SanDisk 2006 Annual Report Download - page 66

without historical information and actual costs may significantly exceed our recorded estimates. Underestimation
of our warranty and similar costs would have an adverse effect on our results of operations and financial condition.
We and Toshiba plan to continue to expand the wafer fabrication capacity of the Flash Partners business
venture and have formed a new venture, Flash Alliance, for which we will make substantial capital investments and
incur substantial start-up and tool relocation costs, which could adversely impact our operating results. We and
Toshiba are making, and plan to continue to make, substantial investments in new capital assets to expand the wafer
fabrication capacity of our Flash Partners business venture in Japan. We and Toshiba intend to invest $1.76 billion to
continue expansion at Fab 3 to bring wafer capacity to 135,000 wafers per month by the end of fiscal year 2007 and
are cooperating in the construction of an additional 300-millimeter NAND wafer fabrication facility, Fab 4, to
produce NAND flash memory products for the parties under the Flash Alliance venture. We and Toshiba intend to
invest 300 billion Japanese yen, or approximately $2.5 billion, based on the exchange rate at December 31, 2006, in
the construction and equipping of Fab 4. Moreover, each time that we and Toshiba add substantial new wafer
fabrication capacity, we will experience significant initial design and development and start-up costs as a result of
the delay between the time of the investment and the time qualified products are manufactured and sold in volume
quantities. For several quarters, we will incur initial design and development costs and start-up costs and pay our
share of ongoing operating activities even if we do not achieve the planned output volume or utilize our full share of
the expanded output, and these costs will impact our gross margins, results of operations and financial condition.
There is no assurance that Flash Partners’ 300-millimeter NAND flash memory facility will perform as
expected, in particular as we transition to new lithography feature sizes. The Flash Partners’ 300-millimeter fab,
Fab 3, is currently transitioning from 70-nanometer to 56-nanometer feature sizes. There can be no assurance that
this transition will occur on schedule or at the yields or costs that we anticipate. This technology transition is
difficult and subject to significant risks in terms of schedule, yield and cost. If Flash Partners, or in the future, Flash
Alliance, encounters difficulties in transitioning to new technologies, our cost per megabyte may not remain
competitive with the costs achieved by other NAND flash memory producers. Also, Samsung is licensed under our
patents to use MLC technology, which enhances its manufacturing capabilities. Samsung began shipping
NAND/MLC products in the third quarter of fiscal year 2005 and may be able to produce product at a lower
cost than we can and increase their market share, thus adversely affecting our operating results and financial
condition.
We have a contingent indemnification obligation and guarantee obligations related to the ventures with
Toshiba. Toshiba has guaranteed FlashVision’s lease arrangement with third-party lessors. The total minimum
remaining lease payments as of December 31, 2006 were 5.8 billion Japanese yen, or approximately $48.6 million
based upon the exchange rate at December 31, 2006. If Toshiba makes payments under its guarantee, we have
agreed to indemnify Toshiba for 49.9% of its costs, subject to certain limitations and exclusions.
In December 2004, December 2005, June 2006 and September 2006, Flash Partners entered into four separate
equipment lease facilities totaling approximately 215.0 billion Japanese yen, or approximately $1.8 billion based
upon the exchange rate at December 31, 2006, of which, as of December 31, 2006, 144.0 billion Japanese yen, or
approximately $1.2 billion based upon the exchange rate at December 31, 2006, net of accumulated lease payments,
had been drawn down. As of December 31, 2006, our cumulative guarantee under the equipment leases, net of
cumulative lease payments, was approximately 72.0 billion Japanese yen, or approximately $605 million based on
the exchange rate at December 31, 2006. On January 10, 2007, Flash Partners drew down the remaining balance of
the September 2006 master lease agreement in the amount of approximately 52.0 billion Japanese yen, or
approximately $437 million, based on the exchange rate at December 31, 2006, of which we guaranteed 26.0 billion
Japanese yen, or approximately $218 million based upon the exchange rate at December 31, 2006. These leases
contain default clauses which, if triggered, could cause us to repay the amounts due under our guarantees. If our
corporate rating is significantly downgraded by any rating agency, it may impair the ability of our ventures with
Toshiba to obtain future equipment lease financings on terms consistent with current leases and would cause a
default under certain current leases, either of which could harm our business and financial condition.
We and Toshiba have also agreed to mutually contribute to, and indemnify each other, Flash Partners and Flash
Alliance for environmental remediation costs or liability resulting from Flash Partners’ and Flash Alliance’s
manufacturing operations in certain circumstances. In addition, we and Toshiba entered into a Patent
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