UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Commission ~~File No.~~file number: 0-26734

SANDISK CORPORATION

(Exact name of ~~Registrant~~registrant as specified in its charter)

(Registrant’s telephone number, including area ~~code:~~code)

~~(408) 542-0500~~(Former name, former address and former fiscal year, if changed since last report)

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

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

Large accelerated filer þ NoAccelerated filer o Non-accelerated filer o

DOCUMENTS INCORPORATED BY REFERENCE

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 ~~under “Factors That May Affect Future Results”~~in “Risk Factors” in Item 71A 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®~~“SanDisk^®,” “we,” “our,” and “us” collectively refer to SanDisk Corporation, a Delaware corporation, and its subsidiaries. All references to years or annual periods are ~~reference~~references to our fiscal years, which consisted of 52 weeks in ~~2002 and 2003 and~~2005, 53 weeks in ~~2004.~~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 ~~card products~~devices used infor a wide variety of consumer ~~electronics.~~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 flash storage card products enable mass-market adoption of digital cameras, feature phones and other digital consumer devices. Our products include flash cards, Universal Serial Bus, or USB, flash drives and digital audio players.

Our Strategy. Our strategy is to identify and develop current and emerging mass consumer markets for flash storage ~~card~~ products and ~~to manufacture~~through our vertical integration supply strategy sell in high volumes ~~and sell~~ 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 ~~2002~~2004 to ~~2004,~~2005, we increased the number of megabytes sold ~~nine fold,~~by 166% in large measure due to a decrease of ~~63%~~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 ~~$493 million in 2002 to~~ $1.6 billion in ~~2004.~~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.,~~Industries, Ltd., or Matsushita, which owns the Panasonic brand, and a subsidiary of Toshiba Corporation, or Toshiba, we launched the Secure Digital card, or SD^tm card, which is currently the most popular form factor of flash storage cards. We followed that effort by working with mobile network operators ~~such as NTT DoCoMo~~ and handset manufacturers ~~such as NEC and Panasonic~~ to develop the miniSD^tm card and ~~TransFlash~~microSD^tm, card, an even smaller form factor memory ~~cards.~~card. Our ~~market driving~~market-driving efforts now include investment in the U3^tm ~~initiative, in~~platform, with which software developers ~~will be enabled to~~can transform USB drives from a simple mass storage device to a platform foron-the-go computing. ~~While we continue to serve mass markets, we~~We are ~~broadening our product offering to include system solutions that add value~~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 becontribute 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 PRO^tm 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 TransFlash^tm in collaboration with Motorola, Inc., or Motorola. We plan to continue to work with leading companies in mobile

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 ~~$125~~approximately $195 million in ~~2004.~~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, ~~manufacturing~~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 ~~a very~~an important factor in our ability to reduce the cost of our flash memory. ~~Our~~We have an extensive patent portfolio ~~consists of over 279 issued patents and~~that has been licensed by ~~four~~three of the ~~five~~four largest semiconductor ~~companies.~~companies based on revenues. Our license and royalty revenues over the last three years cumulatively were over ~~$320~~$511 million.

We have partnerships with key participants in the markets for feature phones, such as camera phones and MP3 phones, as well as other digital consumer devices. 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 PRO^tm format with Sony Corporation, or Sony, worked with Canon, Inc., or Canon, to co-found CompactFlash®, worked with Matsushita and a subsidiary of Toshiba to co-found the SD card, and with Nokia Corporation, or Nokia, and Siemens A.G., or Siemens, to co-found MultiMediaCard^tm, or MMC. We co-developed miniSD with NTT DoCoMo, Inc., Toshiba and Matsushita and pioneered TransFlash in collaboration with Motorola, Inc., or Motorola. We plan to continue to work with leading companies in mobile communications and digital consumer devices to find additional ways for flash storage card products to enable proliferation of those technologies.

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 atake-or-pay basis, to purchase ~~50 percent~~50% of the output of the ventures at manufacturing cost plus amark-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 designin-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. Our finished goods are fulfilled either by direct shipment to OEMs, like Sony Ericsson Mobile Communications Japan, Inc., or Sony Ericsson, or through regional fulfillment centers that ship to our retail customers.

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 ~~cover~~sell to other ~~retailers.~~retailers and dealers. We also are ~~growing our~~expanding a separate network of distributors and retail locations specifically focused on the ~~cellular~~mobile phone market. ~~The combined effect of these channels is over 100,000~~There are now more than 150,000 worldwide retail storefronts where consumers may purchase SanDisk products. We ~~have long standing relationships with manufacturers representatives~~also sell directly and ~~with industrial~~through distributors, ~~like Arrow Electronics, Inc. and Bell Microproducts, Inc. who focus on OEM opportunities. Our direct sales force calls on~~to key OEM accounts, ~~whether in the~~including mobile ~~communications field, like Motorola~~phone manufacturers and ~~NEC Corporation, or NEC, or~~digital camera manufacturers ~~of other digital consumer~~who include our products ~~like Canon and Nikon, Inc.~~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 onForm 10-K, quarterly reports onForm 10-Q, current reports onForm 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 at1-800-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.

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, ~~feature~~mobile phones, ~~personal digital assistants, or PDAs,~~gaming devices, personal computers and portable digital audio ~~players and digital video recorders, as well as industrial devices, like communication routers and switches.~~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 ~~and~~ vibration and ~~extreme~~ 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 ~~and~~with generally ~~has a~~ higher ~~cost~~costs per megabyte and lower storage capacities than ~~NAND flash. We are focused on NAND-based products.~~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 ~~four digital~~five consumer electronics markets: ~~digital cameras and other consumer devices, feature~~imaging, mobile phones, USB flash drives, gaming devices and digital audio players.


	•	~~Digital Cameras and Other Consumer Devices.~~Imaging. Shipments of digital cameras exceeded shipments of traditional film cameras in 2003 and 2004. The resolution quality of digital cameras has improved requiring flash storage cards with greater capacity. 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 ~~personal~~and to store digital data in ~~PDAs,~~many other devices including maps in global positioning ~~system,~~systems, or GPS, ~~receivers~~ and ~~music~~personal data in personal digital ~~audio players.~~assistants, or PDAs. Primary card formats for cameras and other digital devices include CompactFlash, or CF, Secure Digital, or SD, Memory Stick^tm and xD-Picture Card^tm.

	•	~~Feature~~Mobile Phones. ~~Feature~~Multimedia features in mobile phones ~~are phones that contain one or more multimedia features~~ such as camera functionality, audio/MP3, games, video or internet ~~access.~~access have been increasing in popularity. These features require ~~increasing~~additional storage capacity in the ~~phone. We~~phone and transferability of data to and from other devices. Today, we are a leading supplier of microSD, miniSD, SD, ~~TransFlash, MMC~~Memory Stick PRO Duo^tm, and reduced sized MMC, or ~~RS- MMC~~RS-MMC^tm, cards for removable storage in many ~~of these feature phones.~~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 ~~2004,~~2005, we announced ~~our collaboration with M-Systems Flash Disk Pioneers, Ltd., or M-Systems,~~products on the U3 platform, which is designed to make the USB drive a platform foron-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 aour first SanDisk digital audio player, ~~with embedded~~utilizing flash memory ~~and storage capacity~~for storage. Our current line of digital audio players includes a number of products from the Sansa^tm m200 series all the way up to ~~1 gigabyte or 32 hours of music.~~the flagship Sansa e200 series with both embedded and removable memory.

In July 2004, Semico Research Corporation estimated the size of the flash storage card market, measured in revenues, to be approximately $7.5 billion for 2004 and also estimated that the market would grow to $34.3 billion by 2008. In November 2004, Gartner, Inc. estimated the size of the USB Flash Drive market to be approximately $1.4 billion for 2004 and also estimated that the market would grow to $3.1 billion by 2008. In December 2004, IDC estimated the size of the worldwide portable flash digital audio player market would grow from approximately $2.7 billion for 2004 to $4.3 billion in 2008.

Our Sales Channels. Our products are ~~available~~delivered to end-users ~~at over 100,000~~through approximately 150,000 worldwide retail storefronts ~~around the globe~~ 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 on a private label basis.~~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 ande-commerce retailers, drug stores, supermarkets and convenience stores and selected retail distributors. Sales to retailers often involve complex selling arrangements, see “Item 7-Management’s Discussion and Analysis of Results of Operations and Financial Condition-Overview.”stores.


	We support our retail sales channels with both direct and indirect sales representatives. We have four 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 (headquartered in the Netherlands); Japan (headquartered in Yokohama); and non-Japan Asia/ Pacific (headquartered in Hong Kong), 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.

	We also sell product to smaller retailers through distributors. Our retail distributors include AVS Technologies, Inc., Duttenhofer GMBH & Co., Hama Corporation, Inc., Ingram Micro, Inc., Princeton Technology Corporation and Wynit, Inc., in addition to approximately 50 other distributors.

	During 2004, we began building 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 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

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 ~~digital camera manufacturers, mobile phone manufacturers and the~~ 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. ~~Our~~We support our OEM customers with both direct sales ~~force is supported in its sales efforts by more than 50~~representatives and independent manufacturers’ ~~representative firms. These manufacturers’ representative firms sell our products as well as products from other 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 ~~2004~~fiscal 2005 and ~~2003,~~fiscal 2004, our backlog was ~~$78.6~~$105.7 and ~~$78.7~~$78.6 million, respectively. The following table describes the distribution of our net product revenues (in millions):

2004 2003 2002

Retail $ 1,236.0 $ 632.1 $ 315.4
OEM $ 366.8 $ 350.2 $ 177.5


	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 ~~2003~~ and ~~2002,~~2003, revenues from our top 10 customers and licensees accounted for approximately ~~55%~~50%, ~~48%~~55% and ~~45%~~48% of our revenues, respectively. In ~~each~~2005, Best Buy accounted for 11% of ~~those years,~~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~~year-to-year has changed over time, and we expect this pattern to continue as our markets and ~~strategy~~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 ~~performance~~ and ~~technology.~~performance. Form factor generally correlates with our targeted end-market.

~~We make flash storage cards in three different performance grades:~~


	•	~~Our Standard Products.~~ Our products store information in non-volatile memory cells that do not require power to retain information. Our standard products are designed to tolerate fluctuations in shock, vibration, temperature and humidity. During read and write operations, our products use significantly less power than rotating disk drives. At all other times, our products require virtually no power. Depending upon the end product using our flash storage card products, this can translate into longer battery life. Our products utilize sophisticated error detection and correction algorithms to provide data reliability and endurance. We believe that the read and write data rates of our products meet or exceed the read and write data rates required today by the majority of consumer and industrial/communications applications.

	•	~~SanDisk Ultra®~~~~II Products.~~ SanDisk Ultra II products are a line of high-speed CompactFlash, or CF, SD and Memory Stick PRO cards specifically designed for use in high-performance digital cameras and feature phones. This product line is targeted at advanced photographers who require high-speed cards to quickly shoot many high resolution images. Our Ultra II cards feature minimum sustained write speeds of 9 megabytes per second.

	•	~~SanDisk Extreme~~^tm~~Products.~~ SanDisk Extreme products are a comprehensive line of high-performance CF, SD and Memory Stick PRO cards designed to meet performance levels dictated by professional digital photographers, including the ability to withstand a wide range of temperature extremes. Our Extreme III CF and SD cards deliver minimum sustained write and read speeds of 20 megabytes per second. Our Extreme cards are designed to operate in a wide range of temperature from minus 25 to 85 degrees Celsius, making them ideal for harsh shooting conditions. All of our Extreme III products are also bundled with RescuePRO^tm~~, a software program to help recover photos/files that are accidentally deleted.~~

We make many form factors of removable data storage cards as well as USB flash drives and ~~TransFlash semi-removable cards. In addition, we recently introduced a line of~~ flash digital audio players. The principal form factors of our products are:


	•	CompactFlash. Our CF products are characterized by ~~small form factor, ruggedness, and low-power consumption.~~high performance. CF products are well-suited for a range of ~~small form factor~~ consumer applications, including digital still cameras ~~personal communicators~~ and audio recorders. CF cards are available in capacities ranging from 32 megabytes to 8 gigabytes. ~~Our CF family of products accounted for 22%, 34% and 44% of our product revenues in 2004, 2003 and 2002, respectively.~~

	•	~~SD Card.~~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. ~~Our SD card family of products accounted for 30%, 34% and 14% of our product revenues in 2004, 2003 and 2002, respectively.~~

	•	miniSD Card. The miniSD card is a smaller version of the SD card which leverages the ~~industry momentum and~~ feature-set of the standard SD card but is designed ~~into a format targeted at~~for small ~~feature~~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 ofSD-based consumer and telecommunications devices. Capacities range from 16128 megabytes to ~~512 megabytes.~~2 gigabyte.


	•	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.^tm Co-developed with Sony, the Memory Stick PRO product line is sold in capacities ranging ~~between 128~~from 64 megabytes to 24 gigabytes, depending on the format, and is used in digital cameras, digital video camcorders, ~~PDAs~~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^tm line of products, as well as built-in MagicGate^tm 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®~~Cruzer^®USB Flash Drives.  Our Cruzer USB flash drives are available in capacities ranging from ~~128~~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~~flash drive made from titanium and other metals. ~~The Cruzer Titanium is one of the fastest performing USB Flash Drives on the market and is available in 512 megabyte and 1 gigabyte capacities.~~ In conjunction with M-Systems, Inc., or M-Systems, we ~~are developing~~developed the U3 ~~as a new~~^tm platform for USB ~~drives. Our USB flash drive family of products accounted for 14% of our product revenues in 2004.~~
• ~~RS-MMC.~~ ~~Our RS-MMC~~drives, which is designed for use in small Nokia, Samsung or Siemens mobile phones. It is about half the size of a standard MultiMediaCard and has the same simple low power interface. This allows the RS-MMC to be used with an extender in a full-size MMC slot.
• ~~TransFlash.~~ TransFlash, introduced in 2004, is an ultra-small removable flash memory storage format. TransFlash is 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, personal organizers, multimedia message service, email and voicemail capabilities. TransFlash 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.on-the-go computing.

• XD-Picture ~~Card~~Card..^tm  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 ~~for the most portable device~~ and is compatible with all xD cameras. The xD-Picture Card is available in capacities ~~that range~~ranging from 64 megabytes to ~~512 megabytes.~~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.

~~We also utilize branding to differentiate our card products. For example, our line of Shoot & Store~~^tm card products are inexpensive, consumable flash memory cards currently offered in approximately 50-picture (32 megabytes at one mega pixel resolution) and approximately 100-picture (64 megabytes at one mega pixel resolution) sizes. Shoot & Store card products are standard cards available in CF, SD and Memory Stick PRO formats. This line is offered primarily through supermarkets, convenience stores and drug stores.

We also offer a broad line of memory card readers, which provide a fast, convenient way to transfer data between our memory card products and a personal computer through a USB connection. The SanDisk Photo Album rounds out our accessory line and provides users with a very economical and simple way to view digital photographs and multi-media slide shows on a television.

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 andease-of-use.

To achieve compatibility with various electronic platforms regardless of the host processors or operating systems used, we developed new capabilities in flash memory chip design and created intelligent controllers. We

also developed an architecture that can leverage advances in process technology designed for scaleable, high-yielding, cost-effective and highly reliable manufacturing processes. We design our products to be compatible with industry-standard interfaces used in standard operating systems for personal computers, ~~feature~~mobile phones, ~~and smart phones, PDAs~~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 ~~$63.2 million in 2004,~~ 2003, ~~and 2002,~~ 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 7-Factors That May Effect Future Results-We may be unable to protect our intellectual property rights, which would harm our business, financial condition and results of operations.~~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 ~~2004,~~2005, we owned or had ~~exclusive~~ rights to ~~approximately 279~~349 United States patents, ~~approximately 165~~212 foreign patents, ~~approximately 297~~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 ~~currently~~ have various patent ~~license agreements~~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,~~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 ~~wafers~~chips for the memory components and ~~the~~ controller components. The majority of our memory is supplied from ~~the~~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.” ~~To a lesser extent, we source~~We purchase non-captive memory ~~on a foundry basis~~supply primarily from Renesas and Samsung. We are guaranteed ~~supply~~a percentage of ~~percentages of~~the total output byof 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 ~~and purchase from UMC~~ on a purchase order basis. See ~~“Item 7-Factors That May Affect Future Results-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.~~Item 1A, “Risk Factors.”

• Testing and Assembly. We sort and test our wafers at Toshiba in Yokkaichi, Japan, and ~~United Test Center, Inc.,~~Ardentec Corp. in Taiwan. Our tested wafers are then shipped to our third-party memory assembly subcontractors, including StatsChipPAC Ltd., or StatsChipPAC, in China, ~~and~~ 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 ~~Center, ASE Group~~ and ~~DataFab Systems, Inc.~~Assembly Center, in Taiwan, and ~~StatsChipPAC and~~Beautiful Enterprise Co., Ltd., DataFab, Flextronics International, Ltd., or


		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 7-Factors That May Affect Future Results-We depend on third-party subcontractors and our business could be harmed if our subcontractors do not perform as planned.~~Item 1A, “Risk Factors.”

Ventures ~~With~~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~~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 ~~owns~~own 50.1% of FlashVision. FlashVision’s funding takes the form of permanent capital ~~(38~~(37.8 billion Japanese yen, or approximately $321 million based upon the exchange rate at January 1, 2006, in total) and loans ~~(funded~~from Toshiba and us, funded one-half by each owner) from Toshiba and us. At the end of 2004, our loans to FlashVision were 3.6 billion Japanese yen and we are committed to fund an additional 7.0 billion Japanese yen in 2005. 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.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.~~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 ~~was 23.1 billion Japanese yen~~ at the end of ~~2004.~~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. ~~FlashVision’s current~~By the end of 2005, FlashVision successfully transitioned the majority of its production ~~ramp plan contemplates a technology transition~~ from 90-nanometers to ~~70-nanometers in 2005.~~70-nanometers. FlashVision purchases wafers from Toshiba and sells wafers to Toshiba and to us at manufacturing ~~cost.~~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 ~~expansion of FlashVision’s flash memory manufacturing capacity~~equipment purchases for FlashVision and to repay loans from Toshiba and us. We and Toshiba are each committed to take ~~50 percent~~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 ~~that are currently working on the 70-nanometer designs.~~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 asin Item 8 ~~and the common R&D participation agreement which is an exhibit to~~of this report. ~~That agreement should be read carefully in its entirety in order to more fully understand the details of our obligations.~~

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 ~~new~~ wafer fabrication facility, Fab 3, at its Yokkaichi Operations. Flash Partners ~~will purchase and pay to install~~purchases semiconductor manufacturing equipment for Fab 3, which produces 300-millimeter NAND flash wafers. Toshiba began production for Flash Partners in Fab 3.3 in the third quarter of fiscal 2005 and expects to achieve 30,000 wafers per month by March 2006. Flash Partners has ~~specified~~committed to a plan ~~for ramping~~to ramp production to ~~62,500 300-millimeter~~70,000 wafers per month ~~over~~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 ~~period starting in 2005 and ending in 2008. Toshiba and~~portion has already been incurred. Of this amount, we are ~~currently committed~~obligated to fund ~~Flash Partners infrastructure up to a total of 15,000 wafers per month in 2005~~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 ~~2006, which may be increased to meet market demand.~~Leaseback” below.

	•	Capitalization and Related Matters. We own 49.9% of Flash Partners and Toshiba ~~owns~~own 50.1% of Flash Partners. Flash Partners’ funding from its parents ~~will be~~is structured as a combination of permanent capital ~~(currently estimated at 40.0 billion Japanese yen in total)~~ and loans ~~(funded~~from us and Toshiba, funded one-half by each owner) from us and Toshiba. As of January 2, 2005, we estimate our minimum funding commitment to be approximately 55 billion Japanese yen, of which we believe 25 billion Japanese yen will be satisfied with the portion of Flash Partners’ lease facility that we have guaranteed as described below.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 ~~intends to sell and leaseback from a consortium of financial institutions approximately one-half of its tools.~~ has entered into two equipment lease agreements as described below.


	•	In December 2004, Flash Partners entered into a master lease agreement with ~~these~~certain financial institutions providing for up to 5050.0 billion Japanese yen, or approximately $424 million based upon the exchange rate at January 1, 2006, of original lease obligations. ~~There were no amounts outstanding under the~~As of January 1, 2006, Flash Partners had drawn down this entire master lease ~~agreement at the end of 2004.~~facility. We and Toshiba have each guaranteed, on a several basis, 50% of Flash Partners’ obligations under the master lease agreement. ~~Flash Partners will draw individual tranches under the lease agreements during 2005 and each individual draw will have a four-year or five-year term as agreed by Flash Partners and the lessors.~~ Lease payments are due ~~quarterly.~~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,~~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 from90-nanometers to 70-nanometers ~~and~~ to 55-nanometers. Flash Partners ~~currently plans~~purchases wafers from Toshiba and sells wafers to ~~deliver its first production wafers in the second half of 2005.~~us and Toshiba ~~employees will operate~~at a price equal to manufacturing cost plus a mark-up. Toshiba operates Fab 3, and we have ~~assigned a number of~~ our employees ~~in Japan~~assigned to work in Fab 3. The cost of the ~~wafer production facility.~~wafers that Flash Partners ~~will reimburse~~purchases from Toshiba ~~for its~~includes Toshiba’s costs of running Fab 3 and ~~for~~ 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


		protection from operational incidents. We and Toshiba are each committed to take ~~50 percent~~50% of Flash Partners’ wafer output, with each company specifying the type of wafer

in its allocation. ~~Flash Partners will sell wafers to us and Toshiba at a price equal to manufacturing cost.~~


		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.

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 ~~in parallel~~ on the70-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 asin Item 8 ~~and the common R&D participation agreement which is an exhibit to~~of this report. ~~That agreement should be read carefully in its entirety in order to more fully understand the details of our obligations.~~

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. ~~See “Item 7-Factors That May Affect Future Results-We~~We face competition from numerous ~~manufacturers and marketers of products using~~ 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 ~~and alternative technologies, and if we cannot compete effectively, our results of operations and financial condition will suffer.~~technologies. See Item 1A, “Risk Factors.”

Our Key Competitive Advantages. We believe our key competitive advantages in NAND flash products include:


	•	~~Our~~our intellectual property ownership, in particular our patent claims and manufacturing know-how over MLC, provides a cost advantage to ~~ourselves~~us and Toshiba;

	•	~~Through~~through the ventures with Toshiba, we benefit from Toshiba’s manufacturing and research and development experience and expertise;

	•	Wewe 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~~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, ~~Technology, Inc., or Micron,~~ and ~~ST Microelectronics~~STMicroelectronics N.V., or ~~ST Micro,~~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, ~~Micron,~~ 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, ~~Simple Technology,~~SimpleTech, Inc., Sony, Toshiba and Viking Components, Inc., or Viking Components.

~~MP3~~Digital Audio Players. Our ~~new~~ 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, ~~Rio Digital Networks North America, Inc., or Rio,~~ and Samsung.

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,~~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 ~~2, 2005,~~1, 2006, we had ~~876~~1,083 full-time employees, including ~~340~~450 in research and development, ~~131~~167 in sales and marketing, ~~180~~208 in general and administration and ~~225~~258 in operations. None of our employees ~~are~~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, ~~2005)~~2006):


Name	Age			Position

Eli Harari		5960	President, Chief Executive Officer and Director
Sanjay Mehrotra		4647	Executive Vice President and Chief Operating Officer
Nelson Chan		4344	Executive Vice President and General Manager, Consumer and Handset Business
Judy Bruner		4647	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 ~~is currently Executive Vice President and Chief Operating Officer. Mr. Mehrotra~~ has more than 2425 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~~Electrical Engineering and ~~computer sciences~~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

~~Mr. Chan held marketing~~

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 and a board member of the MMCA. He~~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.~~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.

~~Market For Our Common Stock and Related Stockholder Matters~~

~~Unregistered Sales of Equity Securities~~

~~Equity Compensation Plans~~

~~SANDISK CORPORATION SELECTED FINANCIAL DATA~~

~~Critical Accounting Policies & Estimates~~

~~Results of Operations~~

~~Liquidity and Capital Resources~~

~~Contractual Obligations and Off Balance Sheet Arrangements~~

~~Impact of Currency Exchange Rates~~

~~Impact of Recently Issued Accounting Standards~~

~~Factors That May Affect Future Results~~


	•	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 ~~expire or our licensees reach their royalty payment caps;~~and key patents expire;

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

	•	~~continued development of new markets and products for NAND flash memory;~~

	•	~~timing and volume of wafer production from our Flash Partners venture and costs associated with the Flash Partners’ facility;~~

	•	increased purchases of flash memory products from our non-captive sources, ~~that may affect~~which typically have higher costs than our ~~gross margins;~~captive sources;

	•	difficulty in forecasting and managing inventory levels; particularly, building a large inventory of unsold product due to ~~non-cancelable~~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, ~~other fixed assets,~~ equity investments and ~~prepaid wafer credits;~~other assets;

	•	expensing of ~~share based~~share-based compensation;

	•	adverse changes in product and customer mix;

	•	terrorist attacks, governmental responses to those attacks and natural disasters; ~~and~~

	•	changes in general economic ~~conditions.~~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 ~~55%~~50%, ~~48%~~55% and ~~45%~~48% of our total revenues during the fiscal years of 2005, 2004 ~~2003~~ and ~~2002,~~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~~year-to-year as the market demand for our customers’ products changes. Additionally, our license and royalty revenues may decline in the future as our existing license agreements expire, caps are reached or rates change.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 ~~distributor~~our distributors’ customers, in the case of sales to distributors. If our distributors and retailers are not successful in this market, ~~there~~we could beexperience 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 ~~protections~~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

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 ~~declines,~~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 ~~a particular~~the OEM choosing our products over those of our competitors and on the OEM’s ability to create, introduce, market and sell ~~their~~these products successfully in ~~their~~its respective markets. Should our OEM customers be unsuccessful in selling their current or future products ~~which~~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 ~~vast~~ majority of our revenue from the digital camera market. ~~As this~~This market ~~begins~~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. ~~Specifically, one of~~Furthermore, in 2005, our revenue from the ~~new~~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 ~~that we are focused on is the handset market in which feature phones are increasingly being designed to utilize NAND~~for flash memory ~~cards.~~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. ~~We cannot assure you~~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 ~~our~~consumers will adopt memory cards used for storing songs, images and other content. Our new products ~~will~~may not gain market acceptance ~~or that~~and we ~~will~~may not be successful in penetrating the new markets that we target, such as ~~the~~handsets, digital audio ~~player market~~players or ~~the consumable~~pre-recorded flash ~~market with our Shoot and Store products.~~memory cards. As we introduce new standards ~~and new products,~~or technologies, such as TrustedFlash, it ~~will~~can take time for these new standards ~~and products~~or technologies to be adopted, for consumers to accept and transition to these new ~~products~~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. ~~We cannot assure you that any~~Any new applications, products, technologies or standards we develop ~~will~~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 ~~announced plans~~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

operations and financial condition. In addition, current and future competitors produce or could produce alternative flash memory technologies that compete against our NAND ~~MLC~~ flash memory technology.

Our primary semiconductor competitors ~~currently~~continue to include our historical competitors Renesas, Samsung and Toshiba. New competitors include Hynix, Infineon, Micron and ~~ST Micro, who~~STMicro, which began shipping NAND orNAND-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. ~~Additionally, manufacturers of NOR flash memory, such as Intel and Spansion, are attempting to use their flash memory for traditional NAND applications, both embedded and in data storage cards.~~

We compete with flash memory card manufacturers and resellers. These companies purchase, ~~(or~~or have a captive supply ~~of)~~of, flash memory components and assemble memory cards. These companies include, among others,Dane-Elec, ~~Manufacturing,~~ Delkin, ~~Devices,~~ 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 MMCmicro^tm that competes directly with our microSD mobile card. Lexar ~~introduced~~markets a line of flash cards bearing the Kodak brand name, which ~~creates significant competition for~~competes with our flash memory cards. ~~In addition, other companies, such as Matrix Semiconductor, have announced~~Our handset card products ~~or technologies that may compete with our Shoot and Store products. Our TransFlash product faces~~also face competition from embedded solutions from competitors including Intel, M-Systems and ~~Samsung who have announced similar form factors and from Advanced Micro Devices, Inc., Intel, Samsung and Sharp who have competing embedded solutions.~~Samsung. Our ~~new music~~digital audio players face competition from similar products offered by other companies, including Apple, Creative, iriver ~~Rio~~ 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.

~~Futhermore,~~

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;

	•	~~adequate manufacturing capacity;~~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 ~~can~~may not ~~assure you that we will~~ be able to successfully compete in the marketplace.

The semiconductor industry is subject to significant downturns that have harmed our business, financial condition and ~~our take-or-pay commitments to~~results of operations in the ~~ventures with Toshiba~~past and may ~~result~~do so in ~~losses.~~the future. The semiconductor industry is highly

cyclical and is characterized by constant and rapid technological change, rapid product obsolescence and price ~~decline,~~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 ~~the ventures with Toshiba would~~FlashVision and Flash Partners could harm our business and results of operations if ~~there was a downturn in the memory markets.~~our committed supply exceeds demand for our products. The adverse effects could include, among other things, significant decreases in our ~~pricing of products,~~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 ~~downturns~~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 ~~the~~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.~~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, ~~in 2004, more than one earthquake,~~earthquakes, as well as an unrelated power ~~outage,~~outages, have resulted in production line stoppage and loss of wafers in ~~Yokkaichi.~~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 ~~adverse~~ 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 ~~availability,~~supply, which could harm our business, financial condition and results of operations. For example, ~~in 2005, we expect to begin transitioning from 90-nanometer technology to 70-nanometer technology at FlashVision. If yields from~~if the production rampand/or yield of the 70-nanometer, 300-millimeter Flash Partners wafers dodoes not ~~improve~~increase as expected, we may not

have enough supply to meet demand and our cost competitiveness, business, financial condition and results of operations will be harmed.

We depend on our third-party subcontractors and our business could be harmed if our subcontractors do not perform as planned. We rely on third-party subcontractors for our wafer testing, IC assembly, packaged testing, product assembly, product testing and order fulfillment. From time to time, our subcontractors have experienced difficulty in meeting our requirements. If we are unable to increase the capacity of our current 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 ~~products,~~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 productionramp-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 ~~our FlashVision and~~the Flash Partners business ~~ventures in Japan~~venture and as we do so, we will make substantial capital investments and incur substantialstart-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 ~~FlashVision and~~ Flash Partners business ~~ventures~~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 andstart-up costs as a

result of the delay between the time of the investment and the time qualified products are manufactured and sold in volume quantities. For several quarters, we will incur initial design and development costs andstart-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~~condition.

~~Neither we nor Toshiba have operated 300-millimeter flash memory wafer manufacturing lines and there~~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 ~~to be~~ 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 ~~the current, mature~~ 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. Moreover, we have no experience in operating a wafer manufacturing line and we rely on Toshiba’s capability to operate and manage the Yokkaichi facilities. This reliance will increase when the Fab 3 facility commences operations. During the early stages of operating the new 300-millimeter wafer processing equipment, we expect the venture to generate a large number of test wafers and perform numerous process test splits that will increase our research and development expenses through most of 2005, prior to benefiting from any actual production output from Fab 3. We cannot assure you that Flash Partners’ facility ~~will~~may not perform as expected or ~~be ready for~~ramp to volume production on ~~time. Nor can we assure you that~~time, and the cost to equip the facility ~~will not~~may be significantly more than planned. Samsung, the world’s largest NAND flash memory manufacturer, already has experience manufacturing 300-millimeter wafers with ~~90-nanometer~~90- and 70-nanometer feature sizes. Also, Samsung is licensed under our patents to use MLC technology, which further enhances its manufacturing ~~capabilities.~~

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 ~~the end of 2004~~January 1, 2006 were ~~23.1~~17.7 billion Japanese ~~yen.~~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.

~~We have guaranteed up to 25~~

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’ obligations to third-party lessors.~~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 ~~any amounts~~ under ~~the~~this equipment lease facility ~~as of~~at the end of ~~2004, but intends to draw~~fiscal 2005; however, the entire ~~facility~~amount was drawn down in ~~2005.~~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~~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

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. AAlso, 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.

~~During periods~~ In addition, at times inventories may increase in anticipation of ~~excess supply in the market for our flash memory products,~~increased demand or as captive wafer capacity ramps. If demand does not materialize, we may ~~lose market share~~be forced to ~~competitors who aggressively lower their prices. Conversely, under~~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 ~~six-month~~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 aback-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 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, packaged memory final testing, product assembly, product testing and order fulfillment. 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 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.

We are exposed to foreign currency risks. ~~Many of our~~Our purchases of NAND flash memory from ~~our~~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 ~~United States~~U.S. dollar. Management of these foreign exchange exposures and the ~~hedging mechanisms~~foreign currency forward contracts used to mitigate ~~those~~these exposures is complicated and ~~we have limited experience in these activities. If~~if we do not successfully manage our foreign exchange exposures, our business, results of operations and financial condition ~~would~~could be ~~materially adversely affected.~~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, ~~Shenzen~~Shanghai and ~~Shanghai~~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

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.~~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 ~~counter sue~~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 a 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 ~~cannot assure you that we would~~may not be successful in redesigning our products, ~~or that~~ the necessary licenses ~~will~~may not be available under reasonable terms, ~~or that~~ our existing licensees ~~will~~may not renew their licenses upon expiration ~~or that~~and we ~~will~~may not be successful in signing new licensees in the future.

We have historically 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. We may periodically engage in litigation as a result of these indemnification obligations. Our insurance policies exclude coverage for third-party claims for patent infringement. Any future obligation to indemnify our customers or suppliers could harm our business, financial condition or results of operations.

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 ~~would~~may be costly, ~~and would~~may divert the efforts of our key ~~personnel.~~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 productsand/or substantial monetary damages, which if granted or awarded, could have a material adverse effect on our business, financial condition and results of operations.

Litigation is subject to inherent risks and uncertainties that may cause actual results to differ materially from our expectations. Factors that could cause litigation results to differ include, but are not limited to, the discovery of previously unknown facts, changes in the law or in the interpretation of laws, and uncertainties associated with the judicial decision-making process. If we receive an adverse judgment in any litigation, we could be required to pay substantial damagesand/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, ~~subject to,~~ 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 ~~counter-sue~~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 damagesand/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 ~~are required to pay significant monetary damages,~~or our suppliers are enjoined from selling any of our respective products or if we are required to develop new ~~technology~~technologies or pay significant monetary damages or are required to make substantial royalty payments, our business would be harmed.

Moreover, from ~~time-to-time~~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~~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 ~~Israel, China,~~and South ~~Korea and Japan.~~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 ~~results,~~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;


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

	•	imposition of additional duties, chargesand/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.

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. 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 provide 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 estimates resulting 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. Under estimation of our warranty and similar costs would have an adverse effect on our results of operations and financial condition.

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 andramp-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 isrecently 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.~~agreements, Tower may have to cease operations. If ~~Tower is unable to satisfy these requirements,~~this occurs, we will be forced to source our controllers from another supplier and our business, financial condition and results of operations may be ~~adversely effected.~~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.~~Tower, which could take three or more quarters to complete.

We have recognized cumulative losses of approximately ~~$44.0~~$53.6 million as a result of theother-than-temporary decline in the value of our investment in Tower ordinary shares, ~~$12.2~~$10.1 million as a result of the impairment in value on our prepaid wafer credits and ~~$1.2~~$1.3 million of losses on our warrant to purchase Tower ordinary ~~shares.~~shares as of January 1, 2006. Of the approximately ~~9.0~~10.2 million Tower ordinary shares we own, we ~~have~~ agreed not to sell approximately ~~6.3~~7.2 million shares ~~until~~at January 1, 2006. This restriction is no longer in effect in fiscal 2006; however, we do remain subject to certain restrictions on ~~or after~~the transfer of our Tower ordinary shares including certain rights of first refusal, and through January ~~29, 2006.~~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 ~~$20.4~~$12.9 million as of January ~~2, 2005,~~1, 2006, which would ~~adversely affect~~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

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 ~~whom~~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 ~~cannot assure you that we will~~may not be successful in hiring or retaining key personnel ~~or that any of~~and our key personnel ~~will~~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 ~~and FlashVision~~ for at least the next twelve ~~months,~~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,~~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

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 ~~controls,~~control, or if ~~these~~our internal ~~controls~~control over financial reporting ~~are~~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 ~~have~~has increased and will continue to increase our legal and financial compliance costs, and ~~have~~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 ~~controls~~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~~Sarbanes-Oxley Act of 2002, we have identified and will from time to time identify a number of deficiencies in our internal ~~controls~~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 ~~cannot assure you that we will~~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 ~~7A.~~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.


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 inducedand/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

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 ofnon-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 Case4-05CV45 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

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.

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., CaseNo. 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 a2-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.


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)		Includesother-than-temporary impairment charges of ($10.1) million, or ($6.4) million net of tax related to our investment in Tower.

(2)		Includesother-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)		Includesother-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)		Includesother-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 a2-for-1 stock split, in the form of a 100% stock dividend, effected on February 18, 2004.

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 theother-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 theother-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 a2-for-1 stock split, in the form of a 100% stock dividend, effected on February 18, 2004.


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 andstart-up and other production costs. We expect to continue sourcing both captive and non-captive flash memory.

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 thestart-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. Matrix3-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 protectionand/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.

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.

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.

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

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, another-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.

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,

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

$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

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 ~~2, 2005,~~1, 2006, a hypothetical 50 basis point increase in interest rates would result in an approximate ~~$2.8~~$2.6 million decline (less than ~~0.5%~~0.25%) in the fair value of ouravailable-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. ~~See “Factors That May Affect Future Results-We are exposed to~~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 ~~risks”~~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 ~~“Factors That May Affect Future Results-Because~~Note 5 to our consolidated financial statements included in Item 8 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.”this report.

Market Risk. We also holdavailable-for-sale equity securities ~~in equity investments~~ in semiconductor wafer manufacturing companies. As of January ~~2, 2005,~~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 ~~$2.0~~$2.7 million.

All of the potential changes noted above are based on sensitivity analysis performed on our financial position at January ~~2, 2005.~~1, 2006. Actual results may differ materially.


ITEM 8.	*FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA*

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


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

Not applicable.

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 inRules 13a-15(e) and15d-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 inInternal Controls — Integrated Frameworkpublished 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 ~~2, 2005.~~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 inis included atpage F-3.

Independent Registered Public Accounting Firm’s Attestation Report

The report required by this item is set forth atpage ~~F-3.~~F-2.

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 ~~2005~~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”

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 ~~“Investor Relations” under~~ “Corporate” and then on ~~“Corporate Governance.~~scroll down and click on “Business Conduct and Ethics.”

	•	Next, click on ~~“Code~~“SanDisk’s Worldwide Code of ~~Ethics.~~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 ofForm 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 ~~2005~~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 ~~2005~~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 ~~2005~~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 ~~2005~~2006 Annual Meeting of Stockholders, and is incorporated herein by reference.

PART IV


ITEM 15.	*EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ONFORM ~~8-K~~10-K*

~~(a) Documents filed as part of this report~~


(a)	~~1) All financial statements~~Documents filed as part of this report

1) All financial statements


Index to Financial Statements	Page

Reports of ~~Ernst & Young LLP,~~ 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-9~~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~~

2) Exhibits required by Item 601 ofRegulation S-K

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

SANDISK CORPORATION

INDEX TO FINANCIAL STATEMENTS AND RELATED REPORTS

REPORT OF ~~ERNST & YOUNG LLP,~~ 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 December 28, 2003,~~ and the related consolidated ~~income statements,~~ statements of income, stockholders’ equity, and ~~statements of~~ cash flows for each of the three years in the period ended January ~~2, 2005.~~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 ~~consolidated~~ 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 December 28, 2003,~~ and the consolidated results of their operations and their cash flows for each of the three years in the period ended January ~~2, 2005,~~1, 2006, in conformity with ~~accounting principles~~U.S. generally accepted ~~in the United States.~~accounting principles.

We also have ~~also~~ 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 ~~2, 2005,~~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 ~~15, 2005,~~8, 2006, expressed an unqualified opinion thereon.


	~~/s/ Ernst & Young LLP~~

/s/ Ernst & Young LLP

San Jose, California

March ~~15, 2005~~8, 2006

F-2

~~F-2~~

REPORT OF ~~ERNST & YOUNG LLP,~~ 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 ~~2, 2005,~~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 ~~2, 2005,~~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 ~~2, 2005,~~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 December 28, 2003,~~ and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended January ~~2, 2005~~1, 2006 of SanDisk Corporation and our report dated March ~~15, 2005~~8, 2006 expressed an unqualified opinion thereon.


	~~/s/ Ernst & Young LLP~~

/s/ Ernst & Young LLP

San Jose, California

March ~~15, 2005~~8, 2006

F-3

~~F-3~~

SANDISK CORPORATION

CONSOLIDATED BALANCE SHEETS

January 2, December 28,
2005 2003

(In thousands, except per
share amounts)
ASSETS
Current assets:
Cash and cash equivalents $ 463,795 $ 734,479
Short-term investments 859,175 528,117
Investment in foundries 20,398 36,976
Accounts receivable, net of allowance for doubtful accounts of $8,462 in 2004 and $4,882 in 2003 194,535 184,236
Inventories 196,422 116,896
Deferred taxes 83,150 70,806
Prepaid expenses, other current assets and tax receivable 62,653 53,394

Total current assets 1,880,128 1,724,904
Property and equipment, net 147,231 59,470
Notes receivable from FlashVision 35,413 —
Investment in foundries 14,377 40,446
Investment in FlashVision 178,681 169,185
Investment in Flash Partners 24,192 —
Deferred taxes 1,861 —
Deposits and other non-current assets 38,297 46,151

Total assets $ 2,320,180 $ 2,040,156

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable $ 82,974 $ 88,737
Accounts payable to related parties 48,115 45,013
Accrued payroll and related expenses 41,786 28,233
Income taxes payable 39,139 37,254
Research and development liability, related party 5,549 11,800
Other accrued liabilities 45,584 36,661
Deferred income on shipments to distributors and retailers and deferred revenue 90,307 99,136

Total current liabilities 353,454 346,834
Convertible subordinated notes payable — 150,000
Deferred revenue and other non-current liabilities 26,576 27,450

Total liabilities 380,030 524,284
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: 179,964,226 in 2004 and 160,914,000 in 2003 180 160
Capital in excess of par value 1,406,373 1,207,798
Retained earnings 520,240 253,624
Accumulated other comprehensive income 18,893 54,290
Deferred compensation (5,536 ) —

Total stockholders’ equity 1,940,150 1,515,872

Total liabilities and stockholders’ equity $ 2,320,180 $ 2,040,156


	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.

F-4

~~F-4~~

SANDISK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

~~CONSOLIDATED INCOME STATEMENTS~~

January 2, December 28, December 29,
2005 2003 2002

(In thousands, except per share amounts)
Revenues:
Product $ 1,602,836 $ 982,341 $ 492,900
License and royalty 174,219 97,460 48,373

Total revenue 1,777,055 1,079,801 541,273
Cost of product revenues 1,091,350 641,189 352,452

Gross profit 685,705 438,612 188,821
Operating expenses
Research and development 124,994 84,200 63,177
Sales and marketing 91,296 66,317 40,407
General and administrative 50,824 31,057 27,086

Total operating expenses 267,114 181,574 130,670

Operating income 418,591 257,038 58,151
Equity in income of business ventures 568 178 856
Interest income 20,363 8,865 8,675
Interest expense (5,949 ) (6,750 ) (6,700 )
Gain (loss) in investment in foundries (12,927 ) 3,746 (15,163 )
Recovery (loss) on unauthorized sale of UMC shares 6,193 (18,339 ) —
(Loss) in equity investment — (148 ) (2,700 )
Other (loss), net (3,639 ) (2,709 ) (3,140 )

Income before taxes 423,200 241,881 39,979
Provision for income taxes 156,584 73,022 3,739

Net income $ 266,616 $ 168,859 $ 36,240

Net income per share
Basic $ 1.63 $ 1.17 $ 0.26

Diluted $ 1.44 $ 1.02 $ 0.25

Shares used in computing net income per share
Basic 164,065 144,781 137,610

Diluted 188,837 171,616 142,460


	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.

F-5

~~F-5~~

SANDISK CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

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 30, 2001 136,928 $ 136 $ 580,295 $ 48,525 $ 46,423 — $ 675,379

Net income 36,240 36,240
Unrealized gain on available for sale securities 292 292
Unrealized loss on investments in foundries (89,728 ) (89,728 )
Translation gain 7,147 7,147

Comprehensive loss (46,049 )

Exercise of stock options for cash 944 1 2,759 2,760
Issuance of stock pursuant to employee stock purchase plan 438 1 2,776 2,777

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
Translation gain 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 )
Translation gain 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


									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.

F-6

~~F-6~~

SANDISK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

Fiscal Years Ended

2004 2003 2002

(In thousands)
Cash flows from operating activities:

Net income $ 266,616 $ 168,859 $ 36,240
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred taxes 9,326 2,152 (7,729 )
(Gain) loss on investment in foundries 12,927 (3,746 ) 15,163
(Recovery) loss on unauthorized sales of UMC shares (6,193 ) 18,339 —
Depreciation and amortization 38,862 22,952 21,321
Provision for doubtful accounts 4,581 1,400 1,795
FlashVision wafer cost adjustment (1,282 ) (1,613 ) 8,128
Other non-cash charges 3,764 3,143 2,952
Changes in operating assets and liabilities:
Accounts receivable (14,880 ) (104,550 ) (37,658 )
Inventories (79,526 ) (28,301 ) (33,314 )
Prepaid expenses and other current assets (246 ) 7,697 (5,217 )
Deposits and other assets 1,927 (4,116 ) 1,771
Accounts payable (6,298 ) 51,296 8,356
Accrued payroll and related expenses 13,472 16,543 6,411
Income taxes receivable/payable (11,950 ) 27,720 30,717
Other current liabilities, related parties (3,149 ) 29,104 (2,408 )
Other accrued liabilities 8,959 9,196 6,911
Deferred income on shipments to distributors and retailers and deferred revenue (15,489 ) 57,682 51,129
Other non-current liabilities 6,245 (1,225 ) 2,404

Total adjustments (38,950 ) 103,673 70,732

Net cash provided by operating activities 227,666 272,532 106,972

Cash flows from investing activities:

Purchases of short-term investments (1,147,142 ) (622,580 ) (377,690 )
Proceeds from sale of short term investments 810,111 327,457 246,417
Proceeds from sale of investments in foundries — 21,627 —
Release of restricted cash — — 64,734
Acquisition of property and equipment (125,842 ) (54,623 ) (16,638 )
Acquisition of technology license — (1,500 ) (606 )
Consideration paid in a business combination (9,061 ) — —
Notes receivable from FlashVision (33,564 ) — —
Investment in FlashVision — — 4,199
Investment in Flash Partners (23,129 ) — —
Investment in foundries (704 ) (11,001 ) (26,005 )
Proceeds from other sales 6,333 4,880 —

Net cash (used in) investing activities (522,998 ) (335,740 ) (105,589 )

Cash flows from financing activities:

Net proceeds from issuance of convertible subordinated notes — — 24,366
Issuance of common stock in public offering — 521,608 —
Issuance of common stock under employee programs 24,648 55,294 5,537

Net cash provided by financing activities 24,648 576,902 29,903

Net increase (decrease) in cash and cash equivalents (270,684 ) 513,694 31,286
Cash and cash equivalents at beginning of the year 734,479 220,785 189,499

Cash and cash equivalents at end of the year $ 463,795 $ 734,479 $ 220,785

Supplemental disclosure of cash flow information:

Cash paid for income taxes $ (159,436 ) $ (44,244 ) $ (10,076 )

Cash paid for interest expense $ (6,750 ) $ (6,750 ) $ (6,019 )

Non-cash financing and investing activities:

Conversion of subordinated notes $ 150,000 $ — $ —

Issuance of shares in a business combination $ 4,935 $ — $ —


	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.

F-7

~~F-7~~

Notes to Consolidated Financial Statements


Note 1:	Organization and Summary of Significant Accounting Policies

Organization and Nature of Operations. SanDisk Corporation (together with its subsidiaries, the Company) was incorporated in Delaware on June 1, 1988. The Company designs, develops 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 and fiscal 2003 and 2002 each consisted of 52~~ 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. ~~Certain reclassifications have been made to prior year’s amounts to conform to the current year’s presentation. (See Note 2-Accumulated Other Comprehensive Income (Loss).)~~ Share and equity amounts in the accompanying consolidated financial statements give retroactive effect to a2-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 ~~will~~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 ~~providing~~allowing price protectionand/or ~~allowing~~ a right of return and, therefore, the ~~product revenue~~sales and ~~associated~~related costs onof these transactions isare deferred until the retailers or distributors ~~sell~~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 in the accompanying consolidated income statements.~~revenues. The Company ~~records~~recognizes expenses related to sales commissions in the period in which they are ~~incurred.~~earned.

The Company earns license and royalty revenue under patent license agreements with several companies. The timing and amount of these payments can vary substantially from quarter to quarter, depending on the terms of each agreement and, in some cases, the timing of sales of products by the Company’s licensee.

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 ~~fees on a straight-line basis over the term of the license.~~

The Company has cross license arrangements that include a guaranteed access to flash memory supply but the Company does not have vendor specific objective evidence of the fair value of the intellectual property exchanged or supply guarantees received. The license fees under these arrangements are recognizedfee revenue on a straight-line basis over the life of the license. ~~Royalties are recognized when estimable. Revenue from sales of the flash memory supplied by the licensee is recognized as described above.~~

The cost of revenues associated

~~F-8~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

with patent license and royalty revenues was insignificant for each of the three years in the period ended January ~~2, 2005.~~1, 2006.

The Company records estimated reductions toof revenue ~~and trade-accounts receivable~~ for customer and distributor incentive programs and ~~incentive~~ 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 ~~upon management’s estimates~~on historical experience, the number of ~~these obligations.~~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 ~~when granted,~~ are either recorded as a reduction to revenue or as an addition to marketing expense ifin compliance withEITF 01-09,Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the ~~Company receives a separable identifiable benefit (like advertising placement) whose fair value is reasonably estimable from its customer.~~Vendor’s Products).

F-8

Notes to Consolidated Financial Statements — (Continued)

Share Based Compensation. The Company accounts for ~~share~~employee stock based compensation using the intrinsic value method under Statement of Financial Accounting Standards No. 123 ~~(SFAS~~(FAS 123),Accounting for Stock Based Compensation, as amended by Statement of Financial Accounting Standards No. 148 ~~(SFAS~~(FAS 148),Accounting for Stock Based Compensation — Transition and ~~Disclosure.~~Disclosure ~~See Note 3~~, and accordingly no expense has been recognized in the consolidated income statements for ~~detailed assumptions used by~~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 ~~to compute~~has not recognized any expense for the discount provided on the fair market value of ~~share-based~~the stock sold under our qualified non-compensatory employee stock purchase plan. The Company accounts for restricted stock awards ~~for purposes~~by recognizing compensation expense equal to the fair market value of ~~pro forma under SFAS 123.~~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 2, December 28, December 29,
2005 2003 2002

Net income as reported $ 266,616 $ 168,859 $ 36,240
Fair value method expense, net of related tax $ (39,550 ) $ (29,793 ) $ (22,990 )

Pro forma net income $ 227,066 $ 139,066 $ 13,250
Pro forma basic income per share $ 1.38 $ 0.96 $ 0.10
Basic income per share, as reported $ 1.63 $ 1.17 $ 0.26
Pro forma diluted income (loss) per share $ 1.23 $ 0.84 $ 0.10
Diluted income (loss) per share, as reported $ 1.44 $ 1.02 $ 0.25


	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 ~~evaluates~~estimates the collectibility of its accounts receivable based on a combination of factors. IfIn 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 ~~credit losses~~bad debts against amounts due to reduce the net recognized receivable to the amount ~~management~~it reasonably believes will be collected. For all other customers, the Company provides allowances for ~~credit losses~~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~~written-off through a charge to the allowance and a credit to accounts receivable. If circumstances change ~~(i.e.~~(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’s estimates of the recoverability of amounts due~~Company could ~~be reduced by a material amount.~~experience higher write-offs.

~~Deferred~~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 ~~against deferred tax assets if~~to the extent that the Company does not believe it is more likely than not that ~~such an amount~~it will ~~not be realized. The portion~~generate sufficient taxable income in future periods to realize the benefit of ~~the valuation allowance, associated with unrealized capital loss on investments in foundries is reflected in accumulated other comprehensive income.~~its deferred tax assets.

F-9

Notes to Consolidated Financial Statements — (Continued)

Foreign Currency. ~~Foreign operations (except equity investees) are measured using the United States dollar as~~The Company determines the functional ~~currency. Transactions between customers or vendors~~currency for its parent company and each of its subsidiaries by reviewing the ~~Company’s foreign operations~~currencies in which their respective operating activities occur. Transaction gains and losses arising from activities in other than the applicable functional currency are ~~remeasured~~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 ~~foreign~~ exchange rate in effect aton the ~~time of the transaction~~balance sheet date and ~~transaction gain or loss is~~are included in retained earnings. The Company evaluates its foreign currency exposures and may enter into hedges or other ~~income (loss)~~risk mitigating arrangements in the ~~accompanying consolidated income statements.~~future. Aggregate foreign currency transaction gains (loss) recorded to net income were ~~$1.8~~$(0.1) million, ~~$2.1~~$1.8 million and $2.1 million, in 2005, 2004 and 2003, ~~and 2002,~~ respectively. For those equity method investments where the investee’s functional currency is not the United States dollar, the investment amounts are translated using the foreign exchange rate at each balance sheet date. (SeeSee Note ~~2- Accumulated~~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.~~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 ~~and December 28, 2003~~ approximated their carrying value.

Management classifies the Company’s entire investment portfolio as available-for-sale at the time of purchase and periodically reevaluates such designation. Debt securities classified as available-for-sale are reported at fair value. Unrecognized gains or losses on available-for-sale securities are included in the other comprehensive income component of stockholders’ equity until their disposition. The cost Cost of securities sold is based on ~~the~~a specific identification method.

In determining if and when a decline in market value below cost of these investments isother-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 beother-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 ~~five~~ten years.

Equity Investments. The Company accounts for investments in equity securities of other entities under the cost method of accounting if ~~its investment~~investments in voting equity interests of the investee is less than 20%. The ~~Company accounts for these investments under 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 asavailable-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

~~F-10~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

to determine whether the Company is the primary beneficiary of the investee. If the Company ~~were~~is the primary beneficiary of a variable interest entity, the Company ~~would consolidate~~consolidates such entity and ~~reflect~~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

Notes to Consolidated Financial Statements — (Continued)

Inventories and Inventory Valuation. Inventories are stated at the lower of cost ~~(approximating~~ (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. ~~Inventory~~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~~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. ~~In 2004, the Company’s intangible asset balance increased as a result of goodwill and other intangibles acquired as part of an immaterial business combination.~~

Other ~~long-lived assets.~~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.

~~Warranties.~~Warranty Costs. The majority of the Company’s products ~~are warrantied for~~have a warranty ranging from one to five years. A provision for the estimated future cost ~~of performing~~related to warranty ~~obligations~~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

~~F-11~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

as incurred. Prepaid advertising expenses were approximately ~~$0.4~~$0.2 million and ~~$0.9~~$0.4 million at January 1, 2006 and January 2, 2005, ~~and December 28, 2003,~~ respectively. Advertising expenses were $15.2 million, $20.4 million and $5.0 million, in 2005, 2004 and ~~$3.4 million, in 2004,~~ 2003, ~~and 2002~~ respectively.

F-11

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. ~~The Company expects to adopt SFAS 123R in its third quarter~~In April 2005, the SEC amended the effective date of ~~2005, a transition period allowed under SFAS~~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 ~~with~~to the new accounting ~~standard. SFAS~~standard as the Company will use the modified prospective method. FAS 123R ~~will require~~requires the Company to recognize an expense based on the fair value of all ~~share-based~~share based payments to employees, including grants of options to buy shares of ~~its~~the Company’s common stock. ~~The Company~~Share based awards to employees is ~~unable to estimate~~calculated through the ~~effect~~use of ~~adopting SFAS 123R because the actual amount will be determined by reference to inputs to its~~ option pricing ~~model at~~models. These models require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the ~~time~~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 ~~future share based compensation awards.~~applying the fair value provisions of FAS 123. Adoption of ~~SFAS~~FAS 123R is expected to increase the Company’s operating expenses.

~~The~~

In May 2005, the FASB ~~adopted Statement of~~issued Financial Accounting Standards No. ~~151,~~154, or FAS 154,~~Inventory Costs, an Amendment to ARB~~Accounting Changes and Error Corrections. FAS 154 replaced Accounting Pronouncement Board Opinion No. 4320, or APB 20,Accounting Changes, ~~with an effective date of June 15, 2005. SFAS 151~~and Financial Accounting Standards No. 3, or FAS 3,Reporting Accounting Changes in Interim Financial Statements. FAS 154 requires that ~~abnormal amounts of idle facility expense, freight, handling costs, and spoilage~~a voluntary change in accounting principle be ~~recognized as current~~applied retrospectively with all prior period ~~charges and requires the allocation of fixed production overheads to inventory~~financial statements presented based on the ~~normal capacity~~application of the ~~applicable production facility. As permitted by SFAS 151,~~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 ~~SFAS 151 at the beginning of 2005~~this standard on January 2, 2006 and currently does not ~~expect~~anticipate that ~~its adoption~~it will have a material ~~adverse~~ effect on its ~~reported results of operations.~~financial statements or disclosures.


~~Note~~NOTE 2:	~~Balance Sheet Information~~BALANCE SHEET INFORMATION

~~Cash, Cash Equivalents and Short-Term~~Available-for-Sale Investments. ~~The Company’s unrestricted~~

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

Totalavailable-for-sale investments	$	1,666,706	$	—	$	(4,233	)	$	1,662,473

F-12

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

Totalavailable-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

Notes to Consolidated Financial Statements — (Continued)

The following table summarizes the fair ~~market~~ value asand gross unrealized losses of ouravailable-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 ofavailable-for-sale securities during the years ended January 1, 2006, January 2, 2005 and December 28, 2003 were ~~as follows (in thousands):~~immaterial.

January 2, December 28,
2005 2003

Cash and cash equivalents:
Cash $ 10,788 $ 12,660
Money market funds 139,124 501,876
Commercial paper 81,000 157,979
Government agencies 232,883 61,964

Total cash and cash equivalents $ 463,795 $ 734,479

Short-term investments:
U.S. government agency obligations $ 345,465 $ 101,725
Municipal notes/ bonds 286,220 335,102
Corporate notes/ bonds 73,930 42,290
Auction rate preferred stock 153,560 49,000

Total short-term investments $ 859,175 $ 528,117

Investments in foundries:
Marketable equity securities(a) 20,398 36,976

Total investments in foundries $ 20,398 $ 36,976

Total cash, cash equivalents and short-term investments $ 1,343,368 $ 1,299,572


~~(a)~~	Includes Investment in Foundries, short-term, which also includes a warrant to purchase ordinary shares of Tower Semiconductor Ltd.(Tower), with an approximate fair value of $0.1 million as of January 2, 2005 and $1.2 million as of December 28, 2003.

~~F-12~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

The total net unrealized loss on available-for-sale securities at January 2, 2005 was $1.8 million and includes an unrealized gain of $0.8 million on the Company’s investment in United Microelectronics Corporation (UMC) and deferred tax expense of $0.3 million, and $2.3 million of unrealized losses on short-term investments. The total net unrealized gain on available-for-sale securities at December 28, 2003 was $39.1 million and includes an unrealized gain of $4.1 million on the Company’s investment in UMC and $31.4 million on the Company’s investment in Tower and deferred tax expense of $3.2 million, and a $0.4 million unrealized gain on short-term investments. Gross realized gains and losses on sales of available-for-sale securities during the years ended January 2, 2005, December 28, 2003 and December 29, 2002 were immaterial. The cost (including amortized cost of debt instruments) of the Company’s available for sale securities was $1.32 billion and $1.26 billion on January 2, 2005 and December 28, 2003, respectively.

Debt securities at January ~~2, 2005 and December 28, 2003,~~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.

January 2, December 28,
2005 2003

Short-term investments:
Due in one year or less $ 554,440 $ 371,276
Due after one year through five years 304,735 156,841

Total(b) $ 859,175 $ 528,117


			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


~~(b)~~	~~Excludes Investment in Foundries, short-term.~~

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 29, 2002 $ 4,919 $ 1,795 $ (2,151 ) $ 4,563
December 28, 2003 $ 4,563 $ 1,400 $ (1,081 ) $ 4,882
January 2, 2005 $ 4,882 $ 4,581 $ (1,001 ) $ 8,462


			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 2, December 28,
2005 2003

Raw material $ 53,681 $ 12,265
Work-in-process 23,508 40,246
Finished goods 119,233 64,385

Total inventories $ 196,422 $ 116,896


	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

Notes to Consolidated Financial Statements — (Continued)

In 2005, 2004 ~~2003~~ and ~~2002,~~2003, the Company sold $12.4 million, $10.2 million ~~$16.3 million~~ and ~~$11.9~~$16.3 million, respectively, of inventory that had been fully ~~written off~~written-off in previous periods.

~~F-13~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

Property and Equipment. Property and equipment consisted of the following (in thousands):

January 2, December 28,
2005 2003

Machinery and equipment $ 213,043 $ 105,999
Software 29,229 19,193
Furniture and fixtures 2,781 3,726
Leasehold Improvements 8,958 7,495

Property and equipment, at cost 254,011 136,413
Accumulated depreciation and amortization (106,780 ) (76,943 )

Property and equipment, net $ 147,231 $ 59,470


	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 ~~$22.7 million~~ and ~~$21.1~~$22.7 million in fiscal 2005, 2004 ~~2003~~ and ~~2002,~~2003, respectively. Amortization expense of intangible assets and totaled $2.7 million, $0.8 million and $0.3 million in 2005, 2004 and ~~$0.2 million in 2004,~~ 2003, ~~and 2002,~~ respectively.

Warranties. ~~The~~Liability for warranty ~~liability~~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 29, 2002 $ 3,139 $ 3,304 $ (2,971 ) $ 3,472
December 28, 2003 $ 3,472 $ 5,694 $ (5,472 ) $ 3,694
January 2, 2005 $ 3,694 $ 14,790 $ (7,104 ) $ 11,380


			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 ~~debt issuance costs were being amortized over the term of the Notes using the effective interest method and the remaining $1.9 million was recorded as other expense at the time of conversion. The~~ Company amortized $2.6 ~~million, $0.9~~ million and $0.9 million of debt issuance costs in 2004 ~~2003~~ and ~~2002,~~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 ~~unrealized~~ gains and losses onavailable-for-sale marketable securities, including the short-term portion of the Company’s investments in UMC and Tower, and also includes currency translation adjustments related to operations denominated in local functional currencies, net of the related tax effects, for all periods presented (in thousands).

January 2, December 28, December 29,
2005 2003 2002

Net income $ 266,616 $ 168,859 $ 36,240
Unrealized gain (loss) on foundries(c) (38,216 ) 82,741 (89,728 )
Unrealized gain (loss) on available-for-sale securities (2,765 ) (622 ) 292
Translation gain on remeasurement(d) 5,584 8,037 7,147

Comprehensive income (loss) $ 231,219 $ 259,015 $ (46,049 )

~~F-14~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

~~(c)~~

Fiscal 2003 excludes a reversal of approximately $24.4 million in deferred tax expense included in prior periods as a component of accumulated other comprehensive income associated with UMC shares that were fraudulently sold in the third quarter of 2003 and approximately $8.9 million in a similar reversal of deferred tax expense previously included in accumulated other comprehensive income associated with the 35 million UMC shares that the Company disposed of in an authorized sale in the third quarter of 2003.


~~(d)~~		~~In accordance with Statement of Financial Accounting Standards No. 52 (SFAS 52),~~~~Foreign Currency Translation,~~ the Company translates, net of tax impact, its investments accounted for under the equity method for those investees whose functional currency is other than the United States dollar. These translations relate to the Company’s investments in FlashVision and Flash Partners and were recorded in fiscal 2004 and all prior periods have been restated. The effect of this adjustment was to increase translation gain by $8.0 million and $7.1 million in 2003 and 2002, respectively. The amount of income tax expense allocated to translation gain was $3.2 million and $9.4 million at January 2, 2005 and December 28, 2003, respectively.

~~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):

2004 2003

Accumulated net unrealized gain (loss) on:
Available-for-sale short-term investments $ (2,332 ) $ 433
Available-for-sale investments in foundries 457 38,673
Currency translation gain 20,768 15,184

Total accumulated other comprehensive income $ 18,893 $ 54,290

Accumulated other comprehensive income included unrealized gains, net of taxes, on the Company’s investment in (i) UMC of $0.5 million at January 2, 2005 and $4.7 million at December 28, 2003 and (ii) Tower of zero and $34.0 million at the same dates, respectively. The amount of income tax expense (benefit) allocated to unrealized gain/loss on investments was $0.3 million and ($3.2) million at January 2, 2005 and December 28, 2003, respectively.


	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 onavailable-for-sale securities was immaterial at January 1, 2006 and January 2, 2005, ~~and December 28, 2003,~~ respectively.

F-15

~~Deferred Compensation.~~ ~~In 2004, the Company recorded deferred compensation as a part of its purchase price allocation relating~~

Notes to ~~an immaterial business acquisition that occurred during the fiscal year.~~Consolidated Financial Statements — (Continued)


Note 3:	Compensation and Benefits

Stock Based Compensation. ~~SFAS~~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 ~~July 2005.~~January 2006. Until such date, as permitted by ~~SFAS~~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 ~~using~~following the ~~intrinsic value method~~guidance provided by APB 25, which considers certain qualified stock purchase plan as non-compensatory and accordingly, ~~does~~the Company has not ~~recognize~~recognized any expense for the ~~15%~~ discount on the fair market value of the shares of stock sold under the Company’s employee stock purchase plan. The ~~15%~~ 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 ~~2004,~~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 ~~to use~~utilized in the estimate of fair value of valuing share based compensation. Based on such review, the Company ~~revised~~determined the volatility factor it used to estimate

~~F-15~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

the fair value of stock based compensation awarded during the fourth quarter of the year ended January ~~2, 2005~~1, 2006 to be based on ~~historical volatilities and~~ implied forward volatilities. Prior to ~~the fourth quarter of the year ended January 2, 2005,~~this change, the Company estimated future volatility ~~solely~~ based on historical and implied stock volatility. Estimated volatility is one of the inputs used in the ~~Black-Scholes-Merten~~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, ~~and 2002,~~ respectively:

Years Ended

January 2, December 28, December 29,
2005 2003 2002

Dividend yield None None None
Expected volatility 0.92 0.95 0.97
Risk free interest rate 3.07 % 3.39 % 3.84 %
Expected lives 5 years 5 years 5 years

Years Ended

January 1,

January 2,

December 28,

2006

2005

2003

Dividend yield

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

The weighted-average fair value of options granted during the year was $13.03, $22.64 and $8.71 for 2005, 2004 and ~~$4.95 for 2004,~~ 2003, ~~and 2002,~~ 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, ~~and 2002,~~ respectively:

Years Ended

January 2, December 28, December 29,
2005 2003 2002

Dividend yield None None None
Expected volatility 0.57 0.57 0.86
Risk free interest rate 2.69 % 2.94 % 3.68 %
Expected lives ¹/2 year ¹/2 year ¹/2 year

Years Ended

January 1,

January 2,

December 28,

2006

2005

2003

Dividend yield

None

Expected volatility

0.47

0.57

Risk free interest rate

2.69

2.94

Expected lives

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 ~~$3.19~~2003, respectively.

F-16

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 ~~2004, 2003 and 2002, respectively.~~

~~Stock Benefit Plan~~. The 1989 Stock Benefit Plan, in effect through August 1995, comprised two separate programs, the Stock Issuance Program and the Option Grant Program. The Stock Issuance Program allowed eligible individuals to immediately purchase the Company’s common stock at a fair value as determined by the Company’s Board of Directors. Under the Option Grant Program, eligible individuals were granted options to purchase shares of the Company’s common stock at ~~a fair value, as determined by~~any time prior to the ~~Company’s Board~~expiration of ~~Directors,~~the ten-year option term or any earlier termination of ~~such shares on~~those options in connection with the ~~date of grant. The options generally vest over a four-year period, expiring no later than ten years from the date of grant. Unexercised options are canceled upon the termination~~optionee’s cessation of employment or ~~services. Options that are canceled under this plan become available for future grants under~~service with the ~~1995 Stock Option Plan. There were no~~Company. As of January 1, 2006, options granted, net of cancellations, was 38,716,989 shares ~~available for option grants under the 1989 Stock Benefit Plan at January 2, 2005.~~

~~1995 Stock Option Plan. The 1995 Stock Option Plan provides for the issuance of incentive stock options~~ and nonqualified stock options. Under this plan, the Company’s Board of Directors determines the vesting and exercise provisions of option grants. The options generally vest over a four-year period, expiring no later than ten years from the date of grant. In May 1999, the Company’s stockholders increased the1,616,000 shares ~~available for future issuance~~ under the 1995 Stock Option Plan ~~by 14,000,000 shares~~ and ~~approved an automatic share increase feature pursuant to which the number of shares available for issuance under the plan automatically~~

~~F-16~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

increase on the first trading day in January each calendar year, beginning with calendar year 2002 and continuing over the remaining term of the plan, by an amount equal to 4.4% of the total number of shares outstanding on the last trading day in December in the immediately preceding calendar year, but in no event will any annual increase exceed 8,000,000 shares. The automatic share increase was 7,015,396 shares and 6,030,388 shares, in 2004 and 2003, respectively. As of January 2, 2005, there were 47,760,660 shares reserved for issuance under the plan and a total of 34,677,530 options had been granted.

~~1995 Non-Employee Directors Stock Option Plan. In August 1995, the Company adopted~~ the 1995 Non-Employee Directors Stock Option Plan. Under this plan, automatic option grants are made at periodic intervals to eligible non-employee members of the Company’s Board of Directors. Initial option grants vest over a four-year period. Subsequent annual grants vest one year after date of grant. AllPlan, respectively. Outstanding options ~~granted~~ under the ~~Non-Employee Directors~~1995 Stock Option Plan ~~expire ten years after the date of grant. In May 1999, the Company’s stockholders increased the shares available for future issuance~~have exercise prices ranging from $1.64 to $69.75 per share, and outstanding options under the 1995 Non-Employee Directors Stock Option Plan by 800,000 and approved an automatic share increase feature pursuant to which the number of shares available for issuance under the plan will automatically increase on the first trading day in January each calendar year, beginning with calendar year 2002 and continuing over the remaining term of the plan, by an amount equal to 0.2% of the total number of shares outstanding on the last trading day in December in the immediately preceding calendar year, but in no event will any such annual increase exceed 400,000 shares. The automatic share increase was 321,806 shares and 276,622 shares for 2004 and 2003, respectively. At January 2, 2005, the Company had ~~reserved 2,472,284 shares for issuance under the Non-Employee Directors Stock Option Plan and a total of 1,856,000 options had been granted. Outstanding shares were at~~ exercise prices ranging from $6.22 to $35.03 per share.

Special Stock Option ~~Plan~~~~. In January 2000,~~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 adopted~~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 ~~Special~~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 ~~provides~~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 ~~nonqualified options to newly hired employees. Under this plan, a committee appointed by~~continued service, and the ~~Company’s Board of Directors determines~~grants under the automatic grant program will vest in accordance with the specific vesting ~~and exercise~~ provisions ~~of option grants.~~set forth in that program. As of January 2,1, 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

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 ~~4,000,000~~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 ~~Special Stock Option Plan no options have been granted~~1995 plan, and 5,000,000 shares are reserved for issuance under ~~that~~the 2005 plan.

~~A summary~~ Each plan allows eligible employees to purchase shares of ~~activity under all~~the Company’s common stock ~~option plans follows (shares in thousands):~~at the end of each six-month offering period

Total Available Weighted
for Future Total Average
Grant/Issuance Outstanding Exercise Price

Balance at December 30, 2001 12,186 17,238 $ 12.89

Granted (5,540 ) 5,540 $ 6.60
Automatic share increase 6,244 — —
Exercised — (944 ) $ 2.94
Canceled 2,572 (2,572 ) $ 19.47

Balance at December 29, 2002 15,462 19,262 $ 10.69

Granted (6,088 ) 6,088 $ 11.76
Automatic share increase 6,307 — —
Exercised — (5,477 ) $ 9.45
Canceled 481 (481 ) $ 17.13

Balance at December 28, 2003 16,162 19,392 $ 11.21

Granted (6,617 ) 6,617 $ 31.58
Automatic share increase 7,337 — —
Exercised — (2,320 ) $ 8.21
Canceled 1,057 (1,057 ) $ 20.93

Balance at January 2, 2005 17,939 22,632 $ 17.02

~~F-17~~
F-18

Notes to Consolidated Financial Statements — (Continued)

~~At January 2, 2005, options outstanding were as follows:~~

Options Outstanding Options Exercisable

Number Weighted Number
Outstanding as Average Weighted Exercisable as Weighted
of January 2, Remaining Average of January 2, Average
Range of Exercise Prices 2005 Contractual Life Exercise Price 2005 Exercise Price

$ 0.56 - $ 5.41 2,865,288 3.97 $ 3.59 2,722,747 $ 3.50
$ 5.73 - $ 8.29 3,603,100 7.06 $ 6.49 2,166,087 $ 6.47
$ 8.36 - $ 8.87 4,238,129 8.01 $ 8.85 1,716,967 $ 8.84
$ 8.93 - $19.22 4,264,995 5.73 $ 16.33 4,006,897 $ 16.50
$19.82 - $34.50 2,493,892 8.54 $ 24.77 970,566 $ 26.94
$34.59 - $36.63 4,796,458 8.90 $ 34.63 180,728 $ 35.47
$37.25 - $69.75 370,580 6.87 $ 44.41 252,550 $ 46.77

$ 0.56 - $69.75 22,632,442 7.15 $ 17.02 12,016,542 $ 12.42

~~The number of exercisable options and the weighted average exercise~~at a purchase price ~~as of January 2, 2005, December 28, 2003 and December 29, 2002 were 12,016,542, 9,690,363 and 10,967,150 and $12.42, $12.13 and $10.81 per share, respectively.~~

~~Employee Stock Purchase Plan~~. In August 1995, the Company adopted the Employee Stock Purchase Plan (the Purchase Plan). In May 1999, the Company’s stockholders increased the shares available for future issuance under the Purchase Plan by 1,200,000 shares and approved an automatic share increase feature pursuantequal to which the number of shares available for issuance under the Purchase Plan will automatically increase on the first trading day in January each calendar year, beginning with calendar year 2002 and continuing over the remaining term85% of the Purchase Plan, by an amount equal to 0.43% of the total number of shares outstanding on the last trading day in December in the immediately preceding calendar year, but in no event will any annual increase exceed 800,000 shares. Under the Purchase Plan, qualified employees are entitled to purchase shares through payroll deductions at 85%lower of the fair market value atper share on the ~~beginning or end~~start date of the offering period ~~whichever is lower. The offering periods are six months in duration.~~or the fair market value per share on the purchase date. As of ~~January 2, 2005,~~ the Company had reserved 6,608,648 shares of common stock for issuance under the Purchase Plan and the Company’s International Employee Stock Purchase Plan, a comparable stock purchase plan for employeesend of the ~~Company’s foreign subsidiaries who are not residing in the United States, and a total of 3,713,284~~fiscal year ended January 1, 2006, 4,034,858 shares had been issued ~~through January 2, 2005.~~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 ~~$1.2 million~~ and ~~$1.0~~$1.2 million for the years ended January 1, 2006, January 2, 2005 and December 28, 2003, ~~and December 29, 2002,~~ 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.

~~F-18~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

Information regarding geographic areas for fiscal years 2005, 2004 ~~2003~~ and ~~2002~~2003 are as follows (in thousands):

Years Ended

January 2, December 28, December 29,
2005 2003 2002

Revenues:
North America $ 771,659 $ 417,869 $ 243,144
Japan 191,686 184,195 88,298
EMEA 420,645 232,080 116,765
Other foreign countries 393,065 245,657 93,066

Total $ 1,777,055 $ 1,079,801 $ 541,273

Long Lived Assets:
North America $ 86,024 $ 58,569 $ 22,132
Japan 263,248 169,330 150,217
Israel 14,737 40,877 16,869
Other foreign countries 472 325 19,758

Total $ 364,481 $ 269,101 $ 208,976


	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 ~~55%~~50%, ~~48%~~55% and ~~45%~~48% of the Company’s revenues for the years ended January 1, 2006,

F-19

Notes to Consolidated Financial Statements — (Continued)

January 2, 2005 and December 28, 2003, ~~and December 29, 2002,~~ 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. ~~Eight of the top ten customers or licensees~~In 2005, Best Buy accounted for ~~2003, were also part~~11% of the Company’s ~~top ten~~revenues; all other customers ~~or licensees in 2002. In~~were less than 10% of the Company’s revenues. For 2004 ~~2003~~ and ~~2002,~~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.

~~F-19~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

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 5.5, “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 ~~United States~~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 ~~hedge its~~use foreign currency ~~risk~~forward contracts in fiscal 2004 ~~2003~~ and ~~2002.~~fiscal 2003. See Note 5, “Contractual Obligations and Off Balance Sheet Arrangements.”

The Company had net transaction ~~losses~~gains (losses) of approximately $0.1 million, ($1.4) million ~~($1.3) million~~ and ($~~0.5)~~1.3) million for the years ended January 1, 2006, January 2, 2005 and December 28, 2003, ~~and December 29, 2002,~~ respectively. These amounts are included in other income (loss), net, in the accompanying consolidated income statements.


Note 5:	Commitments, Litigation, Contingencies and Guarantees


	*~~Commitments~~*

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

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 ~~(see Note 11)~~ contractually obligate the Company to purchase half of FlashVision’s NAND wafer ~~production output. At~~supply. The Company cannot estimate the total amount of this commitment as of January ~~2, 2005,~~1, 2006, because it is based upon future costs and volumes. In addition, the ~~portions of the Company’s take or pay commitment to FlashVision, which was measurable, was $172.4 million.~~

~~The~~ Company is committed to fund 49.9% of FlashVision’s costs to the extent that FlashVision’s revenues from wafer sales to ~~its parents~~the Company and Toshiba are ~~insufficient.~~ insufficient to cover these costs.

As of January ~~2, 2005,~~1, 2006, the Company ~~held FlashVision~~had notes receivable from FlashVision of ~~3.6~~7.3 billion Japanese ~~yen.~~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 ~~expects~~has a 49.9% ownership interest in Flash Partners, a business venture with Toshiba, formed in fiscal 2004 to ~~advance~~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 ~~FlashVision an additional 7.0~~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, ~~in several tranches through~~or approximately $3.1 billion based upon the ~~end~~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 ~~2005.~~which as of January 1, 2006, approximately $1.0 billion was left to fund.

~~The Company has purchased~~

As of January 1, 2006, Flash Partners had utilized an operating lease facility of 50.0 billion Japanese yen, or approximately ~~$63.4~~$424 million ~~of capital equipment~~ based on the exchange rate ~~in effect when~~at January 1, 2006, to partially fund Fab 3 equipment. As of January 1, 2006, the ~~assets were acquired and has committed to purchase up to~~Company’s guarantee of the Flash Partners’ operating lease obligation, net of accumulated lease payments, was approximately ~~5.4~~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 ~~additional capital equipment.~~35.0 billion Japanese yen, or approximately $297 million based upon the exchange rate at January 1, 2006. The Company ~~will receive 100%~~guaranteed on an unsecured and several basis 50% of the ~~output from~~draw downs under this ~~equipment on terms substantially similar to~~facility. As of January 1, 2006, no draw downs had been made, however the ~~terms for FlashVision output.~~

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, asFlash 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 ~~2, 2005,~~1, 2006, the Company had accrued liabilities related to ~~those~~these expenses of ~~$5.5~~$4.2 million. The common research and development amount is a variable computation, and is subject to payment caps through the end of 2008. Direct research and development liabilities will be computed using a variable percentage of actual research and development expenses incurred.

Toshiba ~~Foundry~~.Foundry. The Company ~~also~~ has the ability to purchase additional capacity under a foundry arrangement ~~as discussed in Note 10~~ with Toshiba. Under the terms of ~~the Company’s foundry~~this agreement, ~~with Toshiba,~~ the Company is required to provide Toshiba with a purchase order commitment based on a six-month rolling forecast. ~~The purchase orders placed under this arrangement relating to the first three months of the six-month forecast are binding~~

Business Ventures and ~~cannot be cancelled.~~

~~Flash Partners~~. The Company is committed to purchase 50% of Flash Partners (see Note 11) NAND memory products. The Company is currently committed to fund Flash Partner’s expansion to 15,000 wafer starts per month. The Company estimates the cost of that commitment, in terms of equipment investment, to have been approximately 55 billion Japanese yen at January 2, 2005, of which 25 billion Japanese yen is expected to be funded from the lease facility discussed below.

~~F-20~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

The Company is committed to purchase one half of Flash Partners output at a formula based on the actual cost to produce the wafers. The Company will incur substantial expenses related to initial design and development of manufacturing process technology and start-up costs for Fab 3.

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

F-21

Notes to Consolidated Financial Statements — (Continued)

binding and cannot be ~~cancelled.~~canceled. At January ~~2, 2005,~~1, 2006, the Company had approximately ~~$68.8~~$116.2 million of ~~non-cancelable~~noncancelable purchase orders for flash memory wafers ~~were outstanding.~~outstanding to FlashVision, Flash Partners and Toshiba.

Other Silicon ~~Sources~~.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 ~~cancelled. At January 2, 2005, approximately $66.5 million~~canceled. Outstanding purchase commitments for other sources of ~~non-cancelable~~silicon are included as part of the total “Noncancelable production purchase ~~orders for memory and controllers were outstanding.~~commitments” in the “Contractual Obligations” table below.

~~Subcontractors~~.

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. ~~As such,~~Accordingly, the Company may be committed to certain costs over and above its open ~~non-cancelable~~noncancelable purchase orders with these subcontractors.


	*~~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 Outstanding purchase commitments for subcontractors are included as part 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.

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, changestotal “Noncancelable production purchase commitments” 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.“Contractual Obligations” table below.

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.

Off Balance Sheet Liabilities

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.

~~F-21~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~


	~~Off Balance Sheet Liabilities~~FlashVision.

~~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 ~~Corporate Bank, Ltd., or 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 ~~2, 2005,~~1, 2006, the maximum amount of the Company’s contingent indemnification obligation, which reflects payments and any lease adjustments, was approximately ~~11.5~~8.8 billion Japanese ~~yen.~~yen, or approximately $75 million based upon the exchange rate at January 1, 2006.

Flash ~~Partners~~.Partners. As described in “Commitments — Flash Partners” above, Flash Partners intends to sell and lease-back from a consortium of financial institutions ~~approximately one-half~~a portion of its ~~tools.~~ 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

F-22

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 ~~entered into~~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 ~~master lease agreement providing~~result of these indemnification obligations. The Company’s insurance policies exclude coverage for upthird-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 ~~50 billion Japanese yen~~pay to its suppliers and customers. Historically, the Company has not made any significant indemnification payments under any such agreements. As of ~~original lease obligations. There were~~January 1, 2006, no ~~amounts outstanding~~amount has been accrued in the accompanying condensed consolidated financial statements with respect to these indemnification guarantees.

As permitted under Delaware law and the ~~master lease agreement~~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 ~~end~~Company’s request in such capacity. The term of ~~2004.~~ 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 ~~guaranteed, on a several basis, 50 percent of~~other and Flash Partners for, environmental remediation costs or liability resulting from Flash Partners’ ~~obligations~~manufacturing operations in certain circumstances. The Company and Toshiba have also entered into a Patent Indemnification Agreement under which in many cases the ~~master lease agreement. Flash Partners~~Company will ~~draw individual tranches under~~share in the ~~lease agreements during 2005~~expenses associated with the defense and ~~each individual draw will have a four-year or five-year term as agreed~~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 ~~lessors. Lease payments~~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 productsand/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.

F-23

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 damagesand/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.

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.

F-24

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 inducedand/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,

F-25

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

F-26

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 ~~quarterly. At~~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 ~~lease term, Flash Partners has~~Company was served with a complaint in an action filed by SoftVault Systems, Inc. in the ~~option~~United States District Court for the Eastern District of ~~purchasing~~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., CaseNo. 2:06-cv-00017-LED. SoftVault accuses the ~~tools at a percentage~~Company, and others, of ~~their original sales price~~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 ~~the lessors. The fair value of the Company’s guarantee of Flash Partners’ lease obligation was insignificant at inception of the guarantee.~~vigorously defend against this action.


	*~~Contingencies~~*

Contingencies

Lee and Li ~~Settlement~~.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

F-27

Notes to Consolidated Financial Statements — (Continued)

as current other assets at January 1, 2006 and January 2, 2005, and ~~December 28, 2003, respectively~~$11.3 million and $22.5 ~~million and $33.7~~ million was classified as non-current other assets in the accompanying consolidated balance sheets as of January 1, 2006 and January 2, 2005, ~~and December 28, 2003,~~ 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.

~~Indemnification Agreements~~. The Company has historically 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 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 and as of January 2, 2005, no amount has been accrued in the accompanying consolidated financial statements with respect to these indemnification guarantees.

~~F-22~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

As permitted under Delaware law, 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 2, 2005 or December 28, 2003 as 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 2, 2005 no amounts have been accrued in the accompanying consolidated financial statements with respect to these indemnification guarantees.

Contractual Obligations and Off Balance Sheet Arrangements

The following summarizes ~~(in thousands)~~ the Company’s contractual cash obligations, commitments and off balance sheet arrangements at January ~~2, 2005,~~1, 2006, and the effect such obligations are expected to have on its liquidity and cash ~~flow~~flows in future ~~periods.~~periods (in thousands).

Less Than More Than
1 Year 2 - 3 Years 4 - 5 Years 5 Years
(Fiscal (Fiscal 2006 (Fiscal 2008 (Beyond
Total 2005) and 2007) and 2009) Fiscal 2009)

CONTRACTUAL OBLIGATIONS:
Operating leases $ 5,111 $ 3,598 $ 1,513 $ — $ —
FlashVision, fabrication capacity expansion costs, and reimbursement for certain other costs including depreciation 621,435 187,676 267,947 126,082 39,730
Flash Partners fabrication capacity expansion and start-up costs, and reimbursement for certain other costs including depreciation 833,628 313,279 221,204 198,306 100,839
Toshiba research and development 97,000 20,000 48,000 29,000 —
Capital equipment purchases commitments 55,879 49,602 6,277 — —
Operating expense commitments 27,231 27,231 — — —
Non-cancelable production purchase commitments 264,398 264,398 — — —

Total contractual cash obligations $ 1,904,682 $ 865,784 $ 544,941 $ 353,388 $ 140,569

Contractual cash (income) from non-cancelable operating subleases $ (124 ) $ (124 ) $ — $ — $ —

As of
January 2,
2005

OFF BALANCE SHEET ARRANGEMENTS:
Indemnification of FlashVision foundry equipment lease $ 111,868
Guarantee of Flash Partners lease $ —


										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 andstart-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

F-28

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 ~~foreign~~ exchange rate asat 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 ~~December 31, 2004,~~cumulative lease payments, is 24.0 billion Japanese yen, or approximately $203 million based upon the ~~last business day of the Company’s fiscal year.~~exchange rate at January 1, 2006.

~~F-23~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

The Company leases its headquarters and sales offices under operating leases that expire at various dates from 2006 through ~~2007.~~2010. Future minimum lease payments under real estate operating leases at January ~~2, 2005~~1, 2006 were as follows (in thousands):

Fiscal Year Ending:
2005 $ 3,598
2006 1,465
2007 48
Thereafter —

Total $ 5,111

~~Rent expense under all operating leases was $3.7 million, $2.9 million,~~


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 ~~$3.0 million~~does not enter into derivatives for speculative or trading purposes. The Company’s derivative instruments are recorded at fair value on the ~~years ended January 2, 2005, December 28, 2003, and December 29, 2002, respectively.~~

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 ~~$120 million~~$1.18 billion at January ~~2, 2005. Under these lines,~~1, 2006 to enter into foreign currency forward contracts. As of January 1, 2006, the Company ~~may enter into~~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 ~~contracts that require the Company to sell or purchase foreign currencies. There were no foreign exchange contracts outstanding~~rate at January ~~2, 2005.~~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.

F-29

Notes to Consolidated Financial Statements — (Continued)


Note 6:	Income Taxes

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

January 2, December 28, December 29,
2005 2003 2002

Current:
Federal $ 138,558 $ 96,399 $ (2,717 )
State 13,731 19,296 432
Foreign 25,336 15,025 13,753

177,625 130,720 11,468
Deferred:
Federal (20,963 ) (50,467 ) (7,729 )
State (78 ) (7,231 ) —
Foreign — — —

(21,041 ) (57,698 ) (7,729 )

Provision for income taxes $ 156,584 $ 73,022 $ 3,739


	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 ~~$17.9~~$95.6 million in ~~2004~~2005 and reduced taxes payable by ~~$28.1 million and increased the deferred tax asset by $17.0~~$17.9 million in ~~2003.~~2004. Such benefits are credited to capital in excess of par value when realized.

~~F-24~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

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 2, December 28, December 29,
2005 2003 2002

U.S. Federal statutory rate 35.0 % 35.0 % 35.0 %
State taxes, net of federal benefit 2.1 3.2 1.1
Utilization of credits and impact of new tax law (0.2 ) (0.5 ) (6.8 )
Reversal of tax benefit previously taken on UMC shares — 13.8 —
Tax exempt interest income (0.5 ) (0.4 ) (2.5 )
Utilization of loss carryforward and change in valuation allowance — (19.3 ) (17.6 )
Other 0.6 (1.6 ) 0.2

37.0 % 30.2 % 9.4 %


	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.

F-30

Notes to Consolidated Financial Statements — (Continued)

Significant components of the Company’s deferred tax assets as of January 1, 2006 and January 2, 2005 ~~and December 28, 2003~~ were as follows (in thousands):

January 2, December 28,
2005 2003

Deferred tax assets:
Inventory valuation $ 15,800 $ 11,500
Deferred revenue recognized for tax purposes 38,400 43,500
Accruals and reserves not currently deductible 51,300 28,500
Foreign tax credit and other credit carry-forwards — 12,700
Net operating loss carry-forward — 1,300
Unrealized loss on permanent impairment of investment in foundries 16,600 12,300
Other 1,200 1,485

Subtotal: Deferred tax assets 123,300 111,285
Valuation allowance for deferred tax assets (12,300 ) —

Total deferred tax assets $ 111,000 $ 111,285

Deferred tax liabilities:
Unrealized gain on sale of foundry shares (29,100 ) (24,500 )
Fixed assets and other 3,100 (8,052 )

Total: Deferred tax liabilities (26,000 ) (32,552 )

Total net deferred tax assets $ 85,000 $ 78,733


	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 ~~2, 2005, $12.3~~1, 2006, a $14.9 million valuation allowance was provided based, more likely than not, on ~~our~~the Company’s inability to recognize a tax benefit from certain ~~unrealized capital losses~~write downs on ~~the Company’s investments~~its investment in Tower. At ~~December 28, 2003, based on the weight of all available evidence, the Company carried no~~January 2, 2005, a $12.3 million valuation allowance was provided based on the net deferred tax ~~assets.~~assets on the same investment.

During the current and prior years, the Company has not made a determination ~~under Accounting Principles Board Opinion No. 23~~ to permanently reinvest earnings of its foreign ~~substantives.~~

~~F-25~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~subsidiaries.


Note 7:	Strategic Investments ~~in Foundries~~

UMC. The Company maintains an investment position in United Microelectronics Corporation, or UMC, one of its suppliers of wafers for its controller ~~wafers,~~components, on the cost basis of accounting. In 1997, the Company invested $51.2 million in a company that was acquired by UMC in 2000. In 2000, the Company recorded a gain on investment of approximately $344.2 million. In 2001, the Company concluded that the market decline in the value of those shares was other than temporary and recorded a loss of $275.8 million. In 2003, the Company sold 35 million UMC shares for net proceeds of approximately $30.0 million, which resulted in a gain of approximately $7.0 million. Also in 2003, the Company recognized a loss of $18.3 million as a result of the fraudulent sale and misappropriation by an employee of the Company’s Taiwan law firm of 127.8 million UMC shares owned by the Company (as described in Note 5). In the fourth quarter of 2004, the Company received a settlement of $6.2 million from a third-party brokerage firm related to the fraudulent sale of the UMC stock. As of January ~~2, 2005,~~1, 2006, the Company owned ~~22.2~~24.5 million UMC shares with a cost basis of $13.4 million and a fair market value ~~on that date~~ of ~~$14.2~~$13.9 million.

Tower Semiconductor. ~~Since July 2000,~~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 ~~has invested $79.0~~owned approximately 10.2 million ~~in Tower’s foundry facility, Fab 2,~~Tower shares with a carrying value and ~~received 9.0~~market value of $12.9 million ~~ordinary shares, $14.3~~and $14.8 million, ~~convertible wafer credits and~~respectively, a warrant to purchase 0.4 million Tower ordinary shares at an exercise price of $7.50 per ~~share. The warrant expires on October 31, 2006. The investment has provided the Company~~share, with a ~~guaranteed source~~carrying value of ~~controller wafers. Since the third quarter~~zero and Tower prepaid wafer credits with a carrying value of ~~2003, the Company has sourced controller wafers from Tower.~~

~~The 9.0 million Tower ordinary shares represented an approximate 14% equity ownership position in Tower as of January 2, 2005.~~zero. In ~~2004,~~fiscal 2005, the Company recorded an ~~other-than-temporary impairment~~unrealized loss of ~~$11.8~~$1.1 million through OCI on its Tower ~~investment. Tower’s~~investment to bring the carrying value of the Tower shares to market value had declined to $2.26 per share at the end of fiscal 2004 from a its cost basis of $3.40 per share. Additionally, Tower’s Fab 2 is operational but has not been completed and Tower’s financial situation is challenging which indicates that Tower’s share price may not appreciate from the value at the end of fiscal 2004. From July 2000 through January 2,value. In December 2005, the Company ~~has recognized cumulative losses~~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 ~~approximately $44.0 million~~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 ~~a result~~the Company will provide greater than 50% of the ~~other-than-temporary decline in the value~~U3, LLC financial support, it would receive more

F-31

Notes to Consolidated Financial Statements — (Continued)

than half of its investment in Tower. As of January 2, 2005, the Company’s Tower ordinary shares had a carrying value and fair market value of $20.4 million. Of the approximately 9.0 million Tower ordinary shares the Company owns, the Company has agreed not to sell approximately 6.3 million shares until on or after January 29, 2006, and the value of these restricted shares is included in the Company’s consolidated balance sheet as long-term investment in foundries. In addition, the Company has extended the date on which it may exercise its demand registration rights on all its shares until the earlier of (i) December 31, 2005 and (ii) such date that Tower has fulfilled all of its obligations to raise any ~~additional financing pursuant to its facility agreement. The Company may be required to recognize additional~~residual losses with respect to ~~its Tower investments in future periods.~~

~~In November 2003,~~the U3, LLC entity. As a result, U3, LLC is considered a variable interest entity and the Company ~~amended its foundry investment agreements with Tower and, among other things, agreed not to use wafer credits until January 1, 2007, except with respect to purchase orders issued before~~is the November 2003 amendment, which had been completely utilized as of the end of the Company’s second fiscal quarter of 2004. In fiscal 2004 the Company utilized approximately $0.7 million of these wafer credits to purchase controller wafers from Tower.primary beneficiary. The Company has consolidated the ~~option to convert~~statement of financial position and the ~~credits it would have otherwise been able to utilize per quarter into Tower ordinary shares at the 15-day average trading price (ATP) preceding the last day~~results of ~~the relevant quarter. During the first nine months of 2004, the Company exercised its option to convert credits it would have otherwise been able to utilize~~operations for the ~~period into Tower ordinary shares and received approximately $0.5 million~~year ended January 1, 2006. The Company’s total investment in Tower ordinary shares, or approximately 117,000 Tower ordinary shares. In the last quarter of 2004, the Company chose not to convert the credit it would have otherwise been able to utilize for the quarter into shares and the unconverted credits are accruing interest at a rate per annum equal to three-month LIBOR plus 2.5% through December 31, 2007. Interest payments will be made quarterly and the aggregate principal amount of the unconverted credits will be repaid in one lump sum on December 31, 2007. Effective as of December 31, 2005, the Company may convert all of the then remaining credits it was issued in connection with its fourth milestone payment into

~~F-26~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

Tower ordinary shares at the 15 day ATP preceding December 31, 2005. If the number of Tower ordinary shares received by the Company and the other wafer partners as a result of this conversion is greater than or equal to an aggregate of 5% of Tower’s issued and outstanding share capital on January 31, 2006, Tower is obligated to make a rights offering for the distribution of rights to all of Tower’s shareholders, other than the Company and the other wafer partners but including Israel Corporation Technologies, at the same 15 day ATP. As of January 2, 2005, the Company’s Tower prepaid wafer credits were valued at zero and the Company has recognized cumulative losses of $12.2 million as a result of the impairment in value on its prepaid wafer credits.

The Company invested in Tower’s rights offering during 2002 and received a warrant to purchase Tower ordinary shares which is included in the accompanying consolidated balance sheets under the caption Investment in Foundries. The fair value of the Tower warrantU3 as of January ~~2, 2005~~1, 2006 was estimated at approximately $65,000 using a Black-Scholes-Merton option pricing model with the following assumptions: dividend yield of 0.0%; expected life of 1.75 years; volatility factor of 0.70; and risk free interest rate of 3.08%. The fair value of the Tower warrant as of December 28, 2003 was estimated at approximately $1.2 million, using the following assumptions: dividend yield of 0.0%; expected life of 2.75 years; volatility factor of 0.70; and risk free interest rate of 2.32%. The fair value of the Tower warrant, at December 29, 2002 was estimated at approximately $0.5 million using the following assumptions: dividend yield of 0.0%; expected life of 3.75 years; volatility factor of 0.845; and risk free interest rate of 2.38%. The fair value of the Tower warrant will continue to fluctuate and additional adjustments to the warrant’s fair value will be recorded in future periods.$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.

~~F-27~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~


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):

2004 2003 2002

Numerator:
Numerator for basic net income per share:
Net income $ 266,616 $ 168,859 $ 36,240

Denominator for basic net income per share:
Weighted average common shares outstanding 164,065 144,781 137,610

Basic net income per share $ 1.63 $ 1.17 $ 0.26

Numerator for diluted net income per share:
Net income $ 266,616 $ 168,859 $ 36,240
Tax-effected interest and bond amortization expenses attributable to the notes 5,368 5,469 —

Net income for diluted income per share $ 271,984 $ 174,328 $ 36,240
Denominator for diluted net income per share:
Weighted average common shares 164,065 144,781 137,610
Incremental common shares attributable to exercise of outstanding employee stock options and warrants (assuming proceeds would be used to purchase common stock) 10,406 10,559 4,850
Conversion of the Notes 14,366 16,276 —

Shares used in computing diluted net income per share 188,837 171,616 142,460

Diluted net income per share $ 1.44 $ 1.02 $ 0.25


	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 ~~excludes~~exclude any dilutive effects of options, warrants, and convertible securities. Diluted earnings per share ~~includes~~include the dilutive effects of stock options, warrants, and convertible securities. Options and warrants to purchase 97,753, 6,140,781 ~~1,253,457~~ and ~~8,031,890~~1,253,457 shares of common stock were outstanding during 2005, 2004 ~~2003~~

F-32

Notes to Consolidated Financial Statements — (Continued)

and ~~2002,~~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. ~~Incremental common shares attributable to the assumed conversion of the Notes were not included in the per share computation for fiscal year 2002 as the effect would be antidilutive.~~


Note 10:	Related Parties

The Company has entered into agreements with Toshiba, under which they formed FlashVision and Flash Partners, to produce advanced NAND flash memory wafers (See Notes 5 and 11). During 2004, the Company purchased approximately $63.4 million of capital equipment, and committed to purchase up to approximately $52.1 million of additional capital equipment, which will be located in Toshiba’s fab operations. In return, the Company will receive 100% of the output from this equipment. The Company purchased NAND flash memory wafers from FlashVision and Toshiba, purchased capital equipment from FlashVision, made payments for shared research and development expenses, loans to FlashVision and made investments in Flash Partners totaling approximately $516.6 million, $223.5 million and $124.7 million in 2004, 2003 and 2002, respectively. These purchases of NAND flash memory wafers are ultimately reflected as a component of the Company’s cost of product revenues. At January 2, 2005 and December 28, 2003, the Company had accounts payable balances due to FlashVision of $30.7 million and $30.4 million respectively, and balances due to Toshiba of $6.1 million and $14.6 million, respectively. At January 2, 2005 and December 28, 2003, the

~~F-28~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

~~Company had accrued current liabilities due to Toshiba for shared research and development expenses of $5.5 million and $11.8 million, respectively.~~

The Company owns approximately ~~14%~~15% of the outstanding shares of Tower, prepaid wafer credits issued by Tower convertible debt and a warrant to purchase Tower ordinary ~~shares (see Note 7).~~shares. The Company’s ~~chief executive officer~~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 ~~$5.3 million in 2004 and 2003,~~January 2, 2005, respectively, for the purchase of controller ~~wafers.~~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, ~~and December 28, 2003,~~ the Company had amounts payable to Tower of approximately ~~$7.6~~$2.4 million and ~~zero,~~$7.6 million, respectively, related to the purchase of controller ~~wafers.~~wafers and related NRE. See Note 7, “Strategic Investments — Tower Semiconductor.”

~~In September 2003, the president~~

The former President and ~~chief executive officer~~Chief Executive Officer of Flextronics ~~joined~~International, Ltd., or Flextronics, has served on the Company’s ~~board~~Board of ~~directors.~~Directors since September 2003. For ~~2004~~the years ended January 1, 2006 and ~~2003,~~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 ~~approximately~~$40.2 million and $37.4 million for the years ended January 1, 2006 and ~~$8.1 million,~~January 2, 2005, respectively, for ~~wafer testing, packaged memory final testing,~~ card assembly and ~~card testing. These activities~~testing which are ultimately reflected as a component of the Company’s cost of product revenues. At January 1, 2006 and January 2, 2005, ~~and December 28, 2003,~~ the Company had amounts payable to Flextronics and its affiliates of approximately ~~$2.0~~$5.4 million and ~~$1.5~~$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


	*~~FlashVision~~*

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 ~~second quarter~~Company will receive 100% of ~~2002,~~ the output from this equipment. The Company purchased NAND flash memory wafers from FlashVision, ~~Dominion Semiconductor business~~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 ~~Virginia was consolidated at Toshiba’s~~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 ~~fabrication facility in Yokkaichi, Japan.~~ 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

F-33

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, ~~and December 28, 2003,~~ respectively. FlashVision’s year-end is March 31, with ~~each quarter~~quarters ending on March 31, June 30, September 30 and December 31 (in thousands).

December 31, December 31,
2004 2003

(Unaudited)
Current Assets $ 148,354 $ 128,774
Property, plant and equipment and other assets $ 516,909 $ 374,438

Total Assets $ 665,263 $ 503,212
Current Liabilities $ 222,017 $ 148,200


	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 ~~$326.0 million~~$298.1 and ~~$294.7~~$326.0 million, as of January 1, 2006 and January 2, 2005, ~~and December 29, 2003,~~ respectively. These amounts are comprised of the Company’s investments, notes receivable and contingent indemnification obligation. At January 1, 2006 and January 2, 2005, ~~and December 29, 2003,~~ the Company’s consolidated retained earnings included approximately ~~$1.7~~$2.1 million and ~~$1.3~~$1.7 million, respectively, of undistributed earnings of FlashVision.

~~F-29~~

~~Notes to Consolidated Financial Statements~~ ~~— (Continued)~~

The following summarizes financial information for FlashVision for the Company’s fiscal years ended January 1, 2006, January 2, 2005 and December 28, 2003, ~~and December 29, 2002,~~ respectively (in thousands).

Twelve Months Ended

2004 2003 2002

(Unaudited)
Net sales(1) $ 481,792 $ 272,507 $ 73,571
Gross profit (loss) 2,553 1,572 (369 )
Net income $ 1,318 $ 296 $ 2,587


	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~~*

~~In September 2004, the Company and Toshiba entered into a series of definitive agreements and created a new semiconductor company,~~ Flash Partners ~~to produce 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’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 ~~year~~years ended January 1, 2006 and January 2, 2005. The entity did not exist during the Company’s fiscal year ended December 28,

F-34

Notes to Consolidated Financial Statements — (Continued)

2003. Flash Partners’ year-end is March 31, with ~~each quarter~~quarters ending on March 31, June 30, September 30 and December 31 (in thousands).

December 31,
2004

(Unaudited)
Current Assets $ 56,793
Property, plant and equipment and other assets 3,820

Total Assets 60,613
Current Liabilities $ 12,139


	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.~~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 ~~years~~year ended December 28, 2003 ~~and December 29, 2002, respectively~~ and therefore no information is provided in this disclosure (in thousands).

December 31,
2004

(Unaudited)
Net revenues(1) $ 21,157
Gross profit —
Net (loss) $ (179 )


	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 of3-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.”

~~F-30~~
F-35

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~~

SANDISK CORPORATION


	By:	/s/ Judy Bruner



	~~Judy Bruner~~
	~~Executive Vice President, Administration~~
	~~Chief Financial Officer~~
	~~(On behalf of the Registrant and as Principal~~
	~~Financial and Accounting Officer)~~

Executive Vice President, Administration,

Chief Financial Officer

(On behalf of the Registrant and as Principal

Financial and Accounting Officer)

Dated: March ~~18, 2005~~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 onForm 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~~ Signature	Title	Date

By:	/s/ (Eli Harari) (Eli Harari)	President, Chief Executive Officer and Director (Principal Executive Officer)	March 15, 2006


By:	/s/ ~~Eli Harari~~(Judy Bruner) ~~(Eli Harari)~~	~~President, Chief Executive Officer and Director (Principal Executive Officer)~~	~~March 18, 2005~~

~~By:~~	~~/s/ Judy Bruner~~ (Judy Bruner)	Executive Vice President, Administration, Chief Financial Officer (Principal Financial and Accounting Officer)	March ~~18, 2005~~15, 2006

By:	/s/ ~~Irwin Federman~~(Irwin Federman) (Irwin Federman)	Chairman of the Board, Director	March ~~18, 2005~~15, 2006

By:	/s/ ~~Catherine~~(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~~Lego) (Catherine Pierson Lego)	Director	March ~~18, 2005~~15, 2006

S-1


	Signature	Title	Date


By:	/s/ ~~Michael~~(Michael E. ~~Marks~~Marks) (Michael E. Marks)	Director	March ~~18, 2005~~15, 2006

By:	/s/ ~~James~~(James D. ~~Meindl~~Meindl) (James D. Meindl)	Director	March ~~18, 2005~~15, 2006

By:	/s/ ~~Alan~~(Alan F. Shugart (Alan F. Shugart)	Director	March ~~18, 2005~~15, 2006

S-2

~~S-1~~

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.(12)

3 .3 Certificate of Amendment of the Restated Certificate of Incorporation of the Registrant dated May 11, 2000.(16)

3 .4 Restated Bylaws of the Registrant, as amended to date.(15)

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.(24)

4 .1 Reference is made to Exhibits 3.1, 3.2 and 3.3.(2), (12),(16)

4 .2 Rights Agreement, dated as of September 15, 2003, between the Registrant and Computershare Trust Company, Inc.(24)

10 .1 License Agreement between the Registrant and Dr. Eli Harari, dated September 6, 1988.(2)

10 .2 Lease Agreement between the Registrant and G.F. Properties, dated March 1, 1996.(3)

10 .3 Amendment to Lease Agreement between the Registrant and G.F. Properties, dated April 3, 1997.(5)

10 .4 Lease Agreement between the Registrant and G.F. Properties, dated June 10, 1998.(8)

10 .5 1989 Stock Benefit Plan.(2), (*)

10 .6 SanDisk Corporation Special Stock Option Plan, as Amended and Restated through February 23, 2000.(20), (*)

10 .7 SanDisk Corporation 1995 Stock Option Plan, as Amended and Restated January 2, 2002.(21), (*)

10 .8 SanDisk Corporation 1995 Non-Employee Directors Stock Option Plan, as Amended and Restated as of January 2, 2004.(22), (*)

10 .9 SanDisk Corporation 1995 Employee Stock Purchase Plan, as Amended and Restated as of January 2, 2002.(21), (*)

10 .10 SanDisk Corporation International Employee Stock Purchase Plan, as Amended and Restated as of January 2, 2002.(21), (*)

10 .11 Share Purchase Agreement, dated as of July 4, 2000, by and between the Registrant and Tower Semiconductor Ltd.(13)

10 .12 Escrow Agreement, dated as of August 14, 2000, by and between the Registrant, Tower Semiconductor Ltd. and Union bank of California, N.A.(13)

10 .13 Additional Purchase Obligation Agreement, dated as of July 4, 2000, by and between the Registrant and Tower Semiconductor Ltd.(13)

10 .14 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.(14)

10 .15 Consolidated Shareholders Agreement, dated as of January 18, 2001, by and among Registrant, The Israel Corporation, Alliance Semiconductor Ltd. And Macronix International Co., Ltd.(14)

10 .16 Amendment to Share Purchase Agreement, dated as of March 20, 2002, by and between the Registrant and Tower Semiconductor Ltd.(17)

10 .17 Amendment to Share Purchase Agreement, dated as of February 21, 2003, by and between the Registrant, Tower Semiconductor Ltd. and the other parties thereto.(23)

10 .18 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.(23)

10 .19 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.(23)


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 ofSeries A-5 Additional Purchase Obligations, Waiver ofSeries A-5 Conditions, Conversion ofSeries 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

Exhibit
Number Exhibit Title

10 .20 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.(26)

10 .21 New Master Agreement, dated as of April 10, 2002, by and between the Registrant and Toshiba Corporation.(18), (1)

10 .22 Amendment to New Master Agreement, dated and effective as of August 13, 2002 by and between the Registrant and Toshiba Corporation.(19), (1)

10 .23 New Operating Agreement, dated as of April 10, 2002, by and between the Registrant and Toshiba Corporation.(18), (1)

10 .24 Indemnification and Reimbursement Agreement, dated as of April 10, 2002, by and between the Registrant and Toshiba Corporation.(18), (1)

10 .25 Amendment to Indemnification and Reimbursement Agreement, dated as of May 29, 2002 by and between the Registrant and Toshiba Corporation.(18)

10 .26 Settlement Agreement, dated as of November 14, 2003, by and among the Registrant, Lee and Li and certain Lee and Li partners.(26), (1)

10 .27 Form of Change of Control Agreement entered into by and between the Registrant and each of the following officers of the Registrant: the Chief Financial Officer; the Executive Vice President and Chief Operating Officer; the Sr. Vice President and General Manager, Retail Business Unit; the Sr. Vice President, Engineering; the Vice President and General Counsel; and the Vice President, Business Development.(27) (*)

10 .28 Change of Control Agreement entered into by and between the Registrant and the President and Chief Executive Officer of the Registrant.(27) (*)

10 .29 Settlement and Release Agreement, dated as of June 29, 2004, by and between the Registrant and Michael Gray.(28)

10 .30 Flash Partners Master Agreement, dated as of September 10, 2004, by and among the Registrant and the other parties thereto.(28), (1)

10 .31 Operating Agreement of Flash Partners Ltd., dated as of September 10, 2004, by and between SanDisk International Limited and Toshiba Corporation.(28), (1)

10 .32 Amended and Restated Common R&D and Participation Agreement, dated as of September 10, 2004, by and between the Registrant and Toshiba Corporation.(28), (1)

10 .33 Amended and Restated Product Development Agreement, dated as of September 10, 2004, by and between the Registrant and Toshiba Corporation.(28), (1)

10 .34 Mutual Contribution and Environmental Indemnification Agreement, dated as of September 10, 2004, by and among the Registrant and the other parties thereto.(28), (1)

10 .35 Patent Indemnification Agreement, dated as of September 10, 2004 by and among the Registrant and the other parties thereto.(28), (1)

10 .36 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.(**), (+)

10 .37 Guarantee Agreement, dated as of December 24, 2004, by and between the Registrant and Mitsui Leasing & Development, Ltd.(**)

21 .1 Subsidiaries of the Registrant(**)

23 .1 Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm(**)

31 .1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(**)


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

Exhibit
Number Exhibit Title

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(**)


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.	1.	Confidential treatment granted as to certain portions of these exhibits.

2.	2.	Previously filed as an Exhibit to the Registrant’s Registration Statement onForm ~~S-1 (No.~~S-1(No. 33-96298).

3.	3.	Previously filed as an Exhibit to the Registrant’s 1995 Annual Report onForm 10-K. (FileNo. 0-26734)

4.	4.	Previously filed as an Exhibit to the Registrant’s Current Report on Form8-K/A dated April 18, 1997.

5.	5.	Previously filed as an Exhibit to the Registrant’sForm 10-Q for the quarter ended June 30, 1997.

6.	6.	Previously filed as an Exhibit to the Registrant’s ~~Current Report on form 8-K dated October 16, 1997.~~

	7.	~~Previously filed as an Exhibit to the Registrant’s~~ Form 10-Q ~~for the quarter ended September 30, 1997.~~

	8.	~~Previously filed as an Exhibit to the Registrant’s Form 10-Q~~ for the quarter ended June 30, 1998.

7.	9.	Previously filed as an Exhibit to the Registrant’s ~~Current Report on Form 8-K dated January 1, 1999.~~


~~10.~~	~~Previously filed as an Exhibit to the Registrant’s~~ Form 10-Q ~~for the quarter ended March 31, 1999.~~

~~11.~~	~~Previously filed as an Exhibit to the Registrant’s 1999 Annual Report on Form 10-K.~~

~~12.~~	~~Previously filed as an Exhibit to the Registrant’s Form 10-Q~~ for the quarter ended June 30, 2000.

~~13.~~ 8.		Previously filed as an Exhibit to the Registrant’sForm 10-Q for the quarter ended September 30, 2000.

~~14.~~ 9.		Previously filed as an Exhibit to the Registrant’s Schedule 13(d) dated January 26, 2001.

~~15.~~ 10.	~~Previously filed as an Exhibit to the Registrant’s 2001 Annual Report on Form 10-K.~~

~~16.~~	Previously filed as an Exhibit to the Registrant’s Registration Statement onForm ~~S-3 (No.~~S-3(No. 333-85686).

~~17.~~ 11.		Previously filed as an Exhibit to the Registrant’sForm 10-Q for the quarter ended March 31, 2002.

~~18.~~ 12.		Previously filed as an Exhibit to the Registrant’sForm 10-Q for the quarter ended June 30, 2002.

~~19.~~ 13.		Previously filed as an Exhibit to the Registrant’sForm 10-Q for the quarter ended September 30, 2002.

~~20.~~ 14.		Previously filed as an Exhibit to the Registrant’s Registration Statement onForm ~~S-8 (No.~~S-8(No. 333-63076).

~~21.~~ 15.		Previously filed as an Exhibit to the Registrant’s Registration Statement onForm ~~S-8 (No.~~S-8(No. 333-85320).

~~22.~~ 16.		Previously filed as an Exhibit to the Registrant’s Registration Statement onForm ~~S-8 (No.~~S-8(No. 333-112139).

~~23.~~ 17.		Previously filed as an Exhibit to the Registrant’sForm 10-Q for the quarter ended March 30, 2003.

~~24.~~ 18.		Previously filed as an Exhibit to the Registrant’s Registration Statement onForm 8-A dated September 25, 2003.

~~25.~~ 19.	~~Previously filed as an Exhibit to the Registrant’s Current Report on form 8-K dated September 25, 2003.~~

~~26.~~	Previously filed as an Exhibit to the Registrant’s 2003 Annual Report onForm 10-K.

~~27.~~ 20.		Previously filed as an Exhibit to the Registrant’sForm 10-Q for the quarter ended June 27, 2004.

~~28.~~ 21.		Previously filed as an Exhibit to the Registrant’sForm 10-Q for the quarter ended September 26, 2004.

22.		Previously filed as an Exhibit to the Registrant’s 2004 Annual Report onForm 10-K.

23.		Previously filed as an Exhibit to the Registrant’s Current Report onForm 8-K dated June 3, 2005.

24.		Previously filed as an Exhibit to the Registrant’sForm 10-Q for the quarter ended ~~September 26, 2004.~~July 3, 2005.

E-3


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

		For the fiscal year ended January ~~2, 2005~~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


Delaware		77-0191793
(State or other jurisdiction of incorporation or organization)		(~~IRS~~I.R.S. Employer Identification No.)

140 Caspian Court Sunnyvale, California (Address of principal executive ~~office)~~offices)		94089 (Zip Code)


Class		Outstanding at March 1, 2006

Common Stock, $0.001 par value per share		194,010,547 shares


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


~~(1)~~	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.

~~(2)~~	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 our UMC investment, 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.

~~(3)~~	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.

~~(4)~~	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.

~~(5)~~	~~Includes gain on investment of UMC of $344.2 million, or $203.9 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.~~


Title of Each Class		Name of Each Exchange on Which Registered

None		None


		meet the minimum standard performance of 15 megabits per second for high-resolution recording of moving images.

	•	~~Cruzer®~~Cruzer^®USB Flash Drives. Our Cruzer USB flash drives are available in capacities ranging from ~~128~~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~~flash drive made from titanium and other metals. ~~The Cruzer Titanium is one of the fastest performing USB Flash Drives on the market and is available in 512 megabyte and 1 gigabyte capacities.~~ In conjunction with M-Systems, Inc., or M-Systems, we ~~are developing~~developed the U3 ~~as a new~~^tm platform for USB ~~drives. Our USB flash drive family of products accounted for 14% of our product revenues in 2004.~~

	•	~~RS-MMC.~~ ~~Our RS-MMC~~drives, which is designed for use in small Nokia, Samsung or Siemens mobile phones. It is about half the size of a standard MultiMediaCard and has the same simple low power interface. This allows the RS-MMC to be used with an extender in a full-size MMC slot.

	•	~~TransFlash.~~ TransFlash, introduced in 2004, is an ultra-small removable flash memory storage format. TransFlash is 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, personal organizers, multimedia message service, email and voicemail capabilities. TransFlash 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.on-the-go computing.

	•	XD-Picture ~~Card~~Card..^tm 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 ~~for the most portable device~~ and is compatible with all xD cameras. The xD-Picture Card is available in capacities ~~that range~~ranging from 64 megabytes to ~~512 megabytes.~~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.


		~~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.~~Item 1A, “Risk Factors.”

	•	Testing and Assembly. We sort and test our wafers at Toshiba in Yokkaichi, Japan, and ~~United Test Center, Inc.,~~Ardentec Corp. in Taiwan. Our tested wafers are then shipped to our third-party memory assembly subcontractors, including StatsChipPAC Ltd., or StatsChipPAC, in China, ~~and~~ 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 ~~Center, ASE Group~~ and ~~DataFab Systems, Inc.~~Assembly Center, in Taiwan, and ~~StatsChipPAC and~~Beautiful Enterprise Co., Ltd., DataFab, Flextronics International, Ltd., or


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


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


		High		Low

2003
	First quarter	$	12.20	$	7.39
	Second quarter	$	20.73	$	8.21
	Third quarter	$	34.08	$	19.00
	Fourth quarter	$	43.15	$	26.60
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


				Years Ended

				January 2,		December 28,		December 29,		December 30,			December 31,
				2005(1)		2003(2)		2002(3)		2001(4)			2000(5)

				(In thousands, except per share data)
Revenues
	Product			$	1,602,836	$	982,341	$	492,900	$	316,867		$	526,359
	License and royalty				174,219		97,460		48,373		49,434			75,453

			Total revenues		1,777,055		1,079,801		541,273		366,301			601,812
Cost of revenues					1,091,350		641,189		352,452		392,293			357,017

Gross profit (loss)					685,705		438,612		188,821		(25,992	)		244,795
Operating income (loss)					418,591		257,038		58,151		(152,990	)		124,666
Net income (loss)				$	266,616	$	168,859	$	36,240	$	(297,944	)	$	298,672
Net income (loss) per share(6)
		Basic		$	1.63	$	1.17	$	0.26	$	(2.19	)	$	2.24
		Diluted		$	1.44	$	1.02	$	0.25	$	(2.19	)	$	2.06
Shares used in per share calculations (6)
		Basic			164,065		144,781		137,610		136,296			133,722
		Diluted			188,837		171,616		142,460		136,296			145,302


			Quarters Ended

			March 28,		June 27,		September 26,		January 2,
			2004		2004		2004		2005

			(Unaudited. In thousands, except per share data)
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(1)				63,568		70,611		54,102		78,335
Net income per share(3)
		Basic(2)	$	0.39	$	0.44	$	0.33	$	0.46
		Diluted(2)	$	0.34	$	0.38	$	0.29	$	0.42


			Quarters Ended

			March 30,		June 29,		September 28,		December 28,
			2003		2003		2003		2003

			(Unaudited. In thousands, except per share data)
2003
Revenues
	Product		$	155,448	$	214,044	$	259,446	$	353,403
	License and royalty			19,032		20,582		21,954		35,892

		Total revenues		174,480		234,626		281,400		389,295
Gross profit				71,591		88,772		113,635		164,614
Operating income				34,686		46,659		66,803		108,890
Net income(1)				24,925		41,326		14,770		87,838
Net income per share(3)
		Basic(2)	$	0.18	$	0.30	$	0.11	$	0.55
		Diluted(2)	$	0.17	$	0.26	$	0.09	$	0.47


~~ITEM 7:~~	*~~MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS~~*


ITEM 2.1A.	*~~PROPERTIES~~RISK FACTORS*


~~ITEM 3.~~	*~~LEGAL PROCEEDINGS~~*


~~ITEM 6.~~	*~~SELECTED FINANCIAL DATA~~*


			Years Ended

			January 2,		% of			December 28,			% of			December 29,			% of
			2005		Revenue			2003			Revenue			2002			Revenue

								(Dollars, in thousands)
Product revenues			$	1,602,836		90.2	%	$	982,341			91.0	%	$	492,900			91.1	%
License and royalty revenues				174,219		9.8	%		97,460			9.0	%		48,373			8.9	%

	Total revenues			1,777,055		100.0	%		1,079,801			100.0	%		541,273			100.0	%
Cost of product revenues				1,091,350		61.4	%		641,189			59.4	%		352,452			65.1	%

Gross profit				685,705		38.6	%		438,612			40.6	%		188,821			34.9	%
Operating expenses
	Research and development			124,994		7.0	%		84,200			7.8	%		63,177			11.7	%
	Sales and marketing			91,296		5.1	%		66,317			6.1	%		40,407			7.5	%
	General and administrative			50,824		2.9	%		31,057			2.9	%		27,086			5.0	%

		Total operating expenses		267,114		15.0	%		181,574			16.8	%		130,670			24.1	%

Operating income				418,591		23.6	%		257,038			23.8	%		58,151			10.7	%
Non-operating income (loss), net				4,609		0.3	%		(15,157	)		(1.4	)%		(18,172	)		(3.4	)%

Income before taxes				423,200		23.8	%		241,881			22.4	%		39,979			7.4	%
Provision for income taxes				156,584		8.8	%		73,022			6.8	%		3,739			0.7	%

Net income			$	266,616		15.0	%	$	168,859			15.6	%	$	36,240			6.7	%


	•	~~the factors listed elsewhere under “Factors That May Affect Future Results”;~~

	•	~~unpredictable or changing demand for our products;~~

	•	decline in the average selling prices, net of promotions, for our products due to ~~excess supply, competitive pricing pressures and~~ strategic price reductions initiated by us or our ~~competitors;~~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 fabstart-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;


ITEM 10.	*DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT*


									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 30, 2001		136,928	$	136	$	580,295	$	48,525	$	46,423			—		$	675,379

Net income								36,240								36,240
Unrealized gain on available for sale securities										292						292
Unrealized loss on investments in foundries										(89,728	)					(89,728	)
Translation gain										7,147						7,147

Comprehensive loss																(46,049	)

Exercise of stock options for cash		944		1		2,759										2,760
Issuance of stock pursuant to employee stock purchase plan		438		1		2,776										2,777

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
Translation gain										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	)
Translation gain										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


				Fiscal Years Ended

				2004			2003			2002

				(In thousands)
Cash flows from operating activities:
Net income				$	266,616		$	168,859		$	36,240
Adjustments to reconcile net income to net cash provided by operating activities:
	Deferred taxes				9,326			2,152			(7,729	)
	(Gain) loss on investment in foundries				12,927			(3,746	)		15,163
	(Recovery) loss on unauthorized sales of UMC shares				(6,193	)		18,339			—
	Depreciation and amortization				38,862			22,952			21,321
	Provision for doubtful accounts				4,581			1,400			1,795
	FlashVision wafer cost adjustment				(1,282	)		(1,613	)		8,128
	Other non-cash charges				3,764			3,143			2,952
	Changes in operating assets and liabilities:
		Accounts receivable			(14,880	)		(104,550	)		(37,658	)
		Inventories			(79,526	)		(28,301	)		(33,314	)
		Prepaid expenses and other current assets			(246	)		7,697			(5,217	)
		Deposits and other assets			1,927			(4,116	)		1,771
		Accounts payable			(6,298	)		51,296			8,356
		Accrued payroll and related expenses			13,472			16,543			6,411
		Income taxes receivable/payable			(11,950	)		27,720			30,717
		Other current liabilities, related parties			(3,149	)		29,104			(2,408	)
		Other accrued liabilities			8,959			9,196			6,911
		Deferred income on shipments to distributors and retailers and deferred revenue			(15,489	)		57,682			51,129
		Other non-current liabilities			6,245			(1,225	)		2,404

			Total adjustments		(38,950	)		103,673			70,732

Net cash provided by operating activities					227,666			272,532			106,972

Cash flows from investing activities:
	Purchases of short-term investments				(1,147,142	)		(622,580	)		(377,690	)
	Proceeds from sale of short term investments				810,111			327,457			246,417
	Proceeds from sale of investments in foundries				—			21,627			—
	Release of restricted cash				—			—			64,734
	Acquisition of property and equipment				(125,842	)		(54,623	)		(16,638	)
	Acquisition of technology license				—			(1,500	)		(606	)
	Consideration paid in a business combination				(9,061	)		—			—
	Notes receivable from FlashVision				(33,564	)		—			—
	Investment in FlashVision				—			—			4,199
	Investment in Flash Partners				(23,129	)		—			—
	Investment in foundries				(704	)		(11,001	)		(26,005	)
	Proceeds from other sales				6,333			4,880			—

Net cash (used in) investing activities					(522,998	)		(335,740	)		(105,589	)

Cash flows from financing activities:
	Net proceeds from issuance of convertible subordinated notes				—			—			24,366
	Issuance of common stock in public offering				—			521,608			—
	Issuance of common stock under employee programs				24,648			55,294			5,537

Net cash provided by financing activities					24,648			576,902			29,903

			Net increase (decrease) in cash and cash equivalents		(270,684	)		513,694			31,286
Cash and cash equivalents at beginning of the year					734,479			220,785			189,499

Cash and cash equivalents at end of the year				$	463,795		$	734,479		$	220,785

Supplemental disclosure of cash flow information:
Cash paid for income taxes				$	(159,436	)	$	(44,244	)	$	(10,076	)

Cash paid for interest expense				$	(6,750	)	$	(6,750	)	$	(6,019	)

Non-cash financing and investing activities:
Conversion of subordinated notes				$	150,000		$	—		$	—

Issuance of shares in a business combination				$	4,935		$	—		$	—


				Additions
		Balance at		Charged to					Balance at
		Beginning		Costs and		Deductions			End of
		of Period		Expenses		(Write-Offs)			Period

For the year ended:
	December 29, 2002	$	4,919	$	1,795	$	(2,151	)	$	4,563
	December 28, 2003	$	4,563	$	1,400	$	(1,081	)	$	4,882
	January 2, 2005	$	4,882	$	4,581	$	(1,001	)	$	8,462


			Total Available						Weighted
			for Future			Total			Average
			Grant/Issuance			Outstanding			Exercise Price

Balance at December 30, 2001				12,186			17,238		$	12.89

	Granted			(5,540	)		5,540		$	6.60
		Automatic share increase		6,244			—			—
	Exercised			—			(944	)	$	2.94
	Canceled			2,572			(2,572	)	$	19.47

Balance at December 29, 2002				15,462			19,262		$	10.69

	Granted			(6,088	)		6,088		$	11.76
		Automatic share increase		6,307			—			—
	Exercised			—			(5,477	)	$	9.45
	Canceled			481			(481	)	$	17.13

Balance at December 28, 2003				16,162			19,392		$	11.21

	Granted			(6,617	)		6,617		$	31.58
		Automatic share increase		7,337			—			—
	Exercised			—			(2,320	)	$	8.21
	Canceled			1,057			(1,057	)	$	20.93

Balance at January 2, 2005				17,939			22,632		$	17.02


	Options Outstanding						Options Exercisable

	Number		Weighted				Number
	Outstanding as		Average		Weighted		Exercisable as		Weighted
	of January 2,		Remaining		Average		of January 2,		Average
Range of Exercise Prices	2005		Contractual Life		Exercise Price		2005		Exercise Price

$ 0.56 - $ 5.41		2,865,288		3.97	$	3.59		2,722,747	$	3.50
$ 5.73 - $ 8.29		3,603,100		7.06	$	6.49		2,166,087	$	6.47
$ 8.36 - $ 8.87		4,238,129		8.01	$	8.85		1,716,967	$	8.84
$ 8.93 - $19.22		4,264,995		5.73	$	16.33		4,006,897	$	16.50
$19.82 - $34.50		2,493,892		8.54	$	24.77		970,566	$	26.94
$34.59 - $36.63		4,796,458		8.90	$	34.63		180,728	$	35.47
$37.25 - $69.75		370,580		6.87	$	44.41		252,550	$	46.77

$ 0.56 - $69.75		22,632,442		7.15	$	17.02		12,016,542	$	12.42


				Less Than							More Than
				1 Year			2 - 3 Years		4 - 5 Years		5 Years
				(Fiscal			(Fiscal 2006		(Fiscal 2008		(Beyond
	Total			2005)			and 2007)		and 2009)		Fiscal 2009)

CONTRACTUAL OBLIGATIONS:
Operating leases	$	5,111		$	3,598		$	1,513	$	—	$	—
FlashVision, fabrication capacity expansion costs, and reimbursement for certain other costs including depreciation		621,435			187,676			267,947		126,082		39,730
Flash Partners fabrication capacity expansion and start-up costs, and reimbursement for certain other costs including depreciation		833,628			313,279			221,204		198,306		100,839
Toshiba research and development		97,000			20,000			48,000		29,000		—
Capital equipment purchases commitments		55,879			49,602			6,277		—		—
Operating expense commitments		27,231			27,231			—		—		—
Non-cancelable production purchase commitments		264,398			264,398			—		—		—

Total contractual cash obligations	$	1,904,682		$	865,784		$	544,941	$	353,388	$	140,569

Contractual cash (income) from non-cancelable operating subleases	$	(124	)	$	(124	)	$	—	$	—	$	—


	As of
	January 2,
	2005

OFF BALANCE SHEET ARRANGEMENTS:
Indemnification of FlashVision foundry equipment lease	$	111,868
Guarantee of Flash Partners lease	$	—


Fiscal Year Ending:
	2005	$	3,598
	2006		1,465
	2007		48
	Thereafter		—

Total		$	5,111


	Twelve Months Ended

	2004		2003		2002

	(Unaudited)
Net sales(1)	$	481,792	$	272,507	$	73,571
Gross profit (loss)		2,553		1,572		(369	)
Net income	$	1,318	$	296	$	2,587


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.(12)

	3	.3	Certificate of Amendment of the Restated Certificate of Incorporation of the Registrant dated May 11, 2000.(16)

	3	.4	Restated Bylaws of the Registrant, as amended to date.(15)

	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.(24)

	4	.1	Reference is made to Exhibits 3.1, 3.2 and 3.3.(2), (12),(16)

	4	.2	Rights Agreement, dated as of September 15, 2003, between the Registrant and Computershare Trust Company, Inc.(24)

	10	.1	License Agreement between the Registrant and Dr. Eli Harari, dated September 6, 1988.(2)

	10	.2	Lease Agreement between the Registrant and G.F. Properties, dated March 1, 1996.(3)

	10	.3	Amendment to Lease Agreement between the Registrant and G.F. Properties, dated April 3, 1997.(5)

	10	.4	Lease Agreement between the Registrant and G.F. Properties, dated June 10, 1998.(8)

	10	.5	1989 Stock Benefit Plan.(2), (*)

	10	.6	SanDisk Corporation Special Stock Option Plan, as Amended and Restated through February 23, 2000.(20), (*)

	10	.7	SanDisk Corporation 1995 Stock Option Plan, as Amended and Restated January 2, 2002.(21), (*)

	10	.8	SanDisk Corporation 1995 Non-Employee Directors Stock Option Plan, as Amended and Restated as of January 2, 2004.(22), (*)

	10	.9	SanDisk Corporation 1995 Employee Stock Purchase Plan, as Amended and Restated as of January 2, 2002.(21), (*)

	10	.10	SanDisk Corporation International Employee Stock Purchase Plan, as Amended and Restated as of January 2, 2002.(21), (*)

	10	.11	Share Purchase Agreement, dated as of July 4, 2000, by and between the Registrant and Tower Semiconductor Ltd.(13)

	10	.12	Escrow Agreement, dated as of August 14, 2000, by and between the Registrant, Tower Semiconductor Ltd. and Union bank of California, N.A.(13)

	10	.13	Additional Purchase Obligation Agreement, dated as of July 4, 2000, by and between the Registrant and Tower Semiconductor Ltd.(13)

	10	.14	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.(14)

	10	.15	Consolidated Shareholders Agreement, dated as of January 18, 2001, by and among Registrant, The Israel Corporation, Alliance Semiconductor Ltd. And Macronix International Co., Ltd.(14)

	10	.16	Amendment to Share Purchase Agreement, dated as of March 20, 2002, by and between the Registrant and Tower Semiconductor Ltd.(17)

	10	.17	Amendment to Share Purchase Agreement, dated as of February 21, 2003, by and between the Registrant, Tower Semiconductor Ltd. and the other parties thereto.(23)

	10	.18	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.(23)

	10	.19	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.(23)