10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

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: 0-26734

SANDISK CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	77-0191793
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
601 McCarthy Blvd.
Milpitas, California	95035
(Address of principal executive offices)	(Zip Code)

(408) 801-1000
(Registrant’s telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of each exchange on which registered
Common Stock, $0.001 par value; Rights to Purchase Series A Junior Participating Preferred Stock	NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act:

None

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes o No þ

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

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ           Accelerated filer o           Non-accelerated filer ¨

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     As of July 2, 2006, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $7,647,717,594 based on the closing sale price as reported on the NASDAQ Global Select Market.

     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 February 15, 2007
Common Stock, $0.001 par value per share	227,362,985 shares

DOCUMENTS INCORPORATED BY REFERENCE

Document	Parts Into Which Incorporated
Annual Report to Stockholders for the Fiscal Year Ended December 31, 2006 (Annual Report)	Parts I, II, and IV
Proxy Statement for the Annual Meeting of Stockholders to be held May 24, 2007 (Proxy Statement)	Part III

SANDISK CORPORATION

Table of Contents

		Page
		No.
	PART I
Item 1.	Business	3
Item 1A.	Risk Factors	12
Item 1B.	Unresolved Staff Comments	29
Item 2.	Properties	30
Item 3.	Legal Proceedings	31
Item 4.	Submission of Matters to a Vote of Security Holders	35
	PART II
Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	36
Item 6.	Selected Financial Data	37
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	38
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	52
Item 8.	Financial Statements and Supplementary Data	53
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	53
Item 9A.	Controls and Procedures	53
Item 9B.	Other Information	54
	PART III
Item 10.	Directors, Executive Officers and Corporate Governance	55
Item 11.	Executive Compensation	55
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	55
Item 13.	Certain Relationships and Related Transactions, and Director Independence	55
Item 14.	Principal Accountant Fees and Services	55
	PART IV
Item 15.	Exhibits and Financial Statement Schedules	56
	OTHER
Index To Financial Statements		F-1
Signatures		S-1
EXHIBIT 10.64
EXHIBIT 12.1
EXHIBIT 21.1
EXHIBIT 23.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

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PART I

ITEM 1. BUSINESS

     Statements in this report, which are not historical facts, are forward-looking statements within the meaning of the federal securities laws. These statements may contain words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” or other wording indicating future results or expectations. Forward-looking statements are subject to risks and uncertainties. Our actual results may differ materially from the results discussed in these forward-looking statements. Factors that could cause our actual results to differ materially include, but are not limited to, those discussed in “Risk Factors” in Item 1A of this report, and elsewhere in this report. Our business, financial condition or results of operations could be materially adversely affected by any of these factors. We undertake no obligation to revise or update any forward-looking statements to reflect any event or circumstance that arises after the date of this report. References in this report to “SanDisk^®,” “we,” “our,” and “us,” collectively refer to SanDisk Corporation, a Delaware corporation, and its subsidiaries. All references to years or annual periods are references to our fiscal years, which consisted of 52 weeks in 2006 and 2005 and 53 weeks in 2004.

Overview

     Who We Are. We are one of the world’s largest suppliers of flash-based data storage products for the consumer, mobile communications, and industrial markets. Our mission is to be the preferred choice in personal storage solutions for the worldwide digital economy. We seek to achieve our mission by developing leading technologies and innovative products and delivering our products through both original equipment manufacturer, or OEM, and retail channels.

     We design, develop, market and manufacture products and solutions in a variety of form factors using our flash memory, controller, and firmware technologies. We source the vast majority of our flash memory supply through our significant venture relationships with Toshiba that provide us with leading edge and low cost memory wafers. Our products are used in a wide range of consumer electronics devices such as digital cameras, mobile phones, Universal Serial Bus drives, or USB drives, gaming consoles, MP3 players and other digital devices. Our products are also embedded in a variety of systems for the enterprise, industrial, military and other markets. Flash storage technology allows data to be stored in a low-power consumption format, as well as a durable and compact format that retains the data after the power has been turned off.

     On November 19, 2006, we closed our acquisition of msystems, Ltd., or msystems, an Israeli-based semiconductor company with a broad embedded NAND product portfolio, deep firmware expertise, and extensive OEM relationships.

     Our Strategy. Our strategy is to identify and develop current and emerging high-growth markets for flash storage products. We maintain our technology leadership and invest in flash memory fabrication capacity in order to produce leading-edge, low cost flash memory for use in our products. We sell in high volumes all major flash storage card formats for our target markets, enabling us to be a one-stop-shop for our retail and OEM customers.

     Our revenues are driven by the sale of our products and the licensing of our intellectual property. We believe the market for flash storage has price elasticity of demand. Excluding the newly acquired msystems business, from 2005 to 2006, we increased the number of megabytes sold by 221% in large measure due to a decrease of 58% in our average selling price per megabyte over the same period. Our management team believes that more applications for flash storage will be created through the continued increase in the number of megabytes a consumer can purchase at a given price point. The dynamics of these price declines driving increased volume resulted, in part, in an increase in our product revenues from $2.1 billion in 2005 to $2.9 billion in 2006. In addition, our license revenue increased from $239.5 million in 2005 to $331.1 million in 2006 as a result of continued adoption of flash technologies by our licensees.

     We enable new markets for NAND flash memory through a variety of removable card form factors, and we are founders or co-founders of most major form factors of flash storage cards in the market today. We pioneered the Secure Digital card, or SD™ card, together with Matsushita Electric Industries, Ltd., or Matsushita, which owns the Panasonic brand, and a subsidiary of Toshiba Corporation, or Toshiba. The SD card is currently the most popular form factor of flash storage cards used predominantly in digital cameras. We followed that effort by working with mobile network operators and handset manufacturers to develop the miniSD™ card and microSD™ card that are even smaller form factor memory cards. The microSD card has become the leading card format for mobile phones. We also co-own the Memory Stick PRO™ format with Sony Corporation, or Sony, and we worked with Canon, Inc. to co-found the CompactFlash^®, or CF, standard. We plan to continue to work with

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leading companies in mobile communications and digital consumer devices to find additional ways for flash storage products to enable proliferation of those technologies and markets.

     Our team has a deep understanding of flash memory technology and we develop and own leading-edge technology and patents for the design, manufacture and operation of flash memory and data storage cards. One of the key technologies that we have patented and successfully commercialized is multi-level cell technology, or MLC, which allows a flash memory cell to be programmed to store two or more bits of data in approximately the same area of silicon that is typically required to store one bit of data. We have an extensive patent portfolio that has been licensed by several leading semiconductor companies. Our cumulative license and royalty revenues over the last three years were more than $744.7 million.

     We continue to invest with Toshiba in high volume, state-of-the-art flash manufacturing facilities in Japan. Our commitment takes the form of capital investments and loans to the ventures, credit enhancements of the ventures’ leases of semiconductor manufacturing equipment, commitments, on a take-or-pay basis, to purchase 50% of the output of the ventures at manufacturing cost plus a mark-up and sharing in the cost of SanDisk-Toshiba joint research and development activities related to flash memory. We supplement our sourcing of flash memory from the Toshiba ventures with purchases of memory on favorable terms primarily from Samsung Electronics Co., Ltd., or Samsung, and Toshiba. Additionally, we design in-house and fabricate at third-party foundries the controllers that interface between the flash memory and digital consumer devices. Our team manages a network of contract manufacturers that assemble and test our flash memory and cards according to our specifications and we are developing an in-house assembly and test facility in Shanghai, China.

     We sell our products globally to retail and OEM customers. We continue to expand our retail customer base to new geographic regions as well as to new outlets such as mobile storefronts, supermarkets and drug stores. In North America, we sell our products principally through retailers, such as Best Buy Co., Inc., or Best Buy, Circuit City Stores, Inc., Wal-Mart Stores, Inc. and Costco Wholesale Corporation. In North America and the rest of the world, we manage a network of distributors who sell to other retailers and dealers. We also are expanding a separate network of distributors and retail locations specifically focused on the mobile phone market. There are now more than 200,000 worldwide retail storefronts where consumers may purchase SanDisk products. We also sell directly and through distributors, to OEM customers, which include mobile phone manufacturers, and digital camera manufacturers, who include our products with their products when sold to end users. This strategy allows us to leverage the market position, geographic footprint and brand strength of our customers to achieve wide market penetration for our products.

     Additional Information. We were incorporated in Delaware in June 1988 under the name SunDisk Corporation and changed our name to SanDisk Corporation in August 1995. We file reports and other information with the Securities and Exchange Commission, or SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy or information statements. Those reports and statements and all amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act (1) may be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549, (2) are available at the SEC’s Internet site (http://www.sec.gov), which contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC and (3) are available free of charge through our website as soon as reasonably practicable after electronic filing with, or furnishing to, the SEC. Information regarding the operation of the SEC’s Public Reference Room may be obtained by calling the SEC at (202) 551-8090. Our website address is www.sandisk.com. Information on our website is not incorporated by reference nor otherwise included in this report. Our principal executive offices are located at 601 McCarthy Blvd, Milpitas, CA 95035 and our telephone number is (408) 801-1000. SanDisk is a trademark of SanDisk Corporation, and is registered in the U.S. and other countries. Other brand names mentioned herein are for identification purposes only and may be the trademarks of their respective holder(s).

Description of Our Business

     Industry Background. We operate in the digital electronics industry, which encompasses traditional personal computers, or PCs, consumer electronics, communications and industrial products. Our products use flash memory to store digital information in devices such as mobile phones, digital still cameras, digital video camcorders, gaming consoles, portable digital audio players and PCs. These applications require storage that is small in form factor, portable and removable, highly reliable, high capacity, low in power consumption and capable of withstanding high levels of shock vibration and temperature fluctuations.

     The flash memory market is primarily comprised of NOR and NAND technologies. NOR is traditionally used for code storage and is characterized by fast read speeds with generally higher costs per megabyte and lower storage capacities than

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NAND. NAND flash memory is traditionally used for embedded and removable data storage and is characterized by fast write speeds, high capacity and lower manufacturing cost than NOR flash memory. We are focused on NAND-based products.

     Our Primary Markets. We currently focus on four primary markets:

• Consumer. We make and sell flash storage cards that address multiple consumer markets. Certain flash storage cards are used as the film for all major brands of digital cameras. Our cards are also used to store video in solid-state digital camcorders and to store digital data in many other devices including maps in global positioning system devices, or GPS, and personal data in personal digital assistants, or PDAs. In addition, portable game consoles now include advanced features and functionality, including storage of game results, digital audio, video playback and photo viewing. These features demand high capacity memory storage cards. We manufacture brightly colored SD and Memory Stick PRO Duo^™ cards for use in gaming devices such as the Sony PSP^®, Nintendo^® Wii^™ and Microsoft xBox^®. Our Cruzer^® CrossFire^™ line of USB drives are geared toward the PC gaming market. Primary card formats for consumer devices include CF, SD, Memory Stick^® and xD-Picture Card^™.

• Computing. We provide multiple flash storage devices and solutions for a variety of computing, industrial and enterprise markets. USB flash drives allow consumers to store computer files on keychain-sized devices and then quickly and easily transfer these files between laptops, desktops and other devices. USB flash drives are fast and easy to use, they have replaced floppy disks and other types of external storage media, and are evolving into intelligent storage devices. NAND flash memory-based data storage allows industrial customers and PC manufacturers to offer systems with solid state drives in lieu of traditional magnetic disk-based drives. In January 2007, we introduced our first 32 gigabyte solid state drive in a 1.8 inch form factor for the notebook PC market.

• Mobile Phones. We provide embedded, semi-removable and removable storage for mobile phones. We are a leading supplier of microSD, miniSD, SD and Memory Stick PRO Duo removable storage cards used in mobile phones. Multimedia features in mobile phones, such as camera functionality, audio/MP3, games, video or internet access, have been increasing in popularity. These features require additional storage capacity in the mobile phone and transferability of data to and from other devices.

• Digital Audio and Video Players. Digital audio players allow consumers to download, store and play music. We sell a broad line of digital audio players with both embedded and removable memory under our Sansa^® brand. We have also launched our first digital video player under the Sansa brand.

     Our Sales Channels. Our products are delivered to end-users through more than 200,000 worldwide retail storefronts and also by bundling data storage cards with host products or by embedding our data storage products in host devices sold by our OEM customers.

     Our sales are made through the following channels:

•	Retail. We ship SanDisk brand name products directly to consumer electronics stores, office superstores, photo retailers, mobile phone stores, mass merchants, catalog and mail order companies, internet and e-commerce retailers, drug stores, supermarkets and convenience stores. We also sell our products to smaller or regional retailers through distributors.
	We have a separate distribution network focused on the mobile phone market. Our distributors provide us access to mobile network operator branded storefronts as well as other retailers with significant mobile communications offerings. We intend to continue to emphasize offering our products throughout the mobile communication retail community as an important driver of our planned growth in that market.
	We support our retail sales channels with both direct sales representatives and independent manufacturers’ representatives. We have multiple domestic retail sales offices and have organized our sales efforts in the rest of the world around three regional territories: Europe, Middle East and Africa, or EMEA, Japan and non-Japan Asia/Pacific, which we refer to as Asia Pacific. Information regarding our sales by geography is included in Note 6 to our consolidated financial statements included in Item 8 of this report.

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• OEM. Our OEM customers include manufacturers of mobile phones, digital cameras and other digital consumer devices, such as GPS. Our products are sold directly to OEMs and through distributors. We support our OEM customers with both direct sales representatives and independent manufacturers’ representatives.

     As of the end of fiscal years 2006 and 2005, our backlog was $177.0 million and $105.7 million, respectively. Due to industry practice that allows customers to change or cancel orders with limited advance notice prior to shipment, we do not believe that backlog as of any particular date is indicative of future sales.

     Our revenues are seasonally higher in our fourth quarter due to the holiday buying season. Our first and third quarters have sometimes been seasonally lower than the preceding quarters.

     Our Customers. In fiscal years 2006, 2005 and 2004, revenues from our top 10 customers and licensees accounted for approximately 52%, 50% and 55% of our revenues, respectively. In fiscal years 2006 and 2004, no single customer or licensee accounted for greater than 10% of our revenues. In fiscal year 2005, Best Buy accounted for 11% of our revenues. The composition of our major customer base has changed over time, and we expect this pattern to continue as our markets and strategies evolve. Sales to our customers are generally made pursuant to purchase orders rather than long-term contracts.

     Our Products. Our products are sold under the SanDisk brand in a wide variety of form factors and include the following:

• Removable Cards. Our removable data storage solutions are available in almost every major form factor in our primary markets. For example, our CompactFlash removable cards, available in capacities up to 16 gigabytes, are well-suited for a range of consumer applications, including digital cameras. Our professional products include the SanDisk Ultra^® and SanDisk Extreme^® product lines which are designed with additional performance and reliability. As another example, our ultra-small microSD removable cards, available in capacities up to 4 gigabytes, are designed for use in mobile phones.

• USB Drives. Our Cruzer^® line of USB drives, available in capacities up to 8 gigabytes, are highly-reliable and high-performance. USB Flash Drives, or UFDs, are used in the computing and consumer markets. A number of our Cruzers ship with U3^™ smart technology which gives the user the ability to carry files and application software on a secure USB drive. Also, our Cruzer Crossfire USB Flash Drives are specially designed to make console or PC gaming experience portable. Using our USB flash drives, gamers can save game data, download portable games and demos and save game replays.

• Embedded. Our embedded products are a set of reliable, high-capacity, high performance and cost-effective embedded flash memory drive, or EFD, solutions for both data and code storage. Ranging in capacities from 128 megabytes to 8 gigabytes, these products are designed to respond to the increasing demand for embedded storage for mobile phones and other portable devices. We also offer high-capacity solid-state drives targeted for the personal computing market in capacities up to 32 gigabytes.

• MP3. The Sansa is our branded line of flash-based MP3 players for the digital audio and video player market. Many of our Sansa models offer a removable card slot for easy transportability of music between devices and storage capacity expansion. The Sansa MP3 players also feature built-in FM tuning for non-European models and voice recording capabilities and are compatible with a variety of music download and subscription services. Sansa is available in capacities ranging from 256 megabytes to 8 gigabytes.

     Technology. Since our inception, we have focused our research, development and standardization efforts on developing highly reliable, high-performance, small form factor and cost-effective flash memory storage products to address a variety of emerging markets. We have been actively involved in all aspects of this development, including flash memory process development, module integration, chip design, controller development and system-level integration to ensure the creation of fully-integrated, broadly interoperable products that are compatible with both existing and newly developed system platforms. We are investing to extend our 2-bits/cell memory storage technology to 3-bits/cell, or X3, and 4-bits/cell, or X4, storage technologies. In addition, we are also investing in three-dimensional memory architecture with re-write capabilities. We believe our core technical competencies are in:

• high-density flash memory process, module integration, device design and reliability;

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• securing data on a flash memory device;

• controller design;

• system-level integration;

• compact packaging; and

• low-cost system testing.

     We have also initiated, defined and developed standards to meet new market needs and to promote wide acceptance of the standards through interoperability and ease-of-use.

     To achieve compatibility with various electronic platforms regardless of the host processors or operating systems used, we developed new capabilities in flash memory chip design and created intelligent controllers. We also developed an architecture that can leverage advances in process technology designed for scaleable, high-yielding, cost-effective and highly reliable manufacturing processes. We design our products to be compatible with industry-standard interfaces used in standard operating systems for personal computers, mobile phones, gaming devices, music players and other consumer and industrial products.

     Our patented intelligent controller technology with its advanced defect management system permits our flash storage card products to achieve a high level of reliability and longevity. Each one of our flash devices contains many millions of flash memory cells. For example, our 4 gigabyte cards may contain as many as 35 billion storage cells. A failure in any one of these cells or in a group or block of cells can result in loss of data such as picture files, and this can occur several years into the life of a flash storage card. The controller chip inside our cards is designed to detect such defects and recover data under most standard conditions.

     Patents and Licenses. We rely on a combination of patents, trademarks, copyright and trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. See Item 1A, “Risk Factors.”

     In 1988, we developed the concept of emulation of a hard disk drive with flash solid-state memory. The first related patents were filed by our chief executive officer, Dr. Eli Harari and exclusively licensed to us. As of the end of fiscal year 2006, we owned or had rights to more than 600 United States patents and more than 300 foreign patents, have more than 1,100 patent applications pending in the United States, and have foreign counterparts pending on many of the applications in multiple jurisdictions. We continually seek additional international and United States patents on our technology.

     Through our acquisitions of Matrix Semiconductor, Inc., or Matrix, in early fiscal year 2006 and msystems in late fiscal year 2006, we have acquired access to fundamental patents on three-dimensional, or 3-D, memory architecture and X4 data storage technologies, respectively. Patents transferred to us upon completion of the Matrix acquisition included 124 United States patents, approximately 14 foreign patents, and approximately 141 patent applications pending in the United States. Patents transferred to us upon completion of the msystems acquisition included 54 United States patents, approximately 66 foreign patents, and approximately 201 patent applications pending in the United States. In addition, through these acquisitions, we have foreign counterparts pending on many of the applications in multiple jurisdictions

     We have various patent licenses with several companies including, among others, Intel Corporation, or Intel, Lexar Media, Inc., or Lexar, a subsidiary of Micron Technology, Inc., or Micron, Matsushita, Renesas Technology Corporation, or Renesas, Samsung, Sharp Electronics KK, or Sharp, Sony and Toshiba. From time-to-time, we have also entered into discussions with other companies regarding potential license agreements for our patents.

     Trade secrets and other confidential information are also important to our business. We protect our trade secrets through confidentiality and invention assignment agreements.

     Supply Chain. Our supply chain is an important competitive advantage.

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• Silicon Sourcing. All of our flash memory card products require silicon chips for the memory and controller components. The majority of our memory is supplied from our ventures with Toshiba and our Toshiba foundry relationship. This represents captive memory supply and we are obligated to take the output from the ventures with Toshiba. See “— Ventures With Toshiba.” In fiscal year 2006, we purchased non-captive memory supply primarily from Samsung. We are guaranteed a certain amount of the total output from Samsung and Hynix Semiconductor Inc., or Hynix, but we are not obligated to use the guaranteed supply until we give them an order for future purchases. Our controller wafers are currently supplied by Tower Semiconductor Ltd., or Tower, and United Microelectronics Corporation, or UMC. We have a foundry agreement with Tower on a purchase order basis. See Item 1A, “Risk Factors.”

• Testing and Assembly. We sort and test our wafers at Toshiba in Yokkaichi, Japan, and Ardentec Corp. in Taiwan. Our tested wafers are then shipped to our third-party memory assembly subcontractors, including StatsChipPAC Ltd., or StatsChipPAC, in China, Silicon Precision Industries Co., Ltd., or SPIL, in Taiwan, and Sharp and Mitsui & Co., Ltd., both in Japan. Our packaged memory final test, card assembly and card test is performed at subcontractors such as ASE Group, DataFab Systems, Inc., or DataFab, SPIL and United Test and Assembly Center, in Taiwan, and Beautiful Enterprise Co., Ltd., DataFab, Flextronics International, Ltd., or Flextronics, Global Brands Manufacturing Ltd. and StatsChipPAC, in China. We believe our use of subcontractors reduces the cost of our operations and gives us access to increased production capacity. On November 29, 2006, we entered into a 50-year land lease in the Zizhu Science-Based Park near Shanghai, China, and we are constructing a captive assembly and test manufacturing facility to provide in-house manufacturing capacity for a portion of our card assembly and test needs. See Item 1A, “Risk Factors” and Item 7, “Liquidity.”

Ventures with Toshiba

     We and Toshiba have entered into several business ventures. In May 2000, we invested in the FlashVision Ltd., or FlashVision, venture, which operated in Manassas, Virginia, until May 2002. In April 2002, we and Toshiba agreed to consolidate the NAND wafer fabrication manufacturing operations in Fabs 1 and 2 of Toshiba’s Yokkaichi, Japan operations. FlashVision produces 200-millimeter NAND flash wafers using both owned and leased equipment. In September 2004, we and Toshiba formed the Flash Partners Ltd., or Flash Partners, venture pursuant to which a wafer fabrication facility, Fab 3, was constructed at Toshiba’s Yokkaichi, Japan operations. Flash Partners purchases and leases semiconductor manufacturing equipment for Fab 3, which produces 300-millimeter NAND flash wafers. Toshiba began production for Flash Partners in Fab 3 in the third quarter of fiscal 2005 and expects to achieve 135,000 wafers per month by the end of fiscal year 2007. In July 2006, we and Toshiba formed Flash Alliance Ltd., or Flash Alliance, to build Fab 4, a new 300-millimeter wafer fabrication facility, at Toshiba’s Yokkaichi, Japan operations. Fab 4 is under construction and initial NAND production at Fab 4 is currently scheduled for the end of fiscal year 2007. We currently expect to expand Fab 4 to approximately 67,500 wafers per month by the end of fiscal year 2008, and the capacity of Fab 4 at full expansion is currently expected to be approximately 150,000 wafers per month, with the timeframe to reach full capacity to be mutually agreed by the parties. We hold a 49.9% ownership position in each venture entity.

     With these ventures, we and Toshiba collaborate in the development and manufacture of NAND flash memory products. These NAND flash memory products are manufactured by Toshiba at Toshiba’s Yokkaichi, Japan operations using the semiconductor manufacturing equipment owned or leased by FlashVision, Flash Partners or, once Fab 4 comes online, Flash Alliance. Each venture entity purchases wafers from Toshiba at cost and then resells those wafers to us and Toshiba at cost plus a mark-up. We are committed to purchase, and entitled to, half of each venture’s NAND wafer supply and are committed to fund 49.9% of each venture’s costs to the extent that the venture’s revenues from wafer sales to us and Toshiba are insufficient to cover these costs. The investments in each venture entity are shared 50/50 between us and Toshiba. In addition, we purchase wafers from Toshiba on a foundry basis.

     We assumed msystems’ ownership interest in its venture with Toshiba, TwinSys Data Storage Limited Partnership, or TwinSys, which was designed to enable the parties to benefit from a portion of each party’s respective sales of USB flash drives. As of December 31, 2006, we had a 50.1% beneficial ownership in TwinSys, consisting of (i) 49.9% ownership in TwinSys and (ii) 0.2% interest held by Twinsys Ltd., in which we have a 51% ownership interest. We and Toshiba are currently negotiating the mutual closure of this venture by the first half of fiscal year 2007. However, no written agreement has been reached.

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Competition

     We face competition from numerous semiconductor manufacturers and manufacturers and resellers of flash memory cards, USB drives, digital audio players and other consumer electronic devices. We also face competition from manufacturers of hard disk drives and from new technologies. See Item 1A, “Risk Factors.”

     Key Competitive Advantages. Our key competitive advantages are:

• we have a tradition of innovation and standards creation which provides us with strength in growing the overall market for NAND memory;

• our intellectual property ownership, in particular our patent claims and MLC manufacturing know-how, provides us certain cost advantages;

• our fab ventures with Toshiba provide us with an attractive cost structure;

• we market and sell a broader range of card formats than any of our competitors, which gives us an advantage in obtaining strong retail and OEM distribution; and

• we have leading market share with number 1 worldwide market share in removable flash cards and USB flash drives and number 2 market share in U.S. flash-based digital audio players.

     Semiconductor Manufacturers. Our primary semiconductor competitors currently include Samsung, Toshiba, Hynix, IM Flash Technologies, LLC, or IM Flash (a company formed by Micron and Intel), Micron, and STMicroelectronics N.V., or STMicro. If the NAND industry increases memory output faster than the increase in demand it will likely result in industry margin compression as the price decline rates exceed normal cost declines.

     Flash Memory Card and USB Drive Manufacturers. Our primary competitors currently include, among others, A-Data Technology Co., Ltd., or A-Data, Buffalo Technology, FUJIFILM Corporation, or Fuji, Hagiwara Sys-Com Co., Ltd., or Hagiwara, Hama Corporation, Inc., or Hama, I/O Data Device, Inc., or I/O Data, Kingmax, Inc., or KingMax, Kingston Technology Company, Inc., or Kingston, Eastman Kodak Company, or Kodak, Lexar, Matsushita, Micron, Netac Technology, Co., or Netac, Panasonic, PNY Technologies, Inc., or PNY, RITEK Corporation, or Ritek, Samsung, Sony, Toshiba, Tradebrands International, or Tradebrands, and Transcend Information, Inc., or Transcend.

     Digital Audio Player Manufacturers. Our digital audio players face strong competition from products offered by other companies, including Apple Inc., or Apple, Creative Technologies, Ltd., or Creative, Microsoft Corporation, or Microsoft, and Samsung.

     Other Technologies. Other technologies compete with our product offerings and many companies are attempting to develop memory cells that use different designs and materials in order to reduce memory costs. One example of an alternative technology is the small hard disk drive, which has a low cost per megabyte for high memory capacity but a high cost per megabyte for low capacities. Hard disk drives also have significant power requirements and they are not as rugged as flash memory. Other future competitive technologies could include different designs and materials such as phase-change technology, charge-trap flash and millipedes/probes.

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Employees

     As of December 31, 2006, we had 2,586 full-time employees, including 1,081 in research and development, 527 in sales and marketing, 422 in general and administration and 556 in operations. None of our employees is represented by a collective bargaining agreement and we have never experienced any work stoppage. We believe that our employee relations are satisfactory.

Executive Officers

     Our executive officers, who are elected by and serve at the discretion of our Board of Directors, are as follows (all ages are as of February 15, 2007):

Name	Age	Position
Eli Harari	61	Chairman of the Board and Chief Executive Officer
Sanjay Mehrotra	48	President and Chief Operating Officer
Judy Bruner	48	Executive Vice President, Administration and Chief Financial Officer
Randhir Thakur	44	Executive Vice President, Technology and Worldwide Operations
Yoram Cedar	54	Executive Vice President, Handset Business and Corporate Engineering

     Dr. Eli Harari, the founder of SanDisk, has served as Chief Executive Officer and as a director of SanDisk since June 1988. He was appointed Chairman of the Board in June 2006. Dr. Harari also served as President from June 1998 to June 2006. Dr. Harari founded Waferscale Integration, Inc., a privately held semiconductor company, in 1983 and was its President and Chief Executive Officer from 1983 to 1986, and Chairman and Chief Technical Officer from 1986 to 1988. From 1973 to 1983, Dr. Harari held various management positions with Honeywell Inc., Intel Corporation and Hughes Microelectronics Ltd. Dr. Harari holds a Ph.D. in Solid State Sciences from Princeton University and has more than 100 patents issued in the field of non-volatile memories and storage systems. In December 2006, Dr. Harari, along with SanDisk’s co-founders Sanjay Mehrotra and Jack Yuan, received the 2006 IEEE Reynold B. Johnson Data Storage Device Technology Award “For leadership in the development and commercialization of Flash EEPROM-based data storage products.” Dr. Harari is a board member of Tower.

     Sanjay Mehrotra co-founded SanDisk in 1988 and has been our President since June 2006. He continues to serve as our Chief Operating Officer, a position he has held since 2001, and he has previously served as our Executive Vice President, Vice President of Engineering, Vice President of Product Development, Director of Memory Design and Product Engineering. Mr. Mehrotra has more than 25 years of experience in the non-volatile semiconductor memory industry including engineering and engineering management positions at Intel Corporation, Seeq Technology, Integrated Device Technology and Atmel Corporation. Mr. Mehrotra earned B.S. and M.S. degrees in Electrical Engineering and Computer Sciences from the University of California, Berkeley. He also holds several patents and has published articles in the area of non-volatile memory design and flash memory systems. In December 2006, Mr. Mehrotra, along with SanDisk’s co-founders Dr. Eli Harari and Jack Yuan, received the 2006 IEEE Reynold B. Johnson Data Storage Device Technology Award “For leadership in the development and commercialization of Flash EEPROM-based data storage products.”

     Judy Bruner has been our Chief Financial Officer and Executive Vice President Administration since June 2004. She served as a member of our board of directors from July 2002 to July 2004. Ms. Bruner has over 25 years of financial management experience, including serving as Senior Vice President and Chief Financial Officer of Palm, Inc., a provider of handheld computing and communications solutions, from September 1999 until June 2004. Prior to Palm, Inc., Ms. Bruner held financial management positions with 3Com Corporation, Ridge Computers and Hewlett-Packard Company. Ms. Bruner also serves on the board of directors of Ciphergen Biosystems, Inc. Ms. Bruner holds a B.A. degree in Economics from the University of California, Los Angeles and an M.B.A. degree from Santa Clara University.

     Dr. Randhir Thakur has been our Executive Vice President, Technology and Worldwide Operations since October 2005. Prior to joining us, Dr. Thakur was group Vice President and General Manager of the Front End Products Group at Applied Materials, Inc. He joined Applied Materials in 2000 as Chief Technical Officer of the Transistor and Capacitor Products Business Group. Previously, from 1997 to 2000, Dr. Thakur was Vice President of Research and Development at AG Associates and Chief Technology Officer and General Manager at Steag Electronic Systems after its acquisition of AG Associates. He also held various technical and management positions at Micron Technology from 1991 to 1997. Dr. Thakur has extensive experience in semiconductor manufacturing, holds more than 250 patents and has published more than 200 technical publications. Dr. Thakur

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received his B.S. degree (honors) in Electronics and Telecommunications Engineering from the Regional Engineering College, Kurukshetra, India, and an M.S. degree in Electrical Engineering from the University of Saskatchewan, Canada. Dr. Thakur received his Ph.D. in Electrical Engineering from the University of Oklahoma.

     Yoram Cedar is our Executive Vice President, Mobile Business and Corporate Engineering. Prior to October 2005, Mr. Cedar served as our Senior Vice President of Engineering and Emerging Market Business Development. Mr. Cedar began his career at SanDisk in 1998 when he joined as Vice President of Systems Engineering. He has extensive experience working in product definition, marketing and development of systems and embedded flash-based semiconductors. Prior to SanDisk, he was the Vice President of New Business Development at Waferscale Integration and has more than 27 years of experience in design and engineering management of electronic systems. Mr. Cedar earned B.S. and M.S. degrees in Electrical Engineering and Computer Architecture from Technion, Israel Institute of Technology, Haifa, Israel.

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Item 1A. Risk Factors

     Our operating results may fluctuate significantly, which may adversely affect our operations and our stock price. Our quarterly and annual operating results have fluctuated significantly in the past and we expect that they will continue to fluctuate in the future. This fluctuation could result from a variety of factors, including, among others:

• average selling prices, net of promotions, declining at a faster rate than cost reduction for our products due to industry or SanDisk excess supply and competitive pricing pressures;

• addition of new competitors, expansion of supply from existing competitors and ourselves creating excess market supply, which could cause our average selling prices to decline faster than our costs decline;

• impairment of goodwill, business integration and other challenges related to our acquisition of msystems and Matrix;

• timing, volume and cost of wafer production from the FlashVision, Flash Partners and Flash Alliance ventures as impacted by fab start-up delays and costs, technology transitions, yields or production interruptions due to natural disasters, power outages, equipment failure or other factors;

• disruption in the manufacturing operations of suppliers, including suppliers of sole-sourced components;

• unpredictable or changing demand for our products, particularly demand for certain types or capacities of our products or demand for our products in certain markets or geographies;

• excess supply from captive sources due to output increasing faster than the growth in demand resulting in excess inventory;

• insufficient supply from captive and non-captive sources or insufficient capacity from our test and assembly subcontractors to meet demand;

• reduction in price elasticity of demand related to pricing changes for some of our more mature markets for NAND flash memory;

• potential delays in the emergence of new markets and products for NAND flash memory and acceptance of our products in these markets;

• our license and royalty revenues may decline significantly in the future as our existing license agreements and key patents expire;

• timing of sell-through by our distributors and retail customers;

• increased purchases of flash memory products from our non-captive sources, which typically cost more than products from our captive sources;

• difficulty in forecasting and managing inventory levels, particularly due to noncancelable contractual obligations to purchase materials such as flash memory and controllers, and the need to build finished product in advance of customer purchase orders;

• errors or defects in our products caused by, among other things, errors or defects in the memory or controller components, including memory and non-memory components we procure from third-party suppliers;

• write-downs of our investments in fabrication capacity, equity investments and other assets;

• estimates used in calculating share-based compensation expense; and

• the other factors described under “Risk Factors” and elsewhere in this report.

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     Our average selling prices, net of promotions, may decline faster than cost reductions due to industry or SanDisk excess supply, competitive pricing pressures or strategic price reductions initiated by us or our competitors. The market for NAND flash products is competitive and characterized by rapid price declines. Price declines may be influenced by, among other factors, supply in excess of demand, technology transitions, including adoption of MLC technology by other competitors, new technologies or other strategic actions by competitors to gain market share. If our technology transitions take longer or are more costly than anticipated to complete, our cost reductions fail to keep pace with the rate of price declines or our price decreases fail to generate sufficient additional demand, our gross margin and operating results will be negatively impacted which could generate quarterly or annual net losses.

     Sales to a small number of customers represent a significant portion of our revenues and, if we were to lose one of our major licensees or customers or experience any material reduction in orders from any of our customers, our revenues and operating results would suffer. Sales to our top 10 customers and licensees accounted for more than 52%, 50%, and 55% of our total revenues during the fiscal years 2006, 2005 and 2004, respectively. No customer exceeded 10% of total revenues in any of these periods except Best Buy, which accounted for 11% of our total revenues in fiscal 2005. If we were to lose one of our major licensees or customers or experience any material reduction in orders from any of our customers or in sales of licensed products by our licensees, our revenues and operating results would suffer. Additionally, our license and royalty revenues may decline significantly in the future as our existing license agreements expire. Our sales are generally made from standard purchase orders rather than long-term contracts. Accordingly, our customers may generally terminate or reduce their purchases from us at any time without notice or penalty. In addition, the composition of our major customer base changes from year-to-year as we enter new markets making our revenues from several customers somewhat less predictable from year-to-year.

     Our business depends significantly upon sales of products in the highly competitive consumer market, a significant portion of which are made to retailers and through distributors, and if our distributors, and, retailers are not successful in this market, we could experience substantial product returns, which would negatively impact our business, financial condition and results of operations. A significant portion of our sales are made through retailers, either directly or through distributors. Sales through these channels typically include rights to return unsold inventory and protection against price declines. As a result, we do not recognize revenue until after the product has been sold through to the end user, in the case of sales to retailers, or to our distributors’ customers, in the case of sales to distributors. If our distributors and retailers are not successful, we could experience reduced sales as well as substantial product returns or price protection claims, which would harm our business, financial condition and results of operations. Availability of sell-through data varies throughout the retail channel, which makes it difficult for us to forecast retail product revenues. Our arrangements with our customers also provide them price protection against declines in our recommended selling prices, which has the effect of reducing our deferred revenue and eventually our revenue. Except in limited circumstances, we do not have exclusive relationships with our retailers or distributors, and therefore, must rely on them to effectively sell our products over those of our competitors.

     Our revenue depends in part on the success of products sold by our OEM customers. An increasing portion of our sales are to OEMs, which can either bundle or embed our flash memory products with their products, such as cameras or mobile phones. Our sales to these customers are dependent upon the OEMs choosing our products over those of our competitors and on the OEMs’ ability to create, introduce, market and sell its products successfully in their markets. Should our OEM customers be unsuccessful in selling their current or future products that include our products, or should they decide to discontinue utilizing our products, our results of operation and financial condition could be harmed. Our future OEM revenues may be significantly impacted by our decision to de-emphasize the former msystems private label USB business and focus on our branded business.

     The continued growth of our business depends on the development of new markets and products for NAND flash memory and continued elasticity in our existing markets. Over the last several years, we derived the majority of our revenues from the digital camera market. This market continues to experience slower growth rates and continues to represent a declining percentage of our total revenue, and therefore, our growth will be increasingly dependent on the development of new markets, new applications and new products for NAND flash memory. For example, in fiscal 2006, our revenue from the digital camera market grew by only 2% over the prior year, and it is possible that our revenue from this market could decline in future years. Newer markets for flash memory include digital audio and video players, mobile phones and solid state drives. There can be no assurance that new markets and products will develop and grow fast enough, or that new markets will adopt NAND flash technologies in general or our products in particular, to enable us to continue our growth. There can be no assurance that the increase in average product capacity and unit demand in response to price reductions will continue to generate revenue growth for us as it has in the past.

     We continually seek to develop new applications, products, technologies and standards, which may not be widely adopted by consumers or, if adopted, may reduce demand by consumers for our older products. We continually seek to develop new

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applications, products and standards and enhance existing products and standards with higher memory capacities and other enhanced features. Any new applications, products, technologies, standards or enhancements we develop may not be commercially successful. New applications, such as the adoption of flash memory cards in mobile phones, can take several years to develop. Early success in working with mobile phone manufacturers to add card slots to their mobile phones does not guarantee that consumers will adopt memory cards used for storing songs, images and other content in mobile phones. Our new products, such as Sansa^® View, pre-recorded flash memory cards and solid state drives, may not gain market acceptance and we may not be successful in penetrating the new markets that we target. As we introduce new standards or technologies, such as TrustedFlash, it can take time for these new standards or technologies to be adopted, for consumers to accept and transition to these new standards or technologies and for significant sales to be generated from them, if this happens at all. Moreover, broad acceptance of new standards, technologies or products by consumers may reduce demand for our older products. If this decreased demand is not offset by increased demand for our other form factors or our new products, our results of operations could be harmed.

     We face competition from numerous manufacturers and marketers of products using flash memory, as well as from manufacturers of new and alternative technologies, and if we cannot compete effectively, our results of operations and financial condition will suffer. Our competitors include many large domestic and international companies that have greater access to advanced wafer manufacturing capacity and substantially greater financial, technical, marketing and other resources than we do, which allows them to produce flash memory chips in high volumes at low costs and to sell these flash memory chips themselves or to our flash card competitors at a low cost. Some of our competitors may sell their flash memory chips at or below their true manufacturing costs to gain market share and to cover their fixed costs. Such practices have been common in the DRAM industry during periods of excess supply, and have resulted in substantial losses in the DRAM industry. Our primary semiconductor competitors include Samsung, Toshiba, Hynix, IM Flash and STMicro. Samsung, in addition to ramping its overall NAND output, continues to ramp its MLC output. In addition, Hynix, is aggressively ramping NAND output and IM Flash, is expected to produce significant NAND output in the future. All leading suppliers, including ourselves, have been substantially increasing NAND capacity, which is resulting in prices declining at a faster rate than cost reductions. We cannot predict when the balance between supply and demand will be achieved. In addition, current and future competitors produce or could produce alternative flash memory technologies that compete against our NAND flash memory technology which may reduce demand or accelerate price decline for NAND. If the balance between supply and demand is not achieved or if pricing continues to decline at a rate faster than cost reduction, our results of operations and financial condition could be harmed.

     We also compete with flash memory card manufacturers and resellers. These companies purchase, or have a captive supply of, flash memory components and assemble memory cards. Our primary competitors currently include, among others, A-Data, Buffalo Technology, Fuji, Hagiwara, Hama, I/O Data, KingMax, Kingston, Kodak, Lexar, Matsushita, Micron, Netac, Panasonic, PNY, Ritek, Samsung, Sony, Toshiba, Tradebrands and Transcend.

     Some of our competitors have substantially greater resources than we do, have well recognized brand names or have the ability to operate their business on lower margins than we do. The success of our competitors may adversely affect our future sales revenues and may result in the loss of our key customers. For example, Toshiba and other manufacturers have recently increased their market share in the mobile market, including the microSD card, which has been a significant driver of our growth. In the digital audio market, we face competition from well established companies such as Apple and Microsoft. In the USB market we face competition from a large number of players including Kingston, Lexar, Memorex and PNY, among others.

     Furthermore, many companies are pursuing new or alternative technologies, such as phase-change technology, charge-trap flash and millipedes/probes, which may compete with flash memory. For example, two of our competitors are advocating charge-trap flash technology, which if successful and if we are unable to scale our technology on an equivalent basis, could provide an advantage to these competitors.

     These new or alternative technologies may provide smaller size, higher capacity, reduced cost, lower power consumption or other advantages. If we cannot compete effectively, our results of operations and financial condition will suffer.

     We have patent cross-license agreements with several of our leading competitors. Under these agreements, we have enabled competitors to manufacture and sell products that incorporate technology covered by our patents. If we continue to license our patents to our competitors, competition may increase and may harm our business, financial condition and results of operations.

     We believe that our ability to compete successfully depends on a number of factors, including:

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• price, quality and on-time delivery to our customers;

• product performance, availability and differentiation;

• success in developing new applications and new market segments;

• sufficient availability of supply;

• efficiency of production;

• timing of new product announcements or introductions by us, our customers and our competitors;

• the ability of our competitors to incorporate standards or develop formats which we do not offer;

• the number and nature of our competitors in a given market;

• successful protection of intellectual property rights; and

• general market and economic conditions.

     While we believe we are well-positioned to compete in the marketplace, there can be no assurance that we will be able to compete successfully in the future.

     The semiconductor industry is subject to significant downturns that have harmed our business, financial condition and results of operations in the past and may do so in the future. The semiconductor industry is highly cyclical and is characterized by constant and rapid technological change, rapid product obsolescence and price declines, evolving standards, short product life cycles and wide fluctuations in product supply and demand. The industry has experienced significant downturns, often in connection with, or in anticipation of, maturing product cycles of both semiconductor companies’ and their customers’ products and declines in general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated declines in selling prices. We have experienced these conditions in our business in the past and may experience such downturns in the future.

     Our business and the markets we address are subject to significant fluctuations in supply and demand and our commitments to our ventures with Toshiba may result in periods of significant excess inventory. With the ramp to volume production at Fab 3 in fiscal 2006, our captive memory supply increased substantially more than in either of the last two years. Our obligation to purchase 50% of the supply from FlashVision, Flash Partners and Flash Alliance, the ventures with Toshiba, could harm our business and results of operations if our committed supply exceeds demand for our products. The adverse effects could include, among other things, significant decreases in our product prices, significant excess, obsolete or lower of cost or market inventory write-downs and the impairment of our investments in the ventures with Toshiba. For example, in the fourth quarter of fiscal 2006, over 90% of our NAND memory wafer purchases were from our ventures with Toshiba. These effects will be magnified once the Flash Alliance venture commences production. Any future excess supply could have a material adverse effect on our business, financial condition and results of operations.

     We depend on third-party foundries for silicon supply and any shortage or disruption in our supply from these sources will reduce our revenues, earnings and gross margins. All of our flash memory card products require silicon supply for the memory and controller components. The substantial majority of our flash memory is currently supplied by our ventures with Toshiba and by Toshiba pursuant to our foundry agreement, and to a lesser extent by Samsung and Hynix. Any disruption in supply of flash memory from our captive or non-captive sources would harm our operating results. We intend to increase production at Fab 3, commence production at Fab 4 and continue to procure wafers from non-captive sources. If the Fab 3 production ramp does not increase as anticipated, we fail to commence production at Fab 4 as planned, Fab 4 does not meet anticipated manufacturing output, or our non-captive sources fail to supply wafers in the amounts and at the times we expect, we may not have sufficient supply to meet demand and our operating results could be harmed. Currently, our controller wafers are only manufactured by Tower and UMC, and some of these controllers are sole-sourced at either UMC or Tower. Any disruption in the manufacturing operations of Tower or UMC would result in delivery delays, would adversely affect our ability to make timely shipments of our products and would harm our operating results until we could qualify an alternate source of supply for our controller wafers,

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which could take three or more quarters to complete. In times of significant growth in global demand for flash memory, demand from our customers may outstrip the supply of flash memory and controllers available to us from our current sources. If our silicon vendors are unable to satisfy our requirements on competitive terms or at all due to lack of capacity, technological difficulties, natural disaster, financial difficulty, power failure, labor unrest, their refusal to do business with us, their relationships with our competitors or other causes, we may lose potential sales and our business, financial condition and operating results may suffer. In addition, these risks are magnified at Toshiba’s Yokkaichi, Japan operations, where the current ventures are operated, Fab 4 is being constructed, and Toshiba’s foundry capacity is located. Earthquakes and power outages have resulted in production line stoppage and loss of wafers in Yokkaichi and similar stoppages and losses may occur in the future. For example, in the first quarter of fiscal 2006, a brief power outage in Fab 3 resulted in a loss of wafers and significant costs associated with bringing the fab back on line. Also, the Tower fabrication facility, from which we source controller wafers, is facing financial challenges and is located in Israel, an area of political and military turmoil. Any disruption or delay in supply from our silicon sources could significantly harm our business, financial condition and results of operations.

     If actual manufacturing yields are lower than our expectations, this may result in increased costs and product shortages. The fabrication of our products requires wafers to be produced in a highly controlled and ultra clean environment. Semiconductor manufacturing yields and product reliability are a function of both design technology and manufacturing process technology and production delays may be caused by equipment malfunctions, fabrication facility accidents or human errors. Yield problems may not be identified or improved until an actual product is made and can be tested. As a result, yield problems may not be identified until the wafers are well into the production process. We have from time-to-time experienced yields that have adversely affected our business and results of operations. We have experienced adverse yields on more than one occasion when we have transitioned to new generations of products. If actual yields are low, we will experience higher costs and reduced product supply, which could harm our business, financial condition and results of operations. For example, if the production ramp and/or yield of the 56-nanometer, 300-millimeter Flash Partners’ wafers do not increase as expected, we may not have enough supply to meet demand and our cost competitiveness, business, financial condition and results of operations will be harmed.

     We depend on our third-party subcontractors and our business could be harmed if our subcontractors do not perform as planned. We rely on third-party subcontractors for our wafer testing, IC assembly, packaged testing, product assembly, product testing and order fulfillment. From time-to-time, our subcontractors have experienced difficulty in meeting our requirements. If we are unable to increase the capacity of our current subcontractors or qualify and engage additional subcontractors, we may not be able to meet demand for our products. We do not have long-term contracts with our existing subcontractors nor do we expect to have long-term contracts with any new subcontract suppliers. We do not have exclusive relationships with any of our subcontractors, and therefore, cannot guarantee that they will devote sufficient resources to manufacturing our products. We are not able to directly control product delivery schedules. Furthermore, we manufacture on a turnkey basis with some of our subcontract suppliers. In these arrangements, we do not have visibility and control of their inventories of purchased parts necessary to build our products or of the progress of our products through their assembly line. Any significant problems that occur at our subcontractors, or their failure to perform at the level we expect, could lead to product shortages or quality assurance problems, either of which would have adverse effects on our operating results.

     We are constructing a captive assembly and test manufacturing facility in China. The Chinese government recently approved a 50-year lease by us of a piece of land to construct and equip a captive assembly and test manufacturing facility in the Zizhu Science-Based Park near Shanghai, China. Our anticipated expenditure for this project is approximately $170 million, of which approximately $150 million is expected to be paid in fiscal 2007. Any delays in the construction and equipping of the facility would harm our results of operations and financial condition. Once constructed, this facility is only intended to replace a portion of our test and assembly needs and therefore, we will continue to depend on our third-party subcontractors for a majority of our test and assembly needs.

     In transitioning to new processes, products and silicon sources, we face production and market acceptance risks that have caused, and may in the future continue to cause significant product delays that could harm our business. Successive generations of our products have incorporated semiconductors with greater memory capacity per chip. The transition to new generations of products, such as the 56-nanometer 8 and 16 gigabit MLC chip, which we expect to begin shipping in volume in fiscal 2007, is highly complex and requires new controllers, new test procedures and modifications of numerous aspects of manufacturing, as well as extensive qualification of the new products by both us and our OEM customers. In addition, Flash Partners is currently ramping the 56-nanometer 8 gigabit MLC chip in the Yokkaichi, Japan 300-millimeter fab and this transition is subject to yield, quality and output risk. Furthermore, procurement of MLC wafers from non-captive sources requires us to develop new controller technologies and may result in inadequate quality or performance in our products that integrate these MLC components. Any material delay in a development or qualification schedule could delay deliveries and adversely impact our

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operating results. We periodically have experienced significant delays in the development and volume production ramp-up of our products. Similar delays could occur in the future and could harm our business, financial condition and results of operations.

     Our products may contain errors or defects, which could result in the rejection of our products, product recalls, damage to our reputation, lost revenues, diverted development resources and increased service costs and warranty claims and litigation. Our products are complex, must meet stringent user requirements, may contain errors or defects and the majority of our products are warrantied for one to five years. Errors or defects in our products may be caused by, among other things, errors or defects in the memory or controller components, including components we procure from non-captive sources such as the MLC products we procure from a third-party supplier. In addition, in the fourth quarter of fiscal year 2006, over 90% of our NAND memory purchases were from our captive ventures with Toshiba and if the wafers contain errors or defects, our overall supply could be adversely affected. These factors could result in the rejection of our products, damage to our reputation, lost revenues, diverted development resources, increased customer service and support costs and warranty claims and litigation. We record an allowance for warranty and similar costs in connection with sales of our product, but actual warranty and similar costs may be significantly higher than our recorded estimate and result in an adverse effect on our results of operations and financial condition.

     Our new products have from time-to-time been introduced with design and production errors at a rate higher than the error rate in our established products. We must estimate warranty and similar costs for new products without historical information and actual costs may significantly exceed our recorded estimates. Underestimation of our warranty and similar costs would have an adverse effect on our results of operations and financial condition.

     We and Toshiba plan to continue to expand the wafer fabrication capacity of the Flash Partners business venture and have formed a new venture, Flash Alliance, for which we will make substantial capital investments and incur substantial start-up and tool relocation costs, which could adversely impact our operating results. We and Toshiba are making, and plan to continue to make, substantial investments in new capital assets to expand the wafer fabrication capacity of our Flash Partners business venture in Japan. We and Toshiba intend to invest $1.76 billion to continue expansion at Fab 3 to bring wafer capacity to 135,000 wafers per month by the end of fiscal year 2007 and are cooperating in the construction of an additional 300-millimeter NAND wafer fabrication facility, Fab 4, to produce NAND flash memory products for the parties under the Flash Alliance venture. We and Toshiba intend to invest 300 billion Japanese yen, or approximately $2.5 billion, based on the exchange rate at December 31, 2006, in the construction and equipping of Fab 4. Moreover, each time that we and Toshiba add substantial new wafer fabrication capacity, we will experience significant initial design and development and start-up costs as a result of the delay between the time of the investment and the time qualified products are manufactured and sold in volume quantities. For several quarters, we will incur initial design and development costs and start-up costs and pay our share of ongoing operating activities even if we do not achieve the planned output volume or utilize our full share of the expanded output, and these costs will impact our gross margins, results of operations and financial condition.

     There is no assurance that Flash Partners’ 300-millimeter NAND flash memory facility will perform as expected, in particular as we transition to new lithography feature sizes. The Flash Partners’ 300-millimeter fab, Fab 3, is currently transitioning from 70-nanometer to 56-nanometer feature sizes. There can be no assurance that this transition will occur on schedule or at the yields or costs that we anticipate. This technology transition is difficult and subject to significant risks in terms of schedule, yield and cost. If Flash Partners, or in the future, Flash Alliance, encounters difficulties in transitioning to new technologies, our cost per megabyte may not remain competitive with the costs achieved by other NAND flash memory producers. Also, Samsung is licensed under our patents to use MLC technology, which enhances its manufacturing capabilities. Samsung began shipping NAND/MLC products in the third quarter of fiscal year 2005 and may be able to produce product at a lower cost than we can and increase their market share, thus adversely affecting our operating results and financial condition.

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     We have a contingent indemnification obligation and guarantee obligations related to the ventures with Toshiba. Toshiba has guaranteed FlashVision’s lease arrangement with third-party lessors. The total minimum remaining lease payments as of December 31, 2006 were 5.8 billion Japanese yen, or approximately $48.6 million based upon the exchange rate at December 31, 2006. If Toshiba makes payments under its guarantee, we have agreed to indemnify Toshiba for 49.9% of its costs, subject to certain limitations and exclusions.

     In December 2004, December 2005, June 2006 and September 2006, Flash Partners entered into four separate equipment lease facilities totaling approximately 215.0 billion Japanese yen, or approximately $1.8 billion based upon the exchange rate at December 31, 2006, of which, as of December 31, 2006, 144.0 billion Japanese yen, or approximately $1.2 billion based upon the exchange rate at December 31, 2006, net of accumulated lease payments, had been drawn down. As of December 31, 2006, our cumulative guarantee under the equipment leases, net of cumulative lease payments, was approximately 72.0 billion Japanese yen, or approximately $605 million based on the exchange rate at December 31, 2006. On January 10, 2007, Flash Partners drew down the remaining balance of the September 2006 master lease agreement in the amount of approximately 52.0 billion Japanese yen, or approximately $437 million, based on the exchange rate at December 31, 2006, of which we guaranteed 26.0 billion Japanese yen, or approximately $218 million based upon the exchange rate at December 31, 2006. These leases contain default clauses which, if triggered, could cause us to repay the amounts due under our guarantees. If our corporate rating is significantly downgraded by any rating agency, it may impair the ability of our ventures with Toshiba to obtain future equipment lease financings on terms consistent with current leases and would cause a default under certain current leases, either of which could harm our business and financial condition.

     We and Toshiba have also agreed to mutually contribute to, and indemnify each other, Flash Partners and Flash Alliance for environmental remediation costs or liability resulting from Flash Partners’ and Flash Alliance’s manufacturing operations in certain circumstances. In addition, we and Toshiba entered into a Patent Indemnification Agreement under which in many cases we will share in the expenses associated with the defense and cost of settlement associated with such claims. This agreement provides limited protection for us against third-party claims that NAND flash memory products manufactured and sold by Flash Partners or Flash Alliance infringe third-party patents.

     None of the foregoing obligations are reflected as liabilities on our consolidated balance sheets. If we have to perform our obligations under these agreements, our business will be harmed and our financial condition and results of operations will be adversely affected.

     Seasonality in our business may result in our inability to accurately forecast our product purchase requirements. Sales of our products in the consumer electronics market are subject to seasonality. For example, sales have typically increased significantly in the fourth quarter of each year, sometimes followed by declines in the first quarter of the following year. This may become more pronounced as sales of our Sansa digital audio player have become a larger portion of our product mix. This seasonality increases the complexity of forecasting our business. If our forecasts are inaccurate, we can lose market share or procure excess inventory or inappropriately increase or decrease our operating expenses, any of which could harm our business, financial condition and results of operations. This seasonality also may lead to higher volatility in our stock price, the need for significant working capital investments in receivables and inventory and our need to build inventory levels in advance of our most active selling seasons.

     From time-to-time, we overestimate our requirements and build excess inventory, and underestimate our requirements and have a shortage of supply, both of which harm our financial results. The majority of our products are sold into consumer markets, which are difficult to accurately forecast. Also, a substantial majority of our quarterly sales are from orders received and fulfilled in that quarter. Additionally, we depend upon timely reporting from our retail and distributor customers as to their inventory levels and sales of our products in order to forecast demand for our products. Our international customers submit these reports on a monthly, not weekly, basis making it more difficult to accurately forecast demand. We have in the past significantly over-forecasted and under-forecasted actual demand for our products. The failure to accurately forecast demand for our products will result in lost sales or excess inventory both of which will have an adverse effect on our business, financial condition and results of operations. In addition, at times inventory may increase in anticipation of increased demand or as captive wafer capacity ramps. If demand does not materialize, we may be forced to write-down excess inventory which may harm our financial condition and results of operations.

     Under conditions of tight flash memory supply, we may be unable to adequately increase our production volumes or secure sufficient supply in order to maintain our market share. If we are unable to maintain market share, our results of operations and

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financial condition could be harmed. Conversely, during periods of excess supply in the market for our flash memory products, we may lose market share to competitors who aggressively lower their prices.

     Our ability to respond to changes in market conditions from our forecast is limited by our purchasing arrangements with our silicon sources. These arrangements generally provide that the first three months of our rolling six-month projected supply requirements are fixed and we may make only limited percentage changes in the second three months of the period covered by our supply requirement projections.

     We are sole-sourced for a number of our critical components and the absence of a back-up supplier exposes our supply chain to unanticipated disruptions. We rely on our vendors, some of which are a sole source of supply, for many of our critical components. We do not have long-term supply agreements with most of these vendors. Our business, financial condition and operating results could be significantly harmed by delays or reductions in shipments if we are unable to develop alternative sources or obtain sufficient quantities of these components.

     We are exposed to foreign currency risks. Our purchases of NAND flash memory from the Toshiba ventures and our investments in those ventures are denominated in Japanese yen. Our sales, however, are primarily denominated in U.S. dollars or other foreign currencies. Additionally, we expect over time to increase the percentage of our sales denominated in currencies other than the U.S. dollar. This exposes us to significant risk from foreign currency fluctuations. Management of these foreign exchange exposures and the foreign currency forward contracts used to mitigate these exposures is complex and if we do not successfully manage our foreign exchange exposures, our business, results of operations and financial condition could be harmed.

     Terrorist attacks, war, threats of war and government responses thereto may negatively impact our operations, revenues, costs and stock price. Terrorist attacks, U.S. military responses to these attacks, war, threats of war and any corresponding decline in consumer confidence could have a negative impact on consumer retail demand, which is the largest channel for our products. Any of these events may disrupt our operations or those of our customers and suppliers and may affect the availability of materials needed to manufacture our products or the means to transport those materials to manufacturing facilities and finished products to customers. Any of these events could also increase volatility in the U.S. and world financial markets, which could harm our stock price and may limit the capital resources available to us and our customers or suppliers or adversely affect consumer confidence. In November 2006, we acquired msystems, which is headquartered and has substantial operations in Israel, and we have a development center in Northern Israel, near the border with Lebanon, areas that have recently experienced significant violence and political unrest. Continued turmoil and unrest in this area could cause delays in the development of our products. This could harm our business and results of operations.

     Natural disasters or epidemics in the countries in which we or our suppliers or subcontractors operate could negatively impact our operations. Our operations, including those of our suppliers and subcontractors, are concentrated in Milpitas, California; Yokkaichi, Japan; Hsinchu and Taichung, Taiwan; and Dongguan, Shanghai and Shenzen, China. In the past, these areas have been affected by natural disasters such as earthquakes, tsunamis and typhoons, and some areas have been affected by epidemics, such as avian flu. If a natural disaster or epidemic were to occur in one or more of these areas, our operations could be significantly impaired and our business may be harmed. This is magnified by the fact that we do not have insurance for most natural disasters, including earthquakes. This could harm our business and results of operations.

     We may be unable to protect our intellectual property rights, which would harm our business, financial condition and results of operations. We rely on a combination of patents, trademarks, copyright and trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. In the past, we have been involved in significant and expensive disputes regarding our intellectual property rights and those of others, including claims that we may be infringing third-parties’ patents, trademarks and other intellectual property rights. We expect that we may be involved in similar disputes in the future. We cannot assure you that:

• any of our existing patents will not be invalidated;

• patents will be issued for any of our pending applications;

• any claims allowed from existing or pending patents will have sufficient scope or strength;

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• our patents will be issued in the primary countries where our products are sold in order to protect our rights and potential commercial advantage; or

• any of our products or technologies do not infringe on the patents of other companies.

     In addition, our competitors may be able to design their products around our patents and other proprietary rights.

     Several companies have recently entered or announced their intentions to enter the flash memory market, and we believe these companies may require a license from us. Enforcement of our rights may require litigation. If we bring a patent infringement action and are not successful, our competitors would be able to use similar technology to compete with us. Moreover, the defendant in such an action may successfully countersue us for infringement of their patent or assert a counterclaim that our patents are invalid or unenforceable. If we did not prevail as a defendant in patent infringement case, we could be required to pay substantial damages, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology, discontinue the use of specific processes or obtain licenses to the infringing technology.

     We may be unable to license intellectual property to or from third-parties as needed, or renew existing licenses, which could expose us to liability for damages reduce our royalty revenues, increase our costs or limit or prohibit us from selling products. If we incorporate third-party technology into our products or if we are found to infringe others’ intellectual property, we could be required to license intellectual property from a third party. We may also need to license some of our intellectual property to others in order to enable us to obtain important cross-licenses to third-party patents. We cannot be certain that licenses will be offered when we need them, or that the terms offered will be acceptable, or that these licenses will help our business. If we do obtain licenses from third-parties, we may be required to pay license fees or royalty payments. In addition, if we are unable to obtain a license that is necessary to the manufacture of our products, we could be required to suspend the manufacture of products or stop our product suppliers from using processes that may infringe the rights of third-parties. We may not be successful in redesigning our products, the necessary licenses may not be available under reasonable terms, our existing licensees may not renew their licenses upon expiration and we may not be successful in signing new licensees in the future.

     We are currently and may in the future be involved in litigation, including litigation regarding our intellectual property rights or those of third parties, which may be costly, may divert the efforts of our key personnel and could result in adverse court rulings, which could materially harm our business. We are involved in a number of lawsuits, including among others, several cases involving our patents and the patents of third-parties. We are the plaintiff in some of these actions and the defendant in other of these actions. Some of the actions could seek injunctions against the sale of our products and/or substantial monetary damages, which if granted or awarded, could have a material adverse effect on our business, financial condition and results of operations.

     Litigation is subject to inherent risks and uncertainties that may cause actual results to differ materially from our expectations. Factors that could cause litigation results to differ include, but are not limited to, the discovery of previously unknown facts, changes in the law or in the interpretation of laws, and uncertainties associated with the judicial decision-making process. If we receive an adverse judgment in any litigation, we could be required to pay substantial damages and/or cease the manufacture, use and sale of products. Litigation, including intellectual property litigation, can be complex, can extend for a protracted period of time, and can be very expensive. Litigation initiated by us could also result in counter-claims against us, which could increase the costs associated with the litigation and result in our payment of damages or other judgments against us. In addition, litigation may divert the efforts and attention of some of our key personnel.

     We have been, and expect to continue to be, subject to claims and legal proceedings regarding alleged infringement by us of the patents, trademarks and other intellectual property rights of third-parties. From time-to-time we have sued, and may in the future sue, third-parties in order to protect our intellectual property rights. Parties that we have sued and that we may sue for patent infringement may countersue us for infringing their patents. If we are held to infringe the intellectual property of others, we may need to spend significant resources to develop non-infringing technology or obtain licenses from third-parties, but we may not be able to develop such technology or acquire such licenses on terms acceptable to us or at all. We may also be required to pay significant damages and/or discontinue the use of certain manufacturing or design processes. In addition, we or our suppliers could be enjoined from selling some or all of our respective products in one or more geographic locations. If we or our suppliers are enjoined from selling any of our respective products or if we are required to develop new technologies or pay significant monetary damages or are required to make substantial royalty payments, our business would be harmed.

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     Moreover, from time-to-time we agree to indemnify certain of our suppliers and customers for alleged patent infringement. The scope of such indemnity varies but generally includes indemnification for direct and consequential damages and expenses, including attorneys’ fees. We may from time-to-time be engaged in litigation as a result of these indemnification obligations. Third-party claims for patent infringement are excluded from coverage under our insurance policies. A future obligation to indemnify our customers or suppliers may have a material adverse effect on our business, financial condition and results of operations. For additional information concerning legal proceedings, see Part I, Item 3, “Legal Proceedings.”

     Because of our international business and operations, we must comply with numerous international laws and regulations, and we are vulnerable to political instability, currency fluctuations and other risks related to international operations. Currently, all of our products are produced overseas in China, Israel, Japan, South Korea and Taiwan. We are, therefore, affected by the political, economic and military conditions in these countries.

     Specifically, China does not currently have a comprehensive and highly developed legal system, particularly with respect to the protection of intellectual property rights. This results, among other things, in the prevalence of counterfeit goods in China. The enforcement of existing and future laws and contracts remains uncertain, and the implementation and interpretation of such laws may be inconsistent. Such inconsistency could lead to piracy and degradation of our intellectual property protection. Although we have increased our efforts to prevent counterfeit products from entering the market, those efforts may not be successful. Our results of operations and financial condition could be harmed by the sale of counterfeit products.

     Our international business activities could also be limited or disrupted by any of the following factors:

• the need to comply with foreign government regulation;

• general geopolitical risks such as political and economic instability, potential hostilities and changes in diplomatic and trade relationships;

• natural disasters affecting the countries in which we conduct our business, particularly Japan, such as the earthquakes experienced in Taiwan in 1999, in Japan in 2004, 2003 and previous years, and in China in previous years;

• reduced sales to our customers or interruption to our manufacturing processes in the Pacific Rim that may arise from regional issues in Asia;

• imposition of regulatory requirements, tariffs, import and export restrictions and other barriers and restrictions;

• imposition of additional duties, charges and/or fees related to customs entries for our products, which are all manufactured offshore;

• inability to successfully manage our foreign exchange exposures;

• longer payment cycles and greater difficulty in accounts receivable collection;

• adverse tax rules and regulations;

• weak protection of our intellectual property rights; and

• delays in product shipments due to local customs restrictions.

     Tower Semiconductor’s Financial Situation is Challenging. Tower supplies a significant portion of our controller wafers from its Fab 2 facility and is currently a sole source of supply for some of our controllers. Tower’s Fab 2 is operational and in the process of expanding capacity and our ability to continue to obtain sufficient supply on a cost-effective basis may be dependent upon completion of this capacity expansion. Tower’s continued expansion of Fab 2 requires sufficient funds to operate in the short-term and raising the funds required to implement the current ramp-up plan. If Tower fails to comply with the financial ratios and covenants contained in the amended credit facility agreement with its banks, fails to attract additional customers, fails to operate its Fab 2 facility in a cost-effective manner, fails to secure additional financing, fails to meet the conditions to receive government grants and tax benefits approved for Fab 2, or fails to obtain the approval of the Israeli Investment Center for a new

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expansion program, Tower’s continued operations could be at risk. If this occurs, we will be forced to source our controllers from another supplier and our business, financial condition and results of operations may be harmed. Specifically, our ability to supply a number of products would be disrupted until we were able to transition manufacturing and qualify a new foundry with respect to controllers that are currently sole sourced at Tower, which could take three or more quarters to complete.

     We have recognized cumulative losses of approximately $54.1 million as a result of the other-than-temporary decline in the value of our investment in Tower ordinary shares, $12.2 million as a result of the impairment in value on our prepaid wafer credits and $1.3 million of losses on our warrant to purchase Tower ordinary shares as of December 31, 2006. We are subject to certain restrictions on the transfer of our approximately 12.8 million Tower ordinary shares including certain rights of first refusal, and through January 2008, have agreed to maintain minimum shareholdings. It is possible that we will record further write-downs of our investment, which was carried on our consolidated balance sheet at $17.5 million at December 31, 2006, which would harm our results of operations and financial condition.

     Our stock price has been, and may continue to be, volatile, which could result in investors losing all or part of their investments. The market price of our stock has fluctuated significantly in the past and may continue to fluctuate in the future. We believe that such fluctuations will continue as a result of many factors, including future announcements concerning us, our competitors or principal customers regarding financial results or expectations, technological innovations, industry supply dynamics, new product introductions, governmental regulations, the commencement or results of litigation or changes in earnings estimates by analysts. In addition, in recent years the stock market has experienced significant price and volume fluctuations and the market prices of the securities of high technology and semiconductor companies have been especially volatile, often for reasons outside the control of the particular companies. These fluctuations as well as general economic, political and market conditions may have an adverse affect on the market price of our common stock as well as the price of our outstanding convertible notes and could impact the likelihood of those notes being converted into our common stock, which would cause further dilution to our stockholders.

     We may make acquisitions that are dilutive to existing stockholders, result in unanticipated accounting charges or otherwise adversely affect our results of operations, and result in difficulties in assimilating and integrating the operations, personnel, technologies, products and information systems of acquired companies or businesses. We continually evaluate and explore strategic opportunities as they arise, including business combinations, strategic partnerships, collaborations, capital investments and the purchase, licensing or sale of assets. If we issue equity securities in connection with an acquisition, the issuance may be dilutive to our existing stockholders. Alternatively, acquisitions made entirely or partially for cash would reduce our cash reserves.

     Acquisitions may require significant capital infusions, typically entail many risks and could result in difficulties in assimilating and integrating the operations, personnel, technologies, products and information systems of acquired companies. In order to realize the intended benefits of our recent acquisitions of msystems and Matrix, we will have to successfully integrate and retain key msystems and Matrix personnel. We may experience delays in the timing and successful integration of acquired technologies and product development through volume production, unanticipated costs and expenditures, changing relationships with customers, suppliers and strategic partners, or contractual, intellectual property or employment issues. In addition, key personnel of an acquired company may decide not to work for us. The acquisition of another company or its products and technologies may also result in our entering into a geographic or business market in which we have little or no prior experience. These challenges could disrupt our ongoing business, distract our management and employees, harm our reputation, subject us to an increased risk of intellectual property and other litigation and increase our expenses. These challenges are magnified as the size of the acquisition increases, and we cannot assure you that we will realize the intended benefits of any acquisition. Acquisitions may require large one-time charges and can result in increased debt or contingent liabilities, adverse tax consequences, substantial depreciation or deferred compensation charges, the amortization of identifiable purchased intangible assets or impairment of goodwill, any of which could have a material adverse effect on our business, financial condition or results of operations.

     Mergers and acquisitions of high-technology companies are inherently risky and subject to many factors outside of our control, and no assurance can be given that our previous or future acquisitions will be successful and will not materially adversely affect our business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions could materially harm our business and operating results. Even when an acquired company has already developed and marketed products, there can be no assurance that such products will be successful after the closing, will not cannibalize sales of our existing products, that product enhancements will be made in a timely fashion or that pre-acquisition due diligence will have

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identified all possible issues that might arise with respect to such company. See “There are numerous risks associated with our acquisition of msystems.”

     Our success depends on key personnel, including our executive officers, the loss of whom could disrupt our business. Our success greatly depends on the continued contributions of our senior management and other key research and development, sales, marketing and operations personnel, including Dr. Eli Harari, our founder, president and chief executive officer. We do not have employment agreements with any of our executive officers and they are free to terminate their employment with us at any time. Our success will also depend on our ability to recruit additional highly skilled personnel. We may not be successful in hiring or retaining key personnel and our key personnel may not remain employed with us.

     To manage our growth, we may need to improve our systems, controls and procedures and relocate portions of our business to new or larger facilities. We have experienced and may continue to experience rapid growth, which has placed, and could continue to place a significant strain on our managerial, financial and operations resources and personnel. Our number of employees, including management-level employees, has increased significantly, due to our acquisition of msystems. We must continue to improve our operational, accounting and financial systems and managerial controls and procedures, including fraud procedures, and we will need to continue to expand, as well as, train and manage our workforce. From time-to-time, we may need to relocate portions of our business to new or larger facilities, which could result in disruption of our business or operations. For example, in May 2006, we relocated our corporate headquarters and significant engineering operations, including labs and data centers, to new facilities in Milpitas, California. If we do not manage our growth effectively, including transitions to new or larger facilities, our business could be harmed.

     We may need to raise additional financing, which could be difficult to obtain, and which if not obtained in satisfactory amounts may prevent us from funding the ventures with Toshiba, increasing our wafer supply, developing or enhancing our products, taking advantage of future opportunities, growing our business or responding to competitive pressures or unanticipated industry changes, any of which could harm our business. We currently believe that we have sufficient cash resources to fund our operations as well as our investments in the ventures with Toshiba for at least the next twelve months; however, we may in the future raise additional funds, including funds to meet our obligations with respect to Flash Partners and Flash Alliance, and we cannot be certain that we will be able to obtain additional financing on favorable terms, if at all. From time-to-time, we may decide to raise additional funds through public or private debt, equity or lease financings. If we issue additional equity securities, our stockholders will experience dilution and the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock. If we raise funds through debt or lease financing, we will have to pay interest and may be subject to restrictive covenants, which could harm our business. If we cannot raise funds on acceptable terms, if and when needed, we may not be able to develop or enhance our products, fulfill our obligations to Flash Partners and Flash Alliance, take advantage of future opportunities, grow our business or respond to competitive pressures or unanticipated industry changes, any of which could have a negative impact on our business.

     Anti-takeover provisions in our charter documents, stockholder rights plan and in Delaware law could discourage or delay a change in control and, as a result, negatively impact our stockholders. We have taken a number of actions that could have the effect of discouraging a takeover attempt. For example, we have a stockholders’ rights plan that would cause substantial dilution to a stockholder, and substantially increase the cost paid by a stockholder, who attempts to acquire us on terms not approved by our board of directors. This could discourage an acquisition of us. In addition, our certificate of incorporation grants our board of directors the authority to fix the rights, preferences and privileges of and issue up to 4,000,000 shares of preferred stock without stockholder action (2,000,000 of which have already been reserved under our stockholder rights plan). Issuing preferred stock could have the effect of making it more difficult and less attractive for a third party to acquire a majority of our outstanding voting stock. Preferred stock may also have other rights, including economic rights senior to our common stock that could have a material adverse effect on the market value of our common stock. In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law. This section provides that a corporation may not engage in any business combination with any interested stockholder during the three-year period following the time that a stockholder became an interested stockholder. This provision could have the effect of delaying or discouraging a change of control of SanDisk.

     Unanticipated changes in our tax provisions or exposure to additional income tax liabilities could affect our profitability. We are subject to income taxes in the United States and numerous foreign jurisdictions. Our tax liabilities are affected by the amounts we charge for inventory, services, licenses, funding and other items in intercompany transactions. We are subject to ongoing tax audits in various jurisdictions. Tax authorities may disagree with our intercompany charges or other matters and assess additional taxes. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision. However, there can be no assurance that we will accurately predict the outcomes of these audits, and the actual

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outcomes of these audits could have a material impact on our net income or financial condition. In addition, our effective tax rate in the future could be adversely affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws and the discovery of new information in the course of our tax return preparation process. In particular, the carrying value of deferred tax assets, which are predominantly in the United States, is dependent on our ability to generate future taxable income in the United States. Any of these changes could affect our profitability. Furthermore, our tax provisions could be adversely affected as a result of any new interpretative accounting guidance related to accounting for uncertain tax provisions.

     Changes in securities laws and regulations have increased our costs; further, in the event we are unable to satisfy regulatory requirements relating to internal control, or if our internal control over financial reporting is not effective, our business could suffer. The Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, that became law in July 2002 required changes in our corporate governance, public disclosure and compliance practices. The number of rules and regulations applicable to us has increased and will continue to increase our legal and financial compliance costs, and has made some activities more difficult, such as approving new or amendments to our option plans. In addition, we have incurred and expect to continue to incur significant costs in connection with compliance with Section 404 of Sarbanes-Oxley regarding internal control over financial reporting. In 2007, we will incur additional costs integrating msystems into our internal control systems and procedures. These laws and regulations and perceived increased risk of liability could make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee, and qualified executive officers. We cannot estimate the timing or magnitude of additional costs we may incur as a result.

     In connection with our certification process under Section 404 of Sarbanes-Oxley, we have identified in the past and will from time-to-time identify deficiencies in our internal control over financial reporting. We cannot assure you that individually or in the aggregate these deficiencies would not be deemed to be a material weakness. Furthermore, we may not be able to implement enhancements on a timely basis, including any enhancements necessary to integrate msystems operations, in order to prevent a failure of our internal controls or enable us to furnish future unqualified certifications. A material weakness or deficiency in internal control over financial reporting could materially impact our reported financial results and the market price of our stock could significantly decline. Additionally, adverse publicity related to the disclosure of a material weakness or deficiency in internal controls could have a negative impact on our reputation, business and stock price. Any internal control or procedure, no matter how well designed and operated, can only provide reasonable assurance of achieving desired control objectives and cannot prevent intentional misconduct or fraud.

     Our debt service obligations may adversely affect our cash flow. While the 1% Notes due 2013 and the 1% Notes due 2035, are outstanding, we will have debt service obligations on the holders of the 1% Notes due 2013 and the 1% Notes due 2035 of approximately $12.3 million per year in interest payments. If we issue other debt securities in the future, our debt service obligations will increase. If we are unable to generate sufficient cash to meet these obligations and must instead use our existing cash or investments, we may have to reduce, curtail or terminate other activities of our business. We intend to fulfill our debt service obligations from cash generated by our operations, if any, and from our existing cash and investments. We may also in the future enter into other financial instruments that could increase our debt service obligations.

     Our indebtedness could have significant negative consequences. For example, it could:

• increase our vulnerability to general adverse economic and industry conditions;

• limit our ability to obtain additional financing;

• require the dedication of a substantial portion of any cash flow from operations to the payment of principal of, and interest on, our indebtedness, thereby reducing the availability of such cash flow to fund our growth strategy, working capital, capital expenditures and other general corporate purposes;

• limit our flexibility in planning for, or reacting to, changes in our business and our industry; and

• place us at a competitive disadvantage relative to our competitors with less debt.

     We have significant financial obligations related to our ventures with Toshiba, which could impact our ability to comply with our obligations under our 1% Notes due 2013 and our 1% Notes due 2035. We have entered into agreements to guarantee,

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indemnify or provide financial support with respect to lease and certain other obligations of our ventures with Toshiba in which we have a 49.9% ownership interest. In addition, we may enter into future agreements to increase manufacturing capacity, including further expansion of Fab 3 and start-up of Fab 4. As of December 31, 2006 we had unfunded commitments of approximately $877 million to fund our various obligations under the FlashVision and Flash Partners ventures with Toshiba. As of December 31, 2006, we had indemnification and guarantee obligations for these ventures of approximately $653 million. Due to these and our other commitments, we may not have sufficient funds to make payments under or repurchase the notes.

     The net share settlement feature of the 1% Notes due 2013 may have adverse consequences. The 1% Notes due 2013 are subject to net share settlement, which means that we will satisfy our conversion obligation to holders by paying cash in settlement of the lesser of the principal amount and the conversion value of the 1% Notes due 2013 and by delivering shares of our common stock in settlement of any and all conversion obligations in excess of the daily conversion values.

     Our failure to convert the 1% Notes due 2013 into cash or a combination of cash and common stock upon exercise of a holder’s conversion right in accordance with the provisions of the indenture would constitute a default under the indenture. We may not have the financial resources or be able to arrange for financing to pay such principal amount in connection with the surrender of the 1% Notes due 2013 for conversion. While we currently only have debt related to the 1% Notes due 2013 and the 1% Notes due 2035 and we do not have other agreements that would restrict our ability to pay the principal amount of the 1% Notes due 2013 in cash, we may enter into such an agreement in the future, which may limit or prohibit our ability to make any such payment. In addition, a default under the indenture could lead to a default under existing and future agreements governing our indebtedness. If, due to a default, the repayment of related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay such indebtedness and amounts owing in respect of the conversion of any 1% Notes due 2013.

     The convertible note hedge transactions and the warrant option transactions may affect the value of the notes and our common stock. We have entered into convertible note hedge transactions with Morgan Stanley & Co. International Limited and Goldman, Sachs & Co., or the dealers. These transactions are expected to reduce the potential dilution upon conversion of the notes. We used approximately $67.3 million of the net proceeds of funds received from the 1% Notes due 2013 to pay the net cost of the convertible note hedge in excess of the warrant transactions. These transactions were accounted for as an adjustment to our stockholders’ equity. In connection with hedging these transactions, the dealers or their affiliates:

• have entered into various over-the-counter cash-settled derivative transactions with respect to our common stock, concurrently with, and shortly after, the pricing of the notes; and

• may enter into, or may unwind, various over-the-counter derivatives and/or purchase or sell our common stock in secondary market transactions following the pricing of the notes, including during any observation period related to a conversion of notes.

     The dealers or their affiliates are likely to modify their hedge positions from time-to-time prior to conversion or maturity of the notes by purchasing and selling shares of our common stock, other of our securities or other instruments they may wish to use in connection with such hedging. In particular, such hedging modification may occur during any observation period for a conversion of the 1% Notes due 2013, which may have a negative effect on the value of the consideration received in relation to the conversion of those notes. In addition, we intend to exercise options we hold under the convertible note hedge transactions whenever notes are converted. To unwind their hedge positions with respect to those exercised options, the dealers or their affiliates expect to sell shares of our common stock in secondary market transactions or unwind various over-the-counter derivative transactions with respect to our common stock during the observation period, if any, for the converted notes.

     The effect, if any, of any of these transactions and activities on the market price of our common stock or the 1% Notes due 2013 will depend in part on market conditions and cannot be ascertained at this time, but any of these activities could adversely affect the value of our common stock and the value of the 1% Notes due 2013 and, as a result, the amount of cash and the number of shares of common stock, if any, holders will receive upon the conversion of the notes.

     There are numerous risks associated with our acquisition of msystems. On November 19, 2006, we acquired msystems. There are numerous risks associated with our acquisition of msystems, including the risks described below.

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     Although we expect that the merger will result in benefits to us, those benefits may not occur because of integration and other challenges, and failure to realize the benefits of the merger may result in the dilution of our per share operating results. Achieving the expected benefits of the merger will depend on the timely and efficient integration of our and msystems’ technology, product lines, operations, business culture and personnel. This will be particularly challenging due to the fact that msystems is headquartered in Israel and we are headquartered in California. The integration may not be completed as quickly as expected, and if we fail to effectively integrate the companies or the integration takes longer than expected, we may not achieve the expected benefits of the merger. The challenges involved in this integration include, among others:

• retaining the customers and sales distribution channels of both companies;

• maintaining employee morale and retaining key employees;

• retaining key sources of supply;

• incorporating msystems’ technology and products into our business and future product lines;

• integrating msystems’ sales force into our worldwide product sales network;

• demonstrating to msystems’ customers that the merger will not result in adverse changes in pricing, customer service standards or product support;

• coordinating research and development activities to enhance introduction of new products and technologies;

• integrating msystems’ internal control over financial reporting with our internal control over financial reporting;

• migrating both companies to a common enterprise resource planning information system to integrate all operations, sales and administrative activities for the combined companies in a timely and cost effective way;

• integrating msystems’ international operations with ours;

• integrating the business cultures of both companies; and

• ensuring there are no delays in releasing new products to market.

     This integration effort will be international in scope, complex, time consuming and expensive, and may disrupt our respective businesses or result in the loss of customers or key employees or the diversion of the attention of management. Neither msystems nor we have experience in integrating businesses and operations of this magnitude and scope. Integration will be particularly difficult because certain key members of msystems’ senior management are no longer with the combined company. In addition, the integration process may strain our financial and managerial controls and reporting systems and procedures. This may result in the diversion of management and financial resources from our core business objectives. There can be no assurance that we and msystems will successfully integrate our respective businesses or that we will realize the anticipated benefits of the merger. If we do not realize the expected benefits of the merger, including the achievement of operating synergies, the merger could result in a reduction of our per share earnings as compared to the per share earnings that would have been achieved by us had the merger not occurred.

     In addition, msystems’ headquarters and significant operations are located in Israel. Therefore, political, economic and military conditions in Israel directly affect its business and operations. We cannot predict the effect of continued or increased violence in Lebanon or Gaza, or the effect of military action elsewhere in the Middle East. Continued armed conflicts or political instability in the region would harm business conditions and could adversely affect the combined company’s results of operations. Furthermore, several countries continue to restrict or ban business with Israel and Israeli companies. These restrictive laws and policies may limit the combined company’s ability to make sales in those countries.

     The merger may result in a loss of customers. We and msystems operate in a highly competitive industry, and our future performance will be affected by our ability to retain each company’s existing customers. Some of msystems’ customers are our competitors or work with our competitors and may reduce or terminate their business relationships with the combined company as

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a result of the merger. msystems sells its products through OEM distribution channels, while we primarily sell our products through retail channels. msystems has a broad base of OEM customers and has substantial experience selling to those customers. In order to achieve the expected benefits of the merger, we must continue to sell, and expand sales levels, to OEM customers. We may not be able to successfully continue or expand sales through OEM channels, particularly because some of msystems’ OEM customers are competitors of ours.

     We and msystems currently sell to several of the same large customers. Our ability to maintain the current level of sales of each company to these common customers may be limited by the desire of these customers to minimize their dependence on a single supplier. If common customers seek alternative suppliers for at least a portion of the products currently provided by both us and msystems, our business may be harmed.

     Third-parties may terminate, alter or litigate under existing contracts or relationships with the combined company. Third-parties, including suppliers, distributors, customers, licensors, licensees and other business partners, have contracts with msystems. In addition, third-parties with whom msystems or we currently have relationships, including suppliers, distributors, customers, licensors, licensees and other business partners, may terminate, otherwise adversely modify their relationship with the combined company or enter into litigation with the combined company or msystems as a result of the merger. Among other things, this may result in the combined company suffering damages or a loss of potential future revenue and possibly losing rights that are material to our business. In order to achieve the expected benefits of the merger, we may seek to renegotiate contracts with some of msystems’ and our suppliers, distributors, customers, licensors, licensees, other business partners and other third-parties, and there is no assurance that such negotiations will be successful or that costly litigation may be avoided.

     General uncertainty related to the merger could harm us. Our or msystems’ existing customers may, in response to the merger, reduce future orders, pursue other sources of supply, or delay or defer purchasing decisions. If any of the foregoing occurs, the revenues of the combined company could be lower than expected and market share could be lost. In addition, the merger may create uncertainty among important suppliers, which might lead suppliers to reduce supply or adversely modify pricing to us or msystems. Any of the foregoing could have an adverse effect on our revenues, margins and profitability which, in turn, could cause our results to be substantially below the expectations of market analysts and have an adverse impact on our stock price.

     Furthermore, our and msystems’ employees may experience or perceive uncertainty about their future roles with the combined company. This may harm our and msystems’ ability to attract and retain key management, marketing, sales, technical and research and development personnel.

     There is pending litigation. Actions purporting to be class and derivative actions on behalf of msystems and its shareholders were filed against us and msystems prior to the closing of the merger. See Part I, Item 3, ''Legal Proceedings.’’ We may be required to expend significant resources, including management time, to defend these actions and could be subject to damages or settlement costs related to these actions. We are responsible for liabilities associated with these and any other class and derivative actions, including indemnification of directors and certain members of management of msystems.

     There are risks related to msystems’ prior option grant practices. As a result of an investigation by a special committee of its board of directors into its prior option grant practices, on July 17, 2006, msystems filed a Form 20-F with the U.S. Securities and Exchange Commission, or SEC, in which it restated its financial statements for each of the fiscal years ended December 31, 1999 through 2005 and, in a separate report on Form 6-K, restated its financial statements for each of the four quarters of fiscal 2005 and the first quarter of fiscal 2006. In addition, msystems has disclosed that the SEC is conducting an informal investigation into msystems’ prior option grant practices and the restatement of its financials.

     Under the merger agreement, the combined company is responsible for liabilities associated with msystems’ prior stock option grant practices, including indemnification of directors and certain members of management of msystems. These liabilities could be substantial and may include, among other things, the costs of defending lawsuits against msystems and its directors, officers, employees and former employees by stockholders and other third-parties; the cost of defending any shareholder derivative suits; the cost of governmental, law enforcement or regulatory investigations; civil or criminal fines and penalties; expenses associated with further financial restatements; auditor, legal and other expenses; and expenses associated with the remedial measures, if any, which may be imposed.

     Charges and other accounting changes resulting from the merger may adversely affect our earnings and the market value of our common stock following the merger. The acquisition of msystems required a one-time write-off by us of in-process research

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and development, and has resulted in the amortization of identifiable purchased intangible assets, increased depreciation and increased share-based compensation charges by us. If goodwill created in the acquisition becomes impaired, we may be required to incur material charges relating to the impairment of that asset. In addition, the acquisition could result in us incurring impairment charges to write down the carrying amount of msystems assets that may not be fully utilized or realized by us. Any of the foregoing could have a material adverse effect on our consolidated financial position and results of operations and the market value of our common stock.

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ITEM 1B. UNRESOLVED STAFF COMMENTS

     Not applicable.

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ITEM 2. PROPERTIES

     Our principal facilities are located in Milpitas, California. We lease four adjacent buildings comprising approximately 444,000 square feet. These facilities house our corporate offices, the majority of our engineering team, as well as a portion of our sales, marketing, operations and corporate services organizations. We occupy this space under lease agreements that expire in 2011 and 2013.

     With our acquisition of msystems, we acquired two owned buildings of approximately 148,000 square feet located at Kfar Saba, Israel, that house our administrative offices, research, development and manufacturing facilities. In addition, we also own a vacant land plot of approximately 70,000 square feet adjacent to our property located at Kfar Saba, Israel, for further expansion.

     Our subsidiary, Microelectronica Espanola S.L.U., leases office space in Madrid, Spain, of approximately 8,800 square feet, and a manufacturing plant in Madrid, Spain, of approximately 7,000 square feet.

     In December 2006, we acquired a 50-year land lease in Shanghai, China, of approximately 199,000 square feet, on which we plan to build an advanced testing and assembly facility, which is expected to be completed in fiscal 2007.

     We also lease sales and marketing offices in the United States, China, Germany, Hong Kong , Ireland, Israel, Japan, Korea, Scotland, Spain and Taiwan; operation support offices in Taichung, Taiwan; Shanghai and Shenzhen, China; Bangalore, India; and design centers in Omer, Tefen and Petah Tikva, Israel; Edinburgh, Scotland and Madrid, Spain.

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ITEM 3. Legal Proceedings

     From time-to-time, it has been and may continue to be necessary to initiate or defend litigation against third parties. These and other parties could bring suit against us. In each case listed below where we are the defendant, we intend to vigorously defend the action.

     On October 31, 2001, the Company filed a complaint for patent infringement in the United States District Court for the Northern District of California against Memorex Products, Inc., Pretec Electronics Corporation, Ritek Corporation, and Power Quotient International Co., Ltd. In the suit, captioned SanDisk Corp. v. Memorex Products, Inc., et al., Civil Case No. CV 01 4063 VRW, the Company seeks damages and injunctions against these companies from making, selling, importing or using flash memory cards that infringe its U.S. Patent No. 5,602,987. The District Court granted summary judgment of non-infringement in favor of defendants Ritek, Pretec and Memorex and entered judgment on May 17, 2004. On June 2, 2004, the Company filed a notice of appeal of the summary judgment rulings to the United States Court of Appeals for the Federal Circuit. On July 8, 2005, the Federal Circuit held in favor of the Company, vacating the judgment of non-infringement and remanding the case back to the District Court. The District Court issued an order on claim construction on February 22, 2007. No trial date has been set for this case.

     On or about June 9, 2003, the Company received written notice from Infineon Technologies AG, or Infineon, that it believes the Company has infringed its U.S. Patent No. 5,726,601 (the ‘601 patent). On June 24, 2003, the Company filed a complaint against Infineon for a declaratory judgment of patent non-infringement and invalidity regarding the ‘601 patent in the United States District Court for the Northern District of California, captioned SanDisk Corporation v. Infineon Technologies AG, a German corporation, et al., Civil Case No. C 03 02931 BZ. On October 6, 2003, Infineon filed an answer and counterclaim: (a) denying that the Company is entitled to the declaration sought by the Company’s complaint; (b) requesting that the Company be adjudged to have infringed, actively induced and/or contributed to the infringement of the ‘601 patent and an additional patent, U.S. Patent No. 4,841,222 (the ‘222 patent). On August 12, 2004, Infineon filed an amended counterclaim for patent infringement alleging that the Company infringes U.S. Patent Nos. 6,026,002 (the ‘002 patent); 5,041,894 (the ‘894 patent); and 6,226,219 (the ‘219 patent), and omitting the ‘601 and ‘222 patents. On August 18, 2004, the Company filed an amended complaint against Infineon for a declaratory judgment of patent non-infringement and invalidity regarding the ‘002, ‘894, and ‘219 patents. On February 9, 2006, the Company filed a second amended complaint to include claims for declaratory judgment that the ‘002, ‘894 and ‘219 patents are unenforceable. On March 17, 2006, the Court granted a stipulation by the parties withdrawing all claims and counterclaims regarding the ‘002 patent. On February 20, 2007, the Court entered an order staying the case to facilitate settlement negotiations.

     On February 20, 2004, the Company and a number of other manufacturers of flash memory products were sued in the Superior Court of the State of California for the City and County of San Francisco in a purported consumer class action captioned Willem Vroegh et al. v. Dane Electric Corp. USA, et al., Civil Case No. GCG 04 428953, alleging false advertising, unfair business practices, breach of contract, fraud, deceit, misrepresentation and violation of the California Consumers Legal Remedy Act. The lawsuit purports to be on behalf of a class of purchasers of flash memory products and claims that the defendants overstated the size of the memory storage capabilities of such products. The lawsuit seeks restitution, injunction and damages in an unspecified amount. The parties have reached a settlement of the case, which is pending final court approval. In April 2006, the Court issued an order preliminarily approving the settlement. In August 2006, the Court held a hearing to consider final approval of the settlement, and on November 20, 2006, the Court issued its formal written order of approval. Two objectors to the settlement have filed separate appeals from the Court’s order granting final approval.

     On October 15, 2004, the Company filed a complaint for patent infringement and declaratory judgment of non-infringement and patent invalidity against STMicroelectronics N.V. and STMicroelectronics, Inc. (collectively, “ST”) in the United States District Court for the Northern District of California, captioned SanDisk Corporation v. STMicroelectronics, Inc., et al., Civil Case No. C 04 04379JF. The complaint alleges that ST’s products infringe one of the Company’s U.S. patents and seeks damages and an injunction. The complaint further seeks a declaratory judgment that the Company does not infringe several of ST’s U.S. patents. By order dated January 4, 2005, the court stayed the Company’s claim that ST infringes the Company’s patent pending an outcome in the ITC investigation initiated on November 15, 2004 (discussed below). On January 20, 2005, the court issued an order granting ST’s motion to dismiss the declaratory judgment causes of action. The Company has appealed this decision to the U.S. Court of Appeals for the Federal Circuit. The remainder of the case, including the Company’s infringement claim against ST, is stayed pending the outcome of the appeal.

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     On October 15, 2004, the Company filed a complaint under Section 337 of the Tariff Act of 1930 (as amended) (Case No. 337-TA 526) titled, “In the matter of certain NAND flash memory circuits and products containing same” in the United States International Trade Commission (“ITC”), naming STMicroelectronics N.V. and STMicroelectronics, Inc. (collectively, “ST”) as respondents. In the complaint, the Company alleges that ST’s NAND flash memory infringes U.S. Patent No. 5,172,338 (the ‘338 patent), and seeks an order excluding ST’s products from importation into the United States. On November 15, 2004, the ITC instituted an investigation pursuant to 19 U.S.C. § 1337 against ST in response to the Company’s complaint. On December 9, 2004, ST filed a response to the complaint, denying that they infringe the ‘338 patent and alleging that the patent is invalid and/or unenforceable. A hearing was held from August 1-8, 2005. On October 19, 2005, the Administrative Law Judge issued an initial determination confirming the validity and enforceability of the Company’s ‘338 patent by rejecting ST’s claims that the patent was invalidated by prior art. The initial determination, however, found that ST’s NAND flash memory chips did not infringe the asserted claims of the ‘338 patent. On October 31, 2005, the Company filed a petition with the ITC to review and reverse the finding of non-infringement. Also, on October 31, 2005, ST filed a petition for review with the ITC to review and reverse the finding that the patent was valid and enforceable. On December 6, 2005, the ITC issued its decision. The ITC declined to review the finding of non-infringement, and, after reviewing the finding of validity, declined to take any position on the issue of validity. The Company is appealing the ITC’s decision to the U.S. Court of Appeals for the Federal Circuit.

     On February 4, 2005, STMicro filed two complaints for patent infringement against the Company in the United States District Court for the Eastern District of Texas, captioned STMicroelectronics, Inc. v. SanDisk Corporation, Civil Case No. 4:05CV44 (the “‘44 Action”), and STMicroelectronics, Inc. v. SanDisk Corporation, Civil Case No. 4:05CV45 (the “‘45 Action”), respectively. The complaints seek damages and injunctions against certain SanDisk products. On April 22, 2005, the Company filed counterclaims on two patents against STMicroelectronics N.V. and STMicroelectronics, Inc. (collectively, “ST”) in the ‘45 Action. The counterclaims seek damages and injunctive relief against ST’s flash memory products. In the ‘44 Action, the District Court granted SanDisk’s motion for summary judgment of non-infringement on all accused products. On February 6, 2007, the District Court dismissed the ‘44 Action with prejudice, ordered that ST take nothing from the Company, and that costs be taxed against ST. ST has filed a motion to amend or correct the final judgment, but no ruling has issued. In the ‘45 Action, the parties have filed motions for summary judgment regarding various aspects of the litigation; no ruling has issued. The ‘45 Action is scheduled currently for jury selection and trial on April 16, 2007.

     On October 14, 2005, STMicroelectronics, Inc. (“STMicro”) filed a complaint against the Company and the Company’s CEO Eli Harari, in the Superior Court of the State of California for the County of Alameda, captioned STMicroelectronics, Inc. v. Harari, Case No. HG 05237216 (the “Harari Matter”). The complaint alleges that STMicro, as the successor to Wafer Scale Integration, Inc.’s (“WSI”) legal rights, has an ownership interest in several SanDisk patents that issued from applications filed by Dr. Harari, a former WSI employee. The complaint seeks the assignment or co-ownership of certain inventions and patents conceived of by Harari, including some of the patents asserted by the Company in its litigations against STMicro, as well as damages in an unspecified amount. On November 15, 2005, Harari and the Company removed the case to the U.S. District Court for the Northern District of California, where it was assigned case number C05-04691. On December 13, 2005, STMicro filed a motion to remand the case back to the Superior Court of Alameda County. The case was remanded to the Superior Court of Alameda County on July 18, 2006, after briefing and oral argument on a motion by STMicro for reconsideration of an earlier order denying STMicro’s request for remand. Due to the remand, the District Court did not rule upon a summary judgment motion previously filed by the Company. In the Superior Court of Alameda County, the Company filed a Motion to Transfer Venue to Santa Clara County on August 10, 2006, which was denied on September 12, 2006. On October 6, 2006, the Company filed a Petition for Writ of Mandate with the First District Court of Appeal which asks that the Superior Court’s September 12 Order be vacated, and the case transferred to Santa Clara County. On October 20, 2006, the Court of Appeal requested briefing on the Company’s petition for a writ of mandate and stayed the action during the pendency of the writ proceedings. On January 17, 2007, the Court of Appeal issued an alternative writ directing the Superior Court to issue a new order granting the Company’s venue transfer motion or to show cause why a writ of mandate should not issue compelling such an order. On January 23, 2007, the Superior Court of Alameda transferred the case to Santa Clara County as a result of the writ proceeding at the Court of Appeal. A Case Management Conference is scheduled for April 26, 2007. The Company also filed a special motion to strike ST’s unfair competition claim, which the Superior Court denied on September 11, 2006. The Company has appealed the denial of that motion.

     On December 6, 2005, the Company filed a complaint for patent infringement in the United States District Court for the Northern District of California against STMicroelectronics, Inc. and STMicroelectronics, NV (collectively, “ST”) (Case No. C0505021 JF). In the suit, the Company seeks damages and injunctions against ST from making, selling, importing or using flash memory chips or products that infringe the Company’s U.S. Patent No. 5,991,517 (the “‘517 patent). The case is presently stayed, pending the termination of the ITC investigation instituted February 8, 2006, discussed below.

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     On January 10, 2006, the Company filed a complaint under Section 337 of the Tariff Act of 1930 (as amended) (Case No. 337-TA-560) titled, “In the matter of certain NOR and NAND flash memory devices and products containing same” in the ITC, naming ST as respondents. In the complaint, the Company alleges that: (i) ST’s NOR flash memory infringes the “338 patent; (ii) ST’s NAND flash memory infringes U.S. Patent No. 6,542,956 (the “‘956 patent”); and (iii) ST’s NOR flash memory and NAND flash memory infringe the ‘517 patent. The complaint seeks an order excluding ST’s NOR and NAND flash memory products from importation into the United States. The ITC instituted an investigation, based on the Company’s complaint, on February 8, 2006. On March 31, 2006, ST filed a motion for partial summary determination or termination of the investigation with respect to the ‘338 patent. On May 1, 2006, the Administrative Law Judge (“ALJ”) denied ST’s motion in an initial determination that is subject to review by the ITC. On May 17, 2006, SanDisk filed a motion to voluntarily terminate the investigation with respect to the ‘956 patent. On June 1, 2006, the ALJ issued an Initial Determination granting the Company’s motion. On August 15, 2006, the ALJ set December 4, 2006 as the date for the hearing, April 4, 2007 for the Initial Determination, and August 13, 2007 as the target date for completion of the investigation. On September 12, 2006, the Company filed a motion to voluntarily terminate the investigation with respect to claims 1, 2, and 4 of the ‘517 patent. On October 10, 2006, the ALJ issued an Initial Determination granting the Company’s motion with respect to claims 2 and 4 of the ‘517 patent. On September 25, 2006, ST filed motions for summary determination of non-infringement of the ‘338 patent with respect to its current products and non-infringement of the ‘338 and ‘517 patents with respect to prospective products and of lack of domestic industry with regard to the ‘338 patent. On the same date, SanDisk filed a motion for summary determination of the economic prong of the domestic industry requirement with regard to the ‘517 patent. On November 17, 2006, the ALJ granted SanDisk’s motion for summary determination of the economic prong of domestic industry, and denied ST’s motion for summary determination of lack of domestic industry with regard to the ‘338 patent. The ALJ denied one of ST’s motions for summary determination of noninfringement of the ‘338 patent. The ALJ granted ST’s motion for summary determination with respect to ST’s binary NOR products, which SanDisk was no longer accusing, and terminated the investigation with respect to certain prospective products. On November 28, 2006, the ALJ denied ST’s second motion for summary determination of non-infringement of the ‘338 patent. The ALJ then held an evidentiary hearing from December 1, 2006 through December 15, 2006. On January 16, 2007, the ALJ extended the due date of the initial determination due to June 1, 2007.

     On or about July 15, 2005, Societa’ Italiana Per Lo Sviluppo Dell’electtronica, S.I.Sv.El., S.p.A., (“Sisvel”) filed suit against the Company and others in the district court of the Netherlands in The Hague in a case captioned Societa’ Italiana Per Lo Sviluppo Dell’electtronica, S.I.Sv.El., S.p.A. adverse to SanDisk International Sales, Moduslink B.V. and UPS SCS (Nederland) B.V., Case No. 999.131.1804 (Cause List numbers 2006/167 and 2006/168). Sisvel alleges that certain of the Company’s MP3 products infringe three European patents of which Sisvel claims to be a licensee with the right to bring suit. Sisvel seeks an injunction and unspecified damages. Sisvel has previously publicly indicated that it will license these and other patents under reasonable and nondiscriminatory terms, and it has specifically offered the Company a license under the patents. The Company has submitted its answer on the substance of Sisvel’s claim. Further pre-trial proceedings must be undertaken and a trial is unlikely in this matter until the end of 2007, at the earliest.

     In a related action, on March 9, 2006, the Company filed an action in the English High Court, Chancery Division, Patents Court, in London, against Sisvel and the owners of the patents Sisvel has asserted against the Company in the Netherlands. The case is SanDisk Corporation v. Koninklijke Philips Electronics N.V. (a Dutch corporation), France Télécom (a French corporation), Télédiffusion de France S.A. (a French corporation), Institut für Rundfunktechnik GmbH (a German corporation) and Societa’ Italiana Per Lo Sviluppo Dell’electtronica, S.I.Sv.El., S.p.A., Case No. HC 06 C 00835. In this action, the Company seeks a declaration of non-infringement of the patents asserted by Sisvel in connection with the Company’s MP3 products. The Company also seeks a declaration that the patents are not “essential” to the technology of MP3 players, as Sisvel presently contends in the case filed in the Netherlands. The defendants have submitted their formal defense and counterclaimed for infringement. The trial in this matter is expected to take place along with the trial for Case No. HC 06 C 00615 in February 2008.

     In another related action, on April 13, 2006, Audio MPEG filed a complaint alleging patent infringement in the District Court for the Eastern District of Virginia. The case is Audio MPEG v. SanDisk Corporation, Case No. 2:06cv209 WDK/JEB. Audio MPEG holds itself out to be the U.S. subsidiary of Sisvel and purports to have the right to enforce certain patents in the U.S. on subject matter related to the patents asserted by Sisvel in the Netherlands. Specifically, Audio MPEG asserts U.S. Patent No. 5,214,678 (entitled “Digital transmission system using subband coding of a digital signal”), U.S. Patent No. 5,323,396 (entitled “Digital transmission system, transmitter and receiver for use in the transmission system”), U.S. Patent No. 5,539,829 (entitled “Subband coded digital transmission system using some composite signals”), and U.S. Patent No. 5,777,992 (entitled “Decoder for decoding and encoded digital signal and a receiver comprising the decoder”). The court has issued a case management order and has indicated that the trial should be expected to take place in December 2007.

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     In another related action, on April 13, 2006, Sisvel filed suit against the Company’s subsidiary, SanDisk GmbH, for patent infringement in the Mannheim District Court in Germany, S.I.Sv.El., S.p.A. v. SanDisk GmbH, file no. 7 O 90/06, which was served on the Company on or about May 10, 2006. The plaintiffs allege that certain of the Company’s MP3 products infringe four German patents of which Sisvel claims to be a licensee with the right to bring suit. Sisvel seeks an injunction and unspecified damages. Sisvel has previously publicly stated that it will license these and other patents under reasonable and nondiscriminatory terms, and it has specifically offered the Company a license under the patents. In a first trial in September of 2006, the Mannheim court expressed reservations about Sisvel’s claim of infringement and ordered further briefing and a resumption of the trial, which was held in January 2007. The court indicated that it expects to hand down a decision in March 2007.

     In another related action, on April 13, 2006, Sisvel filed suit against the Company for patent infringement in the Mannheim District Court in Germany, S.I.Sv.El., S.p.A. v. SanDisk Corporation, file no. 7 O 89/06, which was served on the Company in or about July, 2006. The plaintiffs allege that certain of the Company’s MP3 products infringe four German patents of which Sisvel claims to be a licensee with the right to bring suit. Sisvel seeks an injunction and unspecified damages. Sisvel has previously publicly stated that it will license these and other patents under reasonable and nondiscriminatory terms, and it has specifically offered the Company a license under the patents. Both sides submitted initial pleadings and the court held a trial in January 2007. The court indicated that it expects to hand down a decision in March 2007.

     On August 7, 2006, two purported shareholder class and derivative actions, captioned Capovilla v. SanDisk Corp., No. 106 CV 068760, and Dashiell v. SanDisk Corp., No. 106 CV 068759, were filed in the Superior Court of California in Santa Clara County, California. On August 9, 2006, and August 17, 2006, respectively, two additional purported shareholder class and derivative actions, captioned Lopiccolo v. SanDisk Corp., No. 106 CV 068946, and Sachs v. SanDisk Corp., No. 1-06-CV-069534, were filed in that court. These four lawsuits were subsequently consolidated under the caption In re msystems Ltd. Shareholder Litigation, No. 106 CV 068759 and on October 27, 2006, a consolidated amended complaint was filed that supersedes the four original complaints. The lawsuit is brought by purported shareholders of msystems and names as defendants the Company and each of msystems’ directors, including its President and Chief Executive Officer, and its former Chief Financial Officer (now its Chief Operating Officer), and names msystems as a nominal defendant. The lawsuit asserts purported class action and derivative claims. The alleged derivative claims assert, among other things, breach of fiduciary duties, abuse of control, constructive fraud, corporate waste, unjust enrichment and gross mismanagement with respect to past stock option grants. The alleged class and derivative claims also assert claims for breach of fiduciary duty by msystems’ board, which the Company is alleged to have aided an abetted, with respect to allegedly inadequate consideration for the merger, and allegedly false or misleading disclosures in proxy materials relating to the merger. The complaints seek, among other things, equitable relief, including enjoining the proposed merger, and compensatory and punitive damages.

     On September 11, 2006, Mr. Rabbi, a shareholder of msystems Ltd. (“msystems”), filed a derivative action and a motion to permit him to file the derivative action against four directors of msystems and msystems, arguing that options were allegedly allocated to officers and employees of msystems in violation of applicable law. Mr. Rabbi claimed that the aforementioned actions allegedly caused damage to msystems. On October 17, 2006, msystems filed a motion to change its title in the motion to permit the filing of the derivative action from a “Formal Respondent” to a “Respondent,” and Mr. Rabbi has consented to this motion. msystems received an extension of time to file its response to the motion until March 25, 2007. On January 25, 2007, msystems filed a motion to dismiss the motion to seek leave to file the derivative action and the derivative action on the grounds, inter alia, that Mr. Rabbi ceased to be a shareholder of msystems after the merger between msystems and the Company.

     On February 20, 2007, Texas MP3 Technologies Ltd. filed suit against the Company, Samsung Electronics Co., Ltd., Samsung Electronics America, Inc. and Apple Computer, Inc., Case No. 2:07-CV-52, in the Eastern District of Texas, Marshall Division, alleging patent infringement related to MP3 players.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2006.

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PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     Market For Our Common Stock. Our common stock is traded on the NASDAQ Global Select Market under the symbol “SNDK.” The following table summarizes the high and low sale prices for our common stock as reported by the NASDAQ Global Select Market.

	High		Low
2005
First quarter	$	28.42	$	20.25
Second quarter	$	29.03	$	23.45
Third quarter	$	48.58	$	23.41
Fourth quarter	$	65.49	$	45.65
2006
First quarter	$	79.80	$	52.15
Second quarter	$	66.20	$	49.16
Third quarter	$	60.94	$	37.34
Fourth quarter	$	62.24	$	42.00

     Holders. As of January 31, 2007, we had approximately 619 stockholders of record.

     Dividends. We have never declared or paid any cash dividends on our common stock and do not expect to pay cash dividends on our common stock in the foreseeable future.

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ITEM 6. SELECTED FINANCIAL DATA

SANDISK CORPORATION SELECTED FINANCIAL DATA

	Years Ended
	December 31, 2006(1)		January 1, 2006(2)		January 2, 2005(3)		December 28, 2003(4)		December 29, 2002(5)
	(In thousands, except per share data)
Revenues
Product	$	2,926,472	$	2,066,607	$	1,602,836	$	982,341	$	492,900
License and royalty		331,053		239,462		174,219		97,460		48,373
Total revenues		3,257,525		2,306,069		1,777,055		1,079,801		541,273
Cost of revenues		2,018,052		1,333,335		1,091,350		641,189		352,452
Gross profit		1,239,473		972,734		685,705		438,612		188,821
Operating income		326,334		576,582		418,591		257,038		58,151
Net income	$	198,896	$	386,384	$	266,616	$	168,859	$	36,240
Net income per share(6)
Basic	$	1.00	$	2.11	$	1.63	$	1.17	$	0.26
Diluted	$	0.96	$	2.00	$	1.44	$	1.02	$	0.25
Shares used in per share calculations (6)
Basic		198,929		183,008		164,065		144,781		137,610
Diluted		207,451		193,016		188,837		171,616		142,460
	At
	December 31, 2006		January 1, 2006		January 2, 2005		December 28, 2003		December 29, 2002
	(In thousands)
Working capital	$	3,345,414	$	2,004,598	$	1,526,674	$	1,378,070	$	584,450
Total assets		6,967,783		3,120,187		2,320,180		2,040,156		980,725
Long-term convertible notes		1,225,000		—		—		150,000		150,000
Total stockholders’ equity	$	4,768,134	$	2,523,791	$	1,940,150	$	1,515,872	$	634,867

(1)	Includes IPR&D charges of ($225.6) million related to acquisitions of Matrix in January 2006 and msystems in November 2006, share-based compensation of ($100.6) million and amortization of acquisition-related intangible assets of ($27.8) million.
(2)	Includes other-than-temporary impairment charges of ($10.1) million, or ($6.4) million net of tax related to our investment in Tower.
(3)	Includes other-than-temporary impairment charges of ($11.8) million, or ($7.4) million net of tax related to our investment in Tower, and a gain from a settlement of $6.2 million, or $3.9 million net of tax, from a third-party brokerage firm related to the fiscal 2003 unauthorized disposition of our investment in UMC.
(4)	Includes a loss of approximately ($18.3) million, or ($12.8) million net of tax, as a result of the unauthorized sale of approximately 127.8 million shares of UMC stock, a gain of approximately $7.0 million, or $4.9 million net of tax, related to the sale of 35 million shares of UMC stock, write-downs related to the recoverability of our Tower wafer credits of ($3.9) million, or ($2.7) million net of tax.
(5)	Includes other-than-temporary impairment charges of ($14.4) million on our Tower shares, or ($8.7) million net of tax, write-downs related to the recoverability of our Tower wafer credits of ($2.8) million, or ($1.8) million net of tax.
(6)	Net income per share and the share numbers each gives retroactive effect to a 2-for-1 stock split, in the form of a 100% stock dividend, effected on February 18, 2004.

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ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

	Years Ended
			% of					% of					% of
	December 31, 2006		Revenue			January 1, 2006		Revenue			January 2, 2005		Revenue
	(in thousands, except percentages)
Product revenues	$	2,926,472		89.8	%	$	2,066,607		89.6	%	$	1,602,836		90.2	%
License and royalty revenues		331,053		10.2	%		239,462		10.4	%		174,219		9.8	%
Total revenues		3,257,525		100.0	%		2,306,069		100.0	%		1,777,055		100.0	%
Cost of product revenues		2,018,052		62.0	%		1,333,335		57.8	%		1,091,350		61.4	%
Gross profit		1,239,473		38.0	%		972,734		42.2	%		685,705		38.6	%
Operating expenses
Research and development		306,866		9.4	%		194,810		8.5	%		124,994		7.0	%
Sales and marketing		203,406		6.3	%		122,232		5.3	%		91,296		5.1	%
General and administrative		159,835		4.9	%		79,110		3.4	%		50,824		2.9	%
Write-off of acquired in-process technology		225,600		6.9	%		—		—			—		—
Amortization of acquisition-related intangible assets		17,432		0.5	%		—		—			—		—
Total operating expenses		913,139		28.0	%		396,152		17.2	%		267,114		15.0	%
Operating income		326,334		10.0	%		576,582		25.0	%		418,591		23.6	%
Other income, net		104,374		3.2	%		36,725		1.6	%		4,609		0.2	%
Income before taxes		430,708		13.2	%		613,307		26.6	%		423,200		23.8	%
Provision for income taxes		230,193		7.1	%		226,923		9.8	%		156,584		8.8	%
Minority interest		1,619		—			—		—			—		—
Net income	$	198,896		6.1	%	$	386,384		16.8	%	$	266,616		15.0	%

General

     We are one of the world’s largest suppliers of NAND flash-based data storage products for the consumer, mobile communications, and industrial markets. Our mission is to be the preferred choice of personal storage solutions for the worldwide digital economy. We seek to achieve our mission by developing leading technologies and innovative products and delivering our products through both OEM and retail channels.

     We design, develop, market and manufacture products and solutions in a variety of form factors using our flash memory, controller, and firmware technologies. Our products are used in a wide range of consumer electronics devices such as digital cameras, mobile phones, USB drives, gaming consoles, MP3 players and other digital devices. Our products are also embedded in a variety of systems for the enterprise, industrial, military and other markets. Flash storage technology allows data to be stored in a low-power consumption, durable and compact format that retains the data after the power has been turned off.

     As a supplier to this industry, our results are primarily driven by worldwide demand for flash storage devices, which in turn depends on end-user demand for electronic products. We believe the market for flash storage has price elasticity of demand. We expect that as we reduce the price of our flash devices, consumers will demand an increasing number of megabytes of memory. In order to profitably capitalize on price elasticity of demand in the market for flash storage products, we must reduce our cost per megabyte at a rate similar to the change in selling price per megabyte to the consumer. We seek to achieve these cost reductions through technology improvements primarily focused on increasing the amount of memory stored in a given area of silicon.

     In January 2006, we acquired Matrix, a designer and developer of three-dimensional (3-D) integrated circuits. Matrix^® 3-D Memory is used for one-time programmable storage applications that complement our existing flash storage memory products.

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Matrix 3-D Memory is used for storage applications that do not require rewriteable memory and where low cost is the paramount consideration, such as video games, music and other content, or for archiving. The acquisition of Matrix resulted in a $39.6 million write-off of in-process acquired technology during the first quarter of fiscal 2006.

     In May 2006, we issued and sold $1.15 billion in aggregate principal amount of 1% Convertible Senior Notes due 2013 (the “1% Notes due 2013”). The 1% Notes due 2013 were issued at par and pay interest at a rate of 1% per annum. The 1% Notes due 2013 may be converted into our common stock, under certain circumstances, based on an initial conversion rate of 12.1426 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $82.36 per share). The conversion price will be subject to adjustment in some events but will not be adjusted for accrued interest. The net proceeds to us from the offering of the 1% Notes due 2013 were $1.13 billion. Concurrently with the issuance of the 1% Notes due 2013, we purchased a convertible bond hedge and sold warrants. The separate convertible bond hedge and warrant transactions are structured to reduce the potential future economic dilution associated with the conversion of the 1% Notes due 2013 and to increase the initial conversion price to $95.03 per share. Net proceeds from this offering will be used for general corporate purposes, including capital expenditures for new and existing manufacturing facilities, development of new technologies, general working capital and other non-manufacturing capital expenditures. The net proceeds may also be used to fund strategic investments or acquisitions of products, technologies or complementary businesses or obtain the right or license to use additional technologies.

     On July 7, 2006, we and Toshiba Corporation, or Toshiba, entered into a business venture, Flash Alliance, to build Fab 4, a new advanced 300-millimeter wafer fabrication facility at Toshiba’s Yokkaichi, Japan operations, to meet the anticipated growing demand for NAND flash memory in 2008 and beyond. We own 49.9% and Toshiba owns 50.1% of Flash Alliance. Both we and Toshiba will collaborate in the development and manufacture of NAND flash memory products. These NAND flash memory products will be manufactured by Toshiba at Fab 4 using semiconductor manufacturing equipment owned or leased by Flash Alliance. Flash Alliance will purchase wafers from Toshiba at cost and then resell those wafers to us and Toshiba at cost plus a markup. We account for our 49.9% ownership position in Flash Alliance under the equity method of accounting. We are committed to purchase half of Flash Alliance’s NAND wafer supply. See “- Toshiba Ventures.”

     Beginning in the first quarter of fiscal 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123(R), or SFAS 123(R), Share Based Payments, using the modified-prospective transition method. Under that transition method, compensation cost recognized on a straight-line basis, in the year ended December 31, 2006 included the following: (a) compensation cost based on the grant date fair value related to any share-based awards granted through, but not yet vested as of January 1, 2006, and (b) compensation cost for any share-based awards granted on or subsequent to January 2, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). As a result of adopting SFAS 123(R), we recognized share-based compensation expense of $100.6 million during the year ended December 31, 2006, which affected our reported cost of sales, research and development, selling and marketing and general and administrative expenses. In addition, at December 31, 2006, we capitalized to inventory $3.2 million of compensation cost for share-based awards that were issued to manufacturing personnel. We calculate this share-based compensation expense based on the fair values of the share-based compensation awards as estimated using the Black-Scholes-Merton closed-form option valuation model. As of December 31, 2006, total unrecognized compensation expense related to unvested share-based compensation arrangements already granted under our various plans was $260.1 million, which we expect to recognize over a weighted-average period of 2.7 years.

     On November 19, 2006, we acquired msystems Ltd., or msystems. msystems designs, develops and markets innovative flash data storage solutions for digital consumer electronics markets. msystems primarily targets two digital consumer electronics markets: the mobile phone market and the USB flash drive market. msystems also sells flash data storage products targeted at the embedded systems market. The acquisition of msystems resulted in a $186.0 million write-off of in-process acquired technology during the fourth quarter of fiscal 2006.

     On November 30, 2006, we assumed through our acquisition of msystems, $75.0 million in aggregate principal amount of 1% Convertible Notes due 2035, or the “1% Notes due 2035.” The 1% Notes due 2035 pay interest at a rate of 1% per annum. The 1% Notes due 2035 may be converted into our common stock, under certain circumstances, based on an initial conversion rate of 26.8302 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $37.27 per share). The conversion price will be subject to adjustment in certain events but will not be adjusted for accrued interest.

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Critical Accounting Policies & Estimates

     Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an ongoing basis, we evaluate our estimates, including, among others, those related to customer programs and incentives, product returns, bad debts, inventories and related reserves, investments, income taxes, warranty obligations, stock compensation, contingencies and litigation. We base our estimates on historical experience and on other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for our judgments about the carrying values of assets and liabilities when those values are not readily apparent from other sources. Estimates have historically approximated actual results. However, future results will differ from these estimates under different assumptions and conditions.

     Revenue Recognition, Sales Returns and Allowances and Sales Incentive Programs. We recognize net revenues when the earnings process is complete, as evidenced by an agreement with the customer, transfer of title and acceptance, if applicable, fixed pricing and reasonable assurance of realization. Sales made to distributors and retailers are generally under agreements allowing price protection and/or right of return and, therefore, the sales and related costs of these transactions are deferred until the retailers or distributors sell the merchandise to their end customer, or the rights of return expire. At December 31, 2006 and January 1, 2006, deferred income, from sales to distributors and retailers was $312.9 million and $139.9 million, respectively. Estimated sales returns are provided for as a reduction to product revenue and deferred revenue and were not material for any period presented in our consolidated financial statements.

     We record estimated reductions to revenue or to deferred revenue for customer and distributor incentive programs and offerings, including price protection, promotions, co-op advertising, and other volume-based incentives and expected returns. Additionally, we have incentive programs that require us to estimate, based on historical experience, the number of customers who will actually redeem the incentive. All sales incentive programs are recorded as an offset to product revenues or deferred revenues. In the past, actual returns and rebates have not been significantly different from our estimates. However, actual returns and rebates in any future period could differ from our estimates, which could impact the net revenue we report.

     Inventories and Inventory Valuation. Inventories are stated at the lower of cost (first-in, first-out) or market. Market value is based upon an estimated average selling price reduced by estimated costs of disposal. The determination of market value involves numerous judgments including estimating average selling prices based upon recent sales volumes, industry trends, existing customer orders, current contract prices, industry analysis of supply and demand and seasonal factors. Should actual market conditions differ from our estimates, our future results of operations could be materially affected. The valuation of inventory also requires us to estimate obsolete or excess inventory. The determination of obsolete or excess inventory requires us to estimate the future demand for our products within specific time horizons, generally six to twelve months. To the extent our demand forecast for specific products is less than our product on hand and our noncancelable orders, we could be required to record additional inventory reserves, which would have a negative impact on our gross margin.

     Accounting for Investments. We evaluate whether entities in which we have invested are variable interest entities within the definition of the Financial Accounting Standards Board Interpretation No. 46R, or FIN 46R, Accounting for Variable Interest Entities. If those entities are variable interest entities, then we determine whether we are the primary beneficiary of that entity by reference to our contractual and business arrangements with respect to residual gains and residual losses on liquidation of that entity.

     With respect to all equity investments, we review the degree of control that our investment and other arrangements give us over the entity we have invested in. Generally, after considering all factors, if we hold equity interests representing less than 20% of the outstanding voting interests of an entity we invested in, we use the cost method of accounting. If we hold at least 20% but less than a majority of the outstanding voting interests of an entity we invested in, we use the equity method of accounting.

     We have the financial capability and the intent to hold our loans to the ventures with Toshiba until maturity and accordingly those loans are carried at cost and their value in our financial statements is not adjusted to market value. Changes in our intent could materially impact our financial statements.

40

     Deferred Tax Assets. We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.

     We must assess the likelihood that we will be able to recover our deferred tax assets. We consider historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We carried a valuation allowance on our deferred tax assets of $60.1 million and $14.9 million at December 31, 2006 and January 1, 2006, respectively, based on our view that it is more likely than not that we will not be able to take tax a benefit for certain net operating loss carryforwards, certain capitalized expenses and certain unrealized capital losses on our investments in foundries.

     Share-Based Compensation — Employee Incentive Plans and Employee Stock Purchase Plans. Beginning on January 2, 2006, we began accounting for stock awards and ESPP shares under the provisions of Statement of Financial Accounting Standards No. 123(R), or SFAS 123(R), Share-Based Payments, which requires the recognition of the fair value of share-based compensation. The fair value of stock awards and ESPP shares was estimated using a Black-Scholes-Merton closed-form option valuation model. This model requires the input of assumptions in implementing SFAS 123(R), including expected stock price volatility, expected term and estimated forfeitures of each award. The parameters used in the model are reviewed and adjusted on a quarterly basis. We elected the modified-prospective method for adoption of SFAS 123(R). We recognized compensation expense for the fair values of these awards, which have graded vesting, on a straight-line basis over the requisite service period of each of these awards, net of estimated forfeitures at a rate of 7.74%. We make quarterly assessments of the adequacy of the APIC credit pool generated by previous share-based excess tax benefits to determine if there are any tax deficiencies which require recognition in the condensed consolidated statements of income. Prior to the implementation of SFAS 123(R), we accounted for stock awards and ESPP shares under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and made pro forma footnote disclosures as required by Statement of Financial Accounting Standards No. 148, or SFAS 148, Accounting For Stock-Based Compensation — Transition and Disclosure, which amended Statement of Financial Accounting Standards No. 123, Accounting For Stock-Based Compensation. Pro forma net income and pro forma net income per share disclosed in the footnotes to the consolidated condensed financial statements were estimated using a Black-Scholes-Merton closed-form option valuation model to determine the estimated fair value and by attributing such fair value over the requisite service period on a straight-line basis for those awards that actually vested. The fair value of restricted stock units was calculated based upon the fair market value of our common stock on the date of grant.

     Business Combinations. In accordance with the provisions of Statement of Financial Accounting Standard No. 141, or SFAS 141, Business Combinations, we allocate the purchase price of acquired companies to the tangible and intangible assets acquired, liabilities assumed, and in-process research and development based on their estimated fair values. We engage third-party appraisal firms to assist management in determining the fair values of certain assets acquired and liabilities assumed. Such a valuation requires management to make significant estimates and assumptions, especially with respect to intangible assets.

     Management makes estimates of fair value based upon assumptions believed to be reasonable. These estimates are based on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Critical estimates in valuing certain of the intangible assets include but are not limited to future expected cash flows from product sales, customer relationships and acquired developed technologies and patents, expected costs to develop the in-process research and development into commercially viable products and estimated cash flows from the projects when completed, as well as assumptions about the expected life of the core technology and discount rates. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results.

41

Results of Operations

     Product Revenues.

			Percent					Percent
	FY 2006		Change			FY 2005		Change			FY 2004
			(in millions, except percentages)
Retail	$	1,975.4		22	%	$	1,621.0		31	%	$	1,236.0
OEM		951.0		113	%		445.6		21	%		366.8
Product revenues	$	2,926.4		42	%	$	2,066.6		29	%	$	1,602.8

     The increase in our 2006 product revenues was comprised of a 246% increase in the number of megabytes sold, partially offset by a 59% reduction in our average selling price per megabyte. The markets that we sell to have experienced price elasticity of demand. In 2006, as the price per megabyte decreased, the average memory density of our products sold increased by 67%. Our unit sales also increased by 106% with the growth in our unit sales primarily attributable to growth in sales of cards for mobile phones and flash-based digital audio players. OEM revenues particularly benefited from higher sales of mobile cards to mobile phone manufacturers, 3-D gaming cards and from our acquisition of msystems, which accounted for an additional $115 million of revenue. Retail revenue growth benefited primarily from higher sales of mobile cards, flash-based digital audio players and USB flash drives. We expect to continue to reduce our price per megabyte, including price reductions already initiated in 2007, as a result of competitive pressures, industry supply and demand, as well as technology advances.

     The increase in our 2005 product revenues consisted of a 166% increase in the number of megabytes sold and partially offset by a 52% reduction in our average selling price per megabyte. In 2005, as the price per megabyte came down, the average memory density of our products sold increased by 115%. Our unit sales also increased by 23% with the growth in our unit sales primarily attributable to growth in the markets for mobile cards for camera-phones and music-centric phones, USB flash drives and flash-based digital audio players. Partially offsetting the 2005 growth in revenues was the fact that fiscal 2005 consisted of 52 weeks as compared to 53 weeks in the prior year.

     Geographical Product Revenues.

	FY 2006					FY 2005					FY 2004
			Percent					Percent					Percent
	Revenue		of Total			Revenue		of Total			Revenue		of Total
			(in millions, except percentages)
North America	$	1,298.6		44	%	$	1,049.6		51	%	$	768.1		48	%
Japan		194.0		7	%		104.4		5	%		165.4		10	%
EMEA		728.4		25	%		501.0		24	%		420.6		26	%
Other foreign countries		705.4		24	%		411.6		20	%		248.7		16	%
Product revenues	$	2,926.4		100	%	$	2,066.6		100	%	$	1,602.8		100	%

     In 2006, on an absolute basis, revenues in all regions increased year-over-year. Revenue from other foreign countries, which is primarily Asia, increased the most, primarily reflecting increased sales to mobile phone manufacturers and their related contract manufacturers. Sales in Japan increased primarily from higher sales of 3-D gaming cards from our acquisition of Matrix. The increase in sales in North America was due primarily to sales of our flash-based digital audio players, sales of cards for mobile phones and USB drives.

     In 2005, our revenue from Japan primarily reflects the reduction in the sales of flash memory cards to digital camera OEMs based in Japan to the transition of after market sales of flash memory cards primarily in North America and EMEA.

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     License and Royalty Revenues.

	FY 2006			Percent Change			FY 2005			Percent Change			FY 2004
				(in millions, except percentages)
License and royalty revenues	$	331.1			38	%	$	239.5			37	%	$	174.2
The increase in our 2006 license and royalty revenues was primarily due to increased royalty-bearing sales by our licensees.
The increase in our 2005 license and royalty revenues was primarily due to increased royalty-bearing sales by our licensees.
Gross Margins.
	FY 2006			Percent Change			FY 2005			Percent Change			FY 2004
				(in millions, except percentages)
Product gross margins	$	908.4			24	%	$	733.3			43	%	$	511.5
Product gross margins (as a percent of product revenue)		31.0	%					35.5	%					31.9	%
Total gross margins (as a percent of total revenue)		38.0	%					42.2	%					38.6	%
The 2006 product gross margin decreased from 2005 to 2006 by 4.5 percentage points. Approximately 2.9 percentage points of the gross margin decline was due to average selling prices declining at a faster rate than our product cost. In addition, our margins were negatively impacted by approximately 0.8% due to the acquisition of msystems, whose business in the fourth quarter was primarily based on non-captive memory supply. In addition, cost of product increased due to amortization of acquisition-related intangible assets of $27.8 million and share-based compensation expense related to implementation of FAS 123(R) of $8.0 million, which combined accounted for approximately 0.8% of the decrease in the product gross margins over 2005.
The largest driver of the 2005 increase in product gross margins was the reduction in our cost per megabyte due to the transition to 90-nanometer technology partially offset by decreases in our average selling price per megabyte. Fiscal 2005 gross margins were also benefited due to more production supply coming from captive sources which have lower costs.
Research and Development.
	FY 2006			Percent Change			FY 2005			Percent Change			FY 2004
				(in millions, except percentages)
Research and development	$	306.9			58	%	$	194.8			56	%	$	125.0
Percent of revenue		9.4	%					8.4	%					7.0	%

     Our 2006 research and development expense growth was primarily due to an increase in payroll, payroll-related expenses and facility related expenses of approximately $57 million associated with headcount growth. Share-based compensation expense related to implementation of FAS 123(R) accounted for $41.0 million of the research and development expense growth. In addition, research and development expense growth included initial design and development of 56-nanometer technology.

     Our 2005 research and development expense growth was primarily due to higher vendor engineering costs and costs associated with the initial design and development of manufacturing process technology related to Flash Partners’ 300-millimeter production line of $42.4 million, and payroll and payroll-related expenses of $15.6 million associated with headcount increases related to developing new products.

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     Sales and Marketing.

	FY 2006			Percent Change			FY 2005			Percent Change			FY 2004
				(in millions, except percentages)
Sales and marketing	$	203.4			66	%	$	122.2			34	%	$	91.3
Percent of revenue		6.2	%					5.3	%					5.1	%

     Our 2006 sales and marketing expense growth was primarily related to increased payroll and payroll-related expenses of approximately $22 million associated with headcount growth, share-based compensation expense related to implementation of FAS 123(R) of $21.6 million, increased merchandising on a worldwide basis of approximately $17 million and increased marketing efforts, all in support of our higher revenue base.

     Our 2005 sales and marketing expense growth was primarily related to increased tradeshow, advertising and branding on a worldwide basis of $15.5 million, and payroll and payroll-related expenses of $7.3 million, all in support of our higher revenue base.

     General and Administrative.

	FY 2006			Percent Change			FY 2005			Percent Change			FY 2004
				(in millions, except percentages)
General and administrative	$	159.8			102	%	$	79.1			56	%	$	50.8
Percent of revenue		4.9	%					3.4	%					2.9	%

     Our 2006 general and administrative expense increases were primarily related to increased payroll and payroll-related expenses of approximately $22 million associated with headcount increases, share-based compensation expense related to implementation of FAS 123(R) of $30.0 million, higher legal expenses associated with litigation to defend our intellectual property and consulting expenses related to our acquisition of Matrix and msystems.

     Our 2005 general and administrative expense growth was primarily related to increased legal expenses associated with litigation to defend our intellectual property of $17.3 million, increased payroll and payroll related expenses of $6.0 million and consulting expenses of $5.0 million to support our expanded business. Our 2005 general and administrative expenses also included significant consulting expenses associated with establishing new legal entities and modifying our corporate organization to reflect our global business.

     Write-off of Acquired In-process Technology.

	FY 2006			Percent Change		FY 2005		Percent Change		FY 2004
				(in millions, except percentages)
Write-off of acquired in-process technology	$	225.6			—		n/a		—		n/a
Percent of revenue		6.9	%		—		n/a		—		n/a

     As part of the Matrix and msystems acquisitions, a portion of the purchase price was allocated to acquired in-process technology, which was determined through established valuation techniques in the high-technology industry and written-off at the date of acquisition in the first quarter and fourth quarter of fiscal 2006 because technological feasibility had not been established and no alternative future uses existed. The value was determined by estimating the net cash flows and discounting forecasted net cash flows to their present values. As of December 31, 2006, it was estimated that these in-process projects would be completed over the next one to three years at an estimated total cost of approximately $27 million. See Note 10, “Business Acquisitions,” to our consolidated financial statements included in Item 8 of this report.

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     Amortization of Acquisition-Related Intangible Assets.

	FY 2006			Percent Change			FY 2005			Percent Change			FY 2004
				(in millions, except percentages)
Amortization of acquisition-related intangible assets	$	17.4			—			n/a			—			n/a
Percent of revenue		0.5	%		—			n/a			—			n/a
Our expense from the amortization of acquisition-related intangible assets for the year ended December 31, 2006 was directly related to our acquisition of Matrix in January 2006 and msystems in November 2006. See Note 10, “Business Acquisitions,” to our consolidated financial statements included in Item 8 of this report.
Other Income.
	FY 2006			Percent Change			FY 2005			Percent Change			FY 2004
				(in millions, except percentages)
Equity in income of business ventures	$	0.5			25	%	$	0.4			(20	)%	$	0.5
Interest income		101.1			136	%		42.8			110	%		20.4
Interest expense		(10.6	)		1667	%		(0.6	)		(90	)%		(5.9	)
Gain (loss) in investment in foundries		6.1			(174	)%		(8.2	)		(36	)%		(12.9	)
Recovery on unauthorized sale of UMC shares		—			—			—			—			6.2
Other income (loss), net		7.3			217	%		2.3			(162	)%		(3.7	)
Total other income, net	$	104.4			184	%	$	36.7			698	%	$	4.6
Other income for 2006 was comprised primarily of interest income of $101.1 million offset by interest expense of ($10.6) million resulting from our $1.15 billion debt offering in May 2006. See Note 7, “Financing Arrangements,” to our consolidated financial statements included in Item 8 of this report.
Other income for 2005 was comprised of interest income of $42.8 million, an other-than-temporary reduction in the value of our investment in Tower of ($10.1) million and other items of $4.0 million.
Provision for Income Taxes.
							FY 2006			FY 2005			FY 2004
Provision for Income Taxes								53.5	%		37.0	%		37.0	%

     Our fiscal 2006 tax rate differs from the statutory rate primarily due to state tax expense, net of federal benefit, nondeductible stock option compensation adjustments recorded under FAS 123(R), in-process R&D write-offs, tax exempt interest income and foreign income at other than U.S. tax rates. The 2006 tax rate increased over prior year primarily due to nondeductible stock option compensation adjustments recorded under FAS 123(R), in-process R&D write-offs, partially offset by increases in tax exempt interest income and foreign income at other than U.S. tax rates. Our fiscal 2005 and fiscal 2004 tax rates differ from the statutory rate primarily due to state tax expense, net of federal benefit. Our future tax rate may be impacted by state taxes, our ability to realize tax benefits from capital losses, our ability to obtain tax concessions from certain tax jurisdictions, and the geographic mix of our earnings.

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Liquidity and Capital Resources

     Cash Flows. Operating activities generated $598.1 million of cash during the fiscal year ended December 31, 2006. The primary sources of operating cash flow for the fiscal year ended December 31, 2006 were: (1) net income, adjusted to exclude the effect of non-cash charges including depreciation, amortization, share-based compensation and write-off of acquired in-process technology, which were partially offset by lower deferred taxes and gain on investment in foundries, and (2) increases in accounts payable to related parties and other liabilities, which were partially offset by increases in accounts receivables, inventory and other assets and decreases in accounts payable trade.

     Operating activities generated $480.9 million of cash during the fiscal year ended January 1, 2006. Significant contributors to the generation of cash from operations were net income of $386.4 million, non-cash adjustments to income for depreciation and amortization of $65.8 million, loss on investment in Tower of $10.1 million, foreign currency revaluation of FlashVision notes receivable of $7.7 million, amortization/accretion related to original premium/discount on short-term investments of $2.6 million, decreases in income tax receivable of $64.2 million, increases in accounts payable of $148.2 million, increases in related-party liabilities of $24.7 million, accrued payroll and related expenses of $13.8 million, deferred income of $57.2 million and current and non-current other accrued liabilities of $6.9 million. These were partially offset by increases in the inventory balance of $135.2 million, accounts receivable of $134.2 million, other current and non-current assets of $31.1 million, wafer cost adjustments of $2.3 million and deferred taxes of $1.5 million.

     We used $978.1 million for investing activities during the fiscal year ended December 31, 2006. Purchases of short and long-term investments, net of proceeds from sales and maturities of short-term investments, totaled $638.9 million. Capital expenditures totaling $176.5 million and investments and notes to the flash ventures of $204.1 million, net of repayments was partially offset by cash acquired of $51.8 million as a result of our acquisition of Matrix and msystems.

     We used $299.5 million for investing activities during the fiscal year ended January 1, 2006. We increased our short-term investment balance by $81.0 million, loaned $34.2 million to FlashVision, invested $21.8 million in Flash Partners, loaned $20.0 million to Matrix, purchased $39.1 million of semiconductor wafer manufacturing equipment to be used at Toshiba’s Yokkaichi, Japan operations, purchased $95.4 million of test equipment and $3.5 million of investment in foundries and acquired a technology license for $4.5 million.

     We generated $1.20 billion of cash from financing activities due to $1.13 billion of cash from the issuance of the 1% Convertible Senior Notes, net of issuance costs, partially offset by the purchase of the convertible bond hedge of $386.1 million. We received $308.7 million from the issuance of warrants and $96.3 million from exercises of share-based awards. Additionally, we received a tax benefit of $61.5 million on employee stock programs during the fiscal year ended December 31, 2006.

     We generated $115.4 million of cash from exercises of stock options and sales under our employee stock purchase plan during the fiscal year ended January 1, 2006.

     Liquid Assets. At December 31, 2006, we had cash, cash equivalents and short-term investments of $2.81 billion.

     Short-Term Liquidity. As of December 31, 2006, our working capital balance was $3.3 billion. We do not expect any liquidity constraints over the next twelve months. We currently expect our total investments, loans, expenditures and guarantees over the next 12 months to be approximately $1.4 billion. Of this amount, we expect to loan, make investments or guarantee future operating leases for fab expansion of approximately $1.1 billion and expect to spend approximately $300 million on property and equipment. The additions for property and equipment includes assembly, test and engineering equipment, information systems as well as equipment and the continued construction of a captive assembly and test manufacturing facility in Shanghai, China. The anticipated expenditure for this China project over the next 12 months is approximately $150 million of the total property and equipment expenditure and is subject to approval by the Chinese government.

     In December 2006, we announced that our Board of Directors authorized a stock repurchase program under which we intend to acquire up to $300 million of our outstanding common stock in the open market over the next two years. Under this program, share purchases may be made from time-to-time in the open market at our discretion. The stock repurchase program does not obligate us to purchase any particular amount of shares and the plan may be suspended at our discretion. As of February 15, 2007, we have repurchased $0.4 million of shares.

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     On February 15, 2007, our Board of Directors approved a plan, or Plan, to reduce operating costs, which includes a worldwide reduction in force of up to 10% of our headcount, or approximately 250 employees. We expect to incur a restructuring charge in connection with the Plan in the range of $15 million to $20 million, with the majority of the expense occurring in the first quarter of 2007. Cash payments associated with the Plan will be approximately half of the total restructuring charge, with the remainder comprised of share-based compensation charges resulting primarily from acceleration of certain equity awards as per terms of the msystems acquisition. The workforce reduction will impact functions related to operations, engineering, sales and marketing and administration and will primarily be based in the United States and Israel, and to a lesser degree, other international locations. The Plan is expected to be completed by the third quarter of fiscal 2007. Total annualized operating cash cost savings related to the reduction-in-force and other cost saving measures, excluding severance costs, are expected to be approximately $30 million to $35 million, including cash savings from the reduction-in-force of approximately $20 million to $25 million. In addition, the reduction-in-force is expected to result in a decrease in share-based compensation expense of approximately $10 million on an annualized basis.

     Long-Term Requirements. Depending on the demand for our products, we may decide to make additional investments, which could be substantial, in wafer fabrication foundry capacity and assembly and test manufacturing equipment to support our business in the future. We may also make equity investments in other companies or engage in merger or acquisition transactions. These additional investments or acquisitions may require us to raise additional financing, which could be difficult to obtain, and which if not obtained in satisfactory amounts may prevent us from funding the ventures with Toshiba, increasing our wafer supply, developing or enhancing our products, taking advantage of future opportunities, growing our business or responding to competitive pressures or unanticipated industry changes, any of which could harm our business.

     Financing Arrangements. In May 2006, we issued and sold $1.15 billion in aggregate principal amount of 1% Notes due 2013. The 1% Notes were issued at par and pay interest at a rate of 1% per annum. The 1% Notes may be converted into our common stock, under certain circumstances, based on an initial conversion rate of 12.1426 shares per $1,000 principal amount of notes (which represents an initial conversion price of approximately $82.36 per share). The conversion price will be subject to adjustment in some events but will not be adjusted for accrued interest. The net proceeds to us from the offering of the 1% Notes were $1.13 billion.

     Concurrently with the issuance of the 1% Notes, we purchased a convertible bond hedge and sold warrants. The separate convertible bond hedge and warrant transactions are structured to reduce the potential future economic dilution associated with the conversion of the 1% Notes and to increase the initial conversion price to $95.03 per share. Each of these components are discussed separately below:

• Convertible Bond Hedge. Counterparties agreed to sell to us up to approximately 14.0 million shares of our common stock, which is the number of shares initially issuable upon conversion of the 1% Notes in full, at a price of $82.36 per share. The convertible bond hedge transaction will be settled in net shares and will terminate upon the earlier of the maturity date of the 1% Notes or the first day none of the 1% Notes remain outstanding due to conversion or otherwise. Settlement of the convertible bond hedge in net shares on the expiration date would result in us receiving net shares equivalent to the number of shares issuable by us upon conversion of the 1% Notes. Should there be an early unwind of the convertible bond hedge transaction, the number of net shares potentially received by us will depend upon 1) the then existing overall market conditions, 2) our stock price, 3) the volatility of our stock, and 4) the amount of time remaining before expiration of the convertible bond hedge. The convertible bond hedge transaction cost of $386.1 million has been accounted for as an equity transaction in accordance with Emerging Issues Task Force No. 00-19, or EITF 00-19, Accounting for Derivative Financial Statements Indexed to, and Potentially Settled in, a Company’s Own Stock. We recorded a tax benefit of approximately $145.6 million in stockholders’ equity from the deferred tax assets related to the convertible bond hedge.

• Sold Warrants. We received $308.7 million from the same counterparties from the sale of warrants to purchase up to approximately 14.0 million shares of our common stock at an exercise price of $95.03 per share. As of December 31, 2006, the warrants have an expected life of approximately 6.5 years and expire in August 2013. At expiration, we may, at our option, elect to settle the warrants on a net share basis. As December 31, 2006, the warrants had not been exercised and remained outstanding. The value of the warrants has been classified as equity because they meet all the equity classification criteria of EITF 00-19.

     On November 30, 2006, we assumed through our acquisition of msystems, their $75 million in aggregate principal amount of 1% Convertible Senior Notes due 2035, or the 1% Notes due 2035. The 1% Notes due 2035, pay interest at a rate of 1% per

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annum. The 1% Notes due 2035 may be converted into our common stock, under certain circumstances, based on an initial conversion rate of 26.8302 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $37.27 per share). The conversion price will be subject to adjustment in some events but will not be adjusted for accrued interest.

     Toshiba Ventures. We are a 49.9% percent owner in, FlashVision, Flash Partners and Flash Alliance, our business ventures with Toshiba to develop and manufacture NAND flash memory products. These NAND flash memory products are manufactured by Toshiba at Toshiba’s Yokkaichi, Japan operations using the semiconductor manufacturing equipment owned or leased by FlashVision or Flash Partners or to be owned or leased by Flash Alliance. This equipment is funded or will be funded by investments in or loans to the ventures from us and Toshiba. FlashVision and Flash Partners purchase and Flash Alliance will purchase wafers from Toshiba at cost and then resell those wafers to us and Toshiba at cost plus a markup. We are contractually obligated to purchase half of FlashVision’s, Flash Partners’ and, when operational, Flash Alliance’s NAND wafer supply. We cannot estimate the total amount of our wafer purchase commitment as of December 31, 2006 because our price is determined by reference to the future cost to produce the semiconductor wafers. In addition to the semiconductor assets owned or leased by FlashVision and Flash Partners, we directly own certain semiconductor manufacturing equipment in Toshiba’s Yokkaichi, Japan operations from which we receive 100% of the output. From time-to-time, we and Toshiba mutually approve increases in the wafer supply capacity of Flash Partners that may contractually obligate us to increase capital funding. Our direct research and development contribution is based on a variable computation. We and Toshiba each pay the cost of our own design teams and 50% of the wafer processing and similar costs associated with this direct design and development of flash memory. We account for our 49.9% ownership position in the flash ventures under the equity method of accounting. Toshiba owns 50.1% of each of these ventures.

     The cost of the wafers we purchase from FlashVision and Flash Partners and wafers we will purchase from Flash Alliance is recorded in inventory and ultimately cost of sales. FlashVision, Flash Partners and Flash Alliance are variable interest entities and we are not the primary beneficiary of these ventures because we are entitled to less than a majority of any residual gains and are obligated with respect to less than a majority of residual losses with respect to each venture. Accordingly, we account for our investments under the equity method and do not consolidate. Our share of the net income or loss of FlashVision, Flash Partners and Flash Alliance is included in our Consolidated Statements of Income as “Equity in income of business ventures.”

     Under the FlashVision, Flash Partners and Flash Alliance agreements, we agreed to share in Toshiba’s costs associated with NAND product development and its common semiconductor research and development activities. As of December 31, 2006, we had accrued liabilities related to those expenses of $5.9 million. Our common research and development obligation related to FlashVision, Flash Partners and Flash Alliance is variable but capped at increasing fixed quarterly amounts through 2008. The common research and development participation agreement and the product development agreement are exhibits to this report on Form 10-K and should be read carefully in their entirety for a more complete understanding of these arrangements.

     For semiconductor fixed assets that are leased by FlashVision or Flash Partners, we and/or Toshiba guaranteed, in whole or in part, a portion of the outstanding lease payments under each of those leases through various methods. These obligations are denominated in Japanese yen and are non-cancelable. Under the terms of the FlashVision lease, Toshiba guaranteed these commitments on behalf of FlashVision and we agreed to indemnify Toshiba for certain liabilities Toshiba incurs as a result of its guarantee of the FlashVision equipment lease arrangement. As of December 31, 2006, the maximum amount of our contingent indemnification obligation, which reflects payments and any lease adjustments, was approximately 5.8 billion Japanese yen, or approximately $49 million based upon the exchange rate at December 31, 2006. Under the terms of the Flash Partners leases, we guaranteed on an unsecured and several basis 50% of Flash Partners’ lease obligations under master lease agreements entered into in December 2004, December 2005 and June 2006. Our total lease obligation guarantee, net of lease payments as of December 31, 2006, were 72.0 billion Japanese yen, or approximately $605 million based upon the exchange rate at December 31, 2006.

     The Flash Alliance venture was formed to develop and design NAND flash memory products and is expected to sell these products using semiconductor manufacturing equipment to be owned or leased by Flash Alliance. The NAND flash memory products will be manufactured by Toshiba at the proposed 300-millimeter wafer fabrication facility, Fab 4, being built in Yokkaichi, Japan. Flash Alliance will purchase wafers from Toshiba at cost and then resell those wafers to us and Toshiba at cost plus a markup. Toshiba owns 50.1% of this venture and we own 49.9% of this venture. We are committed to purchase half of Flash Alliance’s NAND wafer supply. The capacity of Fab 4 at full expansion is expected to be greater than 150,000 wafers per month and the timeframe to reach full capacity is to be mutually agreed by the parties. To date, the parties have agreed to an expansion plan to 67,500 wafers per month for which the total investment in Fab 4 is currently estimated at approximately $2.0 billion

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through the end of fiscal year 2008, of which our share is currently estimated to be approximately $1.0 billion. Initial NAND production at Fab 4 is currently scheduled for the end of fiscal year 2007. For expansion beyond 67,500 wafers per month, it is expected that investments and output would continue to be shared 50/50 between us and Toshiba. We are committed to fund 49.9% of Flash Alliance’s costs to the extent that Flash Alliance’s revenues from wafer sales to us and Toshiba are insufficient to cover these costs. We expect to fund our portion of the investment through cash as well as other financing sources.

     We assumed msystems’ ownership interest in the venture with Toshiba, TwinSys, which was designed to enable the parties to benefit from a portion of each party’s respective sales of USB flash drives. As of December 31, 2006, we had a 50.1% beneficial ownership in Twinsys Data Storage L.P., consisting of (i) 49.9% ownership in TwinSys and (ii) 0.2% interest held by Twinsys Ltd., in which we have a 51% ownership interest. We concluded that the venture is a variable interest entity as defined in FIN 46R, and determined that we are the primary beneficiary of the venture, and accordingly, we consolidate the venture. On a routine basis, the parties collectively prepare a joint production forecast for each company’s respective needs. We and Toshiba are currently negotiating the mutual closure of this venture by the first half of fiscal year 2007; however, no written agreement has been reached.

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Contractual Obligations and Off Balance Sheet Arrangements

     Our contractual obligations and off balance sheet arrangements at December 31, 2006, and the effect those contractual obligations are expected to have on our liquidity and cash flow over the next five years is presented in textual and tabular format in Note 8 to our consolidated financial statements included in Item 8 of this report.

Impact of Currency Exchange Rates

     Future exchange rate fluctuations could have a material adverse effect on our business, financial condition and results of operations. In 2006 and 2005, we used foreign currency forward contracts to mitigate transaction gains and losses generated by these monetary assets and liabilities denominated in other currencies than the U.S. dollar, currently only the Japanese yen. We do not enter into derivatives for speculative or trading purposes. Our derivative instruments are recorded at fair value with changes recorded in other income (expense) or accumulated other income. See Note 8 to our consolidated financial statements included in Item 8 of this report.

     For a discussion of foreign operating risks and foreign currency risks, see Item 1A, “Risk Factors.”

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     We are exposed to financial market risks, including changes in interest rates, foreign currency exchange rates and marketable equity security prices.

     Interest Rate Risk. Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This is accomplished by investing in widely diversified short-term investments, consisting primarily of investment grade securities, substantially all of which either mature within the next twelve months or have characteristics of short-term investments. As of December 31, 2006, a hypothetical 50 basis point increase in interest rates would result in an approximate $4.5 million decline (less than 0.25%) in the fair value of our available-for-sale debt securities.

     Foreign Currency Risk. A substantial majority of our revenue, expense and capital purchasing activity is transacted in U.S. dollars. However, we do enter into transactions in other currencies, primarily the Japanese yen. Movements in currency exchange rates, especially the Japanese yen, could cause variability in our revenues, expenses or other income (expense), net. We had forward exchange contracts in place with a notional amount of 8.6 billion Japanese yen, or approximately $72 million based upon the exchange rate at December 31, 2006 and approximately $34 million as of January 1, 2006. The effect of an immediate 10% adverse change in exchange rates on forward exchange contracts would result in an approximate $8 million loss. However, as we utilize foreign currency instruments, for mitigating anticipated balance sheet exposures, a loss in fair value for those instruments is generally offset by increases in the value of the underlying exposure. See Item 1A, “Risk Factors” and Note 8 to our consolidated financial statements included in Item 8 of this report.

     Market Risk. We also hold available-for-sale equity securities in semiconductor wafer manufacturing companies. As of December 31, 2006, a reduction in prices of 10% of these marketable equity securities would result in a decrease in the fair value of our investments in marketable equity securities of approximately $9 million.

     All of the potential changes noted above are based on sensitivity analysis performed on our financial position at December 31, 2006. Actual results may differ materially.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The information required by this item is set forth beginning at page F-1.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES

     Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by this report (the “Evaluation Date”). Based upon the evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective. Disclosure controls are controls and procedures designed to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls include controls and procedures designed to reasonably ensure that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. Our quarterly evaluation of disclosure controls includes an evaluation of some components of our internal control over financial reporting, and internal control over financial reporting is also separately evaluated on an annual basis for purposes of providing the management report which is set forth below.

     Report of Management on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining a comprehensive system of internal control over financial reporting to provide reasonable assurance of the proper authorization of transactions, the safeguarding of assets and the reliability of the financial records. Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements. The system of internal control over financial reporting provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees. The framework upon which management relied in evaluating the effectiveness of our internal control over financial reporting was set forth in Internal Controls — Integrated Framework published by the Committee of Sponsoring Organizations of the Treadway Commission.

     The Company acquired msystems Ltd., or msystems, through a purchase business combination in fiscal 2006. Management has excluded msystems from its assessment of internal control over financial reporting as of December 31, 2006. msystems’ total assets and net assets constituted approximately 7% and 5%, respectively, of the related consolidated financial statement amounts as of December 31, 2006, and total revenues and net loss of approximately 4% and 5%, respectively, of the related consolidated financial statement amounts as of and for the fiscal year ended December 31, 2006.

     Based on the results of our evaluation, our management concluded that our internal control over financial reporting of was effective as of December 31, 2006.

     Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

     Our independent registered public accounting firm, which has audited the financial statements included in Item 8 of this report, has issued an attestation report on management’s assessment of our internal control over financial reporting which is included at page F-2.

     Inherent Limitations of Disclosure Controls and Procedures and Internal Control over Financial Reporting. It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events.

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     Independent Registered Public Accounting Firm’s Attestation Report. The report required by this item is set forth at page F-2.

     Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

     On November 1, 2006, we entered into the Building 5 Sublease Agreement with Maxtor Corporation (the “Sublessor”) for approximately 94,484 square feet of office space at 1100 Sumac Drive, Milpitas, California 95035 (the “Sublease”).

     The term of the Sublease is from January 1, 2007 until July 31, 2011. Pursuant to the terms of the Sublease, the base rent for the Sublease commences on January 1, 2007 and the total rent due for each period described is as follows: January 1, 2007 until March 31, 2007: $28,271.11; April 1, 2007 until June 30, 2007: $61,414.60; July 1, 2007 until June 30, 2008: $65,193.96; July 1, 2008 until June 30, 2009: $68,973.32; July 1, 2009 until June 30, 2010: $72,752.68; and July 1, 2010 until July 31, 2011: $76,532.04.

     The first full month’s rent under the Sublease was due upon the effectiveness of the Sublease. In addition to base rent, we will be responsible for costs, charges and obligations specified in the Sublease, including certain operating expenses, management fees payable to Silicon Valley CA-I, LLC, a Delaware limited liability company (the “Master Lessor”), real estate taxes and utility expenses, standard indemnification of the Sublessor, and for maintaining specified levels of insurance, in addition to being subject to certain terms of the Master Lease between the Master Lessor and the Sublessor for the subleased premises. Pursuant to the terms of the Sublease, we were required to deliver to the Sublessor a security deposit in the form of a letter of credit in the amount of $184,243.80 upon effectiveness of the Sublease.

     The foregoing is a summary description of certain terms of the Sublease. It is qualified in its entirety by the text of the Sublease, attached as an exhibit to this report.

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PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

     The information required by this item is set forth under “Business-Executive Officers” in this report and under “Election of Directors” and “Compliance with Section 16(a) of the Securities Exchange Act of 1934” in our Proxy Statement for our 2007 Annual Meeting of Stockholders, and is incorporated herein by reference.

     We have adopted a code of ethics that applies to our principal executive officer and principal financial and accounting officer. This code of ethics, which consists of the “SanDisk Code of Ethics for Financial Executives” section of our code of ethics that applies to employees generally, is posted on our website, www.sandisk.com. Our code of ethics may be found on our website as follows:

• From our main Web page, first click on “Corporate” and then on scroll down and click on “Business Conduct and Ethics.”

• Next, click on “SanDisk’s Worldwide Code of Business Conduct and Ethics Policy.”

• Finally, scroll down to Part IV, “SanDisk Code of Ethics for Financial Executives.”

     We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding an amendment to, or waiver from, a provision of this code of ethics by posting the required information on our website, at the address and location specified above.

ITEM 11. EXECUTIVE COMPENSATION

     The information required by this item is set forth under “Executive Compensation and Related Information” in our Proxy Statement for our 2007 Annual Meeting of Stockholders, and is incorporated herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

     The information required by this item is set forth under “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Information for Plans or Individual Arrangements with Employees and Non-Employees” in our Proxy Statement for our 2007 Annual Meeting of Stockholders, and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, DIRECTOR INDEPENDENCE

     The information required by this item is set forth under “Compensation Committee Interlocks and Insider Participation,” “Certain Transactions” and under “Election of Directors” in our Proxy Statement for our 2007 Annual Meeting of Stockholders, and is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     The information required by this item is set forth under the caption “Principal Accountant Fees and Services” in our Proxy Statement for our 2007 Annual Meeting of Stockholders, and is incorporated herein by reference.

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K

     (a) Documents filed as part of this report

          1) All financial statements

Index to Financial Statements	Page
Reports of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets		F-4
Consolidated Statements of Income		F-5
Consolidated Statements of Stockholders’ Equity		F-6
Consolidated Statements of Cash Flows		F-7
Notes to Consolidated Financial Statements		F-8

     All other schedules have been omitted because the required information is not present or not present in amounts sufficient to require submission of the schedules, or because the information required is included in the consolidated financial statements or notes thereto.

          2) Exhibits required by Item 601 of Regulation S-K

     The information required by this item is set forth on the exhibit index which follows the signature page of this report.

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SANDISK CORPORATION

INDEX TO FINANCIAL STATEMENTS AND RELATED REPORTS

	Page
Reports of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets		F-4
Consolidated Statements of Income		F-5
Consolidated Statements of Stockholders’ Equity		F-6
Consolidated Statements of Cash Flows		F-7
Notes to Consolidated Financial Statements		F-8

F-1

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of
SanDisk Corporation

     We have audited the accompanying consolidated balance sheets of SanDisk Corporation as of December 31, 2006 and January 1, 2006, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

     We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of SanDisk Corporation at December 31, 2006 and January 1, 2006, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

     As discussed in Note 5 to the consolidated financial statements, on January 2, 2006, SanDisk Corporation adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share Based Payment.

     We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of SanDisk Corporation’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”) and our report, dated February 22, 2007, expressed an unqualified opinion thereon.

                                                       /s/ Ernst & Young LLP

San Jose, California
February 22, 2007

F-2

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of
SanDisk Corporation

     We have audited management’s assessment, included in the accompanying Report of Management on Internal Control Over Financial Reporting, that SanDisk Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). SanDisk Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

     We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

     A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

     Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

     As indicated in the accompanying Management Report on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of msystems Ltd. (“msystems”), which is included in the 2006 consolidated financial statements of SanDisk Corporation and constituted $496 million and $246 million of total and net assets, respectively, as of December 31, 2006, and $115 million and $9 million of revenues and net loss, respectively, for the year then ended. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of msystems.

     In our opinion, management’s assessment that SanDisk Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, SanDisk Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.

     We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of SanDisk Corporation as of December 31, 2006 and January 1, 2006, and the related consolidated statements of operation, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006 of SanDisk Corporation and our report dated February 22, 2007 expressed an unqualified opinion thereon.

                                                       /s/ Ernst & Young LLP

San Jose, California
February 22, 2007

F-3

SANDISK CORPORATION

CONSOLIDATED BALANCE SHEETS

	December 31, 2006		January 1, 2006
	(In thousands, except for share and per share amounts)
ASSETS
Current assets:
Cash and cash equivalents	$	1,580,700	$	762,058
Short-term investments		1,228,773		935,639
Accounts receivable from product revenues, net of allowance for doubtful accounts of $11,452 in 2006 and $8,050 in 2005		611,740		329,014
Inventory		495,984		331,584
Deferred taxes		176,007		95,518
Other current assets		148,657		121,922
Total current assets		4,241,861		2,575,735
Long-term investments		457,184		—
Property and equipment, net		317,965		211,092
Notes receivable and investments in flash ventures		462,307		265,074
Deferred taxes		102,100		—
Goodwill		910,254		5,415
Intangibles, net		389,078		4,608
Other non-current assets		87,034		58,263
Total assets	$	6,967,783	$	3,120,187
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	261,870	$	231,208
Accounts payable to related parties		139,627		74,121
Other current accrued liabilities		311,000		115,525
Deferred income on shipments to distributors and retailers and deferred revenue		183,950		150,283
Total current liabilities		896,447		571,137
Convertible long-term debt		1,225,000		—
Non-current liabilities and deferred revenue		72,226		25,259
Total liabilities		2,193,673		596,396
Minority interest		5,976		—
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.001 par value, Authorized shares: 4,000,000, Issued and outstanding: none		—		—
Common stock, $0.001 par value; Authorized shares: 800,000,000; Issued and outstanding: 226,518,283 in 2006 and 188,221,958 in 2005		226		188
Capital in excess of par value		3,656,895		1,621,819
Retained earnings		1,105,520		906,624
Accumulated other comprehensive income		5,493		2,635
Deferred compensation		—		(7,475	)
Total stockholders’ equity		4,768,134		2,523,791
Total liabilities and stockholders’ equity	$	6,967,783	$	3,120,187

The accompanying notes are an integral part of these consolidated financial statements.

F-4

SANDISK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

	December 31,			January 1,			January 2,
	2006			2006			2005
	(In thousands, except per share amounts)
Revenues:
Product	$	2,926,472		$	2,066,607		$	1,602,836
License and royalty		331,053			239,462			174,219
Total revenues		3,257,525			2,306,069			1,777,055
Cost of product revenues		2,007,684			1,333,335			1,091,350
Amortization of acquisition-related intangible assets		10,368			—			—
Total cost of product revenues		2,018,052			1,333,335			1,091,350
Gross profit		1,239,473			972,734			685,705
Operating expenses:
Research and development		306,866			194,810			124,994
Sales and marketing		203,406			122,232			91,296
General and administrative		159,835			79,110			50,824
Write-off of acquired in-process technology		225,600			—			—
Amortization of acquisition-related intangible assets		17,432			—			—
Total operating expenses		913,139			396,152			267,114
Operating income		326,334			576,582			418,591
Equity in income of business ventures		594			381			568
Interest income		101,088			42,835			20,363
Gain (loss) on investment in foundries		6,084			(8,228	)		(12,927	)
Recovery on unauthorized sale of UMC shares		—			—			6,193
Interest expense and other income (expense), net		(3,392	)		1,737			(9,588	)
Total other income		104,374			36,725			4,609
Income before provision for income taxes		430,708			613,307			423,200
Provision for income taxes		230,193			226,923			156,584
Income after taxes		200,515			386,384			266,616
Minority interest		1,619			—			—
Net income	$	198,896		$	386,384		$	266,616
Net income per share:
Basic	$	1.00		$	2.11		$	1.63
Diluted	$	0.96		$	2.00		$	1.44
Shares used in computing net income per share:
Basic		198,929			183,008			164,065
Diluted		207,451			193,016			188,837

The accompanying notes are an integral part of these consolidated financial statements.

F-5

SANDISK CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

					Capital in					Accumulated
	Common		Common		Excess of					Other						Total
	Stock		Stock		Par			Retained		Comprehensive			Deferred			Stockholders’
	Shares		Amount		Value			Earnings		Income(Loss)			Compensation			Equity
								(In thousands)
Balance at December 28, 2003		160,914	$	160	$	1,207,798		$	253,624	$	54,290		$	—		$	1,515,872
Net income									266,616								266,616
Unrealized loss on available for sale securities											(2,765	)					(2,765	)
Unrealized loss on investments in foundries											(38,216	)					(38,216	)
Foreign currency translation											5,584						5,584
Comprehensive income																	231,219
Exercise of stock options for cash		2,301		3		19,004											19,007
Issuance of stock pursuant to employee stock purchase plan		261		1		5,640											5,641
Deferred compensation		212				6,061								(6,061	)		–
Amortization of deferred compensation														525			525
Debt conversion		16,276		16		149,984											150,000
Income tax benefit from stock options exercised						17,886											17,886
Balance at January 2, 2005		179,964		180		1,406,373			520,240		18,893			(5,536	)		1,940,150
Net income									386,384								386,384
Unrealized loss on available for sale securities											(1,901	)					(1,901	)
Unrealized loss on investments in foundries											(840	)					(840	)
Foreign currency translation											(13,517	)					(13,517	)
Comprehensive income																	370,126
Exercise of stock options for cash		7,937		8		108,686											108,694
Issuance of stock pursuant to employee stock purchase plan		321				6,704											6,704
Deferred compensation						4,438								(4,438	)		—
Amortization of deferred compensation														2,499			2,499
Income tax benefit from stock options exercised						95,618											95,618
Balance at January 1, 2006		188,222		188		1,621,819			906,624		2,635			(7,475	)		2,523,791
Net income									198,896								198,896
Unrealized income on available for sale securities											2,315						2,315
Unrealized loss on investments in foundries											(227	)					(227	)
Foreign currency translation											770						770
Comprehensive income																	201,754
Exercise of stock options for cash		4,861		5		87,049											87,054
Issuance of stock pursuant to employee stock purchase plan		264				9,250											9,250
Issuance of restricted stock		63															—
Income tax benefit from stock options exercised						61,453											61,453
FAS 123R compensation expense and reversal of deferred compensation						96,415								7,475			103,890
Purchased calls						(386,090	)										(386,090	)
Sold Warrants						308,672											308,672
Tax benefit on purchased calls						145,556											145,556
Issuance of stock and equity awards related to acquisitions		33,108		33		1,686,356											1,686,389
Reclass of premium on assumed msystems convertible debt						26,415											26,415
Balance at December 31, 2006		226,518	$	226	$	3,656,895		$	1,105,520	$	5,493		$	—		$	4,768,134

The accompanying notes are an integral part of these consolidated financial statements.

F-6

SANDISK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Fiscal Years Ended
	2006			2005			2004
				(In thousands)
Cash flows from operating activities:
Net income	$	198,896		$	386,384		$	266,616
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred taxes		(25,636	)		(1,538	)		9,326
(Gain) loss on investment in foundries		(2,480	)		8,480			12,927
(Recovery) loss on unauthorized sales of UMC shares		—			—			(6,193	)
Depreciation and amortization		135,585			65,774			38,862
Provision for doubtful accounts		3,316			(272	)		4,581
FlashVision wafer cost adjustment		—			(2,263	)		(1,282	)
Share-based compensation expense		100,641			—			—
Tax benefit from share-based compensation		(57,393	)		—			—
Write-off of acquired in-process technology		225,600			—			—
Other non-cash charges		(313	)		9,833			3,764
Changes in operating assets and liabilities:
Accounts receivable from product revenues		(115,061	)		(134,207	)		(14,880	)
Inventory		(23,660	)		(135,162	)		(79,526	)
Other assets		(12,094	)		(31,148	)		1,681
Accounts payable		(64,228	)		148,234			(6,298	)
Accounts payable and other current liabilities, related parties		24,617			24,657			(3,149	)
Other liabilities		210,273			142,083			1,201
Total adjustments		399,167			94,471			(38,986	)
Net cash provided by operating activities		598,063			480,855			227,630
Cash flows from investing activities:
Purchases of short and long term investments		(2,135,973	)		(803,967	)		(1,147,142	)
Proceeds from sale and maturities of short and long term investments		1,497,120			722,986			810,111
Notes receivable from Matrix Semiconductor, Inc.		—			(20,000	)		—
Acquisition of property and equipment, net		(176,474	)		(134,477	)		(125,842	)
Acquisition of technology license		—			(4,500	)		—
Consideration paid in a business combination		—			—			(9,061	)
Notes receivable from FlashVision Ltd.		23,538			(34,249	)		(33,564	)
Notes receivable from Flash Partners Ltd.		(95,445	)		—			—
Notes receivable from Tower Semiconductor Ltd.		(9,705	)		—			—
Investment in Flash Partners Ltd. and Flash Alliance Ltd.		(132,209	)		(21,790	)		(23,129	)
Investment in foundries		—			(3,500	)		(704	)
Cash acquired in business combinations, net of acquisition costs		51,087			—			—
Proceeds from other sales		—			—			6,333
Net cash (used in) investing activities		(978,061	)		(299,497	)		(522,998	)
Cash flows from financing activities:
Proceeds from issuance of convertible debt, net of issuance costs		1,125,500			—			—
Proceeds from issuance of common stock under employee programs		96,304			115,398			24,648
Purchase of convertible bond hedge		(386,090	)		—			—
Proceeds from issuance of warrants		308,672			—			—
Cash distribution to minority interest		(4,491	)		—			—
Tax benefit from share-based compensation		57,393			—			—
Net cash provided by financing activities		1,197,288			115,398			24,648
Effect of changes in foreign currency exchange rates on cash		1,352			1,507			36
Net increase (decrease) in cash and cash equivalents		818,642			298,263			(270,684	)
Cash and cash equivalents at beginning of the year		762,058			463,795			734,479
Cash and cash equivalents at end of the year	$	1,580,700		$	762,058		$	463,795
Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	(81,100	)	$	(164,345	)	$	(159,436	)
Cash paid for interest expense	$	(6,965	)	$	(17	)	$	(6,750	)
Non-cash financing and investing activities:
Conversion of subordinated notes	$	—		$	—		$	150,000
Issuance of shares in a business combination	$	1,607,450		$	—		$	4,935

The accompanying notes are an integral part of these consolidated financial statements.

F-7

Notes to Consolidated Financial Statements

Note 1: Organization and Summary of Significant Accounting Policies

     Organization and Nature of Operations. SanDisk Corporation (together with its subsidiaries, the Company) was incorporated in Delaware on June 1, 1988. The Company designs, develops, markets and manufactures flash storage card products used in a wide variety of consumer electronics products. The Company operates in one segment, flash memory storage products.

     Basis of Presentation. The Company’s fiscal year ends on the Sunday closest to December 31. Fiscal 2006 and fiscal 2005 each consisted of 52 weeks and fiscal 2004 consisted of 53 weeks.

     Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All intercompany balances and transactions have been eliminated. Minority interest represents the minority shareholders’ proportionate share of the net assets and results of operations of our majority-owned subsidiary. The consolidated financial statements also include the results of companies acquired by the Company from the date of each acquisition. The Company completed two significant acquisitions, Matrix Semiconductor, Inc., or Matrix, and msystems Ltd., or msystems, on January 13, 2006 and November 19, 2006, respectively. See Note 10, “Business Acquisitions” for further details.

     Reclassification. Share and equity amounts in the accompanying consolidated financial statements give retroactive effect to a 2-for-1 stock split, in the form of a 100% stock dividend, effected on February 18, 2004. In connection with the acquisition of msystems, in the fourth quarter of fiscal 2006, the Company revised its methodology for classifying the amortization of acquired intangibles related to core developed technology from operating expenses to cost of sales. The amortization related to core and developed technology associated with the Matrix acquisition was not reclassified from operating expense to cost of sales and was approximately $3 million in each of the first three quarters of fiscal 2006.

     Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The estimates and judgments affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to customer programs and incentives, product returns, bad debts, inventories and related impairment, investments, income taxes, warranty obligations, restructuring and contingencies, share-based compensation and litigation. The Company bases estimates on historical experience and on other assumptions that its management believes are reasonable under the circumstances. These estimates form the basis for making judgments about the carrying values of assets and liabilities when those values are not readily apparent from other sources. Actual results could differ from these estimates.

     Revenue Recognition, Sales Returns and Allowances and Sales Incentive Programs. The Company recognizes net revenues when the earnings process is complete, as evidenced by an agreement with the customer, transfer of title and acceptance, if applicable, fixed or determinable pricing and reasonable assurance of realization. Sales made to distributors and retailers are generally under agreements allowing price protection and/or a right of return and, therefore, the sales and related costs of these transactions are deferred until the retailers or distributors sell-through the merchandise to their end customer, or the rights of return expire. Estimated sales returns are provided for as a reduction to product revenue and were not material for any period presented in the accompanying consolidated financial statements. The cost of shipping products to customers is included in costs of product revenues. The Company recognizes expenses related to sales commissions in the period in which they are earned.

     Revenue from patent licensing arrangements is recognized when earned and estimable. The timing of revenue recognition is dependent on the terms of each license agreement and on the timing of sales of licensed products. The Company generally recognizes royalty revenue when it is reported to the Company by its licensees, which is generally one quarter in arrears from the licensees’ sales. The Company recognizes license fee revenue on a straight-line basis over the life of the license.

     The cost of revenues associated with patent license and royalty revenues was insignificant for each of the three years in the period ended December 31, 2006.

     The Company records estimated reductions of revenue for customer and distributor incentive programs and offerings, including price protection, promotions, co-op advertising and other volume-based incentives and expected returns. Additionally, the Company has incentive programs that require it to estimate, based on historical experience, the number of customers who will

F-8

actually redeem the incentive. All sales incentive programs are recorded as an offset to product revenues or deferred revenues. Marketing development programs are either recorded as a reduction to revenue in compliance with Emerging Issues Task Force No. 01-9, or EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).

     Accounts Receivable and Allowance for Doubtful Accounts. Accounts receivable include amounts owed by geographically dispersed distributors, retailers, and OEM customers. No collateral is required. Provisions are provided for sales returns and credit losses.

     The Company estimates the collectibility of its accounts receivable based on a combination of factors. In circumstances where the Company is aware of a specific customer’s inability to meet its financial obligations to the Company (e.g., bankruptcy filings or substantial down-grading of credit ratings), the Company provides allowance for bad debts against amounts due to reduce the net recognized receivable to the amount it reasonably believes will be collected.

     Income Taxes. The Company accounts for income taxes using an asset and liability approach, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s consolidated financial statements, but have not been reflected in the Company’s taxable income. A valuation allowance is established to reduce deferred tax assets to their estimated realizable value. Therefore, the Company provides a valuation allowance to the extent that the Company does not believe it is more likely than not that it will generate sufficient taxable income in future periods to realize the benefit of its deferred tax assets.

     Foreign Currency. The Company determines the functional currency for its parent company and each of its subsidiaries by reviewing the currencies in which their respective operating activities occur. Transaction gains and losses arising from activities in other than the applicable functional currency are calculated using average exchange rates for the applicable period and reported in net income as a non-operating item in each period. Monetary balance sheet items denominated in a currency other than the applicable functional currency are translated using the exchange rate in effect on the balance sheet date and are included in other comprehensive income. The Company continuously evaluates its foreign currency exposures and may enter into hedges or other risk mitigating arrangements in the future. Aggregate foreign currency transaction gains (loss) recorded to net income were $3.4 million, $(0.1) million and $1.8 million in fiscal 2006, 2005 and 2004, respectively.

     Cash Equivalents, and Short-Term and Long-Term Investments. Cash equivalents consist of short-term, highly liquid financial instruments with insignificant interest rate risk that are readily convertible to cash and have maturities of three months or less from the date of purchase. Short-term investments consist of commercial paper, United States government agency obligations, corporate/municipal notes and bonds with high-credit quality, auction rate certificates and auction rate preferred stock, and have maturities greater than three months and no more than one year from the date of purchase. Short-term investments also include the unrestricted portion of the Company’s investment in foundries and investments for which trading restrictions expire within one year. Long-term investments consist of U.S. Treasury notes, corporate bonds, government agency bonds and tax-advantaged municipal bonds with remaining maturities greater than one year. The fair market value, based on quoted market prices, of cash equivalents, short-term and long-term investments excluding the Company’s short-term investment in foundries at December 31, 2006 and January 1, 2006 approximated their carrying value. Cost of securities sold is based on a specific identification method.

     In determining if and when a decline in market value below cost of these investments is other-than-temporary, the Company evaluates the market conditions, offering prices, trends of earnings, price multiples and other key measures. When such a decline in value is deemed to be other-than-temporary, the Company recognizes an impairment loss in the current period operating results to the extent of the decline.

     Property and Equipment. Property, plant and equipment are carried at cost less accumulated depreciation, estimated residual value, if any, and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter, ranging from two to twenty years.

     Variable Interest Entities. The Company evaluates its equity method investments to determine whether any investee is a variable interest entity within the meaning of Financial Interpretation No. 46R, or FIN 46R, Accounting for Variable Interest Entities, of the Financial Accounting Standards Board. If the Company concludes that an investee is a variable interest entity, the Company evaluates its interest in residual gains and residual losses of such investee to determine whether the Company is the primary beneficiary of the investee. If the Company is the primary beneficiary of a variable interest entity, the Company

F-9

consolidates such entity and reflects the minority interest of other beneficiaries of that entity. If the Company concludes that an investee is not a variable interest entity, the Company does not consolidate the investee.

     Equity Investments. The Company accounts for investments in equity securities of other entities, including variable interest entities that are not consolidated, under the cost method of accounting if investments in voting equity interests of the investee is less than 20%. The equity method of accounting is used if its investment in voting stock is greater than 20% but less than a majority. In considering the accounting method for investments less than 20%, the Company considers other factors such as its ability to exercise significant influence over operating and financial policies of the investee. If certain factors are present, the Company could account for investments for which it has less than a 20% ownership under the equity method of accounting. Certain of the Company’s investments carry restrictions on immediate disposition. Investments in public companies with restrictions of less than one year are classified as available-for-sale and are adjusted to their fair market value with unrealized gains and losses recorded as a component of accumulated other comprehensive income. Investments in public companies with restrictions greater than one year are carried at cost. Investments in public and non-public companies are reviewed on a quarterly basis to determine if their value has been impaired and adjustments are recorded as necessary. Upon disposition of these investments, the specific identification method is used to determine the cost basis in computing realized gains or losses. Declines in value that are judged to be other than temporary are reported in other income (expense).

     Inventories and Inventory Valuation. Inventories are stated at the lower of cost (first-in, first-out) or market. Market value is based upon an estimated average selling price reduced by estimated costs of disposal. Should actual market conditions differ from the Company’s estimates, the Company’s future results of operations could be materially affected. Reductions in inventory valuation are included in costs of product revenues in the accompanying consolidated income statements. The Company’s inventory impairment charges permanently establish a new cost basis and are not subsequently reversed to income even if circumstances later suggest that increased carrying amounts are recoverable. Rather these amounts are reversed into income only if, as and when the inventory is sold.

     The Company reduces the carrying value of its inventory to a new basis for estimated obsolescence or unmarketable inventory by an amount equal to the difference between the cost of the inventory and the estimated market value based upon assumptions about future demand and market conditions, including assumptions about changes in average selling prices. If actual market conditions are less favorable than those projected by management, additional reductions in inventory valuation may be required.

     The Company’s finished goods inventory includes consigned inventory held at customer locations as well as at third-party fulfillment centers and subcontractors.

     Other Long-Lived Assets. Intangible assets with definite useful lives and other long-lived assets are tested for impairment in accordance with Statement of Financial Accounting Standards No. 144, or SFAS 144, Accounting for Impairment of Disposal of Long-Lived Assets. The Company assesses the carrying value of long-lived assets, whenever events or changes in circumstances indicate that the carrying value of these long-lived assets may not be recoverable. Factors the Company considers important which could result in an impairment review include (1) significant under-performance relative to the expected historical or projected future operating results, (2) significant changes in the manner of use of assets, (3) significant negative industry or economic trends, and (4) significant changes in the Company’s market capitalization relative to net book value. Any changes in key assumptions about the business or prospects, or changes in market conditions, could result in an impairment charge and such a charge could have a material adverse effect on the Company’s consolidated results of operations.

     Fair Value of Financial Instruments. For certain of the Company’s financial instruments, including accounts receivable, short term investments and accounts payable, the carrying amounts approximate fair market value due to their short maturities. For those financial instruments where the carrying amounts differ from fair market value, the following table represents the related cost basis and the estimated fair values, which are based on quoted market prices (in millions):

F-10

	As of December 31, 2006				As of January 1, 2006
	Carrying		Estimated Fair		Carrying		Estimated Fair
	Value		Value		Value		Value
1% Convertible senior notes due 2013	$	1,150	$	995		N/A		N/A
1% Convertible notes due 2035		75		98		N/A		N/A
Restricted long-term securities	$	10	$	15	$	8	$	10

     Advertising Expenses. Marketing co-op development programs, where the Company receives, or will receive, an identifiable benefit (goods or services) in exchange for the amount paid to its customer and the Company can reasonably estimate the fair value of the benefit it receives for the customer incentive payment, are classified, when granted, as marketing expense, and costs of this type not meeting this criteria are classified as a reduction to product revenue. Any other advertising expenses not meeting these conditions are expensed as incurred. Prepaid advertising expenses were approximately zero and $0.2 million at December 31, 2006 and January 1, 2006, respectively. Advertising expenses were $24.8 million, $15.2 million and $20.4 million in fiscal 2006, 2005 and 2004, respectively.

     Research and Development Expenses. Research and development expenditures are expensed as incurred. Research and development expenses were $306.9 million, $194.8 million and $125.0 million in fiscal 2006, 2005 and 2004, respectively.

F-11

Note 2: Recent Accounting Pronouncements

     In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, or SFAS 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a market-based framework or hierarchy for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value. SFAS 157 does not expand or require any new fair value measures. The provisions of SFAS 157 are to be applied prospectively and are effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating what effect, if any, the adoption of SFAS 157 will have on the Company’s consolidated results of operations and financial position.

     In June 2006, the FASB issued FASB Interpretation No. 48, or FIN 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, or SFAS 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 will be effective for fiscal years beginning after December 15, 2006. The Company will adopt FIN 48 as of January 1, 2007, as required. The Company estimates that the adoption of FIN 48 will not have a significant impact on the Company’s financial position and results of operations. It is estimated that a cumulative credit in the range of $0.5 million to $2.5 million to retained earnings as of January 1, 2007 could result from the derecognition of tax positions previously taken. The Company intends to treat interest and penalties associated with tax positions as income taxes. The Company also expects that balance sheet reclassifications of deferred taxes could occur during the first quarter of 2007 and greater volatility in the effective tax rate may be experienced due to the requirements of FIN 48.

     In June 2006, the FASB issued Emerging Issues Tax Force Issue No. 06-3, or EITF 06-3, How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation). EITF 06-3 requires disclosure of accounting policy regarding the gross or net presentation of point-of-sales taxes such as sales tax and value-added tax. If taxes included in gross revenues are significant, the amount of such taxes for each period for which an income statement is presented should also be disclosed. EITF 06-3 will be effective for the first annual or interim reporting period after December 15, 2006. The Company will adopt this pronouncement beginning in the first quarter of fiscal 2007 and does not expect the adoption of EITF 06-3 to have a material impact on its consolidated results of operations and financial condition.

     In September 2006, the SEC issued Staff Accounting Bulletin No. 108, or SAB 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 establishes an approach that requires quantification of financial statement errors based on the effects of each of the company’s balance sheet and statement of operations and the related financial statement disclosures. Early application of the guidance in SAB 108 is encouraged in any report for an interim period of the first fiscal year ending after November 15, 2006, and will be adopted by the Company in the first quarter of fiscal 2007. The Company does not expect the adoption of SAB 108 to have a material impact on its consolidated results of operations and financial condition.

F-12

Note 3: Balance Sheet Information

     Available-for-Sale Investments. Available-for-sale investments were as follows for the following fiscal years ended December 31, 2006 and January 1, 2006 (in thousands):

	December 31, 2006									January 1, 2006
			Gross		Gross							Gross		Gross
			Unrealized		Unrealized			Market				Unrealized		Unrealized			Market
	Book Value		Gains		Losses			Value		Book Value		Gains		Losses			Value
Money market funds	$	617,984	$	—	$	—		$	617,984	$	300,833	$	—	$	—		$	300,833
Commercial paper		557,238		—		—			557,238		284,455		—		—			284,455
U.S. government agency		845,389		257		(962	)		844,684		587,352		—		(3,691	)		583,661
Municipal notes/bonds		435,577		224		(200	)		435,601		126,993		—		(219	)		126,774
Corporate notes/bonds		27,860		—		(423	)		27,437		59,033		—		(322	)		58,711
Auction instruments		543,497		—		—			543,497		308,040		—		(1	)		308,039
Equity investments		90,350		14,528		(4,938	)		99,940		—		—		—			—
Total available-for-sale investments	$	3,117,895	$	15,009	$	(6,523	)	$	3,126,381	$	1,666,706	$	—	$	(4,233	)	$	1,662,473

     A summary of the carrying values and balance sheet classification was as follows for the following fiscal years ended December 31, 2006 and January 1, 2006 (in thousands):

	December 31, 2006		January 1, 2006
Available-for-sale investments	$	3,126,381	$	1,662,473
Cash on hand		160,773		35,224
Other		2,223		18,338
Total	$	3,289,377	$	1,716,035
Reported as:
Cash and cash equivalents	$	1,580,700	$	762,058
Short-term investments		1,228,773		935,639
Investment in foundries		22,720		18,338
Long-term investments		457,184		—
Total	$	3,289,377	$	1,716,035

F-13

     The following table summarizes for those securities that have been in an unrealized loss position, the fair value and gross unrealized losses on the available-for-sale investments aggregated by type of investment instrument and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006. Available-for-sale securities that were in an unrealized gain position have been excluded from the table:

	Less than 12 Months					12 Months or Greater					Total
			Gross					Gross					Gross
			Unrealized			Market		Unrealized			Market		Unrealized
	Market Value		Losses			Value		Losses			Value		Losses
	(in thousands)
U.S. government agency	$	514,714	$	(517	)	$	92,164	$	(446	)	$	606,878	$	(963	)
Municipal notes/bonds		248,371		(180	)		10,764		(20	)		259,135		(200	)
Corporate notes/bonds		12,800		(27	)		14,637		(395	)		27,437		(422	)
Equity investments		66,463		(4,938	)		—		—			66,463		(4,938	)
Total	$	842,348	$	(5,662	)	$	117,565	$	(861	)	$	959,913	$	(6,523	)

     The unrealized losses were primarily caused by interest rate increases or market fluctuations. The Company has the ability and intent to hold the fixed income investments until a recovery of fair value is realized. The decline is temporary for equity investments.

     Gross realized gains and losses on sales of available-for-sale securities during the fiscal years ended December 31, 2006, January 1, 2006 and January 2, 2005 were immaterial.

     Debt securities at December 31, 2006 by contractual maturity are shown below (in thousands). Actual maturities may differ from contractual maturities because issuers of the securities may have the right to prepay obligations.

			Estimated
	Cost		Fair Value
Short-term investments:
Due in one year or less	$	2,479,489	$	2,478,625
Due after one year through five years		548,057		547,816
Total	$	3,027,546	$	3,026,441

F-14

     Allowance for Doubtful Accounts. The activity in the allowance for doubtful accounts was as follows (in thousands):

	December 31, 2006			January 1, 2006			January 2, 2005
Balance, beginning of period	$	8,050		$	8,462		$	4,882
Additions charged to costs and expenses		6,142			376			4,581
Deductions (write-offs)		(2,740	)		(788	)		(1,001	)
Balance, end of period	$	11,452		$	8,050		$	8,462
Inventory. Inventories were as follows (in thousands):
				December 31, 2006			January 1, 2006
Raw material				$	157,163		$	99,006
Work-in-process					64,009			61,900
Finished goods					274,812			170,678
Total inventories				$	495,984		$	331,584
In 2006, 2005 and 2004, the Company sold $13.5 million, $12.4 million and $10.2 million, respectively, of inventory that had been fully written-off in previous periods.
Other Current Assets. Other current assets were as follows (in thousands):
				December 31, 2006			January 1, 2006
Royalty and other receivables				$	82,569		$	77,310
Interest receivable					14,561			6,976
Prepaid expenses					22,276			5,047
Investment in foundries					22,720			18,338
Other current assets					6,531			14,251
Total other non-current assets				$	148,657		$	121,922
Property and Equipment. Property and equipment consisted of the following (in thousands):
				December 31, 2006			January 1, 2006
Machinery and equipment				$	507,282		$	318,336
Software					54,411			35,990
Capital land lease					3,197			—
Furniture and fixtures					5,604			1,682
Leasehold improvements					13,957			8,881
Property and equipment, at cost					584,451			364,889
Accumulated depreciation and amortization					(266,486	)		(153,797	)
Property and equipment, net				$	317,965		$	211,092
Depreciation expense of property, plant and equipment totaled $102.5 million, $63.1 million and $38.1 million in fiscal 2006, 2005 and 2004, respectively. Amortization expense of intangible assets and totaled $29.8 million, $2.7 million and $0.8 million in fiscal 2006, 2005 and 2004, respectively.
Notes Receivables and Investments in Flash Ventures. Notes receivable and investments in flash ventures were as follows (in thousands):
				December 31, 2006			January 1, 2006
Notes receivable, FlashVision Ltd.				$	38,229		$	61,927
Notes receivable, Flash Partners Ltd.					92,421			—
Investment in FlashVision Ltd.					159,144			161,080
Investment in Flash Partners Ltd.					168,210			42,067
Investment in Flash Alliance Ltd.					4,303			—
Total notes receivable and investments in flash ventures				$	462,307		$	265,074

F-15

     Other Non-current Assets. Other non-current assets were as follows (in thousands):

				December 31, 2006			January 1, 2006
Investment in foundries				$	17,071		$	11,013
Deposits					6,381			4,709
Other non-current assets					63,582			42,541
Total other non-current assets				$	87,034		$	58,263
Other Accrued Liabilities. Other accrued liabilities were as follows (in thousands):
				December 31, 2006			January 1, 2006
Accrued payroll and related expenses				$	61,050		$	55,614
Income taxes payable					110,009			2,165
Research and development liability, related party					5,850			4,200
Other accrued liabilities					134,091			53,546
Total other accrued liabilities				$	311,000		$	115,525
Warranties. Liability for warranty expense is included in other accrued liabilities in the accompanying consolidated balance sheets and the activity was as follows (in thousands):
	December 31, 2006			January 1, 2006			January 2, 2005
Balance, beginning of period	$	11,257		$	11,380		$	3,694
Additions (reductions) to costs of product revenue		6,606			6,033			14,790
Usage		(2,525	)		(6,156	)		(7,104	)
Balance, end of period	$	15,338		$	11,257		$	11,380
The majority of the Company’s products have a warranty ranging from one to five years. A provision for the estimated future cost related to warranty expense is recorded at the time of customer invoice. The Company’s warranty obligation is affected by customer and consumer returns, product failures and repair or replacement costs incurred. Should actual product failure rates, or repair or replacement costs differ from the Company’s estimates, increases or decreases to its warranty liability would be required.
Accumulated Other Comprehensive Income. Accumulated other comprehensive income presented in the accompanying consolidated balance sheets consists of the foreign currency translation and accumulated gains and losses on available-for-sale marketable securities, net of taxes, for all periods presented (in thousands):
				December 31, 2006			January 1, 2006
Accumulated net unrealized gain (loss) on:
Available-for-sale investments				$	(1,918	)	$	(4,233	)
Available-for-sale investments in foundries					(610	)		(383	)
Foreign currency translation					8,021			7,251
Total accumulated other comprehensive income				$	5,493		$	2,635

     The amount of income tax expense allocated to unrealized gain on available-for-sale securities was immaterial at December 31, 2006 and January 1, 2006, respectively.

F-16

Note 4: Goodwill and Other Intangible Assets

     Goodwill. Goodwill balance is as follows (in thousands):

Balance at January 1, 2006	$	5,415
Goodwill adjustment		97
Matrix goodwill acquired (Note 10)		145,492
msystems goodwill acquired (Note 10)		759,250
Balance at December 31, 2006	$	910,254

     In accordance with Statement of Financial Accounting Standards No. 142, or SFAS 142, Goodwill and Other Intangible Assets, goodwill is not amortized, but instead is reviewed and tested for impairment at least annually and whenever events or circumstances occur which indicate that goodwill might be impaired. Impairment of goodwill is tested at the Company’s reporting unit level by comparing the carrying amount, including goodwill, to the fair value. In performing the analysis, the Company uses the best information available, including reasonable and supportable assumptions and projections. If the carrying amount of the reporting unit exceeds its implied fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss, if any. The Company performs an annual goodwill impairment test with an effective date of the first day of the fourth fiscal quarter.

     Other Intangible Assets. Other intangible assets balances were as follows (in thousands):

	December 31, 2006							January 1, 2006
	Gross Carrying		Accumulated			Net Carrying		Gross Carrying		Accumulated			Net Carrying
	Amount		Amortization			Amount		Amount		Amortization			Amount
Core technology	$	311,801	$	(18,135	)	$	293,666	$	—	$	—		$	—
Developed product technology		12,900		(2,103	)		10,797		1,500		(542	)		958
Trademarks		4,000		(911	)		3,089		—		—			—
Backlog		5,000		(1,139	)		3,861		—		—			—
Supply agreement		2,000		(46	)		1,954		—		—			—
Customer relationships		80,100		(6,008	)		74,092		—		—			—
Acquisition-related intangible assets		415,801		(28,342	)		387,459		1,500		(542	)		958
Technology licenses		7,388		(5,769	)		1,619		7,389		(3,739	)		3,650
Total	$	423,189	$	(34,111	)	$	389,078	$	8,889	$	(4,281	)	$	4,608

     Other intangible assets increased by $414.3 million in the year ended December 31, 2006 as a result of the Company’s acquisition of Matrix and msystems. Technology licenses represent technology licenses purchased from third parties.

F-17

     The annual amortization expense of other intangible assets that existed as of December 31, 2006 is expected to be as follows:

	Estimated Amortization Expenses
	Acquisition-related
Fiscal periods	Intangible Assets		Technology License
	(In thousands)
2007	$	88,562	$	903
2008		76,629		716
2009		72,124		—
2010		71,929		—
2011		65,164		—
2012 and thereafter		13,051		—
Total	$	387,459	$	1,619

F-18

Note 5: Compensation and Benefits

Share-Based Benefit Plans

     2005 Incentive Plan. In May 2005, the Company’s board of directors adopted the 2005 Stock Incentive Plan, which was amended in May 2006 and renamed the 2005 Incentive Plan, or 2005 Plan. Shares of the Company’s common stock may be issued under the 2005 Plan pursuant to three separate equity incentive programs: (i) the discretionary grant program under which stock options and stock appreciation rights may be granted to officers and other employees, non-employee board members and independent consultants, (ii) the stock issuance program under which shares may be awarded to such individuals through restricted stock or restricted stock unit awards or as a stock bonus for services rendered to the Company, and (iii) an automatic grant program for the non-employee board members pursuant to which such individuals will receive option grants or other stock awards at designated intervals over their period of board service. The 2005 Plan also includes a performance-based cash bonus awards program for employees classified under Section 16. Grants and awards under the discretionary grant program generally vest as follows: 25% of the shares will vest on the first anniversary of the vesting commencement date and the remaining 75% will vest proportionately each quarter over the next 32 months of continued service. Awards under the stock issuance program generally vest in equal annual installments over a 4 year period. Grants under the automatic grant program will vest in accordance with the specific vesting provisions set forth in that program. A total of 21,571,644 shares of the Company’s common stock have been reserved for issuance under this plan. The share reserve may increase by up to an additional 10,000,000 shares of common stock to the extent that outstanding options under the 1995 Stock Option Plan and the 1995 Non-Employee Directors Stock Option Plan expire or terminate unexercised, of which as of December 31, 2006, 871,644 shares of common stock has been added to the 2005 Plan reserve. All options granted under the 2005 Plan were granted with an exercise price equal to the fair market value of the common stock on the date of grant and will expire seven years from the date of grant. Through December 31, 2006, awards to purchase a total of 7,767,347 shares of common stock were granted to employees under the 2005 Plan, net of cancellations. For years ended December 31, 2006 and January 1, 2006, awards of 6,103,534 and 1,558,625 shares of common stock, respectively, were granted to employees under the 2005 Plan, net of cancellations.

     1995 Stock Option Plan and 1995 Non-Employee Directors Stock Option Plan. Both of these plans terminated on May 27, 2005, and no further option grants were made under the plans after that date. However, options that were outstanding under these plans on May 27, 2005 will continue to be governed by their existing terms and may be exercised for shares of the Company’s common stock at any time prior to the expiration of the ten-year option term or any earlier termination of those options in connection with the optionee’s cessation of service with the Company. Grants and awards under these plans generally vest as follows: 25% of the shares will vest on the first anniversary of the vesting commencement date and the remaining 75% will vest proportionately each quarter over the next 36 months of continued service. As of December 31, 2006, options had been granted, net of cancellations, to purchase 38,229,457 and 1,616,000 shares of common stock under the 1995 Stock Option Plan and the 1995 Non-Employee Directors Stock Option Plan, respectively.

     2005 Employee Stock Purchase Plan. The 2005 Employee Stock Purchase Plan, or ESPP, was approved by the stockholders on May 27, 2005. The ESPP plan consists of two components: a component for employees residing in the United States and an international component for employees who are non-U.S. residents. The ESPP plan allows eligible employees to purchase shares of the Company’s common stock at the end of each six-month offering period at a purchase price equal to 85% of the lower of the fair market value per share on the start date of the offering period or the fair market value per share on the purchase date. As of December 31, 2006, a total of 5,000,000 shares were reserved for issuance and in the year ended December 31, 2006 and since inception of the 2005 ESPP plan, a total of 264,976 shares of common stock have been issued under this plan.

     msystems Ltd. 1996 Section 102 Stock Option/Stock Purchase Plan and 2003 Stock Option and Restricted Stock Incentive Plan. The msystems Ltd. 1996 Section 102 Stock Option/Stock Purchase Plan and 2003 Stock Option and Restricted Stock Incentive Plan acquired through SanDisk’s acquisition of msystems, were terminated on November 19, 2006, and no further grants were made under these plans after that date. However, awards grants that were outstanding under these plans on November 19, 2006 will continue to be governed by their existing terms and may be exercised for shares of the Company’s common stock at any time prior to the expiration of the ten-year option term or any earlier termination of those options in connection with the optionee’s cessation of service with the Company. Awards granted under these plans generally vest as follows: 50% of the shares will vest on the second anniversary of the vesting commencement date and the remaining 50% will vest proportionately each quarter over the next 24 months of continued service. As of December 31, 2006, options acquired through acquisition, net of cancellations, to purchase 313,364 and 5,050,082 shares of common stock under the msystems 1996 Section 102 Stock Option/Stock Purchase Plan and 2003 Stock Option and Restricted Stock Incentive Plan, respectively.

F-19

     Matrix Semiconductor, Inc. 2005 Stock Incentive Plan, 1999 Stock Plan and 1998 Long-term Incentive Plan. The Matrix Semiconductor, Inc. 2005 Stock Incentive Plan, 1999 Stock Plan and the Rhombus, Inc. 1998 Long-term Incentive Plan, or Matrix Stock Plans, acquired through SanDisk’s acquisition of Matrix were terminated on January 13, 2006, and no further option grants were made under these plans after that date. However, award grants that were outstanding under these plans on January 13, 2006 will continue to be governed by their existing terms and may be exercised for shares of the Company’s common stock at any time prior to the expiration of the ten-year option term or any earlier termination of those options in connection with the optionee’s cessation of service with the Company. Awards granted under these plans generally vest as follows: 1/48 of the shares will vest proportionately each month over the next 48 months of continued service or 1/60 of the shares will vest proportionately each month over the next 60 months of continued service. As of December 31, 2006, awards acquired through acquisition, net of cancellations, to purchase 552,323 shares of common stock under the Matrix Stock Plans.

Adoption of SFAS 123(R)

     Effective January 2, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123(R), or SFAS 123(R), Share-Based Payment, using the modified-prospective transition method, and therefore, has not restated its financial statements for prior periods. For awards expected to vest, compensation cost recognized in the year ended December 31, 2006 includes the following: (a) compensation cost, based on the grant-date estimated fair value and expense attribution method of SFAS 123, related to any share-based awards granted through, but not yet vested as of January 1, 2006, and (b) compensation cost for any share-based awards granted on or subsequent to January 2, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). The Company recognizes compensation expense for the fair values of these awards, which have graded vesting, on a straight-line basis over the requisite service period of each of these awards, net of estimated forfeitures.

     The Company estimates the fair value of stock options granted using the Black-Scholes-Merton option-pricing formula and a single-option award approach. The Company’s expected term represents the period that the Company’s share-based awards are expected to be outstanding and was determined based on historical experience regarding similar awards, giving consideration to the contractual terms of the share-based awards. The Company’s expected volatility is based on the implied volatility of its traded options in accordance with the guidance provided by the U.S. Securities and Exchange Commission’s Staff Accounting Bulletin 107 to place exclusive reliance on implied volatilities to estimate our stock volatility over the expected term of its awards. The Company has historically not paid dividends and has no foreseeable plans to issue dividends. The risk-free interest rate is based on the yield from U.S. Treasury zero-coupon bonds with an equivalent term.

     As a result of adopting SFAS 123(R), the impact to the Consolidated Financial Statements for the year ended December 31, 2006 to income before income taxes and net income was $100.6 million lower than if the Company had continued to account for share-based compensation under APB 25. The basic and diluted earnings per share for the year ended December 31, 2006 was $0.41 and $0.39 lower, respectively, than if the Company had continued to account for share-based compensation under APB 25. In addition, prior to the adoption of SFAS 123(R), the Company presented the tax benefit of stock option exercises as operating cash flows. Upon the adoption of SFAS 123(R), tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options are classified as financing cash flows and a corresponding deduction from operating cash flows.

     On November 10, 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards. The Company has elected to adopt the alternative transition method provided in the FASB Staff Position for calculating the effects of share-based compensation pursuant to FAS 123(R). The alternative transition method includes a simplified method to establish the beginning balance of the additional paid in capital pool (APIC pool) related to the tax effects of employee share-based compensation, which is available to absorb tax deficiencies recognized subsequent to the adoption of FAS 123(R).

F-20

     Stock Options and Stock Appreciation Rights (SARs). The fair value of the Company’s stock options granted to employees for the years ended December 31, 2006, January 1, 2006 and January 2, 2005 was estimated using the following weighted average assumptions:

	December 31, 2006			January 1, 2006			January 2, 2005
Dividend yield	None			None			None
Expected volatility		0.52			0.52			0.92
Risk-free interest rate		4.63	%		3.94	%		3.07	%
Expected lives	3.7 Years			4.5 Years			5.0 Years
Weighted average fair value at grant date	$	25.44		$	13.03		$	22.64

     A summary of option and SARs activity under all of the Company’s share-based compensation plans as of December 31, 2006 and changes during the year ended December 31, 2006 is presented below:

						Weighted
				Weighted		Average
				Average		Remaining		Aggregate
				Exercise		Contractual		Intrinsic
	Shares			Price		Term (Years)		Value
	(In thousands, except exercise price and contractual term)
Options outstanding at January 1, 2006		20,316		$	21.57
Granted		6,021			58.41
Exercised		(4,861	)		17.91
Forfeited		(851	)		41.05
Expired		(40	)		40.29
Options and SARs assumed through acquisition		5,807			30.57
Options and SARs outstanding at December 31, 2006		26,392			31.97		6.7	$	392,469
Options and SARs vested and expected to vest after December 31, 2006		24,890			31.14		6.6	$	385,791
Options and SARs exercisable at December 31, 2006		11,343		$	18.19		5.8	$	284,804

     During the year ended December 31, 2006, the aggregate intrinsic value of options and SARs exercised under the Company’s share-based compensation plans was $205.6 million. At December 31, 2006, the total compensation cost related to options and SARs granted to employees under the Company’s share-based compensation plans but not yet recognized was approximately $231.8 million, net of estimated forfeitures. This cost will be amortized on a straight-line basis over a weighted average period of approximately 2.6 years. Options and SARs valuation assumptions related to Matrix and msystems acquisitions are discussed in Note 10, “Business Acquisitions.”

F-21

     Restricted Stock. Restricted stock and restricted stock units are converted into shares of the Company’s common stock upon vesting on a one-for-one basis. Typically, vesting of restricted stock is subject to the employee’s continuing service to the Company. The cost of these awards is determined using the fair value of the Company’s common stock on the date of the grant, and compensation is recognized on a straight-line basis over the requisite vesting period.

     A summary of the changes in restricted stock units outstanding under the Company’s share-based compensation plan during the fiscal year ended December 31, 2006 is presented below:

				Weighted
				Average Grant		Aggregate Intrinsic
	Shares			Date Fair Value		Value
Non-vested share units at January 1, 2006		105,188		$	42.19
Granted		515,794			57.69
Vested		(97,220	)		52.21
Forfeited		(64,911	)		63.85
Restricted stock units assumed through acquisition		139,338			72.83
Non-vested share units at December 31, 2006		598,189		$	58.71	$	25,740,073

     As of December 31, 2006, the Company had $28.3 million of total unrecognized compensation expense, net of estimated forfeitures, related to restricted stock, which will be recognized over a weighted average estimated remaining life of 2.9 years. Restricted stock unit valuation assumptions related to Matrix acquisition is discussed in Note 10, “Business Acquisitions.”

F-22

     Employee Stock Purchase Plans (ESPP). The fair value of grants under the employee stock purchase plans was estimated on the first date of the purchase period, with the following weighted average assumptions:

	December 31, 2006			January 1, 2006			January 2, 2005
Dividend yield	None			None			None
Expected volatility		0.52			0.47			0.57
Risk-free interest rate		4.96	%		2.69	%		2.69	%
Expected lives	1/2 year			1/2 year			1/2 year
Weighted average fair value at exercise date	$	16.73		$	7.60		$	8.12

     At December 31, 2006, there was $0.3 million of total unrecognized compensation cost related to the ESPP that is expected to be recognized over a period of approximately 0.1 years.

     Share-Based Compensation Expense. The Company recorded $100.6 million of share-based compensation for the year ended December 31, 2006 that included the following:

	December 31, 2006
	(In thousands)
Share-based compensation expense by caption:
Cost of product sales	$	7,991
Research and development		40,999
Sales and marketing		21,617
General and administrative		30,034
Total share-based compensation expense	$	100,641
Share-based compensation expense by type of award:
Stock options and SARs	$	85,862
Restricted stock		11,181
ESPP		3,598
Total share-based compensation expense	$	100,641

     Share-based compensation expense of $3.2 million related to manufacturing personnel was capitalized into inventory as of December 31, 2006.

F-23

Pro Forma Disclosures

     Prior to fiscal 2006, the Company followed the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, or SFAS 123, Accounting for Stock-Based Compensation, as amended. The following table illustrates the effect on net income and earnings per share for the years ended January 1, 2006 and January 2, 2005, if the fair value recognition provisions of SFAS 123, as amended, had been applied to options granted under the Company’s share-based compensation plans. For purposes of this pro forma disclosure, the estimated value of the share-based compensation is recognized over the vesting periods. If the Company had recognized the expense of share-based compensation in the condensed consolidated statement of income, additional paid-in capital would have increased by a corresponding amount, net of applicable taxes.

	January 1, 2006			January 2, 2005
	(In thousands, except per share amounts)
Net income, as reported	$	386,384		$	266,616
Fair value method expense, net of related tax		(52,629	)		(39,550	)
Pro forma net income	$	333,755		$	227,066
Earnings per share as reported:
Basic	$	2.11		$	1.63
Diluted	$	2.00		$	1.44
Pro forma earnings per share:
Basic	$	1.82		$	1.38
Diluted	$	1.73		$	1.23

F-24

Note 6: Concentrations of Risk and Segment Information

     Geographic Information and Major Customers. The Company markets and sells flash-based memory products in the United States and in foreign countries through its sales personnel, dealers, distributors, retailers and its subsidiaries. The Company’s Chief Operating Decision Maker, the Chief Executive Officer, evaluates performance of the Company and makes decisions regarding allocation of resources based on total Company results. Since the Company operates in one segment, all financial segment information can be found in the accompanying consolidated financial statements.

     Other than sales in North America, Japan and Europe, Middle East and Africa, or EMEA, international sales were not material individually in any other international locality. Intercompany sales between geographic areas have been eliminated.

     Information regarding geographic areas for fiscal years 2006, 2005 and 2004 are as follows (in thousands):

	Years Ended
	December 31, 2006		January 1, 2006		January 2, 2005
Revenues:
North America	$	1,311,726	$	1,058,234	$	771,659
Japan		231,835		138,507		191,686
EMEA		728,355		500,998		420,645
Other foreign countries		985,609		608,330		393,065
Total	$	3,257,525	$	2,306,069	$	1,777,055
Long Lived Assets:
North America	$	182,749	$	126,346	$	86,024
Japan		397,011		286,859		263,248
Israel		50,355		8,868		14,737
Other foreign countries		29,704		608		472
Total	$	659,819	$	422,681	$	364,481

     Revenues are attributed to countries based on the geographic location of the customers. Long-lived assets are attributed to the geographic location in which they are located. The Company includes in long-lived assets, property plant and equipment, long-term investment in foundry, and equity investments and attributes those investments to the locality of the investee’s primary operations.

     Customer and Supplier Concentrations. A limited number of customers or licensees have accounted for a substantial portion of the Company’s revenues. Revenues from the Company’s top 10 customers or licensees accounted for approximately 52%, 50% and 55% of the Company’s revenues for the years ended December 31, 2006, January 1, 2006 and January 2, 2005, respectively. All customers were less than 10% of the Company’s revenues in 2006 and 2004. In 2005, Best Buy Co., Inc., accounted for 11% of the Company’s revenues; all other customers were less than 10% of the Company’s revenues.

     All of the Company’s flash memory card products require silicon wafers for the memory components and the controller components. The substantial majority of the Company’s memory wafers or components are currently supplied from FlashVision Ltd., or FlashVision, Flash Partners Ltd., or Flash Partners, and TwinSys Data Storage Limited Partnership, or TwinSys, ventures and to a lesser extent by Renesas and Samsung. The Company’s controller wafers are currently manufactured by Tower and United Microelectronics Corp., or UMC. The failure of any of these sources to deliver silicon could have a material adverse effect on the Company’s business, financial condition and results of operations. Moreover, Toshiba’s employees that produce FlashVision’s and Flash Partners’ products are covered by collective bargaining agreements and any job action by those employees could interrupt the Company’s wafer supply from Toshiba’s Yokkaichi, Japan operations.

     In addition, key components are purchased from single source vendors for which alternative sources are currently not available. Shortages could occur in these essential materials due to an interruption of supply or increased demand in the industry. If the Company were unable to procure certain of such materials, it would be required to reduce its manufacturing operations, which could have a material adverse effect upon its results of operations. The Company also relies on third-party subcontractors to assemble and test its products. The Company has no long-term contracts with these subcontractors and cannot directly control product delivery schedules. This could lead to product shortages or quality assurance problems that could increase the manufacturing costs of its products and have material adverse effects on the Company’s operating results.

F-25

     Concentration of Credit Risk. The Company’s concentration of credit risk consists principally of cash, cash equivalents, short-term and long-term investments and trade receivables. The Company’s investment policy restricts investments to high-credit quality investments and limits the amounts invested with any one issuer. The Company sells to original equipment manufacturers, retailers and distributors in the United States, Japan, EMEA and non-Japan Asia-Pacific, performs ongoing credit evaluations of its customers’ financial condition, and generally requires no collateral.

     Off Balance Sheet Risk. The Company has off balance sheet financial obligations. See Note 8, “Commitments, Contingencies and Guarantees.”

F-26

Note 7: Financing Arrangements

     The following table reflects the carrying value of our long-term borrowings as of December 31, 2006 and January 1, 2006:

	December 31, 2006		January 1, 2006
	(In millions)
1% Convertible Senior Notes due 2013	$	1,150	$	—
1% Convertible Notes due 2035	$	75	$	—

     1% Convertible Senior Notes Due 2013. In May 2006, the Company issued and sold $1.15 billion in aggregate principal amount of 1% Convertible Senior Notes due 2013 (the “1% Notes due 2013”) at par. The 1% Notes due 2013 may be converted, under certain circumstances described below, based on an initial conversion rate of 12.1426 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $82.36 per share). The net proceeds to the Company from the offering of the 1% Notes due 2013 were $1.13 billion.

     The 1% Notes due 2013 may be converted prior to the close of business on the scheduled trading day immediately preceding February 15, 2013, in multiples of $1,000 principal amount at th option of the holder under any of the following circumstances: 1) during the five business-day period after any five consecutive trading-day period (the “measurement period”) in which the trading price per note for each day of such measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such day; 2) during any calendar quarter after the calendar quarter ending June 30, 2006, if the last reported sale price of the Company’s common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 120% of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter; or 3) upon the occurrence of specified corporate transactions. On and after February 15, 2013 until the close of business on the scheduled trading day immediately preceding the maturity date of May 15, 2013, holders may convert their notes at any time, regardless of the foregoing circumstances.

     Upon conversion, a holder will receive the conversion value of the 1% Notes due 2013 to be converted equal to the conversion rate multiplied by the volume weighted average price of the Company’s common stock during a specified period following the conversion date. The conversion value of each 1% Notes due 2013 will be paid in: 1) cash equal to the lesser of the principal amount of the note or the conversion value, as defined, and 2) to the extent the conversion value exceeds the principal amount of the note, a combination of common stock and cash. The conversion price will be subject to adjustment in some events but will not be adjusted for accrued interest. In addition, upon a fundamental change at any time, as defined, the holders may require the Company to repurchase for cash all or a portion of their notes upon a “designated event” at a price equal to 100% of the principal amount of the notes being repurchased plus accrued and unpaid interest, if any.

     The Company will pay cash interest at an annual rate of 1%, payable semi-annually on May 15 and November 15 of each year, beginning November 15, 2006. Debt issuance costs of approximately $24.5 million are being amortized to interest expense over the term of the 1% Notes due 2013.

     Concurrently with the issuance of the 1% Notes due 2013, the Company purchased a convertible bond hedge and sold warrants. The separate convertible bond hedge and warrant transactions are structured to reduce the potential future economic dilution associated with the conversion of the 1% Notes due 2013 and to increase the initial conversion price to $95.03 per share. Each of these components are discussed separately below:

• Convertible Bond Hedge. Counterparties agreed to sell to the Company up to approximately 14 million shares of the Company’s common stock, which is the number of shares initially issuable upon conversion of the 1% Notes due 2013 in full, at a price of $82.36 per share. The convertible bond hedge transaction will be settled in net shares and will terminate upon the earlier of the maturity date of the 1% Notes due 2013 or the first day none of the 1% Notes due 2013 remain outstanding due to conversion or otherwise. Settlement of the convertible bond hedge in net shares, based on the number of shares issued upon conversion of the 1% Notes due 2013, on the expiration date would result in the Company receiving net shares equivalent to the number of shares issuable by the Company upon conversion of the 1% Notes due 2013. Should there be an early unwind of the convertible bond hedge transaction, the number of net shares potentially received by the Company will depend upon 1) the then existing overall market conditions, 2) the Company’s stock price, 3) the volatility of the Company’s stock, and 4) the amount of time remaining before expiration of the convertible bond hedge. The convertible bond hedge transaction cost of $386.1 million has been accounted for as an equity transaction in

F-27

accordance with Emerging Issues Task Force No. 00-19, or EITF 00-19, Accounting for Derivative Financial Statements Indexed to, and Potentially Settled in, a Company’s Own Stock. The Company recorded a tax benefit of approximately $145.6 million in stockholders’ equity from the deferred tax assets related to the convertible bond hedge.

•

Sold Warrants. The Company received $308.7 million from the same counterparties from the sale of warrants to purchase up to approximately 14 million shares of the Company’s common stock at an exercise price of $95.03 per share. The warrants have an expected life of 7.25 years and expire in August 2013. At expiration, the Company may, at its option, elect to settle the warrants on a net share basis. As of December 31, 2006, the warrants had not been exercised and remained outstanding. The value of the warrants has been classified as equity because they meet all the equity classification criteria of EITF 00-19.

     1% Convertible Notes Due 2035. In November 2006, the Company assumed the aggregate principal amount of $75 million 1% Convertible Senior Notes due March 2035 (the “1% Notes due 2035”) from msystems. The Company is obligated to pay interest on the 1% Notes due 2035 semi-annually on March 15 and September 15 commencing September 15, 2005.

     The 1% Notes due 2035 are convertible, at the option of the holders at any time before the maturity date, into shares of the Company at a conversion rate of 26.8302 shares per one thousand dollars principal amount of 1% Notes due 2035, representing a conversion price of approximately $37.27 per share. The securities may be redeemed in cash at the election of the Company, in whole or in part from time to time, at any time beginning on March 15, 2008 and prior to March 15, 2010, at a redemption price equal to 100% of the principal amount of the securities redeemed plus accrued but unpaid interest thereon, if any, to, but excluding the provisional redemption date if: (1) the last reported sales price of the ordinary shares has exceeded 130% of the then applicable conversion price, for at least 20 trading days in any period of 30 consecutive trading days ending on the trading day prior to the date of mailing of the notice of redemption, and (2) if the redemption occurs prior to March 23, 2007, a registration statement covering resales of the securities and the ordinary shares issuable upon conversion thereof is effective and available for use and is expected to remain effective for the 30 days following the provisional redemption date unless registration is no longer required. On and after March 15, 2010, the Company may, at its option, redeem the securities in whole or in part from time-to-time, at a redemption price equal to 100% of the principal amount of the securities redeemed, plus any accrued and unpaid interest thereon, if any, to, but excluding, the optional redemption date.

     Holders have the right to require the Company to purchase all or a portion of their Notes on March 15, 2010, March 15, 2015, March 15, 2020, March 15, 2025 and March 15, 2030. The purchase price payable will be equal to 100% of the principal amount of the Notes to be purchased, plus accrued and unpaid interest, if any, but excluding the purchase date. The Company will pay cash interest at an annual rate of 1%, payable semi-annually on March 15 and September 15 of each year, beginning November 15, 2006.

     In accordance with Accounting Principle Board Opinion No. 14, or APBO 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants, the Company determined the existence of a substantial premium over par value for the 1% Notes due 2035 based upon quoted market prices at the msystems acquisition date and recorded the notes at par value with the resulting excess of fair value over par (the substantial premium) recorded in Capital in excess of par value in Shareholders’ Equity in the amount of $26.4 million.

F-28

Note 8: Commitments, Contingencies and Guarantees

Commitments

     FlashVision. The Company has a 49.9% ownership interest in FlashVision Ltd., or FlashVision, a business venture with Toshiba Corporation, or Toshiba, formed in fiscal 2000. In the venture, the Company and Toshiba have collaborated in the development and manufacture of NAND flash memory products. These NAND flash memory products are manufactured by Toshiba at its 200-millimeter wafer fabrication facilities, located in Yokkaichi, Japan, using the semiconductor manufacturing equipment owned or leased by FlashVision. FlashVision purchases wafers from Toshiba at cost and then resells those wafers to the Company and Toshiba at cost plus a markup. Toshiba owns 50.1% of this venture. The Company accounts for its 49.9% ownership position in FlashVision under the equity method of accounting. The terms of the FlashVision venture contractually obligate the Company to purchase half of FlashVision’s NAND wafer supply. The Company cannot estimate the total amount of this commitment as of December 31, 2006, because it is based upon future costs and volumes. In addition, the Company is committed to fund 49.9% of FlashVision’s costs to the extent that FlashVision’s revenues from wafer sales to the Company and Toshiba are insufficient to cover these costs.

     As of December 31, 2006, the Company had notes receivable from FlashVision of 4.6 billion Japanese yen, or approximately $38 million based upon the exchange rate at December 31, 2006. These notes are secured by the equipment purchased by FlashVision using the note proceeds. In fiscal 2006, the Company received its first cash repayment against the note receivable and expects FlashVision to continue generating cash to pay down this note receivable over time. The Company agreed to indemnify Toshiba for certain liabilities Toshiba incurs as a result of Toshiba’s guarantee of the FlashVision equipment lease arrangement. If FlashVision fails to meet its lease commitments, and Toshiba fulfills these commitments under the terms of Toshiba’s guarantee, then the Company will be obligated to reimburse Toshiba for 49.9% of any claims and associated expenses under the lease, unless the claims result from Toshiba’s failure to meet its obligations to FlashVision or its covenants to the lenders. Because FlashVision’s equipment lease arrangement is denominated in Japanese yen, the maximum amount of the Company’s contingent indemnification obligation on a given date when converted to U.S. dollars will fluctuate based on the exchange rate in effect on that date. See “Off Balance Sheet Liabilities.”

     Flash Partners. The Company has a 49.9% ownership interest in Flash Partners Ltd., or Flash Partners, a business venture with Toshiba, formed in fiscal 2004. In the venture, the Company and Toshiba have collaborated in the development and manufacture of NAND flash memory products. These NAND flash memory products are manufactured by Toshiba at the 300-millimeter wafer fabrication facility, Fab 3, located in Yokkaichi, Japan, using the semiconductor manufacturing equipment owned or leased by Flash Partners. Flash Partners purchases wafers from Toshiba at cost and then resells those wafers to the Company and Toshiba at cost plus a markup. Toshiba owns 50.1% of this venture. The Company accounts for its 49.9% ownership position in Flash Partners under the equity method of accounting. The Company is committed to purchase half of Flash Partners’ NAND wafer supply. The Company cannot estimate the total amount of this commitment as of December 31, 2006, because it is based upon future costs and volumes. In addition, the Company is committed to fund 49.9% of Flash Partners’ costs to the extent that Flash Partners’ revenues from wafer sales to the Company and Toshiba are insufficient to cover these costs.

     As of December 31, 2006, the Company had notes receivable from Flash Partners of 11.0 billion Japanese yen, or approximately $92 million based upon the exchange rate at December 31, 2006. These notes are secured by the equipment purchased by Flash Partners using the note proceeds.

     Flash Alliance. The Company has a 49.9% ownership interest in Flash Alliance Ltd., or Flash Alliance, a business venture with Toshiba, formed on July 7, 2006. In the venture, the Company and Toshiba will collaborate in the development and manufacture of NAND flash memory products. These NAND flash memory products will be manufactured by Toshiba at its 300-millimeter wafer fabrication facility, Fab 4, being built in Yokkaichi, Japan, using the semiconductor manufacturing equipment that will be owned or leased by Flash Alliance. Flash Alliance will purchase wafers from Toshiba at cost and then resell those wafers to the Company and Toshiba at cost plus a markup. Toshiba owns 50.1% of this venture. The Company accounts for its 49.9% ownership position in Flash Alliance under the equity method of accounting. The Company is committed to purchase half of Flash Alliance’s NAND wafer supply.

F-29

     As a part of the FlashVision, Flash Partners and Flash Alliance venture agreements, the Company is required to fund direct and common research and development expenses related to the development of advanced NAND flash memory technologies. As of December 31, 2006, the Company had accrued liabilities related to these expenses of $5.9 million.

     Toshiba Foundry. The Company has the ability to purchase additional capacity under a foundry arrangement with Toshiba. Under the terms of this agreement, the Company is required to provide Toshiba with a purchase order commitment based on a nine-month rolling forecast.

     TwinSys. The Company assumed msystems’ ownership interest in the venture with Toshiba, TwinSys Data Storage Limited Partnership, or TwinSys, designed to enable the parties to benefit from a portion of each party’s respective sales of USB flash drives. As of December 31, 2006, the Company had a 50.1% beneficial ownership in Twinsys, consisting of (i) 49.9% ownership in TwinSys and (ii) 0.2% interest held by Twinsys Ltd., in which the Company has a 51% ownership interest. On a routine basis, the parties collectively prepare a joint production forecast for each company’s respective needs. The Company is committed to purchase the most recent 60 days of the forecast and may cancel its production needs outside of the immediate 60 days without any financial penalty. The Company and Toshiba are currently negotiating the mutual closure of this venture by the first half of fiscal 2007, however, no written agreement has been reached.

     Business Ventures and Foundry Arrangement with Toshiba. Purchase orders placed under the Toshiba ventures and foundry arrangement with Toshiba relating to the first three months of the nine-month forecast are binding and cannot be canceled. At December 31, 2006, the Company had approximately $191.8 million of noncancelable purchase orders for flash memory wafers outstanding to FlashVision, Flash Partners and Toshiba.

     Other Silicon Sources. The Company’s contracts with the other sources of silicon wafers generally require the Company to provide purchase order commitments based on nine-month rolling forecasts. The purchase orders placed under these arrangements relating to the first three months of the nine-month forecast are generally binding and cannot be canceled. Outstanding purchase commitments for other sources of silicon wafers are included as part of the total “Noncancelable production purchase commitments” in the “Contractual Obligations” table below.

     Subcontractors. In the normal course of business, the Company’s subcontractors periodically procure production materials based on the forecast the Company provides to them. The Company’s agreements with these subcontractors require that it reimburse them for materials that are purchased on the Company’s behalf in accordance with such forecast. Accordingly, the Company may be committed to certain costs over and above its open noncancelable purchase orders with these subcontractors. Outstanding purchase commitments for subcontractors are included as part of the total “Noncancelable production purchase commitments” in the “Contractual Obligations” table below.

F-30

Off Balance Sheet Liabilities

     The following table details the Company’s portion of the remaining indemnification or guarantee obligation under each of the FlashVision and Flash Partners master lease facilities in both Japanese yen and United States dollar equivalent based upon the exchange rate at December 31, 2006.

Master Lease Agreements by Execution Date	Lease Amounts(1)				Expiration
	(Yen in billions)		(Dollars in millions)
FlashVision
June 2006	¥	5.8	$	49		2009
Flash Partners
December 2004		19.5		164		2010
December 2005		15.0		126		2011
June 2006		14.5		121		2011
September 2006		23.0		194		2011
Total Flash Partners		72.0		605
Total indemnification or guarantee obligation	¥	77.8	$	654

(1) The maximum amount of the Company’s contingent indemnification or guarantee obligation, net of payments and any lease adjustments.

     FlashVision. In May 2002, FlashVision secured an equipment lease arrangement of approximately 37.9 billion Japanese yen, or approximately $318 million based upon the exchange rate at December 31, 2006, with Mizuho Leasing, and other financial institutions. On May 31, 2006, FlashVision refinanced the remaining balance of this equipment lease arrangement. The refinanced arrangement was approximately 15.0 billion Japanese yen, or approximately $126 million based upon the exchange rate at December 31, 2006. Lease payments are due quarterly and are scheduled to be completed in February 2009 and a residual payment of 3.1 billion Japanese yen, or $26 million based upon the exchange rate at December 31, 2006, will be due in May 2009. Under the terms of the refinanced lease, Toshiba guaranteed these commitments on behalf of FlashVision. The Company agreed to indemnify Toshiba for certain liabilities Toshiba incurs as a result of Toshiba’s guarantee of the FlashVision equipment lease arrangement. If FlashVision fails to meet its lease commitments, and Toshiba fulfills these commitments under the terms of Toshiba’s guarantee, then the Company will be obligated to reimburse Toshiba for 49.9% of any claims and associated expenses under the lease, unless the claims result from Toshiba’s failure to meet its obligations to FlashVision or its covenants to the lenders. Because FlashVision’s equipment lease arrangement is denominated in Japanese yen, the maximum amount of the Company’s contingent indemnification obligation on a given date when converted to U.S. dollars will fluctuate based on the exchange rate in effect on that date. As of December 31, 2006, the maximum amount of the Company’s contingent indemnification obligation, which reflects payments and any lease adjustments, was approximately 5.8 billion Japanese yen, or approximately $49 million based upon the exchange rate at December 31, 2006.

     Flash Partners. Flash Partners sells and lease-back from a consortium of financial institutions a portion of its tools and has entered into four equipment lease agreements of approximately 215.0 billion Japanese yen, or approximately $1.8 billion based upon the exchange rate at December 31, 2006. As of December 31, 2006, Flash Partners had drawn down approximately 144 billion Japanese yen, or approximately $1.2 billion based upon the exchange rate at December 31, 2006, net of accumulated lease payments. The Company and Toshiba have each guaranteed, on a several basis, 50% of Flash Partners’ obligations under the master lease agreements. Lease payments are due quarterly or semi-annually and are scheduled to be completed in stages through 2011. At the end of each of the lease terms, Flash Partners has the option of purchasing the tools from the lessors. Flash Partners is obligated to insure the equipment, maintain the equipment in accordance with the manufacturers’ recommendations and comply with other customary terms to protect the leased assets. The master lease agreements contains covenants that require the Company to maintain a minimum shareholder equity balance of $1.16 billion as well as a long-term loan rating of BB- or Ba3, based on a named independent rating service. In addition, the master lease agreements contain customary events of default for a Japanese lease facility. The master lease agreements are exhibits to the Company’s annual report for Form 10-K for fiscal 2005. These agreements should be read carefully in their entirety for a comprehensive understanding of their terms and the nature of the obligations the Company guaranteed. The fair value of the Company’s guarantee of Flash Partners’ lease obligation was insignificant at inception of the guarantee. In addition, Flash Partners expects to secure additional equipment lease facilities over time, which the Company may be required to guarantee in whole or in part. As of December 31, 2006, the maximum amount of the Company’s guarantee obligation of the Flash Partners master lease agreements, which reflects payments and any lease

F-31

adjustments, was approximately 72.0 billion Japanese yen, or approximately $605 million based upon the exchange rate at December 31, 2006. On January 10, 2007, Flash Partners utilized approximately 52.0 billion Japanese yen, or approximately $437 million based upon the exchange rate at December 31, 2006, of the outstanding lease lines, of which the Company’s guarantee was 26.0 billion Japanese yen, or approximately $218 million based upon the exchange rate at December 31, 2006. See Note 17, “Subsequent Events.” In addition, Flash Partners expects to secure additional equipment lease facilities over time, which the Company may be obligated to guarantee in whole or in part.

Guarantees

     Indemnification Agreements. The Company has agreed to indemnify suppliers and customers for alleged patent infringement. The scope of such indemnity varies, but may, in some instances, include indemnification for damages and expenses, including attorneys’ fees. The Company may periodically engage in litigation as a result of these indemnification obligations. The Company’s insurance policies exclude coverage for third-party claims for patent infringement. Although the liability is not remote, the nature of the patent infringement indemnification obligations prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay to its suppliers and customers. Historically, the Company has not made any significant indemnification payments under any such agreements. As of December 31, 2006, no amount has been accrued in the accompanying condensed consolidated financial statements with respect to these indemnification guarantees.

     As permitted under Delaware law and the Company’s charter and bylaws, the Company has agreements whereby it indemnifies certain of its officers and each of its directors for certain events or occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a Director and Officer insurance policy that may reduce its exposure and enable it to recover all or a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal. The Company has no liabilities recorded for these agreements as of December 31, 2006 or January 1, 2006, as this liability is not reasonably estimable even though liability under these agreements is not remote.

     The Company and Toshiba have agreed to mutually contribute to, and indemnify each other, Flash Partners and Flash Alliance, for environmental remediation costs or liability resulting from Flash Partners or Flash Alliance’s manufacturing operations in certain circumstances. In fiscal years 2004 and 2006, respectively, the Company and Toshiba each engaged consultants to perform a review of the existing environmental conditions at the site of the facility at which Flash Partners operations are located and Flash Alliance operations will be located to establish a baseline for evaluating future environmental conditions. The Company and Toshiba have also entered into a Patent Indemnification Agreement under which in many cases the Company will share in the expenses associated with the defense and cost of settlement associated with such claims. This agreement provides limited protection for the Company against third-party claims that NAND flash memory products manufactured and sold by Flash Partners or Flash Alliance infringe third-party patents. The Company has not made any indemnification payments under any such agreements and as of December 31, 2006, no amounts have been accrued in the accompanying condensed consolidated financial statements with respect to these indemnification guarantees.

F-32

Contractual Obligations and Off Balance Sheet Arrangements

     Contractual Obligations. The following summarizes the Company’s contractual cash obligations, commitments and off balance sheet arrangements at December 31, 2006, and the effect such obligations are expected to have on its liquidity and cash flows in future periods (in thousands).

										More than 5
						2 - 3 Years		3 –5 Years		Years
				Less than		(Fiscal 2008		(Fiscal 2010		(Beyond
	Total			1 Year		and 2009)		and 2011)		Fiscal 2011)
Operating leases	$	52,174		$	8,777	$	16,380	$	13,980	$	13,037
FlashVision, fabrication capacity expansion costs, and reimbursement for certain other costs including depreciation		202,144	(4)		75,428		110,726		15,990		—
Flash Partners fabrication capacity expansion and reimbursement for certain other costs including depreciation (1)		2,593,168	(4)		1,181,142		764,014		564,013		83,999
Flash Alliance start-up and reimbursement for certain other costs		10,000	(4)		—		—		—		10,000
Toshiba research and development		66,000	(4)		31,000		35,000		—		—
Capital equipment purchases commitments		62,960			62,960		—		—		—
1% Convertible Senior Notes principal and interest (2)		1,319,443			12,250		24,500		24,500		1,258,193
Operating expense commitments		8,972			8,972		—		—		—
Noncancelable production purchase commitments (3)		327,745	(4)		327,745		—		—		—
Total contractual cash obligations	$	4,642,606		$	1,708,274	$	950,620	$	618,483	$	1,365,229

     Off Balance Sheet Arrangements.

	As of
	December 31, 2006
Indemnification of FlashVision foundry equipment lease (5)	$	48,640
Guarantee of Flash Partners lease (6)	$	604,797

(1)	As of December 31, 2006, the Company and Toshiba have agreed to expand Fab 3 to 135,000 wafers per month.
(2)	In May 2006, the Company issued and sold $1.15 billion in aggregate principal amount of 1% Convertible Senior Notes due May 15, 2013. The Company will pay cash interest at an annual rate of 1%, payable semi-annually on May 15 and November 15 of each year, beginning November 15, 2006. In addition, in November 2006, through its acquisition of msystems, the Company assumed msystems’ $75 million in aggregate principal amount of 1% Convertible Notes due March 15, 2035. The Company will pay cash interest at an annual rate of 1%, payable semi-annually on March 15 and September 15 of each year until calendar year 2035.
(3)	Includes Toshiba foundries, FlashVision, Flash Partners, related parties vendors and other silicon sources vendors purchase commitments.
(4)	Includes amounts denominated in Japanese yen which are subject to fluctuation in exchange rates prior to payment and have been translated using the exchange rate at December 31, 2006.
(5)	The Company’s contingent indemnification obligation is 5.8 billion Japanese yen, or approximately $49 million based upon the exchange rate at December 31, 2006.
(6)	The Company’s guarantee obligation, net of cumulative lease payments, is 72.0 billion Japanese yen, or approximately $605 million based upon the exchange rate at December 31, 2006.

F-33

     The Company leases its headquarters and sales offices under operating leases that expire at various dates from 2007 through 2016. Future minimum lease payments under real estate operating leases at December 31, 2006 were as follows (in thousands):

Fiscal Year Ending:
2007	$	8,471
2008		8,018
2009		7,850
2010		7,626
2011		6,308
2012 and beyond		13,037
Total	$	51,310

     Foreign Currency Exchange and Other Contracts. The Company’s objective for holding foreign exchange derivatives is to minimize the material risks associated with non-functional currency transactions. The Company’s foreign exchange derivative instruments are designated as fair value hedges and recorded at fair value on the balance sheet with changes in fair value recorded in other income (expense). The Company had foreign currency exchange contract lines available in the amount of $1.57 billion at December 31, 2006 to enter into foreign currency forward contracts. As of December 31, 2006, the Company had foreign currency forward contracts in place with a notional amount of 8.6 billion Japanese yen, or approximately $72 million based upon the exchange rate at December 31, 2006. For the twelve months ended December 31, 2006, these foreign currency contracts resulted in a realized gain of $5.8 million, including forward point income. The foreign currency exposures hedged by these forward contracts had realized losses of $2.2 million. The Company has outstanding cash flow hedges designated to mitigate equity risk associated with certain available for sale equity securities totaling approximately $68 million. The changes in the fair value of the cash flow hedge are included in other comprehensive equity and were immaterial as of and for the year ended December 31, 2006. No cash flow hedges were outstanding in fiscal years prior to 2006. The Company does not enter into derivatives for speculative or trading purposes.

F-34

Note 9: Related Parties and Strategic Investments

     Toshiba. The Company and Toshiba have collaborated in the development and manufacture of NAND flash memory products. These NAND flash memory products are manufactured by Toshiba at Toshiba’s Yokkaichi, Japan operations using the semiconductor manufacturing equipment owned or leased by FlashVision or Flash Partners. See also Note 8, “Commitments, Contingencies and Guarantees.” The Company purchased NAND flash memory wafers from FlashVision, Flash Partners and Toshiba, made payments for shared research and development expenses, made loans to FlashVision and Flash Partners and made investments in Flash Partners totaling approximately $658.4 million, $571.7 million and $516.6 million in the years ended December 31, 2006, January 1, 2006 and January 2, 2005 respectively. The purchases of NAND flash memory wafers are ultimately reflected as a component of the Company’s cost of product revenues. At December 31, 2006 and January 1, 2006, the Company had accounts payable balances due to Toshiba of $19.2 million and $11.7 million, respectively. At December 31, 2006 and January 1, 2006, the Company had accrued current liabilities due to Toshiba for shared research and development expenses of $5.9 million and $4.2 million, respectively.

     FlashVision. The Company owns 49.9% of FlashVision. The Company’s obligations with respect to FlashVision’s lease arrangement, capacity expansion, take-or-pay supply arrangements and research and development cost sharing are described in Note 8. The fair value of the Company’s loan to FlashVision approximates book value. FlashVision is a variable interest entity and the Company is not the primary beneficiary of FlashVision because it is entitled to less than a majority of any residual gains and is obligated with respect to less than a majority of residual losses with respect to the venture. At December 31, 2006 and January 1, 2006, the Company had accounts payable balances due to FlashVision of $19.2 million and $23.0 million, respectively.

     The Company’s maximum reasonably estimable loss exposure (excluding lost profits) as a result of its involvement with FlashVision was $246.0 million and $298.1 million, as of December 31, 2006 and January 1, 2006, respectively. These amounts are comprised of the Company’s investments, notes receivable and contingent indemnification obligation. At December 31, 2006 and January 1, 2006, the Company’s consolidated retained earnings included approximately $2.3 million and $2.1 million, respectively, of undistributed earnings of FlashVision.

     Flash Partners. The Company accounts for its 49.9% ownership position in Flash Partners under the equity method of accounting. The Company’s obligations with respect to Flash Partner’s lease arrangement, capacity expansion, take-or-pay supply arrangements and research and development cost sharing are described in Note 8 “Commitments, Contingencies and Guarantees.” Flash Partners is a variable interest entity and the Company is not the primary beneficiary of Flash Partners because it is entitled to less than a majority of any residual gains and is obligated with respect to less than a majority of residual losses with respect to the venture. At December 31, 2006 and January 1, 2006, the Company had accounts payable balances due to Flash Partners of $42.4 million and $27.0 million, respectively.

     The Company’s maximum reasonably estimable loss exposure (other than lost profits) as a result of its involvement with Flash Partners was $865.4 million and $245.3 million as of December 31, 2006 and January 1, 2006, respectively. These amounts are comprised of the Company’s investments and guarantee of half of Flash Partners’ lease obligation.

     Flash Alliance. The Company has a 49.9% ownership interest in Flash Alliance, a business venture with Toshiba, formed on July 7, 2006. In the venture, the Company and Toshiba will collaborate in the development and manufacture of NAND flash memory products. These NAND flash memory products will be manufactured by Toshiba at its 300-millimeter wafer fabrication facility, Fab 4, being built in Yokkaichi, Japan, using the semiconductor manufacturing equipment that will be owned or leased by Flash Alliance. Flash Alliance will purchase wafers from Toshiba at cost and then resell those wafers to the Company and Toshiba at cost plus a markup. Toshiba owns 50.1% of this venture. The Company accounts for its 49.9% ownership position in Flash Alliance under the equity method of accounting. The Company is committed to purchase half of Flash Alliance’s NAND wafer supply.

     The Company’s maximum reasonably estimable loss exposure (excluding lost profits) as a result of its involvement with Flash Alliance was $4.3 million as of December 31, 2006. These amounts are comprised of the Company’s investments.

F-35

     The following summarizes the aggregated financial information for FlashVision, Flash Partners and Flash Alliance as of December 31, 2006 and January 1, 2006 (in thousands).

	December 31, 2006		January 1, 2006
	(Unaudited)
Current assets	$	448,520	$	373,409
Property, plant and equipment and other assets		1,652,706		1,039,844
Total assets		2,101,226		1,413,253
Current liabilities		1,169,543		881,529
Long-term liabilities	$	262,063	$	124,616

     The following summarizes the aggregated financial information for FlashVision, Flash Partners and Flash Alliance for the fiscal years ended December 31, 2006, January 1, 2006 and January 2, 2005 respectively (in thousands). The Toshiba ventures’ year-ends are March 31, with quarters ending on March 31, June 30, September 30 and December 31.

			Twelve Months Ended
	December 31, 2006		January 1, 2006			January 2, 2005
			(Unaudited)
Net sales(1)	$	1,462,024	$	795,464		$	502,949
Gross profit (loss)		8,894		(349	)		2,553
Net income	$	1,730	$	763		$	1,139

⁽¹⁾ Net sales represent sales to both the Company and Toshiba. In addition, Flash Partners’ revenue in fiscal year 2004 of $21.2 million represents reimbursement of start-up costs.

     TwinSys. The Company assumed msystems’ ownership interest in the venture with Toshiba, TwinSys, designed to enable the parties to benefit from a portion of each party’s respective sales of USB flash drives. As of December 31, 2006, the Company had a 50.1% beneficial ownership in Twinsys, consisting of (i) 49.9% ownership in TwinSys and (ii) 0.2% interest held by Twinsys Ltd., in which the Company has a 51% ownership interest. For the period between the closing date of the msystems acquisition and December 31, 2006, TwinSys had sales to Toshiba of $28.1 million and purchases from Toshiba of $21.9 million. At December 31, 2006, TwinSys had receivables from Toshiba of $18.5 million and payables due to Toshiba of $39.9 million.

     Tower Semiconductor. As of December 31, 2006, the Company owned approximately 12.7% of the outstanding shares of Tower Semiconductor Ltd., or Tower, one of its suppliers of wafers for its controller components, has prepaid wafer credits issued by Tower, and has convertible debt and a warrant to purchase Tower ordinary shares. The Company’s Chief Executive Officer is also a member of the Tower board of directors. As of December 31, 2006, the Company owned approximately 12.8 million Tower shares with a carrying value and market value of $17.5 million and $21.9 million, respectively, and Tower prepaid wafer credits with a carrying value of zero. In addition, the Company holds a Tower convertible debenture with a market value of $5.8 million. Also, as of December 31, 2006, the Company loaned the $9.8 million to Tower to fund a portion of the overall expansion of Tower’s 0.13 micron logic wafer capacity. The loan to Tower is secured by the equipment purchased. The Company purchased controller wafers and related non-recurring engineering, or NRE, of approximately $41.0 million, $31.3 million and $28.4 million in the fiscal years ended December 31, 2006, January 1, 2006 and January 2, 2005, respectively. These purchases of controller wafers are ultimately reflected as a component of the Company’s cost of product revenues. At December 31, 2006 and January 1, 2006, the Company had amounts payable to Tower of approximately $7.7 million and $2.4 million, respectively.

     Flextronics. The Chairman of Flextronics International, Ltd., or Flextronics, has served on the Company’s Board of Directors since September 2003. For the fiscal years ended December 31, 2006, January 1, 2006 and January 2, 2005 the Company recorded revenues related to Flextronics and its affiliates of $106.6 million, $25.3 million and $4.3 million, respectively, and at December 31, 2006 and January 1, 2006, the Company had receivables from Flextronics and its affiliates of $18.9 million and $12.5 million, respectively. In addition, the Company purchased from Flextronics and its affiliates $53.5 million, $40.2 million and $37.4 million of services for card assembly and testing in the fiscal years ended December 31, 2006, January 1, 2006 and January 2, 2005, respectively, which are ultimately reflected as a component of the Company’s cost of product revenues. At December 31, 2006 and January 1, 2006, the Company had amounts payable to Flextronics and its affiliates of approximately $6.7 million and $5.4 million, respectively, for these services.

F-36

Note 10: Business Acquisitions

     msystems Ltd. On November 19, 2006, the Company completed the acquisition of msystems in an all stock transaction. This combination joins together two flash memory companies with complementary products, customers and channels. In the transaction, each msystems common share has been converted into 0.76368 shares of the Company’s common stock. The transaction was accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards No. 141, or SFAS 141, Business Combinations.

     The purchase price is comprised of the following (in thousands):

Fair value of SanDisk common stock issued	$	1,365,150
Estimated fair value of options and stock appreciation rights assumed		115,670
Direct transaction costs		14,918
Total estimated purchase price	$	1,495,738

     As a result of the acquisition, the Company issued approximately 29.4 million shares of SanDisk common stock based on an exchange ratio of 0.76368 shares of the Company’s common stock for each outstanding share of msystems common stock as of November 19, 2006. The average market price per share of SanDisk common stock of $46.48 was based on the average of the closing prices for a range of trading days around the announcement date (July 30, 2006) of the proposed transaction.

     Pursuant to the terms of the merger agreement, each msystems stock option and stock appreciation right outstanding and unexercised as of November 19, 2006 was converted into a stock option and stock appreciation right, or SARs, to purchase the Company’s common stock. Based on msystems’ stock options outstanding at November 19, 2006, the Company assumed msystems’ options and SARs to purchase approximately 5.4 million shares of the Company’s common stock. The fair value of options and SARs assumed was estimated a valuation model with the following assumptions:

	Vested Options			Unvested Options			SARs
Valuation method	Black-Scholes-Merton			Black-Scholes-Merton			Binomial Model
Dividend yield	None			None			None
Expected volatility		0.50			0.50			0.50
Risk-free interest rate		5.04	%		4.68	%		4.67	%
Weighted average expected life	0.9 Years			3.4 Years			3.7 Years
Fair value	$	46.48		$	46.48		$	46.48
Exercise cap		N/A			N/A		$	104.76

     Direct transaction costs of $15 million include investment banking, legal and accounting fees, and other external costs directly related to the acquisition. As of December 31, 2006, substantially all costs for accounting, legal, and other professional services have been paid.

     Net Tangible Assets. The preliminary allocation of the msystems purchase price to the tangible assets acquired and liabilities assumed is summarized below (in thousands). The preliminary allocation was based on management’s estimates of fair value, which included a third-party appraisal. The allocation of the purchase price may be subject to change based on final estimates of fair value, primarily related to acquisition-related restructuring, deferred taxes and actual transaction costs.

F-37

Cash	$	41,657
Short-term investments		101,445
Accounts receivable		163,275
Inventory		133,512
Property and equipment, net		38,790
Other assets		49,127
Total assets acquired		527,806
Accounts payable		(133,263	)
Other liabilities		(180,555	)
Total liabilities assumed		(313,818	)
Net tangible assets acquired	$	213,988

     Purchase Price Allocation. In accordance with SFAS 141, the total preliminary purchase price was allocated to msystems’ net tangible and intangible assets based upon their estimated fair values as of November 19, 2006. The excess purchase price over the value of the net tangible and identifiable intangible assets was recorded as goodwill. The fair values assigned to tangible and intangible assets acquired and liabilities assumed are based on estimates and assumptions of management. Some of these estimates are subject to change, particularly those estimates relating to potential restructuring activities, deferred taxes and actual transaction costs.

     The following represents the allocation of the preliminary purchase price to the acquired net assets of msystems (in thousands):

Net tangible assets acquired	$	213,988
Goodwill		759,250
Other identifiable intangible assets
Core technology		235,500
Trademarks		4,000
Customer relationships		66,000
Backlog		5,000
Supply agreement		2,000
Total other identifiable intangible assets		312,500
Acquired in-process technology		186,000
Deferred tax liability		(31,339	)
Assumed unvested stock-based awards to be expensed		55,339
Total preliminary estimated purchase price	$	1,495,738

     The core technology and customer relationships are being amortized over an estimated useful life of five years. Backlog, trademarks and the supply agreement are being amortized over an estimated useful life of six months to five years. No residual value has been estimated for the intangible assets. In accordance with SFAS 142, the Company will not amortize the goodwill, but will evaluate it at least annually for impairment.

     Acquisition-Related Restructuring. During the fourth quarter of fiscal 2006, the Company established its plans to integrate the msystems operations, which included the involuntary termination of approximately 100 employees and exiting duplicative facilities and recorded $1.6 million for acquisition-related restructuring activities, of which $0.3 million relates to excess lease obligations and $1.3 million is related to personnel. The lease obligations extend through the end of the lease term in fiscal 2016. These acquisition-related restructuring liabilities were included in the purchase price allocation of the cost to acquire msystems. No restructuring accruals were paid or utilized as of December 31, 2006.

     U3 LLC. As a result of the msystems acquisition, the U3 venture between msystems and SanDisk became a wholly-owned subsidiary. At December 31, 2006, the minority interest relating to msystems’ ownership in U3 was eliminated.

     In-process Technology. As part of the msystems purchase agreement, a certain amount of the purchase price was allocated to acquired in-process technology, which was determined through established valuation techniques in the high-technology industry and written-off in the fourth quarter of fiscal 2006 because technological feasibility had not been established and no alternative

F-38

future uses existed. The value was determined by estimating the net cash flows and discounting forecasted net cash flows to their present values. The Company wrote-off the acquired in-process technology of $186.0 million in the fourth quarter of fiscal 2006. As of December 31, 2006, it was estimated that these in-process projects would be completed at an estimated total cost of $13.1 million. The net cash flows from the identified projects were based on estimates of revenues, costs of revenues, research and development expenses, including costs to complete the projects, selling, marketing and administrative expenses, and income taxes from the projects. The Company believes the assumptions used in the valuations were reasonable at the time of the acquisition. The estimated net revenues and gross margins were based on management’s projections of the projects and were in line with industry averages. Estimated total net revenues from the projects were expected to grow through fiscal 2009 and decline thereafter as other new products are expected to become available. Estimated operating expenses included research and development expenses and selling, marketing and administrative expenses based upon historical and expected direct expense level and general industry metrics. Estimated research and development expenses included costs to bring the projects to technological feasibility and costs associated with ongoing maintenance after a product is released. These activities range from 0% to 5% of msystems’ portion of the Company’s net revenues for the in-process technologies.

     The effective tax rate used in the analysis of the in-process technologies reflects a historical industry-specific average for the United States federal income tax rates. A discount rate (the rate utilized to discount the net cash flows to their present values) of 19% was used in computing the present value of net cash flows for the projects. The percentage of completion was determined using costs incurred by msystems prior to the acquisition date compared to the estimated remaining research and development to be completed to bring the projects to technological feasibility.

F-39

     Matrix Semiconductor, Inc. On January 13, 2006, the Company completed the acquisition of Matrix Semiconductor, Inc., or Matrix, a designer and developer of three-dimensional (3-D) integrated circuits. Matrix^® 3-D Memory is used for one-time programmable storage applications that complement the Company’s existing flash storage memory products. The Company acquired 100% of the outstanding shares of Matrix for a total purchase price of $296.4 million, consisting of $20.0 million in cash, 3,722,591 shares of common stock valued at $242.3 million, assumed equity instruments to issue 567,704 shares of common stock valued at $33.2 million and transaction expenses of $0.9 million primarily for accounting and legal fees. The assumed stock options were valued using the Black-Scholes-Merton valuation model with the following assumptions: stock price of $65.09; a weighted average volatility rate of 52.8%; a risk-free interest rate of 4.3%; a dividend yield of zero and a weighted average expected remaining term of 1.4 years. The fair value of unvested assumed stock options, which was valued at the consummation date, will be recognized as compensation expenses, net of forfeitures, over the remaining vesting period.

     Net Tangible Liabilities. The preliminary allocation of Matrix purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed is summarized below (in thousands). The preliminary allocation was based on management’s estimates of fair value, which included a third-party appraisal. The allocation of the purchase price may be subject to change based on final estimates of fair value, primarily related to acquisition-related restructuring.

Cash	$	9,432
Accounts receivable		6,956
Inventory		4,010
Property and equipment, net		1,919
Other assets		1,786
Total assets acquired		24,103
Accounts payable		(2,302	)
Other liabilities		(23,081	)
Total liabilities assumed		(25,383	)
Net tangible liabilities acquired	$	(1,280	)

     Purchase Price Allocation. The allocation of the purchase price to the tangible and intangible assets acquired and liabilities assumed is as follows (in thousands):

Net tangible liabilities acquired	$	(1,280	)
Acquired in-process technology		39,600
Acquisition-related restructuring		(17,462	)
Deferred income tax assets, net		13,666
Goodwill		145,492
Other intangible assets:
Core technology		76,300
Developed product technology		11,400
Customer relationships		14,100
		281,816
Assumed unvested equity instruments to be expensed		14,563
Purchase price	$	296,379

     The core and developed product technology as a result of the acquisition of Matrix are being amortized over an estimated useful life of seven years, and the customer relationships are being amortized over an estimated useful life of three years. No residual value has been estimated for the intangible assets. In accordance with SFAS 142, the Company will not amortize the goodwill, but will evaluate it at least annually for impairment.

     Acquisition-Related Restructuring. During the first quarter of fiscal 2006, the Company established its plans to integrate the Matrix operations, which included exiting duplicative facilities and recorded $17.5 million for acquisition-related restructuring activities, of which $17.4 million relates to excess lease obligations. The lease obligations extend through the end of the lease term in 2016. These acquisition-related restructuring liabilities were included in the purchase price allocation of the cost to

F-40

acquire Matrix. As of December 31, 2006, the outstanding accrual balance was $16.3 million. The reduction in the accrual balance was primarily related to excess lease obligation payments.

     In-process Technology. As part of the Matrix purchase agreement, a certain amount of the purchase price was allocated to acquired in-process technology, which was determined through established valuation techniques in the high-technology computer industry and written off in the first quarter of fiscal 2006 because technological feasibility had not been established and no alternative future uses existed. The value was determined by estimating the net cash flows and discounting forecasted net cash flows to their present values. The Company wrote-off the acquired in-process technology of $39.6 million in the first quarter of fiscal 2006. As of December 31, 2006, it was estimated that these in-process projects would be completed over the next one to three years at an estimated total cost of $14 million.

     The net cash flows from the identified projects were based on estimates of revenues, costs of revenues, research and development expenses, including costs to complete the projects, selling, marketing and administrative expenses, and income taxes from the projects. The Company believes the assumptions used in the valuations were reasonable at the time of the acquisition. The estimated net revenues and gross margins were based on management’s projections of the projects and were in line with industry averages. Estimated total net revenues from the projects were expected to grow through fiscal 2009 and decline thereafter as other new products are expected to become available. Estimated operating expenses included research and development expenses and selling, marketing and administrative expenses based upon historical and expected direct expense level and general industry metrics. Estimated research and development expenses included costs to bring the projects to technological feasibility and costs associated with ongoing maintenance after a product is released. These activities range from 0% to 5% of Matrix’s portion of the Company’s net revenues for the in-process technologies.

     The effective tax rate used in the analysis of the in-process technologies reflects a historical industry-specific average for the United States federal income tax rates. Discount rates (the rates utilized to discount the net cash flows to their present values) ranging from 12.5% to 15.5% were used in computing the present value of net cash flows for the projects. The percentage of completion was determined using costs incurred by Matrix prior to the acquisition date compared to the estimated remaining research and development to be completed to bring the projects to technological feasibility.

     Pro Forma Results. The following unaudited pro forma financial information for the years ended December 31, 2006 and January 1, 2006, presents the combined results of the Company, Matrix and msystems, as if the acquisitions had occurred at the beginning of the periods presented (in thousands, except per share amounts). Certain adjustments have been made to the combined results of operations, including amortization of acquired other intangible assets; however, charges for acquired in-process technology were excluded as these items were non-recurring.

	December 31, 2006		January 1, 2006
Net revenues	$	4,030,645	$	2,925,431
Net income	$	346,784	$	295,305
Net income per share:
Basic	$	1.51	$	1.39
Diluted	$	1.42	$	1.29

     The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company, Matrix and msystems constituted a consolidated entity during such periods.

F-41

Note 11: Income Taxes

     The provision for income taxes consists of the following (in thousands):

	December 31, 2006			January 1, 2006			January 2, 2005
Current:
Federal	$	174,320		$	159,147		$	138,558
State		27,788			24,592			13,731
Foreign		63,841			32,323			25,336
		265,949			216,062			177,625
Deferred:
Federal		(22,623	)		15,663			(20,963	)
State		(9,585	)		(3,413	)		(78	)
Foreign		(3,548	)		(1,389	)		—
		(35,756	)		10,861			(21,041	)
Provision for income taxes	$	230,193		$	226,923		$	156,584

     Income before provision for income taxes consisted of the following (in thousands):

	December 31, 2006		January 1, 2006		January 2, 2005
United States	$	193,845	$	500,727	$	414,968
International		236,863		112,580		8,232
Total	$	430,708	$	613,307	$	423,200

     The tax benefit associated with the exercise of stock options was credited to capital in excess of par value in the amount of $61.5 million, $95.6 million and $17.9 million in fiscal 2006, 2005 and 2004, respectively, when realized. In fiscal 2006, $4.6 million of tax benefit associated with the exercise of stock options was credited goodwill.

     The Company’s provision for income taxes differs from the amount computed by applying the federal statutory rates to income before taxes as follows:

	December 31, 2006			January 1, 2006			January 2, 2005
U.S. Federal statutory rate		35.0	%		35.0	%		35.0	%
State taxes, net of federal benefit		3.1			2.2			2.1
Non-deductible stock option expense		2.9			—			—
Write-off of acquired in-process technology		18.3			—			—
Tax exempt interest income		(2.7	)		(0.8	)		(0.5	)
Foreign earnings at other than U.S. rates		(2.3	)		—			—
Other		(0.8	)		0.6			0.4
		53.5	%		37.0	%		37.0	%

F-42

     Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax return reporting purposes. Significant components of the Company’s deferred tax assets as of December 31, 2006 and January 1, 2006 were as follows (in thousands):

	December 31, 2006			January 1, 2006
Deferred tax assets:
Inventory valuation	$	14,600		$	2,000
Deferred revenue recognized for tax purposes		57,400			51,000
Accruals and reserves not currently deductible		133,800			56,600
Unrealized loss on investments		24,500			20,400
Fixed assets and amortizable intangibles		44,800			15,500
Deductible stock options		19,800			—
Deductible original issue discount		136,700			—
Net operating loss and tax credit carryforwards		53,000			—
Other		3,400			5,200
Subtotal: Deferred tax assets		488,000			150,700
Valuation allowance for deferred tax assets		(60,100	)		(14,900	)
Total deferred tax assets	$	427,900		$	135,800
Deferred tax liabilities:
Acquired intangibles	$	(63,800	)	$	—
Unrealized gain on sale of foundry shares		(28,200	)		(19,500	)
U.S. taxes provided on unremitted earnings of foreign subsidiaries		(88,500	)		(26,500	)
Total deferred tax liabilities		(180,500	)		(46,000	)
Total net deferred tax assets	$	247,400		$	89,800

     At December 31, 2006, a $60.1 million valuation allowance was provided on gross deferred tax assets, based upon available evidence that it is more likely than not that some of the deferred tax assets will not be realized. At January 1, 2006, $14.9 million valuation allowance was provided based, more likely than not, on our inability to recognize a tax benefit from certain write-downs on the Company’s investment in Tower. The valuation allowance increased $45.2 million in fiscal 2006 from fiscal 2005, primarily due to acquired deferred tax assets. Should the Company have the ability to benefit from the valuation allowance in future periods, approximately $45 million would be credited to goodwill, while the remainder would benefit the income statement.

     The Company also has federal and state net operating loss carryforwards of approximately $8 million and $52 million before federal benefit, respectively. Some net operating losses will begin to expire in fiscal 2012, if not utilized. The Company also has federal and state research credit carryforwards of approximately $9 million and $7 million before federal benefit, respectively. Some credit carryforwards will begin to expire in fiscal 2008, if not utilized. These carryforwards are subject to annual limitations, including Section 382 of the Internal Revenue Code of 1986, as amended, for U.S. tax purposes and similar state provisions.

     No provision has been made for U.S. income taxes or foreign withholding taxes on $55 million of cumulative unremitted earnings of certain foreign subsidiaries as of December 31, 2006, since the Company intends to indefinitely reinvest these earnings. If these earnings were distributed to the United States, the Company would be subject to additional U.S. income taxes and foreign withholding taxes (subject to adjustment for foreign tax credits). As of December 31, 2006, the unrecognized deferred tax liability for these earnings was $19 million.

     The Company’s subsidiary, SanDisk IL Ltd., formerly msystems Ltd., is an “industrial company” under the Law for the Encouragement of Industry (Taxation), and its production facilities have been awarded “Approved Enterprise” status by the Israeli government under the Capital Investments Law according to six separate investment plans. SanDisk IL Ltd. has elected the “alternative benefits” track and has waived government grants in return for tax benefits.

     This status allows SanDisk IL Ltd. a four year tax exemption on undistributed earnings for investment plans commencing prior to or during 1996 and two year tax exemption on plans commencing after 1996, followed by a reduced rate of corporate income tax of 10%-25% for the remaining six or eight-year benefit periods respectively. Following SanDisk’s acquisition of SanDisk IL Ltd. the reduced corporate tax rate is expected to be 10%. Benefits relating to these investment plans will expire in fiscal

F-43

years 2006 through 2015. In addition, under an agreement reached with the Israeli tax authorities, the proportionate share of income attributable to an Approved Enterprise facility acquired from Fortress V&T Ltd. in 2000 is subject to a 10-year tax exemption.

     Income from sources other than the Approved Enterprise during the benefit period will be subject to tax at the standard Israeli corporate tax rates.

     An amendment to the Capital Investments Law came into effect on April 1, 2005 and has significantly changed the provisions of the Capital Investments Law. However, SanDisk IL Ltd.’s existing Approved Enterprise plans which were approved prior to these changes in the Capital Investments Law will generally not be subject to the provisions of this amendment to the Capital Investments Law.

     The entitlement to the above benefits is conditional upon SanDisk IL Ltd. fulfilling the conditions stipulated by the Capital Investments Law, regulations published thereunder and the instruments of approval for the specific investments in Approved Enterprises. In the event of failure to comply with these conditions, the benefits may be cancelled and SanDisk IL Ltd. may be required to refund the amount of the benefits, in whole or part, including interest.

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Note 12: Stockholders’ Rights Plan

     On September 15, 2003, the Company amended its existing stockholder rights plan to terminate the rights issued under that rights plan, and the Company adopted a new rights plan. Under the new rights plan, rights were distributed as a dividend at the rate of one right for each share of common stock of the Company held by stockholders of record as of the close of business on September 25, 2003. The rights will expire on April 28, 2007 unless redeemed or exchanged. Under the new rights agreement and after giving effect to the Company’s stock dividend effected on February 18, 2004, each right will, under the circumstances described below, entitle the registered holder to buy one two-hundredths of a share of Series A Junior Participating Preferred Stock for $225.00. The rights will become exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company’s common stock or commences a tender offer or exchange offer upon consummation of which such person or group would beneficially own 15% or more of the Company’s common stock.

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Note 13: Net Income per Share

     The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):

	FY 2006		FY 2005		FY 2004
Numerator:
Numerator for basic net income per share:
Net income	$	198,896	$	386,384	$	266,616
Denominator for basic net income per share: Weighted average common shares outstanding		198,929		183,008		164,065
Basic net income per share	$	1.00	$	2.11	$	1.63
Numerator for diluted net income per share:
Net income	$	198,896	$	386,384	$	266,616
Tax-effected interest and bond amortization expenses attributable to the notes		58		—		5,368
Net income for diluted income per share	$	198,954	$	386,384	$	271,984
Denominator for diluted net income per share:
Weighted average common shares		198,929		183,008		164,065
Incremental common shares attributable to exercise of outstanding employee stock options, restricted stock, restricted stock units and warrants (assuming proceeds would be used to purchase common stock)		8,284		10,008		10,406
Conversion of the Notes		238		—		14,366
Shares used in computing diluted net income per share		207,451		193,016		188,837
Diluted net income per share	$	0.96	$	2.00	$	1.44
Anti-dilutive shares excluded from net income per share calculation		33,381		98		6,141

     Basic earnings per share exclude any dilutive effects of options, SARs, warrants, and convertible securities. Diluted earnings per share include the dilutive effects of stock options, SARs, warrants, and the 1% Notes due 2035. Certain common stock issuable under stock options, SARs, warrants and the 1% Notes due 2013 have been omitted from the diluted net income per share calculation because their inclusion is considered anti-dilutive.

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Note 14: Litigation

     From time-to-time, it has been and may continue to be necessary to initiate or defend litigation against third parties. These and other parties could bring suit against us. In each case listed below where we are the defendant, we intend to vigorously defend the action.

     On October 31, 2001, the Company filed a complaint for patent infringement in the United States District Court for the Northern District of California against Memorex Products, Inc., Pretec Electronics Corporation, Ritek Corporation, and Power Quotient International Co., Ltd. In the suit, captioned SanDisk Corp. v. Memorex Products, Inc., et al., Civil Case No. CV 01 4063 VRW, the Company seeks damages and injunctions against these companies from making, selling, importing or using flash memory cards that infringe its U.S. Patent No. 5,602,987. The District Court granted summary judgment of non-infringement in favor of defendants Ritek, Pretec and Memorex and entered judgment on May 17, 2004. On June 2, 2004, the Company filed a notice of appeal of the summary judgment rulings to the United States Court of Appeals for the Federal Circuit. On July 8, 2005, the Federal Circuit held in favor of the Company, vacating the judgment of non-infringement and remanding the case back to the District Court. The District Court issued an order on claim construction on February 22, 2007. No trial date has been set for this case.

     On or about June 9, 2003, the Company received written notice from Infineon Technologies AG, or Infineon, that it believes the Company has infringed its U.S. Patent No. 5,726,601 (the ‘601 patent). On June 24, 2003, the Company filed a complaint against Infineon for a declaratory judgment of patent non-infringement and invalidity regarding the ‘601 patent in the United States District Court for the Northern District of California, captioned SanDisk Corporation v. Infineon Technologies AG, a German corporation, et al., Civil Case No. C 03 02931 BZ. On October 6, 2003, Infineon filed an answer and counterclaim: (a) denying that the Company is entitled to the declaration sought by the Company’s complaint; (b) requesting that the Company be adjudged to have infringed, actively induced and/or contributed to the infringement of the ’601 patent and an additional patent, U.S. Patent No. 4,841,222 (the ’222 patent). On August 12, 2004, Infineon filed an amended counterclaim for patent infringement alleging that the Company infringes U.S. Patent Nos. 6,026,002 (the ’002 patent); 5,041,894 (the ’894 patent); and 6,226,219 (the ’219 patent), and omitting the ’601 and ’222 patents. On August 18, 2004, the Company filed an amended complaint against Infineon for a declaratory judgment of patent non-infringement and invalidity regarding the ’002, ’894, and ’219 patents. On February 9, 2006, the Company filed a second amended complaint to include claims for declaratory judgment that the ’002, ’894 and ’219 patents are unenforceable. On March 17, 2006, the Court granted a stipulation by the parties withdrawing all claims and counterclaims regarding the ’002 patent. On February 20, 2007, the Court entered an order staying the case to facilitate settlement negotiations.

     On February 20, 2004, the Company and a number of other manufacturers of flash memory products were sued in the Superior Court of the State of California for the City and County of San Francisco in a purported consumer class action captioned Willem Vroegh et al. v. Dane Electric Corp. USA, et al., Civil Case No. GCG 04 428953, alleging false advertising, unfair business practices, breach of contract, fraud, deceit, misrepresentation and violation of the California Consumers Legal Remedy Act. The lawsuit purports to be on behalf of a class of purchasers of flash memory products and claims that the defendants overstated the size of the memory storage capabilities of such products. The lawsuit seeks restitution, injunction and damages in an unspecified amount. The parties have reached a settlement of the case, which is pending final court approval. In April 2006, the Court issued an order preliminarily approving the settlement. In August 2006, the Court held a hearing to consider final approval of the settlement, and on November 20, 2006, the Court issued its formal written order of approval. Two objectors to the settlement have filed separate appeals from the Court’s order granting final approval.

     On October 15, 2004, the Company filed a complaint for patent infringement and declaratory judgment of non-infringement and patent invalidity against STMicroelectronics N.V. and STMicroelectronics, Inc. (collectively, “ST”) in the United States District Court for the Northern District of California, captioned SanDisk Corporation v. STMicroelectronics, Inc., et al., Civil Case No. C 04 04379JF. The complaint alleges that ST’s products infringe one of the Company’s U.S. patents and seeks damages and an injunction. The complaint further seeks a declaratory judgment that the Company does not infringe several of ST’s U.S. patents. By order dated January 4, 2005, the court stayed the Company’s claim that ST infringes the Company’s patent pending an outcome in the ITC investigation initiated on November 15, 2004 (discussed below). On January 20, 2005, the court issued an order granting ST’s motion to dismiss the declaratory judgment causes of action. The Company has appealed this decision to the U.S. Court of Appeals for the Federal Circuit. The remainder of the case, including the Company’s infringement claim against ST, is stayed pending the outcome of the appeal.

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     On October 15, 2004, the Company filed a complaint under Section 337 of the Tariff Act of 1930 (as amended) (Case No. 337-TA 526) titled, “In the matter of certain NAND flash memory circuits and products containing same” in the United States International Trade Commission (“ITC”), naming STMicroelectronics N.V. and STMicroelectronics, Inc. (collectively, “ST”) as respondents. In the complaint, the Company alleges that ST’s NAND flash memory infringes U.S. Patent No. 5,172,338 (the ’338 patent), and seeks an order excluding ST’s products from importation into the United States. On November 15, 2004, the ITC instituted an investigation pursuant to 19 U.S.C. § 1337 against ST in response to the Company’s complaint. On December 9, 2004, ST filed a response to the complaint, denying that they infringe the ’338 patent and alleging that the patent is invalid and/or unenforceable. A hearing was held from August 1-8, 2005. On October 19, 2005, the Administrative Law Judge issued an initial determination confirming the validity and enforceability of the Company’s ’338 patent by rejecting ST’s claims that the patent was invalidated by prior art. The initial determination, however, found that ST’s NAND flash memory chips did not infringe the asserted claims of the ’338 patent. On October 31, 2005, the Company filed a petition with the ITC to review and reverse the finding of non-infringement. Also, on October 31, 2005, ST filed a petition for review with the ITC to review and reverse the finding that the patent was valid and enforceable. On December 6, 2005, the ITC issued its decision. The ITC declined to review the finding of non-infringement, and, after reviewing the finding of validity, declined to take any position on the issue of validity. The Company is appealing the ITC’s decision to the U.S. Court of Appeals for the Federal Circuit.

     On February 4, 2005, STMicro filed two complaints for patent infringement against the Company in the United States District Court for the Eastern District of Texas, captioned STMicroelectronics, Inc. v. SanDisk Corporation, Civil Case No. 4:05CV44 (the “’44 Action”), and STMicroelectronics, Inc. v. SanDisk Corporation, Civil Case No. 4:05CV45 (the “’45 Action”), respectively. The complaints seek damages and injunctions against certain SanDisk products. On April 22, 2005, the Company filed counterclaims on two patents against STMicroelectronics N.V. and STMicroelectronics, Inc. (collectively, “ST”) in the ’45 Action. The counterclaims seek damages and injunctive relief against ST’s flash memory products. In the ’44 Action, the District Court granted SanDisk’s motion for summary judgment of non-infringement on all accused products. On February 6, 2007, the District Court dismissed the ’44 Action with prejudice, ordered that ST take nothing from the Company, and that costs be taxed against ST. ST has filed a motion to amend or correct the final judgment, but no ruling has issued. In the ’45 Action, the parties have filed motions for summary judgment regarding various aspects of the litigation; no ruling has issued. The ’45 Action is scheduled currently for jury selection and trial on April 16, 2007.

     On October 14, 2005, STMicroelectronics, Inc. (“STMicro”) filed a complaint against the Company and the Company’s CEO Eli Harari, in the Superior Court of the State of California for the County of Alameda, captioned STMicroelectronics, Inc. v. Harari, Case No. HG 05237216 (the “Harari Matter”). The complaint alleges that STMicro, as the successor to Wafer Scale Integration, Inc.’s (“WSI”) legal rights, has an ownership interest in several SanDisk patents that issued from applications filed by Dr. Harari, a former WSI employee. The complaint seeks the assignment or co-ownership of certain inventions and patents conceived of by Harari, including some of the patents asserted by the Company in its litigations against STMicro, as well as damages in an unspecified amount. On November 15, 2005, Harari and the Company removed the case to the U.S. District Court for the Northern District of California, where it was assigned case number C05-04691. On December 13, 2005, STMicro filed a motion to remand the case back to the Superior Court of Alameda County. The case was remanded to the Superior Court of Alameda County on July 18, 2006, after briefing and oral argument on a motion by STMicro for reconsideration of an earlier order denying STMicro’s request for remand. Due to the remand, the District Court did not rule upon a summary judgment motion previously filed by the Company. In the Superior Court of Alameda County, the Company filed a Motion to Transfer Venue to Santa Clara County on August 10, 2006, which was denied on September 12, 2006. On October 6, 2006, the Company filed a Petition for Writ of Mandate with the First District Court of Appeal which asks that the Superior Court’s September 12 Order be vacated, and the case transferred to Santa Clara County. On October 20, 2006, the Court of Appeal requested briefing on the Company’s petition for a writ of mandate and stayed the action during the pendency of the writ proceedings. On January 17, 2007, the Court of Appeal issued an alternative writ directing the Superior Court to issue a new order granting the Company’s venue transfer motion or to show cause why a writ of mandate should not issue compelling such an order. On January 23, 2007, the Superior Court of Alameda transferred the case to Santa Clara County as a result of the writ proceeding at the Court of Appeal. A Case Management Conference is scheduled for April 26, 2007. The Company also filed a special motion to strike ST’s unfair competition claim, which the Superior Court denied on September 11, 2006. The Company has appealed the denial of that motion.

     On December 6, 2005, the Company filed a complaint for patent infringement in the United States District Court for the Northern District of California against STMicroelectronics, Inc. and STMicroelectronics, NV (collectively, “ST”) (Case No. C0505021 JF). In the suit, the Company seeks damages and injunctions against ST from making, selling, importing or using flash memory chips or products that infringe the Company’s U.S. Patent No. 5,991,517 (the “’517 patent). The case is presently stayed, pending the termination of the ITC investigation instituted February 8, 2006, discussed below.

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     On January 10, 2006, the Company filed a complaint under Section 337 of the Tariff Act of 1930 (as amended) (Case No. 337-TA-560) titled, “In the matter of certain NOR and NAND flash memory devices and products containing same” in the ITC, naming ST as respondents. In the complaint, the Company alleges that: (i) ST’s NOR flash memory infringes the “338 patent; (ii) ST’s NAND flash memory infringes U.S. Patent No. 6,542,956 (the “’956 patent”); and (iii) ST’s NOR flash memory and NAND flash memory infringe the ’517 patent. The complaint seeks an order excluding ST’s NOR and NAND flash memory products from importation into the United States. The ITC instituted an investigation, based on the Company’s complaint, on February 8, 2006. On March 31, 2006, ST filed a motion for partial summary determination or termination of the investigation with respect to the ’338 patent. On May 1, 2006, the Administrative Law Judge (“ALJ”) denied ST’s motion in an initial determination that is subject to review by the ITC. On May 17, 2006, SanDisk filed a motion to voluntarily terminate the investigation with respect to the ’956 patent. On June 1, 2006, the ALJ issued an Initial Determination granting the Company’s motion. On August 15, 2006, the ALJ set December 4, 2006 as the date for the hearing, April 4, 2007 for the Initial Determination, and August 13, 2007 as the target date for completion of the investigation. On September 12, 2006, the Company filed a motion to voluntarily terminate the investigation with respect to claims 1, 2, and 4 of the ’517 patent. On October 10, 2006, the ALJ issued an Initial Determination granting the Company’s motion with respect to claims 2 and 4 of the ’517 patent. On September 25, 2006, ST filed motions for summary determination of non-infringement of the ’338 patent with respect to its current products and non-infringement of the ’338 and ’517 patents with respect to prospective products and of lack of domestic industry with regard to the ’338 patent. On the same date, SanDisk filed a motion for summary determination of the economic prong of the domestic industry requirement with regard to the ’517 patent. On November 17, 2006, the ALJ granted SanDisk’s motion for summary determination of the economic prong of domestic industry, and denied ST’s motion for summary determination of lack of domestic industry with regard to the ’338 patent. The ALJ denied one of ST’s motions for summary determination of noninfringement of the ’338 patent. The ALJ granted ST’s motion for summary determination with respect to ST’s binary NOR products, which SanDisk was no longer accusing, and terminated the investigation with respect to certain prospective products. On November 28, 2006, the ALJ denied ST’s second motion for summary determination of non-infringement of the ’338 patent. The ALJ then held an evidentiary hearing from December 1, 2006 through December 15, 2006. On January 16, 2007, the ALJ extended the due date of the initial determination due to June 1, 2007.

     On or about July 15, 2005, Societa’ Italiana Per Lo Sviluppo Dell’electtronica, S.I.Sv.El., S.p.A., (“Sisvel”) filed suit against the Company and others in the district court of the Netherlands in The Hague in a case captioned Societa’ Italiana Per Lo Sviluppo Dell’electtronica, S.I.Sv.El., S.p.A. adverse to SanDisk International Sales, Moduslink B.V. and UPS SCS (Nederland) B.V., Case No. 999.131.1804 (Cause List numbers 2006/167 and 2006/168). Sisvel alleges that certain of the Company’s MP3 products infringe three European patents of which Sisvel claims to be a licensee with the right to bring suit. Sisvel seeks an injunction and unspecified damages. Sisvel has previously publicly indicated that it will license these and other patents under reasonable and nondiscriminatory terms, and it has specifically offered the Company a license under the patents. The Company has submitted its answer on the substance of Sisvel’s claim. Further pre-trial proceedings must be undertaken and a trial is unlikely in this matter until the end of 2007, at the earliest.

     In a related action, on March 9, 2006, the Company filed an action in the English High Court, Chancery Division, Patents Court, in London, against Sisvel and the owners of the patents Sisvel has asserted against the Company in the Netherlands. The case is SanDisk Corporation v. Koninklijke Philips Electronics N.V. (a Dutch corporation), France Télécom (a French corporation), Télédiffusion de France S.A. (a French corporation), Institut für Rundfunktechnik GmbH (a German corporation) and Societa’ Italiana Per Lo Sviluppo Dell’electtronica, S.I.Sv.El., S.p.A., Case No. HC 06 C 00835. In this action, the Company seeks a declaration of non-infringement of the patents asserted by Sisvel in connection with the Company’s MP3 products. The Company also seeks a declaration that the patents are not “essential” to the technology of MP3 players, as Sisvel presently contends in the case filed in the Netherlands. The defendants have submitted their formal defense and counterclaimed for infringement. The trial in this matter is expected to take place along with the trial for Case No. HC 06 C 00615 in February 2008.

     In another related action, on April 13, 2006, Audio MPEG filed a complaint alleging patent infringement in the District Court for the Eastern District of Virginia. The case is Audio MPEG v. SanDisk Corporation, Case No. 2:06cv209 WDK/JEB. Audio MPEG holds itself out to be the U.S. subsidiary of Sisvel and purports to have the right to enforce certain patents in the U.S. on subject matter related to the patents asserted by Sisvel in the Netherlands. Specifically, Audio MPEG asserts U.S. Patent No. 5,214,678 (entitled “Digital transmission system using subband coding of a digital signal”), U.S. Patent No. 5,323,396 (entitled “Digital transmission system, transmitter and receiver for use in the transmission system”), U.S. Patent No. 5,539,829 (entitled “Subband coded digital transmission system using some composite signals”), and U.S. Patent No. 5,777,992 (entitled “Decoder for decoding and encoded digital signal and a receiver comprising the decoder”). The court has issued a case management order and has indicated that the trial should be expected to take place in December 2007.

F-49

     In another related action, on April 13, 2006, Sisvel filed suit against the Company’s subsidiary, SanDisk GmbH, for patent infringement in the Mannheim District Court in Germany, S.I.Sv.El., S.p.A. v. SanDisk GmbH, file no. 7 O 90/06, which was served on the Company on or about May 10, 2006. The plaintiffs allege that certain of the Company’s MP3 products infringe four German patents of which Sisvel claims to be a licensee with the right to bring suit. Sisvel seeks an injunction and unspecified damages. Sisvel has previously publicly stated that it will license these and other patents under reasonable and nondiscriminatory terms, and it has specifically offered the Company a license under the patents. In a first trial in September of 2006, the Mannheim court expressed reservations about Sisvel’s claim of infringement and ordered further briefing and a resumption of the trial, which was held in January 2007. The court indicated that it expects to hand down a decision in March 2007.

     In another related action, on April 13, 2006, Sisvel filed suit against the Company for patent infringement in the Mannheim District Court in Germany, S.I.Sv.El., S.p.A. v. SanDisk Corporation, file no. 7 O 89/06, which was served on the Company in or about July, 2006. The plaintiffs allege that certain of the Company’s MP3 products infringe four German patents of which Sisvel claims to be a licensee with the right to bring suit. Sisvel seeks an injunction and unspecified damages. Sisvel has previously publicly stated that it will license these and other patents under reasonable and nondiscriminatory terms, and it has specifically offered the Company a license under the patents. Both sides submitted initial pleadings and the court held a trial in January 2007. The court indicated that it expects to hand down a decision in March 2007.

     On August 7, 2006, two purported shareholder class and derivative actions, captioned Capovilla v. SanDisk Corp., No. 106 CV 068760, and Dashiell v. SanDisk Corp., No. 106 CV 068759, were filed in the Superior Court of California in Santa Clara County, California. On August 9, 2006, and August 17, 2006, respectively, two additional purported shareholder class and derivative actions, captioned Lopiccolo v. SanDisk Corp., No. 106 CV 068946, and Sachs v. SanDisk Corp., No. 1-06-CV-069534, were filed in that court. These four lawsuits were subsequently consolidated under the caption In re msystems Ltd. Shareholder Litigation, No. 106 CV 068759 and on October 27, 2006, a consolidated amended complaint was filed that supersedes the four original complaints. The lawsuit is brought by purported shareholders of msystems and names as defendants the Company and each of msystems’ directors, including its President and Chief Executive Officer, and its former Chief Financial Officer (now its Chief Operating Officer), and names msystems as a nominal defendant. The lawsuit asserts purported class action and derivative claims. The alleged derivative claims assert, among other things, breach of fiduciary duties, abuse of control, constructive fraud, corporate waste, unjust enrichment and gross mismanagement with respect to past stock option grants. The alleged class and derivative claims also assert claims for breach of fiduciary duty by msystems’ board, which the Company is alleged to have aided an abetted, with respect to allegedly inadequate consideration for the merger, and allegedly false or misleading disclosures in proxy materials relating to the merger. The complaints seek, among other things, equitable relief, including enjoining the proposed merger, and compensatory and punitive damages.

     On September 11, 2006, Mr. Rabbi, a shareholder of msystems Ltd. (“msystems”), filed a derivative action and a motion to permit him to file the derivative action against four directors of msystems and msystems, arguing that options were allegedly allocated to officers and employees of msystems in violation of applicable law. Mr. Rabbi claimed that the aforementioned actions allegedly caused damage to msystems. On October 17, 2006, msystems filed a motion to change its title in the motion to permit the filing of the derivative action from a “Formal Respondent” to a “Respondent,” and Mr. Rabbi has consented to this motion. msystems received an extension of time to file its response to the motion until March 25, 2007. On January 25, 2007, msystems filed a motion to dismiss the motion to seek leave to file the derivative action and the derivative action on the grounds, inter alia, that Mr. Rabbi ceased to be a shareholder of msystems after the merger between msystems and the Company.

     On February 20, 2007, Texas MP3 Technologies Ltd. filed suit against the Company, Samsung Electronics Co., Ltd., Samsung Electronics America, Inc. and Apple Computer, Inc., Case No. 2:07-CV-52, in the Eastern District of Texas, Marshall Division, alleging patent infringement related to MP3 players.

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Note 15: Condensed Consolidating Financial Statements

     As part of the acquisition of msystems, the Company entered into a supplemental indenture whereby the Company became an additional obligor and guarantor of the assumed $75 million 1% Convertible Notes due 2035 issued by msystems Finance Company, (the “Subsidiary Issuer” or “mfinco”) and previously guaranteed by msystems Ltd. (the “Other Guarantor Subsidiary” or “msystems”). SanDisk Corporation’s (the “Parent Company” or the “Company”) guarantee is full and unconditional, jointly and severally with msystems. Both msystems and mfinco are wholly-owned subsidiaries of the Company. The following condensed consolidating financial statements present separate information for mfinco as the original issuer, the Company and msystems as guarantors and the Company’s other combined non-guarantor subsidiaries, and should be read in conjunction with the consolidated financial statements of the Company.

     These condensed consolidating financial statements have been prepared using the equity method of accounting. Earnings of subsidiaries are reflected in the Company’s investment in subsidiaries account. The elimination entries eliminate investments in subsidiaries, related stockholders’ equity and other intercompany balances and transactions. Only fiscal year 2006 financials are presented as the inception of the guarantee by the Company coincides only with the consummation of the acquisition of msystems on November 19, 2006. Therefore the results of operations and statement of cashflow presented for mfinco and msystems represent the period from the date of acquisition, November 19, 2006, to December 31, 2006.

Condensed Consolidating Statements of Operations
For the year ended December 31, 2006

					Other			Combined
	Parent		Subsidiary		Guarantor			Non-Guarantor		Consolidating			Total
	Company		Issuer		Subsidiary			Subsidiaries		Adjustments			Company
					(In thousands)
Total revenues	$	2,101,601	$	—	$	89,411		$	4,165,416	$	(3,098,903)		$	3,257,525
Total cost of revenues		1,280,102		—		84,763			3,664,513		(3,011,326	)		2,018,052
Gross profits		821,499		—		4,648			500,903		(87,577	)		1,239,473
Total operating expenses		467,259		—		212,735			324,587		(91,442	)		913,139
Operating income		354,240		—		(208,087	)		176,316		3,865			326,334
Total other income (expense)		96,415		5		1,663			44,925		(40,253	)		102,755
Income (loss) before taxes		450,655		5		(206,424	)		221,241		(36,388	)		429,089
Provision (benefit) for income taxes		229,376		—		(1,485	)		2,302		—			230,193
Equity in net income of consolidated subsidiaries		207,438		—		528			26,077		(234,043	)		—
Net income (loss)	$	428,717	$	5	$	(204,411	)	$	245,016	$	(270,431	)	$	198,896

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Condensed Consolidating Balance Sheets
As of December 31, 2006

							Combined
					Other		Non-
	Parent		Subsidiary		Guarantor		Guarantor		Consolidating			Total
	Company		Issuer		Subsidiary		Subsidiaries		Adjustments			Company
					(In thousands)
ASSETS
Current Assets:
Cash and cash equivalents	$	1,165,473	$	48	$	71,839	$	340,291	$	3,049		$	1,580,700
Short-term investments		1,192,084		—		26,294		2,681		7,714			1,228,773
Accounts receivable, net		256,801		—		55,864		313,407		(14,332	)		611,740
Inventory		106,772		—		71,839		318,154		(781	)		495,984
Deferred taxes		152,791		—		—		23,217		(1	)		176,007
Other current assets		344,722		69,992		74,434		229,912		(570,403	)		148,657
Total current assets		3,218,643		70,040		300,270		1,227,662		(574,754	)		4,241,861
Property and equipment, net		182,750		—		34,870		100,345		—			317,965
Goodwill		—		—		759,729		150,470		55			910,254
Intangibles, net		—		—		312,682		76,396		—			389,078
Other non-current assets		1,735,998		2,882		111,754		368,467		(1,110,476	)		1,108,625
Total assets	$	5,137,391	$	72,922	$	1,519,305	$	1,923,340	$	(1,685,175	)	$	6,967,783
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	43,910	$	—	$	46,349	$	312,219	$	(981	)	$	401,497
Other current accrued liabilities		515,042		226		59,287		512,525		(592,130	)		494,950
Total current liabilities		558,952		226		105,636		824,744		(593,111	)		896,447
Convertible long-term debt		1,150,000		71,471		—		4,614		(1,085	)		1,225,000
Non-current liabilities and deferred revenue		18,029		—		32,229		35,746		(7,802	)		78,202
Total liabilities		1,726,981		71,697		137,865		865,104		(601,998	)		2,199,649
Stockholders’ Equity:
Common stock		2,387,819		—		1,085,277		675,218		(491,193	)		3,657,121
Retained earnings		1,018,566		1,225		290,390		373,881		(578,542	)		1,105,520
Accumulated other comprehensive income		4,025		—		5,773		9,137		(13,442	)		5,493
Total stockholders’ equity		3,410,410		1,225		1,381,440		1,058,236		(1,083,177	)		4,768,134
Total liabilities and stockholders’ equity	$	5,137,391	$	72,922	$	1,519,305	$	1,923,340	$	(1,685,175	)	$	6,967,783

F-52

Condensed Consolidating Statements of Cash Flows
For the year ended December 31, 2006

									Combined
						Other			Non-
	Parent			Subsidiary		Guarantor			Guarantor			Consolidating			Total
	Company			Issuer		Subsidiary			Subsidiaries			Adjustments			Company
	(In thousands)
Net cash provided by (used in) operating activities		458,012			—		(15,214	)		330,026			(174,761	)		598,063
Net cash provided by (used in) investing activities		(1,039,970	)		—		73,927			(12,018	)		—			(978,061	)
Net cash provided by (used in) financing activities		1,201,779			—		(3,222	)		(1,269	)		—			1,197,288
Effect of changes in foreign currency exchange rates on cash		1,542			—		247			(437	)		—			1,352
Net increase (decrease) in cash and cash equivalents		621,363			—		55,738			316,302			(174,761	)		818,642
Cash and cash equivalents at beginning of period		544,110			48		16,101			23,990			177,809			762,058
Cash and cash equivalents at end of period	$	1,165,473		$	48	$	71,839		$	340,292		$	3,048		$	1,580,700

F-53

Note 16: Supplementary Financial Data (Unaudited)

	Quarters Ended
	April 2, 2006		July 2, 2006		October 1, 2006		December 31, 2006
	(In thousands, except per share data)
2006
Revenues
Product	$	537,728	$	636,675	$	673,189	$	1,078,880
License and royalty		85,532		82,510		78,196		84,815
Total revenues		623,260		719,185		751,385		1,163,695
Gross profit(1)		238,393		289,008		296,040		416,032
Operating income(1)		57,925		128,542		128,327		11,540
Net income (loss)	$	35,115	$	95,641	$	103,281	$	(35,141	)
Net income (loss) per share
Basic	$	0.18	$	0.49	$	0.53	$	(0.17	)
Diluted	$	0.17	$	0.47	$	0.51	$	(0.17	)
	Quarters Ended
	April 3, 2005		July 3, 2005		October 2, 2005		January 1, 2006
	(In thousands, except per share data)
2005
Revenues
Product	$	399,679	$	453,762	$	529,735	$	683,431
License and royalty		51,296		61,134		59,896		67,136
Total revenues		450,975		514,896		589,631		750,567
Gross profit		199,787		214,099		256,784		302,064
Operating income		113,519		106,044		158,568		198,451
Net income(2)	$	74,516	$	70,496	$	107,458	$	133,914
Net income per share
Basic(3)	$	0.41	$	0.39	$	0.59	$	0.72
Diluted(3)	$	0.39	$	0.37	$	0.55	$	0.68
(1)         Includes the following charges related to acquisitions of Matrix in January 2006 and msystems in November 2006, share-based             compensation and amortization of acquisition-related intangible assets:

	Quarters Ended
	April 2, 2006		July 2, 2006		October 1, 2006		December 31, 2006
	(In thousands)
Write-off of acquired in-process technology	$	39,600	$	—	$	—	$	186,000
Share-based compensation		18,786		25,870		25,192		30,793
Amortization of acquisition-related intangible assets		3,715		4,432		4,432		15,221
Total	$	62,101	$	30,302	$	29,624	$	232,014

(2)	In the first and second quarter of 2005, we recognized a loss of ($10.1) million and ($0.1) million on the other-than-temporary decline in the fair value of our investment in Tower and our Tower warrants, respectively.
(3)	Quarterly earnings per share figures may not total to yearly earnings per share, due to rounding and fluctuations in the number of options included or omitted from diluted calculations based on the stock price or option strike prices.

F-54

Note 17: Subsequent Events

     In September 2006, Flash Partners entered into a master equipment lease agreement providing for up to 98.0 billion Japanese yen, or approximately $823 million based upon the exchange rate at December 31, 2006, of original lease obligations. On January 10, 2007, Flash Partners utilized approximately 52.0 billion Japanese yen, or approximately $437 million based upon the exchange rate at December 31, 2006, of the total amount provided for under the September 2006 master lease agreement, of which the Company guaranteed 26.0 billion Japanese yen, or approximately $218 million based upon the exchange rate at December 31, 2006. See Note 8, “Commitments, Contingencies and Guarantees.”

     On February 15, 2007, the Board of Directors of the Company approved a plan (the “Plan”) to reduce operating costs, which includes a worldwide reduction in force of up to 10% of the Company’s headcount, or approximately 250 employees. The Company expects to incur a restructuring charge in connection with the Plan of approximately $15 million to $20 million, with the majority of the expense occurring in the first quarter of 2007. Cash payments associated with the Plan will be approximately half of the total restructuring charge, with the remainder comprised of share-based compensation charges resulting primarily from acceleration of certain equity awards as per terms of the msystems acquisition. The workforce reduction will impact functions related to operations, engineering, sales and marketing and administration, and will primarily be based in the United States and Israel, and to a lesser degree, other international locations. The Plan is expected to be completed by the third quarter of fiscal 2007.

F-55

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

SANDISK CORPORATION
By:	/s/ Judy Bruner
	Judy Bruner
	Executive Vice President, Administration and Chief Financial Officer (On behalf of the Registrant and as Principal Financial and Accounting Officer)

Dated: February 27, 2007

POWER OF ATTORNEY

     KNOW ALL PEOPLE BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Eli Harari and Judy Bruner, jointly and severally, his or her attorneys in fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys in fact, or his or her substitute or substitutes, may do or cause to be done by virtue thereof.

     Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

	Signature	Title	Date
By:	/s/ Eli Harari (Dr. Eli Harari)	Chairman of the Board and Chief Executive Officer (Principal Executive Officer)	February 27, 2007
By:	/s/ Judy Bruner (Judy Bruner)	Executive Vice President, Administration and Chief Financial Officer (Principal Financial and Accounting Officer)	February 27, 2007
By:	/s/ Irwin Federman (Irwin Federman)	Vice Chairman of the Board and Lead Independent Director	February 27, 2007
By:	/s/ Steven J. Gomo	Director	February 27, 2007
	(Steven J. Gomo)
By:	/s/ Catherine P. Lego	Director	February 27, 2007
	(Catherine P. Lego)
By:	/s/ Michael E. Marks	Director	February 27, 2007
	(Michael E. Marks)
By:	/s/ James D. Meindl	Director	February 27, 2007
	(James D. Meindl)

S-1

INDEX TO EXHIBITS

Exhibit
Number		Exhibit Title
	2.1	Agreement and Plan of Merger, dated as of October 20, 2005, by and among the Registrant, Mike Acquisition Company LLC, Matrix Semiconductor, Inc. and Bruce Dunlevie as the stockholder representative for the stockholders of Matrix Semiconductor, Inc.(26)
	2.2	Agreement and Plan of Merger, dated as of July 30, 2006, by and among the Registrant, Project Desert Ltd. and msystems Ltd.(30)
	3.1	Restated Certificate of Incorporation of the Registrant.(2)
	3.2	Certificate of Amendment of the Restated Certificate of Incorporation of the Registrant dated December 9, 1999.(7)
	3.3	Certificate of Amendment of the Restated Certificate of Incorporation of the Registrant dated May 11, 2000.(10)
	3.4	Certificate of Amendment to the Amended Restated Certificate of Incorporation of the Registrant dated May 26, 2006.(33)
	3.5	Restated Bylaws of the Registrant, as amended April 5, 2006.(27)
	3.6	Certificate of Designations for the Series A Junior Participating Preferred Stock, as filed with the Delaware Secretary of State on April 24, 1997.(4)
	3.7	Amendment to Certificate of Designations for the Series A Junior Participating Preferred Stock, as filed with the Delaware Secretary of State on September 24, 2003.(19)
	4.1	Reference is made to Exhibits 3.1, 3.2, 3.3, and 3.4.(2), (7), (10), (33)
	4.2	Rights Agreement, dated as of September 15, 2003, between the Registrant and Computershare Trust Company, Inc.(18)
	4.3	Amendment No. 1 to Rights Agreement by and between the Registrant and Computershare Trust Company, Inc., dated as of November 6, 2006.(36)
	4.4	SanDisk Corporation Form of Indenture (including notes).(28)
	4.5	Indenture (including form of Notes) with respect to the Registrant’s 1.00% Convertible Senior Notes due 2013 dated as of May 15, 2006 by and between the Registrant and The Bank of New York.(29)
	10.1	Form of Indemnification Agreement entered into between the Registrant and its directors and officers.(2)
	10.2	License Agreement between the Registrant and Dr. Eli Harari, dated September 6, 1988.(2)
	10.3	Lease Agreement between the Registrant and G.F. Properties, dated March 1, 1996.(3)
	10.4	Amendment to Lease Agreement between the Registrant and G.F. Properties, dated April 3, 1997.(5)
	10.5	Lease Agreement between the Registrant and G.F. Properties, dated June 10, 1998.(6)
	10.6	SanDisk Corporation 1995 Stock Option Plan, as Amended and Restated January 2, 2002.(15), (*)
	10.7	SanDisk Corporation 1995 Non-Employee Directors Stock Option Plan, as Amended and Restated as of January 2, 2004.(16), (*)
	10.8	Share Purchase Agreement, dated as of July 4, 2000, by and between the Registrant and Tower Semiconductor Ltd.(8)

1

Exhibit
Number		Exhibit Title
	10.9	Escrow Agreement, dated as of August 14, 2000, by and between the Registrant, Tower Semiconductor Ltd. and Union Bank of California, N.A.(8)
	10.10	Additional Purchase Obligation Agreement, dated as of July 4, 2000, by and between the Registrant and Tower Semiconductor Ltd.(8)
	10.11	Registration Rights Agreement, dated as of January 18, 2001, by and between the Registrant, The Israel Corporation, Alliance Semiconductor Ltd., Macronix International Co., Ltd. and Quick Logic Corporation.(9)
	10.12	Consolidated Shareholders Agreement, dated as of January 18, 2001, by and among the Registrant, The Israel Corporation, Alliance Semiconductor Ltd. and Macronix International Co., Ltd.(9)
	10.13	Agreement, dated as of September 28, 2006, by and among the Registrant, Bank Leumi Le Israel B.M., a banking corporation organized under the laws of the State of Israel, The Israel Corporation Ltd., Alliance Semiconductor Corporation and Macronix International Co. Ltd.(35)
	10.14	Agreement, dated as of September 28, 2006, by and among the Registrant, Bank Hapoalim B.M., a banking corporation organized under the laws of the State of Israel, The Israel Corporation Ltd., Alliance Semiconductor Corporation and Macronix International Co. Ltd.(35)
	10.15	Amendment to Share Purchase Agreement, dated as of March 20, 2002, by and between the Registrant and Tower Semiconductor Ltd.(11)
	10.16	Amendment to Share Purchase Agreement, dated as of February 21, 2003, by and between the Registrant, Tower Semiconductor Ltd. and the other parties thereto.(17)
	10.17	Side Letter to Amendment to Share Purchase Agreement, dated as of February 24, 2003, by and between the Registrant, Tower Semiconductor Ltd. and the other parties thereto.(17)
	10.18	Side Letter to Amendment to Share Purchase Agreement, dated as of April 14, 2003, by and between the Registrant, Tower Semiconductor Ltd. and the other parties thereto.(17)
	10.19	Amendment No. 3 to Payment Schedule of Series A-5 Additional Purchase Obligations, Waiver of Series A-5 Conditions, Conversion of Series A-4 Wafer Credits and Other Provisions, dated as of November 11, 2003, by and between the Registrant, Tower Semiconductor Ltd. and the other parties thereto.(19)
	10.20	New Master Agreement, dated as of April 10, 2002, by and between the Registrant and Toshiba Corporation.(12), (1)
	10.21	Amendment to New Master Agreement, dated and effective as of August 13, 2002 by and between the Registrant and Toshiba Corporation.(13), (1)
	10.22	New Operating Agreement, dated as of April 10, 2002, by and between the Registrant and Toshiba Corporation.(12), (1)
	10.23	Indemnification and Reimbursement Agreement, dated as of April 10, 2002, by and between the Registrant and Toshiba Corporation.(12), (1)
	10.24	Amendment to Indemnification and Reimbursement Agreement, dated as of May 29, 2002 by and between the Registrant and Toshiba Corporation.(12)
	10.25	Amendment No. 2 to Indemnification and Reimbursement Agreement, dated as of May 29, 2002 by and between the Registrant and Toshiba Corporation.(34)
	10.26	Settlement Agreement, dated as of November 14, 2003, by and among the Registrant, Lee and Li and certain Lee and Li partners.(19), (1)
	10.27	Form of Change of Control Agreement entered into by and between the Registrant and each of the following officers of the Registrant: the Chief Financial Officer; the Executive Vice President and Chief Operating Officer; the Sr. Vice President and General Manager, Retail Business Unit; the Sr. Vice President, Engineering; the Vice President and General Counsel; and the Vice President, Business Development.(20), (*)

2

Exhibit
Number		Exhibit Title
	10.28	Change of Control Agreement entered into by and between the Registrant and the President and Chief Executive Officer of the Registrant.(20), (*)
	10.29	Settlement and Release Agreement, dated as of June 29, 2004, by and between the Registrant and Michael Gray.(21)
	10.30	Flash Partners Master Agreement, dated as of September 10, 2004, by and among the Registrant and the other parties thereto.(21), (1)
	10.31	Flash Alliance Master Agreement, dated as of July 7, 2006, by and among the Registrant, Toshiba Corporation and SanDisk (Ireland) Limited.(31), (+)
	10.32	Operating Agreement of Flash Partners Ltd., dated as of September 10, 2004, by and between SanDisk International Limited and Toshiba Corporation.(21), (1)
	10.33	Operating Agreement of Flash Alliance, Ltd., dated as of July 7, 2006, by and between Toshiba Corporation and SanDisk (Ireland) Limited.(31), (+)
	10.34	Amended and Restated Common R&D and Participation Agreement, dated as of September 10, 2004, by and between the Registrant and Toshiba Corporation.(21), (1)
	10.35	Second Amended and Restated Common R&D and Participation Agreement, dated as of July 7, 2006, by and between the Registrant and Toshiba Corporation.(31), (+)
	10.36	Amended and Restated Product Development Agreement, dated as of September 10, 2004, by and between the Registrant and Toshiba Corporation.(21), (1)
	10.37	Second Amended and Restated Product Development Agreement, dated as of July 7, 2006, by and between the Registrant and Toshiba Corporation.(31), (+)
	10.38	Mutual Contribution and Environmental Indemnification Agreement, dated as of September 10, 2004, by and among the Registrant and the other parties thereto.(21), (1)
	10.39	Flash Alliance Mutual Contribution and Environmental Indemnification Agreement, dated as of July 7, 2006, by and between Toshiba Corporation and SanDisk (Ireland) Limited.(31), (+)
	10.40	Patent Indemnification Agreement, dated as of September 10, 2004 by and among the Registrant and the other parties thereto.(21), (1)
	10.41	Patent Indemnification Agreement, dated as of July 7, 2006, by and among the Registrant and the other parties thereto.(31), (+)
	10.42	Master Lease Agreement, dated as of December 24, 2004, by and among Mitsui Leasing & Development, Ltd., IBJ Leasing Co., Ltd., and Sumisho Lease Co., Ltd. and Flash Partners Ltd.(22), (1)
	10.43	Master Lease Agreement, dated as of September 22, 2006, by and among Flash Partners Limited Company, SMBC Leasing Company, Limited, Toshiba Finance Corporation, Sumisho Lease Co., Ltd., Fuyo General Lease Co., Ltd., Tokyo Leasing Co., Ltd., STB Leasing Co., Ltd. and IBJ Leasing Co., Ltd.(31), (+)
	10.44	Guarantee Agreement, dated as of December 24, 2004, by and between the Registrant and Mitsui Leasing & Development, Ltd.(22)
	10.45	Guarantee Agreement, dated as of September 22, 2006, by and among the Registrant, SMBC Leasing Company, Limited and Toshiba Finance Corporation.(31)
	10.46	Amended and Restated SanDisk Corporation 2005 Incentive Plan.(34), (*)
	10.47	SanDisk Corporation Form of Notice of Grant of Stock Option.(23), (*)

3

Exhibit
Number		Exhibit Title
	10.48	SanDisk Corporation Form of Notice of Grant of Non-Employee Director Automatic Stock Option (Initial Grant).(23), (*)
	10.49	SanDisk Corporation Form of Notice of Grant of Non-Employee Director Automatic Stock Option (Annual Grant).(23), (*)
	10.50	SanDisk Corporation Form of Stock Option Agreement.(23), (*)
	10.51	SanDisk Corporation Form of Automatic Stock Option Agreement.(23), (*)
	10.52	SanDisk Corporation Form of Restricted Stock Unit Issuance Agreement.(23), (*)
	10.53	SanDisk Corporation Form of Restricted Stock Unit Issuance Agreement (Director Grant).(23), (*)
	10.54	SanDisk Corporation Form of Restricted Stock Award Agreement.(23), (*)
	10.55	SanDisk Corporation Form of Restricted Stock Award Agreement (Director Grant).(23), (*)
	10.56	Form of Amendment to Change of Control Agreement for those officers of the Registrant who are party to such Agreement.(24), (*)
	10.57	Guarantee Agreement between the Registrant, IBJ Leasing Co., Ltd., Sumisho Lease Co., Ltd., and Toshiba Finance Corporation.(25)
	10.58	Guarantee Agreement, dated as of June 20, 2006, by and between the Registrant, IBJ Leasing Co., Ltd., Sumisho Lease Co., Ltd. and Toshiba Finance Corporation.(34)
	10.59	Basic Lease Contract between Flash Partners Yuken Kaisha, IBJ Leasing Co., Ltd., Sumisho Lease Co., Ltd., and Toshiba Finance Corporation.(25), (+)
	10.60	Basic Lease Contract, dated as of June 20, 2006, by and between Flash Partners Yuken Kaisha, IBJ Leasing Co., Ltd., Sumisho Lease Co., Ltd. and Toshiba Finance Corporation.(34), (+)
	10.61	SanDisk Corporation Form of Voting Agreement.(30)
	10.62	Sublease (Building 3), dated as of December 21, 2005 by and between Maxtor Corporation and the Registrant.(34)
	10.63	Sublease (Building 4), dated as of December 21, 2005 by and between Maxtor Corporation and the Registrant.(34)
	10.64	Sublease (Building 5), dated as of November 1, 2006 by and between Maxtor Corporation and the Registrant.(**)
	10.65	Sublease (Building 6), dated as of December 21, 2005 by and between Maxtor Corporation and the Registrant.(34)
	10.66	Separation Agreement between the Registrant and Nelson Chan, dated as of December 8, 2006.(32)
	12.1	Computation of ratio of earnings to fixed charges. (**)
	21.1	Subsidiaries of the Registrant(**)
	23.1	Consent of Independent Registered Public Accounting Firm(**)
	31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(**)
	31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(**)
	32.1	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(**)

4

Exhibit
Number		Exhibit Title
	32.2	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(**)

*	Indicates management contract or compensatory plan or arrangement.
**	Filed herewith.
+	Confidential treatment has been requested with respect to certain portions hereof.
1.	Confidential treatment granted as to certain portions of these exhibits.
2.	Previously filed as an Exhibit to the Registrant’s Registration Statement on Form S-1 (No. 33-96298).
3.	Previously filed as an Exhibit to the Registrant’s 1995 Annual Report on Form 10-K. (File No. 0-26734)
4.	Previously filed as an Exhibit to the Registrant’s Current Report on Form 8-K/A dated April 18, 1997.
5.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended June 30, 1997.
6.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended June 30, 1998.
7.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended June 30, 2000.
8.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended September 30, 2000.
9.	Previously filed as an Exhibit to the Registrant’s Schedule 13(d) dated January 26, 2001.
10.	Previously filed as an Exhibit to the Registrant’s Registration Statement on Form S-3 (No. 333-85686).
11.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended March 31, 2002.
12.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended June 30, 2002.
13.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended September 30, 2002.
14.	Previously filed as an Exhibit to the Registrant’s Registration Statement on Form S-8 (No. 333-63076).
15.	Previously filed as an Exhibit to the Registrant’s Registration Statement on Form S-8 (No. 333-85320).
16.	Previously filed as an Exhibit to the Registrant’s Registration Statement on Form S-8 (No. 333-112139).
17.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended March 30, 2003.
18.	Previously filed as an Exhibit to the Registrant’s Registration Statement on Form 8-A dated September 25, 2003.
19.	Previously filed as an Exhibit to the Registrant’s 2003 Annual Report on Form 10-K.
20.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended June 27, 2004.
21.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended September 26, 2004.
22.	Previously filed as an Exhibit to the Registrant’s 2004 Annual Report on Form 10-K.
23.	Previously filed as an Exhibit to the Registrant’s Current Report on Form 8-K dated June 3, 2005.

5

24.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended July 3, 2005.
25.	Previously filed as an Exhibit to the Registrant’s 2005 Annual Report on Form 10-K.
26.	Previously filed as an Exhibit to the Registrant’s Form 8-K dated January 20, 2006.
27.	Previously filed as an Exhibit to the Registrant’s Form 8-K dated April 10, 2006.
28.	Previously filed as an Exhibit to the Registrant’s Form 8-K dated May 9, 2006.
29.	Previously filed as an Exhibit to the Registrant’s Form 8-K dated May 15, 2006.
30.	Previously filed as an Exhibit to the Registrant’s Form 8-K/A dated August 1, 2006.
31.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended October 1, 2006
32.	Previously filed as an Exhibit to the Registrant’s Form 8-K dated December 8, 2006.
33.	Previously filed as an Exhibit to the Registrant’s Form 8-K dated June 1, 2006.
34.	Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended July 2, 2006.
35.	Previously filed as an Exhibit to the Registrant’s Schedule 13(d)/A dated October 12, 2006.
36.	Previously filed as an Exhibit to the Registrant’s Form 8-A/A dated November 8, 2006.

6

EX-10.64

EXHIBIT 10.64

SUBLEASE
(BUILDING 5)

     THIS SUBLEASE (“Sublease”), dated as of November 1, 2006, is made by and between MAXTOR CORPORATION, a Delaware corporation (“Sublessor”), and SANDISK CORPORATION, a Delaware corporation (“Sublessee”).

RECITALS

     A. John Arrillaga, Trustee or his Successor Trustee u/t/a dated 7/20/77 (John Arrillaga Separate Property Trust), as amended, and Richard T. Peery, Trustee or his Successor Trustee u/t/a dated 7/20/77 (Richard T. Peery Separate Property Trust), as amended (collectively, “Original Master Lessor”), and Quantum Corporation, a Delaware corporation (“Quantum”), have entered into: (i) that certain Lease Agreement dated March 23, 1994 pursuant to which Quantum leased from Original Master Lessor the real property commonly called 1100 Sumac Drive, Milpitas, California and the building constructed thereon (“Building 5” or the “Building”), as amended by that certain Amendment No. 1 to Lease dated April 16, 1997 and that certain Amendment No. 2 to Lease dated March 22, 2001 (collectively, the “Building 5 Master Lease” or the “Master Lease”); (ii) that certain Lease Agreement dated September 17, 1990 pursuant to which Quantum leased from Original Master Lessor the real property commonly called 1000 Sumac Drive, Milpitas, California and the building constructed thereon (“Building 4”), as amended by that certain Amendment No. 1 to Lease dated April 16, 1997 and that certain Amendment No. 2 to Lease dated March 26, 2001 (collectively, the “Building 4 Master Lease”); (iii) that certain Lease Agreement dated April 16, 1997 pursuant to which Quantum leased from Original Master Lessor the real property commonly called 601 McCarthy Boulevard, Milpitas, California and the building constructed thereon (“Building 6”), as amended by that certain Amendment No. 1 to Lease dated April 15, 1998 and that certain Amendment No. 2 to Lease dated March 22, 2001 (collectively, the “Building 6 Master Lease”); and (iv) that certain Lease Agreement dated April 10, 1992 pursuant to which Quantum leased from Origiinal Master Lessor the real property commonly called 900 Sumac Drive, Milpitas, California and the building constructed thereon (“Building 3”), as amended by that certain Amendment No. 1 to Lease dated April 16, 1997 and that certain Amendment No. 2 to Lease dated March 22, 2001 (collectively, the “Building 3 Master Lease”). Pursuant to Amendment No. 2 to each of the foregoing leases, Sublessor has succeeded to the interest of Quantum as tenant thereunder. Additionally, Original Master Lessor has transferred all of its right, title and interest in the Building 3 Master Lease, the Building 4 Master Lease, the Building 5 Master Lease and the Building 6 Master Lease to Silicon Valley CA-I, LLC, a Delaware limited liability company (hereinafter, “Master Lessor”). A copy of the Building 5 Master Lease is attached hereto as Exhibit D.

     B. Sublessee has previously subleased from Sublessor, and Sublessor has previously subleased to Sublessee, (i) the entire premises covered by the Building 3 Master Lease upon the terms and conditions set forth in that certain Sublease (Building 3) dated December 21, 2005

between Sublessor and Sublessee (the “Building 3 Sublease”), (ii) the entire premises covered by the Building 4 Master Lease upon the terms and conditions set forth in that certain Sublease (Building 4) dated December 21, 2005 between Sublessor and Sublessee (the “Building 4 Sublease”), and (iii) the entire premises covered by the Building 6 Master Lease upon the terms and conditions set forth in that certain Sublease (Building 6) dated December 21, 2005 between Sublessor and Sublessee (the “Building 6 Sublease”). This Building 3 Sublease, the Building 4 Sublease and the Building 6 Sublease are collectively called the “ Other Subleases”.

     C. Sublessee now desires to sublease from Sublessor, and Sublessor now desires to sublease to Sublessee, the entire premises covered by the Building 5 Master Lease upon the terms and conditions hereinafter set forth in this Sublease. This Sublease, and the Other Subleases are collectively called the “Subleases”.

     NOW, THEREFORE, in consideration of the mutual promises contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Sublessor and Sublessee agree as follows:

     1. Definitions. All capitalized terms not otherwise defined herein shall have the respective meanings ascribed to them under the Master Lease.

     2. Subleased Premises. Subject to the terms and conditions contained in this Sublease, Sublessor hereby subleases to Sublessee, and Sublessee hereby subleases from Sublessor, the entire premises covered by the Master Lease as depicted on Exhibit A hereto (the “Subleased Premises”); provided, however, subject to Section 29 below, Sublessor shall retain for itself and its employees, agents, contractors, invitees, licensees, successors and assigns (and Sublessee does hereby grant to each of the foregoing) the right to non-exclusive use of all common areas, landscaped areas, sidewalks and driveways related to the Building. Moreover, subject to the terms and conditions of this Sublease, Sublessee shall have exclusive use of the service yard adjacent to Building 5 comprising approximately 2862 square feet as depicted on Exhibit A attached hereto as AREA B thereon (the “ B5 Service Yard”), and shall have the non-exclusive use of all common areas, landscaped areas, sidewalks and driveways related to the Building. For all purposes hereunder, the B5 Service Yard shall be treated as a part of the Subleased Premises as of the Commencement Date (as hereinafter defined). For the avoidance of doubt, Sublessee acknowledges that it has no right to access any building other than the Building and Buildings 3, 4 and 6 while the Other Subleases and this Sublease are in effect. Sublessee hereby acknowledges and agrees that Building 5 consists of approximately 94,484 rentable square feet. Nevertheless, the parties agree that the foregoing approximation shall be final and binding for all purposes hereunder; and notwithstanding anything to the contrary contained herein, no adjustment shall be made to the Base Rent (as defined in Section 5.1(a) below) if the actual square footage of Building 5 differs from any reference to square footage contained herein.

     3. Term; Sublease Consent; Early Entry.

          3.1 Term. Provided that Master Lessor has consented to this Sublease (the “Sublease Consent”) and unless sooner terminated in accordance with the provisions contained herein, the term (“Term”) of this Sublease shall commence on January 1, 2007 (the

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“Commencement Date”) and shall expire on July 31, 2011 (the “Expiration Date”) [sixty (60) days prior to the expiration date of the Master Lease]. If the Sublease Consent has not been obtained by January 1, 2007, then the Commencement Date shall be the date that Sublessor delivers the Sublease Consent executed by Master Lessor to Sublessee.

          3.2 Sublease Consent. If Master Lessor has not consented to this Sublease on or prior to November 30, 2006, then either party hereto shall have the right to terminate this Sublease at any time on or prior to December 31, 2006, effective upon written notice to the other party. Sublessor agrees to use commercially reasonable efforts to obtain a non-disturbance agreement for the benefit of Sublessee as part of the Sublease Consent.

          3.3 Delivery of Subleased Premises. Sublessor and Sublessee acknowledge that, despite the commencement of the Term on the Commencement Date, possession of certain portions of the Subleased Premises shall not be delivered to Sublessee until later dates as set forth below. On the Commencement Date, Landlord shall deliver possession of that portion of the Subleased Premises on the first floor of the Building comprising 43,494 rentable square feet and depicted in Exhibit A-1 attached to this Sublease by the areas marked in blue, green and pink lines (and noted thereon as the “Initial Premises”). On or before April 1, 2007, Landlord shall deliver possession of that portion of the Subleased Premises on the first floor of the Building comprising 3,801 rsf and depicted in Exhibit A-1 attached to this Sublease by the areas marked in orange lines, at which time Sublessee shall be deemed to have been delivered all of the first floor of the Building, comprising 47,295 rentable square feet, and all of the Subleased Premises on the second floor of the Building, comprising 47,189 rsf (and noted thereon as the “Remainder Premises”) (such date of actual delivery, the “RP Delivery Date”). Sublessor will use all commercially reasonable efforts to deliver possession of the noted portions of the Subleased Premises to Sublessee by the dates set forth above; provided, however, notwithstanding the dates for delivery of the Initial Premises and the Remainder Premises set forth above, Sublessor shall not be liable for damages to Sublessee for failure to deliver possession of the any part of the Subleased Premises to Sublessee for any reason whatsoever, nor shall this Sublease be void or voidable as a result of such delay, except that the no Rent shall be payable on any portion of the Subleased Premises not delivered until Sublessor delivers possession of such portion of the Subleased Premises to Sublessee (so long as Sublessee is not responsible for such failure or delay), and in the event that any portion of the Premises is not delivered within [sixty (60)] days of the date targeted for delivery as set forth above, Sublessee shall be entitled, as to such portion of the Premises delivered late, to one (1) days’ free rent following the actual delivery of such portion of the Premises for each day beyond [sixty (60)] days that actual delivery thereof is delayed. Sublessee further recognizes and acknowledges that Sublessor will be occupying a portion of the Building during the Term, and that not all portions of the Building occupied by Sublessor and Sublessee will be separately demised and secure from each other’s access. In order to maintain such separation and security to as great a degree as possible, Sublessor shall, at Sublessee’s sole cost and expense, either demise the Building as reasonably appropriate, or engage a private security firm to keep the undemised portions of the Building secure from unauthorized entry by Sublessor and Sublessee. Sublessor shall supply Sublessee with appropriate invoices of all costs and expenses so incurred and Sublessee shall reimburse Sublessor for such costs and expenses within thirty (30) days of receipt of such invoices.

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          3.4 Early Entry. Prior to the delivery of each portion of the Subleased Premises as set forth in Section 3.3 above, Sublessee and Sublessee’s employees, agents and contractors shall be permitted to enter such undelivered portions of the Subleased Premises during Building business hours (as determined by Sublessor in its sole discretion) for the sole purposes of preparing construction drawing, plans and specifications, and for no other purposes. Such entry shall be subject to all of the terms and conditions of the Master Lease and this Sublease, including without limitation, (a) the indemnity and hold harmless provisions of Section 9 of this Sublease and (b) the obligation to pay utilities and janitorial services; provided, however, other than as provided in Section 5.2 below, Sublessee shall not be required to pay any Base Rent nor Operating Expense Payments for Real Property Taxes, insurance premiums and common area expenses with regard to such early entry. Sublessee shall furnish to Sublessor evidence of the insurance required under Section 7 of this Sublease prior to any entry into any portion of the Subleased Premises. Moreover, and without limiting the foregoing, Sublessee shall indemnify, protect, defend with counsel reasonably acceptable to Sublessor and hold harmless Sublessor and Sublessor’s shareholders, directors, officers, employees, agents, affiliates, successors and assigns from and against any and all claims, demands, liabilities, judgments, losses, causes of action, fines, penalties, damages, costs and expenses, including reasonable attorneys’ and experts’ fees (collectively, “Claims”), caused by or arising in connection with the early entry described in this Section 3.4, including without limitation, any Claims by Master Lessor that Sublessor has committed (or allegedly committed) a default and/or breach under the Master Lease by permitting the early entry described in this Section 3.4 if made prior to delivery of the Sublease Consent. Sublessee’s indemnification and other covenants provided in this Section 3.4 shall survive the expiration or termination of this Sublease.

     4. Use; “As Is” Condition; Furniture.

          4.1 Use. Sublessee shall use the Subleased Premises for any legal use permitted under the Master Lease. Sublessee acknowledges that it is thoroughly familiar with the condition of the Subleased Premises, and Sublessee agrees that it is subleasing the Subleased Premises on an “AS IS”, “WHERE IS” basis, subject to all latent or patent defects, without any representation or warranty by Sublessor or Master Lessor or their respective employees or agents as to the condition of the Subleased Premises or their fitness for Sublessee’s use, except as otherwise set forth in this Sublease, and subject to all applicable zoning, municipal, county and state laws, ordinances and regulations governing and regulating the use of the Subleased Premises, and any easements, covenants or restrictions of record. Sublessee acknowledges that Sublessor and Master Lessor and their respective employees or agents have not made any representations or warranties that the Subleased Premises comply with applicable law, ordinance, rule, regulation or covenant or restriction of record (collectively, “Applicable Requirements”), including, but not limited to, the Americans With Disabilities Act, as amended (“ADA”), or any laws relating to earthquake or other life/safety matters or Hazardous Substances (as defined below), except as set forth in this Sublease. The parties hereto agree that the plans attached hereto as Exhibit B accurately reflect all Alterations (as defined below) in the Subleased Premises existing as of the date hereof (collectively, the “Existing Alterations”). Sublessor hereby assigns all of its right, title and interest under any warranties with respect to the Building and/or such Building’s systems and which are then in effect and which by their terms may be assigned without the consent of the counterparty thereto (collectively, “Building Warranties”). The assignment of the Building Warranties is conditioned on this Sublease being in full force

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and effect and that upon expiration or termination of this Sublease, the conditional assignment shall terminate automatically and Sublessee shall not have any further right, title or interest in the Building Warranties.

          4.2 Alterations. Sublessee shall obtain both Sublessor’s and Master Lessor’s prior written consent to the architect and contractor engaged by Sublessee to perform work in or about the Subleased Premises, which consent Sublessor shall not unreasonably withhold. Sublessor agrees that it shall not charge Sublessee any supervisory fee with respect to any alterations, additions or improvements (collectively, “Alterations”) that Sublessee makes to the Subleased Premises, other than any supervisory fee that Master Lessor charges Sublessor with respect thereto (which charge Sublessee shall pay Sublessor as Additional Rent (as defined below) hereunder). Except as modified by this Section, Sublessee shall strictly comply with all obligations of Section 6 of the Master Lease, as incorporated by reference herein. Notwithstanding anything to the contrary contained in this Sublease, (a) if so required in writing by Master Lessor, Sublessee shall remove all Alterations made by or on behalf of Sublessee in or to the Subleased Premises (whether or not Sublessor’s consent was required hereunder) at expiration or termination of this Sublease and restore the Subleased Premises to the condition shown on Exhibit B hereto, ordinary wear and tear and damage caused by Sublessor excepted, all at Sublessee’s sole cost and expense, and (b) Sublessee shall not be required to obtain Sublessor’s consent (but shall still be required to obtain Master Lessor’s consent, if applicable) to any Alteration to the Subleased Premises if (i) (A) the total cost (including soft costs) for such Alteration does not exceed Twenty Thousand Dollars ($20,000), (B) such Alteration does not affect the foundation, roof or any structural component of the Building, (C) such Alteration does not materially affect the Building’s mechanical, electrical, plumbing or life safety systems, and (D) Sublessee provides Sublessor with not fewer than ten (10) days’ prior written notice of Sublessee’s construction or installation of such Alteration, or (ii) if Master Lessor consents in writing to the Alterations in question and agrees that it need not be removed at the end of the term of the Master Lease. Sublessee shall furnish to Sublessor copies of all permits and plans and specifications for all Alterations made by or for Sublessee to the Subleased Premises, whether or not Sublessor’s consent thereto is required hereunder. Sublessee shall pay, when due, all Claims for labor or materials furnished or alleged to have been furnished to or for Sublessee at or for use on the Subleased Premises. If any mechanic’s lien is recorded for work claimed to have been done for, or on behalf of, or for materials claimed to be furnished to or for Sublessee, then Sublessee shall, at its expense, immediately discharge such lien, by bond or otherwise, on demand of Sublessor. As long as otherwise in accordance with the terms and conditions of the Master Lease, Sublessor hereby consents to the installation by Sublessee, at Sublessee’s sole cost, of a nitrogen tank in the B5 Service Yard after the Commencement Date.

          4.3 Repair and Maintenance. Subject to the provisions of Sections 6.3(c) and 8 below, the parties hereto agree that Sublessor shall have no obligation to Sublessee, in any manner whatsoever, to repair and/or maintain the Subleased Premises or the Building, or any portion thereof or the contents therein (including, without limitation, the Personal Property, as defined below). Sublessee shall strictly comply with all other obligations of Section 7 of the Master Lease, as incorporated by reference herein.

          4.4 License for Personal Property and Infrastructure Systems. Sublessor hereby grants Sublessee a license to use in the Subleased Premises during the Term, (i) all

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cubicle systems, work stations, furniture, trade fixtures, equipment, art work, cabling, cafeteria and gym equipment, security systems (including card access, camera and intrusion systems, the “Security Systems”), and other personal property owned by Sublessor and located in the Subleased Premises as of the date hereof, including without limitation, those items described in Exhibit C attached hereto (collectively, the “Personal Property”), and (ii) all generators, uninterruptible power systems (UPS), heating, ventilation and air conditioning systems (HVAC), and data center systems and controls, located in the Subleased Premises (collectively, the “Infrastructure Systems”), and subject to the terms and conditions set forth below:

          (a) The parties shall jointly conduct a walk-through inspection of the Personal Property (and photograph such Personal Property, if needed), and note on Exhibit C any pre-existing damage or defective conditions in the Personal Property.

          (b) SUBLESSEE ACCEPTS THE PERSONAL PROPERTY AND THE INFRASTRUCTURE SYSTEMS IN THEIR “AS IS”, “WHERE IS” CONDITION WITH ALL FAULTS AND WITHOUT WARRANTIES, EXPRESS OR IMPLIED. SUBLESSOR DISCLAIMS ANY IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. SUBLESSEE EXPRESSLY ASSUMES ALL RISK AND RESPONSIBILITY FOR ANY DEFECTS (INCLUDING LATENT DEFECTS) IN THE PERSONAL PROPERTY AND THE INFRASTRUCTURE SYSTEMS.

          (c) Except for pre-existing damage or defective conditions to the Personal Property (as mutually agreed by Sublessor and Sublessee), Sublessee shall maintain the Personal Property and the Infrastructure Systems, and all portions thereof, in good condition and repair throughout the Term. Upon the expiration or earlier termination of this Sublease but subject to Section 4.2(f) below, Sublessee shall surrender the Personal Property and the Infrastructure Systems in the same condition as received, ordinary wear and tear excepted. Except for pre-existing damage or defective conditions to the Personal Property (as mutually agreed by Sublessor and Sublessee) but subject to Section 4.2(f) below, Sublessee shall reimburse Sublessor, as Additional Rent, for the reasonable cost of repairing any damage to the Personal Property and the Infrastructure Systems, ordinary wear and tear excepted.

          (d) Sublessee shall keep the Personal Property and the Infrastructure Systems free from any liens arising out of work performed, materials furnished or obligations incurred by Sublessee.

          (e) Sublessee shall be permitted to remove the Personal Property from the Subleased Premises; provided, however, Sublessee shall not transfer its right to use the Personal Property or dispose of any of the same, without obtaining the prior written consent of Sublessor, and shall comply with Sublessor’s reasonable instructions regarding such transfer or disposition. Sublessee shall not be permitted to remove the Infrastructure Systems or any portion thereof from its location in the Building, without obtaining the prior written consent of Sublessor, which consent shall not be unreasonably withheld.

          (f) Provided that this Sublease has not been terminated in accordance with the terms and conditions contained herein and Sublessee has not surrendered the Personal Property

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in accordance with Section 32 below, on the Expiration Date, Sublessee shall purchase the Personal Property on an “AS IS”, “WHERE IS” basis with all faults and without warranties, express or implied, for the sum of One Dollar ($1.00), pursuant to a bill of sale in a form mutually agreeable to the parties.

     5. Rent; Security Deposit.

          5.1 Base Rent.

          (a) The base rent (“Base Rent”) to be paid by Sublessee to Sublessor under this Sublease is intended to be absolutely triple net. Subject to Section 5.1(b) below, beginning on the Commencement Date and continuing during the Term, Sublessee shall pay to Sublessor monthly Base Rent for the Subleased Premises, payable in advance on the first (1^st) day of each month in accordance with the following schedule (“Base Rent Schedule”):

			Monthly Installment of
	Monthly Base Rent		Base Rent
Time Period	Rate Per RSF		(Bldg 5)
Commencement Date — March 31, 2007 (Initial Premises only)	$	0.65	$	28,271.11
April 1, 2007 — June 30, 2007 (Entire Premises)	$	0.65	$	61,414.60
July 1, 2007 — June 30, 2008	$	0.69	$	65,193.96
July 1, 2008 — June 30, 2009	$	0.73	$	68,973.32
July 1, 2009 — June 30, 2010	$	0.77	$	72,752.68
July 1, 2010 — July 31, 2011	$	0.81	$	76,532.04

          (b) Notwithstanding the foregoing Base Rent Schedule, should the RP Delivery Date slip past April 1, 2007, the Base Rent increase described above shall not be put in place until the RP Delivery Date occurs.

          (c) If the Term commences on a day other than the first (1^st) day of a calendar month or ends on a day other than the last day of a calendar month, Base Rent for the first and/or last fractional month of the Term shall be prorated on the actual number of days elapsed in such month.

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          5.2 Additional Rent. Sublessee shall pay as additional rent (“Additional Rent”), within twenty (20) days after demand therefor, all sums or other charges required to be paid by Sublessee under this Sublease. During the Term, Sublessee shall pay to Sublessor all sums or other charges required to be paid by Sublessor, as tenant, to Master Lessor under the Master Lease, including without limitation, (a) all Real Property Taxes, insurance premiums and common area expenses required to be paid to Master Lessor thereunder (collectively, “Operating Expense Payments”, and which shall include expenses relating to the Parking Areas and Outdoor Areas, as such terms are defined below), (b) all “Additional Rent” (as defined in the Master Lease) due from Sublessor, as tenant, to Master Lessor under Paragraphs 4.D.(a) and (b) of the Master Lease, and (c) the management fee charged by Master Lessor to Sublessor under the Master Lease, but expressly excluding (i) any “Basic Rent” due from Sublessor, as tenant, to Master Lessor under the Master Lease, and (ii) any late charges, default interest and other penalties due from Sublessor, as tenant, to Master Lessor under the Master Lease provided the same are not caused by the default or breach of any of Sublessee’s obligations contained in this Sublease. Sublessor shall not charge Subtenant a management fee with regard to the Building, other than the management fees charged by Master Lessor under the Master Lease. Notwithstanding the foregoing, Sublessee’s obligation to pay Operating Expense Payments for the Subleased Premises shall be prorated for all periods prior to the time that the entire Subleased Premises has been delivered to Sublessee, on the basis of the ratio that the rentable square footage of those portions of the Subleased Premises delivered to Sublessee bears to 94,484 rentable square feet. Moreover, Sublessee agrees to pay its proportionate share of any costs and expenses incurred by Sublessor for (A) any insurance obtained by Sublessor pursuant to Section 54 of the Master Lease, (B) repair or maintenance of the central courtyard amongst the Buildings, and (C) repair, maintenance, replacement or new construction of improvements in such central courtyard, within twenty (20) days after written demand therefor (which written demand shall contain documentation in reasonable detail evidencing the costs and expenses incurred by Sublessor); provided, however, that Sublessee shall have no obligation to reimburse Sublesssor for any (aa) replacement of an existing improvement in the central courtyard, or (bb) construction or installation of any new improvement in the central courtyard, if Sublessor had not first obtained Sublessee’s written approval thereof, which approval shall not be unreasonably withheld, conditioned or delayed by Sublessee. Sublessor shall have the same remedies for a default in the payment of Additional Rent as for a default in the payment of Base Rent. Base Rent and Additional Rent are hereinafter sometimes referred to collectively as “Rent.”

          5.3 Payment of Rent. Rent shall be paid to Sublessor, without deduction, demand, recoupment, offset or counterclaim, in lawful money of the United States of America, at Maxtor Corporation, 333 South Street, Shrewsbury, MA 01545, Attn: Gary Leblanc, or to such other person or at such other place as Sublessor may from time to time designate in writing.

          5.4 Security Deposit; Letter of Credit.

          (a) Upon execution of this Sublease, Sublessee shall deliver to Sublessor a clean, unconditional, irrevocable, transferable letter of credit in the amount of One Hundred Eighty Four Thousand Two Hundred Forty Three and 80/100 Dollars ($184,243.80). (the “Letter of Credit”), in form and issued by a financial institution (“Issuer”) satisfactory to Sublessor in its sole discretion, which Letter of Credit (and all sums drawn by Sublessor thereunder) shall constitute a security deposit to secure Sublessse’s obligations under this

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Sublease and the other Subleases (the “Security Deposit”). Sublessee hereby grants to Sublessor a security interest in the Letter of Credit and all proceeds, replacements and modifications thereof to secure Sublessee’s obligations herein, including without limitation, the obligation to pay Rent, perform its insurance and indemnity obligation and to maintain and restore the Subleased Premises. The Letter of Credit shall permit partial draws, and provide that draws thereunder will be honored upon receipt by Issuer (at its offices in San Francisco, California or such other location that Sublessor shall approve in its sole discretion) of the original or a certified copy of the Letter of Credit accompanied by a written statement signed by Sublessor or its authorized agent stating that Sublessor is entitled to draw on the Letter of Credit pursuant to the terms of this Sublease. The Letter of Credit shall have an expiration period of one (1) year from the date of issuance but shall provide that it will automatically renew by its terms to a date which is sixty (60) days following the Expiration Date of the Building 6 Sublease unless affirmatively cancelled by Issuer following not fewer than sixty (60) days prior written notice of such expiration or cancellation from Issuer to Sublessor. Sublessor shall be entitled to draw the Letter of Credit in part or in full. All costs and expenses related to the Letter of Credit, including any transfer fees, shall be paid by Sublessee.

          (b) Sublessor shall hold the Security Deposit as security for the full and faithful performance by Sublessee of its covenants and obligations under this Sublease and the Other Subleases. If Sublessee defaults in the full and timely performance of any or all of Sublessee’s covenants and obligations under this Sublease or any of the Other Subleases, then Sublessor may, from time to time, without waiving any other remedy available to Sublessor, use the Security Deposit, or any portion thereof, to the extent necessary to cure or remedy the default or to compensate Sublessor for all or any part of the damages sustained by Sublessor resulting from Sublessee’s default. Sublessee shall pay to Sublessor within ten (10) business days after receipt of demand, the amount so applied in order to restore the Security Deposit to its original amount. Sublessor shall not be required to keep the Security Deposit separate from its general accounts and no trust relationship is created between Sublessor and Sublessee with respect to the Security Deposit. If Sublessee performs all of its obligations hereunder and under all of the other Subleases, the Security Deposit, or so much thereof as has not theretofore been applied by Sublessor, shall be returned to Sublessee, without interest or other increment for its use, at the Expiration Date and after Sublessee has vacated the entire Subleased Premises. Sublessee’s failure to provide and keep the Letter of Credit in full force and effect and otherwise in accordance with the terms of this Section 5.4 shall constitute a default of this Sublease and the Other Subleases. Similarly, any failure to maintain the letters of credit provided under the Other Subleases as required thereunder shall be a default under this Sublease.

     6. Master Lease.

          6.1 Subject to Master Lease. This Sublease is and shall at all times be subject and subordinate to the Master Lease attached hereto as Exhibit D, and every provision thereof. Sublessee acknowledges that (a) Sublessee’s use and enjoyment of the Subleased Premises are subject to the rights of Master Lessor pursuant to the Master Lease, and (b) Sublessee has reviewed a copy of each Master Lease and is fully familiar with the provisions thereof. Sublessor represents and warrants that (i) the copy of the Master Lease attached hereto as Exhibit D is a true and complete copy of the Master Lease and all amendments, modifications, written side letter agreements and recorded memoranda of leases with respect thereto, (ii) Sublessor has

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not already assigned its interest in the Master Lease or sublet any of the Subleased Premises, and (iii) as of the date hereof, the Master Lease is in full force and effect and no defaults exist on the part of Sublessor or, to the best of Sublessor’s knowledge, Master Lessor under the terms of the Master Lease. Sublessor shall not assign, terminate or amend the Master Lease without the prior written consent of Sublessee, which consent shall not be unreasonably withheld, conditioned or delayed.

          6.2 No Violation of Master Lease. Neither Sublessor nor Sublessee shall commit or permit to be committed any act or omission which would violate any term or condition of the Master Lease. If a Master Lease terminates, this Sublease shall terminate as to the portion of the Subleased Premises covered thereby and the parties shall be relieved of any further liability or obligation under this Sublease with respect thereto; provided, however, that if the Master Lease terminates as a result of a default or breach by either Sublessor or Sublessee under this Sublease and subject to Section 13 of this Sublease, then the defaulting party shall be liable to the other party for the damage suffered as a result of such termination. Furthermore, Sublessor agrees not to voluntarily terminate the Master Lease without the prior written consent of Sublessee, which consent shall not be unreasonably withheld, conditioned or delayed.

          6.3 Incorporation of Master Lease.

          (a) Subject to and in accordance with the exceptions, qualifications and modifications set forth below and elsewhere in this Sublease, all the provisions of the Master Lease, as set forth in Exhibit D hereto, are hereby incorporated by reference and made a part of this Sublease, and to the extent that such provisions impose obligations or duties on Sublessor as tenant under the Master Lease and are incorporated by reference into the terms of this Sublease, Sublessee does hereby expressly assume and agree with Sublessor to perform and to comply with such obligations and duties of Sublessor as tenant thereunder, as the same accrue on and after the Commencement Date. In the event of any conflict between any provision of the Master Lease incorporated herein and a provision contained in this Sublease, the provision contained in this Sublease shall prevail.

          (b) Except as otherwise expressly provided herein and except for those provisions that are not incorporated into this Sublease, the term “Landlord” (and similar terms) as used in the Master Lease shall mean “Sublessor” hereunder; the term “Tenant” (and similar terms) as used in the Master Lease shall mean “Sublessee” hereunder; the term “Premises” (and similar terms) as used in the Master Lease shall mean “Subleased Premises” hereunder; and the term “Lease” as used in the Master Lease shall mean this “Sublease”.

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          (c) Sublessor shall have no obligation to operate or maintain (i) the Building or any other premises covered by the Master Lease, (ii) any common areas in the Building or any other premises covered by the Master Lease, or (iii) provide any Building services or utilities. With respect to all services to be performed or provided by Master Lessor under the Master Lease, Sublessor’s sole obligation shall be to exercise commercially reasonable efforts (without litigation or the threat thereof) to require Master Lessor to comply with its obligations to perform or provide such services under the Master Lease, including promptly notifying Master Lessor of its nonperformance if so requested by Sublessee in writing.

          (d) Notwithstanding anything to the contrary contained herein, in no event shall Sublessor be deemed to be in default under this Sublease or liable to Sublessee for any failure of Master Lessor to perform its obligations under the Master Lease. Wherever the Master Lease requires the consent of the landlord be obtained, both Master Lessor’s consent and Sublessor’s consent shall be required and the standard for such consent by Sublessor shall be a consent not unreasonably withheld or delayed. For the avoidance of doubt, Sublessee shall be required to obtain both Sublessor’s and Master Lessor’s consent for (i) any assignment or sub-subletting of the Subleased Premises (provided that Sublessor’s consent shall not be required for assignments to entities controlled by or under common control with Sublessee if Sublessee is not released from its obligations under this Sublease), or (ii) any Alterations to the Subleased Premises or any portion thereof, in accordance with the provisions of the Master Lease, as incorporated be referenced herein, but subject to the terms and conditions contained in Section 4.2 above.

          6.4 Exclusions from Master Lease. Sublessor and Sublessee expressly agree that the following provisions of the Master Lease are not incorporated in this Sublease: the first full paragraph of the Master Lease; Sections 2, 4.A and 4.B; Sections 4.E and 4.F; the first two sentences of Section 5; the seventh sentence of Section 6; the first sentence of Section 9; the first sentence of Section 12; Sections 13 and 23; the term “Landlord” in the first and second sentences of Section 21, in the second paragraph of Section 22 and in Section 27 shall be replaced with “Master Lessor”; Sections 29, 31, 34, 36, 38.G, 39 through 44 (inclusive), 45 through 50 (inclusive), 51.A through D (inclusive); the term “Landlord” in Section 52 shall be replaced with “Master Lessor” and all references to extension rights or periods in such Section 52 shall be deleted (i.e., not incorporated by reference into this Sublease); Sections 54, 61, 62, 63 and 64; the term “for lease” in Section 58(ii) shall be replaced with “for sublease”; Sections 1 through 5 (inclusive), Sections 8, 9, 11, 12, 14, 16, 17 and 18 of Amendment No. 1 to Lease; and all of Amendment No. 2 to Lease.

          6.5 Time for Notices and Demands. Whenever in the Master Lease a time is specified for the giving of any notice or the making of any demand by the tenant thereunder, such time is hereby changed (for the purpose of this Sublease only) by subtracting five (5) days thereto (unless the time specified is less than five (5) days in which event two (2) business days shall be subtracted thereto instead); and whenever in the Master Lease a time is specified for the giving of any notice or the making of any demand by the landlord thereunder, such time is hereby changed (for the purpose of this Sublease only) by adding five (5) days if such notice, request or demand of the landlord thereunder relates to any subject other than the payment of fixed annual rent or additional rent under the Master Lease (unless the time specified is less than five (5) days in which event two (2) business days shall be added thereto instead). Whenever in

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the Master Lease a time is specified within which the tenant thereunder must give notice or make a demand following an event, or within which the tenant thereunder must respond to any notice, request or demand previously given or made by the landlord thereunder, or to comply with any obligation on the tenant’s part thereunder, such time is hereby changed (for the purpose of this Sublease only) by subtracting five (5) days if the same shall relate to any obligation other than the payment of fixed annual rent or additional rent under the Master Lease or under this Sublease (unless the time specified is less than five (5) days in which event two (2) business days shall be subtracted thereto instead). Wherever in the Master Lease a time is specified within which the landlord thereunder must give notice or make a demand following an event, or within which the landlord thereunder must respond to any notice, request or demand previously given or made by the tenant thereunder, such time is hereby changed (for the purpose of this Sublease only) by adding five (5) days thereto (unless the time specified is less than five (5) days in which event two (2) business days shall be added thereto instead). It is the purpose and intent of the foregoing provisions, among other things, to provide Sublessor with time within which to transmit to the Master Lessor any notices or demands received from Sublessee and to transmit to Sublessee any notices or demands received from the Master Lessor.

          6.6 Options to Extend Under Master Lease; Amendment to Sublease. In the event that (a) Sublessee notifies Sublessor in writing that Sublessee is actively negotiating a direct lease with Master Lessor (“Direct Lease”) with regard to the Subleased Premises for a term commencing immediately after the Expiration Date, and (b) provided that Sublessee is not then in default under this Sublease, then Sublessor agrees that it will not exercise its Option to Extend with regard to the Subleased Premises until such time as Sublessee notifies Sublessor in writing that it is no longer negotiating a Direct Lease with Master Lessor for the Subleased Premises. Sublessee hereby agrees to respond (in the affirmative or negative), from time to time, within ten (10) business days of its receipt of a written inquiry from Sublessor requesting that Sublessee confirm that Sublessee is or is not actively negotiating a Direct Lease with Master Lessor. In the event that Sublessee and Master Lessor execute and deliver a Direct Lease for the Subleased Premises, with a term commencing immediately after the Expiration Date, then (1) Sublessor shall agree to amend the Master Lease to delete its Options to Extend thereunder, and (2) Sublessor and Sublessee shall execute and deliver an amendment to this Sublease providing: (I) the Expiration Date for this Sublease shall be extended to be co-terminus with the expiration date of the Master Lease on the same terms and conditions as were applicable immediately prior to such extension; (II) Sublessee shall assume the obligations of Sublessor under the Master Lease to remove any Alterations to the applicable Building that Master Lessor requires be removed and to restore the same in accordance with the terms of the Master Lease (collectively, the “Restoration Obligations”); and (III) Sublessee shall indemnify, defend and hold harmless Sublessor and the Sublessor Indemnitees from and against all Claims related to the Restoration Obligations assumed by Sublessee. In the event that Sublessee executes a Direct Lease with Master Lessor for the Subleased Premises, then Sublessor agrees to execute a quitclaim deed with respect thereto for delivery and recordation at expiration or termination of the Master Lease.

     7. Sublessee’s Insurance. Notwithstanding anything to the contrary contained in the Master Lease, Sublessee, at its sole cost and expense, shall keep in force at all times during the Term a policy of commercial general liability insurance with combined single limit coverage of not less than Three Million Dollars ($3,000,000) per occurrence and Five Million Dollars ($5,000,000) in the aggregate for bodily injury and property damage occurring in, on or about the

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Subleased Premises, including parking and landscaped areas. All insured policies required to be maintained by Sublessee hereunder shall name Sublessor and Master Lessor as additional insureds. Except as modified by this Section, Sublessee shall strictly comply with all other obligations under Section 10 of the Master Lease, as incorporated by reference herein.

     8. Casualty; Condemnation.

          (a) In the event that Sublessor’s interest as tenant under the Master Lease is terminated by reason of damage or destruction, condemnation, or any other reason, then this Sublease shall terminate as to Sublessor’s interest therein only (and not as to all Sublessor interests under the Master Lease) on the same date as the termination of such interest, without liability of Sublessor to Sublessee, and Sublessee shall not be entitled to any insurance proceeds or other remuneration from Sublessor except for insurance proceeds from insurance policies purchased by Sublessee for its own personal property. Sublessor agrees to give written notice to Sublessee promptly should Sublessor’s interest in any portion of the Subleased Premises be terminated, or be threatened to be terminated, under the Master Lease. Sublessor shall not terminate the Master Lease due to a casualty or condemnation without the prior written consent of Sublessee, which consent may be withheld in Sublessee’s sole and absolute discretion.

          (b) If the Subleased Premises or any portion thereof is damaged by fire or other casualty, and if the Master Lease is not terminated, then:

               (i) This Sublease shall continue in full force and effect;

               (ii) Sublessor shall have no obligation to repair or restore the damaged space;

               (iii) Sublessor shall use commercially reasonable efforts (without litigation or the threat thereof), as set forth in Section 6.3(c) above, to cause Master Lessor to perform the repairs which Master Lessor is required to perform under the Master Lease; provided that Sublessor shall not be liable for any damages, nor shall Rent due hereunder be abated, nor shall Sublessee be relieved from the performance of any term or covenant hereunder, nor shall Sublessee be deemed to have been evicted, due to any aspect of the repair and restoration of the damaged space (including without limitation any delay of such repair and restoration), except to the extent so abated, relieved or evicted under the Master Lease; and

               (iv) There shall be no reduction or abatement of Rent for any period during which Sublessee is unable to use the affected portion of the Subleased Premises, in whole or part, due to damage or destruction of the same or the Building, unless Sublessor actually receives a reduction or abatement of rent under the Master Lease.

          (c) In the event eminent domain or condemnation is instituted against the Subleased Premises or any portion thereof, and the Master Lease is terminated with respect to all or a portion of the Subleased Premises as a result thereof pursuant to the Master Lease, (i) this Sublease shall terminate as of the date the Master Lease terminates with respect to such portion of the Subleased Premises without any liability on the part of Sublessor to Sublessee, and Sublessee shall not be entitled to any award of damages for Sublessee’s interest in the Subleased

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Premises, except that Sublessee may make a claim against the condemning authority for loss of or damage to Sublessee’s trade fixtures and personal property, relocation expenses, and unamortized subtenant improvements costs that have been paid by Sublessee, and (ii) Sublessor shall have no obligation to rebuild or restore the Subleased Premises. If this Sublease is terminated as to less than all of the Subleased Premises, this Sublease shall continue in full force and effect as to the remaining portion of the Subleased Premises, except that the Base Rent payable hereunder shall be equitably reduced but only to the extent (if any) that rent applicable to the affected portion of the Subleased Premises is reduced under the Master Lease.

          (d) Sublessee expressly waives the provisions of California Civil Code Section 1932(2) and Section 1933(4). Sublessor and Sublessee expressly waive the provisions of California Code of Civil Procedure Sections 1265.120 and 1265.130.

     9. Indemnity; Hold Harmless.

          (a) Sublessor shall not be liable to Sublessee or Sublessee’s employees, agents, invitees, licensees or visitors, or to any other person, for any injury to person, or damage to or loss of property on or about the Subleased Premises or the Building arising from any cause whatsoever, except to the extent caused solely by the gross negligence or willful misconduct of Sublessor. Except to the extent caused solely by the gross negligence or willful misconduct of Sublessor, Sublessee shall indemnify, protect, defend with counsel reasonably acceptable to Sublessor and hold harmless Sublessor and Sublessor’s shareholders, directors, officers, employees, agents, affiliates, successors and assigns (collectively, “Sublessor Indemnitees”) from and against any and all Claims caused by or arising in connection with: (i) the use or occupancy of the Subleased Premises, the Building, the Infrastructure Systems and the Personal Property by Sublessee or its employees, contractors, agents, invitees, licensees, permitted sub-sublessees or assignees or permitted sublessees pursuant to Section 32 below; or (ii) the negligence or willful misconduct of Sublessee or its employees, contractors, agents, invitees, licensees or permitted sub-sublessees or assignees; or (iii) a default or breach of Sublessee’s obligations under this Sublease; or (iv) a default or breach of Sublessor’s obligations under the Master Lease to the extent caused by Sublessee’s default or breach of any of its obligations contained in this Sublease; or (v) any negligence, gross negligence or willful misconduct of Sublessee or its agents, employees, contractors, invitees, licensees, permitted sub-sublessees or assignees or permitted sublessees pursuant to Section 32 below in, on or about the Subleased Premises or the Building; or (vi) any failure of Sublessee to surrender the Subleased Premises (or any portion thereof) to Sublessor at the end of the Term hereof (or such sooner date as provided in this Sublease) or otherwise in the condition required hereunder to the extent required pursuant to the terms of this Sublease, or (vii) all Claims for labor or materials furnished or alleged to have been furnished to or for Sublessee at or for use on the Subleased Premises. Sublessee’s indemnification and other covenants provided in this Section 9 shall survive the expiration or termination of this Sublease.

          (b) Except to the extent caused solely by the gross negligence or willful misconduct of Sublessee but subject to Section 3.4 above, Sublessor shall indemnify, protect, defend with counsel reasonably acceptable to Sublessee and hold harmless Sublessee and Sublessee’s shareholders, directors, officers, employees, agents, affiliates, successors and assigns (collectively, “Sublessee Indemnitees”) from and against any and all Claims caused by or arising

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in connection with: (i) a default or breach of Sublessor’s obligations under the Master Lease that is not caused by Sublessee’s default or breach of any of its obligations contained in this Sublease; or (ii) any negligence, gross negligence or willful misconduct of Sublessor or its agents, employees, contractors, invitees, licensees or permitted sub-sublessees or assignees in, on or about the Subleased Premises or the Building; or (iii) all Claims for labor or materials furnished or alleged to have been furnished to or for Sublessor at or for use on the Subleased Premises. Sublessor’s indemnification and other covenants provided in this Section 9 shall survive the expiration or termination of this Sublease

     10. Utilities; System Connections; Vendors. Pursuant to Section 8 of the Master Lease, as incorporated by reference herein, Sublessee shall be responsible and shall pay directly all utilities and services furnished to the Subleased Premises, including security and janitorial services. Sublessor shall cause, at Sublessor’s expense, Infrastructure Systems and Security Systems within the Building to be separated from Infrastructure Systems and Security Systems for other buildings; and thereafter, Sublessee shall cause, at Sublessee’s expense, Infrastructure Systems and Security Systems within the Building to be reconnected (if necessary). Subject to the terms of the Master Lease and provided that Sublessee obtains both Sublessor’s and Master Lessor’s prior written consent (which consent Sublessor shall not unreasonably withhold), Sublessee shall be permitted to select its own vendors for its repair and maintenance of the Subleased Premises and for janitorial, security and other services to the Subleased Premises.

     11. Notices.

          11.1 Notices Under Sublease. All notices, consents, demands, requests and other communications from one party to the other given pursuant to the terms of this Sublease shall be in writing and shall be delivered by hand, air courier or by United States mail, certified or registered, postage prepaid, and addressed to Sublessee or Sublessor at the addresses respectively specified below or to such other place as Sublessee or Sublessor may from time to time designate in a written notice to the other. Notices shall be deemed given on the earliest of (i) receipt, (ii) one (1) business day after deposit with an courier for overnight delivery, or (iii) three (3) business days after deposit in the United States mail.

The address for
Sublessor is:	Maxtor Corporation 333 South Street Shrewsbury, MA 01545 Attn: Gary Leblanc
with a copy to:	Maxtor Corporation 2452 Clover Basin Drive Longmont, CO 80503 Attention: General Counsel

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The address for
Sublessee is:	SanDisk Corporation 601 McCarthy Boulevard Milpitas, CA 95035 Attn: General Counsel
with a copy to:	SanDisk Corporation 601 McCarthy Boulevard Milpitas, CA 95035 Attn: Edward Palma

          11.2 Notices Under Master Lease. Sublessor shall promptly provide Sublessee with a copy of any notice it receives from Master Lessor relating to the Subleased Premises or the Master Lease. Sublessee shall promptly provide Sublessor with a copy of any notice it receives from Master Lessor relating to the Subleased Premises or the Master Lease.

     12. Confidentiality. Sublessee acknowledges and agrees that the terms and conditions set forth in this Sublease constitute Sublessor’s “Confidential Information” (as defined in the NDA, as defined below) and that such terms and conditions shall be subject to the Mutual Nondisclosure Agreement executed by Sublessor and Sublessee and made effective as of May 4, 2004 (the “NDA”).

     13. Limitation of Liability. Notwithstanding anything to the contrary contained in this Sublease, (a) no director, officer, shareholder, employee, adviser or agent of Sublessor or Sublessee shall be personally liable in any manner or to any extent under or in connection with this Sublease, and (b) neither Sublessor nor any of the Sublessor Indemnitees shall be responsible or liable for any consequential or punitive damages in connection with this Sublease, including, without limitation, on account of lost profits or the interruption of Sublessee’s business.

     14. Signage. Subject to the terms and conditions of the Master Lease, Sublessee, at its sole cost and expense, shall have the same signage rights as Sublessor has under the Master Lease with regard to the Building subleased to Sublessee hereunder, provided that at Sublessee’s sole cost (a) Sublessee shall obtain the prior written consent of Master Lessor thereto, (b) Sublessee shall obtain the prior written consent of Sublessor thereto (which consent of Sublessor shall not be unreasonably withheld), (c) Sublessee shall obtain all necessary permits and approvals from all applicable government agencies with respect thereto, (d) Sublessee shall install, maintain, repair and, to the extent required by Master Lessor, remove all signage at expiration or earlier termination of this Sublease, and (e) Sublessee shall repair all damage to the Subleased Premises caused by the removal of all signage at expiration or earlier termination of this Sublease.

     15. Brokers. Sublessee represents and warrants to Sublessor that no real estate broker, agent or finder negotiated or was instrumental in negotiating or representing Sublessee in the negotiation of this Sublease. Sublessor represents and warrants to Sublessee that no real estate broker, agent or finder negotiated or was instrumental in negotiating or representing

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Sublessor in the negotiation of this Sublease. Sublessee and Sublessor shall each indemnify and hold the other harmless from and against any Claims resulting from breach of such party’s representation and warranty contained above.

     16. Counterparts. This Sublease may be executed in separate counterparts, each of which shall be an original, and all of which taken together shall constitute one and the same agreement.

     17. No Recording. Neither party hereto shall record this Sublease nor any memorandum hereof without the written consent of the other party.

     18. Curing Defaults.

     (a) If Sublessee shall be in default in the performance of any of its obligations hereunder beyond any applicable notice and cure period, Sublessor, without any obligation to do so, in addition to any other rights it may have in law or equity, may elect (but shall not be obligated) to cure such default after the applicable cure period at any time after delivery of five (5) business days’ notice to Sublessee. Sublessee shall reimburse Sublessor, upon demand for one hundred percent (100%) of all costs and expenses paid or incurred by Sublessor in curing such default, and interest thereon from the respective dates of Sublessor’s making the payments and incurring such costs, at the lesser of (i) the prime rate announced by Bank of America NT&SA from time to time (the “Prime Rate”) plus two percent (2%), or (ii) the maximum amount allowed by law, which sums and costs together with interest thereon shall be deemed Additional Rent payable promptly upon being billed therefor.

     (b) If Sublessor shall be in default in the performance of any of its obligations under the Master Lease beyond any applicable notice and cure period, Sublessee, without any obligation to do so, in addition to any other rights it may have in law or equity, may elect (but shall not be obligated) to cure such default after the applicable cure period at any time after delivery of five (5) business days’ notice to Sublessor. Sublessor shall reimburse Sublessee, upon demand for one hundred percent (100%) of all costs and expenses paid or incurred by Sublessee in curing such default, and interest thereon from the respective dates of Sublessee’s making the payments and incurring such costs, at the lesser of (i) the Prime Rate plus two percent (2%), or (ii) the maximum amount allowed by law, which sums and costs together with interest thereon shall be payable promptly upon being billed therefor.

     19. Time. In all instances where Sublessee is required by the provisions of this Sublease to pay any sum of money or to do any act at a particular indicated time or within any indicated period, it is understood and agreed that TIME IS OF THE ESSENCE.

     20. Authority. The individual or individuals signing this Sublease on behalf of Sublessee or Sublessor, represent and warrant that: (i) Sublessee or Sublessor, respectively, is a corporation duly incorporated and organized and validly existing and in good standing under the laws of the State of Delaware; (ii) Sublessee or Sublessor, respectively has full power and authority to enter into this Sublease and to perform its obligations under this Sublease; (iii) the execution, delivery and performance of this Sublease by Sublessee or Sublessor have been duly and validly authorized by all necessary corporate action on the part of Sublessee or Sublessor

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and all required consents and approvals have been duly obtained; and (iv) this Sublease is a legal, valid and binding obligation of Sublessee or Sublessor, respectively, enforceable against Sublessee or Sublessor, respectively in accordance with its terms, subject to the effect of applicable bankruptcy, insolvency, reorganization, arrangement, moratorium or other similar laws affecting the rights of creditors generally.

     21. Attorneys’ Fees. If as a result of any breach or default on the part of Sublessee under this Sublease, Sublessor uses the services of an attorney in order to secure compliance with this Sublease, Sublessee shall reimburse Sublessor upon demand as Additional Rent for any and all reasonable attorneys’ fees and expenses incurred by Sublessor, whether or not formal legal proceedings are instituted. Should either party bring an action against the other party, by reason of or alleging the failure of the other party to comply with any or all of its obligations hereunder, whether for declaratory or other relief, then the party which prevails in such action shall be entitled to its reasonable attorneys’ fees and expenses related to such action, in addition to all other recovery or relief. A party shall be deemed to have prevailed in any such action (without limiting the generality of the foregoing) if such action is dismissed upon the payment by the other party of the sums allegedly due or the performance of obligations allegedly not complied with, or if such party obtains substantially the relief sought by it in the action, irrespective of whether such action is prosecuted to judgment. Attorneys’ fees shall include, without limitation, fees incurred in discovery, contempt proceedings, and bankruptcy litigation. The non-prevailing party shall also pay the reasonable attorneys’ fees and costs incurred by the prevailing party in any post-judgment proceedings to collect and enforce the judgment. The covenant in the preceding sentence is separate and several and shall survive the merger of this provision into any judgment on this Sublease.

     22. Successors. The terms, covenants and conditions of this Sublease shall be binding upon and inure to the benefit of Sublessor and Sublessee and their respective successors, and except as otherwise provided, their assigns.

     23. Remedies; Cross-Defaults. Sublessor shall have the right, upon Sublessee’s default hereunder, in addition to the remedies set forth in this Sublease, to exercise against Sublessee any and all of the rights and remedies described in the Master Lease as available to Master Lessor in the event of a default by the tenant under the Master Lease. Moreover, any default by Sublessee of any of its obligations or duties under any of the Other Subleases shall constitute a default by Sublessee under this Sublease and all of the Other Subleases. Similarly, a default by Sublessee under this Sublease shall constitute a default under each of the Other Subleases.

     24. Not Offer. The submission of this Sublease for review or signature by Sublessee shall not constitute an offer or option to sublease the Subleased Premises, nor shall this Sublease be effective as a sublease or otherwise until both parties execute and deliver execution counterparts of this Sublease and Master Lessor approves this Sublease in writing.

     25. Construction. This Sublease is the result of negotiations between the parties and their respective attorneys and shall be construed in an even and fair manner, regardless of the party who drafted this Sublease or any provision hereof. The headings or captions of sections in

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this Sublease are for convenience and reference only, and in no way define, limit, or describe the scope or intent of this Sublease or the provisions of such sections. The term “including” shall mean “including, but not limited to.”

     26. Entire Agreement; Amendment; Severability. There are no oral agreements between Sublessor and Sublessee affecting this Sublease, and this Sublease (along with the NDA) supersedes and cancels any and all prior negotiations, arrangements, correspondence, communications, agreements and understandings, if any, whether oral or written, between Sublessor and Sublessee with respect to the subject matter of this Sublease, and none of the foregoing shall be used to construe this Sublease. No amendment or modification of this Sublease shall be binding or valid unless expressed in writing and executed and delivered by Sublessor and Sublessee. If any one or more of the provisions contained in this Sublease shall be invalid, illegal or unenforceable in any respect, the validity, legality or enforceability of the remaining provisions contained herein shall not in any way be affected or impaired.

     27. Intentionally Deleted.

     28. No Solicitation. During the Term, Sublessee shall not solicit nor hire any employee of Sublessor with first obtaining the prior written consent of Sublessor, which consent may be withheld in Sublessor’s sole discretion. Sublessee hereby agrees that money damages will not be a sufficient remedy for any breach of this Section 28, such that Sublessor shall be entitled to injunctive relief, specific performance, or both as a remedy for any such breach. Such remedy shall not be deemed to be the exclusive remedy for any such breach but shall be in addition to all other remedies available at law or equity.

     29. Parking. Sublessee shall have the right to use, on an unassigned, non-exclusive basis, all parking spaces in the parking areas designated for the Building, as shown on Exhibit A hereto (the “Parking Areas”). The use of the Parking Areas shall be subject to, and is conditioned upon, compliance by Sublessee with all rules and regulations governing the Parking Areas promulgated by Master Lessor or Sublessor from time to time (and Sublessee shall cause all of its employees, agents, contractors and invitees to comply with the same).

     30. Outdoor Areas. Sublessee shall have the right to use, on a non-exclusive basis, the outdoor sunken amphitheatre, basketball and volleyball courts, seating and lawn areas and other outdoor areas associated with the Buildings (collectively, the “Outdoor Areas”). The use of the Outdoor Areas shall be subject to, and is conditioned upon, compliance by Sublessee with all rules and regulations governing the Outdoor Areas promulgated by Master Lessor or Sublessor from time to time (and Sublessee shall cause all of its employees, agents, contractors and invitees to comply with the same). In the event that Sublessee desires to reserve an Outdoor Area for its exclusive use (a “Reservation”), it may do so subject to the following requirements: (a) Sublessee shall deliver to Sublessor written notice specifying which Outdoor Area it proposes to reserve and the date and time of the proposed Reservation at least fifteen (15) days’ prior to the proposed Reservation date; (b) Sublessee shall not be permitted to reserve an Outdoor Area if Sublessor or Master Lessor intends to use such Outdoor Area (or any portion thereof) during the proposed Reservation period; (c) Sublessee shall not be permitted to reserve an Outdoor Area for longer than a twenty-four (24) hour period (unless otherwise approved in writing by Sublessor

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which approval shall not be unreasonably withheld, conditioned or delayed); (d) Sublessee shall set up and clean up the Outdoor Area at Sublessee’s sole cost; and (e) Sublessee shall comply with all rules and regulations governing the Outdoor Areas promulgated by Master Lessor or Sublessor from time to time, including without limitation, any requirement by Sublessor that Sublessee obtain additional insurance or provide Sublessor with additional indemnities in connection with any alcoholic beverages served by or for Sublessee in or around the Outdoor Area.

     31. Hazardous Substances.

          31.1 Definitions. As used in this Sublease, the term “Hazardous Substance” shall mean any product, substance, or waste whose presence, use, manufacture, disposal, transportation, or release, either by itself or in combination with other materials expected to be on the Subleased Premises, is: (i) potentially injurious to the public health, safety or welfare, the environment or the Subleased Premises, (ii) regulated or monitored by any governmental authority, or (iii) a basis for potential liability of Sublessor to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substances shall include, but not be limited to, PCB’s, hydrocarbons, petroleum, gasoline, asbestos and/or crude oil or any products, by-products or fractions thereof. As used in this Sublease, the term “Reportable Use” shall mean (i) the installation or use of any above ground storage tank, (ii) the generation, possession, storage, use, transportation, release or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental authority, and/or (iii) the presence at the Subleased Premises of a Hazardous Substance with respect to which any Applicable Requirement requires that a notice be given to persons entering or occupying the Subleased Premises or neighboring properties.

          31.2 Reportable Uses and Hazardous Substances Require Consent. Except as expressly provided below and subject to the Master Lease, Sublessee shall not engage in any activity in or on the Subleased Premises which constitutes a Reportable Use of Hazardous Substances, nor shall Sublessee generate, possess, store, use, release or dispose of any Hazardous Substances in, on, under or about the Subleased Premises or the Building, without the express prior written consent of both Sublessor and Master Lessor (which consent Sublessor shall not unreasonably withhold), and Sublessee’s timely compliance (at Sublessee’s expense) with all Applicable Requirements.

          31.3 Duty to Inform Sublessor. If Sublessee knows that a Hazardous Substance has come or may have come to be located in, on, under or about the Subleased Premises, Sublessee shall immediately give written notice of such fact to Sublessor, and provide Sublessor with a copy of any report, notice, claim or other documentation which it has concerning the presence of such Hazardous Substance.

          31.4 Sublessee Remediation. Sublessee shall not cause or permit any Hazardous Substance to be spilled or released in, on, under, or about the Subleased Premises (including through the plumbing or sanitary sewer system) and shall promptly, at Sublessee’s sole cost and expense, take all investigatory and/or remedial action reasonably recommended,

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whether or not formally ordered or required, for the cleanup of any contamination of, and for the maintenance, security and/or monitoring of the Subleased Premises or neighboring properties, that was caused or materially contributed to by Sublessee, or pertaining to or involving any Hazardous Substance brought onto or released in, on or under the Subleased Premises the Subleased Premises by or for Sublessee or Sublessee’s employees, contractors, agents, invitees, licensees or permitted sub-sublessees or assignees. Sublessee shall be solely responsible for the remediation of any condition concerning any Hazardous Substance brought onto or released in, on or under the Subleased Premises by or for Sublessee or Sublessee’s employees, contractors, agents, invitees, licensees or permitted sub-sublessees or assignees.

          31.5 Investigations and Remediations. Sublessee shall have responsibility and shall pay for any investigations or remediation measures required by governmental entities having jurisdiction with respect to the existence of Hazardous Substances brought onto or released in, on or under the Subleased Premises by or for Sublessee or Sublessee’s employees, contractors, agents, invitees, licensees or permitted sub-sublessees or assignees. Sublessee shall cooperate fully in any such activities at the request of Sublessor or Master Lessor, including allowing Sublessor and Master Lessor and their respective employees and agents to have reasonable access to the Subleased Premises at reasonable times in order to carry out any investigative and remedial actions which Sublessor or Master Lessor may elect to do.

          31.6 Sublessee’s Compliance with Applicable Requirements. Sublessee shall obtain, maintain and strictly comply with, at Sublessee’s sole cost and expense, any and all Applicable Requirements with the generation, possession, storage, use, release or disposal of any Hazardous Substance brought onto or released in, on or under the Subleased Premises by or for Sublessee or Sublessee’s employees, contractors, agents, invitees, licensees or permitted sub-sublessees or assignees. Sublessee shall, within ten (10) days after receipt of Sublessor’s or Master Lessor’s written request, provide Sublessor and Master Lessor with copies of all permits and other documents, and other information evidencing Sublessee’s compliance with any Applicable Requirements specified by Sublessor or Master Lessor, and shall immediately upon receipt by Sublessee, notify Sublessor and Master Lessor in writing (and immediately provide to Sublessor and Master Lessor copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving the failure of Sublessee or the Subleased Premises to comply with any Applicable Requirements or the provisions of this Section 31.

          31.7 Inspection; Compliance. Sublessor and Master Lessor and their respective employees and agents shall have the right to enter the Subleased Premises at any time, in the case of an emergency, and otherwise at reasonable times upon reasonable prior notice, which may be verbal, for the purpose of inspecting the condition of the Subleased Premises and for verifying compliance by Sublessee with this Section 31. The reasonable cost of any such inspections shall be paid by Sublessor, unless such inspection reveals that Sublessee has violated the provisions of this Section 31 in which case Sublessee shall reimburse Sublessor for the reasonable out of pocket costs of such inspections. Moreover, Master Lessor shall be permitted at any time (a) to cause testing wells to be installed in or around the Subleased Premises, and (b) to cause ground water to be tested to detect the presence of Hazardous Substances.

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          31.8 Sublessee Indemnification. Sublessee shall indemnify, defend and hold harmless each of Sublessor, the Sublessor Indemnitees and the Master Lessor from and against any and all Claims arising out of or involving any Hazardous Substance brought onto or released in, on or under the Subleased Premises by or for Sublessee or Sublessee’s employees, contractors, agents, invitees, licensees or permitted sub-sublessees or assignees. Sublessee’s obligations shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Sublessee, and the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Sublease. No termination, cancellation or release agreement entered into by Sublessor and Sublessee shall release Sublessee from its obligations under this Sublease with respect to Hazardous Substances, unless Sublessor specifically agrees thereto in writing at the time of such agreement and such agreement specifically identifies this Section 31 of this Sublease.

          31.9 Sublessor Indemnification. Sublessor shall indemnify, defend and hold harmless each of Sublessee and the Sublessee Indemnitees from and against any and all Claims arising out of or involving (a) any Hazardous Substance existing in, on or under the Subleased Premises prior to the Commencement Date other than any Hazardous Substance brought onto or released in, on or under the Subleased Premises by or for Sublessee or Sublessee’s employees, contractors, agents, invitees or licensees prior to the Commencement Date, or (b) any Hazardous Substance brought onto or released in, on or under the Subleased Premises by or for Sublessor on and after the Commencement Date. Sublessor’s obligations shall include, but not be limited to, the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Sublease. No termination, cancellation or release agreement entered into by Sublessor and Sublessee shall release Sublessor from its obligations under this Section 31, unless Sublessee specifically agrees thereto in writing at the time of such agreement and such agreement specifically identifies this Section 31 of this Sublease.

          31.10 Environmental Assessment upon Termination of Sublease. At the request of Sublessor, Sublessee shall, within 60 days of the expiration or earlier termination of this Sublease or the Other Subleases, conduct an “environmental assessment” of Sublessee’s operations involving the use of Hazardous Substances on or about the premises covered by this Sublease or the Other Subleases, and provide an environmental representation to Sublessor, in writing, stating that Sublessee has not, and has no knowledge of any other person who has, released, threatened to release, disposed of, or caused to migrate any Hazardous Substances on or about, or originating or emanating from, the premises covered by this Sublease or the Other Subleases, in any material quantity, and that the said premises have not been the site of, and are not adversely affected by, any release, threatened release, migration, or disposal of Hazardous Substances. For purposes hereof, the term “environmental assessment” shall mean, without limitation, any assessment by means of document review, inspection, investigation, inquiry, due diligence investigation, review, test, sampling or the reporting of environmental matters pertaining to environmental affairs management, compliance management or environmental conditions of property or assets.

     32. Proposed Sub-Subletting; Recapture. In the event that Sublessee desires to sub-sublet all or a portion of the Subleased Premises, Sublessee shall submit to Sublessor for its

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review the terms and conditions of such proposed sub-sublease transaction. Sublessor shall have the option for a period of thirty (30) days, commencing upon the delivery to Sublessor of all of the information described in the succeeding sentence, to elect in Sublessor’s sole discretion to terminate this Sublease (as to the portion of the Subleased Premises that Sublessee proposes to sub-sublet) and enter into a direct sublease (the “Direct Sublease”) with the prospective sub-sublessee (the “Recapture”). In connection with Sublessor’s review process, Sublessee shall submit to Sublessor in writing (i) the name of the proposed sub-sublessee, (ii) such information as to such sub-sublessee’s financial condition and general standing in the community as may be available to Sublessee, (iii) all of the terms and conditions upon which the proposed transaction is to be made, and (iv) such other information as Sublessor shall reasonably request. The parties hereto acknowledge and agree that, if Sublessor elects to Recapture: (a) the consent of Master Lessor is required for the Direct Sublease (the “Direct Sublease Consent”); (b) the parties hereto shall use commercially reasonable efforts to negotiate in good faith to obtain, execute and deliver the Direct Sublease Consent as soon as reasonably practicable; (c) Sublessee shall execute and deliver a guaranty, in form and substance reasonably acceptable to Sublessor and Sublessee, wherein Sublessee shall guaranty for the benefit of Sublessor the prompt payment and performance of each and every obligation of the sublessee under the Direct Sublease; (d) upon the effective date of the Recapture (provided that Master Lessor has executed the Direct Sublease Consent), Sublessee shall surrender possession of the portion of the Subleased Premises covered by the Direct Sublease and any applicable Personal Property and Infrastructure Systems in accordance with the terms and conditions contained in this Sublease for the surrender of the same; and (e) Sublessee shall execute and deliver an amendment to this Sublease modifying the description of the Subleased Premises, the Base Rent and any other relevant provisions contained herein. The provisions contained in this Section 32 are in addition to (and not in lieu of) the provisions contained in Sections 16, 55 and 56 of the Master Lease, as the same have been incorporated by reference into this Sublease.

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     IN WITNESS WHEREOF, the parties have executed this Sublease as of the date first hereinabove written.

Sublessor: MAXTOR CORPORATION
By:	/s/ Pat O’Malley
	Name:	Pat O’Malley
	Title:	Sr. VP Finance

Sublessee: SANDISK CORPORATION
By:	/s/ Judy Bruner
	Name:	Judy Bruner
	Title:	EVP, Administration and CFO

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EX-12.1

EXHIBIT 12.1

Computation of Ratio of Earnings to Fixed Charges

	Fiscal Year Ended
	December 30, 2002			December 28, 2003			January 2, 2005			January 1, 2006		December 31, 2006
				(In thousands, except ratios)
Computation of earnings:
Earnings before provision for income taxes	$	39,979		$	241,881		$	423,200		$	613,307	$	430,708
Fixed charges excluding capitalized interest		8,492			8,565			9,725			1,263		11,934
Distributed earnings from 50%-or-less-owned affiliate		(1,293	)		(148	)		(569	)		2,764		5,782
Adjusted earnings	$	47,178		$	250,298		$	432,356		$	617,334	$	448,424
Computation of fixed charges:
Interest expense	$	7,580		$	7,640		$	8,526		$	17	$	9,506
Interest portion of operating lease expense		912			925			1,199			1,246		2,428
Fixed charges	$	8,492		$	8,565		$	9,725		$	1,263	$	11,934
Ratio of earnings to fixed charges (1)		5.6x			29.2x			44.4x		488.8x			37.6x

⁽¹⁾ Computed by dividing (i) earnings before taxes adjusted for fixed charges by (ii) fixed charges which include interest expense plus amortization of debt issuance costs, the portion of rent expense under operating leases deemed to be representative of the interest factor and interest relating to lease guarantees of 50%-or-less-owned affiliate.

1

EX-21.1

EXHIBIT 21.1

SUBSIDIARIES OF THE REGISTRANT

1)	SanDisk Limited, a Japanese company
2)	SanDisk GmbH, a German company
3)	SanDisk Israel (Tefen) Ltd., an Israeli company
4)	SanDisk Hong Kong Limited, a Hong Kong company
5)	SanDisk (Cayman) Limited, a Cayman Islands company
6)	SanDisk Sweden AB, a Swedish company
7)	SanDisk U.K. Limited, a United Kingdom company
8)	SanDisk Scotland Limited, a United Kingdom company
9)	SanDisk Secure Content Solutions, Inc., a Delaware corporation
10)	SanDisk Secure Content Solutions, Ltd., an Israeli company
11)	SanDisk Equipment Ltd., a Japanese company
12)	SanDisk Manufacturing Limited, a Republic of Ireland company
13)	SanDisk International Limited, a Republic of Ireland company
14)	SanDisk India Device Design Centre, Ltd., an Indian company
15)	SanDisk Korea Ltd, (YH), a Korean company
16)	SanDisk B.V., a Netherlands company
17)	SanDisk Operations Limited, a Republic of Ireland company
18)	SanDisk (Ireland) Limited, a Republic of Ireland company
19)	SanDisk China Holding Limited, a Republic of Ireland company
20)	SanDisk China Limited, a Republic of Ireland company
21)	SanDisk SAS, a French company
22)	SanDisk Taiwan Limited, a Taiwanese company
23)	SanDisk Semiconductor (Shanghai) Co. Ltd., a Peoples Republic of China company
24)	SanDisk 3D LLC, a Delaware company
25)	SanDisk China LLC, a Delaware company
26)	SanDisk IL Ltd. (formerly msystems Ltd.), an Israeli company
27)	SanDisk Holdings Netherlands Antilles N.V., a Netherlands company
28)	M-Systems, Inc, a New York company
29)	M-Systems Holdings LLC, a Delaware company
30)	M-Systems Finance Inc., a Cayman Islands company
31)	M-Systems (Cayman) Limited, a Cayman Islands company
32)	P.P.S. von Koppen Pensioen B.V., a Netherlands company
33)	M-Systems B.V., a Netherlands company
34)	M-Systems Asia Ltd., a Taiwanese company
35)	M-Systems Flash Disk Pioneers (Japan), Inc., a Japanese company
36)	M-Systems UK Ltd., a United Kingdom company
37)	M-Systems Flash Disk Pioneers (Shenzhen) Trading Ltd., a Peoples Republic of China company
38)	M-Systems Italy S.R.L, an Italian company
39)	M-Systems Korea, a Korean company
40)	U3 LLC, a Delaware company
41)	U3 Israel Ltd., an Israeli company
42)	M. Systems Flash Disk Pioneers Espana S.L.U., a Spanish company
43)	Microelectronica Espanola S.A.U., a Spanish company
44)	ExcelData S.A., a Spanish company
45)	TwinSys Ltd., an Israeli company (50.1% ownership)
46)	TwinSys Data Storage L.P., an Israeli partnership (50.1% beneficial interest)
47)	MR-Flash Ltd., an Israeli company (50.1% ownership)
48)	MR-Flash L.P., an Israeli partnership (50.1% beneficial interest)
49)	Smart Caps Ltd., an Israeli company (79.95% ownership)
50)	Flash Holdings, an Israeli company
51)	Eurom Flashware, an Israeli company
52)	Key Computing Ltd., an Israeli company
53)	MegaSIM Ltd., an Israeli company

1

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Registration Statements (Form S-3 No. 333-133890, Form S-8 No. 33-99214, 333-32039, 333-83193, 333-85320, 333-109186, 333-63076, 333-112139, 333-126157, 333-131097, 333-136491, 333-138978 pertaining to the amended and restated 1995 Stock Option Plan, Employee Stock Purchase Plan and International Employee Stock Purchase Plan, 1995 Non-Employee Directors Stock Option Plan, Special Stock Option Plan, SanDisk Corporation 2005 Incentive Plan, SanDisk Corporation 2005 Employee Stock Purchase Plan, SanDisk Corporation 2005 International Employee Stock Purchase Plan, Rhombus, Inc. 1998 Long Term Equity Incentive Plan, Matrix Semiconductor, Inc. 1999 Stock Plan, Matrix Semiconductor, Inc. 2005 Stock Incentive Plan, msystems Ltd. 2003 Stock Option and Restricted Stock Incentive Plan and the msystems Ltd. Section 102 Stock Option/Stock Purchase and Stock Option Plans) of SanDisk Corporation, of our reports dated February 22, 2007, with respect to the consolidated financial statements of SanDisk Corporation, SanDisk Corporation’s management’s assessment of the effectiveness of internal control over financial reporting, and the effectiveness of internal control over financial reporting of SanDisk Corporation, included in the Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

/s/ Ernst & Young LLP

San Jose, California
February 22, 2007

EX-31.1

EXHIBIT 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002

I, Eli Harari, certify that:

1. I have reviewed this annual report on Form 10-K of SanDisk Corporation for the year ended December 31, 2006;

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

     a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

     b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

     c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the period covered by this report based on such evaluation; and

     d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

     a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

     b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 27, 2007

/s/ Eli Harari  

Eli Harari 

Chairman of the Board and Chief Executive Officer
(Principal Executive Officer) 

EX-31.2

EXHIBIT 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002

I, Judy Bruner, certify that:

1. I have reviewed this annual report on Form 10-K of SanDisk Corporation for the year ended December 31, 2006;

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

     a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

     b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

     c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the period covered by this report based on such evaluation; and

     d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

     a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

     b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 27, 2007

/s/ Judy Bruner  

Judy Bruner 

Executive Vice President, Administration and
Chief Financial Officer
(Principal Financial and Accounting Officer) 

EX-32.1

EXHIBIT 32.1

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

     I, Eli Harari, Chief Executive Officer of SanDisk Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the annual report on Form 10-K of SanDisk Corporation for the year ended December 31, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of SanDisk Corporation.

By:	/s/ Eli Harari
	Eli Harari
	Chairman of the Board and Chief Executive Officer
	(Principal Executive Officer)

February 27, 2007

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

EX-32.2

EXHIBIT 32.2

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

     I, Judy Bruner, Chief Financial Officer of SanDisk Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the annual report on Form 10-K of SanDisk Corporation for the year ended December 31, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of SanDisk Corporation.

By:	/s/ Judy Bruner
	Judy Bruner
	Executive Vice President, Administration and Chief Financial Officer
	(Principal Financial and Accounting Officer)

February 27, 2007

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