has no knowledge of any defect in any of the Equipment set forth on Schedule I with respect to design, manufacture, condition (reasonable wear and tear excepted) or in any other respect. Lessee reaffirms, as to the Equipment set forth in Schedule I, each of the waivers acknowledgments and agreements of Lessee set forth in Article VII of the Lease. Exhibit A - 1 29 EXECUTION COPY (2) Delivery and Acceptance. Lessor hereby confirms delivery and lease to Lessee, and Lessee hereby confirms acceptance of delivery and lease under the Lease hereby supplemented, of the Equipment listed on Schedule I hereto and all Related Property. (3) Warranty. Lessee hereby represents and warrants that (i) no event which would constitute a Casualty under the Lease has occurred with respect to any of the Equipment set forth on Schedule I hereto as of the date hereof and (ii) no offset assertable by Lessee exists with respect to the Equipment covered by this Lease Supplement or any Rent that will be payable with respect to such Equipment. Lessee hereby reaffirms each of the representations and warranties set forth in Section 7.2 of the Participation Agreement as if made on the date hereof, including that the Equipment set forth on Schedule I hereto and all Related Property is free and clear of all Liens other than Permitted Liens. (4) Payment of Vendors. Lessee hereby represents and warrants that on or prior to the Lease Supplement Closing Date, it has paid each vendor of the Equipment set forth on Schedule I hereto in full or will pay such vendor in full with the proceeds of the Advance being made on such date pursuant to the terms of the relevant Acquisition Agreement. (5) Confirmation. Lessee hereby confirms its agreement, in accordance with the Lease, as supplemented by this Lease Supplement, to pay Basic Rent to Lessor, for the Equipment subject hereto. Nothing herein shall reduce Lessee's obligation to make all other payments required under the Lease and the other Operative Documents, including those payments to be made on the last day of the Lease Term with respect to the Equipment described on Schedule I hereto pursuant to Article XI of the Lease. (6) Base Term. The Base Term of this Lease Supplement shall commence on the date hereof and end on the first anniversary of the date hereof (the "Scheduled Expiration Date" of this Lease Supplement), subject to renewal or early termination as provided in the Lease. (7) Lease Supplement Balance. Until reduced by any payments of Fixed Rent or any Renewal Payments applied with respect to this Lease Supplement, the Lease Supplement Balance of this Lease Supplement as of the date hereof is $_________. (8) Fixed Rent. Payments of the Fixed Rent are due with respect to this Lease Supplement on the dates and in the amounts set forth in Schedule A to the Lease. Other payments of Basic Rent and Supplemental Rent are due with respect to this Lease Supplement as set forth in Section 3.2 of the Lease. (9) Incorporation into Lease. This Lease Supplement shall be construed in connection with and as part of the Lease, and all terms, conditions and covenants contained in the Lease, as supplemented by this Lease Supplement, shall be and remain in full force and effect and shall govern the Equipment described on Schedule I hereto. (10) References. Any and all notices, requests, certificates and other instruments executed and delivered concurrently with or after the execution and delivery of this Lease Supplement may refer to the "Master Lease Intended as Security (FlashVision/SanDisk Tranche), dated as of December 27, 2000", or may identify the Lease in any other respect Exhibit A - 2 30 EXECUTION COPY without making specific reference to this Lease Supplement, but nevertheless all such references shall be deemed to include this Lease Supplement, unless the context shall otherwise require. (11) Counterparts. This Lease Supplement may be executed in any number of counterparts, each of which shall be an original, but all of which shall together constitute one and the same instrument. Only the counterpart designated as "Counterpart No. 1" shall evidence a monetary obligation of Lessee or shall be deemed to be chattel paper for purposes of the Uniform Commercial Code, and such copy shall be held by Agent. (12) GOVERNING LAW. THIS LEASE SUPPLEMENT SHALL BE GOVERNED BY AND CONSTRUED UNDER THE INTERNAL LAWS OF THE STATE OF CALIFORNIA WITHOUT REGARD TO CONFLICT OF LAW PRINCIPLES. [remainder of page intentionally left blank] Exhibit A - 3 31 IN WITNESS WHEREOF, the parties hereto have caused this Lease Supplement No. ___ to be executed and delivered as of the date first above written. FLASHVISION, L.L.C. By: ------------------------------------- Name Printed: --------------------------- Title: ---------------------------------- ABN AMRO BANK N.V., not individually but solely as Lessor By: ------------------------------------- Name Printed: --------------------------- Title: ---------------------------------- By: ------------------------------------- Name Printed: --------------------------- Title: ---------------------------------- 32 THIS COUNTERPART IS THE ORIGINAL EXECUTED COUNTERPART. Receipt of this original counterpart of the foregoing Lease Supplement is hereby acknowledged as of the date hereof. ABN AMRO BANK N.V., not individually but solely as Agent for the Participants By: ------------------------------------- Name Printed: --------------------------- Title: ---------------------------------- By: ------------------------------------- Name Printed: --------------------------- Title: ---------------------------------- 33 ATTACHMENT A TO LEASE SUPPLEMENT NO. ___ _____________, ______ Funding
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Total Lease Supplement No. ____ $_______________ 34 EX-10.50 4 0004.txt GUARANTEE, DATED 12/27/2000 Exhibit 10.50 =============================================================================== GUARANTEE dated as of December 27, 2000 from SANDISK CORPORATION, as Guarantor to ABN AMRO BANK N.V., as Lessor and Agent, and EACH OF THE PARTICIPANTS =============================================================================== FLASHVISION/SANDISK TRANCHE 2000 LEASE FINANCING TABLE OF CONTENTS Page Section 1. Defined Terms..................................................1 Section 2. Guarantee......................................................8 Section 3. Intentionally Omitted..........................................8 Section 4. No Subrogation; Subordination..................................8 Section 5. Amendments, etc. with Respect to the Guaranteed Obligations; Waiver of Rights...............................................9 Section 6. Guarantee Absolute and Unconditional..........................10 Section 7. Reinstatement.................................................10 Section 8. Payments......................................................11 Section 9. Representations of Guarantor..................................11 Section 10. Covenants of Guarantor........................................15 Section 11. Guarantee Events of Default; Remedies.........................26 Section 12. Notices.......................................................29 Section 13. Severability..................................................29 Section 14. Integration...................................................29 Section 15. Amendments in Writing.........................................29 Section 16. Section Headings..............................................29 Section 17. Successors and Assigns........................................29 Section 18. Submission to Jurisdiction....................................29 Section 19. WAIVER OF JURY TRIAL..........................................29 Section 20. GOVERNING LAW.................................................30 Section 21. Nature of Transaction.........................................30 Section 22. Actions by Guaranteed Parties.................................30 Section 23. Termination...................................................30 i SCHEDULES Schedule I Notice Information Schedule 9(u) Subsidiaries Schedule 10(a)(iv)(M) Form of Annual Plan Schedule 10(b)(i) Indebtedness Schedule 10(b)(ii) Liens Schedule 10(b)(iv)(D) Investments ii GUARANTEE GUARANTEE (this "Guarantee"), dated as of December 27, 2000, made by SANDISK CORPORATION, a Delaware corporation (the "Guarantor"), in favor of ABN AMRO BANK N.V., a bank organized under the laws of the Netherlands, not in its individual capacity, but solely as lessor (together with its permitted successors and assign, the "Lessor"), ABN AMRO BANK N.V., as agent for each of the Participants (in such capacity, together with its successors in such capacity, the "Agent"), and each of the Participants. W I T N E S S E T H: WHEREAS, FlashVision, L.L.C., a Virginia limited liability company (together with its permitted successors and assigns, the "Lessee"), Lessor, Agent and the Participants have entered into that certain Participation Agreement (FlashVision/SanDisk Tranche), dated as of the date hereof (as amended, restated, modified or supplemented after the date hereof, the "Participation Agreement (SanDisk Tranche)"), for the purpose of providing lease financing in respect of certain equipment for Lessee; and WHEREAS, pursuant to the Participation Agreement (SanDisk Tranche) and the other SanDisk Tranche Operative Documents, on each Lease Supplement Closing Date with respect to any Equipment, Lessor, using amounts funded by the Participants, will pay to Lessee the Purchase Price of the Lease Supplement Equipment to be purchased by Lessor on such Lease Supplement Closing Date, which Equipment shall in turn be leased to Lessee by Lessor; and WHEREAS, subject to the terms and conditions of the Participation Agreement (SanDisk Tranche) and the other SanDisk Tranche Operative Documents, from time to time during the Installation Period the Participants are willing to purchase Participation Interests in Advances made by Lessor to fund a portion of the Purchase Price of such Equipment; and WHEREAS, it is a condition precedent to the obligations of Lessor, Agent and the Participants under the Participation Agreement (SanDisk Tranche) that Guarantor shall have executed and delivered this Guarantee to Lessor, Agent and the Participants. NOW, THEREFORE, in consideration of the premises and to induce Lessor to enter into the Lease and the other SanDisk Tranche Operative Documents to which it is a party and the Participants to enter into the Participation Agreement (SanDisk Tranche) and to purchase their Participation Interests, Guarantor hereby agrees as follows: Section 1. Defined Terms. (a) As used herein, the following terms shall have the following respective meanings: "Adverse Proceeding" means any action, suit, proceeding (whether administrative, judicial or otherwise), governmental investigation or arbitration (whether or not purportedly on behalf of Guarantor or any of Guarantor's Subsidiaries) at law or in equity, or before or by any CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION. TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. Governmental Authority (including any Environmental Claims), whether pending or, to the knowledge of Guarantor or its Subsidiaries, threatened in writing against or affecting Guarantor or any of its Subsidiaries or any property of the Guarantor or any of its Subsidiaries. "Consolidated Assets" means, at any date of determination, the total assets of the Guarantor and its Subsidiaries on a consolidated basis. "Deposit Account" means a demand, time, savings, passbook or like account with a bank, savings and loan association, credit union or like organization, other than an account evidenced by a negotiable certificate of deposit. "Domestic Subsidiary" means any Subsidiary organized under the laws of the United States of America, any state thereof or the District of Columbia. "Equity Securities" of any Person shall mean (a) all common stock, preferred stock, participations, shares, partnership interests or other equity interests in and of such Person (regardless of how designated and whether or not voting or non-voting) and (b) all warrants, options and other rights to acquire any of the foregoing. "Fixed Charges" shall mean, for any period for which a determination is made pursuant to the applicable terms of this Guarantee, the sum, without duplication, determined in respect of Guarantor and its Subsidiaries on a consolidated basis, of (a) Interest Expense of Guarantor and its Subsidiaries for such period (including without limitation the interest and yield component of any Funded Indebtedness of any Person (including Lessee) with respect to which and to the extent Guarantor or any of its Subsidiaries has any Guaranty Obligations) plus (b) current maturities of long term Funded Indebtedness of Guarantor and its Subsidiaries, plus (c) all rental expenses of Guarantor and its Subsidiaries for such period. "Fixed Charge Coverage Ratio" shall mean for any period for which a determination is made pursuant to the applicable terms of this Guarantee, with respect to Guarantor and its Subsidiaries on a consolidated basis as of any day, the ratio of (a) Guarantor EBITDAR for such period minus Capital Expenditures for such period (but excluding, at all times during Guarantor's 2001 fiscal year, up to $70,000,000 in the aggregate of Capital Expenditures made during such fiscal year and, at all times during Guarantor's 2002 fiscal year, Capital Expenditures made during such fiscal year in an aggregate amount equal to the portion, if any, of aggregate Capital Expenditures so permitted to be excluded in Guarantor's 2001 fiscal year which were not expended in such 2001 fiscal year), to (b) Fixed Charges for such period. "Foreign Subsidiary" means any Subsidiary that is not a Domestic Subsidiary. "Funded Indebtedness" of any Person shall mean, without duplication: (a) All obligations of such Person evidenced by notes, bonds, debentures or other similar instruments and all other obligations of such Person for borrowed money (including obligations to repurchase receivables and other assets sold with recourse); 2 2 (b) All non-contingent obligations of such Person for the deferred purchase price of property or services (including obligations under letters of credit and other credit facilities which secure or finance such purchase price), other than trade payables incurred by such Person in the ordinary course of its business on ordinary terms and overdue; (c) All obligations of such Person under conditional sale or other title retention agreements with respect to property acquired by such Person (to the extent of the value of such property if the rights and remedies of the seller or lender under such agreement in the event of default are limited solely to repossession or sale of such property), including the interest and yield components of rent under Synthetic Leases and, without duplication, the principal balance of Synthetic Leases; (d) All obligations of such Person as lessee under or with respect to Capitalized Lease Obligations; and (e) any Guaranty Obligations of such Person in respect of obligations described in clauses (a) through (d) above of another Person. "Guarantee Default" shall mean an event, act, condition or occurrence which with the giving of notice or the lapse of time (or both) would become a Guarantee Event of Default. "Guarantee Event of Default" shall mean any of the events specified in Section 11.1; provided, however, that any requirement for the giving of notice, the lapse of time, or both, or any other condition, has been satisfied. "Guaranteed Obligations" means the collective reference to (a) all Rent, including the Lease Balance, any Lease Supplement Balance, any Residual Value Guarantee Amount, any other payments required to be made by Lessee upon any purchase or sale of Equipment, any indemnity payments, any damages and any reimbursements including, without limitation, Transaction Expenses, payable by Lessee under each of the Participation Agreement (SanDisk Tranche), the Lease or any other SanDisk Tranche Operative Documents to which Lessee is a party; (b) Guarantor's obligations under each of the Specified Master Agreement Document Provisions in those Master Agreement Documents to which it is a party. Notwithstanding anything contained in this definition of "Guaranteed Obligations," Guaranteed Obligations shall not include any obligation Lessee may have to Lessor, Agent or any of the Participants under the SanDisk Tranche Operative Documents which have actually been paid to Lessor or Agent by Lessee. "Guaranteed Parties" means Lessor, Agent and the Participants and their respective permitted successors and assigns, collectively. "Guaranty Obligation" shall mean, with respect to any Person, any direct or indirect liability of that Person with respect to any indebtedness, lease, dividend, letter of credit or other obligation, including a Synthetic Lease (the "primary obligations") of another Person (the "primary obligor"), including any obligation of that Person, whether or not contingent, (a) to purchase, repurchase or otherwise acquire such primary obligation or any property constituting direct or indirect security therefor, or (b) to advance or provide funds (i) for the payment or 3 3 discharge of any such primary obligation, or (ii) to maintain working capital or equity capital of the primary obligor or otherwise to maintain the net worth or solvency or any balance sheet item, level of income or financial condition of the primary obligor, or (c) to purchase property, securities or services primarily for the purpose of assuring the owner of any such primary obligation of the ability of the primary obligor to make payment of such primary obligation, or (d) otherwise to assure or hold harmless the holder of any such primary obligation against loss in respect thereof. The amount of any Guaranty Obligation shall be deemed equal to the stated or determinable amount of the primary obligation in respect of which such Guaranty Obligation is made or, if not stated or if indeterminable, the maximum reasonably anticipated liability in respect thereof. "Historical Financial Statements" means as of the Document Closing Date, (i) the audited financial statements of Guarantor and its Subsidiaries as filed with the SEC, for the immediately preceding three fiscal years (or, in the case of balance sheets, for the preceding two fiscal years), consisting of balance sheets and the related consolidated statements of income, stockholders' equity and cash flows for such fiscal years, (ii) the unaudited financial statements of Guarantor and its Subsidiaries as filed with the SEC as at the most recently ended fiscal quarter, consisting of a balance sheet and the related consolidated statements of income, stockholders' equity and cash flows for the three-, six- or nine-month period, as applicable, ending on such date. "Indebtedness" of any Person shall mean, without duplication, (i) all indebtedness of such Person for borrowed money or for the deferred purchase price (or a portion thereof) of property or services, including obligations under Synthetic Leases (other than trade payables incurred in the ordinary course of business of such Person), (ii) all indebtedness of such Person evidenced by a note, bond, debenture or similar instrument, (iii) the principal component of all Capitalized Lease Obligations of such Person and all obligations of such Person under any other lease to the extent that the then present value of the minimum rental commitment thereunder should, in accordance with GAAP, be capitalized on a balance sheet of such Person, (iv) the face amount of all letters of credit issued for the account of such Person and, without duplication, all unreimbursed amounts drawn thereunder, (v) all indebtedness of any other Person secured by any Lien on any property owned by such Person, whether or not such indebtedness has been assumed, (vi) payment obligations under any interest rate protection agreements (including without limitation, any interest rate swaps, caps, floors, collars and similar agreements) and currency swaps and similar agreements, and (vii) any Guaranty Obligations of such Person. "Investment" of any Person shall mean any loan or advance of funds by such Person to any other Person (other than advances to employees of such Person for moving and travel expenses, drawing accounts and similar expenditures in the ordinary course of business), any purchase or other acquisition of any Equity Securities or Indebtedness of any other Person, any capital contribution by such Person to or any other investment by such Person in any other Person; provided, however, that Investments shall not include (a) accounts receivable or other indebtedness owned by customers of such Person which are current assets and arose from sales of inventory in the ordinary course of such Person's business or (b) prepaid expenses of such Person incurred and prepaid in the ordinary course of business. "Material Adverse Effect" means any change or changes, effect or effects, or condition or conditions that individually or in the aggregate are or would reasonably be expected to be 4 4 materially adverse to (i) the business operations or financial condition of Guarantor and its Subsidiaries on a consolidated basis, (ii) the Overall Transaction, (iii) the ability of Guarantor to perform its obligations under the SanDisk Tranche Operative Documents to which it is a party, or (iv) the validity or enforceability of any of the SanDisk Tranche Operative Documents. "Material Subsidiary" means any Subsidiary that would be a "significant subsidiary" within the meaning of Rule 1-02 of the SEC's Regulation S-X. "Permitted Liens" means the following Liens: (a) Liens in favor of Lessor, Agent or any Participant under the SanDisk Tranche Operative Documents; (b) Liens for taxes, assessments or governmental charges or claims not yet due or with respect to which the Guarantor or its Subsidiaries are taking each of the actions required pursuant to Section 10(a)(iii) of this Guarantee; and (c) statutory Liens of landlords, banks (and rights of set-off), of carriers, warehousemen, mechanics, repairmen, workmen and materialmen, and other Liens imposed by law, in each case incurred in the ordinary course of business (i) for amounts not yet overdue or (ii) for amounts that are overdue and that are being contested in good faith by appropriate proceedings, so long as such reserves or other appropriate provisions, if any, as shall be required by GAAP shall have been made for any such contested amounts; (d) Liens incurred or deposits made in the ordinary course of business in connection with workers' compensation, unemployment insurance and other types of social security, or to secure the performance of tenders, statutory obligations, surety and appeal bonds, bids, leases, government contracts, trade contracts, performance and return-of-money bonds and other similar obligations (exclusive of obligations for the payment of borrowed money), so long as no foreclosure, sale or similar proceedings have been commenced with respect thereto or on account thereof; (e) easements, rights-of-way, zoning restrictions, encroachments, imperfections and other minor defects or irregularities in title, which, individually or in the aggregate, are not substantial in amount and do not materially detract from the value of the property subject thereto or interfere with the ordinary conduct of the business of the Guarantor or any of its Subsidiaries; (f) Liens on property or assets of any corporation which becomes a Subsidiary of the Guarantor or on any property or assets acquired by the Guarantor or any of its Subsidiaries after the Document Closing Date, provided that (A) such Liens exist at the time the stock of said corporation or assets or property is or are acquired by such Person and (B) such Liens were not created in contemplation of such acquisition by the Guarantor or such Subsidiary; 5 5 (g) Liens incurred in connection with the purchase or shipping of goods or assets on the related assets and proceeds thereof in favor of the seller or shipper of such goods or assets; (h) Liens on insurance proceeds in favor of insurance companies with respect to the financing of insurance premiums; (i) Liens in favor of customs and revenue authorities arising as a matter of law to secure payment of customs duties in connection with the importation of goods in the ordinary course of Guarantor's and its Subsidiaries' businesses; (j) any zoning or similar law or right reserved to or vested in any governmental office or agency to control or regulate the use of any real property; (k) licenses of patents, trademarks and other intellectual property rights granted by Guarantor or any of its Subsidiaries in the ordinary course of business; (l) judgment liens not constituting a Guarantee Event of Default; (m) Liens described in Schedule 10(b)(ii) to this Guarantee and existing on the Document Closing Date; (n) Liens securing Indebtedness permitted pursuant to Section 10(b)(i)(H), 10(b)(i)(I) and 10(b)(i)(K) of this Guarantee; provided, in the case of Indebtedness permitted by Section 10(b)(i)(I), any Lien permitted hereby shall encumber only the asset acquired with the proceeds of such Indebtedness and such Liens do not secure any other Indebtedness; and (o) other Liens securing Indebtedness permitted to be incurred and secured hereunder, so long as such Liens do not attach to assets of Guarantor or any of its Subsidiaries which in the aggregate exceed 5% of Consolidated Assets; and (p) any extension or replacement of any of the foregoing in accordance with the terms thereof; provided, (i) any Lien imposed pursuant to Section 401(a)(29) or 412(n) of the Code or by ERISA, and (ii) any Lien relating to or imposed in connection with any Environmental Claim, in each case is expressly prohibited hereunder. "Purchase Money Indebtedness" means Indebtedness (i) that is secured by a purchase money security interest pursuant to the UCC or (ii) Indebtedness secured by another lien under Applicable Law, which Indebtedness was incurred by the relevant debtor to finance the acquisition of the asset(s) to which such Lien attaches, including any mortgage, deed of trust, Synthetic Lease or Capitalized Lease Obligations. "Quick Ratio" shall mean, with respect to Guarantor and its Subsidiaries on a consolidated basis at the applicable date such ratio is to be determined, the ratio of: 6 6 (a) The sum (without duplication) of all unencumbered cash, Cash Equivalents, short-term investments and net accounts receivable of Guarantor and its Subsidiaries at such time; to (b) the current liabilities of Guarantor and its Subsidiaries at such time (including current liabilities of Guarantor and its Subsidiaries in connection with Synthetic Leases and including current liabilities of any other Person to the extent Guarantor or any of its Subsidiaries is liable in respect of any Guaranty Obligations of liabilities of such Person). (In calculating the Quick Ratio, Cash Equivalents and short-term investments shall be marked to market quarterly). "Rate Contracts" shall mean swap agreements (as that that term is defined in Section 101 of the Bankruptcy Code) and any other agreements or arrangements designed to provide protection against fluctuations in interest or currency exchange rates. "SanDisk Tranche Operative Documents" means the "Operative Documents" as defined in Appendix 1 to the Participation Agreement (SanDisk Tranche). "Subsidiary" shall mean, with respect to any Person, any corporation or other entity of which securities or other ownership interests having ordinary voting power to elect a majority of the board of directors or other Persons performing similar functions are at the time directly or indirectly owned by such Person. "Surety Instruments" shall mean all letters of credit (including standby and commercial), banker's acceptances, bank guaranties, shipside bonds, surety bonds and similar instruments. "Tangible Net Worth" shall mean, with respect to Guarantor and its Subsidiaries on a consolidated basis at any time, the remainder at such time, determined in accordance with GAAP, of (a) the total assets of Guarantor and its Subsidiaries, minus (b) the sum (without limitation and without duplication of deductions) of (i) the total liabilities of Guarantor and its Subsidiaries, (ii) all reserves established by Guarantor and its Subsidiaries for anticipated losses and expenses (to the extent not deducted in calculating total assets in clause (a) above) and (iii) all intangible assets of Guarantor and its Subsidiaries (to the extent included in calculating total assets in clause (a) above), including, without limitation, goodwill (including any amounts, however designated on the balance sheet, representing the cost of acquisition of businesses and investments in excess of underlying tangible assets), trademarks, trademark rights, trade name rights, copyrights, patents, patent rights, licenses, unamortized debt discount, marketing expenses, organizational expenses, non-compete agreements and deferred research and development. "Wholly-Owned Domestic Subsidiary" means a Domestic Subsidiary of Guarantor that is a Wholly-Owned Subsidiary. 7 7 "Wholly-Owned Foreign Subsidiary" means a Foreign Subsidiary of Guarantor that is a Wholly-Owned Subsidiary. "Wholly-Owned Subsidiary" means a Subsidiary of Guarantor, at least 99% of the capital stock of which (other than directors' qualifying shares) is owned by Guarantor or another Wholly-Owned Subsidiary. (b) Unless otherwise defined herein, terms defined in Appendix 1 to the Participation Agreement and used herein shall have the respective meanings set forth in Appendix 1 to the Participation Agreement, and the provisions regarding interpretation of the SanDisk Tranche Operative Documents set forth in paragraphs (A), (B), (C) and (D) of Appendix 1 to the Participation Agreement (SanDisk Tranche) shall apply to this Guarantee. Section 2. Guarantee. (a) Guarantor hereby unconditionally and irrevocably guarantees to the Guaranteed Parties the prompt payment and performance when due (but in each case only after the expiration of all applicable grace, notice and cure periods provided for in the SanDisk Tranche Operative Documents including with respect to any applicable Event of Default) of the Guaranteed Obligations. (b) Guarantor further agrees to pay any and all reasonable expenses (including, without limitation, all reasonable fees and disbursements of counsel) which may be paid or incurred by Agent or the Guaranteed Parties in enforcing any rights with respect to, or collecting, any or all of the Guaranteed Obligations and/or enforcing any rights with respect to, or collecting against, Guarantor under this Guarantee. Section 3. Intentionally Omitted. Section 4. No Subrogation; Subordination. Notwithstanding any payment or payments made by Guarantor hereunder or any setoff or application of funds of Guarantor by any Guaranteed Party, Guarantor shall not be entitled to be subrogated to any of the rights of any Guaranteed Party, as applicable, against Lessor, Lessee, or any other Person or any collateral security or guarantee or right of offset held by any Guaranteed Party for the payment of the Guaranteed Obligations, nor shall Guarantor seek or be entitled to seek any contribution or reimbursement from Lessor, Lessee, or any other Person in respect of payments made by Guarantor hereunder, until all Guaranteed Obligations are paid in full and such payments cannot be treated as a preferential transfer under the Bankruptcy Code in the event a petition is filed by or against Lessee, as debtor, under the Bankruptcy Code. If any amount shall be paid to Guarantor on account of such subrogation rights at any time when all of the Guaranteed Obligations shall not have been paid in full, such amount shall be held by Guarantor in trust for the Guaranteed Parties, segregated from other funds of Guarantor, and shall, forthwith upon receipt by Guarantor, be turned over to Agent in the exact form received by Guarantor (duly indorsed by Guarantor to Agent, if required), to be applied and credited against the Guaranteed Obligations, whether matured or unmatured, in accordance with the terms of the SanDisk Tranche Operative Documents. If (a) Guarantor shall make payment to any Guaranteed Party of all or any part of the Guaranteed Obligations and (b) all the Guaranteed Obligations shall be paid 8 8 in full, the Guaranteed Parties will, at Guarantor's request and expense, execute and deliver to Guarantor appropriate documents (without recourse as set forth in Section 14.14 of the Participation Agreement in the case of Lessor), necessary to evidence the transfer by subrogation to Guarantor of an interest in the Guaranteed Obligations resulting from such payment by Guarantor. Notwithstanding the foregoing, to the extent that the Guaranteed Parties, as a whole, receive any payments from Guarantor, Lessee, any other guarantor or any other Person by virtue of any action or proceeding or any setoff or appropriation or application at any time in reduction of or in payment of the Guaranteed Obligations and such payments exceed the amount then due for the Guaranteed Obligations, Guarantor shall be promptly reimbursed such excess payments received by the Guaranteed Parties pro rata, with the other guarantors contributing to such excess payment, and before any Guaranteed Party reimburses Lessee or any other Person for its contribution resulting in a payment in excess of the Guaranteed Obligations. Notwithstanding the provisions of Section 11.07 of the Operating Agreement, in the event of a dissolution and liquidation of Lessee, Guarantor agrees that it shall not demand, collect, sue for or otherwise receive payment in respect of any Indebtedness owed by Lessee to Guarantor (or any Subsidiary of Guarantor to whom the Membership Interest in Lessee may have been transferred by Guarantor or any further transferee of such Subsidiary) until the Guaranteed Obligations shall have been paid in full in accordance with the terms hereof. Section 5. Amendments, etc. with Respect to the Guaranteed Obligations; Waiver of Rights. Guarantor shall remain obligated hereunder notwithstanding that, without any reservation of rights against Guarantor and without notice to or further assent by Guarantor, any demand for payment of any of the Guaranteed Obligations made by the Guaranteed Parties may be rescinded by such parties and any of the Guaranteed Obligations continued, and the Guaranteed Obligations, or the liability of any other party upon or for any part thereof, or any collateral security or guarantee therefor or right of offset with respect thereto, may, from time to time, in whole or in part, be renewed, extended, amended, modified, accelerated, compromised, waived, surrendered or released by the Guaranteed Parties, and the Participation Agreement and the other SanDisk Tranche Operative Documents and any other documents executed and delivered in connection therewith may be amended, modified, supplemented or terminated, in whole or in part, from time to time in accordance with their respective terms, and any collateral security, guarantee or right of offset at any time held by any Guaranteed Party for the payment of the Guaranteed Obligations may be sold, exchanged, waived, surrendered or released, provided that no modification or amendment of or supplement to any of the SanDisk Tranche Operative Documents shall be effective for purposes of this Guarantee unless entered into with the prior written consent of Guarantor. No Guaranteed Party shall have any obligation to protect, secure, perfect or insure any Lien at any time held by it as security for the Guaranteed Obligations or for this Guarantee or any property subject thereto. When making any demand hereunder against Guarantor, the Guaranteed Parties may, but shall be under no obligation to (except as expressly required by the SanDisk Tranche Operative Documents), make a similar demand on Lessee or any other guarantor, and any failure by the Guaranteed Parties to make any such demand or to collect any payments from Lessee or any such other guarantor or any release of Lessee or such other guarantor shall not relieve Guarantor of its obligations or liabilities hereunder, and shall not impair or affect the rights and remedies, express or implied, or as a matter of law, of the Guaranteed Parties against Guarantor. For the purposes hereof "demand" shall include the commencement and continuance of any legal proceedings. 9 9 Section 6. Guarantee Absolute and Unconditional. Guarantor waives any and all notice of the creation, renewal, extension or accrual of any of the Guaranteed Obligations and notice of or proof of reliance by any Guaranteed Party upon this Guarantee or acceptance of this Guarantee; the Guaranteed Obligations, and any of them, shall conclusively be deemed to have been created, contracted or incurred, or renewed, extended, amended or waived, in reliance upon this Guarantee; and all dealings between the Guaranteed Parties and Guarantor likewise shall be conclusively presumed to have been had or consummated in reliance upon this Guarantee. Guarantor waives diligence, presentment, protest, demand for payment and notice of default or nonpayment to or upon Guarantor with respect to the Guaranteed Obligations. Guarantor understands and agrees that this Guarantee shall be construed as a continuing, absolute and unconditional guarantee of payment without regard to (a) the validity, regularity or enforceability of the Lease or any other SanDisk Tranche Operative Document, any of the Guaranteed Obligations or any other collateral security therefor or guarantee or right of offset with respect thereto at any time or from time to time held by any Guaranteed Party, (b) any defense, set-off or counterclaim (other than a defense of payment or performance or affirmative discharge, release or termination of this Guarantee by the Guaranteed Parties in accordance with the terms hereof) which may at any time be available to or be asserted by Guarantor or Lessee against any Guaranteed Party, or (c) any other circumstance whatsoever (with or without notice to or knowledge of Guarantor or Lessee) which constitutes, or might be construed to constitute, an equitable or legal discharge of Lessee for the Guaranteed Obligations, or of Guarantor under this Guarantee, in bankruptcy or in any other instance. When pursuing its rights and remedies hereunder against Guarantor, the Guaranteed Parties may, but shall be under no obligation to, pursue such rights and remedies as they may have against Lessee or any other Person or against any collateral security or guarantee for the Guaranteed Obligations or any right of offset with respect thereto, and any failure by the Guaranteed Parties to pursue such other rights or remedies or to collect any payments from Lessee or any such other Person or to realize upon any such collateral security or guarantee or to exercise any such right of offset, or any release of Lessee or any such other Person or any such collateral security, guarantee or right of offset, shall not relieve Guarantor of any liability hereunder, and shall not impair or affect the rights and remedies, whether express, implied or available as a matter of law, of the Guaranteed Parties against Guarantor. This Guarantee shall remain in full force and effect and be binding in accordance with and to the extent of its terms upon Guarantor and its successors and assigns, and shall inure to the benefit of each Guaranteed Party, until all the Guaranteed Obligations shall have been satisfied by payment in full, notwithstanding that from time to time during the term of the Lease Lessee may be free from any obligations or liabilities thereunder or under the other SanDisk Tranche Operative Documents. Guarantor expressly waives any and all benefits under Sections 2787 to 2855 inclusive, and Sections 2899 and 3433, of the California Civil Code. Notwithstanding anything else in this Guarantee, Guarantor shall not be required to pay more under this Guarantee in respect of the Guaranteed Obligations than Lessee is required to pay pursuant to the provisions of any of the other SanDisk Tranche Operative Documents as a result and to the extent of the application of Section 11.3 of the Lease. Section 7. Reinstatement. This Guarantee shall continue to be effective, or be reinstated, as the case may be, if at any time any payment, or any part of any payment, of any of the Guaranteed Obligations is rescinded or must otherwise be restored or returned by any Guaranteed Party upon the insolvency, bankruptcy, dissolution, liquidation or reorganization of 10 10 Lessor (but only if such proceeds were returned to Guarantor or Lessee) or Guarantor or Lessee, or upon or as a result of the appointment of a receiver, intervenor or conservator of, or trustee or similar officer for, Lessor, Guarantor or Lessee or any substantial part of their respective property, or otherwise, all as though such payments had not been made. Section 8. Payments. Guarantor hereby guarantees that payments hereunder will be paid to Agent for the benefit of the applicable Guaranteed Parties, without set-off or counterclaim in United States Dollars at the office of Agent located at 135 South LaSalle Street, Chicago, Illinois 60603; provided, however, that, no such payment shall be deemed a waiver or release by Lessee or Guarantor of any claim of Lessee or Guarantor which may be asserted against the applicable Guaranteed Party or any other Person in a separate action or proceeding. Section 9. Representations of Guarantor. Guarantor represents and warrants to each of Lessor, Agent and each Participant as of the Document Closing Date that: (a) Organization; Existence. Guarantor and each of its Subsidiaries (i) is a duly organized and validly existing corporation in good standing under the laws of its jurisdiction of organization, (ii) has the requisite power and authority to own its property and assets and to transact the business in which it is engaged or presently proposes to engage, and (iii) has duly qualified and is authorized to do business and is in good standing as a foreign corporation in every jurisdiction (other than the jurisdiction of its organization) in which the nature of its business requires it to be so qualified, except where the failure to so qualify, individually or in the aggregate, may not reasonably be expected to have a Material Adverse Effect. (b) Power; Authorization; Enforceable Obligations. Guarantor has the corporate power and authority to execute, deliver and carry out the terms and provisions of this Guarantee and the other SanDisk Tranche Operative Documents to which it is or will be a party and has taken all necessary corporate action (including without limitation any necessary consents of its shareholders) to authorize the execution, delivery and performance by Guarantor of this Guarantee and the other SanDisk Tranche Operative Documents. Guarantor has duly executed and delivered this Guarantee, and this Guarantee and each other SanDisk Tranche Operative Document to which it is a party constitutes (or upon the execution and delivery thereof, will constitute), its legal, valid and binding obligation, enforceable in accordance with its terms, except as enforcement thereof may be subject to (i) the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally and (ii) general principles of equity regardless of whether such enforcement is sought in a proceeding in equity or at law. No order, consent, approval, license, authorization, or validation of, or filing, recording or registration with, or exemption by, any governmental or public body or authority, or any subdivision thereof, is required to authorize, or is required in connection with (i) the execution, delivery and performance by Guarantor of this Guarantee or the other SanDisk Tranche Operative Documents to which Guarantor is a party or the consummation of any of the transactions contemplated hereby or thereby , or (ii) the legality, validity, binding effect or enforceability of this Guarantee or the other SanDisk Tranche Operative Documents to which Guarantor is a party, except for such orders, consents, approvals, licenses, authorizations, validations, filings, recordings or registrations contemplated by the SanDisk Tranche Operative Documents, each of which has been obtained or made as of the Document Closing Date. 11 11 (c) No Violation. Neither the execution, delivery or performance by Guarantor of this Guarantee and the other SanDisk Tranche Operative Documents to which Guarantor is a party, nor compliance by it with the terms and provisions thereof nor the consummation of the Overall Transaction, (i) will contravene any Applicable Laws, (ii) will conflict with or contravene or result in any breach of any of the terms, covenants, conditions or provisions of, or constitute a default under, or result in the creation or imposition of (or the obligation to create or impose) any Lien upon any of the property or assets of Guarantor or any of its Subsidiaries pursuant to the terms of, any indenture, mortgage, deed of trust, material agreement or other material instrument (including without limitation any of the Master Agreement Documents) to which Guarantor or any of its Subsidiaries is a party or by which it or any of its property or assets is bound, except Liens created under the SanDisk Tranche Operative Documents or (iii) will violate any provision of the certificate of incorporation or bylaws of Guarantor. (d) Material Adverse Change. Since October 2, 2000, there has been no material adverse change with respect to the financial condition of Guarantor and its Subsidiaries taken as a whole. (e) Litigation. Except as set forth in Guarantor's 10-Q filed November 15, 2000 in the case of clause (ii) below, there are no actions, suits or proceedings pending or, to the knowledge of Guarantor, threatened against Guarantor or any of its Subsidiaries in any court or before any Governmental Authority (nor shall any order, judgment or decree have been issued or proposed to be issued by any Governmental Authority to set aside, restrain, enjoin or prevent the full performance of any SanDisk Tranche Operative Document or any Master Agreement Document or any transaction contemplated hereby or thereby) that (i) question the validity or enforceability against Guarantor of any SanDisk Tranche Operative Document or any transaction described in the SanDisk Tranche Operative Documents or (ii) has had, or for which there is a reasonable possibility of an adverse decision which would reasonably be expected to have, a Material Adverse Effect. (f) Intentionally Omitted. (g) Financial Statements and Conditions. The factual statements as set forth in the financial statements and other written information delivered to Agent and Lessor prior to the Document Closing Date in connection with the syndication of the Participation Interests (but excluding any financial forecasts or projections) were true and accurate in all material respects as of the date such statements were made or dated, as applicable. All financial statements and other reports required to be delivered to Agent and Lessor pursuant to Section 10(a)(iv) contemporaneously herewith or when delivered pursuant to Section 10(a)(iv) will be true and accurate in all material respects as of the date as of which such information is dated or certified. (h) Governmental Regulations, Etc. Guarantor is not a "public utility holding company" under the Public Utility Holding Company Act of 1935, as amended, nor is it an "investment company" as defined in the Investment Company Act of 1940. 12 12 (i) Chief Executive Office of Guarantor. Guarantor's principal place of business and chief executive office, as such terms are used in Section 9-103(3) of the UCC, are located at 140 Caspian Court, Sunnyvale, California 94089. (j) Brokers, etc. It has not engaged or authorized any broker, finder, investment bank or other third party to act on its behalf, directly or indirectly, as a broker, finder, investment banker, agent or in any other like capacity in connection with any of the SanDisk Tranche Operative Documents or the Overall Transaction, other than ABN AMRO. (k) Intentionally Omitted. (l) Ownership of Property. Guarantor and each of its Material Subsidiaries has good and marketable fee simple title to or valid leasehold interests in all of the real property owned or leased by such person and good title to all of its personal property, except where the failure to hold such title or leasehold interests, individually or in the aggregate, would not reasonably be expected to have a Material Adverse Effect. The personal and real property owned by Guarantor and each of its Material Subsidiaries is not subject to any Lien except Permitted Liens. Guarantor and each of its Subsidiaries enjoys peaceful and undisturbed possession under all of its leases except where the failure to enjoy such peaceful and undisturbed possession would not reasonably be expected to have a Material Adverse Effect. (m) Compliance with Laws. It is not in violation of, or in default with respect to, any Applicable Laws of any Governmental Authority where such violation or default would reasonably be expected to have a Material Adverse Effect. (n) Intentionally Omitted. (o) Appraisal Data. The information provided by Guarantor and its Affiliates to the Appraiser described on Exhibit B to the Initial Appraisal was true and correct in all material respects when provided. (p) Licenses, Permits, Intellectual Property, etc. Guarantor and each of its Subsidiaries own or possess all licenses, permits, franchises, authorizations, patents, copyrights, service marks, trademarks and trade names or rights thereto, that individually or in the aggregate, are material, without known conflict with the rights of others, the failure of which to so own or possess would reasonably be expected to have a Material Adverse Effect. To the knowledge of Guarantor, no product of Guarantor or any of its Subsidiaries infringes in any material respect on any license, permit, franchise, authorization, patent, copyright, service mark, trademark, trade name or other right owned by any other Person, which infringement would reasonably be expected to have a Material Adverse Effect. (q) Payment of Taxes. All federal, state, local and foreign tax returns and reports of Guarantor and its subsidiaries required to be filed by it have been timely filed where the failure to file would have a Material Adverse Effect, and all taxes shown on such tax returns to be due and payable and all assessments, fees and other governmental charges upon Guarantor and its Subsidiaries and upon their respective properties, assets, income, businesses and franchises which are due and payable have been paid when due and payable, other than amounts 13 13 not yet delinquent or those being contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP have been made. Guarantor knows of no proposed tax assessment against Guarantor or any of its Subsidiaries which is not being actively contested by Guarantor or such Subsidiary in good faith and by appropriate proceedings and which would reasonably be expected to have Material Adverse Effect; provided, such reserves or other appropriate provisions, if any, as shall be required in conformity with GAAP shall have been made or provided therefor. (r) Intentionally Omitted. (s) Disclosure. The representations or warranties of Guarantor and its Subsidiaries contained in this Guarantee and in any other document, certificate or written statement furnished to Lessor, Agent and/or the Participants by or on behalf of Guarantor and its Subsidiaries pursuant to the SanDisk Tranche Operative Documents for use in connection with the transactions contemplated by the SanDisk Tranche Operative Documents, when taken as a whole, do not contain any untrue statement of a material fact or omit to state a material necessary in order to make the statements contained herein or therein not misleading in light of the circumstances in which the same were made. (t) Solvency. Guarantor is solvent and has assets having a present fair saleable value at least equal to the amount of its liabilities. (u) Subsidiaries. As of the Document Closing Date, Guarantor has no Subsidiaries except as set forth on Schedule 9(u) hereto and has no Material Subsidiaries other than those identified as Material Subsidiaries on Schedule 9(u) hereto. (v) Employee Benefit Plans. (i) Neither Guarantor nor any ERISA Affiliate maintains or contributes to, or has ever maintained a Pension Plan. Neither Guarantor nor any ERISA Affiliate has any liability with respect to any post-retirement benefit under any Employee Benefit Plan which is a welfare plan (as defined in Section 3(1) of ERISA), other than liability for health plan continuation coverage described in Part 6 of Title I(B) of ERISA, which liability for health plan coverage is not reasonably likely to have a Material Adverse Effect. (ii) Each Employee Benefit Plan complies, in both form and operation, in all material respects, with its terms, ERISA and the Code, and no condition exists or event has occurred with respect to any such plan which would result in the incurrence by either Guarantor or any ERISA Affiliate of any material liability, fine or penalty. Each Employee Benefit Plan, related trust agreement, arrangement and commitment of Guarantor or any ERISA Affiliate is legally valid and binding and in full force and effect in all material respects. No Employee Benefit Plan is being audited or investigated by any governmental authority or is subject to any pending or, to the best knowledge of Guarantor, threatened, claim or suit. To the best of Guarantor's knowledge, neither Guarantor nor any ERISA Affiliate nor any fiduciary of any Employee Benefit Plan has engaged in a prohibited transaction with respect to an Employee Benefit Plan under 14 14 Section 406 of ERISA or section 4975 of the Code, other than a transaction that is exempt under a statutory or administrative exemption. To the best of Guarantor's knowledge, no breach of fiduciary responsibility has occurred with respect to any Employee Benefit Plan under Section 404 of ERISA or Section 4975 of the Code. (iii) Neither Guarantor nor any ERISA Affiliate contributes to or has ever contributed to any Multiemployer Plan. (iv) If Guarantor or any ERISA Affiliate on or after the date of this Guarantee: (1) maintains or contributes to a Pension Plan; (2) contributes or has any material contingent obligations to any Multiemployer Plan; or (3) incurs a liability with respect to any post-retirement benefit under any Employee Benefit Plan which is a welfare plan (as defined in Section 3(1) of ERISA), other than liability for health plan continuation coverage described in Part 6 of Title I(B) of ERISA, which liability for health plan coverage is not reasonably likely to have a Material Adverse Effect, then Guarantor shall promptly provide a written notice thereof and a statement affirming that no Material Adverse Effect could reasonably be expected to occur as a result thereof. Section 10. Covenants of Guarantor. (a) Affirmative Covenants. Guarantor hereby agrees that, so long as this Guarantee is in effect, Guarantor shall and (except in the case of delivery of financial information, reports, and notices) shall cause each of its Subsidiaries to perform each of the following covenants: (i) General Business Operations. Each of Guarantor and its Material Subsidiaries shall preserve and maintain its corporate existence and all of its rights, privileges and franchises reasonably necessary to the conduct of its business; provided, however, that Guarantor and its Subsidiaries may dissolve, liquidate or cause or permit the reorganization or merger of any of its Subsidiaries other than Lessee if such dissolution, liquidation or other action is not reasonably likely to have a Material Adverse Effect or otherwise relates to a Subsidiary which is not at such time a Material Subsidiary; and provided further that the foregoing shall not be construed so as to prohibit a transaction expressly permitted under Section 10(b)(v)(A) or 10(b)(v)(B). (ii) Maintenance of Properties. Guarantor will, and will cause each of its Subsidiaries to, maintain or cause to be maintained in all material respects in good repair, working order and condition, ordinary wear and tear excepted, all property useful and necessary in the business of Guarantor and its Subsidiaries unless the failure to so maintain would not reasonably be expected to give rise to a Material Adverse Effect. (iii) Payment of Taxes and Claims. Guarantor will, and will cause each of its Subsidiaries to, pay and discharge (a) all taxes, assessments and governmental charges or levies imposed upon it, or upon its income or profits, or upon any of its properties, before they shall become delinquent, and (b) all lawful claims (including claims for labor, materials and supplies) which if unpaid might give rise to a Lien upon any of its properties (other than Permitted Liens); provided, neither Guarantor nor any of 15 15 its Subsidiaries shall be required to pay any such tax assessment, charge, levy or claim which is being contested in good faith by appropriate proceedings and for which adequate reserves therefor have been established in accordance with GAAP. Guarantor will not, nor will it permit any of its Subsidiaries to, file or consent to the filing of any consolidated income tax return with any Person (other than Guarantor or any of its Subsidiaries). (iv) Financial Statements and Other Reports. Guarantor will deliver or cause to be delivered to Agent (with sufficient copies for each of the Participants) and to Lessor: (A) as soon as available and in any event within ninety (90) days after the end of each fiscal year of Guarantor, an audited statement of financial position of Guarantor and its consolidated Subsidiaries as of the end of such fiscal year and the related consolidated statements of income, shareholder's equity and cash flows for such fiscal year, setting forth in each case in comparative form the figures for the previous fiscal year, all accompanied by the unqualified opinion of Ernst & Young L.L.P. or other independent public accountants of nationally recognized standing stating that such consolidated financial statements present fairly the financial position of Guarantor and its consolidated Subsidiaries for the periods indicated, in conformity with GAAP, and applied on a basis consistent with prior years; together with an unaudited Responsible Officer's Certificate containing a computation of, and showing compliance with, each of the financial ratios and restrictions contained in Section 10(c) and to the effect that the Responsible Officer executing such certificate is not aware of any Guarantee Event of Default that has occurred and is continuing, or if such officer is aware of any such Guarantee Event of Default, describing it and the steps, if any, being taken to cure it; (B) as soon as available and in any event within forty-five (45) days after the end of each of the first three quarters of each fiscal year of Guarantor, a consolidated statement of financial position of Guarantor as of the end of such quarter and the related consolidated statements of income and cash flows for such quarter and for the portion of Guarantor's fiscal year ended at the end of such quarter, together with an unaudited Responsible Officer's Certificate containing a computation of, and showing compliance with, each of the financial ratios and restrictions contained in Section 10(c) and that no Guarantee Event of Default has occurred or is continuing or, if any Guarantee Event of Default has occurred and is continuing, describing it and the steps, if any, being taken to cure it; (C) if, as a result of any change in accounting principles and policies from those used in the preparation of the Historical Financial Statements, the consolidated financial statements of Guarantor and its Subsidiaries delivered pursuant to Sections 10(a)(iv)(A) or 10(a)(iv)(B) will differ in any material respect from the consolidated financial statements that would have been delivered pursuant to such Sections had no such change in accounting principles and 16 16 policies been made, then together with the first delivery of such financial statements after such change a statement of reconciliation for all such prior financial statements in form and substance satisfactory to the Required Participants; (D) promptly upon transmission or receipt thereof, copies of any filings and registrations with, and reports to or from, the Securities and Exchange Commission, or any successor agency, and copies of all financial statements, proxy statements, notices and reports as Guarantor or any of its Subsidiaries shall send to a holder of any Indebtedness having a principal amount in excess of $15,000,000 or more owed by Guarantor or such Subsidiary in its capacity as such a holder, subject to any applicable confidentiality obligations of Guarantor or such Subsidiary; (E) promptly upon any Responsible Officer of Guarantor obtaining knowledge (i) of the occurrence and continuance of any condition or event that constitutes a Guarantee Default or a Guarantee Event of Default; or (ii) of the occurrence of any event or change that has caused or evidences, either in any case or in the aggregate, a Material Adverse Effect, Guarantor will provide written notice thereof. In addition, concurrently with such written notice by Guarantor, or promptly following Guarantor's receipt of notice from Agent, Lessor or any Participant that a Guarantee Default or a Guarantee Event of Default has occurred, Guarantor shall deliver a certificate of a Responsible Officer specifying the nature and period of existence of such condition, event or change, or specifying the notice given or action taken by Guarantor and the nature of such claimed Guarantee Event of Default, Guarantee Default, event or condition, and what action Guarantor has taken, is taking or proposes to take with respect thereto; (F) promptly upon any Responsible Officer of Guarantor obtaining knowledge thereof, Guarantor will give written notice to Agent of the institution of any Adverse Proceeding not previously disclosed in writing by Guarantor to Lessor, Agent and the Participants and which (i) individually or in the aggregate if adversely determined would reasonably be expected to have a Material Adverse Effect, or (ii) prohibits Guarantor from performing any material obligation under the SanDisk Tranche Operative Documents to which it is a party; (G) (i) promptly upon becoming aware of the occurrence of any ERISA Event, a written notice specifying the nature thereof, what action Guarantor, any of its Subsidiaries or any of their respective ERISA Affiliates has taken, is taking or proposes to take with respect thereto and, when known, any action taken or threatened by the Internal Revenue Service, the Department of Labor or the PBGC with respect thereto; and (ii) upon request of Agent and with reasonable promptness, copies of such other documents or governmental reports or filings relating to any Employee Benefit Plan as Agent shall reasonably request; 17 17 (H) promptly, written notice of any change in either Moody's or S&P's rating for Guarantor's long term Indebtedness, if applicable; and (I) Guarantor and its Material Subsidiaries shall at all times in all material respects keep proper books of record and account in which full, true and correct entries will be made of their transactions in accordance with GAAP; (J) from time to time with reasonable promptness, such other information or documents (financial or otherwise) with respect to Guarantor and its Subsidiaries, or with respect to the status of any matter disclosed pursuant to Section 10(a)(iv)(F), as Agent, Lessor or any Participant through Agent may reasonably request, subject to any applicable confidentiality obligations of Guarantor and provided that in the case of information pertaining to a matter disclosed pursuant to Section 10(a)(iv)(F), Guarantor shall not be required to disclose any such information if such disclosure would, in the reasonable judgment of Guarantor, constitute a waiver by Guarantor of its attorney-client privilege or any applicable work product privilege with respect to such matter. (K) notwithstanding the foregoing, the requirement for delivery of financial statements under Section 10(a)(iv) may be satisfied by delivery of a copy of Forms 10-K or 10-Q as the case may be as filed by Guarantor with the SEC for the most recent fiscal year or fiscal quarter then ended. Guarantor may remit its financial statements via electronic format through delivery by e-mail or otherwise; (L) in the event (i) Guarantor acquires or creates any Subsidiary after the Document Closing Date which is a Material Subsidiary, or (ii) any current Subsidiary (which is not a Material Subsidiary as of the Document Closing Date) becomes a Material Subsidiary after such date, or (iii) any Material Subsidiary identified on the Document Closing Date ceases to be a Material Subsidiary, Guarantor shall provide written notice thereof to Agent as promptly as practicable; and [*] (v) Inspection Rights. Guarantor will, and will cause each of its Subsidiaries to, permit any authorized representatives designated by Lessor, Agent or any Participant to visit and inspect its and their financial and accounting records (to the extent reasonably requested by Lessor, Agent or any Participant), and to discuss its and their affairs, finances and accounts with its and their Responsible Officers (provided, Guarantor may, if it so chooses, be present at or participate in any such discussion), all upon reasonable prior written notice to the chief financial officer, treasurer or the vice president of finance of Guarantor, at such reasonable times during normal business hours and as often as may reasonably be requested; provided, the Participants shall use their reasonable efforts to coordinate with Lessor and Agent in order to minimize the number of such inspections and discussions, and provided further that, absent the occurrence and continuance of a Guarantee Event of Default, such inspections shall not be conducted [*] INDICATES THAT CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION PURSUANT TO RULE 24B-2. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. 18 more frequently than once per fiscal year. Guarantor will, upon the request of Lessor, Agent or the Required Participants, participate in a meeting of Lessor, Agent and the Participants once during each fiscal year to be held at Guarantor's corporate offices (or at such other location as may be agreed to by Guarantor and Agent) at such time as may be agreed to by Guarantor and Agent. (vi) Intentionally Omitted. (vii) Compliance with Laws. Guarantor will comply, and shall cause each of its Subsidiaries to comply, with the requirements of all Applicable Laws noncompliance with which would reasonably be expected to have a Material Adverse Effect. (b) Negative Covenants. Guarantor hereby agrees that, so long as this Guarantee remains in effect or any amount is owing to any Participant, Lessor or Agent hereunder or under any other SanDisk Tranche Operative Document, Guarantor shall, and shall cause each of its Subsidiaries to, comply with each of the following covenants: (i) Indebtedness. Guarantor shall not nor shall it permit any of its Subsidiaries to, directly or indirectly, create, incur, assume or guaranty, or otherwise become or remain directly or indirectly liable with respect to any Indebtedness, except: (A) Indebtedness of Guarantor and its Subsidiaries arising from the endorsement of instruments for collection in the ordinary course of Guarantor's or a Subsidiary's business; (B) Indebtedness of Guarantor and its Subsidiaries for accounts payable and trade payables, provided that such accounts arise in the ordinary course of business; (C) Indebtedness owed to any Person providing worker's compensation, health, disability or other employee benefits or property, casualty or liability insurance to Guarantor or any Subsidiary thereof, or which may be deemed to exist pursuant to reimbursement or indemnification obligations to such Person; (D) Indebtedness of Guarantor and its Subsidiaries with respect to performance, surety, statutory, appeal or similar obligations incurred in the ordinary course of business; (E) Indebtedness in respect of netting services, overdraft protections and otherwise in connection with Deposit Accounts; 19 19 (F) guaranties by Guarantor of Indebtedness of its Subsidiaries or guaranties by a Subsidiary of Guarantor of Indebtedness of Guarantor or another Subsidiary with respect, in each case, to Indebtedness otherwise permitted to be incurred pursuant to this Section 10(b)(i); (G) Indebtedness described in Schedule 10(b)(i), but not any extensions, renewals or replacements of such Indebtedness except (i) renewals and extensions expressly provided for in the agreements evidencing any such Indebtedness as the same are in effect on the date of this Agreement and (ii) refinancings and extensions of any such Indebtedness if the terms thereof are no less favorable to the obligor thereon or to the Participants, but giving effect to then-current market conditions, than the Indebtedness being refinanced or extended; provided, such Indebtedness permitted under clause (i) or clause (ii) above shall not be (1) Indebtedness of an obligor that was not an obligor with respect to the Indebtedness being extended, renewed or refinanced, (2) in a principal amount which exceeds the Indebtedness being renewed, extended or refinanced or (3) incurred, created or assumed if any Guarantee Default or Guarantee Event of Default has occurred and is continuing or would result therefrom; (H) Indebtedness with respect to Capitalized Leases in an aggregate amount not to exceed $10,000,000 at any time with respect to Guarantor and all of its Subsidiaries in the aggregate; (I) Purchase Money Indebtedness (including without duplication Guaranty Obligations of Guarantor or any of its Subsidiaries in respect of Purchase Money Indebtedness of another Person) in an aggregate amount not to exceed at any time $150,000,000 with respect to Guarantor and all of its Subsidiaries in the aggregate; provided, any such Indebtedness (i) shall be recourse only to the asset acquired in connection with the incurrence of such Indebtedness, (ii) such Indebtedness is incurred by such Person at the time of, or not later than thirty (30) days after, the acquisition by such Person of the property so financed, (iii) such Indebtedness (or Guaranty Obligations in respect thereof) does not exceed the purchase price of the property so financed, and (iv) no Guarantee Default or Guarantee Event of Default has occurred and is continuing at the time the Indebtedness (or Guaranty Obligations in respect thereof) is incurred or will occur after giving effect to such Indebtedness (or such Guaranty Obligations), provided that the conditions set forth in clauses (i), (ii) and (iii) of this Section 10(b)(i)(I) shall not applicable in the case of a Synthetic Lease or a Capitalized Lease; (J) Guaranty Obligations of Guarantor to Lessor, Agent and Participants under the SanDisk Tranche Operative Documents; (K) other Indebtedness of Guarantor and its Subsidiaries, provided that the aggregate principal amount of all such other Indebtedness does not exceed $15,000,000 at any time; 20 20 (L) other unsecured Indebtedness of Guarantor and its Subsidiaries, provided that the aggregate principal amount of all such other Indebtedness does not exceed (i) $200,000,000 at any time during Guarantor's 2001 fiscal year, (ii) $300,000,000 at any time during Guarantor's 2002 fiscal year, (iii) $375,000,000 at any time during Guarantor's 2003 fiscal year, or (iv) $450,000,000 at any time during Guarantor's 2004 fiscal year or any fiscal year thereafter, and provided further that at the time any such Indebtedness is incurred and after giving effect thereto, Guarantor shall be in compliance with each of the covenants set forth in Sections 10(c)(i) and 10(c)(iii); and (M) Indebtedness of Guarantor and its Subsidiaries in interest rate protection agreements and currency swaps solely for the purpose of bona fide hedges against existing business risk. (ii) Liens. Guarantor shall not, nor shall it permit any of its Subsidiaries to, directly or indirectly, create, incur, assume or permit to exist any Lien on or with respect to any property or asset of any kind of Guarantor or any of its Subsidiaries, whether now owned or hereafter acquired, or any income or profits therefrom, or file or permit the filing of, or permit to remain in effect, any financing statement or other similar notice of any Lien with respect to any such property, asset, income or profits under the UCC of any state or under any similar recording or notice statute, except Permitted Liens. Without limitation of the foregoing, in no event shall Guarantor create, permit or suffer to exist or cause or permit any of its Subsidiaries to create, permit or suffer to exist, any Lien upon any of their respective rights and interests under the Master Agreement Documents to which they are a party or upon any of the Membership Interests of Lessee. Guarantor or a Subsidiary thereof shall at all times own at least 49.9% of the Membership Interests of Lessee. (iii) Dividends, Redemptions, Etc. Neither Guarantor nor any of its Subsidiaries shall pay any dividends or make any distributions on its Equity Securities; purchase, redeem, retire, defease or otherwise acquire for value any of its Equity Securities; return any capital to any holder of its Equity Securities as such; make any distributions of assets, Equity Securities, obligations or securities to any holder of its Equity Securities as such; or set apart any sum for any such purpose; except as follows: (A) either Guarantor or any of its Subsidiaries may pay dividends on its capital stock payable solely in such Person's own capital stock; (B) any Subsidiary of Guarantor may pay dividends to Guarantor or to such Subsidiary's direct parent; (C) Guarantor may purchase shares of its capital stock for its employee stock option plans and employee stock purchase plans, provided that (A) the aggregate amount of such purchases does not exceed $50,000,000 in any fiscal year of Guarantor, and (B) no Default has occurred and is continuing at the time of such purchase or will occur after giving effect to such purchase; 21 21 (D) Guarantor may purchase shares of its capital stock with the proceeds received by it from a substantially concurrent issue of new shares of its capital stock; (E) Guarantor may otherwise purchase shares of its capital stock provided that the aggregate amount of such purchases does not exceed $100,000,000 and so long as at the time any such purchase is consummated and after giving effect thereto, Tangible Net Worth is not less than the amount then required pursuant to Section 10(c)(iv); and (F) Guarantor may pay cash dividends on its capital stock at any time after Guarantor's 2001 fiscal year, provided the aggregate amount of such cash dividends shall not exceed $10,000,000 in any fiscal year of Guarantor. (iv) Investments. Neither Guarantor nor any of its Subsidiaries shall directly or indirectly make any Investment except for Investments in the following: (A) Investments of Guarantor and its Subsidiaries in Cash Equivalents and in short-term securities rated AA or higher; (B) Any transaction permitted by Section 10(b)(i); (C) Money market mutual funds registered with the SEC, meeting the requirements of Rule 2a-7 promulgated under the Investment Company Act of 1940; (D) Investments listed on Schedule 10(b)(iv)(D) existing on the date of this Guarantee; (E) Other Investments in Persons principally involved in the semiconductor business or other related businesses in an aggregate amount not to exceed, together with any acquisitions made pursuant to Section 10(b)(v)(I)(i), at any time more than [*] of Guarantor's Tangible Net Worth as of the date of any such Investment; and (F) Guarantor may make Investments in, a business or businesses complimentary to the semiconductor business, so long as any such acquisition or Investment is made solely with the proceeds received by Guarantor from a substantially concurrent issue of new shares of its capital stock. (v) Fundamental Changes; Disposition of Assets. Guarantor shall not, and shall not permit any of its Subsidiaries to, alter the corporate, capital or legal structure of Guarantor or any of its Subsidiaries if any such alteration could reasonably be expected to have a Material Adverse Effect, or enter into any transaction of merger or consolidation, or liquidate, wind-up or dissolve itself (or suffer any liquidation or dissolution), or convey, sell, lease or sub-lease (as lessor or sublessor), transfer or otherwise dispose of, in one transaction or a series of transactions, all or any part of its [*] INDICATES THAT CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION PURSUANT TO RULE 24B-2. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. 22 business, property or assets, whether now owned or hereafter acquired, or acquire by purchase or otherwise all or substantially all the business, property or fixed assets of, or stock or other evidence of beneficial ownership of, any Person or any division or line of business of any Person, except: (A) Any Domestic Subsidiary of Guarantor (other than Lessee) may be merged with or into Guarantor or any Wholly-Owned Domestic Subsidiary (other than Lessee), or be liquidated, wound up or dissolved, or all or any part of its business, property or assets may be conveyed, sold, leased, transferred or otherwise disposed of, in one transaction or a series of transactions, to Guarantor or any Wholly-Owned Domestic Subsidiary (other than Lessee); provided, in the case of such a merger, Guarantor or such Wholly-Owned Domestic Subsidiary shall be the continuing or surviving Person; and provided further that in the case of any such transaction involving Guarantor, the surviving Person (if not Guarantor) shall have agreed in writing to assume all of the obligations and liabilities of Guarantor under the SanDisk Tranche Operative Documents. (B) Any Foreign Subsidiary of Guarantor may be merged with or into Guarantor or any Wholly-Owned Foreign Subsidiary, or be liquidated, wound up or dissolved, or all or any part of its business, property or assets may be conveyed, sold, leased, transferred or otherwise disposed of, in one transaction or a series of transactions, to Guarantor or any Wholly-Owned Foreign Subsidiary; provided, in the case of such a merger, Guarantor or such Wholly-Owned Foreign Subsidiary shall be the continuing or surviving corporation; (C) Sales or other dispositions of Investments permitted by Section 10(b)(iv) for not less than fair value; (D) Sales of inventory by Guarantor and its Subsidiaries in the ordinary course of their businesses; (E) Sales or other dispositions of surplus, damaged, worn or obsolete equipment or inventory for not less than fair market value or otherwise in the ordinary course of business; (F) Sales or assignments of defaulted receivables to a collection agency in the ordinary course of business; (G) Licenses to other Persons of intellectual property by Guarantor or any Subsidiary thereof in the ordinary course of business provided that, in each case, the terms of the transaction are terms which then would prevail in the market for similar transactions between unaffiliated parties dealing at arm's length; (H) Sales or other dispositions of assets and property by Guarantor to any of Guarantor's Subsidiaries (other than Lessee except in 23 23 accordance with the Master Agreement Documents) or by any of Guarantor's Subsidiaries (other than Lessee) to Guarantor or any of its other Subsidiaries (other than Lessee except in accordance with the Master Agreement Documents), provided that the terms of any such sales or other dispositions by or to Guarantor are terms which are no less favorable to Guarantor than would prevail in the market for similar transactions between unaffiliated parties dealing at arm's length; (I) Acquisitions of the business, property or fixed assets of any Person engaged in the semiconductor business or other related businesses in an aggregate amount not to exceed, together with any Investments made pursuant to Section 10(b)(iv)(E), at any time more than twenty-five percent (25%) of Guarantor's Tangible Net Worth as of the date of any such acquisition; (ii) acquisitions of all or substantially all of the business, property or fixed assets of any Person engaged in the semiconductor business or other related businesses, so long as such acquisition is made with the proceeds received by Guarantor from a substantially concurrent issue of new shares of its capital stock, and (iii) transactions otherwise permitted under Section 10(b)(iv); (J) Sales of accounts receivable of Guarantor and its Subsidiaries (other than Lessee), provided that (A) each such sale is (1) for not less than fair market value and (2) for cash, and (B) the aggregate book value of all such accounts receivable so sold in any consecutive four quarter period does not exceed ten percent (10%) of the consolidated total accounts receivable of Guarantor and its Subsidiaries on the last day immediately preceding such four quarter period; (K) Other sales, leases, transfers and disposal of assets and property (other than sales by Lessee) for not less than fair market value, provided that the aggregate book value of all such assets and property so sold, leased, transferred or otherwise disposed of in any consecutive four quarter period does not exceed ten percent (10%) of the Consolidated Assets of Guarantor and its Subsidiaries on the last day immediately preceding such four quarter period. (L) Guarantor or any Subsidiary may merge with or into any Person (other than Lessee) so long as (1) Guarantor is the survivor of any such transaction to which Guarantor is a party, or such Subsidiary or Guarantor is the survivor of any such transaction to which such Subsidiary is a party, as the case may be, and (2) at the time of such transaction and after giving effect thereto, no Guarantee Default or Guarantee Event of Default (including without limitation a Change of Control) shall have occurred and be continuing. (vi) Accounting Changes. Neither Guarantor nor any of its Material Subsidiaries shall change (i) its fiscal year (currently) or (ii) its accounting practices except in accordance with GAAP. 24 24 (vii) Change in Business. Neither Guarantor nor any of its Subsidiaries shall engage, either directly or indirectly through Affiliates thereof, in any material line of business other than the business conducted by such Persons as of the Document Closing Date and other businesses incidental or reasonably related thereto and other than other businesses which would not reasonably be expected to have a Material Adverse Effect. (viii) ERISA. Neither Guarantor nor any ERISA Affiliate shall (i) adopt or institute any Pension Plan, (ii) take any action which will result in the partial or complete withdrawal, within the meanings of Section 4203 and 4205 of ERISA, from a Multiemployer Plan to which Guarantor or an ERISA Affiliate contributes, (iii) engage or permit any Person to engage in any transaction prohibited by Section 406 of ERISA or Section 4975 of the Code involving any Employee Benefit Plan or Multiemployer Plan to which Guarantor or an ERISA Affiliate contributes which would subject either Guarantor or any ERISA Affiliate to any tax, penalty or other liability including a liability to indemnify, (iv) incur or allow to exist any accumulated funding deficiency (within the meaning of Section 412 of the Code or Section 302 of ERISA), (v) fail to make full payment when due of all amounts due as contributions to any Employee Benefit Plan or Multiemployer Plan to which Guarantor or an ERISA Affiliate contributes, (vi) fail to comply with the requirements of Section 4980B of the Code or Part 6 of Title I(B) of ERISA, or (vii) adopt any amendment to any Employee Benefit Plan which would require the posting of security pursuant to Section 401(a)(29) of the Code, which, in the case of clauses (i) through (vii) above, singly or cumulatively, could reasonably be expected to have a Material Adverse Effect. (ix) Amendments to Master Agreement Documents. Guarantor shall not cause or permit any of the Master Agreement Documents to which it is a party to be amended, restated, supplemented or otherwise modified in a manner which would constitute a breach of Section 8.1(s) of the Participation Agreement (SanDisk Tranche). (c) Guarantor's Financial Covenants. So long as this Guarantee remains in effect: (i) Leverage Ratio. Guarantor shall not permit its Leverage Ratio to be greater than 2.75 to 1.00 as of the last day of any fiscal quarter for the four fiscal quarter period then ended. (ii) Quick Ratio. Guarantor shall not permit its Quick Ratio as of the last day of any fiscal quarter to be less than 1.50 to 1.00. (iii) Fixed Charge Coverage Ratio. Guarantor shall not permit its Fixed Charge Coverage Ratio as of the last day of any fiscal quarter for the four fiscal quarter period then ended to be less than 2.25 to 1.00. (iv) Tangible Net Worth. Guarantor shall not permit its Tangible Net Worth on the last day of any fiscal quarter (such date to be referred to herein as a "determination date") to be less than the sum on such determination date of the following: 25 25 (A) ninety percent (90%) of the Tangible Net Worth as of September 30, 2000 (the "base date"); plus (B) fifty percent (50%) of the sum of Guarantor's consolidated quarterly net income determined without deduction of any quarterly losses for each fiscal quarter after the base date through and including the fiscal quarter ending on the determination date; plus (C) seventy-five percent (75%) of the net proceeds of all Equity Securities issued by Guarantor and its Subsidiaries (to Persons other than Guarantor or its Subsidiaries) during the period commencing on the base date and ending on the determination date. Section 11. Guarantee Events of Default; Remedies. 11.1 Guarantee Events of Default. Each of the following events shall constitute a Guarantee Event of Default (whether any such event shall be voluntary or involuntary or come about or be effected by operation of law or pursuant to or in compliance with any judgment, decree or order of any court or any order, rule or regulation of any governmental authority) and each such Guarantee Event of Default shall continue so long as, but only as long as, it shall not have been remedied or waived: (a) Guarantor shall default in the payment when due of any amount owing hereunder; or (b) Any representation or warranty of Guarantor contained in this Guarantee or in any certificate, report, financial statement or in other document required to be furnished or delivered pursuant to any SanDisk Tranche Operative Documents by Guarantor or on Guarantor's behalf to any Participant or Agent or Lessor is false or misleading in any material respect when made or reaffirmed, as the case may be and, if capable of being cured, remains uncured for thirty (30) days after the earlier of (i) receipt by Guarantor of notice thereof and (ii) a Responsible Officer of Guarantor obtaining knowledge thereof; or (c) Guarantor or any of its Subsidiaries shall default in the performance or observance of any term, covenant, condition or agreement on its part to be performed or observed under Sections 10(a)(i), 10(b)(v)(A), 10(b)(v)(B), 10(b)(v)(L) or 10(c) hereof; or (d) Guarantor or any of its Subsidiaries shall default in any material respect in the performance or observance of (i) any term, covenant, condition or agreement on its part to be performed or observed under Sections 10(b)(i), 10(b)(ii), 10(b)(iii), 10(b)(iv), 10(b)(v) (other than clauses (A), (B) and (L) of Section 10(b)(v), to which Section 11.1(c) above is applicable) or 10(b)(vii) hereof or (ii) any other term, covenant, condition or agreement on its part to be performed or observed hereunder or under any other SanDisk Tranche Operative Document to 26 26 which it is a party (and not constituting a Guarantee Event of Default under any other clause of this Section 11.1), and such default, in the case of either clause (i) or clause (ii) above, if capable of being remedied, shall continue unremedied for a period of thirty (30) days after the earlier to occur of (x) written notice thereof by Agent or Lessor to Guarantor or (y) a Responsible Officer of Guarantor obtaining knowledge thereof (provided that, upon notice from Guarantor to Agent, if such failure referred to in clause (ii) of this Section 11.1(d) is not reasonably capable of being cured during such 30-day period, such period shall be extended for a total period of 180 days so long as (i) such failure is subject to cure during such 180-day period and (ii) Guarantor is diligently and continuously proceeding to cure or cause to be cured such failure); or (e) Guarantor or any of its Subsidiaries shall default in the payment when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) of any amount owing in respect of any Indebtedness (other than Indebtedness referred to in Section 11.1(a)) in the principal amount of $15,000,000 or more; or (ii) Guarantor or any of its Subsidiaries shall default in the performance or observance of any obligation or condition with respect to any Indebtedness (other than Indebtedness referred to in Section 11.1(a)) or any other event shall occur or condition exist, if the effect of such default, event or condition is to accelerate the maturity of any such Indebtedness or to permit the holder or holders thereof, or any trustee or agent for such holders, to accelerate the maturity of any such Indebtedness, or any such Indebtedness shall become or be declared to be due and payable prior to its stated maturity other than as a result of a regularly scheduled payment, and the principal amount of such Indebtedness is $15,000,000 or more; or (f) (i) Guarantor or any of its Material Subsidiaries shall commence a voluntary case concerning itself under the Bankruptcy Code; or (ii) an involuntary case is commenced against Guarantor or any of its Material Subsidiaries and the petition remains unstayed and in effect for more than sixty (60) days, or is not dismissed within sixty (60) days, after commencement of the case; or (iii) a custodian (as defined in the Bankruptcy Code) is appointed for, or takes charge of, all or substantially all of the property of Guarantor or any of its Material Subsidiaries or Guarantor or any of its Material Subsidiaries commences any other proceedings under any reorganization, arrangement, adjustment of debt, relief of debtors, dissolution, insolvency or liquidation or similar law of any jurisdiction whether now or hereafter in effect relating to Guarantor or any of its Material Subsidiaries or there is commenced against Guarantor or any of its Material Subsidiaries any such proceeding which remains undismissed for a period of sixty (60) days; or (iv) any order of relief is entered in any such case or proceeding; or (v) Guarantor or any of its Material Subsidiaries is adjudicated insolvent or bankrupt; or (vi) Guarantor or any of its Material Subsidiaries suffers any appointment of any custodian or the like for it or any substantial part of its property to continue undischarged or unstayed for a period of sixty (60) days; or (vii) Guarantor or any of its Material Subsidiaries makes a general assignment for the benefit of creditors; or (viii) Guarantor or any of its Material Subsidiaries shall fail to pay, or shall state that it is unable to pay, or shall be unable to pay, its debts generally as they become due; or (ix) Guarantor or any of its Material Subsidiaries shall consent to, or approve in writing any of the foregoing; or (g) an ERISA Event which constitutes grounds for the termination of any Pension Plan maintained by Guarantor or any ERISA Affiliate by the PBGC or for the 27 27 appointment of a trustee by the PBGC to administer any Pension Plan maintained by Guarantor or any ERISA Affiliate shall occur, or any Pension Plan maintained by Guarantor or any ERISA Affiliate shall be terminated within the meaning of Title IV of ERISA or a trustee shall be appointed by the PBGC to administer any Pension Plan maintained by Guarantor or any ERISA Affiliate; or (h) One or more judgments or decrees in an aggregate amount of $15,000,000 or more, to the extent not paid by insurance or coverage thereof has not been acknowledged in writing by the applicable insurer, shall be entered by a court against Guarantor or any of its Subsidiaries and any such judgments or decrees or enforcement proceedings in respect thereof shall not be stayed, discharged, paid, bonded or vacated within 30 days; or (i) a Change in Control shall occur. 11.2 Remedies. Upon the occurrence of any Guarantee Event of Default and so long as the same shall be continuing, Agent or its successors, transferees and assigns, as the case may be, may, at its option, declare a default by written notice to Guarantor and at any time thereafter Agent or such other authorized person may: (a) exercise any right or remedy that may be available hereunder or under any other SanDisk Tranche Operative Document; or (b) exercise any other right or remedy that may be available under applicable law or proceed by appropriate court action to enforce the terms hereof or to recover damages for the breach hereof. 11.3 Costs and Expenses. Guarantor shall be liable for any and all accrued and unpaid amounts due hereunder before, after or during the exercise of any of the foregoing remedies, including, subject to the terms of Section 2(b) hereof, all reasonable legal fees and other reasonable costs and expenses incurred by the Guaranteed Parties in the enforcement of this Guarantee. 11.4 Remedies Cumulative. Except as expressly provided above, no remedy under this Section 11 is intended to be exclusive, but each shall be cumulative and in addition to any other remedy provided under this Section 11 or otherwise available at law or in equity. The exercise by Agent of any one or more of such remedies shall not preclude the simultaneous or later exercise by any such Person or any other Person so entitled of any other remedy or remedies. No express or implied waiver by Agent or any Participant or their respective successors, transferees or assigns of any Guarantee Event of Default shall in any way be, or be construed to be, a waiver of any future or subsequent Guarantee Event of Default. The failure or delay of Agent in exercising any rights granted it hereunder upon any occurrence of any of the contingencies set forth herein shall not constitute a waiver of any such right upon the continuation or recurrence of any such contingencies or similar contingencies and any single or partial exercise of any particular right by Agent shall not exhaust the same or constitute a waiver of any other right provided herein. 28 28 Section 12. Notices. All notices, requests and demands to or upon Lessor, Agent or Guarantor shall be in writing and delivered (i) personally, (ii) by a nationally recognized overnight courier service, (iii) by mail (by registered or certified mail, return receipt requested, postage prepaid) or (iv) by facsimile, in each case addressed to the applicable parties at their respective addresses or transmission numbers for notices set forth on Schedule I hereto. Any such notice shall be effective upon receipt or refusal thereof. Lessor, Agent and Guarantor may each change its address and transmission numbers for notices by notice in the manner provided in this Section 12. Section 13. Severability. Any provision of this Guarantee which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. Section 14. Integration. This Guarantee represents the entire agreement of Guarantor with respect to the subject matter hereof and there are no promises or representations by any Guaranteed Party relative to the subject matter hereof not reflected herein. Section 15. Amendments in Writing. None of the terms or provisions of this Guarantee may be waived, amended, supplemented or otherwise modified except as provided in Section 11.1 of the Participation Agreement. Section 16. Section Headings. The section headings used in this Guarantee are for convenience of reference only and are not to affect the construction hereof or be taken into consideration in the interpretation hereof. Section 17. Successors and Assigns. This Guarantee shall be binding upon the successors and assigns of Guarantor and shall inure to the benefit of the Guaranteed Parties and their respective successors and assigns. Section 18. Submission to Jurisdiction. GUARANTOR HEREBY SUBMITS TO THE NONEXCLUSIVE GENERAL JURISDICTION OF THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA AND ANY CALIFORNIA STATE COURT SITTING IN THE COUNTY OF SANTA CLARA AND APPELLATE COURTS FROM ANY THEREOF FOR PURPOSES OF ALL LEGAL PROCEEDINGS ARISING OUT OF OR RELATING TO THIS GUARANTEE OR THE TRANSACTIONS CONTEMPLATED HEREBY. GUARANTOR IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, ANY OBJECTION WHICH IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF THE VENUE OF ANY SUCH PROCEEDING BROUGHT IN SUCH A COURT AND ANY CLAIM THAT ANY SUCH PROCEEDING BROUGHT IN SUCH A COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM. Section 19. WAIVER OF JURY TRIAL. GUARANTOR HEREBY IRREVOCABLY WAIVES ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATING TO THIS GUARANTEE OR THE TRANSACTIONS CONTEMPLATED HEREBY. 29 29 Section 20. GOVERNING LAW. THIS GUARANTEE SHALL IN ALL RESPECTS BE GOVERNED BY THE INTERNAL LAW OF THE STATE OF CALIFORNIA AS TO ALL MATTERS OF CONSTRUCTION, VALIDITY AND PERFORMANCE, WITHOUT REGARD TO CONFLICTS OF LAW PRINCIPLES. Section 21. Nature of Transaction. Guarantor acknowledges the provisions of Section 5.1 of the Participation Agreement (SanDisk Tranche). Section 22. Actions by Guaranteed Parties. All actions by or on behalf of one or more Guaranteed Parties in respect of this Guarantee or in respect of any right, benefit or remedy under this Guarantee shall only be taken through the Agent as provided in the Participation Agreement. Section 23. Termination. Subject to Section 7 hereof, which shall survive termination hereof, this Guarantee and the obligations of the Guarantor hereunder shall terminate upon payment in full of the Guaranteed Obligations, provided that the obligations of Guarantor hereunder shall survive as to any indemnification obligations of Lessee which survive pursuant to Section 14.1 of the Participation Agreement (SanDisk Tranche). Notwithstanding the foregoing, in no event will the Guaranteed Obligations exceed, as of any date of determination, the sum of the Lease Balance, all accrued and unpaid Variable Rent, all indemnification obligations and Transaction Expenses due and payable by Lessee under the SanDisk Tranche Operative Documents and all amounts payable by Guarantor pursuant to Section 11.3 hereof. [signature page follows] 30 30 IN WITNESS WHEREOF, the undersigned has caused this Guarantee to be duly executed and delivered by its duly authorized officer as of day and year first above written. SANDISK CORPORATION, a Delaware corporation By: ------------------------- Name: ----------------------- Title: ---------------------- 31 EX-23.1 5 0005.txt CONSENT OF ERNST & YOUNG Exhibit 23.1 Consent of Ernst & Young LLP, Independent Auditors We consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-96298 and No. 333-32039) pertaining to the SanDisk Corporation 1995 Stock Option Plan, 1995 Non-Employee Directors Stock Option Plan and Employee Stock Purchase Plan of SanDisk Corporation of our report dated January 23, 2001 with respect to the consolidated financial statements and schedule of SanDisk Corporation included in this Annual Report (Form 10-K) for the year ended December 31, 2000. /s/ Ernst & Young LLP San Jose, California March 28, 2001 -----END PRIVACY-ENHANCED MESSAGE-----