-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OouVUy8GGiPQD5kIkzKZBPLojoKsaNA7HF9TzWq8IWx+f5yI16tqleAeERgoT9oS 8LgT/oQ4MKtz5X0pEDP+3Q== 0000891618-06-000116.txt : 20060315 0000891618-06-000116.hdr.sgml : 20060315 20060315173801 ACCESSION NUMBER: 0000891618-06-000116 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20060101 FILED AS OF DATE: 20060315 DATE AS OF CHANGE: 20060315 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SANDISK CORP CENTRAL INDEX KEY: 0001000180 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER STORAGE DEVICES [3572] IRS NUMBER: 770191793 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-26734 FILM NUMBER: 06689332 BUSINESS ADDRESS: STREET 1: 140 CASPIAN COURT CITY: SUNNYVALE STATE: CA ZIP: 94089 BUSINESS PHONE: 4085620500 MAIL ADDRESS: STREET 1: 140 CASPIAN COURT CITY: SUNNYVALE STATE: CA ZIP: 94089 10-K 1 f18180e10vk.htm FORM 10-K e10vk
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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 January 1, 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
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
140 Caspian Court
Sunnyvale, California
(Address of principal executive offices)
  94089
(Zip Code)
 
(408) 542-0500
(Registrant’s telephone number, including area code)
 
[None]
(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
 
None   None
 
Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, $0.001 par value;
 
Rights to Purchase Series A, Junior Participating Preferred Stock
 
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 o     No þ
 
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.  o
 
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 o
 
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 3, 2005, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $3,559,616,995 based on the closing sale price as reported on the National Association of Securities Dealers Automated Quotation System National Market System.
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
     
Class
 
Outstanding at March 1, 2006
 
Common Stock, $0.001 par value per share   194,010,547 shares
 
DOCUMENTS INCORPORATED BY REFERENCE
 
     
Document
 
Parts Into Which Incorporated
 
Annual Report to Stockholders for the Fiscal Year Ended January 1, 2006 (Annual Report)
  Parts I, II, and IV
Proxy Statement for the Annual Meeting of Stockholders to be held May 25, 2006 (Proxy Statement)
  Part III
 


 

 
SANDISK CORPORATION
 
Table of Contents
 
               
        Page
        No.
 
  Business   3
  Risk Factors   13
  Unresolved Staff Comments   25
  Properties   25
  Legal Proceedings   26
  Submission of Matters to a Vote of Security Holders   29
 
  Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   29
  Selected Financial Data   30
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   32
  Quantitative and Qualitative Disclosures About Market Risk   41
  Financial Statements and Supplementary Data   41
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   41
  Controls and Procedures   42
  Other Information   42
 
  Directors and Executive Officers of the Registrant   42
  Executive Compensation   43
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   43
  Certain Relationships and Related Transactions   43
  Principal Accounting Fees and Services   43
 
  Exhibits and Financial Statement Schedules   44
 
OTHER
  F-1
  S-1
 EXHIBIT 3.4
 EXHIBIT 10.46
 EXHIBIT 10.47
 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 2005, 53 weeks in 2004 and 52 weeks in 2003.
 
Overview
 
Who We Are.  We are the worldwide leader in flash storage card products. We design, develop and market flash storage devices used for a wide variety of consumer electronics products such as digital cameras, mobile phones, Universal Serial Bus, or USB, drives, gaming devices, MP3 players and other digital consumer devices. Flash storage allows data to be stored in a compact format that retains the data for an extended period of time after the power has been turned off.
 
Our Strategy.  Our strategy is to identify and develop current and emerging mass consumer markets for flash storage products and through our vertical integration supply strategy 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 original equipment manufacturer, or OEM, customers.
 
Our revenues are driven by the sale of products and licensing of our intellectual property. We believe the market for flash storage is price elastic. From 2004 to 2005, we increased the number of megabytes sold by 166% in large measure due to a decrease of 52% 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 an increase in our product revenues from $1.6 billion in 2004 to $2.1 billion in 2005. In addition, our license revenue increased from $174.2 million in 2004 to $239.5 million in 2005 as a result of continued adoption of flash technologies by our licensees.
 
We create new markets for flash memory. Together with Matsushita Electric Industries, Ltd., or Matsushita, which owns the Panasonic brand, and a subsidiary of Toshiba Corporation, or Toshiba, we launched the Secure Digital card, or SDtm card, which is currently the most popular form factor of flash storage cards. We followed that effort by working with mobile network operators and handset manufacturers to develop the miniSDtm card and microSDtm card, an even smaller form factor memory card. Our market-driving efforts now include investment in the U3tm platform, with which software developers can transform USB drives from a simple mass storage device to a platform for on-the-go computing. We are also in the early stages of developing the market for pre-loaded content, such as music, and other digital content for end-users in specific fields such as education. We are working with device manufacturers, infrastructure and copyright owners and software developers in developing these emerging markets, which we believe will contribute to the future of flash storage products.
 
We are founders or co-founders of most major form factors of flash storage cards in the market today. We co-own the Memory Stick PROtm format with Sony Corporation, or Sony, we have worked with Canon, Inc., or Canon, to co-found CompactFlash®, and worked with Matsushita and a subsidiary of Toshiba to co-found the SD card. We co-developed miniSD with NTT DoCoMo, Inc., Toshiba and Matsushita, and we pioneered TransFlashtm in collaboration with Motorola, Inc., or Motorola. We plan to continue to work with leading companies in mobile


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communications and digital consumer devices to find additional ways for flash storage card products to enable proliferation of those technologies and markets.
 
We develop and own leading-edge technology and patents for flash memory and data storage cards. Our research and development spending was approximately $195 million in 2005. Our team has a deep understanding of flash memory. We own or control many patents, know-how and other intellectual property covering the design, manufacture and operation of flash memory and flash memory cards. One of the key technologies that we have patented and successfully commercialized to date 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. This technology is an important factor in our ability to reduce the cost of our flash memory. We have an extensive patent portfolio that has been licensed by three of the four largest semiconductor companies based on revenues. Our license and royalty revenues over the last three years cumulatively were over $511 million.
 
We are investing with Toshiba in joint ventures, that are 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 from Renesas Technology Corporation, or Renesas, Samsung Electronics Corporation, or Samsung, and Toshiba. Additionally, we design in-house and fabricate at third-party foundries the controllers which 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.
 
We sell our product globally to retail and OEM customers. We intend to continue to expand our retail customer base to additional new geographic regions as well as to new outlets such as supermarkets and drug stores. We also seek to strengthen our current retailer relationships and establish exclusive arrangements where practical. In North America, we sell our products principally through retailers, such as Best Buy Company, 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 150,000 worldwide retail storefronts where consumers may purchase SanDisk products. We also sell directly and through distributors, to key OEM accounts, including mobile phone manufacturers and digital camera manufacturers who include our products with their products when sold to end users.
 
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 as well as 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 450 Fifth Street, N.W., Washington, DC 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 1-800-SEC-0330. 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 140 Caspian Court, Sunnyvale, California 94089 and our telephone number is (408) 542-0500. “SanDisk” is a registered trademark of SanDisk Corporation. All other trade names used in this report are trademarks of their respective holders.


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Description of Our Business
 
Industry Background.  The digital computing industry includes traditional computers and consumer electronic, communications and industrial products. We focus our products on digital consumer devices like digital cameras, mobile phones, gaming devices, personal computers and portable digital audio players. The storage requirements of these applications include small form factor size, portable and removable storage, high reliability and storage capacity, low power consumption and the capability to withstand 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 characterized by fast read speeds with generally higher costs per megabyte and lower storage capacities than 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 primarily on five consumer electronics markets: imaging, mobile phones, USB flash drives, gaming devices and digital audio players.
 
  •  Imaging.  We make and sell flash storage cards that 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 systems, or GPS, and personal data in personal digital assistants, or PDAs. Primary card formats for cameras and other digital devices include CompactFlash, or CF, Secure Digital, or SD, Memory Sticktm and xD-Picture Cardtm.
 
  •  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 phone and transferability of data to and from other devices. Today, we are a leading supplier of microSD, miniSD, SD, Memory Stick PRO Duotm, and reduced sized MMC, or RS-MMCtm, cards for removable storage in many mobile phone models.
 
  •  USB Flash Drives.  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. We believe USB flash drives will be a key factor in the evolution of mobile computing. In 2005, we announced products on the U3 platform, which is designed to make the USB drive a platform for on-the-go computing.
 
  •  Gaming Devices.  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. In the first quarter of fiscal 2005, we began shipping brightly colored SD and Memory Stick PRO Duo cards for this emerging market.
 
  •  Digital Audio Players.  Digital audio players allow consumers to download, store and play music. In fiscal 2004, we introduced our first SanDisk digital audio player, utilizing flash memory for storage. Our current line of digital audio players includes a number of products from the Sansatm m200 series all the way up to the flagship Sansa e200 series with both embedded and removable memory.
 
Our Sales Channels.  Our products are delivered to end-users through approximately 150,000 worldwide retail storefronts and as data storage cards bundled with host products by our OEM customers. We market our products under the SanDisk brand in the retail channel using a direct sales organization, distributors and manufacturers’ representatives. We also sell directly and through distributors, SanDisk branded and private label products to OEM customers. Our sales efforts are organized as follows:
 
  •  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 product to smaller retailers through distributors. Our retail distributors include AVS Technologies, Inc., D&H Distributing Co., Inc., Duttenhofer GMBH & Co., Hama Corporation, Inc., Holst


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Import BV, Ingram Micro, Inc., Kaga Electronics Co., Ltd., Princeton Technology Corporation, Tech Data Corporation and Wynit, Inc., in addition to approximately 50 other distributors.
 
We have a separate distribution network focused on the cellular 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 4 to our consolidated financial statements included in Item 8 of this report.
 
  •  OEM.  Our OEM customers include manufacturers of digital cameras, mobile phones and other digital consumer devices, such as GPS receivers. Our products are sold directly to OEMs and through distributors. We support our OEM customers with both direct sales representatives and independent manufacturers’ representatives.
 
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. As of the end of fiscal 2005 and fiscal 2004, our backlog was $105.7 and $78.6 million, respectively. The following table describes the distribution of our net product revenues (in millions):
 
                         
    FY 2005     FY 2004     FY 2003  
 
Retail
  $ 1,621.0     $ 1,236.0     $ 632.1  
OEM
    445.6       366.8       350.2  
                         
Product revenue
  $ 2,066.6     $ 1,602.8     $ 982.3  
                         
 
The significance of our North American retail channel to our business has resulted in our revenues being seasonally higher in our fourth quarter due to the holiday buying season. Our first and third quarters have sometimes been seasonally lower than their preceding quarters.
 
Our Customers.  In 2005, 2004 and 2003, revenues from our top 10 customers and licensees accounted for approximately 50%, 55% and 48% of our revenues, respectively. In 2005, Best Buy accounted for 11% of our total revenues; all other customers were less than 10% of our revenues. In 2004 and 2003, no single customer or licensee accounted for greater than 10% of our total revenues. The composition of our major customer base from year-to-year 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 can be categorized by form factor and performance. Form factor generally correlates with our targeted end-market.
 
We make many form factors of removable data storage cards as well as USB flash drives and flash digital audio players. The principal form factors of our products are:
 
  •  CompactFlash.  Our CF products are characterized by high performance. CF products are well-suited for a range of consumer applications, including digital still cameras and audio recorders. CF cards are available in capacities ranging from 32 megabytes to 8 gigabytes.
 
  •  SD.  The SD card provides content copyright protection features. This form factor is used in digital cameras, mobile phones, gaming devices, GPS receivers, PDAs and digital audio players in the consumer electronics marketplace. We offer SD cards in storage capacities of 32 megabytes to 2 gigabytes.
 
  •  miniSD Card.  The miniSD card is a smaller version of the SD card which leverages the feature-set of the standard SD card but is designed for small mobile phones. An optional full-size SD card adapter allows miniSD cards to be used in full size SD card applications thereby acting as a bridge to the large range of SD-based consumer and telecommunications devices. Capacities range from 128 megabytes to 2 gigabyte.


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  •  microSD.  microSD is an ultra-small removable flash memory storage format designed for new mobile phones that are compact yet fully-featured with storage-intensive multimedia applications such as digital cameras, video capture and playback, digital audio players, video games, email and voicemail capabilities. microSD is similar in size and function to embedded flash memory, but can also be readily removed and upgraded to allow for a range of memory capacities as well as interoperability with other consumer electronics devices. Capacities range from 128 megabytes to 1 gigabyte.
 
  •  Memory Stick PRO/Memory Stick PRO Duo.  Co-developed with Sony, the Memory Stick PRO product line is sold in capacities ranging from 64 megabytes to 4 gigabytes, depending on the format, and is used in digital cameras, digital video camcorders, mobile phones and televisions. Memory Stick PRO and Memory Stick PRO Duo offer substantially improved performance in higher write speeds and capacity, as compared with the original Memory Stick line of products, as well as built-in MagicGatetm copyright protection. All products in our Memory Stick PRO product line meet the minimum standard performance of 15 megabits per second for high-resolution recording of moving images.
 
  •  Cruzer® USB Flash Drives.  Our Cruzer USB flash drives are available in capacities ranging from 32 megabytes to 4 gigabytes. Our Cruzers allow users to transfer data files between any device with a USB port. Cruzers offer a high-speed, compact replacement for the floppy disk or other removable media. In addition to our standard Cruzer family, our Cruzer Titanium USB flash drive family is targeted at high-end users. Cruzer Titanium is an extremely rugged USB flash drive made from titanium and other metals. In conjunction with M-Systems, Inc., or M-Systems, we developed the U3tm platform for USB drives, which is designed for on-the-go computing.
 
  •  XD-Picture Card.  In 2003, we began selling the xD-Picture Card format under arrangements with Olympus Optical Co., Ltd., or Olympus, and Fuji Photo Film Co., Ltd., or Fuji. The xD-Picture Card allows for rapid data transfer, is ultra compact and is compatible with all xD cameras. The xD-Picture Card is available in capacities ranging from 64 megabytes to 1 gigabyte.
 
  •  Sansa Digital Audio Music Player.  In late fiscal 2004, we began selling Sansa digital audio music players. These very small flash-based MP3 devices allow consumers to download songs and listen to the radio. Our flagship line offers a removable card slot for easy transportability of the music between devices and for expansion of storage capacity. Sansa is available in capacities ranging from 256 megabytes to 6 gigabytes.
 
  •  Gaming Cards.  In 2005, we began selling SD and Memory Stick Pro Duo cards into the gaming market. These cards allow consumers to store game scores and levels, turn on advanced features in gaming devices, and listen to audio or watch movies in portable gaming devices such as the Sony PlayStation® Portable.
 
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, chip design, controller development and system-level integration to ensure the creation of fully-integrated, broadly interoperable products that are compatible with both existing and newly developed system platforms. We believe our core technical competencies are in:
 
  •  high-density flash memory process, device design and reliability;
 
  •  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


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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 cards 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.
 
Our research and development expenses were $194.8 million, $125.0 million and $84.2 million in 2005, 2004 and 2003, respectively.
 
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 president and chief executive officer Dr. Eli Harari and exclusively licensed to us. As of the end of 2005, we owned or had rights to 349 United States patents, 212 foreign patents, 450 patent applications pending in the United States, and have foreign counterparts pending on many of the applications in multiple jurisdictions. We intend to seek additional international and United States patents on our technology.
 
On January 13, 2006, we completed the acquisition of Matrix Semiconductor, Inc., or Matrix. Matrix is a pioneer in the design and development of three dimensional semiconductor memory technology. Patents transferred to us upon completion of the acquisition included 124 United States patents, approximately 14 foreign patents, and approximately 141 patent applications pending in the United States, and 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, Matsushita, 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.
 
  •  Silicon Sourcing.  All of our flash memory card products require silicon chips for the memory components 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.” We purchase non-captive memory supply primarily from Renesas and Samsung. We are guaranteed a percentage of the total output of each of Renesas and Samsung, but are not obligated to use the guaranteed supply until we give them an order for future purchases. We also source memory products from Fuji and Olympus. 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 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


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  Flextronics and StatsChipPAC, in China. We believe our use of subcontractors reduces the cost of our operations and gives us access to increased production capacity. See Item 1A, “Risk Factors.”
 
Ventures with Toshiba
 
FlashVision.  In May 2000, we invested in the 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 operations in Japan, through a venture named FlashVision, Ltd., or FlashVision.
 
  •  Semiconductor Manufacturing Equipment.  Toshiba owns the wafer fabrication facilities, Yokkaichi Fabs 1 and 2, in which FlashVision’s tools are installed. We have also installed in Yokkaichi Fabs 1 and 2 tools which we own directly, providing us with approximately 10% additional capacity on approximately the same terms as supply from FlashVision. Fabs 1 and 2 produce 200-millimeter wafers.
 
  •  Capitalization and Related Matters.  We own 49.9% of FlashVision and Toshiba own 50.1% of FlashVision. FlashVision’s funding takes the form of permanent capital (37.8 billion Japanese yen, or approximately $321 million based upon the exchange rate at January 1, 2006, in total) and loans from Toshiba and us, funded one-half by each owner.
 
At the end of fiscal 2005, our loans to FlashVision were 7.3 billion Japanese yen, or approximately $62 million based upon the exchange rate at January 1, 2006, and we are not committed to fund additional amounts in fiscal 2006. FlashVision’s stated life will terminate in December 2016, but may be terminated by Toshiba or by us by notice given from May 16, 2008 to May 15, 2009. There are other termination events described in the master agreement and the operating agreement, which are exhibits to this report. Those agreements should be read carefully in their entirety for a comprehensive understanding of our rights and obligations.
 
  •  Lease Facility.  FlashVision sold and leased back from Mizuho Leasing tools which had an original book value of 37.9 billion Japanese yen, or approximately $321 million based upon the exchange rate at January 1, 2006. FlashVision has been making lease payments and the remaining fixed lease payment obligation at the end of 2005 was 17.7 billion Japanese yen, or approximately $150 million based upon the exchange rate at January 1, 2006. Toshiba guaranteed FlashVision’s performance of its obligations under the lease facility and we agreed to reimburse Toshiba for 49.9% of its claims and associated expenses related to its guarantee agreement, unless those claims resulted from Toshiba’s failure to meet its obligations to FlashVision or breach of Toshiba’s covenants with the lessors. We pay Toshiba a credit enhancement fee for providing the direct guarantee of FlashVision’s lease obligations. In May 2006, FlashVision has the option of purchasing the tools from the lessors. FlashVision is obligated to insure the equipment, maintain the equipment in accordance with the manufacturers’ recommendations and other customary terms to protect the leased assets. The lease agreement contains customary events of default for a Japanese lease facility.
 
  •  Operations.  By the end of 2005, FlashVision successfully transitioned the majority of its production from 90-nanometers to 70-nanometers. FlashVision purchases wafers from Toshiba and sells wafers to Toshiba and to us at manufacturing cost plus a mark-up. FlashVision generates cash over time as a result of being paid as part of manufacturing cost for its non-cash depreciation expense. This cash is currently expected to be used to fund equipment purchases for FlashVision and to repay loans from Toshiba and us. We and Toshiba are each committed to take 50% of FlashVision’s wafer output, with each company specifying the type of wafer in its allocation.
 
  •  Research and Development.  We and Toshiba each have design and development teams associated with FlashVision. 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 of the flash memory. We also pay Toshiba for a portion of its semiconductor company’s common research and development activities. See Note 5 to our consolidated financial statements included in Item 8 of this report.


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Flash Partners.  In September 2004, the Flash Partners, Ltd., or Flash Partners, venture was formed. The key elements of the venture are:
 
  •  Semiconductor Manufacturing Equipment.  Toshiba has constructed at its expense a wafer fabrication facility, Fab 3, at its Yokkaichi Operations. Flash Partners purchases 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 30,000 wafers per month by March 2006. Flash Partners has committed to a plan to ramp production to 70,000 wafers per month by March 2007 and currently estimates the total equipment funding obligation to achieve this plan level to be approximately 365.0 billion Japanese yen, or approximately $3.1 billion based upon the exchange rate at January 1, 2006, of which a portion has already been incurred. Of this amount, we are obligated to fund 50% or approximately $1.5 billion based upon the exchange rate at January 1, 2006. Our remaining funding obligation at January 1, 2006 for the current expansion plan is approximately $1.0 billion. See “Sale and Leaseback” below.
 
  •  Capitalization and Related Matters.  We own 49.9% of Flash Partners and Toshiba own 50.1% of Flash Partners. Flash Partners’ funding from its parents is structured as a combination of permanent capital and loans from us and Toshiba, funded one-half by each owner. Flash Partners has a stated life of 15 years, but may be terminated by us or Toshiba by notice given from April 1, 2011 to March 31, 2012. In addition, we have a termination right that may be exercised by notice between April 1, 2007 and March 31, 2008. There are other termination events described in the master agreement and the operating agreement which are exhibits to this report. Those agreements should be read carefully in their entirety for a comprehensive understanding of our rights and obligations.
 
  •  Sale and Leaseback.  Flash Partners has entered into two equipment lease agreements as described below.
 
  •  In December 2004, Flash Partners entered into a master lease agreement with certain financial institutions providing for up to 50.0 billion Japanese yen, or approximately $424 million based upon the exchange rate at January 1, 2006, of original lease obligations. As of January 1, 2006, Flash Partners had drawn down this entire master lease facility. We and Toshiba have each guaranteed, on a several basis, 50% of Flash Partners’ obligations under the master lease agreement. Lease payments are due quarterly and will be completed in stages through 2010. At the end of the lease term, Flash Partners has the option of purchasing the tools from the lessors. Flash Partners is obligated to insure and maintain the equipment in accordance with the manufacturers’ recommendations, and other customary terms to protect the leased assets. The master lease agreement contains customary events of default for a Japanese lease facility and is an exhibit to this report. That agreement should be read carefully in its entirety for a comprehensive understanding of its terms and the nature of the obligations we have guaranteed.
 
  •  In December 2005, Flash Partners entered into a second master lease agreement with certain financial institutions providing up to 35.0 billion Japanese yen, or approximately $297 million based upon the exchange rate at January 1, 2006, of original lease obligations. There were no amounts outstanding under this lease agreement at the end of fiscal 2005; however the entire amount was drawn down in January 2006. We and Toshiba have each guaranteed, on a several basis, 50% of Flash Partners’ obligations under this master lease agreement. Lease payments are due quarterly and will be completed in 2011. At the end of the lease term, Flash Partners has the option of purchasing the tools from the lessors. Flash Partners is obligated to insure and maintain the equipment in accordance with the manufacturers’ recommendations, and other customary terms to protect the leased assets. The master lease agreement contains customary events of default for a Japanese lease facility and is an exhibit to this report. That agreement should be read carefully in its entirety for a comprehensive understanding of its terms and the nature of the obligations we have guaranteed.
 
  •  Operations.  Flash Partners’ current production ramp plan contemplates technology transitions from 90-nanometers to 70-nanometers to 55-nanometers. Flash Partners purchases wafers from Toshiba and sells wafers to us and Toshiba at a price equal to manufacturing cost plus a mark-up. Toshiba operates Fab 3, and we have our employees assigned to work in Fab 3. The cost of the wafers that Flash Partners purchases from Toshiba includes Toshiba’s costs of running Fab 3 and the depreciation cost of the Fab 3 building and improvements. Flash Partners does not receive any commitment from Toshiba as to wafer yield or any


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  protection from operational incidents. We and Toshiba are each committed to take 50% of Flash Partners’ wafer output, with each company specifying the type of wafer in its allocation.
 
Flash Partners is expected to generate cash over time as a result of being paid as part of its manufacturing cost for its non-cash depreciation expense. This cash is currently expected to be used to fund expansion of Flash Partners’ flash memory manufacturing capacity and ultimately to repay loans from us and Toshiba.
 
  •  Research and Development.  We and Toshiba each have teams that are currently working on the 70-nanometer and 55-nanometer designs. Our research and development cost sharing is similar to that of FlashVision. See Note 5 to our consolidated financial statements included in Item 8 of this report.
 
We refer to our wafer purchases from the Toshiba ventures and foundry arrangement with Toshiba as captive capacity as compared with our market-priced purchases of flash memory from Samsung and Renesas, which we refer to as non-captive capacity.
 
Competition
 
Our industry is very competitive. We face competition from numerous flash memory card manufacturers, as well as from semiconductor manufacturers of NAND flash memory. We also face competition from hard disk drives and from new technologies. See Item 1A, “Risk Factors.”
 
Our Key Competitive Advantages.  We believe our key competitive advantages in NAND flash products include:
 
  •  our intellectual property ownership, in particular our patent claims and manufacturing know-how over MLC, provides a cost advantage to us and Toshiba;
 
  •  through the ventures with Toshiba, we benefit from Toshiba’s manufacturing and research and development experience and expertise;
 
  •  we manufacture and sell a broader range of card formats than any of our competitors, which gives us an advantage in obtaining retail and OEM distribution; and
 
  •  our captive NAND flash wafer supply enables us to control our supply chain and provides cost advantages over our competitors, who only have contractual relationships with their suppliers.
 
Semiconductor Competitors.  Our primary semiconductor competitors currently include our historical competitors Renesas, Samsung and Toshiba. New competitors include Hynix Semiconductor, Inc., or Hynix, IM Flash Technologies, LLC, or IM Flash (a new company formed by Micron Technology, Inc., or Micron, and Intel), Infineon Technologies, A.G., or Infineon, Micron, and STMicroelectronics N.V., or STMicro, who began shipping NAND or NAND-competitive memory in 2004. If any of these competitors increase their memory output, it will likely result in a decline in the prevailing prices for packaged NAND semiconductor components. Additionally, manufacturers of NOR flash memory, such as Intel and Spansion LLC, or Spansion, are attempting to use their flash memory for traditional NAND applications, both embedded and in data storage cards.
 
Card and USB Flash Drive Competitors.  We compete with manufacturers and resellers of flash memory cards and USB flash drives. These companies purchase (or have captive supply of) flash memory components and assemble memory cards. These companies include, among others, Buffalo Technology, Dane-Elec Manufacturing, or Dane-Elec, Delkin Devices, Inc., or Delkin, Fuji, Hagiwara Sys-Com Co., Ltd., or Hagiwara, Hama Corporation, Inc., or Hama, I/O Data Device, Inc., or I/O Data, Infineon, Kingmax, Inc., or KingMax, Kingston Technology Company, Inc., or Kingston, Eastman Kodak Company, or Kodak, Lexar, M-Systems, Matsushita, Memorex Products, Inc., or Memorex, Micron, PNY Technologies, Inc., or PNY, PQI Corporation, or PQI Corp., Pretec Electronics Corporation (USA), or Pretec Electronics, Renesas, Samsung, Sharp, SimpleTech, Inc., Sony, Toshiba and Viking Components, Inc., or Viking Components.
 
Digital Audio Players.  Our digital audio players face competition from products offered by other companies, including Apple Computer, Inc., or Apple, Creative Technologies, Ltd., or Creative, iriver America, Inc., or iriver, and Samsung.


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Other.  There are other technologies that compete with our product offerings. There are many companies that are attempting to develop memory cells that use different designs and materials than the semiconductors in the marketplace today. When these technologies can be manufactured in high volume, they could have a significant cost advantage over NAND memory technologies. One example is NROM technology which was invented and patented by Saifun Semiconductors Ltd. We also face competition from hard disk drives. Small hard disk drives have a lower cost per megabyte today than does NAND flash; however the minimum density is higher making the hard disk drive expensive in applications that may not require as much memory as the hard disk provides. The hard disk drives in the market today also have significant power requirements and are not as rugged as flash memory. The competitive disadvantages of these other technologies may be reduced or eliminated over time.
 
Employees
 
As of January 1, 2006, we had 1,083 full-time employees, including 450 in research and development, 167 in sales and marketing, 208 in general and administration and 258 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 March 1, 2006):
 
             
Name
 
Age
 
Position
 
Eli Harari
  60   President, Chief Executive Officer and Director
Sanjay Mehrotra
  47   Executive Vice President and Chief Operating Officer
Nelson Chan
  44   Executive Vice President and General Manager, Consumer and Handset Business
Judy Bruner
  47   Executive Vice President, Administration and Chief Financial Officer
Randhir Thakur
  43   Executive Vice President, Technology and Worldwide Operations
Yoram Cedar
  52   Executive Vice President, Handset Business and Corporate Engineering
 
Eli Harari, the founder of SanDisk, has served as President and Chief Executive Officer and as a director of SanDisk since June 1988. Dr. Harari founded Wafer Scale Integration, a privately held semiconductor company, in 1983 and was its President and Chief Executive Officer from 1983 to 1986, and Chairman and Chief Technical Officer from 1986 to 1988. From 1973 to 1983, Dr. Harari held various management positions with Honeywell Inc., Intel Corporation and Hughes Aircraft Microelectronics. Dr. Harari holds a Ph.D. in Solid State Sciences from Princeton University and has more than 70 patents issued in the field of non-volatile memories and storage systems. Dr. Harari is a board member of Tower.
 
Sanjay Mehrotra co-founded SanDisk in 1988 and is Executive Vice President and Chief Operating Officer. He has also served as our 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.
 
Nelson Chan brings more than 20 years of high-technology marketing and engineering experience and has served as our Vice President of Marketing, Senior Vice President, Worldwide Sales and Marketing and Senior Vice President and General Manager, Retail Business Unit. Mr. Chan is currently our Executive Vice President and General Manager of our Consumer and Handheld Business. Prior to joining us in 1992, Mr. Chan held marketing


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and engineering positions at Chips and Technologies, Inc., Signetics, and Delco Electronics. Mr. Chan was one of the principal organizers of the CompactFlash Association (CFA) and the MultiMediaCard Association (MMCA). He is an officer and board member of the CFA. Mr. Chan holds a B.S. degree in Electrical and Computer Engineering from the University of California, Santa Barbara and an M.B.A. degree from Santa Clara University.
 
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 palmOne, Inc., a provider of handheld computing and communications solutions, from September 1999 until June 2004. Prior to palmOne, 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.
 
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. He joined Applied Materials as Chief Technical Officer of the Transistor and Capacitor Products Business Group. Previously, Dr. Thakur was the Chief Technology Officer and General Manager at Steag Electronic Systems. He also worked at AG Associates as Vice President of Research and Development and he held various technical and management positions at Micron Technology. Dr. Thakur holds more than 250 patents and has published more than 200 technical publications. Dr. Thakur received his B.S. degree (honors) in Electronics and Telecommunications Engineering from the Regional Engineering College, Kurukshetra, India, and a M.S. degrees 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, Handset 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.
 
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, the following:
 
  •  decline in the average selling prices, net of promotions, for our products due to strategic price reductions initiated by us or our competitors, excess supply and competitive pricing pressures;
 
  •  addition of new competitors, expansion of supply from existing competitors or cancellation of orders creating excess market supply, which could cause our average selling prices to decline faster than our costs decline;
 
  •  timing, volume and cost of wafer production from the FlashVision and Flash Partners 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;
 
  •  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;
 
  •  insufficient supply from captive and non-captive sources or insufficient capacity from our test and assembly sub-contractors to meet demand;


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  •  continued development 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 have higher costs than our captive sources;
 
  •  difficulty in forecasting and managing inventory levels; particularly, building a large inventory of unsold product due to noncancelable contractual obligations to purchase materials such as flash memory, controllers, printed circuit boards and discrete components;
 
  •  write-downs of our investments in fabrication capacity, equity investments and other assets;
 
  •  expensing of share-based compensation;
 
  •  adverse changes in product and customer mix;
 
  •  terrorist attacks, governmental responses to those attacks and natural disasters;
 
  •  changes in general economic conditions; and
 
  •  the factors listed elsewhere under “Risk Factors.”
 
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 50%, 55% and 48% of our total revenues during the fiscal years of 2005, 2004 and 2003, respectively. 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 by 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.
 
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 in this market, we could experience 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 determine actual retail product revenues until after the end of each of our fiscal quarters. 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 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 average selling prices, net of promotions, may decline due to excess supply, competitive pricing pressures and 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, strategic price decreases by us or our competitors such as that implemented by us in the first quarter of 2006, supply


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in excess of demand from existing or new competitors, technology transitions, including adoption of multi-level cell, or MLC, by other competitors, new technologies or other strategic actions by competitors to gain market share. If our technology transitions and cost reductions fail to keep pace with the rate of price decline or our price decreases fail to generate sufficient additional demand, our gross margin and operating results will be negatively impacted.
 
Our revenue depends in part on the success of products sold by our OEM customers.  A portion of our sales are to a number of OEMs, who bundle our flash memory products with their products, such as cameras or handsets. Our sales to these customers are dependent upon the OEM choosing our products over those of our competitors and on the OEM’s ability to create, introduce, market and sell these products successfully in its respective markets. Should our OEM customers be unsuccessful in selling their current or future products that include our product, or should they decide to discontinue bundling our products, our results of operation and financial condition could be harmed.
 
The continued growth of our business depends on the development of new markets and products for NAND flash memory.  Over the last several years, we have derived the majority of our revenue from the digital camera market. This market continues to experience slower growth rates for our products 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 and new products for NAND flash memory. Furthermore, in 2005, our revenue from the digital camera market grew by only 4% 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 USB drives, handsets, gaming and digital audio players. 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 or our products, to enable us to continue our growth.
 
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 applications, products and standards and enhance existing products and standards with higher memory capacities and other enhanced features. New applications, such as the adoption of flash memory cards in mobile handsets, can take several years to develop. Early successes in working with handset 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. Our new products may not gain market acceptance and we may not be successful in penetrating the new markets that we target, such as handsets, digital audio players or pre-recorded flash memory cards. 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. For example, the digital still camera market is shifting away from use of CompactFlash memory cards to other form factors, such as SD cards. 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. Any new applications, products, technologies or standards we develop may not be commercially successful.
 
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. In addition, many semiconductor companies have begun to bring up substantial new capacity of flash memory, including MLC flash memory. For example, Samsung began shipping its first MLC chips in the third quarter of 2005 and further ramped its MLC output in the fourth quarter of 2005. In addition, Hynix is aggressively ramping NAND output and IM Flash is expected to produce significant NAND output in the future. If the combined total new flash memory capacity exceeds the corresponding growth in demand, prices may decline dramatically, adversely impacting our results of


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operations and financial condition. In addition, current and future competitors produce or could produce alternative flash memory technologies that compete against our NAND flash memory technology.
 
Our primary semiconductor competitors continue to include our historical competitors Renesas, Samsung and Toshiba. New competitors include Hynix, Infineon, Micron and STMicro, which began shipping NAND or NAND-competitive memory in 2004. If any of these competitors increase their memory output, as Hynix recently has, it will likely result in a decline in the prevailing prices for packaged NAND semiconductor components.
 
We compete with flash memory card manufacturers and resellers. These companies purchase, or have a captive supply of, flash memory components and assemble memory cards. These companies include, among others, Dane-Elec, Delkin, Fuji, Hagiwara, Hama, I/O Data, Infineon, Jessops PLC, KingMax, Kingston, Lexar, M-Systems, Matsushita Battery Industrial Co., Ltd., Matsushita, Micron, Memorex, Panasonic, PNY, PQI Corp., Pretec Electronics, Renesas, Samsung, Sharp, Sony, Toshiba and Viking Components.
 
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, Samsung, with significant manufacturing capacity, brand recognition and access to broad distribution channels, provides competing flash cards, such as the MMC microtm that competes directly with our microSD mobile card. Lexar markets a line of flash cards bearing the Kodak brand name, which competes with our flash memory cards. Our handset card products also face competition from embedded solutions from competitors including Intel, M-Systems and Samsung. Our digital audio players face competition from similar products offered by other companies, including Apple, Creative, iriver and Samsung. Our USB flash drives face competition from Lexar, Memorex, M-Systems and PNY, among others. If our products cannot compete effectively, our market share and profitability will be adversely impacted.
 
Furthermore, many companies are pursuing new or alternative technologies, such as nanotechnologies or microdrives, which may compete with flash memory. These new or alternative technologies may provide smaller size, higher capacity, reduced costs, 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:
 
  •  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.
 
We may not be able to successfully compete in the marketplace.
 
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


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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 losses.  Through our ramp in Flash Partners, we expect our 2006 captive memory supply to increase by a higher percentage than our flash memory supply increased in either of the last two years. Our obligation to purchase 50% of the output from FlashVision and Flash Partners 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. 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 Renesas and Samsung. Any disruption in supply of flash memory from our captive or non-captive sources would harm our operating results. For example, we intend to increase production at Fab 3 and we also procure wafers from non-captive sources. If Fab 3 production ramp does not increase as anticipated 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 will 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, 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 operations, where the ventures are operated and Toshiba’s foundry capacity is located. For example, earthquakes, as well as unrelated power outages, have resulted in production line stoppage and loss of wafers in Yokkaichi and similar stoppages and losses may occur in the future. Also, the Tower fabrication facility, from which we source controller wafers, is facing financial challenges and is located in Israel, an area of political turmoil. Any disruption or delay in supply from our silicon sources could significantly harm our business, financial condition and results of operations.
 
Our actual manufacturing yields may be lower than our expectations resulting 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 which 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 70-nanometer, 300-millimeter Flash Partners wafers does not increase as expected, we may not


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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 sub-contractors or qualify and engage additional sub-contractors, 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 cannot, and will not, be 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.
 
In transitioning to new processes, products and silicon sources, we face production and market acceptance risks that have caused, and may in the future 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 70-nanometer 8 gigabit MLC chip which we began shipping in the third quarter of 2005, 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, procurement of MLC wafers from non-captive sources requires us to develop new controller technology 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 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. 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 as we do so, 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 recently announced our intention to accelerate expansion at Fab 3 to bring wafer capacity to 70,000 wafers per month by March 2007 and in addition, we and Toshiba are considering a potential new advanced NAND Fab beyond Fab 3. 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


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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.  We believe that our future success will continue to depend on the development and introduction of new generations of flash memory wafers, such as the 300-millimeter wafers produced by Flash Partners. These wafers are substantially larger in surface area and therefore more susceptible to new technological and manufacturing issues, such as mechanical and thermal stresses, than 200-millimeter wafers that we use in production at Yokkaichi Fabs 1 and 2. We have limited experience in operating a wafer manufacturing line and we rely on Toshiba’s capability to operate and manage the Yokkaichi facilities. Toshiba does not have prior experience in manufacturing 300-millimeter advanced NAND designs, nor in operating a new equipment set that has to be optimized to process 300-millimeter NAND wafers with competitive yields. Flash Partners’ facility may not perform as expected or ramp to volume production on time, and the cost to equip the facility may be significantly more than planned. Samsung, the world’s largest NAND flash memory manufacturer, already has experience manufacturing 300-millimeter wafers with 90- and 70-nanometer feature sizes. Also, Samsung is licensed under our patents to use MLC technology, which further enhances its manufacturing capabilities, and began shipping NAND/MLC products in the third quarter of 2005. Samsung may be able to produce product at a lower cost than we can and increase their market share, thus adversely affecting our operating results and financial condition.
 
We have a contingent indemnification obligation for certain liabilities Toshiba incurs as a result of Toshiba’s guarantee of the FlashVision equipment lease arrangement and have environmental and intellectual property indemnification as well as guarantee obligations with respect to Flash Partners.  Toshiba has guaranteed FlashVision’s lease arrangement with third-party lessors. The total minimum remaining lease payments as of January  1, 2006 were 17.7 billion Japanese yen, or approximately $150 million based upon the exchange rate at January 1, 2006. If Toshiba makes payments under its guarantee, we have agreed to indemnify Toshiba for 49.9% of its costs.
 
In December 2004, Flash Partners entered into an equipment lease facility of 50.0 billion Japanese yen, or approximately $424 million based upon the exchange rate at January 1, 2006, which, as of January 1, 2006, had been drawn down in its entirety. As of January 1, 2006, our cumulative guarantee under this equipment lease, net of cumulative lease payments was approximately 24.0 billion Japanese yen, or approximately $203 million based on the exchange rate at January 1, 2006. In December 2005, Flash Partners secured an additional equipment lease facility of 35.0 billion Japanese yen, or approximately $296 million based upon the exchange rate at January 1, 2006. Flash Partners had not drawn under this equipment lease facility at the end of fiscal 2005; however, the entire amount was drawn down in January 2006. We and Toshiba each guaranteed, on a several basis, 50% of Flash Partners’ obligation under this master lease.
 
We and Toshiba have also agreed to mutually contribute to, and indemnify each other and Flash Partners for, environmental remediation costs or liability resulting from Flash Partners’ 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 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 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


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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 up inventory levels in advance of our most active selling seasons.
 
From time to time, we overestimate our requirements and build excess inventories, 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 inventories 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 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 nine-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 venture and our investments in those ventures are denominated in Japanese yen. Additionally, we expect over time to increase the percentage of our sales denominated in currencies other than the U.S. dollar. Management of these foreign exchange exposures and the foreign currency forward contracts used to mitigate these exposures is complicated 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 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. 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 Sunnyvale, 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 SARS. If a natural disaster or epidemic were


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to occur in one or more or these areas, our disaster recovery processes may not provide adequate business continuity. In addition, 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;
 
  •  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, and we have agreed to indemnify various suppliers and customers for alleged patent infringement, which could expose us to liability for damages, 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.


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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.
 
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 may in some instances include indemnification for damages and expenses, including attorneys’ fees. We may from time to time be engaged in litigation as a result of these indemnification obligations. 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 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, Taiwan and South Korea. We may, therefore, be 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 result, 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. 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;


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  •  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 but has not been completed and a continued supply of controllers to us from Tower on a cost-effective basis may be dependent on this completion. Tower’s completion of the equipment installation, technology transfer and ramp-up of production at Fab 2 is dependent upon Tower (a) having, or being able to raise, sufficient funds to complete the Fab 2 project; (b) meeting the conditions to receive Israeli government grants and tax benefits approved for Fab 2; and (c) obtaining the approval of the Israeli Investment Center to extend the five-year investment period under its Fab 2 approved enterprise program. In addition, Tower recently entered into an amendment to the credit facility agreement with its banks. If Tower fails to raise funds in the amounts and at the times required under the amended credit facility agreement or otherwise fails to comply with the revised financial ratios and covenants to avoid being in default under its amended bank credit agreements, Tower may have to cease operations. 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 $53.6 million as a result of the other-than-temporary decline in the value of our investment in Tower ordinary shares, $10.1 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 January 1, 2006. Of the approximately 10.2 million Tower ordinary shares we own, we agreed not to sell approximately 7.2 million shares at January 1, 2006. This restriction is no longer in effect in fiscal 2006; however, we do remain subject to certain restrictions on the transfer of our 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 $12.9 million as of January 1, 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, 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.
 
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


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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 acquisition of Matrix Semiconductor, Inc., we will have to successfully integrate and retain key 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 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. Furthermore, 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.
 
Our success depends on key personnel, including our executive officers, the loss of who 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.  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. We expect that our number of employees, including management-level employees, will continue to increase for the foreseeable future. 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. If we do not manage our growth effectively, our business could be harmed.
 
We expect 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 Flash Partners for at least the next twelve months; however, we expect to raise additional funds, including funds to meet our obligations with respect to Flash Partners, 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 or debt securities. 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, 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


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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.
 
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 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 stockholder approval of new option plans. In addition, we have incurred and expect to continue to incur significant costs in connection with compliance with Section 404 of that law regarding internal control over financial reporting. 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 the Sarbanes-Oxley Act of 2002, we have identified and will from time to time identify a number of 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 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 over financial reporting 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 provide only reasonable assurance of achieving desired control objectives.
 
ITEM 1B.   UNRESOLVED STAFF COMMENTS
 
Not applicable.
 
ITEM 2.   PROPERTIES
 
Our principal facilities are located in Sunnyvale, California. We lease three adjacent buildings comprising approximately 206,000 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 June 2006. In January 2006, we entered into an agreement to lease three adjacent buildings located in Milpitas, California, comprising approximately 349,000 square feet. Our corporate offices, the majority of our engineering team, as well as a portion of our sales, marketing, operations and corporate services organizations expect to move to these new facilities in June 2006.
 
We also lease sales and marketing offices in the United States, Japan, Germany, Hong Kong , Ireland, the Netherlands and Scotland, and operation support offices in Taichung, Taiwan, Shanghai and Shenzhen, China and design centers in Tefen and Petah Tikva, Israel, Edinburgh, Scotland and Bangalore, India.


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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.
 
On or about August 3, 2001, the Lemelson Medical, Education & Research Foundation, or Lemelson Foundation, filed a complaint for patent infringement against us and four other defendants. The suit, captioned Lemelson Medical, Education, & Research Foundation, Limited Partnership vs. Broadcom Corporation, et al., Civil Case No. CIV01 1440PHX HRH, was filed in the United States District Court, District of Arizona. On November 13, 2001, the Lemelson Foundation filed an amended complaint, which made the same substantive allegations against us but named more than twenty five additional defendants. The amended complaint alleges that we, and the other defendants, have infringed patents held by the Lemelson Foundation pertaining to bar code scanning technology. By its complaint, the Lemelson Foundation requests that we be enjoined from our allegedly infringing activities and seeks unspecified damages. The case as to us was stayed pending the outcome of litigation in the District Court of Nevada related to the same Lemelson bar code scanning patents asserted against us. In early 2004, the Nevada Court ruled that the Lemelson bar code patents (as well as other Lemelson patents) were invalid, not infringed and unenforceable. The Nevada Court’s findings were thereafter affirmed by the Federal Circuit. Based on the Federal Circuit’s affirmance, the Lemelson Foundation moved to dismiss with prejudice all claims against us, and that request for dismissal has been granted.
 
On October 31, 2001, we 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, we seek damages and injunctions against these companies from making, selling, importing or using flash memory cards that infringe our U.S. Patent No. 5,602,987. The 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, we 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 SanDisk, vacating the judgment of non-infringement and remanding the case back to district court.
 
On or about June 9, 2003, we received written notice from Infineon Technologies AG, or Infineon, that it believes we have infringed its U.S. Patent No. 5,726,601 (the ‘601 patent). On June 24, 2003, we 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 we are entitled to the declaration sought by the our complaint; (b) requesting that we 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 we infringe 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, we 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, we filed a second amended complaint to include claims for declaratory judgment that the ‘002, ‘894 and ‘219 patents are unenforceable.
 
On October 2, 2003, a purported shareholder class action lawsuit was filed on behalf of United States holders of ordinary shares of Tower as of the close of business on April 1, 2002 in the United States District Court for the Southern District of New York. The suit, captioned Philippe de Vries, Julia Frances Dunbar De Vries Trust, et al., v. Tower Semiconductor Ltd., et al., Civil Case No. 03 CV 4999, was filed against Tower and a number of its shareholders and directors, including us and Dr. Harari, who is a Tower board member, and asserts claims arising under Sections 14(a) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 14a 9 promulgated there under. The lawsuit alleges that Tower and certain of its directors made false and misleading statements in a proxy solicitation to Tower shareholders regarding a proposed amendment to a contract between Tower and certain of its shareholders, including us. The plaintiffs are seeking unspecified damages and attorneys’ and experts’ fees and expenses. On August 19, 2004, the court granted our and the other defendants’ motion to dismiss the complaint


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in its entirety with prejudice. On September 29, 2004, plaintiffs appealed the dismissal to the United States Court of Appeals for the Second Circuit.
 
On February 20, 2004, we 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 court approval.
 
On October 15, 2004, we filed a complaint for patent infringement and declaratory judgment of non-infringement and patent invalidity against STMicroelectronics N.V. and STMicroelectronics, Inc. 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 STMicro’s products infringe one of our U.S. patents and seeks damages and an injunction. The complaint further seeks a declaratory judgment that we do not infringe several of STMicro’s U.S. patents. By order dated January 4, 2005, the court stayed our claim that STMicro infringes our 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 STMicro’s motion to dismiss the declaratory judgment causes of action. We have appealed this decision to the U.S. Court of Appeals for the Federal Circuit. The remainder of the case, including our infringement claim against STMicro, is stayed pending the outcome of the appeal.
 
On February 4, 2005, STMicro filed two complaints for patent infringement against us in the United States District Court for the Eastern District of Texas, captioned STMicroelectronics, Inc. v. SanDisk Corporation, Civil Case No. 4 05CV44, and STMicroelectronics, Inc. v. SanDisk Corporation, Civil Case No. 4 05CV45, respectively. The complaints seek damages and injunctions against unspecified SanDisk products. On April 22, 2005, we filed counterclaims on two patents against STMicroelectronics N.V. and STMicroelectronics, Inc. in the Civil Case 4-05CV45 proceeding. The counterclaims seek damages and injunctive relief against STMicroelectronics N.V. and STMicroelectronics, Inc. flash memory products.
 
On October 15, 2004, we filed a complaint under Section 337 of the Tariff Act of 1930 (as amended) titled, “In the matter of certain NAND flash memory circuits and products containing same” in the United States International Trade Commission, naming STMicroelectronics N.V. and STMicroelectronics, Inc. (“STMicro”) as respondents. In the complaint, we allege that STMicro’s NAND flash memory infringes U.S. Patent No. 5,172,338 (the ‘338 patent), and seek an order excluding their products from importation into the United States. In the complaint, we allege that STMicro’s NAND flash memory infringes the ‘338 patent and seeks an order excluding their products from importation into the United States. On November 15, 2004, the ITC instituted an investigation pursuant to 19 U.S.C. Section 1337 against STMicro in response to our complaint. 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 our United States Patent 5,172,338 (‘338 patent) by rejecting STMicro’s claims that the patent was invalidated by prior art. The initial determination, however, found that STMicro’s NAND flash memory chips did not infringe three claims of the ‘338 patent. On October 31, 2005, we filed a petition with the International Trade Commission to review and reverse the finding of non-infringement. Also, on October 31, 2005, STMicro filed a petition for review with the International Trade Commission 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. We are appealing the ITC’s decision to the U.S. Court of Appeals for the Federal Circuit.
 
On October 14, 2005, STMicroelectronics, Inc. filed a complaint against us and our 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 complaint alleges that STMicroelectronics, Inc., 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 of certain inventions and patents conceived of by Harari as well as damages in an unspecified amount. On November 15, 2005, Harari


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and we removed the case to the U.S. District Court for the Northern District of California, where it was assigned case number C05-04691. On November 23, 2005, Harari and we filed counterclaims, asserting our (i.e. SanDisk’s) ownership of the patents and applications raised in the complaint. On December 13, 2005, STMicroelectronics, Inc. filed a motion to remand the case back to the Superior Court of Alameda County. That motion remains pending.
 
On December 6, 2005, we filed a complaint for patent infringement in the United States District Court for the Northern District of California against STMicroelectronics, Inc. and STMicroelectronics, NV (“STMicro”) (Case No. C0505021 JF). In the suit, we seek damages and injunctions against STMicro from making, selling, importing or using flash memory chips or products that infringe our U.S. Patent No. 5,991,517. The case is presently stayed, pending the termination of the ITC investigation instituted February 8, 2006, discussed below.
 
On January 11, 2006, we filed a complaint for patent infringement in the United States District Court for the Northern District of California against STMicro (Case No.C06-00194 JF). In the suit, we seek damages and injunctions against STMicro from making, selling, importing or using flash memory chips or products that infringe our U.S. Patent No. 6,542,956. The case is presently stayed, pending the termination of the ITC investigation instituted February 8, 2006, discussed below.
 
On January 10, 2006, we filed a complaint under Section 337 of the Tariff Act of 1930 (as amended) titled, “In the matter of certain NAND flash memory circuits and products containing same” in the ITC, naming STMicro as respondents. In the complaint, we allege that: (i) STMicro’s NOR flash memory infringes the ‘338 patent; (ii) STMicro’s NAND flash memory infringes U.S. Patent No. 6,542,956; and (iii) STMicro’s NOR flash memory and NAND flash memory infringe U.S. Patent No. 5,991,517. The complaint seeks an order excluding STMicro’s NOR and NAND flash memory products from importation into the United States. The ITC instituted an investigation, based on our complaint, on February 8, 2006.
 
On or about July 15, 2005, Societa’ Italiana Per Lo Sviluppo Dell’electtronica, S.I.Sv.El., S.p.A., (“Sisvel”) filed suit against us 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. Sisvel alleges that certain of our 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 us a license under the patents. We have submitted pleadings asking the court to strike Sisvel’s pleadings as legally insufficient and seeking other procedural relief. The court is still addressing these procedural matters and we will not be required to answer on the substance of Sisvel’s claim until April 2006 at the earliest.
 
In a related action, on February 21, 2006, we filed an action in the English High Court, Chancery Division, Patents Court, in London, against the owners of the patents Sisvel has asserted against us. 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), and Institut für Rundfunktechnik GmbH (a German corporation), Case No. HC06 C 00615. In this action, we seek a declaration that the patents asserted by Sisvel (as well as other patents owned by Philips and the other defendants) are invalid because they fail to properly claim anything new within the meaning of the European Patent Convention and because certain of them fail to comply with other requirements of the Convention. The defendants in that case are required to appear and announce their intention to defend on or about March 7, 2006. The defendants’ formal defense will be due in early April 2006.
 
In another related action, on March 9, 2006, we 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 us 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. HC06C00835. In this action, we seek a declaration of non-infringement of the patents asserted by Sisvel in connection with SanDisk’s MP3 products. We also seek 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 are required to appear and announce their intention to defend at the end of March, 2006. The defendants’ formal defense will be due in early May 2006.


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On or about January 12, 2006, we were served with a complaint in an action filed by SoftVault Systems, Inc. in the United States District Court for the Eastern District of Texas. The case is SoftVault Systems, Inc. v. Yahoo! Inc., Microsoft Corporation, Napster, Inc., Creative Labs, Inc., Dell USA LP, Gateway, Inc., iriver America, Inc., Samsung Electronics America, Inc., Toshiba America Consumer Products, L.L.C., Digital Networks North America, Inc., Palm, Inc., Audiovox Corporation, SanDisk Corporation, and Thomson Inc., Case No. 2:06-cv-00017-LED. SoftVault accuses us, and others, of infringing its patents through the use of Microsoft’s Windows Digital Rights Management technology. We are reviewing the matter and preparing our answer. We intend to vigorously defend against this action.
 
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 2005.
 
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 and Related Stockholder Matters
 
Our common stock is traded on the NASDAQ National Market under the symbol “SNDK”. The information set forth below gives retroactive effect to a 2-for-1 stock split, in the form of a 100% stock dividend, effected on February 18, 2004. The following table summarizes the high and low bid quotations for our common stock as reported by the NASDAQ Stock Market.
 
                 
    High     Low  
 
2004
               
First quarter
  $ 36.35     $ 23.49  
Second quarter
  $ 33.25     $ 19.79  
Third quarter
  $ 28.70     $ 19.28  
Fourth quarter
  $ 31.96     $ 19.66  
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  
 
As of March 1, 2006, we had approximately 605 stockholders of record. We have never declared or paid any cash dividends on our common stock and do not expect to pay cash dividends on our common stock in the foreseeable future.


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ITEM 6.   SELECTED FINANCIAL DATA
 
SANDISK CORPORATION SELECTED FINANCIAL DATA
 
                                         
    Years Ended  
    January 1,
    January 2,
    December 28,
    December 29,
    December 30,
 
    2006(1)     2005(2)     2003(3)     2002(4)     2001(5)  
    (In thousands, except per share data)  
 
Revenues
                                       
Product
  $ 2,066,607     $ 1,602,836     $ 982,341     $ 492,900     $ 316,867  
License and royalty
    239,462       174,219       97,460       48,373       49,434  
                                         
Total revenues
    2,306,069       1,777,055       1,079,801       541,273       366,301  
Cost of revenues
    1,333,335       1,091,350       641,189       352,452       392,293  
                                         
Gross profit (loss)
    972,734       685,705       438,612       188,821       (25,992 )
Operating income (loss)
    576,582       418,591       257,038       58,151       (152,990 )
Net income (loss)
  $ 386,384     $ 266,616     $ 168,859     $ 36,240     $ (297,944 )
Net income (loss) per share(6)
                                       
Basic
  $ 2.11     $ 1.63     $ 1.17     $ 0.26     $ (2.19 )
Diluted
  $ 2.00     $ 1.44     $ 1.02     $ 0.25     $ (2.19 )
Shares used in per share calculations(6)
                                       
Basic
    183,008       164,065       144,781       137,610       136,296  
Diluted
    193,016       188,837       171,616       142,460       136,296  
 
                                         
    At  
    January 1,
    January 2,
    December 28,
    December 29,
    December 30,
 
    2006     2005     2003     2002     2001  
 
Working capital
  $ 2,004,598     $ 1,526,674     $ 1,378,070     $ 584,450     $ 419,289  
Total assets
    3,120,187       2,320,180       2,040,156       980,725       934,261  
Long-term convertible subordinated notes
                150,000       150,000       125,000  
Total stockholders’ equity
  $ 2,523,791     $ 1,940,150     $ 1,515,872     $ 634,867     $ 675,379  
 
 
(1) Includes other-than-temporary impairment charges of ($10.1) million, or ($6.4) million net of tax related to our investment in Tower.
 
(2) Includes other-than-temporary impairment charges of ($11.8) million, or ($7.4) million net of tax related to our investment in Tower, an adjustment to the fair value of our Tower warrant of ($0.2) million, or ($0.1) million net of tax 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 2003 unauthorized disposition of our investment in UMC.
 
(3) 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, and an adjustment to the fair value of our Tower warrant of ($0.6) million, or ($0.5) million net of tax.
 
(4) 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, and an adjustment to the fair value of our Tower warrant of ($0.7) million, or ($0.5) million net of tax.
 
(5) Includes other-than-temporary impairment charges of ($302.3) million on our UMC shares and Tower shares, or ($188.1) million net of tax, and restructuring charges of ($8.5) million or ($6.7) million net of tax.
 
(6) Net income (loss) 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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SANDISK CORPORATION
 
SUPPLEMENTARY QUARTERLY DATA
 
                                 
    Quarters Ended  
    April 3,
    July 3,
    October 2,
    January 1,
 
    2005     2005     2005     2006  
    (In thousands, except per share data)  
    (Unaudited)  
 
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(1)
  $ 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  
 
                                 
    Quarters Ended  
    March 28,
    June 27,
    September 26,
    January 2,
 
    2004     2004     2004     2005  
    (In thousands, except per share data)  
    (Unaudited)  
 
2004
                               
Revenues
                               
Product
  $ 338,779     $ 391,327     $ 365,033     $ 507,697  
License and royalty
    48,151       41,961       42,921       41,186  
                                 
Total revenues
    386,930       433,288       407,954       548,883  
Gross profit
    155,918       178,653       147,381       203,753  
Operating income
    98,559       110,331       83,683       126,018  
Net income(2)
  $ 63,568     $ 70,611     $ 54,102     $ 78,335  
Net income per share(4)
                               
Basic(3)
  $ 0.39     $ 0.44     $ 0.33     $ 0.46  
Diluted(3)
  $ 0.34     $ 0.38     $ 0.29     $ 0.42  
 
 
(1) 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.
 
(2) In the fourth quarter of 2004, we recognized a loss of ($11.8) million on the other-than-temporary decline in the fair value of 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 2003 unauthorized disposition of our investment in UMC. In the third quarter of 2003, we suffered a loss of approximately ($18.3) million as a result of the unauthorized disposition of approximately 127.8 million shares of UMC stock owned by us. Also, during the third quarter of 2003, we sold 35 million shares of UMC stock for a realized gain of approximately $7.0 million, or $4.9 million net of tax.
 
(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.
 
(4) Net income per share 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  
    January 1,
    % of
    January 2,
    % of
    December 28,
    % of
 
    2006     Revenue     2005     Revenue     2003     Revenue  
    (In thousands, except percentages)  
 
Product revenues
  $ 2,066,607       89.6 %   $ 1,602,836       90.2 %   $ 982,341       91.0 %
License and royalty revenues
    239,462       10.4 %     174,219       9.8 %     97,460       9.0 %
                                                 
Total revenues
    2,306,069       100.0 %     1,777,055       100.0 %     1,079,801       100.0 %
Cost of product revenues
    1,333,335       57.8 %     1,091,350       61.4 %     641,189       59.4 %
                                                 
Gross profit
    972,734       42.2 %     685,705       38.6 %     438,612       40.6 %
Operating expenses
                                               
Research and development
    194,810       8.4 %     124,994       7.0 %     84,200       7.8 %
Sales and marketing
    122,232       5.3 %     91,296       5.1 %     66,317       6.1 %
General and administrative
    79,110       3.4 %     50,824       2.9 %     31,057       2.9 %
                                                 
Total operating expenses
    396,152       17.2 %     267,114       15.0 %     181,574       16.8 %
                                                 
Operating income
    576,582       25.0 %     418,591       23.6 %     257,038       23.8 %
Non-operating income (loss), net
    36,725       1.6 %     4,609       0.3 %     (15,157 )     (1.4 )%
                                                 
Income before taxes
    613,307       26.6 %     423,200       23.8 %     241,881       22.4 %
Provision for income taxes
    226,923       9.8 %     156,584       8.8 %     73,022       6.8 %
                                                 
Net income
  $ 386,384       16.8 %   $ 266,616       15.0 %   $ 168,859       15.6 %
                                                 
 
General.  Our flash data storage devices are marketed and sold primarily in the consumer electronics market. We expect that as we reduce the price of our flash cards, consumers will demand an increasing number of megabytes of memory. In order to profitably capitalize on price elasticity in the market for flash data storage cards, we must reduce our cost per megabyte at a rate similar to the change in selling price per megabyte to the consumer.
 
Our operating results are affected by a number of factors including, among others, the unit volume of product sales, the flash memory density of the products sold, competitive pricing pressures, availability of foundry capacity from both captive and non-captive sources, the timing and volume of sell-through by our distributors and retail customers to their customers, variations in manufacturing cycle times, fluctuations in manufacturing yields and manufacturing capacity utilization, the timing of significant orders, our ability to accurately forecast demand and obtain sufficient supply, changes in product and customer mix, market acceptance of new or enhanced versions of our products, changes in the channels through which our products are distributed, timing of new product announcements and introductions by us and our competitors, the timing of license and royalty revenues, fluctuations in product costs, increased research and development expenses and exchange rate fluctuations. See Item 1A, “Risk Factors.”
 
We operate in one business segment, flash memory products. Our chief decision-maker, our President and Chief Executive Officer, evaluates our performance based on company-wide, consolidated results. Revenue is evaluated based on geographic region and by product category.
 
Memory Sourcing.  NAND memory is the largest component of the cost of our products. The majority of our NAND memory is purchased from captive sources of supply and our ventures with Toshiba and our Toshiba foundry arrangement. We also purchase flash memory products from non-captive sources, to supplement our captive supply, allowing us to flexibly capture more market share. This non-captive supply enabled us to generate additional sales and profits even though the gross margin on our non-captive supply is significantly lower than the gross margin on our captive supply. However, our captive supply requires us to invest in capital assets, research and development and start-up and other production costs. We expect to continue sourcing both captive and non-captive flash memory.


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Licensing and Royalties.  The timing and amount of royalty revenues and the recognition of license fees can vary substantially from quarter to quarter depending on the terms of our license agreements and the timing and volume of sales of products by our licensees. Gross margins and operating income fluctuate more with changes in license and royalty revenues than with changes in product revenues since license and royalty revenues have immaterial variable costs of sale.
 
Retail Sales.  Our arrangements with retailers often involve complex terms. These terms include providing the retailer with a right to return unsold product, market development funds, cooperative advertising funds, price protection, volume incentive rebates and other promotions. In some cases, we consign inventory to our customers. These consignment activities involve administrative costs to track and account for our inventory. We defer recognition of revenue on sales to retailers and distributors until they sell-through the product they have purchased from us to their customers. Our retail business is seasonal, with the fourth quarter being the strongest due to holiday sales in North America.
 
Memory Market Dynamics.  Semiconductor memory markets have generally been characterized by cycles of undersupply and oversupply. In an oversupply environment, price reductions occur and the value of our inventory may decrease resulting in a lower of cost or market price adjustment if pricing pressure results in a net realizable value that is lower than our cost. In 2001, for example, we recorded approximately $85.0 million of charges related to inventory revaluation. We may be forced to reduce the carrying value of our inventory if market demand for our products deteriorates and our inventory levels exceed customer orders.
 
Our business is characterized by constant focus on cost reduction. NAND flash memory cost reduction is achieved by transitioning to new generations of technology, by producing larger wafer sizes and by improving yields. Manufacturing yields are lower at the start of manufacturing each successive product generation. During the start-up phase, the fabrication equipment and operating expenses are applied to a relatively small output of production wafers, making this output very expensive. In the next two to three years, we expect to make substantial new investments in additional fabrication capacity in the ventures with Toshiba.
 
Matrix Acquisition.  On January 13, 2006, we acquired Matrix Semiconductor, Inc. Matrix is a pioneer in the design and development of three-dimensional (3-D) integrated circuits. Matrix 3-D memory is used for one-time programmable storage applications where low cost is the paramount consideration, such as video games, music and archiving.
 
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 on-going 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 January 1, 2006 and January 2, 2005, deferred income, from sales to distributors and retailers was $139.9 million and $82.0 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.


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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, deferred revenues or a charge to marketing expenses. 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 that we have invested in are variable interest entities within the definition of the Financial Accounting Standards Board Interpretation No. 46, 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 and our business to confirm that these conclusions are correct. 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.
 
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 $14.9 million and $12.3 million at January 1, 2006 and January 2, 2005, respectively, based on our view that it is more likely than not that we will not be able to take tax a benefit for unrealized capital losses on our investments in foundries.


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Results of Operations
 
Product Revenues.
 
                                         
          Percent
          Percent
       
    FY 2005     Change     FY 2004     Change     FY 2003  
    (In millions, except percentages)  
 
Retail
  $ 1,621.0       31 %   $ 1,236.0       96 %   $ 632.1  
OEM
    445.6       21 %     366.8       5 %     350.2  
                                         
Product revenues
  $ 2,066.6       29 %   $ 1,602.8       63 %   $ 982.3  
                                         
 
The increase in our 2005 product revenues was comprised of a 166% increase in the number of megabytes sold and partially offset by a 52% reduction in our average selling price per megabyte. The markets that we sell to have been price elastic. In 2005, as the price per megabyte came down, the average memory density of our products sold increased by 215%. 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. We expect to continue to reduce our price per megabyte, including price reductions already initiated in 2006, as technology advances allow us to further reduce our cost per megabyte. 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.
 
The increase in our 2004 product revenues was comprised of a 167% increase in the number of megabytes sold and partially offset by a 38% reduction in our average selling price per megabyte. Our 2004 unit sales increased by 53% compared to 2003, with the increase primarily attributable to growth in the markets for digital still cameras, USB flash drives and feature phones with card slots and the introduction, in the fourth quarter of fiscal 2004, of SanDisk flash-based digital audio players. In addition, our fiscal 2004 consisted of 53 weeks as compared to 52 weeks in the prior fiscal year.
 
Geographical Product Revenues.
 
                                                 
    FY 2005     FY 2004     FY 2003  
          Percent of
          Percent of
          Percent of
 
    Revenue     Total     Revenue     Total     Revenue     Total  
    (In millions, except percentages)  
 
North America
  $ 1,049.6       51 %   $ 768.1       48 %   $ 417.4       42 %
Japan
    104.4       5 %     165.4       10 %     161.9       16 %
EMEA
    501.0       24 %     420.6       26 %     232.1       24 %
Other foreign countries
    411.6       20 %     248.7       16 %     170.9       18 %
                                                 
Product revenues
  $ 2,066.6       100 %   $ 1,602.8       100 %   $ 982.3       100 %
                                                 
 
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.
 
In 2004, the increase in North America and EMEA revenue reflects increased retail demand due to the growth in consumer based products requiring additional flash memory.
 
License and Royalty Revenues.
 
                                         
          Percent
          Percent
       
    FY 2005     Change     FY 2004     Change     FY 2003  
    (In millions, except percentages)  
 
License and royalty revenues
  $ 239.5       37 %   $ 174.2       79 %   $ 97.5  
 
The increase in our 2005 and 2004 license and royalty revenue was primarily due to increased royalty bearing sales by our licensees in each of those fiscal years.


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Gross Margins.
 
                                         
          Percent
          Percent
       
    FY 2005     Change     FY 2004     Change     FY 2003  
    (In millions, except percentages)  
 
Product gross margins
  $ 733.3       43 %   $ 511.5       50 %   $ 341.2  
Product gross margins (as a percent of product revenue)
    35.5 %             31.9 %             34.7 %
Total gross margins (as a percent of total revenue)
    42.2 %             38.6 %             40.6 %
 
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.
 
The largest driver of the 2004 decline in product gross margins was an increased reliance on non-captive memory sources. We earn significantly lower gross margins on non-captive memory than on captive memory supply, and non-captive memory accounted for approximately 35% and 24% of our memory sourcing in 2004 and 2003, respectively. Our captive gross margin improved by approximately two percentage points as our cost reductions were greater than the decline in average selling price per megabyte. This partially offset the impact of our higher non-captive mix.
 
Research and Development.
 
                                         
          Percent
          Percent
       
    FY 2005     Change     FY 2004     Change     FY 2003  
    (In millions, except percentages)  
 
Research and development
  $ 194.8       56 %   $ 125.0       48 %   $ 84.2  
Percent of revenue
    8.4 %             7.0 %             7.8 %
 
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.
 
Our 2004 research and development expense growth was primarily due to increased payroll and payroll-related expenses associated with higher headcount in support of our broadening product portfolio, 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. We grew our research and development headcount to 340 at the end of 2004 from 272 at the end of 2003.
 
Sales and Marketing.
 
                                         
          Percent
          Percent
       
    FY 2005     Change     FY 2004     Change     FY 2003  
    (In millions, except percentages)  
 
Sales and marketing
  $ 122.2       34 %   $ 91.3       38 %   $ 66.3  
Percent of revenue
    5.3 %             5.1 %             6.1 %
 
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. In 2006, we plan to capitalize on the growing consumer awareness of the SanDisk brand by increasing our investments in building and promoting the SanDisk brand globally.
 
Our 2004 sales and marketing expenses were primarily related to increased tradeshow, advertising and branding, and payroll and payroll-related expenses, all in support of our higher revenue base. In 2004, advertising and branding activities included television advertising in the United States, increased North American and Asia


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Pacific print media spending and advertising and merchandising for such product lines as USB drives, wireless mobile and Shoot & Store.
 
General and Administrative.
 
                                         
          Percent
          Percent
       
    FY 2005     Change     FY 2004     Change     FY 2003  
    (In millions, except percentages)  
 
General and administrative
  $ 79.1       56 %   $ 50.8       63 %   $ 31.1  
Percent of revenue
    3.4 %             2.9 %             2.9 %
 
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.
 
Our 2004 general and administrative expenses increases were primarily relates to increased legal expenses related in part to higher litigation expenses to defend our intellectual property, increased staffing and consulting expenses to support our expanded business and compliance with the Sarbanes-Oxley Act, as well as provisions for doubtful accounts due to the growth in accounts receivable balances.
 
Non-Operating Income (Loss), net.
 
                                         
          Percent
          Percent
       
    FY 2005     Change     FY 2004     Change     FY 2003  
    (In millions, except percentages)  
 
Equity in income of business ventures
  $ 0.4       (20 )%   $ 0.5       150 %   $ 0.2  
Interest income
    42.8       110 %     20.4       129 %     8.9  
Interest expense
    (0.6 )     (90 )%     (5.9 )     (13 )%     (6.8 )
Gain (loss) in investment in foundries
    (8.2 )     (36 )%     (12.9 )     (449 )%     3.7  
Recovery (loss) on unauthorized sale of UMC shares
          (100 )%     6.2       (134 )%     (18.3 )
Other income (loss), net
    2.3       (162 )%     (3.7 )     28 %     (2.9 )
                                         
Total Non-Operating Income (Loss), net
  $ 36.7       698 %   $ 4.6       (130 )%   $ (15.2 )
                                         
 
Non-operating 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.
 
Non-operating income for 2004 was comprised of interest income of $20.4 million, a settlement of $6.2 million from a third-party brokerage firm related to the unauthorized disposition of our investment in UMC, an other- than-temporary reduction in the value of our investment in Tower of ($11.8) million, interest expense on our 41/2% Convertible Subordinated Note of ($5.9) million and other items of ($4.3) million.
 
Provision for Income Taxes
 
                         
    FY 2005     FY 2004     FY 2003  
 
Provision for income taxes
    37 %     37 %     30 %
 
Our 2005 and 2004 tax rates differ from the statutory rate primarily due to state tax expense, net of federal benefit. Our 2003 tax rate differs from the statutory rate due to state tax expense, a reversal of the tax benefit we recognized in 2001 and 2002 related to the unrealized gain on the disposition of our UMC shares and to the benefit provided by the reversal of $47 million in valuation allowance carried on the net deferred tax assets at the end of fiscal 2002 which could be taken principally because our net operating loss carryforwards have been fully realized. Our future tax rate may be impacted by state taxes, our ability to realize tax benefits from capital losses and the geographic mix of our earnings.


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Liquidity and Capital Resources
 
Cash Flows.  Operating activities generated $480.9 million of cash during the 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 Semiconductor 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.
 
Operating activities generated $227.6 million of cash during the year ended January 2, 2005. Significant contributors to the generation of cash from operations were net income of $266.6 million, non-cash adjustments to income for depreciation and amortization of $38.9 million, allowances for doubtful accounts of $4.6 million, amortization/accretion related to original premium/discount on short-term investments of $3.2 million and amortization of bond issuance costs of $2.6 million; decreases in deposits and other assets of $13.3 million, increases in accrued payroll and related expenses of $13.5 million and both current and non-current other accrued liabilities of $15.2 million. These were partially offset by increases in the inventory balance of $79.5 million, accounts receivable of $14.9 million and decreases in deferred income on shipments to distributors and retailers and deferred revenue of $15.4 million, and decreases in accounts payable, income taxes payable and other current liabilities to related parties of $6.2 million.
 
We used $299.5 million for investing activities during the 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 Semiconductor, Inc., purchased $39.1 million of semiconductor wafer manufacturing equipment to be used at Toshiba’s Yokkaichi 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.
 
For year ended January 2, 2005, we used $523.0 million for investing activities. We increased our short-term investment balance by $337.0 million, loaned $33.6 million to FlashVision, invested $23.1 million in Flash Partners, purchased $63.4 million of 200-millimeter semiconductor wafer manufacturing equipment to be used at Toshiba’s Yokkaichi Operations and purchased $62.4 million of test equipment and other capital items.
 
We generated $115.4 million and $24.6 million of cash from exercises of stock options and sales under our employee stock purchase plan during the years ended January 1, 2006 and January 2, 2005, respectively.
 
Liquid Assets.  At January 1, 2006, we had cash, cash equivalents and short-term investments of $1.7 billion. As of that date, the cost basis of our investment in 24.5 million UMC shares was $13.4 million and its market value was $13.9 million. As of January 1, 2006, we held 10.2 million Tower shares whose carrying value and market value was $12.9 million and $14.8 million, respectively. As of January 1, 2006, we have agreed not to sell 7.2 million of our 10.2 million Tower shares. This restriction is no longer in effect in fiscal 2006. However, we do remain subject to certain restrictions on the transfer of our Tower ordinary shares including certain rights of first refusal, and through January 2008, have agreed to maintain minimum shareholdings.
 
Short-Term Liquidity.  As of January 1, 2006, our working capital balance was $2.0 billion. We do not expect any liquidity constraints in the next twelve months. In 2006, we currently expect to loan or make investments in Flash Partners of approximately $500 million, and additionally to guarantee future operating leases of Flash Partners or procure other financing of approximately $500 million. We also expect to spend approximately $200 million on property and equipment, which includes assembly and test equipment as well as engineering equipment, and spending related to facilities and information systems.
 
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 may require us to raise additional financing,


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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.
 
Contingent Obligations.  We agreed to reimburse Toshiba for 49.9% of losses it sustains under its guarantee of FlashVision’s operating lease with Mizuho Leasing. As of January 1, 2006, the maximum exposure for both us and Toshiba under that guarantee was 17.7 billion Japanese yen, or approximately $150 million based upon the exchange rate at January 1, 2006, and our maximum exposure was 8.8 billion Japanese yen, or approximately $75 million based upon the exchange rate at January 1, 2006. See Item 1, “Business-Ventures With Toshiba-FlashVision.”
 
Toshiba Ventures.  We are a 49.9% percent owner in two ventures, FlashVision and Flash Partners. Toshiba owns 50.1% of each of these ventures. We account for our investments under the equity method and do not consolidate. FlashVision and Flash Partners are variable interest entities and we are not the primary beneficiary of either venture 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 both ventures. Both FlashVision and Flash Partners purchase wafers from Toshiba and then resell those wafers to Toshiba and us at cost plus a markup. The cost of the wafers we purchase from FlashVision and Flash Partners is recorded in inventory and ultimately cost of sales. Our share of the net income or loss of FlashVision and Flash Partners is included in our Consolidated Statement of Income as “Equity in income/(loss) of business ventures”. FlashVision and Flash Partners each own or lease separately semiconductor manufacturing equipment that is placed inside Toshiba’s Yokkaichi, Japan operations. The capital equipment owned by FlashVision and Flash Partners is funded through investments in or loans to the ventures from us and Toshiba. For semiconductor fixed assets that are leased by FlashVision or Flash Partners, we guarantee a portion of the outstanding lease payments under those leases through various methods. This obligation is denominated in Japanese yen and is noncancelable. We are contractually obligated to purchase half of FlashVision and Flash Partners NAND wafer supply. The cost of the wafer supply includes all amounts to reimburse FlashVision and Flash Partners for their costs to produce the NAND wafers. We cannot estimate the total amount of the wafer purchase commitment as of January 1, 2006 because our price is determined by reference to the future cost to produce the semiconductor wafers. In addition to the semiconductor assets owned by FlashVision and Flash Partners, we purchase and directly own semiconductor manufacturing equipment in Toshiba’s Yokkaichi operations for which we receive 100% of the output from this equipment. From time to time, we and Toshiba mutually approve increases in wafer supply capacity of FlashVision and Flash Partners that may contractually obligate us to increased capital funding. 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. See Note 5 and Note 11 to our consolidated financial statements included in Item 8 of this report.
 
As part of the FlashVision and Flash Partners agreements, we agreed to share in Toshiba’s costs associated with NAND product development and its common semiconductor research and development activities. As of January 1, 2006, we had accrued liabilities related to those expenses of $4.2 million. Our common research and development obligation related to FlashVision and Flash Partners is variable but capped at increasing fixed quarterly amounts through 2008 and is not subject to any payment caps thereafter. See Note 5 to our consolidated financial statements included in Item 8 of this report. Our direct research and development contribution is determined based on a variable computation. The common R&D participation agreement and the product development agreement are exhibits to this report and should be read carefully in their entirety for a more complete understanding of these arrangements.
 
We have guaranteed on an unsecured and several basis 50% of Flash Partners’ lease obligation under a master lease agreement entered into in December 2004. Our total lease obligation guarantee, net of lease payments as of January 1, 2006, was 24.0 billion Japanese yen, or approximately $203 million based upon the exchange rate at January 1, 2006. In December 2005, Flash Partners secured an additional equipment lease facility of 35.0 billion Japanese yen, or approximately $297 million based upon the exchange rate at January 1, 2006, from a consortium of financial institutions. We agreed to guarantee on an unsecured and several basis 50% of the draw downs under this facility. As of January 1, 2006, no draw downs had been made, however the entire amount was drawn down in January 2006. Our maximum exposure under the guarantee is 17.5 billion Japanese yen, or approximately


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$148 million based upon the exchange rate at January 1, 2006. See Item 1, “Business-Ventures With Toshiba-Flash Partners.”
 
The terms of the Flash Partners venture contractually obligate us and Toshiba to expand Flash Partners’ capacity. As of February 2006, we and Toshiba have committed to expand Flash Partners’ capacity to 70,000 wafer starts per month. We currently estimate the remaining total equipment funding obligation for the 70,000 wafer starts per month level to be approximately 365.0 billion Japanese yen, or approximately $3.1 billion based upon the exchange rate at January 1, 2006. Of this amount, we are obligated to fund 182.5 billion Japanese yen, or approximately $1.5 billion based upon the exchange rate at January 1, 2006, of which 42.5 billion Japanese yen, or approximately $361 million based upon the exchange rate at January 1, 2006, is being financed through Flash Partners’ operating lease facilities. Our remaining funding obligation at January 1, 2006 is approximately $1.0 billion. See Note 5 to our consolidated financial statements included in Item 8 of this report.
 
Contractual Obligations and Off Balance Sheet Arrangements
 
Our contractual obligations and off balance sheet arrangements at January  1, 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 5 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 result of operations. In 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 did not use foreign currency forward contracts in 2004 and 2003. 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). See Note 5 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.”
 
Impact of Recently Issued Accounting Standards
 
The Financial Accounting Standards Board, or FASB, adopted a revised Statement of Financial Accounting Standards No. 123, or FAS 123R, Share Based Payments, with an effective date of June 15, 2005. In April 2005, the SEC amended the effective date of FAS 123R, and we will now be required to adopt this standard for our first fiscal year beginning after June 15, 2005. We adopted FAS 123R in January 2006 and currently do not expect to restate prior periods to conform to the new accounting standard as we will use the modified prospective method. FAS 123R requires us to recognize an expense based on the fair value of all share-based payments to employees, including grants of options to buy shares of our common stock. See Note 1 to our consolidated financial statements included in Item 8 of this report for information related to the pro forma effect on reported net income and net earnings per share of applying the fair value provisions of the FAS 123. Adoption of FAS 123R is expected to increase our operating expenses. In anticipation of expensing equity instruments, we have reduced overall stock option grants and reduced the percentage of incentive stock options to total stock options granted.
 
In May 2005, the FASB issued Financial Accounting Standards No. 154, or FAS 154, Accounting Changes and Error Corrections. FAS 154 replaced Accounting Pronouncement Board Opinion No. 20, or APB 20, Accounting Changes, and Financial Accounting Standards No. 3, or FAS 3, Reporting Accounting Changes in Interim Financial Statements. FAS 154 requires that a voluntary change in accounting principle be applied retrospectively with all


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prior period financial statements presented based on the application of the new accounting principle. The statement will require the retrospective application of the impact of the direct effect of changes in accounting principles unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. FAS 154 carries forward without change the guidance contained in APB 20 for reporting the correction of an error in previously issued financial statements and changes in accounting estimates. FAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and require prospective application. We will adopt this standard on January 2, 2006 and currently do not anticipate that it will have a material effect on its financial statements or disclosures.
 
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 January  1, 2006, a hypothetical 50 basis point increase in interest rates would result in an approximate $2.6 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 3.95 billion Japanese yen, or approximately $34 million based upon the exchange rate at January 1, 2006 and zero as of January 2, 2005. The effect of an immediate 10% adverse change in exchange rates on forward exchange contracts would result in an approximate $3.0 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 5 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 January 1, 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 $2.7 million.
 
All of the potential changes noted above are based on sensitivity analysis performed on our financial position at January 1, 2006. Actual results may differ materially.
 
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.


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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.
 
Based on the results of our evaluation, our management concluded that our internal control over financial reporting was effective as of January 1, 2006.
 
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-3.
 
Independent Registered Public Accounting Firm’s Attestation Report
 
The report required by this item is set forth at page F-2.
 
ITEM 9B.   OTHER INFORMATION
 
Not applicable.
 
PART III
 
ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
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 2006 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”


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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 2006 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 2006 Annual Meeting of Stockholders, and is incorporated herein by reference.
 
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
The information required by this item is set forth under “Compensation Committee Interlocks and Insider Participation” and “Certain Transactions” in our Proxy Statement for our 2006 Annual Meeting of Stockholders, and is incorporated herein by reference.
 
ITEM 14.   PRINCIPAL ACCOUNTING 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 2006 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 Income Statements
  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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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 January 1, 2006 and January 2, 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended January 1, 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 January 1, 2006 and January 2, 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended January 1, 2006, in conformity with U.S. generally accepted accounting principles.
 
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 January 1, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report, dated March 8, 2006, expressed an unqualified opinion thereon.
 
/s/  Ernst & Young LLP
 
San Jose, California
March 8, 2006


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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 January 1, 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.
 
In our opinion, management’s assessment that SanDisk Corporation maintained effective internal control over financial reporting as of January 1, 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 January 1, 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 January 1, 2006 and January 2, 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended January 1, 2006 of SanDisk Corporation and our report dated March 8, 2006 expressed an unqualified opinion thereon.
 
/s/  Ernst & Young LLP
 
San Jose, California
March 8, 2006


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SANDISK CORPORATION
 
 
                 
    January 1,
    January 2,
 
    2006     2005  
    (In thousands, except per share amounts)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 762,058     $ 463,795  
Short-term investments
    935,639       859,175  
Investment in foundries
    18,338       20,398  
Accounts receivable, net of allowance for doubtful accounts of $8,050 in 2005 and $8,462 in 2004
    329,014       194,535  
Inventories
    331,584       196,422  
Deferred taxes
    95,518       83,150  
Prepaid expenses, other current assets and tax receivable
    103,584       62,653  
                 
Total current assets
    2,575,735       1,880,128  
Property and equipment, net
    211,092       147,231  
Notes receivable from FlashVision
    61,927       35,413  
Investment in foundries
    11,013       14,377  
Investment in FlashVision
    161,080       178,681  
Investment in Flash Partners
    42,067       24,192  
Deferred taxes
          1,861  
Deposits and other non-current assets
    57,273       38,297  
                 
Total assets
  $ 3,120,187     $ 2,320,180  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 231,208     $ 82,974  
Accounts payable to related parties
    74,121       48,115  
Accrued payroll and related expenses
    55,614       41,786  
Income taxes payable
    2,165       39,139  
Research and development liability, related party
    4,200       5,549  
Other accrued liabilities
    53,546       45,584  
Deferred income on shipments to distributors and retailers and deferred revenue
    150,283       90,307  
                 
Total current liabilities
    571,137       353,454  
Deferred revenue and other non-current liabilities
    25,259       26,576  
                 
Total liabilities
    596,396       380,030  
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: 400,000,000; Issued and outstanding: 188,221,958 in 2005 and 179,964,226 in 2004
    188       180  
Capital in excess of par value
    1,621,819       1,406,373  
Retained earnings
    906,624       520,240  
Accumulated other comprehensive income
    2,635       18,893  
Deferred compensation
    (7,475 )     (5,536 )
                 
Total stockholders’ equity
    2,523,791       1,940,150  
                 
Total liabilities and stockholders’ equity
  $ 3,120,187     $ 2,320,180  
                 
 
The accompanying notes are an integral part of these consolidated financial statements.


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SANDISK CORPORATION
 
 
                         
    January 1,
    January 2,
    December 28,
 
    2006     2005     2003  
    (In thousands, except per share amounts)  
 
Revenues:
                       
Product
  $ 2,066,607     $ 1,602,836     $ 982,341  
License and royalty
    239,462       174,219       97,460  
                         
Total revenue
    2,306,069       1,777,055       1,079,801  
Cost of product revenues
    1,333,335       1,091,350       641,189  
                         
Gross profit
    972,734       685,705       438,612  
Operating expenses:
                       
Research and development
    194,810       124,994       84,200  
Sales and marketing
    122,232       91,296       66,317  
General and administrative
    79,110       50,824       31,057  
                         
Total operating expenses
    396,152       267,114       181,574  
                         
Operating income
    576,582       418,591       257,038  
Equity in income of business ventures
    381       568       178  
Interest income
    42,835       20,363       8,865  
Interest expense
    (573 )     (5,949 )     (6,750 )
Gain (loss) in investment in foundries
    (8,228 )     (12,927 )     3,746  
Recovery (loss) on unauthorized sale of UMC shares
          6,193       (18,339 )
Other income (loss), net
    2,310       (3,639 )     (2,857 )
                         
Income before taxes
    613,307       423,200       241,881  
Provision for income taxes
    226,923       156,584       73,022  
                         
Net income
  $ 386,384     $ 266,616     $ 168,859  
                         
Net income per share
                       
Basic
  $ 2.11     $ 1.63     $ 1.17  
                         
Diluted
  $ 2.00     $ 1.44     $ 1.02  
                         
Shares used in computing net income per share
                       
Basic
    183,008       164,065       144,781  
                         
Diluted
    193,016       188,837       171,616  
                         
 
The accompanying notes are an integral part of these consolidated financial statements.


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SANDISK CORPORATION
 
 
                                                         
                            Accumulated
             
    Common
    Common
    Capital in
          Other
          Total
 
    Stock
    Stock
    Excess of Par
    Retained
    Comprehensive
    Deferred
    Stockholders’
 
    Shares     Amount     Value     Earnings     Income(Loss)     Compensation     Equity  
    (In thousands)  
 
Balance at December 29, 2002
    138,310     $ 138     $ 585,830     $ 84,765     $ (35,866 )   $     $ 634,867  
                                                         
Net income
                            168,859                       168,859  
Unrealized loss on available for sale securities
                                    (622 )             (622 )
Unrealized gain on investments in foundries
                                    82,741               82,741  
Foreign currency translation
                                    8,037               8,037  
                                                         
Comprehensive income
                                                    259,015  
                                                         
Exercise of stock options for cash
    5,472       5       51,594                               51,599  
Issuance of stock pursuant to employee stock purchase plan
    608       1       3,694                               3,695  
Sale of common stock, net of issuance costs
    16,524       16       521,592                               521,608  
Income tax benefit from stock options exercised
                    45,088                               45,088  
                                                         
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  
                                                         
 
The accompanying notes are an integral part of these consolidated financial statements.


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Table of Contents

SANDISK CORPORATION
 
 
                         
    Fiscal Years Ended  
    2005     2004     2003  
    (In thousands)  
 
Cash flows from operating activities:
                       
Net income
  $ 386,384     $ 266,616     $ 168,859  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Deferred taxes
    (1,538 )     9,326       2,152  
(Gain) loss on investment in foundries
    8,480       12,927       (3,746 )
(Recovery) loss on unauthorized sales of UMC shares
          (6,193 )     18,339  
Depreciation and amortization
    65,774       38,862       22,952  
Provision for doubtful accounts
    (272 )     4,581       1,400  
FlashVision wafer cost adjustment
    (2,263 )     (1,282 )     (1,613 )
Other non-cash charges
    9,833       3,764       3,143  
Changes in operating assets and liabilities:
                       
Accounts receivable
    (134,207 )     (14,880 )     (104,550 )
Inventories
    (135,162 )     (79,526 )     (28,301 )
Other current assets
    (29,559 )     (246 )     7,697  
Other non-current assets
    (1,589 )     1,927       (4,116 )
Accounts payable
    148,234       (6,298 )     51,296  
Accounts payable and other current liabilities, related parties
    24,657       (3,149 )     29,104  
Accrued payroll and related expenses
    13,827       13,472       16,543  
Income taxes receivable/payable
    64,240       (11,950 )     27,720  
Other accrued liabilities
    7,964       8,959       9,196  
Deferred income on shipments to distributors and retailers and deferred revenue
    57,166       (15,489 )     57,682  
Other non-current liabilities
    (1,114 )     6,209       (1,225 )
                         
Total adjustments
    94,471       (38,986 )     103,673  
                         
Net cash provided by operating activities
    480,855       227,630       272,532  
                         
Cash flows from investing activities:
                       
Purchases of short-term investments
    (803,967 )     (1,147,142 )     (622,580 )
Proceeds from sale of short-term investments
    722,986       810,111       327,457  
Proceeds from sale of investments in foundries
                21,627  
Notes receivable from Matrix Semiconductor
    (20,000 )            
Acquisition of property and equipment, net
    (134,477 )     (125,842 )     (54,623 )
Acquisition of technology license
    (4,500 )           (1,500 )
Consideration paid in a business combination
            (9,061 )      
Notes receivable from FlashVision
    (34,249 )     (33,564 )      
Investment in FlashVision
                 
Investment in Flash Partners
    (21,790 )     (23,129 )      
Investment in foundries
    (3,500 )     (704 )     (11,001 )
Proceeds from other sales
          6,333       4,880  
                         
Net cash (used in) investing activities
    (299,497 )     (522,998 )     (335,740 )
                         
Cash flows from financing activities:
                       
Issuance of common stock in public offering
                521,608  
Issuance of common stock under employee programs
    115,398       24,648       55,294  
                         
Net cash provided by financing activities
    115,398       24,648       576,902  
                         
Effect of changes in foreign currency exchange rates on cash
    1,507       36        
                         
Net increase (decrease) in cash and cash equivalents
    298,263       (270,684 )     513,694  
Cash and cash equivalents at beginning of the year
    463,795       734,479       220,785  
                         
Cash and cash equivalents at end of the year
  $ 762,058     $ 463,795     $ 734,479  
                         
Supplemental disclosure of cash flow information:
                       
Cash paid for income taxes
  $ (164,345 )   $ (159,436 )   $ (44,244 )
                         
Cash paid for interest expense
  $ (17 )   $ (6,750 )   $ (6,750 )
                         
Non-cash financing and investing activities:
                       
Conversion of subordinated notes
  $     $ 150,000     $  
                         
Issuance of shares in a business combination
  $     $ 4,935     $  
                         
 
The accompanying notes are an integral part of these consolidated financial statements.


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Table of Contents

 
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 and markets 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 2005 and 2003 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.
 
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.
 
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 on-going basis, the Company evaluates its estimates, including those related to customer programs and incentives, product returns, bad debts, inventories and related reserves, investments, income taxes, warranty obligations, restructuring and contingencies, stock 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 January 1, 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 actually redeem the incentive. All sales incentive programs are recorded as an offset to product revenues, deferred revenues or a charge to marketing expenses. Marketing development programs are either recorded as a reduction to revenue or as an addition to marketing expense in compliance with EITF 01-09, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).


F-8


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

 
Share Based Compensation.  The Company accounts for employee stock based compensation using the intrinsic value method under Statement of Financial Accounting Standards No. 123 (FAS 123), Accounting for Stock Based Compensation, as amended by Statement of Financial Accounting Standards No. 148 (FAS 148), Accounting for Stock Based Compensation — Transition and Disclosure, and accordingly no expense has been recognized in the consolidated income statements for options granted with an exercise price equal to the market value of the Company’s stock on the date of grant to employees or directors under the Company’s stock option plans. The Company has also accounted for its employee stock purchase plan following the guidance provided in Accounting Principles Board Opinion No. 25, or APB 25, Accounting for Stock Issued to Employees, and accordingly, the Company has not recognized any expense for the discount provided on the fair market value of the stock sold under our qualified non-compensatory employee stock purchase plan. The Company accounts for restricted stock awards by recognizing compensation expense equal to the fair market value of the restricted stock awards on the date of the grant. This compensation expense is recognized ratably over the applicable vesting period.
 
Had compensation expense been determined based on the fair value at the grant dates, with amortization of the deferred stock based compensation using the straight-line method over the vesting periods of the applicable options, the Company’s pro forma net income and net income per share would have been as follows (in thousands, except per share amounts):
 
                         
    Years Ended  
    January 1,
    January 2,
    December 28,
 
    2006     2005     2003  
 
Net income as reported
  $ 386,384     $ 266,616     $ 168,859  
Fair value method expense, net of related tax
    (52,629 )     (39,550 )     (29,793 )
                         
Pro forma net income
  $ 333,755     $ 227,066     $ 139,066  
                         
Pro forma basic income per share
  $ 1.82     $ 1.38     $ 0.96  
Basic income per share, as reported
  $ 2.11     $ 1.63     $ 1.17  
Pro forma diluted income per share
  $ 1.73     $ 1.23     $ 0.84  
Diluted income per share, as reported
  $ 2.00     $ 1.44     $ 1.02  
 
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 a specific allowance for bad debts against amounts due to reduce the net recognized receivable to the amount it reasonably believes will be collected. For all other customers, the Company provides allowances for bad debts based on the length of time the receivables are past due based on the Company’s historical experience. Accounts receivable are aged based on the applicable contractual due date. All accounts or portions thereof that are deemed to be uncollectible are written-off through a charge to the allowance and a credit to accounts receivable. If circumstances change (e.g., higher than expected defaults or an unexpected material adverse change in a major customer’s ability to meet its financial obligations to the Company), the Company could experience higher write-offs.
 
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.


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Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

 
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 retained earnings. The Company 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 $(0.1) million, $1.8 million and $2.1 million, in 2005, 2004 and 2003, respectively. See Note 2, “Accumulated Other Comprehensive Income (Loss).”
 
Cash Equivalents and Short-Term Investments.  Cash equivalents consist of short-term, highly liquid financial instruments with insignificant interest rate risk that are readily convertible to cash and have maturities of three months or less from the date of purchase. Short-term investments consist of taxable commercial paper, United States government agency obligations, corporate/municipal notes and bonds with high-credit quality, money market preferred stock and auction rate preferred stock and have maturities greater than three months 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. The fair market value, based on quoted market prices, of cash equivalents and short-term investments excluding the Company’s short-term investment in foundries at January 1, 2006 and January 2, 2005 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 ten years.
 
Equity Investments.  The Company accounts for investments in equity securities of other entities 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).
 
The Company evaluates its equity method investments to determine whether any investee is a variable interest entity within the meaning of Financial Interpretation No. 46, 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 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.


F-10


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

 
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.
 
Intangible Assets.  The excess of purchase price over the fair market value of acquired tangible assets, net of liabilities, is recorded as identifiable intangible assets or to the extent there are not sufficient identifiable intangible assets, as goodwill. The Company tests its intangible assets for impairment if indicators of impairment exist, and it would then reduce the basis of the intangible asset accordingly. Identifiable intangible assets are amortized on a straight-line basis over their estimated useful life, generally 3-5 years. Goodwill is evaluated for impairment annually by reference to the lowest level reporting unit to which the goodwill relates. The Company has one reporting unit based on the lowest level profit and loss summaries reviewed by the Company’s chief decision maker.
 
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, 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. When impairments are assessed, the Company would record charges to reduce goodwill or other long-lived assets based on the amount by which the carrying amounts of these assets exceed their fair values.
 
Warranty Costs.  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 product failure rates and repair or replacement costs incurred in supporting a product failure. 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.
 
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 $0.2 million and $0.4 million at January 1, 2006 and January 2, 2005, respectively. Advertising expenses were $15.2 million, $20.4 million and $5.0 million, in 2005, 2004 and 2003, respectively.


F-11


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

 
Research and Development Expenses.  Research and development expenditures are expensed as incurred.
 
Recently Issued Accounting Standards.  The Financial Accounting Standards Board, or FASB, adopted a revised Statement of Financial Accounting Standards No. 123, or FAS 123R, Share Based Payments, with an effective date of June 15, 2005. In April 2005, the SEC amended the effective date of FAS 123R, and the Company is now required to adopt this standard for the Company’s first fiscal year beginning after June 15, 2005. The Company has adopted FAS 123R in January 2006 and currently does not expect to restate prior periods to conform to the new accounting standard as the Company will use the modified prospective method. FAS 123R requires the Company to recognize an expense based on the fair value of all share based payments to employees, including grants of options to buy shares of the Company’s common stock. Share based awards to employees is calculated through the use of option pricing models. These models require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company’s calculation is made using the Black-Scholes-Merton option pricing model. See Note 3, “Compensation and Benefits” for assumption incorporated in this model. See “Share Based Compensation” above for information related to the pro forma effect on reported net income and net earnings per share of applying the fair value provisions of FAS 123. Adoption of FAS 123R is expected to increase the Company’s operating expenses.
 
In May 2005, the FASB issued Financial Accounting Standards No. 154, or FAS 154, Accounting Changes and Error Corrections. FAS 154 replaced Accounting Pronouncement Board Opinion No. 20, or APB 20, Accounting Changes, and Financial Accounting Standards No. 3, or FAS 3, Reporting Accounting Changes in Interim Financial Statements. FAS 154 requires that a voluntary change in accounting principle be applied retrospectively with all prior period financial statements presented based on the application of the new accounting principle. The statement will require the retrospective application of the impact of the direct effect of changes in accounting principles unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. FAS 154 carries forward without change the guidance contained in APB 20 for reporting the correction of an error in previously issued financial statements and changes in accounting estimates. FAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and requires prospective application. The Company will adopt this standard on January 2, 2006 and currently does not anticipate that it will have a material effect on its financial statements or disclosures.
 
NOTE 2:   BALANCE SHEET INFORMATION
 
Available-for-Sale Investments.
 
Available-for-sale investments at January 1, 2006 was as follows:
 
                                         
          Gross
    Gross
             
    Book
    Unrealized
    Unrealized
    Market
       
    Value     Gains     Losses     Value        
    (In thousands)        
 
Money market funds
  $ 300,833     $           —     $           —     $ 300,833          
Commercial paper
    284,455                   284,455          
U.S. government agency
    587,352             (3,691 )     583,661          
Municipal notes/bonds
    126,993             (219 )     126,774          
Corporate notes/bonds
    59,033             (322 )     58,711          
Auction instruments
    308,040             (1 )     308,039          
                                         
Total available-for-sale investments
  $ 1,666,706     $     $ (4,233 )   $ 1,662,473          
                                         
 


F-12


Table of Contents

Notes to Consolidated Financial Statements — (Continued)

         
    Carrying
 
    Amount  
 
Available-for-sale investments
  $ 1,662,473  
Cash on hand
    35,224  
Investment in foundries
    18,338  
         
Total
  $ 1,716,035  
         
Reported as:
       
Cash and cash equivalents
  $ 762,058  
Short-term investments
    935,639  
Investment in foundries
    18,338  
         
Total
  $ 1,716,035  
         

 
Available-for-sale investments at January 2, 2005 was as follows:
 
                                         
          Gross
    Gross
             
    Book
    Unrealized
    Unrealized
    Market
       
    Value     Gains     Losses     Value        
    (In thousands)        
 
Money market funds
  $ 139,124     $           —     $           —     $ 139,124          
Commercial paper
    81,000                   81,000          
U.S. government agency
    580,079             (1,840 )     578,239          
Municipal notes/bonds
    99,738             (201 )     99,537          
Corporate notes/bonds
    74,225             (284 )     73,941          
Auction instruments
    340,347             (7 )     340,340          
                                         
Total available-for-sale investments
  $ 1,314,513     $     $ (2,332 )   $ 1,312,181          
                                         
 
         
    Carrying
 
    Amount  
 
Available-for-sale investments
  $ 1,312,181  
Cash on hand
    10,789  
Investment in foundries
    20,398  
         
Total
  $ 1,343,368  
         
Reported as:
       
Cash and cash equivalents
  $ 463,795  
Short-term investments
    859,175  
Investment in foundries
    20,398  
         
Total
  $ 1,343,368  
         

F-13


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

 
The following table summarizes the fair value and gross unrealized losses of our 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 January 1, 2006:
 
                                                 
    Less Than 12 Months     12 Months or Greater     Total  
          Gross
          Gross
          Gross
 
    Market
    Unrealized
    Market
    Unrealized
    Market
    Unrealized
 
    Value     Losses     Value     Losses     Value     Losses  
    (In thousands)  
 
Money market funds
  $ 300,833     $     $     $     $ 300,833     $  
Commercial paper
    284,455                         284,455        
U.S. government agency
    378,914       (1,449 )     204,747       (2,242 )     583,661       (3,691 )
Municipal notes/bonds
    107,628       (171 )     19,146       (48 )     126,774       ( 219 )
Corporate notes/bonds
    18,754       (96 )     39,957       (226 )     58,711       ( 322 )
Auction instruments
    162,074       (1 )     145,965             308,039       ( 1
                                                 
Total
  $ 1,252,658     $ (1,717 )   $ 409,815     $ (2,516 )   $ 1,662,473     $ (4,233 )
                                                 
 
The unrealized losses were primarily caused by interest rate increases.
 
Gross realized gains and losses on sales of available-for-sale securities during the years ended January 1, 2006, January 2, 2005 and December 28, 2003 were immaterial.
 
Debt securities at January 1, 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
  $ 251,167     $ 250,975  
Due after one year through five years
    688,704       684,662  
                 
Total
  $ 939,871     $ 935,637  
                 
 
Allowance for Doubtful Accounts.  The activity in the allowance for doubtful accounts was as follows (in thousands):
 
                                 
          Additions
             
    Balance at
    Charged to
          Balance at
 
    Beginning
    Costs and
    Deductions
    End of
 
    of Period     Expenses     (Write-Offs)     Period  
 
For the year ended:
                               
December 28, 2003
  $ 4,563       1,400       (1,081 )   $ 4,882  
January 2, 2005
  $ 4,882       4,581       (1,001 )   $ 8,462  
January 1, 2006
  $ 8,462       376       (788 )   $ 8,050  
 
Inventories.  Inventories were as follows (in thousands):
 
                 
    January 1,
    January 2,
 
    2006     2005  
 
Raw material
  $ 99,006     $ 53,681  
Work-in-process
    61,900       23,508  
Finished goods
    170,678       119,233  
                 
Total inventories
  $ 331,584     $ 196,422  
                 


F-14


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

 
In 2005, 2004 and 2003, the Company sold $12.4 million, $10.2 million and $16.3 million, respectively, of inventory that had been fully written-off in previous periods.
 
Property and Equipment.  Property and equipment consisted of the following (in thousands):
 
                 
    January 1,
    January 2,
 
    2006     2005  
 
Machinery and equipment
  $ 318,336     $ 213,043  
Software
    35,990       29,229  
Furniture and fixtures
    1,682       2,781  
Leasehold improvements
    8,881       8,958  
                 
Property and equipment, at cost
    364,889       254,011  
Accumulated depreciation and amortization
    (153,797 )     (106,780 )
                 
Property and equipment, net
  $ 211,092     $ 147,231  
                 
 
Depreciation expense of property, plant and equipment totaled $63.1 million, $38.1 million and $22.7 million in fiscal 2005, 2004 and 2003, respectively. Amortization expense of intangible assets and totaled $2.7 million, $0.8 million and $0.3 million in 2005, 2004 and 2003, respectively.
 
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):
 
                                 
          Additions
             
    Balance at
    Charged to
          Balance at
 
    Beginning
    Costs of
          End of
 
    of Period     Revenue     (Usage)     Period  
 
For the year ended:
                               
December 28, 2003
  $ 3,472       5,694       (5,472 )   $ 3,694  
January 2, 2005
  $ 3,694       14,790       (7,104 )   $ 11,380  
January 1, 2006
  $ 11,380       6,033       (6,156 )   $ 11,257  
 
Subordinated Notes.  On December 24, 2001, the Company completed a private placement of $125.0 million of 41/2% Convertible Subordinated Notes due 2006 (the Notes), and on January 10, 2002 the Company sold an additional $25.0 million of Notes. The Notes provided for semi-annual interest payments of $3.4 million each on May 15 and November 15. The Notes were converted into approximately 16.3 million shares of the Company’s common stock on November 17, 2004. The Company amortized $2.6 million and $0.9 million of debt issuance costs in 2004 and 2003, respectively, as a component of other income (loss) in the accompanying consolidated income statements.
 
Accumulated Other Comprehensive Income (Loss).  Accumulated other comprehensive income (loss) presented in the accompanying consolidated balance sheets consists of the accumulated gains and losses on available-for-sale marketable securities, net of taxes, for all periods presented (in thousands):
 
                 
    January 1,
    January 2,
 
    2006     2005  
 
Accumulated net unrealized gain (loss) on:
               
Available-for-sale short-term investments
  $  (4,233 )   $ (2,332 )
Available-for-sale investments in foundries
    (383 )     457  
Foreign currency translation
    7,251       20,768  
                 
Total accumulated other comprehensive income
  $ 2,635     $ 18,893  
                 
 
The amount of income tax expense allocated to unrealized gain on available-for-sale securities was immaterial at January 1, 2006 and January 2, 2005, respectively.


F-15


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

 
Note 3:   Compensation and Benefits
 
Stock Based Compensation.  FAS 123R will require the Company to change its method of accounting for share based compensation, by recognizing the fair value of share based compensation as an expense in its consolidated financial statements, beginning in January 2006. Until such date, as permitted by FAS 148, the Company is accounting for employee stock based compensation using the intrinsic value method and accordingly, no expense has been recognized for options granted to employees or directors under the plans as the grant exercise price is set at the fair market value of the stock on the day of grant. The Company accounts for its employee purchase plan following the guidance provided by APB 25, which considers certain qualified stock purchase plan as non-compensatory and accordingly, the Company has not recognized any expense for the discount on the fair market value of the shares of stock sold under the Company’s employee stock purchase plan. The discount is applied to the fair market value of the shares either at the beginning or the end of the purchase period, whichever is lower.
 
During the fourth quarter of 2005, the Company considered the guidance provided by the Securities and Exchange Commission in SAB 107 and reviewed both the actual volatility in the trading market for its common stock and the implied volatility of tradable forward call options to purchase shares of its common stock as part of its efforts to make a thorough and accurate estimate of expected volatility utilized in the estimate of fair value of valuing share based compensation. Based on such review, the Company determined the volatility factor it used to estimate the fair value of stock based compensation awarded during the fourth quarter of the year ended January 1, 2006 to be based on implied forward volatilities. Prior to this change, the Company estimated future volatility based on historical and implied stock volatility. Estimated volatility is one of the inputs used in the Black-Scholes-Merton model currently used by the Company to make a reasonable estimate of the fair value of options granted under the Company’s stock plans and the rights to purchase shares under the Company’s employee stock purchase plan.
 
The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton option-pricing model, with the following weighted-average assumptions for grants made in 2005, 2004 and 2003, respectively:
 
                         
    Years Ended  
    January 1,
    January 2,
    December 28,
 
    2006     2005     2003  
 
Dividend yield
    None       None       None  
Expected volatility
    0.52       0.92       0.95  
Risk free interest rate
    3.94 %     3.07 %     3.39 %
Expected lives
    4.5 years       5 years       5 years  
 
The weighted-average fair value of options granted during the year was $13.03, $22.64 and $8.71 for 2005, 2004 and 2003, respectively.
 
The fair value of issuance under the employee stock purchase plans is estimated on the date of issuance using the Black-Scholes-Merton model, with the following weighted-average assumptions for issuances made in 2005, 2004 and 2003, respectively:
 
                         
    Years Ended  
    January 1,
    January 2,
    December 28,
 
    2006     2005     2003  
 
Dividend yield
    None       None       None  
Expected volatility
    0.47       0.57       0.57  
Risk free interest rate
    2.69 %     2.69 %     2.94 %
Expected lives
    1/2 year       1/2 year       1/2 year  
 
The weighted-average fair value of employee stock purchases for the year was $7.60, $8.12 and $3.36 for 2005, 2004 and 2003, respectively.


F-16


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

 
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 will be made under the plans after that date. However, options which 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 employment or service with the Company. As of January 1, 2006, options granted, net of cancellations, was 38,716,989 shares and 1,616,000 shares under the 1995 Stock Option Plan and the 1995 Non-Employee Directors Stock Option Plan, respectively. Outstanding options under the 1995 Stock Option Plan have exercise prices ranging from $1.64 to $69.75 per share, and outstanding options under the 1995 Non-Employee Directors Stock Option Plan had exercise prices ranging from $6.22 to $35.03 per share.
 
Special Stock Option Plan.  This plan expired on May 27, 2005. No options were ever granted under this plan.
 
2005 Stock Incentive Plan.   5,700,000 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 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. The shares may be issued under the 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 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. Grants and awards under the discretionary grant and stock issuance programs will generally vest incrementally over a four-year period of continued service, and the grants under the automatic grant program will vest in accordance with the specific vesting provisions set forth in that program. As of January 1, 2006, options granted, net of cancellations, under the plan was 1,558,625 shares with exercise prices ranging from $23.76 to $64.20, and restricted stock units covering an additional 105,188 shares were also outstanding.


F-17


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

 
A summary of activity under all stock incentive plans follows (shares in thousands):
 
                         
    Total Available
          Weighted
 
    for Future
    Total
    Average
 
    Grant/Issuance     Outstanding     Exercise Price  
 
Balance at December 29, 2002
    15,462       19,262     $ 10.69  
                         
Granted
    (6,088 )     6,088     $ 11.76  
Automatic share increase
    6,307              
Exercised
          (5,472 )   $ 9.45  
Canceled
    481       (481 )   $ 17.13  
                         
Balance at December 28, 2003
    16,162       19,397     $ 11.21  
                         
Granted
    (6,617 )     6,617     $ 31.58  
Automatic share increase
    7,337              
Exercised
          (2,301 )   $ 8.21  
Canceled
    1,057       (1,057 )   $ 20.93  
                         
Balance at January 2, 2005
    17,939       22,656     $ 17.02  
                         
Granted
    (6,472 )     6,472     $ 28.37  
Automatic share increase
    8,206              
1995 Plan termination
    (22,106 )            
Initial reserve under 2005 plan
    5,700              
Exercised
          (7,937 )   $ 13.75  
Canceled
    1,157       (767 )   $ 24.37  
                         
Balance at January 1, 2006
    4,424       20,424     $ 21.57  
                         
 
At January 1, 2006, options outstanding were as follows:
 
                                         
    Options Outstanding     Options Exercisable  
    Number
    Weighted
          Number
       
    Outstanding as of
    Average
    Weighted
    Exercisable as of
    Weighted
 
Range of Exercise
  January 1,
    Remaining
    Average
    January 1,
    Average
 
Prices
  2006     Contractual Life     Exercise Price     2006     Exercise Price  
 
$ 1.64 - $ 6.41
    3,116,635       5.11     $ 5.22       2,857,492     $ 5.12  
$ 6.45 - $ 8.87
    3,097,417       6.96     $ 8.73       1,684,816     $ 8.71  
$ 8.93 - $17.19
    1,223,369       5.00     $ 15.40       1,167,652     $ 15.57  
$17.22 - $22.90
    1,972,277       6.04     $ 19.31       1,412,866     $ 18.88  
$22.95 - $28.09
    5,438,073       8.81     $ 24.47       113,066     $ 25.67  
$28.18 - $34.72
    4,033,374       7.93     $ 34.20       1,444,981     $ 33.91  
$35.03 - $44.32
    659,823       6.41     $ 39.71       204,080     $ 37.07  
$44.79 - $69.75
    777,880       6.47     $ 52.56       111,250     $ 54.81  
                                         
$ 1.64 - $69.75
    20,318,848       7.12     $ 21.57       8,996,203     $ 15.53  
                                         
 
1995 and 2005 Employee Stock Purchase Plans.  The 2005 Employee Stock Purchase Plan was approved by the stockholders on May 27, 2005 as the successor to the Company’s 1995 Employee Stock Purchase Plan. The final offering period under the 1995 plan ended on July 29, 2005, and the first offering period under the 2005 plan began on August 1, 2005. Both plans consist of two components: a component for employees residing in the United States and an international component for employees who are non-U.S. residents. 7,382,594 shares were reserved for issuance under the 1995 plan, and 5,000,000 shares are reserved for issuance under the 2005 plan. Each plan allows eligible employees to purchase shares of the Company’s common stock at the end of each six-month offering period


F-18


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

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 the end of the fiscal year ended January 1, 2006, 4,034,858 shares had been issued under the 1995 plan, and no shares had been issued under the 2005 plan.
 
Retirement Plan.  The Company maintains a tax-deferred savings plan, the SanDisk 401(k) Plan, for the benefit of qualified employees. Qualified employees may elect to make contributions to the plan on a monthly basis. The Company may make annual contributions to the plan at the discretion of the Company’s Board of Directors. The Company contributed $1.8 million, $1.6 million and $1.2 million for the years ended January 1, 2006, January 2, 2005 and December 28, 2003, respectively.
 
Deferred Compensation.  In 2005, the Company recorded deferred compensation related to the issuance of restricted stock units. In 2004, the Company recorded deferred compensation as a part of its purchase price allocation relating to an immaterial business acquisition.
 
Note 4:   Concentrations of Risk and Segment Information
 
Geographic Information and Major Customers.  The Company markets and sells its products in the United States and in foreign countries through its sales personnel, dealers, distributors, retailers and its subsidiaries. The Company’s chief 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 (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 2005, 2004 and 2003 are as follows (in thousands):
 
                         
    Years Ended  
    January 1,
    January 2,
    December 28,
 
    2006     2005     2003  
 
Revenues:
                       
North America
  $ 1,058,234     $ 771,659     $ 417,869  
Japan
    138,507       191,686       184,195  
EMEA
    500,998       420,645       232,080  
Other foreign countries
    608,330       393,065       245,657  
                         
Total
  $ 2,306,069     $ 1,777,055     $ 1,079,801  
                         
Long Lived Assets:
                       
North America
  $ 126,346     $ 86,024     $ 58,569  
Japan
    286,859       263,248       169,330  
Israel
    8,868       14,737       40,877  
Other foreign countries
    608       472       325  
                         
Total
  $ 422,681     $ 364,481     $ 269,101  
                         
 
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, 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 50%, 55% and 48% of the Company’s revenues for the years ended January 1, 2006,


F-19


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

January 2, 2005 and December 28, 2003, respectively. Eight of the top ten customers or licensees for 2005, were also part of the Company’s top ten customers or licensees in 2004. Nine of the top ten customers or licensees for 2004 were also part of the Company’s top ten customers or licensees for 2003. In 2005, Best Buy accounted for 11% of the Company’s revenues; all other customers were less than 10% of the Company’s revenues. For 2004 and 2003, no single customer or licensee accounted for more than 10% of total 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 Toshiba’s Yokkaichi Operations and to a lesser extent by Renesas and Samsung. The Company’s controller wafers are currently manufactured by Tower and 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 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.
 
Concentration of Credit Risk.  The Company’s concentration of credit risk consists principally of cash, cash equivalents, short-term investments and trade receivables. The Company’s investment policy restricts investments to high-credit quality investments and limits the amounts invested with any one issuer. The Company sells to original equipment manufacturers, retailers and distributors in the United States, Japan, 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 5, “Off Balance Sheet Liabilities.”
 
Foreign Exchange Exposures.  The Company is exposed to foreign currency exchange rate risk inherent in sales, cost of sales, and assets and liabilities denominated in currencies other than the U.S. Dollar. In 2005, the Company used foreign currency forward contracts to mitigate the transaction gains and losses generated by these assets and liabilities denominated in currencies other than the U.S. dollar. The Company did not use foreign currency forward contracts in fiscal 2004 and fiscal 2003. See Note 5, “Contractual Obligations and Off Balance Sheet Arrangements.”
 
The Company had net transaction gains (losses) of approximately $0.1 million, ($1.4) million and ($1.3) million for the years ended January 1, 2006, January 2, 2005 and December 28, 2003, respectively. These amounts are included in other income (loss), net, in the accompanying consolidated income statements.
 
Note 5:   Commitments, Litigation, Contingencies and Guarantees
 
Commitments
 
FlashVision.  The Company has a 49.9% ownership interest in FlashVision, a business venture with Toshiba Corporation, or Toshiba, formed in fiscal 2000 to purchase from Toshiba NAND flash memory products. FlashVision operates in two of Toshiba’s 200-millimeter wafer fabrication facilities, located in Yokkaichi, Japan.


F-20


Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

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 January 1, 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 January 1, 2006, the Company had notes receivable from FlashVision of 7.3 billion Japanese yen, or approximately $62 million based upon the exchange rate at January 1, 2006. These notes are secured by the equipment purchased by FlashVision using the note proceeds.
 
Flash Partners.  The Company has a 49.9% ownership interest in Flash Partners, a business venture with Toshiba, formed in fiscal 2004 to purchase from Toshiba NAND flash memory products at a new 300-millimeter wafer fabrication facility, Fab 3, at Toshiba’s Yokkaichi operations. 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 January 1, 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.
 
In February 2006, the Company and Toshiba committed to expand Flash Partners’ capacity to 70,000 wafer starts per month. The Company currently estimates the total equipment funding obligation at the 70,000 wafer starts per month level to be approximately 365.0 billion Japanese yen, or approximately $3.1 billion based upon the exchange rate at January 1, 2006. Of this amount, the Company is obligated to fund 182.5 billion Japanese yen, or approximately $1.5 billion based upon the exchange rate at January 1, 2006, of which as of January 1, 2006, approximately $1.0 billion was left to fund.
 
As of January 1, 2006, Flash Partners had utilized an operating lease facility of 50.0 billion Japanese yen, or approximately $424 million based on the exchange rate at January 1, 2006, to partially fund Fab 3 equipment. As of January 1, 2006, the Company’s guarantee of the Flash Partners’ operating lease obligation, net of accumulated lease payments, was approximately 24.0 billion Japanese yen, or approximately $203 million based upon the exchange rate at January 1, 2006. In December 2005, Flash Partners secured an additional lease facility of 35.0 billion Japanese yen, or approximately $297 million based upon the exchange rate at January 1, 2006. The Company guaranteed on an unsecured and several basis 50% of the draw downs under this facility. As of January 1, 2006, no draw downs had been made, however the entire amount was drawn down in January 2006. The Company’s maximum exposure under the guarantee is 17.5 billion Japanese yen, or approximately $148 million based upon the exchange rate at January 1, 2006. 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. See “Off Balance Sheet Liabilities” below.
 
As a part of the FlashVision and Flash Partners 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. In fiscal 2004, the Company and Toshiba increased the maximum quarterly amounts the Company may be required to pay under these agreements and clarified the allocation methodologies for direct research and development costs. As of January 1, 2006, the Company had accrued liabilities related to these expenses of $4.2 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 six-month rolling forecast.
 
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 six-month forecast are


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Notes to Consolidated Financial Statements — (Continued)

binding and cannot be canceled. At January 1, 2006, the Company had approximately $116.2 million of noncancelable purchase orders for flash memory wafers outstanding to FlashVision, Flash Partners and Toshiba.
 
Other Silicon Sources.  The Company’s contracts with its other sources of silicon generally require the Company to provide a purchase order commitment based on a six-month rolling forecast. The purchase orders placed under these arrangements relating to the first three months of the six-month forecast are generally binding and cannot be canceled. Outstanding purchase commitments for other sources of silicon 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.
 
Off Balance Sheet Liabilities
 
FlashVision.  FlashVision secured an equipment lease arrangement of approximately 37.9 billion Japanese yen, or approximately $321 million based upon the exchange rate at January 1, 2006, in May 2002 with Mizuho Leasing, and other financial institutions. Under the terms of the 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 January 1, 2006, the maximum amount of the Company’s contingent indemnification obligation, which reflects payments and any lease adjustments, was approximately 8.8 billion Japanese yen, or approximately $75 million based upon the exchange rate at January 1, 2006.
 
Flash Partners.  As described in “Commitments — Flash Partners” above, Flash Partners intends to sell and lease-back from a consortium of financial institutions a portion of its tools and has entered into two equipment lease agreements as described below.
 
  •  In December 2004, Flash Partners entered into a master lease agreement with certain financial institutions providing for up to 50.0 billion Japanese yen, or approximately $424 million based upon the exchange rate at January 1, 2006, of original lease obligations. As of January 1, 2006, Flash Partners had drawn down this entire master lease facility. The Company and Toshiba have each guaranteed, on a several basis, 50% of Flash Partners’ obligations under the master lease agreement. Lease payments are due quarterly and will be completed in stages through 2010. At the end of the lease term, 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 other customary terms to protect the leased assets. The master lease agreement contains customary events of default for a Japanese lease facility and is an exhibit to this report. That agreement should be read carefully in its entirety for a comprehensive understanding of its terms and the nature of the obligations the Company guaranteed.
 
  •  In December 2005, Flash Partners entered into a second master lease agreement with certain financial institutions providing up to 35.0 billion Japanese yen, or approximately $297 million based upon the exchange rate at January 1, 2006, of original lease obligations. There were no amounts outstanding under this lease agreement at the end of fiscal 2005; however the entire amount was drawn down in January 2006. The Company and Toshiba have each guaranteed, on a several basis, 50% of Flash Partners’ obligations


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Notes to Consolidated Financial Statements — (Continued)

  under this master lease agreement. Lease payments are due quarterly and will be completed in 2011. At the end of the lease term, 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 other customary terms to protect the leased assets. The master lease agreement contains customary events of default for a Japanese lease facility and is an exhibit to this report. That agreement should be read carefully in its entirety for a comprehensive understanding of its terms and the nature of the obligations the Company guaranteed.

 
In addition, Flash Partners expects to secure additional equipment lease facilities over time.
 
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 January 1, 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 January 1, 2006 or January 2, 2005, 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 and Flash Partners for, environmental remediation costs or liability resulting from Flash Partners’ manufacturing operations in certain circumstances. 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 infringe third-party patents. In 2004, the Company and Toshiba each engaged consultants to perform a review of the existing environmental conditions at the site of the facility in which Flash Partners operations are located to establish a baseline for evaluating future environmental conditions. The Company has not made any indemnification payments under any such agreements and as of January 1, 2006, no amounts have been accrued in the accompanying condensed consolidated financial statements with respect to these indemnification guarantees.
 
See also “Off Balance Sheet Liabilities” above regarding Flash Partner equipment lease facilities.
 
Litigation
 
The Company is involved in a number of lawsuits, including, among others, cases involving the Company’s patents and the patents of third parties. The Company cannot reasonably estimate a probable loss in any of these matters. Some of the actions seek injunctions against the Company’s sale of its products and/or substantial monetary damages, which if granted or awarded could have a material adverse effect on the Company’s business, financial condition and results of operations.


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Notes to Consolidated Financial Statements — (Continued)

 
Litigation is subject to inherent risks and uncertainties that may cause actual results to differ materially from the Company’s 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 the Company receives an adverse judgment in any litigation, it 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 expensive. Litigation initiated by the Company could also result in counter-claims against it, which could increase the costs associated with the litigation and result in the Company’s payment of damages or other judgments against it.
 
The Company has been subject to, and expects to continue to be subject to, claims and legal proceedings regarding alleged infringement by the Company of the patents, trademarks and other intellectual property rights of third parties. From time to time the Company has sued, and may in the future sue, third parties in order to protect its intellectual property rights. Parties that the Company has sued and that it may sue for patent infringement may counter-sue the Company for infringing their patents. If the Company was held to infringe the intellectual property of others, the Company may need to spend significant resources to develop non-infringing technology or obtain licenses from third parties, but the Company may not be able to develop such technology or acquire such licenses on terms acceptable to it or at all.
 
From time to time the Company agrees to indemnify certain of its suppliers and customers for alleged patent infringement. The scope of such indemnity varies but may in some instances include indemnification for damages and expenses, including attorneys’ fees. The Company may from time to time be engaged in litigation as a result of such indemnification obligations. Third-party claims for patent infringement are excluded from coverage under the Company’s insurance policies. Any future obligation to indemnify the Company’s customers or suppliers may have a material adverse effect on the Company’s business, financial condition and results of operations.
 
Legal Proceedings
 
On or about August 3, 2001, the Lemelson Medical, Education & Research Foundation, or Lemelson Foundation, filed a complaint for patent infringement against the Company and four other defendants. The suit, captioned Lemelson Medical, Education, & Research Foundation, Limited Partnership vs. Broadcom Corporation, et al., Civil Case No. CIV01 1440PHX HRH, was filed in the United States District Court, District of Arizona. On November 13, 2001, the Lemelson Foundation filed an amended complaint, which made the same substantive allegations against the Company but named more than twenty five additional defendants. The amended complaint alleges that the Company, and the other defendants, have infringed patents held by the Lemelson Foundation pertaining to bar code scanning technology. By its complaint, the Lemelson Foundation requests that the Company be enjoined from its allegedly infringing activities and seeks unspecified damages. The case as to the Company was stayed pending the outcome of litigation in the District Court of Nevada related to the same Lemelson bar code scanning patents asserted against the Company. In early 2004, the Nevada Court ruled that the Lemelson bar code patents (as well as other Lemelson patents) were invalid, not infringed and unenforceable. The Nevada Court’s findings were thereafter affirmed by the Federal Circuit. Based on the Federal Circuit’s affirmance, the Lemelson Foundation moved to dismiss with prejudice all claims against the Company, and that request for dismissal has been granted.
 
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 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 SanDisk, vacating the judgment of non-infringement and remanding the case back to district court.


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Notes to Consolidated Financial Statements — (Continued)

 
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 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 infringed 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 October 2, 2003, a purported shareholder class action lawsuit was filed on behalf of United States holders of ordinary shares of Tower as of the close of business on April 1, 2002 in the United States District Court for the Southern District of New York. The suit, captioned Philippe de Vries, Julia Frances Dunbar De Vries Trust, et al., v. Tower Semiconductor Ltd., et al., Civil Case No. 03 CV 4999, was filed against Tower and a number of its shareholders and directors, including the Company and Dr. Harari, who is a Tower board member, and asserts claims arising under Sections 14(a) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 14a 9 promulgated there under. The lawsuit alleges that Tower and certain of its directors made false and misleading statements in a proxy solicitation to Tower shareholders regarding a proposed amendment to a contract between Tower and certain of its shareholders, including the Company. The plaintiffs are seeking unspecified damages and attorneys’ and experts’ fees and expenses. On August 19, 2004, the court granted the Company and the other defendants’ motion to dismiss the complaint in its entirety with prejudice. On September 29, 2004, plaintiffs appealed the dismissal to the United States Court of Appeals for the Second Circuit.
 
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 court 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. 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 STMicro’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 STMicro’s U.S. patents. By order dated January 4, 2005, the court stayed the Company’s claim that STMicro infringes its 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 STMicro’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 STMicro, is stayed pending the outcome of the appeal.
 
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, and STMicroelectronics, Inc. v. SanDisk Corporation, Civil Case No. 4 05CV45, respectively. The complaints seek damages and injunctions against unspecified SanDisk products. On April 22,


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Notes to Consolidated Financial Statements — (Continued)

2005, the Company filed counterclaims on two patents against STMicroelectronics N.V. and STMicroelectronics, Inc. in the Civil Case 4-05CV45 proceeding. The counterclaims seek damages and injunctive relief against STMicroelectronics N.V. and STMicroelectronics, Inc. flash memory products.
 
On October 15, 2004, the Company filed a complaint under Section 337 of the Tariff Act of 1930 (as amended) titled, “In the matter of certain NAND flash memory circuits and products containing same” in the United States International Trade Commission, naming STMicroelectronics N.V. and STMicroelectronics, Inc. (“STMicro”) as respondents. In the complaint, the Company alleges that STMicro’s NAND flash memory infringes U.S. Patent No. 5,172,338 (the ’338 patent), and seek an order excluding their products from importation into the United States. In the complaint, the Company alleges that STMicro’s NAND flash memory infringes the ’338 patent and seeks an order excluding their products from importation into the United States. On November 15, 2004, the ITC instituted an investigation pursuant to 19 U.S.C. Section 1337 against STMicro in response to the Company’s complaint. 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 United States Patent 5,172,338 (the ’338 patent) by rejecting STMicro’s claims that the patent was invalidated by prior art. The initial determination, however, found that STMicro’s NAND flash memory chips did not infringe three claims of the ’338 patent. On October 31, 2005, the Company filed a petition with the International Trade Commission to review and reverse the finding of non-infringement. Also, on October 31, 2005, STMicro filed a petition for review with the International Trade Commission 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 October 14, 2005, STMicroelectronics, Inc. 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 complaint alleges that STMicroelectronics,Inc., 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 of certain inventions and patents conceived of by Harari 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 November 23, 2005, Harari and the Company filed counterclaims, asserting the Company’s (i.e. SanDisk’s) ownership of the patents and applications raised in the complaint. On December 13, 2005, STMicroelectronics, Inc. filed a motion to remand the case back to the Superior Court of Alameda County. That motion remains pending.
 
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 (“STMicro”) (Case No. C0505021 JF). In the suit, the Company seeks damages and injunctions against STMicro from making, selling, importing or using flash memory chips or products that infringe the Company’s U.S. Patent No. 5,991,517. The case is presently stayed, pending the termination of the ITC investigation instituted February 8, 2006, discussed below.
 
On January 11, 2006, the Company filed a complaint for patent infringement in the United States District Court for the Northern District of California against STMicro (Case No.C06-00194 JF). In the suit, the Company seeks damages and injunctions against STMicro from making, selling, importing or using flash memory chips or products that infringe the Company’s U.S. Patent No. 6,542,956. The case is presently stayed, pending the termination of the ITC investigation instituted February 8, 2006, discussed below.
 
On January 10, 2006, the Company filed a complaint under Section 337 of the Tariff Act of 1930 (as amended) titled, “In the matter of certain NAND flash memory circuits and products containing same” in the ITC, naming STMicro as respondents. In the complaint, the Company alleges that: (i) STMicro’s NOR flash memory infringes the ’338 patent; (ii) STMicro’s NAND flash memory infringes U.S. Patent No. 6,542,956; and (iii) STMicro’s NOR flash memory and NAND flash memory infringe U.S. Patent No. 5,991,517. The complaint seeks an order


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Notes to Consolidated Financial Statements — (Continued)

excluding STMicro’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 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. 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 pleadings asking the court to strike Sisvel’s pleadings as legally insufficient and seeking other procedural relief. The court is still addressing these procedural matters and the Company will not be required to answer on the substance of Sisvel’s claim until April 2006 at the earliest.
 
In a related action, on February 21, 2006, the Company filed an action in the English High Court, Chancery Division, Patents Court, in London, against the owners of the patents Sisvel has asserted against the Company. 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), and Institut für Rundfunktechnik GmbH (a German corporation), Case No. HC06 C 00615. In this action, the Company seeks a declaration that the patents asserted by Sisvel (as well as other patents owned by Philips and the other defendants) are invalid because they fail to properly claim anything new within the meaning of the European Patent Convention and because certain of them fail to comply with other requirements of the Convention. The defendants in that case are required to appear and announce their intention to defend on or about March 7, 2006. The defendants’ formal defense will be due in early April 2006.
 
In another 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. HC06C00835. In this action, the Company seeks a declaration of non-infringement of the patents asserted by Sisvel in connection with SanDisk’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 are required to appear and announce their intention to defend at the end of March, 2006. The defendants’ formal defense will be due in early May 2006.
 
On or about January 12, 2006, the Company was served with a complaint in an action filed by SoftVault Systems, Inc. in the United States District Court for the Eastern District of Texas. The case is SoftVault Systems, Inc. v. Yahoo! Inc., Microsoft Corporation, Napster, Inc., Creative Labs, Inc., Dell USA LP, Gateway, Inc., iriver America, Inc., Samsung Electronics America, Inc., Toshiba America Consumer Products, L.L.C., Digital Networks North America, Inc., Palm, Inc., Audiovox Corporation, SanDisk Corporation, and Thomson Inc., Case No. 2:06-cv-00017-LED. SoftVault accuses the Company, and others, of infringing its patents through the use of Microsoft’s Windows Digital Rights Management technology. The Company is reviewing the matter and preparing its answer. The Company intends to vigorously defend against this action.
 
Contingencies
 
Lee and Li Settlement.  Effective as of November 14, 2003, the Company and Lee and Li entered into a Settlement and General Release Agreement, or Settlement Agreement, concerning UMC shares embezzled by a former employee of that firm. Pursuant to the Settlement Agreement, the Company received a cash payment of $20.0 million at the time of signing. In addition, Lee and Li agreed to pay the Company $45.0 million (inclusive of interest $47.9 million) over four years in sixteen quarterly installments. Of this amount $11.3 million was classified


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Notes to Consolidated Financial Statements — (Continued)

as current other assets at January 1, 2006 and January 2, 2005, and $11.3 million and $22.5 million was classified as non-current other assets in the accompanying consolidated balance sheets as of January 1, 2006 and January 2, 2005, respectively. These amounts are secured by irrevocable standby letters of credit issued by the International Commercial Bank of China, or ICBC. Further, Lee and Li extended a credit to the Company in the amount of $18.3 million to be applied against future legal services provided by Lee and Li and to be spread equally over 18 years. This amount was reduced by $6.2 million as a result of a recovery from a third party brokerage firm in 2004. As a result of the recovery, the credit has been reduced to approximately $12 million to be spread equally over approximately 12 years. If any of the stolen assets are recovered, the net amount after recovery of expenses will be split between the Company and Lee and Li, in specified proportions until the Company receives a maximum amount of $106.6 million, including all amounts described above.
 
Contractual Obligations and Off Balance Sheet Arrangements
 
The following summarizes the Company’s contractual cash obligations, commitments and off balance sheet arrangements at January 1, 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 2007
    (Fiscal 2009
    (Beyond
 
    Total     1 Year     and 2008)     and 2010)     Fiscal 2011)  
 
Contractual Obligations:
                                       
Operating leases(1)
  $ 4,095     $ 2,758     $ 1,147     $ 190     $  
FlashVision, fabrication capacity expansion costs, and reimbursement for certain other costs including depreciation
    303,559       98,966       135,713       66,536       2,344  
Flash Partners fabrication capacity expansion and start-up costs, and reimbursement for certain other costs including depreciation(2)
    1,756,798       734,725       481,137       351,176       189,760  
Toshiba research and development
    104,483       36,483       68,000              
Capital equipment purchases commitments
    62,548       62,548                    
Operating expense commitments
    67,998       67,998                    
Noncancelable production purchase commitments(3)
    356,594 (4)     356,594                    
                                         
Total contractual cash obligations
  $ 2,656,075     $ 1,360,072     $ 685,997     $ 417,902     $ 192,104  
                                         
 
         
    As of
 
    January 1,
 
    2006  
 
Off Balance Sheet Arrangements:
       
Indemnification of FlashVision foundry equipment lease(5)
  $ 75,048  
Guarantee of Flash Partners lease(2)(6)
  $ 203,207  
 


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Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

 
(1) In January 2006, the Company incurred additional property lease obligations related to its lease of 3 buildings in Milpitas, California and from its acquisition of Matrix Semiconductor, Inc. The Company’s additional property lease obligation subsequent to January 1, 2006 will be $2.7 million, $9.5 million, $10.3 million and $17.2 million for less than 1 year, 2-3 years, 3-5 years and over 5 years, respectively. See Note 12, “Subsequent Events.”
 
(2) In January 2006, Flash Partners drew down the entire December 2005 lease facility which resulted in an increase of the Company’s guarantee of 17.5 billion Japanese yen, or approximately $148 million based upon the exchange rate at January 1, 2006. Lease payments are due quarterly and will be completed in 2011. The Company’s additional lease commitment related to this lease will be $28.2 million, $43.1 million, $41.6 million and $35.5 million for less than 1 year, 2-3 years, 3-5 years and over 5 years, respectively. See Note 12, “Subsequent Events.”
 
(3) Includes Toshiba foundries, FlashVision, Flash Partners, related parties vendors and other silicon sources vendors purchase commitments.
 
(4) Amounts are denominated in Japanese yen, are subject to fluctuation in exchange rates prior to payment and have been translated using the exchange rate at January 1, 2006.
 
(5) The Company’s contingent indemnification obligation is 8.8 billion Japanese yen, or approximately $75 million based upon the exchange rate at January 1, 2006.
 
(6) The Company’s guarantee obligation, net of cumulative lease payments, is 24.0 billion Japanese yen, or approximately $203 million based upon the exchange rate at January 1, 2006.
 
The Company leases its headquarters and sales offices under operating leases that expire at various dates from 2006 through 2010. Future minimum lease payments under real estate operating leases at January 1, 2006 were as follows (in thousands):
 
         
Fiscal Year Ending:
       
2006
  $ 2,422  
2007
    653  
2008
    211  
2009
    117  
2010
    61  
         
Total
  $ 3,464  
         
 
The Company’s objective for holding derivatives is to minimize the material risks associated with non-functional currency transactions and does not enter into derivatives for speculative or trading purposes. The Company’s derivative instruments are 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 $1.18 billion at January 1, 2006 to enter into foreign currency forward contracts. As of January 1, 2006, the Company had foreign currency forward contracts in place with a notional amount of 3.95 billion Japanese yen, or approximately $34 million based upon the exchange rate at January 1, 2006. The fair value of these foreign currency forward contracts as of January 1, 2006 were immaterial. The realized gains and losses on foreign currency forward contracts for the fiscal year ended January 1, 2006 was immaterial.


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Notes to Consolidated Financial Statements — (Continued)

 
Note 6:   Income Taxes
 
The provision for income taxes consists of the following (in thousands):
 
                         
    January 1,
    January 2,
    December 28,
 
    2006     2005     2003  
 
Current:
                       
Federal
  $ 159,147     $ 138,558     $ 96,399  
State
    24,592       13,731       19,296  
Foreign
    32,323       25,336       15,025  
                         
      216,062       177,625       130,720  
Deferred:
                       
Federal
    15,663       (20,963 )     (50,467 )
State
    (3,413 )     (78 )     (7,231 )
Foreign
    (1,389 )            
                         
      10,861       (21,041 )     (57,698 )
                         
Provision for income taxes
  $ 226,923     $ 156,584     $ 73,022  
                         
 
Income before provision for income taxes consisted of the following (in thousands):
 
                         
    January 1,
    January 2,
    December 28,
 
    2006     2005     2003  
 
United States
  $ 500,727     $ 414,968     $ 247,953  
International
    112,580       8,232       (6,072 )
                         
Total
  $ 613,307     $ 423,200     $ 241,881  
                         
 
The tax benefits associated with the exercise of stock options reduced taxes payable by $95.6 million in 2005 and reduced taxes payable by $17.9 million in 2004. Such benefits are credited to capital in excess of par value when realized.
 
The Company’s provision for income taxes differs from the amount computed by applying the federal statutory rates to income before taxes as follows:
 
                         
    January 1,
    January 2,
    December 28,
 
    2006     2005     2003  
 
U.S. Federal statutory rate
    35.0 %     35.0 %     35.0 %
State taxes, net of federal benefit
    2.2       2.1       3.2  
Utilization of credits
    (0.1 )     (0.2 )     (0.5 )
Reversal of tax benefit previously taken on UMC shares
                13.8  
Tax exempt interest income
    (0.8 )     (0.5 )     (0.4 )
Utilization of loss carryforward and change in valuation allowance
    0.4             (19.3 )
Other
    0.3       0.6       (1.6 )
                         
      37.0 %     37.0 %     30.2 %
                         
 
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.


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Notes to Consolidated Financial Statements — (Continued)

Significant components of the Company’s deferred tax assets as of January 1, 2006 and January 2, 2005 were as follows (in thousands):
 
                 
    January 1,
    January 2,
 
    2006     2005  
 
Deferred tax assets:
               
Inventory valuation
  $ 2,000     $ 15,800  
Deferred revenue recognized for tax purposes
    51,000       38,400  
Accruals and reserves not currently deductible
    56,600       51,300  
Fixed assets
    15,500       4,700  
Unrealized loss on permanent impairment of investment in foundries
    20,400       16,600  
Other
    5,200       1,200  
                 
Subtotal: Deferred tax assets
  $ 150,700     $ 128,000  
Valuation allowance for deferred tax assets
    (14,900 )     (12,300 )
                 
Total deferred tax assets
  $ 135,800     $ 115,700  
Deferred tax liabilities:
               
Unrealized gain on sale of foundry shares
    (19,500 )     (29,100 )
US taxes provided on unremitted earnings of foreign subsidiaries
    (26,500 )     (1,600 )
                 
Total: Deferred tax liabilities
    (46,000 )     (30,700 )
                 
Total net deferred tax assets
  $ 89,800     $ 85,000  
                 
 
At January 1, 2006, a $14.9 million valuation allowance was provided based, more likely than not, on the Company’s inability to recognize a tax benefit from certain write downs on its investment in Tower. At January 2, 2005, a $12.3 million valuation allowance was provided based on the net deferred tax assets on the same investment.
 
During the current and prior years, the Company has not made a determination to permanently reinvest earnings of its foreign subsidiaries.
 
Note 7:   Strategic Investments
 
UMC.  The Company maintains an investment position in United Microelectronics Corporation, or UMC, one of its suppliers of wafers for its controller components, on the cost basis of accounting. As of January 1, 2006, the Company owned 24.5 million UMC shares with a cost basis of $13.4 million and a fair market value of $13.9 million.
 
Tower Semiconductor.  The Company owns approximately 15% of the outstanding shares of Tower Semiconductor Ltd., or Tower, one of its suppliers of wafers for its controller components. The Company has sourced controller wafers from Tower since the third quarter of fiscal 2003. As of January 1, 2006, the Company owned approximately 10.2 million Tower shares with a carrying value and market value of $12.9 million and $14.8 million, respectively, a warrant to purchase 0.4 million Tower ordinary shares at an exercise price of $7.50 per share, with a carrying value of zero and Tower prepaid wafer credits with a carrying value of zero. In fiscal 2005, the Company recorded an unrealized loss of $1.1 million through OCI on its Tower investment to bring the carrying value of the Tower shares to market value. In December 2005, the Company invested $3.5 million in a Tower convertible debenture offering. Conversion is not restricted. See Note 10, “Related Parties — Tower.”
 
U3, LLC.  In the first quarter of fiscal 2005, the Company entered into an agreement with M-Systems, Inc., or M-Systems, under which they formed U3, LLC. U3, LLC was founded to develop a platform for which software developers can transform USB drives from a simple mass storage device to a platform for on-the-go computing. The Company and M-Systems each own 50% of U3, LLC. The Company is entitled to half of any residual gains. However, as the Company will provide greater than 50% of the U3, LLC financial support, it would receive more


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Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

than half of any residual losses with respect to the U3, LLC entity. As a result, U3, LLC is considered a variable interest entity and the Company is the primary beneficiary. The Company has consolidated the statement of financial position and the results of operations for the year ended January 1, 2006. The Company’s total investment in U3 as of January 1, 2006 was $2.8 million.
 
Note 8:   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.
 
Note 9:   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 2005     FY 2004     FY 2003  
 
Numerator:
                       
Numerator for basic net income per share:
                       
Net income
  $ 386,384     $ 266,616     $ 168,859  
                         
Denominator for basic net income per share: Weighted average common shares outstanding
    183,008       164,065       144,781  
                         
Basic net income per share
  $ 2.11     $ 1.63     $ 1.17  
                         
Numerator for diluted net income per share:
                       
Net income
  $ 386,384     $ 266,616     $ 168,859  
Tax-effected interest and bond amortization expenses attributable to the notes
          5,368       5,469  
                         
Net income for diluted income per share
  $ 386,384     $ 271,984     $ 174,328  
                         
Denominator for diluted net income per share:
                       
Weighted average common shares
    183,008       164,065       144,781  
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)
    10,008       10,406       10,559  
Conversion of the Notes
          14,366       16,276  
                         
Shares used in computing diluted net income per share
    193,016       188,837       171,616  
                         
Diluted net income per share
  $ 2.00     $ 1.44     $ 1.02  
                         
 
Basic earnings per share exclude any dilutive effects of options, warrants, and convertible securities. Diluted earnings per share include the dilutive effects of stock options, warrants, and convertible securities. Options and warrants to purchase 97,753, 6,140,781 and 1,253,457 shares of common stock were outstanding during 2005, 2004


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Notes to Consolidated Financial Statements — (Continued)

and 2003, respectively, but have been omitted from the diluted earnings per share calculation because the options’ exercise price was greater than the average market price of the common shares and, therefore the effect would be antidilutive.
 
Note 10:   Related Parties
 
The Company owns approximately 15% of the outstanding shares of Tower, prepaid wafer credits issued by Tower convertible debt and a warrant to purchase Tower ordinary shares. The Company’s Chief Executive Officer is a member of the Tower board of directors. The Company paid Tower approximately $31.3 million and $28.4 million fiscal years ended January 1, 2006 and January  2, 2005, respectively, for the purchase of controller wafers and related non-recurring engineering, or NRE. These purchases of controller wafers are ultimately reflected as a component of the Company’s cost of product revenues. At January 1, 2006 and January 2, 2005, the Company had amounts payable to Tower of approximately $2.4 million and $7.6 million, respectively, related to the purchase of controller wafers and related NRE. See Note 7, “Strategic Investments — Tower Semiconductor.”
 
The former President and Chief Executive Officer of Flextronics International, Ltd., or Flextronics, has served on the Company’s Board of Directors since September 2003. For the years ended January 1, 2006 and January 2, 2005, the Company recorded revenues related to Flextronics and its affiliates of $25.3 million and $4.3 million, respectively, and at January 1, 2006 and January 2, 2005, the Company had amounts receivable from Flextronics and its affiliates of $12.5 million and $2.7 million, respectively. In addition, the Company paid Flextronics and its affiliates $40.2 million and $37.4 million for the years ended January 1, 2006 and January 2, 2005, respectively, for card assembly and testing which are ultimately reflected as a component of the Company’s cost of product revenues. At January 1, 2006 and January 2, 2005, the Company had amounts payable to Flextronics and its affiliates of approximately $5.4 million and $2.0 million, respectively, for these services.
 
The Company and M-Systems entered into an agreement to form U3, LLC, an entity to develop and market a next generation platform for universal serial bus flash drives. See Note 7, “Strategic Investments — U3, LLC.”
 
See also Note 11 for disclosures related to investments in Toshiba ventures.
 
Note 11:   Investment in Toshiba Ventures
 
Toshiba
 
The Company entered into agreements with Toshiba; under which FlashVision and Flash Partners were formed to purchase from Toshiba advanced NAND flash memory wafers (see also Note 5, “Commitments, Contingencies and Guarantees”). During fiscal 2005, the Company purchased approximately $39.1 million of capital equipment which is located in Toshiba’s Yokkaichi operations. In return, the Company will receive 100% of the output from this equipment. The Company purchased NAND flash memory wafers from FlashVision, Flash Partners and Toshiba, purchased capital equipment from FlashVision, made payments for shared research and development expenses, made loans to FlashVision and made investments in Flash Partners totaling approximately $571.7 million, $516.6 million and $223.5 million for the comparable periods of fiscal 2005, 2004 and 2003, respectively. The purchases of NAND flash memory wafers are ultimately reflected as a component of the Company’s cost of product revenues. At January  1, 2006 and January 2, 2005, the Company had accounts payable balances due to FlashVision of $23.0 million and $30.7 million, respectively, balances due to Flash Partners of $27.0 million and zero, respectively, and balances due to Toshiba of $11.7 million and $6.1 million, respectively. At January 1, 2006 and January 2, 2005, the Company had accrued current liabilities due to Toshiba for shared research and development expenses of $4.2 million and $5.5 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 5. The fair value of the Company’s loan to FlashVision approximates book value. FlashVision is a


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Table of Contents

 
Notes to Consolidated Financial Statements — (Continued)

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.
 
The following is the summarized financial information for FlashVision at the Company’s fiscal years ended January 1, 2006 and January 2, 2005, respectively. FlashVision’s year-end is March 31, with quarters ending on March 31, June 30, September 30 and December 31 (in thousands).
 
                 
    December 31,
    December 31,
 
    2005     2004  
    (Unaudited)  
 
Current assets
  $ 117,448     $ 148,354  
Property, plant and equipment and other assets
    455,855       516,909  
                 
Total assets
    573,303       665,263  
Current liabilities
    125,882       222,017  
Long-term liabilities
  $ 124,616     $ 71,533  
 
The Company’s maximum reasonably estimable loss exposure (excluding lost profits) as a result of its involvement with FlashVision was $298.1 and $326.0 million, as of January 1, 2006 and January 2, 2005, respectively. These amounts are comprised of the Company’s investments, notes receivable and contingent indemnification obligation. At January 1, 2006 and January 2, 2005, the Company’s consolidated retained earnings included approximately $2.1 million and $1.7 million, respectively, of undistributed earnings of FlashVision.
 
The following summarizes financial information for FlashVision for the Company’s fiscal years ended January 1, 2006, January 2, 2005 and December 28, 2003, respectively (in thousands).
 
                         
    Twelve Months Ended  
    January 1,
    January 2,
    December 28,
 
    2006     2005     2003  
    (Unaudited)  
 
Net sales(1)
  $ 528,487     $ 481,792     $ 272,507  
Gross profit
  $ 2,122     $ 2,553     $ 1,572  
Net income
  $ 1,438     $ 1,318     $ 296  
 
 
(1) Net sales represent sales to both the Company and Toshiba.
 
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 5. 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.
 
The following is the summarized financial information for Flash Partners at the Company’s fiscal years ended January 1, 2006 and January 2, 2005. The entity did not exist during the Company’s fiscal year ended December 28,


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Notes to Consolidated Financial Statements — (Continued)

2003. Flash Partners’ year-end is March 31, with quarters ending on March 31, June 30, September 30 and December 31 (in thousands).
 
                 
    December 31,
    December 31,
 
    2005     2004  
    (Unaudited)  
 
Current assets
  $ 255,961     $ 56,793  
Property, plant and equipment and other assets
    583,989       3,820  
                 
Total assets
    839,950       60,613  
Current liabilities
  $ 755,647     $ 12,139  
 
The Company’s maximum reasonably estimable loss exposure (other than lost profits) as a result of its involvement with Flash Partners was $245.3 million and $166.9 million as of January 1, 2006 and January 2, 2005, respectively. These amounts are comprised of the Company’s investments and guarantee of half of Flash Partners’ lease obligation.
 
The following summarizes financial information for Flash Partners for the Company’s year ended January 1, 2006 and January 2, 2005. The entity did not exist for the year ended December 28, 2003 and therefore no information is provided in this disclosure (in thousands).
 
                 
    Twelve Months Ended  
    January 1,
    January 2,
 
    2006     2005(1)  
    (Unaudited)  
 
Net revenues
  $ 266,977     $ 21,157  
Gross loss
  $ (2,471 )   $  
Net loss
  $ (675 )   $ (179 )
 
 
(1) Net revenues represent reimbursement of start up costs from both the Company and Toshiba.
 
Note 12:   Subsequent Events
 
On January 13, 2006, the Company completed its acquisition of Matrix Semiconductor, Inc., or Matrix, and acquired all of the outstanding stock of Matrix. The acquisition consideration was approximately $302 million, consisting of 3,722,591 shares of common stock and approximately 600,000 shares of equity incentives valued at approximately $282 million and $20.0 million of cash, respectively. Matrix has pioneered the development of 3-D one time programmable integrated circuits and will be integrated into the Company’s existing product lines. Acquisition will be accounted for under the purchase method. The purchase price allocation has not yet been finalized. As part of its acquisition of Matrix, the Company assumed the obligation of Matrix’s existing facility lease totaling approximately $21 million which will run through 2016.
 
In December 2005, Flash Partners entered into a master equipment lease agreement providing for up to 35.0 billion Japanese yen, or approximately $297 million based upon the exchange rate at January 1, 2006, of original lease obligations. There were no amounts outstanding under this master lease agreement at the end of fiscal 2005; however, the entire amount was drawn down in January 2006 and the Company provided a guarantee for 50% of the outstanding balances, or approximately $148 million based upon the exchange rate at January 1, 2006. See Note 5, “Contractual Obligations and Off Balance Sheet Arrangements.”
 
In January 2006, the Company executed a facility lease agreement for a new corporate office complex to be located in Milpitas, California. This new corporate facility will house the Company’s research and development, sales and marketing and general and administrative functions. The facility lease agreement runs through 2013 with the total obligation of approximately $19 million. See Note 5, “Contractual Obligations and Off Balance Sheet Arrangements.”


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Table of Contents

 
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
Executive Vice President, Administration,
Chief Financial Officer
(On behalf of the Registrant and as Principal
Financial and Accounting Officer)
 
Dated: March 15, 2006
 
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)
(Eli Harari)
  President, Chief Executive Officer
and Director
(Principal Executive Officer)
  March 15, 2006
             
By:   /s/  (Judy Bruner)
(Judy Bruner)
  Executive Vice President, Administration, Chief Financial Officer (Principal Financial and
Accounting Officer)
  March 15, 2006
             
By:   /s/  (Irwin Federman)
(Irwin Federman)
  Chairman of the Board, Director   March 15, 2006
             
By:   /s/  (Steven J. Gomo)
(Steven J. Gomo)
  Director   March 15, 2006
             
By:   /s/  (Eddy W. Hartenstein)
(Eddy W. Hartenstein)
  Director   March 15, 2006
             
By:   /s/  (Catherine Pierson Lego)
(Catherine Pierson Lego)
  Director   March 15, 2006


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Signature
 
Title
 
Date
 
             
By:   /s/  (Michael E. Marks)
(Michael E. Marks)
  Director   March 15, 2006
             
By:   /s/  (James D. Meindl)
(James D. Meindl)
  Director   March 15, 2006
             
By:   /s/  (Alan F. Shugart
(Alan F. Shugart)
  Director   March 15, 2006

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Table of Contents

INDEX TO EXHIBITS
 
         
Exhibit
   
Number
 
Exhibit Title
 
  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   Restated Bylaws of the Registrant, as amended to date.(**)
  3 .5   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 .6   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 and 3.3.(2), (7),(10)
  4 .2   Rights Agreement, dated as of September 15, 2003, between the Registrant and Computershare Trust Company, Inc.(18)
  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)
  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 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 Registrant, The Israel Corporation, Alliance Semiconductor Ltd. And Macronix International Co., Ltd.(9)
  10 .13   Amendment to Share Purchase Agreement, dated as of March 20, 2002, by and between the Registrant and Tower Semiconductor Ltd.(11)
  10 .14   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 .15   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 .16   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 .17   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 .18   New Master Agreement, dated as of April 10, 2002, by and between the Registrant and Toshiba Corporation.(12), (1)


E-1


Table of Contents

         
Exhibit
   
Number
 
Exhibit Title
 
  10 .19   Amendment to New Master Agreement, dated and effective as of August 13, 2002 by and between the Registrant and Toshiba Corporation.(13), (1)
  10 .20   New Operating Agreement, dated as of April 10, 2002, by and between the Registrant and Toshiba Corporation.(12), (1)
  10 .21   Indemnification and Reimbursement Agreement, dated as of April 10, 2002, by and between the Registrant and Toshiba Corporation.(12), (1)
  10 .22   Amendment to Indemnification and Reimbursement Agreement, dated as of May 29, 2002 by and between the Registrant and Toshiba Corporation.(12)
  10 .23   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 .24   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) (*)
  10 .25   Change of Control Agreement entered into by and between the Registrant and the President and Chief Executive Officer of the Registrant.(20) (*)
  10 .26   Settlement and Release Agreement, dated as of June 29, 2004, by and between the Registrant and Michael Gray.(21)
  10 .27   Flash Partners Master Agreement, dated as of September 10, 2004, by and among the Registrant and the other parties thereto.(21), (1)
  10 .28   Operating Agreement of Flash Partners Ltd., dated as of September 10, 2004, by and between SanDisk International Limited and Toshiba Corporation.(21), (1)
  10 .29   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 .30   Amended and Restated Product Development Agreement, dated as of September 10, 2004, by and between the Registrant and Toshiba Corporation.(21), (1)
  10 .31   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 .32   Patent Indemnification Agreement, dated as of September 10, 2004 by and among the Registrant and the other parties thereto.(21), (1)
  10 .33   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 .34   Guarantee Agreement, dated as of December 24, 2004, by and between the Registrant and Mitsui Leasing & Development, Ltd.(22)
  10 .35   SanDisk Corporation 2005 Stock Incentive Plan.(23), (*)
  10 .36   SanDisk Corporation Form of Notice of Grant of Stock Option.(23), (*)
  10 .37   SanDisk Corporation Form of Notice of Grant of Non-Employee Director Automatic Stock Option (Initial Grant).(23), (*)
  10 .38   SanDisk Corporation Form of Notice of Grant of Non-Employee Director Automatic Stock Option (Annual Grant).(23), (*)
  10 .39   SanDisk Corporation Form of Stock Option Agreement.(23), (*)
  10 .40   SanDisk Corporation Form of Automatic Stock Option Agreement.(23), (*)
  10 .41   SanDisk Corporation Form of Restricted Stock Unit Issuance Agreement.(23), (*)
  10 .42   SanDisk Corporation Form of Restricted Stock Unit Issuance Agreement (Director Grant).(23), (*)
  10 .43   SanDisk Corporation Form of Restricted Stock Award Agreement.(23), (*)
  10 .44   SanDisk Corporation Form of Restricted Stock Award Agreement (Director Grant).(23), (*)


E-2


Table of Contents

         
Exhibit
   
Number
 
Exhibit Title
 
  10 .45   Form of Amendment to Change of Control Agreement for those officers of the Registrant who are party to such Agreement.(24), (*)
  10 .46   Guarantee Agreement between the Registrant, IBJ Leasing Co., Ltd., Sumisho Lease Co., Ltd., and Toshiba Finance Corporation.(**)
  10 .47   Basic Lease Contract between Flash Partners Yuken Kaisha, IBJ Leasing Co., Ltd., Sumisho Lease Co., Ltd., and Toshiba Finance Corporation.(**), (+)
  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(**)
  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.
 
24. Previously filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended July 3, 2005.


E-3

EX-3.4 2 f18180exv3w4.htm EXHIBIT 3.4 exv3w4
 

EXHIBIT 3.4
RESTATED BYLAWS
OF
SANDISK CORPORATION
(Amended as of December 9, 2005)
ARTICLE I
OFFICES
     Section 1. The registered office shall be in the City of Wilmington, County of New Castle, State of Delaware.
     Section 2. The corporation may also have offices at such other places both within and without the State of Delaware as the Board of Directors may from time to time determine or the business of the corporation may require.
ARTICLE II
MEETINGS OF STOCKHOLDERS
     Section 1. All meetings of the stockholders for the election of directors shall be held at such place either within or without the State of Delaware as shall be designated from time to time by the Board of Directors and stated in the notice of the meeting. Meetings of stockholders for any other purpose may be held at such time and place, within or without the State of Delaware, as shall be stated in the notice of the meeting or in a duly executed waiver of notice thereof.
     Section 2. Annual meetings of stockholders, commencing with the year 1996, shall be held at such place, date and hour as shall be fixed by the Board of Directors (the “Board”) and stated in the notice of the meeting, at which the stockholders shall elect a board of directors, and transact such other business as may properly be brought before the meeting shall be held at such place, date and hour as shall be fixed by the Board of Directors (the “Board”) and stated in the notice of the meeting, at which the stockholders shall elect a board of directors, and transact such other business as may properly be brought before the meeting.
     Section 3. Written notice of the annual meeting stating the place, date and hour of the meeting shall be given to each stockholder entitled to vote at such meeting not less than ten (10) nor more than sixty (60) days before the date of the meeting.
     Section 4. The officer who has charge of the stock ledger of the corporation shall prepare and make, or cause a third party to prepare and make, at least ten days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present.
     Section 5. Special meetings of the stockholders, for any purpose or purposes, unless otherwise prescribed by statute or by the certificate of incorporation, may be called by the president and shall be called by the president or secretary at the request in writing of a majority of the Board of Directors, or at the request in writing of

 


 

stockholders owning at least a majority of the entire capital stock of the corporation issued and outstanding and entitled to vote. Such request shall state the purpose or purposes of the proposed meeting
     Section 6. Written notice of a special meeting stating the place, date and hour of the meeting and the purpose or purposes for which the meeting is called, shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting, to each stockholder entitled to vote at such meeting.
     Section 7. Business transacted at any special meeting of stockholders shall be limited to the purposes stated in the notice.
     Section 8. The holders of a majority of the stock issued and outstanding and entitled to vote thereat, present in person or represented by proxy, shall constitute a quorum at all meetings of the stockholders for the transaction of business, except as otherwise provided by statute or by the certificate of incorporation. If, however, such quorum shall not be present or represented at any meeting of the stockholders, the stockholders entitled to vote thereat, present in person or represented by proxy, shall have power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting.
     Section 9. When a quorum is present at any meeting, the vote of the holders of a majority of the stock having voting power present in person or represented by proxy shall decide any question brought before such meeting, unless the question is one upon which by express provision of the statutes or of the certificate of incorporation, a different vote is required, in which case such express provision shall govern and control the decision of such question.
     Section 10. Unless otherwise provided in the certificate of incorporation, each stockholder shall at every meeting of the stockholders be entitled to one vote in person or by proxy for each share of the capital stock having voting power held by such stockholder, but no proxy shall be voted on after three years from its date, unless the proxy provides for a longer period. A proxy shall be deemed signed if the stockholder’s name is placed on the proxy (whether by manual signature, typewriting, telegraphic transmission or otherwise) by the stockholder or the stockholder’s attorney-in-fact. The revocability of a proxy that states on its face that it is irrevocable shall be governed by the provisions of the General corporation Law of Delaware.
     Section 11. Provided the candidate’s name has been placed in nomination prior to the voting and one or more stockholders has given notice at the meeting prior to the voting of the stockholder’s intent to cumulate the stockholder’s votes, every stockholder entitled to vote at any election for directors shall have the right to cumulate such stockholder’s votes and give one candidate a number of votes equal to the number of directors to be elected multiplied by the number of votes to which the stockholder’s shares are normally entitled, or distribute the stockholder’s votes on the same principle among as many candidates as the stockholder shall think fit. The candidates receiving the highest number of votes of the shares entitled to be voted for them up to the number of directors to be elected by such shares are elected.
     Section 12. Unless otherwise provided in the certificate of incorporation, any action required to be taken at any annual or special meeting of stockholders of the corporation, or any action which may be taken at any annual or special meeting of such stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing.
     Section 13. At any meeting of the stockholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before a meeting, business must be:

2


 

(a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors;
(b) otherwise properly brought before the meeting by or at the direction of a majority of the total number of directors which the corporation would have if there were no vacancies (the “Whole Board”); or
(c) otherwise properly be requested to be brought before any meeting by a stockholder.
For business to be properly requested to be brought before any meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the secretary of the corporation. To be timely, a stockholder’s notice must be delivered to or mailed and received at the principal executive offices of the corporation, not less than eighty (80) days prior to the meeting; provided, however, that in the event that the date of the meeting is not publicly announced by the corporation by mail, press release or otherwise more than ninety (90) days prior to the meeting, notice by the stockholder to be timely must be delivered to the secretary of the corporation not later than the close of business on the tenth day following the day on which such announcement of the date of the meeting was communicated to stockholders. A stockholder’s notice to the secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting
(a) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting,
(b) the name and address of the stockholder proposing such business,
(c) a representation that the stockholder is a holder of record of stock of the corporation entitled to vote on such business on the date of such notice and, if applicable, intends to appear in person or by proxy at the meeting to introduce the business specified in the notice;
(d) the class and number of shares of the corporation which are beneficially owned by the stockholder,
(e) such other information regarding each matter of business to be proposed by such stockholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission, had the matter been proposed, or intended to be proposed, by the Board of Directors, and
(f) any material interest of the stockholder in such business. Notwithstanding anything in the bylaws to the contrary, no business shall be conducted at any meeting except in accordance with the procedures set forth in this Section 12 of the bylaws. The chairman of the meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting and in accordance with the provisions of this Section 12 of the bylaws, and if he/she should so determine, he/she shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. Notwithstanding the foregoing provisions of this Section 12, a stockholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder with respect to the matters set forth in this Section 12.
     Section 14. Subject to the rights of holders of any class or series of stock having a preference over the Common Stock as to dividends or upon liquidation, nominations for the election of directors may be made by the Board of Directors or a committee appointed by the Board of Directors or by any stockholder entitled to vote in the election of directors generally. However, any stockholder entitled to vote in the election of directors generally may nominate one or more persons for election as directors at a meeting only if written notice of such stockholder’s intent to make such nomination or nominations has been received by the secretary of the corporation not less than 80 days in advance of such meeting; provided however, that in the event that the date of the meeting was not publicly announced by the corporation by mail, press release or otherwise more than 90 days prior to the meeting, notice by the stockholder to be timely must be delivered to the secretary of the corporation not later than the close of business on the tenth day following the day on which such announcement of the date of the meeting was communicated to stockholders. Each such notice shall set forth:

3


 

(a) The name and address of the stockholder who intends to make the nomination and of the person or persons to be nominated;
(b) A representation that the stockholder is a holder of record of stock of the corporation entitled to vote for the election of directors on the date of such notice and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice;
(c) A description of all arrangements or understandings between the stockholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the stockholder;
(d) Such other information regarding each nominee proposed by such stockholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission, had the nominee been nominated, or intended to be nominated, by the Board of Directors; and
(e) The consent of each nominee to serve as a director of the corporation if so elected.
ARTICLE III
DIRECTORS
     Section 1. The number of directors which shall constitute the whole board shall be eight (8). Each director shall be elected at the annual meeting of the stockholders except as provided in Section 2 of this Article III, and shall hold office until his or her successor is elected and qualified.
     Section 2. Vacancies and newly created directorships resulting from any increase in the authorized number of directors may be filled by a majority of the directors then in office, though less than a quorum, or by a sole remaining director, except that in the event a director is removed by the stockholders for cause, the stockholders shall be entitled to fill the vacancy created as a result of such removal. The directors so chosen shall serve for the remainder of the term of the vacated directorships being filled and until their successors are duly elected and shall qualify, unless sooner displaced. If there are no directors in office, then an election of directors may be held in the manner provided by statute.
     Section 3. The business of the corporation shall be managed by or under the direction of its board of directors, which may exercise all such powers of the corporation and do all such lawful acts and things as are not by statute or by the certificate of incorporation or by these bylaws directed or required to be exercised or done by the stockholders.
MEETINGS OF THE BOARD OF DIRECTORS
     Section 4. The Board of Directors of the corporation may hold meetings, both regular and special, either within or without the State of Delaware.
     Section 5. The first meeting of each newly elected Board of Directors shall be held at such time and place as shall be fixed by the vote of the stockholders at the annual meeting and no notice of such meeting shall be necessary to the newly elected directors in order legally to constitute the meeting, provided a quorum shall be present. In the event of the failure of the stockholders to fix the time or place of such first meeting of the newly elected Board of Directors, or in the event such meeting is not held at the time and place so fixed by the stockholders, the meeting may be held at such time and place as shall be specified in a notice given as hereinafter provided for special meetings of the Board of Directors, or as shall be specified in a written waiver signed by all of the directors.
     Section 6. Regular meetings of the Board of Directors may be held without notice at such time and at such place as shall from time to time be determined by the board.
     Section 7. Special meetings of the board may be called by the president or chairman on five (5) days’ notice to each director by mail or twenty-four (24) hours notice to each director either personally or by telephone,

4


 

telegram or facsimile; special meetings shall be called by the president or secretary in like manner and on like notice on the written request of two directors unless the board consists of only one director, in which case special meetings shall be called by the president or secretary in like manner and on like notice on the written request of the sole director. A written waiver of notice, signed by the person entitled thereto, whether before or after the time of the meeting stated therein, shall be deemed equivalent to notice.
     Section 8. At all meetings of the board a majority of the then existing directors shall constitute a quorum for the transaction of business, and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the Board of Directors, except as may be otherwise specifically provided by statute or by the certificate of incorporation. If a quorum shall not be present at any meeting of the Board of Directors, the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present.
     Section 9. Meetings of the Board of Directors shall be presided over by the chairman of the board, if any, or in his or her absence by the president, or in their absence by a chairman chosen at the meeting. The secretary shall act as secretary of the meeting, but in his or her absence the chairman of the meeting may appoint any person to act as secretary of the meeting. The chairman of any meeting shall determine the order of business and the procedures at the meeting.
     Section 10. Unless otherwise restricted by the certificate of incorporation or these bylaws, any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, if all members of the board or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the board or committee.
     Section 11. Unless otherwise restricted by the certificate of incorporation or these bylaws, members of the Board of Directors, or any committee designated by the Board of Directors, may participate in a meeting of the Board of Directors, or any committee, by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at the meeting.
COMMITTEES OF DIRECTORS
     Section 12. The Board of Directors may, by resolution passed by a majority of the whole board, designate one or more committees, each committee to consist of one or more of the directors of the corporation. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee.
In the absence of disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he/she or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member.
Any such committee, to the extent provided in the resolution of the Board of Directors, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers which may require it; but no such committee shall have the power or authority in reference to amending the certificate of incorporation, adopting an agreement of merger or consolidation, recommending to the stockholders the sale, lease or exchange of all or substantially all of the corporation’s property and assets, recommending to the stockholders a dissolution of the corporation or a revocation of a dissolution, or amending the bylaws of the corporation; and, unless the resolution or the certificate of incorporation expressly so provide, no such committee shall have the power or authority to declare a dividend or to authorize the issuance of stock. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board of Directors.
     Section 13. Each committee shall keep regular minutes of its meetings and report the same to the Board of Directors when required.
COMPENSATION OF DIRECTORS

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     Section 14. Unless otherwise restricted by the certificate of incorporation or these bylaws, the Board of Directors shall have the authority to fix the compensation of directors. Director compensation may include, among other things, payment of their expenses, if any, of attendance at each meeting of the Board of Directors, payment of a fixed sum for attendance at each meeting of the Board of Directors or payment of a stated salary as director. No such payment shall preclude any director from serving the corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings.
REMOVAL OF DIRECTORS
     Section 15. Unless otherwise restricted by the certificate of incorporation or bylaw, any director or the entire Board of Directors may be removed, with or without cause, by the holders of a majority of shares entitled to vote at an election of directors.
ARTICLE IV
NOTICES
     Section 1. Whenever, under the provisions of the statutes or of the certificate of incorporation or of these bylaws, notice is required to be given to any director or stockholder, such notice may be given in writing, by mail, addressed to such director or stockholder, at his address as it appears on the records of the corporation, with postage thereon prepaid, and such notice shall be deemed to be given at the time when the same shall be deposited in the United States mail. An affidavit of the secretary or an assistant secretary or of the transfer agent of the corporation that the notice has been given shall, in the absence of fraud, be prima facie evidence of the facts stated therein. Notice to directors may also be given personally or by telephone or telegram.
     Section 2. Whenever any notice is required to be given under the provisions of the statutes or of the certificate of incorporation or of these bylaws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the stockholders need be specified in any written waiver of notice unless so required by the certificate of incorporation or these bylaws.
ARTICLE V
OFFICERS
     Section 1. The Board of Directors shall designate certain officers of the corporation as executive officers of the corporation, and such executive officers shall include the chairman of the board, if any, and the president, one of whom shall be designated as the chief executive officer, the chief financial officer, and such other officers as the Board of Directors may designate.
The Board of Directors may also create other offices of the corporation that are not designated as executive offices and such non-executive offices may include one or more vice-presidents, a secretary, assistant secretaries, a treasurer, a controller and other assistants to the chief financial officer.
     Section 2. The executive officers of the corporation shall be its members a chairman of the board and one or more vice-chairmen of the board. The non-executive officers of the corporation may be appointed by the Board of Directors or by the chief executive officer. Any number of offices may be held by the same person, unless the certificate of incorporation or these bylaws otherwise provide.

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     Section 3. The Board of Directors at its first meeting after each annual meeting of stockholders shall choose a president or chief executive officer, a chief financial officer and such other executive officers as the board may elect.
     Section 4. With respect to the non-executive offices established by the Board of Directors, the Board of Directors or, if so delegated by the chief executive officer may appoint such other non-executive officers, who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board of Directors or by the president.
     Section 5. The compensation of all the executive officers of the corporation shall be fixed by the Board of Directors, and the salaries of all the non-executive officers of the corporation shall be fixed by the Board of Directors or, if so delegated by the Board, the chief executive officer.
     Section 6. The officers of the corporation shall hold office until their successors are duly elected and qualified. Any officer elected or appointed by the Board of Directors may be removed at any time by the affirmative vote of a majority of the Board of Directors. Any non- executive officer appointed by the chief executive officer may be removed at any time by such person. Any vacancy occurring in any office of the corporation appointed by the Board of Directors shall be filled by the Board of Directors, and any vacancy occurring in any non- executive office of the corporation appointed by the chief executive officer shall be filled by the Board of Directors or by the chief executive officer.
THE CHAIRMAN OF THE BOARD
     Section 7. The chairman of the board, if any, shall preside at all meetings of the Board of Directors and of the stockholders at which he/she shall be present. He/she shall have and may exercise such powers as are, from time to time, assigned to him by the Board and as may be provided by law.
     Section 8. In the absence of the chairman of the board, the vice-chairman of the board, if any, shall preside at all meetings of the Board of Directors and of the stockholders at which he/she shall be present. He/she shall have and may exercise such powers as are, from time to time, assigned to him by the and as may be provided by law.
THE PRESIDENT AND VICE-PRESIDENT
     Section 9. The president shall be the chief executive officer of the corporation; and in the absence of the chairman and vice-chairman of the board, he/she shall preside at all meetings of the stockholders and the Board of Directors; he/she shall have general and active management of the business of the corporation and shall see that all orders and resolutions of the Board of Directors are carried into effect.
     Section 10. The president or any vice-president shall execute bonds, mortgages and other contracts requiring a seal, under the seal of the corporation, except where required or permitted by law to be otherwise signed and executed and except where the signing and execution thereof shall be expressly delegated by the Board of Directors to some other officer or agent of the corporation.
     Section 11. In the absence of the president or in the event of his inability or refusal to act, the vice-president, if any, (or in the event there be more than one vice-president, the vice-presidents in the order designated by the directors, or in the absence of any designation, then in the order of their election) shall perform the duties of the president, and when so acting, shall have all the powers of and be subject to all the restrictions upon the president. The vice- presidents shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe.
THE SECRETARY AND ASSISTANT SECRETARY
     Section 12. The secretary shall attend all meetings of the Board of Directors and all meetings of the stockholders and record all the proceedings of the meetings of the corporation and of the Board of Directors in a book to be kept for that purpose and shall perform like duties for the standing committees when required. He/she shall give, or cause to be given, notice of all meetings of the stockholders and special meetings of the Board of Directors, and shall

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perform such other duties as may be prescribed by the Board of Directors or president, under whose supervision he/she shall be. He/she shall have custody of the corporate seal of the corporation and he, or an assistant secretary, shall have authority to affix the same to any instrument requiring it and when so affixed, it may be attested by his signature or by the signature of such assistant secretary. The Board of Directors may give general authority to any other officer to affix the seal of the corporation and to attest the affixing by his signature.
     Section 13. The assistant secretary, or if there be more than one, the assistant secretaries in the order determined by the Board of Directors (or if there be no such determination, then in the order of their election) shall, in the absence of the secretary or in the event of his inability or refusal to act, perform the duties and exercise the powers of the secretary and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe.
THE CHIEF FINANCIAL OFFICER
     Section 14. The chief financial officer shall keep and maintain, or cause to be kept and maintained, adequate and correct books and records of accounts of the properties and business transactions of the corporation, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital, retained earnings and shares. The books of account shall at all reasonable times be open to inspection by any director.
     Section 15. The chief financial officer shall deposit all money and other valuables in the name and to the credit of the corporation with such depositaries as may be designated by the Board of Directors. He/she shall disburse the funds of the corporation as may be ordered by the Board of Directors, shall render to the president and directors, whenever they request it, an account of all of his transactions as chief financial officer and of the financial condition of the corporation, and shall have such other powers and perform such other duties as may be prescribed by the Board of Directors or these bylaws.
     Section 16. If required by the Board of Directors, the chief financial officer shall give the corporation a bond (which shall be renewed every six years) in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his office and for the restoration to the corporation, in case of his death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the corporation.
     Section 17. The treasurer, controller and the other assistants to the chief financial officer in the order determined by the Board of Directors or the chief executive officer (or if there be no such determinations then in the order of their election) shall, in the absence of the chief financial officer or in the event of his inability or refusal to act, perform the duties and exercise the powers of the chief financial officer and shall perform such other duties and have such other powers as the Board of Directors or the chief executive officer may from time to time prescribe.
ARTICLE VI
CERTIFICATE OF STOCK
     Section 1. Every holder of stock in the corporation shall be entitled to have a certificate, signed by, or in the name of the corporation by, the chairman or vice-chairman of the Board of Directors, or the president or a vice-president and the treasurer or an assistant treasurer, or the secretary or an assistant secretary of the corporation, certifying the number of shares owned by him in the corporation.
Certificates may be issued for partly paid shares and in such case upon the face or back of the certificates issued to represent any such partly paid shares, the total amount of the consideration to be paid therefor, and the amount paid thereon shall be specified.
If the corporation shall be authorized to issue more than one class of stock or more than one series of any class, the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock or series thereof and the qualification, limitations or restrictions of such preferences and/or rights shall be set forth in full or summarized on the face or back of the certificate which the corporation shall issue to represent such class or series of stock, provided that, except as otherwise provided in section 202 of the General Corporation Law of Delaware, in lieu

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of the foregoing requirements, there may be set forth on the face or back of the certificate which the corporation shall issue to represent such class or series of stock, a statement that the corporation will furnish without charge to each stockholder who so requests the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights.
     Section 2. Any of or all the signatures on the certificate may be facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if he/she were such officer, transfer agent or registrar at the date of issue.
LOST CERTIFICATES
     Section 3. The Board of Directors may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of a new certificate or certificates, the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or certificates, or his legal representative, to advertise the same in such manner as it shall require and/or to give the corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the corporation with respect to the certificate alleged to have been lost, stolen or destroyed.
TRANSFER OF STOCK
     Section 4. Upon surrender to the corporation or the transfer agent of the corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignation or authority to transfer, it shall be the duty of the corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books.
FIXING RECORD DATE
     Section 5. In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which shall not be more than sixty nor less than ten days before the date of such meeting, nor more than sixty days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting: provided, however, that the Board of Directors may fix a new record date for the adjourned meeting.
REGISTERED STOCKHOLDERS
     Section 6. The corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and to hold liable for calls and assessments a person registered on its books as the owner of shares and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware.
ARTICLE VII
GENERAL PROVISIONS
DIVIDENDS
     Section 1. Dividends upon the capital stock of the corporation, subject to the provisions of the certificate of incorporation, if any, may be declared by the Board of Directors at any regular or special meeting,

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pursuant to law. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the certificate of incorporation.
     Section 2. Before payment of any dividend, there may be set aside out of any funds of the corporation available for dividends such sum or sums as the directors from time to time, in their absolute discretion, think proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the corporation, or for such other purposes as the directors shall think conducive to the interest of the corporation, and the directors may modify or abolish any such reserve in the manner in which it was created.
CHECKS
     Section 3. All checks or demands for money and notes of the corporation shall be signed by such officer or officers or such other person or persons as the Board of Directors may from time to time designate.
FISCAL YEAR
     Section 4. The fiscal year of the corporation shall be fixed by resolution of the Board of Directors.
SEAL
     Section 5. The Board of Directors may adopt a corporate seal having inscribed thereon the name of the corporation, the year of its organization and the words “Corporate Seal, Delaware”. The seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise.
INDEMNIFICATION
     Section 6. The corporation shall indemnify its officers and directors to the full extent and in the manner permitted by the General Corporation Law of Delaware against expenses (including attorneys’ fees), judgements, fines, settlements and other amounts actually and reasonably incurred in connection with any proceeding arising by reason of the fact such person is or was an agent of the corporation. Reasonable expenses incurred by a director or officer of the corporation in defending a civil or criminal action, suit or proceeding by reason of the fact that he/she is or was a director or officer of the corporation (or was serving at the corporation’s request as a director or officer of another corporation, partnership, joint venture, trust or other enterprise) shall be paid by the corporation in advance of the final disposition of such action, suit or proceeding upon receipt of a statement from such director or officer requesting such advance and an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that he/she is not entitled to be indemnified by the corporation as authorized by relevant sections of the General Corporation Law of Delaware.
The corporation shall have the power, to the extent and in the manner permitted by the General Corporation Law of Delaware, to indemnify each of its employees and agents (in addition to directors and officers) against expenses (including attorneys’ fees), judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding, arising by reason of the fact that such person is or was an agent of the corporation. For purposes of this Section, an “employee” or “agent” of the corporation includes any person (i) who is or was an employee or agent of the corporation, or (ii) who is or was serving at the request of the corporation as an employee or agent of another corporation, partnership, joint venture, trust or other enterprise.
A director of the corporation shall not be personally liable to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director’s duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law, or (iv) for any transaction from which the director derived any improper personal benefit. If the Delaware General Corporation Law is hereafter amended to authorize, with the approval of a corporation’s stockholders, further reductions in the liability of the corporation’s directors for breach of fiduciary duty, then a director of the corporation shall not be liable for any such breach to the fullest extent permitted by the Delaware General Corporation Law as so amended. Any repeal or modification of the foregoing provisions of this Article VII, Section 6 by the stockholders of the corporation shall not

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adversely affect any right or protection of a director of the corporation existing at the time of such repeal or modification.
The corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the corporation would have the power to indemnify him against such liability under the provisions of the General Corporation Law of Delaware.
The foregoing rights of indemnification shall not be deemed exclusive of any other rights to which any director or officer may be entitled apart from the provisions of this Article VII.
CORPORATION STOCKHOLDINGS
     Section 7. The chairman of the board, the president, the chief financial officer, or any other person authorized by the Board of Director is authorized to vote, represent, and exercise on behalf of this corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of this corporation. The authority granted herein may be exercised either by such person directly or by any other person authorized to do so by proxy or power of attorney duly executed by such person having the authority.
ARTICLE VIII
AMENDMENTS
     Section 1. These bylaws may be altered, amended or repealed or new bylaws may be adopted by the stockholders or by the Board of Directors, when such power is conferred upon the Board of Directors by the certificate of incorporation, at any regular meeting of the stockholders or of the Board of Directors or at any special meeting of the stockholders or of the Board of Directors if notice of such alteration, amendment, repeal or adoption of new bylaws be contained in the notice of such special meeting. If the power to adopt, amend or repeal bylaws is conferred upon the Board of Directors by the certificate of incorporation, it shall not divest or limit the power of the stockholders to adopt, amend or repeal bylaws.

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EX-10.46 3 f18180exv10w46.htm EXHIBIT 10.46 exv10w46
 

EXHIBIT 10.46
Guarantee Agreement
December 16, 2005
SanDisk Corporation
IBJ Leasing Co., Ltd.
Sumisho Lease Co., Ltd.
Toshiba Finance Corporation

 


 

Guarantee Agreement
     SanDisk Corporation (the “Guarantor”) and IBJ Leasing Co., Ltd., Sumisho Lease Co., Ltd., and Toshiba Finance Corporation as SD Lessor thereunder (in such capacity, collectively, the “SD Lessors”) hereby enter into this guarantee agreement (the “Agreement”) with respect to the Master Lease Agreement dated December 16, 2005 and individual agreements thereunder (collectively, the “Lease Agreement”) by and between the SD Lessors and IBJ Leasing Co., Ltd. and Sumisho Lease Co., Ltd. as Toshiba Lessor thereunder (in such capacity, collectively, the “Toshiba Lessors”) and Flash Partners Yugen Kaisha (the “Lessee”).
     Unless as otherwise specified in this Agreement, the words defined in the Lease Agreement shall have the same meaning in this Agreement.
Article 1. (Guarantee)
     The Guarantor shall guarantee the performance, from time to time, of the obligations subject to the guarantee below (the “Guaranteed Obligation”) to the SD Lessors, jointly and severally (rentai-hosho) with the Lessee (the “Guarantee”).
(Guaranteed Obligation)
     Guaranteed Obligation shall mean payment obligations of lease (lease-ryo), stipulated loss payment (kitei-songaikin), purchase option exercise price (konyu-sentakuken-koshikagaku), terminal return adjustment amount (henkanji-choseikin), break funding cost, late charges (chien-songaikin), and any and all payment obligations of other amounts concerning SD Tranche I and SD Tranche II in individual transactions pursuant to the Lease Agreement; provided that the Guarantor and the SD Lessors may consult in the event of any doubt concerning “other amounts” as mentioned above.
     In any event, the Guarantor shall not pay any obligation concerning Toshiba Tranche 1 and Toshiba Tranche 2.
Article 2. (Period of Request for the Performance of Guarantee Obligation)
     In the event the SD Lessors request the performance of the Guarantee to the Guarantor, the SD Lessors shall make a written demand to the Guarantor requesting the performance of the Guaranteed Obligation which the Lessee fails to duly and punctually perform. The SD Lessors may, upon each failure of due and punctual performance of the Guaranteed Obligation, make a request pursuant to this Article; provided that the delay in making such request will not exempt the Guarantor from the obligations under the Guarantee.
Article 3. (Performance of Guaranteed Obligation)
     3.1 The Guarantor shall, in the event the Lessee fails to perform all or any part of its obligations under the Guaranteed Obligation within 10 business days from each due date, perform the Guarantee in favor of the SD Lessors within 20 business days from the receipt of the written demand from the SD Lessors.

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     3.2 If there is any Guaranteed Obligation in the event of a termination event (kaijo-jiyu) under the Lease Agreement, the Guarantor shall perform the Guarantee within 20 business days from the arrival of the written demand from the SD Lessors.
     3.3 In the event a termination event under the Lease Agreement occurs, the Guarantor may, pursuant to Article 26, Paragraph 8 or Article 26, Paragraph 9 of the Lease Agreement, succeed the rights, obligations and legal title of the Lessee under the Lease Agreement or the rights, obligations and legal title of Other Guarantor (defined below) under the guarantee agreement dated the same date hereof by and between the Toshiba Corporation (the “Other Guarantor”) and the Toshiba Lessors whereupon such termination event is cured.
     3.4 The Guarantor may not exercise the right of subrogation, prior indemnity and post indemnity with respect to the Guarantee against the Lessee until any and all receivables of the SD Lessors and Toshiba Lessors against the Lessee have been paid in full.
Article 4. (Relationship with Other Security Rights)
     4.1 The guarantee under this Agreement shall be granted in addition to other security interests or guarantees held by the SD Lessors in connection with the Guaranteed Obligation, and the effectiveness of such other securities or guarantees shall not be affected by the security interests pursuant to this Agreement.
     4.2 The Guarantor shall not claim the exemption even if the SD Lessors, at its reasonable discretion, alter or terminate other security interests or guarantees securing the Guaranteed Obligations, provided, however, that the SD Lessors shall give at least fifteen (15) days prior notice to the Guarantor in case of such alteration or termination unless the same is contemplated by the Related Agreements (honken-kanren-keiyaku).
Article 5. (Transfer of Rights and Obligations)
     The SD Lessors and the Guarantor shall not, without obtaining prior written consent of the other party, transfer or pledge the rights and obligations under this Agreement to any third party, provided, however, this Article shall not prohibit any assignment by the Guarantor to the persons who acquire all or substantial part of assets, business and shares in the Guarantor by means of sale, merger, acquisition or other alteration in management rights. In addition, in each individual transaction, (i) pursuant to the SD Receivables Sale and Purchase Agreement (Honken-SD-Saiken-Baibai-Keiyaku), the SD Lessors may transfer the right to require the performance of the Guaranteed Obligation with respect to SD Tranche I hereunder to the SD Borrower (Honken-SD-Kariirenin) and (ii) pursuant to the SD Receivables Security Assignment Agreement (Honken-SD-Saiken-Joto-Tampo-Keiyaku), the SD Borrower may transfer the right to require the performance of the Guaranteed Obligation with respect to SD Tranche I hereunder to the SD Lenders (Honken-SD-Kashitsukenin). The Guarantor hereby grants prior consent to such transfers and agrees to cooperate with the SD Lessors in preparing and delivering the documents requested by the SD Lessors.

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Article 6. (Limited Recourse)
     Limitation of liability by the limited recourse pursuant to Article 29, Paragraph 1 of the Lease Agreement shall not intervene the exercise of the rights of the SD Lessors against the Guarantor pursuant to this Agreement, nor shall the provisions thereof affect the performance of the guarantee obligations pursuant to this Agreement
Article 7. (Modification of the Agreement)
     This Agreement may not be modified except with the written consent of the Guarantor, the SD Lessors and the Toshiba Lessors.
Article 8. (Governing Law)
     This Agreement shall be governed by, and construed in accordance with, the laws of Japan in every respect.
Article 9. (Jurisdiction)
     Any and all disputes arising out of or in connection with this Agreement shall be subject to the exclusive jurisdiction of the Tokyo District Court.
     This Guarantee Agreement shall be prepared in four counterparts and the Guarantor and the SD Lessors shall each retain one copy hereof.
December 16, 2005
         
  [Guarantee Agreement]
Guarantor: SanDisk Corporation


 
  /s/ Eli Harari  
  By: Eli Harari   
  Title:   Chief Executive Officer   
 
 
  [Guarantee Agreement]
SD Lessor: IBJ Leasing Co., Ltd.


 
  /s/ IBJ Leasing Co., Ltd.  
  By:    
  Title:      
 

4


 

         
  [Guarantee Agreement]
SD Lessor: Sumisho Lease Co., Ltd.


 
  /s/ Sumisho Lease Co., Ltd.  
  By:    
  Title:      
 
 
  [Guarantee Agreement]
SD Lessor: Toshiba Finance Corporation


 
  /s/ Toshiba Finance Corporation  
  By:    
  Title:      
 

5

EX-10.47 4 f18180exv10w47.htm EXHIBIT 10.47 exv10w47
 

EXHIBIT 10.47
FOIA Confidential Treatment Requested
[Signature Copy]
Basic Lease Contract
Flash memory manufacturing equipment
December 16, 2005
I  B  J     L  e  a  s  i  n  g    C  o  .  ,    L   t  d  .
S  u  m  i  s  h  o    L  e  a  s  e    C  o  .  ,    L  t  d  .
T  o  s  h  i  b  a    F  i  n  a  n  c  e    C  o  .  ,    L  t  d  .
SD Lessor
I  B  J    L  e  a  s  i  n  g    C  o  .  ,    L  t  d  .
S  u  m  i  s  h  o    L  e  a  s  e    C  o  .  ,    L  t  d  .
Toshiba Lessor

 


 

Flash Partners Limited Company
Lessee
Table of Contents
             
        Page
Article 1
  (Definitions)     1  
Article 2
  (Composition of transactions)     9  
Article 3
  (Lease)     10  
Article 4
  (Delivery)     10  
Article 5
  (Prior conditions regarding delivery)     11  
Article 6
  (Related documents)     12  
Article 7
  (Payment of lease payment etc.)     12  
Article 8
  (Defective security indemnity)     15  
Article 9
  (Burden for loss, damage and danger)     16  
Article 10
  (Representation of owner)     18  
Article 11
  (Peaceful use)     18  
Article 12
  (Installation and use)     18  
Article 13
  (Possession and re-leasing)     18  
Article 14
  (Maintenance management)     19  
Article 15
  (Change in original condition)     20  
Article 16
  (Ownership of parts)     20  
Article 17
  (Inspection)     20  
Article 18
  (Burden etc.)     21  
Article 19
  (Insurance)     21  
Article 20
  (Representation and warranty)     22  
Article 21
  (Commitment matters)     23  
Article 22
  (Compensation and burden of expense)     25  
Article 23
  (Number of individual transactions and change of deliverable period)     26  
Article 24
  (Purchase option right)     27  
Article 25
  (Return)     28  
Article 26
  (Termination of contract)     30  
Article 27
  (Default interest)     33  
Article 28
  (Transfer of rights and obligations)     33  
Article 29
  (Responsible assets)     34  
Article 30
  (Notice etc.)     36  
Article 31
  (Revision of contract)     36  

 


 

             
        Page
Article 32
  (Confidentiality)     36  
Article 33
  (Governing law)     36  
Article 34
  (Court of competent jurisdiction)     37  
     
Appendix 1
  Lease Conditions
Appendix 2
  Loan Certificate
Appendix 3
  Permitted Liens
Appendix 4
  Certificate of Return
Appendix 5
  Certificate of Transfer
Appendix 6
  Situation requirements at the time of return
Appendix 7
  Notification address

 


 

Basic Lease Contract
This basic lease contract was concluded on December 16, 2005 between IBJ Leasing Co., Ltd., Sumisho Lease Co., Ltd. and Toshiba Finance Co., Ltd. as SD Lessor (hereinafter generically named as “SD Lessor”), IBJ Leasing Co., Ltd. and Sumisho Lease Co., Ltd. as Toshiba Lessor (hereinafter generically named as “Toshiba Lessor”, and it is combined with SD Lessor. They are generically named as “Lessor”), and Flash Partners Limited Company (hereinafter referred to as “Lessee”).
Article 1 (Definitions)
  1   Terms in the left column below that are used in this contact shall have meanings listed in the right column below corresponding to the relevant terms except where they apparently represent different contextual meanings.
     
SD Group Companies
  San Disk Corporation and companies San Disk Corporation directly or indirectly owns 50% or more of their voting stocks
 
   
SD Lessor RA
  Sumisho Lease Co., Ltd. acting on behalf of SD Lessor with respect to common portions of SD Lessor at the time of return, sale and other forms of disposition of Subject property pursuant to the provision of Article 4 of Subject Statement of Mutual Agreement among Involved Parties, or acting on behalf of the SD Lender with respect to the Property or the common portions of the SD Lessor.
 
   
Reason for cancellation
  All or part of reasons stipulated in Article 26, Item 1
 
   
Loan certificate
  Loan certificate for subject properties for respective individual transaction to be prepared in the form provided in Appendix 2 based on Article 4, Item 5
 
   
Prescribed damages
  Amounts to be calculated for each Tranche on a certain day based on Appendix 1, Item 9
 
   
Taxes and public dues
  Present or future tax, levy, tax collected at the source, fees, handling fees, burden charges as well as other monies (regardless of their names) and penalty charges, foul charges, additional charges, delayed charges and delayed interest thereon (regardless of their names)

 


 

     
 
   
Banking Business Day
  Days on which banks operate in Japan
 
   
Purchase option exercise cost
  Amounts to be calculated on each Tranche on a payment day based on Appendix 1, Item 6
 
   
Individual transaction
  Each individual transaction to be conducted based on this contract and each loan certificate
 
   
Original purchase agreement
  Each purchase agreement concluded between the Lessee and the manufacturer of properties on the purchase of Subject properties
 
   
Sub lessee
  Persons who are sub-leased based on the regulations of Article 13
 
   
Repayment base money
  Amounts to be calculated based on Appendix 1, Item 8 for the day of return stipulated in Article 25, Item 1
 
   
Performance, etc.
  Performance, structure, design, design specification, practical value, exchange value, usability, sales possibility, commercial value, durability, operability, economical efficiency, compatibility with purpose, legality and any other performance, function, characteristics, value and utility of Subject properties
 
   
Reason for total loss
  (a) Loss or missing location, (b) damage or glitch reasonably recognized by the Lessee as impossible to repair or re-use from an economic viewpoint, which is confirmed by the appraisal company appointed by the Lessor or (c) confiscation, expropriation or theft occurred to Subject property, its unit component part or Subject property composing unit component part
 
   
Loss, etc.
  Losses, damages, costs, fees, handling fees, liabilities, responsibilities, penal charges, penalty, delinquency charges, complaints and judicial actions

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Unit component part
  A set of each property (including the Subject parts fixed or furnished in the relevant properties) to be independently listed in the loan certificate of Subject property. Provided, however, that when a part of the unit component part subject to the relevant Individual transaction is excluded from this contract, the remaining unit component part shall compose the unit component part subject to the relevant Individual transaction thereafter.
 
   
Toshiba Lessor RA
  Sumisho Lease Co., Ltd. acting on behalf of Toshiba Lessor with respect to common portions of Toshiba Lessor at the time of return, sale and other forms of disposition of Subject property pursuant to the provision of Article 4 of Subject Statement of Mutual Agreement among Involved Parties, or acting on behalf of the SD Lender with respect to the Property or the common portions of the SD Lessor.
 
   
Toshiba group companies
  Toshiba Corporation and companies Toshiba Corporation directly or indirectly owns 50% or more of their voting shares
 
   
Tranche
  Collective term for SD Tranche 1, SD Tranche 2, Toshiba Tranche 1 and Toshiba Tranche 2 composed with respect to lease payment or other claimable assets under this contract pursuant to Article 7, Item 1.
 
   
Delivery period
  Period from the day of this contract to the final deliverable day stipulated in Appendix 1, Item 1
 
   
Delivery place
  Place where Subject property or each unit component part exists on the relevant scheduled delivery day to be notified by the Lessee to the Lessor by a Banking Business Day immediately prior to each scheduled delivery day
 
   
Deliver day
  Each day on which each unit component part composing Subject property is delivered based on Article 4

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Scheduled delivery day
  Each day stipulated in Appendix 1, Item 1 as a scheduled delivery day for each Individual transaction or other banking business days during the delivery period to be agreed upon by the Lessee and the Lessor
 
   
Person to be compensated
  Lessor, Subject borrower, Subject lender and all or either of the successor thereto, director, employee or agent
 
   
Burden etc.
  Ownership, right of possession, lease right, lease, mortgage, right of pledge, lien, security interests, right of mortgage and conditional rights thereto, subscription rights thereto, any other usufructuary right as well as security right and rights based on attachment or provisional attachment
 
   
Property purchase cost
  Sales cost to be determined pursuant to Article 3, Item 1 of the Subject Sales Contract with respect to Subject property or each unit component part
 
   
Property manufacturing agency
  A person described in the column of “manufacturer” of the itemized property list to be attached in a loan certificate
 
   
Default reason
  Reason for cancellation or reasons constituting reasons for cancellation due to notification, passing of time or other conditions
 
   
Break funding cost
  Damages or expenses to be borne with respect to raising of purchase cost for Subject property when each Lessor fails to implement or terminates this contract before expiration. The cost shall be calculated as damage cost, penal charge or other monies (provided, however, that if Lessee has doubts about other monies, Lessor, Lessee and Subject Lender shall have consultations thereon) imposed by Subject lender on Subject borrower with respect to non-performance of loans or prepayment, etc. based on the Subject Loan Agreement.
 
   
Reimbursement adjustment fee
  Amounts to be calculated about the day of return stipulated in Article 25, Item 1 pursuant to Appendix 1, Item 7

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Subject lender
  Collectively means Subject SD lender and Subject Toshiba lender.
 
   
Subject SD lender
  Collectively means persons listed as Subject SD lender in Appendix 1, Item 11
 
   
Subject Toshiba lender
  Persons listed as Subject Toshiba lender in Appendix 1, Item 11
 
   
Subject Loan Agreement
  Collectively means Subject SD Loan Agreement and Subject Toshiba Loan Agreement
 
   
Subject SD Loan Agreement
  Collectively means Limited Loan Agreement (SD Tranche) to be concluded between Subject SD borrower and Subject SD lender as of the same date as this Contract and Acknowledgement of debts and Repayment Agreement based on Limited Loan Agreement.
 
   
Subject Toshiba Loan Agreement
  Collectively means Limited Loan Agreement (Toshiba Tranche) to be concluded between Subject Toshiba borrower and Subject Toshiba lender as of the same date as this Contract and Acknowledgment of debts and Repayment Agreement based on Limited Loan Agreement.
 
   
Subject borrower
  Collectively means Subject SD borrower and Subject Toshiba borrower.
 
   
Subject SD borrower
  Persons listed as Subject SD borrower in Appendix 1, Item 12
 
   
Subject Toshiba borrower
  Persons listed as Subject Toshiba borrower in Appendix 1, Item 12
 
   
Subject Statement of Mutual Agreement among Involved Parties
  Agreement on senior or subordinated relations, etc. among Subject lender, Lessor and Subject borrower as of the same date as this Contract

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Subject related contracts
  This Contract, Subject Sales Contract, Subject Loan Sales Contract, Subject Statement of Mutual Agreement among Involved Parties, Subject Loan Agreement, Subject Loan Transfer Security Contract, Subject property transfer security reservation contract, Subject Contract of Clerical Work Commission, Subject Guarantee Agreement, Subject Letter of Agreement and agreements and other documents related thereto
 
   
Subject Loan Transfer Security Contract
  Collectively means Subject SD Loan Transfer Security Contract and Subject Toshiba Loan Transfer Security Contract.
 
   
Subject SD Loan Transfer Security Contract
  Collectively means Basic Loan Transfer Security Contract (SD Tranche) on the Right to claim performance of obligations of guarantee for (i) credits with respect to SD Tranche 1 under this Contract and (ii) credits with respect to SD Tranche 1 under this Contract under Subject SD Guarantee Agreement to be concluded between Subject SD borrower and Subject SD lender as of the same date as this Contract and each individual agreement based thereon.
 
   
Subject Toshiba Loan Transfer Security Contract
  Collectively means Basic Loan Transfer Security Contract (Toshiba Tranche) on the Right to claim performance of obligations of guarantee for (i) credits with respect to Toshiba Tranche 1 under this Contract and (ii) credits with respect to Toshiba Tranche 1 under Subject Toshiba Guarantee Agreement to be concluded between Subject Toshiba borrower and Subject Toshiba lender as of the same date as this Contract and each individual agreement based thereon.
 
   
Subject Loan Sales Contract
  Collectively means Subject SD Loan Sales Contract and Subject Toshiba Loan Sales Contract

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Subject SD Loan Sales Contract
  Collectively means Basic Lease Credit Sales Contract (SD Tranche) on the Right to claim performance of obligations of guarantee for (i) credits with respect to SD Tranche 1 under this Contract and (ii) credits with respect to SD Tranche 1 under Subject SD Guarantee Agreement to be concluded between SD Lessor and Subject SD borrower as of the same date as this Contract and each individual agreement based thereon.
 
   
Subject Toshiba Loan Sales Contract
  Collectively means Basic Lease Credit Sales Contract (Toshiba Tranche) on the Right to claim performance of obligations of guarantee for (i) credits with respect to Toshiba Tranche 1 under this Contract and (ii) credits with respect to Toshiba Tranche 1 under Subject Toshiba Guarantee Agreement to be concluded between Toshiba Lessor and Subject Toshiba borrower as of the same date as this Contract and each individual agreement based thereon.
 
   
Subject Contract of Clerical Work Commission
  Collectively means the Subject SD Contract of Clerical Work Commission and the Subject Toshiba Contract of Clerical Work Commission
 
   
Subject SD Contract of Clerical Work Commission
  Contract of Clerical Work Commission (SD Tranche) to be concluded between the SD Lessor and the Subject Clerical Work Assignee as of the same date as this contract
 
   
Subject Toshiba Contract of Clerical Work Commission
  Contract of Clerical Work Commission (Toshiba Tranche) to be concluded between Toshiba Lessor and Subject Clerical Work Assignee as of the same date as this contract
 
   
Subject Clerical Work Assignee
  Persons described in Appendix 1, Item 14

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Subject Letter of Agreement
  Letter of consent by Subject guarantor and Lessee in a specified form with respect to transfer of receivables based on each Subject Loan Transfer Security Contract and establishment of transfer security reservation completion right based on Subject property transfer security reservation contract
 
   
Subject Sales Contract
  Collectively means Basic Sales Contract on Subject property to be concluded between Lessee and Lessor as of the same date as this Contract and each individual agreement based thereon.
 
   
Subject property
  Each unit component part (including Subject parts) in each Individual transaction to be notified by Lessee to Lessor pursuant to Article 4, Item 1 of the Subject Sales Contract and to be confirmed by certificate of transfer, receipt and loan certificate to be delivered on the delivery day for the relevant Individual transaction. Provided, however, that if a part of unit component part is excluded from this Contract due to occurrence of reasons for all-loss and the exercise of the purchase selection right, the remaining unit component part shall be Subject property thereafter.
 
   
Subject property transfer security reservation contract
  Collectively means the Basic Property Transfer Security Reservation Contract for Subject property to be concluded between the Lessor and the Subject lender as of the same date as this contract and individual contracts pursuant thereto
 
   
Subject parts
  Equipment and parts composing unit component part as well as equipment, accessories, attachments and parts (including aggregates of single parts and similar kinds) fixed or furnished as needed with Subject property
 
   
Subject Guarantee Agreement
  Collectively means Subject SD Guarantee Agreement and Subject Toshiba Guarantee Agreement.
 
   
Subject SD Guarantee Agreement
  Guarantee Agreement to be concluded between SanDisk and SD Lessor as of the same date as this contract

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Subject Toshiba Guarantee Agreement
  Guarantee Agreement to be concluded between Toshiba and Toshiba Lessor as of the same date as this contract
 
   
Subject guarantor
  Collectively means SanDisk and Toshiba.
 
   
SanDisk
  Persons described as SanDisk in Appendix 1, Item 13.
 
   
Toshiba
  Persons described as Toshiba in Appendix 1, Item 13
 
   
Waived burdens, etc.
  Burdens, etc. excluded pursuant to Article 18, Item 1
 
   
Lease period
  A period starting on a delivery day stipulated in Appendix 1, Item 2. Provided, however, that if this contract is cancelled before expiration, lease period shall terminate on the relevant cancellation day.
 
   
Lease period expiration period
  The last day of Lease period
 
   
lease payment
  Lease payment to be determined for each unit component part of each Tranche based on Appendix 1, Item 3
 
   
lease payment calculation period
  A period stipulated in Appendix 1, Item 5
 
   
lease payment day
  A day stipulated in Appendix 1, Item 4
  2   In the event of quoting other agreements and documents in this Contract, if the relevant agreements and documents were revised, added or changed after the Contract was initially concluded, they shall mean the relevant agreements and documents after they were revised, added or changed.
 
  3   In the event of quoting provisions in this Contract, they shall mean, unless otherwise specially designated, the provisions of this Contract.
 
  4   In the event of referring to parties to Subject related contracts in this Contract, they shall include their successors and accredited transferees (assignees) as well.
Article 2 (Composition of transactions)
  1   Lessee and Lessor confirm that transactions listed in Appendix 1, Item 15 are planned on Subject property and they are inextricably linked with each other.
 
  2   Lessee confirms that Lessor has the ownership of Subject property during the Lease period under this Contract.

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Article 3 (Lease)
  1   Lessor shall be delivered each unit component part composing Subject property from Lessee on each delivery day based on the Subject Sales Contract and shall lease the relevant unit component part to Lessee pursuant to the provision of this Contract while Lessee shall be leased the relevant lease from Lessor.
 
  2   Lease of Subject property and each unit component part under this Contract shall exist in each Individual transaction for each Lease period and it shall reckon from the day of delivery of each loan certificate pursuant to Article 4, Item 5. Except where explicitly provided, lease of Subject property shall not be cancelled nor caused to be terminated before each Lease period expiration period.
 
  3   Lessee shall pay lease payment pursuant to Article 7, Item 2 as a price of lease under this Contract.
 
  4   Lessee shall have the right to quietly use Subject property pursuant to Article 11 or other provisions of this Contract.
Article 4 (Delivery)
  1   Lessee shall designate a scheduled day of delivery of each unit component part composing Subject property to Lessor pursuant to Appendix 1, Item 1.
 
  2   Lessor shall deliver the relevant unit component part to Lessee on the same day and at the same place for leasing under the preceding Article on condition that terms and conditions stipulated in Article 5 be satisfied and each unit component part be delivered from Lessee on the scheduled day of delivery and at the delivery place pursuant to Subject Sales Contract, and the relevant part shall be delivered to Lessee from Lessor.
 
  3   In the case where change of each scheduled delivery day becomes necessary, Lessee shall notify Lessor to that effect as soon as possible (at the latest by 5 Banking Business Days before). Lessee and Lessor shall agree on respective amount of lease payment, purchase option exercise cost, reimbursement adjustment fee, repayment standard amount and prescribed damages in each Individual transaction based on the actual property purchase price of and delivery day for subject unit component part. In such cases, the agreed amount of lease payment, purchase option exercise cost, reimbursement adjustment fee, repayment standard amount and Prescribed damages shall be filled in documents together with the actual property purchase price and delivery day and be attached to each loan certificate in the form specified in Appendix 2.
 
  4   Lessee shall bear the cost and liabilities (including Break funding cost. When Lessee bears the responsibility to pay Break funding cost under this Contract, Lessee shall pay the amount calculated based on the definition stipulated in Article 1 for both SD Tranche

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      1 and Toshiba Tranche 1. Provided, however, that if respective amounts of and payment times for SD Tranche 1 and Toshiba Tranche 1 are different, they shall be appropriately adjusted. Hereinafter the same in this Contract) caused by change or delay in each scheduled delivery day or inability (excluding cases attributable to Lessor).
 
  5   Lessee shall prepare and deliver to Lessor a loan certificate in the form specified in Appendix 2 at the same time as delivery of each unit component part pursuant to this Article, Item 2.
 
  6   Delivery of each unit component part for lease of each Individual transaction under this Contract shall be considered completed by delivery of each loan certificate under the preceding Item and Lessee may use each unit component part on the day of delivery of the relevant loan certificate.
 
  7   Lessee shall bear all the cost for delivery of Subject property under this Article.
 
  8   In the case where delivery of Subject property is not completed during the delivery period under this Article, Item 2, Lessee and Lessor shall faithfully consult possibilities of extension of delivery period with each other.
Article 5 (Prior conditions regarding delivery)
      Lessor’s obligation of delivery of each unit component part for each individual transaction under Article 4 presupposes that the following conditions be fully satisfied before the day of scheduled delivery. Provided, however, that this shall not apply in the event that Lessor notifies Lessee before the completion of delivery that Lessor does not demand that these conditions are satisfied.
  (1)   That events have not occurred by the scheduled delivery day that would cause Lessor or Lessee to expect legal, administrative guidance or tax changes in laws, orders, notices and others that Lessor or Lessee reasonably judges to be appropriate in consideration of the relevant objective to suspend or postpone the execution of transaction planned under Subject related contracts, or that the transaction is illegal. (However, if Lessor or Lessee determines that events applicable under this Clause have occurred, Lessor or Lessee shall immediately notify the other party and have consultation with the other party in advance.)
 
  (2)   That the relevant unit component parts have been purchase by Lessee before the relevant scheduled delivery day from property manufacturer under the original purchase agreement, and Lessee has acquired the ownership thereof without any burdens etc. (excluding waived burdens).
 
  (3)   That the relevant unit component part is insured under Article 19 by insurance that is effective as of the day of the relevant scheduled delivery day.
 
  (4)   That no events of default have occurred.

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  (5)   That no events have occurred that make Lessor reasonably judge that events that constitute total loss events or lead to total loss events regarding the relevant unit component part.
 
  (6)   That Subject related contracts to which Lessor or Lessee should be the parties concerned are signed by all parties concerned, issued and continued to be in force.
 
  (7)   That representations and warrants by Lessee in Article 20 are entirely correct as of the relevant scheduled delivery day under the conditions that exist on the same day.
 
  (8)   That no significant change has been added to the FLASH PARTNERS MASTER AGREEMENT concluded as of September 10, 2004 between the Guarantor and SanDisk International Limited, and that this Agreement has not been terminated, dissolved or ended.
 
  (9)   That long-term loan rating of SanDisk by Standard & Poor’s Rating Services or Moody’s Investors Service is BB- or Ba3 or above respectively as of the relevant scheduled delivery day.
Article 6 (Related documents)
  1   Lessee and Lessor shall take procedures necessary for the conclusion of this Contract and other Subject related contracts and the empowerment for the implementation of obligations under this Contract by the date of this Contract or each delivery day and, at the same time, submit to each other a certificate of seal impression that was used in these contracts (issued within three months prior to each day of signing), certified copy of company registration (issued within three months prior to the day of signing each contract) and Articles of Incorporation (valid as of the day of signing this Contract).
 
  2   Lessee shall submit the following documents to Lessor by each scheduled delivery day:
  (1)   Insurance certificate for the relevant unit component part designated in Article 19
 
  (2)   Original Subject Letter of Agreement on the relevant unit component part as of the day determined by notary
 
  (3)   Copies of other documents reasonably requested by Lessor
Article 7 (Payment of lease payment etc.)
  1   Lessee and each Lessor agree that monetary claim of Lessor against Lessee regarding payment of lease payment, prescribed damages, reimbursement adjustment fee, purchase option exercise cost regarding each individual transaction under this Contract constitute each of SD Tranche 1, SD Tranche 2, Toshiba Tranche 1 and Toshiba Tranche 2. Each Tranche regarding each individual transaction shall constitute credits obtained by dividing the applicable monetary claim by the rate provided in loan certificate regarding the relevant individual transaction. Further, specific amount of each Tranche regarding lease

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      payment, prescribed damages, reimbursement adjustment fee, purchase option exercise cost regarding each individual transaction shall follow the rules provided by Appendix 1 Clause 3, Clause 6, Clause 7 and Clause 9 of this Contract and loan certificate regarding the relevant individual transaction.
 
      In addition, credits related to lease payment, prescribed damages, reimbursement adjustment fee, purchase option exercise cost regarding SD Tranche 1 and SD Tranche 2 shall be attributed to only SD Lessor (each SD Lessor maintains as divided credits according to the rate of shared equity of Subject property), and the money regarding the relevant credit shall be paid only to SD Lessor, and credits related to lease payment, prescribed damages, reimbursement adjustment fee, purchase option exercise cost regarding Toshiba Tranche 1 and Toshiba Tranche 2 shall be attributed to only Toshiba Lessor (each Toshiba Lessor maintains as divided credits according to the rate of shared equity of Subject property), and the money regarding the relevant credit shall be paid only to Toshiba Lessor.
 
  2   Lessee shall, for each individual transaction, pay the lease payment for the lease payment calculation period that ends on each payment day of lease payment to Lessor by 11 am of the payment day of the relevant lease payment.
 
  3   In the event that the day that Lessee is supposed to make payment in the amount that Lessee has payment obligation for each individual transaction under this Contract is not a banking business day, for lease payment, prescribed damages, reimbursement adjustment fee, purchase option execution price, Lessee shall make payment on the following banking business day (if the following banking business day is in the next month, the previous banking business day) and the payment amount shall be adjusted accordingly, and for other amounts, the applicable payment shall be made on the following banking business day and the payment amount shall not be adjusted.
 
  4   The amount that Lessee has payment obligation under this Contract shall be paid in methods set forth in Appendix 1 Clause 10(2), except as otherwise agreed between the parties concerned. However, lease payment, prescribed damages, purchase option exercise cost and reimbursement adjustment fee regarding SD Tranche 1 and SD Tranche 2 under this Contract shall be paid to Subject SD borrower, and lease payment, prescribed damages, purchase option exercise cost and reimbursement adjustment fee regarding Toshiba Tranche 1 and Toshiba Tranche 2 under this Contract shall be paid to Subject Toshiba borrower in accordance with Appendix 1 Clause 10(1). Lessee confirms that regarding reception of the relevant amount to the bank account of each Subject borrower, SD Lessor has entrusted Subject SD borrower, and Toshiba Lessor has entrusted Subject Toshiba borrower, and each Subject borrower has accepted this entrustments. In the event that the applicable entrustment were cancelled by prior written notice by SD Lessor or

- 13 -


 

      Toshiba Lessor to Subject SD borrower or Subject Toshiba borrower, Lessor shall notify Lessee that effect 1 banking business day before the first payment day of lease payment that arrives after the cancellation. (In this case, of lease payment, prescribed damages, purchase option exercise cost and reimbursement adjustment fee under this Contract, the amount regarding SD Tranche 1 shall be received in the bank account of each Subject SD lender provided in Appendix 1 Clause 10(2), the amount regarding Toshiba Tranche 1 shall be received in the bank account of each Subject Toshiba lender provided in Appendix 1 Clause 10(2), the amount regarding SD Tranche 2 shall be received in the bank account of each SD Lessor provided in Appendix 1 Clause 10(2), and the amount regarding Toshiba Tranche 2 shall be received in the bank account of each Toshiba Lessor provided in Appendix 1 Clause 10(2))
 
  5   The amount that Lessee should pay Lessor under this Contract shall be in full amount without any deduction, offsetting or defense regardless of any reasons (except for the case that caused by matters ought to be attributed to Lessor’s responsibility) including existence of defects regarding performance etc. of Subject property, existence of burdens etc. against Subject property, existence of infringement against use of Subject property or bankruptcy of parties concerned (that is, bankruptcy, civil rehabilitation, corporate consolidation, corporate reorganization and other legal arrangement procedures, or similar procedures under laws of countries other than Japan have started and continue to be implemented). In the event that Lessee is required by decree to withhold tax for the applicable payment, Lessee shall make additional payment that is needed to ensure the amount that the receiving party would have received if the relevant withholding was not required.
 
  6   If lease of each individual transaction under this Contract is terminated on a day other than the payment day of lease payment regardless of the reasons including occurrence of total loss event of Subject property or unit component part, occurrence of cancellation events, execution of purchase option or return option right by Lessee and others (however, except for the case of cancellation caused by matters ought to be attributed to Lessor’s responsibility), Lessee shall pay break funding cost to Lessor on the relevant termination day.
 
  7   In the event that the amount of money that Lessee paid to Lessor or money received by Lessor by disposition of Subject property under this Contract is less than the total amount of debts that the time for performance has arrived as of the relevant payment day or receiving day under this Contract, the relevant amount of money shall be appropriated to each debt in the order below. However, debts of the same order shall be distributed proportionally to the amount of credit that each Lessor holds.
  (1)   Cost that Lessee is required to pay Lessor under Subject related contracts.

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  (2)   Default interest related to lease payment, prescribed damages, reimbursement adjustment fee, purchase option exercise cost regarding SD Tranche 1 and Toshiba Tranche 1.
 
  (3)   The amount equivalent to lease payment interest (each amount in Appendix 1 Clause 3 (a) (2) and the same Clause (c) (2), and Appendix 1 Clause 9 (3) and (9) specified in loan certificate for each individual transaction regarding the relevant Tranche) of lease payment or prescribed damages regarding SD Tranche 1 and Toshiba Tranche 1.
 
  (4)   Of lease payment or prescribed damages regarding SD Tranche 1 and Toshiba Tranche 1, the amount equivalent to original principal of lease payment (each amount of Appendix 1 Clause 3 (a) (1) and the same clause (c) (1) and Appendix 1 Clause 9 (1), (2), (7) and (8) specified in loan certificate for each individual transaction regarding the relevant Tranche), the amount equivalent to purchase option exercise cost, or reimbursement adjustment fee.
 
  (5)   Default interest regarding lease payment, prescribed damages, reimbursement adjustment fee, purchase option exercise cost regarding SD Tranche 2 and Toshiba Tranche 2.
 
  (6)   Of lease payment or prescribed damages regarding SD Tranche 2 and Toshiba Tranche 2, the amount equivalent to lease payment interest (each amount of Appendix 1 Clause 3 (b) (2) and the same clause (d) (2) and Appendix 1 Clause 9 (6) and (12) specified in loan certificate for each individual transaction regarding the relevant Tranche).
 
  (7)   Of lease payment or prescribed damages regarding SD Tranche 2 and Toshiba Tranche 2, the amount equivalent to original principal of lease payment (each amount of Appendix 1 Clause 3 (b) (1) and the same clause (d) (1) and Appendix 1 Clause 9 (4), (5), (10) and (11) specified in loan certificate for each individual transaction regarding the relevant Tranche), purchase option exercise cost, or the amount equivalent to reimbursement adjustment fee.
 
  (8)   Amount of other credits.
Article 8 (Defective security indemnity)
  1   Lessor shall lease Subject property to Lessee on an as is basis, without warranty of any kind regarding Subject property, whether express or implied, and shall not be liable for defects in the property whether apparent or hidden. Further, no guarantee shall be made regarding non-existence of burdens etc. regarding Subject property or Subject parts, and shall not be liable for defects whether the defects are known or not.
 
  2   Lessee, on its own responsibility and at its own expense, shall acquire appropriate quality

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      assurance with property manufacture or Subject parts supplier, and at the same time make an arrangement of after the sale service and hereby transfer to Lessor (except for those that the applicable transfer is prohibited) the rights regarding Subject property such as right to claim security and guarantee (including right to claim guarantee against defects). However, Lessee may exercise the applicable right to claim security and guarantee in the name of itself provided that no events of cancellations have occurred, and may directly receive execution of security and guarantee during lease period from property manufacturer or Subject parts supplier.
 
  3   In the event that Lessee incurs damages or loss due to lack of performance etc. in Subject property, Lessee may, on its own responsibility and at its own expense, demand recuperation of such damages or loss directly from property manufacturer or manufacturer of Subject parts under the right set forth in provision of the previous clause, and Lessor shall not be responsible for this. However, Lessee’s obligations under Article 14 shall not be affected.
Article 9 (Burden for loss, damage and danger)
  1   In the events that events for total loss occurred to all or any unit component part of Subject property (provided, however, that reasons attributable to Lessor shall be excluded) Lessee shall immediately notify Lessor and pay Lessor the amount of debt that is in time for performance of prescribed damages and others regarding the applicable Subject property or unit component part as of the day payment in the amount greater than the amount equivalent to the following prescribed damages as insurance coverage of the insurance as prescribed in Article 19 by earlier of (a) the day 90 days after the occurrence of the relevant events for total loss (provided, however, that cases where the relevant reasons for total loss were caused not by those attributable to Lessee, and Lessor and Lessee separately agree shall be excluded.) or (b) the following banking business day of the relevant day of payment.
 
  2   When Lessee has paid the amount prescribed in the previous clause, Lessor shall transfer to Lessee the right to Subject property or unit component part subject to the total loss event or the right to third party acquired by occurrence of the relevant total loss event (excluding the right to claim indemnity of liability for damages that Lessor should incur) on an as is basis as the time of the transfer without securing performance and monetary capacity, trust and others of the third party.
 
  3   In the event that Lessor has received insurance coverage for total loss or compensation payment from a third party due to occurrence of total loss event regarding Subject property or unit component part (including the monetary amount paid with the purpose to indemnify damages and drawback etc. incurred by the total loss event regardless of its

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      title, and not including the amount of money to indemnify liability for damages that Lessor should incur), and when Lessee has lapsed the payment due date of prescribed under Clause 1 (whether or not if Lessee is aware that the payment due date of Clause 1 has arrived as the result of payment of insurance coverage for total loss), the relevant received amount shall be appropriated for payment of the relevant prescribed damages, and if there is surplus after the relevant appropriation, the surplus amount shall be immediately return to Lessee upon subtracting unpaid amount that Lessee owes Lessor under Subject related contracts (including delinquency charges), and if there is still deficient after the relevant appropriation, Lessee shall not avoid payment of the relevant deficient amount. Further, if Lessee has paid the relevant prescribed damages at the time above, Lessor shall immediately return the remaining amount of the relevant received amount to Lessee upon subtracting, if any, unpaid amount by Lessee under Subject related contracts.
 
  4   Lessee shall incur all dangers and related expenses regarding loss (including total loss events) or damage (however, in either case, except as in the case that caused by matters attributed to Lessor’s responsibility).
 
  5   In the event that total loss events regarding any of unit component part has occurred and Lessee has made payment prescribed damages regarding the relevant component part or the unpaid amount regarding total loss events, the relevant unit component part shall be removed from transactions under Subject related contracts, and Lessee shall be exempt from obligations to pay lease payment regarding the relevant unit component part in future.
 
  6   Unit component part that Lessee reasonably judges that does not qualify the required specification of Lessee upon consulting to opinions of property manufacturer or property maintenance agent after delivery day shall be considered as occurrence of total loss event by matters not attributed to Lessee’s responsibility immediately after delivery on the delivery day, and provisions of this Article shall be applied accordingly.
 
  7   In the event that total loss event has occurred regarding Subject property or any of unit component parts, or that Lessee judges that Subject property or any of unit component part needs to be replaced in performing its business, Lessee may request to Lessor replacement of the relevant Subject property or unit component part conditional upon agreement of Subject borrower and Subject lender (Lessor may not reject such agreement without any reasonable reasons, and such reasonable reasons shall include the case where Lessor judges at its own discretion that the value of Subject property after replacement of the relevant Subject property or unit component part has decreased compared to the value before the replacement (excluding slight decrease). The relevant replacement shall be performed at the expense of Lessee if Lessor, Subject borrower and Subject lender reach

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      agreement on the conditions upon taking replacement property, its price and other matters into consideration.
Article 10 (Representation of Owner)
      Lessee shall, on its own responsibility and at its own expense, install signs that include statement of Lessor’s ownership of Subject property in ways that can be easily recognized by third parties in installation location of Subject property and each of major unit component parts and unit component parts that Lessor requests.
Article 11 (Peaceful Use)
      Lessee may, unless termination matter has occurred, use Subject property peacefully, and Lessor shall not disturb the use by Lessee without valid reasons.
Article 12 (Installation and Use)
  1   Lessee shall, on its own responsibility and at its own expense, install Subject property to Toshiba Yokkaichi Factory in accordance with the installation standards or methods provided by property manufacturer and regulatory authority, and shall not change the installation location without prior consent of Lessor. Installation location of Subject property or any of unit component part outside of Japan is contingent upon, in addition to prior consent of Lessor, compliance of provisions of each Articles of this Contract regarding Subject property or the relevant unit component part outside of Japan, not affecting the rights of Lessor, Subject borrower and Subject lender regarding Subject property and rights provided in Subject related contracts, and compliance of laws regarding export and reexport control of Japan and the United States.
 
  2   Lessee shall comply with demand, conditions and instructions by property manufacturer, Subject parts supplier and insurance company, and agreements with such parties on all laws applicable to Subject property and installation, use, operation and handling thereof (including environmental laws) and all important points, and at the same time, shall use Subject property only for legal applications.
 
  3   Lessee shall, on its own responsibility and at its own expense, keep and maintain records regarding use and operation of Subject property.
Article 13 (Possession and Re-leasing)
  1   Lessee shall not, without prior consent of Lessor, relocate possession of Subject property to a third party, or re-lease Subject property. However, Lessee may, on its own responsibility and at its own expense, without consent of Lessor, relocate possession of Subject property for maintenance or repair to property manufacturer or approved

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      maintenance or repair provider, and re-lease Subject property to a SD group company or a Toshiba group company.
 
  2   In the event that relocation of possession or re-leasing is executed in accordance with the previous clause, the relevant relocation of possession or re-leasing shall not affect Lessee’s obligations under this Contract, and at the same time its articles, survival and others shall be subject to the provisions of this Contract, and if taxes and public dues occur to Lessee regarding the relevant relocation of possession or re-leasing, the relevant taxes and public dues shall not affect the conditions of lease under this Contract such as lease payment. Further, Lessee shall, on its own responsibility and at its own expense, take all reasonable measures so that Lessor and Subject lender maintains security as before (not limited to those expressed in this Contract).
Article 14 (Maintenance Management)
  1   Lessee shall, on its own responsibility and at its own expense, place Subject property in safe condition at all time.
 
  2   Lessee shall, on its own responsibility and at its own expense, perform maintenance and management of Subject property in accordance with provisions of law, and perform maintenance and repair in method approved or recommended by property manufacturer or Subject parts supplier and method that is at lease equivalent to the methods Lessee employs for other similar properties that Lessee uses, and at the same time, retain Subject property in the save level condition as the initial condition on the delivery day at all time (however, excluding normal wear and tear). In all cases, Lessee shall not perform acts that might cause significant adverse effect to guarantee of Subject property by property manufacturer.
 
  3   Lessee shall, on its own responsibility and at its own expense, keep and maintain records regarding maintenance and repair of Subject property including maintenance log.
 
  4   Lessee may, for the purpose of maintenance and repair provided in Clause 2, on its own responsibility and at its own expense, replace Subject parts with alternative part that has a similar level of performance etc. to the relevant Subject parts and owned by Lessee without any burdens for itself (excluding the waived burdens), and may install parts owned by Lessee without any burdens for itself (excluding the waived burdens) to Subject Property, not as a replacement of Subject parts. However, in either case, the replacement or installation shall not cause any changes that are reasonably expected to decrease performance etc. of Subject property, or have adverse effect on its performance etc.
 
  5   Lessee may, on its own responsibility and at its own expense, after delivery of Subject property to Lessee in accordance with Article 4, may remove parts that are installed to Subject property as an addition, not as a replacement to other Subject parts, or Subject

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      parts with which removal of the relevant Subject parts does not cause reduction in performance etc. of Subject property, without installing alternative parts to Subject property.
Article 15 (Change in Original Condition)
      Lessee may, on its own responsibility and at its own expense, may perform change, alteration or addition to Subject property that is considered necessary or desirable for business reasons within the range of changes that would not decrease its performance etc. nor have adverse effect on its performance etc.
Article 16 (Ownership of Parts)
  1   Except as in the case of Clause 2, Subject parts that Lessee installed to Subject property under Article 14 Clause 4 shall become Subject parts that constitutes Subject property at the same instance of installation to Subject property, and at the same time automatically become a possession of Lessor, and be leased from Lessor to Lessee under this Contract. For subject parts that are removed from Subject property, ownership of the relevant removed Subject parts shall be transferred to Lessee at the same instance that ownership of the alternative parts are transferred to Lessor. However, Subject parts that are changed and removed but not substituted by similar parts shall still be under the ownership of Lessor regardless of its location and be subject to this Contract.
 
  2   Lessee may retain the ownership of parts that are installed to Subject property as an addition, not as a replacement to other Subject parts, under Article 14, after Subject property was delivered to Lessee under Article 4, and that removal of the relevant parts from Subject property without reducing performance etc. of Subject property is possible. Lessor may consider the relevant parts as Subject parts in application of Article 26 Clause 3.
Article 17 (Inspection)
      Lessor and parties designated by Lessor may, upon prior notice to Lessee no less than 5 banking business days in advance, regarding Subject property or Subject parts, enter office, factory or facility of Lessee or its installation location, or on a premise of Lessee or its installation location, and inspect conditions of Subject property such as conditions, installation, use, operation, storage, maintenance and repair. However, when performing the applicable inspection, normal operations of Lessee or its installation location shall not be disturbed and at the same time, confidential, safety, and security restrictions charged by Lessee or its installation location shall be abided by.

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Article 18 (Burden etc.)
  1   Lessee shall not establish, approve, or cause to create any burden etc. to Subject property, Subject parts or rights in this Contract, or benefits. Provided, however, it shall not apply to burden etc. occurred from (a) rights of Lessor and Lessee provided in this Contract, (b) retention right of employees, maintenance provider and repair provider that occur in the process of normal operations of Lessee or similar security right, with which its payment has not passed the payment due date and there is no danger that the relevant burden etc. be executed on the relevant property, and (c) rights of Lessor, Subject lender and its successor and its approved grantee provided in Subject related contracts (including contracts of loan and security scheduled in these contracts.).
 
  2   In the event that burden etc. that is not excluded in the conditional clause in the previous clause has occurred, Lessee, on its own responsibility and at its own expense, shall eliminate this in an appropriate method.
Article 19 (Insurance)
  1   Lessee shall, on its own responsibility and at its own expense, personally, conclude insurance contract to cover damage and loss of Subject property through Subject guarantor or Toshiba group companies or SD group companies at all time during the lease period with an insurance company that Lessor recognizes as internationally trustworthy.
 
  2   Regarding insurance of the previous clause, the amount of insurance shall be no less than the amount equivalent to 100% of prescribed damages as of the payment day of lease payment right before the day of coverage.
 
  3   Lessee shall, in the case of occurrence of event insured against Subject property regardless of total loss or partial loss event, promptly notify Lessor.
 
  4   In the event that loss event where restoration or repair of Subject property is possible (partial loss event), insurance money paid for such event shall be received by Lessee. Upon receiving payment of the applicable insurance money, Lessee shall appropriate the entire amount of the insurance money for expense of restoration and repair of Subject property unless the relevant loss has already been restored or repaired. In addition, in the case of total loss event, provisions of Article 9 shall be abided by.
 
  5   Before the property delivery day under Article 4 and the start time of each insurance period of the period required to be insured under this Article (at least once a year), Lessee shall obtain document that proves the coverage that meets the above conditions from the insurance company prescribed in Clause 1, and deliver such document to Lessor.
 
  6   Condition of insurance set forth in this Article shall, in all cases, not be less than insurance that covers property that is similar to Subject property that Lessee uses in all respects. In the event that the condition of insurance under this Article become less than

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      the condition of the relevant other insurance, condition in this Article regarding insurance shall be increased up to the condition of the relevant other insurance, and Lessee shall promptly conform to the increased condition.
Article 20 (Representation and Warranty)
  1   Lessee shall represent and warrant the following items as of the day of this Contract:
  (1)   That Lessee has concluded Subject related contracts in which Lessee is a party concerned, has capacity and authority by law and internal provisions of the company to exercise the right under the relevant Subject related contracts and fulfill obligations, and resolution of internal general meeting and other measures necessary by law and internal provisions of the company for preparation of such Subject related contracts and execution of its own rights and fulfillment of obligations.
 
  (2)   That preparation and delivery and execution by Lessee of Subject related contracts that Lessee is a party concerned does not violate laws, company contract of Lessee and other documents related to organizations, and provisions of contracts that Lessee is a party concerned in all respects.
 
  (3)   That Subject related contracts that Lessee is a party concerned are legal, effective and binding contracts of Lessee that office grant is possible in accordance with each articles.
 
  (4)   That any of preparation and delivery of Subject related contracts that Lessee is a party concerned and performance or fulfillment by Lessee of transaction intended therein do not need in any way approval and license by government and other public offices or court or notification or registration, or other procedure to government and other public offices or court, with the exception of ones already completed.
 
  (5)   That no pending judicial or administrative procedure in any way that might cause adverse effect to execution of rights or fulfillment of obligations by Lessee in Subject related contracts that Lessee is a party concerned.
 
  (6)   That Lessee has disclosed to Lessor, Subject borrower and Subject lender business plans determined by the board meeting of Lessee regarding the business year that this contract day belongs to, that is considered to be reasonably necessary for implementation of this Contract.
  2   Lessor shall represent and warrant the following items as of the day of this Contract:
  (1)   That Lessor has concluded Subject related contracts in which Lessor is a party concerned, has capacity and authority by law and internal provisions of the company to exercise the right under the relevant Subject related contracts and

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      fulfill obligations, and resolution of internal general meeting and other measures necessary by law and internal provisions of the company for preparation of such Subject related contracts and execution of its own rights and fulfillment of obligations.
 
  (2)   That preparation and delivery and execution by Lessor of Subject related contracts that Lessor is a party concerned does not violate laws, company contract of Lessee and other documents related to organizations, and provisions of contracts that Lessor is a party concerned in all respects.
 
  (3)   That Subject related contracts that Lessor is a party concerned are legal, effective and binding contracts of Lessor that office grant is possible in accordance with each articles.
 
  (4)   That any of preparation and delivery of Subject related contracts that Lessor is a party concerned and performance or fulfillment by Lessor of transaction intended therein do not need in any way approval and license by government and other public offices or court or notification or registration, or other procedure to government and other public offices or court, with the exception of ones already completed.
 
  (5)   That no pending judicial or administrative procedure in any way that might cause adverse effect to execution of rights or fulfillment of obligations by Lessor in Subject related contracts that Lessor is a party concerned.
  3   Representation and warranty of each item in the previous two Clauses shall be considered to be repeated by Lessee and Lessor on delivery day of each individual transaction and payment day of each lease payment under the conditions exist on those days.
Article 21 (Commitment Matters)
  1   Lessee shall make the following commitment to Lessor:
  (1)   Lessee shall manage during the lease period Subject property, each unit component part and Subject parts in distinction from other properties.
 
  (2)   Lessee shall fulfill and comply with Lessee’s obligations in Subject related contracts (including the original purchase contract for the purpose of this Contract) in accordance with its provisions.
 
  (3)   In the event that default matters or matters that would cause significant adverse effect to Lessor’s entire rights in Subject related contracts or fulfillment of Lessee’s obligations, Lessee shall notify Lessor to that effect promptly after learning of occurrence of such matters.
 
  (4)   In the event that Lessee has acquired consent, permission, approval, license or acceptance of government or other public offices or court which Lessee is required

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      by government or other public offices or court in order to continue essentially the same business as the present time or regarding Subject related contracts, maintains its effect, and conditions or restrictions imposed regarding these, Lessee shall abide by all.
 
  (5)   Lessee shall provide Lessor and Subject lender upon their request with information regarding financial situation and business conditions of Lessor or Subject guarantor Lessor that Lessor reasonably requests including financial statements that is not particularly under confidentiality obligation, and information regarding installation, condition, storage, use, maintenance and repair of Subject property after the end of its business year (however, after the end of its half year period or business year for Subject guarantor).
 
  (6)   Lessee shall perform all acts that Lessor reasonably requests as necessary for establishment, transfer or formation of fluctuation of rights or fulfillment of perfection in Subject related contracts that are recognized by Subject related contracts or scheduled, to the extent that Lessee perform in accordance with provisions thereof.
 
  (7)   Lessee shall, for each business year, report promptly after the end of each relevant business year to Lessor progress status of business plan of the relevant business year determined at a board meeting of Lessee, to the extent that is reasonably recognized necessary for implementation of this Contract.
 
  (8)   If there is a reasonable request from Lessor, Lessee shall cooperate with Lessor and Subject lender to achieve objects of Subject related contracts.
 
  (9)   Accounting and financial handling of Lessee and Subject guarantor regarding transaction under this Contract and Subject related contracts shall be performed by Lessee and Subject guarantor at their own discretion and responsibility.
 
  (10)   Lessee shall ensure that the Guarantor makes no significant changes to the FLASH PARTNERS MASTER AGREEMENT concluded between Subject guarantor and SanDisk International Limited as of September 10, 2004 as the day of this Contract. Provided, however, that this shall not apply in the event that the Lessor and the Lender agree otherwise.
 
  (11)   Lessee shall have SanDisk abide by the following provisions. Provided, however, that this shall not apply in the event that the Lessor and the Lender agree otherwise as to (1) and (3) below.
  (1)   SanDisk shall maintain long-term loan rating by Standard & Poor’s Rating Services or Moody’s Investors Service to BB- or Ba3 or above respectively.
 
  (2)   SanDisk shall promise that no security interest shall be established in any San Disk assets SanDisk without prior written approval by Lessor. Provided,

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      however, that this shall exclude cases involving normal securitization transactions regarding loan or inventory or any of the specified security interests listed in Appendix 3 below (Permitted Liens).
 
  (3)   SanDisk shall maintain the amount of equity (Total Stockholders’ Equity) in consolidated balance sheet as of the last of accounting term and mid accounting term of each year at no less than 1,164 million US dollars until the termination of this Contract and completion of fulfillment of all of Lessee’s and SanDisk’s obligations to Lessor in this Contract.
Article 22 (Compensation and Burden of Expense)
  1   Lessee shall, except as otherwise provided in this Article, incur burdens and compensations for taxes and public dues to be imposed on all or any of persons to be compensated in direct or indirect relation to any of Subject property, unit component part or Subject parts, or ownership, possession, use, application, operation, lease, re-lease, installation, storage, maintenance, repair, improvement, modification, insurance, burdens etc., delivery, purchase, transfer, return, performance etc., structure, design, specification, functions, durability, operability, manufacture or Subject related contracts thereof, or payment regarding those (except payment of property purchase price under Subject Sales Contract and payment of principal and interest under Subject Loan Agreement) and other transactions intended by those, and loss etc. to be incurred by all or any of persons to be compensated, and if there is an instruction from the relevant persons to be compensated, directly pay to the authorities or third parties. However, Lessee is not obliged to fulfill obligation of compensation or payment under this clause for either of taxes and public dues imposed on the basis of net profit, or taxes and public dues otherwise provided in this clause.
 
  2   Of expenses regarding preparation and conclusion of Subject related contracts, attorney’s fee shall be incurred by each party.
 
  3   Expenses regarding fulfillment of obligations and transactions under Subject related contracts shall be determined as specified in express provisions and as provided below:
  (1)   Lessee shall incur bank fee regarding payment etc. in Article 7.
 
  (2)   Lessee shall incur expenses including attorney’s fee regarding purchase option right or return of Subject property by Lessee.
 
  (3)   Expenses including attorney’s fee that arises from occurrence of default by any of parties involved shall be incurred by the relevant parties involved.
  4   Taxes and public dues regarding Subject related contracts shall be determined as specified in express provisions and as provided below
  (1)   For consumption tax imposed on payment of purchase price of Subject property and payment etc. of lease fee under Subject related contracts, except as otherwise

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      agreed on between parties involved in this Contract, the parties involved that make these payment shall pay the amount of consumption tax to the receiving parties along with these payment. Provided, however, this shall not apply in the case that any of parties involved in this Contract may be exempt from imposition of consumption tax under the provisions of laws related to consumption tax.
 
  (2)   Fixed property tax imposed on Subject property shall be paid by those subject to incur by law, however, if Lessor is subject to such payment, Lessee shall pay Lessor the amount equivalent to the fixed property tax.
  5   Taxes and public dues that Lessee compensates or pays persons to be compensated under this Article shall be based upon net amount after tax.
 
  6   If the interest of loan is increased or each Subject borrower is charged with additional expense in accordance with each Subject Loan Agreement, Lessor may, upon written notice, based on charges from each Subject borrower, increase lease payment applicable to SD Tranche 1 or Toshiba Tranche 1 based on reasonably calculation method or demand payment of the relevant additional expense to Lessee. In such case, each amount of the applicable purchase option exercise cost, reimbursement adjustment fee, repayment standard money and prescribed damages shall be recalculated as well.
 
  7   In the event that taxes and public dues and other expenses to be incurred by Lessee under Subject related contracts are charged to Lessor or paid advance by Lessor, Lessee shall immediately pay Lessor upon request by Lessor the amount of the relevant payment and interest calculated in accordance with provisions of Article 27 from the day of payment. Provided, however, Lessor shall immediately notify Lessee in the case that Lessor was charged such taxes and public dues and other expenses, or paid such amount.
Article 23 (Number of individual transactions and change of deliverable period)
  1   Lessee and Lessor shall perform the first individual transaction in the period starting [*] ending [*], and may execute up to [*] times in [*] months after the first individual transaction. Provided, however, number of individual transactions and deliverable period shall be set forth in Appendix 1 Clause 1.
 
  2   Lessee and Lessor may, if prior written approval of Subject lender and Subject borrower are obtained, change executable period of individual transactions and number of individual transaction provided in the previous clause, and in this case, Lessee and Lessor, if change is needed regarding change of payment conditions including lease payment, prescribed damages, purchase option exercise cost, reimbursement adjustment fee, shall discuss the relevant changes.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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Article 24 (Purchase Option Right)
  1   Lessee may, for each individual transaction, by notifying Lessor no less than 30 days in advance of each lease payment day, purchase all of Subject property or any of unit component parts (provided, however, exercise of purchase option right for any of unit component part only shall be determined by provisions of Clause 4.) by paying Lessor with purchase option exercise cost and the amount of other debts in time for performance of Subject property or the relevant unit component part as of the relevant lease payment day (provided, however, for each individual transaction on the final lease payment day, whether or not there is notification from Lessee, unless otherwise return under Article 25 is made, purchase option right shall be considered to have been exercised). Notice of exercise of purchase option right under this clause shall not be withdrawn.
 
  2   If Lessee exercised purchase option right under the previous clause and paid the amount as prescribed in the previous clause, Lessor’s ownership and any other rights regarding Subject property or the relevant unit component part shall be transferred to Lessee on an as is basis without security for performance etc. and others at the time of completion of its payment. Provided, however, Lessor shall warrant Lessee that no burdens etc. that arise based on matters established by Lessor or attributable to Lessor exist at the time of such transfer to Subject property or the relevant unit component part.
 
  3   Lessor shall deliver transfer certificate of Appendix 4 to Lessee when receiving the amount as prescribed in Clause 1.
 
  4   Exercise of purchase option right on not the entire Subject property but only some of unit component parts may be allowed only if the total amount of property purchase cost of the unit component parts that Lessee is to purchase on the relevant lease payment day under this Article exceeds [*] Yen and Lessor’s consent is obtained (Lessor may not reject such consent without any reasonable reasons, and such reasonable reasons shall include the case that Lessor judges at its own discretion that the relative value of Subject property against purchase option exercise cost of Subject property after the purchase of the relevant unit component part has decreased (excluding slight decrease) compared to that of Subject property before the purchase. Further, the limit amount of purchase option exercise cost that is appropriated to the original principal of each of SD Tranche 1 and Toshiba Tranche 1 shall be the amount of money calculated by multiplying property purchase cost of the relevant subject unit component part by rates each time provided in the prescribed damages (A) and (C) of loan certificate.
 
  5   Lessee shall incur all expenses regarding exercise of purchase option right by Lessee.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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Article 25 (Return)
  1   Lessee may, in accordance with the following provisions, for each individual transaction, may return to Lessor all unit component parts that are subject to the relevant individual transaction at the location designated by Lessor on the corresponding day of delivery day each year of lease period (hereinafter referred to as “return day”) by notifying Lessor and Subject lender no less than [*] days in advance. Provided, however, in the event that any one of reason for cancellation or default reason (including reason for cancellation and default reason regarding clauses on return under this Article) has occurred on return day, or purchase by purchase option right under Article 24 is exercised on the same day as return day, Lessee may not implement return of Subject property under this Article. Notification of exercise of return option right may be withdrawn until [*] days before return day.
  (1)   When Lessee returns Subject property to Lessor under this Clause, Subject property shall be in a good condition as in the time of delivery in Article 4, that normal use is possible, and that Lessor reasonably judges to satisfy all of the requirements for conditions at the time of return regarding Subject property prescribed in Appendix 6, except for normal wear and tear and changes etc. performed in accordance with provisions of Article 14 Clause 4 or 5, or Article 15.
 
  (2)   Lessee shall deliver with return of Subject property to Lessor, in addition to maintenance and repair log, all records or copy thereof regarding installation, storage, use, operation, maintenance and repair of Subject property, and if Lessor requests, certificate by property maintenance and repair provider approved by property manufacturer, Subject parts supplier or property manufacturer that certifies the matters provided in Item (1) of this Clause.
 
  (3)   Lessee shall approve that Lessor, Subject lender or party that is to become a buyer of Subject property that Lessor has designated (and related parties thereof) enters office and factory etc. of Lessee or its installation location to inspect Subject property ahead of return of Subject property under Article 17.
 
  (4)   Lessee shall, on the return day, at the same time as return of Subject property, pay Lessor the amount of reimbursement fee of Subject property as of the return day and the amount of other debts under Subject related contracts.
 
  (5)   If Lessor incurs debt against Lessee under Subject related contracts on the return day, Lessor shall, on the return day, at the same time as return of Subject property, pay Lessee the amount of the relevant debt.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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  (6)   Return of Subject property under this Article shall be applied to all of the unit component parts subject to the relevant individual transaction only, and shall not be applied to only some of the unit component part.
 
  (7)   Lessee shall, in the case of selecting return under this Clause, upon discussion with Lessor, work to mediate a third party that purchases Subject property with purchase conditions that Lessor objectively satisfies. Provided, however, this shall not apply in the case that Subject property or any of unit component part is to be discarded in accordance with Clause 4.
  2   Lessor shall, when receiving the return of Subject property, prepare return certificate of Appendix 4 and delivery to Lessee.
 
  3   Lessee shall, if requested by Lessor, on its own responsibility and at its own expense, shall hold in trust Subject property for Lessor for maximum of [*] after the return day, and shall perform maintenance management, inspection and maintenance in accordance with this Contract in order to maintain the same level of performance etc. as on the delivery day in Subject property at all time, and if Subject property is damaged, regardless of the cause, shall repair to the perfect condition.
 
  4   Notwithstanding provisions of Clause 1, Lessor may request Lessee disposition of all or a portion of unit component parts that constitute Subject property before return day. In this case, Lessee shall, upon delivery of acknowledgement document to Lessor, on its own responsibility and at its own expense, immediately perform disposition of the requested unit component parts within Japan. Lessee shall, for such disposition, abide by the applicable laws (including environmental laws). Provided, however, in the case that Lessor needs to perform disposition under the name of itself, Lessee shall perform necessary cooperation along with covering its expenses. In any event, Lessor may request Lessee to provide with documents that confirm disposition or related documents, or copies thereof.
 
  5   Lessee shall incur maintenance expense, removal expense, transport expense, storage expense, resale expanse and all other expenses related to return of Subject property, and all expenses related to disposition of Subject property.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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  6   If Lessor sells Subject property to a third party within [*] of return of Subject property by Lessee to Lessor under this Article, and the net amount after deducting taxes and public dues, sales fee, and any other expenses from the received amount of the sales exceeds the repayment standard money of Subject property as of the return day, Lessor shall pay Lessee the amount equivalent to [*]% of the difference of such received amount of sales and the repayment standard money. Lessee shall incur taxes and public dues charged on such payment.
 
  7   In the case of disposition of Subject property that is returned under this Article, conditions and methods etc. of disposition shall be determined upon discussion by SD Lessor RA and Toshiba Lessor RA.
Article 26 (Termination of Contract)
  1   Lessor may, in the event of any one of the following events, with only written notice without formal demand, have Lessee lose benefit of term regarding loans on this Contract or any or all of individual transactions, and terminate this Contract or any or all of individual transactions.
  (1)   If Lessee defaults payment of lease payment and other debts under Subject related contracts, and does not make the relevant payment within 2 banking business days of receipt of written notice to that effect from Lessor.
 
  (2)   If Lessee neglect obtain and keep required insurance in accordance with this Contract.
 
  (3)   If Lessee neglects to eliminate burdens etc. in accordance with this Contract.
 
  (4)   If Lessee violates the provisions of Subject related contracts outside of the previous Item, and does not heal the relevant violations within 10 banking business days of receipt of written notice to that effect from Lessor.
 
  (5)   If Lessee or Subject guarantor are subjected to compulsory execution, petition for auction or disposition for failure to pay taxes and public dues, or petition for bankruptcy, civil rehabilitation, corporate consolidation, corporate reorganization and other similar procedures (including petition for similar procedure or disposition under foreign law). Provided, however, except as in the case that the relevant petition or disposition is cancelled or dissolved within 30 days.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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  (6)   If Lessee or Subject guarantor starts private disposition, passes a resolution to abolish or dissolve all or the major part of the business operation (provided, however, except as in the case of corporate reorganization that is not accompanied by procedure of Item (5) by Lessee or Subject guarantor, and Lessor, Subject borrower, Subject lender have agreed upon), or receives disposition of business suspension of all or major part of business or operation or other discontinuance of all or major part of business or operation from public office(It shall be considered to fall under this Item (6) if operation of Subject property by Lessee has been ceased for more than 2 months and without scheduled resuming).
 
  (7)   If Lessee or Subject guarantor transfer all or major part of business. Provided, however, except as in the case of corporate reorganization that is not accompanied by procedure of Item (5) by Lessee or Subject guarantor, and Lessor, Subject borrower, Subject lender have agreed upon.
 
  (8)   If Lessee or Subject guarantor stops payment or receives transaction stoppage disposition by bill clearing house.
 
  (9)   If direct and indirect rate of equity participation of each Subject guarantor to Lessee is changed. However, except as in the case that Lessor, Subject borrower and Subject lender agreed upon.
 
  (10)   If FLASH PARTNERS MASTER AGREEMENT concluded between Toshiba Corporation, SanDisk Corporation and SanDisk International Limited as of September 10, 2004 is cancelled, dissolved, or terminated.
 
  (11)   If Lessee or Subject guarantor loses term of benefit regarding monetary debts for greater than 20 million US dollars that they incur. Provided, however, that this shall not apply in the event that it is determined that the obligee has agreed or consented to the delinquency (including cases where, under industry custom, silence is deemed to signify consent).
 
  (12)   If the amount of equity (Total Stockholders’ Equity) in consolidated balance sheet as of the last of accounting term and mid accounting term of each year of SanDisk becomes less than 1,164 million US dollars.
 
  (13)   If long-term loan rating of SanDisk by Standard & Poor’s Rating Services or Moody’s Investors Service is decreased to below BB- or Ba3 respectively (13) If, in the event that there exists adequate cause that is objectively recognized that voluntary and smooth fulfillment of debts in this Contract becomes difficult due to significant change in the condition regarding assets and trusts of Lessee or Subject guarantor other than each of the previous Items, no discussion was arranged within 30 days of receipt of notice to that effect from Lessor by Lessee.
  2   If this Contract is terminated under the previous Clause, Lessee shall return Subject

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      property to Lessor on the day specified by Lessor (hereinafter referred to as “termination day”), and pay debts that have not been paid as of the termination day such as unpaid lease payment that is supposed to be paid on lease payment day before the termination day and delinquency charges regarding those, and prescribed damages on the termination day provided in Appendix 1 Clause 9.
 
  3   In the event that this Contract was terminated in accordance with Clause 1, Lessor shall, following its selection, liquidate all or a portion of debts of the previous Clause by method provided in each of the following Items.
  (1)   Upon disposing Subject property by sale under sales conditions determined at its own discretion, the amount equivalent to the amount after expense is deducted from such received amount by sales is reduced from the amount debt in the previous Clause.
 
  (2)   Upon evaluating fair market price of Subject property, the amount equivalent to the amount after expense is deducted from such evaluated amount is reduced from the amount debt in the previous Clause.
      In addition, of the debts of the previous Clause, Lessee shall be subject to the debts regarding the amount remained after such liquidation. Lessor shall immediately return to Lessee the remaining balance after the total amount of debts of the previous Clause is satisfied by such liquidation.
 
  4   When Lessee shall return Subject property by Clause 2, condition of Subject property, method of return and others shall be determined by provisions of Article 25, unless otherwise provided in this Article.
 
  5   Notwithstanding provisions of each of the previous Clauses, Lessee may, until Lessor disposes Subject property or unit component part by sales in accordance with Clause 3, purchase such Subject property or unit component part that has not been sold by paying Lessor prescribed damages of such Subject property or unit component part as of the termination day, unpaid lease payment and other amount that Lessee is subject to make payment to Lessor under Clause 2 (including delinquency charges) (provided, however, this may be approved only in the case that Lessor’s consent is provided unless in the case of purchase of the entire Subject property). If Lessee purchases Subject property or unit component part by making such payment to Lessor, Lessor shall transfer such Subject property or unit component part to Lessee on an as is basis without securing its performance etc. and others. Such transfer shall be under provisions of transfer certificate in the form provided in Appendix 5.
 
  6   Lessor may, regarding every term of Subject related contracts, claim for injunction of violation acts or specific benefits and claim for compensation regarding debts or liability that is incurred by Lessor, as well as receives other remedies recognized by law.

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  7   In the event that any reason for termination set forth in Clause 1 (12) or (13) occurs, that termination event shall be deemed not to have occurred if SanDisk, the SD Lessor, and the SD Lender have agreed on the supplementary collateral to be supplied by SanDisk, or if they have agreed on the lease amount and stipulated damages pursuant to this agreement and on the revision to the spread used to calculate the interest rate pursuant to the Loan Agreement.
 
  8   Lessee may, in the event that any reason for cancellation provided in each Item of Clause 1 occurs, by obtaining prior written consent of Lessor, transfer the status of Lessee under this Contract and Subject related contracts to both or one of Subject guarantor, and in this case, it shall be considered that the relevant reason for cancellation did not occur.
 
  9   In the event that reason for cancellation provided in Clause 1 (5) through (8) and (10) through (14) occurs for either Guarantor, the other Guarantor may succeed the status of Guarantor within 30 days of the date that occurrence of the relevant event became known, and pledge warranty or security that Lessor, Lender and the other Guarantor agree upon, in which case, that termination event shall be deemed not to have occurred.
Article 27 (Default Interest)
      If Lessee defaults payment of money to Lessor under this Contract, Lessee shall pay delinquency charges at the rate of [*]% annual interest (on a prorated daily basis with 1 year as 360 days) for that delinquent period.
Article 28 (Transfer of Rights and Obligations)
      Lessee and Lessor shall not, without obtaining prior written approval of the other party, transfer to a third party right of use of Subject property and rights and obligations under this Contract, or give as security. Provided, however, except for the following cases:
  (1)   For each individual transaction, SD Lessor may transfer to Subject SD borrower under Subject SD Loan Sales Contract lease payment, prescribed damages, purchase option exercise cost, reimbursement adjustment fee, break funding cost regarding SD Tranche 1 and delinquency charges regarding those, and any other monetary credits.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 33 -


 

  (2)   For each individual transaction, Toshiba Lessor may transfer to Subject Toshiba borrower under Subject Toshiba Loan Sales Contract lease payment, prescribed damages, purchase option exercise cost, reimbursement adjustment fee, break funding cost regarding Toshiba Tranche 1 and delinquency charges regarding those, and any other monetary credits (3) For each individual transaction, Subject SD borrower may, as security for Subject SD Loan Agreement, for Subject SD lender, transfer assigned credits of Clause 1 under Subject SD Loan Transfer Security Contract.
 
  (4)   For each individual transaction, Subject Toshiba borrower may, as security for Subject Toshiba Loan Agreement, for Subject Toshiba lender, transfer assigned credits of Clause 1 under Subject Toshiba Loan Transfer Security Contract.
 
  (5)   For each individual transaction, Lessor may, as security for Subject Loan Agreement, for Subject lender, transfer Subject property under Subject property transfer security reservation contract.
      Lessee shall hereby approve transfer and establishment of security right of such loans, cooperate with Lessor in preparation and delivery of documents requested by Lessor. In addition, Lessee and SD Lessor shall approve exercise of SD Lessor’s rights provided in this Contract to the extent necessary to exercise assigned credits that Subject SD borrower acquired under Subject SD Loan Sales Contract, and Lessee and Toshiba Lessor shall approve exercise of Toshiba Lessor’s rights provided in this Contract to the extent necessary to exercise assigned credits that Subject Toshiba borrower acquired under Subject Toshiba Loan Sales Contract.
Article 29 (Responsible Assets)
  1   Except as in the case of provisions under Clause 3 of this Article, fulfillment of monetary obligations that Lessee incurs against SD Lessor under this Contract shall be have only the following money and other assets (hereinafter referred to as “SD responsible assets”) as payment underlying assets, and Lessee shall not be responsible for default by parties involved in Subject related contracts other than itself or price trends or disposition possibility of Subject property. SD Lessor shall not file petition for starting seizure, temporary seizure or other compulsory execution procedures, or protective order to Lessee’s assets other than such SD responsible assets, and shall not file petition for starting of bankruptcy procedure to Lessee.
  (1)   The amount equivalent to lease payment, prescribed damages, purchase option exercise cost, reimbursement adjustment fee and delinquency charges regarding SD Tranche 1 and SD Tranche 2 under Subject Lease Contract and other monetary amount to be incurred regarding SD Tranche 1 and SD Tranche 2 under Subject

- 34 -


 

      Lease Contract.
 
  (2)   Monetary amount that SD Lessor receives regarding rights applied to monetary amount provided in the previous Item under Subject SD Guarantee Agreement.
 
  (3)   SD Lessor’s shared equity of Subject property.
 
  (4)   The amount that SD Lessor receives as the result of exercise or execution of rights acquired under Subject related contracts (whether or not compulsory or voluntary procedure).
  2   Except as in the case of provisions under Clause 3 of this Article, fulfillment of monetary obligations that Lessee incurs against Toshiba Lessor under this Contract shall be have only the following money and other assets (hereinafter referred to as “Toshiba responsible assets”) as payment underlying assets, and Lessee shall not be responsible for default by parties involved in Subject related contracts other than itself or price trends or disposition possibility of Subject property. Toshiba Lessor shall not file petition for starting seizure, temporary seizure or other compulsory execution procedures, or protective order to Lessee’s assets other than such Toshiba responsible assets, and shall not file petition for starting of bankruptcy procedure to Lessee.
  (1)   The amount equivalent to lease payment, prescribed damages, purchase option exercise cost, reimbursement adjustment fee and delinquency charges regarding Toshiba Tranche 1 and Toshiba Tranche 2 under Subject Lease Contract and other monetary amount to be incurred regarding Toshiba Tranche 1 and Toshiba Tranche 2 under Subject Lease Contract.
 
  (2)   Monetary amount that Toshiba Lessor receives regarding rights applied to monetary amount provided in the previous Item under Subject Toshiba Guarantee Agreement.
 
  (3)   Toshiba Lessor’s shared equity of Subject property.
 
  (4)   The amount that Toshiba Lessor receives as the result of exercise or execution of rights acquired under Subject related contracts (whether or not compulsory or voluntary procedure).
  3   Notwithstanding provisions of the previous two Clauses, Lessee shall not be exempt from responsibility to Lessor under Subject Lease Contract or Subject related contracts regarding loss, damages, expenses and costs attributable to Lessee’s responsibility that Lessor incurred or absorbed, and shall incur absolute obligation and responsibility, and in that case, provisions of the previous two Clauses shall not be applied. Further, this Clause shall not extend debts divided to each Tranche regarding Subject guarantor under Subject Guarantee Agreement to other Tranche.
 
  4   Provisions of Clause 1 and Clause 2 shall only restrict payment underlying assets for payment of monetary debts provided in the same Clauses, and shall not effect occurrence of such debts or limit such debts, nor restrict exercise of Lessor’s rights under Subject

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      related contracts or security right held of Lessor.
Article 30 (Notice etc.)
      All written notice necessary in this Contract shall be sent by postal mail, personal delivery or facsimile transmission to the notified parties listed on Appendix 7. In addition, external clerical work of Lessor such as notice and other transmissions shall be performed by IBJ Leasing Co., Ltd. on behalf of Lessor, expect as otherwise provided in this Contract.
Article 31 (Revision of Contract)
      This Contract shall not be revised unless with written consent of all parties concerned.
Article 32 (Confidentiality)
  1   Each party to this Contract shall pledge to not leak contents of this Contract or Subject related contracts and information or documents received regarding negotiations for them or in accordance with provisions thereof for [*] years from the day of this Contract, and shall securely keep confidential. Provided, however, except as in the case of disclosure of information or documents that are already publicly known, disclosure that accompanies marketing of Subject property, disclosure that is necessary for maintenance or exercise of rights, or fulfillment of obligations in Subject related contracts, and disclosure under the request of tax authorities and other related authorities or disclosure under prior consent of all parties to this Contract.
 
  2   Period of confidentiality provided in the previous Clause shall be automatically renewed for [*] year if there is no notice of cancellation of confidentiality from Lessee, and the same shall apply after that. Provided, however, Lessor may request confirmation of Lessee regarding extension of period of confidentiality at the [*] year or at the end of the extended period.
 
  3   In the event that party concerned to this Contract infringes the obligations of Clause 1, the relevant party concerned shall compensate economic damages incurred by other parties concerned.
Article 33 (Governing Law)
      This Contract shall be subject to laws of Japan and be interpreted in accordance with law of Japan in all respects.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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Article 34 (Court of Competent Jurisdiction)
      Any disputes that may arise under this Contract or regarding this Contract shall be referred to exclusive competency of Tokyo District Court.

- 37 -


 

In order to verify this Contract described above, on the date first above written, Lessor and Lessee shall prepare 4 original copies of this Contract and each shall maintain 1 copy each.

- 38 -


 

         
 
      (basic lease contract)
SD Lessor
  :   IBJ Leasing Co., Ltd.
as well as
       
Toshiba Lessor
       

- 39 -


 

         
 
      (basic lease contract)
SD Lessor
  :   Sumisho Lease Co., Ltd.
as well as
       
Toshiba Lessor
       

- 40 -


 

         
 
      (basic lease contract)
SD Lessor   
  :   Toshiba Finance Co., Ltd.

- 41 -


 

         
 
      (basic lease contract)
Lessee  
  :   Flash Partners Limited Company

- 42 -


 

Lease Contract Appendix 1
Lease Conditions
1   Specification of scheduled delivery day, the final deliverable day and properties
A corresponding day from [*] to [*] that falls on a banking business day and Lessee objectively specifies the relevant unit component part by a serial number, etc. and notifies Lessor as a scheduled day by 20 days before the relevant scheduled delivery day shall be a scheduled delivery day in each individual transaction and the final scheduled delivery day during the relevant period shall be the final deliverable day under this Contract. Lessee and Lessor shall conduct the first individual transaction in a period from [*] to [*], and they may execute up to [*] transactions in the following [*] months. Provided, however, that Lessee and Lessor may change the period mentioned above and the number of transactions to be implemented pursuant to Article 23.
2   Lease period
 
    For each individual transaction four or five years from the delivery day to be described in related loan certificates (including delivery day but not including Lease period expiration period).
3   Calculation of lease payment
 
    Calculation is done with the total amount of the following SD Tranche 1, SD Tranche 2, Toshiba Tranche 1, Toshiba Tranche 2.
  (a)   (SD Tranche 1)
For each lease payment calculation period, total amounts of (1) amount of Subject property purchase price in each individual transaction multiplied by the ratio in the following (A) and (2) total amount of interest on the amount to be calculated based on the following Clause 9 (1) as of the lease payment day for the lease payment calculation period immediately prior to the relevant lease payment calculation period (in the event that the immediately prior lease payment calculation period does not exist, delivery day) multiplied by the interest rate of Euro Yen TIBOR plus the following SD Tranche 1 spread from the first day to the last day of the relevant lease payment calculation period (calculated on a pro-rate basis with 360 days a year).
(SD Tranche 1 spread)
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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In the event that long-term loan rating of SanDisk by Standard & Poor’s Rating Services or Moody’s Investors Service (hereinafter collectively referred to as the “designated rating agency” as of the day of this Contract is “BB-” or “Ba3” or below respectively;
  [*]% p.a.
In the event that long-term loan rating of SanDisk by the designated rating agency is “BB” or “Ba2” respectively;
  [*]% p.a.
In the event that long-term loan rating of SanDisk by the designated rating agency is “BB+” or “Ba1” or above respectively.
  [*]% p.a.
      Changes in SD Tranche 1 spread based on the above formula shall be applicable in the lease payment calculation period that comes after the formal public announcement by the designated rating agency (Provided, however, that if the relevant public announcement is made after 10 business days prior to the start of lease payment calculation period, they shall apply as from the next lease payment calculation period that comes after the next lease payment calculation period.).
 
  (b)   (SD Tranche 2)
 
      For each lease payment calculation period, total amounts of (1) amount to be obtained by multiplying purchase price of Subject property in each individual transaction by the ratio in the following (B) and (2) amount of interest as of the lease payment day on the amount to be calculated based on the following Clause 9 (4) for a lease payment calculation period immediately prior to the lease payment calculation period (delivery day in the event that the immediately prior lease payment calculation period does not exist) multiplied by the interest rate of Euro Yen TIBOR for a period from the first day to the last day of the relevant lease payment calculation period plus the following SD Tranche 2 spread (calculated on a pro-rate basis with 360 days a year).
(SD Tranche 2 spread)
     
In the event that long-term loan rating of San Disk as of the day of the Contract by the designated rating agency is “BB-” or “Ba3” or below respectively;
  [*]% p.a.
In the event that long-term loan rating of SanDisk by the designated rating agency is “BB” or “Ba2” respectively;
  [*]% p.a.
In the event that long-term loan rating of SanDisk by the designated rating agency is “BB+” or “Ba1” or above respectively;
  [*]% p.a.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 44 -


 

      Changes in the SD Tranche 2 spread based on the above formula shall be applicable as from the lease payment calculation period that comes after the formal public announcement by the designated rating agency (Provided, however, that if the relevant formal announcement is made after 10 business days prior to the first day of lease payment calculation period, they shall apply as from the next lease payment calculation period that comes after the next lease payment calculation period.).
 
  (c)   (Toshiba Tranche 1)
 
      For each lease payment calculation period, total amounts of (1) amount to be obtained by multiplying purchase price of Subject property in each individual transaction by the rate in the following (c) and (2) amount of interest on the amount to be calculated based on the following Clause 9 (7) as of the lease payment day for a lease payment calculation period immediately prior to the relevant lease payment calculation period (delivery day in the event that the immediately prior lease payment calculation period does not exist) multiplied by the interest rate of Euro Yen TIBOR for a period from the first day to the last day of the relevant lease payment calculation period plus [*]% p.a. (calculated on a pro-rate basis with 360 days a year).
 
  (d)   (Toshiba Tranche 2)
 
      For each lease payment calculation period, total amounts of (1) amount to be obtained by multiplying the purchase price of Subject property in each individual transaction by the ratio in the following (D) and (2) amount of interest on the amount to be calculated based on the following Clause 9 (10) as of the lease payment day for a lease payment calculation period immediately prior to the relevant lease payment calculation period (delivery day in the event that the immediately prior lease payment calculation period does not exist) multiplied by the interest rate of Euro Yen TIBOR for a period from the first day to the last day of the relevant lease payment calculation period plus [*]% p.a. (calculated on a pro-rate basis with 360 days a year).
  (A)   Provided in loan certificate regarding the relevant individual transaction
 
  (B)   Provided in loan certificate regarding the relevant individual transaction
 
  (C)   Provided in loan certificate regarding the relevant individual transaction
 
  (D)   Provided in loan certificate regarding the relevant individual transaction
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 45 -


 

    In this Clause, “Euro Yen TIBOR” shall be indicated by the rate of Yen offered trade for a three-month term (per annum) (for the final payment due date) as of 11:00 a.m. Japan time on the date of loan (in the event of the first payment due date) or on a day two banking business days before the previous interest calculation day (as defined in Article 1) based on the outline publicly announced on the Telerate screen number 23070 by the Japanese Bankers Association to be designated by the Japanese Bankers Association. Provided, however, that in the event that the lease payment calculation period is less than three months, the rate shall be separately defined in the loan certificate.
 
4   Lease payment day
 
    For each individual transaction a corresponding day of delivery day three months after the respective delivery day and corresponding days of delivery days three months after the respective delivery days shall be the first lease payment day (in the event that a delivery day falls on the last banking business day of a month, the last banking business day of every three month shall be the lease payment day). However, in the event that the relevant corresponding day is not a banking business day, it shall be determined based on the provision of Article 7, Clause 3 of this Contract.
 
5   Lease payment calculation period
 
    In each individual transaction, a period that starts on the delivery day until the day before the first lease payment day and from the following day of the last day of the immediately prior lease payment calculation period thereafter until the previous day of the next lease payment day shall be the first lease payment calculation period. Provided, however, that in the event that this Contract is cancelled before termination, the lease payment calculation period is until the relevant cancellation day.
 
6   Purchase option exercise price
 
    Described in the related loan certificate for each individual transaction.
 
7   Reimbursement adjustment fee
 
    Described in the related loan certificate for each individual transaction.
 
8   Repayment standard amount
 
    Described in the related loan certificate for each individual transaction.

- 46 -


 

9   Prescribed damages
 
    Total amounts of the following (1), (4), (7) and (10) for delivery day or lease payment day. Provided, however, that lease payment as of the relevant lease payment day shall be paid separately. In the event that a day on which Prescribed damages shall be paid is not delivery day or lease payment day, total amounts of the following (2), (3), (5), (6), (8), (9), (11) and (12).
 
    (SD Tranche 1)
  (1)   Amount to be obtained by multiplying Subject property or the relevant unit component part purchase price of delivery day or lease payment day by the rate in the following (A)
 
  (2)   Amount to be obtained by multiplying Subject property or the relevant unit component part purchase price of the immediately prior delivery day or lease payment day of a day on which their payment should be made by the rate in the following (A)
 
  (3)   Amount of interest on the amount mentioned under above (2) for a period from the first day of the relevant lease payment calculation period until the day when Prescribed damages should be paid multiplied by the interest rate of Euro Yen TIBOR stipulated in the list attached to Subject Loan Agreement, Clause 6 (3) plus SD Tranche 1 spread mentioned below (calculated on a pro-rate basis with 360 days a year).
 
      (SD Tranche 1 spread)
     
In the event that long-term loan rating of SanDisk by the designated rating agency as of the day of this Contract is “BB-” or “Ba3” or below respectively;
  [*]% p.a.
Long-term loan rating of SanDisk by the designated rating agency is “BB” or “Ba2” respectively;
  [*]% p.a.
Long-term loan rating of SanDisk by the designated rating agency is “BB+” or “Ba1” or more respectively.
  [*]% p.a.
      The above changes shall be applicable only when formal public announcement by the designated rating agency is made 10 business days before the immediately prior delivery day or lease payment day.
  (SD Tranche 2)
 
  (4)   Amount to be obtained by multiplying Subject property or the relevant unit component part purchase price of delivery day or lease payment day by the rate in the following (B)
 
  (5)   Amount to be obtained by multiplying Subject property or the relevant unit component part purchase price of delivery day or lease payment day immediately prior to the day on which the relevant payment should be made by the rate in the following (B)
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 47 -


 

  (6)   Amount of interest on the amount mentioned under (5) above for a period from the first day of the relevant lease payment calculation period to the day on which Prescribed damages should be made multiplied by the interest rate of Euro Yen TIBOR stipulated in Clause 6 (3) of the list attached to the Subject Loan Agreement plus the following SD Tranche 2 spread (calculated on a pro-rate basis with 360 days a year).
 
      (SD Tranche 2 spread)
     
Long-term loan rating of SanDisk as of the day of this Contract by the designated rating agency is “BB-” or “Ba3” or below respectively;
  [*]% p.a.
Long-term loan rating of SanDisk is “BB” or “Ba2” respectively;
  [*]% p.a.
Long-term loan rating of SanDisk by the designated rating agency is “BB+” or “Ba1” or more respectively;
  [*]% p.a.
      The above changes shall be applicable only when formal public announcement by the designated rating agency is made 10 business days before the immediately prior delivery day or lease payment day.
  (Toshiba Tranche 1)
 
  (7)   Amount to be obtained by multiplying Subject property or the relevant unit component part purchase price of delivery day or lease payment day by the rate in the following
 
  (8)   Amount to be obtained by multiplying Subject property or the relevant unit component part purchase price of delivery day or lease payment day immediately prior to the day on which the relevant payment should be made by the rate in the following (C)
 
  (9)   Amount of interest on the amount mentioned under (8) above for a period from the first day of the relevant lease payment calculation period to the day on which Prescribed damages should be made multiplied by the interest rate of Euro Yen TIBOR stipulated in Clause 6 (3) of the list attached to the Subject Loan Agreement plus [*]% p.a. (calculated on a pro-rate basis with 360 days a year).
 
  (Toshiba Tranche 2)
 
  (10)   Amount to be obtained by multiplying Subject property or the relevant unit component part purchase price of delivery day or lease payment day by the rate in the following (D)
 
  (11)   Amount to be obtained by multiplying Subject property or the relevant unit component part purchase price of delivery day or lease payment day immediately prior to the day on which their payment should be made by the rate in the following (D)
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 48 -


 

  (12)   Amount of interest on the amount mentioned under above (11) for a period from the first day of the relevant lease payment calculation period until the day when Prescribed damages should be paid multiplied by the interest rate of Euro Yen TIBOR stipulated in the list attached to Subject Loan Agreement, Clause 6 (3) plus [*]% p.a. (calculated on a pro-rate basis with 360 days a year).
  (A)   Provided in loan certificate regarding the relevant individual transaction
 
  (B)   Provided in loan certificate regarding the relevant individual transaction
 
  (C)   Provided in loan certificate regarding the relevant individual transaction
 
  (D)   Provided in loan certificate regarding the relevant individual transaction
10   Payment method
         
(1)
  o   Lease payment, prescribed damages, purchase option exercise cost and reimbursement adjustment fee related to SD Tranche 1 and SD Tranche 2 shall be remitted to the following account of Subject SD borrower in cash or by account transfer by delegation of payment receipt stipulated in Article 7, Clause 4 (Lessee shall incur the bank transfer fee.).
 
       
 
      [*]
 
       
 
      [*]
 
       
 
      [*]
 
       
 
      [*]
 
       
 
  o   Lease payment, prescribed damages, purchase option exercise cost and reimbursement adjustment fee related to Toshiba Tranche 1 and Toshiba Tranche shall be remitted to the following account of Subject Toshiba borrower in cash or by account transfer by delegation of payment receipt stipulated in Article 7, Clause 4 (Lessee shall incur the bank transfer fee.).
 
       
 
      [*]
 
       
 
      [*]
 
       
 
      [*]
 
       
 
      [*]
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 49 -


 

  (2)   Other monies or in the event that proxy receipt for each Subject borrower stipulated in Article 7, Clause 4 is cancelled, they shall be remitted to the account of each Lessor or each subject lender in cash or by account transfer (Lessee shall incur the bank transfer fee.).
 
      [*]
 
      [*]
 
      [*]
 
      [*]
 
       
 
      [*]
 
      [*]
 
      [*]
 
      [*]
 
       
 
      [*]
 
      [*]
 
      [*]
 
      [*]
 
       
 
      [*]
 
      [*]
 
      [*]
 
      [*]
 
       
 
      [*]
 
      [*]
 
      [*]
 
      [*]
 
      [*]
 
      [*]
 
      [*]
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 50 -


 

11   Subject lender
(Subject SD lender)
IBJ Leasing Co., Ltd.
Sumisho Lease Co., Ltd.
Toshiba Finance Co., Ltd.
Agricultural and Forestry Central Bank
Bank of Yokohama, Ltd.
(Subject Toshiba lender)
Mizuho Corporate Bank Co., Ltd.
12   Subject borrower
(Subject SD borrower)
Lancelot Leasing Limited Company
(Subject Toshiba borrower)
Facile Princeps Limited Company
  13   Subject guarantor (SanDisk)
          SanDisk Corporation as a guarantor of debts related to SD Tranche 1 and SD Tranche 2 under this Contract (Toshiba )
          Toshiba Corporation a guarantor of debts related to Toshiba Tranche 1 and Toshiba Tranche 2 under this Contract
14   Subject Clerical Work Assignee
IBJ Leasing Co., Ltd.
15   Composition of transactions
  (1)   Lessor shall purchase each unit component part in each individual transaction from Lessee on delivery day based on the Subject Sales Contract and owns their ownership. SD Lessor and Toshiba Lessor share the ownership with a ratio of 1 and 1.
      (2) Based on its own option and discretion, SD Lessor shall sell claimable assets related to SD Tranche 1 under this Contract to Subject SD borrower on each delivery day in order to raise an amount worth about [*]% of property purchase price.
 
      (3) Based on its own option and discretion, Toshiba Lessor shall sell claimable assets related to Toshiba Tranche 1 under this Contract to Subject Toshiba borrower on each delivery day based on the Subject Toshiba Loan Sales Contract in order to raise an amount worth about [*]% of property purchase price.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

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  (4)   Based on its own option and discretion, Subject SD borrower shall be extended loans from Subject SD lender on each delivery day based on the Subject SD Loan Agreement in order to raise claimable assets purchase price.
 
  (5)   Based on its own option and discretion, Subject Toshiba borrower shall be extended loans from Subject Toshiba lender on each delivery day based on the Subject Toshiba Loan Agreement in order to raise claimable assets purchase price.
 
  (6)   SD Lessor and Toshiba Lessor shall raise an amount equivalent to about [*]% from their own funds.
 
  (7)   Lessor shall lease the relevant unit component part to Lessee on each delivery day based on this Contract. SD Tranche 1 and Toshiba Tranche 1 as well as SD Tranche 2 and Toshiba Tranche 2 shall share claimable assets with a ratio of 1 and 1 respectively.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 52 -


 

(Loan certificate, Appendix 2)
Ratio of each Tranche based on the Subject Lease Contract, Article 7, Item 1
         
SD Tranche 1
    [*]  
SD Tranche 2
    [*]  
Toshiba Tranche 1
    [*]  
Toshiba Tranche 2
    [*]  
Subject Lease Contract, Appendix 1, Item 3 lease payment calculation
                 
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
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[*]
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[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 2 -


 

Subject Lease Contract Appendix 1, Item 6 Purchase option exercise price
Amounts to be obtained by multiplying the property purchase cost by the following ratios. Provided, however, that the lease payment as of the relevant lease payment day shall be paid separately.
     
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
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[*]
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[*]
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[*]
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[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
Subject Lease Contract Appendix 1, Item 7 reimbursement adjustment fee
Amount to be obtained by multiplying the property purchase cost for Subject property or the relevant unit component part by the following ratios. Provided, however, that the lease payment as of the relevant lease payment day shall be paid separately.
     
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 3 -


 

Subject Lease Contract Appendix 1, Item 8 Repayment standard money
Amounts to be obtained by multiplying the property purchase cost for Subject property or the relevant unit component part by the following ratios.
     
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
[*]
  [*]
Subject Lease Contract Appendix 1, Item 9 Prescribed damages
                 
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
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  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
[*]
  [*]   [*]   [*]   [*]
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 4 -


 

[*]
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 5 -


 

Lease Contract Appendix 3
Permitted Liens
  (a)   Liens existing on the date hereof and Liens securing refinancing indebtedness in respect of secured indebtedness;
 
  (b)   Indebtedness represented by F, F&E Financing Agreements and/or Capitalized Lease Obligations by secured by the assets acquired pursuant to the respective capital lease (in the case of Capitalized Lease Obligations) or with the proceeds of the respective F, F&E Financing Agreements, so long as such Liens do not extend to any other assets;
 
  (c)   Working Capital Indebtedness up to 50% of SanDisk’s and its Subsidiaries accounts receivable and inventory balances (and refinancings thereof) may be secured by the assets of SanDisk and its Subsidiaries;
 
  (d)   any Lien arising by reason of (i) any judgment, decree or order of any court, so long as such Lien is adequately bonded and any appropriate legal proceedings which may have been duly initiated for the review of such judgment, decree or order shall not have been finally terminated or the period within which such proceedings may be initiated shall not have expired; (ii) security for payment of workmen’s compensation or other insurance; (iii) good faith deposits in connection with tenders, leases and contracts (other than contracts for the payment of money); and (iv) deposits to secure, or guarantees of, public, governmental or statutory obligations, or in lieu of surety or appeal bonds;
 
  (e)   Liens for taxes, assessments of other governmental charges not yet due or which are being contested in good faith and by appropriate proceedings by SanDisk or any of its Subsidiaries if adequate reserves with respect thereto are maintained on the books of SanDisk or any of its Subsidiaries, as the case may be, in accordance with GAAP;
 
  (f)   purchase money security interests arising in the ordinary course of business securing only the assets so acquired;
 
  (g)   statutory Liens of carriers, warehousemen, mechanics, landlords, laborers, materialmen, repairmen or other like Liens arising by operation of law in the ordinary course of business and consistent with industry practices and Liens on deposits made to obtain the release of such Liens if (i) the underlying obligations are not overdue for a period of more than 60 days or (ii) such Liens are being contested in good faith and by appropriate proceedings by

- 6 -


 

      SanDisk or any of its Subsidiaries and adequate reserves with respect thereto are maintained on the books of SanDisk or any of its Subsidiaries, as the case may be, in accordance with GAAP;
 
  (h)   Easements, rights-of-way, zoning and similar restrictions and other similar encumbrances or title defects, which, if they are incurred by SanDisk or any of its Subsidiaries after it acquires the property subject thereto, are incurred in the ordinary course of business and consistent with industry practices which, individually or in the aggregate, do not materially detract from the value of the property subject thereto (as such property is used or proposed to be used by SanDisk or any of its Subsidiaries) or interfere with the ordinary conduct of the business of SanDisk or any of its Subsidiaries, provided, that any such Liens are not incurred in connection with any borrowing of money or any commitment to loan any money or to extend any credit;
 
  (i)   Liens that secure Acquired Indebtedness (and refinancings thereof), provided, in each case, that such Liens do not secure any property or assets other than the property or asset so acquired;
 
  (j)   leases or subleases granted to other persons not materially interfering with the conduct of the business of SanDisk or any of its Subsidiaries or materially detracting from the value of the relative assets of SanDisk or such Subsidiary;
 
  (k)   Liens arising from precautionary Uniform Commercial Code financing statement filings regarding operating leases entered into by SanDisk or any of its Subsidiaries;
 
  (l)   A notice of intention filed by a mechanic, materialman, or laborer under applicable mechanic’s lien law, or a building contract filed by a contractor or subcontractor thereunder; and
 
  (m)   Other Liens as SanDisk and the Lessors may agree upon from time to time.
Related Definitions
“Acquired Indebtedness” means indebtedness of any Person (a) existing at the time such Person becomes a Subsidiary of SanDisk, including by designation, or is merged or consolidated into or with SanDisk or one of its Subsidiaries or (b) assumed in connection with the Acquisition of assets from such Person.
“Capital Lease Obligations” means any amount capitalized under any lease which is required under GAAP to be capitalized by SanDisk or one of its consolidated Subsidiaries.
“F, F&E Financing Agreement” means an agreement which creates a Lien upon any after-acquired tangible personal property and/or other items constituting operating assets, which are financed, purchased or leased for the purpose of engaging in or developing SanDisk’s and its Subsidiaries’

- 7 -


 

respective businesses.
“GAAP” means generally accepted accounting principals as in effect from time to time in the applicable jurisdiction.
“Lien” means any mortgage, charge, pledge, lien (statutory or otherwise), privilege, security interest, hypothecation or other encumbrance upon or with respect to any property of any kind, real or personal, movable or immovable, now owned or hereafter acquired by SanDisk.
“Person” means any individual, corporation, company, partnership, or governmental agency.
“Subsidiary” of any Person means (i) a corporation a majority of whose Voting Stock is at the time, directly or indirectly, owned by such Person, by such Person and one or more Subsidiaries of such Person or by one or more Subsidiaries of such Person, (ii) any other Person (other than a corporation) in which such Person, one or more Subsidiaries of such Person, or such Person and one or more Subsidiaries of such Person, directly or indirectly, at the date of determination thereof has a majority ownership interest, or (iii) a partnership in which such Person of a Subsidiary of such Person is, at the time, a general partner and has a majority ownership interest.
“Voting Stock” means all classes of equity interests then outstanding and normally entitled to vote in the election of directors (or similar body) of the issuer of such Voting Securities.
“Working Capital Indebtedness” means indebtedness incurred under a credit facility available to SanDisk or any of its Subsidiaries the proceeds of which are used for working capital or similar purposes.
[Reference Translation]
  (a)   Security interests existing at the time this Agreement is entered into, as well as security interests to guarantee refinancing debt related to the secured debt.
 
  (b)   Security interests established by an agreement to establish security interest and obtain operating assets (an agreement to obtain (including purchases and/or leases) operating assets after the execution of this Agreement in order to implement or develop each enterprise of SanDisk or affiliated companies ((i) any company owned directly or indirectly at that time by SanDisk through ownership of a majority of the voting shares (shares which have been issued by that time and which grant in the normal course of business the right to select the directors and similar positions of the issuer) by SanDisk alone, or by SanDisk and an affiliated company, or by a SanDisk affiliated company alone, (ii) any entity (excluding a corporation) in which SanDisk independently, or SanDisk and an affiliated company, or a SanDisk affiliated company alone owns a majority interest directly or indirectly on the determined date, or (iii) any partnership in which SanDisk or a SanDisk affiliated company is a general partner and owns a majority

- 8 -


 

      interest; similarly throughout this Article) executed to establish a security interest in those operating assets for the purpose of securing payment of the price of those assets), as well as security interests established in assets obtained pursuant to a capital lease (a lease or other financing required by SanDisk or an affiliated company under U.S. accounting standards (GAAP) for capitalization; similarly below) to secure the payment of the price of those assets.
 
  (c)   Security interests established in the assets of SanDisk or its affiliated companies to secure accounts receivable or inventory balances, as well as up to 50 percent of working capital debt (debt borrowed under a credit facility available for the use of SanDisk or its affiliated companies, and which is used for working capital or some similar purpse) to refinance either of the above.
 
  (d)   (i) Security interests arising pursuant to court judgment, decision, or order (provided, however, that this shall only apply if a bond sufficient for purposes of appealing the judgment, decision, or order has been paid, and all legal procedures properly instituted for obtaining a rehearing of the judgment, decision, or order have not been conclusively resolved, or the period for instituting such procedures has not ended); (ii) security interests to guarantee payment of worker’s compensation insurance and other insurance; (iii) good-faith deposit monies for deposits related to bids, leases, and contracting (excluding contracts paid in cash); and (4) deposits to secure a public duty, government obligation, or legal obligation, or appeal bond.
 
  (e)   Security interests to secure payable taxes, public charges, and other governmental levies, and security interests to secure taxes, public charges, and other governmental levies that SanDisk or its affiliated companies are disputing in good faith and pursuant to appropriate procedures. Provided, however, that this shall be limited to cases in which SanDisk or its affiliate d companies have set aside sufficient reserves on its books for these charges as appropriate pursuant to GAAP.
 
  (f)   Purchase money security interests arising in the normal course of business. Provided, however, that this shall be limited to the subject matter of this interest.
 
  (g)   Judicial liens for carriers, warehousemen, workmen, landlords, laborers, material suppliers, and mechanics, as well as other similar liens arising in the normal course of business by operation of law that are not contrary to

- 9 -


 

      standard industry custom, and any security interests for deposit monies to release any of these liens. Provided, however, that this shall be limited to situations (i) within 60 days since the payment of the underlying indebtedness has come due, or (ii) the lien is being disputed in good faith and according to the appropriate procedures by SanDisk or its affiliated companies and SanDisk or its affiliated companies have set aside sufficient reserves on their books for these charges as appropriate pursuant to GAAP.
 
  (h)   Easements, limitations on use, or other limitations or similar encumbrances or defect in rights that have, in the normal course of business in a manner not contrary to industry customs, encumbered property, but that do not, whether in whole or in part, reduce the actual value of the property and do not interfere with the normal operations of SanDisk or its affiliated companies. Provided, however, that these security interests shall exclude encumbrances related to the borrowing of money, the lending of money, or the granting of credit.
 
  (i)   Security interests to secure the debt of predecessors ((i) debt of an entity that has become a SanDisk affiliated company, or with which SanDisk or its affiliated companies have merged, where that debt existed at that time or (ii) debt acquired in relation to the acquisition of assets from some entity) or the refinancing of that debt. Provided, however, that these security interests shall be limited to those established in the assets of the predecessors.
 
  (j)   A lease or sublease of SanDisk or its affiliated companies’ assets that pose no actual obstacle to the operational activity of SanDisk or its affiliated companies. Provided, however, that such lease or sublease does not reduce the actual value of the assets.
 
  (k)   Security interests arising from the filing of a provisional Uniform Commercial Code financing statement related to an operating lease executed by SanDisk or its affiliated companies.

- 10 -


 

Lease Contract Appendix 6
Situational requirements at the time of return
     When Flash Partners Limited Company (hereinafter referred to as “Lessee”) returns the Subject property to Lessor (hereinafter referred to as “Lessors”) based on the provision of Clause 25 of the Lease, in addition to the provision of Clause 25 of the Lease the following requirements shall be satisfied.
     When Lessee returns the Equipment pursuant to Clause 25 of the Lease, Lessee shall satisfy the following conditions, in addition to the conditions specified in Clause 25 of the Lease.
     (A) Lessee shall no later than [*] days prior to the expiration or other termination of the lease (with regard to all but not less than all Equipment) provide, at its expense:
          1. a detailed inventory of the Equipment (including the model and serial number of each major component thereof), including, without limitation, all internal circuit boards, module boards, and software features
          2. a complete and current set of al manuals, blue prints, process flow diagrams, equipment configuration diagrams, operation, maintenance and repair records and other data (in Japanese and English) reasonably requested by Lessors concerning the configuration and operation of the Equipment, and
          3. a certification of the manufacturer or of a maintenance provider acceptable to Lessors that the Equipment (a) has been tested and is operating in accordance with manufacturer’s specifications together with a report detailing the condition of the Equipment, the results of such test (s) and inspection (s) and all repairs that were performed as a result of such test (s) and inspection (s), and (b) that the Equipment qualifies for the manufacturer’s used equipment maintenance program.
     (B) Upon the request of Lessors and at the expense of Lessee, Lessee shall, not later than [*] days prior to the expiration or other termination of the Lease make the Equipment available for on-site operational inspection by persons designated by Lessors who shall be qualified to inspect the Equipment in its operational environment.
     (C) At the expense of Lessee, all Equipment shall be cleaned and treated with respect to rust, corrosion and appearance in accordance with manufacturer’s recommendations and consistent with the best practices of dealers in used equipment similar to the Equipment. At Lessors’ option and at the expense of Lessee, Lessee shall (a) properly remove all Lessee installed markings which are not necessary for the operation, maintenance or repair of the Equipment; or (b) translate said markings to a language as specified by Lessors and reattach those markings.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

 


 

     (D) Lessee shall, at its expense, ensure all Equipment and Equipment operations conform to all applicable local, state, and federal laws, health and safety guidelines which may be in effect at the time of return, or as specified by Lessors.
     (E) Lessee shall, at its expense, provide for the deinstallation, packing, transporting, and certifying of the Equipment to include, but not limited to, the following: (1) the manufacturer’s representative or such other person acceptable to Lessors shall de-install all Equipment (including all wire, cable and mounting hardware) in accordance with the specifications of Lessors; (2) each item of Equipment will be returned with a certificate supplied by the manufacturer’s representative qualifying the Equipment to be in good condition and (where applicable) to be eligible for the manufacturer’s maintenance plan; the certificate of eligibility shall be transferable to another operator of the Equipment; this assignment shall extend to any software licensing or relicensing or other requirements of the manufacturer to enable an alternate user/purchaser of the Equipment to enjoy all rights and privileges as would the original purchaser of the Equipment directly from the manufacturer; (3) the Equipment shall be packed properly and in accordance to Lessors’ specifications; (4) upon sale of the Equipment to a third party, provide transportation in a manner and to locations specified by Lessors; (5) without limitation, as applicable, all Equipment shall be professionally de-contaminated and certified for removal and transport by appropriate authorities, in accordance with industry standards, and consistent with the mode of transport specified by Lessors; all internal fluids and/or gases shall be purged and properly disposed of, any applicable reservoirs etc. shall be secured in accordance with manufacturers recommendations and in accordance with all applicable laws, rules, and regulations.
     (F) At the expense of Lessee all Equipment shall conform to or be modified to conform to established standards in Japan, the United States or Taiwan; including, but not limited to wiring codes, software, keyboards, control consoles, all fittings and lines for gas, water, exhaust; Equipment labeling i.e. (operational, warning, safety labels) all current operational and service manuals. At the expense of Lessee accommodation of power requirements different from where originally shall be provided including but not limited to step-up/step-down transformers shall be fitted by original manufacturer or by certified party in compliance with manufacturers specifications.
     (G) All tariffs, duties, taxes, import/export fees, bonding fees, bonded warehousing fees, licenses, permits, approvals, permissions, and/or freight forwarder fees without limitation shall be the responsibility of the Lessee.
     (H) Lessee shall, at its expense, obtain and pay for a policy of transit insurance for the redelivery period in an amount equal to the replacement value of the Equipment and Lessors shall be named as the loss payee on all such policies of insurance;
     (I) Lessee shall, at its expense, provide insurance and safe, secure storage for the Equipment for a period specified by Lessors after expiration of the Lease at locations acceptable to Lessors which shall not exceed three (3) years from the return of the Equipment;

- 2 -


 

     (J) With regard to any Equipment that has been modified or reconfigured by the Lessee, at Lessors’ options, Lessee shall, at its expense: (a) return or restore the Equipment to its original configuration, as specified by the manufacturer, or (b) make available for a period of [*] days following successful re-installation and test runs, as required, any engineering and technical personnel necessary for the training of personnel with respect to the operation, maintenance and repair of the Equipment (said engineering and technical personnel will be made available by Lessee for an additional [*] day period for consultation regarding the operation of the Equipment);
     (K) Lessee shall, at its expense, allow Lessors the right to attempt resale of the Equipment from the Toshiba’s Yokkaichi facility with the Lessee’s full cooperation and assistance, for a period of [*] days from the Lease expiration. Lessee will allow Lessors to show prospective buyers the Equipment while it is operational during the [*] days from the Lessee’s notification of its intent to return the Equipment and the Lease expiration date. Lessee shall, at its expense, provide safe, secure storage for Equipment if requested by Lessors for a [*] period. If an equipment auction is necessary, Lessors should be permitted to auction the Equipment on-site.
 
*Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

- 3 -

EX-21.1 5 f18180exv21w1.htm EXHIBIT 21.1 exv21w1
 

EXHIBIT 21.1
SUBSIDIARIES OF THE REGISTRANT
1)   SanDisk Limited, a Japanese company
 
2)   SanDisk GmbH, a German company
 
3)   SanDisk Israel 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 YK, 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

EX-23.1 6 f18180exv23w1.htm EXHIBIT 23.1 exv23w1
 

EXHIBIT 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-99214, 333-32039, 333-83193, 333-85320, 333-109186, 333-63076, 333-112139, 333-126157, and 333-131097) 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, and Special Stock Option Plan, and SanDisk Corporation 2005 Stock Incentive, 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, and the Matrix Semiconductor, Inc. 2005 Stock Incentive plan of SanDisk Corporation of our reports dated March 8, 2006, with respect to the consolidated financial statements of SanDisk Corporation, SanDisk Corporation 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 this Annual Report (Form 10-K) for the year ended January 1, 2006.
         
     
  /s/ Ernst & Young LLP    
     
     
 
San Jose, California
March 8, 2006

EX-31.1 7 f18180exv31w1.htm EXHIBIT 31.1 exv31w1
 

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 fiscal year ended January 1, 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: March 15, 2006
         
     
    /s/ Eli Harari    
    Eli Harari   
    Chief Executive Officer   
    (Principal Executive Officer)   

EX-31.2 8 f18180exv31w2.htm EXHIBIT 31.2 exv31w2
 

         
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 fiscal year ended January 1, 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: March 15, 2006
         
     
    /s/ Judy Bruner    
    Judy Bruner   
    Chief Financial Officer   
    (Principal Financial Officer)   

EX-32.1 9 f18180exv32w1.htm EXHIBIT 32.1 exv32w1
 

         
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 on Form 10-K for the fiscal year ended January 1, 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
Chief Executive Officer
(Principal Executive Officer)
March 15, 2006
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 10 f18180exv32w2.htm EXHIBIT 32.2 exv32w2
 

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 on Form 10-K for the fiscal year ended January 1, 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
Chief Financial Officer
(Principal Financial Officer)
March 15, 2005
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.

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