# As filed with the
Securities Exchange Commission on April 2, 2007

---

---

# SECURITIES AND
EXCHANGE COMMISSIONWashington, D.C. 20549

# Form 20-F

o REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

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

# For the Fiscal Year
Ended December 31, 2006

OR

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

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

SAIFUN SEMICONDUCTORS LTD. (Exact name of
Registrant as specified in its charter)

Israel (Jurisdiction of
incorporation or organization)

6 Arie Regev Street 
Sappir Industrial Park 
Netanya, 42504 
Israel(Address of
principal executive offices)

Securities
registered or to be registered pursuant to Section 12(b) of the Act: None.

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

# Ordinary Shares, par
value NIS 0.01 per share

Securities
for which there is a reporting obligation pursuant to Section 15(d) of the Act: None.

The
number of outstanding shares of each of the issuers classes of capital or common
stock as of December 31, 2006:

# 31,500,109 Ordinary
Shares, par value NIS 0.01 per share

|Indicate  by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act.
|------------------------------------------------------------------------------------------------------------------------

Yes o No x

|If  this report is an annual or transition report, indicate by check mark if the registrant is
not required to file reports pursuant to Section 
13 or 15(d)  of the Securities Exchange
Act of 1934.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Yes o No x

|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 x 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. (Check
one):
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Large
accelerated filer o Accelerated filer x Non-accelerated filer o

Indicate
by check mark which financial statement item the registrant has elected to follow.

Item 17 o Item 18 x

|If
this is an annual report, indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act).
|---------------------------------------------------------------------------------------------------------------------------------------------

Yes o No x



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# TABLE OF CONTENTS

|          |                                                                              | Page
|--------- | ---------------------------------------------------------------------------- | ----
|
|
|
|
|PART I    |                                                                              |     
|Item 1.   | Identity of Directors, Senior Management and Advisers                        | 3   
|Item 2.   | Offer Statistics and Expected Timetable                                      | 3   
|Item 3.   | Key Information                                                              | 3   
|Item 4.   | Information on the Company                                                   | 21  
|Item 5.   | Operating and Financial Review and Prospects                                 | 33  
|Item 6.   | Directors, Senior Management and Employees                                   | 50  
|Item 7.   | Major Shareholders and Related Party Transactions                            | 60  
|Item 8.   | Financial Information                                                        | 64  
|Item 9.   | The Offer and Listing                                                        | 65  
|Item 10.  | Additional Information                                                       | 66  
|Item 11.  | Quantitative and Qualitative Disclosures about Market Risk                   | 82  
|Item 12.  | Description of Securities other than Equity Securities                       | 83  
|         
|PART II  
|Item 13.  | Defaults, Dividend Arrearages and Delinquencies                              | 84  
|Item 14.  | Material Modifications to the Rights of Security Holders and Use of Proceeds | 84  
|Item 15.  | Controls and Procedures                                                      | 84  
|Item 15T. | Controls and Procedures                                                      | 85  
|Item 16.  | [Reserved]                                                                   | 85  
|Item 16A. | Audit Committee Financial Expert                                             | 85  
|Item 16B. | Code of Ethics                                                               | 85  
|Item 16C. | Principal Accountant's Fees and Services                                     | 86  
|Item 16D. | Exemptions from the Listing Standards for Audit Committees                   | 86  
|Item 16E. | Purchases of Equity Securities by the Issuer and Affiliated Purchasers       | 86  
|         
|PART III 
|Item 17.  | Financial Statements                                                         | 87  
|Item 18.  | Financial Statements                                                         | 87  
|Item 19.  | Exhibits                                                                     | 87  

The SAIFUN logo is our trademark or
registered trademark. All other registered trademarks appearing herein are owned by their
holders.

- 2 -

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---

# PART I

|ITEM 1. | IDENTITY
OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
|------- | -----------------------------------------------------

Not
applicable.

|ITEM 2. | OFFER
STATISTICS AND EXPECTED TIMETABLE
|------- | ---------------------------------------

Not
applicable.

|ITEM 3. | KEY
INFORMATION
|------- | ---------------

# A. SELECTED FINANCIAL
DATA

You
should read the following selected consolidated financial data in conjunction with our
consolidated financial statements and related notes, as well as Item 5 Operating and
Financial Review and Prospects, included elsewhere in this Annual Report. For fiscal
years 2006, 2005 and 2002, we used a calendar year ending on December 31. For fiscal years
2003 and 2004, we used a 52-week fiscal year ending on the last Sunday in December. For
fiscal years 2003 and 2004, the fiscal year ended on December 28 and December 26,
respectively. The consolidated statements of operations data for the years ended December
26, 2004 and December 31, 2005 and 2006 and the consolidated balance sheet data as of
December 31, 2005 and 2006 are derived from our audited consolidated financial statements
included elsewhere in this Annual Report, which have been prepared in accordance with
generally accepted accounting principles in the United States. The consolidated statements
of operations for the years ended December 31, 2002 and December 28, 2003 and the
consolidated balance sheet data as of December 31, 2002, December 28, 2003 and December
26, 2004 have been derived from our audited consolidated financial statements which are
not included in this Annual Report.

|                                              | Year ended,
|--------------------------------------------- | -----------
|
|
|
|
|Statements of operations data:                |            
|Revenues:(1)                                  |            
|Licenses and royalties                        |            
|Services                                      |            
|                                              |            
|Total revenues                                |            
|                                              |            
|Cost of service revenues(2)                   |            
|                                              |            
|                                              |            
|                                              |            
|Operating expenses:                           |            
|Research and      development, net(2)         |            
|Marketing and selling(2)                      |            
|General and      administrative(2)            |            
|                                              |            
|Total operating expenses                      |            
|                                              |            
|Operating income (loss)                       |            
|Financial income, net                         |            
|Equity in losses of   equity method investees |            
|Compensation expense related to issuance      |            
|of options to employees of equity             |            
|method investees                              |            

- 3 -

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---

|                                                                        | Year ended,
|----------------------------------------------------------------------- | -----------
|
|
|
|
|                                                                        |            
|Capital loss from sale of equity method   investees                     |            
|                                                                        |            
|                                                                        |            
|Income (loss) from continuing operations                                |            
|before income taxes                                                     |            
|Income taxes                                                            |            
|Income (loss) from continuing operations                                |            
|after income taxes                                                      |            
|Loss from discontinued operations(2)(3)                                 |            
|                                                                        |            
|Income (loss) before cumulative                                         |            
|effect of change in accounting                                          |            
|principle                                                               |            
|                                                                        |            
|Cumulative effect of a change in   accounting principle(4)              |            
|                                                                        |            
|Net income (loss)                                                       |            
|                                                                        |            
|Allocation of undistributed earnings to   convertible preferred shares  |            
|                                                                        |            
|Net income (loss) attributed to ordinary                                |            
|shares after allocation of                                              |            
|undistributed earnings                                                  |            
|                                                                        |            
|Basic earnings (loss) from continuing   operations per ordinary share . |            
|                                                                        |            
|Basic earnings (loss) from discontinued                                 |            
|operations and cumulative effect of                                     |            
|change in accounting principle per                                      |            
|ordinary share                                                          |            
|                                                                        |            
|Basic net earnings (loss) per ordinary   share                          |            
|                                                                        |            
|Weighted average number of ordinary                                     |            
|shares used in computing net earnings                                   |            
|(loss) per share amounts--basic                                         |            
|                                                                        |            
|Diluted earnings (loss) from continuing   operations per ordinary share |            
|                                                                        |            
|Diluted earnings (loss) from discontinued                               |            
|operations  and cumulative effect of                                    |            
|change in accounting principle per                                      |            
|ordinary share                                                          |            
|                                                                        |            
|Diluted net earnings (loss) per ordinary   share                        |            
|                                                                        |            
|Weighted average number of ordinary                                     |            
|shares used in computing net earnings                                   |            
|(loss) per share amounts-- diluted                                      |            
|                                                                        |            

- 4 -

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|                                                                                  | Year ended,
|--------------------------------------------------------------------------------- | -----------
|
|
|
|
|                                                                                  |            
|Pro forma basic earnings from continuing   operations per ordinary share (5)      |            
|                                                                                  |            
|Pro forma basic loss from discontinued                                            |            
|operations per ordinary share (5)                                                 |            
|                                                                                  |            
|Pro forma basic net earnings per ordinary   share (5)                             |            
|                                                                                  |            
|Weighted average number of ordinary                                               |            
|shares used in computing pro forma net                                            |            
|earnings per share amounts-- basic                                                |            
|                                                                                  |            
|Pro forma diluted earnings from
   continuing operations per ordinary   share (5) |            
|                                                                                  |            
|Pro forma diluted loss from discontinued                                          |            
|operations per ordinary share (5)                                                 |            
|                                                                                  |            
|Pro forma diluted earnings per ordinary   share (5)                               |            
|                                                                                  |            
|Weighted average number of ordinary                                               |            
|shares used in computing pro forma net                                            |            
|earnings per share amounts-- diluted                                              |            
|                                                                                  |            

|                           | As of
|-------------------------- | -----
|
|
|
|
|Balance sheet data:        |      
|Cash and cash equivalents  |      
|Short-term investments     |      
|Marketable securities      |      
|Working capital (6)        |      
|Total assets               |      
|Total liabilities          |      
|Capital stock              |      
|Accumulated deficit        |      
|Total shareholders' equity |      

---

|(1) | Includes revenues from related parties, principally from design and product
               development services provided to our former joint venture, consisting of $3,150
               for 2002, $6,440 for 2003, and $8,425 for 2004. License revenues for 2005
               include non-cash revenues of $19,182 resulting from the termination of our
               former joint venture.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 5 -

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---

|(2) | Costs and expenses include stock-based compensation related to options granted
          to employees and others as follows:
|--- | ----------------------------------------------------------------------------------------------------------------------------

|                                  | Year ended,
|--------------------------------- | -----------
|
|
|
|
|Cost of services                  |            
|Research and development, net     |            
|Marketing and selling             |            
|General and administrative        |            
|Loss from discontinued operations |            
|                                  |            
|Total                             |            
|                                  |            

|(3) | We
decided to discontinue product sales in the second quarter of 2005. During
               the third quarter of 2005, we began accounting for products sales
operations as                discontinued operations and prior year financial information
has been                reclassified.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | On
January 1, 2006, we adopted FAS 123(R), Share-Based Payment.
               Accordingly, we recorded a cumulative effect of change in accounting
principle                relating to estimated forfeitures for the compensation cost that
was recognized                in the financial statements under the provisions of FAS 123
for the years ended                December 26, 2004 and December 31, 2005.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Pro
forma basic and diluted net earnings (loss) per ordinary share for 2005
               gives effect to the automatic conversion of all of our issued and
outstanding                convertible preferred shares and options into ordinary shares
at a ratio of 1:1                that occurred prior to the completion of our initial
public offering on November                8, 2005, as if the conversion occurred at the
beginning of the fiscal year ended                December 31, 2005. We apply the
two-class method as required by EITF No. 03-6,                Participating
Securities and the Two-Class Method under FASB Statement No.                128, Earnings
per Share. EITF No. 03-6 requires earnings per share for                each class
of shares (ordinary shares and preferred shares) to be calculated                assuming
100% of our earnings were distributed as dividends to each class of                shares
based on their contractual rights. The allocation of undistributed
               earnings related to convertible preferred shares was no longer necessary
upon                consummation of our IPO. Since all the preferred shares were
converted as a                result of our initial public offering, the pro forma
presentation provides a                better comparison of the earnings per share data
following our initial public                offering.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Current
assets less current liabilities.
|--- | ----------------------------------------

- 6 -

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# CAUTIONARY LANGUAGE
REGARDING FORWARD-LOOKING STATEMENTS

This
Annual Report contains forward-looking statements. We have based these forward-looking
statements on our current expectations and projections about future events. These
statements include but are not limited to:

| |  | the
amount and timing of the recognition of deferred revenue and of additional license fees
from our current               licensees and the impact of adding additional licenses;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | statements
as to the timing of our future research and development expenses;
| | - | ----------------------------------------------------------------------------

| |  | statements
as to our discontinued operations;
| | - | ---------------------------------------------

| |  | statements
as to the future technological innovations, including the implementation of our NROM
technology               with multi-level cell functionality;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | statements
as to our ability to meet anticipated cash needs based on our current business plan;
| | - | -----------------------------------------------------------------------------------------------

| |  | expectations
as to any increase in the amount and proportion of our revenues derived from royalties
and the               timing of recognition of these revenues; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | statements
as to the impact of the rate of inflation and the political and security situation on our
              business.
| | - | ----------------------------------------------------------------------------------------------------------------------------

In
addition, statements that use the terms believe, expect,
plan, intend, estimate, anticipate and
similar expressions are intended to identify forward-looking statements. All
forward-looking statements in this Annual Report reflect our current views about future
events and are based on assumptions and are subject to risks and uncertainties that could
cause our actual results to differ materially from future results expressed or implied by
the forward-looking statements. Many of these factors are beyond our ability to control or
predict. You should not put undue reliance on any forward-looking statements. Unless we
are required to do so under U.S. federal securities laws or other applicable laws, we do
not intend to update or revise any forward-looking statements.

# B. CAPITALIZATION AND
INDEBTEDNESS

Not
applicable.

# C. REASON FOR THE OFFER
AND USE OF PROCEEDS

Not
applicable.

- 7 -

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# D. RISK FACTORS

# Risks Related to Our
Business

| | We
depend on a small number of licensees for our revenues and the further loss of any of
these licensees may adversely impact our revenues and cause our share price to drop
substantially.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenues
from three semiconductor manufacturers accounted for 87% of our licensing and service
revenues in 2005 and 84% of our licensing and service revenues in 2006:

|                                                      | Year ended December 31,
|----------------------------------------------------- | -----------------------
|
|
|
|
|Macronix International Co., Ltd.                      |                        
|Infineon Technologies AG/Qimonda AG                   |                        
|Semiconductor Manufacturing International Corporation |                        
|Spansion LLC                                          |                        

---

(*)
          Less than 10% of revenues

In
October 2006, Qimonda AG, a majority-owned subsidiary of Infineon Technologies, and the
assignee of our license with Infineon Technologies, informed us of its decision to
phase-out NROM-based activities. As a result of this decision, we have not received any
license or services fees from Qimonda AG after 2006. In the future, we expect to receive
only very limited royalties from Qimonda AG with respect to previously developed NROM
products. This decision resulted in the cancellation of a contractual commitment for a
significant amount of license fees payable in 2007 and beyond. On October 13, 2006, after
we announced the Qimonda AG decision, the closing price of our ordinary shares dropped by
over $7.00.

As
of December 31, 2006, our remaining license agreements contained contractual commitments
for license fees payable to us before December 31, 2008 totaling approximately $15
million, the substantial majority of which we expect to recognize prior to December 31,
2008. The majority of this amount is payable by Semiconductor Manufacturing International
Corporation. Substantially all of these fees are subject to cancellation by our licensees.
Subject to these licensees successfully incorporating our intellectual property into their
products, we expect that a significant portion of our future revenues will continue to be
derived from them for the foreseeable future. The loss of any of these licensees would
cause our revenues to fall below our expectations and may cause the price of our ordinary
shares to drop substantially.

| | Our
future growth could be adversely affected if our licensees do not successfully implement
our NROM technology in a wide range of their products, especially data flash products.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

An
important element of our strategy is to accelerate the adoption of our NROM technology by
our licensees in the code, data and embedded flash segments of the non-volatile memory
market. If our licensees fail to implement our NROM technology in a timely manner or in a
large number of their products, our future prospectus could be harmed. In particular, the
failure of our licensees to successfully implement our NROM technology in data flash
products may adversely affect our ability to take advantage of the projected growth in the
data flash market. According to Web-Feet Research, the data flash market is projected to
grow between 2006 and 2011 at a compound annual growth rate of 24.8% to $45.8 billion,
while the code flash market is projected to grow at a compound annual growth rate of 8.2%
to $11.6 billion over the same period. We have granted a license to use our NROM
technology in data flash applications to Macronix, Semiconductor Manufacturing
International Corporation and Spansion. In addition, Qimonda AG holds a license for data
flash applications; however, due to its decision to phase-out NROM-based activities, we
have not received any license fees since 2006 and in the future we expect to receive only
very limited royalty revenues from Qimonda with respect to previously developed NROM
products. We have granted a license to use our NROM technology in code flash applications
to Spansion, Macronix and Matsushita. Our licensees in the embedded flash market are
Matsushita, Sony Corporation, Tower Semiconductors, Macronix and NEC Electronics Corp. Our
licensees may elect to rely on other licensed or internally-developed technologies for
some or all of their products instead of implementing our NROM technology. If a leading
semiconductor manufacturer adopts and achieves success with another technology or
incorporates our NROM technology but fails to achieve success with its products, our
reputation and revenues could be adversely affected.

- 8 -

---

---

| | Our
revenues may be harmed if our licensees encounter difficulties or fail to implement our
Quad NROM technology in their products.
| | -----------------------------------------------------------------------------------------------------------------------------------

Our
Quad NROM technology is designed to enable the storage of four bits per cell. This
technology is intended, in part, to strengthen our licensees ability to compete in
the data flash segment of the non-volatile memory market. Currently, two of our licensees
are developing products incorporating our Quad NROM technology. We and our licensees face
challenges in implementing this technology. In particular, in order to program and read a
Quad NROM device, each cell must be capable of reliably storing and reading multiple
voltage levels. The need to program and reliably distinguish between multiple voltage
levels, without generating unacceptable error levels or materially degrading performance,
requires more precise and sophisticated operation control. We believe that this is similar
to the challenge that companies face when attempting to make two-bit-per-cell devices
using floating gate technology. We invest in research and development and provide design
and product development services to our licensees to assist them in meeting the
manufacturing challenges presented by these demands. If our licensees are unsuccessful in
introducing products that meet the technical demands described above, or in migrating
products incorporating our NROM technology to more advanced manufacturing processes, our
business and financial results could be seriously harmed.

| | Our
growth and future prospects could be harmed if we are unable to license our NROM
technology to new licensees.
| | -----------------------------------------------------------------------------------------------------------------

The
code and data flash memory segments are each dominated by a small number of large
manufacturers. According to Web-Feet Research, the top six manufacturers accounted for
82.6% of revenues in the code and data memory segments in 2006. Due to the projected
growth in the data flash market compared to the code flash market, a failure to enter into
new license agreements in the data flash segments could adversely affect our growth and
future prospects. We have agreed with Macronix that we will be allowed to grant a license
to manufacture products incorporating our NROM technology to only one other new licensee
in Taiwan for code and data flash products, provided we pay Macronix a portion of the
license fees that we receive from any such license. If additional significant
manufacturers of non-volatile memory products are established in Taiwan in the future,
this restriction may limit the revenues that we can derive from this market, or result in
additional costs, to enter into license agreements with these manufacturers. The majority
of manufacturers in the code and data flash memory segments use floating gate technology
and may be evaluating other alternative competing technologies. It takes a significant
amount of time to design, develop and manufacture non-volatile memory devices and, as a
result, if a semiconductor manufacturer starts to manufacture products based on a
competing technology, it may be difficult for us to displace that technology. If a leading
semiconductor manufacturer in the code or data flash memory segment adopts and achieves
success with a competing technology our reputation and revenues could be adversely
affected.

In
addition, we must negotiate license agreements with favorable license fees and royalty
payments. The license fees and royalties under our current license agreements vary
significantly among our licensees. For example, our first license agreement with Spansion,
which in 2006, according to Web-Feet Research, was the largest vendor worldwide of code
flash with total sales of $2.6 billion, or 33.6% of the total code flash market, contains
a uniform royalty rate that is lower than the royalty rates in some of our other license
agreements and stepped thresholds that limit the amount from which we can derive royalties
to $1.2 billion of annual net sales of products by Spansion incorporating our NROM
technology. If we are unable to negotiate favorable license agreements with new licensees,
our growth and future prospects could be harmed.

| | Our
historical financial data may be of limited value in evaluating our future prospects.
| | -----------------------------------------------------------------------------------------

Our
historical financial data may be of limited value in evaluating our future prospects due
to the following significant changes in our business:

| |  | Increase
in recurring royalties and decrease in license fees revenues. To date, we have
derived substantially all of our revenues from licensing our intellectual property to
third parties. In addition, to date, we have derived the majority of our licensing
revenues from licensing fees revenues. Over time, typically, the license fees revenues
per licensee decrease and subject to our licensees increasing sales of products
incorporating our licensed intellectual property, we expect that the proportion of our
revenues derived from license royalties will increase relative to license fees.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 9 -

---

---

| |  | Termination
of the joint venture with Infineon Technologies. In December 2004, we exited our
joint venture with Infineon Technologies. As a result, as of the first quarter of 2005,
we ceased to recognize a percentage share of the net loss of the joint venture in our
statement of operations.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Qimonda
AGs decision to phase-out NROM based activities. In 2006, Qimonda AG accounted
for 44% of our revenues. In October 2006, Qimonda AG informed us of its decision to
phase-out NROM-based activities. As a result of this decision, we have not received any
license or services fees from Qimonda AG after 2006. In the future, we expect to receive
only very limited royalties from Qimonda AG with respect to previously developed NROM
products. This decision resulted in the cancellation of a contractual commitment for a
significant amount of license fees payable in 2007 and beyond.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Our
NROM technology faces competition from alternate technologies and our revenues and
business will be harmed if we do not develop new innovations in a timely,
cost-effective manner
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Acceleration
in the development of alternative technologies or viable solutions to the challenges faced
by floating gate technology may hinder the adoption of our NROM-technology. To store two
bits of information in a cell, current floating gate technology uses multi-level
technology which requires four different threshold voltage levels and to store four bits
of information, floating gate technology would require sixteen different levels. While we
believe that this presents a major challenge in the creation of a four-bit-per-cell
floating gate device, it is possible that one of our competitors may successfully
introduce a multi-level four-bit-per-cell technology in the future. In order to gain new
licensees, we must persuade potential licensees of the benefits of our technology over
existing floating gate technology as well as a number of alternative technologies,
including Ferroelectric Random Access Memory (FRAM), Magnetoresistive Random Access Memory
(MRAM), polymer and phase-change based memory technologies. FRAM is a non-volatile memory
technology that utilizes a ferroelectric layer to achieve volatility. Sales of FRAM
accounted for a minor portion of the overall semiconductor market. MRAM is a non-volatile
memory technology, which utilizes magnetic storage devices. MRAM is not in widespread use
as it is still in development. On March 21, 2007, Hynix Semiconductor Inc. and SanDisk
Corporation announced that they had signed a memorandum of understanding outlining a joint
venture between the two companies to manufacture memory components and sell NAND memory
system solutions. The joint venture will be engaged, inter alia, in the development of X4
technology. X4 technology has been developed by M-Systems, Ltd. which was acquired by
SanDisk Corporation in November 2006, and is designed to enable utilization of 4-bit/cell
NAND flash.

Our
future success depends on our ability to develop new generations of our technology. In
particular, we believe that all non-volatile memory technologies, including NROM
technology, must be able to deliver the following:

| |  | increased
memory and features on same size or smaller chip;
| | - | -----------------------------------------------------------

| |  | migration
to smaller process technologies;
| | - | ------------------------------------------

| |  | faster
read and write speeds that allow a system microprocessor to access data very quickly;
| | - | --------------------------------------------------------------------------------------------

| |  | lower
power consumption to allow for longer operating times using the same power source;
| | - | ----------------------------------------------------------------------------------------

| |  | ability
to withstand extreme temperature fluctuations; and
| | - | ----------------------------------------------------------

| |  | the
ability to read and modify data many times without impacting reliability adversely.
| | - | ---------------------------------------------------------------------------------------

| | If
we are unable to successfully protect our inventions through the issuance and enforcement
of patents, our business could be significantly harmed.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------

As
we derive a significant portion of our revenue from licensing activities, our ability to
innovate and protect our innovations by applying for, obtaining and enforcing our patents
is important to our business and revenues. As of December 31, 2006, we owned over 80
issued U.S. patents (including 11 co-owned U.S. patents) and 18 non-U.S. patents, and over
70 pending U.S. patent applications and over 120 pending non-U.S. patent applications. In
particular, our NROM technology is based on the concept of trapping bits of
information in a non-conductive material. Recently, several leading semiconductor
companies, that are not our licensees, have announced their interest in trapping
technology as an alternative to their current floating gate technology. If we fail to
obtain patents, are unable to obtain patents with claims of a scope necessary to cover our
technology, or our issued patents are determined invalid or not to cover our technology,
our licensees and others could use portions of our intellectual property without paying
license fees and royalties, which could weaken our competitive position, significantly
harm our revenues and prospects, and increase the likelihood of costly litigation. We have
an active program to protect our proprietary inventions through the filing of patent
applications and taking certain steps to preserve the confidentiality of our confidential
and proprietary information. There can be no assurance, however, that:

- 10 -

---

---

| |  | current
or future U.S. or foreign patent applications will be approved;
| | - | -----------------------------------------------------------------------

| |  | our
issued patents will protect our intellectual property and not be challenged by third
parties;
| | - | -------------------------------------------------------------------------------------------------

| |  | the
validity of our patents will be upheld;
| | - | -------------------------------------------

| |  | the
patents of others will not have an adverse effect on our ability to do business; or
| | - | ---------------------------------------------------------------------------------------

| |  | others
will not independently develop similar or competing products or methods or designs around
any patents that may be issued to us and, in particular, around the trapping technology
concept.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Our
failure to protect the intellectual property created by us would cause our business to
suffer.
| | --------------------------------------------------------------------------------------------------

In
addition to patent protection, we rely on a combination of trade secret, copyright and
trademark laws and restrictions on disclosure to protect our intellectual property rights,
including through confidentiality agreements with our employees, consultants and
customers. We cannot be certain that these contracts have not been and will not be
breached, that we will have adequate remedies for any breach or that our trade secrets
will not otherwise become known or be independently discovered by competitors. Further,
the growth of our business depends in large part on our ability to convince third parties
of the applicability of our intellectual property to their products, and our ability to
enforce our intellectual property rights against them. As part of our marketing efforts,
we disclose to our prospective customers some of our proprietary information, not all of
which is patent protected. Monitoring unauthorized use of our technology is difficult, and
we cannot be certain that the steps we have taken will prevent unauthorized use of our
technology, particularly in foreign countries where the laws may not protect our
proprietary rights as fully as do the laws of the United States or in countries where we
have not obtained or have limited patents on our technology, including China and Taiwan.
We cannot be certain that the steps we have taken to protect our proprietary information
will be sufficient.

| | Potential
intellectual property claims by and against us and resulting litigation could subject us
to significant costs and could invalidate our proprietary rights.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
the semiconductor industry, it is not unusual for companies to receive notices alleging
infringement of patents or other intellectual property rights of others. We are not
currently subject to any proceedings for infringement of patents or intellectual property
rights of others and are not aware of any parties that intend to pursue such claims
against us. If it appears necessary or desirable, we may seek to license intellectual
property that we are alleged to be infringing. Licenses may not be offered and the terms
of any offered licenses may not be acceptable to us. The failure to obtain a license under
a key patent or intellectual property directly from a third party for technology used by
us or provided by us to our licensees could cause us to incur substantial liabilities and
to suspend the manufacture of the products utilizing certain technology or to attempt to
develop non-infringing products, any of which could harm our business. We may find it
necessary to litigate to enforce our patents and other intellectual property rights, to
protect our trade secrets, to determine the validity and scope of the proprietary rights
of others or to defend against claims of infringement of others intellectual
property or invalidity of our own intellectual property. For example, in 2002 we incurred
expenses of approximately $2.2 million in connection with a settlement and license
agreement with Fujitsu Limited and Advanced Micro Devices, Inc., pursuant to which we
agreed to settle a claim that we filed in the United States District Court for the
Southern District of New York for infringement of patents, breach of contract and unjust
enrichment. In addition, we have provided a limited indemnity to certain of our licensees
against losses resulting from claims that our NROM technology incorporated into their
products infringes certain third party intellectual property rights, and we may agree to
indemnify other licensees in the future. These indemnification obligations could result in
significant expense. Litigation is inherently uncertain and any adverse decision could
result in a loss of our proprietary rights, subject us to significant liabilities, require
us to seek licenses from others, limit the value of our licensed technology and otherwise
negatively impact our business. Even if we adequately protect our intellectual property
rights, litigation may be necessary to enforce these rights, which could result in
substantial costs to us and a substantial diversion of management attention, which could
harm our business.

- 11 -

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---

| | The
timing and amount of our revenues from new license agreements and the amount of our
revenues from royalties is difficult to predict and may fluctuate.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

The
amount of time it takes to enter into a new license agreement and generate a license fee
and to establish a royalty stream can range from three or more months, for the entry into
the license agreement, to two years or more, for the establishment of a royalty stream. As
such, it is difficult to make an accurate prediction of future license fees and royalties
from new licensees. Where we are not providing initial customer support to our licensees,
we recognize license fees upon delivery, provided no extended payment terms exist. In
other cases, we recognize license fees ratably over the period during which we expect to
provide initial customer support, if any, to our licensees to assist them in incorporating
our intellectual property into their products, independent of the actual payment schedules
under the license agreement, but provided that payment is due or guaranteed according to
the terms of the agreement. We review our assumptions regarding the support periods on a
regular basis; however, there can be no assurance that we will accurately estimate the
period during which we will provide initial customer support to our licensees, or that we
will have, or be able to expend, sufficient resources required to complete a project. We
have in the past experienced changes and delays to our licensees projected product
development schedules and there can be no assurance that they will not be changed or
delayed in the future. Royalties are also dependent upon fluctuating sales volumes and
prices of products that include our NROM technology, all of which are beyond our ability
to control or assess in advance. As a result of these uncertainties, the timing and amount
of license revenues and the amount of royalty revenues are difficult to predict. This may
make accurate financial forecasts difficult to achieve, which could cause our stock price
to become volatile and decline.

| | Our
licensees may be subject to intellectual property infringement claims by third parties or
other licensees of our technology.
| | --------------------------------------------------------------------------------------------------------------------------------

Our
licensees use various aspects of their own patents and intellectual property in the
manufacture, design and testing of non-volatile memory products incorporating our NROM
technology. Third parties may claim that the products manufactured by our licensees
infringe the third partys patents and other intellectual property. In addition, our
licensees may sue each other for infringement of each others patent and intellectual
property rights. While two of our licensees have agreed not to block certain other
licensees from manufacturing products incorporating our NROM technology, these
arrangements are subject to exceptions and may be difficult to enforce. The code and data
flash memory segments of the non-volatile memory market are each dominated by a small
number of large manufacturers. As a result, there are a limited number of companies to
which we can license our patents and intellectual property in these segments. While there
are a larger number of potential licensees in the embedded flash memory market, these
licensees too could be subject to intellectual property infringement claims from third
parties or each other. Our ability to receive royalties depends on our licensees
sales of products incorporating our NROM technology. Our royalty revenues may be adversely
affected if third parties attempt to block our licensees, or if our licensees attempt to
block other licensees, from manufacturing products incorporating our NROM technology.

| | Our
difficulties in verifying royalty amounts and other payments owed to us under our license
and other agreements may cause us to lose revenues.
| | -------------------------------------------------------------------------------------------------------------------------------------------------

Our
long-term success depends in part on future royalties paid to us by licensees. Royalties
are based on a percentage of the revenues received by licensees on sales of products
incorporating our licensed intellectual property. We are dependent upon our ability to
enforce agreements for the payment of royalties. The standard terms of our license
agreements require our licensees to document the manufacture and sale of products that
incorporate our NROM technology and report this data to us on a periodic basis. We have
also entered into a collaboration and distribution agreement with Spansion pursuant to
which we share the profits from sales of agreed-upon serial flash products. Although our
license agreements and this collaboration and distribution agreement give us the right to
audit books and records of our counterparties and to verify this information, audits can
be expensive, time consuming, and potentially detrimental to our ongoing business
relationships. In addition, our agreements generally limit our audit rights to one audit
each year. As a result, to date, we have relied exclusively on the accuracy of the reports
themselves without independently verifying the information in them. Any inaccuracies or
reporting errors that we fail to discover may result in us receiving less revenue than we
are entitled to receive.

- 12 -

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---

| | A
decrease in the demand for consumer electronic, communications, automotive and industrial
products may significantly decrease the demand for the products sold by our
licensees and reduce our revenues and profitability.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Flash
memory devices that are based on our NROM technology are incorporated into products for
consumer electronic, communications, automotive and industrial markets. These products
include mobile phones, still and video digital cameras, personal digital assistants (or
PDAs), portable computers, portable digital music players, digital video recorders,
set-top boxes, network computers, communication routers and switches, digital televisions
and other electronic systems. A significant decrease in the demand for these products may
decrease the demand for the products of our licensees and could adversely affect our
results of operations.

| | We
cannot be certain that our substantial investments in research and development will lead
to timely improvements in technology or that we will have sufficient resources to
invest in the level of research and development that is required to remain
competitive.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We
make substantial investments in research and development for the design, development,
pre-manufacture and testing of, and enhancements to, our NROM technology. These costs
consist of salaries and related personnel costs and consist also of wafer costs and
engineering expenses associated with the introduction of our products, lease costs,
subcontractor/outsourced engineering services and software and depreciation of laboratory
equipment. We view the total amounts we spend on research and development, together with
our cost of service revenues, as providing a more complete picture of our overall research
and development activities because our research and development activities directly
benefit from the design and product development services that we provide to licensees. For
example, research and development expenses increased by $5.4 million to $12.8 million in
2006 from $7.4 million in 2005. Research and development expenses, together with cost of
service revenues, increased by $8.2 million to $27.7 million in 2006 from $19.5 million in
2005.

We
cannot assure you that we will have sufficient resources to maintain the level of
investment in research and development that is required for us to remain competitive,
which could materially adversely affect us. Further, we cannot assure you that our
investments in research and development will result in increased sales or competitive
advantage, which could adversely affect our operating results.

| | Cyclicality
in the non-volatile memory market may affect our revenues and, as a result, our operating
results could be adversely affected.
| | ------------------------------------------------------------------------------------------------------------------------------------------

The
non-volatile memory market has historically been cyclical and is characterized by wide
fluctuations in product supply and demand. From time to time, the industry has experienced
significant downturns, often in connection with, or in anticipation of, maturing product
and technology cycles, excess inventories and declines in general economic conditions.
This cyclicality could cause our operating results to decline dramatically from one period
to the next. Our royalty revenues will depend heavily upon sales by our licensees and
products incorporating our NROM technology, which, in turn, depend upon the current and
anticipated market demand for semiconductors and products that use semiconductors. Our
design and product development service revenues depend in part upon the outsourcing of
design and product development projects by our licensees. Semiconductor manufacturers
generally have adopted a variable cost structure, which has allowed them to sharply
curtail their spending during industry downturns. Historically, many of these
manufacturers have lowered their spending more than the decline in their revenues. As a
result, if we are unable to control our expenses adequately in response to lower revenues
from our licensees and service customers, our operating results will suffer and we might
experience operating losses.

| | The
average selling prices of non-volatile memory devices has tended to decrease historically
and this trend may negatively impact our revenue and gross margins.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

Average
selling prices of non-volatile memory devices have historically declined over the course
of a particular devices life. For example, according to Web-Feet Research, the
average selling price per megabyte in a data flash device declined from 2005 to 2006 by
62.0% and is forecasted to decline from 2006 to 2007 by 50.5% and in a code flash device
declined from 2005 to 2006 by 29.8% and is forecasted to decline from 2006 to 2007 by
31.0%. We expect this trend to continue in the future. Because royalty payments under our
license agreements are based on a percentage of our licensees net sales, any
decrease in the average selling prices of non-volatile memory devices incorporating our
NROM technology will adversely impact our revenues.

- 13 -

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---

| | The
semiconductor memory market in which we participate is highly competitive and, if we do
not compete effectively, our operating results would be harmed.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------

We
consider the primary competition for our NROM technology to be traditional floating gate
technology in its single-level, one-bit-per-cell and multi-level, two-bit-per cell
implementations. This technology and its enhancements are developed primarily by the
internal research and development departments of large semiconductor companies, some of
which are our licensees and many of which we believe are potential licensees of our NROM
technology. Many of these companies consider flash memory research and development to be
one of their core competencies. In the code flash memory market, the leading manufacturers
are Spansion, Intel Corporation, STMicroelectronics and Silicon Storage Technology (SST)
Inc. In the data flash memory market, the leading manufacturers include Samsung
Electronics Co. Ltd., Toshiba Corporation, Hynix Semiconductor and SanDisk Corporation. In
addition, in early 2006 Intel and Micron Technology Inc., formed a joint venture targeting
the data flash market. Intel, Samsung, STMicroelectronics, Toshiba, Hynix and SanDisk
(through its joint venture with Toshiba) market floating gate devices incorporating
multi-level-cell technology. Other companies have indicated that they are developing
multi-level-cell floating gate technology. Also, it is possible that one of our
competitors will successfully introduce a multi-level four-bit-per-cell technology in the
future, which could materially harm our competitive position. In the embedded flash memory
market, we compete directly with the technology of application companies that manufacture
embedded products, as well as with a number of other companies that license their
intellectual property, principally Silicon Storage Technologies, Inc. Many of our
competitors have significantly greater name recognition, larger customer bases, more
established customer relationships and greater financial, technical, manufacturing,
marketing and other resources than us. Our failure to compete successfully in these or
other areas could harm our business and financial results.

| | If
we fail to support our growth in operations, particularly by enhancing our sales and
marketing, and internal controls systems, our business could suffer.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

Over
the last three years, our business has grown rapidly with revenues increasing from $30.6
million in 2004 to $62.8 million in 2006. As of December 31, 2006, we had 232 employees
compared to 236 employees as of December 31, 2005. We may plan to expand our operations,
domestically and internationally, and may do so through both internal growth and
acquisitions. We may face significant challenges and risks in building and managing our
growth. To succeed in the implementation of our business strategy, we may need to expand
our business development and marketing activities and enhance our internal controls
systems. Our systems, procedures and controls may not be adequate to support growth in
operations. Failure to manage our future growth effectively could result in increased
costs and harm our financial results.

| | We
depend on our ability to attract and retain our key management and technical personnel.
| | ------------------------------------------------------------------------------------------

Our
success depends, in large part, on the continued service of our key management,
engineering, business development, marketing and finance personnel, many of whom are
highly skilled and would be difficult to replace. In particular, we depend on the
continued service of Dr. Boaz Eitan, our founder, Chief Executive Officer and Chairman.
Our President, Kobi Rozengarten, who had worked with us for nine years, will be leaving
the company in July 2007 and, as a result, our dependence on Dr. Boaz Eitan will likely
increase. None of our senior management, key technical personnel or key sales personnel
are bound by written employment contracts to remain with us for a specified period. In
addition, we do not currently maintain key personnel life insurance covering any of our
personnel. The loss of any of our senior management or other key personnel could harm our
ability to implement our business strategy and respond to the rapidly changing market
conditions in which we operate. Our success also depends on our ability to attract, train
and retain highly skilled managerial, engineering, sales, marketing, legal and finance
personnel and on the abilities of new personnel to function effectively, both individually
and as a group. Further, we must train our new personnel, especially our technical support
personnel, to respond to and support our licensees and customers. If we fail to do this,
it could lead to dissatisfaction among our licensees or customers, which could slow our
growth or result in a loss of business.

| | The
international nature of our business exposes us to financial and regulatory risks and we
may have difficulty protecting our intellectual property in some foreign countries.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

To
date, we have derived the substantial majority of our licensing and service revenues from
licensees headquartered outside the United States, principally in Europe and the
Asia-Pacific region, and these revenues accounted for 72% of our licensing and service
revenues in the fiscal year ended December 31, 2006. International operations are subject
to a number of risks, including the following:

- 14 -

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---

| |  | laws
and business practices favoring local companies;
| | - | -----------------------------------------------------

| |  | withholding
tax obligations on license revenues that we may not be able to offset fully against our
tax obligations, including the further risk that foreign tax authorities may
re-characterize license fees or increase tax rates, which could result in increased tax
withholdings and penalties;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | less
effective protection of intellectual property than is afforded to us in the United
States, or other developed countries;
| | - | -----------------------------------------------------------------------------------------------------------------------------

| |  | technology
export license requirements and trade restrictions;
| | - | --------------------------------------------------------------

| |  | imposition
of or increases in tariffs; and
| | - | ------------------------------------------

| |  | changes
in regulatory requirements.
| | - | -----------------------------------

Our
intellectual property is also used in a large number of countries. There are countries,
including China, in which we currently have no issued patents, and others, such as Taiwan,
in which we have a limited number of issued patents. In addition, effective intellectual
property enforcement may be unavailable or limited in some foreign countries. It may be
difficult for us to protect our intellectual property from misuse or infringement by other
companies in these countries. We expect this to become a greater problem for us as our
licensees increase their manufacturing in countries that provide less protection for
intellectual property. Our inability to enforce our intellectual property rights in some
countries may harm our business.

| | Our
international operations expose us to the risk of fluctuations in currency exchange rates.
| | ----------------------------------------------------------------------------------------------

In
2006, we derived all of our revenues in U.S. dollars. However, 53% of our expenses were
denominated in New Israeli Shekels. Our shekel-denominated expenses consist principally of
salaries and related personnel expenses, as well as vehicle lease payments. We anticipate
that a material portion of our expenses will continue to be denominated in shekels. If the
U.S. dollar weakens against the shekel, there will be a negative impact on our profit
margins. In addition, to the extent that our licensees sales are not denominated in
U.S. dollars, they are translated into U.S. dollars at the prevailing exchange rate for
the purpose of calculating the royalty payable to us. Therefore, if the U.S. dollar
strengthens against the currency in which any of our licensees makes its sales, the
dollar-denominated amount of the royalties that we receive would be reduced and subject to
fluctuations. If the effective price of licensed semiconductors sold by our foreign
licensees were to increase as a result of fluctuations in the exchange rate of relevant
currencies, demand for licensed semiconductors could fall, which in turn would reduce our
royalties.

| | If
our prototypes or products based on our designs are used in defective products, we may be
subject to product liability or other claims.
| | ------------------------------------------------------------------------------------------------------------------------------------------

If
products incorporating our technology are used in defective or malfunctioning products, we
could be sued for damages, especially if the defect or malfunction causes physical harm to
people. The occurrence of a problem could result in product liability claims and/or a
recall of, or safety alert or advisory notice relating to, the product. While we believe
the amount of product liability insurance maintained by us, combined with the indemnities
that we have been granted under our license agreements, are adequate, there can be no
assurance that these will be adequate enough to satisfy claims made against us in the
future, or that we will be able to obtain insurance in the future at satisfactory rates or
in adequate amounts. Product liability claims in the future, regardless of their ultimate
outcome, could have a material adverse effect on our business, financial condition and
reputation, and on our ability to attract and retain licensees and customers.

| | We
may need to raise additional capital in the future and may be unable to do so on
acceptable terms. This couldlimit our ability to grow and carry out
our business plan.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our
future capital requirements will depend on the acceptance of our licensees products
that incorporate our NROM technology and the costs associated with the growth of our
business. If the proceeds from our initial public offering in November 2005 and follow-on
offering in April 2006, together with other sources of cash and cash flows, are not
sufficient to fund our activities, we may need to raise additional capital, which may not
be available on favorable terms, or at all. In addition, we may seek to take advantage of
any capital raising opportunities that arise in the future. We cannot be certain that we
will be able to obtain additional financing on commercially reasonable terms or at all,
which could limit our ability to grow, or that any such additional financing, if raised
through the issuance of equity securities, will not be dilutive to our existing
shareholders.

- 15 -

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---

| | Our
reported financial results may be adversely affected by changes in U.S. generally
accepted accounting principles.
| | ---------------------------------------------------------------------------------------------------------------------

We
prepare our financial statements in conformity with U.S. generally accepted accounting
principles. These accounting principles are subject to interpretation by the Financial
Accounting Standards Board, the American Institute of Certified Public Accountants, the
Securities and Exchange Commission and various bodies formed to interpret and create
appropriate accounting principles. A change in these principles or interpretations could
have a significant effect on our reported financial results, and could affect the
reporting of transactions completed before the announcement of a change.

# Risks Relating to our
Ordinary Shares

Our
quarterly financial performance is likely to vary in the future, and may not meet our
guidance or the expectations of analysts or investors, which may lead to additional
volatility in our share price. In 2006, the closing price of our shares varied from a high
of $37.90 to a low of $16.55, and the closing price of our shares dropped by over $7.00 on
one day in October 2006 after we announced the decision by Qimonda AG to phase-out its
NROM-related activities.

The
market price of our ordinary shares may continue to be volatile and fluctuate
substantially in the future due to many factors, including:

| |  | announcements
regarding our licensees' decisions to introduce new products or to continue NROM-related
             activities;
| | - | -------------------------------------------------------------------------------------------------------------------------------

| |  | announcements
or introductions of technological innovations or new products, or product enhancements or
             pricing policies by us or our competitors;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | disputes
or other developments with respect to our or our competitors' intellectual property
rights;
| | - | ----------------------------------------------------------------------------------------------------

| |  | announcements
of strategic partnerships, joint ventures or other agreements by us or our competitors;
| | - | -----------------------------------------------------------------------------------------------------

| |  | recruitment
or departure of key personnel;
| | - | ------------------------------------------

| |  | the
gain or loss of licensees;
| | - | ------------------------------

| |  | regulatory
developments in the United States, Israel and abroad;
| | - | ----------------------------------------------------------------

| |  | our
sale of ordinary shares or other securities in the future;
| | - | --------------------------------------------------------------

| |  | changes
in the estimation of the future size and growth of our markets; and
| | - | ---------------------------------------------------------------------------

| |  | market
conditions in our industry, the industries of our customers and the economy as a whole.
| | - | ----------------------------------------------------------------------------------------------

Share
price fluctuations may be exaggerated if the trading volume of our ordinary shares is too
low. The lack of a trading market may result in the loss of research coverage by
securities analysts. Moreover, we cannot assure you that any securities analysts will
maintain research coverage of our company and our ordinary shares. If our future quarterly
operating results are below the expectations of securities analysts or investors, the
price of our ordinary shares would likely decline. Securities class action litigation has
often been brought against companies following periods of volatility. Any securities
litigation claims brought against us could result in substantial expense and divert
managements attention from our business.

- 16 -

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---

| | Our
Chief Executive Officer and Chairman, Dr. Boaz Eitan, has significant influence over
matters requiring shareholder approval, which could delay or prevent a change of
control.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
largest beneficial owner of our ordinary shares, our Chief Executive Officer and Chairman,
Dr. Boaz Eitan, beneficially owns 34.8% of our outstanding ordinary shares. As a result,
Dr. Eitan has significant influence over our operations and business strategy, as well as
sufficient voting power to control the outcome of matters requiring shareholder approval.
These matters may include:

| |  | the
composition of our board of directors, which has the authority to direct our business and
to appoint and              remove our officers;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------

| |  | approving
or rejecting a merger or other business combination;
| | - | --------------------------------------------------------------

| |  | raising
future capital; and
| | - | ---------------------------

| |  | amending
our Articles of Association, which govern the rights attached to our ordinary shares.
| | - | ----------------------------------------------------------------------------------------------

This
concentration of ownership of our ordinary shares could delay or prevent proxy contests,
mergers, tender offers, open-market purchase programs or other purchases of our ordinary
shares that might otherwise give you the opportunity to realize a premium over the
then-prevailing market price of our ordinary shares. This concentration of ownership may
also adversely affect our share price.

| | Substantial
future sales of our ordinary shares in the public market may cause the price of our
shares to decline.
| | ------------------------------------------------------------------------------------------------------------------

As
of March 20, 2007, we had 31,477,170 ordinary shares outstanding (not including 46,000
ordinary shares repurchased by us following the approval by our board of directors in
February 2007 of a repurchase plan). If our shareholders sell substantial amounts of our
ordinary shares in the public market, including shares issued upon the exercise of
outstanding options, the market price of our ordinary shares could fall. Such sales also
might make it more difficult for us to issue equity or equity-related securities in the
future at a time and price that we deem appropriate.

As
of March 20, 2007, we had outstanding approximately 19.2 million ordinary shares that
are freely tradable without restriction or registration under the Securities Act, unless
purchased by affiliates as that term is defined under Rule 144 of the Securities Act.

As
of February 28, 2007, we had outstanding (i) options to purchase approximately
3.5 million ordinary shares of which approximately 1.1 million were vested and
exercisable and (ii) approximately 2.9 million shares issued pursuant to our
share option plans. These shares may be sold pursuant to a registration statement on
Form S-8 that we have filed with respect to such shares. Sales of a significant
amount of shares underlying options or the perception that such sales may occur, may cause
the price of our shares to decline.

| | Any
shareholder that acquires more than 9.9% of our shares will have limited voting rights
with respect to those shares.
| | ------------------------------------------------------------------------------------------------------------------------

Each
Ten Percent Shareholder in a non-U.S. corporation that is classified as a
controlled foreign corporation, or a CFC, for United States federal income tax
purposes in any taxable year is required to include in income for U.S. tax purposes such
Ten Percent Shareholders pro rata share of the CFCs Subpart
F income and investment of earnings in U.S. property, even if the CFC has made no
distributions to its shareholders. A non-U.S. corporation will be classified as a CFC for
United States federal income tax purposes in any taxable year in which Ten Percent
Shareholders own, directly or indirectly, more than 50.0% of either the total
combined voting power of all classes of stock of such corporation entitled to vote or of
the total value of the stock entitled to vote of such corporation. A Ten Percent
Shareholder is a United States person (as defined by the U.S. Internal Revenue Code
of 1986, as amended (the Code)) who owns or is considered to own, on any day
during such taxable year, 10% or more of the total combined voting power of all classes of
stock entitled to vote of such corporation.

- 17 -

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---

Although
we were a CFC in the beginning of the 2005 tax year, we believe based on our current
ownership that provisions limiting voting power in our Articles of Association and other
factors, we are no longer so classified and expect that we will not be classified as a CFC
in future years. In order to reduce the risk that we will once again be considered a CFC
in future years, our Articles of Association provide that any United States persons that
purchase our shares, directly, indirectly or constructively, after September 29, 2005 will
be limited to voting a maximum of 9.9% of our total combined voting power, to the extent
that their voting rights notwithstanding such limitation would cause us to be considered a
CFC.

See
Memorandum and Articles of Association  Limitations on Voting and
Taxation  United States Federal Income Taxation  Controlled Foreign
Corporation Considerations.

| | Our
U.S. shareholders may suffer adverse tax consequences if we are characterized as a
Passive Foreign Investment Company.
| | --------------------------------------------------------------------------------------------------------------------------

Generally,
if for any taxable year 75.0% or more of our gross income is passive income, or at least
50.0% of our assets are held for the production of, or produce, passive income, we would
be characterized as a passive foreign investment company for U.S. federal income tax
purposes. If we are characterized as a passive foreign investment company, our U.S.
shareholders may suffer adverse tax consequences, including having gains realized on the
sale of our ordinary shares treated as ordinary income, rather than capital gain, the loss
of the preferential rate applicable to dividends received on our ordinary shares by
individuals who are U.S. holders, and having potentially punitive interest charges apply
to the proceeds of share sales. Because the market price of our ordinary shares is likely
to fluctuate and the market price of the shares of technology companies has been
especially volatile, and because that market price may affect the determination of whether
we will be considered a passive foreign investment company, there can be no assurance that
we will not be considered a passive foreign investment company for any taxable year. See
Taxation  United States Federal Income Taxation  Passive Foreign
Investment Company Considerations.

# Risks Relating to our
Location in Israel

| | Conditions
in Israel could adversely affect our business.
| | ---------------------------------------------------------

We
are incorporated under Israeli law and our principal offices and our research and
development facilities are located in Israel. Therefore, political, economic and military
conditions in Israel directly affect our operations. Although Israel has entered into
various agreements with Egypt, Jordan and the Palestinian Authority, there has been an
increase in unrest and terrorist activity, which began in September 2000 and which has
continued with varying levels of severity into 2007. The election of representatives of
the Hamas movement to a majority of seats in the Palestinian Legislative Council has
resulted in an escalation in violence among Israel, the Palestinian Authority and other
groups. In July and August 2006, significant fighting took place between Israel and
Hezbollah in Lebanon, resulting in rockets being fired from Lebanon up to 50 miles
into Israel. We do not believe that the political and security situation has had any
material impact on our business to date; however, we can give no assurance that security
and political conditions will have no such effect in the future. Any armed conflict,
political instability or continued violence in the region may have a negative effect on
our business condition, harm our results of operations and adversely affect the share
price of publicly traded Israeli companies such as us.

| | Our
operations could be disrupted as a result of the obligation of key personnel in Israel to
perform military service.
| | -----------------------------------------------------------------------------------------------------------------------

As
of December 31, 2006, we had 232 employees of whom 229 were based in Israel. Generally,
our male employees in Israel, including some of our executive officers, may be called upon
to perform up to one month (in some cases more) of annual military reserve duty until they
reach age 45 and, in emergency circumstances, could be called to active duty. In
response to increased tension and hostilities, there have been since September 2000
occasional call-ups of military reservists. For example, in July 12, 2006 fighting broke
out between Israel and Lebanon that continued until September 2006. During this period,
approximately 40 employees were called up for military service for a period ranging from a
few days to a few weeks and it is possible that there will be additional call-ups in the
future. Our operations could be disrupted by the absence for a significant period of one
or more of our executive officers or key employees due to military service. Any disruption
to our operations could materially adversely affect the development of our business and
our financial condition.

- 18 -

---

---

| | We
have recently been granted a government grant for research and development expenditure
from the government ofIsrael through the Office of the Chief
Scientist of the Israeli Ministry of Industry, Trade and Labor. This grantlimits
our ability to manufacture products and transfer technologies outside of Israel and
requires us to satisfyspecified conditions.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
2006, the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and
Labor approved a government grant for research and development expenditures in connection
with our controller card activity project in the amount of up to $470,000. We will be
required to pay royalties to the Chief Scientist of between 3% and 3.5% of revenues
derived from technology developed using these grants, until 100% of the grants are repaid,
together with an annual interest, accrued from the date of the grant, as set forth in the
research and development regulations (currently equal to the 12 month London Interbank
Offered Rate). In addition, the terms of the grants prohibit recipients from manufacturing
products developed using these grants outside of Israel without special approvals. Even if
we receive approval to manufacture the products developed with government grants outside
of Israel, we will be required to pay an increased total amount of royalties (possibly up
to 300% of the grant amount plus interest), depending on the manufacturing volume that is
performed outside of Israel, as well as a possible increased royalty rates. Additionally,
under the law governing the research grants, we will be prohibited from transferring the
financed technologies and related intellectual property rights outside of Israel except
under limited circumstances and provided the transfer is approved by the Research
Committee of the Office of the Chief Scientist. Approval of the transfer of technology to
residents of Israel is also required, and may be granted in specific circumstances only if
the recipient abides by the provisions of applicable laws, including the restrictions on
the transfer of know-how and the obligation to pay royalties in an amount that may be
increased. We cannot provide any assurance that consent, if requested, will be granted.
Additionally, such restrictions may impair our ability to outsource manufacturing, engage
in change-of-control transactions or otherwise transfer our technology developed with
government grants outside Israel.

Further,
if we fail to comply with any of the conditions imposed by the Office of the Chief
Scientist, we may be required to refund any grants received together with interest and
penalties, and may be subject to criminal charges. In recent years, the government of
Israel has accelerated the rate of repayment of Chief Scientist grants and may further
accelerate them in the future. In addition, the Israeli government has, from time to time,
discussed reducing or eliminating the availability of these grants. There can be no
assurance that the Israeli governments support of such grants will continue.

| | We
receive tax benefits that may be reduced or eliminated in the future.
| | ------------------------------------------------------------------------

Our
investment program in equipment at our facility in Netanya, Israel has been granted
approved enterprise status and we are therefore eligible for tax benefits under the
Israeli Law for Encouragement of Capital Investments, 1959, referred to as the Investments
Law. In April 2005, a comprehensive amendment to the Investments Law came into effect.
Since the amended Investments Law does not apply retroactively to investment programs
having an approved enterprise approval certificate issued by the Israeli Investment Center
prior to December 31, 2004, part of our future tax benefits are subject to the provisions
of the Investments Law prior to its revision, while new benefits that will be received in
the future, if any, will be subject to the provisions of the Investments Law, as amended.
Subject to our compliance with the applicable requirements, the portion of our net income
derived from our licensing and services activities will be exempt from income tax during
the first two years in which these investment programs produce taxable income, which will
be after we have utilized our net operating loss carry forwards. Thereafter it will be
subject to a reduced tax rate of between 10% and 25% for the remaining five to eight years
of the program, depending on the extent of non-Israeli investment in our company during
the relevant year. Israeli companies were subject to income tax at the corporate rate of
31% for the 2006 tax year, 29% for the 2007 tax year and the rate is set to decline
annually to 25% for the 2010 tax year and thereafter. As of December 31, 2006, the end of
our last fiscal year, our net operating loss carry forwards for Israeli tax purposes
amounted to approximately $10.8 million. The period during which we receive these tax
benefits is limited to the earlier of 12 years from the year in which operations or
production by the enterprise commenced and 14 years from the year in which approval of the
program was granted. The benefits under our existing approval enterprises are due to
expire between 2011 and 2015. The benefits available to an approved enterprise are
conditional upon our fulfilling certain requirements stipulated in the Investments Law and
its regulations and the criteria set forth in the specific certificate of approval. If we
do not meet these requirements in the future, the tax benefits may be canceled and we
could be required to refund any tax benefits that we have already received. See
Taxation  Israeli Tax Considerations and Government Programs  Taxation
of Companies  Law for the Encouragement of Capital Investments, 1959 for more
information about the requirements. In addition, in order to manage certain investments,
we have established a wholly owned subsidiary, Saifun (BVI) Limited, a company
incorporated under the laws of the British Virgin Islands. Under our approved enterprise
status, we are not entitled to receive any tax benefits from any income derived from
investments made through Saifun (BVI) Limited. As of December 31, 2006, Saifun (BVI)
Limited taxable income is subject to Israeli income tax, which is considered a
deemed dividend and taxed at 25% tax rate.

- 19 -

---

---

| | It
may be difficult to enforce a U.S. judgment against us, our officers and directors in
Israel or the United States, or to assert U.S. securities laws claims in Israel or
serve process on our officers and directors.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We
are incorporated in Israel. The majority of our executive officers and directors are not
residents of the United States, and the majority of our assets and the assets of these
persons are located outside the United States. Therefore, it may be difficult for an
investor, or any other person or entity, to enforce a U.S. court judgment based upon the
civil liability provisions of the U.S. federal securities laws against us or any of these
persons in a U.S. or Israeli court, or to effect service of process upon these persons in
the United States. Additionally, it may be difficult for an investor, or any other person
or entity, to assert U.S. securities law claims in original actions instituted in Israel.
Israeli courts may refuse to hear a claim based on a violation of U.S. securities laws
because Israel is not the most appropriate forum in which to bring such a claim. In
addition, even if an Israeli court agrees to hear a claim, it may determine that Israeli
law and not U.S. law is applicable to the claim. If U.S. law is found to be applicable,
the content of applicable U.S. law must be proved as a fact which can be a time-consuming
and costly process. Certain matters of procedure will also be governed by Israeli law.
There is little binding case law in Israel addressing the matters described above.

| | Under
current Israeli law, we may not be able to enforce covenants not to compete and therefore
may be unable to prevent our competitors from benefiting from the expertise of some
of our former employees.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We
have entered into non-competition agreements with all of our Israeli employees. These
agreements prohibit our employees, if they cease working for us, from competing directly
with us or working for our competitors for a limited period. Under current Israeli law, we
may be unable to enforce these agreements and it may be difficult for us to restrict our
competitors from gaining the expertise our former employees gained while working for us.
For example, Israeli courts have required employers seeking to enforce non-compete
undertakings of a former employee to demonstrate that the competitive activities of the
former employee will harm one of a limited number of material interests of the employer
that have been recognized by the courts, such as the secrecy of a companys
confidential commercial information or its intellectual property. If we cannot demonstrate
that harm would be caused to us, we may be unable to prevent our competitors from
benefiting from the expertise of our former employees.

| | Provisions
of Israeli law and our Articles of Association may delay, prevent or make undesirable an
acquisition of all or a significant portion of our shares or assets.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our
Articles of Association contain certain provisions that may delay or prevent a change of
control. These provisions include a classified board of directors and a prohibition on
certain transactions with a 15% shareholder approval unless certain board approvals are
received. In addition, Israeli corporate law regulates acquisitions of shares through
tender offers and mergers, requires special approvals for transactions involving
significant shareholders and regulates other matters that may be relevant to these types
of transactions. These provisions of Israeli law could have the effect of delaying or
preventing a change in control and may make it more difficult for a third party to acquire
us, even if doing so would be beneficial to our shareholders, and may limit the price that
investors may be willing to pay in the future for our ordinary shares. Furthermore,
Israeli tax considerations may make potential transactions undesirable to us or to some of
our shareholders.

|ITEM 4. | INFORMATION
ON THE COMPANY
|------- | --------------------------

# A. HISTORY AND
DEVELOPMENT OF THE COMPANY

Our
legal and commercial name is Saifun Semiconductors Ltd. We were incorporated
under the laws of the State of Israel in November 1996 and commenced operations in July
1997. In November 2005, we conducted an initial public offering and listed 5,750,000
ordinary shares on The Nasdaq Stock Market.In April 2006, we conducted a follow-up
offering of 4,393,170 shares, out of which 340,000 ordinary shares were sold by us and
4,053,170 were sold by certain of our shareholders.

- 20 -

---

---

In
February 2007, we announced that our board of directors authorized us to purchase up to
1.5 million of our ordinary shares, which represent approximately 4.8% of our total
outstanding shares as of December 31, 2006. Shares may be purchased from time to time in
open market transactions in accordance with applicable federal securities laws. The
repurchase plan, including the timing of repurchases and the exact number of securities to
be purchased will depend upon prevailing market conditions and other factors to be
determined by our management and our board of directors. Such repurchases will be made
using our own cash resources.

We
are registered with the Israeli registrar of companies in Jerusalem. Our registration
number is 51-239733-2. Our principal executive offices are located at 6 Arie Regev Street,
Sappir Industrial Park, Netanya 42504, Israel, and our telephone number is +972 (9)
892-8444. Our web site address is www.saifun.com. The information on our web site does not
constitute part of this Annual Report. We have irrevocably appointed Saifun
Semiconductors, Inc. as our agent to receive service of process in any action against us
in any United States federal or state court. The address of Saifun Semiconductors, Inc. is
2350 Mission College Blvd., Suite 1070, Santa Clara, CA 95054, U.S.A.

See
Item 5 for a description of our discontinuation of product sales activities in the second
quarter of 2005. See Items 5 and 18 for a description of capital expenditures by us for
the past three fiscal years. We have not made any divestitures during the same time
period.

# B. BUSINESS OVERVIEW

# Overview

We
have invented and patented a technology that we refer to as nitride-read-only memory, or
NROM, that we believe is leading a revolutionary shift in the non-volatile semiconductor
memory market. Unlike volatile semiconductor memory devices, which lose stored information
after electrical power is turned off, non-volatile semiconductor memory devices retain
stored information even without a power source. Demand for non-volatile memory is
experiencing rapid growth as consumer electronics, communications, automotive and
industrial products proliferate, and require increasingly complex programming codes, and
as digitization of information, including photographs, video, music and documents require
increased data storage capacity. According to market estimates from Web-Feet Research, a
market research firm in the electronics and the semiconductor industry, the code flash and
data flash markets that our technology addresses accounted for sales of $22.9 billion in
2006, and are expected to grow to $57.4 billion by 2011, representing a compound annual
growth rate of 20.1%. Web-Feet Research estimates that the embedded flash market that our
technology addresses accounted for sales of $3.2 billion in 2006, and is expected to grow
to $6.7 billion by 2011, representing a compound annual growth rate of 14.4%.. Taken as a
whole, we believe that our NROM technology can be applied in the semiconductor memory
market, which in 2006 accounted for sales of $26.1 billion and is expected to grow to
$64.1 billion by 2011, representing a compound annual growth rate of 19.7%.

We
believe that our NROM technology represents a breakthrough in the non-volatile memory
market because it offers a number of significant advantages over existing non-volatile
memory technology. These advantages include a doubling of storage capacity of a basic
semiconductor memory cell resulting from our two-bit-per-cell and four-bit-per-cell
architectures and a simpler cell architecture that reduces manufacturing steps, thereby
enabling semiconductor manufacturers to reduce manufacturing costs. We believe that our
technology is the only commercially-available technology that can be applied to all
segments of the non-volatile memory market using principally the same manufacturing
process. In addition to licensing our intellectual property, we provide design and product
development services to our licensees. Our goal is to establish our NROM technology as a
leading technology in the non-volatile memory market. We are addressing the three primary
segments of the non-volatile semiconductor memory market by licensing our technology to
leading semiconductor companies who are in different stages of development.

| |  | Code
flash.  Code flash is typically used to store basic operating instructions,
operating system software or program code. A sub-segment of code flash in serial flash,
which is characterized as small, low-power flash memory that uses a serial interface for
data access. Our licensees for this segment are: Spansion, Macronix and Matsushita. In
regards to our agreement with Spansion for code products, we are limited to $1.2 billion
of annual net sales of products incorporating our NROM technology by Spansion from which
we can derive royalties. In addition, we have an agreement with Spansion for serial code
products which is on a profit sharing basis.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 21 -

---

---

| |  | Data
flash.  Data flash is typically used to store digital content such as
multimedia files and memory cards for digital cameras. Our licensees for this segment
are: Spansion, Semiconductor Manufacturing International Corporation (SMIC), and Qimonda
AG. As a result of Qimonda AGs announcement to phase-out NROM-based activities, we
expect to receive very limited royalties from Qimonda AG.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Embedded
flash.  Embedded flash combines non-volatile memory and logic systems on a
single chip for use in applications such as consumer electronics, automotive applications
and smart cards. Our licensees for this segment are: Matsushita, Sony Corporation, Tower
and NEC Electronics Corp.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Industry Overview

Demand
for non-volatile memory devices has grown rapidly in recent years due to the expansion of
digital computing and processing beyond desktop computer systems to include a broader
array of consumer electronic, communications, automotive and industrial products. These
products include mobile phones, still and video digital cameras, personal digital
assistants, or PDAs, portable computers, portable digital music players, digital video
recorders, set-top boxes, communication routers and switches, digital televisions and
other electronic systems. Each of these products requires a non-volatile memory device to
store the products operating system and may also require data storage capabilities.
Non-volatile memory was developed in the late 1960s. Since then, a range of non-volatile
memory architectures have evolved, differentiated primarily by the ability of the user to
reprogram the device. These memory architectures include ROM (Read Only Memory),
PROM (Programmable Read Only Memory), EPROM (Erasable Programmable Read Only
Memory) and EEPROM (Electrically Erasable Programmable Read Only Memory). Flash
memory was invented in 1984 and in 2006 was the largest segment of the non-volatile memory
market. Flash memory is similar to EEPROM in that it can also be erased and reprogrammed
repeatedly through the application of an electrical voltage. Unlike EEPROM, flash memory
cells can be erased in blocks by a single action or flash, and unlike EEPROM,
flash memory does not require two transistors per cell. This enables flash memory devices
to be more cost-effective and to have faster program and erase speeds than EEPROM devices.

| | Flash
Memory Applications
| | -------------------------

The
flash memory market has traditionally been divided into three segments: code flash, data
flash and embedded flash. The following table sets forth the principal characteristics and
applications of, and market data for, each of these segments:

- 22 -

---

---

|Segment        | Characteristics | Applications                                                                                                                       | Global Sales
in 2006 | Projected
Global Sales
in 2011                                                                                                                                                               | Projected
Compound Annual
Growth Rate from
2006 to 2011
|-------------- | --------------- | ---------------------------------------------------------------------------------------------------------------------------------- | -------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------
|
|
|Code flash     |                | Used to store    
executable code, 
such as operating
system software  
of a device                                                |                     | Communications 
products (e.g.,
mobile
telephones)                                                                                                                                           | $7,786                                                 
|               |                 |                                                                                                                                    |                     | Consumer                                                                                                                                                                                     |                                                        
|               |                | Characterized   
by random access
to stored       
information and 
fast read speeds                                               |                      | electronics
products (e.g.,
DVD players,
computers, TV
set-top boxes,
Bluetooth,
modems, monitors)                                                                                           |                                                        
|               |                 |                                                                                                                                    |                      |                                                                                                                                                                                              |                                                        
|Data flash     |                | Used for         
high-density data
storage                                                                                        |                     | Memory cards      
for digital
cameras, USB flash
drives and MP3
players                                                                                                                     | $15,137                                                
|               |                | Characterized
by sequential
access and fast
write speeds                                                                           |                      |                                                                                                                                                                                              |                                                        
|               |                 |                                                                                                                                    |                      |                                                                                                                                                                                              |                                                        
|Embedded flash |                | Combines flash  
memory and logic
systems on the  
same die                                                                        |                     | Microcontrollers  
or digital signal 
processors        
embedded with     
Flash memory. Used
in consumer       
electronics,      
automotive        
applications,     
smart cards, etc. | $3,238(1)                                              
|               |                 |                                                                                                                                    |                      |                                                                                                                                                                                              |                                                        
|               |                | The Flash        
portion is       
typically        
characterized by 
fast access, low 
power consumption
and increased
security |                      |                                                                                                                                                                                              |                                                        

Source: Web-Feet Research.

---

|(1) | Excludes
revenue attributable to the microcontroller, digital signal processor
               and/or programmable logic components of an embedded flash device.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Trends
in the Flash Memory Market
| | ---------------------------------

The
following are recent trends in the flash memory market:

| |  | Accelerating
growth in the data flash market. According to Web-Feet Research, the code flash markets
rate of growth decreased by 4.4% in 2006, while the data flash market grew at 24.7%, with
revenues of $15.1 billion. The data flash market is projected by Web-Feet Research to
grow between 2006 and 2011 at a compound annual growth rate of 24.8% to $45.8 billion,
while the code flash market is projected to grow at only 8.2% to $11.6 billion over the
same period. The growth in the data flash market is driven by high demand for portable
storage and computing applications.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Higher
volumes and densities.  The increasing demand for storing large amounts of data,
such as pictures, music, and video in handsets, telephones and mobile media players is
driving an increase in the average number of bits available in a memory device. Total
demand measured in bits of information stored in code and data flash memory devices is
expected to grow by 134.5% from 2006 to 2007, where one bit is the smallest unit of data
stored with a value of either 0 or 1. From 2006 to 2007, demand measured in bit density
is expected to grow 71.7% for code flash and 136.7% for data flash, according to Web-Feet
Research.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 23 -

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---

| |  | Demand
for greater performance and reliability. Product manufacturers are demanding faster
read and write speeds to allow a systems microprocessor to access data and execute
program code faster, the ability to read and modify stored information repeatedly without
adversely impacting reliability, and the ability to retain stored information for an
extended period. In addition, product manufacturers are requiring devices with lower
power consumption to allow for longer operating times using the same power source and the
ability to operate devices under extreme environmental conditions.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Constant
price pressure and demand for device shrink. At the same time as demand has increased
for higher density and higher performance memory devices, the price for flash memory
products, measured on a per bit basis, has decreased. According to Web-Feet Research, the
average selling price per megabyte is forecasted to decline from 2006 to 2007 by 50.5% in
a data flash device and by 31% in a code flash device. In order to achieve
profitability, semiconductor manufacturers must continually reduce their unit and per bit
costs by reducing the size of the individual transistors that make up a memory chip. The
process of reducing the size of the individual transistor is commonly referred to as
device shrink and results in an increase in the number of transistors per wafer.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Greater
design and manufacturing challenges. The demand for higher density and enhanced
performance, at a reduced cost, has resulted in continual design and manufacturing
challenges for semiconductor manufacturers. As a consequence, semiconductor manufacturers
are continuously seeking advancements to existing technologies, mainly through migration
to smaller manufacturing process geometries, and exploring new technologies and materials
in order to address the demanding market requirements.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Prevailing Non-Volatile
Semiconductor Memory Technology

The
most widely-used technology for non-volatile semiconductor memory devices is floating gate
technology, which was developed in the late 1960s and has been the prevalent technology
for non-volatile semiconductor memory devices since then. A floating gate device is a
variation of a standard metal oxide semiconductor in that it has an additional
electrically isolated floating gate, made of a conductive material. A floating
gate device stores information by holding an electrical charge within the floating gate.
Adding or removing the charge from the floating gate changes the threshold voltage of the
cell thereby defining whether the memory cell is in a programmed or erased state. Because
a conventional floating device only has a programmed or erased state  representing a
1" or a 0  it can only store one bit of information in each
cell. Non-volatile memory based on floating gate technology is subject to the following
limitations:

| |  | Barriers
to device shrink. Floating gate technology faces significant challenges in reducing
cell size and packing cells into smaller spaces on the wafer, referred to as device
shrink. As floating gate cell size is reduced, a thinner isolating layer may lead to
poorer reliability due to potential leakage of the charge from the floating gate. In
addition, as the device shrinks and cells get closer together, one cell could affect the
state of its neighbor cell, leading to errors in the data. Some of the floating gate
manufacturers, including Samsung and Toshiba, have stated that they believe these
limitations will become a substantial technology barrier to device shrink in the future.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Complicated
manufacturing process. Semiconductor manufacturing requires the replication of a
series of patterns onto a silicon wafer. Floating gate technology requires a high number
of these replications, referred to as masking steps, which results in high manufacturing
costs and a long manufacturing cycle, and may also result in lower yields. As cell size
decreases, the need to move to more advanced manufacturing processes and to develop
error-free masks has increased the cost of manufacturing floating gate devices.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Different
design and manufacturing process for each market segment. Floating gate devices
require different cell and array architectures, and thus different manufacturing
processes for each type of non-volatile memory device. Due to the high cost and technical
challenges associated with implementing different manufacturing processes. most
manufacturers of non-volatile memory devices concentrate in a particular segment, such as
code or data flash.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 24 -

---

---

Due
to the high cost and the technological challenges that need to be resolved to achieve
device shrink, semiconductor manufacturers have sought other methods to increase the
storage density of non-volatile memory devices. One such method is through multi-level
cells, which use the same architecture as single-cell memory devices, but stores
fractional charge levels within a single cell. Current implementations of multi-level
cells in floating gate devices permit the storage of two bits of information per cell and
require four levels of charge. A more precise program and read function than single-cell
memory devices are required to identify these levels. As a result, current implementations
of multi-level cell technology in floating gate devices have slow read and write times
compared to single-bit-per-cell devices. In addition, multi-level cells have a reduced
overall level of reliability because the loss of even a few electrons from the floating
gate can cause data corruption and device failure. While current floating gate multi-level
two-bit-per-cell technology requires four different levels, sixteen different levels are
required for a four-bit-per-cell floating gate device. While we believe that this presents
a major challenge in the creation of a four-bit-per-cell floating gate device, it is
possible that one of our competitors may successfully introduce a multi-level
four-bit-per-cell technology in the future.

# Our NROM Technology

We
believe that our NROM technology represents a breakthrough in the non-volatile
semiconductor memory market as it offers a number of significant advantages over
traditional non-volatile memory technology:

| |  | Increased
storage capacity. Our NROM technology doubles the storage capacity of each memory
cell by enabling the storage of two physically distinct and independent charges, each
representing one bit of information, within a single memory cell. This significantly
reduces the amount of silicon wafer required for each non-volatile memory device,
resulting in a significant cost reduction to semiconductor manufacturers. In addition, we
believe that our next generation NROM technology, Quad NROM, which enables
the storage of four bits per cell, will increase storage capacity and further lower the
cost per bit.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Device
shrink. Due to a simpler cell architecture than floating gate technology, we believe
that devices based on our NROM technology are easier to migrate to smaller manufacturing
process geometries, enabling them to be highly scalable and allowing semiconductor
manufacturers to continue to be cost competitive. To date, some of our licensees have
sold devices based on our NROM technology down to 90 nanometer process geometries and are
also developing products based on our Quad NROM using 65 nanometer processes. Based on
our advanced research and development program, we are confident that further device
shrink will be possible using our NROM technology.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Simple,
low cost manufacturing process. Non-volatile memory devices that incorporate our NROM
technology require fewer masking and processing steps than floating gate devices. The
reduction in the number of manufacturing steps leads to higher yields, shorter silicon
cycles and lowers overall manufacturing costs for devices based on our NROM technology.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | High
performance and reliability. Each cell in a device incorporating our NROM technology
stores the trapped charge in a non-conducting material, thereby preventing the charge
from moving within the trapping layer and leaking out through a point defect.
Such point defects may result in device failure for floating gate device. In addition,
the relatively thick oxide layers surrounding the trapping layer of the NROM cell prevent
the trapped charge from leaking-out of the cell. This enhances the reliability of the
NROM cells at smaller process geometries when compared to floating gate devices.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Same
platform for all primary segments of non-volatile memory market. In contrast to
floating gate technology, where each segment of the non-volatile memory market requires a
different floating gate device structure, our NROM technology uses the same manufacturing
process and cell and array architecture for all primary segments of the non-volatile
memory market, such as code, data, and embedded flash. This allows us to leverage our
research and development across all segments and allows our licensees to compete in all
segments without the need for separate manufacturing lines for each segment.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 25 -

---

---

We
are currently developing products which incorporate our new Quad NROM technology with two
of our licensees, namely Spansion and SMIC, which we are assisting in the development of a
8 gigabit data flash NROM device. In a Quad NROM implementation, the storage capacity of a
single NROM cell is doubled to four-bits-per-cell compared to two-bits-per-cell in a
multi-level floating gate cell.We believe that our NROM technology is best suited
to the mass production of four-bit-per-cell devices because floating gate cells would be
required to maintain as many as 16 threshold voltage levels per cell to store four bits.
To achieve this result, our competitors would have to develop an advanced design and
sophisticated controller algorithms. Despite these challenges, it is possible that one of
our competitors may introduce a multi-level four-bit-per-cell technology in the future. On
March 21, 2007, Hynix Semiconductor Inc. and SanDisk Corporation announced that they have
signed a memorandum of understanding outlining a joint venture between the two companies
to manufacture memory components and sell NAND memory system solutions. The joint venture
will be engaged, inter alia, in the development of the X4 technology. The X4 technology
has been developed by M-systems, Ltd. which was acquired by SanDisk Corporation in
November 2006, and is designed to enable utilization of 4-bit/cell NAND flash.

In
developing and implementing our Quad NROM technology, we face similar challenges to those
challenges faced by two-bit-per-cell devices based on floating gate technology, namely,
implementing a more precise program and read function required for multi-level-cell
devices. We expect that the program function in our Quad NROM technology will be slower
than that of a regular two-bit-per-cell NROM device. Yet, we believe that we can achieve
accurate read functions without compromising read speed. We also expect that the first
generation of our Quad NROM technology will have data retention characteristics similar to
two-bit-per-cell NROM devices, but a lower number of program-erase cycles than
two-bit-per-cell NROM devices.

Our
NROM technology has some limitations. NROM devices may require a higher programming
electrical current than some comparable floating gate devices. This may require a more
complex design to meet comparable specifications and may result in a longer development
time.

# Licensees

As
part of our strategy to accelerate the adoption of our NROM technology in the non-volatile
memory market, we have entered into the license agreements described below.

| | Infineon
Technologies AG and Qimonda AG
| | ---------------------------------------

Infineon
Technologies manufactures digital, mixed signal and analog integrated circuits for
applications such as communications, automotive, computers, security chip cards and other
industries. We began deriving license revenues from Infineon Technologies in January 2004.

In
January 2005, in connection with the termination of our former joint venture with Infineon
Technologies, we entered into an amended license agreement with Infineon Technologies and
in June 2005, Infineon Technologies exercised its right to terminate the license for code
flash products. In May 2006, Infineon Technologies transferred its memory products
business to Qimonda AG, a majority-owned subsidiary of Infineon Technologies. In
connection with this transfer, our license agreements with Infineon Technologies were
assigned to Qimonda AG.

In
October 2006, Qimonda AG, informed us of its decision to phase-out its NROM-based
activities and to continue to license previously developed NROM technology under an
amended license agreement. As a result of this decision, we have not received any license
or services fees from Qimonda AG after 2006. In the future, we expect to receive only very
limited royalties from Qimonda AG with respect to previously developed NROM products.

| | Macronix
International Co., Ltd.
| | --------------------------------

Macronix
is the leading Taiwanese vendor of non-volatile memory semiconductor products. Macronix
was founded in 1989, listed on the Taiwan Stock Exchange in 1995, and in 1996, was one of
the first Taiwanese companies to be listed on The Nasdaq Stock Market. Since its
inception, Macronix has focused on non-volatile memory semiconductor solutions. According
to Web-Feet Research, Macronix was ranked as the worlds 12th largest vendor of flash
memory in 2006 and the 6th largest vendor of code flash devices. Macronix
operates manufacturing facilities in Taiwan and currently produces the majority of its
semiconductors at process geometries ranging from 130 to 250 nanometers. In 2000, we
granted Macronix a worldwide, non-exclusive license to manufacture non-volatile memory
products incorporating our NROM technology, except for certain EEPROM applications. The
license remains in existence until the expiration of the patents it covers, unless
terminated earlier at will by Macronix. In 2002, Macronix commenced shipping code and
embedded flash products incorporating our NROM technology marketed under its own Nbit
trademark. In 2006, Macronix announced production of three new serial code flash products
based on our NROM technology, at densities of 16 megabits, 32 megabits and 64 megabits.

- 26 -

---

---

We
are entitled to a license fee and royalties based on Macronixs annual net
sales of products incorporating our NROM technology. The license fees are payable in
installments at the earlier of the completion of a technological milestone or a
predetermined date. If we grant a license for similar products to another semiconductor
manufacturer, we are required to offer those royalty rates to Macronix. In December 2005,
we amended our license agreement with Macronix to reduce the amount of prepaid royalties
that it may use each quarter to offset its ongoing royalty obligations to us. In addition,
we have agreed with Macronix that we will be allowed to grant a license to manufacture
products incorporating our NROM technology to only one other new licensee in Taiwan for
code and data flash products, provided we pay Macronix a portion of the license fees that
we receive from any such license. Our licensees are not precluded from having products
manufactured in Taiwan at the facilities of another semiconductor manufacturer. Macronix
may terminate the license agreement at any time. Macronix may only terminate the
manufacturing agreement upon one years notice. In the event that we extend a license
to another semiconductor manufacturer, other than Tower Semiconductor, that permits the
other semiconductor manufacturer to manufacture products incorporating our NROM technology
for third parties, we are required to extend the same license to Macronix. To date,
Macronix has paid us the substantial majority of the license fee, which is payable in
installments upon the achievement of the earlier of technological or time-related
milestones. The technological milestones were not met within the prescribed dates and we
have therefore received payments based on the time-related milestones.

| | Matsushita
Electric Industrial Co., Ltd.
| | ----------------------------------------

Matsushita
is one of the worlds largest vendors of consumer electric and electronic products,
with revenue of approximately $76.0 billion for the fiscal year ended March 31, 2006.
Matsushita has a broad portfolio of products including communications and networking
equipment, household appliances and consumer electronics sold under brand names such as
Panasonic, Technics and JVC. Matsushita is also a supplier of electronic components and
semiconductors. In 2006, the company ranked as the worlds 17th largest semiconductor
vendor and, according to iSuppli, had revenues of $4.2 billion from semiconductor sales.

In
2003, we granted Matsushita a worldwide, non-exclusive license to manufacture and sell
embedded products incorporating our NROM technology. In February 2006, we amended and
restated our license agreement with Matsushita to permit it, in addition to its existing
license, to manufacture and sell embedded products and certain system in package products
(SIPs) in a single manufacturing technology process. To date, Matsushita has
paid us a portion of a license fee which is payable in installments on the earlier of the
achievement of technological milestones or time-related milestones. Matsushita is required
to pay royalties based on net sales of embedded products and SIPs incorporating our NROM
technology. If we grant a license for embedded products and SIPs with more favorable
royalty rates under substantially similar circumstances and terms, we are required to
offer those royalty rates to Matsushita. Matsushita may terminate the agreement, which
remains in existence until the expiration of the patents it covers, unless terminated
earlier by Matsushita if it terminates the development of licensed products before
February 2010 or at any time after February 2010. To date, revenues from Matsushita have
not constituted a significant part of our total revenues.

| | NEC
Electronics Corp.
| | ---------------------

NEC
Electronics Corp. is a Japanese world-leading semiconductor manufacturer listed on the
Tokyo Stock Exchange. In September 2006, we signed a patent license agreement with NEC
Electronics Corp. to provide our patent for the usage in embedded flash memory products
that are manufactured at 90 nanometer process. The agreement shall remain in force until
March 2016 unless terminated earlier by NEC Electronics Corp. with notice of 90 days.
Under the agreement, we are entitled to license fees, prepaid royalties and ongoing
royalties. If we grant a license under our patents to the same category of NEC licensed
products in better terms, we are required to offer those favorable terms to NEC.

- 27 -

---

---

| | Semiconductor
Manufacturing International Corporation (SMIC)
| | ------------------------------------------------------------

SMIC
is one of the worlds leading semiconductor foundries, offering its customers
integrated circuit manufacturing service at the 0.35 micron to 90 nanometer and finer line
technologies. Established in 2000, SMIC has four 8-inch wafer fabrication facilities in
volume production in Beijing, Shanghai and Tianjin, China. In Beijing, the foundry also
has a 12-inch wafer facility in production since July 2004. According to IC Insights Inc.,
SMIC was ranked the fourth largest pure-play foundry in 2006.

In
July 2005, we granted SMIC a worldwide, non-exclusive license to manufacture and sell data
flash products incorporating our NROM technology. We also agreed to provide design,
development and support services to SMIC in connection with these products. We are
entitled to receive a license fee which is payable in installments on the earlier of the
achievement of technological milestones or specified dates. The license remains in
existence until the expiration of the patents it covers, unless terminated earlier by SMIC
upon three months notice or, prior to June 30, 2006, on 30 days prior notice. In addition
to a license fee, we are entitled to receive royalties based on SMICs net sales of
products incorporating our NROM technology.In November 2005, we signed an addendum
to the license agreement in which we agreed to license and provide certain card form
factor intellectual property. Additionally, SMIC agreed to pay us a percentage of the
profit calculated under the agreement and derived from the cards developed under the
addendum. In November 2006, we signed a statement of work whereby we will collaborate on
delivering an eight gigabit data flash based on our Quad NROM technology and designs using
SMICs advanced process technology.

| | Sony
Corporation
| | ----------------

Sony
Corporation is one of the worlds largest vendors of consumer electric and electronic
products, with revenues of approximately $63.9 billion for the fiscal year ended March 31,
2006. Sony Corporation has a broad portfolio of products including consumer electronics,
home entertainment hardware and software and image-based software. Sony Corporation is
also a supplier of semiconductors and, in 2006, according to iSuppli, the company ranked
as the worlds 15th largest semiconductor vendor with revenues of $4.8 billion from
semiconductor sales.

In
December 2004, we granted Sony Corporation a worldwide, non-exclusive license to
manufacture and sell embedded flash memory products incorporating our NROM technology in a
single manufacturing technology process. We also agreed to provide design, development and
support services to Sony Corporation in connection with these embedded flash memory
products. We are entitled to receive service fees and license fees, a portion of which
were paid on the signing of the agreement, and the remainder of which are payable in
installments on the earlier of the achievement of technological milestones or time-related
milestones. Sony Corporation is also required to pay royalties based on its quarterly net
sales of embedded products incorporating our technology. Sony Corporation may terminate
the license agreement after December 31, 2010.

| | Spansion
LLC
| | ------------

In
2006, Spansion was the 23rd largest semiconductor vendor globally according to iSuppli.
Spansion is the largest vendor of code flash memory devices with revenues of $2.6 billion
and a 33.6% market share in 2006 according to Web-Feet Research. The company is
primarily focused on solutions for wireless and embedded code flash memory solutions for
automotive, networking and consumer electronics. In 2006, we derived 28% of our revenues
from Spansion. Current MirrorBit products based on our NROM technology that are
commercially available range from 1 megabit to 1 gigabit in density on processes from 220
nanometer down to 90 nanometers. Additionally, Spansion has announced plans for products
based on 65 nanometer process geometry.

Spansion
also sells code flash products based on floating-gate technology; however, Spansions
MirrorBit sales, as a percentage of net sales, accounted for over 60% for the fourth
quarter of 2006.

In
2002, we granted Fujitsu Limited and Advanced Micro Devices, Inc. a worldwide,
non-exclusive license to patents that are filed before July 2012 covering our NROM
technology in their semiconductor products as part of a settlement in connection with an
intellectual property action we had commenced against them. The license, which terminates
in July 2012, includes implementations of our NROM technology in multi-level cell devices
and also applies to Spansion as a jointly-owned subsidiary of Fujitsu and Advanced Micro
Devices. The license contains a uniform royalty rate that is lower than the royalty rates
in some of our other license agreements and stepped thresholds that limit the amount from
which we can derive royalties to $1.2 billion of annual net sales of products by Spansion
incorporating our NROM technology.

- 28 -

---

---

In
2002, Spansion introduced its MirrorBit technology which incorporates our NROM technology
and during 2002 it started shipping MirrorBit code flash memory devices. Initial MirrorBit
devices were based on 220 nanometer process geometry for serial flash devices.

In
2003, we entered into a joint collaboration and distribution agreement with Spansion.
Under the agreement, we share equally with Spansion the profit from sales of serial flash
products based on our designs that Spansion manufactures for us, and Spansion shares with
us equally the profit from sales of serial flash products based on our designs that either
we manufacture at a third party foundry or that Spansion manufactures. The agreement is
for an initial term of five years and can be terminated by either party upon six
months notice, subject to a further two-year phase-out period. During 2005 and 2006,
we designed serial flash products ranging from 4 megabit to 64 megabit densities, which
Spansion is currently offering to the market. In addition, in 2006, we started to design a
128 megabit serial flash product.

In
July 2005, we entered into a license and development agreement with Spansion, pursuant to
which we will design, develop and license to Spansion certain four-bit-per-cell products
based on our Quad NROM. In August 2006, we updated the agreement, whereby we have agreed
to carry out a minimum amount of design projects. We have also formed a committee with
Spansion to oversee issues relating to the implementation of the design and development of
products under the agreement. We are entitled to receive royalty payments based on net
quarterly sales of products incorporating our Quad NROM technology. We have agreed that a
portion of these royalty payments may be offset against service fees paid under the
agreement. Royalties under this agreement are not subject to thresholds, as was the case
with royalties derived under the license we granted in 2002. In addition, a lower royalty
rate is applied in the event that Spansion independently designs and develops a
four-bit-per-cell product incorporating our technology.The agreement terminates on
December 31, 2010, and can be terminated by Spansion upon 90-days notice or by either
party upon a change in control of the other party.

| | Tower
Semiconductor Ltd.
| | ------------------------

Tower
Semiconductor is an independent Israeli wafer foundry. In 1997, we granted Tower
Semiconductor a license to incorporate our NROM technology into its non-volatile memory
products, other than EEPROM, data flash, multimedia cards and smart cards. In September
2006, we entered into a new agreement with Tower Semiconductor whereby we granted a
license of our NROM technology to Tower Semiconductor for the manufacture of embedded
flash and embedded EEPROM products. Tower Semiconductor is currently offering its
customers a wide variety of qualified NROM-based embedded-Flash modules under the
microFLASH® brand name. The microFLASH® embedded modules are manufactured on Tower
Semiconductor s 0.18 micron process in various densities and speeds and optimized
for integration into various embedded microcontroller applications, as well as wireless
connectivity, smart card and security applications. Under the terms of the new agreement,
Tower Semiconductor may also offer NROM-based embedded-flash modules on further advanced
process generations.

# Design and Product
Development Services

In
addition to initial support services to assist our licensees incorporate our NROM
technology into their products, we provide certain of our licensees with design and
product development services that we believe accelerate the adoption of our NROM
technology in a broader range of our licensees products and aid in our understanding
of their future requirements. Our design and product development services are focused on
our licensees leading products with a view to increasing our future royalty stream.
These services generally involve research and development, manufacturing process
development, product design, and product testing. We currently provide design and product
development services to Spansion, Sony and SMIC.

# Technology

| | Floating
Gate Devices
| | ---------------------

Non-volatile memory devices have
traditionally relied on floating gate technology. A floating gate memory cell contains an
electrically isolated gate, a floating gate, below the standard control gate and above the
transistor channel. The floating gate is composed of a conducting material, typically a
polysilicon layer. The floating gate memory device stores information by holding
electrical charge within the floating gate. Adding or removing charge from the floating
gate changes the threshold voltage of the cell, thereby defining whether the memory cell
is in a programmed or erased state.

- 29 -

---

---



Floating Gate Memory Cell

| | NROM
Devices
| | ------------

The
NROM cell comprises a nitride layer, surrounded by two insulating oxide layers. The
nitride layer serves as a trapping dielectric for two separate localized charge packets at
each end of the cell, effectively storing two bits. Each charge packet can be maintained
in one of two states, either programmed or erased, represented by
the presence or absence of a pocket of trapped electrons. This enables the storage of two
bits of information without the complexities associated with multi-level-cell technology.

The
following is a diagram of a cell based on our NROM technology:



The NROM Cell

Program
and erase.Each storage area in an NROM cell can be programmed or erased independently
of the other storage area. An NROM cell is programmed by applying a voltage that causes
negatively charged electrons to be injected into the nitride layer near one end of the
cell. Erasing is accomplished by applying to a cell voltages that cause positive charges,
referred to as holes  the electrical opposite of electrons  to be
injected into the nitride layer and cancel the effect of the electrons previously stored
there during programming. As a consequence of using a localized charge trapped in the
non-conducting nitride and reading the information in a direction opposite to the
direction it was programmed, a smaller total charge may be used to represent a bit.
Because a significantly smaller amount of trapped charges are needed to program a device,
and due to the physical mechanisms used for programming and erasing, the device can be
both programmed and erased faster than devices based on traditional floating gate
technology.

Because
the stored charge is confined close to the ends of an NROM cell device, numerous
program-erase cycles may be performed without significantly degrading the cells
performance, and the single bit failures that are common to floating gate technology may
be avoided even after 100,000 cycles. As a result, it is possible to achieve estimated
data retention of at least 10 years and, unlike floating gate cells, NROM cells are not
generally susceptible to oxide defects. In addition, the relatively thick oxide layers
surrounding the trapping layer of the NROM cell prevent the trapped charge from
leaking-out of the cell by a tunneling mechanism. This enhances the data retention ability
of NROM cells when compared to floating gate devices.

- 30 -

---

---

Array
architecture and operation.Our proprietary technology addresses architectural aspects
of the NROM array, such as segmentation of the array to handle disruption in its
operation, and symmetric architecture and non-symmetric architecture for specific
products, as well as the use of NROM array as a virtual ground array. We also hold patents
directed to additional aspects at the architecture level, including the peripheral
circuits that control the NROM array, for example, multiple select transistors per one bit
line to improve the functionality and operation of the array. We have also developed
methodologies directed to several key methods of operation of the NROM arrays, such as
algorithms related to programming, erasing, and reading NROM arrays. Our proprietary
processes include methods to control a programming level or to complete the programming of
a cell at the lowest drain level that we believe are generic to the NROM technology.
Further protection has been obtained for our method of erasing a memory cell by hitting it
with an extra pulse.

Process
technology.Features of our NROM technology include less cumbersome manufacturing
process technology that reduces costs and improves reliability, and array architecture
that increases density, shortens programming and improves read times without sacrificing
reliability. We have developed manufacturing processes, such as the process of forming a
thin nitride layer that traps the hot electrons as they are injected into the nitride
layer.

Application-specific
implementations of our technology.In addition to the above general methods of
operation, we have developed algorithms and methods of operation for each segment or
technological application, such as:

| |  | fast
programming methodologies in all flash memory segments, with particular focus on the data
flash segment;
| | - | -------------------------------------------------------------------------------------------------------------

| |  | smart
programming algorithms in our Quad NROM architecture, as well as in the code flash and
EEPROM              segments; and
| | - | ------------------------------------------------------------------------------------------------------------------------------

| |  | a
single device containing a combination of data flash, code flash and EEPROM.
| | - | ------------------------------------------------------------------------------

Multi-level
cell.We believe that our NROM technology is the best solution to high density,
four-bit-per-cell products because floating gate cells would be required to maintain as
many as 16 different charge levels per cell in order to emulate four bits. We also believe
that due to the different characteristics, structure, and physical mechanisms,
multi-level-cells based on our NROM technology, we can overcome many of the limitations of
floating gate multi-level-cell devices.

# Patents and Intellectual
Property

We
have developed a significant amount of proprietary technology, including intellectual
property relating to our NROM technology and related processes. We rely on a combination
of patent, trade secret, copyright and trademark laws and restrictions on disclosure to
protect our intellectual property rights. An important part of our technology development
strategy is to seek protection for our proprietary technology by obtaining patents in the
United States and elsewhere. The semiconductor industry is characterized by vigorous
protection and pursuit of intellectual property rights. We have in the past and intend in
the future to continue to prosecute and defend aggressively the rights in our intellectual
property.

In
1998, the first patent related to our NROM technology, naming Dr. Boaz Eitan as the
inventor, was issued and was assigned to Saifun. As of December 31, 2006, we owned more
than 80 issued U.S. patents, including 11 co-owned patents, none of which expire before
2016, and 18 non-U.S. patents. As of December 31, 2006, we had more than 70 pending U.S.
patent applications and more than 120 pending non-U.S. patent applications. These patents
and patent applications protect a variety of key aspects of our NROM technology. Many of
our patents protect subject matter used to practice our technology in any market segment,
including code flash, data flash, embedded flash and EEPROM segments.

We
operate an internal program to identify patentable developments and to document other
technological developments that may be subject to intellectual property protection,
including trade secrets. Our policy is to require employees and consultants to execute
confidentiality agreements when their relationship with us begins. We also seek these
protective agreements from licensees.

We
have obtained U.S. trademark registration for Saifun NROM, a term that we use
to identify our technology, and for the name Saifun. We have obtained an
Israel trademark and have a U.S. trademark pending for Saifun Quad NROM.

- 31 -

---

---

# Government Regulation

The Office of the
Chief Scientist of the Israeli Ministry of Industry, Trade and Labor

In
2006, the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and
Labor approved a government grant for research and development expenditures in connection
with our controller card activity project in the amount of up to $470,000. We will be
required to pay royalties to the Chief Scientist of between 3% and 6% of revenues derived
from technology developed using these grants until 100% of the grants are repaid, together
with an annual interest as set forth in the research and development regulations
(currently equal to the 12 month London Interbank Offered Rate). As a result, our business
is subject to various restrictions imposed by the terms of the grant. The terms of the
grants prohibit recipients from manufacturing products developed using these grants
outside of Israel without special approvals. Even if we receive approval to manufacture
the products developed with government grants outside of Israel, we will be required to
pay an increased total amount of royalties (possibly up to 300% of the grant amount plus
interest), depending on the manufacturing volume that is performed outside of Israel, as
well as a possible increased royalty rates. Additionally, under the law governing the
research grants, we will be prohibited from transferring the financed technologies and
related intellectual property rights outside of Israel except under limited circumstances
and provided the transfer is approved by the Research Committee of the Office of the Chief
Scientist. Approval of the transfer of technology to residents of Israel is also required,
and may be granted in specific circumstances only if the recipient abides by the
provisions of applicable laws, including the restrictions on the transfer of know-how and
the obligation to pay royalties in an amount that may be increased. Such restrictions may
impair our ability to outsource manufacturing, engage in change-of-control transactions or
otherwise transfer our technology developed with government grants outside Israel.

Further,
if we fail to comply with any of the conditions imposed by the Office of the Chief
Scientist, we may be required to refund any grants received together with interest and
penalties, and may be subject to criminal charges. In recent years, the government of
Israel has accelerated the rate of repayment of Chief Scientist grants and may further
accelerate them in the future. In addition, the Israeli government has, from time to time,
discussed reducing or eliminating the availability of these grants. There can be no
assurance that the Israeli governments support of such grants will continue.

# Competition

The
code and data flash memory markets are dominated by a small number of large semiconductor
manufacturers. As a licensor of code and data flash memory technology, we compete
primarily with the technologies developed by these companies, principally from their
internal research and development departments. Many of these companies consider flash
memory research and development to be one of their core competencies. To date, the
technology with which we compete is traditional floating gate technology based on
single-bit-per-cell or multi-level-cell devices.

In
the code flash memory market, the leading manufacturers are Spansion, Intel Corporation,
STMicroelectronics and Silicon Storage Technology (SST) Inc. and are expected to
collectively account for 80.7% of global code flash revenues in 2006. In the data flash
memory market, the leading manufacturers include Samsung Electronics Co. Ltd., Toshiba
Corporation, Hynix Semiconductor and SanDisk Corporation and, according to Web-Feet
Research, are expected to collectively account for 88.2% of global flash revenues in 2006.
Intel, Samsung, Toshiba, STMicroelectronics and SanDisk (through its joint venture with
Toshiba) market floating gate devices incorporating multi-level-cell technology.

In
the embedded flash memory market, we compete directly with the technology of application
companies that manufacture embedded products, as well as with a number of other companies
that offer a licenses to their intellectual property, principally Silicon Storage
Technologies, Inc.

# Sales and Marketing

Our
sales and marketing activities in connection with our licensing agreements focus primarily
on developing strong, direct relationships at the technical, marketing and executive
management levels with existing licensees. Additionally, our sales and marketing team is
actively pursuing semiconductor companies as new licensees. As of December 31,
2006, our sales and marketing staff consisted of nine employees.

- 32 -

---

---

# C. ORGANIZATIONAL
STRUCTURE

Saifun
Semiconductors Ltd. is organized under the laws of the State of Israel and, as of December
31, 2006, held directly and indirectly the percentage indicated of the outstanding capital
stock of the following subsidiaries:

|Name of Subsidiary                       | Country of Incorporation | Percentage Ownership
|---------------------------------------- | ------------------------ | --------------------
|
|
|
|
|Saifun Semiconductors USA, Inc.          |                          |                     
|Saifun (BVI) Limited                     |                          |                     
|Tulip Semiconductor L.P.                 |                          |                     
|Tulip Semiconductor Holdings (2005) Ltd. |                          |                     
|Tulip Semiconductor Ltd.                 |                          |                     

# D. PROPERTY, PLANTS AND
EQUIPMENT

We
have recently entered into a new lease agreement for a new facility for our principal
administrative, sales, marketing and research and development activities, which expires in
2012. We moved our entire Israeli activity in March 2007 to one facility occupying
approximately 64,585 square feet. Our previous lease of approximately 26,395 square feet
in one building in Netanya, Israel, expired upon our transfer to the new facility.
However, we still lease an additional 4,240 square feet in the building that was occupied
by our previous facility pursuant to a lease that expires in September 2009. We also lease
an additional 3,057 square feet in the same building pursuant to a lease that expires in
September 2010 and an additional 5,005 square feet in the same building pursuant to a
lease that expires in November 2010. We are currently sub-leasing these additional leases
to third party sub-lessees. In addition, our U.S. subsidiary occupies approximately 1,953
square feet in one building in Santa Clara, California under a lease that expires in
January 2010. We believe that our existing and new facilities will be adequate to meet our
needs for the next 12 months.

|ITEM 4A. | UNRESOLVED
STAFF COMMENTS
|-------- | -------------------------

Not applicable.

|ITEM 5. | OPERATING
AND FINANCIAL REVIEW AND PROSPECTS
|------- | --------------------------------------------

# A. OPERATING RESULTS

# Overview

We
have invented and patented a technology that we refer to as nitride-read-only memory, or
NROM, that we believe is leading a revolutionary shift in the non-volatile semiconductor
memory market.

We
were incorporated in Israel in November 1996 and commenced operations in July 1997. In
1997, we entered into a license agreement with Tower Semiconductor for the implementation
of our technology. In 1999, we generated initial fees from Advanced Micro Devices and
Fujitsu. In 2000, we entered into a license agreement with Macronix. We entered into a
license agreement with Spansion in 2002 and with Matsushita in 2003. In December 2004, we
entered into a license and service agreement with Sony Corporation. In July 2005, we
entered into a license agreement with Semiconductor Manufacturing International
Corporation (SMIC) and in September 2005 we entered into a service agreement with them.
Our initial public offering and listing on The Nasdaq Stock Market occurred in November
2005 and we completed a secondary offering of our shares on The Nasdaq Stock Market in
April 2006. In 2006, we amended or extended our existing agreements with several licensees, including Macronix, SMIC, Matsushita, Spansion and Tower Semiconductor. In
September 2006, we entered into a new license agreement with NEC Electronics. In October
2006, Qimonda AG, a majority-owned subsidiary of Infineon Technologies and the assignee of
our license with Infineon Technologies, informed us of its decision to phase-out its
current NROM-related activity.

We
generate revenues from two sources:

| |  | license
and royalties revenues, which consist of license fees for our intellectual property and
license royalties paid by licensees that sell products incorporating our intellectual
property; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | service
revenues, from design and product development services that we provide to our licensees.
| | - | ------------------------------------------------------------------------------------------------

- 33 -

---

---

To
date, we have derived most of our revenues from license and royalties revenues. Our
remaining revenues have derived from design and product development services provided to
our licensees.

As
of December 31, 2006, our license agreements contained contractual commitments for license
fees payable to us before December 31, 2008 totaling approximately $15 million, the
substantial majority of which we expect to recognize prior to December 31, 2008. The
majority of this amount is payable by SMIC. Substantially all of these fees are subject to
cancellation in the event of early termination of our license agreements.

# Key Factors Affecting
our Performance

Our
business, financial position and results of operations are significantly affected by a
number of factors, some of which are outside of our control. The following factors also
affect our business prospects:

| | Addition
and loss of licensees
| | ------------------------------

The
code and data flash memory segments are each dominated by a small number of large
manufacturers. Due to the concentrated nature of such segments, we believe that the
addition or loss of any single licensee could significantly impact the penetration of our
NROM technology and accordingly, would affect any future source of license and royalties,
and service revenues. As such, the addition of any single new licensee could significantly
increase our expected revenues, while the loss of any single customer, as in the case of
Qimonda AGs phase-out of our NROM technology, would cause our revenues to fall below
our expectations. We intend to continue licensing our NROM technology to market leaders,
and we expect that a significant portion of our revenues will continue to be concentrated
among a small number of licensees.

To date, we have derived the majority
of our revenues from a small number of licensees:

|                                          | Year ended
|----------------------------------------- | ----------
|
|
|
|
|Infineon Technologies AG/Qimonda AG(1)    |           
|Macronix International Co., Ltd.          |           
|Spansion LLC                              |           
|Semiconductor Manufacturing International |           
|Corporation                               |           

---

|(*) | Less
than 10% of revenues
|--- | -------------------------

|(1) | Includes
revenues from Infineon Technologies Flash Israel, the Israeli entity in
               our former joint venture which we exited in December 2004.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | Timing
of implementation of technology by licensees
| | ---------------------------------------------------

Our
revenues are affected by the ability of our licensees to implement our NROM technology in
a timely manner. Under our license agreements, we are typically paid an upfront license
fee and then periodic license fees. Periodic license fees are generally payable upon
achieving the earlier of technological or time-based milestones, or a combination of the
two.

The
timing of implementation of our NROM technology by licensees also impacts the commencement
of recurring royalties. We are generally entitled to receive royalties from our licensees
based on their net sales of products incorporating our NROM technology. As such, our
ability to derive substantial revenues from recurring royalties is dependent upon the
success of our licensees in meeting technological milestones, implementing our technology
and commencing sales of their products that incorporate such technology. Certain of our
license agreements contain provisions for prepaid royalty payments irrespective of sales
by our licensees, which are recognized by us as license fees revenues. In such cases,
until the entire prepaid royalty amounts are offset, we earn lower recurring royalty
revenues than we would have recognized without such an offset.

- 34 -

---

---

| | Mix
of license and royalties and service revenues
| | -------------------------------------------------

The
following table sets forth information for the periods presented regarding the percentage
of our revenues derived from license and royalties revenues and service revenues. The
table does not include revenues from product sales during the periods indicated since we
decided to discontinue product sales in the second quarter of 2005 and our product sales
operations are accounted for in our financial statements as discontinued operations:

|                               | Year Ended
|------------------------------ | ----------
|
|
|
|
|License and royalties revenues |           
|Service revenues               |           

Excluding
$19.2 million in non-cash license revenues in 2005 resulting from the termination of our
former joint venture, license and royalties revenues represented 78% of our total revenues
and service revenues represented 22% of our total revenues.

We
expect that the proportion of our revenues derived from license fees will decrease
relative to license royalties as our existing licensees start production of products
incorporating our intellectual property and, where applicable, start to exceed minimum
royalty thresholds and/or prepaid royalty payments.

| | Historical
impact of joint venture with Infineon Technologies
| | -------------------------------------------------------------

Our
historical results of operations have been materially impacted by the results of
operations of our joint venture with Infineon Technologies, which we exited in December
2004. We accounted for the results of operations of the joint venture under the equity
method and therefore our net loss for the periods during which we held an equity interest
included our percentage share of the net loss of the joint venture. Our percentage share
of the equity of the joint venture was 49.0% from April 2001 through January 2003 and
30.0% until the sale of our interest in the joint venture on December 23, 2004. In
addition, pursuant to a research and development services agreement entered into in March
2003, Infineon Technologies Flash Israel provided services to Infineon Technologies Flash
Germany in connection with the design, development, testing and manufacture of data flash
and code flash memory devices. Infineon Technologies Flash Israel was reimbursed for its
direct and indirect costs and an agreed margin was applied.

We
believe that the fees paid to Infineon Technologies Flash Israel reflect the fees that
would have been paid in a comparable arms length transaction. For the year ended
December 31, 2003, Infineon Technologies Flash Israel derived all of its revenues,
totaling $11.4 million, from Infineon Technologies Flash Germany in respect of these
services. Pursuant to an agreement between Infineon Technologies Flash Israel and us, from
time to time Infineon Technologies Flash Israel was entitled to request that we provide
design and product development services to it in respect of certain projects that it was
undertaking for Infineon Technologies Flash Germany. Revenues from Infineon Technologies
Flash Israel for design and product development services accounted for $7.3 million, or
24%, of our licensing and service revenues in 2004. In 2005, we ceased to derive revenues
from Infineon Technologies Flash Israel and derived all of our revenues from Infineon
Technologies Flash Germany. Our fees for these services were based on a fixed hourly rate
per employee agreed by the parties that was subject to periodic updates. Infineon
Technologies Flash Israel was not obligated to engage us to provide these services and we
believe that our fees reflect the fees that would have been paid in a comparable
arms length transaction.

| | Financial
Operations
| | --------------------

| | Revenues
| | --------

| | License
and royalties revenues
| | ------------------------------

License
fees.Under our license agreements, we are typically paid an upfront license fee and
then periodic license fees. Periodic license fees are generally payable upon achieving
technological or time-based milestones, or a combination of the two. As part of our
licensing arrangements, in some cases, we provide a limited amount of initial customer
support to our licensees to assist them in incorporating our intellectual property into
their products until commercialization of their products.

- 35 -

---

---

Where
we are entitled to receive prepaid royalty payments irrespective of the amount of sales by
our licensees, we consider the prepaid royalty payments to be a component of the license
fee. We recognize license fees ratably over the period during which we expect to provide
initial customer support to our licensees and when all other criteria for revenue
recognition are met. When we do not provide initial customer support to a licensee, we
recognize license fees upon delivery, provided no extended payment terms exist. In
addition, revenue recognition is limited to the amount that is due or billable under the
agreement when extended payment terms exist. Since the initial customer support is
typically provided until the expected commercialization date of the licensees
products, we determine the period in which we will provide support based on estimates of
our project managers determined in conjunction with our licensees, as well as the
monitoring of the progression of our licensees product development through the
customer support we provide them. Our licensees are all well-established semiconductor
manufacturers with significant experience in the design, development and commercialization
of products in the semiconductor memory market. Since we typically determine projections
based on our licensees estimates and our own experience, we believe these estimates
are reliable. The estimate of the initial support period could change due to unexpected
delays or progress by our licensees in the development and design of the products
incorporating our NROM technology. We review assumptions regarding the initial customer
support periods on a regular basis to determine if it is necessary to revise the estimate
of the support period. The total amount of revenues recognized over the life of the
contract would not be affected in the event of revision in the length of the support
period; however, to the extent the new assumptions regarding support periods were less
than the original assumptions, the license fees would be recognized ratably over a shorter
period. Conversely, if the new estimated period were longer than the original assumptions,
the license fees would be recognized ratably over a longer period.

License
royalties.The royalty rate and structure of royalty payments vary
significantly among our license agreements. Royalties under some of our license agreements
are based on a fixed royalty rate, while for others the royalty rate declines as net sales
of products incorporating our NROM technology increase. In addition, the royalty rates
under our license agreements vary, among other things, depending on which segment or
segments of the non-volatile memory market the agreement addresses. Where an agreement
provides for a prepaid royalty payment, the amounts of prepaid royalties paid are deducted
from ongoing royalties payable by the licensee in the future. Generally, we expect to
recognize royalties one quarter in arrears based on reports that we receive from a
licensee in that quarter. In the case of Infineon Technologies Flash, prior to the sale of
our interest in the joint venture, we recognized the royalties in the quarter in which the
related sales took place due to the earlier receipt of the royalty report. Following our
exit from our joint venture, we recognize royalties in the quarter subsequent to the
quarter in which the related sales took place. We expect that the proportion of our
revenues derived from license fees will decrease relative to license royalties as our
existing licensees move into production of products incorporating our intellectual
property and, where applicable, start to exceed minimum royalty thresholds and prepaid
royalty payments. We intend, however, to seek new licensees for our intellectual
property that would result in the payment of additional license fees in the future.

Our
first license agreement with Spansion contains a uniform royalty rate that is lower than
the royalty rates in some of our other license agreements and stepped thresholds that
ultimately limit to $1.2 billion the amount of annual net sales of products incorporating
our NROM technology by Spansion from which we can derive royalties. In July 2005, we
entered into a multi-bit per cell license and development agreement with Spansion,
pursuant to which we will develop and license certain multi-level cell products to
Spansion. Under the new agreement with Spansion, we are entitled to receive payments for
design and product development services, as well as royalty payments that are not subject
to the above annual threshold.

| | Service
revenues
| | ----------------

We
derive service revenues for design and product development services that we provide to our
licensees. The majority of our service revenues for the periods presented in the financial
statements were derived from arrangements with Infineon Technologies Flash where the fee
was based on a fixed price per employee providing the respective service. In October 2006,
Qimonda AG, a majority-owned subsidiary of Infineon Technologies, and the assignee of our
license with Infineon Technologies, informed us of its decision to phase-out its
NROM-based activities and to continue to license the NROM technology under an amended
license agreement. As a result of this decision, we have not received any license or
services fees from Qimonda after 2006. In the future, we expect to receive only very
limited royalties from Qimonda AG with respect to previously developed NROM products. For
a description of our former arrangements with Infineon Technologies Flash Israel, see
Exit from Joint Venture with Infineon Technologies.

- 36 -

---

---

In
fixed fee service contracts, revenues are recognized based on the proportional performance
model and completion is measured according to the costs of employee services rendered as a
percentage of total project costs. However, revenue recognition based on this methodology
is always limited to output measures (technological milestones) , when applicable, or
amounts due or billable under the agreement.

| | Geographical
breakdown
| | ----------------------

Because
to date we have derived our revenues from a limited number of customers, the geographical
breakdown of our revenues is solely a function of the location of these customers. The
following table sets forth the geographic breakdown of our licensing and service revenues
for the periods indicated:

|              | Year Ended
|------------- | ----------
|
|
|
|
|Germany       |           
|Taiwan        |           
|United States |           
|Japan         |           
|Israel        |           
|China         |           

---

| | (1) | Consists
primarily of revenues from design and product development services
               provided to the Israeli entity in our former joint venture, Infineon
               Technologies Flash Israel, which we exited in December 2004.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Less
than 10%
| | --- | -------------

The
foregoing table does not include revenues from product sales during the periods indicated
since we decided to discontinue product sales in the second quarter of 2005. Our product
sales operations are accounted for in our financial statements as discontinued operations.

| | Cost
of revenues
| | ----------------

Licenses
and royalties.The direct cost associated with our licenses and royalties revenues is
insignificant.

Services.Cost of service revenues consists primarily of costs associated with
          providing design and product development services, principally salaries and
          related personnel costs, and software, as well as depreciation of equipment,
          software and laboratory facilities. We account for the salaries and related
          personnel costs of research and development personnel as cost of revenues when
          those personnel undertake design and product development services for a
          licensee. The determination in advance of the costs of fulfilling a fixed fee
          service contract is based on our estimates. In 2006, we had higher overall
          service margins compared to prior years mainly due to service revenues in the
          amount of $3.2 million for which the cost of revenues was recorded in the
          previous year.

| | Operating
expenses
| | ------------------

We
expect that our research and development, net, marketing and selling, and general and
administrative expenses will continue to represent a significant percentage of our
revenues. We intend to fund these expenditures through our cash flow from operations, and
our existing cash balances. Whether such expenses increase or decrease as a percentage of
revenues will be substantially dependent upon the rate at which our revenues change. Our
incurrence of research and development expenses during each quarter is generally unrelated
to the timing of our recognition of revenues under our license agreements because the
intellectual property generating license revenues has a long development cycle. Our
general and administrative expenses are unrelated to our current revenues.

Research
and development, net.Our research and development expenses consist primarily of costs
associated with the design, development, pre-manufacture and testing of, and enhancements
to, our technology. These costs consist of salaries and related personnel costs and
consist also of wafer costs and engineering expenses associated with the introduction of
our products, lease costs, subcontractor/outsourced engineering services and software and
depreciation of laboratory equipment. We expense all of our research and development costs
as they are incurred. We view the total amounts we spend on research and development,
together with our cost of service revenues, as providing a more complete picture of our
overall research and development activities because our research and development
activities directly benefit from the design and product development services that we
provide to licensees.

- 37 -

---

---

Marketing
and selling.Our marketing and selling expenses consist of activities related to our
licensing activities. These costs consisted primarily of salaries, travel and related
costs for our licensing sales staff, commissions to representatives, and promotional and
public relations activities. We plan to continue our marketing and selling activities for
our licensing and services business and expect to incur additional marketing expenses.

General
and administrative.Our general and administrative expenses consist primarily of
salaries and related costs for our administrative staff and legal, accounting, insurance
and consulting expenses. We do not expect our general and administrative expenses to
increase materially in the foreseeable future, unless we incur unforeseen legal expenses.

Financial
income, net.Financial income consists primarily of interest earned on our cash
balances and other financial investments, interest we received on loans made to Infineon
Technologies Flash prior to December 2004, interest accrued on loans made to employees,
foreign currency exchange gains. Financing expenses consist primarily of bank fees,
foreign currency exchange losses.

Equity
in losses of equity method investees.Equity in losses of equity method investees
consists of the losses attributable to the equity interest that we held until December
2004 in Infineon Technologies Flash, our former joint venture with Infineon Technologies.

| | Discontinued
Operations
| | -----------------------

We
decided to discontinue our product sales activities in the second quarter of 2005. We
account for product sales as discontinued operations in accordance with Financial
Accounting Standards Board (FASB) Statement No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. Accordingly, our results of operations for product
sales activities were reported as a separate line item entitled Loss from
discontinued operations in our statement of operations, and financial information
for prior years has been reclassified.

The
results of the operations of the product business included in discontinued operations are
summarized as follows:

|                                      | December 26,
2004 | December 31,
2005
|------------------------------------- | ----------------- | -----------------
|
|
|
|
|Revenues                              |                   |                  
|Cost of revenues                      |                   |                  
|                                      |                   |                  
|Gross loss                            |                   |                  
|Research and development              |                   |                  
|Marketing and selling                 |                   |                  
|General and administrative            |                   |                  
|                                      |                   |                  
|Net loss from discontinued operations |                   |                  
|                                      |                   |                  

- 38 -

---

---

| | Taxation
| | --------

Israeli
companies are subject to income tax at the corporate tax rate of 31% for the 2006 tax
year, 29% for the 2007 tax year, 27% for the 2008 tax year, 26% for the 2009 tax year and
25% for the 2010 tax year and thereafter. In addition, our investment program in equipment
and software at our facilities in Netanya, Israel has been granted Approved Enterprise
status under the Law for the Encouragement of Capital Investments, 1959, referred to as
the Investments Law and, therefore, we are eligible for tax benefits described later in
this section in  Corporate Tax. These benefits should result in income
recognized by us from our licensing and services activities being tax exempt for a
specified period after we exhaust any net operating loss carryforwards and begin to report
taxable income. In April 2005, a comprehensive amendment to the Investments Law came into
effect. Since the amended Investments Law does not apply retroactively to investment
programs having an approved enterprise approval certificate issued by the Israeli
Investment Center prior to December 31, 2004, part of our future tax benefits are subject
to the provisions of the Investments Law prior to its revision, while new benefits that
will be received in the future, if any, will be subject to the provisions of the
Investments Law, as amended. We have received approval from the Office of the Chief
Scientist of Israel to allow a tax deduction for part of our research and development
expenses incurred during the years, 2003 and 2004. The unapproved research and development
expenses are deducted over a three-year period in accordance with and subject to Israeli
tax law. We intend to continue applying to the Office of the Chief Scientist of Israel in
order to receive an approval to allow a tax deduction for our research and development
expenses.

In
order to manage certain investments, we have established a wholly owned subsidiary, Saifun
(BVI) Limited, a company incorporated under the laws of the British Virgin Islands. Under
our approved enterprise status, we are not entitled to receive any tax benefits from any
income derived from investments made through Saifun (BVI) Limited. The taxable income will
be subject to Israeli income tax, which will be considered a deemed dividend
and taxed at a 25% tax rate.

# Exit from Joint Venture
with Infineon Technologies

In
December 2004, we sold our interest in our joint venture to Infineon Technologies. The
joint venture consisted of a German partnership, Infineon Technologies Flash GmbH &
Co. KG, which we refer to as Infineon Technologies Flash Germany, and an Israeli entity,
Infineon Technologies Flash Ltd., which we refer to as Infineon Technologies Flash Israel,
and, together, Infineon Technologies Flash. We also entered into an amended license
agreement with Infineon Technologies and a basic agreement on development orders, pursuant
to which we may provide development services based on a fixed fee per employee. As part of
the transfer of the memory products business of Infineon Technologies to Qimonda AG, a
majority-owned subsidiary of Infineon Technologies, our agreements with Infineon
Technologies were assigned to Qimonda AG in May 2006. In October 2006, Qimonda AG informed
Saifun of its decision to phase-out its NROM-related activity.

From
the establishment of the joint venture in April 2001 until the termination, we invested an
aggregate of $18.6 million in the equity of the joint venture and made loans of $24.4
million, including a loan of $6.3 million to finance, in part, the purchase by Infineon
Technologies Flash Israel of 1,072,407 of our ordinary shares intended to be used by it
for an equity incentive plan for its employees. Our interest in the joint venture was
initially 49.0% and was reduced to 30.0% in January 2003 by means of an additional
investment of $21.3 million from Infineon Technologies. At the time that the joint venture
was ready to commence mass production of its first product, we and Infineon Technologies
decided to terminate the joint venture so that we could focus on our core business model
of licensing and providing design and development services to semiconductor manufacturers.
In furtherance of this strategy, at the time of the termination, the parties agreed to
enter into an amended license agreement directly with Infineon Technologies and a basic
agreement on development orders in order to provide design and development services to
Infineon Technologies in connection with that license agreement.

As
a result of the termination, we (1) sold our equity interest in Infineon Technologies
Flash Germany and Infineon Technologies Flash Israel to Infineon Technologies for an
aggregate cash payment of $1.0 million, (2) assigned our right to Infineon Technologies to
receive repayment of a $6.3 million loan that we had made to the joint venture, (3)
cancelled our right to receive the approximately $18.1 million of remaining indebtedness,
and (4) offered employment to certain Infineon Technologies Flash Israel employees and
undertook certain liabilities related to those employees. In addition, Infineon
Technologies Israel transferred 1,072,407 of our ordinary shares that it owned to Infineon
Technologies which sold these shares in February 2005 to Argos Capital Appreciation Master
Fund L.P. We do not have any further funding or guaranty obligations in connection with
the former joint venture, although we have agreed to assume 30% of any unforeseen
liabilities that may arise in connection with the dissolution of Infineon Technologies
Flash Israel.

Since
the termination agreement, the license agreement and the basic agreement on development
orders were signed in contemplation of one another, for accounting purposes, the total net
consideration derived from these agreements was allocated to the proceeds from the sale of
our interest in Infineon Technologies Flash, the development services and the license.
Since the fair value of the joint venture was more reliably measurable, we performed a
valuation of the joint venture and allocated the consideration based on the fair value
determined. Accordingly, the residual amount of the consideration from the agreements was
allocated to the license, resulting in non-cash license revenues in the amount of $19.2
million, all of which was recognized in 2005. The fair value of our interest in the joint
venture was determined to be zero, after forgiveness of loans and future capital
commitments by us and Infineon Technologies, based on a valuation prepared using the
adjusted book value method. The capital loss on the sale of the joint venture was
determined based on the difference between our investment in the joint venture and its
fair value.

- 39 -

---

---

# Results of Operations

| | Year
Ended December 31, 2006 compared to Year Ended December 31, 2005
| | ---------------------------------------------------------------------

| | Revenues
| | --------

Licenses
and royalties.Licenses and royalties revenues decreased by $24.8 million, or 38%, to
$41.0 million in 2006 from $65.8 million in 2005. The substantial majority of this
decrease resulted from a decrease of $19.2 million of non-cash license revenues from
Qimonda AG resulting from the sale of our interest in our former joint venture. The
remainder of the decrease was attributable principally to a decrease in license revenues
mainly from Macronix. The decrease in licensee fees revenues was partially offset by an
increase in royalty revenues mainly from Spansion and Macronix. The proportion of our
revenues derived from license fees decreased relative to royalties derived from license
royalties as our existing licensees started to exceed minimum royalty thresholds and
prepaid royalty payments.

Services.Service revenues increased by $9.0 million, or 70%, to $21.8 million in 2006
          from $12.8 million in 2005. This increase resulted principally from service
          revenues from Spansion, SMIC and Qimonda AG.

| | Cost
of revenues
| | ----------------

Services.
          Cost of services increased by $2.9 million, or 23%, to $14.9 million in 2006
          from $12.0 million in 2005. This increase resulted from an increase in service
          revenues. The increase in cost of services is not proportional to the increase
          in service revenues due to service revenues recognized in 2006 in the amount of
          $ 3.2 million for which cost of service revenues was recorded in the previous
          year.

| | Operating
expenses
| | ------------------

Research
and development, net.Research and development expenses, net increased by $5.4
million, or 73%, to $12.8 million in 2006 from $7.4 million in 2005. Research and
development expenses, net, together with cost of services revenues, increased by $8.2
million, or 42%, to $27.7 million in 2006 from $19.5 million in 2005. This increase was
primarily due to increased salary and related expenses, as well as increased
subcontractors expenses and an increase of $1.6 million in stock-based compensation
expense. The increase in stock-based compensation expenses resulted from an increase in
the average fair value of options granted during the year. Research and development
expenses, net together with cost of services revenues as a percentage of revenues
increased from 25% (or 33%, excluding the non-cash component of revenues in 2005,
resulting from the sale of our interest in our former joint venture) in 2005 to 44% in
2006.

Marketing
and selling.Marketing and selling expenses decreased by $2.0 million, or 40%, to $2.9
million in 2006 from $4.9 million in 2005. This decrease was mainly due to a decrease of
$1.3 million in expenses to Tower Semiconductor, which represented a percentage of part of
our license and royalties revenues from certain third party licensees. The decrease was
also a result of a decrease of $0.3 million in expenses representing withholding tax
deductions on licensing fees, which were expensed in 2005. Marketing and selling expenses
as a percentage of revenues decreased from 6% (or 8%, excluding the non-cash component of
revenues in 2005 resulting from the sale of our interest in our former joint venture) in
2005 to 5% in 2006.

General
and administrative.General and administrative expenses decreased by $0.2 million, or
3%, to $6.0 million in 2006 from $6.2 million in 2005. This decrease resulted primarily
from a decrease of $0.9 million in stock-based compensation expense, as well as a decrease
of $0.8 million in expenses related to a legal claim provision. The decrease in
stock-based compensation expense was primarily due to the exercise of the majority of the
SARPs in 2006, which had no material effect in 2006. This decrease was offset by an
increase of $0.6 million in legal and patent expenses, an increase of $0.4 in insurance
expenses and an increase of $0.3 million in consulting expenses. Since November 2005,
these expenses increased mainly as a result of our listing on a public exchange. General
and administrative expenses as a percentage of revenues increased from 8% (or 10%,
excluding the non-cash component of revenues in 2005 resulting from the sale of our
interest in our former joint venture) in 2005 to 10% in 2006.

- 40 -

---

---

| | Financial
income, net
| | ---------------------

Financial
income, net increased by $8.1 million, or 459%, to $9.8 million in 2006 from $1.7 million
in 2005. The increase resulted from an increase in interest income on cash equivalents,
short term investment and marketable securities and amortization of premium and accretion
of discount on marketable securities. This increase is due to the increase in 2006 of the
average balance of cash equivalents, short term investment and marketable securities
compared to 2005.

| | Year
Ended December 31, 2005 compared to Year Ended December 26, 2004
| | ---------------------------------------------------------------------

| | Revenues
| | --------

Licenses
and royalties.Licenses and royalties revenues increased by $43.2 million, or 191%, to
$65.8 million in 2005 from $22.6 million in 2004. The substantial majority of this
increase resulted from an increase in license revenues from Infineon Technologies
resulting from our amended license agreement that we entered into upon the sale of our
interest in our former joint venture. License revenues in 2005 include $19.2 million of
non-cash license fees recognized in connection with the sale of our interest in our former
joint venture. The remainder of the increase was attributable principally to additional
license revenues from Macronix and Matsushita as a result of achieving contractual
milestones.

Services.Service revenues increased by $4.9 million, or 62%, to $12.8 million in 2005
          from $7.9 million in 2004. This increase resulted principally from service
          revenues from Sony, Spansion and SMIC. The remainder of the increase was
          attributable to an increase of $0.9 million in service revenues from Infineon
          Technologies.

| | Cost
of revenues
| | ----------------

Services.Cost of services increased by $5.0 million, or 70%, to $12.0 million in 2005
          from $7.1 million in 2004. Substantially all of this increase resulted from
          increased service revenues during the same period and from cost of services of
          $1.4 million performed for a licensee pursuant to which no revenues were
          recognized in this period.

| | Operating
expenses
| | ------------------

Research
and development, net.Research and development, net expenses increased by $0.6
million, or 9%, to $7.4 million in 2005 from $6.8 million in 2004. Research and
development, net expenses, together with cost of service revenues, increased by $5.6
million, or 40%, to $19.5 million in 2005 from $13.9 million in 2004. This increase was
primarily due to an increase in the number of research and development personnel, as well
as an increase of $0.8 million in stock-based compensation expense. Research and
development, net expenses together with cost of services revenues as a percentage of
revenues decreased from 45% in 2004 to 25% in 2005. Excluding the non-cash component of
revenues resulting from the sale of our interest in our former joint venture, research and
development, net expenses together with cost of services revenues as a percentage of
revenues were 33% in 2005.

Marketing
and selling.Marketing and selling expenses increased by $2.0 million, or 68%, to $4.9
million in 2005 from $2.9 million in 2004. This increase was due to an increase of $0.8
million in salary and related expenses mainly due to an increase in business development
and marketing personnel as well as due to an increase of $0.8 million in marketing
commission expenses, and an increase of $0.6 million in stock-based compensation expense.
The increase was partially offset by a decrease of $0.5 million in expenses representing
withholding tax deductions on licensing fees, which have been expensed. Marketing and
selling expenses as a percentage of revenues decreased from 10% in 2004 to 6% in 2005.
Excluding the non-cash component of revenues resulting from the sale of our interest in
our former joint venture, marketing and selling expenses as a percentage of revenues were
8% in 2005.

- 41 -

---

---

General
and administrative.General and administrative expenses increased by $4.1 million, or
194%, to $6.2 million in 2005 from $2.1 million in 2004. This increase resulted primarily
from an increase of $2.3 million in stock-based compensation expense, an increase of $0.5
million in salary and related expenses mainly due to an increase in administrative
personnel due to the expansion of our operations, as well as an increase of $0.8 million
in a provision recorded in respect of a legal claim. The increase in stock-based
compensation expense was primarily due to the increase in the weighted average fair value
of options granted from $4.47 in 2004 to $8.23 in 2005, mainly because, as of June 2004,
we stopped applying the minimum value method as prescribed by SFAS No. 123 for private
companies in calculating the fair value of options granted and started using the
volatility of comparable publicly traded companies for options granted after June 2004, as
well as an appreciation of the SAR liability in the amount of $1.1 million. General and
administrative expenses as a percentage of revenues increased from 7% in 2004 to 8% in
2005. Excluding the non-cash component of revenues resulting from the sale of our interest
in our former joint venture, general and administrative expenses as a percentage of
revenues were 10% in 2005.

| | Financial
income, net
| | ---------------------

Financial
income, net was $1.7 million in 2005 and in 2004. Financial income included an increase in
interest income on cash equivalents, marketable securities and premium on marketable
securities compared to 2004, offset by a decrease in interest income on loans provided to
our former joint venture that we exited in December 2004 and by losses from foreign
currency exchange differences.

Loss
from discontinued operations decreased by $1.9 million, or 27%, to $5.3 million in 2005
from $7.2 million in 2004. This decrease was due to a decrease of $0.3 million in the
gross loss on product sales, as well as due to a decrease of $1.7 million in operating
expenses related to product-related activities. The decrease in operating expenses
resulted from our decision in the second quarter of 2005 to discontinue product sales
operations.

# Quarterly Results of
Operations

The
table below sets forth unaudited consolidated statements of operations data in dollars for
each of the eight consecutive quarters ended December 31, 2006. In managements
opinion, the unaudited consolidated financial statements have been prepared on the same
basis as our audited consolidated financial statements contained elsewhere in this Annual
Report and include all adjustments, consisting of normal recurring adjustments, necessary
for a fair presentation of such financial information.

|                                                                                                                               | Three months ended,
|------------------------------------------------------------------------------------------------------------------------------ | -------------------
|
|
|
|
|Statements of operations data:                                                                                                 |                    
|Revenues:                                                                                                                      |                    
|Licenses and royalties(*)                                                                                                      |                    
|Services                                                                                                                       |                    
|                                                                                                                               |                    
|Total revenues                                                                                                                 |                    
|                                                                                                                               |                    
|                                                                                                                               |                    
|Cost of services revenues:                                                                                                     |                    
|                                                                                                                               |                    
|                                                                                                                               |                    
|Operating expenses:                                                                                                            |                    
|Research and development, net                                                                                                  |                    
|Marketing and selling                                                                                                          |                    
|General and administrative                                                                                                     |                    
|                                                                                                                               |                    
|Total operating expenses                                                                                                       |                    
|                                                                                                                               |                    
|Operating income                                                                                                               |                    
|Financial income (expenses), net                                                                                               |                    
|Income from continuing operations   before income taxes                                                                        |                    
|Income taxes                                                                                                                   |                    
|Income  from continuing operations   after income taxes                                                                        |                    
|Income (loss) from discontinued                                                                                                |                    
|operations                                                                                                                     |                    
|Income before cumulative effect of   change in accounting principle                                                            |                    
|Cumulative effect of change in                                                                                                 |                    
|accounting principle                                                                                                           |                    
|                                                                                                                               |                    
|Net income                                                                                                                     |                    
|                                                                                                                               |                    
|Basic earnings per Ordinary share                                                                                              |                    
|from continuing operations                                                                                                     |                    
|                                                                                                                               |                    
|Basic earnings per Ordinary share
   from discontinued operations
   and cumulative effect of change   in accounting principle |                    
|                                                                                                                               |                    
|Basic net earnings  per Ordinary                                                                                               |                    
|share                                                                                                                          |                    
|                                                                                                                               |                    
|Diluted earnings per Ordinary
   share from continuing   operations                                                            |                    
|                                                                                                                               |                    
|Diluted earnings per Ordinary                                                                                                  |                    
|share from discontinued                                                                                                        |                    
|operations  and cumulative                                                                                                     |                    
|effect of change in accounting                                                                                                 |                    
|principle                                                                                                                      |                    
|                                                                                                                               |                    
|Diluted net earnings per Ordinary   share                                                                                      |                    
|                                                                                                                               |                    

(*)
          License and royalties revenues include non-cash revenues resulting from the
          termination of our former joint venture of $9.6 million, $6.8 million, $2.4
          million, and $0.4 million for the three months ended March 27, 2005, June 26,
          2005, September 25, 2005 and December 31, 2005, respectively.

- 42 -

---

---

We
expect that in the future our quarterly revenues will fluctuate depending on the timing of
recognition of licensee fees and, as we started to derive more significant royalty
payments, upon the sales volumes and prices of products of our licensees, which are beyond
our ability to control or assess in advance.

See
Item 11 for a description of the impact of inflation and foreign currency fluctuations on
our business. See Item 3 Risk Factors for information regarding any
governmental economic, fiscal, monetary or political policies of factors that could affect
our operations.

# Critical Accounting
Policies and Estimates

The
preparation of financial statements in conformity with U.S. generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and expenses
during the reporting period. These estimates and judgments are subject to an inherent
degree of uncertainty. However, certain of our accounting policies are particularly
important to the portrayal of our financial position and results of operations. In
applying these critical accounting policies, our management uses its judgment to determine
the appropriate assumptions to be used in making certain estimates. Those estimates are
based on our historical experience, the terms of existing contracts, our observance of
trends in our industry, information provided by our customers and information available
from other outside sources, as appropriate. Our estimates are guided by observing the
following critical accounting policies:

Revenue
recognition  license and royalties.License revenues are recognized when there
is persuasive evidence of an arrangement, delivery has occurred or service has been
rendered, the fee is fixed or determinable, and collectibility is probable. All such fees
are comprised of license and support fees in some cases, as well as in certain cases
nonrefundable prepaid royalties. Normally, because it is not possible to determine
objective and reliable evidence of fair value of the undelivered contract elements to
allocate the fees among the elements, license and support fees are accounted for as one
unit of accounting in accordance with Emerging Issues Task Force Issue No. 00-21
Revenue Arrangements with Multiple Deliverables We recognize license fees
ratably over the period during which we expect to provide initial customer support to our
licensees and when all other criteria for revenue recognition are met. In addition,
revenue recognition is limited to the amount that is due or billable under the agreement
if extended payment terms exist. In agreements where no initial customer support is
provided, license fees are recognized upon delivery provided no extended payment terms
exist. Since the initial customer support is typically provided until the expected
commercialization date of the licensees products, we determine the period in which
we will provide support based on estimates that our project managers determine in
conjunction with our licensees, as well as the monitoring of the progression of our
licensees product development through the customer support we provide them. We
review assumptions regarding the customer support periods on a regular basis. If we
determine that it is necessary to revise our estimates of the customer support periods,
the total amount of revenue recognized over the life of the contract would not be
affected, but the license fees would be recognized ratably over a longer or shorter
period. We record the excess of license fees paid to us over revenues recognized as
deferred revenues. Revenues from royalties are recognized as earned.

- 43 -

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---

| | Revenue
recognition  services.
| | -------------------------------

We
recognize revenues from design and product development services provided to licensees in
fixed fee service contracts based on the proportional performance model, using costs of
employee services rendered as a percentage of total project costs. However, revenues are
always limited to output measures (technological milestones) or amounts due or billable
under the agreement.

Accounting
for income taxes.We and our subsidiaries account for income taxes in accordance with
Statement of Accounting Financial Standard (SFAS) No. 109 Accounting for Income
Taxes. As part of the process of preparing our consolidated financial statements we
are required to estimate our income taxes in each of the jurisdictions in which we
operate. This process requires us to estimate our actual current tax exposure and make an
assessment of temporary differences resulting from differing treatment of items, for tax
and accounting purposes. We must then assess the likelihood that our deferred tax assets
will be recovered from future taxable income and, to the extent we believe that recovery
is not likely, we must establish a valuation allowance. Significant management judgment is
required in determining our provision for income taxes, our deferred tax assets and
liabilities and any valuation allowance recorded against our net deferred tax assets. We
expect that during the period in which net operating loss carryforwards are utilized in
Saifun Semiconductors Ltd., our income will be substantially tax exempt. Accordingly,
there will be no tax benefit available for such losses and accordingly, no deferred income
taxes were recorded as of December 31, 2006. In 2006, we have utilized all the
carryforward losses for Saifun (BVI) Limited and accordingly, we started recording a
provision for income tax for the estimated taxable income. In addition, with respect to
the carryforward losses of Saifun Semiconductors USA, Inc. a valuation allowance has been
recorded as management currently believes that it is more likely than not that the
deferred tax related to these carryforward losses will not be realized in the foreseeable
future.

Valuation
of stock-based awards.Effective January 1, 2006, we adopted Statement of Financial
Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS
123(R)), which is a revision of FASB Statement No. 123, Accounting for
Stock-Based Compensation (SFAS 123) which requires the measurement and
recognition of compensation expense based on estimated fair values for all shared based
payment awards made to employees and directors. In March 2005, the Securities and Exchange
Commission issued Staff Accounting Bulletin No. 107 (SAB 107) relating to SFAS
123(R). We applied the provisions of SAB 107 in the adoption of SFAS 123(R).

SFAS
123(R) requires companies to estimate the fair value of equity-based payment awards on the
date of grant using an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as an expense over the requisite service periods
in the our consolidated statement of operations. Prior to the adoption of SFAS 123(R), we
accounted for equity based awards under the fair value recognition provisions of SFAS 123.

We
adopted SFAS 123(R) using the Modified Prospective Method. Under that transition method,
compensation cost recognized in the year ended December 31, 2006, includes: (a)
compensation cost for all share-based payments granted prior to, but not yet vested as of
January 1, 2006, based on the grant date fair value estimated in accordance with the
original provisions of SFAS 123, and (b) compensation cost for all share-based
payments granted subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of Statement 123(R). Results for prior periods
have not been restated.

Beginning
on the date of adoption of SFAS 123(R), forfeitures are estimated based on historical
experience and other factors; previously, forfeitures were recorded as they occurred.

- 44 -

---

---

We
have selected the binomial lattice option-pricing model to estimate the fair value for any
options granted after December 31, 2005. The binomial model considers characteristics of
fair value option pricing that are not available under the Black-Scholes model. Similar to
the Black-Scholes model, the binomial model takes into account variables such as
volatility, dividend yield rate, and risk free interest rate. However, in addition, the
binomial model considers the contractual term of the option, the probability that the
option will be exercised prior to the end of its contractual life, and the probability of
termination or retirement of the option holder in computing the value of the option. For
these reasons, we believe that the binomial model provides a fair value that is more
representative of actual experience and future expected experience than that calculated
using the Black-Scholes model. The use of option valuation models is subjective to the
underlying assumptions, which are generally based on our and representative industry
historical experiences and may not be representative of the actual movements of the value
of our shares.

Stock-based
compensation cost is measured at the grant date, based on the fair value of the award, and
is recognized as an expense on a straight line basis over the requisite service period for
each of the awards. Accordingly, we recorded a cumulative effect of change in accounting
principle in the amount of $378 relating to estimated forfeitures for awards granted and
outstanding at the date of the adoption.

We
have applied SFAS 123 and Emerging Issues Task Force No. 96-18, Accounting for
Equity Instruments that are Issued to other than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services (EITF 96-18), with respect
to options and warrants issued to non-employees. SFAS 123 and EITF 96-18 require the
use of option valuation models to measure the fair value of the options and warrants at
the measurement date.

As
of December 31, 2006, there was $18.1 million of total unrecognized compensation cost
related to nonvested options granted under our share option plans. That cost is expected
to be recognized over a weighted-average period of 2.5 years.

# B. LIQUIDITY AND CAPITAL
RESOURCES

We
do not have any long-term borrowings. Our investments consist of cash and cash
equivalents, short-term bank deposits and interest bearing, investment-grade investments
in marketable securities with maturities of up to three years, which currently consist
mainly of corporate debt securities and auction rate securities, and may in the future
include commercial paper, money market funds, government and non-government debt
securities.

We
finance our operations through the proceeds of sales of our equity securities and through
cash derived from operations. In our initial public offering that occurred in November
2005 we raised net proceeds of approximately $120.9 million and in a follow-on offering
that occurred in April 2006 we raised net proceeds of $9.3 million and an additional $3.2
million from the exercise of stock options by certain selling shareholders. As of December
31, 2006, we had $54.9 million in cash and cash equivalents and short term investments and
$176.2 million in marketable securities. Our working capital, which we calculate by
subtracting our current liabilities from our current assets, was $171.7 million. The
following table of our material contractual and other obligations known to us as of
December 31, 2006, summarizes the aggregate effect that these obligations are expected to
have on our cash flows in the periods indicated:

|Contractual and other obligations | Total | 2007 | 2008 | 2009   | 2010 | 2011 | 2012 
|--------------------------------- | ----- | ---- | ---- | ------ | ---- | ---- | -----
|
|
|
|
|Operating leases(1)               |       |      | $    | 7,256  |      | $    | 1,990
|Software lease                    |       |      |      | 5,660  |      |      | 2,297
|Severance pay(2)                  |       |      |      | 3,734  |      |      | --   
|                                  |       |      |      |        |      |      |      
|Total                             |       |      | $    | 16,650 |      | $    | 4,287

---

|(1) | Consists
of operating lease agreements for our facilities in Netanya, Israel,                and
Santa Clara, California, and operating leases for vehicles.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Severance
pay relates to accrued severance obligations to our Israeli employees                as
required under Israeli labor laws. These obligations are payable only upon
               the termination of the respective employee and may be reduced if the
               employees termination is voluntary. As of December 31, 2006, the
severance                pay funds were $3.6 million and will be used to satisfy a
portion of our                obligations.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 45 -

---

---

During
2006, we entered into agreements with several banks for revolving credit lines. Pursuant
to the agreements, the total amount of funds available under the revolving credit lines is
based on certain percentages of the assets managed by the banks. The agreements provide
for interest on any outstanding balances based on the LIBOR Rate plus 0.25%. Any
outstanding balances would be have been collateralized by the funds of the banks. As of
December 31, 2006, we have not borrowed any amounts under the credit lines.

Based
on our current business plan, we believe that our existing cash balances and cash
generated from operations, will be sufficient to meet our anticipated cash needs for
working capital and capital expenditures for at least the next 12 months. If our estimates
of revenues, expenses or capital or liquidity requirements change or are inaccurate or if
cash generated from operations is insufficient to satisfy our liquidity requirements, we
may seek to sell additional equity or arrange additional debt financing. In addition, we
may seek to sell additional equity or arrange debt financing to give us financial
flexibility to pursue opportunities that may arise in the future.

The
following table sets forth the components of our cash flows for the periods indicated:

|                                                 | Year ended
|------------------------------------------------ | ----------
|
|
|
|
|Net cash provided by operating activities        |           
|Net cash used in investing activities            |           
|Net cash provided by financing activities        |           
|Increase (decrease) in cash and cash equivalents |           

Our
cash flow statement presents cash flows from discontinued operations combined with cash
flows from continuing operations within each cash flow statement category (operating,
investing and financing activities).

| | Operating
activities
| | --------------------

Net
cash provided by operating activities in 2006 was $31.8 million compared to $14.1 million
in 2005. Net cash provided by operating activities in 2006 was generated primarily by our
net income of $35.0 million increased for non-cash expenses of $5.3 million (principally
stock-based compensation expense of $4.9 million) and by an increase in accrued expenses
and other liabilities of $1.5 million. This was reduced in part by an increase in trade
receivables of $6.8 million and a decrease in deferred revenues of $3.8 million.

The
decrease in deferred revenues during the year was primarily due to the recognition of
previously received license fees from Spansion. The increase in trade receivables was
primarily due to payments due from Spansion and SMIC. The increase in accrued expenses and
other liabilities was primarily due to the provision for income taxes

Net
cash provided by operating activities in 2005 was $14.1 million compared to $18.0 million
in 2004. Net cash provided by operating activities in 2005 was generated primarily by our
net income of $44.5 million adjusted for non-cash expenses of $6.9 million and non-cash
revenues of $19.2 million, by a decrease of $4.8 million in trade receivables, a decrease
in total assets attributed to discontinued operations of $4.9 million and an increase in
accrued expenses and other liabilities of $1.8 million. This was offset in part by an
increase in other accounts receivable and prepaid expenses of $1.3 million, a decrease in
total liabilities attributed to discontinued operations of $3.7 million and a decrease in
deferred revenues of $24.3 million (excluding non-cash revenues).

The
decrease in deferred revenues during the year was due to the recognition of previously
received license fees from Macronix, Spansion and Matsushita. The decrease in trade
receivables was primarily due to payments received from Infineon Technologies Flash
Israel. The increase in other accounts receivable and prepaid expenses was primarily due
to an increase in prepaid expenses mainly related to operating lease prepayments and an
increase in deferred service projects costs. The decrease in total assets attributed to
discontinued operations of $4.9 million was offset by the decrease in total liabilities
attributed to discontinued operations of $3.7 million. This decrease was primarily due to
a decline in payables to our subcontractors for the manufacturing of our products as a
result of the discontinuation of our products sales in the second quarter of 2005.

- 46 -

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---

Net
cash provided by operating activities in 2004 was $18.0 million compared to net cash
provided by operating activities of $2.3 million in 2003. Net cash provided by operating
activities in 2004 was generated primarily by our operating income of $11.7 million
adjusted for non-cash expenses of $1.9 million, an increase in deferred revenues of $13.1
million, and an increase in total liabilities attributed to discontinued operations of
$3.8 million, offset in part by an increase of $4.8 million in total assets attributed to
discontinued operations, and an increase of $2.2 million in trade receivables.

The
increase in deferred revenues was primarily due to non-cash license revenues of $19.2
million from Infineon Technologies. The increase in trade receivables was mainly due to
payments due from Infineon Technologies Flash. The increase in total assets attributed to
discontinued operations of $4.8 million was offset by the increase in total liabilities
attributed to discontinued operations of $3.8 million. This increase was mainly due to
payables to our subcontractors for the manufacturing of our products, which we commenced
selling in the first quarter of 2004.

| | Investing
activities
| | --------------------

Net
cash used in investing activities in 2006 was $97.3 million compared to net cash used in
investing activities of $66.1 million in 2005. The increase was primarily due to an
increase in net investment in marketable securities of $94.0 million.

Net
cash used in investing activities in 2005 was $66.1 million compared to net cash used in
investing activities of $20.4 million in 2004. The increase was primarily due to increase
in net investment in marketable securities of $58.6 million which mainly resulted from
proceeds raised in our initial public offering and by an increase of $1.2 million in
capital investments primarily in laboratory equipment and computers. This increase was
partially offset by a decrease, as a result of the termination of our joint venture with
Infineon Technologies in December 2004, of $13.1 million in loans made to Infineon
Technologies Flash Germany in 2004 as part of our agreement with Infineon Technologies
regarding the joint venture. Net cash used in investing activities in 2004 was $20.4
million and consisted primarily of net investment of $6.7 million in held-to-maturity
marketable securities which had previously been held in short-term bank deposits and cash
equivalents, $13.1 million of loans to Infineon Technologies Flash Germany and $0.8
million of capital investments primarily in laboratory equipment, computers and software.

| | Financing
activities
| | --------------------

Net
cash provided by financing activities was $18.1 million in 2006, $125.1 million in 2005
and $0.3 million in 2004. Financing activities in 2006 include $9.3 million from secondary
offering securities and $9.1 million from the exercise of options and stock appreciation
rights. The increase in 2005 resulted from proceeds of $123.7 million raised in our
initial public offering, net of issuance expenses.

# Corporate Tax

Israeli
companies are subject to income tax at the corporate rate of 31% for the 2006 tax year,
29% for the 2007 tax year, 27% for the 2008 tax year, 26% for the 2009 tax year and 25%
for the 2010 tax year and thereafter. In addition, we have net operating loss
carryforwards and we are subject to Israeli government tax benefits that will reduce our
effective statutory tax rate. Furthermore, our former equity interest in losses of
Infineon Technologies Flash Germany was attributed to us for tax purposes. As of December
31, 2006, the end of our last fiscal year, our net operating loss carryforwards for
Israeli tax purposes amounted to approximately $10.8 million. We have additional
carryforward capital losses of approximately $ 5.3 million as well as temporary
differences of $2.1 million. We have received from the Office of the Chief Scientist of
Israel an approval to allow a tax deduction for part of our research and development
expenses incurred during the years 2003 and 2004. The remaining unapproved research and
development expenses are deducted for tax purposes over a three-year period in accordance
with and subject to Israeli tax law. We intend to continue applying to the Office of the
Chief Scientist of Israel for an approval to allow a tax deduction for our research and
development expenses. Under Israeli law, net operating losses can be carried forward
indefinitely and offset against certain future taxable income. We expect that we will
generate the substantial majority of our taxable income in Israel.

- 47 -

---

---

In
addition, our investment program in equipment at our facility in Netanya, Israel has been
granted approved enterprise status and we are, therefore, eligible for tax benefits under
the Law for the Encouragement of Capital Investments, 1959, referred to as the Investments
Law. Subject to compliance with applicable requirements, the portion of our net income
derived from our licensing and services activities will be exempt from income tax during
the first two years in which these investment programs produce taxable income, which will
be after we have utilized our net operating loss carryforwards, and subject to a reduced
tax rate of between 10% and 25% for the remaining five to eight years of the program,
depending on the extent of non-Israeli ownership in our company during the relevant year.
The period during which we receive these tax benefits is limited to 12 years from the year
in which operations or production by the enterprise commenced or 14 years from the year in
which approval of the program was granted, whichever is earlier. The benefits under our
existing approval enterprises are due to expire between 2011 and 2015. In addition,
availability of these tax benefits is subject to certain requirements, including making
specified investments in property and equipment, and financing a percentage of investments
with share capital. If we do not meet these requirements in the future, the tax benefits
may be canceled and we could be required to refund any tax benefits that we have already
received. See Taxation  Israeli Tax Considerations and Government Programs
 Taxation of Companies  Law for the Encouragement of Capital Investments,
1959. We cannot assure you that tax benefits for approved enterprises will continue
at current levels or at all. In addition, our effective tax rate in our statement of
income may be different than our approved enterprise tax rate because the basis of
computing theoretical taxes on income for financial statement purposes in U.S. dollars
under U.S. generally accepted accounting principles differs from the basis for computing
taxes under Israeli law where income is based on financial statements in shekels that are
adjusted for inflation in Israel. We have elected to measure our results for tax purposes
based on the U.S. dollar exchange rate commencing January 1, 2006. In addition, other
items included in our financial statements such as financial income, can affect our
effective tax rate since they may not be eligible for the approved enterprise benefits.

In
April 2005, a comprehensive amendment to the Investments Law came into effect. Since the
amended Investments Law does not retroactively apply for investments programs having an
approved enterprise approval certificate issued by the Israeli Investment Center prior to
December 31, 2004, part of our future tax benefits are subject to the provisions of the
Investments Law prior to its revision, while new benefits that we receive in the future,
if any, will be subject to the provisions of the Investments Law, as amended. According to
the amendment to the Investments Law, only approved enterprises receiving cash grants
require the approval of the Investment Center. Approved enterprises that do not receive
benefits in the form of governmental cash grants, such as benefits in the form of tax
benefits, are no longer required to obtain this approval (such enterprises are referred to
as privileged enterprises). However, a privileged enterprise is required to comply with
certain requirements and make certain investments as specified in the amended Investments
Law. A privileged enterprise may, at its discretion, in order to provide greater
certainty, elect to apply for a pre-ruling from the Israeli tax authorities confirming
that it is in compliance with the provisions of the amended Investments Law and is
therefore entitled to receive such benefits provided under the amended Investments Law. In
March 2006, we received a pre-ruling confirming that we are in compliance with the amended
law.

In
order to manage certain investments, we have established a wholly owned subsidiary, Saifun
(BVI) Limited, a company incorporated under the laws of the British Virgin Islands. Under
our Approved Enterprise status, we are not entitled to receive any tax benefits from any
income derived from investments made through Saifun (BVI) Limited. As of December 31,
2006, we utilized all the carryforward losses related to Saifun (BVI) Limited. Thus,
beginning January 1, 2007, all of Saifun (BVI) Limiteds taxable income will be
subject to Israeli income tax, which will be considered a deemed dividend and
taxed at 25% tax rate.

There
can be no assurance that we will comply with the conditions set forth in the Investments
Law in the future or that we will be entitled to any additional benefits under it.

# Recent Accounting
Pronouncements

In
September 2006, the Financial Accounting Standards Board (FASB) issued SFAS
No. 157, Fair Value Measurements. This Standard defines fair value,
establishes a framework for measuring fair value in generally accepted accounting
principles and expands disclosures about fair value measurements. SFAS No. 157 is
effective for financial statements issued for fiscal years beginning after November 15,
2007 and interim periods within those fiscal years. We believes this Standard will not
have a material effect on our consolidated financial statements.

In
June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes (FIN 48), an interpretation of SFAS 109, Accounting
for Income Taxes. FIN 48 prescribes a comprehensive model for how companies should
recognize, measure, present and disclose in their financial statements uncertain tax
positions taken or expected to be taken on a tax return. Under FIN 48, tax positions shall
initially be recognized in the financial statements when it is more-likely-than-not the
position will be sustained upon examination by the tax authorities. Such tax positions
shall initially and subsequently be measured as the largest amount of tax benefit that is
greater than 50% likely of being realized upon ultimate settlement with the tax authority
assuming full knowledge of the position and all relevant facts. FIN 48 also revises
disclosure requirements to include an annual tabular rollforward of unrecognized tax
benefits. The provisions of this interpretation are required to be adopted for fiscal
periods beginning after December 15, 2006. The Company will be required to apply the
provisions of FIN 48 to all tax positions upon initial adoption with any cumulative effect
adjustments to be recognized as an adjustment to retained earnings. Based on initial
evaluation as of December 31, 2006, we do not believe that FIN 48 will have a material
impact on our financial statements.

- 48 -

---

---

In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities, (SFAS No. 159), which permits
companies to choose to measure certain financial instruments and other items at fair value
that are not currently required to be measured at fair value. SFAS No. 159 is effective
for fiscal years beginning after November 15, 2007. The Company will adopt SFAS No. 159 no
later than January 1, 2008. We have not yet determined the effect that the adoption of
SFAS No. 159 will have on our consolidated financial statements.

# C. RESEARCH AND
DEVELOPMENT

We
conduct all of our research and development activities in-house and as of December 31,
2006, we had 204 employees engaged in research and development, including in connection
with design and product development services provided to licensees, representing 88% of
our total workforce. Approximately 10% of our employees have advanced technical degrees
and 8% have PhDs. We engage in substantial research and development activities that are
focused principally on the following areas:

| |  | Improving
the functionality and features of our NROM technology.We, together with our
licensees, seek to develop innovative solutions based on our NROM technology to maintain
our advantage. We are developing our QUAD NROM technology that enables storage of four
bits per cell with a few of our licensees.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Services
for licensees.We work closely with our licensees to assist them in incorporating our
NROM technology into their products. We are currently working with licensees to develop
advanced manufacturing technologies for products incorporating our NROM technology using
smaller process geometries.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our
research and development expenses were $12.8 million in 2006, $7.4 million in 2005 and
$6.8 million in 2004. In addition, because our license agreements often call for us to
provide design and product development services, a portion of our total research and
development expenses have been allocated to cost of revenues for design and product
development services, even though these services have direct applicability to our
technology development as well. We view the total amounts we spend on research and
development, together with our cost of service revenues, as providing a more complete
picture of our overall research and development activities because our research and
development activities directly benefit from the design and product development services
that we provide to licensees. We expect that we will continue to invest substantial funds
in research and development activities.

- 49 -

---

---

# D. TREND INFORMATION

See
discussion in Parts A and B of Item 5 Operating Results and Financial Review and
Prospects.

|E.  OFF-BALANCE SHEET ARRANGEMENTS
|----------------------------------

Not
applicable.

# F. TABULAR DISCLOSURE OF
CONTRACTUAL OBLIGATIONS

Not
applicable.

# G. SAFE HARBOR

Not
applicable.

|ITEM 6: | DIRECTORS,
SENIOR MANAGEMENT AND EMPLOYEES
|------- | ------------------------------------------

# A. DIRECTORS AND SENIOR
MANAGEMENT

Our
executive officers and directors and their ages and positions as of the date of this
annual report are as follows:

|Name                          | Age | Position                                      
|----------------------------- | --- | ----------------------------------------------
|
|
|
|
|Dr. Boaz Eitan                | 58  | Chief Executive Officer, Chairman and Director
|Kobi Rozengarten(1)           | 50  | President and Director                        
|Igal Shany                    | 35  | Chief Financial Officer                       
|Ramy Langer                   | 53  | Vice President-Business Development           
|Eduardo Maayan                | 46  | Vice President-Product Development            
|Dr. Meir Janai                | 59  | Vice President-Quality and Reliability        
|
|
|Kenneth Levy(2)(4)            | 64  | Director                                      
|Matty Karp(2)(3)              | 57  | Director                                      
|Yossi Sela(2)(4)              | 54  | Director                                      
|George Hervey(2)(3)(5)        | 60  | Director                                      
|Ida Keidar-Malits(2)(3)(4)(5) | 59  | Director                                      

---

|(1) | Mr.
Rozengarten has announced that he will resign as President effective July
               15, 2007, but will remain as a member of the Board of Directors.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Independent
director under The Nasdaq Stock Market rules.
|--- | ---------------------------------------------------------

|(3) | Member
of our audit committee.
|--- | ------------------------------

|(4) | Member
of our compensation, nominating and governance committee.
|--- | ----------------------------------------------------------------

|(5) | Outside
director under the Israeli Companies Law.
|--- | -------------------------------------------------

Dr.
          Boaz Eitanfounded Saifun in 1996 and since that time has served as our
          Chief Executive Officer and Chairman of our board of directors. He is the
          inventor of our NROM technology. From 1992 to 1997, Dr. Eitan managed the
          Israeli design center of WaferScale Integration Inc., which he established in
          1992. From 1983 to 1992, Dr. Eitan held various positions at WaferScale
          Integration Inc., including manager of the Device Physics group, director of
          memory products and Vice President of Product and Technology Development. From
          1981 to 1983, Dr. Eitan served as a physicist at Intels research and
          development center in Santa Clara, California. Dr. Eitan holds a Ph.D. and an
          M.Sc. in Applied Physics from the Hebrew University, Jerusalem and a B.Sc. in
          Mathematics and Physics from the Hebrew University, Jerusalem. Dr. Boaz Eitan is
          named as the inventor of over 85 issued U.S. patents, over 45 pending U.S.
          patent applications and a number of issued non-U.S. patents and pending non-U.S.
          patent applications.

- 50 -

---

---

Kobi
Rozengartenhas served as our President since 2004 and was appointed to our board of
directors on March 7, 2006. Mr. Rozengarten has announced that he will resign as
President effective July 1, 2007. He will remain as a member of the Board of Directors.
Previously, Mr. Rozengarten was Executive Vice President  Business and Chief
Executive Officer of Saifun Semiconductors, Inc. since 1997. Prior to that, from 1994 to
1997, he served as Managing Director of Micro-Swiss Ltd., a subsidiary of Kulicke and
Soffa Industries, Inc., a leading supplier of equipment for the semiconductor industry.
From 1987 to 1994, Mr. Rozengarten held several senior management positions at Kulicke and
Soffa Industries, including Director of Operations and Vice President of Business
Development. From 1983 to 1987, Mr. Rozengarten worked at Elbit Computer Ltd., an Israeli
defense electronics supplier, as Manager of Finance Planning and Control. Mr. Rozengarten
holds an M.Sc. in Industrial Management and a B.Sc. in Industrial Engineering from the
Technion  The Israel Institute of Technology.

Igal
Shanyjoined our company in December 2000 and has served as our Chief Financial
Officer since July 2002. Prior to joining us, from 1998 to 2000 he was the Director of
Finance at Agentics Ltd., an Israeli company specializing in web-based content management.
From 1995 to 1998, Mr. Shany was a manager at Deloitte Touche Tohmatsu in Tel Aviv,
Israel, where he was responsible for clients from the high-tech, communications and
services industries. Mr. Shany is qualified as a CPA and holds a B.A. in economics and
accounting from the Tel Aviv University and an MBA from the Recanaty School of Business
Administration at the Tel Aviv University.

Ramy
Langerbecame General Manager and began serving as our Vice President  Business
Development in January 2005. Prior to joining us, Mr. Langer was Vice President 
Marketing and Sales at Tower Semiconductors for three years and then served as the
Managing Director of Infineon Technologies Flash Israel for two years. Before that, Mr.
Langer held senior technical and business positions at Kulicke and Soffa Industries Inc.,
a supplier of equipment for the semiconductor industry. Mr. Langer holds a B.Sc. in
Electrical Engineering from Technion  The Israel Institute of Technology and a M.Sc.
in Electrical Engineering from Drexel University, Philadelphia.

Eduardo
Maayanhas served as our Vice President  Product Development since July 2002.
From 1998 to 2002, he held the position of circuit design manager. Prior to joining us,
from 1994 to 1998, Mr. Maayan worked at Intels design center in Haifa, where he lead
the Global Circuit team in the microprocessor department and was involved in the design of
digital and analog integrated circuits, the definition of design methodologies, and the
development of CAD tools. From 1990 to 1994, Mr. Maayan carried out research on
Selective Epitaxial MOCVD Growth for Optoelectronic Integrated Devices at the
Microelectronics Center of the Technion  Israel Institute of Technology. Mr. Maayan
also serves as a lecturer at the Technions Electrical Engineering faculty. Mr.
Maayan holds a B.Sc. and M.Sc. in Electrical Engineering from the Technion  Israel
Institute of Technology. Mr. Maayan is named as the inventor on over 20 issued U.S.
patents and over 35 pending U.S. patent applications.

Dr.
          Meir Janaihas served as our Vice President  Quality and Reliability
          since January 2006 and, prior to that, from July 2005 to January 2006, served as
          our Vice President  Productization, Quality and Reliability. From 2002 to
          July 2005, Mr. Janai serviced as our Vice President of Operations and, from 2001
          to 2002, as our Vice President of Quality and Reliability. Prior to joining us,
          Dr. Janai served as Director of Business Development and Vice President of
          Corporate Quality at Chip Express Corporation. From 1985 to 1997, Dr. Janai
          served as Chief Scientist at Chip Express research and development center
          in Haifa, Israel. From 1978 to 1985, Dr. Janai worked for Kulicke and Soffa
          Industries, Inc. as Director of Quality and as a consultant. From 1977 to 1984,
          he was a senior research associate at the Department of Physics at the Technion,
          Israel Institute of Technology, and a visiting professor at the Optical Science
          Center at the University of Arizona. Dr. Janai served as a member of the Israeli
          National Committee for Microelectronics Foundations and he has been a member of
          numerous other scientific and governmental review boards both in Israel and the
          United States. Dr. Janai holds M.Sc. and D.Sc. degrees in Physics from the
          Technion  Israel Institute of Technology and a B.Sc. in Physics and
          Mathematics from the Hebrew University in Jerusalem.

Kenneth
Levyhas served as a director since November 2000. Mr. Levy is a private investor and
the founder of KLA Instruments Corporation. From July 1999 till October 2006, Mr. Levy
served as Chairman of the Board and director of KLA-Tencor Corporation. Upon his
retirement, he was appointed Chairman Emiretus of KLA-Tencor Corporation. From July 1998
to June 1999, he served as the Chief Executive Officer and a director of KLA-Tencor. From
April 1997 to June 1998, Mr. Levy was Chairman of the Board of Directors of KLA-Tencor.
From 1975 to 1997, he served as Chairman of the Board of Directors and Chief Executive
Officer of KLA Instruments Corporation. In addition, since 2001 Mr. Levy has served on the
serves on the boards of directors of Extreme Networks, Inc. a provider of network
infrastructure solutions, Juniper Networks, Inc., a provider of internet infrastructure
solutions. In addition, Mr. Levy serves as a director emeritus on the board of
Semiconductor Equipment and Materials Institute (SEMI), an industry trade association and
is an elected member of the National Academy of Engineering. Mr. Levy holds as M.Sc.
in Electrical Engineering from Syracuse University and a B.Sc. in Electrical Engineering
from City College of New York.

- 51 -

---

---

Matty
Karphas served as a director since March 2001. In 1997, Mr. Karp co-founded Concord
Ventures, a leading Israeli capital venture fund. From 1994 to 1997, Mr. Karp served as
the President of Nitzanim Venture Fund. From 1987 to 1994, Mr. Karp served as Chief
Executive Officer of Kardan Technologies. Prior to that, Mr. Karp served as Corporate Vice
President for Business Development, Marketing, and Sales and Head of the Systems and
Products Group at Elbit Computers Ltd., a leading Israeli high-tech company with worldwide
activities in the defense and healthcare sectors. Mr. Karp has served on the Board of
Directors of Galileo Technology, Accord Networks and Wintegra. Mr. Karp holds a B.Sc. cum
laude in Electrical Engineering from the Technion  Israel Institute of Technology
and is a graduate of the Harvard Business School Advanced Management Program.

Yossi
Selahas served as a director since 2000. Mr. Sela is the Managing Partner of Gemini
Israel Funds, a leading Venture Capital fund, which invests primarily in seed and early
stage Israeli technology. In this capacity, Mr. Sela sits on the board of a number of
Gemini portfolio companies, including Adimos Inc., Allot Communications, Ltd., and IXI
Mobile, Ltd. Mr. Selas past board positions include CommTouch Software Ltd., Precise
Software Solutions Ltd. and Envara Inc. In 1995, he served as the Chief Executive Officer
of Ornet Data Communication Technologies Ltd., which was a Gemini portfolio company.
Mr. Sela led that company until its acquisition by Siemens AG in September 1995. From
1990 to 1992, Mr. Sela served as Vice President of Marketing at DSP Group, an
American-Israeli company specializing in proprietary Digital Signal Processing for
consumer and telecommunication applications. He later served as VP Marketing at DSP
Communications, Inc., a spin-off of DSP Group. From 1985 to 1989, Mr. Sela worked at Daisy
Systems Inc. where he was Director for CAD Development and PCB Marketing Manager for
Europe. From 1974 to 1984, he served in the Israel Defense Forces and was responsible for
the definition and development of systems for communication applications. Mr. Sela holds a
B.Sc. in Electrical Engineering from the Technion  Israel Institute of Technology
and an MBA from Tel Aviv University.

George
Herveyhas served as a director since August 2004 and his service as an outside
director under the Israeli Companies Law was ratified by our shareholders on March 22,
2006. Since 2000, Mr. Hervey has served as the Vice President of Finance and Chief
Financial Officer of the Marvell Technology Group Ltd., and has served in a similar
capacity for Marvell Semiconductor, Inc. From March 1997 to April 2000, Mr. Hervey served
as Senior Vice President, Chief Financial Officer and Secretary for Galileo Technology
Ltd., which Marvell acquired in January 2001. From June 1992 to February 1997, Mr. Hervey
was Senior Vice President and Chief Financial Officer of S3 Incorporated, a designer and
manufacturer of graphics and video accelerators for personal computers and related
peripheral products. Mr. Hervey holds a B.Sc. in Business Administration from the
University of Rhode Island.

Ms.
          Ida Keidar-Malitswas appointed as an outside director on March 22, 2006.
          Ms. Keidar-Malits is a 50% owner of Adres Ltd., an Israeli private company
          engaged in import, stockholding, processing and distribution of steel as well as
          in real estate, and since 1998 has been a director of this company. From 1998
          until July 2003, Ms. Keidar-Malits served as a director of Packer Steels &
          Metals Ltd., a leading Israeli steel and metal service company. From 1998 until
          July 2002, she served as a director of Elbit Vision Systems Ltd. (OTCBB:
          EVSNF.OB), as well as the Chairman of the Audit Committee and a member of its
          Remuneration Committee. Elbit Vision Systems is an Israeli provider of
          computerized vision systems for industrial automatic quality inspection
          processes. Ms. Keidar-Malits also acts as a business consultant and mediator.
          From 1991 until 1997, Ms. Keidar-Malits served as Vice President of Finance and
          Chief Financial Officer of Elbit Ltd. (NASDAQ: ELBTF) until completion of its
          November 1996 restructuring into three companies: Elbit Systems Ltd. (NASDAQ:
          ESLT), Elbit Medical Imaging Ltd. (NASDAQ: EMITF) and Elbit Ltd. Prior to the
          restructuring, Elbit was engaged in worldwide operations in three non-related
          business areas: defense electronics, medical imaging and communications. From
          1986 until 1991, Ms. Keidar-Malits served as Corporate Secretary of Elbit and
          from 1984 until 1996, she served as Head of the Economics Department of Elbit.
          Ms. Keidar-Malits holds an M.Sc. in industrial management from the Technion,
          Israel Institute of Technology in Haifa and a B.Sc. in Chemistry &
          Biochemistry from the Hebrew University in Jerusalem.

# B. COMPENSATION

The
aggregate compensation to our directors and executive officers, including stock-based
compensation, for 2006 was $3.5 million. This amount includes approximately $1.8 million
of stock-based compensation, but does not include business travel, relocation,
professional and business association due and expenses reimbursed to officer holders, and
other benefits commonly reimbursed or paid by companies in Israel. As compensation for
service on our board of directors, we will grant (1) an initial annual grant of options to
purchase 30,000 ordinary shares (which will vest annually in three equal parts over a
three-year period) upon each non-employee directors appointment or election to the
board, (2) options to purchase 45,000 ordinary shares for a board member who is the
Chairman of our Audit Committee or (3) options to purchase 35,000 ordinary shares for a
board member who is also Chairman of our Compensation, Nominating and Governance
Committee, and (4) subsequent grants of options to purchase 3,750 of our ordinary shares
granted each quarter to each of our non-employee directors whose options are fully vested
and exercisable upon the date of grant. We also pay an annual cash retainer and per
meeting cash fee to each of our directors.

- 52 -

---

---

# C. BOARD PRACTICE

# Board of Directors and
Officers

Our
current board of directors consists of seven directors, certain of whom were appointed by
the shareholder or group of shareholders named in the directors biography pursuant
to rights of appointment granted to such shareholder in connection with its purchase of
our shares. Our Articles of Association provide that we may have up to nine directors.

Under
our Articles of Association, our directors (other than the outside directors) are divided
into three classes. Each class of directors consists, as nearly as possible, of one-third
of the total number of directors constituting the entire board of directors (other than
the outside directors). At each annual general meeting of our shareholders, the election,
or re-election of directors, following the expiration of the term of office of the
directors of that class of directors, is for a term of office that expires on the third
annual general meeting following such election or re-election, such that each year the
term of office of only one class of directors will expire. Class I directors, consisting
of Dr. Boaz Eitan and Kobi Rozengarten, were re-elected by our annual meeting of
shareholders held in 2006, and will hold office until our annual meeting of shareholders
to be held in 2009. Class II directors, consisting of Yossi Sela and Matty Karp, will hold
office until our annual meeting of shareholders to be held in 2007. In March 2007, our
board of directors approved the nomination of Yossi Sela and Matty Karp as board members
until 2010. This nomination has to be approved at our annual meeting of shareholders to be
held in 2007. Class III directors, consisting of Kenneth Levy, will hold office until our
annual meeting of shareholders to be held in 2008. The directors shall be elected by a
vote of the holders of a majority of the voting power present and voting at that meeting.
Each director, will hold office until the annual general meeting of our shareholders for
the year in which his or her term expires and until his or her successor shall be elected
and qualified.

The
approval of a special majority of the holders of at least 75.0% of the voting rights
represented at a general meeting is generally required to remove any of our directors from
office, other than the outside directors. A simple majority of our shareholders at a
general meeting may elect directors in their stead or fill any vacancy, however created,
in our board of directors. In addition, vacancies on the board of directors, other than
vacancies created by an outside director, may be filled by a vote of a majority of the
directors then in office. Our board of directors may also appoint additional directors up
to the maximum number permitted under our Articles of Association. A director so chosen or
appointed will hold office until the next general meeting of our shareholders.

Each
of our executive officers serves at the discretion of the board of directors and holds
office until his or her successor is elected or until his or her earlier resignation or
removal. There are no family relationships among any of our directors or executive
officers.

The
Companies Law requires that, in addition to having one outside director with financial and
accounting expertise, a public company must have such number of directors with financial
and accounting expertise as determined by the board of directors. In determining the
number of directors required to have such expertise, the Board of Directors must consider,
among other things, the type and size of the company and the scope and complexity of its
operations. Our Board of Directors has determined that we require at least one director
with the requisite financial and accounting expertise and that Ms. Ida Keidar-Malits has
such expertise.

- 53 -

---

---

# Outside Directors

| | Qualifications
of Outside Directors
| | -----------------------------------

Under
Israeli Companies Law, companies incorporated under the laws of the State of Israel whose
shares are listed on an exchange, including The Nasdaq Stock Market, are required to
appoint at least two outside directors. Mr. George Hervey and Ms. Keidar-Malits serve as
our outside directors and their terms expire in 2009.

The
Companies Law provides that a person may not be appointed as an outside director if the
person, or the persons relative, partner, employer or any entity under the
persons control, has, or had, during the two years preceding the date of
appointment, any affiliation with the company or any entity controlling, controlled by or
under common control with the company.

The
term affiliation includes:

| |  | an
employment relationship;
| | - | ---------------------------

| |  | a
business or professional relationship maintained on a regular basis;
| | - | ----------------------------------------------------------------------

| |  | control;
and
| | - | ------------

| |  | service
as an office holder, excluding service as a director in a private company prior to the
first offering of its shares to the public if such director was appointed as a director
of the private company in order to serve as an outside director following the public
offering.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
term office holder is defined as a director, general manager, chief business manager,
deputy general manager, vice general manager, executive vice president, vice president,
other manager directly subordinate to the general manager or any other person assuming the
responsibilities of any of the foregoing positions, without regard to such persons
title.

No
person can serve as an outside director if the persons position or other business
creates, or may create, a conflict of interests with the persons responsibilities as
an outside director or may otherwise interfere with the persons ability to serve as
an outside director. If at the time an outside director is appointed all current members
of the board of directors are of the same gender, then that outside director must be of
the other gender.

The
Companies Law requires that at least one of the appointed outside directors have financial
and accounting expertise and that the other outside director meet certain professional
qualifications. However, if at least one of our directors meets the independence
requirements of the Securities Exchange Act of 1934, as amended, and the standards of the
Nasdaq rules for membership on the audit committee, and also has financial and accounting
expertise as defined in the Companies Law and applicable regulations, then our outside
directors are only required to meet the professional qualifications. The regulations
implementing the amendment define a director with financial and accounting expertise as a
director whose education, professional experience and skills enable him to understand, on
a high level, matters relating to business, accounting, internal auditing and financial
statements, and who as a result is able to thoroughly comprehend the financial statements
of the company and initiate debate regarding the manner in which financial information is
presented. The regulations define a director who meets certain professional qualifications
as a director who satisfies one of the following requirements: (i) the director holds an
academic degree in either economics, business administration, accounting, law or public
administration, (ii) the director either holds an academic degree in any other field or
has completed higher education in the primary field of business of the company or in an
area which is relevant to the office of an outside director, (iii) the director has at
least five (5) years of experience serving in one or more of the following capacities: (a)
in a senior management position of a corporation with a substantial scope of business, (b)
in a senior position in the primary field of business of the company or (c) in a senior
position of public administration. Based on information provided by Mr. George Hervey and
Ms. Ida Keidar-Malits, our board of directors has resolved that each such individual
possesses the requisite financial and accounting expertise as required under the Companies
Law and the regulations promulgated thereunder.

Until
the lapse of two years from termination of office, a company may not engage an outside
director to serve as an office holder and cannot employ or receive services from that
person, either directly or indirectly, including through a corporation controlled by that
person.

- 54 -

---

---

| | Election
of Outside Directors
| | -----------------------------

Outside
directors are elected by a majority vote at a shareholders meeting, provided that
either:

| |  | the
majority of shares voted at the meeting (not including abstentions), including at least
one-third of the shares of non-controlling shareholders voted at the meeting, vote in
favor of the election of the outside director; or
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
total number of shares held by non-controlling shareholders and voted against the
election of the outside director does not exceed one percent of the aggregate voting
rights in the company.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
initial term of an outside director is three years and he or she may be reelected to
additional terms of three years each by a majority vote at a shareholders meeting,
subject to the conditions described above for election of outside directors. Reelection to
each additional term beyond the first extension needs to comply with the following
additional conditions: (1) the audit committee and, subsequently, the board of
directors confirmed that the reelection for an additional term is for the benefit of the
company, taking into account the outside directors expertise and special
contribution to the function of the board of directors and its committees, and
(2) the general meeting of the companys shareholders, prior to its approval of
the reelection of the outside director, was informed of the term previously served by him
or her and of the reasons of the board of directors and audit committee for the extension
of the outside directors term. Outside directors may only be removed by the same
majority of shareholders as is required for their election, or by a court, as follow:
(1) if the board of directors is made aware of a concern that an outside director has
ceased to meet the statutory requirements for his or her appointment, or has violated his
or her duty of loyalty to the company, then the board of directors is required to discuss
the concern and determine whether it is justified, and if the board of directors
determines that the concern is justified, to call a special general meeting of the
companys shareholders, the agenda of which includes the dismissal of the outside
director, and (2) at the request of a director or a shareholder of the company a
court may remove an outside director from office if it determines that the outside
director has ceased to meet the statutory requirements for his or her appointment, or has
violated his or her duty of loyalty to the company, or (3) at the request of the
company, a director, a shareholder or a creditor of the company, a court may remove an
outside director from office if it determines that the outside director is unable to
perform his or her duties on a regular basis, or is convicted of certain offenses set
forth in the Companies Law. If an outside directorship becomes vacant, a companys
board of directors is required under the Companies Law to call a shareholders
meeting immediately to appoint a new outside director.

Each
committee of a companys board of directors is required to include at least one
outside director and the audit committee is required to include all of the outside
directors.

An
outside director is entitled to compensation as provided in regulations promulgated under
the Companies Law and is otherwise prohibited from receiving any other compensation,
directly or indirectly, in connection with services provided as an outside director. The
regulations provide three alternatives for cash compensation to outside directors: (1) a
fixed amount determined by the regulations, (2) an amount within a range contained in the
regulations, or (3) an amount proportional to the amount paid to the other directors of
the company provided that such proportional amount (A) may not be lower than the
compensation granted to all other directors of the company who are not controlling
shareholders of the company or employees or service providers of the company or its
affiliates and (B) does not exceed the average compensation granted to all such directors.
A company may also issue shares or options to an outside director in an average amount
which (A) may not be lower than the amount granted to directors who are not controlling
shareholders of the company or employees or service providers of the company or its
affiliates; and (B) may not exceed the average amount granted to all such directors.
Compensation determined in any manner (other than cash compensation at the fixed amount
determined by the regulations) requires the approval of the companys shareholders.
All outside directors must receive identical compensation.

| | Nasdaq
Requirements
| | -------------------

Under
the rules of The Nasdaq Stock Market, a majority of directors must meet the definition of
independence contained in the rules. Our board of directors has determined that all of our
directors, other than our Chief Executive Officer and Chairman, Dr. Boaz Eitan, and our
President and board member, Kobi Rozengarten, meet the majority independence standards
contained in the rules of The Nasdaq Stock Market. We do not believe that any of these
directors have a relationship that would preclude a finding of independence under these
rules and, in reaching their determination, our board of directors determined that the
other relationships that these directors have with us do not impair their independence.

- 55 -

---

---

# Audit Committee

| | Companies
Law Requirements
| | --------------------------

Under
the Companies Law, the board of directors of any company whose shares are listed on any
exchange must also appoint an audit committee comprised of at least three directors
including all of the outside directors, but excluding the:

| |  | chairman
of the board of directors;
| | - | -----------------------------------

| |  | controlling
shareholder or a relative of a controlling shareholder; and
| | - | -----------------------------------------------------------------------

| |  | any
director employed by the company or who provides services to the company on a regular
basis.
| | - | ------------------------------------------------------------------------------------------------

| | Nasdaq
Requirements
| | -------------------

Under
The Nasdaq Stock Market rules, we are required to maintain an audit committee consisting
of at least three independent directors, all of whom are financially literate and one of
whom has accounting or related financial management expertise. Our audit committee members
are required to meet additional independence standards, including minimum standards set
forth in rules of the Securities and Exchange Commission and adopted by The Nasdaq Stock
Market.

| | Approval
of Transactions with Office Holders and Controlling Shareholders
| | -------------------------------------------------------------------------

The
approval of the audit committee is required to effect specified actions and transactions
with office holders and controlling shareholders. The term controlling shareholder means a
shareholder with the ability to direct the activities of the company, other than by virtue
of being an office holder. A shareholder is presumed to be a controlling shareholder if
the shareholder holds 50.0% or more of the voting rights in a public company or has the
right to appoint the majority of the directors of the company or its general manager; For
the purpose of approving transactions with controlling shareholders, the term also
includes any shareholder that holds 25.0% or more of the voting rights of the company if
the company has no shareholder that owns more than 50.0% of its voting rights.. For
purposes of determining the holding percentage stated above, two or more shareholders who
have a personal interest in a transaction that is brought for the companys approval
are deemed as joint holders. The audit committee may not approve an action or a
transaction with a controlling shareholder or with an office holder unless at the time of
approval the company has two outside directors, both of whom are serving as members of the
audit committee, and at least one of whom was present at the meeting at which the approval
was granted.

| | Audit
Committee Role
| | --------------------

Our
board of directors has adopted an audit committee charter setting forth the
responsibilities of the audit committee consistent with the rules of the Securities and
Exchange Commission and The Nasdaq Stock Market rules, which include:

| |  | retaining
and terminating the company's independent accountants, subject to shareholder
ratification;
| | - | -----------------------------------------------------------------------------------------------------

| |  | pre-approval
of audit and non-audit services provided by the independent accountants; and
| | - | -----------------------------------------------------------------------------------------

| |  | approval
of transactions with office holders and controlling shareholders, as described above, and
other related-party transactions.
| | - | ------------------------------------------------------------------------------------------------------------------------------------

Additionally,
under the Companies Law, the role of the audit committee is to identify irregularities in
the business management of the company in consultation with the internal auditor and the
companys independent accountants and suggest an appropriate course of action. The
audit committee charter states that in fulfilling this role the committee is entitled to
rely on interviews and consultations with our management, our internal auditor and our
independent public accountant, and is not obligated to conduct any independent
investigation or verification.

- 56 -

---

---



Our
audit committee consists of our directors, George Hervey (Chairperson), Matty Karp and Ida
Keidar-Malits. The financial expert on the audit committee pursuant to the definition of
the Securities and Exchange Commission is George Hervey.

# Compensation, Nominating
and Governance Committee

We
comply with the rules of The Nasdaq Stock Market with respect to the establishment and
composition of a compensation committee and a nominating committee. This committee will
also oversee matters related to our corporate governance practices. Our compensation,
nominating and governance committee consists of our directors, Ken Levy (Chairperson),
Yossi Sela and Ida Keidar Malits. Our board of directors has adopted a compensation,
nominating and governance committee charter setting forth the responsibilities of the
committee consistent with The Nasdaq Stock Market rules which include:

| |  | determining
the compensation of our Chief Executive Officer and other executive officers;
| | - | -----------------------------------------------------------------------------------------

| |  | granting
options to our employees and the employees of our subsidiaries;
| | - | ------------------------------------------------------------------------

| |  | recommending
candidates for nomination as members of our board of directors; and
| | - | --------------------------------------------------------------------------------

| |  | developing
and recommending to the board corporate governance guidelines and a code of business
ethics and conduct in accordance with applicable laws.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------

# Internal Auditor

Under
the Companies Law, the board of directors must appoint an internal auditor nominated by
the audit committee. The role of the internal auditor is to examine whether a
companys actions comply with applicable law and orderly business procedure. Under
the Companies Law, the internal auditor may be an employee of the company but not an
interested party or an office holder, or affiliate, or a relative of an interested party
or an office holder, nor may the internal auditor be the companys independent
accountant or its representative. An interested party is defined in the Companies Law as a
5.0% or greater shareholder, any person or entity who has the right to designate one
director or more or the chief executive officer of the company or any person who serves as
a director or as a chief executive officer. In December 2005, our board of directors
appointed the firm of Chaikan-Cohen as our internal auditor.

# D. EMPLOYEES

As
of December 31, 2006, we had 232 employees of whom 229 were based in Israel and three in
the United States. The breakdown of our employees by department is as follows:

|                              | December 26,2004 | December 31,2005 | December 31,2006
|----------------------------- | ---------------- | ---------------- | ----------------
|
|
|
|
|Department                    |                  |                  |                 
|Research and development(1)   |                  |                  |                 
|Sales and marketing           |                  |                  |                 
|Management and administration |                  |                  |                 
|                              |                  |                  |                 
|Total                         |                  |                  |                 

---

|(1) | Research
and development personnel are engaged in internal research and                development
efforts and in providing design and product development services to                our
licensees.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes
employees temporarily loaned to our former joint venture, Infineon
               Technologies Flash.
|--- | --------------------------------------------------------------------------------------------------------------

Under
applicable Israeli law, we and our employees are subject to protective labor provisions,
including restrictions on working hours, minimum wages, minimum vacation, sick pay,
severance pay and social security as well as equal opportunity and anti-discrimination
laws. Orders issued by the Israeli Ministry of Industry, Trade and Labor make certain
industry-wide collective bargaining agreements applicable to us. These agreements affect
matters such as cost of living adjustments to salaries, length of working hours and week,
recuperation, travel expenses, and pension rights. Our employees are not represented by a
labor union. We provide our employees with benefits and working conditions above the
required minimum, which we believe are competitive with benefits and working conditions
provided by similar companies in Israel. We have entered into employment agreements with
all of our Israeli employees and with our senior non-Israeli employees. Competition for
qualified personnel in our industry is intense and we dedicate significant resources to
employee retention. We have never experienced labor-related work stoppages and believe
that our relations with our employees are good.

- 57 -

---

---



# E. SHARE OWNERSHIP

# Share Ownership by
Directors and Executive Officers

For
information regarding ownership of our ordinary shares by our directors and executive
officers, see Item 7 Major Shareholders and Related Party Transactions.

# Share Option Plans

We
have adopted three share option/incentive plans and, as of February 28, 2007, we had
4,818,608 ordinary shares reserved for issuance under these plans of which options to
purchase 3,454,675 ordinary shares at a weighted average exercise price of $14.54 per
share are outstanding. As of February 28, 2007, 1,040,242 options were vested and
exercisable. In addition, we have 25,734 options outstanding, which were not granted under
our stock option plan, of which 25,734 are vested and exercisable.

| | 2003
Share Option Plan
| | ----------------------

Our
2003 share option plan provides for the grant of options to our directors, employees,
consultants and service providers, and to the directors, employees, consultants and
service providers of our subsidiaries and affiliates. The 2003 share option plan also
permits the issuance of restricted shares under terms and conditions to be further
determined by our board of directors.

As
of February 28, 2007, there were 1,363,933 ordinary shares available for issuance under
the plan, and options to purchase 3,101,318 ordinary shares have been granted and 857,600
were vested and exercisable. The number of shares available for issuance under the plan is
automatically increased on the first trading day in January of each calendar year during
the term of the 2003 share option plan beginning with calendar year 2005 by the lowest of
(1) 1,333,333 ordinary shares, subject to adjustments as provided in the plan, (2) a
number equal to 4% of our outstanding ordinary shares on December 31 in the previous
calendar year, and (3) an amount determined by our board of directors. Any unvested or
other option that terminate without exercise revert to the plan and become available for
future issuance.

The
plan is administered by our compensation, nominating and governance committee which makes
recommendations to our board of directors regarding grantees of options and the terms of
the grant, including, exercise prices, method of payment, vesting schedules, acceleration
of vesting and the other matters necessary in the administration of the plan. Options
granted under the plan to eligible employees and office holders who are Israeli residents
may be granted under Section 102(b)(2) of the Israeli Income Tax Ordinance pursuant to
which the options or the ordinary shares issued upon their exercise and/or other shares
received subsequently following any realization of rights, including without limitation
bonus shares, must be allocated or issued to a trustee and be held in trust for the lesser
of (a) 30 months, or (b) two years following the end of the tax year in which the options
are granted, provided that options granted after January 1, 2006 are only subject to being
held in trust for two years. Under Section 102, (1) any tax payable by an employee from
the grant or exercise of the options is deferred until the transfer of the options or
ordinary shares by the trustee to the employee or upon the sale of the options or ordinary
shares and (2) gains are subject to capital gains tax of 25.0%. We will not be entitled to
a tax deduction with respect of the issuance or exercise of options.

Options
granted under the plan to U.S. residents may qualify as incentive stock options within the
meaning of Section 422 of the Code. The exercise price for incentive stock options must
not be less than the fair market value on the date the option is granted, or 110.0% of the
fair market value if the optionholder holds more than 10.0% of our share capital.

- 58 -

---

---



Options
granted under our share option plans generally vest over five years such that 40.0% vest
after two years and an additional 20.0% each year thereafter. Typically, options granted
upon promotion of employees vest over five years such that 20.0% vest each year. In
addition, we have granted options under our stock option plans that vest at the end of
five years. Generally, any option not exercised within 10 years from the grant date
expires unless extended by the board of directors. If we terminate an employee for cause,
all of the employees vested and unvested options expire at the time of delivery of
the notice of discharge, unless determined otherwise by the committee. Upon termination of
employment for any other reason, an employee may exercise his or her vested options within
three months of the date of termination, unless prescribed otherwise by the committee.
Upon termination of employment due to death or disability, an employee may exercise his or
her vested options within a period of between six and twelve months from the date of death
or disability, depending on the terms of the employees option agreement. Upon
termination, any option not exercised within the aforesaid periods or unvested options
return to the plan for re-issuance.

In
the event of a merger, consolidation, reorganization or similar transaction in which our
ordinary shares are exchanged for shares of another corporation, each optionholder will be
entitled to purchase the number of shares of the other corporation as it would have
received if he or she had exercised its option immediately prior to such transaction. In
the event of a change of control, or merger, consolidation, reorganization or similar
transaction resulting in the acquisition of at least 50.0% of our voting power, or the
sale of all or substantially all of our assets, each optionholder is required to
participate in the transaction and sell or exchange their shares received pursuant to the
exercise of an option.

| | 2001
Share Option Plan
| | ----------------------

Our
2001 share option plan provides for the grant of options to our directors, employees,
consultants and service providers, and to the directors, employees, consultants and
service providers of our subsidiaries. As of February 28, 2007, we have granted options to
purchase 248,097 shares under our 2001 share option plan and 91,382 are vested and
exercisable.

Generally,
options granted under the plan to eligible employees who are Israeli residents have been
granted under Section 102 of the Israeli Income Tax Ordinance (as was then in effect),
pursuant to which the options or the ordinary shares issued upon their exercise and/or
other shares received subsequently following any realization of rights, including without
limitation bonus shares must be allocated or issued to a trustee and held in trust for at
least two years following the date of grant. Under Section 102 (then in effect) the
employee will recognize capital gain on the earlier of: (i) transfer of the options or
ordinary shares from the trustee to the employee; or (ii) upon the sale of ordinary shares
issued upon exercise of options. Generally, under Section 102 (then in effect) when the
employee is required to recognize income, gains are subject to tax according to the
employees marginal tax rate. We will be entitled for a tax deduction with respect to
such capital gain.

If
we terminate an employee for cause, all of the employees vested and unvested options
expire at the time of delivery of the notice of discharge. Upon termination of employment
for any other reason, an employee may exercise his or her vested options within three
months of the date of termination. Upon termination of employment due to death or
disability, an employee may exercise his or her vested options within six months after
termination. The committee may prescribe post-termination exercise periods different from
the above. Upon termination, any option not exercised within the aforesaid periods or
unvested options return to the plan for re-issuance.

In
the event of a consolidation, reorganization or merger in which we are not the surviving
entity, or the sale of all or substantially all of our assets or shares, the options will
be assumed or substituted with the appropriate number of options to purchase shares of the
other corporation with the same rights to be granted to our ordinary shareholders.

| | 1997
Share Option Plan
| | ----------------------

Our
1997 share option plan provides for the grant of options to our directors and employees.
As of February 28, 2007, we have granted options to purchase 105,260 shares under our 1997
stock option plan and 91,260 are vested and exercisable under this plan.

Generally,
options granted under the plan to eligible employees who are Israeli residents have been
granted under Section 102 of the Israeli Income Tax Ordinance (as was then in effect),
pursuant to which the options or the ordinary shares issued upon their exercise and/or
other shares received subsequently following any realization of rights, including without
limitation bonus shares must be allocated or issued to a trustee and held in trust for at
least two years following the date of grant. Under Section 102 (then in effect) the
employee will recognize capital gain on the earlier of: (i) transfer of the options or
ordinary shares from the trustee to the employee; or (ii) upon the sale of ordinary shares
issued upon exercise of options. Generally, under Section 102 (then in effect) when the
employee is required to recognize income, gains are subject to tax according to the
employees marginal tax rate. We will be entitled for a tax deduction with respect to
such capital gain.

- 59 -

---

---



If
we terminate an employee for cause, all of the employees vested and unvested options
expire at the time of delivery the notice of discharge. Upon termination of employment for
any other reason, all of an employees unvested options, other than options that may
be exercised within a certain period of time after cessation of employment, expire. All
vested options and options that may be exercised within a certain period of time after
cessation of employment and which are not exercised within the prescribed period terminate
upon the expiration of such period. Upon termination of employment due to retirement,
disability or death, an employee will, subject to the approval of the share option
committee, continue to enjoy rights under the plan on such terms as the committee may
determine.

In
the event of a merger, consolidation, recapitalization or similar transaction in which our
ordinary shares are exchanged for shares of another corporation, each optionholder will be
entitled to purchase such number of shares of the other corporation as were exchangeable
for the number of our ordinary shares which such optionholder would have been entitled to
purchase except for such action.

# Employee Stock Purchase
Plan

We
have adopted an employee stock purchase plan, or ESPP, pursuant to which our employees and
employees of our subsidiaries may elect to have payroll deductions (or, when not allowed
under local laws or regulations, another form of payment) made on each pay day during the
offering period in an amount not exceeding fifteen percent of the compensation which the
employees receives on each pay day during the offering period.

On
the first day of each offering period, each participating employee will be granted an
option to purchase on the exercise date of such offering period up to a number of the
companys ordinary shares determined by dividing (1) the employees payroll
deductions accumulated prior to such exercise date and retained in the employees
account as of the exercise date by (2) the applicable purchase price. The applicable
purchase price may be adjusted by the board of directors and the board of directors is
entitled to determine that the purchase price shall be the discount percentage equal to
the lesser of (1) the fair market value of an ordinary share on the exercise date, or (2)
the fair market value of an ordinary share on the offering date.

To
date, we have not granted employees the right to make purchases under the plan.

|ITEM 7. | MAJOR
SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
|------- | -------------------------------------------------

# A. MAJOR SHAREHOLDERS

The
following table sets forth certain information regarding the beneficial ownership of our
outstanding ordinary shares as of the date of this Annual Report:

| |  | each
person who we know beneficially owns 5.0% or more of the outstanding ordinary shares;
| | - | ------------------------------------------------------------------------------------------

| |  | each
of our directors individually;
| | - | -----------------------------------

| |  | each
of our executive officers individually; and
| | - | ------------------------------------------------

| |  | all
of our directors and executive officers as a group.
| | - | -------------------------------------------------------

Beneficial
ownership of shares is determined under rules of the Securities and Exchange Commission
and generally includes any shares over which a person exercises sole or shared voting or
investment power. The following table includes the number of shares underlying options
that are exercisable within 60 days of the date of this Annual Report. Ordinary shares
subject to these options are deemed to be outstanding for the purpose of computing the
ownership percentage of the person holding these options, but are not deemed to be
outstanding for the purpose of computing the ownership percentage of any other person. The
table assumes 31,477,170 ordinary shares outstanding as of March 20, 2007, and does not
include 46,000 ordinary shares repurchased by us following the approval by our board of
directors in February 2007 of a repurchase plan. In accordance with the Companies Law, as
long as the repurchased shares are held by us, these shares are considered dormant
shares with the result that they will not be entitled to any rights (e.g. voting
rights and dividend rights. See Item 16E, Purchases of Equity Securities by the Issuer
and Affiliated.

- 60 -

---

---



As
of the date of this Annual Report, we are aware of 7 U.S. persons that are holders
of record of our ordinary shares holding an aggregate of 2,718,028 shares.

Unless
otherwise noted below, each shareholders address is c/o Saifun Semiconductors Ltd.,
6 Arie Regev Street, Sappir Industrial Park, Netanya, Israel.

|Name and Address                                | Number of SharesBeneficially Owned | Percentage ofSharesBeneficially Owned
|----------------------------------------------- | ---------------------------------- | -------------------------------------
|
|
|
|
|Principal shareholders:                         |                                    |                                      
|Dr. Boaz Eitan(1)                               |                                    |                                      
|IDB Holding Corporation Ltd.(2)                 |                                    |                                      
|Argos Capital Appreciation Master Fund LP(3)    |                                    |                                      
|Directors and executive officers:               |                                    |                                      
|Dr. Boaz Eitan(1)                               |                                    |                                      
|Kobi Rozengarten(4)                             |                                    |                                      
|Ramy Langer                                     |                                    |                                      
|Igal Shany                                      |                                    |                                      
|Eduardo Maayan                                  |                                    |                                      
|Dr. Meir Janai(5)                               |                                    |                                      
|Kenneth Levy(6)                                 |                                    |                                      
|Matty Karp(7)                                   |                                    |                                      
|Yossi Sela(8)                                   |                                    |                                      
|George Hervey(9)                                |                                    |                                      
|Ida Keidar-Malits (10)                          |                                    |                                      
|All directors and executive officers as a group |                                    |                                      

---

* Less than 1.0%

|(1) | Based
on a Schedule 13G filed on February 14, 2007and on other
               information provided to us, the number of shares beneficially owned
consists of                4,920,440 ordinary shares and options to purchase 66,957
ordinary shares held                directly by Dr. Boaz Eitan, 1,905,780 ordinary shares
held by Adi & Gal                Ltd., 1,429,336 ordinary shares held by Sharon & Yoav
Ltd., 1,200,000                ordinary shares held by Shikmat Eitan Ltd., 952,892
ordinary shares held by                Yonatan & Maya Ltd., 476,444 ordinary shares
held by Batya and Yoseph Ltd.                and 10,000 ordinary shares held by MIRAGE
BVBA. Each of these entities is                jointly owned and controlled by Dr. Boaz
Eitan and his wife. This number also                includes 26,666 ordinary shares owned
by Dr. Boaz Eitans wife. Dr. Boaz                Eitan disclaims beneficial
ownership of the shares held by the foregoing except                to the extent of his
pecuniary interest therein.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Based
on a report pursuant to Companies Law 5759-1999 dated March 14, 2007.
|--- | ---------------------------------------------------------------------------

|(3) | Based
on a Schedule 13G filed on February 13, 2007 and on other information
               provided to us, this number consists of 1,502,471 ordinary shares. The
general                partner of Argos Appreciation Master Fund LP is Argo Capital
Management, Inc.                which is wholly-owned by Mr. Ephraim Gildor. The address
of Argos Capital                Appreciation Master Fund LP is 1290 Avenue of the
Americans                34th Floor, New York, New York.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | The
number of shares beneficially owned consists of 374,850 ordinary shares and
               options to purchase 49,434 ordinary shares.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------

- 61 -

---

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|(5) | The
number of shares beneficially owned consists of options to purchase 63,500
               ordinary shares.
|--- | --------------------------------------------------------------------------------------------------------------

|(6) | Based
on information provided to us, the number of shares beneficially owned
               consists of 83,000 ordinary shares and options to purchase 35,000 ordinary
               shares.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Based
on ainformation provided to us, the number of shares beneficially
               owned consists of 647,014 ordinary shares held by K.T. Concord Venture
Fund                (Cayman) L.P., 128,908 ordinary shares held by K.T. Concord Venture
Fund                (Israel) L.P. and 128,143 ordinary shares held by Concord Venture I
Annex-B L.P.                and options to purchase 45,000 ordinary shares held by Mr.
Karp. Mr. Karp is a                managing partner of Concord Ventures and, by virtue of
his position, may be                deemed to have voting and investment power, and thus
beneficial ownership, with                respect to the shares held by these entities.
Mr. Karp disclaims such beneficial                ownership except to the extent of his
pecuniary interest therein.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Based
on a Schedule 13G filed on February 6, 2007.
|--- | --------------------------------------------------

|(9) | The
number of shares beneficially owned consists of options to purchase 75,000
               ordinary shares.
|--- | --------------------------------------------------------------------------------------------------------------

|(10) | The
number of shares beneficially owned consists of options to purchase 10,000
               ordinary shares.
|---- | --------------------------------------------------------------------------------------------------------------

During
the fourth quarter of 2004 and the first quarter of 2005, certain of our principal
shareholders sold our ordinary shares. Ordinary shares beneficially owned by Tower
Semiconductors, representing 11.9% of our outstanding ordinary shares, were sold in the
fourth quarter of 2004 primarily to IDB Holding Corporation Ltd., as well as to entities
affiliated with Gemini Israel Funds, entities affiliated with Concord Ventures, and
certain other shareholders. In February 2005, our ordinary shares beneficially owned by
Infineon Technologies were sold to Argos Capital Appreciation Master Fund LP. Concurrently
with the sale by Infineon Technologies of its ordinary shares, our Chief Executive Officer
and Chairman, Dr. Boaz Eitan, and our President, Mr. Kobi Rozengarten, sold 265,000 and
132,530 shares, respectively, to Argos Capital Appreciation Master Fund L.P. In March
2005, 96,774 ordinary shares owned by Dr. Boaz Eitan were sold to two of our individual
shareholders. In April 2006, principle shareholders as well as directors and executive
officers sold 2,629,291 ordinary shares as part of a public offering of 4,393,170 ordinary
shares. Pursuant to a loan agreement entered into in January 2006 between an affiliate of
Dr. Boaz Eitan and a financial institution, Dr. Boaz Eitan has pledged on February 5, 2007
4,212,221 shares owned directly by him as security for a loan. This amount is subject to a
limited change based on the market price of ordinary shares of Saifun Semiconductors Ltd.
Dr. Boaz Eitan retains the right to vote the shares. The pledge does not have any voting
or dispositive rights over the pledged securities prior to an event of default and, based
on applicable law, is not deemed to be the beneficial owner of the pledged securities

Our
majority shareholders may have different voting rights under particular circumstances. See
Item 10 Memorandum and Articles of Association for more information.

# B. RELATED PARTY
TRANSACTIONS

Our
policy is to enter into transactions with related parties on terms that, on the whole, are
no more favorable, or no less favorable, than those available from unaffiliated third
parties. Based on our experience in the business sectors in which we operate and the terms
of our transactions with unaffiliated third parties, we believe that all of the
transactions described below met this policy standard at the time they occurred.

- 62 -

---

---



# Sale of Shares as part
of our Follow-on Offering

In
April 2006, our Chief Executive Officer and Chairman, Dr. Boaz Eitan, and our President,
Mr. Kobi Rozengarten, sold 500,000 and 106,432 shares, respectively, as part of a public
offering of 4,393,170 ordinary shares. In addition, as part of this offering, entities
affiliated with Gemini Israel Funds Ltd., as well as entities affiliated with Concord
Ventures, sold 811,183 and 699,975 ordinary shares, respectively.

# Registration Rights

| | Demand
registration rights
| | --------------------------

At
any time after nine months following the completion of our initial public offering, at the
request of one or more of our former preferred shareholders that hold at least 33% of our
then outstanding ordinary shares held by our former preferred shareholders, we must use
our best efforts to register any or all of these shareholders ordinary shares as
follows:

| |  | before
we become eligible under applicable securities laws to file a registration statement on
Form F-3, we are required to effect up to two such registrations, but only if the minimum
aggregate offering price of the shares to be registered, net of underwriting discounts
and commissions, exceeds $5.0 million, and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | after
we become eligible under applicable securities laws to file a registration statement on
Form F-3, we are required to effect an unlimited number of registrations, but only (1) if
the minimum aggregate offering price of the shares to be registered, net of underwriting
discounts and commissions, exceeds $500,000, and (2) if we have not effected an offering
pursuant to a demand registration or a piggyback registrationwithin the
preceding six-month period in which all requesting shareholders were able to sell the
number of ordinary shares they requested to include.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Upon
receipt of a request, we must also give notice of the registration to our other former
preferred shareholders and to our other shareholders who held ordinary shares issued prior
to our initial public offering, including entities controlled by Dr. Boaz Eitan, our Chief
Executive Officer and Chairman, and include in the registration any ordinary shares that
they request to include.

| | Piggyback
registration rights
| | -----------------------------

Our
former preferred shareholders and our other shareholders who held ordinary shares issued
prior to our initial public offering, including entities controlled by Dr. Boaz Eitan, our
Chief Executive Officer and Chairman, have the right to request that we include their
ordinary shares in any registration statements filed by us in the future for the purposes
of a public offering, subject to specified limitations.

| | Termination
| | -----------

All
registration rights terminate on the fifth anniversary of the closing of our initial
public offering and, with respect to any individual shareholder, at such time as all
registrable securities of such shareholder may be sold publicly without restriction
pursuant to Rule 144(k) under the Securities Act.

| | Expenses
| | --------

We
will pay all expenses incurred in carrying out the above registrations (excluding
underwriters commissions and fees or any fees of others employed by selling
shareholders), as well as the reasonable fees and expenses of one legal counsel for the
selling shareholders in each registration.

-63 -

---

---



# Agreements with
Directors and Officers

| | Employment
agreements
| | ---------------------

We
have entered into employment agreements with each of our officers. All of these agreements
contain industry-standard provisions regarding non-competition, confidentiality of
information and assignment of inventions. The enforceability of covenants not to compete
in Israel is limited.

Our
employment agreement with Dr. Boaz Eitan, our Chairman and Chief Executive Officer,
effective as of July 1, 2004, shall continue unless terminated by either
Dr. Boaz Eitan or the Company upon one year notice. We shall have the right not to
take advantage of the notice period (in full or in part) and may terminate the employment
of Dr. Boaz Eitan at any time during the notice period, provided that we shall pay Dr.
Boaz Eitan consideration, payments and social benefits for the remainder of the notice
period. We may also terminate the agreement immediately for cause.

| | Exculpation,
indemnification and insurance
| | ------------------------------------------

Our
Articles of Association permit us to exculpate, indemnify and insure our directors and
officers to the fullest extent permitted by the Companies Law. We have entered into
agreements with each of our office holders undertaking to indemnify them to the fullest
extent permitted by law, to the extent that these liabilities are not covered by
insurance.

# Legal Services

One
of the senior partners of our legal counsel in Israel, Eitan, Mehulal, Pappo, Kugler,
Advocates  Patent Attorneys, is the wife of our Chief Executive Officer and
Chairman, Dr. Boaz Eitan. Our expenses to Eitan, Mehulal, Pappo, Kugler, Advocates-Patent
Attorneys or its predecessors for fees for legal services and disbursements totaled
$695,000 in 2004, $865,000 in 2005 and $1,392,000 in 2006.

One
of the senior partners of our a legal counsel in Israel, Makovsky Harpaz & Co.
representing us in the litigation with the former CEO of Ingentix is the brother-in-law of
our Chief Executive Officer and Chairman, Dr. Boaz Eitan. Our expenses to Makovsky Harpaz
& Co. totaled$34,000 in 2004, $27,000 in 2005 and $76,000 in 2006.

# C. INTERESTS OF EXPERTS
AND COUNSEL

Not
applicable.

|ITEM 8. | FINANCIAL
INFORMATION
|------- | ---------------------

# A. CONSOLIDATED
STATEMENTS AND OTHER FINANCIAL INFORMATION

# Financial Statements

See
Item 18 for audited consolidated financial statements.

# Legal Proceedings

Former
CEO of Ingentix Ltd. In October 2002, the former Chief Executive Officer of Ingentix
Ltd., the predecessor of Infineon Technologies Flash Israel, filed a claim against us and
Ingentix in the Tel Aviv Labor Court seeking an order requiring us to reinstate options to
purchase 420,000 of our ordinary shares at an exercise price of $1.69 per share. In
addition, the plaintiff is seeking from Infineon Technologies Flash Israel cash damages of
approximately $284,000 and reinstatement of stock appreciation rights granted by Ingentix.
In January 2004, we submitted our response to the plaintiffs claim. Subsequently, we
agreed to commence mediation in August 2004 at the suggestion of the court in an effort to
resolve without further court proceedings. The mediation ended with no resolution to the
proceedings. We believe that we have meritorious defenses to the claims alleged by the
plaintiff and intend to defend this suit vigorously in the event court proceedings resume.
We have also submitted in the Tel Aviv District court a counter claim against the
plaintiff for breach of contract and fiduciary duty seeking cash damages of approximately
$2.4 million, which we intend to pursue vigorously. We have recorded a provision with
respect to this claim, based on an estimate of our management and based on the opinion of
our legal counsel. The plaintiff filed his summary in December, 2006. We intend to file
our summary in February 2007.

- 64 -

---

---



# Dividend Policy

We
have never declared or paid any cash dividends on our ordinary shares and we do not
anticipate paying any cash dividends on our ordinary shares in the future. We currently
intend to retain all future earnings to finance our operations and to expand our business.
Any future determination relating to our dividend policy will be made at the discretion of
our board of directors and will depend on a number of factors, including future earnings,
capital requirements, financial condition and future prospects and other factors our board
of directors may deem relevant.

See
Item 16E  Purchase of Equity Securities by the Issuer and Affiliated
Purchasers for a discussion of our repurchase plan.

# B. SIGNIFICANT CHANGES

Except
as otherwise disclosed in this Annual Report, there has been no significant change in our
financial position since December 31, 2006.

|ITEM 9. | THE
OFFER AND LISTING
|------- | ---------------------

# A. OFFER AND LISTING
DETAILS

Our
ordinary shares began trading publicly on November 9, 2005. Prior to that date, there was
no public market for our ordinary shares. The following table lists the high and low
closing sale prices for our ordinary shares for the periods indicated as reported by The
Nasdaq Stock Market.

|2005           | High | Low
|-------------- | ---- | ---
|
|
|
|
|               |      |    
|Fourth quarter |      |    

|2006           | High | Low
|-------------- | ---- | ---
|
|
|
|
|First quarter  |      |    
|Second quarter |      |    
|Third quarter  |      |    
|Fourth quarter |      |    
|               |      |    
|2007           |      |    
|               |      |    
|First quarter  |      |    

|Most Recent Six Months | High | Low
|---------------------- | ---- | ---
|
|
|
|
|March 2007             |      |    
|February 2007          |      |    
|January 2007           |      |    
|December 2006          |      |    
|November 2006          |      |    
|October 2006           |      |    
|September 2006         |      |    

On
March 28, 2007, the last reported sale price of our ordinary shares on The Nasdaq Stock
Market was $11.52 per share. According to our transfer agent, as of March 20, 2007, there
were approximately 26 holders of record of our ordinary shares.

- 65 -

---

---



|B. | PLAN
OF DISTRIBUTION
|-- | --------------------

Not
applicable.

|C. | MARKETS
|-- | -------

Our
ordinary shares have traded publicly on the Nasdaq Stock Market under the symbol
SFUN since November 9, 2005.

|D. | SELLING
SHAREHOLDERS
|-- | --------------------

Not
applicable.

|E. | DILUTION
|-- | --------

Not
applicable.

|F. | EXPENSES
OF THE ISSUE
|-- | ---------------------

Not
applicable.

|ITEM 10. | ADDITIONAL
INFORMATION
|-------- | ----------------------

|A. | SHARE
CAPITAL
|-- | -------------

Not
applicable.

|B. | MEMORANDUM
AND ARTICLES OF ASSOCIATION
|-- | --------------------------------------

We
are registered with the Israeli Registrar of Companies in Jerusalem. Our registration
number is 51-239733-2

# Objectives

Our
objectives under our memorandum of association are to engage in any lawful activity in
order to achieve our purposes. According to our memorandum of association, the purposes
for which we were established are: (1) to develop, manufacture and sell semiconductor
technologies and related products, (2) to engage in the operation and exploitation of
software business, and (3) to perform any activity permitted by law.

# Transfer of Shares and
Notices

Fully
paid ordinary shares are issued in registered form and may be freely transferred under our
Articles of Association unless the transfer is restricted or prohibited by another
instrument, Israeli law or the rules of a stock exchange on which the shares are traded.
Our Articles of Association provide that each shareholder of record is entitled to receive
at least 21 days prior notice of any shareholders meeting.

# Election of Directors

Our
ordinary shares do not have cumulative voting rights for the election of directors.
Rather, under our Articles of Association our directors are elected by the holders of a
simple majority of our ordinary shares at a general shareholder meeting. As a result, the
holders of our ordinary shares that represent more than 50.0% of the voting power
represented at a shareholder meeting have the power to elect any or all of our directors
whose positions are being filled at that meeting, subject to the special approval
requirements for outside directors under the Israeli Companies Law described under Item 6
Board Practice  Outside Directors

- 66 -

---

---

# Dividend and Liquidation
Rights

Our
board of directors may declare a dividend to be paid to the holders of ordinary shares in
proportion to the paid up capital attributable to the shares that they hold. Dividends may
only be paid out of our profits and other surplus funds, as defined in the Israeli
Companies Law, as of the end of the most recent fiscal year or as accrued over a period of
two years, whichever is higher, provided that there is no reasonable concern that a
payment of a dividend will prevent us from satisfying our existing and foreseeable
obligations as they become due. If we do not have profits legally available for
distribution, we may seek the approval of the court to distribute a dividend. The court
may approve our request if it is convinced that there is no reasonable concern that a
payment of a dividend will prevent us from satisfying our existing and foreseeable
obligations as they become due.

In
the event of our liquidation, after satisfaction of liabilities to creditors, our assets
will be distributed to the holders of ordinary shares in proportion to the paid up capital
attributable to the shares that they hold. This right may be affected by the grant of
preferential dividend or distribution rights to the holders of a class of shares with
preferential rights that may be authorized in the future.

# Shareholder Meetings

We
are required to convene an annual general meeting of our shareholders once every calendar
year within a period of not more than 15 months following the preceding annual general
meeting. Our board of directors is required to convene a special general meeting of our
shareholders at the request of two directors or one quarter of the members of our board of
directors or at the request of one or more holders of 5.0% or more of our share capital
and 1.0% of our voting power or the holder or holders of 5.0% or more of our voting power.
All shareholder meetings require prior notice of at least 21 days. The chairperson
of our board of directors presides over our general meetings. Subject to the provisions of
the Companies Law and the regulations promulgated thereunder, shareholders entitled to
participate and vote at general meetings are the shareholders of record on a date to be
decided by the board of directors, which may be between four and 60 days prior to the date
of the meeting.

# Quorum

In
accordance with our Articles of Association, the quorum required for an ordinary meeting
of shareholders consists of at least two shareholders present, in person or by proxy, who
hold or represent between them at least 33.33% of our issued share capital. A meeting
adjourned for lack of a quorum generally is adjourned to the same day in the following
week at the same time and place or any time and place as the directors designate in a
notice to the shareholders. At the reconvened meeting, the required quorum consists of at
least two shareholders present, in person or by proxy, who hold or represent between them
at least 20% of our issued share capital. If within half an hour of the time appointed for
the reconvened meeting, the required quorum is not present, the reconvened meeting shall
be convened, provided at least two or more shareholders present in person or by proxy,
unless the meeting was called pursuant to a request by our shareholders in which case the
quorum required is the number of shareholders required to call the meeting as described
under  Shareholder Meetings.

# Voting

Except
as provided below under  Limitations on Voting, holders of our ordinary
shares have one vote for each ordinary share held on all matters submitted to a vote of
shareholders at a shareholder meeting. Shareholders may vote at a shareholder meeting
either in person or by proxy. Israeli law does not provide for public companies, such as
us, to have shareholder resolutions adopted by means of a written consent in lieu of a
shareholder meeting. Shareholder voting rights may be affected by the grant of any special
voting rights to the holders of a class of shares with preferential rights that may be
authorized in the future. The Companies Law provides that a shareholder, in exercising his
or her rights and performing his or her obligations toward the company and its other
shareholders, must act in good faith and in an acceptable manner, and avoid abusing his or
her powers. This is required when voting at general meetings on matters such as changes to
the articles of association, increasing the companys registered capital, mergers and
approval of related party transactions. A shareholder also has a general duty to refrain
from depriving any other shareholder of their rights as a shareholder. In addition, any
controlling shareholder, any shareholder who knows that its vote can determine the outcome
of a shareholder vote and any shareholder who, under the companys articles of
association, can appoint or prevent the appointment of an office holder, is required to
act with fairness towards the company. The Companies Law does not describe the substance
of this duty, except to state that the remedies generally available upon a breach of
contract will apply also in the event of a breach of the duty to act with fairness, and
there is no binding case law that addresses this subject directly. Any voting agreement is
also subject to observance of these duties.

- 67 -

---

---

# Limitations on Voting

In
general, and except as provided below, shareholders have one vote for each ordinary share
held by them and are entitled to vote, on a non-cumulative basis, at all meetings of
shareholders. However, pursuant to a mechanism specified in our Articles of Association,
the voting rights exercisable by a shareholder may be limited. In any situation in which
the controlled shares (as defined below) of any United States person (as
defined below) would constitute 9.9% or more of the votes conferred by our issued and
outstanding ordinary shares, the excess shares will be considered dormant
shares under the Israeli Companies Law with the result that they will not be
entitled to any voting rights, provided that the existence of any dormant shares may not
cause a U.S. person to exceed the 9.9% limitation as a result of such allocation and may
not cause the controlled shares of the permitted United States shareholder (as defined
below) to constitute more than 49.9% of the voting power of all issued and outstanding
shares. In accordance with our Articles of Association, the holder of dormant shares will
be entitled to receive dividends and other distributions.

A
United States person means a United States person as defined in Section 957(c)
of the Code. Controlled shares include, among other things, all ordinary
shares that a person owns directly, indirectly or constructively (within the meaning of
Section 958 of the Code). The permitted United States shareholder means the United States
person, among all United States persons, the controlled shares of which constitute as of
September 29, 2005 the greatest percentage of the total voting power of all issued and
outstanding shares of the Company.

# Resolutions

An
ordinary resolution requires approval by the holders of a simple majority of the voting
rights represented at the meeting, in person, by proxy or by written ballot, and voting on
the resolution.

Under
the Companies Law, unless otherwise provided in the articles of association or applicable
law, all resolutions of the shareholders require a simple majority. A resolution for the
voluntary winding up of the company requires the approval by holders of 75.0% of the
voting rights represented at the meeting, in person, by proxy or by written ballot and
voting on the resolution. Under our Articles of Association (1) certain shareholders
resolutions require the approval of a special majority of the holders of at least 75.0% of
the voting rights represented at the meeting, in person, by proxy or by written ballot and
voting on the resolution, and (2) certain shareholders resolutions require the
approval of a special majority of the holders of at least two-thirds of the voting
securities of the company then outstanding.

# Access to Corporate
Records

Under
the Companies Law, all shareholders generally have the right to review minutes of our
general meetings, our shareholder register, our Articles of Association and any document
we are required by law to file publicly with the Israeli Companies Registrar. Any
shareholder who specifies the purpose of its request may request to review any document in
our possession that relates to any action or transaction with a related party which
requires shareholder approval under the Companies Law. We may deny a request to review a
document if we determine that the request was not made in good faith, that the document
contains a commercial secret or a patent or that the documents disclosure may
otherwise harm our interests.

# Acquisitions under
Israeli Law

Full
Tender Offer. A person wishing to acquire shares or any class of shares of a publicly
traded Israeli company and who would as a result hold over 90.0% of the companys
issued and outstanding share capital or of a class of shares that are listed, is required
by the Companies Law to make a tender offer to all of the companys shareholders or
to all shareholders who hold shares of the same class, as the case may be, for the
purchase of all of the issued and outstanding shares of the company or for the purchase of
all of the issued and outstanding shares of the same class, as the case may be. If the
shareholders who do not respond to the offer hold less than 5.0% of the issued share
capital of the company or of the applicable class, all of the shares that the acquirer
offered to purchase will be transferred to the acquirer by operation of law. However, the
shareholders may petition the court to alter the consideration for the acquisition. If the
dissenting shareholders hold more than 5.0% of the issued and outstanding share capital of
the company or of the applicable class, the acquirer may not acquire additional shares of
the company from shareholders who accepted the tender offer if following such acquisition
the acquirer would then own over 90.0% of the companys issued and outstanding share
capital or of the applicable class.

- 68 -

---

---

Special
Tender Offer. The Companies Law provides that an acquisition of shares of
a public company must be made by means of a tender offer if as a result of the acquisition
the purchaser would hold 25.0% or more of the voting rights at the companys general
meeting, unless one of the exemptions described in the Companies Law is met. This rule
does not apply if there is already another shareholder who holds 25.0% or more of the
voting rights at the companys general meeting. Our Chief Executive Officer and
Chairman, Dr. Boaz Eitan, currently holds more than 25.0% of our outstanding ordinary
shares as determined in accordance with the Companies Law. Similarly, the Companies Law
provides that an acquisition of shares in a public company must be made by means of a
tender offer if, as a result of the acquisition, the purchaser would hold more than a
45.0% of the voting rights of the company, if there is no other shareholder of the company
who holds more than 45.0% of the voting rights in the company, unless one of the
exemptions in the Companies Law is met. A tender offer is not required in the following
circumstances: (i) the purchase was made in a private offer that was approved by the
shareholders as a private offer and was meant to grant the purchaser more than 25% of the
voting rights of a company in which no other shareholder holds more than 25.0% of the
voting rights, or to grant the purchaser more than 45.0% of the voting rights of a company
in which no other shareholder holds more than 45.0% of the voting rights, (ii) the
purchaser would hold more than 25.0% of the voting rights after purchasing shares from a
person that held more than 25% of the voting rights, or (iii) the purchaser would hold
more than 45.0% of the voting rights after purchasing shares from a person that held more
than 45.0% of the voting rights.

In
the event that a special tender offer is made, a companys board of directors is
required to express its opinion on the advisability of the offer, or shall abstain from
expressing any opinion if it is unable to do so, provided that it gives the reasons for
its abstention. An office holder in a target company who, in his or her capacity as an
office holder, performs an action the purpose of which is to cause the failure of an
existing or foreseeable special tender offer or is to impair the chances of its
acceptance, is liable to the potential purchaser and shareholders for damages, unless such
office holder acted in good faith and had reasonable grounds to believe he or she was
acting for the benefit of the company. However, office holders of the target company may
negotiate with the potential purchaser in order to improve the terms of the special tender
offer, and may further negotiate with third parties in order to obtain a competing offer.

If
a special tender offer was accepted by a majority of the shareholders who announced their
stand on such offer, then shareholders who did not announce their stand or who had
objected to the offer may accept the offer within four days of the last day set for the
acceptance of the offer.

In
the event that a special tender offer is accepted, then the purchaser or any person or
entity controlling it or under common control with the purchaser or such controlling
person or entity shall refrain of making a subsequent tender offer for the purchase of
shares of the target company and cannot execute a merger with the target company for a
period of one year from the date of the offer, unless the purchaser or such person or
entity undertook to effect such an offer or merger in the initial special tender offer.

Merger. The
Companies Law permits merger transactions if approved by each           partys
board of directors and, unless certain requirements described under           the
Companies Law are met, the majority of each partys shares voted on the
          proposed merger at a shareholders meeting called on at least 21 days          prior
notice. The board of directors of a merging company is required pursuant           to the
Companies Law to discuss and determine whether in its opinion there           exists a
reasonable concern that as a result of a proposed merger, the surviving           company
will not be able to satisfy its obligations towards its creditors, such
          determination taking into account the financial status of the merging
companies.           If the board has determined that such a concern exists, it may not
approve a           proposed merger. Following the approval of the board of directors of
each of the           merging companies, the boards must jointly prepare a merger
proposal for           submission to the Israeli Registrar of Companies. Under the
Companies Law, if           the approval of a general meeting of the shareholders is
required, merger           transactions may be approved by holders of a simple majority
of our shares           present, in person or by proxy, at a general meeting and voting
on the           transaction. In determining whether the required majority has approved
the           merger, if shares of the Company are held by the other party to the merger,
or           by any person holding at least 25.0% of the outstanding voting shares or
25.0%           of the means of appointing directors of the other party to the merger,
then a           vote against the merger by holders of the majority of the shares present
and           voting, excluding shares held by the other party or by such person, or
anyone           acting on behalf of either of them, is sufficient to reject the merger
          transaction. If the transaction would have been approved but for the exclusion
          of the votes of certain shareholders as provided above, a court may still
          approve the merger upon the request of holders of at least 25.0% of the voting
          rights of a company, if the court holds that the merger is fair and reasonable,
          taking into account the value of the parties to the merger and the
consideration           offered to the shareholders. Upon the request of a creditor of
either party to           the proposed merger, the court may delay or prevent the merger
if it concludes           that there exists a reasonable concern that, as a result of the
merger, the           surviving company will be unable to satisfy the obligations of any
of the           parties to the merger. In addition, a merger may not be completed unless
at           least 50 days have passed from the date that a proposal for approval of the
          merger was filed with the Israeli Registrar of Companies and 30 days have
passed           from the date that shareholder approval of both merging companies was
obtained.

- 69 -

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# Anti-Takeover Measures

Undesignated
preferred stock. The Companies Law allows us to create and issue shares having rights
different than those attached to our ordinary shares, including shares providing certain
preferred or additional rights to voting, distributions or other matters and shares having
preemptive rights. We do not have any authorized or issued shares other than ordinary
shares. In the future, if we do create and issue a class of shares other than ordinary
shares, such class of shares, depending on the specific rights that may be attached to
them, may delay or prevent a takeover or otherwise prevent our shareholders from realizing
a potential premium over the market value of their ordinary shares. The authorization of a
new class of shares will require an amendment to our Articles of Association which
requires the prior approval of a majority of our shareholders at a general meeting.
Shareholders voting at such a meeting will be subject to the restrictions under the
Companies Law described in  Voting.

Transactions
with interested shareholders. Our Articles of Association contain a provision that
prohibits us from engaging in any business combination with any interested shareholder for
a period of three years following the date that the shareholder became an interested
shareholder, unless:

| |  | prior
to that date, the board of directors of the corporation approved either the business
combination or the transaction that resulted in the shareholder becoming an interested
shareholder;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | upon
consummation of the transaction that resulted in the shareholder becoming an interested
shareholder, the interested shareholder owned at least 75% of the voting share of the
corporation outstanding at the time the transaction commenced, excluding, for purposes of
determining the number of shares outstanding, unissued shares of the company which may be
issued pursuant to any agreement, arrangement or understanding, or upon exercise of
conversion rights, warrants or options, or otherwise.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A
business combination is defined to include the following:

| |  | any
merger or consolidation involving the corporation and the interested shareholder;
| | - | -------------------------------------------------------------------------------------

| |  | any
sale, transfer, pledge or other disposition of 10% or more of the assets of the
corporation involving              the interested shareholder;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------

| |  | subject
to certain exceptions, any transaction that results in the issuance or transfer by the
corporation              of any shares of the corporation to the interested shareholder;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | any
transaction involving the corporation that has the effect of increasing the proportionate
share of the shares of any class or series of the corporation beneficially owned by the
interested shareholder; or
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
receipt by the interested shareholder or the benefit of any loans, advances, guarantees,
pledges or other financial benefits provided by or through the corporation.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 70 -

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---

An
interested shareholder is defined as an entity or person beneficially owning
15% or more of the outstanding voting shares of the company and any entity or person
affiliated with or controlling or controlled by any of these entities or persons.

Supermajority
voting. Under our Articles of Association (1) certain shareholders resolutions
require the approval of a special majority of the holders of at least 75.0% of the voting
rights represented at the meeting, in person, by proxy or by written ballot and voting on
the resolution, and (2) certain shareholders resolutions require the approval of a
special majority of the holders of at least two-thirds of the voting securities of the
company then outstanding.

Classified
board of directors. Our amended and restated Articles of Association provide for a
classified board of directors. See Management  Board of Directors and
Officers.

# Transfer Agent and
Registrar

The
transfer agent and registrar for our ordinary shares is American Stock Transfer &
Trust Company. Its address is 59 Maiden Lane, New York, New York 10038 and its telephone
number at this location is (212) 936-5100.

|C. | MATERIAL
CONTRACTS
|-- | ------------------

Summaries
of the following material contracts are included in this Annual Report in the places
indicated:

|Material Contract               |  | Location                                         | 
|------------------------------- |  | ------------------------------------------------ | 
|
|License Agreement with Macronix |  | Item 4.B:  "Information on the Company - Part B: | 
|                                |  | Business Overview - Licensees."                  | 
|License Agreement with Spansion |  | Item 4.B:  "Information on the Company - Part B: | 
|                                |  | Business Overview - Licensees."                  | 

|D. | EXCHANGE
CONTROLS
|-- | -----------------

In
1998, Israeli currency control regulations were liberalized significantly, so that Israeli
residents generally may freely deal in foreign currency and foreign assets, and
non-residents may freely deal in Israeli currency and Israeli assets. There are currently
no Israeli currency control restrictions on remittances of dividends on the ordinary
shares or the proceeds from the sale of the shares provided that all taxes were paid or
withheld; however, legislation remains in effect pursuant to which currency controls can
be imposed by administrative action at any time.

Non-residents
of Israel may freely hold and trade our securities. Neither our memorandum of association
nor our articles of association nor the laws of the State of Israel restrict in any way
the ownership or voting of ordinary shares by non-residents, except that such restrictions
may exist with respect to citizens of countries which are in a state of war with Israel.
Israeli residents are allowed to purchase our ordinary shares.

|E. | TAXATION
|-- | --------

# Israeli Tax
Considerations and Government Programs

General

The
following is a general discussion only and is not exhaustive of all possible tax
considerations. It is not intended, and should not be construed, as legal or professional
tax advice and should not be relied upon for tax planning purposes. In addition, this
discussion does not address all of the tax consequences that may be relevant to purchasers
of our ordinary shares in light of their particular circumstances, or certain types of
purchasers of our ordinary shares subject to special tax treatment. Examples of this kind
of investor include residents of Israel and traders in securities who are subject to
special tax regimes not covered in this discussion. Each individual/entity should consult
its own tax or legal advisor as to the Israeli tax consequences of the purchase, ownership
and disposition of our ordinary shares.

- 71 -

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---

To
the extent that part of the discussion is based on new tax legislation, which has not been
subject to judicial or administrative interpretation, we cannot assure that the tax
authorities or the courts will accept the views expressed in this section.

The
following summary describes the current tax structure applicable to companies in Israel,
with special reference to its effect on us. The following also contains a discussion of
the material Israeli tax consequences to holders of our ordinary shares.

Taxation of Companies

General
Corporate Tax Structure. Generally, Israeli companies are subject to corporate tax at
the rate of 31% on taxable income for the year 2006 and are subject to capital gains tax
at a rate of 25% on capital gains (other than gains derived from the sale of listed
securities that are taxed at the prevailing corporate tax rates) derived after January 1,
2003. However, the effective tax rate payable by a company that derives income from an
approved enterprise (as discussed below) may be considerably lower. Depending on the
relevant tax treaties at issue, dividends or interest received by an Israeli company from
foreign subsidiaries are generally subject to tax regardless of the companys status
as an approved enterprise. Under recently adopted legislation, taxes paid by Israeli
companies will be gradually reduced to a rate of 29% for the 2007 tax year, 27% for the
2008 tax year, 26% for the 2009 tax year and 25% for the 2010 tax year and thereafter.

Tax
Benefits and Grants for Research and Development. Israeli tax law allows, under
specified conditions, a tax deduction for expenditures, including capital expenditures,
for the year in which they are incurred. These expenses must relate to scientific research
and development projects and must be approved by the relevant Israeli government ministry,
determined by the field of research. Furthermore, the research and development must be for
the promotion of the companys business and carried out by or on behalf of the
company seeking such tax deduction. However, the amount of such deductible expenses is
reduced by the sum of funds received through government grants for the finance of such
scientific research and development projects. Expenditures not so approved are deductible
over a three-year period.

We
have applied to the Office of the Chief Scientist of Israel, in order to receive approval
for a tax deduction for all research and development expenses during the year incurred. We
have received an approval from the Office of the Chief Scientist for such tax deduction
with respect to the 2004 tax year. However, there is no assurance that our application for
subsequent years will be accepted.

Tax
Benefits Under the Law for the Encouragement of Industry (Taxes), 1969. According to
the Law for the Encouragement of Industry (Taxes), 1969 (Industry Encouragement
Law), industrial companies are entitled to the following tax benefits, among others:

| |  | deduction
of purchases of know-how and patents over an eight-year period for tax purposes;
| | - | ------------------------------------------------------------------------------------------

| |  | expenses
involved with the issuance and listing of shares on The Tel Aviv Stock Exchange or on a
recognized stock market outside of Israel, are deductible over a three-year period;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
right to elect, under specified conditions, to file a consolidated tax return with other
related Israeli industrial companies; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------

| |  | accelerated
depreciation rates on equipment and buildings.
| | - | ----------------------------------------------------------

According
to the law, an industrial company is defined as a company resident in Israel,
at least 90% of the income of which, in any tax year, determined in Israeli currency
(exclusive of income from government loans, capital gains, interest and dividends) is
derived from an industrial enterprise owned by it. An industrial
enterprise is defined as an enterprise whose major activity in a given tax year is
industrial production activity. Eligibility for benefits under the Industry Encouragement
Law is not subject to receipt of prior approval from any governmental authority.

We
believe that we currently qualify as an industrial company within the definition under the
Industry Encouragement Law. However, we cannot give any assurance that we will continue to
qualify as an industrial company or that the benefits described above will be
available in the future.

- 72 -

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---

Law
for the Encouragement of Capital Investments, 1959. The Law for the Encouragement of
Capital Investments, 1959, as amended (the Investments Law), provides that a
capital investment in eligible facilities may, upon application to the Investment Center
of the Ministry of Industry, Trade and Labor of the State of Israel, be designated as an
Approved Enterprise. Each certificate of approval for an approved enterprise
relates to a specific investment program, delineated both by the financial scope of the
investment and by the physical characteristics of the facility or the asset. An approved
enterprise is entitled to benefits including Israeli Government cash grants and tax
benefits in specified development areas. The extent of the tax benefits available under
the Investment Law and the period for which tax benefits are available are determined by
the geographic location of the enterprise. The benefits are dependent upon the fulfillment
of conditions stipulated in the Investment Law and its regulations, including the criteria
set forth in the specific certificate of approval. The tax benefits from any certificate
of approval relate only to taxable profits attributable to the specific approved
enterprise. If a company has more than one approval or only a portion of its enterprise is
approved, its effective tax rate is the result of a weighted average of the applicable
rates (such weighted average is calculated in accordance with the guidelines of the
Investment Law).

Tax
benefits given under the Investment Law also apply to income generated by a company from
the grant of a usage right with respect to know-how developed by the approved enterprise,
income generated from royalties, and income derived from a service which is auxiliary to
such usage right or royalties, provided that such income is generated in the course of the
approved enterprises ordinary course of business.

Each
application to the Investment Center is reviewed separately and a decision as to whether
or not to approve such application is based, among other things, on the then-prevailing
criteria set forth in the law, the specific objectives of the applicant company set forth
in such application and certain financial criteria of the applicant company. Accordingly,
there can be no assurance that any future application will be approved. In addition, as
described above, the benefits available to an approved enterprise are dependent upon the
fulfillment of certain conditions stipulated in the Investments Law and its regulations
and the criteria set forth in the specific certificate of approval. In the event that
these conditions are violated, in whole or in part, we would be required to refund the
amount of tax benefits, with the addition of the Israeli consumer price index linkage
adjustment and interest. We believe our approved enterprise operates in substantial
compliance with all such conditions and criteria.

On
April 1, 2005, a comprehensive amendment to the Investments Law came into effect. As the
amended Investments Law does not retroactively apply to investments programs having an
approved enterprise approval certificate issued by the Israeli Investment Center prior to
December 31, 2004, our current tax benefits are subject to the provisions of the
Investments Law prior to its revision. Our approved plans subsequent to 2002 and others
that may be received in the future will be subject to the provisions of the Investments
Law, as amended. Accordingly, the following description includes a summary of the
Investments Law prior to its amendment as well as the relevant changes contained in the
Investments Law.

In
1998, our investment program in our facility in Netanya, Israel, was approved as an
approved enterprise under the alternative program provided by the Investments
Law. Our requests for expansion of our approved enterprise were approved in November 2000
and December 2002. The expansion of our approved enterprise that was approved in December
2002, which we did not utilize, was cancelled by us in March 2006. The cancellation was
made in accordance with a pre-ruling we have obtained from the Israeli tax authorities,
providing that the investment made by us under the 2002 expansion will be considered as
part of the investment required under the amendment Investments Law in order to comply
with the definition of privileged enterprise as defined thereunder and as
further detailed below.

Under
the terms of our approved enterprise, once we begin generating taxable net income, we will
be entitled to a tax exemption with respect to the income derived from our approved
enterprise program for two years and will be subject to a reduced company tax rate of
between 10% and 25% for the following five to eight years, depending on the extent of
foreign (non-Israeli) investment in our company during the relevant year. The tax rate
will be 20% if the foreign investment level is more than 49% but less than 74%, 15% if the
foreign investment level is more than 74% but less than 90%, and 10% if the foreign
investment level is 90% or more. The lowest level of foreign investment during a
particular year will be used to determine the relevant tax rate for that year. The period
in which we receive these tax benefits is limited to 12 years from the year in which
operations or production by the enterprise commenced or 14 years from the year in which
approval was granted, whichever is the earlier. Dividends distributed from tax-exempt
income would be taxed according to the company tax rate that would have been applicable
had the company not been exempt from taxation that year. This rate is generally 10% to 25%
depending on the extent of foreign investment in the company.

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Dividends
paid out of income generated by an approved enterprise (or out of dividends received from
a company whose income is generated by an approved enterprise) are generally subject to
withholding tax at the rate applicable to dividends from approved enterprises (15%),
unless a different rate is provided according to a treaty between Israel and the
shareholders country of residence (if the dividend is distributed out of income
derived during the tax exemption period or within 12 years thereafter). The company must
withhold this tax at source.

The
Investments Law also provides that an approved enterprise is entitled to accelerated
depreciation on its property and equipment that are included in an approved investment
program. We have not utilized this benefit.

Grants
and other incentives received by a company in accordance with the Investments Law remain
subject to final ratification by the Investment Center of the Israeli Ministry of
Industry, Trade and Labor, such ratification being conditional upon fulfillment of all
terms of the approved program. We received ratification from the Investment Center for our
first approved enterprise program in 2001, and in 2003 for the request for expansion of
such program, which was approved in November 2000. The expansion of our approved
enterprise that was approved in December 2002 was cancelled by us in March 2006. Under a
pre-ruling we have received from tax authorities, hereinafter referred to as the
pre-ruling, the investment made by us under the December 2002 expansion we have cancelled
will be considered as part of the investment required under the amended Investments Law in
order to comply with the definition of privileged enterprise as defined
thereunder.

Pursuant
to the amendment to the Investment Law, effective as of April 1, 2005, the basic condition
for receiving the benefits (both under the grant and the tax benefits programs) is the
enterprises contribution to the economic independence of Israel and its contribution
to the gross domestic product. In order to fulfill these conditions, the enterprise is
required to be categorized as an industrial enterprise which complies with any of the
following:

| |  | its
major activity is in the field of biotechnology or nano-technology;
| | - | -----------------------------------------------------------------------

| |  | its
revenues during the applicable tax year from any single market (i.e. country or a
separate customs               territory) do not exceed 75% of the privileged
enterprise's aggregate revenues during such               year; or
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 25%
or more of its revenues during the applicable tax year are generated from sales into a
single market (i.e. country or a separate customs territory) with a population of at
least 12 million residents.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

It
should be noted that the amendment to the Investments Law further addresses benefits that
are being granted to enterprises and the length of the benefits period.

There
can be no assurance that we will comply with the above conditions in the future or with
the conditions set forth in the pre-ruling, or that we will be entitled to any additional
benefits under the amended Investments Law.

According
to the amendment to the Investments Law, only approved enterprises receiving cash grants
require the approval of the Investment Center. Approved enterprises, which do not receive
benefits in the form of governmental cash grants, such as benefits in the form of tax
benefits, are no longer required to obtain this approval (such enterprises are referred to
as privileged enterprises). In order to be eligible for the tax benefits,
privileged enterprises are required to comply with certain requirements and make certain
investments as specified in the amended Investments Law. The privileged enterprises are
subject to the responsibility of the Israeli Tax Authority and may, at their discretion,
in order to provide greater certainty, elect to apply for a pre-ruling from the Israeli
tax authorities confirming that they are in compliance with the provisions of the amended
Investments Law and therefore are entitled to receive the benefits provided under the
amended Investments Law as was recently obtained by us as detailed above. The amended
Investment Law also specifies which income of the privileged enterprise is entitled to tax
benefits (for example income generated from the sale of products that were manufactured by
the privileged enterprise, income generated from usage right with respect to know-how
developed by the privileged enterprise, etc.).

There
can be no assurance that we will comply with the conditions required for privileged
enterprises under the amended Investment Law in the future or with the conditions set
forth in the pre-ruling, or that we will be entitled to any additional benefits under the
amended Investments Law.

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In
addition, the amended Investment Law changed the definition of foreign
investment according to the Investment Law so that the definition, instead of a
foreign currency investment, now requires a minimal investment of NIS 5 million by foreign
investors. Furthermore, such definition now also includes the purchase of shares of a
company from another shareholder (secondary market purchase), provided that the
companys outstanding and paid-up share capital exceed NIS 5 million. Such changes to
the aforementioned definition will take effect retroactively from 2003.

In
order to manage certain investments, we have established a wholly owned subsidiary, Saifun
(BVI) Limited, a company incorporated under the laws of the British Virgin Islands. Under
our Approved Enterprise status, we are not entitled to receive any tax benefits from any
income derived from investments made through Saifun (BVI) Limited. As of December 31,
2006, we have utilized all the carryforward losses related to Saifun (BVI) Limited. After
the carryforward losses are utilized, the taxable income will be subject to Israeli income
tax, which will be considered a deemed dividend and taxed at a 25% tax rate.

Special
Provisions Relating to Taxation Under Inflationary Conditions. The Income Tax Law
(Inflationary Adjustments), 1985, generally referred to as the Inflationary Adjustments
Law, represents an attempt to overcome the problems presented to a traditional tax system
by an economy undergoing rapid inflation. The Inflationary Adjustments Law is highly
complex. The features that are material to us can be described as follows:

| |  | When
the value of a companys equity, as calculated under the Inflationary Adjustments
Law, exceeds the depreciated cost of its fixed assets (as defined in the Inflationary
Adjustments Law), a deduction from taxable income is permitted equal to the excess
multiplied by the applicable annual rate of inflation. The maximum deduction permitted in
any single tax year is 70% of taxable income, with the unused portion permitted to be
carried forward, linked to the increase in the consumer price index.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | If
the depreciated cost of the companys fixed assets exceeds its equity, then the
excess multiplied by the applicable annual rate of inflation is added to taxable income.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Subject
to certain limitations, depreciation deductions on fixed assets and losses carried
forward are adjusted for inflation based on the increase in the Israeli consumer price
index.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
Minister of Finance may, with the approval of the Knesset Finance Committee, determine by
decree, during a certain fiscal year (or until February 28th of the following year) in
which the rate of increase of the Israeli consumer price index would not exceed or did not
exceed 3%, that some or all of the provisions of the Inflationary Adjustments Law shall
not apply with respect to such fiscal year, or, that the rate of increase of the Israeli
consumer price index relating to such fiscal year shall be deemed to be 0%, and to make
the adjustments required to be made as a result of such determination. The Minister made
no such determination in respect of 2006, even though the price index in 2006 declined by
0.1%.

The
ITO and regulations promulgated thereunder allow Foreign-Invested Companies,
(as defined in the Investments Law) that maintain their accounts in U.S. dollars in
compliance with regulations published by the Israeli Minister of Finance, to base their
tax returns on their operating results as reflected in their U.S. dollar financial
statements or to adjust their tax returns based on exchange rate changes rather than
changes in the Israeli consumer price index, in lieu of the principles set forth by the
Inflationary Adjustments Law. For these purposes, a Foreign-Invested Company is a company
(1) more than 25% of whose share capital, in terms of rights to profits, voting and
appointment of directors are held by persons who are not residents of Israel, and (2) more
than 25% of whose combined share and loan capital is held by persons who are not residents
of Israel. A company that elects to measure its results for tax purposes based on the
U.S. dollar exchange rate cannot change such election for a period of three years
following the election. We have elected to measure our results for tax purposes based on
the U.S. dollar exchange rate as of January 1, 2006.

Transfer
Pricing. As part of the Israeli 2003 tax reform, the Israeli Tax Ordinance was amended
to include section 85A, dealing with international transactions transfer pricing. Section
85A provides that regardless of the actual conditions of an international transaction
between related parties, the transaction shall be reported and taxed, based on the
arms length standard, i.e., based on market conditions in similar
transactions between unrelated parties. On October 30, 2006, the Income Tax Regulations
(Determination of Market Conditions), hereinafter referred to as the Regulations, which
provide instructions for the implementation of section 85A, came into effect.

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In
accordance with the Regulations, a transaction shall be considered an international
transaction if one of the parties is a foreign resident as defined thereunder
or if the income generated from such transaction, in all or in part, is taxed both in and
outside of Israel. The Regulations establish acceptable methods for comparison between
transactions, and methods for calculating the price range against which the transaction is
measured.

Taxpayers
are required to include in their yearly income tax returns a report regarding their
international transactions at arms length prices.

| | Taxation
of our Shareholders
| | ----------------------------

Taxation
of Non-Israeli Shareholders on Receipt of Dividends. Non-residents of Israel are
generally subject to Israeli income tax on the receipt of dividends paid on our ordinary
shares at the rate of 20% for dividends paid to individuals or foreign corporations or 15%
for dividends or income generated by an approved enterprise, unless a different rate is
provided in a treaty between Israel and the shareholders country of residence. The
company must withhold this tax at source.

However,
the tax rate on dividends paid to a substantial shareholder (which is someone
who alone, or together with another person, holds, directly or indirectly, at least 10% in
one or all of any of the means of control in the corporation) is 25%. Means of
control generally include the right to vote, receive profits, nominate a director or
an officer, receive assets upon liquidation, or order someone who holds any of the
aforesaid rights how to act, and all regardless of the source of such right. The
determination of whether an individual is a substantial shareholder will be made on the
date the shares are being sold. However, an individual will be also deemed to be a
substantial shareholder if at any time during the 12 months preceding such date he or
she had been a substantial shareholder.

Under
the U.S.-Israel Tax Treaty, the maximum rate of tax withheld in Israel on dividends paid
to a holder of our ordinary shares who is a U.S. resident (within the meaning of the
U.S.-Israel Tax Treaty) is 25%. However, dividends paid from income derived from our
approved enterprise are subject to withholding at the rate of 15%, although we cannot
assure you that we will designate the profits that are being distributed in a way that
will reduce shareholders tax liability according to the U.S.-Israel Tax Treaty.
Furthermore, the maximum rate of withholding tax on dividends, not generated by our
approved enterprise, that are paid to a U.S. corporation holding 10% or more of our
outstanding voting capital during the part of the tax year that precedes the date of the
payment of the dividend and during the whole of its prior tax year, is 12.5%. This reduced
rate will not apply if more than 25% of the Israeli companys gross income consists
of interest or dividends, other than dividends or interest received from a subsidiary
corporation 50% or more of the outstanding shares of the voting shares of which are owned
by the company.

A
non-resident of Israel who receives dividends from which tax was fully paid is generally
exempt from the duty to file returns in Israel in respect of such income, provided such
income was not derived from a business conducted in Israel by the taxpayer, and the
taxpayer has no other taxable sources of income in Israel.

Capital
Gains Taxes Applicable to Non-Israeli Shareholders. In general, Israel imposes capital
gains tax on the sale of capital assets, including shares of Israeli companies by both
Israeli residents and non-Israeli resident shareholders, unless a specific exemption is
available or unless a tax treaty between Israel and the shareholders country of
residence provided otherwise.Shareholders that are not Israeli residents are
generally exempt from Israeli capital gains tax on any gains derived from the sale of our
ordinary shares, provided that (1) such shareholders did not acquire their shares prior to
our initial public offering, (2) the shares are listed for trading on a stock exchange in
a jurisdiction with which Israel has a treaty, (3) the provisions of the Inflationary
Adjustments Law or section 130A of the ITO do not apply to such gain, and (4) such gains
did not derive from a permanent establishment of such shareholders in Israel. However,
non-Israeli corporations will not be entitled to the foregoing exemptions if an Israeli
resident (i) has a controlling interest of 25% or more in such non-Israeli corporation, or
(ii) is the beneficiary of or is entitled to 25% or more of the revenues or profits of
such non-Israeli corporation, whether directly or indirectly. These provisions dealing
with capital gains are not applicable to a person whose gains from selling or otherwise
disposing of the shares are deemed to be business income.

In
certain instances where our non-Israeli shareholders may be liable to Israeli tax on the
sale of their ordinary shares, the payment of the consideration may be subject to Israeli
withholding tax.

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In
addition, the sale, exchange or disposition of our ordinary shares by shareholders who are
U.S. residents (within the meaning of the U.S.-Israel Tax Treaty) holding the ordinary
shares as a capital asset will also be exempt from Israeli capital gains tax under the
U.S.-Israel Tax Treaty unless either (i) the shareholders hold, directly or indirectly,
shares representing 10% or more of our voting capital during any part of the 12-month
period preceding such sale, exchange or disposition, or (ii) the capital gains arising
from such sale, exchange or disposition are attributable to a permanent establishment of
the shareholders located in Israel. In such case the shareholders would be subject to
Israeli capital gain tax, to the extent applicable, as mentioned above. However, under the
U.S.-Israel Tax Treaty, the U.S. resident would be permitted to claim a credit for
such taxes against the U.S. federal income tax imposed on the sale, exchange or
disposition, subject to the limitation in the U.S. law applicable to foreign tax credits.
The U.S.-Israel Tax Treaty does not relate to U.S. state or local taxes. In addition, a
temporary provision of the Israeli tax laws exempts treaty country residents from capital
gains tax on the sale of securities in Israeli companies purchased between July 1, 2005
and December 31, 2008, if certain conditions are met.

# United States Federal
Income Taxation

The
following is a description of the material United States federal income tax consequences
of the acquisition, ownership and disposition of our ordinary shares. This description
addresses only the United States federal income tax considerations of holders that will
hold our ordinary shares as capital assets. This description does not address tax
considerations applicable to holders that may be subject to special tax rules, including:

| |  | financial
institutions or insurance companies;
| | - | ----------------------------------------------

| |  | real
estate investment trusts, regulated investment companies or grantor trusts;
| | - | --------------------------------------------------------------------------------

| |  | dealers
or traders in securities or currencies;
| | - | -----------------------------------------------

| |  | tax-exempt
entities;
| | - | --------------------

| |  | persons
that received our shares as compensation for the performance of services;
| | - | ---------------------------------------------------------------------------------

| |  | holders
that will hold our shares through a partnership or other pass-through entity;
| | - | -------------------------------------------------------------------------------------

| |  | persons
that will hold our shares as part of a hedging or conversion transaction
or as a position in a straddle for United States federal income tax purposes;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | certain
former citizens or residents of the United States;
| | - | ----------------------------------------------------------

| |  | persons
whose "functional currency" is not the United States dollar; or
| | - | -----------------------------------------------------------------------

| |  | holders
that own directly, indirectly or through attribution 10.0% or more, of the voting power
or value, of our shares.
| | - | ------------------------------------------------------------------------------------------------------------------------

Moreover,
this description does not address the United States federal estate and gift or alternative
minimum tax consequences of the acquisition, ownership and disposition of our ordinary
shares.

This
description is based on the Code, existing, proposed and temporary United States Treasury
Regulations and judicial and administrative interpretations thereof, in each case as in
effect and available on the date of this Annual Report. All of the foregoing are subject
to change, which change could apply retroactively and could affect the tax consequences
described below.

For
purposes of this description, a U.S. Holder is a beneficial owner of our
ordinary shares that, for United States federal income tax purposes, is:

| |  | a
corporation or other entity treated as a corporation for Untied States federal income tax
purposes created or organized under the laws of the United States or any state thereof,
including the District of Columbia;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
citizen or resident of the United States;
| | - | -------------------------------------------

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| |  | an
estate the income of which is subject to United States federal income taxation regardless
of its source;               or
| | - | ----------------------------------------------------------------------------------------------------------------------------

| |  | a
trust if such trust has validly elected to be treated as a United States person for
United States federal income tax purposes or if (1) a court within the United States is
able to exercise primary supervision over its administration and (2) one or more United
States persons have the authority to control all of the substantial decisions of such
trust.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A
Non-U.S. Holder is a beneficial owner of our ordinary shares that is not a
U.S. Holder.

If
a partnership (or any other entity treated as a partnership for United States federal
income tax purposes) holds our ordinary shares, the tax treatment of a partner in such
partnership will generally depend on the status of the partner and the activities of the
partnership. Such a partner or partnership should consult its tax advisor as to its tax
consequences.

You
should consult your tax advisor with respect to the United States federal, state, local
and foreign tax consequences of acquiring, owning and disposing of our ordinary shares.

| | Distributions
| | -------------

Subject
to the discussion below under Passive Foreign Investment Company
Considerations and Controlled Foreign Corporation Considerations, if you
are a U.S. Holder, for United States federal income tax purposes, the gross amount of any
distribution made to you, with respect to your ordinary shares before reduction for any
Israeli taxes withheld therefrom, other than certain distributions, if any, of our
ordinary shares distributed pro rata to all of our shareholders, will be includible in
your income as dividend income to the extent such distribution is paid out of our current
or accumulated earnings and profits as determined under United States federal income tax
principles. Subject to the discussion below under Passive Foreign Investment Company
Considerations, non-corporate U.S. Holders may qualify for the lower rates of
taxation with respect to dividends on ordinary shares applicable to long-term capital
gains (i.e., gains from the sale of capital assets held for more than one year) with
respect to taxable years beginning on or before December 31, 2010, provided that certain
conditions are met, including certain holding period requirements and the absence of
certain risk reduction transactions. However, such dividends will not be eligible for the
dividends received deduction generally allowed to corporate U.S. Holders. Subject to the
discussion below under Passive Foreign Investment Company Considerations and
Controlled Foreign Corporation Considerations, to the extent, if any, that the
amount of any distribution by us exceeds our current and accumulated earnings and profits
as determined under United States federal income tax principles, it will be treated first
as a tax-free return of your adjusted tax basis in your ordinary shares and thereafter as
capital gain. We do not expect to maintain calculations of our earnings and profits under
United States federal income tax principles, and, therefore, if you are a U.S. Holder you
should expect that the entire amount of any distribution generally will be reported as
dividend income to you.

If
you are a U.S. Holder, dividends paid to you with respect to your ordinary shares will be
treated as foreign source income, which may be relevant in calculating your foreign tax
credit limitation. Subject to certain conditions and limitations, Israeli tax withheld on
dividends may be deducted from your taxable income or credited against your United States
federal income tax liability. The limitation on foreign taxes eligible for credit is
calculated separately with respect to specific classes of income. For this purpose, for
taxable years beginning before January 1, 2007, dividends that we distribute generally
will constitute passive income, or, in the case of certain U.S. Holders,
financial services income and for taxable years beginning after December 31,
2006 dividends that we distribute generally should constitute passive category
income, or in the case of certain U.S. Holders, general category income.
The rules relating to the determination of the foreign tax credit are complex, and you
should consult your personal tax advisors to determine whether and to what extent you
would be entitled to this credit.

Subject
to the discussion below under Backup Withholding Tax and Information Reporting
Requirements, if you are a Non-U.S. Holder, you generally will not be subject to
United States federal income or withholding tax on dividends received by you on your
ordinary shares, unless you conduct a trade or business in the United States and such
income is effectively connected with that trade or business.

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| | Sale,
Exchange or Other Disposition of Ordinary Shares
| | ------------------------------------------------------

Subject
to the discussion below under Passive Foreign Investment Company
Considerations and Controlled Foreign Corporation Considerations, if you
are a U.S. Holder, you generally will recognize gain or loss on the sale, exchange or
other disposition of your ordinary shares equal to the difference between the amount
realized on such sale, exchange or other disposition and your adjusted tax basis in your
ordinary shares. Such gain or loss will be capital gain or loss. If you are a noncorporate
U.S. Holder, capital gain from the sale, exchange or other disposition of ordinary shares
is eligible for the preferential rate of taxation applicable to long-term capital gains,
with respect to taxable years beginning on or before December 31, 2010, if your holding
period for such ordinary shares exceeds one year (i.e., such gain is long-term capital
gain). Gain or loss, if any, recognized by you generally will be treated as United States
source income or loss for United States foreign tax credit purposes. The deductibility of
capital losses for U.S. federal income tax purposes is subject to limitations.

Subject
to the discussion below under Backup Withholding Tax and Information Reporting
Requirements, if you are a Non-U.S. Holder, you generally will not be subject to
United States federal income or withholding tax on any gain realized on the sale or
exchange of such ordinary shares unless:

| |  | such
gain is effectively connected with your conduct of a trade or business in the United
States; or
| | - | ----------------------------------------------------------------------------------------------------

| |  | you
are an individual and have been present in the United States for 183 days or more in the
taxable year of such sale or exchange and certain other conditions are met.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Passive
Foreign Investment Company Considerations
| | -------------------------------------------------

A
non-U.S. corporation will be classified as a passive foreign investment
company, or a PFIC, for United States federal income tax purposes in any taxable
year in which, after applying certain look-through rules, either

| |  | at
least 75 percent of its gross income is "passive income"; or
| | - | ---------------------------------------------------------------

| |  | at
least 50 percent of the average value of its gross assets (based on the quarterly value
of such gross assets) is attributable to assets that produce passive income or
are held for the production of passive income.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Passive
income for this purpose generally includes dividends, interest, royalties, rents, gains
from commodities and securities transactions, the excess of gains over losses from the
disposition of assets which produce passive income, and includes amounts derived by reason
of the temporary investment of funds raised in offerings of our ordinary shares.

Based
on our estimated gross income, the average value of our gross assets (the latter
determined by reference to the market value of our shares and valuing our intangible
assets using the methods prescribed for publicly traded corporations) and the nature of
our business, we expect that we would not be classified as a PFIC for the taxable year
ended December 31, 2006. although, based on the value of our gross assets determined by
reference to the market value of our shares at the end of the first quarter of the 2007
taxable year, we expect that we would be classified as a PFIC for the 2007 taxable year.
However, because PFIC status is based on our income, assets and activities for the entire
taxable year, it is not possible to determine whether we will have become a PFIC for the
2007 taxable year until after the close of the year. Moreover, we must determine our PFIC
status annually based on tests which are factual in nature and our status in future years
will depend on our income, assets and activities in those years, although you will be
treated as continuing to own an interest in a PFIC if we are a PFIC in any year while you
own your shares unless you make certain elections as described further below. While we
intend to manage our business so as to avoid PFIC status, to the extent consistent with
our other business goals, we cannot predict whether our business plans will allow us to
avoid PFIC status determination. Because the market price of our ordinary shares is likely
to fluctuate and the market price of the shares of technology companies has been
especially volatile, and because that market price may affect the determination of whether
we will be considered a PFIC, we cannot assure you that we will not be considered a PFIC
for any taxable year. If we were a PFIC, you generally would be subject to imputed
interest charges and other disadvantageous tax treatment (including the denial of the
taxation of such dividends at the lower rates applicable to long-term capital gains, as
discussed above under Distributions) with respect to any gain from the sale or
exchange of, and excess distributions with respect to, the ordinary shares.

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Under
the PFIC rules, unless a U.S. Holder makes one of the elections described in the next
paragraphs, a special tax regime will apply to both (a) any excess
distribution by us (generally, the U.S. Holders ratable portion of
distributions in any year which are greater than 125% of the average annual distribution
received by such U.S. Holder in the shorter of the three preceding years or the U.S.
Holders holding period) and (b) any gain realized on the sale or other disposition
of the ordinary shares. Under this regime, any excess distribution and realized gain will
be treated as ordinary income and will be subject to tax as if (a) the excess distribution
or gain had been realized ratably over the U.S. Holders holding period, (b) the
amount deemed realized had been subject to tax in each year of that holding period, and
(c) the interest charge generally applicable to underpayments of tax had been imposed on
the taxes deemed to have been payable in those years. In addition, dividend distributions
made to you will not qualify for the lower rates of taxation applicable to long term
capital gains discussed above under Distributions.

Certain
elections are available to U.S. Holders of shares that may serve to alleviate some of the
adverse tax consequences of PFIC status. If we agreed to provide the necessary
information, you could avoid the interest charge imposed by the PFIC rules by making a
qualified electing fund (a QEF) election, which election may be made
retroactively under certain circumstances, in which case you generally would be required
to include in income on a current basis your pro rata share of our ordinary earnings as
ordinary income and your pro rata share of our net capital gains as long-term capital
gain. We do not expect to provide to U.S. Holders the information needed to report income
and gain pursuant to a QEF election, and we make no undertaking to provide such
information in the event that we are a PFIC.

Under
an alternative tax regime, you may also avoid certain adverse tax consequences relating to
PFIC status discussed above by making a mark-to-market election with respect to your
ordinary shares annually, provided that the shares are marketable. Shares will
be marketable if they are regularly traded on certain U.S. stock exchanges (including
NASDAQ) or on certain non-U.S. stock exchanges. For these purposes, the shares will
generally be considered regularly traded during any calendar year during which they are
traded, other than in negligible quantities, on at least 15 days during each calendar
quarter.

If
you choose to make a mark-to-market election, you would recognize as ordinary income or
loss each year an amount equal to the difference as of the close of the taxable year
between the fair market value of the PFIC shares and your adjusted tax basis in the PFIC
shares. Losses would be allowed only to the extent of net mark-to-market gain previously
included by you under the election for prior taxable years. If the mark-to-market election
were made, then the PFIC rules set forth above relating to excess distributions and
realized gains would not apply for periods covered by the election. If you make a
mark-to-market election after the beginning of your holding period of our ordinary shares,
you would be subject to interest charges with respect to the inclusion of ordinary income
attributable to the period before the effective date of such election.

Under
certain circumstances, ordinary shares owned by a Non-U.S. Holder may be attributed to a
U.S. person owning an interest, directly or indirectly, in the Non-U.S. Holder. In this
event, distributions and other transactions in respect of such ordinary shares may be
treated as excess distributions with respect to such U.S. person, and a QEF election may
be made by such U.S. person with respect to its indirect interest in us, subject to the
discussion in the preceding paragraphs.

We
may invest in stock of non-U.S. corporations that are PFICs. In such a case, provided that
we are classified as a PFIC, a U.S. Holder would be treated as owning its pro rata share
of the stock of the PFIC owned by us. Such a U.S. Holder would be subject to the rules
generally applicable to shareholders of PFICs discussed above with respect to
distributions received by us from such a PFIC and dispositions by us of the stock of such
a PFIC (even though the U.S. Holder may not have received the proceeds of such
distribution or disposition). Assuming we receive the necessary information from the PFIC
in which we own stock, certain U.S. Holders may make the QEF election discussed above with
respect to the stock of the PFIC owned by us, with the consequences discussed above.
However, no assurance can be given that we will be able to provide U.S. Holders with such
information.

If
we were a PFIC, a holder of ordinary shares that is a U.S. Holder must file United States
Internal Revenue Service Form 8621 for each tax year in which the U.S. Holder owns the
ordinary shares.

You
should consult your own tax advisor regarding our potential status as a PFIC and the tax
consequences that would arise if we were treated as a PFIC.

- 80 -

---

---

| | Controlled
Foreign Corporation Considerations
| | ---------------------------------------------

A
non-U.S. corporation will be classified as a controlled foreign corporation,
or a CFC, for United States federal income tax purposes in any taxable year in which more
than 50.0% of either

| |  | the
total combined voting power of all classes of stock of such corporation entitled to vote,
or
| | - | ------------------------------------------------------------------------------------------------

| |  | the
total value of the stock of such corporation
| | - | ------------------------------------------------

is owned or considered owned, on any
day during such taxable year, by United States persons who own or are considered to own
10.0% or more of the total combined voting power of all classes of stock entitled to vote
of such corporation (Ten Percent Shareholders).

The
CFC rules provide that, even if the CFC has made no distributions to its shareholders,
each Ten Percent Shareholder of a CFC is required to include in income each year such Ten
Percent Shareholders pro rata share of the CFCs Subpart F income and
investment of earnings in U.S. property. The CFC rules also provide that gains, if any,
realized by a Ten Percent Shareholder on the sale of shares in a CFC generally will be
recharacterized as dividend income and subject to tax at ordinary income tax rates to the
extent of any undistributed earnings and profits of the CFC, as determined under United
States federal income tax principles. Although we were a CFC in the beginning of the 2005
tax year, we believe based on our current ownership and provisions limiting voting power
in our Articles of Association that we are no longer so classified and expect that we will
not be classified as a CFC in future years.

In
order to reduce the risk that we will once again be considered a CFC, our articles of
association provide that any United States persons that purchase our shares will be
limited to voting a maximum of 9.9% of our total combined voting power, to the extent that
their voting rights notwithstanding such limitation would cause us to be considered a CFC.

| | Backup
Withholding Tax and Information Reporting Requirements
| | -------------------------------------------------------------

United
States backup withholding tax and information reporting requirements generally apply to
certain payments to certain non-corporate holders of stock. Information reporting
generally will apply to payments of dividends on, and to proceeds from the sale or
redemption of, ordinary shares made within the United States, or by a United States payor
or United States middleman, to a holder of ordinary shares, other than an exempt recipient
(including a corporation, a payee that is not a United States person that provides an
appropriate certification and certain other persons). A payor will be required to withhold
backup withholding tax from any payments of dividends on, or the proceeds from the sale or
redemption of, ordinary shares within the United States, or by a United States payor or
United States middleman, to a holder, other than an exempt recipient, if such holder fails
to furnish its correct taxpayer identification number or otherwise fails to comply with,
or establish an exemption from, such backup withholding tax requirements. The backup
withholding tax rate is 28.0% for years through 2010.

Any
amounts withheld under the backup withholding rules will be allowed as a refund or credit
against the beneficial owners United States federal income tax liability, if any,
provided that the required information is furnished to the IRS.

The
above description is not intended to constitute a complete analysis of all tax
consequences relating to acquisition, ownership and disposition of our ordinary shares.
You should consult your tax advisor concerning the tax consequences of your particular
situation.

|F. | DIVIDENDS
AND PAYING AGENTS
|-- | ---------------------------

Not
applicable.

|G. | STATEMENTS
BY EXPERTS
|-- | ---------------------

Not
applicable.

- 81 -

---

---

|H. | DOCUMENTS
ON DISPLAY
|-- | --------------------

We
are currently subject to the information and periodic reporting requirements of the U.S.
Securities Exchange Act of 1934, as amended (the Exchange Act), and file
periodic reports and other information with the Securities and Exchange Commission through
its electronic data gathering, analysis and retrieval (EDGAR) system. Our securities
filings, including this Annual Report and the exhibits thereto, are available for
inspection and copying at the public reference facilities of the Securities and Exchange
Commission located at Room 1580, 100 F Street, N.E., Washington, D.C. 20549 and at the
Securities and Exchange Commissions regional office at Citicorp Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. You may also obtain copies of the
documents at prescribed rates by writing to the Public Reference Section of the Securities
and Exchange Commission at 100 F Street, N.E., Washington, DC 20549. Please call the
Securities and Exchange Commission at 1-800-SEC-0330 for further information on the public
reference room. The Commission also maintains a website at http://www.sec.gov from which
certain filings may be accessed.

As
a foreign private issuer, we are exempt from the rules under the Exchange Act relating to
the furnishing and content of proxy statements, and our officers, directors and principal
shareholders will be exempt from the reporting and short-swing profit recovery provisions
contained in Section 16 of the Exchange Act. In addition, we are not required under the
Exchange Act to file periodic reports and financial statements with the Securities and
Exchange Commission as frequently or as promptly as United States companies whose
securities are registered under the Exchange Act.

|I. | SUBSIDIARY
INFORMATION
|-- | ----------------------

Not
applicable.

|ITEM 11. | QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------

Market
risk is the risk of loss related to changes in market prices, including interest rates and
foreign exchange rates, of financial instruments that may adversely impact our
consolidated financial position, results of operations or cash flows.

We
do not use derivative financial instruments for trading purposes. Accordingly, we have
concluded that there is no material market risk exposure of the type contemplated by Item
11, and that no quantitative tabular disclosures are required. We are exposed to certain
other types of market risks as described below.

| | Risk
of Interest Rate Fluctuation
| | ---------------------------------

We
do not have any long-term borrowings. Our investments consist of cash and cash
equivalents, short-term bank deposits and interest bearing, investment-grade investments
in marketable securities with maturities of up to three years, which currently consist
mainly of corporate debt securities and auction rate securities, and may in the future
include commercial paper, money market funds, government and non-government debt
securities. The primary objective of our investment activities is to preserve principal
while maximizing the income that we receive from our investments without significantly
increasing risk and loss. Our investments are exposed to market risk due to fluctuation in
interest rates, which may affect our interest income and the fair market value of our
investments. We manage this exposure by performing ongoing evaluations of our investments.
Due to the short and medium-term maturities of our investments to date, the carrying value
approximates the fair value. It is our policy to hold investments to maturity in order to
avoid recognizing the effect of interest rate fluctuations in our financial statements.

| | Foreign
Currency Exchange Risk
| | ------------------------------

Our
foreign currency exposures give rise to market risk associated with exchange rate
movements of the U.S. dollar, our functional and reporting currency, against the shekel
and the euro. We are exposed to the risk of fluctuation in the U.S. dollar/shekel exchange
rate. In 2006, we derived all of our revenues in U.S. dollars. However, 53% of our
expenses were denominated in shekels. Our shekel-denominated expenses consist principally
of salaries and related personnel expenses, as well as vehicle lease payments. We
anticipate that a material portion of our expenses will continue to be denominated in
shekels. If the U.S. dollar weakens against the shekel, we will experience a negative
impact on our profit margins. To manage this risk, from time to time, we have entered into
forward exchange contracts to hedge some of our foreign currency exposure. As of December
31, 2006, we had outstanding forward exchange contracts for the acquisition of 2.6 million
shekels in consideration for $0.6 million maturing in a period of up to a month from that
date. As of December 31, 2006, the fair value of these contracts was $14,000.

- 82 -

---

---

To
date, the amount of royalties payable to us is based on the dollar-denominated value of
our licensees net sales of products incorporating our intellectual property.
Therefore, to the extent that our licensees sales to third parties are not
denominated in U.S. dollars, any royalties that we receive as a result of such sales could
be subject to fluctuations in the exchange rate between the currency of the sale and the
U.S. dollar. If the U.S. dollar strengthens against the currency in which any of our
licensees makes its sales, the dollar-denominated amount of the royalties that we receive
would be reduced.

All
financial instruments are managed and controlled under a program of risk management in
accordance with established policies. We do not hold derivative financial instruments for
speculative purposes, and we do not issue any derivative financial instruments for trading
or speculative purposes. The only derivative financial instruments we have are in place to
manage exposure to fluctuations in foreign exchange rates.

| | Impact
of Inflation
| | -------------------

We
believe that the rate of inflation in Israel has had a minor effect on our business to
date. However, our U.S. dollar costs in Israel will increase if inflation in Israel
exceeds the devaluation of the shekel against the U.S. dollar or if the timing of such
devaluation lags behind inflation in Israel.

|ITEM 12. | DESCRIPTION
OF SECURITIES OTHER THAN EQUITY SECURITIES
|-------- | ------------------------------------------------------

Not
applicable.

- 83 -

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# PART II

|ITEM 13. | DEFAULTS,
DIVIDEND ARREARAGES AND DELINQUENCIES
|-------- | -----------------------------------------------

None.

|ITEM 14. | MATERIAL
MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
|-------- | ----------------------------------------------------------------------------

There
are no material modifications to the rights of security holders that are required to be
disclosed.

The
effective date of the registration statement (no. 333-129-167) for our initial public
offering of ordinary shares, par value NIS 0.01, was November 8, 2005. The offering
commenced on November 9, 2005 and terminated after the sale of all the securities
registered. Lehman Brothers Inc. acted as the sole book-running manager for the offering
and, along with Deutsche Bank Securities Inc., CIBC World Markets Corp., William Blair
& Company, L.L.C. and Raymond James & Associates, Inc., as representatives of the
underwriters. We registered 5,750,000 ordinary shares in the offering, including shares
issued pursuant to the exercise of the underwriters over-allotment option. We sold
5,750,000 ordinary shares at an aggregate offering price of $135.1 million at a price per
share of $23.50. Under the terms of the offering, we incurred aggregate underwriting
discounts of $9.5 million. We also incurred expenses of $4.8 million in connection with
the offering. The net proceeds that we received as a result of the offering were $120.9
million. As of December 31, 2006, the net proceeds had been used as follows:

|Use of Proceeds                                      |  | Description | Amount (in thousands)
|---------------------------------------------------- |  | ----------- | ---------------------
|
|
|
|
|Construction of plant, buildings and                 |  |             |                      
|facilities                                           |  |             |                      
|Purchase and installation of machinery and equipment |  |             |                      
|Purchase of real estate                              |  |             |                      
|Repayment of indebtedness                            |  |             |                      
|Working capital                                      |  |             |                      
|Temporary investments                                |  |             |                      
|Any other use involving $100,000 of the proceeds     |  |             |                      
|                                                     |  |             |                      
|                                                     |  |            
|Total:                                               |  |             |                      

None
of the net proceeds of the offering was paid directly or indirectly to any director,
officer, general partner of ours or to their associates, persons owning ten percent or
more of any class of our equity securities, or to any of our affiliates.

We
completed an additional offering of our ordinary shares on March 30, 2006, in which we and
certain of our shareholders sold 4,393,170 ordinary shares, out of which 340,000 were sold
by us in consideration for which we raised net proceeds of $9.3 million.

|ITEM 15. | CONTROLS
AND PROCEDURES
|-------- | -----------------------

Not
applicable.

|ITEM 15T. | Controls
and Procedures
|--------- | -----------------------

| | (a) | Disclosure
Controls and Procedures
| | --- | ----------------------------------

As
of the end of the period covered by this Annual Report, our management (with the
participation of our chief executive officer and chief financial officer) conducted an
evaluation, pursuant to Rule 13a-15 promulgated under the Exchange Act, of the
effectiveness of the design and operation of our disclosure controls and procedures. Based
on this evaluation, our chief executive officer and chief financial officer concluded that
as of the end of the period covered by this Annual Report such disclosure controls and
procedures were effective to provide reasonable assurance that information required to be
disclosed by us in reports we file or submit under the Exchange Act is (1) recorded,
processed, summarized and reported within the time periods specified in the rules and
forms of the SEC, and (2) accumulated and communicated to the Companys management,
including its chief executive officer and chief financial officer, as appropriate to allow
timely decisions regarding required disclosure.

- 84 -

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| | (b) | Managements
Annual Report on Internal Control over Financial Reporting
| | --- | -----------------------------------------------------------------------

Our
management is responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Rule 13a-15(f) promulgated under the
Exchange Act. Our internal control system was designed to provide reasonable assurance to
the Companys management and board of directors regarding the reliability of
financial reporting and the preparation and fair presentation of published financial
statements for external purposes in accordance with generally accepted accounting
principles. All internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can provide only
reasonable assurance with respect to financial statement preparation and presentation.

Our
management (with the participation of our chief executive officer and chief financial
officer) conducted an evaluation, pursuant to Rule 13a-15(c) promulgated under the
Exchange Act, of the effectiveness, as of the end of the period covered by this Annual
Report, of its internal control over financial reporting based on the framework in
Internal ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on the results of this evaluation,
management concluded that our internal control over financial reporting was effective as
of December 31, 2006.

This
Annual Report does not include an attestation report of our registered public accounting
firm regarding internal control over financial reporting. Managements report was not
subject to attestation by our registered public accounting firm pursuant to temporary
rules of the SEC that permit us to provide only managements report in this Annual
Report.

| | (c) | Changes
in Internal Control over Financial Reporting
| | --- | ----------------------------------------------------

There
were not any changes in our internal control over financial reporting identified in
connection with the evaluation required by Rule 13a-15(d) promulgated under the
Exchange Act that occurred during the period covered by this Annual Report that have
materially affected, or are reasonably likely to materially affect, our internal control
over financial reporting.

|ITEM 16. | [RESERVED]
|-------- | ----------

|ITEM 16A. | AUDIT
COMMITTEE FINANCIAL EXPERT.
|--------- | ---------------------------------

The
board of directors has determined that George Hervey is the financial expert serving on
its audit committee and that Mr. Hervey is independent under the rules of the Nasdaq Stock
Market.

|ITEM 16B. | CODE
OF ETHICS.
|--------- | ---------------

We
have adopted a code of ethics applicable to our Chief Executive Officer, Chief Financial
Officer, controller and persons performing similar functions. This code has been posted on
our website, www.saifun.com.

|ITEM 16C. | PRINCIPAL
ACCOUNTANT FEES AND SERVICES
|--------- | --------------------------------------

The
following table sets forth the total remuneration that was paid by us and our subsidiaries
to our independent accountants, Kost, Forer, Gabbay and Kasierer, a member of Ernst &
Young Global, in each of our previous two fiscal years:

- 85 -

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| |                        | 2005 | 2006
| | ---------------------- | ---- | ----
|
|
|
|
| | Audit fees             |      |     
| | Audit-related fees (1) |      |     
| | Tax fees (2)           |      |     
| | All other fees         |      |     
| |                        |      |     
| | Total                  |      |     

---

| | (1) | Audit-related
fees includes fees for services performed in                connection with our
registration statement on Form F-1 for our initial public                offering, our
Annual Report on Form 20-F and compliance with Section 404 of the
               Sarbanes-Oxley Act.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Tax
fees includes fees for professional services rendered by our
               auditors for tax compliance and tax advice on actual or contemplated
               transactions.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our
audit committee pre-approved all audit and non-audit services provided to us and to our
subsidiaries during the periods listed above.

|ITEM 16D. | EXEMPTIONS
FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.
|--------- | -----------------------------------------------------------

None.

|ITEM 16E. | PURCHASES
OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
|--------- | ----------------------------------------------------------------------

We
did not have a repurchase plan during 2006. In February 2007, we announced that our board
of directors authorized us to purchase up to 1.5 million of our ordinary shares, which
represent approximately 4.8% of our total outstanding shares as of December 31, 2006.
Shares may be purchased from time to time in open market transactions in accordance with
applicable federal securities laws. The repurchase plan, including the timing of
repurchases and the exact number of securities to be purchased will depend upon prevailing
market conditions and other factors to be determined by our management and our board of
directors. Such repurchases will be made using our own cash resources. In accordance with
the Companies Law, as long as the repurchased shares are held by us, these shares will be
considered dormant shares with the result that they will not be entitled to
any rights (e.g. voting rights and dividend rights).

- 86 -

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# PART III

|ITEM 17. | FINANCIAL
STATEMENTS
|-------- | --------------------

Not
applicable.

|ITEM 18. | FINANCIAL
STATEMENTS
|-------- | --------------------

See
pages F-1 to F-38 incorporated herein by reference.

|ITEM19. | EXHIBITS
|------- | --------

|Exhibit |  | Description
|------- |  | -----------

|1.1 |  | Articles
of Association (incorporated by reference to Exhibit 3.4 of the Registration Statement on
Form F-1 (File No. 333-129167) filed with the Commission on October 21,
2005).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2.1 |  | Registration
Rights Agreement, dated October 2, 2000, by and among the Registrant and the parties
thereto (incorporated by reference to Exhibit 10.2 of the Registration Statement on Form F-1
(File No. 333-129167) filed with the Commission on October 21, 2005).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2.2 |  | Amendment
to Registration Rights Agreement and Shareholder Rights Agreement, dated as of September
29, 2005, by and among the parties thereto and the Registrant (incorporated by reference
to Exhibit 10.2 of the Registration Statement on Form F-1 (File No. 333-129167)
filed with the Commission on October 21, 2005).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.1 |  | Technology
Agreement, dated May 4, 2000, by and between Macronix International Co., Ltd. and the
Registrant                  (incorporated by reference to Exhibit 10.7 of the
Registration Statement on Form F-1 (File No. 333-129167) filed
with the Commission on October 21, 2005).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.2 |  | Amendment
to the Technology Agreement, dated April 10, 2003, by and between Macronix International
Co., Ltd.                  and the Registrant (incorporated by reference to Exhibit 10.8
of the Registration Statement on Form F-1 (File No. 333-129167)           filed with
the Commission on October 21, 2005).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | Second
Addendum to the Technology Agreement, dated April 22, 2004, by and between Macronix
International Co.,                  Ltd. and the Registrant (incorporated by reference to
Exhibit 10.9 of the Registration Statement on Form F-1 (File No. 333-129167) filed
with the Commission on October 21, 2005).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Settlement
and License Agreement, dated July 1, 2002, by and between Advanced Micro Devices,
Inc., Fujitsu Limited and the Registrant (incorporated by reference to Exhibit 10.11 of
the Registration Statement on Form F-1 (File No. 333-129167) filed with the
Commission on October 21, 2005).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.8 |  | Form
of Director and Officer Letter of Indemnification (incorporated by reference to Exhibit
10.18 of the Registration Statement on Form F-1 (File No. 333-129167) filed
with the Commission on October 21, 2005).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8.1 |  | List
of Subsidiaries of the Registrant, (incorporated by reference to Exhibit 21.1 of the
Registration Statement on Form F-filed with the Commission on November 4, 2005.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.0 |  | Consent
of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global.
|---- |  | --------------------------------------------------------------------------

|11.1 |  | Code
of Ethics effective as of September 2005. (incorporated by reference to Exhibit 11.1 of
the Annual                  Report on Form 20-F filed with the Commission on April 11,
2006).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|12.1 |  | Certification
of Chief Executive Officer of the Registrant pursuant to Section 302 of the
Sarbanes-Oxley Act                  of 2002.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
of Chief Financial Officer of the Registrant pursuant to Section 302 of the
Sarbanes-Oxley Act                  of 2002.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------

- 87 -

---

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|13.1 |  | Certification
of Chief Executive Officer of the Registrant pursuant to Section 906 of the
Sarbanes-Oxley Act                  of 2002.*
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------

|13.2 |  | Certification
of Chief Financial Officer of the Registrant pursuant to Section 906 of the
Sarbanes-Oxley Act                  of 2002.*
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------

|* | This
document is being furnished in accordance with SEC Release Nos. 33-8212 and
34-47551.
|- | ------------------------------------------------------------------------------------------

| | Portions
of this exhibit were omitted and have been filed separately with the Secretary of the
Securities and Exchange Commission pursuant to the Registrants application
requesting confidential treatment under Rule 406 of the Securities Act.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 88 -

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# SIGNATURES

Pursuant
to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant
hereby certifies that it meets all of the requirements for filing on Form 20-F and that it
has duly caused and authorized the undersigned to sign this Annual Report on its behalf.

| |  | SAIFUN SEMICONDUCTORS LTD.By: /s/ Boaz Eitan
Dr. Boaz EitanChief Executive Officer and Chairman By: /s/ Igal Shany
Igal ShanyChief Financial Officer
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: April 2, 2007

- 89 -

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SAIFUN SEMICONDUCTORS LTD. AND ITS
SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2006

IN U.S. DOLLARS

INDEX

|                                                                                                                       |  |               
|---------------------------------------------------------------------------------------------------------------------- |  | --------------
|                                                                                                                       |  | Page          
|                                                                                                                       |  |               
|                                                                                                                      
|Report of Independent
Registered
  Public Accounting Firm                                                              |  | F  2         
|                                                                                                                       |  |               
|Consolidated Balance
  Sheets as of December 31, 2005 and 2006                                                         |  | F  3  F  4 
|                                                                                                                       |  |               
|Consolidated Statements
  of Operations for the Years Ended December 26, 2004 and December 31,
  2005 and 2006         |  | F  5         
|                                                                                                                       |  |               
|Statements of Changes in
  Shareholders Equity for the Years Ended December 26, 2004 and December 31,
  2005 and 2006 |  | F  6         
|                                                                                                                       |  |               
|Consolidated Statements
  of Cash Flows for the Years Ended December 26, 2004 and December 31,
  2005 and 2006         |  | F  7         
|                                                                                                                       |  |               
|Notes to Consolidated
  Financial Statements                                                                           |  | F  8  F  38



---

---

---



(ERNST&YOUNG LOGO)

REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Shareholders of

SAIFUN SEMICONDUCTORS LTD.

We
have audited the accompanying consolidated balance sheets of Saifun
Semiconductors Ltd. (the
Company) and its subsidiaries as of December 31, 2005 and 2006, and the
related consolidated statements of operations, changes in shareholders equity
and cash flows for the 52-week period ended December 26, 2004 and the years
ended December 31, 2005 and 2006. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
financial statements of Infineon Technologies Flash Ltd. and Infineon
Technologies Flash GmbH & Co. KG., accounted for by the equity method, the
equity in net loss in which amounted to $ 26,741 thousand for the period
ended December 26, 2004. The financial statements of these entities were
audited by other auditors, whose reports have been furnished to us, and our
opinion, insofar as it relates to the amounts included for such entities, is
based solely on the reports of the other auditors.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Companys internal control over financial reporting.Our audits
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Companys internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits and the reports of other auditors provide a reasonable basis
for our opinion.

In
our opinion, based on our audits and the reports of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company and its
subsidiaries as of December 31, 2005 and 2006, and the consolidated
results of their operations and their cash flows for the 52-week period ended
December 26, 2004 and the years ended December 31, 2005 and 2006, in conformity
with U.S. generally accepted accounting principles.

As
discussed in Note 2 to the consolidated financial statements, in 2006, the
Company adopted Statement of Financial Accounting Standard 123 (revised 2004), Share-Based
Payment, using the modified prospective method.

|                   |                                  |                                     | 
|------------------ | -------------------------------- | ----------------------------------- | 
|                   |                                  | KOST FORER GABBAY & KASIERER (LOGO) | 
|Tel-Aviv,
  Israel | KOST FORER
GABBAY & KASIERER     |                                    
|March 28,
  2007   | A Member of Ernst & Young Global |                                    

F  2

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|                              |                                                  
|----------------------------- | -------------------------------------------------
|                              | SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                              |                                                  
|CONSOLIDATED
  BALANCE SHEETS |                                                  
|                             
|U.S. dollars in thousands     |                                                  

|                                                     |  |      |    |              |   |         |  |   |         | 
|---------------------------------------------------- |  | ---- | -- | ------------ | - | ------- |  | - | ------- | 
|                                                     |  |      |    | December 31, |  
|                                                     |  |      |    |              |  
|                                                     |  | Note |    | 2005         |   | 2006    | 
|                                                     |  |      |    |              |   |         | 
|ASSETS                                               |  |      |    |              |   |         |  |   |         | 
|                                                     |  |      |    |              |   |         |  |   |         | 
|CURRENT
  ASSETS:                                    |  |      |    |              |   |         |  |   |         | 
|Cash and cash
equivalents                            |  |      | 2e |              | $ | 100,327 |  | $ | 52,919  | 
|Short-term
investments                               |  |      |    |              |   |        |  |   | 2,016   | 
|Marketable securities                                |  |      | 3  |              |   | 75,501  |  |   | 115,657 | 
|Trade receivables                                    |  |      |    |              |   | 2,663   |  |   | 9,483   | 
|Loans to employees                                   |  |      | 5  |              |   | 613     |  |   | 44      | 
|Other accounts receivable and
prepaid
  expenses     |  |      |    |              |   | 2,181   |  |   | 1,693   | 
|Total assets attributed to
discontinued
  operations |  |      | 9  |              |   | 212     |  |   |        | 
|                                                     |  |      |    |              |   |         |  |   |         | 
|                                                     |  |      |    |              |   |         |  |   |         | 
|Total
  current assets                               |  |      |    |              |   | 181,497 |  |   | 181,812 | 
|                                                     |  |      |    |              |   |         |  |   |         | 
|                                                     |  |      |    |              |   |         |  |   |         | 
|Marketable
  securities                              |  |      | 3  |              |   | 5,995   |  |   | 60,507  | 
|Property and
  equipment, net                        |  |      | 6  |              |   | 2,668   |  |   | 3,403   | 
|Loans to
  employees                                 |  |      | 5  |              |   | 1,097   |  |   | 92      | 
|Severance
  pay fund                                 |  |      |    |              |   | 2,122   |  |   | 3,605   | 
|Lease
  deposits                                     |  |      |    |              |   | 289     |  |   | 759     | 
|Other assets                                         |  |      | 4  |              |   | 70      |  |   |        | 
|                                                     |  |      |    |              |   |         |  |   |         | 
|                                                     |  |      |    |              |   |         |  |   |         | 
|                                                     |  |      |    |              |   | 12,241  |  |   | 68,366  | 
|                                                     |  |      |    |              |   |         |  |   |         | 
|                                                     |  |      |    |              |   |         |  |   |         | 
|Total
  assets                                       |  |      |    |              | $ | 193,738 |  | $ | 250,178 | 
|                                                     |  |      |    |              |   |         |  |   |         | 

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

F  3

---

---



SAIFUN SEMICONDUCTORS LTD. AND ITS
SUBSIDIARIES

|                                                          
|----------------------------------------------------------
|CONSOLIDATED BALANCE SHEETS                               
|                                                          
|U.S. dollars in thousands, except share and per share data

|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |         |   |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | ---- | ------------ | ------- | - | - | ------- | -
|                                                                                                                                                                                                                                                                                             |  |      |    |      | December 31, |        
|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |        
|                                                                                                                                                                                                                                                                                             |  | Note |    | 2005 |              | 2006    |  
|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |         |  
|LIABILITIES
  AND SHAREHOLDERS EQUITY                                                                                                                                                                                                                                                       |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |         |   |   |         |  
|CURRENT LIABILITIES:                                                                                                                                                                                                                                                                         |  |      |    |      |              |         |   |   |         |  
|Trade payables                                                                                                                                                                                                                                                                               |  |      |    |      | $            | 1,165   |   | $ | 1,138   |  
|Accrued expenses and other
liabilities                                                                                                                                                                                                                                                       |  |      | 7  |      |              | 9,913   |   |   | 9,019   |  
|Deferred revenues                                                                                                                                                                                                                                                                            |  |      |    |      |              | 3,786   |   |   |        |  
|Total liabilities attributed to
  discontinued operations                                                                                                                                                                                                                                    |  |      | 9  |      |              | 146     |   |   |        |  
|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                                                                                                                                            
|Total current
  liabilities                                                                                                                                                                                                                                                                  |  |      |    |      |              | 15,010  |   |   | 10,157  |  
|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                                                                                                                                            
|ACCRUED SEVERANCE PAY                                                                                                                                                                                                                                                                        |  |      |    |      |              | 2,655   |   |   | 3,734   |  
|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                                                                                                                                            
|COMMITMENTS AND CONTINGENT LIABILITIES                                                                                                                                                                                                                                                       |  |      | 8  |      |              |         |   |   |         |  
|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |         |   |   |         |  
|SHAREHOLDERS EQUITY:                                                                                                                                                                                                                                                                        |  |      | 10 |      |              |         |   |   |         |  
|Share capital -                                                                                                                                                                                                                                                                              |  |      |    |      |              |         |   |   |         |  
|Ordinary shares of NIS 0.01 par
value:
  Authorized: 200,000,000 shares at December 31, 2005 and 2006; Issued:
  30,251,247 and 31,495,909 shares at December 31, 2005 and 2006,
  respectively; Outstanding: 29,456,722 and 31,495,909 shares at December 31,
  2005 and 2006, respectively |  |      |    |      |              | 120     |   |   | 125     |  
|Additional paid-in
capital                                                                                                                                                                                                                                                                   |  |      |    |      |              | 211,706 |   |   | 236,958 |  
|Accumulated other comprehensive
income                                                                                                                                                                                                                                                       |  |      |    |      |              | 38      |   |   |        |  
|Accumulated deficit                                                                                                                                                                                                                                                                          |  |      |    |      |              | (35,791 | ) |   | (796    | )
|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                                                                                                                                            
|Total
  shareholders equity                                                                                                                                                                                                                                                                 |  |      |    |      |              | 176,073 |   |   | 236,287 |  
|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |         |   |   |         |  
|                                                                                                                                                                                                                                                                                            
|Total liabilities
  and shareholders equity                                                                                                                                                                                                                                                 |  |      |    |      | $            | 193,738 |   | $ | 250,178 |  
|                                                                                                                                                                                                                                                                                             |  |      |    |      |              |         |   |   |         |  

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

F  4

---

---



SAIFUN SEMICONDUCTORS LTD. AND ITS
SUBSIDIARIES

|                                                  
|--------------------------------------------------
|CONSOLIDATED STATEMENTS OF OPERATIONS             
|                                                  
|U.S. dollars in thousands, except per share
  data

|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|--------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----- | -------------------------------------- | - | ---------------------------- | - | - | ------- | - | - | ------ | 
|                                                                                                                                  |  | Note |       | Year
  ended
  December 26,
  2004 (*) |   | Year
  ended 
  December 31, |  
|                                                                                                                                  |  |      |       |                                        |  
|                                                                                                                                  |  |      |       | 2005                                   |   | 2006                         |  
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |        
|                                                                                                                                 
|Revenues (**):                                                                                                                    |  |      | 13,4c |                                        |   |                              |   |   |         |   |   |        | 
|Licenses and royalties                                                                                                            |  |      |       |                                        | $ | 22,640                       |   | $ | 65,790  |   | $ | 40,983 | 
|Services                                                                                                                          |  |      |       |                                        |   | 7,926                        |   |   | 12,811  |   |   | 21,794 | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|                                                                                                                                 
|                                                                                                                                  |  |      |       |                                        |   | 30,566                       |   |   | 78,601  |   |   | 62,777 | 
|Cost of revenues:                                                                                                                 |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Services (***)                                                                                                                    |  |      |       |                                        |   | 7,084                        |   |   | 12,048  |   |   | 14,863 | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|                                                                                                                                 
|                                                                                                                                  |  |      |       |                                        |   | 23,482                       |   |   | 66,553  |   |   | 47,914 | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Operating expenses:                                                                                                               |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Research and development, net
(***)                                                                                               |  |      |       |                                        |   | 6,792                        |   |   | 7,427   |   |   | 12,818 | 
|Marketing and selling
(***)                                                                                                       |  |      |       |                                        |   | 2,914                        |   |   | 4,889   |   |   | 2,927  | 
|General and administrative
(***)                                                                                                  |  |      |       |                                        |   | 2,115                        |   |   | 6,216   |   |   | 6,048  | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|                                                                                                                                 
|Total
  operating expenses                                                                                                        |  |      |       |                                        |   | 11,821                       |   |   | 18,532  |   |   | 21,793 | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|                                                                                                                                 
|Operating income                                                                                                                  |  |      |       |                                        |   | 11,661                       |   |   | 48,021  |   |   | 26,121 | 
|Financial income, net                                                                                                             |  |      | 14    |                                        |   | 1,699                        |   |   | 1,749   |   |   | 9,777  | 
|Equity in losses of equity method
investees                                                                                       |  |      | 4     |                                        |   | (26,172                      | ) |   |        |   |   |       | 
|Compensation expense related to issuance of
options to employees of
  equity method investees                                     |  |      | 4     |                                        |   | (569                         | ) |   |        |   |   |       | 
|Capital loss from sale of equity method
investees                                                                                 |  |      | 4     |                                        |   | (17,334                      | ) |   |        |   |   |       | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|                                                                                                                                 
|Income (loss) from continuing operations before
income taxes                                                                      |  |      |       |                                        |   | (30,715                      | ) |   | 49,770  |   |   | 35,898 | 
|Income taxes                                                                                                                      |  |      | 12    |                                        |   |                             |   |   |        |   |   | 1,281  | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|                                                                                                                                 
|Income (loss) from continuing operations after
income taxes                                                                       |  |      |       |                                        |   | (30,715                      | ) |   | 49,770  |   |   | 34,617 | 
|Loss from discontinued operations (***)                                                                                           |  |      | 9     |                                        |   | (7,189                       | ) |   | (5,263  | ) |   |       | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Income (loss) before cumulative effect of change
in accounting
  principle                                                        |  |      |       |                                        |   | (37,904                      | ) |   | 44,507  |   |   | 34,617 | 
|Cumulative effect of change in accounting
principle                                                                               |  |      | 2k    |                                        |   |                             |   |   |        |   |   | 378    | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Net income (loss)                                                                                                                 |  |      |       |                                        | $ | (37,904                      | ) | $ | 44,507  |   | $ | 34,995 | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Allocation of undistributed earnings to
Convertible Preferred shares                                                              |  |      |       |                                        |   |                             |   |   | (39,529 | ) |   |       | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Net income (loss) attributed to Ordinary shares
after allocation of
  undistributed earnings                                      |  |      |       |                                        | $ | (37,904                      | ) | $ | 4,978   |   | $ | 34,995 | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Net earnings (loss) per share:                                                                                                    |  |      | 15    |                                        |   |                              |   |   |         |   |   |        | 
|Basic earnings (loss) per
Ordinary share from continuing operations                                                               |  |      |       |                                        | $ | (1.81                        | ) | $ | 0.46    |   | $ | 1.13   | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Basic earnings (loss) per
Ordinary share from discontinued operations
  and cumulative effect of change in accounting principle   |  |      |       |                                        | $ | (0.43                        | ) | $ | (0.29   | ) | $ | 0.01   | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Basic net earnings (loss) per
Ordinary share                                                                                      |  |      |       |                                        | $ | (2.24                        | ) | $ | 0.17    |   | $ | 1.14   | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Diluted earnings (loss) per
Ordinary share from continuing operations                                                             |  |      |       |                                        | $ | (1.81                        | ) | $ | 0.36    |   | $ | 1.07   | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Diluted earnings (loss) per
Ordinary share from discontinued
  operations and cumulative effect of change in accounting principle |  |      |       |                                        | $ | (0.43                        | ) | $ | (0.20   | ) | $ | 0.01   | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 
|Diluted net earnings (loss) per
Ordinary share                                                                                    |  |      |       |                                        | $ | (2.24                        | ) | $ | 0.16    |   | $ | 1.08   | 
|                                                                                                                                  |  |      |       |                                        |   |                              |   |   |         |   |   |        | 

|      |                                                                                                                                                                                   
|----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(*)   | Reclassified, see Note 9.                                                                                                                                                         
|      |                                                                                                                                                                                   
|(**)  | Includes revenues from
  related parties (principally service revenues from the Companys former joint
  venture) for the period ended December 26, 2004 in the amount of $ 8,425.
|      |                                                                                                                                                                                   
|(***) | Costs and expenses include
  stock-based compensation related to options granted to employees and others
  as follows:                                                            

| |                                        |  |                                    |      |                              |      |       |  |   |       | 
| | -------------------------------------- |  | ---------------------------------- | ---- | ---------------------------- | ---- | ----- |  | - | ----- | 
| |                                        |  | Year
  ended
  December 26,
  2004 |      | Year
  ended 
  December 31, |     
| |                                        |  |                                    |      |                             
| |                                        |  |                                    | 2005 |                              | 2006 |      
| |                                        |  |                                    |      |                              |      |       | 
|
| | Cost of services                       |  | $                                  | 175  |                              | $    | 834   |  | $ | 1,716 | 
| | Research and development expenses, net |  |                                    | 220  |                              |      | 330   |  |   | 1,036 | 
| | Marketing and selling expenses         |  |                                    | 87   |                              |      | 667   |  |   | 732   | 
| | General and administrative expenses    |  |                                    | 96   |                              |      | 2,410 |  |   | 1,477 | 
| | Loss from discontinued operations      |  |                                    | 23   |                              |      | 54    |  |   |      | 
| |                                        |  |                                    |      |                              |      |       |  |   |       | 
|
| |                                        |  | $                                  | 601  |                              | $    | 4,295 |  | $ | 4,961 | 
| |                                        |  |                                    |      |                              |      |       |  |   |       | 

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

F  5

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY    
|                                                 
|U.S. dollars in thousands, except share data     

|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|--------------------------------------------------------------------------------------------- |  | ---------------- | ---------- | -------- |  | --------------- |  | ------------------------------ | ------- | -------------------------- | - | ------------------------------- | - | -------------------------------------------- | ------ | --------------------- | - | ----------------- | - | ------------------------------------- | ---- | ------------------------------ | - | ------- | - | - | ------ | - | - | ------- | - | - | ------- | -
|                                                                                              |  |                  |            |          |  | Share
  capital |  | Additional
  paid-in
  capital |         | Subscription
  receivables |   | Deferred
  stock
  compensation |   | Accumulated
  other
  comprehensive
  income |        | Accumulated
  deficit |   | Treasury
  shares |   | Total
  comprehensive
  income (loss) |      | Total
  shareholders
  equity |  
|                                                                                              |  | Number of shares |            |          |  |                 |  |                                |         |                            |   |                                
|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                
|                                                                                              |  | Preferred        |            | Ordinary |  |                 |  |                                |         |                            |   |                                 |   |                                             
|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |  
|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|Balance as of December 28, 2003                                                               |  |                  | 4,609,686  |          |  | 16,921,261      |  | $                              | 60      |                            | $ | 83,662                          |   | $                                            | (7,375 | )                     | $ | (367              | ) | $                                     | 386  |                                | $ | (42,394 | ) | $ | (4,116 | ) |   | -       |   | $ | 29,856  |  
|Receipts on account of shares                                                                 |  |                  | -          |          |  | -               |  |                                | -       |                            |   | -                               |   |                                              | 845    |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 845     |  
|Options exercised                                                                             |  |                  | 5,730      |          |  | 16,160          |  |                                | (*) -   |                            |   | 130                             |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 130     |  
|Compensation expense related to issuance of options
to employees of
  equity method investees |  |                  | -          |          |  | -               |  |                                | -       |                            |   | 813                             |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 813     |  
|Amortization of deferred stock
compensation                                                   |  |                  | -          |          |  | -               |  |                                | -       |                            |   | (367                            | ) |                                              | -      |                       |   | 367               |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | -       |  
|Stock-based compensation related to options issued
to employees and
  others                  |  |                  | -          |          |  | -               |  |                                | -       |                            |   | 1,539                           |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 1,539   |  
|Reissuance of treasury shares                                                                 |  |                  | -          |          |  | -               |  |                                | -       |                            |   | 871                             |   |                                              | 6,280  |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | 4,116  |   |   | -       |   |   | 11,267  |  
|Deferred costs relating to initial public
offering                                            |  |                  | -          |          |  | -               |  |                                | -       |                            |   | (1,222                          | ) |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | (1,222  | )
|Comprehensive loss:                                                                           |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|Foreign currency translation adjustments                                                      |  |                  | -          |          |  | -               |  |                                | -       |                            |   | -                               |   |                                              | -      |                       |   | -                 |   |                                       | (386 | )                              |   | -       |   |   | -      |   | $ | (386    | ) |   | (386    | )
|Net loss                                                                                      |  |                  | -          |          |  | -               |  |                                | -       |                            |   | -                               |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | (37,904 | ) |   | -      |   |   | (37,904 | ) |   | (37,904 | )
|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|Total comprehensive loss                                                                      |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   | $ | (38,290 | ) |   |         |  
|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|Balance as of December 26, 2004                                                               |  |                  | 4,615,416  |          |  | 16,937,421      |  |                                | 60      |                            |   | 85,426                          |   |                                              | (250   | )                     |   | -                 |   |                                       | -    |                                |   | (80,298 | ) |   | -      |   |   | -       |   |   | 4,938   |  
|Issuance of share capital upon initial public
offering, net                                   |  |                  | -          |          |  | 5,750,000       |  |                                | 12      |                            |   | (**)   122,063                  |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 122,075 |  
|Options exercised                                                                             |  |                  | 984,283    |          |  | 1,140,111       |  |                                | 48      |                            |   | 488                             |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 536     |  
|Conversion of Convertible Preferred
shares                                                    |  |                  | (5,599,699 | )        |  | 5,599,699       |  |                                | -       |                            |   | -                               |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | -       |  
|Warrants exercised                                                                            |  |                  | -          |          |  | 29,491          |  |                                | (*)   - |                            |   | 550                             |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 550     |  
|Receipts on account of shares                                                                 |  |                  | -          |          |  | -               |  |                                | -       |                            |   | -                               |   |                                              | 250    |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 250     |  
|Stock-based compensation related to options issued
to employees and
  others                  |  |                  | -          |          |  | -               |  |                                | -       |                            |   | 3,179                           |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 3,179   |  
|Comprehensive income:                                                                         |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|Changes in fair value of cash flow
derivative                                                 |  |                  | -          |          |  | -               |  |                                | -       |                            |   | -                               |   |                                              | -      |                       |   | -                 |   |                                       | 38   |                                |   | -       |   |   | -      |   | $ | 38      |   |   | 38      |  
|Net income                                                                                    |  |                  | -          |          |  | -               |  |                                | -       |                            |   | -                               |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | 44,507  |   |   | -      |   |   | 44,507  |   |   | 44,507  |  
|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|Total comprehensive income                                                                    |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   | $ | 44,545  |   |   |         |  
|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|Balance as of December 31, 2005                                                               |  |                  | -          |          |  | 29,456,722      |  |                                | 120     |                            |   | 211,706                         |   |                                              | -      |                       |   | -                 |   |                                       | 38   |                                |   | (35,791 | ) |   | -      |   |   | -       |   |   | 176,073 |  
|Issuance of share capital upon public offering,
net                                           |  |                  | -          |          |  | 340,000         |  |                                | 1       |                            |   | (***)  9,282                    |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 9,283   |  
|Options exercised                                                                             |  |                  | -          |          |  | 1,614,587       |  |                                | 4       |                            |   | 8,610                           |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 8,614   |  
|Stock appreciation rights exercised                                                           |  |                  | -          |          |  | 84,600          |  |                                | (*)  -  |                            |   | 2,708                           |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 2,708   |  
|Cumulative effect of change in accounting
principle                                           |  |                  | -          |          |  | -               |  |                                | -       |                            |   | (378                            | ) |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | (378    | )
|Stock-based compensation related to options issued
to employees and
  others                  |  |                  | -          |          |  | -               |  |                                | -       |                            |   | 5,030                           |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | -       |   |   | -      |   |   | -       |   |   | 5,030   |  
|Comprehensive income:                                                                         |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|Changes in fair value of cash flow
derivative                                                 |  |                  | -          |          |  | -               |  |                                | -       |                            |   | -                               |   |                                              | -      |                       |   | -                 |   |                                       | (38  | )                              |   | -       |   |   | -      |   | $ | (38     | ) |   | (38     | )
|Net income                                                                                    |  |                  | -          |          |  | -               |  |                                | -       |                            |   | -                               |   |                                              | -      |                       |   | -                 |   |                                       | -    |                                |   | 34,995  |   |   | -      |   |   | 34,995  |   |   | 34,995  |  
|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|Total comprehensive income                                                                    |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   | $ | 34,957  |   |   |         |  
|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  
|Balance as of December 31, 2006                                                               |  |                  | -          |          |  | 31,495,909      |  | $                              | 125     |                            | $ | 236,958                         |   | $                                            | -      |                       | $ | -                 |   | $                                     | -    |                                | $ | (796    | ) | $ | -      |   |   |         |   | $ | 236,287 |  
|                                                                                              |  |                  |            |          |  |                 |  |                                |         |                            |   |                                 |   |                                              |        |                       |   |                   |   |                                       |      |                                |   |         |   |   |        |   |   |         |   |   |         |  

|      |                                                     
|----- | ----------------------------------------------------
|(*)   | Represents an amount lower
  than $1.               
|     
|(**)  | Net of issuance expenses of
  $13,050, see Note 10a.
|     
|(***) | Net of
  issuance expenses of $1,002, see Note 10a. 

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

F  6

---

---



|                                                 
|-------------------------------------------------
|SAIFUN
  SEMICONDUCTORS LTD. AND ITS SUBSIDIARIES
|                                                 
|CONSOLIDATED
  STATEMENTS OF CASH FLOWS          
|                                                 
|U.S. dollars in thousands                        

|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  
|------------------------------------------------------------------------------------------------------ |  | ------------------------- | ------- | -------------------------- | - | ------- | - | - | -------- | -
|                                                                                                       |  | Year ended
  December 26, |         | Year ended 
  December 31, |  
|                                                                                                       |  |                           |         |                           
|                                                                                                       |  | 2004 (*)                  |         | 2005                       |   | 2006    |  
|                                                                                                       |  |                           |         |                            |   |         |  
|Cash flows from operating activities:                                                                  |  |                           |         |                            |   |         |   |   |          |  
|Net income (loss)                                                                                      |  | $                         | (37,904 | )                          | $ | 44,507  |   | $ | 34,995   |  
|Adjustments to reconcile net income (loss) to net cash provided by
  operating activities:             |  |                           |         |                            |   |         |   |   |          |  
|Equity in losses of equity method investees                                                            |  |                           | 26,172  |                            |   | -       |   |   | -        |  
|Compensation expense related to issuance of options to employees of
  equity method investees          |  |                           | 569     |                            |   | -       |   |   | -        |  
|Depreciation                                                                                           |  |                           | 1,070   |                            |   | 1,195   |   |   | 1,751    |  
|Stock-based compensation related to options issued to employees and
  others                           |  |                           | 601     |                            |   | 4,295   |   |   | 4,961    |  
|Cumulative effect of change in accounting principle                                                    |  |                           | -       |                            |   | -       |   |   | (378     | )
|Non-cash deferred revenues (see Note 4c)                                                               |  |                           | 19,182  |                            |   | (19,182 | ) |   | -        |  
|Capital loss from sale of equity method investees                                                      |  |                           | 17,334  |                            |   | -       |   |   | -        |  
|Accrued severance pay, net                                                                             |  |                           | 185     |                            |   | 72      |   |   | (404     | )
|Amortization of premium and accretion of discount, net and accrued
  interest on marketable securities |  |                           | 546     |                            |   | 889     |   |   | (668     | )
|Amortization and impairment of other assets                                                            |  |                           | -       |                            |   | 490     |   |   | 70       |  
|Accrued interest on loans to employees                                                                 |  |                           | (136    | )                          |   | (84     | ) |   | (75      | )
|Increase in accrued interest on loans granted to equity method
  investees                             |  |                           | (149    | )                          |   | -       |   |   | -        |  
|Decrease (increase) in trade receivables                                                               |  |                           | (2,228  | )                          |   | 4,808   |   |   | (6,820   | )
|Decrease (increase) in other accounts receivable and prepaid
expenses                                  |  |                           | (407    | )                          |   | (1,263  | ) |   | 450      |  
|Decrease (increase) in total assets attributed to discontinued
  operations                            |  |                           | (4,776  | )                          |   | 4,939   |   |   | 212      |  
|Increase (decrease) in trade payables                                                                  |  |                           | (396    | )                          |   | (458    | ) |   | 199      |  
|Increase in accrued expenses and other liabilities                                                     |  |                           | 625     |                            |   | 1,820   |   |   | 1,477    |  
|Decrease in deferred revenues                                                                          |  |                           | (6,128  | )                          |   | (24,254 | ) |   | (3,786   | )
|Increase (decrease) in total liabilities attributed to discontinued
  operations                       |  |                           | 3,804   |                            |   | (3,658  | ) |   | (146     | )
|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  
|                                                                                                      
|Net cash provided by operating activities                                                              |  |                           | 17,964  |                            |   | 14,116  |   |   | 31,838   |  
|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  
|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  
|Cash flows from investing activities:                                                                  |  |                           |         |                            |   |         |   |   |          |  
|Collection of (investment in) short-term bank deposits,
net                                            |  |                           | 353     |                            |   | 161     |   |   | (2,016   | )
|Purchase of marketable securities                                                                      |  |                           | (12,471 | )                          |   | (85,934 | ) |   | (294,266 | )
|Proceeds from marketable securities                                                                    |  |                           | 5,727   |                            |   | 20,614  |   |   | 200,266  |  
|Loans granted to equity method investees                                                               |  |                           | (13,104 | )                          |   | -       |   |   | -        |  
|Lease deposits                                                                                         |  |                           | (57     | )                          |   | (44     | ) |   | (470     | )
|Purchase of property and equipment                                                                     |  |                           | (765    | )                          |   | (1,953  | ) |   | (2,486   | )
|Loans granted to employees                                                                             |  |                           | (241    | )                          |   | (154    | ) |   | -        |  
|Loans repaid by employees                                                                              |  |                           | 182     |                            |   | 1,242   |   |   | 1,649    |  
|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  
|                                                                                                      
|Net cash used in investing activities                                                                  |  |                           | (20,376 | )                          |   | (66,068 | ) |   | (97,323  | )
|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  
|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  
|Cash flows from financing activities:                                                                  |  |                           |         |                            |   |         |   |   |          |  
|Issuance
  of Ordinary shares in respect of the Companys public offerings, net                        |  |                           | -       |                            |   | 125,666 |   |   | 9,332    |  
|Other issuance costs in respect of the Companys Initial Public
  Offering                             |  |                           | (719    | )                          |   | (1,951  | ) |   | (395     | )
|Proceeds from issuance of shares                                                                       |  |                           | 845     |                            |   | 250     |   |   | -        |  
|Proceeds from options, stock appreciation rights and warrants
  exercised                              |  |                           | 130     |                            |   | 1,086   |   |   | 9,140    |  
|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  
|                                                                                                      
|Net cash provided by financing activities                                                              |  |                           | 256     |                            |   | 125,051 |   |   | 18,077   |  
|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  
|                                                                                                      
|Increase (decrease) in cash and cash equivalents                                                       |  |                           | (2,156  | )                          |   | 73,099  |   |   | (47,408  | )
|Cash and cash equivalents at beginning of year                                                         |  |                           | 29,384  |                            |   | 27,228  |   |   | 100,327  |  
|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  
|                                                                                                      
|Cash and cash equivalents at end of year                                                               |  | $                         | 27,228  |                            | $ | 100,327 |   | $ | 52,919   |  
|                                                                                                       |  |                           |         |                            |   |         |   |   |          |  

Non-cash
transactions related to the disposal of the Joint Venture interest and exercise
of SARPs - see Note 4c.

(*)          Reclassified, see Note 9.

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

F  7

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |        
|----------- | -------
|NOTE 1:    | GENERAL

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Saifun
  Semiconductors Ltd., established in 1996, is an intellectual property
  supplier of advanced Non Volatile Memory (NVM) technology. The
  nitride-read-only-memory (NROM) technology of Saifun Semiconductors Ltd.
  (collectively with its subsidiaries (Note 2d), the Company or Saifun) is
  applicable to the design and manufacturing of products in the major NVM
  market segments (i.e. Code Flash, Data Flash, Embedded Flash), enabling
  high-density applications. Saifuns NROM technology is serving the fast
  growing portable markets, such as mobile phones, still and video digital
  cameras, digital music players, set top boxes, USB flash drives,
  communication applications, and other electronic applications. During 2006, a
  substantial majority of the Companys revenues were derived from three major
  customers (see Note 13c).

|            |                                
|----------- | -------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES

| |                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------
| | The
  accompanying consolidated financial statements are prepared in accordance
  with U.S. generally accepted accounting principles (U.S. GAAP).

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Use of
  estimates:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | The
  preparation of financial statements in conformity with U.S. GAAP requires
  management to make estimates and assumptions that affect the amounts reported
  in the financial statements and accompanying notes. Actual results could
  differ from those estimates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | b. | Financial
  statements in U.S. dollars:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | All of the
  Companys revenues are denominated in United States dollars (dollars). In
  addition, a substantial portion of the Companys costs is denominated in
  dollars. The Companys management believes that the dollar is the primary
  currency of the economic environment in which Saifun Semiconductors Ltd. and
  each of its subsidiaries operate. Thus, the dollar is their functional and
  reporting currency. Accordingly, monetary accounts maintained in currencies
  other than the dollar are remeasured into dollars in accordance with
  Statement of Financial Accounting Standard (SFAS) No. 52, Foreign Currency
  Translation. Changes in currency exchange rates between the Companys
  functional currency and the currency in which a transaction is denominated
  are included in the Companys results of operations as financial income
  (expense) in the period in which the currency exchange rates change.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | The
  representative rate of exchange between the dollar and the New Israeli Shekel
  (NIS) as of December 31, 2006 was $ 1.00 = NIS 4.225 (December 31,
  2005 - $ 1.00 = NIS 4.603 and December 26, 2004 - $ 1.00 = NIS 4.331).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

F  8

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                        
|----------- | ---------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | The
  financial statements of Infineon Technologies Flash GmbH & Co. KG (IFL
  KG), which were accounted for under the equity method until December 2004,
  the functional currency of which is not the U.S. dollar, have been translated
  into dollars in accordance with SFAS No. 52. Statement of operations amounts
  have been translated using the average exchange rate prevailing during the
  year. The resulting aggregate translation adjustments were reported as a
  component of accumulated other comprehensive income in shareholders equity.
  In December 2004, the Company divested its entire interest in IFL KG and,
  accordingly, the entire balance of accumulated other comprehensive income in
  the amount of $ 651 was realized (see Note 4).
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | c. | Basis of
  presentation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | During
  fiscal year 2005, the Company changed its fiscal year from a 52-week fiscal
  year ending on the last Sunday in December to a calendar year ending on the
  last day of December. For fiscal 2004, the fiscal year ended on December 26.
  Accordingly, the financial statements for the period from December 27, 2004
  through December 31, 2005 are not necessarily comparable. The Company
  believes that this difference is immaterial.                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | d. | Principles
  of consolidation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | The
  consolidated financial statements include the accounts of the Companys
  wholly-owned subsidiaries, Saifun Ventures Ltd. (ceased operations at the
  beginning of 2005), Saifun Semiconductors USA, Inc., Saifun BVI (Limited) and
  Tulip Semiconductor LP. All intercompany balances and transactions have been
  eliminated upon consolidation.                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | e. | Cash and
  cash equivalents:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Cash
  equivalents are short-term, highly liquid investments that are readily
  convertible to cash, with an original maturity of three months or less when
  purchased.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | This item
  includes cash in the banks in the amount of $ 5,886 (2005 - $ 67,630), bank
  deposits in U.S. dollars in the amount of $ 46,220 (2005 - $ 31,949), bank
  deposits in NIS in the amount of $ 813 (2005 - $ 734) and bank deposits in Euro
  in the amount of $ 0 (2005 - $ 14).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | f. | Short-term
  investments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Short-term
  investments include bank deposits with maturities of more than three months
  but less than one year. The deposits are in dollars and bear interest at an
  average annual rate of 5.25% at December 31, 2006. The short-term deposits
  are presented at cost, accreted for interest.                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

F  9

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                        
|----------- | ---------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | g. | Marketable
  securities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | The Company
  accounts for certain investments in debt securities in accordance with
  Statement of Financial Accounting Standards No. 115, Accounting for Certain
  Investments in Debt and Equity Securities (SFAS No. 115). Management
  determines the appropriate classification of its investments in debt
  securities at the time of purchase and reevaluates such determinations at
  each balance sheet date. Debt securities are classified as held-to-maturity
  when the Company has the positive intent and ability to hold the securities
  to maturity and are stated at amortized cost. The amortized cost of
  held-to-maturity securities is adjusted for amortization of premiums and
  accretion of discounts to maturity. Such amortization, impairment of value
  judged to be other than temporary, if any, and interest are included in
  financial income, net.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Auction rate
  securities are classified as available-for-sale and are carried at fair
  value.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | h. | Discontinued
  operations - inventories:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | During 2005,
  the Company discontinued its product business and accordingly, the results of
  operations of product sales operations were reported separately as
  discontinued operations for all periods presented (see Note 9). Inventory
  write-offs for the years ended December 26, 2004 and December 31, 2005
  were $ 3,019 and $ 2,893, respectively, and are included in the results of
  discontinued operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | i. | Property and
  equipment, net:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Property and
  equipment are stated at cost, net of accumulated depreciation. Depreciation
  is calculated by the straight-line method over the estimated useful lives of
  the assets. Annual rates of depreciation are as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

|                         |  |          
|------------------------ |  | ---------
|                         |  | %        
|                         |  |          
|                        
|Laboratory
  equipment   |  | 15
  - 33
|Computers
  and software |  | 33       
|Furniture
  and fixtures |  | 6 - 33   
|Leasehold
  improvements |  | 20       

| |  |                                                                                                          
| |  | ---------------------------------------------------------------------------------------------------------
| |  | Leasehold
  improvements are amortized over the shorter of the estimated useful life or
  the lease term.

F  10

---

---



|                                                  | 
|------------------------------------------------- | 
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                  | 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                         | 

|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|---------- | --------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:   | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|           | j.                                      | Research and
  development costs, net:                                                                                                                                                                                                                                                                                                                                                                                                                               
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|           |                                         | Research and
  development costs consist primarily of salary and related costs for
  personnel, as well as costs related to materials, supplies and equipment
  depreciation. All research and development costs are expensed as incurred.                                                                                                                                                                                                                           
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|           |                                         | Royalty
  bearing grants from the Office of the Chief Scientist of the Israel Ministry
  of Industry, Trade & Labor (OCS) for funding approved research and
  development projects, are recognized at the time the Company is entitled to
  such grants, on the basis of the research and development expenses incurred.
  Such grants are recorded as a reduction to research and development costs.
  Royalties accrued or paid are recorded as cost of revenues.
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|           | k.                                      | Stock-based
  compensation:                                                                                                                                                                                                                                                                                                                                                                                                                                          
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|           |                                         | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Effective
  January 1, 2006, the Company adopted Statement of Financial Accounting
  Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)),
  which is a revision of FASB Statement No. 123, Accounting for Stock-Based
  Compensation (SFAS 123) which requires the measurement and recognition of
  compensation expense based on estimated fair values for all shared based
  payment awards made to employees and directors. In March 2005, the Securities
  and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107)
  relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in
  its adoption of SFAS 123(R).
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | SFAS 123(R)
  requires companies to estimate the fair value of equity-based payment awards
  on the date of grant using an option-pricing model. The value of the portion
  of the award that is ultimately expected to vest is recognized as an expense
  over the requisite service periods in the Companys consolidated statement of
  operations. Prior to the adoption of SFAS 123(R), the Company accounted for
  equity based awards under the fair value recognition provisions of SFAS 123.                                                                                                                                                                             
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | The Company
  adopted SFAS 123(R) using the Modified Prospective Method. Under that
  transition method, compensation cost recognized in the year ended December
  31, 2006, includes: (a) compensation cost for all share-based payments
  granted prior to, but not yet vested as of January 1, 2006, based on the
  grant date fair value estimated in accordance with the original provisions of
  SFAS 123, and (b) compensation cost for all share-based payments granted
  subsequent to January 1, 2006, based on the grant-date fair value estimated
  in accordance with the provisions of SFAS 123(R). Results for prior periods
  have not been restated.             
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | Beginning on
  the date of adoption of SFAS 123(R), forfeitures are estimated based on
  historical experience and other factors; previously, forfeitures were
  recorded as they occurred. Accordingly, the Company recorded cumulative
  effect of change in accounting principle in the amount of $ 378 relating to
  estimated forfeitures for awards granted and outstanding at the date of the
  adoption.                                                                                                                                                                                                                                                                  

F  11

---

---



|                                                  | 
|------------------------------------------------- | 
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                  | 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                         | 

|           |                                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|---------- | --------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:   | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|           |                                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|           |                                         |  | The Company has selected
  the binomial lattice option-pricing model to estimate the fair value for any
  options granted after December 31, 2005. The binomial model considers
  characteristics of fair value option pricing that are not available under the
  Black-Scholes model. Similar to the Black-Scholes model, the binomial model
  takes into account variables such as volatility, dividend yield rate, and
  risk free interest rate. However, the binomial model allows for the use of
  dynamic assumptions and also considers the contractual term of the option,
  the probability that the option will be exercised prior to the end of its
  contractual life, and the probability of termination or retirement of the
  option holder in computing the value of the option. For these reasons, the
  Company believes that the binomial model provides a better estimate of an
  employee stock options fair value than that calculated using the
  Black-Scholes model.
|           |                                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|           |                                         |  | Stock-based
  compensation cost is measured at the grant date, based on the fair value of
  the award, and is recognized as an expense on a straight-line basis over the
  requisite service period for each of the awards.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|           |                                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|           |                                         |  | The fair value of each
  option award is estimated on the date of grant using a binomial option
  valuation model for all grants starting January 1, 2006 using the following
  assumptions:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

|                                       |  |                    
|-------------------------------------- |  | -------------------
|                                       |  | December 31,
  2006
|                                       |  |                    
|                                      
|Dividend
  yield                       |  | 0%                 
|Expected
  volatility                  |  | 35-55%             
|Weighted
  average expected volatility |  | 43%                
|Risk-free
  interest                   |  | 4.4-5.2%           
|Sub optimal
  exercise multiple        |  | 1.8-2.5            
|Expected
  life of                     |  | 5.7%               
|Forfeiture
  rate                      |  | 6%-11%             

| |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | Expected
  volatility is based on historical stock price volatility of comparable
  companies, since it does not have sufficient Company specific data due to its
  recent IPO. The Company uses statistics derived from comparable companies and
  economic literature to estimate option exercise behavior. The risk-free rates
  are based on the yield rates of non-indexed linked U.S. Federal Reserve
  Treasury bonds for the contractual term in effect at the time of grant. The
  expected life of options granted is derived from the output of the option
  valuation model and represents the period of time the options are expected to
  be outstanding.
| |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |  |  | For options granted prior
  to January 1, 2006, the fair value of each option granted was estimated at
  the date of grant using a Black-Scholes options pricing model with the
  following weighted average assumptions:                                                                                                                                                                                                                                                                                                                                                                                                                                              

|                      |  |                     |  |                    
|--------------------- |  | ------------------- |  | -------------------
|                      |  | December 26,
  2004 |  | December 31,
  2005
|                      |  |                     |  |                    
|                     
|Dividend
  yield      |  | 0%                  |  | 0%                 
|Expected
  volatility |  | 0 and 45%           |  | 45%                
|Risk-free
  interest  |  | 2.6-3.3%            |  | 2.6-4.4%           
|Expected
  life of    |  | 3.2-5 years         |  | 1-5 years          

F  12

---

---



|                                                  | 
|------------------------------------------------- | 
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                  | 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                         | 

|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|---------- | --------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:   | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | In
  calculating the fair value of the options granted until June 2004 (initial
  filing date with the SEC), the Company applied the minimum value method as
  prescribed by SFAS 123 for private companies with expected volatility of 0%.
  Volatility of comparable publicly traded companies was used for options
  granted after June 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | The Company
  applied SFAS 123 and Emerging Issues Task Force No. 96-18, Accounting for
  Equity Instruments that are Issued to other than Employees for Acquiring, or
  in Conjunction with Selling, Goods or Services (EITF 96-18), with respect
  to options and warrants issued to non-employees. SFAS 123 and EITF 96-18
  require the use of option valuation models to measure the fair value of the
  options and warrants at the measurement date.                                                                                                                                                                                                                                                                                                                                                                                                            
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|           |                                         | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | The Company
  undertook a liability relating to a Stock Appreciation Rights Plan (the
  SARP) as a result of the sale of its entire interest in the Joint Venture
  (see Note 4c). The SARP liability was recorded at the intrinsic value of the
  underlying shares as required by SFAS 123 with changes in the intrinsic value
  recorded in the statement of operations. During 2006, the majority of the
  SARPs were exercised the remaining SARPs were expired. The liability was
  remeasured until the date of exercise or expiration. Upon exercise of SARPs,
  liability amount of $ 2,182 was recorded as additional paid-in capital in
  shareholders equity. The Company recorded expenses in the amount of $ 0,
  $ 1,116 and income of $ 69 for the years ended December 26, 2004,
  December 31, 2005 and 2006, respectively, with respect to the SARPs.
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|           | l.                                      | Revenue
  recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|           |                                         | The Company
  earns revenues from license fees and royalties, and from providing design and
  development services. Revenues from licenses and royalties are generated from
  agreements with semiconductor companies that enter into licenses for use of
  the Companys technology. While the license fees are generally paid
  irrespective of the amount of sales generated from the use of the technology,
  the license fees, together with the subsequent royalties, represent the
  consideration for the exploitation of the Companys technology. Service
  revenues are generated from design and development services provided by the
  Company to its licensees.
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|           |                                         | Generally,
  the licenses allow a semiconductor manufacturer to use the Companys patents
  and trade secrets, and in some cases, convey an implied right to receive
  initial support in order to implement the Companys technology in the
  licensees products.                                                                                                                                                                                                                                                                                                                                                                                                          
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|           |                                         | License and royalty revenues                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|           |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|           |                                         | The Company
  recognizes revenues in accordance with Staff Accounting Bulletin No. 104,
  Revenue Recognition (SAB No. 104) and, when necessary, allocates proceeds
  to multiple elements, according to Emerging Issues Task Force Issue No.
  00-21, Revenue Arrangements with Multiple Deliverables (EITF No. 00-21).                                                                                                                                                                                                                                                                                                                                             

F  13

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                        
|----------- | ---------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | License
  revenues are recognized when persuasive evidence of an arrangement exists,
  delivery has occurred or the service has been rendered, the fee is fixed or
  determinable and collectibility is probable. The fees for the licenses
  provided under these agreements are comprised of license fees, support fees
  in some cases, as well as in certain cases, non refundable, prepaid
  royalties. Generally, such fees are accounted for as one unit of accounting
  in accordance with EITF No. 00-21, since it is not possible to determine
  objective and reliable evidence of fair value of the undelivered contract
  elements in order to allocate the fees among the elements. The license fees
  are payable upon the achievement of certain technological or time-based
  milestones. Accordingly, revenues from such license fees are recognized
  ratably over the period during which the initial customer support is expected
  to be provided in order to implement the Companys technology in the
  licensees products and only when all other criteria for revenue recognition
  are met. In addition, revenue recognition is limited to the amount that is
  due or billable under the agreement if extended payment terms exist. In
  agreements where no initial customer support is provided, license fees are
  recognized upon delivery provided no extended payment terms exist. The
  Company reviews assumptions regarding the support periods on a regular basis.
  If it determines that it is necessary to revise its estimates of the customer
  support periods, the total amount of revenue recognized over the life of the
  contract would not be affected. However, to the extent the new assumptions
  regarding the post contract customer support periods are less than the
  original assumptions, the license fees would be recognized ratably over the
  shorter period. Conversely, if the new estimated periods are longer than the
  original assumptions, the license fees would be recognized over a longer
  period. The excess of contract fees received over revenues recognized is
  presented in the balance sheet as deferred revenues.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | Revenues
  from royalties are recognized as earned.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | Service revenues                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | Revenues
  from design and development services provided to licensees in fixed fee
  service contracts that are separable from the license agreement are
  recognized based on the proportional performance model, using costs of employee
  services rendered as a percentage of total project costs. However, revenues
  are always limited to output measures (technological milestones) or amounts
  due or billable under the agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | Discontinued operations - product revenues                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | Revenues from
  product sales were recognized in accordance with SAB No. 104 when persuasive
  evidence of an agreement exists, delivery has occurred, the fee is fixed or
  determinable, no further obligation exists and collectibility is probable.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | The Company
  generally did not grant a right of return to its customers. However, the
  Company granted certain distributors in connection with the discontinued
  product business (see note 9) a limited right of return on unsold products.
  When a right of return existed, the Company deferred revenues based upon the
  agreed upon return rights until the right of return expired, at which time
  revenue was recognized provided that all other revenue recognition criteria
  were met. The Company provided product warranties for up to one year. There
  is no provision for warranties as of December 31, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

F  14

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                        
|----------- | ---------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |                                                                                                                                                                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | During 2005,
  the Company discontinued its product business and accordingly, the results of
  operations of the product business were reported separately as discontinued
  operations for all periods presented (see Note 9). The liabilities attributed
  to discontinued operations included an estimate of the cost of warranty
  provided on the discontinued products sales.

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | m. | Equity
  method investment:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | The
  Companys investment in entities which are held to the extent of 20% to 50%
  and with respect to which it has the ability to exercise significant
  influence over operating and financial policies are accounted for under the
  equity method. The Company applies Emerging Issues Task Force 99-10,
  Percentage Used to Determine the Amount of Equity Method Losses.
  Accordingly, losses of the investees are recognized based on the ownership
  level of the particular investee security or loans held by the investor.                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | n. | Income
  taxes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | The Company
  accounts for income taxes in accordance with Statement of Financial
  Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109).
  SFAS No. 109 prescribes the use of the liability method whereby deferred tax
  asset and liability account balances are determined based on differences
  between the financial reporting and tax bases of assets and liabilities and
  are measured using the enacted tax rates and laws that will be in effect when
  the differences are expected to reverse. The Company provides a valuation
  allowance, if necessary, to reduce deferred tax assets to their estimated
  realizable value.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | Up to the
  year ended December 31, 2005, results for tax purposes were measured and
  reflected in real terms in accordance with the change in the Israeli Consumer
  Price Index (CPI). As explained in b above, the consolidated financial
  statements are presented in dollars. In accordance with paragraph 9(f) of
  SFAS No. 109, the Company has not provided deferred income taxes on the
  differences resulting from changes in exchange rates and indexing for tax
  purposes.                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | o. | Fair value
  of financial instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | The carrying
  amount reported in the consolidated balance sheet for cash and cash
  equivalents, short-term investments, trade receivables and trade payables
  approximates their fair value due to the short-term maturities of such
  instruments.                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | The fair
  value of marketable securities is based on quoted market prices and does not
  differ significantly from the carrying amount.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | The fair
  value of the loans to employees is estimated by discounting the future cash
  flows using current interest rates for loans of similar terms and maturities.
  The carrying amount of the loans approximates their fair value.                                                                                                                                                                                                                                                                                                                                                                                                                             

F  15

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                        
|----------- | ---------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | p. | Impairment
  of long-lived assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | The
  Companys long-lived assets and other assets are reviewed for impairment in
  accordance with Statement of Financial Accounting Standards No. 144,
  Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No.
  144) whenever events or changes in circumstances indicate that the carrying
  amount of the asset may not be recoverable. Recoverability of an asset to be
  held and used is measured by a comparison of the carrying amount of an asset
  to the future undiscounted cash flows expected to be generated by the asset. If such asset is considered to be
  impaired, the impairment to be recognized is measured by the amount by which
  the carrying amount of the asset exceeds its fair value.                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | q. | Severance
  pay:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | The
  Companys liability for severance pay is calculated pursuant to Israels
  Severance Pay Law, based on the most recent salary of the employees multiplied
  by the number of years of employment, as of the balance sheet date. Employees
  are entitled to one months salary for each year of employment or a portion
  thereof. The Companys liability for all of its Israeli employees is covered
  by monthly deposits for insurance policies and/or pension funds, by central
  severance funds and by an accrual. The value of these policies and/or funds
  is recorded as an asset in the Companys balance sheet. The deposited funds
  include profits accumulated to the balance sheet date. The deposited amounts
  may be withdrawn only upon the fulfillment of the obligations pursuant to the
  Israels Severance Pay Law or labor agreements. The value of the deposited
  funds is based on the cash surrendered value of these policies, and includes
  immaterial profits.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | Severance
  expense for the years ended December 26, 2004 and December 31, 2005 and 2006
  amounted to $ 745, $ 645 and $ 1,020, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | r. | Concentrations
  of credit risk:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | Financial
  instruments that potentially subject the Company to concentrations of credit
  risk consist principally of cash and cash equivalents, short-term
  investments, marketable securities and trade receivables.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | Cash and
  cash equivalents and short-term bank deposits are invested in dollars, Euros
  and NIS with major banks in the United States, Switzerland and Israel.
  Management believes that the financial institutions that hold the Companys
  investments are financially sound and, accordingly, minimal credit risk
  exists with respect to these investments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | The
  Companys investments in marketable securities include investments in
  debentures of U.S. and European corporations and government institutions.
  Management believes that these corporations are financially sound, the
  portfolio is well diversified and accordingly, minimal credit risk exists
  with respect to these marketable securities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | The
  Companys trade receivables are generally derived from license revenues and
  services rendered to large and well established organizations located
  primarily in the Asia-Pacific region, the United States and Europe (see Note
  13a). The Company has not experienced any material losses to date.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | No
  off-balance sheet concentrations of credit risk exist.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

F  16

---

---



|                                                         
|---------------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS SUBSIDIARIES          
|                                                         
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS               
|                                                         
|U.S. dollars in thousands except share and per share data

|            |                                        
|----------- | ---------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | s. | Net earnings
  (loss) per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    | Basic net
  earnings (loss) per share are computed using the weighted average number of
  Ordinary shares outstanding during the period. Diluted net earnings (loss)
  per share are computed based on the weighted average number of Ordinary
  shares outstanding during the period, plus dilutive potential Ordinary shares
  considered outstanding during the period in accordance with Statement of
  Financial Accounting Standards No. 128, Earnings Per Share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    | In 2005, the
  Company applied the two-class method as required by EITF No. 03-6,
  Participating Securities and the Two-Class Method under FASB Statement No.
  128, Earnings per Share (EITF No. 03-6). EITF No. 03-6 requires the
  earnings per share for each class of shares (Ordinary shares and Preferred
  shares) to be calculated assuming 100% of the Companys earnings are distributed
  as dividends to each class of shares based on their contractual rights.
  Accordingly, until the Company reaches a certain company valuation, each
  holder of the Class B Preferred shares is entitled to receive, prior to and
  in preference to payments to the holders of Class A Preferred shares and
  Ordinary shares, an amount equal to 128% of the amount of its investment in
  the Company and, thereafter, on a pro rata basis among all shareholders. In 2005, earnings per
  share was calculated assuming that all of the Companys profit generated for
  the period December 27, 2004 through November 8, 2005 (the IPO Date) was
  first distributed to the holder of Class B Preferred shares as if it were a
  deemed liquidation event (for the period from December 27, 2004 until the
  date of the IPO, whereby the Class B Preferred shares were converted to
  Ordinary shares).
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    | In
  compliance with EITF No. 03-6, the series of Preferred shares did not
  participate in losses, and therefore were not included in the computation of
  net loss per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    | In 2005, the
  weighted average number of Ordinary shares outstanding for basic and diluted
  net earnings (loss) per share was calculated separately for two isolated
  periods (from December 27, 2004 until the IPO Date and from the IPO Date
  until December 31, 2005). Diluted net earnings (loss) per share were computed
  based on the weighted average number of Ordinary shares outstanding during
  the two periods described above, plus dilutive potential Ordinary shares
  considered outstanding during each of the two periods in accordance with
  Statement of Financial Accounting Standards No. 128, Earnings Per Share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    | For the year
  ended December 26, 2004, all outstanding stock options, warrants and
  Convertible Preferred shares have been excluded from the calculation of the
  diluted net loss per share since their effect was anti-dilutive. For the
  years ended December 31, 2005 and December 31, 2006, 189,823 and 284,741
  stock options and 89,100 and 0 shares exercisable as a result of the SARPs,
  respectively, have been excluded from the calculation of the diluted net
  earnings per share since their effect was anti-dilutive.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    | Basic and
  diluted pro forma net earnings (loss) per share for the year ended December
  31, 2005, as presented in Note 15b, have been calculated as described above
  and give effect to the automatic conversion of the Convertible Preferred
  shares (Class A and Class B) and options into Ordinary shares that occurred
  upon the completion of the Companys IPO on November 8, 2005 (using the as
  if converted method as if the conversion occurred as of the beginning of the
  year ended December 31, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

F  17

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                        
|----------- | ---------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | t. | Derivative instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | The Company
  sometimes uses derivative financial instruments to manage its exposure to
  fluctuations in foreign exchange rates. The Company accounts for derivative
  financial instruments in accordance with SFAS 133, Accounting for Derivative
  Instruments and Hedging Activities (SFAS No. 133). Under SFAS No. 133, all
  derivatives are recorded as either assets or liabilities in the consolidated
  balance sheet, and periodically adjusted to fair value. The classification of
  gains and losses resulting from changes in the fair values of derivatives is
  dependent on the intended use of the derivative and its resulting
  designation. Adjustments to reflect changes in fair values of derivatives not
  designated as hedging instruments are reflected in earnings. For derivative
  instruments that are designated and qualify as a cash flow hedge, the
  effective portion of the gain or loss on the derivative instrument is
  reported as a component of other comprehensive income and reclassified into
  earnings in the same line item associated with the forecasted transaction in
  the same period during which the hedge transaction affects earnings.                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | u. | Recently issued Accounting Standards:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | In September
  2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157,
  Fair Value Measurements. This Standard defines fair value, establishes a
  framework for measuring fair value in generally accepted accounting
  principles and expands disclosures about fair value measurements. SFAS No.
  157 is effective for financial statements issued for fiscal years beginning
  after November 15, 2007 and interim periods within those fiscal years.
  Management believes this Standard will not have a material effect on its
  consolidated financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | In June
  2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in
  Income Taxes (FIN 48), an interpretation of SFAS 109, Accounting for
  Income Taxes. FIN 48 prescribes a comprehensive model for how companies
  should recognize, measure, present and disclose in their financial statements
  uncertain tax positions taken or expected to be taken on a tax return. Under
  FIN 48, tax positions shall initially be recognized in the financial statements
  when it is more-likely-than-not that the position will be sustained upon
  examination by the tax authorities. Such tax positions shall initially and
  subsequently be measured as the largest amount of tax benefit that is greater
  than 50% likely of being realized upon ultimate settlement with the tax
  authority assuming full knowledge of the position and all relevant facts. FIN
  48 also revises disclosure requirements to include an annual tabular
  rollforward of unrecognized tax benefits. The provisions of this
  interpretation are required to be adopted for fiscal periods beginning after
  December 15, 2006. The Company will be required to apply the provisions of
  FIN 48 to all tax positions upon initial adoption with any cumulative effect
  adjustments to be recognized as an adjustment to retained earnings. Based on
  Companys initial evaluation as of December 31, 2006, the Company does not
  believe that FIN 48 will have a material impact on its financial statements.

F  18

---

---



|                                               
|-----------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS SUBSIDIARIES
|                                               
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS     
|                                               
|U.S. dollars in thousands                      

|            |                                        
|----------- | ---------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In February
  2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
  Assets and Financial Liabilities (SFAS No. 159), which permits companies
  to choose to measure certain financial instruments and other items at fair
  value that are not currently required to be measured at fair value. SFAS No.
  159 is effective for fiscal years beginning after November 15, 2007. The
  Company will adopt SFAS No. 159 no later than January 1, 2008. The Company
  has not yet determined the effect that the adoption of SFAS No. 159 will have
  on its consolidated financial statements.

|            |                                                                                          
|----------- | -----------------------------------------------------------------------------------------
|NOTE 3:    | MARKETABLE SECURITIES                                                                    
|            |                                                                                          
|            | Marketable
  securities with contractual maturities of less than one year are as follows:

| |                           |  |                                     |        |            |   |                                     |  |            |         |  |   |         | 
| | ------------------------- |  | ----------------------------------- | ------ | ---------- | - | ----------------------------------- |  | ---------- | ------- |  | - | ------- | 
| |                           |  | December 31,                        |       
| |                           |  |                                     |       
| |                           |  | 2005                                |        | 2006       |  
| |                           |  |                                     |        |            |  
| |                           |  | Amortized
  cost /
  Carrying Value |        | Fair value |   | Amortized
  cost /
  Carrying Value |  | Fair value |        
| |                           |  |                                     |        |            |   |                                     |  |            |        
| |                           |  |                                     |        |            |   |                                     |  |            |        
| | Commercial
  bonds        |  | $                                   | 10,864 |            | $ | 10,836                              |  | $          | 26,079  |  | $ | 26,004  | 
| | Government
  bonds        |  |                                     | 2,750  |            |   | 2,746                               |  |            | 24,707  |  |   | 24,666  | 
| | Auction
  rate securities |  |                                     | 61,887 |            |   | 61,887                              |  |            | 64,871  |  |   | 64,871  | 
| |                           |  |                                     |        |            |   |                                     |  |            |         |  |   |         | 
| |                           |  |                                     |        |            |   |                                     |  |            |         |  |   |         | 
| |                           |  | $                                   | 75,501 |            | $ | 75,469                              |  | $          | 115,657 |  | $ | 115,541 | 
| |                           |  |                                     |        |            |   |                                     |  |            |         |  |   |         | 

| |                                                                                                      
| | -----------------------------------------------------------------------------------------------------
| | Marketable
  securities with contractual maturities of one year through three years are as
  follows:

| |                         |  |                                     |       |            |   |                                     |  |            |        |  |   |        | 
| | ----------------------- |  | ----------------------------------- | ----- | ---------- | - | ----------------------------------- |  | ---------- | ------ |  | - | ------ | 
| |                         |  | December 31,                        |      
| |                         |  |                                     |      
| |                         |  | 2005                                |       | 2006       |  
| |                         |  |                                     |       |            |  
| |                         |  | Amortized
  cost /
  Carrying Value |       | Fair value |   | Amortized
  cost /
  Carrying Value |  | Fair value |       
| |                         |  |                                     |       |            |   |                                     |  |            |       
| |                         |  |                                     |       |            |   |                                     |  |            |       
| |                         |  |                                     |       |            |   |                                     |  |            |        |  |   |        | 
| | Commercial
  bonds      |  | $                                   | 4,688 |            | $ | 4,659                               |  | $          | 24,440 |  | $ | 24,485 | 
| | Government
  bonds      |  |                                     | 1,307 |            |   | 1,304                               |  |            | 33,567 |  |   | 33,470 | 
| | Auction rate securities |  |                                     |      |            |   |                                    |  |            | 2,500  |  |   | 2,500  | 
| |                         |  |                                     |       |            |   |                                     |  |            |        |  |   |        | 
| |                         |  |                                     |       |            |   |                                     |  |            |        |  |   |        | 
| |                         |  | $                                   | 5,995 |            | $ | 5,963                               |  | $          | 60,507 |  | $ | 60,455 | 
| |                         |  |                                     |       |            |   |                                     |  |            |        |  |   |        | 

|            |                                                                                                           
|----------- | ----------------------------------------------------------------------------------------------------------
|            | As of
  December 31, 2005 and 2006, the fair value of the securities approximates
  their carrying amount.
|            |                                                                                                           
|NOTE 4:    | DISPOSAL OF EQUITY METHOD INVESTEES                                                                       

| |    |                                                                                                                                                                                                                                                                                                                                                                               
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | In 2001, the
  Company and Infineon Technologies (Infineon) established a Joint Venture,
  which was engaged in the development, production and distribution of flash
  products. The Joint Venture consisted of an Israeli corporation, Infineon
  Technologies Flash Ltd. (IFL Ltd.), and a German partnership, Infineon
  Technologies Flash GmbH & Co. KG. (IFL KG).
| |    |                                                                                                                                                                                                                                                                                                                                                                               
| |    | As of
  December 26, 2004, the Company had disposed of its ownership in each of the
  affiliated entities (see c below).                                                                                                                                                                                                                                                      

F  19

---

---



|                                                          
|----------------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES         
|                                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|            |                                            
|----------- | -------------------------------------------
|NOTE 4:    | DISPOSAL OF EQUITY METHOD INVESTEES (Cont.)

| |                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------
| | The Company
  recognized a loss from the sale of the interest in the Joint Venture, which
  is computed as follows (see c below):
|

|                                                                                                        |  |                                  |         |  
|------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------- | -
|                                                                                                        |  | Year ended
  December 26,
  2004 |        
|                                                                                                        |  |                                  |        
|                                                                                                        |  |                                  |         |  
|Reissuance of treasury shares (including
  $ 871 increase in additional paid-in capital - see Note 10e) |  | $                                | 4,987   |  
|Assignment
  of subscription receivable                                                                 |  |                                  | 6,280   |  
|Write-off of
  interest receivables on loans granted to the Joint Venture                               |  |                                  | 275     |  
|Realization
  of comprehensive income (see Note 2b)                                                     |  |                                  | 651     |  
|                                                                                                        |  |                                  |         |  
|                                                                                                       
|                                                                                                        |  |                                  | (2,365  | )
|Less - fair
  value of the Companys interest in the Joint Venture                                      |  |                                  | (19,699 | )
|                                                                                                        |  |                                  |         |  
|                                                                                                       
|Capital loss                                                                                            |  | $                                | 17,334  |  
|                                                                                                        |  |                                  |         |  

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In
  connection with a former share compensation plan for the employees of IFL
  Ltd., IFL Ltd. purchased 1,072,407 Ordinary shares of the Company in 2001 for
  approximately $ 20,000. This purchase was financed by a loan granted to
  IFL Ltd. by the Company amounting to $ 6,280, as well as by an equity
  contribution of $ 13,720 provided by the Company and Infineon. The Companys
  share in the above investment (including the loan) amounting to $ 13,003
  was presented as treasury shares and subscription receivable, as a deduction
  from the Companys shareholders equity. Following the Companys dilution
  from a 49% interest to a 30% interest in the Joint Venture in 2003, the
  Companys share in the aforementioned investment was reduced to
  $ 10,396. Accordingly, the Company reduced its investment in treasury
  shares by $ 2,607. In January 2005, as part of the sale of the Joint Venture,
  the shares were sold by IFL Ltd. to Infineon. The Company accounted for the
  sale as reissuance of the treasury shares to Infineon (see c below).
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

| |    |                                                                             
| | -- | ----------------------------------------------------------------------------
| | b. | Summarized
  financial information of the Joint Venture until sale:         
| |    |                                                                             
| |    | The
  following summarizes the aggregate information of IFL Ltd. and IFL KG:

| |                                   |  |                                  |         
| | --------------------------------- |  | -------------------------------- | --------
| |                                   |  | Year ended
  December 26,
  2004
| |                                   |  |                                 
| |                                   |  |                                  |         
| | Revenues                          |  | $                                | 58,111  
| | Gross loss                        |  | $                                | (23,488)
| | Loss from
  continuing operations |  | $                                | (86,906)
| | Net loss                          |  | $                                | (86,906)

F  20

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                            
|----------- | -------------------------------------------
|NOTE 4:    | DISPOSAL OF EQUITY METHOD INVESTEES (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | c. | Sale of
  Joint Venture:                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | On December
  23, 2004, the Company and Infineon consummated a series of agreements that
  led to the termination of their Joint Venture interests, the establishment of
  new agreements that govern the licensing of the Companys technology to
  Infineon and performance of certain development services. The Company sold
  its 30% equity interest in the Joint Venture to Infineon, which holds the
  remaining interest in the Joint Venture.

| |  |    |                                                                                                                                                          |                                                                                                                                                                                                              
| |  | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 1. | Termination
  of the Joint Venture and related transactions (the Agreement) was signed by
  the two parties, whereby in accordance with the Agreement:
| |  |    |                                                                                                                                                          |                                                                                                                                                                                                              
| |  |    | a)                                                                                                                                                       | All former agreements signed by the two parties were terminated,                                                                                                                                             
| |  |    |                                                                                                                                                          |                                                                                                                                                                                                              
| |  |    | b)                                                                                                                                                       | Both parties rights and obligations in respect of financing
  arrangements were terminated, releasing them from any past, present or future
  obligations to provide further financing to the Joint Venture,
| |  |    |                                                                                                                                                          |                                                                                                                                                                                                              
| |  |    | c)                                                                                                                                                       | The Companys right to receive repayment of the subscription
  receivable of $ 6,280 was assigned to Infineon,                                                                                               
| |  |    |                                                                                                                                                          |                                                                                                                                                                                                              
| |  |    | d)                                                                                                                                                       | The Company was obligated to offer employment to certain of IFL
  Ltd.s employees (workforce), valued at $ 560,                                                                                           
| |  |    |                                                                                                                                                          |                                                                                                                                                                                                              
| |  |    | e)                                                                                                                                                       | The Company undertook certain liabilities relating to the Stock
  Appreciation Rights Plan of IFL Ltd. (the SARP), valued at $ 1,140 (see Note
  7).                                                       
| |  |    |                                                                                                                                                          |                                                                                                                                                                                                              
| |  | 2. | License
  agreement:                                                                                                                                    

| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | In addition
  to the termination of the Joint Venture, the Company entered into an Amended
  License Agreement (the License Agreement) with Infineon. Under the License
  Agreement, in consideration of a new license that was granted, the Company
  will receive: 1) nonrefundable license fees payable in quarterly installments
  over 10 years from the date of the License Agreement pursuant to a fixed
  payment schedule, 2) additional, nonrefundable license fees capped at a
  certain amount of the proceeds received by Infineon from the sale of the
  Companys treasury shares (that were reissued to Infineon), payable over
  eight quarters following the sale of the shares and 3) running royalties
  based on Infineon sales. Infineon may terminate the license at any time, and
  Saifun will not receive any additional consideration, beyond payments already
  received or due on the termination date. On June 28, 2005, Infineon exercised
  its cancellation privileges for certain of the licensed technologies, thereby
  reducing its maximum remaining obligation to Saifun. In October 2006, Qimonda
  AG (Qimonda), a majority-owned subsidiary of Infineon and the assignee of
  the license with Infineon, informed the Company of its decision to phase out
  its current NROM-related activity. As a result of this change, the Company
  does not expect to receive from Qimonda any license fees or services fees,
  and only limited royalties, after 2006.

F  21

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                            
|----------- | -------------------------------------------
|NOTE 4:    | DISPOSAL OF EQUITY METHOD INVESTEES (Cont.)

| |    |                                                                                                                                                                    
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 3. | Development
  services agreement:                                                                                                                                  
| |    |                                                                                                                                                                    
| |    | Under the
  development services agreement, the Company will provide development services
  to Infineon in accordance with a basic agreement on development orders.

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | As the above
  mentioned agreements were signed in contemplation of one another, for
  accounting purposes, the total net consideration (cash, workforce received,
  liabilities assumed) derived from the above agreements was allocated to the
  proceeds from the sale of  the Joint
  Venture, the development services and the license. Since the fair value of
  the Joint Venture and development services was more reliably measurable, the
  Company performed a valuation of the Joint Venture and allocated the
  consideration based on the fair value determined. Accordingly, the residual
  amount of the consideration from the agreements was allocated to the license.
  This allocation resulted in $ 19,182 non-cash revenues for the year ended
  December 31, 2005.                                                                               
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | The fair
  value of the elements above was determined as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | Interest in the Joint Venture                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | The fair
  value of the Companys interest in the Joint Venture was deemed to be zero,
  after giving recognition to the forgiveness of loans and future capital
  commitments ($ 19,699) by the Company and Infineon, based on a valuation
  prepared using the adjusted book value method. It was determined that
  substantially all of the waived commitments represented non-cash license
  revenues in the amount of $ 19,182 in respect of the amended license granted
  by the Company to Infineon.                                                                                                                                                                                                                                                                                                                                                             
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | Development services                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | The
  development services are charged based on a fixed fee per employee. The fair
  value of these services was determined based on fees for similar services
  provided by the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | The Company
  recorded the reissuance of treasury shares at fair value (treasury shares
  were previously presented at cost). The difference between the fair value and
  the book value of the treasury shares in the amount of $ 871 was recorded as
  an increase in additional paid-in capital.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | The capital
  loss recorded by the Company as a result of the sale of its entire interest
  in the Joint Venture amounted to $ 17,334.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | The
  workforce received by the Company is recorded at fair value based on a
  Company valuation and amortized over an estimated useful life of two years.
  The SARP liability is recorded at the intrinsic value of the underlying
  shares as required by SFAS 123 with changes in the intrinsic value recorded
  in the statement of operations (see Note 2m). During 2006, the majority of
  the SARPs were exercised, the remaining SARPs were expired. The liability
  was remeasured until the date of exercise or expiration. Upon exercise of
  SARPs, liability in the amount of $ 2,182 was recorded as additional paid-in
  capital in shareholders equity. The Company recorded expenses in the amount
  of $ 0, $ 1,116 and income of $ 69 for the years ended December 26, 2004,
  December 31, 2005 and 2006, respectively, with respect to the SARPs.

F  22

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 5:    | LOANS TO EMPLOYEES                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            | The loans to
  employees are to be repaid within five years from date of grant and bear interest
  at an annual rate of 4%. As of December 31, 2006, an amount of $ 68 is in
  dollars and the remainder is in NIS, linked to the changes in the Israeli
  CPI. The loans are recourse loans and are secured by certain assets of the
  employees, including share options granted to them. As of December 31, 2006,
  the maturities of the loans are as follows:

| |      |   |     |  | 
| | ---- | - | --- |  | 
| | 2007 | $ | 44  | 
| | 2008 |   | 24  | 
| | 2009 |   | 68  | 
| |      |   |     | 
| |      |   |     | 
| |      | $ | 136 | 
| |      |   |     | 

|            |                            
|----------- | ---------------------------
|NOTE 6:    | PROPERTY AND EQUIPMENT, NET

|                            |  |              |       |      |   |        | 
|--------------------------- |  | ------------ | ----- | ---- | - | ------ | 
|                            |  | December 31, |      
|                            |  |              |      
|                            |  | 2005         |       | 2006 |  
|                            |  |              |       |      |  
|Cost:                       |  |              |       |      |   |        | 
|Laboratory equipment        |  | $            | 3,594 |      | $ | 5,424  | 
|Computers and software      |  |              | 4,981 |      |   | 5,420  | 
|Furniture and fixtures      |  |              | 387   |      |   | 403    | 
|Leasehold improvements      |  |              | 872   |      |   | 1,073  | 
|                            |  |              |       |      |   |        | 
|                            |  |              |       |      |   |        | 
|                            |  |              | 9,834 |      |   | 12,320 | 
|                            |  |              |       |      |   |        | 
|Accumulated
  depreciation: |  |              |       |      |   |        | 
|Laboratory equipment        |  |              | 2,307 |      |   | 3,081  | 
|Computers and software      |  |              | 4,112 |      |   | 4,657  | 
|Furniture and fixtures      |  |              | 132   |      |   | 225    | 
|Leasehold improvements      |  |              | 615   |      |   | 954    | 
|                            |  |              |       |      |   |        | 
|                            |  |              |       |      |   |        | 
|                            |  |              | 7,166 |      |   | 8,917  | 
|                            |  |              |       |      |   |        | 
|                           
|Depreciated
  cost          |  | $            | 2,668 |      | $ | 3,403  | 
|                            |  |              |       |      |   |        | 

| |                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Substantially
  the entire property and equipment are located in Israel. Depreciation expense
  for the years ended December 26, 2004 and December 31, 2005 and 2006 was
  $ 1,070, $ 1,195 and $ 1,751, respectively.
| |                                                                                                                                                                                                                       
| | During 2006,
  part of the Companys leasehold improvements and furniture and fixtures were
  fully amortized since the Company is moving to a new facility.                                                          

F  23

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                       
|----------- | --------------------------------------
|NOTE 7:    | ACCRUED EXPENSES AND OTHER LIABILITIES

|                                    |  |              |       |      |   |       | 
|----------------------------------- |  | ------------ | ----- | ---- | - | ----- | 
|                                    |  | December 31, |      
|                                    |  |              |      
|                                    |  | 2005         |       | 2006 |  
|                                    |  |              |       |      |  
|                                    |  |              |       |      |   |       | 
|Payroll and
  related expenses (*)  |  | $            | 3,434 |      | $ | 3,440 | 
|Accrued
  issuance expenses (**)    |  |              | 1,859 |      |   | 1,600 | 
|Other
  accrued expenses            |  |              | 2,369 |      |   | 2,695 | 
|SARP liability
  (***)              |  |              | 2,251 |      |   | -     | 
|Tax
  Provision                     |  |              | -     |      |   | 1,284 | 
|                                    |  |              |       |      |   |       | 
|                                    |  |              |       |      |   |       | 
|                                    |  | $            | 9,913 |      | $ | 9,019 | 
|                                    |  |              |       |      |   |       | 
|                                    |  |              |       |      |   |       | 
|(*) Includes
  accrued vacation pay |  | $            | 853   |      | $ | 1,037 | 
|                                    |  |              |       |      |   |       | 

|      |                                                         
|----- | --------------------------------------------------------
|(**)  | Includes
  stamp tax provision in the amount of $ 1,351.
|      |                                                         
|(***) | See Note 4c.                                            

|            |                                       
|----------- | --------------------------------------
|NOTE 8:    | COMMITMENTS AND CONTINGENT LIABILITIES

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|a. | Commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | During 2006,
  the Company entered into a new operating lease agreement for new facilities
  in Israel. The new agreement expires in March 2012, with an option to extend
  the lease until March 2017 (with a rent increase of 10%). The Company also
  leases additional spaces in its old Israeli facilities pursuant to leases
  that expire in September 2009, September 2010 and November 2010. In addition,
  the Companys facilities in the United States are leased under an operating
  lease that expires on January 31, 2010. The Company has also leased its motor
  vehicles and certain software under operating leases.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | Annual
  minimum commitments under non-cancelable leases are as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

| |                           |  |   |        |  | 
| | ------------------------- |  | - | ------ |  | 
| | Year ended
  December 31, |  |   |        | 
|
| | 2007                      |  | $ | 4,287  | 
| | 2008                      |  |   | 3,457  | 
| | 2009                      |  |   | 2,867  | 
| | 2010                      |  |   | 1,105  | 
| | 2011                      |  |   | 1,029  | 
| | 2012                      |  |   | 171    | 
| |                           |  |   |        | 
| |                           |  |   |        | 
| |                           |  | $ | 12,916 | 
| |                           |  |   |        | 

| |                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------
| | Rental
  expense for the years ended December 26, 2004 and December 31, 2005 and 2006
  amounted to $ 2,612, $ 3,722 and $ 4,833, respectively.

F  24

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                               
|----------- | ----------------------------------------------
|NOTE 8:    | COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)

|   |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-- | -------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|b. | Contingencies:
|   |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 1.             | Several
  years ago, the Company received an approval from the U.S. Israel BIRD
  Foundation (BIRD) for royalty-bearing participation in its research and
  development, of approximately $ 250. The Company is obligated to pay royalties
  at the rate of 2.5% in the first year and 5.0% thereafter on 30% of sales of
  products for which participations were received in the research and
  development of those products. The royalties are limited to between 100%-150%
  of the participations received, depending on the extent of the period during
  which the royalties are paid. The Companys total contingent liability for
  royalties payable with respect to future sales, based on participations
  received or accrued, net of royalties paid or accrued, totaled approximately
  $ 310 as of December 31, 2006.
|   |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 2.             | In October
  2002, the former Chief Executive Officer of IFL Ltd. filed a claim against
  IFL Ltd. for certain rights and compensation and against the Company for
  420,000 share options with an exercise price of $ 1.69 per share. The
  Companys management believes it has meritorious defenses against the claims
  above. A provision has been recorded in respect of the above claim based on
  an estimate by the Companys management, as well as the opinion of its legal counsel.                                                                                                                                                                                                                                                                                                                                        
|   |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 3.             | Derivative
  financial instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                | As of
  December 31, 2006, the Company has forward exchange contracts for the
  acquisition of approximately NIS 2,595 thousand, in consideration for $ 600,
  maturing in a period of up to a month. The fair value of said contracts as of
  December 31, 2006 was $ 14 (see Note 2t).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | 4.             | In 2006, the Company received partial financing for its
  research and development expenditures under programs sponsored by the OCS for
  the support of certain research and development activities conducted in
  Israel.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                | In exchange
  for participation in the program by the OCS, the Company agreed to pay
  3%-3.5% of total net consolidated revenues related to the products developed
  within the framework of this program. The royalties will be paid up to a
  maximum amount equaling 100% of the grants provided by the OCS and bear
  annual interest at a rate based on LIBOR. Repayment of such grants is not
  required in the event that there are no sales of products developed within
  the framework of such funded program.                                                                                                                                                                                                                                                                                                              
|   |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                | Research and
  development grants amounted to approximately $ 220 in 2006. No royalties were
  paid or accrued as of December 31, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                | As of
  December 31, 2006, the Company had a contingent liability to pay royalties of
  approximately $ 227 (including accrued interest of $ 7 from the date of grant).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

F  25

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 8:    | COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | 5.                                                                                                                                                                                     | Revolving
  credit lines:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                        | During 2006,
  the Company entered into agreements with several banks for revolving credit
  lines. Pursuant to the agreements, the total amount of funds available under
  the revolving credit lines is based on certain percentages of the assets
  managed by the banks. The agreements provide for interest on any outstanding
  balances based on the LIBOR rate plus 0.25% (5.57% as of December 31, 2006).
  If any, outstanding balances would have been collateralized by the funds to
  the banks. As of December 31, 2006, the Company had not borrowed any amounts
  under its credit lines.
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|NOTE 9:    | DISCONTINUED OPERATIONS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | In April
  2005, the Company decided to discontinue its product business (manufacturing,
  marketing and sale of Serial Flash and EEPROM products). As a result, the
  Company (i) scrapped certain inventory items not suitable for sale; (ii) sold
  its remaining inventory and (iii) terminated the employment of certain
  employees. During the third quarter of 2005, the Company completed the
  process of winding down the product business and ceased sales activities.
  Accordingly, the discontinued product operations were accounted for in
  accordance with Financial Accounting Standards Board (FASB) No. 144,
  Accounting for the Impairment or Disposal of Long-Lived Assets, and the
  results of operations of the product sales operations were reported
  separately as discontinued operations for all periods presented.
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | The results
  of the operations of the product business included in discontinued operations
  for the years ended December 26, 2004 and December 31, 2005 are
  summarized as follows:

| |                                       |  |                               |        |                               |   |        |  
| | ------------------------------------- |  | ----------------------------- | ------ | ----------------------------- | - | ------ | -
| |                                       |  | Year ended
  December 26,2004 |        | Year ended
  December 31,2005 |  
| |                                       |  |                               |        |                               |  
| |                                       |  |                               |        |                               |  
| | Revenues                              |  | $                             | 1,673  |                               | $ | 4,495  |  
| | Cost of
  revenues                    |  |                               | 5,894  |                               |   | 8,458  |  
| |                                       |  |                               |        |                               |   |        |  
|
| | Gross loss                            |  |                               | (4,221 | )                             |   | (3,963 | )
| | Research and
  development expenses   |  |                               | 1,732  |                               |   | 568    |  
| | Marketing
  and selling expenses      |  |                               | 1,160  |                               |   | 684    |  
| | General and
  administrative expenses |  |                               | 76     |                               |   | 48     |  
| |                                       |  |                               |        |                               |   |        |  
|
| | Loss from
  discontinued operations   |  | $                             | (7,189 | )                             | $ | (5,263 | )
| |                                       |  |                               |        |                               |   |        |  

F  26

---

---



|                                                          
|----------------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES         
|                                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|            |                                 |                                                                                                                               | 
|----------- | ------------------------------- | ----------------------------------------------------------------------------------------------------------------------------- | 
|NOTE 9:    | DISCONTINUED OPERATIONS (Cont.)
|            |                                
|            | b.                              | The
  breakdown of assets and liabilities attributed to the discontinued operations
  as of December 31, 2005 was as follows:

| |                                        |  |                    |     | 
| | -------------------------------------- |  | ------------------ | --- | 
| |                                        |  | December
  31,2005 |    
| |                                        |  |                    |    
|
| | Assets:                                |  |                    |     | 
| | Trade receivables                      |  | $                  | 212 | 
| |                                        |  |                    |     | 
|
| | Liabilities:                           |  |                    |     | 
| | Trade payables                         |  | $                  | 55  | 
| | Accrued expenses and other liabilities |  |                    | 91  | 
| |                                        |  |                    |     | 
|
| |                                        |  | $                  | 146 | 
| |                                        |  |                    |     | 

|            |                      |                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | 
|----------- | -------------------- | ---------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|NOTE 10:   | SHAREHOLDERS EQUITY
|            |                      |                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | 
|            | a.                   | Share
  capital:
|            |                      |                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | 
|            |                      | 1.               | On March 30,
  2006, the Company completed a public offering of 4,393,170 shares at a price
  per share of $ 30.25. Of the shares sold in the offering, 4,053,170 shares
  were sold by selling shareholders (including 573,022 shares resulting from
  exercise in full of an option to purchase additional shares from the selling
  shareholders granted to underwriters), and 340,000 Ordinary shares were sold
  by the Company. The Company received net proceeds of $ 9,283 (net of $ 1,002
  in issuance expenses), as well as an amount of $ 3,155 from the exercise of
  524,390 options by certain of the selling shareholders.                                                                                         
|            |                      |                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | 
|            |                      |                  | On November
  8, 2005, 5,750,000 Ordinary shares (including 750,000 Ordinary shares resulting
  from the exercise of an option granted to the underwriters) were issued in an
  IPO for $ 23.50 per share in consideration of net proceeds of $ 120,853 (net
  of $ 14,272 in issuance expenses, of which $ 1,222 were already recorded
  in shareholders equity as of December 26, 2004).                                                                                                                                                                                                                                                                                                                                        
|            |                      |                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | 
|            |                      |                  | Upon the
  completion of the IPO, all of the Companys outstanding Convertible Preferred
  shares (see a(3) and c below), were converted into 5,599,699 Ordinary shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                      |                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | 
|            |                      | 2.               | The
  Companys Ordinary shares included shares reserved for allocation in respect
  of employee options granted but not yet exercised, held by a trustee. The
  total number of Ordinary shares held by the trustee was 794,525 and 0 shares
  as of December 31, 2005 and December 31, 2006, respectively.
  Ordinary shares generally confer upon their holders the right to receive
  notice to participate and vote in general meetings of the Company and the
  right to receive dividends, if declared. The Ordinary shares held by the
  trustee were unpaid and, therefore, do not benefit from any of these rights
  and are not considered outstanding for the purpose of calculating earnings
  per share or otherwise.

F  27

---

---



|                                                           | 
|---------------------------------------------------------- | 
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES         
|                                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data | 

|NOTE 10:   | SHAREHOLDERS EQUITY (Cont.)
|----------- | ----------------------------

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | The
  Companys Preferred shares entitled their holders to have all the rights of
  the Ordinary shares and in addition, they had preferences in the event of
  liquidation, dividend participation, registration and anti-dilution rights.
  Each Preferred share was convertible into one Ordinary share at any time, at
  the holders discretion, and automatically upon an IPO of the Companys
  shares. Class B Preferred shares had preference over Class A Preferred shares
  in connection with the abovementioned rights. Upon the completion of the IPO,
  all of the Companys outstanding Convertible Preferred shares were converted
  into Ordinary shares.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | b. | Warrants:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    | In
  connection with a line of credit from a bank granted to the Company in 2000
  (which was cancelled during 2001), the Company issued a warrant to the bank
  to purchase 10,724 Ordinary shares at an exercise price of $ 18.65 per share.
  The warrant was exercised in October 2005.                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    | In
  connection with a line of credit in the amount of $ 7,000 from a bank granted
  to the Company in 2001 (which expired in October 2004), the Company issued to
  a bank a warrant to purchase 18,767 Ordinary shares at an exercise price of
  $ 18.65 per share. The warrant was exercised in October 2005.                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | c. | Share
  options:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    | In 1998, the
  Company granted the purchasers of Class A Preferred shares options to
  purchase 1,140,598 Class A Preferred shares at an exercise price of $ 3.15 per
  share exercisable at any time prior to the completion of an IPO. During 2004,
  5,730 options to purchase Class A Preferred shares were exercised. During
  2005, 11,460 options were exercised into 11,460 Preferred shares (5,730
  Preferred shares upon the completion of the IPO) and 1,123,408 options were
  exercised into 972,823 Preferred shares (in a cashless exercise) upon the
  completion of the IPO, and were then converted into Ordinary shares.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | d. | Share option
  plans:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    | In 1997,
  2001 and 2003, the Company adopted Share Option Plans (the Plans),
  according to which up to 7,673,421 options to purchase Ordinary shares may be
  granted to employees, directors, consultants and affiliates of the Company.                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    | The number
  of shares available for issuance under the 2003 Plan is automatically
  increased on the first trading day in January of each calendar year during
  the term of the 2003 Plan, beginning with calendar year 2005 by the lowest of
  (1) 1,333,333 Ordinary shares, subject to adjustments as provided in the 2003
  Plan; (2) a number equal to 4% of the Companys outstanding Ordinary shares on
  December 31 of the previous calendar year; and (3) an amount determined by
  the board of directors. The 2003 Plan complies with the Israeli tax reform.                                                                 

F  28

---

---



|                                                           | 
|---------------------------------------------------------- | 
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES         
|                                                           | 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data | 

|            |                             
|----------- | ----------------------------
|NOTE 10:   | SHAREHOLDERS EQUITY (Cont.)

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | With regard
  to the Plans, the exercise period may not exceed 10 years from the date of
  grant. Options are granted with an exercise price equal to the market price
  of the Companys stock at the date of grant or at a lower price as determined
  by the board of directors at the date of grant. The options vest ratably
  mainly over a period of up to five years. As of December 31, 2005 and
  December 31, 2006, 1,076,574 and 1,272,257options, respectively, were
  available for future grants under the Plans. Options which are forfeited or
  cancelled revert to the pool of options available for future grants. Options
  granted subsequent to December 2004 can be exercised only through a cashless
  exercise mechanism. In 2006, approximately 59,000 options were exercised
  through a cashless mechanism.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | A summary of
  the Companys share option activity under the Plans for the year ended
  December 31, 2006 is as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

|                                             |  |                                |            |                                     |   |                                                     |  |                             |      |  |   |        | 
|-------------------------------------------- |  | ------------------------------ | ---------- | ----------------------------------- | - | --------------------------------------------------- |  | --------------------------- | ---- |  | - | ------ | 
|                                             |  | Year ended
  December 31, 2006 |           
|                                             |  |                                |           
|                                             |  | Amount
  of options            |            | Weighted
  average
  exercise price |   | Weighted
  average
  remaining
  contractual
  life |  | Aggregate
  intrinsic value |     
|                                             |  |                                |            |                                     |   |                                                     |  |                             |     
|                                             |  |                                |            |                                     |   |                                                     |  | (Years)                     |      |  |   |       
|Outstanding - beginning of
  year            |  |                                | 4,705,016  |                                     | $ | 11.61                                               |  |                             |      |  |   |        | 
|Granted                                      |  |                                | 932,874    |                                     | $ | 13.51                                               |  |                             |      |  |   |        | 
|Exercised                                    |  |                                | (1,614,587 | )                                   | $ | 5.70                                                |  |                             |      |  |   |        | 
|Forfeited                                    |  |                                | (428,557   | )                                   | $ | 15.23                                               |  |                             |      |  |   |        | 
|                                             |  |                                |            |                                     |   |                                                     |  |                             |      |  |   |        | 
|                                             |  |                                |            |                                     |   |                                                     |  |                             |      |  |   |        | 
|Outstanding at end of year                   |  |                                | 3,594,746  |                                     | $ | 14.33                                               |  |                             | 7.74 |  | $ | 21,235 | 
|                                             |  |                                |            |                                     |   |                                                     |  |                             |      |  |   |        | 
|                                             |  |                                |            |                                     |   |                                                     |  |                             |      |  |   |        | 
|Vested and expected to vest
  at end of year |  |                                | 2,955,910  |                                     | $ | 13.97                                               |  |                             | 7.51 |  | $ | 18,179 | 
|                                             |  |                                |            |                                     |   |                                                     |  |                             |      |  |   |        | 
|                                             |  |                                |            |                                     |   |                                                     |  |                             |      |  |   |        | 
|Options exercisable at end
  of year         |  |                                | 1,016,337  |                                     | $ | 14.05                                               |  |                             | 6.46 |  | $ | 6,248  | 
|                                             |  |                                |            |                                     |   |                                                     |  |                             |      |  |   |        | 

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The
  aggregate intrinsic value is the difference between the Companys closing
  stock price on the last trading day of the fiscal year 2006 and the exercise
  price, multiplied by the number of in-the-money options that would have been
  received by the option holders had all option holders exercised their options
  on December 31, 2006. This aggregate intrinsic values change based on
  the fair market value of the Companys shares.

F  29

---

---



|                                                          
|----------------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES         
|                                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|            |                              |                                                                                                                  
|----------- | ---------------------------- | -----------------------------------------------------------------------------------------------------------------
|NOTE 10:   | SHAREHOLDERS EQUITY (Cont.)
|            |                             
|            |                              | The
  following table summarizes information about options outstanding and
  exercisable as of December 31, 2006:

| |                     |  |                                                        |  |           |                                                   |  |  |                                       |      |  |                                                     |  |   |                                       |  |  |  |  |           |  |  |  |   |       |  | 
| | ------------------- |  | ------------------------------------------------------ |  | --------- | ------------------------------------------------- |  |  | ------------------------------------- | ---- |  | --------------------------------------------------- |  | - | ------------------------------------- |  |  |  |  | --------- |  |  |  | - | ----- |  | 
| | Options outstanding |  | Options exercisable                                    | 
| |                     |  |                                                        | 
| | Exercise price      |  | Amount 
  outstanding 
  as of 
  December 31, 
  2006 |  |           | Weighted   average   remaining   contractual life |  |  | Weighted 
  average 
  exercise price |      |  | Amount 
  outstanding 
  as of December 31, 
  2006 |  |   | Weighted 
  average 
  exercise price |  | 
| |                     |  |                                                        |  |           |                                                   |  |  |                                       |      |  |                                                     |  |   |                                       |  | 
| |                     |  |                                                        |  |           | (Years)                                           |  |  |                                       |      |  |                                                     |  |   |                                       |  | 
| | $0.10               |  |                                                        |  | 370,584   |                                                   |  |  |                                       | 9.45 |  |                                                     |  | $ | 0.10                                  |  |  |  |  | -         |  |  |  | $ | -     |  | 
| | $1.25-$1.69         |  |                                                        |  | 29,294    |                                                   |  |  |                                       | 1.95 |  |                                                     |  | $ | 1.37                                  |  |  |  |  | 29,294    |  |  |  | $ | 1.37  |  | 
| | $3.75               |  |                                                        |  | 6,000     |                                                   |  |  |                                       | 2.08 |  |                                                     |  | $ | 3.75                                  |  |  |  |  | 6,000     |  |  |  | $ | 3.75  |  | 
| | $6.25               |  |                                                        |  | 372,137   |                                                   |  |  |                                       | 5.16 |  |                                                     |  | $ | 6.25                                  |  |  |  |  | 197,302   |  |  |  | $ | 6.25  |  | 
| | $9.00               |  |                                                        |  | 547,368   |                                                   |  |  |                                       | 6.39 |  |                                                     |  | $ | 9.00                                  |  |  |  |  | 143,315   |  |  |  | $ | 9.00  |  | 
| | $13.00              |  |                                                        |  | 354,383   |                                                   |  |  |                                       | 7.26 |  |                                                     |  | $ | 13.00                                 |  |  |  |  | 219,786   |  |  |  | $ | 13.00 |  | 
| | $15.50              |  |                                                        |  | 607,810   |                                                   |  |  |                                       | 7.58 |  |                                                     |  | $ | 15.50                                 |  |  |  |  | 208,920   |  |  |  | $ | 15.50 |  | 
| | $17.97-$18.82       |  |                                                        |  | 248,651   |                                                   |  |  |                                       | 9.76 |  |                                                     |  | $ | 18.24                                 |  |  |  |  | 23,200    |  |  |  | $ | 18.63 |  | 
| | $20.75-$21.50       |  |                                                        |  | 618,015   |                                                   |  |  |                                       | 8.41 |  |                                                     |  | $ | 20.83                                 |  |  |  |  | 43,379    |  |  |  | $ | 20.80 |  | 
| | $27.02              |  |                                                        |  | 81,635    |                                                   |  |  |                                       | 9.45 |  |                                                     |  | $ | 27.02                                 |  |  |  |  | 15,000    |  |  |  | $ | 27.02 |  | 
| | $28.15-$28.85       |  |                                                        |  | 91,078    |                                                   |  |  |                                       | 9.15 |  |                                                     |  | $ | 28.62                                 |  |  |  |  | 15,000    |  |  |  | $ | 28.85 |  | 
| | $29.30-$29.59       |  |                                                        |  | 267,791   |                                                   |  |  |                                       | 7.37 |  |                                                     |  | $ | 29.48                                 |  |  |  |  | 115,141   |  |  |  | $ | 29.55 |  | 
| |                     |  |                                                        |  |           |                                                   |  |  |                                       |      |  |                                                     |  |   |                                       |  |  |  |  |           |  |  |  |   |       |  | 
|
| |                     |  |                                                        |  | 3,594,746 |                                                   |  |  |                                       | 7.74 |  |                                                     |  | $ | 14.33                                 |  |  |  |  | 1,016,337 |  |  |  | $ | 14.05 |  | 
| |                     |  |                                                        |  |           |                                                   |  |  |                                       |      |  |                                                     |  |   |                                       |  |  |  |  |           |  |  |  |   |       |  | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | The weighted
  average grant date fair values of the options granted during the years ended
  December 26, 2004 and December 31, 2005 and 2006 were $ 4.47, $ 8.23 and
  $ 17.92, respectively. The total intrinsic value of options exercised during
  the years ended December 26, 2004, December 31, 2005 and 2006 was $ 0.1
  million, $ 23.2 million and $ 37.1 million, respectively. Compensation expense
  recognized (including SARPs) amounted to $ 1,170, $ 4,295 and $ 4,961 for the
  years ended December 26, 2004 and December 31, 2005 and 2006,
  respectively.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | As of
  December 31, 2006, there was $ 18,056 of total unrecognized compensation cost
  related to nonvested options granted under the Plan. That cost is expected to
  be recognized over a weighted-average period of 2.5 years.                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Upon
  exercise of options by employees, the Company satisfies the requirements by
  issuing newly issued shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | e. | Treasury
  shares:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |    | The treasury
  shares were in respect of the Companys shares issued to an equity method
  investee. Until December 2004, the Companys share in the consideration paid
  by the investee for the shares issued was recorded as treasury shares, which
  were reissued as part of the sale of the Companys entire equity interest,
  see Note 4. In connection with the termination agreement, the treasury shares
  were deemed reissued, resulting in an increase in additional paid-in capital
  of $ 871 in December 2004.                                                 

F  30

---

---



|                                                          
|----------------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES         
|                                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|----------- | --------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 10:   | SHAREHOLDERS EQUITY (Cont.)           
|            |                                        
|            | f.                                      | Loan to
  director:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         | In 2000, the
  Company granted a loan included in subscription receivables, in the amount of
  $ 250 to one of its directors for the purchase of 60,000 restricted Ordinary
  shares of the Company for a price of $ 6.25 per share. The loan bears interest
  at an annual rate of 4.0% and is payable at the earlier of (1) five
  years from the grant date of the loan; (2) an IPO or (3) 60 days from the
  directors termination of rendering services to the Company. The loan was
  repaid in October 2005.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|NOTE 11:   | RELATED PARTY BALANCES AND TRANSACTIONS
|            |                                        
|            | a.                                      | Balances
  with related parties:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

| |                                                               |  |              |     |      |   |     | 
| | ------------------------------------------------------------- |  | ------------ | --- | ---- | - | --- | 
| |                                                               |  | December 31, |    
| |                                                               |  |              |    
| |                                                               |  | 2005         |     | 2006 |  
| |                                                               |  |              |     |      |  
| |                                                               |  |              |     |      |   |     | 
| | Trade
  payables and accrued expenses (related party) (1) (2) |  | $            | 328 |      | $ | 592 | 
| |                                                               |  |              |     |      |   |     | 

| |     |                                                                                                                                                                                                      
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | One of the
  related parties is a legal firm that provides services to the Company, and in
  which a senior partner of the firm is an immediate family member of one of
  the Companys shareholders.
| |     |                                                                                                                                                                                                      
| | (2) | The above
  balances are derived from services received in the ongoing course of
  business. Accordingly, these balances have normal credit terms.                                                   
| |     |                                                                                                                                                                                                      

| |    |                                     
| | -- | ------------------------------------
| | b. | Transactions
  with related parties:

| |                                                                |  |  |                                  |       |  |                           |  |   |     |      |  |  |   |       |  | 
| | -------------------------------------------------------------- |  |  | -------------------------------- | ----- |  | ------------------------- |  | - | --- | ---- |  |  | - | ----- |  | 
| |                                                                |  |  | Year ended
  December 26,
  2004 |       |  | Year ended
  December 31, | 
| |                                                                |  |  |                                  |       |  |                          
| |                                                                |  |  |                                  |       |  | 2005                      |  |   |     | 2006 |  | 
| |                                                                |  |  |                                  |       |  |                           |  |   |     |      |  |  |  
| | Revenues (former Joint Venture)                                |  |  | $                                | 8,425 |  |                           |  | $ | -   |      |  |  | $ | -     |  | 
| | Sales and marketing expenses (shareholder
  and related party) |  |  | $                                | 925   |  |                           |  | $ | 86  |      |  |  | $ | 54    |  | 
| | General and administrative expenses (related
party)            |  |  | $                                | 612   |  |                           |  | $ | 586 |      |  |  | $ | 1,176 |  | 
| | Interest income (former Joint Venture)                         |  |  | $                                | 604   |  |                           |  | $ | -   |      |  |  | $ | -     |  | 
| | Issuance expenses (recorded in shareholders
equity)           |  |  | $                                | 195   |  |                           |  | $ | 220 |      |  |  | $ | 238   |  | 

F  31

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|----------- | --------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 12:   | TAXES ON INCOME
|           
|            | a.              | As of
  January 1, 2006, the Company has elected to measure its results for tax
  purposes based on the U.S. dollar exchange rate as permitted for
  Foreign-Invested Companies (as defined in the Israeli Law for the
  Encouragement of Capital Investments, 1959).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                 | In previous
  years, results for tax purposes were measured and reflected in real terms in
  accordance with the change in the CPI, in accordance with the measurement of
  taxable income under the Israeli Income Tax (Inflationary Adjustments) Law,
  1985.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | b.              | Tax benefits
  under the Law For Encouragement of Capital Investments, 1959:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                 | In 1998, the
  Companys investment plan in equipment in the amount of approximately $ 2,200
  received approval in accordance with the Law for the Encouragement of Capital
  Investments, 1959 (Approved Enterprise status). In 2000 and 2002, the
  Companys additional investment programs totaling $ 2,485 and $ 6,615 were
  granted Approved Enterprise status. The Company has chosen to receive its
  benefits through the Alternative Benefits track, and as such, is eligible for
  various tax benefits. These benefits include accelerated depreciation of
  equipment used in the investment program, as well as a full tax exemption on
  undistributed income for a period of two years and reduced tax rate (25%) for
  an additional period of up to five years. The 25% rate may be reduced
  further, depending on the rate of foreign share ownership in the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                 | The period
  of tax benefits, detailed above, is subject to a limit of 12 years from the
  commencement of production, or 14 years from the approval date, whichever is
  earlier (2011-2015). The entitlement to the above benefits is conditional
  upon Saifun fulfilling the conditions stipulated by the above law,
  regulations published thereunder and the letters of approval for the specific
  investments in Approved Enterprises. In the event of failure to comply with
  these conditions, the benefits may be cancelled and Saifun may be required to
  pay taxes on taxable income, based on regular corporate tax rates, as
  described below, in whole or in part, including interest. As of December 31,
  2006, management believes that the Company is meeting all of the
  aforementioned conditions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                 | On April 1,
  2005, an amendment to the Investment Law came into effect (the Amended law)
  that has significantly changed the provisions of the Investment Law. The
  Amended Law limits the scope of enterprises which may be approved by the
  Investment Center by setting criteria for the qualification of a company as
  an Approved Enterprise, such as provisions generally requiring that at least
  25% of the Approved Enterprises income will be derived from export and that
  minimum qualifying investments in productive assets be made. Additionally,
  the Amended Law enacted major changes in the manner in which tax benefits are
  awarded under the Investment Law so that companies no longer require
  Investment Center approval in order to qualify for tax benefits. However, the
  Investment Law provides that terms and benefits included in any certificate
  of approval already granted will remain subject to the provisions of the Law
  as they were on the date of such approval. Therefore the Companys existing
  Approved Enterprise will generally not be subject to the provisions of the
  Amended Law. Under the Amended Law, the year in which the company elects to
  commence its tax benefits is designated as the year of election (Year of
  Election). A company may choose its Year of Election by notifying the
  Israeli Tax authorities in connection with filings its annual tax return or
  within 12 months after the end of the Year of Election, whichever is earlier,
  or by requesting an advanced ruling from the Israeli tax authorities no later
  than within 6 months after the end of the Year of Election.

F  32

---

---



|                                               
|-----------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS SUBSIDIARIES
|                                               
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS     
|                                               
|U.S. dollars in thousands                      

|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|----------- | ----------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 12:   | TAXES ON INCOME (Cont.)
|            |                        
|            |                         | In 2005, the
  Company applied for cancellation of the 2002 investment program and pre
  approval of a new investment plan in accordance with the Amended Law, and in
  2006, received a pre ruling that cancels the 2002 investment program and
  confirms that 2004 will be elected as the Year of Election based on the
  provisions of the Amended Law.                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                         | As of
  December 31, 2006, the Company does not have retained earnings and
  accordingly, no tax-exempt income. Tax-exempt income attributable to the
  Approved Enterprise cannot be distributed to shareholders without
  subjecting the Company to taxes at the corporate tax rate applicable to such
  profits as if the Company had not elected alternative tax benefits (currently
  - 25%). The Companys board of directors does not intend to distribute any
  amounts of its undistributed tax exempt income as dividends.                                                                                                                                                                                                                                                  
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                         | Income from
  sources other than the Approved Enterprise during the benefit period will
  be subject to tax at the regular corporate tax rate. Israeli companies are
  subject to income tax at the corporate tax rate of 35% for the 2004 tax year
  and 34% in 2005. On July 25, 2005, the Knesset (Israeli Parliament)
  passed the Law for the Amendment of the Income Tax Ordinance (No. 147), 2005,
  which prescribes, among others, a gradual decrease in the corporate tax rate
  in Israel to the following tax rates: in 2006 - 31%, in 2007 - 29%, in 2008
  -27%, in 2009 - 26% and in 2010 and thereafter - 25%.                                                                                                                                                        
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                         | Due to
  reported losses for tax purposes, the benefit period under the Approved
  Enterprise program has not yet commenced.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | c.                      | As of
  December 31, 2006, Saifun Semiconductors Ltd. had carryforward losses in the amount
  of approximately  $ 18,200, including a carryforward capital loss amounting to
  approximately $ 5,300, which may be carried forward indefinitely, and
  temporary differences of approximately $ 2,100. As of December 31, 2006,
  carryforward losses related to Saifun Semiconductors USA, Inc. amounted to
  approximately $ 2,400 and have an expiration date of 2023. Utilization of U.S.
  net operating losses may be subject to substantial annual limitation due to
  the change in ownership provisions of the Internal Revenue Code of 1986 and
  similar state provisions. The annual limitation may result in the expiration
  of net operating losses before utilization.
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                         | The Company
  expects that during the period in which operating tax losses and other
  temporary differences related to Saifun Semiconductors Ltd. are utilized, its
  income would be substantially tax exempt. Accordingly, there will be no tax
  benefit available from such losses and other temporary differences, and no
  deferred income taxes have been included in these financial statements.                                                                                                                                                                                                                                                                                                                                                                               
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                         | Income tax
  expense in the amount of $ 1,281 for the year ended December 31, 2006 is
  related to Saifun BVI (Limited). The Companys income is subject to Israeli
  income tax, considered a deemed dividend and taxed at a tax rate of 25%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

F  33

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                        
|----------- | -----------------------
|NOTE 12:   | TAXES ON INCOME (Cont.)

| |    |                                                                
| | -- | ---------------------------------------------------------------
| | d. | Income
  (loss) before taxes on income is comprised as follows:

| |            |  |                                  |         |                           |      |        |   |   |        |  
| | ---------- |  | -------------------------------- | ------- | ------------------------- | ---- | ------ | - | - | ------ | -
| |            |  | Year ended
  December 26,
  2004 |         | Year ended
  December 31, |     
| |            |  |                                  |         |                          
| |            |  |                                  | 2005    |                           | 2006 |       
| |            |  |                                  |         |                           |      |        |  
| | Israel (*) |  | $                                | (36,824 | )                         | $    | 45,356 |   | $ | 36,325 |  
| | Foreign    |  |                                  | (1,080  | )                         |      | (849   | ) |   | (49    | )
| |            |  |                                  |         |                           |      |        |   |   |        |  
| |            |  | $                                | (37,904 | )                         | $    | 44,507 |   | $ | 36,276 |  
| |            |  |                                  |         |                           |      |        |   |   |        |  

| |    |                                                                                                                                                                                                                                                                                                                     |                                                             
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------
| |    | (*)                                                                                                                                                                                                                                                                                                                 | Includes
  income (loss) attributed to Saifun BVI (Limited).
| |    |                                                                                                                                                                                                                                                                                                                     |                                                             
| | e. | Deferred
  income taxes:                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                     |                                                             
| |    | Deferred
  income taxes reflect the net tax effect of temporary differences between the
  carrying amounts of assets and liabilities for financial reporting purposes
  and the amounts used for income tax purposes. Significant components of the
  Companys deferred tax liabilities and assets are as follows:

| |                                                                                                   |  |              |        |      |   |        |  
| | ------------------------------------------------------------------------------------------------- |  | ------------ | ------ | ---- | - | ------ | -
| |                                                                                                   |  | December 31, |       
| |                                                                                                   |  |              |       
| |                                                                                                   |  | 2005         |        | 2006 |  
| |                                                                                                   |  |              |        |      |  
| | Operating loss carryforwards (Saifun Semiconductors
  USA, Inc. and in 2005 Saifun BVI (Limited)) |  | $            | 1,848  |      | $ | 984    |  
| | Capital loss carryforwards (Saifun
  Semiconductors Ltd.)                                         |  |              | 1,320  |      |   | 1,320  |  
| | Valuation allowance                                                                               |  |              | (3,168 | )    |   | (2,304 | )
| |                                                                                                   |  |              |        |      |   |        |  
| | Net deferred tax asset                                                                            |  | $            | -      |      | $ | -      |  
| |                                                                                                   |  |              |        |      |   |        |  

| |                                                                                                                                                                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Management
  currently believes that it is more likely than not that the deferred tax
  assets related to the carryforward losses of Saifun Semiconductors USA, Inc.
  and capital loss carryforwards of Saifun Semiconductors Ltd. will not be
  realized in the foreseeable future. Accordingly, a valuation allowance has
  been recorded for the entire amount.

F  34

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                         |                                                                                                                                                                                                                                            
|----------- | ----------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 12:   | TAXES ON INCOME (Cont.)
|            |                         |                                                                                                                                                                                                                                            
|            | f.                      | Income tax
  reconciliation:                                                                                                                                                                                                               
|            |                         |                                                                                                                                                                                                                                            
|            |                         | A
  reconciliation of the theoretical tax expenses, assuming all income is taxed
  at the statutory rate applicable to the income of the Company, and the actual
  income taxes as reported in the Statements of Operations, is as follows:

| |                                                                                       |  |                         |        | 
| | ------------------------------------------------------------------------------------- |  | ----------------------- | ------ | 
| |                                                                                       |  | Year ended December 31, |       
| |                                                                                       |  |                         |       
| |                                                                                       |  | 2006                    |       
| |                                                                                       |  |                         |       
| | Income before taxes as reported in the
  Statement of Operations                      |  | $                       | 36,276 | 
| | Theoretical income taxes computed at the
  statutory rate of 31% in 2006 in Israel    |  |                         | 11,246 | 
| | Decrease (increase) in income taxes
  resulting from:                                 |  |                         |        | 
| | Utilization of carryforward losses for
  which full valuation allowances was provided |  |                         | 1,018  | 
| | Utilization of Approved Enterprise
  carryforward losses                              |  |                         | 9,000  | 
| | Differences due to statutory tax rate of
  subsidiaries                               |  |                         | 308    | 
| | Others                                                                                |  |                         | 361    | 
| |                                                                                       |  |                         |        | 
|
| | Income taxes                                                                          |  | $                       | 1,281  | 
| |                                                                                       |  |                         |        | 

| |                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The main reconciling items between the statutory tax rate of the
Company and the effective tax rate for the years ended December 31, 2005 and
December 26, 2004 are the non-recognition of tax benefits from accumulated
net operating losses carryforwards due to the effect of Approved Enterprise.

|            |                                                                            |                                                                                             
|----------- | -------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------
|NOTE 13:   | MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION                                
|            |                                                                           
|            | The Company
  manages its business on the basis of one reportable segment.
|            |                                                                            |                                                                                             
|            | a.                                                                         | Revenues are
  attributed to geographic areas based on location of end customers as follows:

| |                 |  |                                  |           |                           |      |        |  |   |        | 
| | --------------- |  | -------------------------------- | --------- | ------------------------- | ---- | ------ |  | - | ------ | 
| |                 |  | Year ended
  December 26,
  2004 |           | Year ended
  December 31, |     
| |                 |  |                                  |           |                          
| |                 |  |                                  | 2005      |                           | 2006 |       
| |                 |  |                                  |           |                           |      |        | 
| | Taiwan          |  | $                                | 11,417    |                           | $    | 14,047 |  | $ | 2,302  | 
| | Israel          |  |                                  | (*) 7,276 |                           |      | 32     |  |   | 1,001  | 
| | United
  States |  |                                  | 7,701     |                           |      | 9,265  |  |   | 17,783 | 
| | Japan           |  |                                  | 3,022     |                           |      | 9,793  |  |   | 6,519  | 
| | Germany         |  |                                  | 1,150     |                           |      | 44,796 |  |   | 27,580 | 
| | China           |  |                                  | -         |                           |      | 668    |  |   | 7,592  | 
| |                 |  |                                  |           |                           |      |        |  |   |        | 
| |                 |  | $                                | 30,566    |                           | $    | 78,601 |  | $ | 62,777 | 
| |                 |  |                                  |           |                           |      |        |  |   |        | 

| |     |                                                                                 
| | --- | --------------------------------------------------------------------------------
| | (*) | Includes
  mainly services provided to the former Joint Venture through IFL Ltd.

F  35

---

---



|                                                 
|-------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES
|                                                 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                                                 
|U.S. dollars in thousands                        

|            |                                            |                                                                                               
|----------- | ------------------------------------------ | ----------------------------------------------------------------------------------------------
|NOTE 13:   | MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION
|            |                                           
|            | b.                                         | Long-lived
  assets:                                                                          
|            |                                            |                                                                                               
|            |                                            | Substantially
  all of the Companys long-lived assets are located in Israel.                 
|            |                                            |                                                                                               
|            | c.                                         | Revenues
  from major customers representing more than 10% of total revenues are as
  follows:

| |            |  |                                  |      |                           |      |     |  |  |     | 
| | ---------- |  | -------------------------------- | ---- | ------------------------- | ---- | --- |  |  | --- | 
| |            |  | Year ended
  December 26,
  2004 |      | Year ended
  December 31, |     
| |            |  |                                  |      |                          
| |            |  |                                  | 2005 |                           | 2006 |    
| |            |  |                                  |      |                           |      |     | 
| | Customer A |  |                                  | 37%  |                           |      | 18% |  |  | (*) | 
| | Customer B |  |                                  | 25%  |                           |      | 12% |  |  | 28% | 
| | Customer C |  |                                  | 28%  |                           |      | 57% |  |  | 44% | 
| | Customer D |  |                                  | -    |                           |      | (*) |  |  | 12% | 

| |     |                
| | --- | ---------------
| | (*) | Less than
  10%

|            |                      
|----------- | ---------------------
|NOTE 14:   | FINANCIAL INCOME, NET

| |                                                                                                                                      |  |                                  |       |                           |      |       |   |   |        |  
| | ------------------------------------------------------------------------------------------------------------------------------------ |  | -------------------------------- | ----- | ------------------------- | ---- | ----- | - | - | ------ | -
| |                                                                                                                                      |  | Year ended
  December 26,
  2004 |       | Year ended
  December 31, |     
| |                                                                                                                                      |  |                                  |       |                          
| |                                                                                                                                      |  |                                  | 2005  |                           | 2006 |      
| |                                                                                                                                      |  |                                  |       |                           |      |       |  
| | Income:                                                                                                                              |  |                                  |       |                           |      |       |   |   |        |  
| | Interest on cash equivalents, marketable
  securities and amortization of premium and accretion of discount on marketable securities |  | $                                | 555   |                           | $    | 2,163 |   | $ | 10,001 |  
| | Foreign currency exchange differences,
net                                                                                           |  |                                  | 487   |                           |      | -     |   |   | -      |  
| | Interest from loans issued to equity method
  investees                                                                              |  |                                  | 604   |                           |      | -     |   |   | -      |  
| | Interest from loans to employees                                                                                                     |  |                                  | 120   |                           |      | 108   |   |   | 37     |  
| |                                                                                                                                      |  |                                  |       |                           |      |       |   |   |        |  
| | Expenses:                                                                                                                            |  |                                  |       |                           |      |       |   |   |        |  
| | Bank commissions                                                                                                                     |  |                                  | (67   | )                         |      | (46   | ) |   | (121   | )
| | Foreign currency exchange differences,
net                                                                                           |  |                                  | -     |                           |      | (476  | ) |   | (140   | )
| |                                                                                                                                      |  |                                  |       |                           |      |       |   |   |        |  
|
| |                                                                                                                                      |  | $                                | 1,699 |                           | $    | 1,749 |   | $ | 9,777  |  
| |                                                                                                                                      |  |                                  |       |                           |      |       |   |   |        |  

F  36

---

---



|                                                          
|----------------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
SUBSIDIARIES           
|                                                          
|NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S.
dollars in thousands, except share and per share data

|            |                              
|----------- | -----------------------------
|NOTE 15:   | NET EARNINGS (LOSS) PER SHARE

| |    |                                                                                                   
| | -- | --------------------------------------------------------------------------------------------------
| | a. | The
  following table sets forth the computation of basic and diluted earnings
  (loss) per share:

| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | ----------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | ------------------------- | - | ---------- | - | - | ------ | 
| |                                                                                                                                                 |  | Year ended
  December 26, |         | Year ended
  December 31, |  
| |                                                                                                                                                 |  |                           |         |                          
| |                                                                                                                                                 |  | 2004                      |         | 2005                      |   | 2006       |  
| |                                                                                                                                                 |  |                           |         |                           |   |            |  
| | Numerator:                                                                                                                                      |  |                           |         |                           |   |            |   |   |        | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Net earnings (loss)                                                                                                                             |  | $                         | (37,904 | )                         | $ | 44,507     |   | $ | 34,995 | 
| | Allocation of undistributed earnings to
  Convertible Preferred shares                                                                          |  |                           | -       |                           |   | (39,529    | ) |   | -      | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Net income (loss) attributed to Ordinary
  shares after allocation of undistributed earnings                                                    |  | $                         | (37,904 | )                         | $ | 4,978      |   | $ | 34,995 | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Denominator:                                                                                                                                    |  |                           |         |                           |   |            |   |   |        | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Weighted average number of Ordinary shares
  outstanding during the year used to compute basic net earnings (loss) per
  share (in thousands)   |  |                           | 16,927  |                           |   | (*) 29,453 |   |   | 30,761 | 
| | Incremental shares attributable to exercise
  of outstanding options and warrants (in thousands)                                                |  |                           | -       |                           |   | 2,494      |   |   | 1,694  | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Weighted average number of Ordinary shares
  outstanding during the year used to compute diluted net earnings (loss) per
  share (in thousands) |  |                           | 16,927  |                           |   | 31,947     |   |   | 32,455 | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Basic earnings (loss) per Ordinary share
  from continuing operations                                                                           |  | $                         | (1.81   | )                         | $ | 0.46       |   | $ | 1.13   | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Basic earnings (loss) per Ordinary share
  from discontinued operations and cumulative effect of change in accounting
  principle               |  | $                         | (0.43   | )                         | $ | (0.29      | ) | $ | 0.01   | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Basic earnings (loss) per Ordinary share                                                                                                        |  | $                         | (2.24   | )                         | $ | 0.17       |   | $ | 1.14   | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Diluted earnings (loss) per Ordinary share
  from continuing operations                                                                         |  | $                         | (1.81   | )                         | $ | 0.36       |   | $ | 1.07   | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Diluted earnings (loss) per Ordinary share
  from discontinued operations and cumulative effect of change in accounting
  principle             |  | $                         | (0.43   | )                         | $ | (0.20      | ) | $ | 0.01   | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 
| | Diluted net earnings (loss) per Ordinary
  share                                                                                                |  | $                         | (2.24   | )                         | $ | 0.16       |   | $ | 1.08   | 
| |                                                                                                                                                 |  |                           |         |                           |   |            |   |   |        | 

| |     |                                                                                                                                                                                                                                                                                                                                                       
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (*) | The sum of
  the proportionate weighted average of Ordinary shares outstanding was
  calculated separately for the two periods (from December 27, 2004 until the
  IPO Date (November 8, 2005) and from the IPO Date until December 31,
  2005). Prior to the IPO, all of the Companys earnings were allocated to the
  convertible Preferred shares.

F  37

---

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|                                                          
|----------------------------------------------------------
|SAIFUN SEMICONDUCTORS LTD. AND ITS
  SUBSIDIARIES         
|                                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                
|                                                          
|U.S. dollars in thousands, except share and per share data

|            |                                      
|----------- | -------------------------------------
|NOTE 15:   | NET EARNINGS (LOSS) PER SHARE (Cont.)

| |    |                                                                                                                                                                                                                                                                                          
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | b. | The
  following table sets forth the computation of pro forma basic and diluted net
  earnings (loss) per share that would have resulted had the Preferred shares
  and related options been converted at the beginning of fiscal year ended
  December 31, 2005 instead of the IPO date:

| |                                                                                                                                                    |  |                               |        |  
| | -------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------ | -
| |                                                                                                                                                    |  | Year ended
  December 31,2005 |       
| |                                                                                                                                                    |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  
| | Numerator:                                                                                                                                         |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  
| | Net earnings                                                                                                                                       |  | $                             | 44,507 |  
| |                                                                                                                                                    |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  
| | Denominator:                                                                                                                                       |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  
| | Weighted average number of Ordinary shares
  outstanding during the year used to compute pro forma basic net earnings per
  share (in thousands)   |  |                               | 24,154 |  
| | Incremental shares attributable to exercise
  of outstanding options and warrants (in thousands)                                                   |  |                               | 2,087  |  
| |                                                                                                                                                    |  |                               |        |  
| | Weighted average number of Ordinary shares
  outstanding during the year used to compute pro forma diluted net earnings per
  share (in thousands) |  |                               | 26,241 |  
| |                                                                                                                                                    |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  
| | Pro forma basic earnings per Ordinary share
  from continuing operations                                                                           |  | $                             | 2.06   |  
| |                                                                                                                                                    |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  
| | Pro forma basic loss per Ordinary share
  from discontinued operations                                                                             |  | $                             | (0.22  | )
| |                                                                                                                                                    |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  
| | Pro forma basic net earnings per Ordinary
  share                                                                                                  |  | $                             | 1.84   |  
| |                                                                                                                                                    |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  
| | Pro forma diluted earnings per Ordinary
  share from continuing operations                                                                         |  | $                             | 1.90   |  
| |                                                                                                                                                    |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  
| | Pro forma diluted loss per Ordinary share
  from discontinued operations                                                                           |  | $                             | (0.20  | )
| |                                                                                                                                                    |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  
| | Pro forma diluted net earnings per Ordinary
  share                                                                                                |  | $                             | 1.70   |  
| |                                                                                                                                                    |  |                               |        |  
| |                                                                                                                                                    |  |                               |        |  

|
|
|

F  38

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# ANNUAL REPORT ON FORM
20-F

# INDEX OF EXHIBITS

|Exhibit |  | Description
|------- |  | -----------

|1.1 |  | Articles
of Association (incorporated by reference to Exhibit 3.4 of the Registration Statement on
                Form F-1 (File No. 333-129167) filed with the Commission on October 21,
2005).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2.1 |  | Registration
Rights Agreement, dated October 2, 2000, by and among the Registrant and the parties
thereto (incorporated by reference to Exhibit 10.2 of the Registration Statement on Form
F-1 (File No. 333-129167) filed with the Commission on October 21, 2005).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2.2 |  | Amendment
to Registration Rights Agreement and Shareholder Rights Agreement, dated as of September
29, 2005, by and among the parties thereto and the Registrant (incorporated by reference
to Exhibit 10.2 of the Registration Statement on Form F-1 (File No. 333-129167) filed
with the Commission on October 21, 2005.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.1 |  | Technology
Agreement, dated May 4, 2000, by and between Macronix International Co., Ltd. and the
                Registrant (incorporated by reference to Exhibit 10.7 of the Registration
Statement on Form F-1                 (File No. 333-129167) filed with the Commission on
October 21, 2005).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.2 |  | Amendment
to the Technology Agreement, dated April 10, 2003, by and between Macronix International
                Co., Ltd. and the Registrant (incorporated by reference to Exhibit 10.8
of the Registration                 Statement on Form F-1 (File No. 333-129167) filed
with the Commission on October 21, 2005).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | Second
Addendum to the Technology Agreement, dated April 22, 2004, by and between Macronix
                International Co., Ltd. and the Registrant (incorporated by reference to
Exhibit 10.9 of the                 Registration Statement on Form F-1 (File No.
333-129167) filed with the Commission on October 21,                 2005).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Settlement
and License Agreement, dated July 1, 2002, by and between Advanced Micro Devices, Inc.,
Fujitsu Limited and the Registrant (incorporated by reference to Exhibit 10.11 of the
Registration Statement on Form F-1 (File No. 333-129167) filed with the Commission on
October 21, 2005).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.8 |  | Form
of Director and Officer Letter of Indemnification (incorporated by reference to Exhibit
10.18 of the Registration Statement on Form F-1 (File No. 333-129167) filed with the
Commission on October 21, 2005).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8.1 |  | List
of Subsidiaries of the Registrant (incorporated by reference to Exhibit 21.1 of the
Registration Statement on Form F-1 filed with the Commission on November 4, 2005).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.0 |  | Consent
of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global.
|---- |  | --------------------------------------------------------------------------

|11.1 |  | Code
of Ethics effective as of September 2005 (incorporated by reference to Exhibit 11.1 of
the Annual Report on Form 20-F filed with the Commission on April 11, 2006).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|12.1 |  | Certification
of Chief Executive Officer of the Registrant pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
of Chief Financial Officer of the Registrant pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------

|13.1 |  | Certification
of Chief Executive Officer of the Registrant pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002.*
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------

|13.2 |  | Certification
of Chief Financial Officer of the Registrant pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002.*
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------

|* | This
document is being furnished in accordance with SEC Release Nos. 33-8212 and 34-47551.
|- | ------------------------------------------------------------------------------------------

| | Portions
of this exhibit were omitted and have been filed separately with the Secretary of the
Securities and Exchange Commission pursuant to the Registrants application
requesting confidential treatment under Rule 406 of the Securities Act.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 90 -

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