10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC. 20549
     

FORM 10-Q

(Mark One)
x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 2003
or
o	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from             to

Commission File Number 0-24085
     

AXT, INC.

(Exact name of registrant as specified in its charter)

DELAWARE
(State or other jurisdiction of
Incorporation or organization) 94-3031310
(I.R.S. Employer
Identification No.)

4281 Technology Drive, Fremont, California 94538

(Address of principal executive offices)    (Zip code)
(510) 683-5900
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
  YES x     NO o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES x     NO o

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at March 31, 2003
Common Stock, $.001 par value	22,693,984

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF INCOME
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Qualitative and Quantitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATION
EXHIBIT INDEX
EXHIBIT 10.15
EXHIBIT 99.1
EXHIBIT 99.2

AXT, INC.

TABLE OF CONTENTS

			Page
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets at March 31, 2003 and December 31, 2002	3
		Condensed Consolidated Statements of Income for the three months ended March 31, 2003 and 2002	4
		Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002	5
		Notes To Condensed Consolidated Financial Statements	6-12
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12-31
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
	Item 4.	Controls and Procedures	32
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	32
	Item 6.	Exhibits and Reports on Form 8-K	33
		Signatures	34
		Certifications	35-36

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

AXT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands, except per share data)

				March 31,			December 31,
				2003			2002
				(Unaudited)
Assets:
	Current assets
		Cash and cash equivalents		$	18,335		$	13,797
		Short-term investments			9,107			8,205
		Accounts receivable, net			7,947			7,195
		Inventories			34,487			37,598
		Prepaid expenses and other current assets			2,979			4,002
		Income tax receivable			8,220			8,783
		Asset held for sale			—			5,957
			Total current assets		81,075			85,537
	Property, plant and equipment				39,178			39,982
	Other assets				5,936			5,341
	Restricted deposits				10,722			11,150
	Long-term investments				2,197			3,657
			Total assets	$	139,108		$	145,667
Liabilities and Stockholders’ Equity:
	Current liabilities
		Accounts payable		$	4,221		$	4,228
		Accrued liabilities			10,499			11,407
		Current portion of long-term debt			944			965
		Current portion of capital lease obligation			3,411			3,562
			Total current liabilities		19,075			20,162
		Long-term debt, net of current portion			13,062			13,289
		Long-term capital lease, net of current portion			3,990			4,847
		Other long-term liabilities			1,746			1,712
			Total liabilities		37,873			40,010
	Stockholders’ equity:
		Preferred stock, $.001 par value per share; 2,000 shares authorized; 883 shares issued and outstanding			3,532			3,532
		Common stock, $.001 par value per share; 70,000 shares authorized; 22,694 and 22,495 shares issued and outstanding			154,670			154,485
		Accumulated deficit			(56,514	)		(52,197	)
		Other comprehensive income (loss)			(453	)		(163	)
			Total stockholders’ equity		101,235			105,657
		Total liabilities and stockholders’ equity		$	139,108		$	145,667

     See accompanying notes to these unaudited condensed consolidated financial statements.

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AXT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In thousands, except per share data)

			Three Months Ended
			March 31,
			2003			2002
Revenue			$	12,657		$	16,777
Cost of revenue				12,938			16,484
Gross profit (loss)				(281	)		293
Operating expenses:
	Selling, general and administrative			3,286			5,202
	Research and development			744			1,353
		Total operating expenses		4,030			6,555
Loss from operations				(4,311	)		(6,262	)
Interest expense				237			385
Other (income)/expense, net				(231	)		(717	)
Loss before income tax benefit				(4,317	)		(5,930	)
Income tax benefit				—			(2,372	)
Net loss			$	(4,317	)	$	(3,558	)
Basic loss per share				(0.19	)		(0.16	)
Diluted loss per share				(0.19	)		(0.16	)
Shares used in per share calculations:
	Basic			22,628			22,414
	Diluted			22,628			22,414

     See accompanying notes to these unaudited condensed consolidated financial statements.

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AXT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)

					Three Months Ended
					March 31,
					2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES:
	Net loss:				$	(4,317	)	$	(3,558	)
	Adjustments to reconcile net loss to cash provided by operations:
		Depreciation				1,722			2,582
		Amortization				79			66
		Non-cash gain on marketable securities				—			(251	)
		(Gain) loss on disposal of property, plant and equipment				(11	)		296
		Changes in assets and liabilities:
			Accounts receivable, net			(752	)		1,275
			Inventories			3,111			3,134
			Prepaid expenses			1,268			255
			Other assets			(45	)		(432	)
			Accounts payable			(7	)		1,007
			Accrued liabilities			(908	)		(1,812	)
			Income tax receivable			563			—
			Other long-term liabilities			34			(55	)
				Net cash provided by operating activities		737			2,507
CASH FLOWS FROM INVESTING ACTIVITIES:
	Purchases of property, plant and equipment					(917	)		(2,760	)
	Proceeds from sale of property, plant and equipment					5,172			—
	Investment in marketable securities					(37	)		(1,911	)
	Proceeds from sale of marketable securities					700			3,632
				Net cash provided by (used in) investing activities		4,918			(1,039	)
CASH FLOWS FROM FINANCING ACTIVITIES:
	Proceeds from (payments of):
		Issuance of common stock				185			429
		Capital leases payments				(1,008	)		(1,169	)
		Long-term debt payments				(248	)		(624	)
				Net cash used in financing activities		(1,071	)		(1,364	)
Effect of exchange rate changes						(46	)		103
Net increase in cash and cash equivalents						4,538			207
Cash and cash equivalents at the beginning of the period						13,797			37,538
Cash and cash equivalents at the end of the period					$	18,335		$	37,745
Non cash activity:
	Purchase of PP&E through financing				$	—		$	295

     See accompanying notes to these unaudited condensed consolidated financial statements.

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AXT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

     The accompanying condensed consolidated balance sheets as of March 31, 2003 and December 31, 2002, the condensed consolidated income statements for the three months ended March 31, 2003 and 2002, and the condensed consolidated statements of cash flows for the three months ended March 31, 2003 and 2002 have been prepared by AXT, Inc. (“AXT” or the “Company”) and are unaudited. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosure normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, considered necessary to present fairly the financial position, results of operations and cash flows of AXT and its subsidiaries for all periods presented.

     Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these condensed consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ materially from those estimates.

     The results of operations are not necessarily indicative of the results to be expected in the future or for the full fiscal year. It is recommended that these condensed consolidated financial statements be read in conjunction with the Company’s consolidated financial statements and the notes thereto included in its 2002 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 21, 2003.

     As a result of the significant revenue declines experienced over the past six quarters, the Company has taken cost reduction measures and continues to pursue additional measures to reduce costs and increase cash flows. At March 31, 2003, the Company had available cash, cash equivalents and liquid short and long-term investments of $29.7 million. The Company believes that its existing cash and liquid investments, cash generated from operations, coupled with additional efforts to reduce expenditures in support of substrate and opto-electronic businesses, will be sufficient to meet working capital expenditure requirements for the next 12 months. However, existing cash and liquid investments could continue to decline during 2003 due to a continued or further weakening of the economy or changes in our planned cash outlay.

     If the Company’s sales continue to decrease, the ability to generate cash from operations will be adversely affected which could adversely affect its future liquidity, requiring it to use cash at a more rapid rate than expected, and require it to seek additional capital. There can be no assurance that such additional capital will be available or, if available it will be at terms acceptable to the Company.

     Certain reclassifications have been made to the prior years consolidated financial statements to conform to current period presentation.

Note 2. Accounting for Stock Options

     The Company records compensation expense for employee stock options based upon their intrinsic value on the date of grant pursuant to Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees.” Because the Company establishes the exercise price based on the fair market value of the Company’s stock at the date of grant, the options have no intrinsic value upon grant, and therefore no expense is recorded. Each quarter, the Company reports the potential dilutive impact of stock options in its diluted earnings per share using the treasury-stock method. Out-of-the-money stock options (i.e., the average stock price during the period is below the strike price of the option) are not included in diluted earnings per share.

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     As required under Statement of Financial Accounting Standards No. 123 (FAS 123), “Accounting for Stock-Based Compensation,” and Statement of Financial Accounting Standards No. 148 (FAS 148), “Accounting for Stock-Based Compensation Transition and Disclosure,” the pro forma effects of stock-based compensation on net income and net earnings per common share have been estimated at the date of grant using the Black-Scholes option-pricing model.

     The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no restrictions and are fully transferable and negotiable in a free trading market. Black-Scholes does not consider the employment, transfer or vesting restrictions that are inherent in the Company’s employee options. Use of an option valuation model, as required by FAS 123, includes highly subjective assumptions based on long-term predictions, including the expected stock price volatility and average life of each option grant. Because the Company’s employee options have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect the Company’s estimate of the fair value of those options, in the Company’s opinion, the existing valuation models, including Black-Scholes, are not reliable single measures and may misstate the fair value of the Company’s employee options.

     The Company calculated the fair value of each option grant on the date of grant using the Black-Scholes option pricing model as prescribed by SFAS No. 123 using the following assumptions:

	Three Months Ended
	March 31,
	2003			2002
Risk free interest rate		3.0	%		3.0	%
Expected life (in years)		5.0			5.0
Dividend yield		0.0	%		0.0	%
Volatility		110.2	%		101.0	%

     The weighted average grant-date fair value of options granted during the three months ended March 31, 2003 and 2002 were $1.07 and $9.11 respectively.

     Had compensation cost for the Company’s options been determined based on the fair value at the grant dates, as prescribed in SFAS 123 and SFAS 148, the Company’s pro forma net income and net income per share would have been as summarized below (in thousands except per share data):

			Three Months Ended
			March 31,
			2003			2002
Net loss:
	As reported		$	(4,317	)	$	(3,558	)
	Pro forma option expense			(1,904	)		(2,337	)
	Pro forma net loss		$	(6,221	)	$	(5,895	)
Net loss per share:
	As reported:
		Basic	$	(0.19	)	$	(0.16	)
		Diluted		(0.19	)		(0.16	)
Pro forma net loss:
		Basic	$	(0.27	)	$	(0.26	)
		Diluted		(0.27	)		(0.26	)

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Note 3. Investments

     The Company classifies its investment securities as available-for-sale securities as prescribed by Statement of Financial Accounting Standards No. 115 or “SFAS 115,” “Accounting for Certain Investments in Debt and Equity Securities.” All investments are carried at fair market value, which is determined based on quoted market prices, with net unrealized gains and losses included in comprehensive income, net of tax. The components of investments at March 31, 2003 are summarized below (in thousands):

			Aggregate		Unrealized
Available for sale	Cost		Fair value		Gain/(loss)
Money market	$	3,683	$	3,683		—
Corporate bonds		13,634		13,718		84
Government agency bonds		6,346		6,392		46
Corporate equity securities		1,115		916		(199	)
	$	24,778	$	24,709	$	(69	)
Recorded as:
Cash equivalents	$	3,683
Short-term investments		9,107
Restricted deposits		9,722
Long-term investments		2,197
	$	24,709

Note 4. Asset Held for Sale

During the fourth quarter of 2002, the Company began to market its property located at 4281 Technology Drive, Fremont, California, and in November of 2002, entered into a contract to sell the property to a third party. On March 11, 2003, the Company completed the sale of its property located at 4281 Technology Drive, Fremont, California, for $6.3 million. Net cash proceeds from the sale were $5.2 million. Under the terms of the sale agreement, the Company has agreed to lease back the property for a five-year period. Accordingly, on March 11, 2003, the company signed an operating lease for 4281 Technology Drive through March 2008. Annual rent under this operating lease is approximately $600,000.

Note 5. Inventories

     The components of inventory are summarized below (in thousands):

			March 31,			December 31,
			2003			2002
Inventories:
	Raw materials		$	16,043		$	17,566
	Work in process			25,831			30,042
	Finished goods			14,736			15,108
		Valuation allowances		(22,123	)		(25,118	)
			$	34,487		$	37,598

Note 6. Net Loss Per Share

     Basic earnings per common share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common and common equivalent shares include the dilutive effect of common stock equivalents outstanding during

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the period calculated using the treasury stock method. Common stock equivalents consist of the shares issuable upon the exercise of stock options.

     A reconciliation of the numerators and denominators of the basic and diluted earnings per share calculations is summarized below (in thousands except per share data):

			Three Months Ended
			March 31,
			2003			2002
Numerator:
	Net loss		$	(4,317	)	$	(3,558	)
	Less: Preferred stock dividends			(44	)		(44	)
	Net loss available to common stockholders		$	(4,361	)	$	(3,602	)
Denominator:
	Denominator for basic earnings per share - weighted average common shares			22,628			22,414
	Effect of dilutive securities:
		Common stock options		—			—
Denominator for dilutive earnings per share				22,628			22,414
Basic loss per share			$	(0.19	)	$	(0.16	)
Diluted loss per share			$	(0.19	)	$	(0.16	)
Options excluded from diluted net income per share as the impact is antidilutive				3,376			2,981

Note 7. Comprehensive Loss

     The components of comprehensive loss are summarized below (in thousands):

	Three Months Ended
	March 31,
	2003			2002
Net loss	$	(4,317	)	$	(3,558	)
Foreign currency translation gain (loss)		(46	)		103
Unrealized gain (loss) on available for sale investments		(244	)		(1,877	)
Comprehensive loss	$	(4,607	)	$	(5,332	)

Note 8. Segment Information

     The Company has two reportable segments: substrates and opto-electronics.

     Selected industry segment information is summarized below (in thousands):

		Three Months Ended
		March 31,
		2003			2002
Substrates Division
	Net revenues from external customers	$	8,535		$	11,739
	Gross profit		273			206
	Operating loss		(2,606	)		(4,709	)
	Identifiable assets		115,758			183,617
Opto-electronics Division
	Net revenues from external customers	$	4,122		$	5,038
	Gross profit (loss)		(554	)		87
	Operating loss		(1,705	)		(1,553	)
	Identifiable assets		23,350			44,382
Total
	Net revenues from external customers	$	12,657		$	16,777
	Gross profit (loss)		(281	)		293
	Operating loss		(4,311	)		(6,262	)
	Identifiable assets		139,108			227,999

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     The Company sells its substrates and opto-electronics products in the United States and in other parts of the world. Also, the Company has operations in Japan and China. Revenues by geographic location based on the country of the customer were as follows (in thousands):

		Three Months Ended
		March 31,
		2003		2002
Net revenues:
	United States	$	4,420	$	7,332
	Europe		1,309		1,081
	Canada		61		690
	Japan		529		451
	Malaysia		223		2,545
	Taiwan		3,872		1,496
	Asia Pacific and other		2,243		3,182
	Consolidated	$	12,657	$	16,777

Note 9. Corporate Affiliates

     The Company’s investments in its corporate affiliates are summarized below (in thousands):

	Investment		Investment
	Balance		Balance
	March 31,		December 31,		Accounting	Ownership
Affiliate	2003		2002		Method	Percentage
Xilingol Tongli Ge Co. Ltd.	$	764	$	773	Equity		25	%
Emeishan Jia Mei High Pure Metals Co., Ltd.		612		614	Equity		25	%
Beijing Ji Ya Semiconductor Material Co., Ltd.		1,071		1,071	Consolidated		51	%
Nanjing Jin Mei Gallium Co., Ltd.		616		616	Consolidated		88	%
Beijing BoYu Manufacturing Co., Ltd.		409		409	Consolidated		70	%

     The investment balances for those affiliates accounted for under the equity method are included within “Other assets” in the consolidated balance sheets.

     Undistributed retained earnings relating to the Company’s corporate affiliates was $835,000 at March 31, 2003 and $515,000 at March 31, 2002. Net loss recorded from the Company’s corporate affiliates was $26,000 for the three months ended March 31, 2003 and $164,000 for the three months ended March 31, 2002.

     The Company invested in these companies because each provides materials that are important to the Company’s substrate business, each can provide products at lower cost than other suppliers, and each has a market beyond that provided by the Company. At March 31, 2003, the Company had no obligations to make further investments in any of these companies, although it may choose to do so under certain conditions.

Note 10. Commitments and Contingencies

     From time to time we are involved in judicial or administrative proceedings concerning matters arising in the ordinary course of our business, including matters relating to workers’ compensation claims, claims of unlawful termination or other employee-related claims. We do not expect that any of these matters, individually or in the aggregate, will have a material adverse effect on our business, financial condition, cash flows or results of operation.

     On May 1, 2001, the Santa Clara Center for Occupational Safety and Health filed a complaint for injunctive relief and civil penalties against the Company in the Superior Court of California, County of Alameda, Hayward Division, Case No. H218237-5. The complaint alleged violations of California Business and Professions Code

10

section 17200 et seq., and violations under Proposition 65 and California Health and Safety Code section 25249 et seq. as a result of AXT’s use of arsenic and inorganic arsenic compounds in its workplace. On June 24, 2002, the Company participated in a private mediation, and as a result, reached a settlement of all claims, pursuant to which the Company agreed to pay the Santa Clara Center for Occupational Safety and Health an amount equal to $175,000. The parties have executed a settlement agreement, and the court approved the settlement on December 31, 2002, and dismissal of the case is pending.

     The Company has entered into contracts to supply several large customers with GaAs wafers. The contracts guarantee the delivery of a certain number of wafers between January 1, 2001 and December 31, 2003 with a current contract value of $3.2 million. The contract sales prices are subject to review quarterly and can be adjusted in the event that raw material prices change. In the event of non-delivery of the determined wafer quantities in any monthly delivery period, the Company could be subject to non-performance penalties of between 5% and 10% of the value of the delinquent monthly deliveries. The Company has not received any claims for non-performance penalties due to non-delivery. Partial prepayments received for these supply contracts totaling $1.5 million are included in accrued liabilities at March 31, 2003. As of March 31, 2003, the Company has met all of its delivery obligations under these contracts and expects to do so for the remainder of the contract terms.

Note 11. Recent Accounting Pronouncements

     In November 2002, the FASB issued FASB Interpretation No. 45 ( FIN 45 ), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN No. 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements of FIN No. 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. Our adoption of FIN No. 45 did not have a material effect on our consolidated financial statements.

     In January 2003, the FASB issued FASB Interpretation No. 46 ( FIN 46 ), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The adoption of FIN 46 did not have a material impact on the Company’s consolidated statements of income or financial position

Note 12. Foreign Exchange Contracts and Transaction Gains/Losses

     The Company uses short-term forward exchange contracts for hedging purposes to reduce the effects of adverse foreign exchange rate movements. The Company has purchased foreign exchange contracts to hedge against certain trade accounts receivable denominated in Japanese yen. The change in the fair value of the forward contracts is recognized as part of the related foreign currency transactions as they occur. As of March 31, 2003, the Company’s outstanding commitments with respect to the foreign exchange contracts, which were commitments to sell Japanese yen, had a total contract value of approximately $1.9 million.

     The Company incurred a foreign currency transaction exchange gain of $63,000 for the three months ended March 31, 2003, and a loss of $40,000 for the three months ended March 31, 2002.

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Note 13. Related Party Transactions

     Since January 2002, there has not been, nor is there currently proposed, any transaction or series of similar transactions to which we were or are to be a party in which the amount involved exceeds $60,000, and in which any director, executive officer or holder of more than 5% of any class of our voting securities or members of that person’s immediate family had or will have a direct or indirect material interest other than the transactions described below.

     The Company entered into an operating lease for warehouse space in Fremont, CA with 4160 Business Center, LLC, a real estate holding company, in which Davis Zhang, the president of our substrate division, is the sole shareholder. Lease payments to 4160 Business Center, LLC were approximately $121,000 for the three months ended March 31, 2003. In April of 2003, Mr. Zhang sold this warehouse to a party unrelated to the Company. The Company began leasing this warehouse from the new owner on the date of sale. Mr. Zhang will continue to hold a $3.7 million note on the property through April 2005.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements made pursuant to the provisions of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based upon management’s current views with respect to future events and financial performance, and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated. Such risks and uncertainties include those set forth under “Risks Related to our Business” below. Forward-looking statements may be identified by the use of terms such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” and similar expressions. Statements concerning our financial position, business strategy and plans or objectives for future operations are forward-looking statements. These forward-looking statements are not guarantees of future performance. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. This discussion should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 and the condensed consolidated financial statements included elsewhere in this report.

Overview

     We were founded in 1986 to commercialize and enhance our proprietary vertical gradient freeze (VGF) technique for producing high-performance compound semiconductor substrates. We currently operate two divisions: our substrate division and our opto-electronics division. We made our first substrate sales in 1990 and our substrate division currently sells gallium arsenide (GaAs) and indium phosphide (InP) substrates to manufacturers of semiconductor devices for use in applications such as fiber optic and wireless telecommunications, light emitting diodes (LEDs) and lasers. We also sell germanium substrates for use in satellite solar cells. We acquired Lyte Optronics, Inc., on May 28, 1999, and currently operate part of Lyte’s historical business as our opto-electronics division. The opto-electronics division manufactures high-brightness LED’s (HBLEDs) for the illumination markets, including full-color displays, automobile lighting and traffic signals, and also manufactures vertical cavity surface emitting lasers (VCSELs) and laser diodes for fiber optic communications and storage area networks.

Critical Accounting Policies and Estimates

     We have prepared our consolidated financial statements in accordance with accounting principals generally accepted in the United States of America. As such, we have had to make estimates, assumptions and judgments that affect the amounts reported on our financial statements. These estimates, assumptions and judgments about future events and their effects on our results cannot be determined with certainty, and are made based upon our historical experience and on other assumptions that are believed to be reasonable under the circumstances. These estimates may change as new events occur or additional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are not within our control and may not be known for a prolonged period of time. The discussion and analysis of our results of operations and financial condition are based upon these statements. We have identified the policies below as critical to our business operations and understanding of our

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financial condition and results of operations. A critical accounting policy is one that is both material to the presentation of our financial statements and requires us to make difficult, subjective or complex judgments that could have a material effect on our financial condition and results of operations. They may require us to make assumptions about matters that are highly uncertain at the time of the estimate, and different estimates that we could have used, or changes in the estimate that are reasonably likely to occur, may have a material impact on our financial condition or results of operations.

     We believe that the following are our critical accounting policies:

Revenue Recognition

     We recognize revenue upon shipment of products to our customers provided that we have received a signed purchase order, the price is fixed or determinable, title has transferred, collection of resulting receivables is probable, product returns are reasonably estimable, there are no customer acceptance requirements and there are no remaining obligations. We assess the probability of collection based on a number of factors including past history with the customer and credit worthiness. We provide for future returns based on historical experience, current economic trends and changes in customer demand at the time revenue is recognized. Except for sales in Japan and some sales in Taiwan, which in both cases are denominated in Japanese yen, we denominate and collect our international sales in U.S. dollars. We do not provide for warranty related exposure as such exposure has historically been immaterial.

Allowance for Doubtful Accounts

     We periodically review the likelihood of collecting our accounts receivable balances and provide an allowance for doubtful accounts receivable primarily based upon the age of these accounts. We provide a 100% allowance for U.S. receivables in excess of 90 days and for foreign receivables in excess of 120 days. At March 31, 2003, our accounts receivable balance was $7.9 million net of an allowance for doubtful accounts of $6.3 million.

Inventory

     Inventories are stated at the lower of cost or net realizable value. Cost is determined using the weighted average cost method. Finished goods and work-in-process inventories include material, labor and manufacturing overhead costs. We routinely evaluate the levels of our inventory in light of current market conditions in order to identify excess and obsolete inventory and we provide a valuation allowance for certain inventories based upon the age and quality of the product. The lives of our substrate products are relatively long and accordingly, obsolescence has historically not been a significant factor. We also review our inventory to ensure costs can be realized upon ultimate sale to our customers. If we determine that the value of any items in ending inventory exceeds the sales value less any related selling costs, a reserve is established for the difference.

Impairment of Long-Lived Assets

     We review the carrying value of our long-lived assets and investments in order to identify any impairment. Long-lived assets are written down to their current fair market value when the carrying value of an asset exceeds their related undiscounted future cash flows. To determine the fair market value of our long-lived assets, we obtain appraisals from outside consultants.

Investments

     The Company classifies its investments in marketable securities as available-for-sale securities as prescribed in Financial Accounting Standard No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” All investments are carried at fair market value, which is determined based on quoted market prices, with net unrealized gains and losses included in comprehensive income, net of tax. If a decline in fair value is judged to be other than temporary, the cost basis of the individual security is written down to fair value as a new cost basis with the amount of the write down included in other (income) expense.

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Income Taxes

     The Company accounts for deferred income taxes using the liability method, under which the expected future tax consequences of timing differences between the book and tax basis of assets and liabilities are recognized as deferred tax assets and liabilities. Valuation allowances are established when necessary to reduce net deferred tax assets when management estimates, based on available objective evidence, that it is more likely than not that the future income tax benefit represented by the net deferred tax asset will not be realized. At March 31, 2003, a full valuation allowance has been recorded against our net deferred tax asset.

Results of Operations

     The following table sets forth certain information relating to the operations of the Company expressed as a percentage of total revenues for the periods indicated:

			Three Months Ended
			March 31,
			2003			2002
Revenues				100.0	%		100.0	%
Cost of revenues				102.2			98.3
Gross profit (loss)				(2.2	)		1.7
Operating expenses:
	Selling, general and administrative			26.0			31.0
	Research and development			5.9			8.1
		Total operating expenses		31.9			39.1
Loss from operations				(34.1	)		(37.4	)
Interest expense				1.9			2.3
Other (income)/expense, net				(1.8	)		(4.3	)
Loss before income tax benefit				(34.2	)		(35.4	)
Income tax benefit				—			(14.1	)
Net loss				(34.2	)%		(21.3	)%

Three months ended March 31, 2003 compared to three months ended March 31, 2002

     Revenue. Revenue decreased $4.1 million, or 24.6%, to $12.7 million for the three months ended March 31, 2003 compared to $16.8 million for the three months ended March 31, 2002.

     Revenue from our substrate division, which represents 67.4% of total revenue for the three months ended March 31, 2003, decreased $3.3 million, or 27.3%, to $8.5 million compared to $11.8 million for the three months ended March 31, 2002. Total GaAs substrate revenue decreased $630,000, or 8.3%, to $7.0 million for the three months ended March 31, 2003 compared to $7.6 million for the three months ended March 31, 2002. Sales of 5” and 6” GaAs subtrates was unchanged at $1.3 million for the three months ended March 31, 2003 compared to $1.3 million for the three months ended March 31, 2002. InP substrate revenue decreased $2.4 million, or 81.3%, to $564,000 for the three months ended March 31, 2003 compared to $3.0 million for the three months ended March 31, 2002. The decrease in GaAs and InP substrate revenue is due to decreased volume and sales prices as a result of the slowdown in our markets including telecommunications, high speed electronic devices, and short wavelength lasers.

     Revenue from our opto-electronics division, which represents 32.6% of total revenue for the three months ended March 31, 2003, decreased $900,000, or 18.2% to $4.1 million compared to $5.0 million for the three months

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ended March 31, 2002. High-brightness light emitting diode (HBLED) revenue decreased $1.0 million, or 23.3%, to $3.4 million for the three months ended March 31, 2003 compared to $4.4 million for the three months ended March 31, 2002. The decrease in HBLED revenue was primarily due to lower sales volume as a result of losing a large customer in mid-2002 and a decline in average sales prices during the quarter. Vertical cavity surface emitting laser (VCSEL) revenue was unchanged at $160,000 for the three months ended March 31, 2003 and 2002. Laser diode (LD) revenue increased $119,000, or 25.9%, to $578,000 for the three months ended March 31, 2003 compared to $459,000 for the three months ended March 31, 2002.

     International revenue increased to 65.1% of total revenue for the three months ended March 31, 2003 compared to 56.3% of total revenue for the three months ended March 31, 2002. The increase was primarily due to increased sales of HBLED products to customers in Asia.

     The majority of our substrate manufacturing activities are conducted in China, along with a portion of our opto-electronics manufacturing. In addition, we source key raw materials, including gallium, from our joint ventures in China. The SARS outbreak has been most notable in China. One employee at our LED production facility in China contracted SARS in late April prompting us to close the facility for ten days. There was no significant impact to our ability to fill customer orders. If other employees contract SARS, we may be required to temporarily close our manufacturing operations. Similarly, if one of our key suppliers is required to close for an extended period, we may not have enough raw material inventory to continue manufacturing operations. In addition, while we possess management skills among our China staff that enable us to maintain our manufacturing operations with minimal on-site supervision from our US-based staff, our business could also be harmed if travel to or from Asia and the United States is restricted or inadvisable. None of our substrate competitors is and few of our opto-electronics competitors are as dependent on manufacturing facilities in China as we are. If our manufacturing operations were closed for a significant period, we could lose revenue and market share during that period which would depress our financial performance and could be difficult to recapture. Finally, if one of our key customers is required to close for an extended period, we may not be able to ship product to them, our revenue would decline and our financial performance would suffer.

     Gross margin. Gross margin decreased to negative 2.2% of total revenue for the three months ended March 31, 2003 compared to 1.7% of total revenue for the three months ended March 31, 2002. Gross margin at the substrate division increased to 3.2% of substrate revenue for the three months ended March 31, 2003 compared to 1.8% of substrate revenue for the three months ended March 31, 2002. The increase was primarily due to costs reductions implemented to align our costs with lower expected sales volumes and prices. We continue shifting much of our substrate manufacturing to China, where costs are lower, and reducing capacity at our Fremont, California facility. Gross margin at the opto-electronics division decreased to negative 13.4% of opto-electronics revenue for the three months ended March 31, 2003 compared to 1.7% of opto-electronics revenue for the three months ended March 31, 2002. The decrease was primarily due to the decline in revenue and to a decrease in average selling price.

     Selling, general and administrative expenses. Selling, general and administrative expenses decreased $1.9 million, or 36.8%, to $3.3 million for the three months ended March 31, 2003 compared to $5.2 million for the three months ended March 31, 2002. As a percentage of total revenue, selling, general and administrative expenses were 26.0% for the three months ended March 31, 2003 compared to 31.0% for the three months ended March 31, 2002. In order to align our cost structure with the rapid decline in revenues, we have initiated and are aggressively pursuing cost reductions in this area, which led to the decrease.

     Research and development expenses. Research and development expenses decreased $600,000, or 45.0%, to $744,000 for the three months ended March 31, 2003 compared to $1.4 million for the three months ended March 31, 2002. As a percentage of total revenue, research and development expenses were 5.9% for the three months ended March 31, 2003 compared to 8.1% for the three months ended March 31, 2002. Although we reduced research and development expenses as part of our effort to reduce costs, we believe that continued investment in product development is critical to attaining our strategic objectives of maintaining and increasing our technology leadership, and as a result, we expect research and development expenses to remain at current levels in future periods. Research and development efforts during the first quarter of 2003 were focused primarily on improving the yield and surface quality of our GaAs substrates, and improving the brightness, reliability, and yield of our HBLED products.

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     Interest expense. Interest expense decreased $148,000, or 38.4%, to $237,000 for the three months ended March 31, 2003 compared to $385,000 for the three months ended March 31, 2002 due to the repayment of debt and a reduction of rates on our variable interest rate debt.

     Other income and expense, net. Other income decreased $486,000 to $231,000 for the three months ended March 31, 2003 compared to $717,000 for the three months ended March 31, 2002.

     Provision for income taxes. Due to our continuing operating losses and uncertainty regarding future profitability, we recorded a full valuation allowance against our net deferred tax assets of $31.2 million in 2002. As a result, our effective tax rate decreased to 0.0% for the three months ended March 31, 2003 compared to 40% for the three months ended March 31, 2002.

Liquidity and Capital Resources

     Cash and cash equivalents increased $4.5 million to $18.3 million at March 31, 2003 compared to $13.8 million at December 31, 2002.

     Net cash provided by operating activities of $737,000 for the three months ended March 31, 2003 was comprised primarily of our net loss adjusted for non-cash items of $1.8 million, consisting primarily of depreciation expense of $1.7 million, and by a $3.3 million net change in assets and liabilities. The net change in assets and liabilities resulted primarily from decreases in inventory and prepaid expenses.

     Accounts receivable increased $752,000, or 10.0%, to $8.0 million at March 31, 2003 compared to $7.2 million at December 31, 2002. The change reflects higher sales volume, collections of $12.7 million and a decrease in our allowance for doubtful accounts of $412,000. Inventories decreased $3.1 million, or 8.3% to $34.5 million at March 31, 2003 compared to $37.6 million at December 31, 2002. The decrease in inventory is a result of our continued effort to minimize cash outflows utilizing more effective inventory management policies. We expect this trend to continue throughout 2003.

     If our sales continue to decrease, our ability to generate cash from operations will be adversely affected which could adversely affect our future liquidity and cause us to seek additional capital, if available on acceptable terms or at all.

     Net cash from investing activities of $4.9 million for the three months ended March 31, 2003 includes net proceeds from the sale of property and equipment of $5.2 million and purchases of equipment of $917,000. It also includes $37,000 in purchases of high grade investment securities with maturities of less than two years offset by $700,000 in sales of these securities.

     We do not have any plans to initiate any major new capital spending projects during 2003. We are currently completing certain projects at our China facilities and are continuously constructing minor improvements to our existing production facilities in China and California. We expect to invest an additional $5.1 million in capital projects throughout the remainder of 2003. We believe that our existing and planned facilities and equipment are sufficient to fulfill current and expected future orders.

     In February 2003, our Board of Directors authorized the repurchase of up to 2 million shares of our common stock over a one year period. To date we have not repurchased any shares. When repurchased, repurchased shares will be retired. We expect to sell shares of common stock of Finisar Corporation in connection with our stock repurchase program.

     Net cash used in financing activities of $1.1 million for the three months ended March 31, 2003 includes proceeds of $185,000 from the sale of common stock through our employee stock compensation programs, offset by payments of $248,000 on long-term debt and $1.0 million for capital lease payments.

     We generally finance equipment purchases through secured equipment loans and capital leases over four or five-year terms at interest rates ranging from 3.6% to 8.8% per annum. Our main Fremont, California manufacturing

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facility is financed by long-term borrowings, which were refinanced by taxable variable rate revenue bonds in 1998. These bonds mature in 2023 and bear interest at a variable rate that was 1.6% at March 31, 2003. The bonds are traded in the public market. Repayment of principal and interest under the bonds is supported by a letter of credit from our bank and is paid on a quarterly basis. We have the option to redeem the bonds in whole or in part during their term. At March 31, 2003, $8.9 million was outstanding under these bonds.

     At March 31, 2002 the credit facility maintained by the Company with a bank included a letter of credit supporting repayment of our industrial bonds with an outstanding amount of $8.9 million and foreign exchange obligations in the amount of $570,000. The Company has pledged and placed certain investment securities with the trust department of the bank as additional collateral for this facility. As a result, $10.7 million of our long-term investments are restricted. As of March 31, 2003, we were out of compliance with our tangible net worth covenant. We obtained a waiver from our bank for this covenant default through April 30, 2003. On April 7, 2003, we obtained a credit facility with another bank which includes a letter of credit supporting our industrial revenue bonds. The Company has pledged and placed certain investment securities with the trust department of the bank as additional collateral for this facility.

     As a result of the significant revenue declines that we have experienced over the past six quarters, we have taken cost reduction measures and continue to pursue additional measures to reduce our costs and increase our cash flows. At March 31, 2003, we had available cash, cash equivalents and liquid short and long-term investments of $29.7 million. We believe that our existing cash and liquid investments, cash generated from operations, coupled with additional efforts to reduce our expenditures in support of our substrate and opto-electronic businesses, will be sufficient to meet our working capital expenditure requirements for the next 12 months. However, our existing cash and liquid investments could continue to decline during 2003 due to a continued or further weakening of the economy or changes in our planned cash outlay.

     If our sales continue to decrease, our ability to generate cash from operations will be adversely affected which could adversely affect our future liquidity, require us to use cash at a more rapid rate than expected, and require us to seek additional capital. There can be no assurance that such additional capital will be available or, if available it will be at terms acceptable to the Company. Cash from operations could be affected by various risks and uncertainties, including, but not limited to those set forth below under “Risks Related to Our Business.”

Risks Related to Our Business

The recent outbreak of Severe Acute Respiratory Syndrome (SARS) may adversely impact our manufacturing operations and some of our key suppliers and customers

     The majority of our substrate manufacturing activities are conducted in China, along with a portion of our opto-electronics manufacturing. In addition, we source key raw materials, including gallium, from our joint ventures in China. The SARS outbreak has been most notable in China. One employee at our LED production facility in China contracted SARS in late April prompting us to close the facility for ten days. There was no significant impact to our ability to fill customer orders. If other employees contract SARS, we may be required to temporarily close our manufacturing operations. Similarly, if one of our key suppliers is required to close for an extended period, we may not have enough raw material inventory to continue manufacturing operations. In addition, while we possess management skills among our China staff that enable us to maintain our manufacturing operations with minimal on-site supervision from our US-based staff, our business could also be harmed if travel to or from Asia and the United States is restricted or inadvisable. None of our substrate competitors is and few of our opto-electronics competitors are as dependent on manufacturing facilities in China as we are. If our manufacturing operations were closed for a significant period, we could lose revenue and market share during that period which would depress our financial performance and could be difficult to recapture. Finally, if one of our key customers is required to close for an extended period, we may not be able to ship product to them, our revenue would decline and our financial performance would suffer.

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Our Inability to Maintain Our Listing on the NASDAQ National Market Will Reduce the Market and Liquidity of our Shares and Damage Our General Reputation

     In connection with our listing on the Nasdaq National Market we must maintain compliance with several requirements related to the trading price of our stock, our financial condition and our board of directors, among other factors. Our stock was trading beneath the $1.00 minimum bid price on the Nasdaq National Market since February 24, 2003 and on April 7, 2003 we received notice from the Nasdaq National Market that we will be delisted if we are unable to meet the continued listing requirements during the 180 days ended October 6, 2003. If we are unable to comply with the continued listing requirements, we would be delisted from the Nasdaq National Market, and, if we qualified, would move to the SmallCap listing of Nasdaq. This could reduce the market and liquidity of our shares and consequently the ability of our stockholders to purchase and sell our shares in an orderly manner. Furthermore, our delisting from the Nasdaq National Market could damage our general business reputation and harm our financial condition and operating results. The trading price of our stock has been over $1.00 since April 25, 2003.

The semiconductor industry is cyclical and is currently experiencing a severe and prolonged downturn which has adversely impacted our operating results.

     Our business depends in significant part upon manufacturers of electronic and opto-electronic semiconductor devices, as well as the current and anticipated market demand for such devices and products using such devices. The semiconductor industry is highly cyclical. The industry has in the past, and will likely in the future, experience periods of oversupply that result in significantly reduced demand for semiconductor devices and components, including our products, both as a result of general economic changes and overcapacity. When these periods occur, our operating results and financial condition are adversely affected, and create pressure on our revenue, gross margins and net income. Inventory buildups in telecommunications products and slower than expected sales of computer equipment resulted in overcapacity and led to reduced sales by our customers, and therefore reduced purchases of our products. During periods of declining demand such as those experienced over the past year, customers typically reduce purchases, delay delivery of products and/or cancel orders of component parts such as our products. Increased price competition may result, causing pressure on our net sales, gross margin and net income. We have over the past year experienced cancellations, delays and push outs of orders, which have resulted in reduced revenues. If the economic downturn continues, further order cancellations, reductions in order size or delays in orders will materially adversely affect our business and results of operations. Although we have taken actions to reduce our costs, if our actions are insufficient to align our structure with prevailing business conditions, we may be required to undertake additional cost-cutting measures, and may be unable to invest in marketing, research and development and engineering at the levels we believe are necessary to maintain our competitive position. Our failure to make these investments could seriously harm our business. In addition, we may continue to experience a decline in our cash and cash equivalents and therefore we may be required to seek additional sources of cash, which may not be available on acceptable terms or at all.

The impact of changes in global economic conditions on our customers may cause us to fail to meet expectations, which would negatively impact the price of our stock.

     Our operating results can vary significantly based upon the impact of changes in global economic conditions on our customers. More specifically, the macro-economic environment that we faced in the second half of 2001 and continued to face in 2002 is more uncertain than in prior periods, has lasted longer than expected and has materially and adversely affected us and our operating results and may continue to do so. The revenue growth and profitability of our business depends on the overall demand for our substrates, LED’s and laser diodes, and we are particularly dependant on the market conditions for the wireless, fiber optics and telecommunications industries. Because our sales are primarily to major corporate customers whose businesses fluctuate with general economic and business conditions, a softening of demand for products that use our substrates, LEDs and laser diodes caused by a weakening economy may result in further or prolonged decreased revenues. Customers may find themselves facing excess inventory from earlier purchases, and may defer or reconsider purchasing products due to the downturn in their business and in the general economy.

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Unpredictable fluctuations in our operating results could disappoint analysts or our investors, which could cause our stock price to decline.

     We have not over the past year been able to sustain growth, and may not be able to return to historic growth levels in the current economic environment. Our net loss in 2002 is the largest in our history. We have and may continue to experience significant fluctuations in our revenue and earnings. Our quarterly and annual revenue and operating results have varied significantly in the past and may vary significantly in the future due to a number of factors, including:

• decline in general economic conditions or downturns in the industry in which we compete;

• fluctuations in demand for our products;

• expansion of our manufacturing capacity;

• expansion of our operations in China;

• limited availability and increased cost of raw materials;

• the volume and timing of orders from our customers, and cancellations, push outs and delays of customer orders;

• fluctuation of our manufacturing yields;

• decreases in the prices of our competitors’ products;

• costs incurred in connection with any future acquisitions of businesses or technologies;

• increases in our expenses, including expenses for research and development; and

• our ability to develop, manufacture and deliver high quality products in a timely and cost-effective manner.

     Due to these factors, we believe that period-to-period comparisons of our operating results may not be a meaningful indicator of our future performance. Our operating results have over the past year at times been below the expectations of securities analysts or investors. If this occurs again in future periods, the price of our common stock would likely decline or fluctuate.

     A substantial percentage of our operating expenses are fixed in the short term and we may be unable to adjust spending to compensate for an unexpected shortfall in revenues. As a result, any delay in generating revenue could cause our operating results to be below the expectations of market analysts or investors, which could also cause our stock price to fall.

     The lead-time for customer orders is generally shorter than it was eighteen months ago. As a result, our visibility regarding future financial performance is uncertain and we have and may continue to provide investors with financial guidance that we cannot meet. As a result, our operating results could be below the expectations of market analysts or investors, which could also cause our stock price to fall.

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If the economy recovers and we are again in a period of high demand for our products, we may be unable to expand our manufacturing capacity quickly enough to meet increased demand, and we may be unable to lower our costs or increase revenue.

     Although we are currently in a period of overcapacity, reduced sales, and decreased margins, if the economy recovers, demand may increase rapidly as it has in prior years after other cyclical downturns in the economy and the industries in which we operate. If this happens, in order to meet increased demand and maintain our market share, we may need to increase production, which could require us to build new facilities, expand and modify our existing facilities, purchase additional manufacturing equipment, and add qualified staff. If we are not at that time able to expand our manufacturing capacity, we will be unable to increase production, which may adversely impact our ability to meet increased production demand while reducing unit costs, margins and improving our operating results.

     We are currently constructing and modifying facilities in California and China. Our construction activities subject us to a number of risks, including:

• unforeseen environmental or engineering problems;

• unavailability or late delivery of production equipment;

• delays in completing new facilities;

• delays in bringing production equipment on-line;

• work stoppages or delays;

• inability to recruit and train qualified staff;

• unanticipated cost increases and restrictions imposed by requirements of local, state or federal regulatory agencies in the United States and China.

     If any of these risks occurs, construction may be costlier than anticipated and completion could be delayed, which could hurt our ability to expand capacity and increase our sales. In addition, if we experience delays in expanding our manufacturing capacity, we might not be able to timely meet customer requirements, and we could lose future sales. We are also completing selective investments in equipment and facilities as part of our previously planned capacity expansion. To offset the additional fixed operating expenses, we must increase our revenue by increasing production and improving yields. If demand for our products does not grow or if our yields do not improve as anticipated, we may be unable to offset these costs against increased revenue, which would adversely impact our operating results.

Our results of operations may suffer if we do not effectively manage our inventory.

     We must manage our inventory of component parts and finished goods effectively to meet changing customer requirements, while keeping inventory costs down and improving gross margins. Some of our products and supplies have in the past and may in the future become obsolete while in inventory due to changing customer specifications, or become excess inventory due to decreased demand for our products and an inability to sell the inventory within a foreseeable period. Furthermore, if current costs of production increase or sales prices drop below the standard prices at which we value inventory, we may need to take a charge for a reduction in inventory values. We have in the past had to take inventory valuation and impairment charges. If we are not successfully able to manage our inventory, we may need to write off unsaleable, obsolete or excess inventory, which could adversely affect our results of operations.

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We may need additional capital to fund our future operations, expansion of capacity, or changes in manufacturing processes, which may not be available.

     We may need additional capital to fund expansion of our manufacturing and production capacity and our future operations or acquisitions. If we raise additional capital through the sale of equity or debt securities, the issuance of such securities could result in dilution to existing stockholders. These securities could have rights, preferences and privileges that are senior to those of holders of our common stock. For example, in December 1998 we issued debt securities for the purchase and improvement of our facilities in Fremont, California.

     If we require additional capital in the future, it might not be available on acceptable terms, or at all. If we are unable to obtain additional capital when needed, we may be required to reduce the scope of our product line, the planned expansion of our manufacturing capacity or of our product development and marketing efforts, which could adversely affect our business and operating results.

Our HBLED and VCSEL products are in their early stages, and we may not be able to achieve anticipated sales of these products.

     We have experienced declining revenue for both our HBLED and laser diode products as a result of a loss of revenue from our leading LED customer and a decline in the market for our laser diode products, as well as due to quality control problems experienced on these products. We may be unable to successfully market and increase sales of these products. To market and increase sales of our HBLED and VCSEL products, we will have to continue to develop additional distribution channels and achieve certain product and reliability specifications. We may be unable to obtain significant increases in revenue and may seek potential investors for our opto-electronics business. We must also continue our research and development efforts to apply our proprietary VGF technique to new substrate products and successfully introduce and market new opto-electronic semiconductor devices, including enhancements to our HBLED and VCSEL products.

If we do not successfully develop new products to respond to rapidly changing customer requirements, our ability to generate sales and obtain new customers may suffer.

     Our success depends on our ability to offer new products that incorporate leading technology and respond to technological advances. In addition, our new products must meet customer needs and compete effectively on quality, price and performance. The life cycles of our products are difficult to predict because the markets for our products are characterized by rapid technological change, changing customer needs and evolving industry standards. If our competitors introduce products employing new technologies, our existing products could become obsolete and unmarketable. If we fail to offer new products, we may not generate sufficient revenue to offset our development costs and other expenses or meet our customers’ requirements. Other companies, including IBM and Motorola, are actively developing substrate materials that could be used to manufacture devices that could provide the same high-performance, low-power capabilities as GaAs-based devices at competitive prices. In addition, some of our competitors have developed VGF technology similar to ours. If these substrate materials or VGF derived products are successfully developed and semiconductor device manufacturers adopt them, demand for our GaAs substrates could decline and our revenue could suffer. Similarly, other companies, including Kopin, are developing alternative production technologies for HBLEDs. If they are successful, demand for our HBLEDs could drop and our revenue could decline.

     The development of new products can be a highly complex process, and we may experience delays in developing and introducing new products. Any significant delays could cause us to fail to timely introduce and gain market acceptance of new products. Further, the costs involved in researching, developing and engineering new products could be greater than anticipated.

Our operating results depend in large part on further customer acceptance of our existing substrate products and on our ability to develop new products based on our core VGF technology.

     Some of our competitors have developed a crystal growth technique similar to our VGF technology. As a result, some customers are now allocating their requirements for VGF grown substrates across more competitors and

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we believe that we may have lost revenue and market share as a result of these customer decisions, which we may be unable to recover. If we are unable to retain our market share, our revenue and performance will decline.

     To shift more of our substrate manufacturing operations to China successfully, we will need our customers to qualify products manufactured in China. If we are unable to achieve qualifications for these products, our China facility will be underutilized, our investments in China will not be recouped and we will be unable to lower our costs by moving to China. We may lose sales of our products to competitors who are not manufacturing in China, or whose operations in China have already been qualified by customers. All of these events could reduce our revenue but increase our cost structure.

Intense competition in the markets for our products could prevent us from increasing revenue and sustaining profitability.

     The markets for our products are intensely competitive. We face competition for our substrate products from other manufacturers of substrates, such as Freiberger, Hitachi Cable, Japan Energy and Sumitomo Electric and from semiconductor device manufacturers that produce substrates for their own use, and from companies, such as IBM and Motorola, that are actively developing alternative materials to GaAs and some semiconductor devices are being marketed using these materials. We believe that at least two of our competitors are shipping GaAs substrates manufactured using a technique similar to our VGF technique. Other competitors may develop and begin using similar technology. If we are unable to compete effectively, our revenue may not increase and we may be unable to be profitable. We face many competitors that have a number of significant advantages over us, particularly in our compound semiconductor device products, including:

• greater experience in the business;

• more manufacturing experience;

• extensive intellectual property;

• broader name recognition; and

• significantly greater financial, technical and marketing resources.

     Our competitors could develop new or enhanced products that are more effective than the products that we have developed or may develop. For example, some competitors in the HBLED market offer devices that are brighter than our HBLEDs and have other desirable features. Some of our competitors may also develop technologies that enable the production of commercial products with characteristics similar to or better than ours, but at a lower cost.

     The level and intensity of competition has increased over the past year and we expect competition to continue to increase in the future. Competitive pressures caused by the current economic conditions have resulted in reductions in the prices of some of our products, and continued or increased competition could reduce our market share, require us to further reduce the prices of our products, affect our ability to recover costs or result in reduced gross margins.

If we have low product yields, the shipment of our products may be delayed and our operating results may be adversely impacted.

     Our products are manufactured using complex technologies, and the number of usable substrates and devices we can produce can fluctuate as a result of many factors, including:

• impurities in the materials used;

• contamination of the manufacturing environment;

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• substrate breakage;

• equipment failure, power outages or variations in the manufacturing process; and

• performance of personnel involved in the manufacturing process.

     Because many of our manufacturing costs are fixed, our revenue could decline if our yields decrease but our costs would change little, if at all. We have experienced product shipment delays and difficulties in achieving acceptable yields on both new and older products, and delays and poor yields have adversely affected our operating results, as have quality control problems experienced on both our substrate and LED products. We may experience similar problems in the future and we cannot predict when they may occur or their severity. In addition, many of our manufacturing processes are new and are still being refined, which can result in lower yields, particularly as we focus on producing higher diameter substrates and new opto-electronic semiconductor devices. For example, we recently made substantial investments in equipment and facilities to manufacture blue, green and cyan HBLEDs and VCSELs. If we are unable to produce adequate quantities of our high-brightness LEDs and VCSELs, we may not be able to meet customer demand and our revenue may decrease while our costs remain largely unchanged.

Demand for our products may decrease if our customers experience difficulty manufacturing, marketing or selling their products.

     Our products are used as components in our customers’ products. Accordingly, demand for our products is subject to factors affecting the ability of our customers to successfully introduce and market their products, including:

• the competition our customers face in their particular industries;

• the technical, manufacturing, sales and marketing and management capabilities of our customers;

• the financial and other resources of our customers; and

• the inability of our customers to sell their products if they infringe third party intellectual property rights.

If demand for the products offered by our customers decreases, our customers may reduce purchases of our products.

     As inventory of telecommunication products and computer equipment remained high during the past year, resulting in overcapacity in the market, our customers have reduced sales of their products, causing them to reduce purchases of our products for both production and research and development purposes. As a result, our revenues have declined and may fail to recover until the overcapacity has been depleted and demand for our customers’ products once again increases and their expenditures for research and development increase.

We purchase critical raw materials and parts for our equipment from single or limited sources, and could lose sales if these sources fail to fill our needs.

     We depend on a limited number of suppliers for certain raw materials, components and equipment used in manufacturing our products, including key materials such as gallium, arsenic, quartz, and parts for our MOCVD reactors. We generally purchase these materials through standard purchase orders and not pursuant to long-term supply contracts and none of our suppliers guarantees supply of raw materials or equipment to us. If we lose any of our key suppliers, our manufacturing efforts could be significantly hampered and we could be prevented from timely producing and delivering products to our customers. We have experienced delays obtaining critical raw materials and spare parts, including gallium, due to shortages of these materials. We may experience delays due to shortages of materials and may be unable to obtain an adequate supply of materials. These shortages and delays could result in

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higher materials costs and cause us to delay or reduce production of our products. If we have to delay or reduce production, we could fail to meet customer delivery schedules, and our revenue and operating results could suffer.

     We have periodically encountered a decline in quality of parts that are critical to the performance of our MOCVD reactors, which has led to lower yields of our HBLED products. If these quality problems continue, our ability to manufacture our HBLED products would be reduced, we could fail to meet customer delivery schedules, and our revenue and operating results could suffer.

If we fail to comply with environmental and safety regulations, we may be subject to significant fines or cessation of our operations.

     We are subject to federal, state and local environmental and safety laws and regulations in all of our operating locations. These laws, rules and regulations govern the use, storage, discharge and disposal of hazardous chemicals during manufacturing, research and development and sales demonstrations. If we fail to comply with applicable regulations, we could be subject to substantial liability for clean-up efforts, personal injury and fines or suspension or cessation of our operations. In March 2001, we settled a claim made by the California Occupational Safety and Health Administration, or Cal-OSHA, in an investigation primarily regarding impermissible levels of potentially hazardous materials in certain areas of our manufacturing facility in Fremont, California for $204,415. Although we have put in place engineering, administrative and personnel protective equipment programs to address these issues, our ability to expand or continue to operate our present locations could be restricted or we could be required to acquire costly remediation equipment or incur other significant expenses. In addition, existing or future changes in laws or regulations may require us to incur significant expenditures or liabilities, or may restrict our operations.

The loss of one or more of our key substrate customers would significantly hurt our operating results.

     A small number of substrate and HBLED customers have historically accounted for a substantial portion of our total revenue. Five customers accounted for 37.6% of our total revenue for the three months ended March 31, 2003 and 38.9% for the three months ended March 31, 2002. One customer accounted for 16.7% of our revenue for the three months ended March 31, 2003. Our substrate revenue accounted for 67.4% of our total revenue for the three months ended March 31, 2003 and 70% for the three months ended March 31, 2002. We expect that a significant portion of our future revenue will continue to be derived from a limited number of substrate and HBLED customers. Our customers are not obligated to purchase a specified quantity of our products or to provide us with binding forecasts of product purchases. In addition, our customers may reduce, delay or cancel orders at any time without any significant penalty, and during the past year, we have experienced slower bookings, significant push outs and cancellation of orders. In addition, due to the difficult economic environment, several of our previously large customers have stopped operations entirely. If we lose a major customer or if a customer cancels, reduces or delays orders, our revenue would decline. In addition, customers that have accounted for significant revenue in the past may not continue to generate revenue for us in any future period. Any delay in scheduled shipments of our products could cause net sales to fall below our expectations and the expectations of market analysts or investors, causing our stock price to decline.

Defects in our products could diminish demand for our products.

     Our products are complex and may contain defects. In the past we have experienced quality control problems with some of our products, which caused customers to return products to us or reduce orders for our products, such as our recent reduction in orders for our LED products by Agilent, and certain quality control problems experience in our substrate products. If we continue to experience quality control problems, or experience these problems in new products, customers may cancel or reduce orders or purchase products from our competitors. Defects in our products could cause us to incur higher manufacturing costs and suffer product returns and additional service expenses, all of which could adversely impact our operating results.

     We are also developing new products and product enhancements, including substrates and compound semiconductor device products. If our new products contain defects when released, our customers may be

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dissatisfied and we may suffer negative publicity or customer claims against us, lose sales or experience delays in market acceptance of our new products.

Our substrate and opto-electronic semiconductor device products have a long qualification cycle that makes it difficult to plan our expenses and forecast our results.

     Customers typically place orders with us for our substrate and opto-electronic semiconductor device products three months to a year or more after our initial contact with them. The sale of our products may be subject to delays due to our customers’ lengthy internal budgeting, approval and evaluation processes. During this time, we may incur substantial expenses and expend sales, marketing and management efforts while the customers evaluate our products. These expenditures may not result in sales of our products. If we do not achieve anticipated sales in a period as expected, we may experience an unplanned shortfall in our revenue. As a result, we may not be able to cover expenses, causing our operating results to vary. In addition, if a customer decides not to incorporate our products into its initial design, we may not have another opportunity to sell products to this customer for many months or even years. In this difficult economic climate, the average sales cycle for our products has lengthened even further and is expected to continue to make it difficult to accurately forecast our future sales. We anticipate that sales of any future substrate and opto-electronic semiconductor device products under development will also have lengthy sales cycles and will, therefore, be subject to risks substantially similar to those inherent in the lengthy sales cycle of our current substrate and opto-electronic semiconductor device products.

As our business matures, we may need to upgrade our systems.

     In the past, periods of rapid growth and expansion has strained our management and other resources. The expansion of our manufacturing capacity and the shift of manufacturing operations to China has placed and continues to place a significant strain on our operations and management resources, and we are in the process of upgrading our inventory control systems and may implement additional systems relating to consolidation of our financial results. If we fail to manage these changes effectively, our operations may be disrupted. In addition, the Sarbanes-Oxley Act of 2002 requires us to improve the quality of our systems and procedures.

     To manage our business effectively, we may need to implement additional and improved management information systems, further develop our operating, administrative, financial and accounting systems and controls, add experienced senior level managers, and maintain close coordination among our executive, engineering, accounting, marketing, sales and operations organizations.

     If necessary, we will spend substantial sums to support our future growth and shift to China and to comply with the reporting and attestation requirements of the Sarbanes-Oxley Act of 2002. We may incur additional unexpected costs. Our systems, procedures or controls may not be adequate to support our operations, and we may be unable to expand quickly enough to exploit potential market opportunities.

If we fail to manage periodic contractions, we may utilize our cash balances and our existing cash and cash equivalent balances could decline.

     If we fail to manage our contractions successfully we may continue to draw down our cash reserves, which would adversely affect our operating results and financial condition, reduce our value and may impinge our ability to raise debt and equity funding in the future, at a time when we may be required to raise additional cash. As part of our effort to reduce costs, we may lose key staff, production resources, and technology that we will need to grow when end markets recover. These events could reduce our ability to grow profitably as markets recover.

As a result of the difficult economic conditions, we have implemented restructuring and workforce reductions, which may adversely affect the morale and performance of our personnel and our ability to hire new personnel.

     In connection with our efforts to streamline operations, reduce costs and bring staffing and structure in line with current demand for our products, we implemented a corporate restructuring beginning in 2001 and reduced our workforce, shifted production activities to China and reduced capital expenditures. Our restructuring may yield unanticipated consequences, such as attrition beyond our planned reduction in workforce and loss of employee

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morale and decreased performance. In addition, the recent trading levels of our stock have decreased the value of our stock options granted to employees under our stock option plan. As a result of these factors, our remaining personnel may seek employment with larger, more established companies or companies that they perceive as having less volatile stock prices. Continuity of personnel can be very important factors in the sales and production of our products and completion of our research and development efforts.

Any future acquisitions may disrupt our business, dilute stockholder value or distract management attention.

     As part of our strategy, we may consider acquisitions of, or significant investments in, businesses that offer products, services and technologies complementary to ours, such as our acquisition of Lyte Optronics in May 1999. Acquisitions entail numerous risks, including:

• we may have difficulty assimilating the operations, products and personnel of the acquired businesses;

• our ongoing business may be disrupted;

• we may incur unanticipated costs;

• our management may be unable to manage the financial and strategic position of acquired or developed products, services and technologies;

• we may be unable to maintain uniform standards, controls and procedures and policies; and

• our relationships with employees and customers may be impaired as a result of any integration.

     For example, we incurred substantial costs in connection with our acquisition of Lyte Optronics, including the assumption of approximately $10.0 million of debt, much of which has been repaid or renegotiated, resulting in a decline of cash available. We have also incurred consistent operating losses for the business since the acquisition.

     To the extent that we issue shares of our stock or other rights to purchase stock in connection with any future acquisitions, dilution to our existing stockholders will result and our earnings per share may suffer. Any future acquisitions may not generate additional revenue or provide any benefit to our business.

If any of our facilities is damaged by actions such as fire, explosion, or natural disaster, we may not be able to manufacture our products.

     The ongoing operation of our manufacturing and production facilities in California and China is critical to our ability to meet demand for our products. If we are not able to use all or a significant portion of our facilities for prolonged periods for any reason, we will not be able to manufacture products for our customers. For example, a natural disaster, fire or explosion caused by our use of combustible chemicals and high temperatures during our manufacturing processes would render some or all of our facilities inoperable for an indefinite period of time. Actions outside of our control, such as earthquakes, could also damage our facilities, rendering them inoperable. Some of our crystal growth is currently performed at our Fremont, California facilities, which are located near an active seismic fault line. If we are unable to operate our facilities and manufacture our products, we will lose customers and revenue and our business will be harmed.

If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may not be able to successfully manage our business or achieve our objectives.

     Our success depends upon the continued service of Morris S. Young, Ph.D., our president, chairman of the board and chief executive officer, as well as other key management and technical personnel. We do not have long-term employment contracts with, or key person life insurance on, any of our key personnel.

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     We believe our future success will also depend in large part upon our ability to attract and retain highly skilled managerial, engineering, sales and marketing, finance and manufacturing personnel. The competition for these employees is intense and we cannot assure you that we will be successful in attracting and retaining new personnel. The loss of the services of any of our key personnel, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel, particularly engineers, could make it difficult for us to manage our business and meet key objectives, including the timely introduction of new products.

If we are unable to protect our intellectual property, we may lose valuable assets or incur costly litigation.

     We rely on a combination of patents, copyrights, trademark and trade secret laws, non-disclosure agreements and other intellectual property protection methods to protect our proprietary technology. However, we believe that, due to the rapid pace of technological innovation in the markets for our products, our ability to establish and maintain a position of technology leadership also depends on the skills of our development personnel.

     Despite our efforts to protect our intellectual property, a third party could develop products or processes similar to ours. Our means of protecting our proprietary rights may not be adequate and our competitors may independently develop similar technology, duplicate our products or design around our patents. We believe that at least two of our competitors have begun to ship GaAs substrates produced using a process similar to our VGF technique. Our competitors may also develop and patent improvements to the VGF, LED and VCSEL technologies upon which we rely, and thus may limit any exclusivity we enjoy by virtue of our patents or trade secrets.

     It is possible that pending or future United States or foreign patent applications made by us will not be approved, that our issued patents will not protect our intellectual property, or that third parties will challenge the ownership rights or the validity of our patents. In addition, the laws of some foreign countries may not protect our proprietary rights to as great an extent as do the laws of the United States and it may be more difficult to monitor the use of our intellectual property. Our competitors may be able to legitimately ascertain non-patented proprietary technology embedded in our systems. If this occurs, we may not be able to prevent the development of technology substantially similar to ours.

     We may have to resort to costly litigation to enforce our intellectual property rights, to protect our trade secrets or know-how or to determine their scope, validity or enforceability. Enforcing or defending our proprietary technology is expensive, could cause us to divert resources and may not prove successful. Our protective measures may prove inadequate to protect our proprietary rights, and if we fail to enforce or protect our rights, we could lose valuable assets.

We might face intellectual property infringement claims that may be costly to resolve and could divert management attention.

     Other companies may hold or obtain patents on inventions or may otherwise claim proprietary rights to technology necessary to our business. The markets in which we compete are comprised of competitors who in some cases hold substantial patent portfolios covering aspects of products that could be similar to ours. We could become subject to claims that we are infringing patent, trademark, copyright or other proprietary rights of others, and are currently in discussions with one company concerning alleged patent infringement. Litigation to determine the validity of alleged claims could be time-consuming and result in significant expense to us and divert the efforts of our technical and management personnel, whether or not the litigation is ultimately determined in our favor. If a lawsuit is decided against us, we could be subject to significant liabilities, requiring us to seek costly licenses or preventing us from manufacturing and selling our products. We may not be able to obtain required licensing agreements on terms acceptable to us or at all.

We derive a significant portion of our revenue from international sales, and our ability to sustain and increase our international sales involves significant risks.

     Our revenue growth depends in part on the expansion of our international sales and operations. International sales represented 65.1% of our total revenue for the three months ended March 31, 2003 and 56.3% for the three

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months ended March 31, 2002. We expect that sales to customers outside the U.S. will continue to represent a significant portion of our revenue, particularly sales to customers in Asia.

Our dependence on international sales involves a number of risks, including:

• changes in tariffs, import or export restrictions and other trade barriers;

• unexpected changes in regulatory requirements;

• longer periods to collect accounts receivable;

• changes in export license requirements;

• political and economic instability;

• unexpected changes in diplomatic and trade relationships; and

• foreign exchange rate fluctuations.

     Our sales are denominated in U.S. dollars, except for sales to our Japanese and some Taiwanese customers, which are denominated in Japanese yen. Thus, increases in the value of the U.S. dollar could increase the price of our products in non-U.S. markets and make our products more expensive than competitors’ products in these markets. Also, denominating some sales in Japanese yen subjects us to fluctuations in the exchange rates between the U.S. dollar and the Japanese yen. The functional currencies of our Japanese and Chinese subsidiaries are the local currencies. We incur transaction gains or losses resulting from consolidation of expenses incurred in local currencies for these subsidiaries, as well as in translation of the assets and liabilities of these assets at each balance sheet date. If we do not effectively manage the risks associated with international sales, our revenue, cash flows and financial condition could be adversely affected.

If our expansion in China is more costly than we expect, our operating results will suffer.

     As part of our planned reduction of our cost structure, we are building new facilities and expanding existing facilities in China. If we are unable to build and expand our Chinese facilities in a timely manner, we may not be able to reduce the costs of our products as planned. If our expansion in China proves more costly than we anticipate or we incur greater ongoing costs than we expect, our operating results would be adversely affected. If we do not realize expected cost savings once our expansion is complete in China, our margins may be negatively impacted and our operating results may suffer.

Changes in China’s political, social and economic environment may affect our financial performance.

     Our financial performance may be affected by changes in China’s political, social and economic environment. The role of the Chinese central and local governments in the Chinese economy is significant. Chinese policies toward economic liberalization, and laws and policies affecting technology companies, foreign investment, currency exchange rates and other matters could change, resulting in greater restrictions on our ability to do business and operate our manufacturing facilities in China. Any imposition of surcharges or any increase in Chinese tax rates could hurt our operating results. The Chinese government could revoke, terminate or suspend our license for national security and similar reasons without compensation to us. If the government of China were to take any of these actions, we would be prevented from conducting all or part of our business. Any failure on our part to comply with governmental regulations could result in the loss of our ability to manufacture our products in China.

     China has from time to time experienced instances of civil unrest and hostilities. Confrontations have occurred between the military and civilians. Events of this nature could influence the Chinese economy, result in nationalization of foreign-owned operations such as ours, and could negatively affect our ability to operate our facilities in China.

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The effect of terrorist threats and actions on the general economy could decrease our revenues.

     On September 11, 2001, the United States was subject to terrorist attacks at the World Trade Center buildings in New York and the Pentagon in Washington D.C., and continues to be on alert for further terrorist activity. In addition, the United States has invaded Iraq and may now be more subject to action by terrorists. The potential near- and long-term impact of these attacks and other terrorist activities may have in regards to our suppliers, customers and markets for our products and the U.S. economy, are uncertain. There may be other potential adverse effects on our operating results due to a significant event that we cannot foresee.

Our stock price has been and may continue to be volatile.

     Our stock price has fluctuated significantly since we began trading on the Nasdaq National Market. For the three months ended March 31, 2003, the high and low closing sales prices of our common stock were $1.95 and $0.67, respectively. A number of factors could cause the price of our common stock to continue to fluctuate substantially, including:

• actual or anticipated fluctuations in our quarterly or annual operating results;

• changes in expectations about our future financial performance or changes in financial estimates of securities analysts;

• announcements of technological innovations by us or our competitors;

• new product introduction by us or our competitors;

• large customer orders or order cancellations; and

• the operating and stock price performance of comparable companies.

     In addition, the stock market in general has experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the trading price of our common stock, regardless of our actual operating performance.

Provisions in our charter, bylaws or Delaware law may delay or prevent a change in control of our company.

     Provisions in our amended and restated certificate of incorporation and bylaws may have the effect of delaying or preventing a merger, acquisition or change of control of us, or changes in our management. These provisions include:

• the division of our board of directors into three separate classes, each with three year terms;

• the right of our board to elect a director to fill a space created by a board vacancy or the expansion of the board;

• the ability of our board to alter our bylaws;

• the ability of our board to authorize the issuance of up to 2,000,000 shares of blank check preferred stock; and

• the requirement that only our board or the holders of at least 10% of our outstanding shares may call a special meeting of our stockholders.

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     Furthermore, because we are incorporated in Delaware, we are subject to the provisions of Section 203 of the Delaware General Corporation Law. These provisions prohibit large stockholders, in particular those owning 15% or more of the outstanding voting stock, from consummating a merger or combination with a corporation unless:

• 66 2/3% of the shares of voting stock not owned by these large stockholders approve the merger or combination, or

• the board of directors approves the merger or combination or the transaction which resulted in the large stockholder owning 15% or more of our outstanding voting stock.

We have adopted certain anti-takeover measures that may make it more difficult for a third party to acquire us.

     Our board of directors has the authority to issue up to 2,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of shares of preferred stock, while potentially providing desirable flexibility in connection with possible acquisitions and for other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. We have no present intention to issue shares of preferred stock.

     Further, on April 24, 2001, our board of directors adopted a preferred stock purchase rights plan intended to guard against certain takeover tactics. The adoption of this plan was not in response to any proposal to acquire us, and the board is not aware of any such effort. The existence of this plan could also have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. In addition, certain provisions of our certificate of incorporation may have the effect of delaying or preventing a change of control, which could adversely affect the market price of our common stock.

The financial condition of our customers may affect their ability to pay amounts owed to us.

     Many of our customers are facing business downturns that have reduced their cash balances and their prospects. We frequently allow our customers to pay for products we ship to them within 30 to 90 days after delivery. Subsequent to our shipping a product some customers have been unable to make payments as due, reducing our cash balances and causing us to incur charges to allow for a possibility that some accounts might not be paid. At least two customers that owed us a significant amount have filed for bankruptcy protection and we are unlikely to receive a substantial portion or any of the amount owed to us as part of a bankruptcy settlement. Other customers may also be forced to file for bankruptcy. If our customers do not pay their accounts when due, we will be required to incur charges that would reduce our earnings.

Legislative actions, higher insurance costs and potential new accounting pronouncements are likely to cause our general and administrative expenses to increase and impact our future financial position and results of operations.

     In order to comply with the newly adopted Sarbanes-Oxley Act of 2002, as well as proposed changes to listing standards by Nasdaq, and proposed accounting changes by the Securities and Exchange Commission, we may be required to increase our internal controls, hire additional personnel and additional outside legal, accounting and advisory services, all of which will cause our general and administrative costs to increase. Insurers are likely to increase premiums as a result of the high claims rates incurred over the past year, and so our premiums for our various insurance policies, including our directors’ and officers’ insurance policies, are likely to increase. Proposed changes in the accounting rules, including legislative and other proposals to account for employee stock options as a compensation expense among others, could materially increase the expense that we report under generally accepted accounting principles and adversely affect our operating results.

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Liquidity

     The Company anticipates that its existing cash resources will fund any anticipated operating losses, purchases of capital equipment and provide adequate working capital for the next twelve months. The Company’s liquidity is affected by many factors including, among others, the extent to which the Company pursues additional capital expenditures, the level of the Company’s production efforts, and other factors related to the uncertainties of the industry and global economies. Accordingly, there can be no assurance that events in the future will not require the Company to seek additional capital sooner, or, if so required, that such capital will be available on terms acceptable to the Company if at all.

Item 3.   Qualitative and Quantitative Disclosures About Market Risk

Foreign Currency Risk

     The Company uses short-term forward exchange contracts for hedging purposes to reduce the effects of adverse foreign exchange rate movements. The Company has purchased foreign exchange contracts to hedge against certain trade accounts receivable denominated in Japanese yen. The change in the fair value of the forward contracts is recognized as part of the related foreign currency transactions as they occur. As of March 31, 2003, the Company’s outstanding commitments with respect to the foreign exchange contracts, which were commitments to sell Japanese yen, had a total contract value of approximately $1.9 million.

     The Company incurred a foreign currency transaction exchange gain of $63,000 for the three months ended March 31, 2003, and a loss of $40,000 for the three months ended March 31, 2002.

Interest Rate Risk

     Cash and cash equivalents earning interest and certain variable rate debt instruments are subject to interest rate fluctuations. The following table sets forth the probable impact of a 10% change in interest rates (in thousands):

						Current			Proforma			Proforma
	Balance		Current			Interest			10% Interest			10% Interest
	March 31,		Interest			Income/			Rate Decline			Rate Increase
Instrument	2003		Rate			(Expense)			Income/(Expense)			Income/(Expense)
Cash and cash equivalents	$	18,335		3.80	%	$	697		$	627		$	766
Bonds		8,880		1.60	%		(142	)		(128	)		(156	)
Capital lease		556		4.20	%		(23	)		(21	)		(26	)
Capital lease		2,195		3.60	%		(79	)		(71	)		(87	)
						$	452		$	407		$	498

Equity Risk

     We also maintain minority investments in private and publicly traded companies. These investments are reviewed for other than temporary declines in value on a quarterly basis. Reasons for other than temporary declines in value include whether the related company would have insufficient cash flow to operate for the next twelve months, significant changes in the operating performance and changes in market conditions. As of March 31, 2003, the minority investments we continue to hold totaled $4.7 million at estimated fair value. In 2000, we recorded a $27.3 million non-cash gain as a result of acquiring Finisar Corporation common stock in connection with Finisar Corporation’s acquisition of Demeter Technologies, a company in which we held warrants to purchase preferred stock. In 2001 and 2002, we recorded a $15.6 million and $10.8 million non-cash loss respectively, as a result of writing down our investment in Finisar Corporation common stock to market value. These gains and losses were included in other expense.

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Item 4.   Controls and Procedures

(a)  Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), within 90 days of the filing date of this report. Based on their evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective.

(b)  There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in paragraph (a) above.

PART II   OTHER INFORMATION

Item 1.   Legal Proceedings

     From time to time we are involved in judicial or administrative proceedings concerning matters arising in the ordinary course of our business. We do not expect that any of these matters, individually or in the aggregate, will have a material adverse effect on our business, financial condition, cash flows or results of operation.

     On May 1, 2001, the Santa Clara Center for Occupational Safety and Health filed a complaint for injunctive relief and civil penalties against us in the Superior Court of California, County of Alameda, Hayward Division, Case No. H218237-5. The complaint alleged violations of California Business and Professions Code section 17200 et seq., and violations under Proposition 65 and California Health and Safety Code section 25249 et seq. as a result of AXT’s use of arsenic and inorganic arsenic compounds in its workplace. On June 24, 2002, we participated in a private mediation, and as a result, reached a settlement of all claims, pursuant to which we agreed to pay the Santa Clara Center for Occupational Safety and Health an amount equal to $175,000. The parties have executed a settlement agreement, and the court approved the settlement on December 31, 2002, and dismissal of the case is pending.

     On April 15, 2003, Sumitomo Electric Industries, Ltd., (SEI) filed a complaint in the Tokyo District Court, Civil Division against us and our Japanese distributor alleging patent infringement of two patents held by SEI in Japan. The suit seeks penalties from AXT in the amount of $1.67 million plus interest and court costs and the cessation of AXT’s sales of gallium arsenide substrates in Japan. AXT intends to defend itself vigorously in these lawsuits and continues to sell its products in Japan.

Item 2.   Changes in Securities and Use of Proceeds

None

Item 3.   Defaults upon Senior Securities

None

Item 4.   Submission of Matters to a Vote of Security Holders

None

Item 5.   Other Information

None

Item 6.   Exhibits and Reports on Form 8-K

a.     Exhibits

32

3.1(1)	Restated Certificate of Incorporation
3.2(2)	Certificate of Designation, Preferences and Rights of Series A Preferred Stock, as filed with the Secretary of State of the state of Delaware on May 27, 1999 (which is incorporated herein by reference to Exhibit 2.1 to the registrant’s Form 8-K filed on June 14, 1999)
3.3(3)	Second Amended and Restated Bylaws
4.1(4)	Registration Rights Agreement dated as of May 27, 1999, by and among American Xtal Technology, Inc., Lyte Optronics, Inc. and Keith Halsey and Robert Shih
4.2(3)	Rights Agreement dated as of April 24, 2001, by and between AXT, Inc. and Computershare Trust Company
10.14(5)	Second Modification to Credit Agreement between U.S. Bank National Association and us dated September 30, 2002
10.15	Reimbursement Agreement between Wells Fargo Bank National Association and us dated March 14, 2003
99.1	Certification by Chief Executive Officer
99.2	Certification by Chief Financial Officer

(1)	As filed with the SEC in our Annual Report on Form 10-K for the year ended December 31, 1998.
(2)	As filed with the SEC in our Form 8-K on June 14, 1999.
(3)	As filed with the SEC in our Form 8-K on May 30, 2001.
(4)	As filed with the SEC in our Annual Report on Form 10-K for the year ended December 31, 1999.
(5)	As filed with the SEC in our Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2002.
b.	Reports on Form 8-K

     On March 14, 2003, we filed a report on form 8-K reporting earnings guidance for the three months ended March 31, 2003 as required under Item 9 – Regulation FD Disclosures.

     On April 23, 2003, we filed a report on form 8-K reporting our earnings for the three months ended March 31, 2003 as required under Item 12 – Disclosure of Results of Operations and Financial Condition.

33

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

	AXT, INC.
Dated: May 9, 2003	By:	/s/   Morris S. Young
		Morris S. Young
		Chief Executive Officer
Dated: May 9, 2003	By:	/s/   Donald L. Tatzin
		Donald L. Tatzin
		Chief Financial Officer
Dated: May 9, 2003	By:	/s/            John Drury
		John Drury
		Corporate Controller

34

CERTIFICATION

I, Morris S. Young, certify that:

     1.     I have reviewed this quarterly report on Form 10-Q of AXT, Inc.;

     2.     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

     3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

     4.     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

     a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

     b. evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

     c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

     5.     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

     a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

     b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

     6.     The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated: May 9, 2003	By:	/s/    Morris S. Young
		Morris S. Young
		Chief Executive Officer

35

I, Donald L. Tatzin, certify that:

     1.     I have reviewed this quarterly report on Form 10-Q of AXT, Inc.;

     2.     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

     3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

     4.     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

     a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

     b. evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

     c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

     5.     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:

     a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

     b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

     6.     The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated: May 9, 2003	By:	/s/    Donald L. Tatzin
		Donald L. Tatzin
		Chief Financial Officer

36

EXHIBIT INDEX

3.1(1)	Restated Certificate of Incorporation
3.2(2)	Certificate of Designation, Preferences and Rights of Series A Preferred Stock, as filed with the Secretary of State of the state of Delaware on May 27, 1999 (which is incorporated herein by reference to Exhibit 2.1 to the registrant’s Form 8-K filed on June 14, 1999)
3.3(3)	Second Amended and Restated Bylaws
4.1(4)	Registration Rights Agreement dated as of May 27, 1999, by and among American Xtal Technology, Inc., Lyte Optronics, Inc. and Keith Halsey and Robert Shih
4.2(3)	Rights Agreement dated as of March 14, 2003, by and between AXT, Inc. and Computershare Trust Company
10.14(5)	Second Modification to Credit Agreement between U.S. Bank National Association and us dated September 30, 2002
10.15	Reimbursement Agreement between Wells Fargo Bank National Association and us dated March 14, 2003
99.1	Certification by Chief Executive Officer
99.2	Certification by Chief Financial Officer

(1)	As filed with the SEC in our Annual Report on Form 10-K for the year ended December 31, 1998.
(2)	As filed with the SEC in our Form 8-K on June 14, 1999.
(3)	As filed with the SEC in our Form 8-K on May 30, 2001.
(4)	As filed with the SEC in our Annual Report on Form 10-K for the year ended December 31, 1999.
(5)	As filed with the SEC in our Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2002.

EX-10.15 3 f89948exv10w15.txt EXHIBIT 10.15 EXHIBIT 10.15 ================================================================================ REIMBURSEMENT AGREEMENT Between AXT, INC. and WELLS FARGO BANK, NATIONAL ASSOCIATION Dated as of March 14, 2003 (Letter of Credit No. NZS472650 $9,022,930.00) ================================================================================ TABLE OF CONTENTS

Section Page - ------- ---- 1 Definitions and Rules of Construction..................................... 1 (a) Certain Defined Terms........................................... 1 (b) Accounting Terms and Determinations............................. 5 (c) Interpretation.................................................. 5 2 Terms and Amount of Letter of Credit...................................... 5 (a) Terms of Letter of Credit....................................... 5 3 Reimbursement and Other Payments.......................................... 5 (a) Reimbursement Obligations....................................... 5 (b) Tender Reimbursement Obligations................................ 6 (c) Bank's Option to Redeem Bank Bonds.............................. 7 (d) Letter of Credit Fees; Other Payments to Bank................... 8 (e) Miscellaneous................................................... 8 4 Reimbursement Deposit Account; Amortization Payments; Collateral; Optional Redemption of Bonds.................................. 9 (a) Scheduled Redemptions of Bonds.................................. 9 (b) Reimbursement Deposit Account................................... 9 (c) Interest and Letter of Credit Fee Payments...................... 9 (d) Other Optional Redemptions of Bonds............................. 10 (e) Personal Property Collateral.................................... 10 5 Issuance of the Letter of Credit.......................................... 10 (a) Agreement of Bank............................................... 10 (b) Conditions Precedent to Issuance of the Letter of Credit........ 10 6 Obligations Absolute...................................................... 12 7 Representations and Warranties............................................ 13 (a) Authority/Enforceability........................................ 13 (b) Binding Obligations............................................. 13 (c) Legal Status/Formation and Organizational Documents............. 13 (d) Approvals....................................................... 13 (e) No Violation.................................................... 14 (f) Disclosure of Information....................................... 14 (g) Litigation...................................................... 14 (h) Financial Condition............................................. 14 (i) Bond Proceeds................................................... 14 (j) Accuracy........................................................ 14 (k) Tax Liability................................................... 14 (l) Government Regulations.......................................... 14 (m) Securities Activities........................................... 14 (n) Environmental Matters........................................... 14 (o) Related Documents............................................... 15 (p) ERISA........................................................... 15 (q) Other Obligations............................................... 15

i

SECTION PAGE - ------- ---- 8 Covenants of Borrower..................................................... 15 (a) Reporting Requirements............................................ 15 (b) Collateral Value.................................................. 15 (c) ERISA Compliance.................................................. 15 (d) Further Assurances................................................ 16 (e) Conduct of Business and Maintenance of Existence.................. 16 (f) Compliance with Laws.............................................. 16 (g) Inspection of Property, Books and Records......................... 16 (h) Notices........................................................... 16 (i) Related Documents................................................. 16 (j) Taxes and Other Liabilities....................................... 16 (k) Maintenance of Property; Insurance................................ 17 9 Events of Default......................................................... 17 (a) Required Payments................................................. 17 (b) Misrepresentation................................................. 17 (c) Other Covenants................................................... 17 (d) Collateral........................................................ 17 (e) Invalidity........................................................ 17 (f) Voluntary Bankruptcy; Insolvency; Dissolution..................... 17 (g) Involuntary Bankruptcy............................................ 18 (h) Other Defaults.................................................... 18 (i) Material Adverse Change........................................... 18 (j) Change in Business................................................ 18 10 Remedies.................................................................. 18 11 Amendments, Etc.......................................................... 18 12 Notices................................................................... 19 13 No Waiver; Remedies....................................................... 19 14 Right of Set-off; Waiver of Right of Set-Off.............................. 19 15 Indemnification........................................................... 19 16 Continuing Obligation..................................................... 20 17 Transfer of Letter of Credit.............................................. 20 18 Liability of Bank......................................................... 20 19 Costs, Expenses, Attorneys' Fees and Taxes; Allocation of Increased Costs............................................. 21 (a) Costs, Expenses, Attorneys' Fees and Taxes........................ 21 (b) Allocation of Increased Costs..................................... 21 20 No Third Party Beneficiaries.............................................. 21

ii

SECTION PAGE - ------- ---- 21 Time...................................................................... 22 22 Severability.............................................................. 22 23 Successors, Assignment.................................................... 22 24 Confidentiality........................................................... 22 25 Governing Law............................................................. 23 26 Consent of Jurisdiction and Venue, etc.................................... 23 27 Headings.................................................................. 23 28 Satisfaction Requirement.................................................. 23 29 Counterparts.............................................................. 23 30 Rights and Remedies Cumulative............................................ 23 31 Bank Reliance............................................................. 23 32 Permitted Contests........................................................ 24 33 Arbitration............................................................... 24 (a) Arbitration....................................................... 24 (b) Governing Rules........................................ .......... 24 (c) No Waiver; Provisional Remedies, Self-Help and Foreclosure....................................................... 24 (d) Arbitrator Qualifications and Powers; Awards...................... 25 (e) Judicial Review................................................... 25 (f) Real Property Collateral; Judicial Reference...................... 25 (g) Miscellaneous..................................................... 25 34 Facsimile Transmissions of Demands under the Letter of Credit............. 26

EXHIBIT A FORM OF IRREVOCABLE LETTER OF CREDIT EXHIBIT B FORM OF NOTICE OF INTENT TO BORROW SCHEDULE I REDEMPTION SCHEDULE iii REIMBURSEMENT AGREEMENT This REIMBURSEMENT AGREEMENT, dated as of March 14, 2003 (the "Agreement") is by and between AXT, INC., a Delaware corporation (formerly known as American Xtal Technology, Inc.) ("Borrower"), and WELLS FARGO BANK, NATIONAL ASSOCIATION, a national banking association ("Bank"). RECITALS WHEREAS, Borrower issued a series of taxable bonds designated "American Xtal Technology, Inc. Variable Rate Taxable Demand Revenue Bonds Series 1998" in the aggregate principal amount of $11,615,000.00 (the "Bonds") pursuant to an Indenture, dated as of December 1, 1998 (such indenture, together with any indentures supplemental thereto, hereinafter referred to as the "Indenture"), between Borrower and Harris Trust Company of California, as Trustee ("Original Trustee"), to provide funds to finance the Project; WHEREAS, BNY Western Trust Company ("BNY") is the successor trustee under the Indenture to the Original Trustee (BNY, in its capacity as Trustee under the Indenture, hereinafter referred to as the "Trustee"); WHEREAS, as a condition precedent to the issuance of the Bonds, Borrower caused U.S. Bank National Association to issue and deliver to the Trustee, for the benefit of the holders of the Bonds, an irrevocable direct pay letter of credit in the initial stated amount of $11,986,680 (the "Existing Letter of Credit"); WHEREAS, Borrower desires to replace the Existing Letter of Credit and Borrower has requested that Bank issue an irrevocable direct-pay letter of credit to the Trustee substantially in the form attached hereto as Exhibit A (such letter of credit as it may be extended, together with any amendments thereto and any substitute letter of credit of Bank, is hereafter referred to as the "Letter of Credit") in the amount of Nine Million Twenty-Two Thousand Nine Hundred Thirty and No/100 Dollars ($9,022,930.00) (the "Stated Amount") as an Alternate Letter of Credit and, pursuant to the terms of the Indenture, to replace the Existing Letter of Credit; and WHEREAS, Borrower will be responsible for all amounts drawn under the Letter of Credit and for certain fees and amounts due with respect to the Letter of Credit. NOW, THEREFORE, in consideration of the premises and in order to induce Bank to issue the Letter of Credit, Borrower and Bank, subject to the terms and conditions of this Agreement, hereby agree as follows: SECTION 1. DEFINITIONS AND RULES OF CONSTRUCTION. (a) Certain Defined Terms. As used in this Agreement and unless otherwise expressly indicated, or unless the context clearly requires otherwise, the following terms shall have the following meanings: "A Drawing" means any draw in the form of Annex A to the Letter of Credit made under the Letter of Credit to pay the principal amount upon an optional and/or a mandatory redemption of a portion of the Bonds in accordance with the Indenture. 1 "Affiliate" of any Person means any other Person directly or indirectly controlling, controlled by or under common control with such Person. A Person shall be deemed to control another Person if the controlling Person possesses, directly or indirectly, the power to direct or cause the direction of the management or policies of the controlled Person, whether through ownership of stock, by contract, or otherwise. "Agreement" means this Reimbursement Agreement, as the same may be from time to time amended or supplemented. "Alternate Letter of Credit" has the meaning ascribed to that term in the Indenture. "Bank" means Wells Fargo Bank, National Association. "Bankruptcy Code" means the Bankruptcy Reform Act, Title 11 of the United States Code, as amended or recodified from time to time. "B Drawing" means any draw in the form of Annex B to the Letter of Credit made under the Letter of Credit to pay unpaid interest upon an optional and/or a mandatory redemption of a portion of the Bonds. "Bank Bonds" mean Bonds purchased or deemed to be purchased or otherwise acquired with drawings under the Letter of Credit, during any period such Bonds are registered in the name of Bank (or its nominee) or held by the Tender Agent on behalf of Bank at the time of a Tender Drawing. "Bonds" has the meaning ascribed to that term in the Recitals hereto. "Business Day" means any day other than (i) a Saturday or a Sunday or (ii) a day on which commercial banks in the City of New York, New York, or the city or cities in which the Principal Corporate Trust Office (as defined in the Indenture) of Trustee or Tender Agent or the office of Bank at which demands for payment under the Letter of Credit are to be presented are authorized or required by law to close or (iii) a day on which the New York Stock Exchange is closed. "Collateral Value" means the percentage set forth below for each type of investment property held in the Investment Account at the time of computation: (i) 100% of the face amount of cash and cash equivalents; (ii) 90% of the market value of obligations of the United States of America, with maturities equal to or less than five (5) years ("U.S. Obligations"), but not to exceed the face amount; (iii) 90% of the market value of any repurchase agreements backed by U.S. Obligations, but not to exceed the face amount of such U.S. Obligations; (iv) 85% of the market value of corporate and municipal bonds (excluding convertible bonds), with maturities equal to or less than five (5) years and rated at least AA or SP-1 by a nationally recognized rating agency, but not to exceed the face amount; and (v) 80% of the market value of commercial paper rated at least A1 or P1 by a nationally recognized rating agency, but not to exceed the face amount. "C Drawing" means any draw in the form of Annex C to the Letter of Credit made under the Letter of Credit to pay the principal portion of those Bonds which the Remarketing Agent has been unable to remarket within the time limits established in the Indenture. 2 "D Drawing" means any draw in the form of Annex D to the Letter of Credit made under the Letter of Credit to pay the unpaid interest on those Bonds which the Remarketing Agent has been unable to remarket within the time limits established in the Indenture. "Date of Issuance" means the date on which Bank issues the Letter of Credit. "Default" means any event or condition which with the giving of notice or the lapse of time or both would, unless cured or waived, become an Event of Default. "Default Rate" means a variable rate of interest equal to the Prime Rate in effect from time to time plus four percent (4.0%). "Deposit Account Proceeds" means all of that personal property defined as "Proceeds" in the Deposit Account Security Agreement. "Deposit Account Security Agreement" means that certain Security Agreement: Deposit Account, dated as of the date hereof, executed by Borrower in favor of Bank. "Drawing" means an A Drawing, B Drawing, C Drawing, D Drawing, E Drawing or F Drawing, as the context may require. "E Drawing" means any draw in the form of Annex E to the Letter of Credit made under the Letter of Credit to pay the total unpaid principal and accrued and unpaid interest, if any, at stated maturity, upon acceleration following an Event of Default, or upon redemption as a whole, of all of the Bonds outstanding in accordance with the Indenture. "ERISA" means the Employee Retirement Income Security Act of 1974 and any rule or regulation issued thereunder. "Event of Default" has the meaning set forth in Section 9 hereof. "Expiration Date" has the meaning assigned to such term in the Letter of Credit. "Existing Letter of Credit" has the meaning set forth in the Recitals hereto. "F Drawing" means any draw in the form of Annex F to the Letter of Credit made under the Letter of Credit to pay accrued and unpaid interest with respect to the Bonds, on an Interest Payment Date in accordance with the Indenture. "Financial Institutions" means any bank, savings bank, savings and loan association or insurance company, and any Affiliate of Bank that is controlled, either directly or indirectly, by such Person. "GAAP" means, at any time, generally accepted accounting principles then in effect. "Indenture" has the meaning set forth in the Recitals hereto. "Letter of Credit" means Bank's irrevocable direct-pay Letter of Credit No. NZS472650. "Notice of Intent to Borrow" means the notice in the form attached hereto as Exhibit B. 3 "Person" means an individual, a corporation, a partnership, an association, a trust or any other entity or organization, including a government or political subdivision or agency or instrumentality thereof. "Prime Rate" means a base rate that Bank from time to time establishes and which serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto. "Proceeds" means collectively all of the Deposit Account Proceeds plus all of the Securities Account Proceeds. "Project" has the meaning assigned to such term in the Indenture. "Reimbursement Deposit Account" has the meaning set forth in Section 4(b) hereof. "Reimbursement Obligations" has the meaning set forth in Section 3(a) hereof. "Related Documents" means this Agreement, the Bonds, the Indenture, the Security Agreements, the Control Agreement, the UCC financing statements, if any, and any other agreement or instrument related to the issuance of the Letter of Credit or the Bonds. "Remarketing Agent" has the meaning assigned to such term in the Indenture. "Securities Account Proceeds" means all of that personal property defined as Proceeds in the Securities Account Security Agreement. "Securities Account Security Agreement" means the Security Agreement: Securities Account, dated as of the date hereof, executed by Borrower in favor of Bank. "Security Agreements" has the meaning set forth in Section 5(b)(i)(A) of this Agreement. "Stated Amount" means $9,022,930.00. "Tender Drawing" means any draw upon the Letter of Credit pursuant to a draft accompanied by a certificate in the form of Annex C or D to the Letter of Credit for the purchase price of the Bonds which are tendered for repurchase pursuant to Article IV of the Indenture. "Tender Drawing Date" has the meaning set forth in Section 3(b)(iii) hereof. "Tender Reimbursement Obligation" means any obligation of Borrower to Bank resulting from a Tender Drawing. "Tender Reimbursement Rate" means a variable rate of interest equal to the Prime Rate in effect from time to time plus one percent (1.0%). "Termination Date" means the date upon which all of the following events have occurred: (i) no further draws are available under the Letter of Credit; (ii) the original Letter of Credit has been returned to Bank; and (iii) all amounts owing by Borrower to Bank under the Letter of Credit and the Reimbursement Agreement have been paid in full. "Transferee" means any Person to whom Bank has sold, assigned, transferred, negotiated or granted a participation in all or any part of, or any interest in, Bank's rights and benefits under this Agreement and the Related Documents. 4 "Trustee" means BNY Western Trust Company. "UCP" means the Uniform Customs and Practices for Documentary Credits (1993 Revision), Publication No. 500 of the International Chamber of Commerce, or any substitution therefor or replacement thereof. (b) Accounting Terms and Determinations. Unless otherwise specified herein, all accounting terms used herein shall be interpreted and all accounting determinations hereunder shall be made in accordance with GAAP in effect from time to time, on a basis consistent with the most recent financial statements of Borrower delivered to Bank. (c) Interpretation. For all purposes of this Agreement, except as otherwise expressly provided or unless the context otherwise requires, (i) terms used in this Agreement include, as appropriate, all genders and the plural as well as the singular, (ii) references to this Agreement include all Exhibits and Schedules hereto, (iii) references to words such as "herein", "hereof" and the like shall refer to this Agreement as a whole and not to any particular part or Section herein, (iv) references to a Section such as "Section 1" shall refer to the applicable Section of this Agreement, (v) the term "include" and all variations thereof shall mean "include without limitation", (vi) the term "or" shall include "and/or", (vii) any defined term which relates to a document shall include within its definition any amendments, modifications, renewals, restatements, extensions, supplements or substitutions which have been or are hereafter executed and delivered in accordance with the terms thereof, (viii) any defined term which relates to a Person shall include within its definition the successors and permitted assigns of such Person and (ix) in the computation of a period of time from a specified date to a later specified date, the word "from" shall mean "from and including" and the words "to" and "until" shall mean "to but excluding." SECTION 2. TERMS AND AMOUNT OF LETTER OF CREDIT. (a) Terms of Letter of Credit. Bank hereby agrees, on the terms and subject to the conditions set forth in this Agreement, to issue its irrevocable direct-pay Letter of Credit for the account of Borrower in favor of Trustee in an initial amount not to exceed the Stated Amount, which amount is equal to the aggregate principal amount of the Bonds on the Date of Issuance plus one hundred six (106) days' interest calculated at twelve percent (12%), based on a 360 day year, actual days elapsed, on such amount. The Letter of Credit shall be issued on the date that Bank, in its sole discretion, determines that all of the conditions precedent set forth in Section 5 of this Agreement have been satisfied, and the Letter of Credit shall expire on the Expiration Date. Notwithstanding anything herein to the contrary, this Agreement shall not expire or be otherwise terminated until such time as all payment obligations to Bank due or to become due hereunder have been paid. SECTION 3. REIMBURSEMENT AND OTHER PAYMENTS. (a) Reimbursement Obligations. Except as provided in Section 3(b) hereof, Borrower agrees to pay to Bank (i) on the day that any Drawing is made by Trustee under the Letter of Credit all amounts to be advanced by Bank pursuant to the Letter of Credit on behalf of Borrower in respect of each such Drawing; and (ii) interest on any and all amounts Borrower fails to pay when due under this Agreement from the date such amounts become payable until payment in full (collectively, the "Reimbursement Obligations"). Except as provided in Section 3(b) hereof, interest shall accrue on any unpaid Reimbursement Obligations at a rate per annum equal to the Default Rate. 5 (b) Tender Reimbursement Obligations. (i) Each Tender Drawing paid by Bank under the Letter of Credit shall constitute a Tender Reimbursement Obligation, which obligation shall be due and payable by Borrower as set forth below. Trustee shall use the proceeds of Tender Drawings only for the purpose of purchasing Bonds tendered or deemed tendered for purchase pursuant to Article IV of the Indenture. (ii) The Tender Agent (as defined in the Indenture) shall cause Bank (or its designated nominee) to be registered as the owner of all Bonds purchased with the proceeds of a Tender Drawing in the registration books of Depository Trust Company, and all such Bonds that are not Book-Entry Bonds (as defined in the Indenture) shall be held by the Tender Agent, for the benefit of Bank, unless Bank requests that such Bonds be delivered to Bank (or its designated nominee), and the Tender Agent shall register Bank (or its designated nominee) as owner of such Bonds in its registration books, which Bonds shall evidence the corresponding Tender Reimbursement Obligation. Such Bonds shall be deemed "Bank Bonds" and shall be entitled to all of the rights and privileges of, and shall be governed by all of the terms and conditions of the Bonds and the Indenture; provided, however, that: a. such Bank Bonds may be redeemed or purchased and all principal and interest owing thereon shall be payable to Bank; b. if Bank receives reimbursement in full of amounts paid by Bank with respect to any Tender Drawing by 5:00 p.m. (San Francisco Time) on the day of such Tender Drawing, no interest shall be payable by Borrower with respect thereto; c. such Bank Bonds may not be tendered or deemed tendered for purchase pursuant to Sections 2.04 and 4.06 of the Indenture; d. to the maximum extent allowed under the Indenture, such Bank Bonds shall be redeemed, in the event of a redemption pursuant to Section 4.01 of the Indenture, prior to the redemption of other Bonds; and e. such Bank Bonds shall not be entitled to payment of any premium upon redemption. (iii) Upon receiving notification of any Tender Drawing, Bank shall notify Borrower of such Tender Drawing and the amount of the Tender Drawing. The amount of any Tender Drawing shall be due and payable within two (2) Business Days of the date of such Tender Drawing (the "Tender Drawing Date"), unless within such two (2) Business Days period Borrower executes and delivers to Bank a Notice of Intent to Borrow in the form attached hereto as Exhibit B, pursuant to which Borrower specifies its intent to borrow the amount of such Tender Drawing. Interest shall accrue on the entire amount of each Tender Drawing from the Tender Drawing Date related thereto at the Default Rate, unless a Notice of Intent to Borrow with respect to such Tender Drawing is delivered to Bank within two (2) Business Days of the Tender Drawing Date, in which case interest shall accrue on the entire amount of the Tender Drawing from the Tender Drawing Date at the Tender Reimbursement Rate; provided, however, that Borrower shall have the option to reimburse a portion of the Tender Drawing amount, in which case, Borrower shall, within the applicable two (2) Business Day period, pay to Bank the amount of the reimbursed portion of the Tender Drawing, together with any accrued interest on said amount calculated from the Tender Drawing Date at the Tender Reimbursement Rate, and deliver the Notice of Intent to Borrow to Bank, specifying the amount of the Tender Drawing which is 6 reimbursed and the amount which is unreimbursed. Notwithstanding the foregoing, if Bank receives full reimbursement of all amounts paid by Bank with respect to any Tender Drawing by 5:00 p.m. (San Francisco time) on the Tender Drawing Date, no interest shall be payable by Borrower with respect thereto. (iv) Borrower agrees to pay to Bank, within thirty (30) days after the applicable Tender Drawing Date, the amount of any Tender Drawing with respect to which Borrower has executed and returned a Notice of Intent to Borrow in accordance with the preceding subsection (iii). The unreimbursed amount of any such Tender Drawing shall bear interest at the Tender Reimbursement Rate from the Tender Drawing Date until the date that payment of the principal amount of such Tender Drawing becomes due hereunder and at the Default Rate thereafter. Interest due on such amounts shall be paid to Bank on the last day of each month which last day occurs at least ten (10) days after the Tender Drawing Date, and on the date that reimbursement of the principal amount of such Tender Reimbursement Obligation is due and payable. Borrower shall submit to Bank together with every payment of a Tender Reimbursement Obligation and accrued interest due thereon under this Section 3, a statement specifying the amounts paid, the principal and interest portions of such payments, and the basis upon which Borrower calculated such amounts. (v) Borrower may, upon at least one (1) Business Day's notice to Bank, prepay the outstanding amount of any Tender Reimbursement Obligation in whole or in part (but not in sums less than $10,000.00 per prepayment) together with accrued interest at the Tender Reimbursement Rate to the date of such prepayment on the amount prepaid; provided, however, that prepayments shall be credited first to interest due and owing on any Reimbursement Obligations outstanding hereunder other than Tender Reimbursement Obligations, then to principal due and owing on any Reimbursement Obligations outstanding hereunder other than Tender Reimbursement Obligations, then to interest due and owing on any Tender Reimbursement Obligations, and finally to principal due and owing on any Tender Reimbursement Obligations, applied in the order in which draws connected therewith were made; provided, further, that the proceeds paid to Bank from any redemption of Bank Bonds pursuant to the Indenture or from any remarketing of Bank Bonds pursuant to Section 4.07 of the Indenture will be credited toward the Tender Reimbursement Obligations of Borrower, applied in the order in which draws connected therewith were made. (vi) Reimbursement Following Reinstatement for Remarketed Bonds. All proceeds of the sale by the Remarketing Agent (as provided in Section 4.07 of the Indenture) of Bank Bonds, and all proceeds from the redemption of Bank Bonds, shall be delivered to Trustee and transferred to Bank to be credited to any then outstanding Tender Reimbursement Obligations, applied in the order in which the draws connected therewith were made. At such time as no Reimbursement Obligations are outstanding hereunder (including, without limitation, Tender Reimbursement Obligations), and neither a Default nor an Event of Default has occurred hereunder, then Bank shall disburse to Borrower the balance of all proceeds received by Bank from the redemption of Bank Bonds or from the sale of Bank Bonds by the Remarketing Agent. (c) Bank's Option to Redeem Bank Bonds. In the event that Borrower has paid all or part of a Tender Reimbursement Obligation for a Tender Drawing and all or a portion of the Bank Bonds purchased in connection with such Tender Drawing have not been remarketed within six (6) months after the Tender Drawing Date, Bank, at its option, may effect the redemption or cancellation of Bank Bonds in an amount up to the principal actually reimbursed to it by Borrower in such manner as may be permitted by the Indenture. 7 (d) Letter of Credit Fees; Other Payments to Bank. Borrower shall pay to Bank annual, continuing nonrefundable letter of credit fees (each, a "Letter of Credit Fee" and collectively, the "Letter of Credit Fees") for providing the Letter of Credit, which Letter of Credit Fees shall be in an amount equal to forty-five one hundredths of one percent (0.45%) per annum of the Stated Amount (hereafter, the "Primary Letter of Credit Fee Rate") on the date that any such fee is determined, less amounts drawn under the Letter of Credit which are not reinstated as of such date. The foregoing Letter of Credit Fees shall be payable in advance as follows: (i) on or before the Date of Issuance for the period commencing on the Date of Issuance and ending on November 30, 2003 (which initial Letter of Credit Fee shall be prorated to equal sixty-six and two-thirds percent (66 2/3%) of the annual Letter of Credit Fee); (ii) three (3) Business Days prior to December 1, 2003 for the one year period commencing December 1, 2003 and continuing up to November 30, 2004; and (iii) three (3) Business Days prior to each subsequent December 1, for the one year period commencing on such subsequent December 1 and continuing up to and including the immediately succeeding November 30. From and after the occurrence and during the continuance of an Event of Default hereunder, the Letter of Credit Fees shall immediately and without further notice to Borrower increase to an amount equal to two and one-half percent (2.50%) per annum of the Stated Amount (less the amounts drawn under the Letter of Credit which are not reinstated as of the date any Letter of Credit Fee is due) (hereafter, the "Increased Letter of Credit Fee Rate"), which increase in the Letter of Credit Fees shall be in addition to all other rights and remedies of Bank, at law or in equity, or under this Agreement or any of the Related Documents. The additional amount due for the increased Letter of Credit Fee for the period commencing on the date that an Event of Default occurs hereunder through the next occurring November 30 shall be due from Borrower immediately upon Borrower's receipt from Bank of a notice regarding such Event of Default; provided, however, that if Bank determines that Borrower has remedied, or Bank has waived, all Events of Default prior to the next occurring November 30, and Borrower has paid all Letter of Credit Fees then due hereunder, then Bank shall credit to the amount of the next due and owing annual Letter of Credit Fee an amount equal to the difference between the Primary Letter of Credit Fee Rate and the Increased Letter of Credit Fee multiplied by the Stated Amount as of the payment date of the Increased Letter of Credit Fee, with such amount pro-rated for the number of days from and after the cure or waiver of all Events of Default up to and including the next occurring November 30 as compared to the number of days for which such Increased Letter of Credit Fee was charged; provided, further that if such cure or waiver of Events of Default occurs during the last year of the Letter of Credit term, then Bank shall rebate to Borrower the excess fee paid in accordance with the formula in the preceding proviso. Borrower shall also pay to Bank fees upon the payment or negotiation of each draft under any Letter of Credit and upon the occurrence of any other activity with respect to any Letter of Credit (including, without limitation, the transfer, amendment or cancellation of any Letter of Credit) determined in accordance with Bank's standard fees and charges then in effect for such activity. (e) Miscellaneous. Borrower agrees to pay, in lawful currency of the United States and in immediately available funds, all amounts due Bank under this Agreement directly to Bank at the address listed on the signature page hereof until such time as Borrower is notified in writing by Bank of a different address. Subject to Section 4 hereof, Bank shall, and Borrower hereby authorizes Bank to, debit any demand deposit account of Borrower with Bank designated by Borrower in writing for all payments of principal, interest, fees and other payments payable under the Agreement, as they become due. Should, for any reason whatsoever, the funds in any such demand deposit account be insufficient to pay all such sums when due, Borrower shall immediately upon demand remit to Bank the full amount of any such delinquency. If any amount payable under this Agreement shall fall due on a day that is not a Business Day, then such due date shall be extended to the next succeeding Business Day, and interest shall continue to accrue during such extension. Interest and the Letter of Credit Fees payable hereunder (including interest at the Default Rate and the Tender Drawing Rate) shall be computed on the basis of the actual number of days elapsed in a year of 360 days. 8 SECTION 4. REIMBURSEMENT DEPOSIT ACCOUNT; AMORTIZATION PAYMENTS; COLLATERAL; OPTIONAL REDEMPTION OF BONDS. (a) Scheduled Redemptions of Bonds. Borrower covenants to take all necessary action to cause optional redemptions of the Bonds (the "Scheduled Redemptions") pursuant to the Indenture and this Section 4 at a price equal to the principal amount of the Bonds to be redeemed, together with accrued interest to the redemption date, commencing with July 1, 2003 and continuing on each October 1, January 1 and April 1, and July 1 thereafter (each a, "Scheduled Redemption Date") until the earlier to occur of (i) the earliest date on which both no further demands may be made for a Drawing under the Letter of Credit and all amounts due to Bank under this Agreement have been paid in full, or (ii) the Expiration Date, in the principal amounts set forth on Schedule 1, which is attached hereto and incorporated herein by this reference, for such Scheduled Redemption Date. The portion of the principal amount of Bonds to be redeemed on each Scheduled Redemption Date commencing July 1, 2003 and continuing on each Scheduled Redemption Date thereafter shall be the principal amount set forth on Schedule 1 for such Scheduled Redemption Date. Scheduled Redemptions shall be effected by A Drawings and B Drawings under the Letter of Credit. Borrower shall provide Trustee with sixty (60) days prior written notice of any optional redemption of the Bonds to be made in connection with the Scheduled Redemptions, and shall provide Bank a copy of such notice concurrently therewith. The amounts required to reimburse Bank for the draws on the Letter of Credit made in order to accomplish such Scheduled Redemptions shall be deposited into the Reimbursement Deposit Account (as defined below) three (3) Business Days prior to each such Scheduled Redemption Date. (b) Reimbursement Deposit Account. Borrower agrees to open a deposit account with Bank in Borrower's name (the "Reimbursement Deposit Account"), which is hereby pledged to Bank as security for Borrower's performance of its obligations under this Agreement and over which Borrower shall have no control. Borrower agrees to pay all fees and other amounts due to Bank hereunder, directly to Bank by deposit into the Reimbursement Deposit Account established with Bank at the address listed on the signature page hereof. Bank shall, and Borrower hereby authorizes Bank to, debit the Reimbursement Deposit Account and any other demand deposit account of Borrower with Bank designated by Borrower in writing for all payments of principal, interest, the Letter of Credit Fees and any other fees payable under this Agreement, as they become due. Should, for any reason whatsoever, the funds in such demand deposit account be insufficient to pay all such sums when due, Borrower shall immediately upon demand remit to Bank the full amount of any such shortfall. (c) Interest and Letter of Credit Fee Payments. Not later than three (3) Business Days prior to each Interest Payment Date under the Indenture, commencing with the Interest Payment Date for July 1, 2003 and continuing on each Interest Payment Date thereafter until the Expiration Date, Borrower shall deposit into the Reimbursement Deposit Account an amount equal to the amount of the interest payment for the Bonds that Borrower is obligated to make under the Indenture for such Interest Payment Date. The amount deposited by Borrower in the Reimbursement Deposit Account pursuant to this Section 4(c) shall be sufficient to reimburse Bank for each F Drawing which shall be made by the Trustee on each Interest Payment Date. In addition, Borrower agrees to deposit or cause to be deposited into the Reimbursement Deposit Account, or to otherwise pay to Bank pursuant to Bank's instructions (i) on or before the Date of Issuance, the Letter of Credit Fee for the period commencing on the Date of Issuance and continuing up to and including November 30, 2003, and (ii) thereafter annually in advance three (3) Business Days before December 1 of each year thereafter, commencing with November 25, 2003, and continuing up to and including the Expiration Date, the amount necessary to pay when due the annual Letter of Credit Fee. Borrower shall deposit or cause to be deposited into the Reimbursement Deposit Account any additional amounts that Borrower may from time to time owe on account of the Letter of Credit Fees, as further described in Section 3(d) of this Agreement. Notwithstanding the foregoing, Bank shall not be obligated to extend the Expiration Date and may send the notice of termination contemplated 9 by the Letter of Credit and the Letter of Credit will expire on the Expiration Date regardless of whether or not the Letter of Credit Fee has been paid for a period after the Expiration Date. In such event, and within a reasonable period of time after the occurrence of the Expiration Date, Bank shall refund to Borrower the prorated portion of the unused Letter of Credit Fees (if any). (d) Other Optional Redemptions of Bonds. Notwithstanding any contrary provision of this Agreement, any optional redemption of the Bonds under the Indenture, other than the Scheduled Redemptions, shall require the advance written consent of Bank and Bank's receipt of satisfactory evidence of Borrower's ability to reimburse Bank for any Drawing under the Letter of Credit for such redemption. (e) Personal Property Collateral. As collateral for Borrower's performance of its obligations to Bank under this Agreement, Borrower shall grant to Bank a first priority security interest in Borrower's Investment Account No. 14413400 (the "Investment Account"), including, without limitation, all financial assets credited to the Investment Account, all security entitlements with respect to the financial assets credited to the Investment Account, and any and all other investment property or assets maintained or recorded in the Investment Account (whether held in Borrower's name or as a Bank collateral account for the benefit of Borrower) maintained with Wells Fargo Capital Management, the Reimbursement Deposit Account and all replacements or substitutions for either the Investment Account or the Reimbursement Deposit Account, including any accounts resulting from a renumbering or other administrative re-identification thereof (together with the Investment Account and the Reimbursement Deposit Account, the "Collateral"). Borrower hereby represents, warrants and covenants to Bank that the Collateral is, free and clear of liens and encumbrances, other than liens and encumbrances in favor of Bank, and shall continue to remain free and clear of liens and encumbrances through the Termination Date. SECTION 5. ISSUANCE OF THE LETTER OF CREDIT. (a) Agreement of Bank. On the terms set forth in this Agreement and subject to the satisfaction of the conditions set forth in Section 5(b) below on the Date of Issuance, Bank shall issue the Letter of Credit in the Stated Amount effective on the Date of Issuance. (b) Conditions Precedent to Issuance of the Letter of Credit. The obligation of Bank to issue the Letter of Credit is subject to the following conditions precedent: (i) Bank shall have received on or before the Date of Issuance the following, each dated such date and, in form and substance as is satisfactory to Bank and its counsel: (A) Executed security agreements and/or pledge agreements, together with any addendum thereto, each in form and substance satisfactory to Bank, duly executed by Borrower granting to Bank a first priority security interests in the Collateral and Bank Bonds, such agreements to contain such other covenants and agreements as Bank in its sole discretion may require, including, without limitation, covenants not to encumber or dispose of the Collateral (collectively, the "Security Agreements"); (B) Executed securities account control agreement, in form and substance satisfactory to Bank, duly executed by Borrower and an intermediary acceptable to Bank, to perfect Bank's security interest in the Investment Account, such agreement to contain such other covenants and agreements as Bank in its sole discretion may require, including, without limitation, covenants not to encumber or dispose of the Collateral (the "Control Agreement"); 10 (C) An opinion of Foley & Lardner, Bond Counsel (as defined in the Indenture), dated as of the Date of Issuance, in form and substance satisfactory to Bank, opining that the delivery of the Letter of Credit to the Trustee and the transactions contemplated by this Agreement are authorized under and in compliance with the terms of the Indenture and addressing such other matters as Bank may request (the "Bond Counsel Opinion"); (D) An opinion of Gray Cary Ware & Freidenrich LLP, Borrower's counsel, dated as of the Date of Issuance, in form and substance satisfactory to Bank, regarding the due authorization, delivery, execution and enforceability of this Agreement and the Related Documents and addressing such other matters as the Bank may request (the "Borrower's Counsel Opinion" and together with the Bond Counsel Opinion, the "Opinions"); (E) Written evidence from the Rating Agency (as defined in the Indenture) to the effect that such rating agency has reviewed the proposed Letter of Credit and (i) if the Bonds are in a Weekly Interest Rate Period (as defined in the Indenture) or the effective date of such Letter of Credit will be on the first day of a new Term Interest Rate Period (as defined in the Indenture), indicating the prospective rating of the Bonds, and indicating that the Bonds will be rated at least "A", or (ii) if the Bonds are in a Term Interest Rate Period, stating that the delivery of such Letter of Credit will not, in and of itself, result in a lowering or withdrawal of the rating on the Bonds; (F) Acknowledgment copies of proper UCC-1 Financing Statements, if any, duly filed in the office of all jurisdictions as may be necessary or, in the opinion of Bank, desirable and any other evidence that all other actions necessary or, in the opinion of Bank, desirable to perfect and protect the security interests and liens created by the Security Agreements have been taken; (G) Executed copies of: (i) this Agreement; (ii) each of the Related Documents; and (iii) the Opinions; (H) Certificates of the Borrower certifying as to its authority, and as to the incumbency and specimen signatures of its officers, to sign this Agreement and the Related Documents to which it is a party and the other documents to be delivered by Borrower hereunder, upon which Bank may rely until it receives a new such certificate and certified copies of organizational/formation documents of Borrower and each member of Borrower, including, but not limited to Borrower's Certificate of Incorporation and Bylaws; (I) Financial statements of Borrower (signed by an authorized officer of Borrower), including an income and expense statement, a balance sheet, and a statement of cash flow and all footnotes, 10K, annual report and proxy statement; (J) Resolutions from Borrower, authorizing the transactions contemplated by this Agreement and the Related Documents; and (K) Such other documents, instruments, approvals (and, if requested by Bank, certified duplicates of executed copies thereof) or opinions, including opinions of Borrower's legal counsel, as Bank may reasonably request. 11 (ii) The following statements shall be true and correct on the Date of Issuance as they pertain to Borrower, Bank shall have received a certificate signed by Borrower dated the Date of Issuance, stating that: (A) the representations and warranties contained in Section 7 of this Agreement or in any instrument delivered pursuant to or in connection with this Agreement are correct on and as of the Date of Issuance (and after giving effect to the issuance of the Letter of Credit) as though made on and as of such date; (B) no Default or Event of Default has occurred and is continuing, or would result from the issuance of the Letter of Credit; (C) no material adverse change has occurred in the operations or condition (financial or otherwise) of Borrower since the date of the most recent Financial Statements, except as disclosed in writing to Bank, or would result from the issuance of the Letter of Credit; (D) the Collateral Value of the Investment Account shall be not less than the Stated Amount. (iii) on or prior to the Date of Issuance, Bank shall have received reimbursement of Bank's fees and expenses (including outside counsel and allocated in-house counsel legal fees) incurred in connection with this Agreement and the Letter of Credit, together with payment of the Letter of Credit Fee due for the first quarter. SECTION 6. OBLIGATIONS ABSOLUTE. Except as hereinafter provided, the obligations of Borrower under this Agreement shall be absolute, unconditional and irrevocable and shall be paid and performed strictly in accordance with the terms of this Agreement under all circumstances whatsoever, including, without limitation, the following circumstances: (a) any lack of validity or enforceability of the Letter of Credit or any of the Related Documents except if such lack of validity or enforceability results from Bank's gross negligence or willful misconduct; (b) any amendment or waiver of, or any consent to this Agreement or any Related Documents; (c) the existence of any claim, set-off, defense or other rights which Borrower may have at any time against Trustee, any beneficiary or any transferee of the Letter of Credit (or any Person for whom Trustee, any such beneficiary or any such transferee may be acting), Bank or any other Person, whether in connection with this Agreement, the Related Documents or any unrelated transaction; provided that nothing in this Section 6 shall prevent the assertion of any such claim by separate suit or counterclaim; (d) any statement in any certificate or any other document presented under the Letter of Credit proving to be forged, fraudulent or invalid in any respect or any statement therein being untrue or inaccurate in any respect whatsoever; (e) payment by Bank under the Letter of Credit against presentation of a draft or certificate which does not comply with the terms of the Letter of Credit except if such payment constitutes the gross negligence or willful misconduct of Bank; 12 (f) any notice of nonrenewal of the Letter of Credit sent by Bank to Trustee not being received on time or at any time by Trustee; (g) any other circumstance or happening whatsoever, whether or not similar to any of the foregoing, other than resulting from Bank's gross negligence or willful misconduct; (h) any delay, extension of time, renewal, compromise or other indulgence agreed to by Bank, without notice to or approval of Borrower in respect to any of Borrower's indebtedness to Bank under this Agreement; or (i) any exchange, release or nonperfection of any lien or security interest in any collateral pledged or otherwise provided to secure any of the obligations contemplated herein or in any of the other Related Documents. SECTION 7. REPRESENTATIONS AND WARRANTIES. Borrower makes the following representations and warranties to Bank, which representations and warranties shall survive the execution of this Agreement and shall continue in full force and effect until the full and final payment, and satisfaction and discharge, of all obligations of Borrower to Bank subject to this Agreement: (a) Authority/Enforceability. Borrower is in compliance with all laws and regulations applicable to its organization, existence and transaction of business and has all necessary rights and powers to carry on its business as now conducted. (b) Binding Obligations. Borrower is authorized to execute, deliver and perform its obligations under this Agreement and the Related Documents, and such obligations shall be valid and binding obligations of Borrower. (c) Legal Status/Formation and Organizational Documents. Borrower is a corporation validly existing and in good standing under the laws of the State of Delaware, and is qualified or licensed to do business in all jurisdictions in which such qualification or licensing is required or in which the failure to so qualify or to be so licensed could have a material adverse effect on Borrower. Borrower has delivered to Bank all formation and organizational documents of Borrower, and all such formation and organizational documents remain in full force and effect and have not been amended or modified since they were delivered to Bank. Borrower shall immediately provide Bank with copies of any amendments or modifications of the formation or organizational documents. (d) Approvals. No further approval, authorization, consent, order, notice to or filing or registration with any governmental authority or any public board or body (other than in connection or in compliance with the provisions of the securities or "blue sky" laws of any jurisdiction which were not required on or prior to the Date of Issuance) is legally required with respect to Borrower's participation in the issuance of the Bonds and the performance by Borrower of this Agreement and the Related Documents to which it is a party. 13 (e) No Violation. Borrower's execution, delivery, and performance under this Agreement and the Related Documents do not: (a) require any consent or approval not heretofore obtained under any certificate of incorporation, bylaws or other document; (b) violate any governmental requirement applicable to the Borrower or any other statute, law, regulation or ordinance or any order or ruling of any court or governmental entity; (c) conflict with, or constitute a breach or default or permit the acceleration of obligations under any agreement, contract, lease, or other document by which the Borrower is bound or regulated; or (d) violate any statute, law, regulation or ordinance, or any order of any court or governmental entity. (f) Disclosure of Information. There are no facts that Borrower has failed to disclose to Bank that, individually or in the aggregate, could have a materially adverse effect on Borrower's ability to perform its obligations under any of the Related Documents. Each of the representations and warranties shall survive any investigations or inquiries made by Bank or any of its representatives. (g) Litigation. Except as disclosed to Bank in writing, there are no claims, actions, suits, or proceedings pending, or to Borrower's knowledge threatened, against Borrower. (h) Financial Condition. All financial statements and information heretofore and hereafter delivered to Bank by Borrower, including, without limitation, information relating to the financial condition of Borrower, fairly and accurately represent the financial condition of the subject thereof and have been prepared (except as noted therein) in accordance with generally accepted accounting principles consistently applied. Borrower acknowledges and agrees that Bank may request and obtain additional information from third parties regarding any of the above, including, without limitation, credit reports. There has been no material adverse change in the financial condition of Borrower since the dates of the latest financial statements furnished to Bank and, except as otherwise disclosed to Bank in writing, Borrower has not entered into any material transaction which is not disclosed in such financial statements. (i) Bond Proceeds. All of the proceeds received from the sale of the Bonds have been fully disbursed and used by Borrower to finance costs and expenses incurred in connection with the Project. (j) Accuracy. All reports, documents, instruments, information and forms of evidence delivered to Bank concerning or required by this Agreement or the Related Documents are accurate, correct and sufficiently complete to give Bank true and accurate knowledge of their subject matter, and do not contain any misrepresentation or omission. (k) Tax Liability. Borrower has filed all required federal, state, county and municipal tax returns and has paid all taxes and assessments owed and payable, and Borrower has no knowledge of any basis for any additional payment with respect to any such taxes and assessments. (l) Government Regulations. Borrower is not subject to regulation under the Investment Company Act of 1940, the Federal Power Act, the Interstate Act, the Public Utility Holding Company Act of 1935 or any federal or state statute or regulation limiting its ability to incur indebtedness for money borrowed. (m) Securities Activities. Borrower is not engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying any margin stock (as defined within Regulations G, T and U of the Board of Governors of the Federal Reserve System), and not more than twenty-five percent (25%) of the value of Borrower's assets consists of such margin stock. (n) Environmental Matters. Except as disclosed by Borrower to Bank in writing prior to the date hereof, Borrower is in compliance in all material respects with all applicable federal or state environmental, hazardous waste, health and safety statutes, and any rules or regulations adopted pursuant 14 thereto, which govern or affect any of Borrower's operations and/or properties, including, without limitation, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, the Superfund Amendments and Reauthorization Act of 1986, the Federal Resource Conservation and Recovery Act of 1976, and the Federal Toxic Substances Control Act, as any of the same may be amended, modified or supplemented from time to time. None of the operations of Borrower is the subject of any active federal or state investigation evaluating whether any remedial action involving a material expenditure is needed to respond to a release of any toxic or hazardous waste or substance into the environment. Borrower does not have material contingent liability in connection with any release of any toxic or hazardous waste or substance into the environment. (o) Related Documents. Borrower makes the representations and warranties made by it in the Related Documents as if the same were set forth in this Agreement. (p) ERISA. Borrower is in compliance in all material respects with all applicable provisions of the Employee Retirement Income Security Act of 1974, as amended or recodified from time to time ("ERISA"); Borrower has not violated any provision of any defined employee pension benefit plan (as defined in ERISA) maintained or contributed to by Borrower (each, a "Plan"); no Reportable Event as defined in ERISA has occurred and is continuing with respect to any Plan initiated by Borrower; Borrower has met its minimum funding requirements under ERISA with respect to each Plan; and each Plan will be able to fulfill its benefit obligations as they come due in accordance with the Plan documents and under generally accepted accounting principles (q) Other Obligations. Borrower is not in default on any obligation for borrowed money, any purchase money obligation or any other material lease, commitment, contract, instrument or obligation. SECTION 8. COVENANTS OF BORROWER. So long as the Termination Date has not occurred or any amount is due or owing to Bank hereunder, Borrower agrees that it will comply with the following covenants: (a) Reporting Requirements. Borrower will deliver, in form and detail satisfactory to Bank and consistent with GAAP: (i) not later than one hundred twenty (120) days after and as of each fiscal year end of Borrower, an audited and consolidated financial statement of Borrower, prepared by an independent certified public accountant acceptable to Bank, to include a balance sheet, an income statement, a statement of cash flow, together with all supporting schedules and footnotes, Borrower's 10K, Borrower's annual report and proxy statement; and (ii) not later than forty-five (45) days after and as of the end of each fiscal quarter end of Borrower, consolidated financial statements of Borrower, prepared by Borrower, to include a balance sheet, an income statement and Borrower's 10Q. (b) Collateral Value. The Collateral Value of the Investment Account shall at all times be equal to or greater than one hundred percent (100%) of the Stated Amount. In the event the Collateral Value, for any reason and at any time, is less than the required amount, Borrower shall promptly deposit additional assets of a nature satisfactory to Bank into the Investment Account in amounts sufficient to achieve the required Collateral Value. (c) ERISA Compliance. Borrower shall at all times comply with the provisions of ERISA with respect to any retirement or other employee benefit plan to which it is a party as employer, and as soon as possible after Borrower knows, or has reason to know, that any Reportable Event (as defined in ERISA) with respect to any such plan of Borrower has occurred, it shall furnish to Bank a written 15 statement setting forth details as to such Reportable Event and the action, if any, which Borrower proposes to take with respect thereto, together with a copy of the notice of such Reportable Event furnished to the Pension Benefit Guaranty Corporation. (d) Further Assurances. Upon Bank's request and at Borrower's sole cost and expense, Borrower shall execute, acknowledge and deliver any other instruments and perform any other acts necessary, desirable or proper, as determined by Bank, to carry out the purposes of this Agreement and the Related Documents or to perfect and preserve any liens created by this Agreement or the Related Documents. (e) Conduct of Business and Maintenance of Existence. Borrower will preserve, renew and keep in full force and effect all rights, privileges, contracts and leases necessary or desirable for the normal conduct of its business. Borrower will also continue to conduct its business in an orderly manner without voluntary interruption and remain qualified to do business in the States of Delaware and California and in each other jurisdiction where such qualification is required. (f) Compliance with Laws. Borrower will comply, in all material respects, with all applicable laws, ordinances, rules, regulations, and requirements of governmental authorities except where the necessity of compliance therewith is contested in good faith by appropriate proceedings; provided, however, that the foregoing shall not require compliance with any such law, ordinance, rule, regulation and/or requirement so long as failure to comply shall not have a material adverse effect on the condition of Borrower its ability to perform their obligations under this Agreement and the Related Documents. (g) Inspection of Property, Books and Records. Borrower will keep proper books of record and account in which full, true and correct entries shall be made of all dealings and transactions in relation to their business and activities. Borrower will permit representatives of Bank at reasonable times and intervals upon prior written notice to visit and inspect any of Borrower's properties, books and records, to examine and make copies of, subject to proprietary and confidentiality policies and agreements binding upon Borrower, of any books and records, and to discuss its affairs, finances and accounts with its employees and independent public accountants, all at such reasonable times and as often as may reasonably be desired. (h) Notices. Borrower will promptly give written notice to Bank of the occurrence of any Default or Event of Default at the earliest possible date after discovery of such Default or Event of Default, but in any event no later than three (3) Business Days following discovery of a Default or Event of Default relating to payment obligations of Borrower, and five (5) Business Days following discovery of any other Default or Event of Default, signed by Borrower setting forth the details of, and the actions which Borrower proposes to take with respect to, such Default or Event of Default. Borrower will also promptly give notice to Bank of any pending or threatened action, suit or proceeding with a claim against Borrower in excess of $250,000.00, or of any other action, suit or proceeding with a claim in any amount, which could materially and adversely affect the operations or the conditions (financial or otherwise) of Borrower. (i) Related Documents. Borrower will comply with the terms and covenants of the Related Documents to which it is a party. Borrower will not amend, modify or terminate or agree to amend, modify or terminate any Related Documents other than as otherwise set forth therein. (j) Taxes and Other Liabilities. Borrower shall pay and discharge when due any and all indebtedness, obligations, assessments and taxes, both real and personal and including federal and state income taxes, except such as Borrower may in good faith contest or as to which a bona fide dispute may 16 arise, provided provision is made to the satisfaction of Bank for eventual payment thereof in the event that it is found that the same is an obligation of Borrower. (k) Maintenance of Property; Insurance. Borrower will keep all property useful and necessary in its business in reasonably good working order and condition and will, except to the extent tenants are required to do so, maintain, with financially sound and reputable insurance companies, insurance on all its property of the types, in the amounts and against such risks as are usually insured against in the same general area by companies of established repute engaged in the same or a similar business, including, but not limited to, fire, extended coverage, public liability, property damage and workers' compensation, and will deliver to Bank from time to time at Bank's request schedules setting forth all insurance then in effect. SECTION 9. EVENTS OF DEFAULT. The occurrence of any of the following shall constitute an "Event of Default" under this Agreement: (a) Required Payments. Borrower shall fail to pay when due any amount specified under this Agreement or any Related Document or to deposit with Bank any amount specified in this Agreement when due to be deposited; or (b) Misrepresentation. Any representation or warranty made by Borrower in this Agreement or in any Related Document or in any certificate, financial or other statement furnished by Borrower pursuant to this Agreement shall prove to have been untrue or incomplete in any material respect when made; or (c) Other Covenants. Borrower shall fail to perform or observe any material term, covenant or agreement on its part to be performed or observed hereunder or under the Security Agreements (other than as specified in paragraphs (a) and (b) above); provided, however, that if a cure period is provided for the remedy of such failure, Borrower's failure to perform will not constitute an Event of Default until such date as the specified cure period expires; or (d) Collateral. (i) Any impairment of the rights of Bank in any Collateral or Proceeds, including, without limitation, any attachment or like levy on any Collateral or Proceeds; or (ii) Bank, in good faith, believes any or all of the Collateral and/or Proceeds to be in danger of misuse, dissipation, commingling, loss, theft, damage or destruction, or otherwise in jeopardy or unsatisfactory in character or value. (e) Invalidity. Any material provision of this Agreement or any Related Document shall at any time for any reason cease to be in full force and effect or valid and binding on Borrower, or shall be declared to be null and void, or the validity or enforceability thereof shall be contested by Borrower, or Borrower shall deny that it has any further liability or obligation under this Agreement or any Related Document, and such event shall have or be likely to have a material adverse effect on the condition of Borrower and its ability to perform its obligations under this Agreement and the Related Documents; or (f) Voluntary Bankruptcy; Insolvency; Dissolution. Borrower shall: (i) apply for or consent to the appointment of a receiver, trustee, custodian, liquidator or the like of Borrower or any of its property; or (ii) admit in writing its inability to pay its debts generally as they become due; or (iii) make a general assignment for the benefit of creditors, (iv) be adjudicated a bankrupt or insolvent; or (v) commence a voluntary case under the Bankruptcy Code or file a voluntary petition or answer seeking reorganization, an arrangement with creditors or an order for relief or seeking to take advantage of any insolvency law or file an answer admitting the material allegations of a petition filed against it in any bankruptcy, reorganization or insolvency proceeding; or (vi) shall take any corporate action for the purpose of effecting any of the foregoing; or 17 (g) Involuntary Bankruptcy. If without the application, approval or consent of Borrower, an involuntary case or other proceeding shall be instituted in any court of competent jurisdiction, under the Bankruptcy Code or any law relating to bankruptcy, insolvency, reorganization, or relief of debtors seeking in respect of Borrower, an order for relief or an adjudication in bankruptcy, reorganization, dissolution, winding-up, liquidation, a composition or arrangement with creditors, a readjustment of debts, the appointment of a trustee, receiver, liquidator or custodian or the like of Borrower, or of all or any substantial part of the assets of Borrower, or other like relief in respect thereof under any bankruptcy or insolvency law; or (h) Other Defaults. (i) Borrower shall default in the payment or performance of any tax liability, provided, however, such default in the payment or performance of any tax liability in which Borrower may in good faith contest or as to which a bona fide dispute has arisen shall not constitute a default under this Section 9(h), provided Borrower has made provision satisfactory to Bank for eventual payment thereof if it is determined that the same is an obligation of Borrower; or (ii) Borrower shall default in any obligation under any Related Document; or (iii) any defined event of default occurs under any Related Document; or (iv) Borrower (A) fails to make any payment when due (whether by scheduled maturity, acceleration or otherwise) in respect of any indebtedness, whether direct or contingent (other than indebtedness under this Agreement) having an aggregate principal amount (including undrawn committed or available amounts and including amounts owing to all creditors under any combined or syndicated credit arrangement) of more than $500,000, or (B) fails to observe or perform any other agreement or condition relating to any such indebtedness or contained in any instrument or agreement evidencing, securing or relating thereto, or any other event occurs, the effect of which default or other event is to cause, or to permit any holder of such indebtedness (or a trustee or agent on behalf of such holder or beneficiary) to cause such indebtedness to be demanded or to become due or to be repurchased or redeemed prior to its stated maturity and, with respect to any failure under Section 9(h)(iv), such failure remains unremedied for a period of fifteen (15) calendar days; or (i) Material Adverse Change. There shall exist or occur any event or condition which Bank reasonably and in good faith believes impairs or is substantially likely to impair the prospect of payment or performance by Borrower of its obligations under this Agreement or the Related Documents; or (j) Change in Business. Borrower suspends the transaction of its usual business or is no longer listed on the NASDAQ stock market; provided, however, that if the sole reason Borrower is no longer listed on the NASDAQ stock market is due to the acquisition of all of Borrower's outstanding stock in a going private transaction, then such listing change shall not constitute an Event of Default. SECTION 10. REMEDIES. Upon the occurrence of an Event of Default, Bank may, and upon the occurrence of an Event of Default for which Bank has received a notice from Trustee that an event of default has occurred under the Indenture and such default is not cured by Borrower within the applicable time period, Bank shall, declare all amounts payable by Borrower under this Agreement to be immediately due and payable (and the same shall upon such notice become immediately due and payable), in each case without any presentment, demand, protest or other notice or formality of any kind. Upon any such occurrence, Bank may, in addition, (a) exercise all of its rights and remedies under any Related Document (to which Bank is a party or Bank is a third party beneficiary) or applicable law, (b) require Trustee to redeem all Bonds as provided in the Indenture, or (c) exercise all or any combination of the remedies provided for in this Section. SECTION 11. AMENDMENTS, ETC. No amendment or waiver of any provision of this Agreement nor consent to any departure by Borrower therefrom shall in any event be effective unless the same shall be in writing and signed by Bank, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. 18 SECTION 12. NOTICES. Except as expressly provided for herein, all notices and other communications provided for hereunder and in the Security Agreements shall be in writing (including tested telex, telegraphic and facsimile communication) and mailed, telegraphed, telexed, faxed or delivered to each party at the address or telex or facsimile number specified for such party on the signature page of this Agreement, or at such other address or telex or facsimile number as shall be designated by such party in a written notice to the other party. All such notices and other communications shall, when mailed, telegraphed or faxed, be effective when received addressed as aforesaid, if telexed, when the appropriate answer back is received, and if faxed, when confirmation of receipt is received. Communications by Trustee with Bank with respect to the Letter of Credit shall be made as provided in the Letter of Credit. Any tested telex, telegraphic or facsimile communication provided to Bank hereunder shall be promptly followed by a written confirmation thereof. SECTION 13. NO WAIVER; REMEDIES. No failure on the part of Bank to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof; nor shall any single or partial exercise of any right hereunder preclude any other further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law. SECTION 14. RIGHT OF SET-OFF; WAIVER OF RIGHT OF SET-OFF. Upon the occurrence and during the continuance of any Event of Default, Bank is hereby authorized at any time and from time to time, without notice to Borrower (any such notice being expressly waived by Borrower), to set-off and apply any and all deposits (general or special, time or demand, provisional or final, including, but not limited to, indebtedness evidenced by certificates of deposit, whether matured or unmatured, but not including trust accounts) at any time held and other indebtedness at any time owing by Bank to or for the credit or the account of Borrower against any and all of the obligations of Borrower now or hereafter existing under this Agreement, irrespective of whether or not Bank shall have made any demand under this Agreement and although such obligations may be contingent and unmatured. Bank agrees promptly to notify Borrower after any such set-off and application, provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of Bank under this Section are in addition to other rights and remedies which Bank may have including, without limitation, other rights of set-off; provided, however, that Bank waives any such right, and any other similar right it may have at law or otherwise, during the pendency of any bankruptcy, insolvency, reorganization, arrangement, readjustment of debt, dissolution, liquidation, or similar proceedings against Borrower under the laws of any jurisdiction, to the extent that the exercise of such rights during the pendency of such proceedings would result in Bank's being released, prevented or restrained from or delayed in fulfilling Bank's obligations with respect to the Letter of Credit, as provided herein. SECTION 15. INDEMNIFICATION. In addition to its other obligations hereunder, Borrower hereby agrees, to the fullest extent permitted by law, to indemnify and hold harmless Bank, its officers, directors, employees and agents (collectively, the "Indemnitees") from and against any and all claims, damages, losses, liabilities, costs or expenses (collectively "Claims") (including attorneys' fees) whatsoever which the Indemnitees may incur (or which may be claimed against the Indemnitees by any Person) by reason of or in connection with (a) any failure by Borrower to comply with applicable federal and state laws and regulations, including, without limitation, any such laws and regulations pertaining to the Bonds and the Related Documents; (b) any breach by Borrower of any representation, warranty or covenant made in or pursuant to this Agreement; (c) any action by Bank upon, in accordance with or as a result of receiving a Facsimile Demand (as defined below), whether such Facsimile Demand was received by Bank prior to or after the Expiration Date of the Letter of Credit; or (d) any action or proceeding relating to a court order, injunction or other process or decree restraining or seeking to restrain Bank from paying any amount under the Letter of Credit. Nothing in this Section 15 is intended to limit any 19 obligation of Borrower contained in this Agreement or to include any Claims caused by Bank's gross negligence or willful misconduct. If any action shall be brought against Bank or any other Indemnitee in respect of which indemnity may be sought against Borrower, Bank shall promptly notify Borrower in writing, and Borrower shall promptly assume the defense thereof, including the employment of counsel (the selection of which shall have been approved by Bank), the payment of all expenses and the right to negotiate and consent to settlement. In addition, Bank shall have the right at Borrower's expense to employ separate counsel and to participate in the defense of any such action if Bank has been advised by counsel of recognized standing in matters of banking or securities laws that it has defenses or causes of action separate from those of Borrower. If Borrower elects not to defend such action, Bank shall have the right to employ counsel to defend such action and to participate in the defense thereof, and the fees and expenses of such counsel shall be at the expense of Borrower. Borrower shall not be liable for any settlement of any such action effected without its consent by Bank, but if settled with the consent of Borrower or if there be a final judgment for the plaintiff in any such action against Borrower or Bank, with or without the consent of Borrower, Borrower agrees to indemnify and hold harmless Bank to the extent provided herein. SECTION 16. CONTINUING OBLIGATION. The obligation of Borrower under this Agreement shall continue until the Termination Date and shall (i) be binding upon Borrower and Bank, their successors and assigns, and (ii) inure to the benefit of and be enforceable by Bank and Borrower and their successors and assigns. Notwithstanding the foregoing, the indemnities set forth in Section 15 hereof shall survive the termination of this Agreement. SECTION 17. TRANSFER OF LETTER OF CREDIT. The Letter of Credit may be transferred in accordance with the provisions set forth therein and in the Indenture. All fees and costs incurred in connection with any transfer of the Letter of Credit shall be for the account of Borrower. SECTION 18. LIABILITY OF BANK. As between Borrower and Bank, Borrower assumes all risk of the acts or omissions of the Trustee and any transferee of the Letter of Credit with respect to its use of the Letter of Credit; provided, however, that this assumption is not intended to, and shall not, preclude Borrower from pursuing such rights and remedies as they may have against Trustee at law or in equity or under any other agreement; unless any such act or omission is the result of Bank's willful misconduct or gross negligence. 20 SECTION 19. COSTS, EXPENSES, ATTORNEYS' FEES AND TAXES; ALLOCATION OF INCREASED COSTS. (a) Costs, Expenses, Attorneys' Fees and Taxes. Borrower agrees to pay on demand by Bank all costs, expenses and attorneys' fees incurred or assessed by Bank in connection with the preparation, execution and delivery of this Agreement, the Letter of Credit (including any extensions thereof), any Related Document and any other documents, agreements or certificates which may be delivered in connection with this Agreement, the Letter of Credit and any Related Document, any waiver or amendment or the giving of any consent under, this Agreement, the Related Documents and such instruments or any transfer of the Letter of Credit, including, without limitation, the fees and out-of-pocket expenses of counsel for Bank (to include outside counsel fees and all allocated costs of Bank's in-house counsel) with respect thereto and with respect to advising Bank as to its rights and responsibilities under this Agreement, all costs and expenses, including the fees and out-of-pocket expenses of counsel for Bank (to include outside counsel fees and all allocated costs of Bank's in-house counsel), if any, in connection with the enforcement of this Agreement and such other documents which may be delivered in connection with this Agreement or the defense of any provision of this Agreement, any of the other Related Documents, or as a consequence of any Default or Event of Default under the Related Documents, with or without the filing of any legal action or proceeding, and including, without limitation, any fees and expenses incurred in any bankruptcy proceeding of the Borrower, together with interest thereon from the date of such demand until paid at the Default Rate. In addition, Borrower shall pay any and all stamp and other taxes and fees payable or determined to be payable in connection with the execution, delivery, filing and recording of this Agreement, the Letter of Credit, the Related Documents and such other documents and agrees to save Bank harmless from and against any an all liabilities with respect to or resulting from any delay by Borrower in paying or omitting to pay such taxes and fees. Bank agrees promptly to notify Borrower of any such taxes and fees which are incurred by Bank. (b) Allocation of Increased Costs. If any past, present or future legislative, administrative or judicial action has the direct or indirect effect of imposing upon Bank any requirement or condition regarding this Agreement, the Letter of Credit, or any Related Document that directly or indirectly increases the cost to Bank of issuing, maintaining or honoring draws under the Letter of Credit, over the cost thereof as of the date of this Agreement, Bank shall so notify Borrower and Borrower shall pay to Bank on or before the due date or dates specified in Bank's notice all additional amounts necessary to compensate Bank for such additional costs. Bank shall deliver to Borrower a certificate showing the amount and manner of calculation of such increased costs, and stating that the assessment of such increase in costs is fair and reasonable and has not been arbitrarily applied to Borrower. Such certificate shall be conclusive (absent manifest error) as to such amount. Without limiting the generality of the foregoing, if (a) any insurance premium is imposed by the Federal Deposit Insurance Corporation or other similar banking authority in connection with the Letter of Credit, (b) any reserve requirement is imposed by any banking authority in connection with the Letter of Credit, or (c) any capital adequacy requirement not currently in effect is imposed by any banking authority which has the effect of reducing the anticipated return on capital of Bank in connection with the Letter of Credit, then the cost to Bank of such premium, reserve requirement and/or capital adequacy requirement shall be payable by Borrower as an additional cost in accordance with this Section. SECTION 20. NO THIRD PARTY BENEFICIARIES. This Agreement is made and entered into for the sole protection and benefit of the parties hereto and their respective permitted successors and assigns, and no other person or entity shall be a third party beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Agreement or any other of the Related Documents to which it is not a party. 21 SECTION 21. TIME. Time is of the essence of each and every provision of this Agreement and each other of the Related Documents. SECTION 22. SEVERABILITY. Any provision of this Agreement which is prohibited, unenforceable or not authorized in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition, unenforceability or nonauthorization without invalidating the remaining provisions hereof or affecting the validity, enforceability or legality of such provision in any other jurisdiction. SECTION 23. SUCCESSORS, ASSIGNMENT. This Agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties; provided, however, that Borrower may not assign or transfer its interest hereunder without Bank's prior written consent. Bank reserves the right to sell, assign, transfer, negotiate or grant participations in all or any part of, or any interest in, Bank's rights and benefits under this Agreement and each of the Related Documents. In connection therewith, Bank may disclose, subject to Section 24 herein, all documents and information which Bank now has or may hereafter acquire relating to any credit subject hereto, Borrower or its business or any collateral required hereunder. SECTION 24. CONFIDENTIALITY. Bank agrees to maintain the confidentiality of the Information (as defined below), except that Information may be disclosed: (a) to its and its Affiliates' directors, officers, employees and agents, including accountants, legal counsel and other advisors (it being understood that the Persons to whom such disclosure is made will be informed of the confidential nature of such Information and instructed to keep such Information confidential); (b) to the extent requested by any regulatory authority; (c) to the extent required by applicable laws or regulations or by any subpoena or similar legal process; (d) to any other party to this Agreement or any other Related Document; (e) in connection with the exercise of any remedies hereunder or under any Related Document or any suit, action or proceeding relating to this Agreement or any Related Document or the enforcement of rights hereunder or thereunder; (f) subject to an agreement containing provisions substantially the same as those of this section, to (i) any Transferee, or any prospective Transferee of, any of its rights or obligations under this Agreement or any Related Document or (ii) any direct or indirect contractual counterparty or prospective counterparty (or such contractual counterparty's or prospective counterparty's professional advisor) to any credit derivative transaction relating to obligations of Borrower; (g) with the consent of Borrower; (h) to the extent such Information (i) becomes publicly available other than as a result of a breach of this section or (ii) becomes available to Bank on a non-confidential basis from a source other than Borrower; provided, however, that Bank may not disclose such information to the extent that it has become available to Bank under this Section 24(h)(ii) if such source has violated a confidentiality agreement with Borrower and Bank has actual knowledge of the violation of such agreement; or (i) to the National Association of Insurance Commissioners or any other similar organization or any nationally recognized rating agency that requires access to information about Bank's or its Affiliates' investment portfolio in connection with ratings issued with respect to Bank or its Affiliates. In addition, Bank may disclose the existence of this Agreement and the other Related Documents and information about this Agreement and the other Related Documents to market data collectors, similar service providers to the lending industry, and service providers to Bank in connection with the administration and management of the Letter of Credit, this Agreement and the other Related Documents. For the purposes of this section, "Information" means all information received from Borrower relating to Borrower or its business, other than any such information that is available to Bank on a non-confidential basis prior to disclosure by Borrower; provided that, in the case of information received from Borrower after the date hereof, such information is clearly identified in writing at the time of delivery as confidential. Any Person required to maintain the confidentiality of Information as provided in this section shall be considered to have complied with its obligation to do so if such Person has exercised the same degree of care to maintain the confidentiality of such Information as such Person would accord to its own confidential information. 22 SECTION 25. GOVERNING LAW. This Agreement shall be governed by, and construed in accordance with, the laws of the State of California, without giving effect to conflicts of law principles. Unless Bank otherwise specifically agrees in writing, the Letter of Credit, even if it is not a documentary credit, the opening of the Letter of Credit, the performance by Bank under the Letter of Credit, and the performance by the beneficiary and any advising, confirming, negotiating, paying or other bank under the Letter of Credit, shall be governed by and be construed in accordance with the UCP in force on the Date of Issuance of the Letter of Credit. SECTION 26. CONSENT OF JURISDICTION AND VENUE, ETC. (a) Borrower irrevocably (i) agrees that any suit, action or other legal proceeding arising out of or relating to this Agreement or such other documents which may be delivered in connection with this Agreement may be brought in a court of record in the State of California or in the Courts of the United States of America located in the State of California, (ii) consents to the jurisdiction of each such court in any such suit, action or proceeding, and (iii) waives any objection which it may have to the laying of venue of any suit, action or proceeding in any of such courts and any claim that any such suit, action or proceeding has been brought in an inconvenient forum. Borrower irrevocably consents to the service of any and all process in any such suit, action or proceeding by mailing of copies of such process to Borrower at its addresses specified on the signature page hereto by certified mail, return receipt requested. Borrower agrees that a final and non-appealable judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. (b) Nothing in this Section shall affect the right of Bank to serve legal process in any other manner permitted by law or affect the right of Bank to bring any suit, action or proceeding against Borrower or its property in the courts of any other jurisdictions. SECTION 27. HEADINGS. Section headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose. SECTION 28. SATISFACTION REQUIREMENT. If any agreement, certificate or other writing, or any action taken or to be taken, is by the terms of this Agreement required to be satisfactory to Bank, the determination of such satisfaction shall be made by Bank in its sole and exclusive judgment. SECTION 29. COUNTERPARTS. This Agreement may be signed in any number of counterparts, each of which shall be an original with the same effect as if the signatures thereto and hereto were upon the same instrument. Delivery of an executed counterpart of a signature page to this Agreement or any of the Related Documents by facsimile shall be as effective as delivery of a manually executed counterpart of this Agreement or such Related Document, as applicable. SECTION 30. RIGHTS AND REMEDIES CUMULATIVE. All rights and remedies of Bank under this Agreement are in addition to all rights and remedies of Bank as a bondholder under the Indenture. SECTION 31. BANK RELIANCE. It is specifically understood by Borrower that all statements, representations and warranties made by Borrower in this Agreement and any other Related Document to which any Borrower is a party shall be deemed to have been relied upon by Bank as an inducement to enter into this Agreement and the other agreements contemplated hereby and that if any such statements, representations and warranties were materially incorrect at the time they were made, Bank may consider any such misrepresentation or breach an Event of Default hereunder. Each of the 23 representations and warranties shall survive any investigations or inquiries made by Bank or any of its representatives. SECTION 32. PERMITTED CONTESTS. Borrower shall have the right, before any delinquency occurs, to contest or object in good faith to any claim, demand, levy or assessment (other than in respect of any indebtedness or obligation of Borrower under any of the Related Documents), by appropriate legal proceedings which are not prejudicial to Bank's rights, but this shall not be deemed or construed as in any way relieving, modifying or providing any extension of time with respect to Borrower's covenant to pay and comply with any such claim, demand, levy or assessment, unless Borrower shall have given prior written notice to Bank of Borrower's intent to so contest or object thereto, and unless (i) Borrower shall have demonstrated to Bank's satisfaction that such legal proceedings shall conclusively operate to prevent enforcement prior to final determination of such proceedings, and (ii) Borrower shall have furnished such bond, surety, undertaking, or other security in connection therewith as is requested by and satisfactory to Bank, in the amount of such claim plus reasonable sums to pay costs, interest and penalties, to assure payment of the matters under contest and to prevent any sale or forfeiture of the Project. SECTION 33. ARBITRATION. (a) Arbitration. Upon the demand of any party, any dispute shall be resolved by binding arbitration (except as set forth in Sections 33(e) and (f) below) in accordance with the terms of this Agreement. A "Dispute" shall mean any action, dispute, claim or controversy of any kind, whether in contract or tort, statutory or common law, legal or equitable, now existing or hereafter arising under or in connection with, or in any way pertaining to, this Agreement or any of the Related Documents and each other document, contract and instrument required hereby or thereby or now or hereafter delivered to Bank in connection herewith or therewith, or any past, present or future extensions of credit and other activities, transactions or obligations of any kind related directly or indirectly to any of the foregoing documents, including, without limitation, any of the foregoing arising in connection with the exercise of any self-help, ancillary or other remedies pursuant to any of the foregoing documents. Any party may by summary proceedings bring an action in court to compel arbitration of a Dispute. Any party who fails or refuses to submit to arbitration following a lawful demand by any other party shall bear all costs and expenses incurred by such other party in compelling arbitration of any Dispute. (b) Governing Rules. Arbitration proceedings shall be administered by the American Arbitration Association ("AAA") or such other administrator as the parties shall mutually agree upon in accordance with the AAA Commercial Arbitration Rules. All Disputes submitted to arbitration shall be resolved in accordance with the Federal Arbitration Act (Title 9 of the United States Code), notwithstanding any conflicting choice of law provision in any of the foregoing documents. The arbitration shall be conducted at a location in California selected by the AAA or other administrator. If there is any inconsistency between the terms hereof and any such rules, the terms and procedures set forth herein shall control. All statutes of limitation applicable to any Dispute shall apply to any arbitration proceeding. All discovery activities shall be expressly limited to matters directly relevant to the Dispute being arbitrated. Judgment upon any award rendered in an arbitration may be entered in any court having jurisdiction; provided, however, that nothing contained herein shall be deemed to be a waiver by any party that is a bank of the protections afforded to it under Section 91 of Title 12 of the United States Code or any similar applicable state law. (c) No Waiver; Provisional Remedies, Self-Help and Foreclosure. No provision hereof shall limit the right of any party to exercise self-help remedies such as sotoff, foreclosure against or sale of any real or personal property collateral or security, or to obtain provisional or ancillary remedies, including, 24 without limitation, injunctive relief, sequestration, attachment, garnishment or the appointment of a receiver from a court of competent jurisdiction before, after or during the pendency of any arbitration or other proceeding. The exercise of any such remedy shall not waive the right of any party to compel arbitration or reference hereunder. (d) Arbitrator Qualifications and Powers; Awards. Arbitrators must be active members of the California State Bar or retired judges of the state or federal judiciary of California, with expertise in the substantive law applicable to the subject matter of the Dispute. Arbitrators are empowered to resolve Disputes by summary rulings in response to motions filed prior to the final arbitration hearing. Arbitrators (i) shall resolve all Disputes in accordance with the substantive law of the State of California, (ii) may grant any remedy or relief that a court of the State of California could order or grant within the scope hereof and such ancillary relief as is necessary to make effective any award, and (iii) shall have the power to award recovery of all costs and fees, to impose sanctions and to take such other actions as they deem necessary to the same extent a judge could pursuant to the Federal Rules of Civil Procedure, the California Rules of Civil Procedure or other applicable law. Any Dispute in which the amount in controversy is $5,000,000 or less shall be decided by a single arbitrator who shall not render an award of greater than $5,000,000 (including damages, costs, fees and expenses). By submission to a single arbitrator, each party expressly waives any right or claim to recover more than $5,000,000. Any Dispute in which the amount in controversy exceeds $5,000,000 shall be decided by majority vote of a panel of three arbitrators; provided, however, that all three arbitrators must actively participate in all hearings and deliberations. (e) Judicial Review. Notwithstanding anything herein to the contrary, in any arbitration in which the amount in controversy exceeds $25,000,000, the arbitrators shall be required to make specific, written findings of fact and conclusions of law. In such arbitrations (i) the arbitrators shall not have the power to make any award which is not supported by substantial evidence or which is based on legal error, (ii) an award shall not be binding upon the parties unless the findings of fact are supported by substantial evidence and the conclusions of law are not erroneous under the substantive law of the State of California, and (iii) the parties shall have in addition to the grounds referred to in the Federal Arbitration Act for vacating, modifying or correcting an award the right to judicial review of (1) whether the findings of fact rendered by the arbitrators are supported by substantial evidence, and (2) whether the conclusions of law are erroneous under the substantive law of the State of California. Judgment confirming an award in such a proceeding may be entered only if a court determines the award is supported by substantial evidence and not based on legal error under the substantive law of the State of California. (f) Real Property Collateral; Judicial Reference. Notwithstanding anything herein to the contrary, no Dispute shall be submitted to arbitration if the Dispute concerns indebtedness secured directly or indirectly, in whole or in part, by any real property unless (i) the holder of the mortgage, lien or security interest specifically elects in writing to proceed with the arbitration, or (ii) all parties to the arbitration waive any rights or benefits that might accrue to them by virtue of the single action rule statute of California, thereby agreeing that all indebtedness and obligations of the parties, and all mortgages, liens and security interests securing such indebtedness and obligations, shall remain fully valid and enforceable. If any such Dispute is not submitted to arbitration, the Dispute shall be referred to a referee in accordance with California Code of Civil Procedure Section 638 et seq., and this general reference agreement is intended to be specifically enforceable in accordance with such Section 638. A referee with the qualifications required herein for arbitrators shall be selected pursuant to the AAA's selection procedures. Judgment upon the decision rendered by a referee shall be entered in the court in which such proceeding was commenced in accordance with California Code of Civil Procedure Sections 644 and 645. (g) Miscellaneous. To the maximum extent practicable, the AAA, the arbitrators and the 25 parties shall take all action required to conclude any arbitration proceeding within 180 days of the filing of the Dispute with the AAA. No arbitrator or other party to an arbitration proceeding may disclose the existence, content or results thereof, except for disclosures of information by a party required in the ordinary course of its business, by applicable law or regulation, or to the extent necessary to exercise any judicial review rights set forth herein. If more than one agreement for arbitration by or between the parties potentially applies to a Dispute, the arbitration provision most directly related to the foregoing documents or the subject matter of the Dispute shall control. This Agreement may be amended or modified only in writing signed by Bank and Borrower. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or any remaining provisions of this Agreement. This arbitration provision shall survive termination, amendment or expiration of any of the foregoing documents or any relationship between the parties. SECTION 34. FACSIMILE TRANSMISSIONS OF DEMANDS UNDER THE LETTER OF CREDIT. Borrower has requested that Bank issue the Letter of Credit in a form which permits Trustee to use facsimile transmission equipment ("FTE") to transmit to Bank such demands as may be made by Trustee from time to time under the Letter of Credit, and as are authorized therein. Each such transmission sent by FTE shall be in such form as may be determined by Trustee, which otherwise complies with the requirements of the Letter of Credit. Each demand as may be received by Bank by FTE shall be referred to hereinafter individually as a "Facsimile Demand" and collectively as the "Facsimile Demands". Bank has agreed to issue the Letter of Credit providing for Facsimile Demands, only upon Borrower's agreement to the following additional terms and conditions: (a) Borrower acknowledges that Bank is not obligated to Borrower to issue letters of credit which provide for Facsimile Demands, but that Bank has agreed to do so at Borrower's request and solely as a convenience to Borrower and Trustee. Borrower further acknowledges that such Facsimile Demands cause additional risks for Bank as follows: (i) Facsimile Demands may or may not ever be completely received by Bank due to defective or incomplete transmission, mechanical breakdowns, empty paper supplies and innumerable other reasons affecting the transmission or reception by FTE; (ii) a Facsimile Demand, if received, may be illegible or undecipherable, or missing pages or portions of pages; (iii) a Facsimile Demand may not be in a form to permit Bank to determine whether such a Facsimile Demand constitutes a conforming demand or a draw under the Letter of Credit; (iv) a Facsimile Demand may be received by Bank following the Expiration Date of the Letter of Credit and Trustee claims to have transmitted such Facsimile Demand prior to such Expiration Date; (v) a Facsimile Demand may be determined to be non-conforming after such time as the Letter of Credit has expired, leading to uncertainty and ambiguity as to the relative rights and duties of the parties to the Letter of Credit. (b) Borrower understands that Bank will not see the original of the draw, demand or notification underlying the Facsimile Demand and that Bank may have relied upon such Facsimile Demand in transferring funds to the account of Trustee, and that Bank may not be able to verify that the Facsimile Demand has been received by Bank prior to the Expiration Date of the Letter of Credit and in such a form that Bank can determine that such Facsimile Demand constitutes a conforming demand or draw under the Letter of Credit. Borrower also understands that Bank has agreed to receive Facsimile Demands in this manner as an accommodation to Borrower, and that Borrower therefore accepts the risk that a Facsimile Demand, whether heretofore or hereafter received by Bank so as to permit Bank's timely action in accordance therewith; may not have been received in such a form as to constitute a conforming demand or draw under the Letter of Credit; even though sent by Trustee so as to permit adequate opportunity for cure if non-conforming, may not have been received by Bank until after such time as Trustee may reasonably have an opportunity to cure. (c) Borrower acknowledges that the use of FTE to transmit Facsimile Demands to Bank, and Bank's ability to act upon and in accordance with Facsimile Demands so received, may be interrupted by 26 industrial disputes, acts of government, fires, power failures, computer malfunctions, civil disturbances or other causes or events not within the control of Bank. (d) Borrower hereby waives, in advance, any defense to payment by Bank of any Facsimile Demand due to resubmission of any such Facsimile Demand following the Expiration Date of the Letter of Credit. In addition, Borrower agrees to indemnify and reimburse Bank immediately upon demand for any payment or payments made by Bank under or in connection with any Facsimile Demand. The foregoing reimbursement obligations of Borrower shall be considered "Reimbursement Obligations" of Borrower under this Agreement. (e) This Section 34 shall apply to and govern all Facsimile Demands made under the Letter of Credit. [THE REMAINDER OF THIS PAGE IS INTENTIONALLY BLANK] 27 Executed as of the date first written above. BORROWER: BANK: AXT, INC. WELLS FARGO BANK, NATIONAL ASSOCIATION By: /s/ Morris S. Young By: /s/ Manao Keegan -------------------------- -------------------------- Morris S. Young Manao Keegan President Vice President Address for Notices: Address for Notices: 4281 Technology Drive Wells Fargo Bank, Peninsula RCBO Fremont, California 94538 400 Hamilton Avenue, P.O. Box 150 Attention: Donald L. Tatzin Palo Alto, CA 94302 Attention: Manao Keegan Facsimile: (510) 438-4793 Facsimile: (650) 328-0814 EXHIBIT A IRREVOCABLE LETTER OF CREDIT EXHIBIT A IRREVOCABLE LETTER OF CREDIT April 7, 2003 -- Letter of Credit No. NZS472650 BNY Western Trust Company 700 South Flower Street, Suite 500 Los Angeles, California 90017 Attn: Corporate Trust Department Ladies and Gentlemen: We hereby establish in your favor at the request and for the account of AXT, Inc., a Delaware corporation (formerly known as American Xtal Technology, Inc.), our irrevocable letter of credit (this "Letter of Credit") in the amount of U.S. $9,022,930.00 (Nine Million Twenty-Two Thousand Nine Hundred Thirty and No/00 Dollars) in connection with the Bonds (as defined below) available with ourselves by sight payment against presentation of one or more (a) telegraphic demands, (b) signed and dated demands ("Signed Demands") or (c) telefacsimile demands ("Telefacsimile Demands") addressed by you to Wells Fargo Bank, N.A., Letter of Credit Operations Office, San Francisco, California, each in the form of Annex A (an "A Drawing"), Annex B (a "B Drawing"), Annex C (a "C Drawing"), Annex D (a "D Drawing"), Annex E (an "E Drawing"), or Annex F (an "F Drawing") hereto, with all instructions in brackets therein being complied with. Each such presentation must be made on a Business Day (as hereinafter defined) to our Letter of Credit Operations Office in San Francisco, California (presently located at 525 Market Street, 25th Floor, San Francisco, California 94105) at or before 5:00 p.m., San Francisco time on or before the Expiration Date (as hereinafter defined). This Letter of Credit expires at our above office on December 1, 2008 but shall be automatically extended, without written amendment, to December 1 in each succeeding calendar year up to, but not beyond, December 1, 2023, unless you shall have received at your address above our written notice sent by registered mail or express courier that we elect not to extend this Letter of Credit beyond the date specified in such notice, which date shall be December 1, 2008 or any subsequent December 1 occurring before December 1,2023 and be at least forty-five (45) calendar days after the date you receive such notice. AS used herein, the term "Expiration Date" means the earlier of (a) December 1, 2023 or (b) the date specified in any notice of non-extension received by you pursuant to the immediately preceding sentence as the date beyond which this Letter of Credit will not be extended. If the Expiration Date falls on a day which is not a Business Day, then such Expiration Date shall be automatically extended to the next succeeding Business Day. As used herein, the term "Business Day" means a day of the year on which our San Francisco Letter of Credit Operations Office is open for business. The amount of any demand presented hereunder will be the amount inserted in numbered Paragraph 4 of said demand. By honoring any such demand we make no representation as to the correctness of the amount demanded. We hereby agree with you that each demand presented hereunder in full compliance with the terms hereof will be duly honored by our payment to you of the amount of such demand, in immediately available funds of Wells Fargo Bank, N.A.: Page 1 EXHIBIT A (i) not later than 10:00 a.m., San Francisco time, on the Business Day following the Business Day on which such demand is presented to us as aforesaid if such presentation is made to us at or before noon, San Francisco time. or (ii) not later than 10:00 a.m., San Francisco time, on the second Business Day following the Business Day on which such demand is presented to us as aforesaid, if such presentation is made to us after noon, San Francisco time. Notwithstanding the foregoing, any demand presented hereunder, in full compliance with the terms hereof, for a C Drawing or D Drawing will be duly honored (i) not later than 12:30 p.m., San Francisco time, on the Business Day on which such demand is presented to us as aforesaid if such presentation is made to us at or before 8:00 a.m., San Francisco time, and (ii) not later than 11:00 a.m., San Francisco time, on the Business Day following the Business Day on which such demand is presented to us as aforesaid if such presentation is made to us after 8:00 a.m., San Francisco time. If the remittance instructions included with any demand presented under this Letter of Credit require that payment is to be made by transfer to an account with us or with another bank, we and/or such other bank may rely solely on the account number specified in such instructions even if the account is in the name of a person or entity different from the intended payee. With respect to any demand that is honored hereunder, the total amount of this Letter of Credit shall be reduced as follows: (A) With respect to any A Drawing or B Drawing, the total amount of this Letter of Credit shall be reduced, as to all demands subsequent to the applicable demand, by the amount of the applicable demand as of the time of presentation of such demand and shall not be reinstated; (B) With respect to any C Drawing or D Drawing, the total amount of this Letter of Credit shall be reduced, as to all demands subsequent to the applicable demand, by the amount of the applicable demand as of the time of presentation of such demand subject to reinstatement in full or in part, if and to the extent, prior to the Expiration Date, we are reimbursed from remarketing proceeds for all or a portion of such demand, at which time we shall advise you in writing of such reinstatement and the amount reinstated; and (C) With respect to any F Drawing, the total amount of this Letter of Credit shall be reduced, as to all demands subsequent to the applicable demand, by the amount of the applicable demand as of the time of presentation of such demand; provided, however, that such amount shall be automatically reinstated on the tenth (10th) calendar day following the date of presentation of such demand unless (i) you shall have received notice from us by telegraph, telex, courier service or registered mail at the above address within seven (7) calendar days after the presentation of such demand that there shall be no such reinstatement, or (ii) the tenth (10th) calendar day after such presentation would be after the Expiration Date. Upon presentation to us of an E Drawing in compliance with the terms of this Letter of Credit, no further demand whatsoever may be presented hereunder. An F Drawing shall not be presented to us (i) more than once during any eighty-four (84) calendar day period, or (ii) with respect to any single F Drawing, for an amount more than Three Hundred Seven Thousand Nine Hundred Thirty and no/100 Dollars ($307,930.00). Page 2 EXHIBIT A Except as otherwise provided herein, this Letter of Credit shall be governed by and construed in accordance with the Uniform Customs and Practice for Documentary Credits (1993 Revision), Publication No. 500 of the International Chamber of Commerce (the "UCP"); provided, however, that Article 41, paragraphs d, e, f, g, h, i and j of Article 48 and the second sentence of Article 17 shall not apply to this Letter of Credit. Furthermore, as provided in the first sentence of Article 17 of the UCP, we assume no liability or responsibility for consequences arising out of the interruption of our business by Acts of God, riots, civil commotions, insurrections, wars or any other causes beyond our control, or strikes or lockouts. As to matters not covered by the UCP and to the extent not inconsistent with the UCP or made inapplicable by this Letter of Credit, this Letter of Credit shall be governed by the laws of the State of California, including the Uniform Commercial Code as in effect in the State of California, without giving effect to conflicts of law principles. This Letter of Credit is transferable and may be transferred more than once, but in each case only in the amount of the full unutilized balance hereof to any single transferee who you shall have advised us pursuant to Annex G has succeeded BNY Western Trust Company or a successor trustee as Trustee under the Indenture, dated as of December 1, 1998, as supplemented from time to time (the "Indenture") between AXT, Inc. (formerly known as American Xtal Technology, Inc.), as Issuer, and BNY Western Trust Company (successor trustee to Harris Trust Company of California), as Trustee, pursuant to which U.S. $11,615,000.00 in aggregate principal amount of American Xtal Technology, Inc. Variable Rate Taxable Demand Revenue Bonds Series 1998 (Xtal Project) (the "Bonds") were issued. Transfers may be effected only through ourselves and only upon presentation to us of a duly executed instrument of transfer in the form attached hereto as Annex G. Any transfer of this Letter of Credit as aforesaid must be endorsed by us on the reverse hereof and may not change the place of presentation of demands from our Letter of Credit Operations Office in San Francisco, California. All payments hereunder shall be made from our own funds. Page 3 EXHIBIT A This Letter of Credit sets forth in full our undertaking, and such undertaking shall not in any way be modified, amended, amplified or limited by reference to any document, instrument or agreement referred to herein (including, without limitation, the Bonds and the Indenture), except the UCP to the extent provided herein, and to the extent that the UCP is not inconsistent with or made inapplicable by this Letter of Credit; and any such reference shall not be deemed to incorporate herein by reference any document, instrument or agreement except the UCP to the extent provided herein. WELLS FARGO BANK, NATIONAL ASSOCIATION By: ---------------------------- Letter of Credit Operations Office Telephone Nos.: (415) 396-5458 and (415) 396-4014 Letter of Credit Operations Office Telefacsimile No.: (415) 284-9453 Page 4 EXHIBIT A Annex A to Wells Fargo Bank, N.A. Irrevocable Letter of Credit No. NZS472650 Wells Fargo Bank, N.A. Letter of Credit Operations Office San Francisco, California FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER: [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO. NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE "INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE LETTER OF CREDIT) THAT: (1) THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE INDENTURE. (2) THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF CREDIT WITH RESPECT TO THE PAYMENT OF PRINCIPAL UPON AN OPTIONAL AND/OR MANDATORY REDEMPTION OF LESS THAN ALL OF THE BONDS CURRENTLY OUTSTANDING. (3) THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE WITH THE TERMS AND CONDITIONS OF THE BONDS AND THE INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS: [INSERT REMITTANCE INSTRUCTIONS]. (4) THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS $[INSERT AMOUNT]. (5) THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND TELEFACSIMILE AN OFFICER OF THE BANK'S LETTER OF CREDIT OFFICE IN SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED. Page 5 EXHIBIT A (6) IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE NOON, SAN FRANCISCO TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE NEXT BUSINESS DAY. IF THIS DEMAND IS RECEIVED BY YOU AFTER NOON, SAN FRANCISCO TIME, ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE SECOND BUSINESS DAY FOLLOWING SUCH BUSINESS DAY. [INSERT NAME OF BENEFICIARY] [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT SIGNATURE AND DATE] Page 6 EXHIBIT A Annex B to Wells Fargo Bank, N.A. Irrevocable Letter of Credit No. NZS472650 Wells Fargo Bank, N.A. Letter of Credit Operations Office San Francisco, California FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER: [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO. NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE "INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE LETTER OF CREDIT) THAT: (1) THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE INDENTURE. (2) THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF CREDIT WITH RESPECT TO THE PAYMENT OF UNPAID INTEREST UPON AN OPTIONAL AND/OR MANDATORY REDEMPTION OF LESS THAN ALL OF THE BONDS CURRENTLY OUTSTANDING. (3) THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE WITH THE TERMS AND CONDITIONS OF THE AFORESAID BONDS AND THE INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS: [INSERT REMITTANCE INSTRUCTIONS]. (4) THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS $[INSERT AMOUNT]. (5) THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND TELEFACSIMILE AN OFFICER OF THE BANK'S LETTER OF CREDIT OFFICE IN SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED. Page 7 EXHIBIT A (6) IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE NOON, SAN FRANCISCO TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE NEXT BUSINESS DAY. IF THIS DEMAND IS RECEIVED BY YOU AFTER NOON, SAN FRANCISCO TIME, ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE SECOND BUSINESS DAY FOLLOWING SUCH BUSINESS DAY. [INSERT NAME OF BENEFICIARY] [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT SIGNATURE AND DATE] Page 8 EXHIBIT A Annex C to Wells Fargo Bank, N.A. Irrevocable Letter of Credit No. NZS472650 Wells Fargo Bank, N.A. Letter of Credit Operations Office San Francisco, California FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER: [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO. NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE "INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE LETTER OF CREDIT) THAT: (1) THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE INDENTURE. (2) THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF CREDIT WITH RESPECT TO THE PAYMENT OF THE PRINCIPAL AMOUNT OF THOSE BONDS WHICH THE REMARKETING AGENT (AS DEFINED IN THE INDENTURE) HAS BEEN UNABLE TO REMARKET WITHIN THE TIME LIMITS ESTABLISHED IN THE INDENTURE. (3) THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE WITH THE TERMS AND CONDITIONS OF THE AFORESAID BONDS AND THE INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS: [INSERT REMITTANCE INSTRUCTIONS]. (4) THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS $[INSERT AMOUNT]. (5) THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND TELEFACSIMILE AN OFFICER OF THE BANKS LETTER OF CREDIT OFFICE IN SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED. Page 9 EXHIBIT A (6) IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE 8:00 A.M., SAN FRANCISCO TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 12:30 P.M., SAN FRANCISCO TIME, ON SAID BUSINESS DAY. IF THIS DEMAND IS RECEIVED BY YOU AFTER 8:00 A.M., SAN FRANCISCO TIME, ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 11:00 A.M., SAN FRANCISCO TIME, ON THE BUSINESS DAY FOLLOWING SAID BUSINESS DAY. [INSERT NAME OF BENEFICIARY] [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT SIGNATURE AND DATE] Page 10 EXHIBIT A Annex D to Wells Fargo Bank, N.A. Irrevocable Letter of Credit No. NZS472650 Wells Fargo Bank, N.A. Letter of Credit Operations Office San Francisco, California FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER: [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO. NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE "INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE LETTER OF CREDIT) THAT: (1) THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE INDENTURE. (2) THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF CREDIT WITH RESPECT TO THE PAYMENT OF THE UNPAID INTEREST ON THOSE BONDS WHICH THE REMARKETING AGENT (AS DEFINED IN THE INDENTURE) HAS BEEN UNABLE TO REMARKET WITHIN THE TIME LIMITS ESTABLISHED IN THE INDENTURE. (3) THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE WITH THE TERMS AND CONDITIONS OF THE AFORESAID BONDS AND THE INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS: [INSERT REMITTANCE INSTRUCTIONS]. (4) THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS $[INSERT AMOUNT]. (5) THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND TELEFACSIMILE AN OFFICER OF THE BANK'S LETTER OF CREDIT OFFICE IN SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED. Page 11 EXHIBIT A (6) IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE 8:00 A.M., SAN FRANCISCO TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 12:30 P.M., SAN FRANCISCO TIME, ON SAID BUSINESS DAY. IF THIS DEMAND IS RECEIVED BY YOU AFTER 8:00 A.M., SAN FRANCISCO TIME, ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 11:00 A.M., SAN FRANCISCO TIME, ON THE BUSINESS DAY FOLLOWING SAID BUSINESS DAY. [INSERT NAME OF BENEFICIARY] [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT SIGNATURE AND DATE] Page 12 EXHIBIT A Annex E to Wells Fargo Bank, N.A. Irrevocable Letter of Credit No. NZS472650 Wells Fargo Bank, N.A. Letter of Credit Operations Office San Francisco, California FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER: [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO. NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE "INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE LETTER OF CREDIT) THAT: (1) THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE INDENTURE. (2) THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF CREDIT WITH RESPECT TO THE PAYMENT, AT STATED MATURITY, UPON ACCELERATION FOLLOWING AN EVENT OF DEFAULT, OR UPON REDEMPTION AS A WHOLE, OF THE TOTAL UNPAID PRINCIPAL OF, AND UNPAID INTEREST ON, ALL OF THE BONDS WHICH ARE PRESENTLY OUTSTANDING. (3) THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE WITH THE TERMS AND CONDITIONS OF THE AFORESAID BONDS AND THE INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS: [INSERT REMITTANCE INSTRUCTIONS]. (4) THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS $[INSERT AMOUNT WHICH IS THE SUM OF THE TWO AMOUNTS SET FORTH IN PARAGRAPH 5, BELOW]. (5) THE AMOUNT OF THIS DEMAND IS EQUAL TO THE SUM OF (A) $[INSERT AMOUNT] BEING DRAWN IN RESPECT OF THE PAYMENT OF UNPAID PRINCIPAL OF THE AFORESAID BONDS AND (B) $[INSERT AMOUNT] BEING DRAWN IN RESPECT OF THE PAYMENT OF UNPAID INTEREST ON THE AFORESAID BONDS. (6) THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND TELEFACSIMILE AN OFFICER OF THE BANK'S LETTER OF CREDIT OFFICE IN SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED. Page 13 EXHIBIT A (7) IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE NOON, SAN FRANCISCO TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE NEXT BUSINESS DAY. IF THIS DEMAND IS RECEIVED BY YOU AFTER NOON, SAN FRANCISCO TIME, ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE SECOND BUSINESS DAY FOLLOWING SUCH BUSINESS DAY. [INSERT NAME OF BENEFICIARY] [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT SIGNATURE AND DATE] Page 14 EXHIBIT A Annex F to Wells Fargo Bank, N.A. Irrevocable Letter of Credit No. NZS472650 Wells Fargo Bank, N.A. Letter of Credit Operations Office San Francisco, California FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER: [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO. NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE "INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE LETTER OF CREDIT) THAT: (1) THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE INDENTURE. (2) THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF CREDIT WITH RESPECT TO THE PAYMENT, ON AN INTEREST PAYMENT DATE (AS DEFINED IN THE INDENTURE), OF UNPAID INTEREST WITH RESPECT TO THE BONDS. (3) THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE WITH THE TERMS AND CONDITIONS OF THE AFORESAID BONDS AND THE INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS: [INSERT REMITTANCE INSTRUCTIONS]. (4) THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS $[INSERT AMOUNT]. (5) THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND TELEFACSIMILE AN OFFICER OF THE BANK'S LETTER OF CREDIT OFFICE IN SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED. Page 15 EXHIBIT A (6) IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE NOON, SAN FRANCISCO TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE NEXT BUSINESS DAY. IF THIS DEMAND IS RECEIVED BY YOU AFTER NOON, SAN FRANCISCO TIME, ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE SECOND BUSINESS DAY FOLLOWING SUCH BUSINESS DAY. [INSERT NAME OF BENEFICIARY] [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT SIGNATURE AND DATE] Page 16 EXHIBIT A Annex G to Wells Fargo Bank, N.A. Irrevocable Letter of Credit No. NZS472650 Wells Fargo Bank, N.A. 525 Market Street, 25th Floor Letter of Credit Operations Office San Francisco, California Subject: Your Letter of Credit No. NZS472650 Ladies and Gentlemen: For value received, we hereby irrevocably assign and transfer all of our rights under the above-captioned Letter of Credit, as heretofore and hereafter amended, extended or increased, to: [Name of Transferee] [Address of Transferee] By this transfer, all of our rights in the Letter of Credit are transferred to the transferee, and the transferee shall have sole rights as beneficiary under the Letter of Credit, including sole rights relating to any amendments, whether increases or extensions or other amendments, and whether now existing or hereafter made. You are hereby irrevocably instructed to advise future amendment(s) of the Letter of Credit to the transferee without our consent or notice to us. The original Letter of Credit is returned with all amendments to this date. Please notify the transferee in such form as you deem advisable of this transfer and of the terms and conditions to this Letter of Credit, including amendments as transferred. Page 17 EXHIBIT A You are hereby advised that the transferee named above has succeeded BNY Western Trust Company or a successor trustee, as Trustee under the Indenture, dated as of December 1, 1998, as supplemented from time to time (the "Indenture") between AXT, Inc. (formerly known as American Xtal Technology, Inc.), as Issuer, and BNY Western Trust Company (successor trustee to Harris Trust Company of California), as Trustee, pursuant to which U.S. $11,615,000.00 in aggregate principal amount of American Xtal Technology, Inc. Variable Rate Taxable Demand Revenue Bonds Series 1998 (Xtal Project) were issued. Very truly yours, [Insert Name of Transferor] By: ----------------------------- [Insert Name and Title] TRANSFEROR'S SIGNATURE GUARANTEED BY: --------------------------------------- [Bank Name] BY: --------------------------------------- [Insert Name and Title] By its signature below, the undersigned transferee acknowledges that it has duly succeeded BNY Western Trust Company, or a successor trustee, as Trustee under the Indenture. [Insert Name of Transferee] By: ---------------------------------------------- [Insert Name and Title] Page 18 EXHIBIT B NOTICE OF INTENT TO BORROW Pursuant to that certain Reimbursement Agreement, dated as of March 14, 2003 (the "Reimbursement Agreement"; capitalized terms used herein without definition shall have the meanings set forth in the Reimbursement Agreement) between AXT, INC. (formerly known as American Xtal Technology, Inc. ("Borrower") and WELLS FARGO BANK, NATIONAL ASSOCIATION (the "Bank"), this represents Borrower's notice to Bank of its intention to borrow from Bank, at the Tender Reimbursement Rate. [the full amount of the Tender Drawing made on ___________, 20__ in the amount of ___________] or [a portion of the Tender Drawing made on ___________, 20__ in the amount of $___________; the portion borrowed being $_____________, with the remainder of $________ paid in full herewith together with interest thereon at the Tender Reimbursement Rate.] The proceeds of such borrowing are to be used to reimburse Bank for unreimbursed Tender Drawings in accordance with Section 3(b) of the Reimbursement Agreement. Borrower certifies that (i) the representations and warranties contained in Section 7 of the Reimbursement Agreement are correct on and as of the date hereof to the same extent as though made on and as of the date hereof (except to the extent that any such representation and warranty expressly relates to an earlier date); and (ii) no Event of Default has occurred or is continuing. By _________________________ _________________________ SCHEDULE I (Redemption Schedule Referenced in Section 3(a)) REDEMPTION SCHEDULE

QUARTERLY PAYMENT DATE PRINCIPAL AMORTIZATION PRINCIPAL BALANCE - ------------ ---------------------- ----------------- 4/1/03 $ 103,400 $ 8,715,000 7/1/03 $ 103,400 $ 8,611,600 10/1/03 $ 103,400 $ 8,508,200 1/1/04 $ 103,400 $ 8,404,800 4/1/04 $ 103,400 $ 8,301,400 7/1/04 $ 103,400 $ 8,198,000 10/1/04 $ 103,400 $ 8,094,600 1/1/05 $ 103,400 $ 7,991,200 4/1/05 $ 103,400 $ 7,887,800 7/1/05 $ 103,400 $ 7,784,400 10/1/05 $ 103,400 $ 7,681,000 1/1/06 $ 103,400 $ 7,577,600 4/1/06 $ 103,400 $ 7,474,200 7/1/06 $ 103,400 $ 7,370,800 10/1/06 $ 103,400 $ 7,267,400 1/1/07 $ 103,400 $ 7,164,000 4/1/07 $ 103,400 $ 7,060,600 7/1/07 $ 103,400 $ 6,957,200 10/1/07 $ 103,400 $ 6,853,800 1/1/08 $ 103,400 $ 6,750,400 4/1/08 $ 103,400 $ 6,647,000 7/1/08 $ 103,400 $ 6,543,600 10/1/08 $ 103,400 $ 6,440,200 12/1/08 $ 68,934 $ 6,336,800

EX-99.1 4 f89948exv99w1.txt EXHIBIT 99.1 EXHIBIT 99.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of AXT, Inc. (the "Company") on Form 10-Q for the three months ended March 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Morris S. Young, as Chief Executive Officer of the Company, hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. A signed original of this written statement required by Section 906 has been provided to AXT, Inc. and will be retained by AXT,Inc. and furnished to the Securities and Exchange Commission or its staff upon request. May 9, 2003 /s/ Morris S. Young ------------------------------------ Morris S. Young Chief Executive Officer EX-99.2 5 f89948exv99w2.txt EXHIBIT 99.2 EXHIBIT 99.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of AXT, Inc. (the "Company") on Form 10-Q for the three months ended March 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Donald L. Tatzin, as Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. A signed original of this written statement required by Section 906 has been provided to AXT, Inc. and will be retained by AXT,Inc. and furnished to the Securities and Exchange Commission or its staff upon request. May 9, 2003 /s/ Donald L. Tatzin ------------------------------------ Donald L. Tatzin Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----

EX-10.15

                                                                   EXHIBIT 10.15

================================================================================

                             REIMBURSEMENT AGREEMENT

                                     Between

                                    AXT, INC.

                                       and

                                WELLS FARGO BANK,
                              NATIONAL ASSOCIATION

                           Dated as of March 14, 2003

                 (Letter of Credit No. NZS472650 $9,022,930.00)

================================================================================



                                TABLE OF CONTENTS



Section                                                                               Page
- -------                                                                               ----
                                                                                   
1     Definitions and Rules of Construction.....................................       1
      (a)       Certain Defined Terms...........................................       1
      (b)       Accounting Terms and Determinations.............................       5
      (c)       Interpretation..................................................       5

2     Terms and Amount of Letter of Credit......................................       5
      (a)       Terms of Letter of Credit.......................................       5

3     Reimbursement and Other Payments..........................................       5
      (a)       Reimbursement Obligations.......................................       5
      (b)       Tender Reimbursement Obligations................................       6
      (c)       Bank's Option to Redeem Bank Bonds..............................       7
      (d)       Letter of Credit Fees; Other Payments to Bank...................       8
      (e)       Miscellaneous...................................................       8

4     Reimbursement Deposit Account; Amortization Payments;
      Collateral; Optional Redemption of Bonds..................................       9
      (a)       Scheduled Redemptions of Bonds..................................       9
      (b)       Reimbursement Deposit Account...................................       9
      (c)       Interest and Letter of Credit Fee Payments......................       9
      (d)       Other Optional Redemptions of Bonds.............................      10
      (e)       Personal Property Collateral....................................      10

5     Issuance of the Letter of Credit..........................................      10
      (a)       Agreement of Bank...............................................      10
      (b)       Conditions Precedent to Issuance of the Letter of Credit........      10

6     Obligations Absolute......................................................      12

7     Representations and Warranties............................................      13
      (a)       Authority/Enforceability........................................      13
      (b)       Binding Obligations.............................................      13
      (c)       Legal Status/Formation and Organizational Documents.............      13
      (d)       Approvals.......................................................      13
      (e)       No Violation....................................................      14
      (f)       Disclosure of Information.......................................      14
      (g)       Litigation......................................................      14
      (h)       Financial Condition.............................................      14
      (i)       Bond Proceeds...................................................      14
      (j)       Accuracy........................................................      14
      (k)       Tax Liability...................................................      14
      (l)       Government Regulations..........................................      14
      (m)       Securities Activities...........................................      14
      (n)       Environmental Matters...........................................      14
      (o)       Related Documents...............................................      15
      (p)       ERISA...........................................................      15
      (q)       Other Obligations...............................................      15


                                        i





SECTION                                                                              PAGE
- -------                                                                              ----
                                                                                  
8     Covenants of Borrower.....................................................      15
      (a)     Reporting Requirements............................................      15
      (b)     Collateral Value..................................................      15
      (c)     ERISA Compliance..................................................      15
      (d)     Further Assurances................................................      16
      (e)     Conduct of Business and Maintenance of Existence..................      16
      (f)     Compliance with Laws..............................................      16
      (g)     Inspection of Property, Books and Records.........................      16
      (h)     Notices...........................................................      16
      (i)     Related Documents.................................................      16
      (j)     Taxes and Other Liabilities.......................................      16
      (k)     Maintenance of Property; Insurance................................      17

9     Events of Default.........................................................      17
      (a)     Required Payments.................................................      17
      (b)     Misrepresentation.................................................      17
      (c)     Other Covenants...................................................      17
      (d)     Collateral........................................................      17
      (e)     Invalidity........................................................      17
      (f)     Voluntary Bankruptcy; Insolvency; Dissolution.....................      17
      (g)     Involuntary Bankruptcy............................................      18
      (h)     Other Defaults....................................................      18
      (i)     Material Adverse Change...........................................      18
      (j)     Change in Business................................................      18

10    Remedies..................................................................      18

11    Amendments, Etc..........................................................       18

12    Notices...................................................................      19

13    No Waiver; Remedies.......................................................      19

14    Right of Set-off; Waiver of Right of Set-Off..............................      19

15    Indemnification...........................................................      19

16    Continuing Obligation.....................................................      20

17    Transfer of Letter of Credit..............................................      20

18    Liability of Bank.........................................................      20

19    Costs, Expenses, Attorneys' Fees and Taxes;
      Allocation of Increased Costs.............................................      21
      (a)     Costs, Expenses, Attorneys' Fees and Taxes........................      21
      (b)     Allocation of Increased Costs.....................................      21

20    No Third Party Beneficiaries..............................................      21


                                       ii





SECTION                                                                              PAGE
- -------                                                                              ----
                                                                                  
21    Time......................................................................      22

22    Severability..............................................................      22

23    Successors, Assignment....................................................      22

24    Confidentiality...........................................................      22

25    Governing Law.............................................................      23

26    Consent of Jurisdiction and Venue, etc....................................      23

27    Headings..................................................................      23

28    Satisfaction Requirement..................................................      23

29    Counterparts..............................................................      23

30    Rights and Remedies Cumulative............................................      23

31    Bank Reliance.............................................................      23

32    Permitted Contests........................................................      24

33    Arbitration...............................................................      24
      (a)     Arbitration.......................................................      24
      (b)     Governing Rules........................................ ..........      24
      (c)     No Waiver; Provisional Remedies, Self-Help and
              Foreclosure.......................................................      24
      (d)     Arbitrator Qualifications and Powers; Awards......................      25
      (e)     Judicial Review...................................................      25
      (f)     Real Property Collateral; Judicial Reference......................      25
      (g)     Miscellaneous.....................................................      25

34    Facsimile Transmissions of Demands under the Letter of Credit.............      26


EXHIBIT A     FORM OF IRREVOCABLE LETTER OF CREDIT
EXHIBIT B     FORM OF NOTICE OF INTENT TO BORROW

SCHEDULE I    REDEMPTION SCHEDULE

                                       iii



                             REIMBURSEMENT AGREEMENT

         This REIMBURSEMENT AGREEMENT, dated as of March 14, 2003 (the
"Agreement") is by and between AXT, INC., a Delaware corporation (formerly known
as American Xtal Technology, Inc.) ("Borrower"), and WELLS FARGO BANK, NATIONAL
ASSOCIATION, a national banking association ("Bank").

                                    RECITALS

         WHEREAS, Borrower issued a series of taxable bonds designated "American
Xtal Technology, Inc. Variable Rate Taxable Demand Revenue Bonds Series 1998" in
the aggregate principal amount of $11,615,000.00 (the "Bonds") pursuant to an
Indenture, dated as of December 1, 1998 (such indenture, together with any
indentures supplemental thereto, hereinafter referred to as the "Indenture"),
between Borrower and Harris Trust Company of California, as Trustee ("Original
Trustee"), to provide funds to finance the Project;

         WHEREAS, BNY Western Trust Company ("BNY") is the successor trustee
under the Indenture to the Original Trustee (BNY, in its capacity as Trustee
under the Indenture, hereinafter referred to as the "Trustee");

         WHEREAS, as a condition precedent to the issuance of the Bonds,
Borrower caused U.S. Bank National Association to issue and deliver to the
Trustee, for the benefit of the holders of the Bonds, an irrevocable direct pay
letter of credit in the initial stated amount of $11,986,680 (the "Existing
Letter of Credit");

         WHEREAS, Borrower desires to replace the Existing Letter of Credit and
Borrower has requested that Bank issue an irrevocable direct-pay letter of
credit to the Trustee substantially in the form attached hereto as Exhibit A
(such letter of credit as it may be extended, together with any amendments
thereto and any substitute letter of credit of Bank, is hereafter referred to as
the "Letter of Credit") in the amount of Nine Million Twenty-Two Thousand Nine
Hundred Thirty and No/100 Dollars ($9,022,930.00) (the "Stated Amount") as an
Alternate Letter of Credit and, pursuant to the terms of the Indenture, to
replace the Existing Letter of Credit; and

         WHEREAS, Borrower will be responsible for all amounts drawn under the
Letter of Credit and for certain fees and amounts due with respect to the Letter
of Credit.

         NOW, THEREFORE, in consideration of the premises and in order to induce
Bank to issue the Letter of Credit, Borrower and Bank, subject to the terms and
conditions of this Agreement, hereby agree as follows:

         SECTION 1.        DEFINITIONS AND RULES OF CONSTRUCTION.

         (a)      Certain Defined Terms. As used in this Agreement and unless
otherwise expressly indicated, or unless the context clearly requires otherwise,
the following terms shall have the following meanings:

         "A Drawing" means any draw in the form of Annex A to the Letter of
Credit made under the Letter of Credit to pay the principal amount upon an
optional and/or a mandatory redemption of a portion of the Bonds in accordance
with the Indenture.

                                        1



         "Affiliate" of any Person means any other Person directly or indirectly
controlling, controlled by or under common control with such Person. A Person
shall be deemed to control another Person if the controlling Person possesses,
directly or indirectly, the power to direct or cause the direction of the
management or policies of the controlled Person, whether through ownership of
stock, by contract, or otherwise.

         "Agreement" means this Reimbursement Agreement, as the same may be from
time to time amended or supplemented.

         "Alternate Letter of Credit" has the meaning ascribed to that term in
the Indenture.

         "Bank" means Wells Fargo Bank, National Association.

         "Bankruptcy Code" means the Bankruptcy Reform Act, Title 11 of the
United States Code, as amended or recodified from time to time.

         "B Drawing" means any draw in the form of Annex B to the Letter of
Credit made under the Letter of Credit to pay unpaid interest upon an optional
and/or a mandatory redemption of a portion of the Bonds.

         "Bank Bonds" mean Bonds purchased or deemed to be purchased or
otherwise acquired with drawings under the Letter of Credit, during any period
such Bonds are registered in the name of Bank (or its nominee) or held by the
Tender Agent on behalf of Bank at the time of a Tender Drawing.

         "Bonds" has the meaning ascribed to that term in the Recitals hereto.

         "Business Day" means any day other than (i) a Saturday or a Sunday or
(ii) a day on which commercial banks in the City of New York, New York, or the
city or cities in which the Principal Corporate Trust Office (as defined in the
Indenture) of Trustee or Tender Agent or the office of Bank at which demands for
payment under the Letter of Credit are to be presented are authorized or
required by law to close or (iii) a day on which the New York Stock Exchange is
closed.

         "Collateral Value" means the percentage set forth below for each type
of investment property held in the Investment Account at the time of
computation:

         (i)      100% of the face amount of cash and cash equivalents;

         (ii)     90% of the market value of obligations of the United States of
                  America, with maturities equal to or less than five (5) years
                  ("U.S. Obligations"), but not to exceed the face amount;

         (iii)    90% of the market value of any repurchase agreements backed by
                  U.S. Obligations, but not to exceed the face amount of such
                  U.S. Obligations;

         (iv)     85% of the market value of corporate and municipal bonds
                  (excluding convertible bonds), with maturities equal to or
                  less than five (5) years and rated at least AA or SP-1 by a
                  nationally recognized rating agency, but not to exceed the
                  face amount; and

         (v)      80% of the market value of commercial paper rated at least A1
                  or P1 by a nationally recognized rating agency, but not to
                  exceed the face amount.

         "C Drawing" means any draw in the form of Annex C to the Letter of
Credit made under the Letter of Credit to pay the principal portion of those
Bonds which the Remarketing Agent has been unable to remarket within the time
limits established in the Indenture.

                                        2



         "D Drawing" means any draw in the form of Annex D to the Letter of
Credit made under the Letter of Credit to pay the unpaid interest on those Bonds
which the Remarketing Agent has been unable to remarket within the time limits
established in the Indenture.

         "Date of Issuance" means the date on which Bank issues the Letter of
Credit.

         "Default" means any event or condition which with the giving of notice
or the lapse of time or both would, unless cured or waived, become an Event of
Default.

         "Default Rate" means a variable rate of interest equal to the Prime
Rate in effect from time to time plus four percent (4.0%).

         "Deposit Account Proceeds" means all of that personal property defined
as "Proceeds" in the Deposit Account Security Agreement.

         "Deposit Account Security Agreement" means that certain Security
Agreement: Deposit Account, dated as of the date hereof, executed by Borrower in
favor of Bank.

         "Drawing" means an A Drawing, B Drawing, C Drawing, D Drawing, E
Drawing or F Drawing, as the context may require.

         "E Drawing" means any draw in the form of Annex E to the Letter of
Credit made under the Letter of Credit to pay the total unpaid principal and
accrued and unpaid interest, if any, at stated maturity, upon acceleration
following an Event of Default, or upon redemption as a whole, of all of the
Bonds outstanding in accordance with the Indenture.

         "ERISA" means the Employee Retirement Income Security Act of 1974 and
any rule or regulation issued thereunder.

         "Event of Default" has the meaning set forth in Section 9 hereof.

         "Expiration Date" has the meaning assigned to such term in the Letter
of Credit.

         "Existing Letter of Credit" has the meaning set forth in the Recitals
hereto.

         "F Drawing" means any draw in the form of Annex F to the Letter of
Credit made under the Letter of Credit to pay accrued and unpaid interest with
respect to the Bonds, on an Interest Payment Date in accordance with the
Indenture.

         "Financial Institutions" means any bank, savings bank, savings and loan
association or insurance company, and any Affiliate of Bank that is controlled,
either directly or indirectly, by such Person.

         "GAAP" means, at any time, generally accepted accounting principles
then in effect.

         "Indenture" has the meaning set forth in the Recitals hereto.

         "Letter of Credit" means Bank's irrevocable direct-pay Letter of Credit
No. NZS472650.

         "Notice of Intent to Borrow" means the notice in the form attached
hereto as Exhibit B.

                                        3



         "Person" means an individual, a corporation, a partnership, an
association, a trust or any other entity or organization, including a government
or political subdivision or agency or instrumentality thereof.

         "Prime Rate" means a base rate that Bank from time to time establishes
and which serves as the basis upon which effective rates of interest are
calculated for those loans making reference thereto.

         "Proceeds" means collectively all of the Deposit Account Proceeds plus
all of the Securities Account Proceeds.

         "Project" has the meaning assigned to such term in the Indenture.

         "Reimbursement Deposit Account" has the meaning set forth in Section
4(b) hereof.

         "Reimbursement Obligations" has the meaning set forth in Section 3(a)
hereof.

         "Related Documents" means this Agreement, the Bonds, the Indenture, the
Security Agreements, the Control Agreement, the UCC financing statements, if
any, and any other agreement or instrument related to the issuance of the Letter
of Credit or the Bonds.

         "Remarketing Agent" has the meaning assigned to such term in the
Indenture.

         "Securities Account Proceeds" means all of that personal property
defined as Proceeds in the Securities Account Security Agreement.

         "Securities Account Security Agreement" means the Security Agreement:
Securities Account, dated as of the date hereof, executed by Borrower in favor
of Bank.

         "Security Agreements" has the meaning set forth in Section 5(b)(i)(A)
of this Agreement.

         "Stated Amount" means $9,022,930.00.

         "Tender Drawing" means any draw upon the Letter of Credit pursuant to a
draft accompanied by a certificate in the form of Annex C or D to the Letter of
Credit for the purchase price of the Bonds which are tendered for repurchase
pursuant to Article IV of the Indenture.

         "Tender Drawing Date" has the meaning set forth in Section 3(b)(iii)
hereof.

         "Tender Reimbursement Obligation" means any obligation of Borrower to
Bank resulting from a Tender Drawing.

         "Tender Reimbursement Rate" means a variable rate of interest equal to
the Prime Rate in effect from time to time plus one percent (1.0%).

         "Termination Date" means the date upon which all of the following
events have occurred: (i) no further draws are available under the Letter of
Credit; (ii) the original Letter of Credit has been returned to Bank; and (iii)
all amounts owing by Borrower to Bank under the Letter of Credit and the
Reimbursement Agreement have been paid in full.

         "Transferee" means any Person to whom Bank has sold, assigned,
transferred, negotiated or granted a participation in all or any part of, or any
interest in, Bank's rights and benefits under this Agreement and the Related
Documents.

                                        4



         "Trustee" means BNY Western Trust Company.

         "UCP" means the Uniform Customs and Practices for Documentary Credits
(1993 Revision), Publication No. 500 of the International Chamber of Commerce,
or any substitution therefor or replacement thereof.

         (b)      Accounting Terms and Determinations. Unless otherwise
specified herein, all accounting terms used herein shall be interpreted and all
accounting determinations hereunder shall be made in accordance with GAAP in
effect from time to time, on a basis consistent with the most recent financial
statements of Borrower delivered to Bank.

         (c)      Interpretation. For all purposes of this Agreement, except as
otherwise expressly provided or unless the context otherwise requires, (i) terms
used in this Agreement include, as appropriate, all genders and the plural as
well as the singular, (ii) references to this Agreement include all Exhibits and
Schedules hereto, (iii) references to words such as "herein", "hereof" and the
like shall refer to this Agreement as a whole and not to any particular part or
Section herein, (iv) references to a Section such as "Section 1" shall refer to
the applicable Section of this Agreement, (v) the term "include" and all
variations thereof shall mean "include without limitation", (vi) the term "or"
shall include "and/or", (vii) any defined term which relates to a document shall
include within its definition any amendments, modifications, renewals,
restatements, extensions, supplements or substitutions which have been or are
hereafter executed and delivered in accordance with the terms thereof, (viii)
any defined term which relates to a Person shall include within its definition
the successors and permitted assigns of such Person and (ix) in the computation
of a period of time from a specified date to a later specified date, the word
"from" shall mean "from and including" and the words "to" and "until" shall mean
"to but excluding."

         SECTION 2.        TERMS AND AMOUNT OF LETTER OF CREDIT.

         (a)      Terms of Letter of Credit. Bank hereby agrees, on the terms
and subject to the conditions set forth in this Agreement, to issue its
irrevocable direct-pay Letter of Credit for the account of Borrower in favor of
Trustee in an initial amount not to exceed the Stated Amount, which amount is
equal to the aggregate principal amount of the Bonds on the Date of Issuance
plus one hundred six (106) days' interest calculated at twelve percent (12%),
based on a 360 day year, actual days elapsed, on such amount. The Letter of
Credit shall be issued on the date that Bank, in its sole discretion, determines
that all of the conditions precedent set forth in Section 5 of this Agreement
have been satisfied, and the Letter of Credit shall expire on the Expiration
Date. Notwithstanding anything herein to the contrary, this Agreement shall not
expire or be otherwise terminated until such time as all payment obligations to
Bank due or to become due hereunder have been paid.

         SECTION 3.        REIMBURSEMENT AND OTHER PAYMENTS.

         (a)      Reimbursement Obligations. Except as provided in Section 3(b)
hereof, Borrower agrees to pay to Bank (i) on the day that any Drawing is made
by Trustee under the Letter of Credit all amounts to be advanced by Bank
pursuant to the Letter of Credit on behalf of Borrower in respect of each such
Drawing; and (ii) interest on any and all amounts Borrower fails to pay when due
under this Agreement from the date such amounts become payable until payment in
full (collectively, the "Reimbursement Obligations"). Except as provided in
Section 3(b) hereof, interest shall accrue on any unpaid Reimbursement
Obligations at a rate per annum equal to the Default Rate.

                                        5



         (b)      Tender Reimbursement Obligations.

                  (i)      Each Tender Drawing paid by Bank under the Letter of
         Credit shall constitute a Tender Reimbursement Obligation, which
         obligation shall be due and payable by Borrower as set forth below.
         Trustee shall use the proceeds of Tender Drawings only for the purpose
         of purchasing Bonds tendered or deemed tendered for purchase pursuant
         to Article IV of the Indenture.

                  (ii)     The Tender Agent (as defined in the Indenture) shall
         cause Bank (or its designated nominee) to be registered as the owner of
         all Bonds purchased with the proceeds of a Tender Drawing in the
         registration books of Depository Trust Company, and all such Bonds that
         are not Book-Entry Bonds (as defined in the Indenture) shall be held by
         the Tender Agent, for the benefit of Bank, unless Bank requests that
         such Bonds be delivered to Bank (or its designated nominee), and the
         Tender Agent shall register Bank (or its designated nominee) as owner
         of such Bonds in its registration books, which Bonds shall evidence the
         corresponding Tender Reimbursement Obligation. Such Bonds shall be
         deemed "Bank Bonds" and shall be entitled to all of the rights and
         privileges of, and shall be governed by all of the terms and conditions
         of the Bonds and the Indenture; provided, however, that:

                           a.       such Bank Bonds may be redeemed or purchased
                  and all principal and interest owing thereon shall be payable
                  to Bank;

                           b.       if Bank receives reimbursement in full of
                  amounts paid by Bank with respect to any Tender Drawing by
                  5:00 p.m. (San Francisco Time) on the day of such Tender
                  Drawing, no interest shall be payable by Borrower with respect
                  thereto;

                           c.       such Bank Bonds may not be tendered or
                  deemed tendered for purchase pursuant to Sections 2.04 and
                  4.06 of the Indenture;

                           d.       to the maximum extent allowed under the
                  Indenture, such Bank Bonds shall be redeemed, in the event of
                  a redemption pursuant to Section 4.01 of the Indenture, prior
                  to the redemption of other Bonds; and

                           e.       such Bank Bonds shall not be entitled to
                  payment of any premium upon redemption.

                  (iii)    Upon receiving notification of any Tender Drawing,
         Bank shall notify Borrower of such Tender Drawing and the amount of the
         Tender Drawing. The amount of any Tender Drawing shall be due and
         payable within two (2) Business Days of the date of such Tender Drawing
         (the "Tender Drawing Date"), unless within such two (2) Business Days
         period Borrower executes and delivers to Bank a Notice of Intent to
         Borrow in the form attached hereto as Exhibit B, pursuant to which
         Borrower specifies its intent to borrow the amount of such Tender
         Drawing. Interest shall accrue on the entire amount of each Tender
         Drawing from the Tender Drawing Date related thereto at the Default
         Rate, unless a Notice of Intent to Borrow with respect to such Tender
         Drawing is delivered to Bank within two (2) Business Days of the Tender
         Drawing Date, in which case interest shall accrue on the entire amount
         of the Tender Drawing from the Tender Drawing Date at the Tender
         Reimbursement Rate; provided, however, that Borrower shall have the
         option to reimburse a portion of the Tender Drawing amount, in which
         case, Borrower shall, within the applicable two (2) Business Day
         period, pay to Bank the amount of the reimbursed portion of the Tender
         Drawing, together with any accrued interest on said amount calculated
         from the Tender Drawing Date at the Tender Reimbursement Rate, and
         deliver the Notice of Intent to Borrow to Bank, specifying the amount
         of the Tender Drawing which is

                                        6



         reimbursed and the amount which is unreimbursed. Notwithstanding the
         foregoing, if Bank receives full reimbursement of all amounts paid by
         Bank with respect to any Tender Drawing by 5:00 p.m. (San Francisco
         time) on the Tender Drawing Date, no interest shall be payable by
         Borrower with respect thereto.

                  (iv)     Borrower agrees to pay to Bank, within thirty (30)
         days after the applicable Tender Drawing Date, the amount of any Tender
         Drawing with respect to which Borrower has executed and returned a
         Notice of Intent to Borrow in accordance with the preceding subsection
         (iii). The unreimbursed amount of any such Tender Drawing shall bear
         interest at the Tender Reimbursement Rate from the Tender Drawing Date
         until the date that payment of the principal amount of such Tender
         Drawing becomes due hereunder and at the Default Rate thereafter.
         Interest due on such amounts shall be paid to Bank on the last day of
         each month which last day occurs at least ten (10) days after the
         Tender Drawing Date, and on the date that reimbursement of the
         principal amount of such Tender Reimbursement Obligation is due and
         payable. Borrower shall submit to Bank together with every payment of a
         Tender Reimbursement Obligation and accrued interest due thereon under
         this Section 3, a statement specifying the amounts paid, the principal
         and interest portions of such payments, and the basis upon which
         Borrower calculated such amounts.

                  (v)      Borrower may, upon at least one (1) Business Day's
         notice to Bank, prepay the outstanding amount of any Tender
         Reimbursement Obligation in whole or in part (but not in sums less than
         $10,000.00 per prepayment) together with accrued interest at the Tender
         Reimbursement Rate to the date of such prepayment on the amount
         prepaid; provided, however, that prepayments shall be credited first to
         interest due and owing on any Reimbursement Obligations outstanding
         hereunder other than Tender Reimbursement Obligations, then to
         principal due and owing on any Reimbursement Obligations outstanding
         hereunder other than Tender Reimbursement Obligations, then to interest
         due and owing on any Tender Reimbursement Obligations, and finally to
         principal due and owing on any Tender Reimbursement Obligations,
         applied in the order in which draws connected therewith were made;
         provided, further, that the proceeds paid to Bank from any redemption
         of Bank Bonds pursuant to the Indenture or from any remarketing of Bank
         Bonds pursuant to Section 4.07 of the Indenture will be credited toward
         the Tender Reimbursement Obligations of Borrower, applied in the order
         in which draws connected therewith were made.

                  (vi)     Reimbursement Following Reinstatement for Remarketed
         Bonds. All proceeds of the sale by the Remarketing Agent (as provided
         in Section 4.07 of the Indenture) of Bank Bonds, and all proceeds from
         the redemption of Bank Bonds, shall be delivered to Trustee and
         transferred to Bank to be credited to any then outstanding Tender
         Reimbursement Obligations, applied in the order in which the draws
         connected therewith were made. At such time as no Reimbursement
         Obligations are outstanding hereunder (including, without limitation,
         Tender Reimbursement Obligations), and neither a Default nor an Event
         of Default has occurred hereunder, then Bank shall disburse to Borrower
         the balance of all proceeds received by Bank from the redemption of
         Bank Bonds or from the sale of Bank Bonds by the Remarketing Agent.

         (c)      Bank's Option to Redeem Bank Bonds. In the event that Borrower
has paid all or part of a Tender Reimbursement Obligation for a Tender Drawing
and all or a portion of the Bank Bonds purchased in connection with such Tender
Drawing have not been remarketed within six (6) months after the Tender Drawing
Date, Bank, at its option, may effect the redemption or cancellation of Bank
Bonds in an amount up to the principal actually reimbursed to it by Borrower in
such manner as may be permitted by the Indenture.

                                        7



         (d)      Letter of Credit Fees; Other Payments to Bank. Borrower shall
pay to Bank annual, continuing nonrefundable letter of credit fees (each, a
"Letter of Credit Fee" and collectively, the "Letter of Credit Fees") for
providing the Letter of Credit, which Letter of Credit Fees shall be in an
amount equal to forty-five one hundredths of one percent (0.45%) per annum of
the Stated Amount (hereafter, the "Primary Letter of Credit Fee Rate") on the
date that any such fee is determined, less amounts drawn under the Letter of
Credit which are not reinstated as of such date. The foregoing Letter of Credit
Fees shall be payable in advance as follows: (i) on or before the Date of
Issuance for the period commencing on the Date of Issuance and ending on
November 30, 2003 (which initial Letter of Credit Fee shall be prorated to equal
sixty-six and two-thirds percent (66 2/3%) of the annual Letter of Credit Fee);
(ii) three (3) Business Days prior to December 1, 2003 for the one year period
commencing December 1, 2003 and continuing up to November 30, 2004; and (iii)
three (3) Business Days prior to each subsequent December 1, for the one year
period commencing on such subsequent December 1 and continuing up to and
including the immediately succeeding November 30. From and after the occurrence
and during the continuance of an Event of Default hereunder, the Letter of
Credit Fees shall immediately and without further notice to Borrower increase to
an amount equal to two and one-half percent (2.50%) per annum of the Stated
Amount (less the amounts drawn under the Letter of Credit which are not
reinstated as of the date any Letter of Credit Fee is due) (hereafter, the
"Increased Letter of Credit Fee Rate"), which increase in the Letter of Credit
Fees shall be in addition to all other rights and remedies of Bank, at law or in
equity, or under this Agreement or any of the Related Documents. The additional
amount due for the increased Letter of Credit Fee for the period commencing on
the date that an Event of Default occurs hereunder through the next occurring
November 30 shall be due from Borrower immediately upon Borrower's receipt from
Bank of a notice regarding such Event of Default; provided, however, that if
Bank determines that Borrower has remedied, or Bank has waived, all Events of
Default prior to the next occurring November 30, and Borrower has paid all
Letter of Credit Fees then due hereunder, then Bank shall credit to the amount
of the next due and owing annual Letter of Credit Fee an amount equal to the
difference between the Primary Letter of Credit Fee Rate and the Increased
Letter of Credit Fee multiplied by the Stated Amount as of the payment date of
the Increased Letter of Credit Fee, with such amount pro-rated for the number of
days from and after the cure or waiver of all Events of Default up to and
including the next occurring November 30 as compared to the number of days for
which such Increased Letter of Credit Fee was charged; provided, further that if
such cure or waiver of Events of Default occurs during the last year of the
Letter of Credit term, then Bank shall rebate to Borrower the excess fee paid in
accordance with the formula in the preceding proviso. Borrower shall also pay to
Bank fees upon the payment or negotiation of each draft under any Letter of
Credit and upon the occurrence of any other activity with respect to any Letter
of Credit (including, without limitation, the transfer, amendment or
cancellation of any Letter of Credit) determined in accordance with Bank's
standard fees and charges then in effect for such activity.

         (e)      Miscellaneous. Borrower agrees to pay, in lawful currency of
the United States and in immediately available funds, all amounts due Bank under
this Agreement directly to Bank at the address listed on the signature page
hereof until such time as Borrower is notified in writing by Bank of a different
address. Subject to Section 4 hereof, Bank shall, and Borrower hereby authorizes
Bank to, debit any demand deposit account of Borrower with Bank designated by
Borrower in writing for all payments of principal, interest, fees and other
payments payable under the Agreement, as they become due. Should, for any reason
whatsoever, the funds in any such demand deposit account be insufficient to pay
all such sums when due, Borrower shall immediately upon demand remit to Bank the
full amount of any such delinquency. If any amount payable under this Agreement
shall fall due on a day that is not a Business Day, then such due date shall be
extended to the next succeeding Business Day, and interest shall continue to
accrue during such extension. Interest and the Letter of Credit Fees payable
hereunder (including interest at the Default Rate and the Tender Drawing Rate)
shall be computed on the basis of the actual number of days elapsed in a year of
360 days.

                                        8



         SECTION 4.        REIMBURSEMENT DEPOSIT ACCOUNT; AMORTIZATION PAYMENTS;
COLLATERAL; OPTIONAL REDEMPTION OF BONDS.

         (a)      Scheduled Redemptions of Bonds. Borrower covenants to take all
necessary action to cause optional redemptions of the Bonds (the "Scheduled
Redemptions") pursuant to the Indenture and this Section 4 at a price equal to
the principal amount of the Bonds to be redeemed, together with accrued interest
to the redemption date, commencing with July 1, 2003 and continuing on each
October 1, January 1 and April 1, and July 1 thereafter (each a, "Scheduled
Redemption Date") until the earlier to occur of (i) the earliest date on which
both no further demands may be made for a Drawing under the Letter of Credit and
all amounts due to Bank under this Agreement have been paid in full, or (ii) the
Expiration Date, in the principal amounts set forth on Schedule 1, which is
attached hereto and incorporated herein by this reference, for such Scheduled
Redemption Date. The portion of the principal amount of Bonds to be redeemed on
each Scheduled Redemption Date commencing July 1, 2003 and continuing on each
Scheduled Redemption Date thereafter shall be the principal amount set forth on
Schedule 1 for such Scheduled Redemption Date. Scheduled Redemptions shall be
effected by A Drawings and B Drawings under the Letter of Credit. Borrower shall
provide Trustee with sixty (60) days prior written notice of any optional
redemption of the Bonds to be made in connection with the Scheduled Redemptions,
and shall provide Bank a copy of such notice concurrently therewith. The amounts
required to reimburse Bank for the draws on the Letter of Credit made in order
to accomplish such Scheduled Redemptions shall be deposited into the
Reimbursement Deposit Account (as defined below) three (3) Business Days prior
to each such Scheduled Redemption Date.

         (b)      Reimbursement Deposit Account. Borrower agrees to open a
deposit account with Bank in Borrower's name (the "Reimbursement Deposit
Account"), which is hereby pledged to Bank as security for Borrower's
performance of its obligations under this Agreement and over which Borrower
shall have no control. Borrower agrees to pay all fees and other amounts due to
Bank hereunder, directly to Bank by deposit into the Reimbursement Deposit
Account established with Bank at the address listed on the signature page
hereof. Bank shall, and Borrower hereby authorizes Bank to, debit the
Reimbursement Deposit Account and any other demand deposit account of Borrower
with Bank designated by Borrower in writing for all payments of principal,
interest, the Letter of Credit Fees and any other fees payable under this
Agreement, as they become due. Should, for any reason whatsoever, the funds in
such demand deposit account be insufficient to pay all such sums when due,
Borrower shall immediately upon demand remit to Bank the full amount of any such
shortfall.

         (c)      Interest and Letter of Credit Fee Payments. Not later than
three (3) Business Days prior to each Interest Payment Date under the Indenture,
commencing with the Interest Payment Date for July 1, 2003 and continuing on
each Interest Payment Date thereafter until the Expiration Date, Borrower shall
deposit into the Reimbursement Deposit Account an amount equal to the amount of
the interest payment for the Bonds that Borrower is obligated to make under the
Indenture for such Interest Payment Date. The amount deposited by Borrower in
the Reimbursement Deposit Account pursuant to this Section 4(c) shall be
sufficient to reimburse Bank for each F Drawing which shall be made by the
Trustee on each Interest Payment Date. In addition, Borrower agrees to deposit
or cause to be deposited into the Reimbursement Deposit Account, or to otherwise
pay to Bank pursuant to Bank's instructions (i) on or before the Date of
Issuance, the Letter of Credit Fee for the period commencing on the Date of
Issuance and continuing up to and including November 30, 2003, and (ii)
thereafter annually in advance three (3) Business Days before December 1 of each
year thereafter, commencing with November 25, 2003, and continuing up to and
including the Expiration Date, the amount necessary to pay when due the annual
Letter of Credit Fee. Borrower shall deposit or cause to be deposited into the
Reimbursement Deposit Account any additional amounts that Borrower may from time
to time owe on account of the Letter of Credit Fees, as further described in
Section 3(d) of this Agreement. Notwithstanding the foregoing, Bank shall not be
obligated to extend the Expiration Date and may send the notice of termination
contemplated

                                        9



by the Letter of Credit and the Letter of Credit will expire on the Expiration
Date regardless of whether or not the Letter of Credit Fee has been paid for a
period after the Expiration Date. In such event, and within a reasonable period
of time after the occurrence of the Expiration Date, Bank shall refund to
Borrower the prorated portion of the unused Letter of Credit Fees (if any).

         (d)      Other Optional Redemptions of Bonds. Notwithstanding any
contrary provision of this Agreement, any optional redemption of the Bonds under
the Indenture, other than the Scheduled Redemptions, shall require the advance
written consent of Bank and Bank's receipt of satisfactory evidence of
Borrower's ability to reimburse Bank for any Drawing under the Letter of Credit
for such redemption.

         (e)      Personal Property Collateral. As collateral for Borrower's
performance of its obligations to Bank under this Agreement, Borrower shall
grant to Bank a first priority security interest in Borrower's Investment
Account No. 14413400 (the "Investment Account"), including, without limitation,
all financial assets credited to the Investment Account, all security
entitlements with respect to the financial assets credited to the Investment
Account, and any and all other investment property or assets maintained or
recorded in the Investment Account (whether held in Borrower's name or as a Bank
collateral account for the benefit of Borrower) maintained with Wells Fargo
Capital Management, the Reimbursement Deposit Account and all replacements or
substitutions for either the Investment Account or the Reimbursement Deposit
Account, including any accounts resulting from a renumbering or other
administrative re-identification thereof (together with the Investment Account
and the Reimbursement Deposit Account, the "Collateral"). Borrower hereby
represents, warrants and covenants to Bank that the Collateral is, free and
clear of liens and encumbrances, other than liens and encumbrances in favor of
Bank, and shall continue to remain free and clear of liens and encumbrances
through the Termination Date.

         SECTION 5.        ISSUANCE OF THE LETTER OF CREDIT.

         (a)      Agreement of Bank. On the terms set forth in this Agreement
and subject to the satisfaction of the conditions set forth in Section 5(b)
below on the Date of Issuance, Bank shall issue the Letter of Credit in the
Stated Amount effective on the Date of Issuance.

         (b)      Conditions Precedent to Issuance of the Letter of Credit. The
obligation of Bank to issue the Letter of Credit is subject to the following
conditions precedent:

                  (i)      Bank shall have received on or before the Date of
         Issuance the following, each dated such date and, in form and substance
         as is satisfactory to Bank and its counsel:

                           (A)      Executed security agreements and/or pledge
                  agreements, together with any addendum thereto, each in form
                  and substance satisfactory to Bank, duly executed by Borrower
                  granting to Bank a first priority security interests in the
                  Collateral and Bank Bonds, such agreements to contain such
                  other covenants and agreements as Bank in its sole discretion
                  may require, including, without limitation, covenants not to
                  encumber or dispose of the Collateral (collectively, the
                  "Security Agreements");

                           (B)      Executed securities account control
                  agreement, in form and substance satisfactory to Bank, duly
                  executed by Borrower and an intermediary acceptable to Bank,
                  to perfect Bank's security interest in the Investment Account,
                  such agreement to contain such other covenants and agreements
                  as Bank in its sole discretion may require, including, without
                  limitation, covenants not to encumber or dispose of the
                  Collateral (the "Control Agreement");

                                       10



                           (C)      An opinion of Foley & Lardner, Bond Counsel
                  (as defined in the Indenture), dated as of the Date of
                  Issuance, in form and substance satisfactory to Bank, opining
                  that the delivery of the Letter of Credit to the Trustee and
                  the transactions contemplated by this Agreement are authorized
                  under and in compliance with the terms of the Indenture and
                  addressing such other matters as Bank may request (the "Bond
                  Counsel Opinion");

                           (D)      An opinion of Gray Cary Ware & Freidenrich
                  LLP, Borrower's counsel, dated as of the Date of Issuance, in
                  form and substance satisfactory to Bank, regarding the due
                  authorization, delivery, execution and enforceability of this
                  Agreement and the Related Documents and addressing such other
                  matters as the Bank may request (the "Borrower's Counsel
                  Opinion" and together with the Bond Counsel Opinion, the
                  "Opinions");

                           (E)      Written evidence from the Rating Agency (as
                  defined in the Indenture) to the effect that such rating
                  agency has reviewed the proposed Letter of Credit and (i) if
                  the Bonds are in a Weekly Interest Rate Period (as defined in
                  the Indenture) or the effective date of such Letter of Credit
                  will be on the first day of a new Term Interest Rate Period
                  (as defined in the Indenture), indicating the prospective
                  rating of the Bonds, and indicating that the Bonds will be
                  rated at least "A", or (ii) if the Bonds are in a Term
                  Interest Rate Period, stating that the delivery of such Letter
                  of Credit will not, in and of itself, result in a lowering or
                  withdrawal of the rating on the Bonds;

                           (F)      Acknowledgment copies of proper UCC-1
                  Financing Statements, if any, duly filed in the office of all
                  jurisdictions as may be necessary or, in the opinion of Bank,
                  desirable and any other evidence that all other actions
                  necessary or, in the opinion of Bank, desirable to perfect and
                  protect the security interests and liens created by the
                  Security Agreements have been taken;

                           (G)      Executed copies of: (i) this Agreement; (ii)
                  each of the Related Documents; and (iii) the Opinions;

                           (H)      Certificates of the Borrower certifying as
                  to its authority, and as to the incumbency and specimen
                  signatures of its officers, to sign this Agreement and the
                  Related Documents to which it is a party and the other
                  documents to be delivered by Borrower hereunder, upon which
                  Bank may rely until it receives a new such certificate and
                  certified copies of organizational/formation documents of
                  Borrower and each member of Borrower, including, but not
                  limited to Borrower's Certificate of Incorporation and Bylaws;

                           (I)      Financial statements of Borrower (signed by
                  an authorized officer of Borrower), including an income and
                  expense statement, a balance sheet, and a statement of cash
                  flow and all footnotes, 10K, annual report and proxy
                  statement;

                           (J)      Resolutions from Borrower, authorizing the
                  transactions contemplated by this Agreement and the Related
                  Documents; and

                           (K)      Such other documents, instruments, approvals
                  (and, if requested by Bank, certified duplicates of executed
                  copies thereof) or opinions, including opinions of Borrower's
                  legal counsel, as Bank may reasonably request.

                                       11



                  (ii)     The following statements shall be true and correct on
         the Date of Issuance as they pertain to Borrower, Bank shall have
         received a certificate signed by Borrower dated the Date of Issuance,
         stating that:

                           (A)      the representations and warranties contained
                  in Section 7 of this Agreement or in any instrument delivered
                  pursuant to or in connection with this Agreement are correct
                  on and as of the Date of Issuance (and after giving effect to
                  the issuance of the Letter of Credit) as though made on and as
                  of such date;

                           (B)      no Default or Event of Default has occurred
                  and is continuing, or would result from the issuance of the
                  Letter of Credit;

                           (C)      no material adverse change has occurred in
                  the operations or condition (financial or otherwise) of
                  Borrower since the date of the most recent Financial
                  Statements, except as disclosed in writing to Bank, or would
                  result from the issuance of the Letter of Credit;

                           (D)      the Collateral Value of the Investment
                  Account shall be not less than the Stated Amount.

                  (iii)    on or prior to the Date of Issuance, Bank shall have
         received reimbursement of Bank's fees and expenses (including outside
         counsel and allocated in-house counsel legal fees) incurred in
         connection with this Agreement and the Letter of Credit, together with
         payment of the Letter of Credit Fee due for the first quarter.

         SECTION 6.        OBLIGATIONS ABSOLUTE. Except as hereinafter provided,
the obligations of Borrower under this Agreement shall be absolute,
unconditional and irrevocable and shall be paid and performed strictly in
accordance with the terms of this Agreement under all circumstances whatsoever,
including, without limitation, the following circumstances:

         (a)      any lack of validity or enforceability of the Letter of Credit
or any of the Related Documents except if such lack of validity or
enforceability results from Bank's gross negligence or willful misconduct;

         (b)      any amendment or waiver of, or any consent to this Agreement
or any Related Documents;

         (c)      the existence of any claim, set-off, defense or other rights
which Borrower may have at any time against Trustee, any beneficiary or any
transferee of the Letter of Credit (or any Person for whom Trustee, any such
beneficiary or any such transferee may be acting), Bank or any other Person,
whether in connection with this Agreement, the Related Documents or any
unrelated transaction; provided that nothing in this Section 6 shall prevent the
assertion of any such claim by separate suit or counterclaim;

         (d)      any statement in any certificate or any other document
presented under the Letter of Credit proving to be forged, fraudulent or invalid
in any respect or any statement therein being untrue or inaccurate in any
respect whatsoever;

         (e)      payment by Bank under the Letter of Credit against
presentation of a draft or certificate which does not comply with the terms of
the Letter of Credit except if such payment constitutes the gross negligence or
willful misconduct of Bank;

                                       12



         (f)      any notice of nonrenewal of the Letter of Credit sent by Bank
to Trustee not being received on time or at any time by Trustee;

         (g)      any other circumstance or happening whatsoever, whether or not
similar to any of the foregoing, other than resulting from Bank's gross
negligence or willful misconduct;

         (h)      any delay, extension of time, renewal, compromise or other
indulgence agreed to by Bank, without notice to or approval of Borrower in
respect to any of Borrower's indebtedness to Bank under this Agreement; or

         (i)      any exchange, release or nonperfection of any lien or security
interest in any collateral pledged or otherwise provided to secure any of the
obligations contemplated herein or in any of the other Related Documents.

         SECTION 7.        REPRESENTATIONS AND WARRANTIES. Borrower makes the
following representations and warranties to Bank, which representations and
warranties shall survive the execution of this Agreement and shall continue in
full force and effect until the full and final payment, and satisfaction and
discharge, of all obligations of Borrower to Bank subject to this Agreement:

         (a)      Authority/Enforceability. Borrower is in compliance with all
laws and regulations applicable to its organization, existence and transaction
of business and has all necessary rights and powers to carry on its business as
now conducted.

         (b)      Binding Obligations. Borrower is authorized to execute,
deliver and perform its obligations under this Agreement and the Related
Documents, and such obligations shall be valid and binding obligations of
Borrower.

         (c)      Legal Status/Formation and Organizational Documents. Borrower
is a corporation validly existing and in good standing under the laws of the
State of Delaware, and is qualified or licensed to do business in all
jurisdictions in which such qualification or licensing is required or in which
the failure to so qualify or to be so licensed could have a material adverse
effect on Borrower. Borrower has delivered to Bank all formation and
organizational documents of Borrower, and all such formation and organizational
documents remain in full force and effect and have not been amended or modified
since they were delivered to Bank. Borrower shall immediately provide Bank with
copies of any amendments or modifications of the formation or organizational
documents.

         (d)      Approvals. No further approval, authorization, consent, order,
notice to or filing or registration with any governmental authority or any
public board or body (other than in connection or in compliance with the
provisions of the securities or "blue sky" laws of any jurisdiction which were
not required on or prior to the Date of Issuance) is legally required with
respect to Borrower's participation in the issuance of the Bonds and the
performance by Borrower of this Agreement and the Related Documents to which it
is a party.

                                       13



         (e)      No Violation. Borrower's execution, delivery, and performance
under this Agreement and the Related Documents do not: (a) require any consent
or approval not heretofore obtained under any certificate of incorporation,
bylaws or other document; (b) violate any governmental requirement applicable to
the Borrower or any other statute, law, regulation or ordinance or any order or
ruling of any court or governmental entity; (c) conflict with, or constitute a
breach or default or permit the acceleration of obligations under any agreement,
contract, lease, or other document by which the Borrower is bound or regulated;
or (d) violate any statute, law, regulation or ordinance, or any order of any
court or governmental entity.

         (f)      Disclosure of Information. There are no facts that Borrower
has failed to disclose to Bank that, individually or in the aggregate, could
have a materially adverse effect on Borrower's ability to perform its
obligations under any of the Related Documents. Each of the representations and
warranties shall survive any investigations or inquiries made by Bank or any of
its representatives.

         (g)      Litigation. Except as disclosed to Bank in writing, there are
no claims, actions, suits, or proceedings pending, or to Borrower's knowledge
threatened, against Borrower.

         (h)      Financial Condition. All financial statements and information
heretofore and hereafter delivered to Bank by Borrower, including, without
limitation, information relating to the financial condition of Borrower, fairly
and accurately represent the financial condition of the subject thereof and have
been prepared (except as noted therein) in accordance with generally accepted
accounting principles consistently applied. Borrower acknowledges and agrees
that Bank may request and obtain additional information from third parties
regarding any of the above, including, without limitation, credit reports. There
has been no material adverse change in the financial condition of Borrower since
the dates of the latest financial statements furnished to Bank and, except as
otherwise disclosed to Bank in writing, Borrower has not entered into any
material transaction which is not disclosed in such financial statements.

         (i)      Bond Proceeds. All of the proceeds received from the sale of
the Bonds have been fully disbursed and used by Borrower to finance costs and
expenses incurred in connection with the Project.

         (j)      Accuracy. All reports, documents, instruments, information and
forms of evidence delivered to Bank concerning or required by this Agreement or
the Related Documents are accurate, correct and sufficiently complete to give
Bank true and accurate knowledge of their subject matter, and do not contain any
misrepresentation or omission.

         (k)      Tax Liability. Borrower has filed all required federal, state,
county and municipal tax returns and has paid all taxes and assessments owed and
payable, and Borrower has no knowledge of any basis for any additional payment
with respect to any such taxes and assessments.

         (l)      Government Regulations. Borrower is not subject to regulation
under the Investment Company Act of 1940, the Federal Power Act, the Interstate
Act, the Public Utility Holding Company Act of 1935 or any federal or state
statute or regulation limiting its ability to incur indebtedness for money
borrowed.

         (m)      Securities Activities. Borrower is not engaged principally, or
as one of its important activities, in the business of extending credit for the
purpose of purchasing or carrying any margin stock (as defined within
Regulations G, T and U of the Board of Governors of the Federal Reserve System),
and not more than twenty-five percent (25%) of the value of Borrower's assets
consists of such margin stock.

         (n)      Environmental Matters. Except as disclosed by Borrower to Bank
in writing prior to the date hereof, Borrower is in compliance in all material
respects with all applicable federal or state environmental, hazardous waste,
health and safety statutes, and any rules or regulations adopted pursuant

                                       14



thereto, which govern or affect any of Borrower's operations and/or properties,
including, without limitation, the Comprehensive Environmental Response,
Compensation and Liability Act of 1980, the Superfund Amendments and
Reauthorization Act of 1986, the Federal Resource Conservation and Recovery Act
of 1976, and the Federal Toxic Substances Control Act, as any of the same may be
amended, modified or supplemented from time to time. None of the operations of
Borrower is the subject of any active federal or state investigation evaluating
whether any remedial action involving a material expenditure is needed to
respond to a release of any toxic or hazardous waste or substance into the
environment. Borrower does not have material contingent liability in connection
with any release of any toxic or hazardous waste or substance into the
environment.

         (o)      Related Documents. Borrower makes the representations and
warranties made by it in the Related Documents as if the same were set forth in
this Agreement.

         (p)      ERISA. Borrower is in compliance in all material respects with
all applicable provisions of the Employee Retirement Income Security Act of
1974, as amended or recodified from time to time ("ERISA"); Borrower has not
violated any provision of any defined employee pension benefit plan (as defined
in ERISA) maintained or contributed to by Borrower (each, a "Plan"); no
Reportable Event as defined in ERISA has occurred and is continuing with respect
to any Plan initiated by Borrower; Borrower has met its minimum funding
requirements under ERISA with respect to each Plan; and each Plan will be able
to fulfill its benefit obligations as they come due in accordance with the Plan
documents and under generally accepted accounting principles

         (q)      Other Obligations. Borrower is not in default on any
obligation for borrowed money, any purchase money obligation or any other
material lease, commitment, contract, instrument or obligation.

         SECTION 8.        COVENANTS OF BORROWER. So long as the Termination
Date has not occurred or any amount is due or owing to Bank hereunder, Borrower
agrees that it will comply with the following covenants:

         (a)      Reporting Requirements. Borrower will deliver, in form and
detail satisfactory to Bank and consistent with GAAP:

                           (i)      not later than one hundred twenty (120) days
         after and as of each fiscal year end of Borrower, an audited and
         consolidated financial statement of Borrower, prepared by an
         independent certified public accountant acceptable to Bank, to include
         a balance sheet, an income statement, a statement of cash flow,
         together with all supporting schedules and footnotes, Borrower's 10K,
         Borrower's annual report and proxy statement; and

                           (ii)     not later than forty-five (45) days after
         and as of the end of each fiscal quarter end of Borrower, consolidated
         financial statements of Borrower, prepared by Borrower, to include a
         balance sheet, an income statement and Borrower's 10Q.

         (b)      Collateral Value. The Collateral Value of the Investment
Account shall at all times be equal to or greater than one hundred percent
(100%) of the Stated Amount. In the event the Collateral Value, for any reason
and at any time, is less than the required amount, Borrower shall promptly
deposit additional assets of a nature satisfactory to Bank into the Investment
Account in amounts sufficient to achieve the required Collateral Value.

         (c)      ERISA Compliance. Borrower shall at all times comply with the
provisions of ERISA with respect to any retirement or other employee benefit
plan to which it is a party as employer, and as soon as possible after Borrower
knows, or has reason to know, that any Reportable Event (as defined in ERISA)
with respect to any such plan of Borrower has occurred, it shall furnish to Bank
a written

                                       15



statement setting forth details as to such Reportable Event and the action, if
any, which Borrower proposes to take with respect thereto, together with a copy
of the notice of such Reportable Event furnished to the Pension Benefit Guaranty
Corporation.

         (d)      Further Assurances. Upon Bank's request and at Borrower's sole
cost and expense, Borrower shall execute, acknowledge and deliver any other
instruments and perform any other acts necessary, desirable or proper, as
determined by Bank, to carry out the purposes of this Agreement and the Related
Documents or to perfect and preserve any liens created by this Agreement or the
Related Documents.

         (e)      Conduct of Business and Maintenance of Existence. Borrower
will preserve, renew and keep in full force and effect all rights, privileges,
contracts and leases necessary or desirable for the normal conduct of its
business. Borrower will also continue to conduct its business in an orderly
manner without voluntary interruption and remain qualified to do business in the
States of Delaware and California and in each other jurisdiction where such
qualification is required.

         (f)      Compliance with Laws. Borrower will comply, in all material
respects, with all applicable laws, ordinances, rules, regulations, and
requirements of governmental authorities except where the necessity of
compliance therewith is contested in good faith by appropriate proceedings;
provided, however, that the foregoing shall not require compliance with any such
law, ordinance, rule, regulation and/or requirement so long as failure to comply
shall not have a material adverse effect on the condition of Borrower its
ability to perform their obligations under this Agreement and the Related
Documents.

         (g)      Inspection of Property, Books and Records. Borrower will keep
proper books of record and account in which full, true and correct entries shall
be made of all dealings and transactions in relation to their business and
activities. Borrower will permit representatives of Bank at reasonable times and
intervals upon prior written notice to visit and inspect any of Borrower's
properties, books and records, to examine and make copies of, subject to
proprietary and confidentiality policies and agreements binding upon Borrower,
of any books and records, and to discuss its affairs, finances and accounts with
its employees and independent public accountants, all at such reasonable times
and as often as may reasonably be desired.

         (h)      Notices. Borrower will promptly give written notice to Bank of
the occurrence of any Default or Event of Default at the earliest possible date
after discovery of such Default or Event of Default, but in any event no later
than three (3) Business Days following discovery of a Default or Event of
Default relating to payment obligations of Borrower, and five (5) Business Days
following discovery of any other Default or Event of Default, signed by Borrower
setting forth the details of, and the actions which Borrower proposes to take
with respect to, such Default or Event of Default. Borrower will also promptly
give notice to Bank of any pending or threatened action, suit or proceeding with
a claim against Borrower in excess of $250,000.00, or of any other action, suit
or proceeding with a claim in any amount, which could materially and adversely
affect the operations or the conditions (financial or otherwise) of Borrower.

         (i)      Related Documents. Borrower will comply with the terms and
covenants of the Related Documents to which it is a party. Borrower will not
amend, modify or terminate or agree to amend, modify or terminate any Related
Documents other than as otherwise set forth therein.

         (j)      Taxes and Other Liabilities. Borrower shall pay and discharge
when due any and all indebtedness, obligations, assessments and taxes, both real
and personal and including federal and state income taxes, except such as
Borrower may in good faith contest or as to which a bona fide dispute may

                                       16



arise, provided provision is made to the satisfaction of Bank for eventual
payment thereof in the event that it is found that the same is an obligation of
Borrower.

         (k)      Maintenance of Property; Insurance. Borrower will keep all
property useful and necessary in its business in reasonably good working order
and condition and will, except to the extent tenants are required to do so,
maintain, with financially sound and reputable insurance companies, insurance on
all its property of the types, in the amounts and against such risks as are
usually insured against in the same general area by companies of established
repute engaged in the same or a similar business, including, but not limited to,
fire, extended coverage, public liability, property damage and workers'
compensation, and will deliver to Bank from time to time at Bank's request
schedules setting forth all insurance then in effect.

         SECTION 9.        EVENTS OF DEFAULT. The occurrence of any of the
following shall constitute an "Event of Default" under this Agreement:

         (a)      Required Payments. Borrower shall fail to pay when due any
amount specified under this Agreement or any Related Document or to deposit with
Bank any amount specified in this Agreement when due to be deposited; or

         (b)      Misrepresentation. Any representation or warranty made by
Borrower in this Agreement or in any Related Document or in any certificate,
financial or other statement furnished by Borrower pursuant to this Agreement
shall prove to have been untrue or incomplete in any material respect when made;
or

         (c)      Other Covenants. Borrower shall fail to perform or observe any
material term, covenant or agreement on its part to be performed or observed
hereunder or under the Security Agreements (other than as specified in
paragraphs (a) and (b) above); provided, however, that if a cure period is
provided for the remedy of such failure, Borrower's failure to perform will not
constitute an Event of Default until such date as the specified cure period
expires; or

         (d)      Collateral. (i) Any impairment of the rights of Bank in any
Collateral or Proceeds, including, without limitation, any attachment or like
levy on any Collateral or Proceeds; or (ii) Bank, in good faith, believes any or
all of the Collateral and/or Proceeds to be in danger of misuse, dissipation,
commingling, loss, theft, damage or destruction, or otherwise in jeopardy or
unsatisfactory in character or value.

         (e)      Invalidity. Any material provision of this Agreement or any
Related Document shall at any time for any reason cease to be in full force and
effect or valid and binding on Borrower, or shall be declared to be null and
void, or the validity or enforceability thereof shall be contested by Borrower,
or Borrower shall deny that it has any further liability or obligation under
this Agreement or any Related Document, and such event shall have or be likely
to have a material adverse effect on the condition of Borrower and its ability
to perform its obligations under this Agreement and the Related Documents; or

         (f)      Voluntary Bankruptcy; Insolvency; Dissolution. Borrower shall:
(i) apply for or consent to the appointment of a receiver, trustee, custodian,
liquidator or the like of Borrower or any of its property; or (ii) admit in
writing its inability to pay its debts generally as they become due; or (iii)
make a general assignment for the benefit of creditors, (iv) be adjudicated a
bankrupt or insolvent; or (v) commence a voluntary case under the Bankruptcy
Code or file a voluntary petition or answer seeking reorganization, an
arrangement with creditors or an order for relief or seeking to take advantage
of any insolvency law or file an answer admitting the material allegations of a
petition filed against it in any bankruptcy, reorganization or insolvency
proceeding; or (vi) shall take any corporate action for the purpose of effecting
any of the foregoing; or

                                       17



         (g)      Involuntary Bankruptcy. If without the application, approval
or consent of Borrower, an involuntary case or other proceeding shall be
instituted in any court of competent jurisdiction, under the Bankruptcy Code or
any law relating to bankruptcy, insolvency, reorganization, or relief of debtors
seeking in respect of Borrower, an order for relief or an adjudication in
bankruptcy, reorganization, dissolution, winding-up, liquidation, a composition
or arrangement with creditors, a readjustment of debts, the appointment of a
trustee, receiver, liquidator or custodian or the like of Borrower, or of all or
any substantial part of the assets of Borrower, or other like relief in respect
thereof under any bankruptcy or insolvency law; or

         (h)      Other Defaults. (i) Borrower shall default in the payment or
performance of any tax liability, provided, however, such default in the payment
or performance of any tax liability in which Borrower may in good faith contest
or as to which a bona fide dispute has arisen shall not constitute a default
under this Section 9(h), provided Borrower has made provision satisfactory to
Bank for eventual payment thereof if it is determined that the same is an
obligation of Borrower; or (ii) Borrower shall default in any obligation under
any Related Document; or (iii) any defined event of default occurs under any
Related Document; or (iv) Borrower (A) fails to make any payment when due
(whether by scheduled maturity, acceleration or otherwise) in respect of any
indebtedness, whether direct or contingent (other than indebtedness under this
Agreement) having an aggregate principal amount (including undrawn committed or
available amounts and including amounts owing to all creditors under any
combined or syndicated credit arrangement) of more than $500,000, or (B) fails
to observe or perform any other agreement or condition relating to any such
indebtedness or contained in any instrument or agreement evidencing, securing or
relating thereto, or any other event occurs, the effect of which default or
other event is to cause, or to permit any holder of such indebtedness (or a
trustee or agent on behalf of such holder or beneficiary) to cause such
indebtedness to be demanded or to become due or to be repurchased or redeemed
prior to its stated maturity and, with respect to any failure under Section
9(h)(iv), such failure remains unremedied for a period of fifteen (15) calendar
days; or

         (i)      Material Adverse Change. There shall exist or occur any event
or condition which Bank reasonably and in good faith believes impairs or is
substantially likely to impair the prospect of payment or performance by
Borrower of its obligations under this Agreement or the Related Documents; or

         (j)      Change in Business. Borrower suspends the transaction of its
usual business or is no longer listed on the NASDAQ stock market; provided,
however, that if the sole reason Borrower is no longer listed on the NASDAQ
stock market is due to the acquisition of all of Borrower's outstanding stock in
a going private transaction, then such listing change shall not constitute an
Event of Default.

         SECTION 10.       REMEDIES. Upon the occurrence of an Event of Default,
Bank may, and upon the occurrence of an Event of Default for which Bank has
received a notice from Trustee that an event of default has occurred under the
Indenture and such default is not cured by Borrower within the applicable time
period, Bank shall, declare all amounts payable by Borrower under this Agreement
to be immediately due and payable (and the same shall upon such notice become
immediately due and payable), in each case without any presentment, demand,
protest or other notice or formality of any kind. Upon any such occurrence, Bank
may, in addition, (a) exercise all of its rights and remedies under any Related
Document (to which Bank is a party or Bank is a third party beneficiary) or
applicable law, (b) require Trustee to redeem all Bonds as provided in the
Indenture, or (c) exercise all or any combination of the remedies provided for
in this Section.

         SECTION 11.       AMENDMENTS, ETC. No amendment or waiver of any
provision of this Agreement nor consent to any departure by Borrower therefrom
shall in any event be effective unless the same shall be in writing and signed
by Bank, and then such waiver or consent shall be effective only in the specific
instance and for the specific purpose for which given.

                                       18



         SECTION 12.       NOTICES. Except as expressly provided for herein, all
notices and other communications provided for hereunder and in the Security
Agreements shall be in writing (including tested telex, telegraphic and
facsimile communication) and mailed, telegraphed, telexed, faxed or delivered to
each party at the address or telex or facsimile number specified for such party
on the signature page of this Agreement, or at such other address or telex or
facsimile number as shall be designated by such party in a written notice to the
other party. All such notices and other communications shall, when mailed,
telegraphed or faxed, be effective when received addressed as aforesaid, if
telexed, when the appropriate answer back is received, and if faxed, when
confirmation of receipt is received. Communications by Trustee with Bank with
respect to the Letter of Credit shall be made as provided in the Letter of
Credit. Any tested telex, telegraphic or facsimile communication provided to
Bank hereunder shall be promptly followed by a written confirmation thereof.

         SECTION 13.       NO WAIVER; REMEDIES. No failure on the part of Bank
to exercise, and no delay in exercising, any right hereunder shall operate as a
waiver thereof; nor shall any single or partial exercise of any right hereunder
preclude any other further exercise thereof or the exercise of any other right.
The remedies herein provided are cumulative and not exclusive of any remedies
provided by law.

         SECTION 14.       RIGHT OF SET-OFF; WAIVER OF RIGHT OF SET-OFF. Upon
the occurrence and during the continuance of any Event of Default, Bank is
hereby authorized at any time and from time to time, without notice to Borrower
(any such notice being expressly waived by Borrower), to set-off and apply any
and all deposits (general or special, time or demand, provisional or final,
including, but not limited to, indebtedness evidenced by certificates of
deposit, whether matured or unmatured, but not including trust accounts) at any
time held and other indebtedness at any time owing by Bank to or for the credit
or the account of Borrower against any and all of the obligations of Borrower
now or hereafter existing under this Agreement, irrespective of whether or not
Bank shall have made any demand under this Agreement and although such
obligations may be contingent and unmatured. Bank agrees promptly to notify
Borrower after any such set-off and application, provided that the failure to
give such notice shall not affect the validity of such set-off and application.
The rights of Bank under this Section are in addition to other rights and
remedies which Bank may have including, without limitation, other rights of
set-off; provided, however, that Bank waives any such right, and any other
similar right it may have at law or otherwise, during the pendency of any
bankruptcy, insolvency, reorganization, arrangement, readjustment of debt,
dissolution, liquidation, or similar proceedings against Borrower under the laws
of any jurisdiction, to the extent that the exercise of such rights during the
pendency of such proceedings would result in Bank's being released, prevented or
restrained from or delayed in fulfilling Bank's obligations with respect to the
Letter of Credit, as provided herein.

         SECTION 15.       INDEMNIFICATION. In addition to its other obligations
hereunder, Borrower hereby agrees, to the fullest extent permitted by law, to
indemnify and hold harmless Bank, its officers, directors, employees and agents
(collectively, the "Indemnitees") from and against any and all claims, damages,
losses, liabilities, costs or expenses (collectively "Claims") (including
attorneys' fees) whatsoever which the Indemnitees may incur (or which may be
claimed against the Indemnitees by any Person) by reason of or in connection
with (a) any failure by Borrower to comply with applicable federal and state
laws and regulations, including, without limitation, any such laws and
regulations pertaining to the Bonds and the Related Documents; (b) any breach by
Borrower of any representation, warranty or covenant made in or pursuant to this
Agreement; (c) any action by Bank upon, in accordance with or as a result of
receiving a Facsimile Demand (as defined below), whether such Facsimile Demand
was received by Bank prior to or after the Expiration Date of the Letter of
Credit; or (d) any action or proceeding relating to a court order, injunction or
other process or decree restraining or seeking to restrain Bank from paying any
amount under the Letter of Credit. Nothing in this Section 15 is intended to
limit any

                                       19



obligation of Borrower contained in this Agreement or to include any Claims
caused by Bank's gross negligence or willful misconduct.

         If any action shall be brought against Bank or any other Indemnitee in
respect of which indemnity may be sought against Borrower, Bank shall promptly
notify Borrower in writing, and Borrower shall promptly assume the defense
thereof, including the employment of counsel (the selection of which shall have
been approved by Bank), the payment of all expenses and the right to negotiate
and consent to settlement. In addition, Bank shall have the right at Borrower's
expense to employ separate counsel and to participate in the defense of any such
action if Bank has been advised by counsel of recognized standing in matters of
banking or securities laws that it has defenses or causes of action separate
from those of Borrower. If Borrower elects not to defend such action, Bank shall
have the right to employ counsel to defend such action and to participate in the
defense thereof, and the fees and expenses of such counsel shall be at the
expense of Borrower. Borrower shall not be liable for any settlement of any such
action effected without its consent by Bank, but if settled with the consent of
Borrower or if there be a final judgment for the plaintiff in any such action
against Borrower or Bank, with or without the consent of Borrower, Borrower
agrees to indemnify and hold harmless Bank to the extent provided herein.

         SECTION 16.       CONTINUING OBLIGATION. The obligation of Borrower
under this Agreement shall continue until the Termination Date and shall (i) be
binding upon Borrower and Bank, their successors and assigns, and (ii) inure to
the benefit of and be enforceable by Bank and Borrower and their successors and
assigns. Notwithstanding the foregoing, the indemnities set forth in Section 15
hereof shall survive the termination of this Agreement.

         SECTION 17.       TRANSFER OF LETTER OF CREDIT. The Letter of Credit
may be transferred in accordance with the provisions set forth therein and in
the Indenture. All fees and costs incurred in connection with any transfer of
the Letter of Credit shall be for the account of Borrower.

         SECTION 18.       LIABILITY OF BANK. As between Borrower and Bank,
Borrower assumes all risk of the acts or omissions of the Trustee and any
transferee of the Letter of Credit with respect to its use of the Letter of
Credit; provided, however, that this assumption is not intended to, and shall
not, preclude Borrower from pursuing such rights and remedies as they may have
against Trustee at law or in equity or under any other agreement; unless any
such act or omission is the result of Bank's willful misconduct or gross
negligence.

                                       20



         SECTION 19.       COSTS, EXPENSES, ATTORNEYS' FEES AND TAXES;
ALLOCATION OF INCREASED COSTS.

         (a)      Costs, Expenses, Attorneys' Fees and Taxes. Borrower agrees to
pay on demand by Bank all costs, expenses and attorneys' fees incurred or
assessed by Bank in connection with the preparation, execution and delivery of
this Agreement, the Letter of Credit (including any extensions thereof), any
Related Document and any other documents, agreements or certificates which may
be delivered in connection with this Agreement, the Letter of Credit and any
Related Document, any waiver or amendment or the giving of any consent under,
this Agreement, the Related Documents and such instruments or any transfer of
the Letter of Credit, including, without limitation, the fees and out-of-pocket
expenses of counsel for Bank (to include outside counsel fees and all allocated
costs of Bank's in-house counsel) with respect thereto and with respect to
advising Bank as to its rights and responsibilities under this Agreement, all
costs and expenses, including the fees and out-of-pocket expenses of counsel for
Bank (to include outside counsel fees and all allocated costs of Bank's in-house
counsel), if any, in connection with the enforcement of this Agreement and such
other documents which may be delivered in connection with this Agreement or the
defense of any provision of this Agreement, any of the other Related Documents,
or as a consequence of any Default or Event of Default under the Related
Documents, with or without the filing of any legal action or proceeding, and
including, without limitation, any fees and expenses incurred in any bankruptcy
proceeding of the Borrower, together with interest thereon from the date of such
demand until paid at the Default Rate. In addition, Borrower shall pay any and
all stamp and other taxes and fees payable or determined to be payable in
connection with the execution, delivery, filing and recording of this Agreement,
the Letter of Credit, the Related Documents and such other documents and agrees
to save Bank harmless from and against any an all liabilities with respect to or
resulting from any delay by Borrower in paying or omitting to pay such taxes and
fees. Bank agrees promptly to notify Borrower of any such taxes and fees which
are incurred by Bank.

         (b)      Allocation of Increased Costs. If any past, present or future
legislative, administrative or judicial action has the direct or indirect effect
of imposing upon Bank any requirement or condition regarding this Agreement, the
Letter of Credit, or any Related Document that directly or indirectly increases
the cost to Bank of issuing, maintaining or honoring draws under the Letter of
Credit, over the cost thereof as of the date of this Agreement, Bank shall so
notify Borrower and Borrower shall pay to Bank on or before the due date or
dates specified in Bank's notice all additional amounts necessary to compensate
Bank for such additional costs. Bank shall deliver to Borrower a certificate
showing the amount and manner of calculation of such increased costs, and
stating that the assessment of such increase in costs is fair and reasonable and
has not been arbitrarily applied to Borrower. Such certificate shall be
conclusive (absent manifest error) as to such amount. Without limiting the
generality of the foregoing, if (a) any insurance premium is imposed by the
Federal Deposit Insurance Corporation or other similar banking authority in
connection with the Letter of Credit, (b) any reserve requirement is imposed by
any banking authority in connection with the Letter of Credit, or (c) any
capital adequacy requirement not currently in effect is imposed by any banking
authority which has the effect of reducing the anticipated return on capital of
Bank in connection with the Letter of Credit, then the cost to Bank of such
premium, reserve requirement and/or capital adequacy requirement shall be
payable by Borrower as an additional cost in accordance with this Section.

         SECTION 20.       NO THIRD PARTY BENEFICIARIES. This Agreement is made
and entered into for the sole protection and benefit of the parties hereto and
their respective permitted successors and assigns, and no other person or entity
shall be a third party beneficiary of, or have any direct or indirect cause of
action or claim in connection with, this Agreement or any other of the Related
Documents to which it is not a party.

                                       21



         SECTION 21.       TIME. Time is of the essence of each and every
provision of this Agreement and each other of the Related Documents.

         SECTION 22.       SEVERABILITY. Any provision of this Agreement which
is prohibited, unenforceable or not authorized in any jurisdiction shall, as to
such jurisdiction, be ineffective to the extent of such prohibition,
unenforceability or nonauthorization without invalidating the remaining
provisions hereof or affecting the validity, enforceability or legality of such
provision in any other jurisdiction.

         SECTION 23.       SUCCESSORS, ASSIGNMENT. This Agreement shall be
binding upon and inure to the benefit of the heirs, executors, administrators,
legal representatives, successors and assigns of the parties; provided, however,
that Borrower may not assign or transfer its interest hereunder without Bank's
prior written consent. Bank reserves the right to sell, assign, transfer,
negotiate or grant participations in all or any part of, or any interest in,
Bank's rights and benefits under this Agreement and each of the Related
Documents. In connection therewith, Bank may disclose, subject to Section 24
herein, all documents and information which Bank now has or may hereafter
acquire relating to any credit subject hereto, Borrower or its business or any
collateral required hereunder.

         SECTION 24.       CONFIDENTIALITY. Bank agrees to maintain the
confidentiality of the Information (as defined below), except that Information
may be disclosed: (a) to its and its Affiliates' directors, officers, employees
and agents, including accountants, legal counsel and other advisors (it being
understood that the Persons to whom such disclosure is made will be informed of
the confidential nature of such Information and instructed to keep such
Information confidential); (b) to the extent requested by any regulatory
authority; (c) to the extent required by applicable laws or regulations or by
any subpoena or similar legal process; (d) to any other party to this Agreement
or any other Related Document; (e) in connection with the exercise of any
remedies hereunder or under any Related Document or any suit, action or
proceeding relating to this Agreement or any Related Document or the enforcement
of rights hereunder or thereunder; (f) subject to an agreement containing
provisions substantially the same as those of this section, to (i) any
Transferee, or any prospective Transferee of, any of its rights or obligations
under this Agreement or any Related Document or (ii) any direct or indirect
contractual counterparty or prospective counterparty (or such contractual
counterparty's or prospective counterparty's professional advisor) to any credit
derivative transaction relating to obligations of Borrower; (g) with the consent
of Borrower; (h) to the extent such Information (i) becomes publicly available
other than as a result of a breach of this section or (ii) becomes available to
Bank on a non-confidential basis from a source other than Borrower; provided,
however, that Bank may not disclose such information to the extent that it has
become available to Bank under this Section 24(h)(ii) if such source has
violated a confidentiality agreement with Borrower and Bank has actual knowledge
of the violation of such agreement; or (i) to the National Association of
Insurance Commissioners or any other similar organization or any nationally
recognized rating agency that requires access to information about Bank's or its
Affiliates' investment portfolio in connection with ratings issued with respect
to Bank or its Affiliates. In addition, Bank may disclose the existence of this
Agreement and the other Related Documents and information about this Agreement
and the other Related Documents to market data collectors, similar service
providers to the lending industry, and service providers to Bank in connection
with the administration and management of the Letter of Credit, this Agreement
and the other Related Documents. For the purposes of this section, "Information"
means all information received from Borrower relating to Borrower or its
business, other than any such information that is available to Bank on a
non-confidential basis prior to disclosure by Borrower; provided that, in the
case of information received from Borrower after the date hereof, such
information is clearly identified in writing at the time of delivery as
confidential. Any Person required to maintain the confidentiality of Information
as provided in this section shall be considered to have complied with its
obligation to do so if such Person has exercised the same degree of care to
maintain the confidentiality of such Information as such Person would accord to
its own confidential information.

                                       22



         SECTION 25.       GOVERNING LAW. This Agreement shall be governed by,
and construed in accordance with, the laws of the State of California, without
giving effect to conflicts of law principles. Unless Bank otherwise specifically
agrees in writing, the Letter of Credit, even if it is not a documentary credit,
the opening of the Letter of Credit, the performance by Bank under the Letter of
Credit, and the performance by the beneficiary and any advising, confirming,
negotiating, paying or other bank under the Letter of Credit, shall be governed
by and be construed in accordance with the UCP in force on the Date of Issuance
of the Letter of Credit.

         SECTION 26.       CONSENT OF JURISDICTION AND VENUE, ETC.

         (a)      Borrower irrevocably (i) agrees that any suit, action or other
legal proceeding arising out of or relating to this Agreement or such other
documents which may be delivered in connection with this Agreement may be
brought in a court of record in the State of California or in the Courts of the
United States of America located in the State of California, (ii) consents to
the jurisdiction of each such court in any such suit, action or proceeding, and
(iii) waives any objection which it may have to the laying of venue of any suit,
action or proceeding in any of such courts and any claim that any such suit,
action or proceeding has been brought in an inconvenient forum. Borrower
irrevocably consents to the service of any and all process in any such suit,
action or proceeding by mailing of copies of such process to Borrower at its
addresses specified on the signature page hereto by certified mail, return
receipt requested. Borrower agrees that a final and non-appealable judgment in
any such action or proceeding shall be conclusive and may be enforced in other
jurisdictions by suit on the judgment or in any other manner provided by law.

         (b)      Nothing in this Section shall affect the right of Bank to
serve legal process in any other manner permitted by law or affect the right of
Bank to bring any suit, action or proceeding against Borrower or its property in
the courts of any other jurisdictions.

         SECTION 27.       HEADINGS. Section headings in this Agreement are
included herein for convenience of reference only and shall not constitute a
part of this Agreement for any other purpose.

         SECTION 28.       SATISFACTION REQUIREMENT. If any agreement,
certificate or other writing, or any action taken or to be taken, is by the
terms of this Agreement required to be satisfactory to Bank, the determination
of such satisfaction shall be made by Bank in its sole and exclusive judgment.

         SECTION 29.       COUNTERPARTS. This Agreement may be signed in any
number of counterparts, each of which shall be an original with the same effect
as if the signatures thereto and hereto were upon the same instrument. Delivery
of an executed counterpart of a signature page to this Agreement or any of the
Related Documents by facsimile shall be as effective as delivery of a manually
executed counterpart of this Agreement or such Related Document, as applicable.

         SECTION 30.       RIGHTS AND REMEDIES CUMULATIVE. All rights and
remedies of Bank under this Agreement are in addition to all rights and remedies
of Bank as a bondholder under the Indenture.

         SECTION 31.       BANK RELIANCE. It is specifically understood by
Borrower that all statements, representations and warranties made by Borrower in
this Agreement and any other Related Document to which any Borrower is a party
shall be deemed to have been relied upon by Bank as an inducement to enter into
this Agreement and the other agreements contemplated hereby and that if any such
statements, representations and warranties were materially incorrect at the time
they were made, Bank may consider any such misrepresentation or breach an Event
of Default hereunder. Each of the

                                       23



representations and warranties shall survive any investigations or inquiries
made by Bank or any of its representatives.

         SECTION 32.       PERMITTED CONTESTS. Borrower shall have the right,
before any delinquency occurs, to contest or object in good faith to any claim,
demand, levy or assessment (other than in respect of any indebtedness or
obligation of Borrower under any of the Related Documents), by appropriate legal
proceedings which are not prejudicial to Bank's rights, but this shall not be
deemed or construed as in any way relieving, modifying or providing any
extension of time with respect to Borrower's covenant to pay and comply with any
such claim, demand, levy or assessment, unless Borrower shall have given prior
written notice to Bank of Borrower's intent to so contest or object thereto, and
unless (i) Borrower shall have demonstrated to Bank's satisfaction that such
legal proceedings shall conclusively operate to prevent enforcement prior to
final determination of such proceedings, and (ii) Borrower shall have furnished
such bond, surety, undertaking, or other security in connection therewith as is
requested by and satisfactory to Bank, in the amount of such claim plus
reasonable sums to pay costs, interest and penalties, to assure payment of the
matters under contest and to prevent any sale or forfeiture of the Project.

         SECTION 33.       ARBITRATION.

         (a)      Arbitration. Upon the demand of any party, any dispute shall
be resolved by binding arbitration (except as set forth in Sections 33(e) and
(f) below) in accordance with the terms of this Agreement. A "Dispute" shall
mean any action, dispute, claim or controversy of any kind, whether in contract
or tort, statutory or common law, legal or equitable, now existing or hereafter
arising under or in connection with, or in any way pertaining to, this Agreement
or any of the Related Documents and each other document, contract and instrument
required hereby or thereby or now or hereafter delivered to Bank in connection
herewith or therewith, or any past, present or future extensions of credit and
other activities, transactions or obligations of any kind related directly or
indirectly to any of the foregoing documents, including, without limitation, any
of the foregoing arising in connection with the exercise of any self-help,
ancillary or other remedies pursuant to any of the foregoing documents. Any
party may by summary proceedings bring an action in court to compel arbitration
of a Dispute. Any party who fails or refuses to submit to arbitration following
a lawful demand by any other party shall bear all costs and expenses incurred by
such other party in compelling arbitration of any Dispute.

         (b)      Governing Rules. Arbitration proceedings shall be administered
by the American Arbitration Association ("AAA") or such other administrator as
the parties shall mutually agree upon in accordance with the AAA Commercial
Arbitration Rules. All Disputes submitted to arbitration shall be resolved in
accordance with the Federal Arbitration Act (Title 9 of the United States Code),
notwithstanding any conflicting choice of law provision in any of the foregoing
documents. The arbitration shall be conducted at a location in California
selected by the AAA or other administrator. If there is any inconsistency
between the terms hereof and any such rules, the terms and procedures set forth
herein shall control. All statutes of limitation applicable to any Dispute shall
apply to any arbitration proceeding. All discovery activities shall be expressly
limited to matters directly relevant to the Dispute being arbitrated. Judgment
upon any award rendered in an arbitration may be entered in any court having
jurisdiction; provided, however, that nothing contained herein shall be deemed
to be a waiver by any party that is a bank of the protections afforded to it
under Section 91 of Title 12 of the United States Code or any similar applicable
state law.

         (c)      No Waiver; Provisional Remedies, Self-Help and Foreclosure. No
provision hereof shall limit the right of any party to exercise self-help
remedies such as sotoff, foreclosure against or sale of any real or personal
property collateral or security, or to obtain provisional or ancillary remedies,
including,

                                       24



without limitation, injunctive relief, sequestration, attachment, garnishment or
the appointment of a receiver from a court of competent jurisdiction before,
after or during the pendency of any arbitration or other proceeding. The
exercise of any such remedy shall not waive the right of any party to compel
arbitration or reference hereunder.

         (d)      Arbitrator Qualifications and Powers; Awards. Arbitrators must
be active members of the California State Bar or retired judges of the state or
federal judiciary of California, with expertise in the substantive law
applicable to the subject matter of the Dispute. Arbitrators are empowered to
resolve Disputes by summary rulings in response to motions filed prior to the
final arbitration hearing. Arbitrators (i) shall resolve all Disputes in
accordance with the substantive law of the State of California, (ii) may grant
any remedy or relief that a court of the State of California could order or
grant within the scope hereof and such ancillary relief as is necessary to make
effective any award, and (iii) shall have the power to award recovery of all
costs and fees, to impose sanctions and to take such other actions as they deem
necessary to the same extent a judge could pursuant to the Federal Rules of
Civil Procedure, the California Rules of Civil Procedure or other applicable
law. Any Dispute in which the amount in controversy is $5,000,000 or less shall
be decided by a single arbitrator who shall not render an award of greater than
$5,000,000 (including damages, costs, fees and expenses). By submission to a
single arbitrator, each party expressly waives any right or claim to recover
more than $5,000,000. Any Dispute in which the amount in controversy exceeds
$5,000,000 shall be decided by majority vote of a panel of three arbitrators;
provided, however, that all three arbitrators must actively participate in all
hearings and deliberations.

         (e)      Judicial Review. Notwithstanding anything herein to the
contrary, in any arbitration in which the amount in controversy exceeds
$25,000,000, the arbitrators shall be required to make specific, written
findings of fact and conclusions of law. In such arbitrations (i) the
arbitrators shall not have the power to make any award which is not supported by
substantial evidence or which is based on legal error, (ii) an award shall not
be binding upon the parties unless the findings of fact are supported by
substantial evidence and the conclusions of law are not erroneous under the
substantive law of the State of California, and (iii) the parties shall have in
addition to the grounds referred to in the Federal Arbitration Act for vacating,
modifying or correcting an award the right to judicial review of (1) whether the
findings of fact rendered by the arbitrators are supported by substantial
evidence, and (2) whether the conclusions of law are erroneous under the
substantive law of the State of California. Judgment confirming an award in such
a proceeding may be entered only if a court determines the award is supported by
substantial evidence and not based on legal error under the substantive law of
the State of California.

         (f)      Real Property Collateral; Judicial Reference. Notwithstanding
anything herein to the contrary, no Dispute shall be submitted to arbitration if
the Dispute concerns indebtedness secured directly or indirectly, in whole or in
part, by any real property unless (i) the holder of the mortgage, lien or
security interest specifically elects in writing to proceed with the
arbitration, or (ii) all parties to the arbitration waive any rights or benefits
that might accrue to them by virtue of the single action rule statute of
California, thereby agreeing that all indebtedness and obligations of the
parties, and all mortgages, liens and security interests securing such
indebtedness and obligations, shall remain fully valid and enforceable. If any
such Dispute is not submitted to arbitration, the Dispute shall be referred to a
referee in accordance with California Code of Civil Procedure Section 638 et
seq., and this general reference agreement is intended to be specifically
enforceable in accordance with such Section 638. A referee with the
qualifications required herein for arbitrators shall be selected pursuant to the
AAA's selection procedures. Judgment upon the decision rendered by a referee
shall be entered in the court in which such proceeding was commenced in
accordance with California Code of Civil Procedure Sections 644 and 645.

         (g)      Miscellaneous. To the maximum extent practicable, the AAA, the
arbitrators and the

                                       25



parties shall take all action required to conclude any arbitration proceeding
within 180 days of the filing of the Dispute with the AAA. No arbitrator or
other party to an arbitration proceeding may disclose the existence, content or
results thereof, except for disclosures of information by a party required in
the ordinary course of its business, by applicable law or regulation, or to the
extent necessary to exercise any judicial review rights set forth herein. If
more than one agreement for arbitration by or between the parties potentially
applies to a Dispute, the arbitration provision most directly related to the
foregoing documents or the subject matter of the Dispute shall control. This
Agreement may be amended or modified only in writing signed by Bank and
Borrower. If any provision of this Agreement shall be held to be prohibited by
or invalid under applicable law, such provision shall be ineffective only to the
extent of such prohibition or invalidity, without invalidating the remainder of
such provision or any remaining provisions of this Agreement. This arbitration
provision shall survive termination, amendment or expiration of any of the
foregoing documents or any relationship between the parties.

         SECTION 34.       FACSIMILE TRANSMISSIONS OF DEMANDS UNDER THE LETTER
OF CREDIT. Borrower has requested that Bank issue the Letter of Credit in a form
which permits Trustee to use facsimile transmission equipment ("FTE") to
transmit to Bank such demands as may be made by Trustee from time to time under
the Letter of Credit, and as are authorized therein. Each such transmission sent
by FTE shall be in such form as may be determined by Trustee, which otherwise
complies with the requirements of the Letter of Credit. Each demand as may be
received by Bank by FTE shall be referred to hereinafter individually as a
"Facsimile Demand" and collectively as the "Facsimile Demands". Bank has agreed
to issue the Letter of Credit providing for Facsimile Demands, only upon
Borrower's agreement to the following additional terms and conditions:

         (a)      Borrower acknowledges that Bank is not obligated to Borrower
to issue letters of credit which provide for Facsimile Demands, but that Bank
has agreed to do so at Borrower's request and solely as a convenience to
Borrower and Trustee. Borrower further acknowledges that such Facsimile Demands
cause additional risks for Bank as follows: (i) Facsimile Demands may or may not
ever be completely received by Bank due to defective or incomplete transmission,
mechanical breakdowns, empty paper supplies and innumerable other reasons
affecting the transmission or reception by FTE; (ii) a Facsimile Demand, if
received, may be illegible or undecipherable, or missing pages or portions of
pages; (iii) a Facsimile Demand may not be in a form to permit Bank to determine
whether such a Facsimile Demand constitutes a conforming demand or a draw under
the Letter of Credit; (iv) a Facsimile Demand may be received by Bank following
the Expiration Date of the Letter of Credit and Trustee claims to have
transmitted such Facsimile Demand prior to such Expiration Date; (v) a Facsimile
Demand may be determined to be non-conforming after such time as the Letter of
Credit has expired, leading to uncertainty and ambiguity as to the relative
rights and duties of the parties to the Letter of Credit.

         (b)      Borrower understands that Bank will not see the original of
the draw, demand or notification underlying the Facsimile Demand and that Bank
may have relied upon such Facsimile Demand in transferring funds to the account
of Trustee, and that Bank may not be able to verify that the Facsimile Demand
has been received by Bank prior to the Expiration Date of the Letter of Credit
and in such a form that Bank can determine that such Facsimile Demand
constitutes a conforming demand or draw under the Letter of Credit. Borrower
also understands that Bank has agreed to receive Facsimile Demands in this
manner as an accommodation to Borrower, and that Borrower therefore accepts the
risk that a Facsimile Demand, whether heretofore or hereafter received by Bank
so as to permit Bank's timely action in accordance therewith; may not have been
received in such a form as to constitute a conforming demand or draw under the
Letter of Credit; even though sent by Trustee so as to permit adequate
opportunity for cure if non-conforming, may not have been received by Bank until
after such time as Trustee may reasonably have an opportunity to cure.

         (c)      Borrower acknowledges that the use of FTE to transmit
Facsimile Demands to Bank, and Bank's ability to act upon and in accordance with
Facsimile Demands so received, may be interrupted by

                                       26



industrial disputes, acts of government, fires, power failures, computer
malfunctions, civil disturbances or other causes or events not within the
control of Bank.

         (d)      Borrower hereby waives, in advance, any defense to payment by
Bank of any Facsimile Demand due to resubmission of any such Facsimile Demand
following the Expiration Date of the Letter of Credit. In addition, Borrower
agrees to indemnify and reimburse Bank immediately upon demand for any payment
or payments made by Bank under or in connection with any Facsimile Demand. The
foregoing reimbursement obligations of Borrower shall be considered
"Reimbursement Obligations" of Borrower under this Agreement.

         (e)      This Section 34 shall apply to and govern all Facsimile
Demands made under the Letter of Credit.

               [THE REMAINDER OF THIS PAGE IS INTENTIONALLY BLANK]

                                       27



         Executed as of the date first written above.

BORROWER:                                BANK:

AXT, INC.                                WELLS FARGO BANK,
                                          NATIONAL ASSOCIATION

By: /s/ Morris S. Young                  By: /s/ Manao Keegan
    --------------------------               --------------------------
    Morris S. Young                          Manao Keegan
    President                                Vice President

Address for Notices:                     Address for Notices:
     4281 Technology Drive                    Wells Fargo Bank, Peninsula RCBO
     Fremont, California 94538                400 Hamilton Avenue, P.O. Box 150
     Attention: Donald L. Tatzin              Palo Alto, CA 94302
                                              Attention: Manao Keegan

Facsimile: (510) 438-4793                Facsimile: (650) 328-0814



                                    EXHIBIT A

                          IRREVOCABLE LETTER OF CREDIT


                                                                       EXHIBIT A



                          IRREVOCABLE LETTER OF CREDIT



                                                                   April 7, 2003
                                                                         --

                                                  Letter of Credit No. NZS472650

BNY Western Trust Company
700 South Flower Street, Suite 500
Los Angeles, California 90017
Attn: Corporate Trust Department

Ladies and Gentlemen:

      We hereby establish in your favor at the request and for the account of
AXT, Inc., a Delaware corporation (formerly known as American Xtal Technology,
Inc.), our irrevocable letter of credit (this "Letter of Credit") in the amount
of U.S. $9,022,930.00 (Nine Million Twenty-Two Thousand Nine Hundred Thirty and
No/00 Dollars) in connection with the Bonds (as defined below) available with
ourselves by sight payment against presentation of one or more (a) telegraphic
demands, (b) signed and dated demands ("Signed Demands") or (c) telefacsimile
demands ("Telefacsimile Demands") addressed by you to Wells Fargo Bank, N.A.,
Letter of Credit Operations Office, San Francisco, California, each in the form
of Annex A (an "A Drawing"), Annex B (a "B Drawing"), Annex C (a "C Drawing"),
Annex D (a "D Drawing"), Annex E (an "E Drawing"), or Annex F (an "F Drawing")
hereto, with all instructions in brackets therein being complied with.

      Each such presentation must be made on a Business Day (as hereinafter
defined) to our Letter of Credit Operations Office in San Francisco, California
(presently located at 525 Market Street, 25th Floor, San Francisco, California
94105) at or before 5:00 p.m., San Francisco time on or before the Expiration
Date (as hereinafter defined). This Letter of Credit expires at our above office
on December 1, 2008 but shall be automatically extended, without written
amendment, to December 1 in each succeeding calendar year up to, but not beyond,
December 1, 2023, unless you shall have received at your address above our
written notice sent by registered mail or express courier that we elect not to
extend this Letter of Credit beyond the date specified in such notice, which
date shall be December 1, 2008 or any subsequent December 1 occurring before
December 1,2023 and be at least forty-five (45) calendar days after the date you
receive such notice. AS used herein, the term "Expiration Date" means the
earlier of (a) December 1, 2023 or (b) the date specified in any notice of
non-extension received by you pursuant to the immediately preceding sentence as
the date beyond which this Letter of Credit will not be extended. If the
Expiration Date falls on a day which is not a Business Day, then such Expiration
Date shall be automatically extended to the next succeeding Business Day. As
used herein, the term "Business Day" means a day of the year on which our San
Francisco Letter of Credit Operations Office is open for business.

      The amount of any demand presented hereunder will be the amount inserted
in numbered Paragraph 4 of said demand. By honoring any such demand we make no
representation as to the correctness of the amount demanded.

      We hereby agree with you that each demand presented hereunder in full
compliance with the terms hereof will be duly honored by our payment to you of
the amount of such demand, in immediately available funds of Wells Fargo Bank,
N.A.:




                                                                          Page 1

                                                                       EXHIBIT A



      (i) not later than 10:00 a.m., San Francisco time, on the Business Day
following the Business Day on which such demand is presented to us as aforesaid
if such presentation is made to us at or before noon, San Francisco time.

                                       or

      (ii) not later than 10:00 a.m., San Francisco time, on the second Business
Day following the Business Day on which such demand is presented to us as
aforesaid, if such presentation is made to us after noon, San Francisco time.

      Notwithstanding the foregoing, any demand presented hereunder, in full
compliance with the terms hereof, for a C Drawing or D Drawing will be duly
honored (i) not later than 12:30 p.m., San Francisco time, on the Business Day
on which such demand is presented to us as aforesaid if such presentation is
made to us at or before 8:00 a.m., San Francisco time, and (ii) not later than
11:00 a.m., San Francisco time, on the Business Day following the Business Day
on which such demand is presented to us as aforesaid if such presentation is
made to us after 8:00 a.m., San Francisco time.

      If the remittance instructions included with any demand presented under
this Letter of Credit require that payment is to be made by transfer to an
account with us or with another bank, we and/or such other bank may rely solely
on the account number specified in such instructions even if the account is in
the name of a person or entity different from the intended payee.

      With respect to any demand that is honored hereunder, the total amount of
this Letter of Credit shall be reduced as follows:

      (A) With respect to any A Drawing or B Drawing, the total amount of this
Letter of Credit shall be reduced, as to all demands subsequent to the
applicable demand, by the amount of the applicable demand as of the time of
presentation of such demand and shall not be reinstated;

      (B) With respect to any C Drawing or D Drawing, the total amount of this
Letter of Credit shall be reduced, as to all demands subsequent to the
applicable demand, by the amount of the applicable demand as of the time of
presentation of such demand subject to reinstatement in full or in part, if and
to the extent, prior to the Expiration Date, we are reimbursed from remarketing
proceeds for all or a portion of such demand, at which time we shall advise you
in writing of such reinstatement and the amount reinstated; and

      (C) With respect to any F Drawing, the total amount of this Letter of
Credit shall be reduced, as to all demands subsequent to the applicable demand,
by the amount of the applicable demand as of the time of presentation of such
demand; provided, however, that such amount shall be automatically reinstated on
the tenth (10th) calendar day following the date of presentation of such demand
unless (i) you shall have received notice from us by telegraph, telex, courier
service or registered mail at the above address within seven (7) calendar days
after the presentation of such demand that there shall be no such reinstatement,
or (ii) the tenth (10th) calendar day after such presentation would be after the
Expiration Date.

      Upon presentation to us of an E Drawing in compliance with the terms of
this Letter of Credit, no further demand whatsoever may be presented hereunder.

      An F Drawing shall not be presented to us (i) more than once during any
eighty-four (84) calendar day period, or (ii) with respect to any single F
Drawing, for an amount more than Three Hundred Seven Thousand Nine Hundred
Thirty and no/100 Dollars ($307,930.00).




                                                                          Page 2

                                                                       EXHIBIT A


      Except as otherwise provided herein, this Letter of Credit shall be
governed by and construed in accordance with the Uniform Customs and Practice
for Documentary Credits (1993 Revision), Publication No. 500 of the
International Chamber of Commerce (the "UCP"); provided, however, that Article
41, paragraphs d, e, f, g, h, i and j of Article 48 and the second sentence of
Article 17 shall not apply to this Letter of Credit. Furthermore, as provided in
the first sentence of Article 17 of the UCP, we assume no liability or
responsibility for consequences arising out of the interruption of our business
by Acts of God, riots, civil commotions, insurrections, wars or any other causes
beyond our control, or strikes or lockouts. As to matters not covered by the UCP
and to the extent not inconsistent with the UCP or made inapplicable by this
Letter of Credit, this Letter of Credit shall be governed by the laws of the
State of California, including the Uniform Commercial Code as in effect in the
State of California, without giving effect to conflicts of law principles.

      This Letter of Credit is transferable and may be transferred more than
once, but in each case only in the amount of the full unutilized balance hereof
to any single transferee who you shall have advised us pursuant to Annex G has
succeeded BNY Western Trust Company or a successor trustee as Trustee under the
Indenture, dated as of December 1, 1998, as supplemented from time to time (the
"Indenture") between AXT, Inc. (formerly known as American Xtal Technology,
Inc.), as Issuer, and BNY Western Trust Company (successor trustee to Harris
Trust Company of California), as Trustee, pursuant to which U.S. $11,615,000.00
in aggregate principal amount of American Xtal Technology, Inc. Variable Rate
Taxable Demand Revenue Bonds Series 1998 (Xtal Project) (the "Bonds") were
issued. Transfers may be effected only through ourselves and only upon
presentation to us of a duly executed instrument of transfer in the form
attached hereto as Annex G. Any transfer of this Letter of Credit as aforesaid
must be endorsed by us on the reverse hereof and may not change the place of
presentation of demands from our Letter of Credit Operations Office in San
Francisco, California.

      All payments hereunder shall be made from our own funds.




                                                                          Page 3

                                                                       EXHIBIT A



      This Letter of Credit sets forth in full our undertaking, and such
undertaking shall not in any way be modified, amended, amplified or limited by
reference to any document, instrument or agreement referred to herein
(including, without limitation, the Bonds and the Indenture), except the UCP to
the extent provided herein, and to the extent that the UCP is not inconsistent
with or made inapplicable by this Letter of Credit; and any such reference shall
not be deemed to incorporate herein by reference any document, instrument or
agreement except the UCP to the extent provided herein.


                                           WELLS FARGO BANK,
                                           NATIONAL ASSOCIATION



                                           By:
                                              ----------------------------

 Letter of Credit Operations Office
       Telephone Nos.:
       (415) 396-5458 and
       (415) 396-4014

 Letter of Credit Operations Office
       Telefacsimile No.:
       (415) 284-9453




                                                                          Page 4

                                                                       EXHIBIT A


                       Annex A to Wells Fargo Bank, N.A.
                          Irrevocable Letter of Credit
                                 No. NZS472650


Wells Fargo Bank, N.A.
Letter of Credit Operations Office
San Francisco, California

              FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER:

      [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS
FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO.
NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE
"INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE
LETTER OF CREDIT) THAT:

      (1)   THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE
            INDENTURE.

      (2)   THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF
            CREDIT WITH RESPECT TO THE PAYMENT OF PRINCIPAL UPON AN OPTIONAL
            AND/OR MANDATORY REDEMPTION OF LESS THAN ALL OF THE BONDS CURRENTLY
            OUTSTANDING.

      (3)   THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE
            WITH THE TERMS AND CONDITIONS OF THE BONDS AND THE INDENTURE AND IS
            DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH AMOUNT PLEASE REMIT
            TO THE UNDERSIGNED AS FOLLOWS: [INSERT REMITTANCE INSTRUCTIONS].

      (4)   THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS $[INSERT
            AMOUNT].

      (5)   THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND
            TELEFACSIMILE AN OFFICER OF THE BANK'S LETTER OF CREDIT OFFICE IN
            SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND
            THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED.




                                                                          Page 5

                                                                       EXHIBIT A


      (6)   IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE NOON, SAN FRANCISCO
            TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR
            BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE NEXT BUSINESS DAY. IF
            THIS DEMAND IS RECEIVED BY YOU AFTER NOON, SAN FRANCISCO TIME, ON A
            BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE
            10:00 A.M., SAN FRANCISCO TIME, ON THE SECOND BUSINESS DAY FOLLOWING
            SUCH BUSINESS DAY.

                          [INSERT NAME OF BENEFICIARY]

               [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT
                               SIGNATURE AND DATE]




                                                                          Page 6

                                                                       EXHIBIT A





                     Annex B to Wells Fargo Bank, N.A.
                       Irrevocable Letter of Credit
                               No. NZS472650


Wells Fargo Bank, N.A.
Letter of Credit Operations Office
San Francisco, California

              FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER:

      [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS
FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO.
NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE
"INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE
LETTER OF CREDIT) THAT:

      (1)   THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE
            INDENTURE.

      (2)   THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF
            CREDIT WITH RESPECT TO THE PAYMENT OF UNPAID INTEREST UPON AN
            OPTIONAL AND/OR MANDATORY REDEMPTION OF LESS THAN ALL OF THE BONDS
            CURRENTLY OUTSTANDING.

      (3)   THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE
            WITH THE TERMS AND CONDITIONS OF THE AFORESAID BONDS AND THE
            INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH
            AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS:
            [INSERT REMITTANCE INSTRUCTIONS].

      (4)   THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS
            $[INSERT AMOUNT].

      (5)   THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND
            TELEFACSIMILE AN OFFICER OF THE BANK'S LETTER OF CREDIT OFFICE IN
            SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND
            THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED.




                                                                          Page 7

                                                                       EXHIBIT A



      (6)   IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE NOON, SAN FRANCISCO
            TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR
            BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE NEXT BUSINESS DAY. IF
            THIS DEMAND IS RECEIVED BY YOU AFTER NOON, SAN FRANCISCO TIME, ON A
            BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE
            10:00 A.M., SAN FRANCISCO TIME, ON THE SECOND BUSINESS DAY FOLLOWING
            SUCH BUSINESS DAY.

                          [INSERT NAME OF BENEFICIARY]

               [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT
                               SIGNATURE AND DATE]




                                                                          Page 8

                                                                       EXHIBIT A




                          Annex C to Wells Fargo Bank, N.A.
                             Irrevocable Letter of Credit
                                 No. NZS472650

Wells Fargo Bank, N.A.
Letter of Credit Operations Office
San Francisco, California

              FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER:

      [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS
FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO.
NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE
"INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE
LETTER OF CREDIT) THAT:

      (1)   THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE
            INDENTURE.

      (2)   THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF
            CREDIT WITH RESPECT TO THE PAYMENT OF THE PRINCIPAL AMOUNT OF THOSE
            BONDS WHICH THE REMARKETING AGENT (AS DEFINED IN THE INDENTURE) HAS
            BEEN UNABLE TO REMARKET WITHIN THE TIME LIMITS ESTABLISHED IN THE
            INDENTURE.

      (3)   THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE
            WITH THE TERMS AND CONDITIONS OF THE AFORESAID BONDS AND THE
            INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH
            AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS:
            [INSERT REMITTANCE INSTRUCTIONS].

      (4)   THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS
            $[INSERT AMOUNT].

      (5)   THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND
            TELEFACSIMILE AN OFFICER OF THE BANKS LETTER OF CREDIT OFFICE IN SAN
            FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND THE
            DATE AND TIME BY WHICH PAYMENT IS DEMANDED.




                                                                          Page 9

                                                                       EXHIBIT A




      (6)   IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE 8:00 A.M., SAN
            FRANCISCO TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS
            DEMAND AT OR BEFORE 12:30 P.M., SAN FRANCISCO TIME, ON SAID BUSINESS
            DAY. IF THIS DEMAND IS RECEIVED BY YOU AFTER 8:00 A.M., SAN
            FRANCISCO TIME, ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS
            DEMAND AT OR BEFORE 11:00 A.M., SAN FRANCISCO TIME, ON THE BUSINESS
            DAY FOLLOWING SAID BUSINESS DAY.

                          [INSERT NAME OF BENEFICIARY]

               [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT
                               SIGNATURE AND DATE]




                                                                         Page 10

                                                                       EXHIBIT A





                     Annex D to Wells Fargo Bank, N.A.
                       Irrevocable Letter of Credit
                               No. NZS472650


Wells Fargo Bank, N.A.
Letter of Credit Operations Office
San Francisco, California

           FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER:

       [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS
 FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT
 NO. NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY"
 AND THE "INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET
 FORTH IN THE LETTER OF CREDIT) THAT:

      (1)   THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE
            INDENTURE.

      (2)   THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF
            CREDIT WITH RESPECT TO THE PAYMENT OF THE UNPAID INTEREST ON THOSE
            BONDS WHICH THE REMARKETING AGENT (AS DEFINED IN THE INDENTURE) HAS
            BEEN UNABLE TO REMARKET WITHIN THE TIME LIMITS ESTABLISHED IN THE
            INDENTURE.

      (3)   THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE
            WITH THE TERMS AND CONDITIONS OF THE AFORESAID BONDS AND THE
            INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH
            AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS:
            [INSERT REMITTANCE INSTRUCTIONS].

      (4)   THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS
            $[INSERT AMOUNT].

      (5)   THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND
            TELEFACSIMILE AN OFFICER OF THE BANK'S LETTER OF CREDIT OFFICE IN
            SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND
            THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED.




                                                                         Page 11

                                                                       EXHIBIT A



      (6)   IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE 8:00 A.M., SAN
            FRANCISCO TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS
            DEMAND AT OR BEFORE 12:30 P.M., SAN FRANCISCO TIME, ON SAID BUSINESS
            DAY. IF THIS DEMAND IS RECEIVED BY YOU AFTER 8:00 A.M., SAN
            FRANCISCO TIME, ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS
            DEMAND AT OR BEFORE 11:00 A.M., SAN FRANCISCO TIME, ON THE BUSINESS
            DAY FOLLOWING SAID BUSINESS DAY.

                          [INSERT NAME OF BENEFICIARY]

               [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT
                               SIGNATURE AND DATE]




                                                                         Page 12

                                                                       EXHIBIT A





                       Annex E to Wells Fargo Bank, N.A.
                          Irrevocable Letter of Credit
                                 No. NZS472650


Wells Fargo Bank, N.A.
Letter of Credit Operations Office
San Francisco, California

              FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER:

      [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS
FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO.
NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE
"INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE
LETTER OF CREDIT) THAT:

      (1)   THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE
            INDENTURE.

      (2)   THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF
            CREDIT WITH RESPECT TO THE PAYMENT, AT STATED MATURITY, UPON
            ACCELERATION FOLLOWING AN EVENT OF DEFAULT, OR UPON REDEMPTION AS A
            WHOLE, OF THE TOTAL UNPAID PRINCIPAL OF, AND UNPAID INTEREST ON, ALL
            OF THE BONDS WHICH ARE PRESENTLY OUTSTANDING.

      (3)   THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE
            WITH THE TERMS AND CONDITIONS OF THE AFORESAID BONDS AND THE
            INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH
            AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS: [INSERT
            REMITTANCE INSTRUCTIONS].

      (4)   THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS $[INSERT
            AMOUNT WHICH IS THE SUM OF THE TWO AMOUNTS SET FORTH IN PARAGRAPH 5,
            BELOW].

      (5)   THE AMOUNT OF THIS DEMAND IS EQUAL TO THE SUM OF (A) $[INSERT
            AMOUNT] BEING DRAWN IN RESPECT OF THE PAYMENT OF UNPAID PRINCIPAL OF
            THE AFORESAID BONDS AND (B) $[INSERT AMOUNT] BEING DRAWN IN RESPECT
            OF THE PAYMENT OF UNPAID INTEREST ON THE AFORESAID BONDS.

      (6)   THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND
            TELEFACSIMILE AN OFFICER OF THE BANK'S LETTER OF CREDIT OFFICE IN
            SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND
            THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED.




                                                                         Page 13

                                                                       EXHIBIT A




      (7)   IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE NOON, SAN FRANCISCO
            TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR
            BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE NEXT BUSINESS DAY. IF
            THIS DEMAND IS RECEIVED BY YOU AFTER NOON, SAN FRANCISCO TIME, ON A
            BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE
            10:00 A.M., SAN FRANCISCO TIME, ON THE SECOND BUSINESS DAY FOLLOWING
            SUCH BUSINESS DAY.

                          [INSERT NAME OF BENEFICIARY]

                [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT
                               SIGNATURE AND DATE]




                                                                         Page 14

                                                                       EXHIBIT A





                       Annex F to Wells Fargo Bank, N.A.
                          Irrevocable Letter of Credit
                                 No. NZS472650


Wells Fargo Bank, N.A.
Letter of Credit Operations Office
San Francisco, California

              FOR THE URGENT ATTENTION OF LETTER OF CREDIT MANAGER:

      [INSERT NAME OF BENEFICIARY] (THE "TRUSTEE") HEREBY CERTIFIES TO WELLS
FARGO BANK, N.A. (THE "BANK") WITH REFERENCE TO IRREVOCABLE LETTER OF CREDIT NO.
NZS472650 (THE "LETTER OF CREDIT"; THE TERMS THE "BONDS", "BUSINESS DAY" AND THE
"INDENTURE" IF USED HEREIN SHALL HAVE THEIR RESPECTIVE MEANINGS SET FORTH IN THE
LETTER OF CREDIT) THAT:

      (1)   THE TRUSTEE IS THE TRUSTEE OR A SUCCESSOR TRUSTEE UNDER THE
            INDENTURE.

      (2)   THE TRUSTEE IS MAKING A DEMAND FOR PAYMENT UNDER THE LETTER OF
            CREDIT WITH RESPECT TO THE PAYMENT, ON AN INTEREST PAYMENT DATE (AS
            DEFINED IN THE INDENTURE), OF UNPAID INTEREST WITH RESPECT TO THE
            BONDS.

      (3)   THE AMOUNT OF THIS DEMAND FOR PAYMENT WAS COMPUTED IN ACCORDANCE
            WITH THE TERMS AND CONDITIONS OF THE AFORESAID BONDS AND THE
            INDENTURE AND IS DEMANDED IN ACCORDANCE WITH THE INDENTURE, WHICH
            AMOUNT PLEASE REMIT TO THE UNDERSIGNED AS FOLLOWS: [INSERT
            REMITTANCE INSTRUCTIONS].

      (4)   THE AMOUNT HEREBY DEMANDED UNDER THE LETTER OF CREDIT IS $[INSERT
            AMOUNT].

      (5)   THE TRUSTEE HAS CONTACTED OR ATTEMPTED TO CONTACT BY TELEPHONE AND
            TELEFACSIMILE AN OFFICER OF THE BANK'S LETTER OF CREDIT OFFICE IN
            SAN FRANCISCO, CALIFORNIA REGARDING THE AMOUNT OF THIS DEMAND AND
            THE DATE AND TIME BY WHICH PAYMENT IS DEMANDED.




                                                                         Page 15

                                                                       EXHIBIT A



      (6)   IF THIS DEMAND IS RECEIVED BY YOU AT OR BEFORE NOON, SAN FRANCISCO
            TIME ON A BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR
            BEFORE 10:00 A.M., SAN FRANCISCO TIME, ON THE NEXT BUSINESS DAY. IF
            THIS DEMAND IS RECEIVED BY YOU AFTER NOON, SAN FRANCISCO TIME, ON A
            BUSINESS DAY, YOU MUST MAKE PAYMENT ON THIS DEMAND AT OR BEFORE
            10:00 A.M., SAN FRANCISCO TIME, ON THE SECOND BUSINESS DAY FOLLOWING
            SUCH BUSINESS DAY.

                          [INSERT NAME OF BENEFICIARY]

               [FOR SIGNED AND TELEFACSIMILE DEMANDS ONLY, INSERT
                               SIGNATURE AND DATE]




                                                                         Page 16

                                                                       EXHIBIT A





                       Annex G to Wells Fargo Bank, N.A.
                          Irrevocable Letter of Credit
                                 No. NZS472650


Wells Fargo Bank, N.A.
525 Market Street, 25th Floor
Letter of Credit Operations Office
San Francisco, California

 Subject: Your Letter of Credit No. NZS472650

 Ladies and Gentlemen:

      For value received, we hereby irrevocably assign and transfer all of our
rights under the above-captioned Letter of Credit, as heretofore and hereafter
amended, extended or increased, to:


 [Name of Transferee]


 [Address of Transferee]




      By this transfer, all of our rights in the Letter of Credit are
transferred to the transferee, and the transferee shall have sole rights as
beneficiary under the Letter of Credit, including sole rights relating to any
amendments, whether increases or extensions or other amendments, and whether now
existing or hereafter made. You are hereby irrevocably instructed to advise
future amendment(s) of the Letter of Credit to the transferee without our
consent or notice to us.

      The original Letter of Credit is returned with all amendments to this
date. Please notify the transferee in such form as you deem advisable of this
transfer and of the terms and conditions to this Letter of Credit, including
amendments as transferred.




                                    Page 17

                                                                       EXHIBIT A



      You are hereby advised that the transferee named above has succeeded BNY
Western Trust Company or a successor trustee, as Trustee under the Indenture,
dated as of December 1, 1998, as supplemented from time to time (the
"Indenture") between AXT, Inc. (formerly known as American Xtal Technology,
Inc.), as Issuer, and BNY Western Trust Company (successor trustee to Harris
Trust Company of California), as Trustee, pursuant to which U.S. $11,615,000.00
in aggregate principal amount of American Xtal Technology, Inc. Variable Rate
Taxable Demand Revenue Bonds Series 1998 (Xtal Project) were issued.

Very truly yours,

[Insert Name of Transferor]


By:
    -----------------------------
    [Insert Name and Title]


 TRANSFEROR'S SIGNATURE GUARANTEED BY:


    ---------------------------------------
             [Bank Name]

       BY:
             ---------------------------------------
             [Insert Name and Title]

      By its signature below, the undersigned transferee acknowledges that it
has duly succeeded BNY Western Trust Company, or a successor trustee, as Trustee
under the Indenture.

[Insert Name of Transferee]


By:
   ----------------------------------------------
   [Insert Name and Title]




                                                                         Page 18





                                    EXHIBIT B

                           NOTICE OF INTENT TO BORROW

                  Pursuant to that certain Reimbursement Agreement, dated as of
March 14, 2003 (the "Reimbursement Agreement"; capitalized terms used herein
without definition shall have the meanings set forth in the Reimbursement
Agreement) between AXT, INC. (formerly known as American Xtal Technology, Inc.
("Borrower") and WELLS FARGO BANK, NATIONAL ASSOCIATION (the "Bank"), this
represents Borrower's notice to Bank of its intention to borrow from Bank, at
the Tender Reimbursement Rate.

[the full amount of the Tender Drawing made on ___________, 20__ in the amount
of ___________]

                                       or

         [a portion of the Tender Drawing made on ___________, 20__ in the
         amount of $___________; the portion borrowed being $_____________, with
         the remainder of $________ paid in full herewith together with interest
         thereon at the Tender Reimbursement Rate.]

The proceeds of such borrowing are to be used to reimburse Bank for unreimbursed
Tender Drawings in accordance with Section 3(b) of the Reimbursement Agreement.

                  Borrower certifies that (i) the representations and warranties
contained in Section 7 of the Reimbursement Agreement are correct on and as of
the date hereof to the same extent as though made on and as of the date hereof
(except to the extent that any such representation and warranty expressly
relates to an earlier date); and (ii) no Event of Default has occurred or is
continuing.

By _________________________
   _________________________



                                   SCHEDULE I
                (Redemption Schedule Referenced in Section 3(a))

                               REDEMPTION SCHEDULE



 QUARTERLY
PAYMENT DATE           PRINCIPAL AMORTIZATION               PRINCIPAL BALANCE
- ------------           ----------------------               -----------------
                                                      
 4/1/03                      $ 103,400                         $ 8,715,000
 7/1/03                      $ 103,400                         $ 8,611,600
10/1/03                      $ 103,400                         $ 8,508,200
 1/1/04                      $ 103,400                         $ 8,404,800
 4/1/04                      $ 103,400                         $ 8,301,400
 7/1/04                      $ 103,400                         $ 8,198,000
10/1/04                      $ 103,400                         $ 8,094,600
 1/1/05                      $ 103,400                         $ 7,991,200
 4/1/05                      $ 103,400                         $ 7,887,800
 7/1/05                      $ 103,400                         $ 7,784,400
10/1/05                      $ 103,400                         $ 7,681,000
 1/1/06                      $ 103,400                         $ 7,577,600
 4/1/06                      $ 103,400                         $ 7,474,200
 7/1/06                      $ 103,400                         $ 7,370,800
10/1/06                      $ 103,400                         $ 7,267,400
 1/1/07                      $ 103,400                         $ 7,164,000
 4/1/07                      $ 103,400                         $ 7,060,600
 7/1/07                      $ 103,400                         $ 6,957,200
10/1/07                      $ 103,400                         $ 6,853,800
 1/1/08                      $ 103,400                         $ 6,750,400
 4/1/08                      $ 103,400                         $ 6,647,000
 7/1/08                      $ 103,400                         $ 6,543,600
10/1/08                      $ 103,400                         $ 6,440,200
12/1/08                      $  68,934                         $ 6,336,800

EX-99.1

                                                                    EXHIBIT 99.1

              CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
                             18 U.S.C. SECTION 1350,
                             AS ADOPTED PURSUANT TO
                  SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

     In connection with the Quarterly Report of AXT, Inc. (the "Company") on
Form 10-Q for the three months ended March 31, 2003 as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), Morris S. Young, as
Chief Executive Officer of the Company, hereby certifies, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, that:

         (1)      The Report fully complies with the requirements of section
13(a) of the Securities Exchange Act of 1934; and

         (2)      The information contained in the Report fairly presents, in
all material respects, the financial condition and result of operations of the
Company.

         A signed original of this written statement required by Section 906 has
been provided to AXT, Inc. and will be retained by AXT,Inc. and furnished to the
Securities and Exchange Commission or its staff upon request.

May 9, 2003                                 /s/ Morris S. Young
                                            ------------------------------------
                                                  Morris S. Young
                                                  Chief Executive Officer

EX-99.2

                                                                    EXHIBIT 99.2

              CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
                             18 U.S.C. SECTION 1350,
                             AS ADOPTED PURSUANT TO
                  SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

     In connection with the Quarterly Report of AXT, Inc. (the "Company") on
Form 10-Q for the three months ended March 31, 2003 as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), Donald L. Tatzin, as
Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, that:

         (1)      The Report fully complies with the requirements of section
13(a) of the Securities Exchange Act of 1934; and

         (2)      The information contained in the Report fairly presents, in
all material respects, the financial condition and result of operations of the
Company.

         A signed original of this written statement required by Section 906 has
been provided to AXT, Inc. and will be retained by AXT,Inc. and furnished to the
Securities and Exchange Commission or its staff upon request.

May 9, 2003                                 /s/ Donald L. Tatzin
                                            ------------------------------------
                                                  Donald L. Tatzin
                                                  Chief Financial Officer