UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended April 1, 2007

OR

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

For the transition period from                      to                     

Commission file number: 000-26734

SANDISK CORPORATION

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

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

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ            No o

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

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

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o            No þ

     Number of shares outstanding of the issuer’s common stock $0.001 par value, as of April 1, 2007: 228,212,880.

 

 

SanDisk Corporation

Index

		Page No.
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of April 1, 2007 and December 31, 2006		3
Condensed Consolidated Statements of Operations for the three months ended April 1, 2007 and April 2, 2006		4
Condensed Consolidated Statements of Cash Flows for the three months ended April 1, 2007 and April 2, 2006		5
Notes to Condensed Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		41
Item 3. Quantitative and Qualitative Disclosures About Market Risk		52
Item 4. Controls and Procedures		52
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		53
Item 1A. Risk Factors		57
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		73
Item 3. Defaults upon Senior Securities		73
Item 4. Submission of Matters to a Vote of Security Holders		73
Item 5. Other Information		73
Item 6. Exhibits		74
Signatures		75
Exhibit Index		76
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (in thousands)

SANDISK CORPORATION

		April 1, 2007				December 31, 2006*
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	1,811,109			$	1,580,700
Short-term investments			1,144,838				1,228,773
Accounts receivable from product revenues, net			144,228				611,740
Inventory			594,156				495,984
Deferred taxes			175,770				176,007
Other current assets			187,379				148,657
Total current assets			4,057,480				4,241,861
Long-term investments			527,363				457,184
Property and equipment, net			328,645				317,965
Notes receivable and investments in flash ventures			442,884				462,307
Deferred taxes			95,366				102,100
Goodwill			852,862				910,254
Intangibles, net			376,827				389,078
Other non-current assets			68,783				87,034
Total assets		$	6,750,210			$	6,967,783
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable trade		$	188,680			$	261,870
Accounts payable to related parties			159,710				139,627
Other accrued liabilities			162,687				311,000
Deferred income on shipments to distributors and retailers and deferred revenue			99,273				183,950
Total current liabilities			610,350				896,447
Convertible long-term debt			1,225,000				1,225,000
Deferred taxes and other non-current liabilities			115,269				72,226
Total liabilities			1,950,619				2,193,673
Minority interest			3,651				5,976
Commitments and contingencies
Stockholders’ equity:
Preferred stock			—				—
Common stock			228				226
Capital in excess of par value			3,686,334				3,656,895
Retained earnings			1,099,580				1,105,520
Accumulated other comprehensive income			9,798				5,493
Total stockholders’ equity			4,795,940				4,768,134
Total liabilities and stockholders’ equity		$	6,750,210			$	6,967,783

*Information derived from the audited Consolidated Financial Statements.

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

SANDISK CORPORATION

		Three months ended
		April 1, 2007				April 2, 2006
		(In thousands, except per share amounts)
Revenues:
Product		$	689,357			$	537,728
License and royalty			96,729				85,532
Total revenues			786,086				623,260
Cost of product revenues			570,088				384,867
Amortization of acquisition-related intangible assets			21,062				—
Total cost of product revenues			591,150				384,867
Gross profit			194,936				238,393
Operating expenses:
Research and development			95,640				63,762
Sales and marketing			56,206				43,375
General and administrative			46,991				30,016
Write-off of acquired in-process technology			—				39,600
Amortization of acquisition-related intangible assets			9,100				3,715
Restructuring			6,516				—
Total operating expenses			214,453				180,468
Operating income (loss)			(19,517	)			57,925
Interest income			37,488				15,277
Interest expense and other income (expense), net			(1,229	)			3,187
Total other income			36,259				18,464
Income before taxes			16,742				76,389
Provision for income taxes			12,157				41,274
Income after taxes			4,585				35,115
Minority interest			5,160				—
Net income (loss)		$	(575	)		$	35,115
Net income (loss) per share:
Basic		$	(0.00	)		$	0.18
Diluted		$	(0.00	)		$	0.17
Shares used in computing net income (loss) per share:
Basic			227,455				193,077
Diluted			227,455				201,892

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

SANDISK CORPORATION

		Three months ended
		April 1, 2007				April 2, 2006
		(In thousands)
Cash flows from operating activities:
Net income (loss)		$	(575	)		$	35,115
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Deferred taxes			11,431				(13,456	)
Gain on investment in foundries			(2,204	)			(593	)
Depreciation and amortization			65,096				26,397
Provision for doubtful accounts			913				(526	)
Share-based compensation expense			31,219				18,785
Tax benefit from share-based compensation			(6,261	)			(41,909	)
Write-off of acquired in-process technology			—				39,600
Other non-cash charges (income)			4,749				(1,208	)
Changes in operating assets and liabilities:
Accounts receivable from product revenues			467,030				90,546
Inventories			(98,109	)			(75,484	)
Other assets			63,426				59,581
Accounts payable trade			(73,234	)			(58,135	)
Accounts payable to related parties			22,547				6,208
Other liabilities			(230,779	)			(32,472	)
Total adjustments			255,824				17,334
Net cash provided by operating activities			255,249				52,449
Cash flows from investing activities:
Purchases of short and long-term investments			(537,162	)			(119,769	)
Proceeds from sale and maturities of short and long-term investments			549,146				154,664
Investment in Flash Partners and Flash Alliance			—				(43,581	)
Acquisition of property and equipment, net			(43,799	)			(52,597	)
Notes receivable from FlashVision			24,777				—
Purchased technology and other assets			(13,240	)			—
Cash acquired in business combination, net of acquisition costs			—				9,432
Net cash used in investing activities			(20,278	)			(51,851	)
Cash flows from financing activities:
Proceeds from employee stock programs			38,370				46,061
Distribution to minority interest			(7,485	)			—
Tax benefit from share-based compensation			6,261				41,909
Share repurchase programs			(42,096	)			—
Net cash provided by (used in) financing activities			(4,950	)			87,970
Effect of changes in foreign currency exchange rates on cash			388				(61	)
Net increase in cash and cash equivalents			230,409				88,507
Cash and cash equivalents at beginning of the period			1,580,700				762,058
Cash and cash equivalents at end of the period		$	1,811,109			$	850,565
Supplemental disclosures of cash flow information:
Issuance of stock for acquisition		$	—			$	260,908

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

SANDISK CORPORATION

1. Organization and Summary of Significant Accounting Policies

Organization

     These interim condensed consolidated financial statements are unaudited but reflect, in the opinion of management, all adjustments, consisting of normal recurring adjustments and accruals, necessary to present fairly the financial position of SanDisk Corporation and its subsidiaries (the “Company”) as of April 1, 2007, the statements of operations for the three months ended April 1, 2007 and April 2, 2006 and the statements of cash flows for the three months ended April 1, 2007 and April 2, 2006. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), have been omitted in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s most recent Annual Report on Form 10-K. Certain prior period amounts have been reclassified to conform to the current period presentation. The results of operations for the three months ended April 1, 2007 are not necessarily indicative of the results to be expected for the entire fiscal year.

     The Company’s fiscal year ends on the Sunday closest to December 31, and its fiscal quarters end on the Sunday closest to March 31, June 30, and September 30, respectively. The first quarters of fiscal 2007 and fiscal 2006 ended on April 1, 2007 and April 2, 2006, respectively. Fiscal 2007 ends on December 30, 2007 and fiscal 2006 ended on December 31, 2006.

     Organization and Nature of Operations. 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.

     Principles of Consolidation. The condensed consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All intercompany balances and transactions have been eliminated. Minority interest represents the minority shareholders’ proportionate share of the net assets and results of operations of our majority-owned subsidiary. The condensed consolidated financial statements also include the results of companies acquired by the Company from the date of each acquisition.

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

Recent Accounting Pronouncements

     SFAS No. 159. In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 159 (“SFAS 159”), Establishing the Fair Value Option for Financial Assets and Liabilities. The FASB has issued SFAS 159 to permit all entities to choose to elect, at specified election dates, to measure eligible financial instruments at fair value. An entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date, and recognize upfront costs and fees related to those items in earnings as incurred and not deferred. SFAS 159 applies to fiscal years beginning after November 15, 2007, or the Company’s 2008 fiscal year, with early adoption permitted for an entity that has also elected to apply the provisions of SFAS No. 157, Fair Value Measurements. An entity is prohibited from retrospectively applying SFAS 159, unless it chooses early adoption. SFAS 159 also applies to eligible items existing at November 15, 2007 (or early adoption date). The Company has not completed its analysis but does not expect the adoption of SFAS 159 to have a material effect on the Company’s financial condition.

     EITF Issue No. 07-2. In the Emerging Issues Task Force (“Task Force”) March 15, 2007 meeting, the Task Force opened EITF Issue No. 07-2 (“EITF 07-2”), Accounting for Convertible Debt Instruments That Require or Permit Partial Cash

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

Settlement upon Conversion. The Task Force was asked to consider how a company should account for a convertible debt instrument that requires or permits partial cash settlement upon conversion if, at issuance, the embedded conversion option is not required to be separately accounted for as a derivative under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. The question is whether such instruments should be accounted for as convertible debt in accordance with Accounting Principles Board Opinion 14 (“APB 14”), Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants, and its related interpretations. Under APB 14, no proceeds would be allocated to the conversion feature of convertible debt. The scope of this issue would include Instrument C in EITF Issue No. 90-19, Convertible Bonds with Issuer Option to Settle for Cash upon Conversion, which is a debt instrument that, on conversion, must be satisfied with cash for the accreted value of the obligation and with either cash or stock for the conversion spread. As of April 1, 2007, the Task Force discussed the scope of this issue without reaching any conclusions.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

2. Balance Sheet Detail

     Accounts Receivable from Product Revenues, net. Accounts receivable from product revenues, net, were as follows (in thousands):

		April 1, 2007				December 31, 2006
Trade accounts receivable		$	605,310			$	1,056,616
Related party accounts receivable			86,446				41,708
Allowance for doubtful accounts			(12,152	)			(11,452	)
Price protection, promotions and other reserves			(535,376	)			(475,132	)
Total accounts receivable from product revenues, net		$	144,228			$	611,740

     In the three months ended April 1, 2007, the Company’s accounts receivable from product revenues have decreased from the prior quarter primarily due to collection on higher fourth quarter of fiscal 2006 receivable balances, decreased shipments and increased price protection and promotional activities.

     Inventory. Inventories were as follows (in thousands):

		April 1, 2007				December 31, 2006
Raw material		$	200,834			$	157,163
Work-in-process			59,201				64,009
Finished goods			334,121				274,812
Total inventories		$	594,156			$	495,984

     Other Current Assets. Other current assets were as follows (in thousands):

		April 1, 2007				December 31, 2006
Royalty and other receivables		$	89,736			$	82,569
Interest receivable			15,542				14,561
Prepaid expenses			27,395				22,276
Investment in foundries			24,957				22,720
Other current assets			29,749				6,531
Total other current assets		$	187,379			$	148,657

     Notes Receivables and Investments in Flash Ventures. Notes receivable and investments in flash ventures were as follows (in thousands):

		April 1, 2007				December 31, 2006
Notes receivable, FlashVision		$	13,192			$	38,229
Notes receivable, Flash Partners			93,625				92,421
Investment in FlashVision			161,640				159,144
Investment in Flash Partners			170,164				168,210
Investment in Flash Alliance			4,263				4,303
Total notes receivable and investments in flash ventures		$	442,884			$	462,307

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

		April 1, 2007				December 31, 2006
Investment in foundries		$	10,925			$	17,071
Deposits			6,253				6,381
Other non-current assets			51,605				63,582
Total other non-current assets		$	68,783			$	87,034

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

     Other Accrued Liabilities. Other accrued liabilities were as follows (in thousands):

		April 1, 2007				December 31, 2006
Accrued payroll and related expenses		$	48,827			$	61,050
Taxes payable and deferred tax liability			9,317				119,502
Research and development liability, related party			8,314				5,850
Other accrued liabilities			96,229				124,598
Total other accrued liabilities		$	162,687			$	311,000

     Convertible Long-term Debt. The carrying value of our long-term borrowings as of April 1, 2007 and December 31, 2006 are as follows (in thousands):

		April 1, 2007				December 31, 2006
1% Convertible Senior Notes due 2013		$	1,150,000			$	1,150,000
1% Convertible Notes due 2035			75,000				75,000
Total long-term debt		$	1,225,000			$	1,225,000

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

3. Share-Based Compensation

Share-Based Plans

     The Company has a share-based compensation program that provides its Board of Directors with broad discretion in creating equity incentives for employees, officers, non-employee board members and non-employees. This program includes incentive and non-statutory stock option awards, stock appreciation rights awards, restricted stock awards, performance-based cash bonus awards for Section 16 executive officers and an automatic grant program for 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. These awards are granted under various plans, all of which are stockholder approved. Grants and awards under the discretionary grant program generally vest as follows: 25% of the shares vest on the first anniversary of the vesting commencement date and the remaining 75% vest proportionately each quarter over the next 12 quarters of continued service. Awards under the stock issuance program generally vest in equal annual installments over a 4 year period. Grants under the automatic grant program vest in accordance with the specific vesting provisions set forth in that program. Additionally, we have an Employee Stock Purchase Plan (“ESPP”) that allows employees to purchase shares of common stock at 85% of the fair market value at the date of purchase.

Valuation Assumptions

     The fair value of the Company’s stock options granted to employees for the three months ended April 1, 2007 and April 2, 2006 was estimated using the following weighted average assumptions:

		Three months ended
		April 1, 2007				April 2, 2006
Option Plan Shares
Dividend yield		None				None
Expected volatility			0.46				0.51
Risk-free interest rate			4.55	%			4.39	%
Expected lives		3.5 years				3.6 years
Estimated annual forfeitures rate			7.74	%			8.20	%
Weighted average fair value at grant date		$	15.64			$	27.17
Employee Stock Purchase Plan Shares
Dividend yield		None				None
Expected volatility			0.44				0.54
Risk-free interest rate			5.16	%			4.69	%
Expected lives		1/2 year				1/2 year
Weighted average fair value at exercise date		$	11.44			$	20.45

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

Share-Based Compensation Plan Activities

     Stock Option and SARs. Stock option and SAR activity for the three months ended April 1, 2007, is as follows (in thousands, except exercise price and contractual term):

										Weighted
										Average
						Weighted				Remaining
						Average				Contractual				Aggregate
		Shares				Exercise Price				Term (Years)				Intrinsic Value
Options and SARs outstanding at December 31, 2006			26,392			$	31.97
Granted			3,952				42.02
Exercised			(1,671	)			21.13
Forfeited			(457	)			45.21
Expired			(44	)			55.92
Options and SARs outstanding at April 1, 2007			28,172				33.78				6.5			$	372,452
Options and SARs vested and expected to vest after April 1, 2007			26,312				33.00				6.4			$	365,847
Options and SARs exercisable at April 1, 2007			12,239			$	21.85				5.7			$	287,838

     During the three months ended April 1, 2007 and April 2, 2006, the aggregate intrinsic value of options and SARs exercised under the Company’s share-based compensation plans was $32.0 million and $117.7 million, respectively. At April 1, 2007, the total compensation cost related to options granted to employees under the Company’s share-based compensation plans but not yet recognized was approximately $252.1 million, net of estimated forfeitures. The unamortized compensation expense will be amortized on a straight-line basis, and the weighted average period of this expense is approximately 2.7 years.

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

     A summary of the changes in restricted stock units outstanding under the Company’s share-based compensation plan during the three months ended April 1, 2007, is presented below (in thousands, except for grant date fair value):

						Weighted Average
						Grant Date Fair				Aggregate
		Shares				Value				Intrinsic Value
Non-vested share units at December 31, 2006			598			$	58.71
Granted			86				41.21
Vested			(119	)			61.47
Forfeited			(29	)			68.90
Non-vested share units at April 1, 2007			536			$	54.73			$	23,457

     As of April 1, 2007, the Company had $28.0 million of total unrecognized compensation expense, net of estimated forfeitures, related to restricted stock. The unamortized compensation expense will be recognized on a straight-line basis, and the weighted average estimated remaining life is 2.9 years.

     Employee Stock Purchase Plans. At April 1, 2007, there was $1.6 million of total unrecognized compensation cost related to the ESPP that is expected to be recognized over a period of approximately 4 months.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

     Share-Based Compensation Expense. Share-based compensation for the three months ended April 1, 2007 and April 2, 2006 is as follows (in thousands):

		Three months ended
		April 1, 2007				April 2, 2006
Share-based compensation expense by caption:
Cost of product sales		$	3,214			$	—
Research and development			12,687				8,785
Sales and marketing			6,923				4,041
General and administrative			8,395				5,959
Total share-based compensation expense		$	31,219			$	18,785
Share-based compensation expense by type of award:
Stock options and SARs		$	26,645			$	16,054
Restricted stock			3,466				2,036
ESPP			1,108				695
Total share-based compensation expense		$	31,219			$	18,785

     Share-based compensation expense of $3.3 million and $2.5 million related to manufacturing personnel was capitalized into inventory as of April 1, 2007 and April 2, 2006, respectively.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

4. Restructuring

     During the first quarter of fiscal 2007, the Company implemented a restructuring plan which included reductions in workforce in all functions of the organization worldwide and closures of redundant facilities in order to reduce the Company’s cost structure. A restructuring charge of $6.5 million was recorded, of which $5.9 million related to severance and benefits to 149 terminated employees. All expenses, including adjustments, associated with the Company’s restructuring plans are included in “Restructuring” in the Condensed Consolidated Statements of Operations.

     The following table sets forth an analysis of the components of the restructuring charge and the provision adjustment and payments made against the reserve through April 1, 2007 (in thousands):

						Lease
						Obligations
		Severance				and Other
		And Benefits				Charges				Total
Restructuring provision		$	5,947			$	569			$	6,516
Cash paid			(969	)			—				(969	)
Reserve balance at April 1, 2007		$	4,978			$	569			$	5,547

     The Company anticipates that approximately $5.0 million of the remaining restructuring reserve balance will be paid out in cash in the second quarter of fiscal 2007 with the remaining balance payable through the first quarter of fiscal 2010.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

5. Warranty

     Changes to the Company’s warranty reserve activity were as follows (in thousands):

		Three months ended
		April 1, 2007				April 2, 2006
Balance, beginning of period		$	15,338			$	11,258
Reductions to costs of product revenue			(1,496	)			(2,607	)
Usage			(3,110	)			(228	)
Balance, end of period		$	10,732			$	8,423

     The majority of the Company’s products have a warranty ranging from one to five years. A provision for the estimated future cost related to warranty expense is recorded at the time of customer invoice. The Company’s warranty obligation is affected by customer and consumer returns, product failures and repair or replacement costs incurred.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

6. Goodwill and Other Intangible Assets

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

Balance at December 31, 2006		$	910,254
Goodwill adjustment			(57,392	)
Balance at April 1, 2007		$	852,862

     The goodwill adjustment in the first quarter of fiscal 2007 was a result of purchase price adjustments related to the msystems Ltd. (“msystems”) acquisition. See Note 12, “Business Acquisition.”

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

		April 1, 2007												December 31, 2006
		Gross Carrying				Accumulated				Net Carrying				Gross Carrying				Accumulated				Net Carrying
		Amount				Amortization				Amount				Amount				Amortization				Amount
Core technology		$	311,801			$	(36,337	)		$	275,464			$	311,801			$	(18,135	)		$	293,666
Developed product technology			12,900				(3,135	)			9,765				12,900				(2,103	)			10,797
Trademarks			4,000				(2,911	)			1,089				4,000				(911	)			3,089
Backlog			5,000				(3,639	)			1,361				5,000				(1,139	)			3,861
Supply agreement			2,000				(2,000	)			—				2,000				(46	)			1,954
Customer relationships			80,100				(10,482	)			69,618				80,100				(6,008	)			74,092
Acquisition-related intangible assets			415,801				(58,504	)			357,297				415,801				(28,342	)			387,459
Technology licenses			29,243				(9,713	)			19,530				7,388				(5,769	)			1,619
Total		$	445,044			$	(68,217	)		$	376,827			$	423,189			$	(34,111	)		$	389,078

     Intangible assets increased by $21.9 million in the three months ended April 1, 2007, primarily due to technology licenses obtained from third parties.

     The annual amortization expense of other intangible assets that existed as of April 1, 2007, is expected to be as follows (in thousands):

		Estimated Amortization Expenses
		Acquisition-Related
Fiscal periods:		Intangible Assets				Technology License
2007 (remaining nine months)		$	59,955			$	3,053
2008			76,229				3,648
2009			71,724				3,023
2010			71,529				3,023
2011			64,809				3,023
2012 and thereafter			13,051				3,760
Total		$	357,297			$	19,530

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

7. Accumulated Other Comprehensive Income

     Accumulated other comprehensive income presented in the accompanying balance sheet consists of the accumulated unrealized gains and losses on available-for-sale marketable securities, including the Company’s investments in foundries, as well as currency translation adjustments relating to local currency denominated subsidiaries and equity investees.

		April 1, 2007				December 31, 2006
		(In thousands)
Accumulated net unrealized gain (loss) on:
Available-for-sale investments		$	(2,173	)		$	(1,918	)
Available-for-sale investments in foundries			(284	)			(610	)
Foreign currency translation			12,255				8,021
Total accumulated other comprehensive income		$	9,798			$	5,493

     Comprehensive income is as follows:

		Three months ended
		April 1, 2007				April 2, 2006
		(In thousands)
Net income (loss)		$	(575	)		$	35,115
Unrealized income on available-for-sale investment in foundries			326				1,977
Unrealized income (loss) on available-for-sale investments			(255	)			1,737
Currency translation income (loss)			4,234				(1,365	)
Comprehensive net income		$	3,730			$	37,464

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

8. Net Income Per Share

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

		Three months ended
		April 1, 2007				April 2, 2006
Numerator for basic net income (loss) per share:
Net income (loss), as reported		$	(575	)		$	35,115
Denominator for basic net income (loss) per share:
Weighted average common shares outstanding			227,455				193,077
Basic net income (loss) per share		$	(0.00	)		$	0.18
Numerator for diluted net income (loss) per share:
Net income (loss), as reported		$	(575	)		$	35,115
Denominator for diluted net income (loss) per share:
Weighted average common shares outstanding			227,455				193,077
Effect of dilutive options and restricted stock			—				8,815
Shares used in computing diluted net income (loss) per share			227,455				201,892
Diluted net income (loss) per share		$	(0.00	)		$	0.17
Anti-dilutive shares excluded from net income per share calculation			39,156				2,893

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

9. Share Repurchase Program

     During the fourth quarter of fiscal 2006, the Company’s Board of Directors authorized the repurchase of up to $300 million of the Company’s common stock in the open market over two years following the date of authorization. Share repurchases have been and will be made from time-to-time in the open market at the Company’s discretion within the authorized program. The stock repurchase program does not obligate the Company to repurchase any particular amount of shares and may be suspended at the Company’s discretion. During the first quarter ended April 1, 2007, the Company repurchased 190,184 shares, for an aggregate purchase price of approximately $7.1 million on the open market, all of which are held as treasury stock and accounted for using the cost method. In addition, during the first quarter of fiscal 2007, the Company entered into a $35 million prepaid forward variable share repurchase agreement with a third-party investment bank to deliver shares by May 7, 2007, and has recorded this amount as a prepaid stock repurchase under stockholders’ equity. The Company entered into this agreement in order to enable it to repurchase shares at a guaranteed discount of the Volume Weighted Average Price (“VWAP”) of its common shares over the period. The Company only enters into such transactions when the discount that it receives is higher than the foregone return on its cash prepayment to the financial institution. The Company did not pay any explicit commissions or fees on this prepaid forward repurchase agreement.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

10. Commitments, Contingencies and Guarantees

     FlashVision. The Company has a 49.9% ownership interest in FlashVision Ltd. (“FlashVision”), a business venture with Toshiba Corporation (“Toshiba”), formed in fiscal 2000. In the venture, the Company and Toshiba have collaborated in the development and manufacture of NAND flash memory products. These NAND flash memory products are manufactured by Toshiba at its 200-millimeter wafer fabrication facilities, located in Yokkaichi, Japan, using the semiconductor manufacturing equipment owned or leased by FlashVision. FlashVision purchases wafers from Toshiba at cost and then resells those wafers to the Company and Toshiba at cost plus a markup. Toshiba owns 50.1% of this venture. The Company accounts for its 49.9% ownership position in FlashVision under the equity method of accounting. The terms of the FlashVision venture contractually obligate the Company to purchase its provided three month forecast for FlashVision’s NAND wafer supply, which generally equals 50 percent of the venture’s output. The Company cannot estimate the total amount of this commitment as of April 1, 2007, because it is based upon future costs and volumes. In addition, the Company is committed to fund 49.9% of FlashVision’s costs to the extent that FlashVision’s revenues from wafer sales to the Company and Toshiba are insufficient to cover these costs.

     As of April 1, 2007, the Company had notes receivable from FlashVision of 1.5 billion Japanese yen, or approximately $13 million based upon the exchange rate at April 1, 2007. These notes are secured by the equipment purchased by FlashVision using the note proceeds. Since fiscal 2006, the Company has been receiving cash repayments against the note receivable and expects FlashVision to continue generating cash to pay down this note receivable over time. The Company agreed to indemnify Toshiba for certain liabilities Toshiba incurs as a result of Toshiba’s guarantee of the FlashVision equipment lease arrangement. If FlashVision fails to meet its lease commitments, and Toshiba fulfills these commitments under the terms of Toshiba’s guarantee, then the Company will be obligated to reimburse Toshiba for 49.9% of any claims and associated expenses under the lease, unless the claims result from Toshiba’s failure to meet its obligations to FlashVision or its covenants to the lenders. Because FlashVision’s equipment lease arrangement is denominated in Japanese yen, the maximum amount of the Company’s contingent indemnification obligation on a given date when converted to U.S. dollars will fluctuate based on the exchange rate in effect on that date. See “Off Balance Sheet Liabilities.”

     Flash Partners. The Company has a 49.9% ownership interest in Flash Partners Ltd. (“Flash Partners”), a business venture with Toshiba, formed in fiscal 2004. In the venture, the Company and Toshiba have collaborated in the development and manufacture of NAND flash memory products. These NAND flash memory products are manufactured by Toshiba at the 300-millimeter wafer fabrication facility, Fab 3, located in Yokkaichi, Japan, using the semiconductor manufacturing equipment owned or leased by Flash Partners. Flash Partners purchases wafers from Toshiba at cost and then resells those wafers to the Company and Toshiba at cost plus a markup. Toshiba owns 50.1% of this venture. The Company accounts for its 49.9% ownership position in Flash Partners under the equity method of accounting. The Company is committed to purchase its provided three month forecast for Flash Partner’s NAND wafer supply, which generally equals 50 percent of the venture’s output. The Company cannot estimate the total amount of this commitment as of April 1, 2007, because it is based upon future costs and volumes. In addition, the Company is committed to fund 49.9% of Flash Partners’ costs to the extent that Flash Partners’ revenues from wafer sales to the Company and Toshiba are insufficient to cover these costs.

     As of April 1, 2007, the Company had notes receivable from Flash Partners of 11.0 billion Japanese yen, or approximately $94 million based upon the exchange rate at April 1, 2007. These notes are secured by the equipment purchased by Flash Partners using the note proceeds.

     Flash Alliance. The Company has a 49.9% ownership interest in Flash Alliance Ltd. (“Flash Alliance”), a business venture with Toshiba, formed in fiscal 2006. In the venture, the Company and Toshiba will collaborate in the development and manufacture of NAND flash memory products. These NAND flash memory products will be manufactured by Toshiba at its 300-millimeter wafer fabrication facility, Fab 4, being built in Yokkaichi, Japan, using the semiconductor manufacturing equipment that will be owned or leased by Flash Alliance. Flash Alliance will purchase wafers from Toshiba at cost and then resell those wafers to the Company and Toshiba at cost plus a markup. Toshiba owns 50.1% of this venture. The Company accounts for its 49.9% ownership position in Flash Alliance under the equity method of accounting. The Company is committed to purchase its provided three month forecast for Flash Alliance’s NAND wafer supply, which is expected to equal 50 percent of the venture’s output. In addition, the Company is committed to fund 49.9% of Flash Alliance’s costs to the extent that Flash Alliance’s revenues from wafer sales to the Company and Toshiba are insufficient to cover these costs.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

     As a part of the FlashVision, Flash Partners and Flash Alliance venture agreements, the Company is required to fund direct and common research and development expenses related to the development of advanced NAND flash memory technologies. As of April 1, 2007, the Company had accrued liabilities related to these expenses of $8.3 million.

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

     TwinSys. As of March 31, 2007, the Company had a 50.1% beneficial ownership in TwinSys Data Storage Limited Partnership (“TwinSys”), a business venture with Toshiba, consisting of (i) 49.9% ownership in TwinSys and (ii) 0.2% interest held by TwinSys Ltd., in which the Company has a 51% ownership interest. The Company and Toshiba have ceased operations of TwinSys as of March 31, 2007 and are in the process of liquidating the venture.

     Business Ventures and Foundry Arrangement with Toshiba. Purchase orders placed under the Toshiba ventures and foundry arrangement with Toshiba for up to three months are binding and cannot be canceled.

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

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

Off Balance Sheet Liabilities

     The following table details the Company’s portion of the remaining indemnification or guarantee obligation under each of the FlashVision and Flash Partners master lease facilities in both Japanese yen and United States dollar equivalent based upon the exchange rate at April 1, 2007.

Master Lease Agreements by Execution Date		Lease Amounts(1)								Expiration
		(Yen in billions)				(Dollars in millions)
FlashVision
June 2006		¥	5.0			$	43				2009
Flash Partners
December 2004			18.7				159				2010
December 2005			14.2				121				2011
June 2006			13.6				116				2011
September 2006			45.9				391				2011
March 2007			15.0				128				2012
Total Flash Partners			107.4				915
Total indemnification or guarantee obligation		¥	112.4			$	958

     FlashVision. In May 2002, FlashVision secured an equipment lease arrangement of approximately 37.9 billion Japanese yen, or approximately $322 million based upon the exchange rate at April 1, 2007, with Mizuho Leasing, and other financial institutions. On May 31, 2006, FlashVision refinanced the remaining balance of this equipment lease arrangement. The refinanced arrangement was approximately 15.0 billion Japanese yen, or approximately $128 million based upon the exchange rate at April 1, 2007. Lease payments are due quarterly and are scheduled to be completed in February 2009 and a residual payment of 3.1 billion Japanese yen, or $26 million based upon the exchange rate at April 1, 2007, will be due in May 2009. Under the terms of the refinanced lease, Toshiba guaranteed these commitments on behalf of FlashVision. The Company agreed to indemnify Toshiba for certain liabilities Toshiba incurs as a result of Toshiba’s guarantee of the FlashVision equipment lease arrangement. If FlashVision fails to meet its lease commitments, and Toshiba fulfills these commitments under the terms of Toshiba’s guarantee, then the Company will be obligated to reimburse Toshiba for 49.9% of any claims and associated expenses under the lease, unless the claims result from Toshiba’s failure to meet its obligations to FlashVision or its covenants to the lenders. Because FlashVision’s equipment lease arrangement is denominated in Japanese yen, the maximum amount of the Company’s contingent indemnification obligation on a given date when converted to U.S. dollars will fluctuate based on the exchange rate in effect on that date. As of April 1, 2007, the maximum amount of the Company’s contingent indemnification obligation, which reflects payments and any lease adjustments, was approximately 5.0 billion Japanese yen, or approximately $43 million based upon the exchange rate at April 1, 2007.

     Flash Partners. Flash Partners sells and leases-back from a consortium of financial institutions a portion of its tools and has entered into five equipment master lease agreements totaling approximately 275.0 billion Japanese yen, or approximately $2.3 billion based upon the exchange rate at April 1, 2007. As of April 1, 2007, Flash Partners had drawn down approximately 245 billion Japanese yen, or approximately $2.1 billion based upon the exchange rate at April 1, 2007, of which 215 billion Japanese yen, or approximately $1.8 billion based upon the exchange rate at April 1, 2007, was outstanding at April 1, 2007. The Company and Toshiba have each guaranteed, on a several basis, 50% of Flash Partners’ obligations under the master lease agreements. As of April 1, 2007, the maximum amount of the Company’s guarantee obligation of the Flash Partners master lease agreements, which reflects payments and any lease adjustments, was approximately 107.4 billion Japanese yen, or approximately $915 million based upon the exchange rate at April 1, 2007. Lease payments are due quarterly or semi-annually and are scheduled to be completed in stages through fiscal 2011. At the end of each of the lease terms, Flash Partners has the option of purchasing the tools from the lessors. Flash Partners is obligated to insure the equipment, maintain the equipment in accordance with the manufacturers’ recommendations and comply with other customary terms to protect the leased assets. The master lease agreements contains covenants that require the Company to maintain a minimum shareholder equity balance of $1.16 billion as well as a long-term loan rating of BB- or Ba3, based on a named independent rating service. In addition, the master lease

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

agreements contain customary events of default for a Japanese lease facility. The master lease agreements are exhibits to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006. These agreements should be read carefully in their entirety for a comprehensive understanding of their terms and the nature of the obligations the Company guaranteed. The fair value of the Company’s guarantee of Flash Partners’ lease obligation was insignificant at inception of the guarantee. In addition, Flash Partners expects to secure additional equipment lease facilities over time, which the Company may be required to guarantee in whole or in part.

Guarantees

     Indemnification Agreements. The Company has agreed to indemnify suppliers and customers for alleged patent infringement. The scope of such indemnity varies, but may, in some instances, include indemnification for damages and expenses, including attorneys’ fees. The Company may periodically engage in litigation as a result of these indemnification obligations. The Company’s insurance policies exclude coverage for third-party claims for patent infringement. Although the liability is not remote, the nature of the patent infringement indemnification obligations prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay to its suppliers and customers. Historically, the Company has not made any significant indemnification payments under any such agreements. As of April 1, 2007, no amount had been accrued in the accompanying condensed consolidated financial statements with respect to these indemnification guarantees.

     As permitted under Delaware law and the Company’s charter and bylaws, the Company has agreements whereby it indemnifies certain of its officers and each of its directors for certain events or occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a Director and Officer insurance policy that may reduce its exposure and enable it to recover all or a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal. The Company has no liabilities recorded for these agreements as of April 1, 2007 or January 1, 2006, as this liability is not reasonably estimable even though liability under these agreements is not remote.

     The Company and Toshiba have agreed to mutually contribute to, and indemnify each other, Flash Partners and Flash Alliance, for environmental remediation costs or liability resulting from Flash Partners or Flash Alliance’s manufacturing operations in certain circumstances. In fiscal 2004 and 2006, respectively, the Company and Toshiba each engaged consultants to perform a review of the existing environmental conditions at the site of the facility at which Flash Partners operations are located and Flash Alliance operations will be located to establish a baseline for evaluating future environmental conditions. The Company and Toshiba have also entered into a Patent Indemnification Agreement under which in many cases the Company will share in the expenses associated with the defense and cost of settlement associated with such claims. This agreement provides limited protection for the Company against third-party claims that NAND flash memory products manufactured and sold by Flash Partners or Flash Alliance infringe third-party patents. The Company has not made any indemnification payments under any such agreements and as of April 1, 2007, no amounts have been accrued in the accompanying condensed consolidated financial statements with respect to these indemnification guarantees.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

Contractual Obligations and Off Balance Sheet Arrangements

     Contractual Obligations. The following summarizes the Company’s contractual cash obligations, commitments and off balance sheet arrangements at April 1, 2007, and the effect such obligations are expected to have on its liquidity and cash flows in future periods (in thousands).

																		More than 5
						Less than				2 - 3 Years				4 –5 Years (Fiscal				Years
						1 Year				(Fiscal 2008				2010				(Beyond
		Total				(9 months)				and 2009)				and 2011)				Fiscal 2011)				Other
Operating leases		$	51,522			$	7,051			$	17,132			$	14,136			$	13,203			$	—
FlashVision fabrication capacity expansion costs, and reimbursement for certain other costs including depreciation			184,617	(5)			55,082				113,256				16,139				140				—
Flash Partners fabrication capacity expansion and reimbursement for certain other costs including depreciation (1)			2,533,460	(5)			907,143				914,913				616,376				95,028				—
Flash Alliance fabrication capacity expansion and reimbursement for certain other costs including depreciation and start-up			1,080,906	(5)			135,916				621,768				216,686				106,536				—
Toshiba research and development			58,250	(5)			23,250				35,000				—				—				—
Capital equipment purchases commitments			207,233				207,233				—				—				—				—
Convertible notes principal and interest (2)			1,316,381				9,188				24,500				24,500				1,258,193				—
Income taxes payable (3)			44,646				—				—				—				—				44,646
Operating expense commitments			10,147				10,147				—				—				—				—
Noncancelable production purchase commitments (4)			212,701	(5)			212,701				—				—				—				—
Total contractual cash obligations.		$	5,699,863			$	1,567,711			$	1,726,569			$	887,837			$	1,473,100			$	44,646

     Off Balance Sheet Arrangements.

		As of
		April 1, 2007
Indemnification of FlashVision foundry equipment lease (6)		$	42,638
Guarantee of Flash Partners lease (7)		$	914,873

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

     The Company leases its headquarters and sales offices under real estate operating leases that expire at various dates from fiscal 2007 through 2016. Future minimum lease payments under real estate operating leases at April 1, 2007 were as follows (in thousands):

Fiscal Year Ending
2007		$	6,430
2008			8,068
2009			7,848
2010			7,713
2011			6,367
2012 and beyond			13,202
Total real estate operating leases		$	49,628

     Foreign Currency Exchange and Other Contracts. The Company’s objective for holding foreign exchange derivatives is to minimize the material risks associated with non-functional currency transactions. The Company’s foreign exchange derivative instruments are designated as fair value hedges and recorded at fair value on the balance sheet with changes in fair value recorded in other income (expense). The Company had foreign currency exchange contract lines available in the amount of $1.07 billion at April 1, 2007 to enter into foreign currency forward contracts. As of April 1, 2007, the Company had foreign currency forward contracts in place with a notional amount of 4.2 billion Japanese yen, or approximately $35 million based upon the exchange rate at April 1, 2007. For the three months ended April 1, 2007, these foreign currency contracts resulted in a realized gain of $0.7 million, including forward point income. The foreign currency exposures hedged by these forward contracts had realized losses of $0.1 million. The Company has outstanding cash flow hedges designated to mitigate equity risk associated with certain available-for-sale equity securities totaling approximately $62 million. The changes in the fair value of the cash flow hedge are included in other comprehensive equity and were immaterial as of and for the three months ended April 1, 2007. The Company does not enter into derivatives for speculative or trading purposes.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

11. Related Parties and Strategic Investments

     Toshiba. The Company and Toshiba have collaborated in the development and manufacture of NAND flash memory products. These NAND flash memory products are manufactured by Toshiba at Toshiba’s Yokkaichi, Japan operations using the semiconductor manufacturing equipment owned or leased by FlashVision or Flash Partners. See also Note 10, “Commitments, Contingencies and Guarantees.” The Company purchased NAND flash memory wafers from FlashVision, Flash Partners and Toshiba, made payments for shared research and development expenses, made loans to FlashVision and Flash Partners and made investments in Flash Partners totaling approximately $222.8 million and $174.6 million in the three months ended April 1, 2007 and April 2, 2006, respectively. During the first quarter of fiscal 2007, the Company had sales to Toshiba of $26.4 million. The purchases of NAND flash memory wafers are ultimately reflected as a component of the Company’s cost of product revenues. At April 1, 2007 and December 31, 2006, the Company had accounts payable balances due to Toshiba of $43.6 million and $19.2 million, respectively, and accounts receivable balances from Toshiba of $27.3 million and $1.4 million, respectively. At April 1, 2007 and December 31, 2006, the Company had accrued current liabilities due to Toshiba for shared research and development expenses of $8.3 million and $5.9 million, respectively.

     Ventures with Toshiba. The Company owns 49.9% of FlashVision, Flash Partners and Flash Alliance, jointly called “Flash Ventures.” The Company accounts for its 49.9% ownership position in Flash Ventures under the equity method of accounting. The Company’s obligations with respect to Flash Ventures’ lease arrangements, capacity expansion, take-or-pay supply arrangements and research and development cost sharing are described in Note 10, “Commitments, Contingencies and Guarantees.” Flash Ventures are all variable interest entities and the Company is not the primary beneficiary of Flash Ventures because it is entitled to less than a majority of any residual gains and is obligated with respect to less than a majority of residual losses with respect to the venture. At April 1, 2007 and December 31, 2006, the Company had accounts payable balances due to Flash Ventures of $76.5 million and $61.6 million, respectively.

     TwinSys. The Company assumed msystems’ ownership interest in the venture with Toshiba, TwinSys, designed to enable the parties to benefit from a portion of each party’s respective sales of USB flash drives. The Company had a 50.1% beneficial ownership in TwinSys, consisting of (i) 49.9% ownership in TwinSys and (ii) 0.2% interest held by TwinSys Ltd., in which the Company has a 51% ownership interest. The Company consolidated the venture under FASB Interpretation No. 46R (“FIN 46R”), Accounting for Variable Interest Entities. During the first quarter of fiscal 2007, TwinSys had sales to and purchases from Toshiba of $53.0 million and $28.5 million, respectively. At April 1, 2007, TwinSys had receivables from and payables to Toshiba of $20.6 million and $14.3 million, respectively. The Company and Toshiba ceased operations of TwinSys as of March 31, 2007 and are in the process of liquidating the venture.

     Tower Semiconductor. As of April 1, 2007, the Company owned approximately 11.3% of the outstanding shares of Tower Semiconductor Ltd. (“Tower”), one of its suppliers of wafers for its controller components, has prepaid wafer credits issued by Tower, and has convertible debt and a warrant to purchase Tower ordinary shares. The Company’s Chief Executive Officer is also a member of the Tower Board of Directors. As of April 1, 2007, the Company owned approximately 14 million Tower shares with a carrying value and market value of $21.4 million and $23.9 million, respectively, and Tower prepaid wafer credits with a carrying value of zero. In addition, the Company holds a Tower convertible debenture with a market value of $5.7 million. Also, as of April 1, 2007, the Company had loaned a total of $9.8 million to Tower to fund a portion of the overall expansion of Tower’s 0.13 micron logic wafer capacity. The loan to Tower is secured by the equipment purchased. The Company purchased controller wafers and related non-recurring engineering, or NRE, of $16.0 million and $6.6 million in the three months ended April 1, 2007 and April 2, 2006, respectively. These purchases of controller wafers are ultimately reflected as a component of the Company’s cost of product revenues. At April 1, 2007 and December 31, 2006, the Company had amounts payable to Tower of $10.2 million and $7.7 million, respectively.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

     Flextronics. The Chairman of Flextronics International Ltd. (“Flextronics”), has served on the Company’s Board of Directors since September 2003. For the three months ended April 1, 2007 and April 2, 2006, the Company recorded revenues related to Flextronics and its affiliates of $50.5 million and $19.2 million, respectively, and at April 1, 2007 and December 31, 2006, the Company had receivables from Flextronics and its affiliates of $38.4 million and $18.9 million, respectively. In addition, the Company purchased from Flextronics and its affiliates $15.7 million and $14.4 million of services for card assembly and testing during the three months ended April 1, 2007 and April 2, 2006, respectively, which are ultimately reflected as a component of the Company’s cost of product revenues. At April 1, 2007 and December 31, 2006, the Company had amounts payable to Flextronics and its affiliates of $6.9 million and $6.7 million, respectively, for these services.

     UMC. The Company maintains an investment position in United Microelectronics Corporation (“UMC”), one of its suppliers of wafers for its controller components, on the cost basis of accounting. As of April 1, 2007 the Company owned 24.7 million UMC shares with a cost basis of $13.4 million and a fair market value of $14.5 million. At April 1, 2007 and December 31, 2006, the Company had amounts payable to UMC of $8.2 million and $4.5 million, respectively.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

12. Business Acquisition

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

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

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

     Direct transaction costs of approximately $15 million include investment banking, legal and accounting fees, and other external costs directly related to the acquisition. As of April 1, 2007 substantially all costs for accounting, legal, and other professional services had been paid.

     Net Tangible Assets. The preliminary allocation of the msystems’ purchase price to the tangible assets acquired and liabilities assumed is summarized below (in thousands). The preliminary allocation was based on management’s estimates of fair value, which included a third-party appraisal. The allocation of the purchase price may be subject to change based on final estimates of fair value, primarily related to acquisition-related restructuring, deferred taxes and actual transaction costs. In the first quarter of fiscal 2007, the Company booked an adjustment to the net tangible assets acquired of approximately $57.4 million, largely related to a revised estimate of the assumed Hynix Semiconductor, Inc. (“Hynix”) deferred purchase credits.

Cash		$	41,657
Short-term investments			100,341
Accounts receivable			163,705
Inventory			133,512
Property and equipment, net			37,060
Other assets			108,819
Total assets acquired			585,094
Accounts payable			(133,263	)
Other liabilities			(180,429	)
Total liabilities assumed			(313,692	)
Net tangible assets acquired		$	271,402

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

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

Net tangible assets acquired		$	271,402
Goodwill			701,836
Other identifiable intangible assets:
Core technology			235,500
Trademarks			4,000
Customer relationships			66,000
Backlog			5,000
Supply agreement			2,000
Total other identifiable intangible assets			312,500
Acquired in-process technology			186,000
Deferred tax liability			(31,339	)
Assumed unvested share-based awards to be expensed			55,339
Total preliminary estimated purchase price		$	1,495,738

     Acquisition-Related Restructuring. During the fourth quarter of fiscal 2006, the Company established its plans to integrate the msystems operations, which included the involuntary termination of approximately 100 employees and exiting duplicative facilities, and recorded $1.6 million for acquisition-related restructuring activities, of which, $0.3 million relates to excess lease obligations and $1.3 million is related to personnel. The lease obligations extend through the end of the lease term in fiscal 2009. These acquisition-related restructuring liabilities were included in the purchase price allocation of the cost to acquire msystems. In the first quarter of fiscal 2007, the Company reversed through goodwill approximately $0.5 million of the restructuring accrual based on actual costs being less than the original estimates. As of April 1, 2007, there is approximately $0.4 million remaining of the acquisition-related restructuring accrual that has not been paid or utilized.

     In-process Technology. As part of the msystems purchase agreement, a certain amount of the purchase price was allocated to acquired in-process technology, which was determined through established valuation techniques in the high-technology industry and written-off in the fourth quarter of fiscal 2006 because technological feasibility had not been established and no alternative future uses existed. The value was determined by estimating the net cash flows and discounting forecasted net cash flows to their present values. The Company wrote-off the acquired in-process technology of $186.0 million in the fourth quarter of fiscal 2006. As of April 1, 2007, it was estimated that these in-process projects would be completed at an estimated total cost of $19.2 million. The net cash flows from the identified projects were based on estimates of revenues, costs of revenues, research and development expenses, including costs to complete the projects, selling, marketing and administrative expenses, and income taxes from the projects. The Company believes the assumptions used in the valuations were reasonable at the time of the acquisition. The estimated net revenues and gross margins were based on management’s projections of the projects and were in line with industry averages. Estimated total net revenues from the projects were expected to grow through fiscal 2009 and decline thereafter as other new products are expected to become available. Estimated operating expenses included research and development expenses and selling, marketing and administrative expenses based upon historical and expected direct expense level and general industry metrics. Estimated research and development expenses included costs to bring the projects to technological feasibility and costs associated with ongoing maintenance after a product is released. These activities are approximately 2% of msystems’ portion of the Company’s net revenues for the in-process technologies.

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

     Matrix Semiconductor, Inc. On January 13, 2006, the Company completed the acquisition of Matrix Semiconductor, Inc. (“Matrix”), a designer and developer of three-dimensional (3-D) integrated circuits. Matrix^® 3-D Memory is used for one-time programmable storage applications that complement the Company’s existing flash storage memory products. The Company acquired 100% of the outstanding shares of Matrix for a total purchase price of $296.4 million.

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

Fair value of SanDisk common stock issued		$	242,303
Estimated fair value of options assumed			33,169
Cash consideration			20,000
Direct transaction costs			907
Total estimated purchase price		$	296,379

     Acquisition-Related Restructuring. During the first quarter of fiscal 2006, the Company established its plans to integrate the Matrix operations, which included exiting duplicative facilities and recorded $17.5 million for acquisition-related restructuring activities, of which $17.4 million relates to excess lease obligations. The lease obligations extend through the end of the lease term in 2016. These acquisition-related restructuring liabilities were included in the purchase price allocation of the cost to acquire Matrix. As of April 1, 2007, the outstanding accrual balance was $16.0 million. The reduction in the accrual balance was primarily related to excess lease obligation payments.

     In-process Technology. As part of the Matrix purchase agreement, a certain amount of the purchase price was allocated to acquired in-process technology, which was determined through established valuation techniques in the high-technology computer industry and written off in the first quarter of fiscal 2006 because technological feasibility had not been established and no alternative future uses existed. The value was determined by estimating the net cash flows and discounting forecasted net cash flows to their present values. The Company wrote-off the acquired in-process technology of $39.6 million in the first quarter of fiscal 2006. As of April 1, 2007, it was estimated that these in-process projects would be completed over the next one to two years at an estimated total cost of $8 million.

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

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

     Pro Forma Results. The following unaudited pro forma financial information for the three months ended April 2, 2006 presents the combined results of the Company, Matrix and msystems, as if the acquisitions had occurred at the beginning of the period presented (in thousands, except per share amounts). Certain adjustments have been made to the combined results of operations, including amortization of acquired other intangible assets; however, charges for acquired in-process technology were excluded as these items were non-recurring.

		April 2, 2006
Net revenues		$	843,212
Net income		$	47,834
Net income per share:
Basic		$	0.21
Diluted		$	0.20

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

13. Income Taxes

     The Company recorded tax provisions of $12.2 million and $41.3 million for the three months ended April 1, 2007 and April 2, 2006, respectively, or effective tax rates of 72.6% and 54.0% for the three months ended April 1, 2007 and April 2, 2006, respectively. Our effective tax rate for the first quarter of fiscal 2007 differed from the statutory federal rate of 35.0% primarily due to the impact of state taxes, stock option compensation adjustments recorded under Statement of Financial Accounting Standards No. 123(R), Share Based Payments, tax exempt interest income, research and development tax credits, the tax impact of acquisition-related intangible amortization taxed at rates lower than federal rates and certain other tax items recognized in the quarter, including a net adjustment of $3.4 million primarily related to the prior year.

     The Company adopted FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 at the beginning of fiscal 2007. As a result of the implementation of FIN 48 the Company recognized approximately a $1.0 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007, balance of retained earnings. The total taxes payable of $44.0 million on uncertain tax positions is before federal tax benefit of state income taxes of $6.1 million. Of the net taxes payable of $37.9 million, $33.2 million would favorably impact the effective tax rate in future periods and $4.7 million would increase capital in excess of par value. The Company expects to recognize a $0.6 million tax benefit within the next 12 months as a result of the expiration of statutes of limitation. The Company will continue to recognize interest and/or penalties related to income taxes in income tax expense of which a $5.0 million accrual was outstanding as of the date of adoption and an additional $0.5 million was recorded in the three months ended April 1, 2007.

     The Company is subject to U.S. federal income tax as well as income taxes in many state and foreign jurisdictions. The federal statute of limitations on assessment remains open for the tax years 2003 through 2006 and the statute of limitations in state jurisdictions remain open generally from tax years 2002 through 2006. The major foreign jurisdictions remain open for examination generally for tax years 2001 through 2006. The Company also had federal and state net operating loss carryforwards of approximately $89 million and $52 million before federal benefit, respectively, at December 31, 2006.

     The tax benefit associated with the exercise of stock options for the three months ended April 1, 2007 and April 2, 2006 was credited to capital in excess of par value in the amount of $2.1 million and $41.9 million, respectively, when realized. On adoption of FIN 48, the Company recorded a $4.7 million reduction in capital in excess of par value.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

14. Litigation

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

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

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

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

     On October 15, 2004, the Company filed a complaint for patent infringement and declaratory judgment of non-infringement and patent invalidity against STMicroelectronics N.V. and STMicroelectronics, Inc. (collectively, “ST”) in the United States District Court for the Northern District of California, captioned SanDisk Corporation v. STMicroelectronics, Inc., et al., Civil Case No. C 04 04379JF. The complaint alleges that ST’s products infringe one of the Company’s U.S. patents and seeks damages and an injunction. The complaint further seeks a declaratory judgment that the Company does not infringe several of ST’s U.S. patents. On January 20, 2005, the District Court issued an order granting ST’s motion to dismiss the declaratory judgment causes of action based on lack of subject matter jurisdiction. The Company appealed this decision to the U.S. Court of Appeals for the Federal Circuit. On March 26, 2007, the United States Court of Appeals for the Federal Circuit reversed the District Court’s ruling and remanded the case to the district court for further proceedings. The case is presently stayed until June 11, 2007.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

     On October 15, 2004, the Company filed a complaint under Section 337 of the Tariff Act of 1930 (as amended) (Case No. 337-TA 526) titled, “In the matter of certain NAND flash memory circuits and products containing same” in the United States International Trade Commission (“ITC”), naming STMicroelectronics N.V. and STMicroelectronics, Inc. (collectively, “ST”) as respondents. In the complaint, the Company alleges that ST’s NAND flash memory infringes U.S. Patent No. 5,172,338 (the ’338 patent), and seeks an order excluding ST’s products from importation into the United States. On November 15, 2004, the ITC instituted an investigation pursuant to 19 U.S.C. § 1337 against ST in response to the Company’s complaint. On December 9, 2004, ST filed a response to the complaint, denying that they infringe the ’338 patent and alleging that the patent is invalid and/or unenforceable. A hearing was held from August 1-8, 2005. On October 19, 2005, the Administrative Law Judge issued an initial determination confirming the validity and enforceability of the Company’s ’338 patent by rejecting ST’s claims that the patent was invalidated by prior art. The initial determination, however, found that ST’s NAND flash memory chips did not infringe the asserted claims of the ’338 patent. On October 31, 2005, the Company filed a petition with the ITC to review and reverse the finding of non-infringement. Also, on October 31, 2005, ST filed a petition for review with the ITC to review and reverse the finding that the patent was valid and enforceable. On December 6, 2005, the ITC issued its decision. The ITC declined to review the finding of non-infringement, and, after reviewing the finding of validity, declined to take any position on the issue of validity. The Company appealed the ITC’s decision to the U.S. Court of Appeals for the Federal Circuit and the Federal Circuit affirmed the ITC’s decision on March 6, 2007.

     On February 4, 2005, STMicro filed two complaints for patent infringement against the Company in the United States District Court for the Eastern District of Texas, captioned STMicroelectronics, Inc. v. SanDisk Corporation, Civil Case No. 4:05CV44 (the “’44 Action”), and STMicroelectronics, Inc. v. SanDisk Corporation, Civil Case No. 4:05CV45 (the “’45 Action”), respectively. The complaints seek damages and injunctions against certain SanDisk products. On April 22, 2005, the Company filed counterclaims on two patents against STMicroelectronics N.V. and STMicroelectronics, Inc. (collectively, “ST”) in the ’45 Action. The counterclaims seek damages and injunctive relief against ST’s flash memory products. In the ’44 Action, the District Court granted SanDisk’s motion for summary judgment of non-infringement on all accused products. ST has filed a motion to amend or correct the final judgment but no ruling has issued. On February 6, 2007, the District Court dismissed the ’44 Action with prejudice, ordered that ST take nothing from the Company, and that costs be taxed against ST. In the ’45 Action, the parties have filed motions for summary judgment regarding various aspects of the litigation. The magistrate judge has made recommendations on some but not all issues raised on summary judgment, but the trial judge has not made any final decisions on the magistrate judge’s recommendations. On March 26, 2007, the trial judge issued an order to stay the ’45 Action for 90 days. The court will address the schedule for remaining activities in the case shortly before the end of the stay period.

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

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

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

     On or about July 15, 2005, Societa’ Italiana Per Lo Sviluppo Dell’electtronica, S.I.Sv.El., S.p.A., (“Sisvel”) filed suit against the Company and others in the district court of the Netherlands in The Hague in a case captioned Societa’ Italiana Per Lo Sviluppo Dell’electtronica, S.I.Sv.El., S.p.A. adverse to SanDisk International Sales, Moduslink B.V. and UPS SCS (Nederland) B.V., Case No. 999.131.1804 (Cause List numbers 2006/167 and 2006/168). Sisvel alleges that certain of the Company’s MP3 products infringe three European patents of which Sisvel claims to be a licensee with the right to bring suit. Sisvel seeks an injunction and unspecified damages. Sisvel has previously publicly indicated that it will license these and other patents under reasonable and nondiscriminatory terms, and it has specifically offered the Company a license under the patents. The Company has submitted its answer on the substance of Sisvel’s claim. In March 2007, the Company and Sisvel entered into a confidential agreement settling this matter and all related matters, including those described below. Accordingly, all claims and counterclaims between the parties have been dismissed.

     In a related action, on March 9, 2006, the Company filed an action in the English High Court, Chancery Division, Patents Court, in London, against Sisvel and the owners of the patents Sisvel has asserted against the Company in the Netherlands. The case is SanDisk Corporation v. Koninklijke Philips Electronics N.V. (a Dutch corporation), France Télécom (a French corporation), Télédiffusion de France S.A. (a French corporation), Institut für Rundfunktechnik GmbH (a German corporation) and Societa’ Italiana Per Lo Sviluppo Dell’electtronica, S.I.Sv.El., S.p.A., Case No. HC 06 C 00835. In this action, the Company seeks a declaration of non-infringement of the patents asserted by Sisvel in connection with the Company’s MP3 products. The Company also seeks a declaration that the patents are not “essential” to the technology of MP3 players, as Sisvel presently contends in the case filed in the Netherlands. The defendants have submitted their formal defense and counterclaimed for infringement. As described above, in March 2007, the Company and Sisvel entered into a confidential agreement settling this matter and all related matters. Accordingly, all claims and counterclaims between the parties have been dismissed.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

     In another related action, on April 13, 2006, Audio MPEG filed a complaint alleging patent infringement in the District Court for the Eastern District of Virginia. The case is Audio MPEG v. SanDisk Corporation, Case No. 2:06cv209 WDK/JEB. Audio MPEG holds itself out to be the U.S. subsidiary of Sisvel and purports to have the right to enforce certain patents in the U.S. on subject matter related to the patents asserted by Sisvel in the Netherlands. Specifically, Audio MPEG asserts U.S. Patent No. 5,214,678 (entitled “Digital transmission system using subband coding of a digital signal”), U.S. Patent No. 5,323,396 (entitled “Digital transmission system, transmitter and receiver for use in the transmission system”), U.S. Patent No. 5,539,829 (entitled “Subband coded digital transmission system using some composite signals”), and U.S. Patent No. 5,777,992 (entitled “Decoder for decoding and encoded digital signal and a receiver comprising the decoder”). As described above, in March 2007, the Company and Sisvel entered into a confidential agreement settling this matter and all related matters. Accordingly, all claims and counterclaims between the parties have been dismissed.

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

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

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

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

     On February 20, 2007, Texas MP3 Technologies Ltd. filed suit against the Company, Samsung Electronics Co., Ltd., Samsung Electronics America, Inc. and Apple, Inc., Case No. 2:07-CV-52, in the Eastern District of Texas, Marshall Division, alleging patent infringement related to MP3 players. A trial date has not been set.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

15. Condensed Consolidating Financial Statements

     As part of the acquisition of msystems in November 2006, the Company entered into a supplemental indenture whereby the Company became an additional obligor and guarantor of the assumed $75 million 1% Convertible Notes due 2035 issued by msystems Finance Company, (the “Subsidiary Issuer” or “mfinco”) and guaranteed by SanDisk Israel Ltd. (the ”Other Guarantor Subsidiary” or formerly “msystems”). SanDisk Corporation’s (the “Parent Company” or the “Company”) guarantee is full and unconditional, jointly and severally with msystems. Both msystems and mfinco are wholly-owned subsidiaries of the Company. The following condensed consolidating financial statements present separate information for mfinco as the original issuer, the Company and msystems as guarantors and the Company’s other combined non-guarantor subsidiaries, and should be read in conjunction with the condensed consolidated financial statements of the Company.

     These condensed consolidating financial statements have been prepared using the equity method of accounting. Earnings of subsidiaries are reflected in the Company’s investment in subsidiaries account. The elimination entries eliminate investments in subsidiaries, related stockholders’ equity and other intercompany balances and transactions. Only the three months ended April 1, 2007 are presented for the statements of operations and cash flows as the inception of the guarantee by the Company coincides only with the consummation of the acquisition of msystems on November 19, 2006.

Condensed Consolidating Statements of Operations
For the three months ended April 1, 2007

										Other				Combined
		Parent				Subsidiary				Guarantor				Non-Guarantor				Consolidating				Total
		Company (1)				Issuer (1)				Subsidiary (1)				Subsidiaries (2)				Adjustments				Company
										(In thousands)
Total revenues		$	421,493			$	—			$	92,395			$	941,841			$	(669,643	)		$	786,086
Total cost of revenues			226,786				—				99,596				907,834				(643,066	)			591,150
Gross margin			194,707				—				(7,201	)			34,007				(26,577	)			194,936
Total operating expenses			129,588				—				38,487				69,116				(22,738	)			214,453
Operating income (loss)			65,119				—				(45,688	)			(35,109	)			(3,839	)			(19,517	)
Total other income (expense)			38,354				(187	)			3,252				(2,332	)			(2,828	)			36,259
Income (loss) before taxes			103,473				(187	)			(42,436	)			(37,441	)			(6,667	)			16,742
Provision (benefit) for income taxes			12,281				—				(972	)			(331	)			1,179				12,157
Minority interest			—				—				5,160				—				—				5,160
Equity in net income (loss) of consolidated subsidiaries			(35,556	)			—				5,212				(1,040	)			31,384				—
Net income (loss)		$	55,636			$	(187	)		$	(41,412	)		$	(38,150	)		$	23,538			$	(575	)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

Condensed Consolidating Balance Sheets
As of April 1, 2007

														Combined
														Non-
										Other				Guarantor
		Parent				Subsidiary				Guarantor				Subsidiaries				Consolidating				Total
		Company (1)				Issuer (1)				Subsidiary (1)				(2)				Adjustments				Company
		(In thousands)
ASSETS
Current Assets:
Cash and cash equivalents		$	1,378,691			$	49			$	138,407			$	292,985			$	977			$	1,811,109
Short-term investments			1,135,057				—				264				1,352				8,165				1,144,838
Accounts receivable, net			(11,640	)			—				34,950				129,204				(8,286	)			144,228
Inventory			146,301				—				47,486				403,130				(2,761	)			594,156
Deferred taxes			153,790				—				—				23,392				(1,412	)			175,770
Other current assets			299,359				—				13,277				381,772				(507,029	)			187,379
Total current assets			3,101,558				49				234,384				1,231,835				(510,346	)			4,057,480
Property and equipment, net			178,747				—				33,912				115,986				198,718				527,363
Goodwill			—				—				702,316				132,405				(506,076	)			328,645
Intangibles, net			—				—				276,163				100,664				66,057				442,884
Other non-current assets			1,565,528				71,977				112,157				337,121				(692,945	)			1,393,838
Total assets		$	4,845,833			$	72,026			$	1,358,932			$	1,918,011			$	(1,444,592	)		$	6,750,210
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	43,860			$	—			$	21,846			$	284,923			$	(2,239	)		$	348,390
Other current accrued liabilities			292,905				602				22,777				535,294				(589,618	)			261,960
Total current liabilities			336,765				602				44,623				820,217				(591,857	)			610,350
Convertible long-term debt			1,150,000				75,000				—				—				—				1,225,000
Non-current liabilities and deferred revenue			31,538				—				31,629				10,264				41,838				115,269
Total liabilities			1,518,303				75,602				76,252				830,481				(550,019	)			1,950,619
Minority interest			—				—				3,651				—				—				3,651
Stockholders’ Equity:
Common stock			2,500,240				(4,614	)			1,028,024				993,378				(830,466	)			3,686,562
Retained earnings			821,325				1,038				245,677				85,209				(53,669	)			1,099,580
Accumulated other comprehensive income			5,965				—				5,328				8,943				(10,438	)			9,798
Total stockholders’ equity			3,327,530				(3,576	)			1,279,029				1,087,530				(894,573	)			4,795,940
Total liabilities and stockholders’ equity		$	4,845,833			$	72,026			$	1,358,932			$	1,918,011			$	(1,444,592	)		$	6,750,210