SanDisk 2002 Annual Report Download - page 23

2 1 2 0 0 2 Annua l Re port
m em ory w afers. Even if FlashVision successfully produces
quantities at planned levels, the Yokkaichi fabrication foundry
facilities m ay not produce satisfactory quantities of w afers
w ith acceptable prices, reliability and yields. Any failure in this
regard m ay curtail our business, financial condition and
results of operations, as our right to purchase NAND flash
m em ory products from Samsung is lim ited and m ay not be
sufficient to replace any shortfall in production at the
Yokkaichi facilities. In addition, any disruption in supply from
the Yokkaichi fabrication facility due to natural disaster,
power failure, labor unrest or other causes could significantly
harm our business, financial condition and results of opera-
tions. M oreover, w e have no experience in operating a w afer
m anufacturing line and w e intend to rely on the existing m an-
ufacturing organizations at the Yokkaichi fabrication facilities.
If Toshiba and FlashVision are uncom petitive or are unable to
satisfy our w afer supply requirem ents, our business, financial
condition and results of operations w ould be harm ed.
Our o b lig ations under o ur w afer s up ply ag re e m ents
w ith To shiba a nd FlashVisio n, o r d e c re a se d d em and fo r
our p rod uc ts , m ay res ult in e xc e s s inventorie s and le ad
to inventory w rite o ffs, and any tec hnic al d iffic ultie s o r
m anufa c turing p ro b lem s m a y re sult in sho rtag es in sup -
ply, e ither o f w hic h w o uld ad ve rse ly affec t o ur b usines s.
Under the term s of our w afer supply agreem ents w ith
Toshiba, w e are obligated to purchase half of FlashVision’s
NAND w afer production output and w e w ill also purchase
NAND w afers from Toshiba’s current Yokkaichi fabrication
facility on a foundry relationship basis. If w e are unable for
any reason to achieve custom er acceptance of our card
products built with these NAND flash chips or if dem and
decreases, w e w ill experience a significant increase in our
inventory, w hich m ay result in inventory w rite-offs and harm
our business, results of operations and financial condition.
Apart from our com m itm ent to purchase w afer output from
FlashVision, under our foundry relationship w ith Toshiba, w e
order NAND w afers under purchase orders that cannot be
cancelled. If w e place purchase orders w ith Toshiba and our
business condition deteriorates, w e m ay end up w ith excess
inventories of NAND w afers, w hich could harm our business
and financial condition. Should custom er dem and for NAND
flash products be less than our available supply, w e m ay suf-
fer from reduced revenues and increased expenses, and
increased inventory of unsold NAND flash wafers, w hich
could adversely affect our operating results.
Under the term s of our foundry relationship w ith Toshiba
and w afer supply agreem ents w ith FlashVision, w e are obli-
gated to provide a six-m onth rolling forecast of anticipated
purchase orders, w hich are difficult to estim ate. Generally,
the estim ates for the first three m onths of each rolling fore-
cast are binding comm itm ents. The estim ates for the remain-
ing m onths of the forecast m ay only be changed by a certain
percentage from the previous m onth’s forecast. This lim its
our ability to react to fluctuations in dem and for our products.
In addition, in order for us to sell NAND based CF cards,
SD cards and M ultiMediaCards, w e have been developing
new controllers, printed circuit boards and test algorithm s.
Any technical difficulties or delays in the developm ent of
these elem ents could prevent us from taking advantage of
the available NAND output and could adversely affect our
results of operations. See “– Risks Related to Our FlashVision
Joint Venture.”
W e have c ontingent inde m nific a tion o b lig ations for
c e rtain liabilitie s To shiba inc urs as a re sult o f
Tos hiba’s g ua rantee o f the FlashVision e q uipm ent
leas e a rrang e m ent.
FlashVision secured a new equipm ent lease arrange-
m ent of approxim ately 37.9 billion Japanese Yen (or
approxim ately $305 m illion based on the exchange rate in
effect on the date the agreem ent w as executed) in M ay
2002 w ith M izuho Corporate Bank, Ltd., or M izuho, and
certain other financial institutions. Under the term s of the
new lease, Toshiba is required to provide a guarantee to
these financial institutions on behalf of FlashVision. We have
agreed to indem nify Toshiba in certain circum stances for
certain liabilities Toshiba incurs as a result of Toshiba’s
guarantee of the FlashVision equipm ent lease arrangem ent.
If FlashVision fails to m eet its lease comm itm ents, and
Toshiba fulfills these com m itm ents under the term s of
Toshiba’s guarantee, then w e w ill be obligated to reim burse
Toshiba for 49.9% of any claim s under the lease, unless
such claim s result from Toshiba’s failure to m eet its obliga-
tions to FlashVision or its covenants to the lenders.
Because FlashVision’s new equipm ent lease arrangement is
denom inated in Japanese Yen, the m aximum am ount of our
contingent indem nification obligation on a given date w hen
converted to U.S. Dollars w ill fluctuate based on the
exchange rate in effect on that date. As of Decem ber 31,
2002, the m axim um am ount of our contingent indem nifica-
tion obligation, w hich reflects paym ents and any lease
adjustm ents, w as approxim ately $142.4 m illion.
Risk s Re la te d to O ur Inve stm e nt in Tow e r
Se m ico nd uc tor Ltd .
Our inves tm e nts in To w e r Se m ico nd uc to r Ltd . are s ub-
jec t to c ertain inhere nt risks, inc luding thos e a ss oc iated
w ith c e rtain Israe li re g ulato ry re q uire m ents, p o litic a l
unrest and financ ing d iffic ultie s , w hic h c ould harm o ur
bus iness a nd financ ial c ond itio n.
In July 2000, w e entered into a share purchase agree-
m ent to m ake a $75.0 m illion investm ent in Tow er for its
new w afer foundry facility, Fab 2. As of Decem ber 31, 2002,
w e had invested $68.0 m illion in Tow er and obtained
6,100,959 ordinary shares, $14.3 m illion of prepaid w afer
9credits, and a w arrant to purchase 360,313 ordinary Tow er
shares at an exercise price of $7.50 per share. This w arrant
expires on October 31, 2006. The investm ent in the ordinary
shares represents an approxim ate 14% current equity ow n-
ership position in Tow er as of Decem ber 31, 2002. In 2002
and 2001, w e recognized losses of $14.4 m illion and $26.1
m illion, respectively, on the other- than- temporary decline in
the value of our Tow er investm ent and the im pairm ent in
value on our prepaid w afer credits and approxim ately $0.7
m illion in unrealized losses related to the fair value of the
w arrants purchased in October of 2002. Our investm ent in
Tow er w as valued at $21.3 m illion as of Decem ber 31, 2002.
At Decem ber 31, 2002, our prepaid w afer credits w ere val-
ued at $6.0 m illion, w hich is net of $2.8 m illion in write-
downs recorded in fiscal 2002, related to the recoverability
of these prepaid w afer credits.
In M arch 2002, w e am ended our foundry investm ent
agreem ents w ith Tow er by agreeing to advance the pay-
m ents for the third and fourth m ilestones. The paym ent for
the third m ilestone of $11.0 m illion w as made on April 5,
2002. In exchange for this paym ent w e received 1,071,497