UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
 FORM
10-Q
 
 þ
              
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the quarterly period ended September 28,
      2008OR ̈
              
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the transition period from ________________ to
  ________________
 
 Commission
file number:  000-26734
 
 SanDisk Logo
  SANDISK
CORPORATION
 (Exact
name of registrant as specified in its charter)
 
 Delaware
              
              77-0191793(State
      or other jurisdiction of
              
              (I.R.S.
      Employerincorporation
      or organization)
              
              Identification
      No.)601
      McCarthy Blvd.
                Milpitas,
      California
              
              95035(Address
      of principal executive offices)
              
              (Zip
      Code)
 
 Registrant’s
telephone number, including area code
 (408)
801-1000
 
 Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 Yes þ
              No  ̈
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
 Large
      accelerated filer þ
              Accelerated
      filer  ̈
              Non
      accelerated filer  ̈
              Smaller
      reporting company  ̈
 (Do
not check if a smaller reporting company)
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 Yes  ̈
              No þ
 
 Number
of shares outstanding of the issuer’s common stock $0.001 par value, as of
September 28, 2008: 226,038,296.
 
 
  
  SanDisk
Corporation
 Index
 
 Page No.PART
      I. FINANCIAL INFORMATIONItem
      1.
              Condensed
      Consolidated Financial Statements:Condensed Consolidated Balance Sheets as of
      September 28, 2008 and December 30, 2007
              3Condensed Consolidated Statements of Operations
      for the three and nine months ended September 28, 2008 and
      September 30, 2007
              4Condensed Consolidated Statements of Cash Flows for the
      nine months ended September 28, 2008 and September 30,
      2007
              5Notes to Condensed Consolidated Financial Statements
              6Item
      2.
              Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
              47Item
      3.
              Quantitative and Qualitative Disclosures About Market
      Risk
              59Item
      4.
              Controls and Procedures
              59PART
      II. OTHER INFORMATIONItem
      1.
              Legal Proceedings
              60Item
      1A.
              Risk Factors
              60Item
      2.
              Unregistered Sales of Equity Securities and Use of
      Proceeds
              81Item
      3.
              Defaults Upon Senior Securities
              81Item
      4.
              Submission of Matters to a Vote of Security
      Holders
              81Item
      5.
              Other Information
              81Item
      6.
              Exhibits
              81Signatures
              
              82Exhibit Index
              
              83
 
  -
2 -
 Table of Contents
  PART
I. FINANCIAL INFORMATION
 
 Item
      1.
              Condensed
      Consolidated Financial Statements
 
 SANDISK
CORPORATION
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (in thousands)
 
 September 28,
      2008
              
              
              December 30,
      2007*(Unaudited)ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              721,107
              
              
              $
              833,749Short-term
      investments
              
              
              853,111
              
              
              
              1,001,641Accounts
      receivable from product revenues, net
              
              
              118,563
              
              
              
              462,983Inventory
              
              
              712,406
              
              
              
              555,077Deferred
      taxes
              
              
              186,726
              
              
              
              212,255Other
      current assets
              
              
              309,508
              
              
              
              233,952Total
      current assets
              
              
              2,901,421
              
              
              
              3,299,657Long-term
      investments
              
              
              1,070,040
              
              
              
              1,060,393Property
      and equipment, net
              
              
              409,281
              
              
              
              422,895Notes
      receivable and investments in the flash ventures with
    Toshiba
              
              
              1,294,654
              
              
              
              1,108,905Deferred
      taxes
              
              
              169,819
              
              
              
              117,130Goodwill
              
              
              844,101
              
              
              
              840,870Intangibles,
      net
              
              
              265,483
              
              
              
              322,023Other
      non-current assets
              
              
              58,236
              
              
              
              62,946Total
      assets
              
              $
              7,013,035
              
              
              $
              7,234,819LIABILITIES AND STOCKHOLDERS’
      EQUITYCurrent
      liabilities:Accounts
      payable trade
              
              $
              242,175
              
              
              $
              285,711Accounts
      payable to related parties
              
              
              129,436
              
              
              
              158,443Other
      current accrued liabilities
              
              
              221,969
              
              
              
              286,850Deferred
      income on shipments to distributors and retailers and deferred
      revenue
              
              
              158,717
              
              
              
              182,879Total
      current liabilities
              
              
              752,297
              
              
              
              913,883Convertible
      long-term debt
              
              
              1,225,000
              
              
              
              1,225,000Non-current
      liabilities
              
              
              184,344
              
              
              
              135,252Total
      liabilities
              
              
              2,161,641
              
              
              
              2,274,135Minority
      interest
              
              
              151
              
              
              
              1,067Commitments
      and contingencies (see Note 11)Stockholders’
      equity:Preferred
      stock
              
              
              —
              
              
              
              —Common
      stock
              
              
              226
              
              
              
              224Capital
      in excess of par value
              
              
              3,887,924
              
              
              
              3,796,849Retained
      earnings
              
              
              924,878
              
              
              
              1,130,069Accumulated
      other comprehensive income
              
              
              38,215
              
              
              
              32,475Total
      stockholders’ equity
              
              
              4,851,243
              
              
              
              4,959,617Total
      liabilities and stockholders’ equity
              
              $
              7,013,035
              
              
              $
              7,234,819
 _________________
 *
              Information
      derived from the audited Consolidated Financial
  Statements.
 
 
 The accompanying notes are an
integral part of these condensed consolidated financial
statements.
  -
3 -
 Table of Contents
  SANDISK
CORPORATION
 CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS
 (Unaudited)
 
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
      2008
              
              
              September 30,
      2007
              
              
              September 28,
      2008
              
              
              September 30,
      2007(In thousands,
      except per share amounts)Revenues:Product
              
              $
              689,556
              
              
              $
              918,810
              
              
              $
              2,101,115
              
              
              $
              2,328,158License
      and royalty
              
              
              131,941
              
              
              
              118,613
              
              
              
              386,360
              
              
              
              322,383Total
      revenues
              
              
              821,497
              
              
              
              1,037,423
              
              
              
              2,487,475
              
              
              
              2,650,541Cost
      of product revenues
              
              
              812,832
              
              
              
              680,521
              
              
              
              2,039,994
              
              
              
              1,839,345Amortization
      of acquisition-related intangible assets
              
              
              14,582
              
              
              
              14,582
              
              
              
              43,746
              
              
              
              50,227Total
      cost of product revenues
              
              
              827,414
              
              
              
              695,103
              
              
              
              2,083,740
              
              
              
              1,889,572Gross
      profit (loss)
              
              
              (5,917
              )
              
              
              342,320
              
              
              
              403,735
              
              
              
              760,969Operating
      expenses:Research
      and development
              
              
              104,560
              
              
              
              110,533
              
              
              
              328,137
              
              
              
              307,358Sales
      and marketing
              
              
              87,859
              
              
              
              72,455
              
              
              
              245,653
              
              
              
              189,178General
      and administrative
              
              
              47,091
              
              
              
              45,581
              
              
              
              158,579
              
              
              
              133,737Amortization
      of acquisition-related intangible assets
              
              
              4,766
              
              
              
              4,600
              
              
              
              13,794
              
              
              
              20,750Restructuring
              
              
              —
              
              
              
              —
              
              
              
              4,085
              
              
              
              6,728Total
      operating expenses
              
              
              244,276
              
              
              
              233,169
              
              
              
              750,248
              
              
              
              657,751Operating
      income (loss)
              
              
              (250,193
              )
              
              
              109,151
              
              
              
              (346,513
              )
              
              
              103,218Interest
      income
              
              
              25,988
              
              
              
              31,790
              
              
              
              75,026
              
              
              
              104,005Interest
      expense and other income (expense), net
              
              
              (26,438
              )
              
              
              (2,590
              )
              
              
              (29,052
              )
              
              
              10Total
      other income (expense)
              
              
              (450
              )
              
              
              29,200
              
              
              
              45,974
              
              
              
              104,015Income
      (loss) before provision for (benefit from) income taxes
              
              
              (250,643
              )
              
              
              138,351
              
              
              
              (300,539
              )
              
              
              207,233Provision
      for (benefit from) income taxes
              
              
              (95,449
              )
              
              
              53,713
              
              
              
              (95,348
              )
              
              
              89,475Income
      (loss) after taxes
              
              
              (155,194
              )
              
              
              84,638
              
              
              
              (205,191
              )
              
              
              117,758Minority
      interest
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              5,211Net
      income (loss)
              
              $
              (155,194
              )
              
              $
              84,638
              
              
              $
              (205,191
              )
              
              $
              112,547Net
      income (loss) per share:Basic
              
              $
              (0.69
              )
              
              $
              0.37
              
              
              $
              (0.91
              )
              
              $
              0.49Diluted
              
              $
              (0.69
              )
              
              $
              0.36
              
              
              $
              (0.91
              )
              
              $
              0.48Shares
      used in computing net income (loss) per share:Basic
              
              
              225,682
              
              
              
              228,689
              
              
              
              225,030
              
              
              
              228,034Diluted
              
              
              225,682
              
              
              
              236,930
              
              
              
              225,030
              
              
              
              235,992
 
 
 The accompanying notes are an
integral part of these condensed consolidated financial
statements.
  -
4 -
 Table of Contents
  SANDISK
CORPORATION
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 
 Nine
      months endedSeptember 28,
      2008
              
              
              September 30,
      2007(In
      thousands)Cash
      flows from operating activities:Net
      income (loss)
              
              $
              (205,191
              )
              
              $
              112,547Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Deferred
      and other taxes
              
              
              (30,784
              )
              
              
              89,475(Gain)
      loss on equity investments
              
              
              27,578
              
              
              
              (2,701
              )Depreciation
      and amortization
              
              
              199,954
              
              
              
              196,444Provision
      for doubtful accounts
              
              
              6,211
              
              
              
              2,977Share-based
      compensation expense
              
              
              73,885
              
              
              
              102,317Excess
      tax benefit from share-based compensation
              
              
              (2,037
              )
              
              
              (15,714
              )Other
      non-cash charges
              
              
              15,730
              
              
              
              2,649Changes
      in operating assets and liabilities:Accounts
      receivable from product revenues
              
              
              338,210
              
              
              
              171,177Inventory
              
              
              (157,336
              )
              
              
              (47,211
              )Other
      assets
              
              
              28,250
              
              
              
              47,001Accounts
      payable trade
              
              
              (43,536
              )
              
              
              (38,596
              )Accounts
      payable to related parties
              
              
              (29,007
              )
              
              
              22,513Other
      liabilities
              
              
              (199,803
              )
              
              
              (139,163
              )Total
      adjustments
              
              
              227,315
              
              
              
              391,168Net
      cash provided by operating activities
              
              
              22,124
              
              
              
              503,715Cash
      flows from investing activities:Purchases
      of short and long-term investments
              
              
              (1,668,510
              )
              
              
              (3,145,884
              )Proceeds
      from sale of short and long-term investments
              
              
              1,288,906
              
              
              
              1,492,256Proceeds
      from maturities of short and long-term investments
              
              
              479,848
              
              
              
              1,142,826Proceeds
      from sales of capital equipment
              
              
              39,680
              
              
              
              —Acquisition
      of capital equipment
              
              
              (152,360
              )
              
              
              (179,903
              )Investment
      in Flash Alliance Ltd.
              
              
              (96,705
              )
              
              
              (38,003
              )Distributions
      from FlashVision Ltd.
              
              
              102,530
              
              
              
              —Proceeds
      from notes receivable from FlashVision Ltd.
              
              
              —
              
              
              
              37,512Issuance
      of notes receivable from Flash Partners Ltd.
              
              
              (37,418
              )
              
              
              (409,601
              )Issuance
      of notes receivable from Flash Alliance Ltd.
              
              
              (93,110
              )
              
              
              —Purchased
      technology and other assets
              
              
              (875
              )
              
              
              (27,803
              )Acquisition
      of MusicGremlin, Inc.
              
              
              (4,604
              )
              
              
              —Net
      cash used in investing activities
              
              
              (142,618
              )
              
              
              (1,128,600
              )Cash
      flows from financing activities:Proceeds
      (repayment) from debt financing
              
              
              (9,785
              )
              
              
              7,803Proceeds
      from employee stock programs
              
              
              19,358
              
              
              
              97,310Distribution
      to minority interest
              
              
              —
              
              
              
              (9,880
              )Excess
      tax benefit from share-based compensation
              
              
              2,037
              
              
              
              15,714Share
      repurchase programs
              
              
              —
              
              
              
              (97,417
              )Net
      cash provided by financing activities
              
              
              11,610
              
              
              
              13,530Effect
      of changes in foreign currency exchange rates on cash
              
              
              (3,758
              )
              
              
              1,575Net
      decrease in cash and cash equivalents
              
              
              (112,642
              )
              
              
              (609,780
              )Cash
      and cash equivalents at beginning of the period
              
              
              833,749
              
              
              
              1,580,700Cash
      and cash equivalents at end of the period
              
              $
              721,107
              
              
              $
              970,920
 
 
 The accompanying notes are an
integral part of these condensed consolidated financial
statements.
  -
5 -
 Table of Contents
  SANDISK
CORPORATION
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 
 1.
              Organization
      and Summary of Significant Accounting
Policies
 
 Organization
 
 These
interim Condensed Consolidated Financial Statements are unaudited but reflect,
in the opinion of management, all adjustments, consisting of normal recurring
adjustments and accruals, necessary to present fairly the financial position of
SanDisk Corporation and its subsidiaries (the “Company”) as of
September 28, 2008, the Condensed Consolidated Statements of Operations for
the three and nine months ended September 28, 2008 and September 30,
2007 and the Condensed Consolidated Statements of Cash Flows for the nine months
ended September 28, 2008 and September 30, 2007.  Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with U.S. generally accepted accounting principles
(“GAAP”) have been omitted in accordance with the rules and regulations of the
Securities and Exchange Commission (“SEC”).  These Condensed
Consolidated Financial Statements should be read in conjunction with the audited
consolidated financial statements and accompanying notes included in the
Company’s most recent Annual Report on Form 10-K.  Certain prior
period amounts have been reclassified to conform to the current period
presentation.  The results of operations for the three and nine months
ended September 28, 2008 are not necessarily indicative of the results to
be expected for the entire fiscal year.
 
 The
Company’s fiscal year ends on the Sunday closest to December 31, and its
fiscal quarters end on the Sunday closest to March 31, June 30, and
September 30, respectively.  The third quarter of fiscal years
2008 and 2007 ended on September 28, 2008 and September 30, 2007,
respectively.  Fiscal year 2008 ends on December 28, 2008
and fiscal year 2007 ended on December 30, 2007.
 
 Organization and
Nature of Operations.The Company was
incorporated in Delaware on June 1, 1988.  The Company
designs, develops and markets flash storage products used in a wide variety of
consumer electronics products.  The Company operates in one segment,
flash memory storage products.
 
 Principles of
Consolidation.The Condensed
Consolidated Financial Statements include the accounts of the Company and its
majority-owned subsidiaries.  All intercompany balances and
transactions have been eliminated.  Minority interest represents the
minority shareholders’ proportionate share of the net assets and results of
operations of the Company’s majority-owned subsidiaries.  The
Condensed Consolidated Financial Statements also include the results of
companies acquired by the Company from the date of each
acquisition.
 
 Use of
Estimates.The preparation of
Condensed Consolidated Financial Statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the Condensed Consolidated Financial Statements and accompanying
notes.  The estimates and judgments affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
liabilities.  On an ongoing basis, the Company evaluates its
estimates, including those related to customer programs and incentives,
intellectual property claims, product returns, bad debts, inventories and
related reserves, investments, income taxes, warranty obligations, restructuring
and contingencies, share-based compensation and litigation.  The
Company bases estimates on historical experience and on other assumptions that
its management believes are reasonable under the circumstances.  These
estimates form the basis for making judgments about the carrying value of assets
and liabilities when those values are not readily apparent from other
sources.  Actual results could materially differ from these
estimates.
  -
6 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  Recent
Accounting Pronouncements
 
 SFAS No.
160.In December 2007, the Financial Accounting Standards
Board (“FASB”) issued Statement of Financial Accounting Standards No. 160 (“SFAS
160”), Noncontrolling
Interests in Consolidated Financial Statements, an amendment of ARB No.
51.  SFAS 160 changes the accounting for noncontrolling
(minority) interests in consolidated financial statements, including the
requirements to classify noncontrolling interests as a component of consolidated
stockholders’ equity, to identify earnings attributable to noncontrolling
interests reported as part of consolidated earnings, and to measure gain or loss
on the deconsolidated subsidiary based upon the fair value of the noncontrolling
equity investment.  Additionally, SFAS 160 revises the accounting for
both increases and decreases in a parent’s controlling ownership
interest.  SFAS 160 is effective for fiscal years beginning after
December 15, 2008, with early adoption prohibited.  The Company
is assessing the impact of SFAS 160 to its consolidated results of operations
and financial position.
 
 SFAS No. 141
(revised).  In December 2007, the FASB issued Statement of
Financial Accounting Standards No. 141 (revised) (“SFAS 141(R)”), Business
Combinations.  SFAS 141(R) changes the accounting for business
combinations by requiring that an acquiring entity measure and recognize
identifiable assets acquired and liabilities assumed at fair value with limited
exceptions on the acquisition date.  The changes include the treatment
of acquisition-related transaction costs, the valuation of any noncontrolling
interest at acquisition date fair value, the recording of acquired contingent
liabilities at acquisition date fair value and the subsequent re-measurement of
such liabilities after the acquisition date, the recognition of capitalized
in-process research and development, the accounting for acquisition-related
restructuring cost accruals subsequent to the acquisition date, and the
recognition of changes in the acquirer’s income tax valuation
allowance.  In addition, any changes to the recognition or measurement
of uncertain tax positions related to pre-acquisition periods will be recorded
through income tax expense, whereas the current accounting treatment requires
any adjustment to be recognized through the purchase price.  SFAS
141(R) is effective for fiscal years beginning after December 15, 2008,
with early adoption prohibited.  The adoption of SFAS 141(R) is
expected to change the Company’s accounting treatment prospectively for all
business combinations consummated after the effective date.
 
  -
7 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  FSP No. APB
14-1.In May 2008, the FASB issued FASB Staff Position (“FSP”)
No. APB 14-1 (“FSP APB 14-1”), Accounting for Convertible Debt
Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash
Settlement).  FSP APB 14-1 requires the issuer to separately
account for the liability and equity components of the convertible debt
instrument that may be settled in cash upon conversion (including partial cash
settlement) in a manner that reflects the issuer’s economic interest
cost.  Further, FSP APB 14-1 requires bifurcation of a component of
the debt, classification of that component to equity, and then accretion of the
resulting discount on the debt to result in the “economic interest cost” being
reflected in the statement of operations.  FSP APB 14-1 is effective
for fiscal years beginning after December 15, 2008, with early application
not permitted, and requires retrospective application to all periods
presented.
 
 The
following tables illustrate the Company’s convertible long-term debt, net income
(loss) and net income (loss) per share on an as reported basis and the estimated
pro forma effect if the Company had applied the provisions of FSP APB 14-1 for
all periods affected (in thousands):
  September 28,
      2008
              
              
              December 30,
      2007Convertible
      long-term debt, as reported
              
              $
              1,225,000
              
              
              $
              1,225,000Convertible
      long-term debt, pro forma
              
              $
              916,160
              
              
              $
              891,204
 
 Amortization
of bond discount, as described above, net of tax for the three and nine months
ended September 28, 2008 and September 30, 2007, and for the fiscal
years ended December 30, 2007 and December 31, 2006, respectively, is
estimated as follows (in thousands, except for per share amounts):
  Three
      months ended
              
              
              Nine
      months ended
              
              
              Twelve
      months endedSeptember 28,
      2008
              
              
              September 30,
      2007
              
              
              September 28,
      2008
              
              
              September 30,
      2007
              
              
              December 30,
      2007
              
              
              December 31,
      2006Net
      income (loss), as reported
              
              $
              (155,194
              )
              
              $
              84,638
              
              
              $
              (205,191
              )
              
              $
              112,547
              
              
              $
              218,357
              
              
              $
              198,896Amortization
      of bond discount
              
              
              (12,950
              )
              
              
              (12,021
              )
              
              
              (38,139
              )
              
              
              (35,419
              )
              
              
              (47,664
              )
              
              
              (28,504
              )Tax
      effect of amortization of bond discount
              
              
              4,895
              
              
              
              4,556
              
              
              
              14,417
              
              
              
              13,424
              
              
              
              18,065
              
              
              
              10,860Pro
      forma net income (loss)
              
              $
              (163,249
              )
              
              $
              77,173
              
              
              $
              (228,913
              )
              
              $
              90,552
              
              
              $
              188,758
              
              
              $
              181,252Basic
      net income (loss) per shareAs
      reported
              
              $
              (0.69
              )
              
              $
              0.37
              
              
              $
              (0.91
              )
              
              $
              0.49
              
              
              $
              0.96
              
              
              $
              1.00Pro
      forma
              
              $
              (0.72
              )
              
              $
              0.34
              
              
              $
              (1.02
              )
              
              $
              0.40
              
              
              $
              0.83
              
              
              $
              0.91Diluted
      net income (loss) per shareAs
      reported
              
              $
              (0.69
              )
              
              $
              0.36
              
              
              $
              (0.91
              )
              
              $
              0.48
              
              
              $
              0.93
              
              
              $
              0.96Pro
      forma
              
              $
              (0.72
              )
              
              $
              0.33
              
              
              $
              (1.02
              )
              
              $
              0.38
              
              
              $
              0.80
              
              
              $
              0.87
 
 The
amortization of bond discount required under FSP APB 14-1 is a
non-cash expense and has no impact on the total operating, investing and
financing cash flows in the prior period or future Condensed Consolidated
Statements of Cash Flows.  May 2006 was the date of first
issuance of convertible debt by the Company that is subject to the provisions of
FSP APB 14-1.
  -
8 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 2.
              Fair
      Value Measurements
  Effective
December 31, 2007, the Company adopted the fair value measurement and
disclosure provisions of Statement of Financial Accounting Standards No. 157
(“SFAS 157”), Fair Value
Measurements, which establishes specific criteria for the fair value
measurements of financial and nonfinancial assets and liabilities that are
already subject to fair value measurements under current accounting rules.
SFAS 157 also requires expanded disclosures related to fair value
measurements.  In February 2008, the FASB approved FSP Statement of
Financial Accounting Standards No. 157-2 (“FSP SFAS 157-2”), Effective Date of FASB Statement No.
157, which allows companies to elect a one-year delay in applying
SFAS 157 to certain fair value measurements, primarily related to
nonfinancial instruments.  The Company elected the delayed adoption
date for the portions of SFAS 157 impacted by FSP SFAS 157-2.  The
partial adoption of SFAS 157 was prospective and did not have a significant
effect on the Company’s Condensed Consolidated Financial
Statements.  The Company is currently evaluating the impact of
applying the deferred portion of SFAS 157 to the nonrecurring fair value
measurements of its nonfinancial assets and liabilities.  In
accordance with FSP SFAS 157-2, the fair value measurements for nonfinancial
assets and liabilities will be adopted effective for fiscal years beginning
after November 15, 2008.
 
 Concurrently
with the adoption of SFAS 157, the Company adopted Statement of Financial
Accounting Standards No. 159 (“SFAS 159”), Establishing the Fair Value Option
for Financial Assets and Liabilities,which permitsentities to elect, at
specified election dates, to measure eligible financial instruments at fair
value.  As of September 28, 2008, the Company did not elect the
fair value option under SFAS 159 for any financial assets and liabilities that
were not previously measured at fair value.
 
 Fair Value
Hierarchy.SFAS 157 establishes a fair value hierarchy that prioritizes
the inputs to valuation techniques used to measure fair value.  The
hierarchy gives the highest priority to unadjusted quoted prices in active
markets for identical assets or liabilities (Level 1 measurements) and the
lowest priority to unobservable inputs (Level 3 measurements).  The
three levels of the fair value hierarchy under SFAS 157 are described
below:
  Level
      1
              Valuations
      based on quoted prices in active markets for identical assets or
      liabilities that the entity has the ability to access.Level
      2
              Valuations
      based on quoted prices for similar assets or liabilities, quoted prices in
      markets that are not active, or other inputs that are observable or can be
      corroborated by observable data for substantially the full term of the
      assets or liabilities.Level
      3
              Valuations
      based on inputs that are supported by little or no market activity and
      that are significant to the fair value of the assets or
      liabilities.
 
 A
financial instrument’s level within the fair value hierarchy is based on the
lowest level of any input that is significant to the fair value
measurement.
 
 The
Company’s financial assets are measured at fair value on a recurring
basis.  Instruments that are classified within Level 1 of the fair
value hierarchy generally include most money market securities, U.S. Treasury
securities and equity investments.  Instruments that are classified
within Level 2 of the fair value hierarchy generally include U.S. agency
securities, commercial paper, U.S. corporate bonds and municipal
obligations.
 
  -
9 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 Financial
assets and liabilities measured at fair value under SFAS 157 on a recurring
basis as of September 28, 2008 were as follows (in thousands):
  Total
              
              
              Quoted
      Prices in Active Markets for Identical Assets
                  (Level
      1)
              
              
              Significant
      Other Observable Inputs
                  Level
      2)
              
              
              Significant
      Unobservable Inputs
                  (Level
      3)Fixed
      income securities
              
              $
              2,396,145
              
              
              $
              390,967
              
              
              $
              2,005,178
              
              
              $
              —Equity
      securities
              
              
              59,228
              
              
              
              59,228
              
              
              
              —
              
              
              
              —Derivative
      assets
              
              
              31,341
              
              
              
              —
              
              
              
              31,341
              
              
              
              —Other
              
              
              3,296
              
              
              
              —
              
              
              
              3,296
              
              
              
              —Total
      financial assets
              
              $
              2,490,010
              
              
              $
              450,195
              
              
              $
              2,039,815
              
              
              $
              —Derivative
      liabilities
              
              $
              8,593
              
              
              $
              —
              
              
              $
              8,593
              
              
              $
              —Total
      financial liabilities
              
              $
              8,593
              
              
              $
              —
              
              
              $
              8,593
              
              
              $
              —
 
 Assets
and liabilities measured at fair value under SFAS 157 on a recurring basis were
presented on the Company’s Condensed Consolidated Balance Sheet as follows (in
thousands):
 
 Total
              
              
              Quoted
      Prices in Active Markets for Identical Assets
                  (Level
      1)
              
              
              Significant
      Other Observable Inputs
                  Level
      2)
              
              
              Significant
      Unobservable Inputs
                  (Level
      3)Cash
      equivalents(1)
              
              $
              546,430
              
              
              $
              390,967
              
              
              $
              155,463
              
              
              $
              —Short-term
      investments
              
              
              853,111
              
              
              
              9,198
              
              
              
              843,913
              
              
              
              —Long-term
      investments
              
              
              1,070,040
              
              
              
              50,030
              
              
              
              1,020,010
              
              
              
              —Other
      current assets and other non-current assets
              
              
              20,429
              
              
              
              —
              
              
              
              20,429
              
              
              
              —Total
      financial assets
              
              $
              2,490,010
              
              
              $
              450,195
              
              
              $
              2,039,815
              
              
              $
              —Other
      current accrued liabilities
              
              $
              8,593
              
              
              $
              —
              
              
              $
              8,593
              
              
              $
              —Total
      financial liabilities
              
              $
              8,593
              
              
              $
              —
              
              
              $
              8,593
              
              
              $
              —
 _________________
 (1)
              Excludes
      Cash of $174.7 million included in Cash and Cash Equivalents on the
      balance sheet as of
  September 28, 2008.
  -
10 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 3.
              Balance
      Sheet Detail
 
 Accounts
Receivable from Product Revenues, net.Accounts receivable from product
revenues, net, were as follows (in thousands):
  September 28,
      2008
              
              
              December 30,
      2007Trade
      accounts receivable
              
              $
              590,690
              
              
              $
              1,027,588Related
      party accounts receivable
              
              
              —
              
              
              
              4,725Allowance
      for doubtful accounts
              
              
              (19,626
              )
              
              
              (13,790
              )Price
      protection, promotions and other activities
              
              
              (452,501
              )
              
              
              (555,540
              )Total
      accounts receivable from product revenues, net
              
              $
              118,563
              
              
              $
              462,983
  During
the first quarter of fiscal year 2008, the Company recorded an additional
provision for doubtful accounts as well as a reversal of $12.0 million of
product revenues associated with receivable balances related to a customer
having severe financial difficulties.
 
 Inventory.Inventories,
net of reserves, were as follows (in thousands):
  September 28,
      2008
                
                
                December 30,
      2007Raw
      material
                
                $
                350,530
                
                
                $
                197,077Work-in-process
                
                
                47,043
                
                
                
                94,283Finished
      goods
                
                
                314,833
                
                
                
                263,717Total
      inventory
                
                $
                712,406
                
                
                $
                555,077
  
 Other Current
Assets.Other current assets were as follows
(in thousands):
  September 28,
      2008
              
              
              December 30,
      2007Royalty
      and other receivables
              
              $
              38,801
              
              
              $
              103,802Prepaid
      expenses
              
              
              20,011
              
              
              
              15,128Tax
      related receivables
              
              
              233,564
              
              
              
              40,335Other
      current assets
              
              
              17,132
              
              
              
              74,687Total
      other current assets
              
              $
              309,508
              
              
              $
              233,952
 
 Notes Receivable
and Investments in the Flash Ventures with Toshiba.Notes
receivable and investments in the flash ventures with Toshiba Corporation
(“Toshiba”) were as follows (in thousands):
  September 28,
      2008
              
              
              December 30,
      2007Notes
      receivable, Flash Partners Ltd.
              
              $
              721,654
              
              
              $
              639,834Notes
      receivable, Flash Alliance Ltd.
              
              
              94,643
              
              
              
              —Investment
      in FlashVision Ltd.
              
              
              50,951
              
              
              
              159,146Investment
      in Flash Partners Ltd.
              
              
              190,341
              
              
              
              177,529Investment
      in Flash Alliance Ltd.
              
              
              237,065
              
              
              
              132,396Total
      notes receivable and investments in the flash ventures with
      Toshiba
              
              $
              1,294,654
              
              
              $
              1,108,905
  -
11 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  Other Current
Accrued Liabilities.Other current accrued liabilities were as
follows (in thousands):
  September 28,
      2008
              
              
              December 30,
      2007Accrued
      payroll and related expenses
              
              $
              58,615
              
              
              $
              94,220Taxes
      payable
              
              
              2,115
              
              
              
              56,945Accrued
      restructuring
              
              
              2,181
              
              
              
              2,071Research
      and development liability, related party
              
              
              4,000
              
              
              
              8,000Foreign
      currency forward contract payables
              
              
              8,593
              
              
              
              5,714Other
      accrued liabilities
              
              
              146,465
              
              
              
              119,900Total
      other current accrued liabilities
              
              $
              221,969
              
              
              $
              286,850
 
 Convertible
Long-term Debt.  The carrying
value of convertible long-term debt was as follows
(in thousands):
  September 28,
      2008
              
              
              December 30,
      20071%
      Senior Convertible Notes due 2013
              
              $
              1,150,000
              
              
              $
              1,150,0001%
      Convertible Notes due 2035
              
              
              75,000
              
              
              
              75,000Total
      convertible long-term debt
              
              $
              1,225,000
              
              
              $
              1,225,000
 
 Non-current
liabilities.Non-current liabilities were as follows (in
thousands):
  September 28,
      2008
              
              
              December 30,
      2007Deferred
      tax liability
              
              $
              20,136
              
              
              $
              14,479Income
      taxes payable
              
              
              111,934
              
              
              
              79,608Accrued
      restructuring
              
              
              10,580
              
              
              
              11,891Other
      non-current liabilities
              
              
              41,694
              
              
              
              29,274Total
      non-current liabilities
              
              $
              184,344
              
              
              $
              135,252
 
 As
of September 28, 2008 and December 30, 2007, the total current and
non-current accrued restructuring liabilities were primarily related to excess
lease obligations.  The reduction in the accrual balance was primarily
related to cash lease obligation payments.  The lease obligations
extend through the end of the lease term in fiscal year 2016.
 
  -
12 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  4.
              Goodwill
      and Other Intangible Assets
 
 Goodwill.  Goodwill
balance is presented below (in thousands):
  Balance
      at December 30, 2007
              
              $
              840,870Goodwill
      additions, net
              
              
              3,231Balance
      at September 28, 2008
              
              $
              844,101
 
 Goodwill
increased by approximately $3.2 million due to the Company’s acquisition of
MusicGremlin, Inc. (“MusicGremlin”) during the second quarter of fiscal year
2008.
 
 Statement
of Financial Accounting Standards No. 142 (“SFAS 142”), Goodwill and Other Intangible
Assets, requires that goodwill of the Company be tested for impairment,
at minimum, on an annual basis or earlier in circumstances whereby certain
events might trigger a decrease in the value of goodwill.  Due to the
decline in the Company’s stock price, the Company performed an interim Step 1
goodwill impairment test under SFAS 142 during each of the first three quarters
of fiscal year 2008, all of which resulted in no
impairment.  Subsequent to the end of the third quarter of fiscal year
2008, the Company’s stock price declined below net book value per
share.  If the stock price remains below the net book value per share,
or other negative business factors exist as outlined in SFAS 142, the Company
may be required to perform another Step 1 analysis and potentially a Step 2
analysis, which could result in an impairment of up to the entire balance of the
Company’s goodwill in the fourth quarter of fiscal year 2008.  If we
perform a Step 2 goodwill impairment analysis as defined by SFAS 142, we will
also be required to evaluate our intangible assets for impairment under
Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets.
 
 Intangible
Assets.  Intangible asset balances are presented below
(in thousands):
  September 28,
      2008
              
              
              December 30,
      2007Gross
      Carrying Amount
              
              
              Accumulated
      Amortization
              
              
              Net
      Carrying Amount
              
              
              Gross
      Carrying Amount
              
              
              Accumulated
      Amortization
              
              
              Net
      Carrying AmountCore
      technology
              
              $
              315,301
              
              
              $
              (121,756
              )
              
              $
              193,545
              
              
              $
              311,801
              
              
              $
              (78,863
              )
              
              $
              232,938Developed
      product technology
              
              
              12,900
              
              
              
              (5,911
              )
              
              
              6,989
              
              
              
              12,900
              
              
              
              (4,689
              )
              
              
              8,211Customer
      relationships
              
              
              80,100
              
              
              
              (37,333
              )
              
              
              42,767
              
              
              
              80,100
              
              
              
              (23,907
              )
              
              
              56,193Acquisition-related
      intangible assets
              
              
              408,301
              
              
              
              (165,000
              )
              
              
              243,301
              
              
              
              404,801
              
              
              
              (107,459
              )
              
              
              297,342Technology
      licenses and patents
              
              
              42,243
              
              
              
              (20,061
              )
              
              
              22,182
              
              
              
              39,243
              
              
              
              (14,562
              )
              
              
              24,681Total
              
              $
              450,544
              
              
              $
              (185,061
              )
              
              $
              265,483
              
              
              $
              444,044
              
              
              $
              (122,021
              )
              
              $
              322,023
 
 The
annual expected amortization expense of intangible assets that existed as of
September 28, 2008, is presented below (in thousands):
  Estimated
      Amortization ExpensesFiscal
      year:
              
              Acquisition-Related Intangible Assets
              
              
              Technology
      Licenses and Patents2008
      (remaining three months)
              
              $
              19,349
              
              
              $
              1,7002009
              
              
              72,891
              
              
              
              6,7992010
              
              
              72,695
              
              
              
              5,4752011
              
              
              65,315
              
              
              
              3,6232012
              
              
              12,529
              
              
              
              2,9752013
      and thereafter
              
              
              522
              
              
              
              1,610Total
              
              $
              243,301
              
              
              $
              22,182
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13 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 5.
              Warranty
 
 Changes
to the Company’s warranty reserve activity are presented below
(in thousands):
  Three
      months ended
              
              
              Nine
      months endedSeptember 28,
      2008
              
              
              September 30,
      2007
              
              
              September 28,
      2008
              
              
              September 30,
      2007Balance,
      beginning of period
              
              $
              21,130
              
              
              $
              13,164
              
              
              $
              18,662
              
              
              $
              15,338Additions
      and adjustments to costs of product revenue
              
              
              5,558
              
              
              
              2,492
              
              
              
              9,159
              
              
              
              7,280Usage
              
              
              (378
              )
              
              
              (856
              )
              
              
              (1,511
              )
              
              
              (7,818
              )Balance,
      end of period
              
              $
              26,310
              
              
              $
              14,800
              
              
              $
              26,310
              
              
              $
              14,800
 
 The
majority of the Company’s products have a warranty ranging from one to five
years.  A provision for the estimated future cost related to warranty
expense is recorded at the time of customer invoice.  The Company’s
warranty obligation is affected by customer and consumer returns, product
failures and repair or replacement costs incurred.
  -
14 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 6.
              Restructuring
 
 During
the second quarter of fiscal year 2008, the Company implemented a restructuring
plan, which included reductions in workforce in all functions of the
organization worldwide in order to reduce the Company’s cost structure and to
eliminate redundant activities.  A restructuring charge of
$4.1 million was recorded during the nine months ended September 28,
2008, of which $3.9 million related to severance and benefits to
131 terminated employees.  All expenses, including adjustments,
associated with the Company’s restructuring plans are included in
“Restructuring” in the Condensed Consolidated Statements of
Operations.
 
 The
following table sets forth an analysis of the components of the restructuring
charge and payments made against the reserve for the nine months ended
September 28, 2008 (in thousands):
  Severance
      and Benefits
              
              
              Other
      Charges
              
              
              TotalRestructuring
      provision
              
              $
              3,888
              
              
              $
              197
              
              
              $
              4,085Cash
      paid
              
              
              (3,087
              )
              
              
              (3
              )
              
              
              (3,090
              )Restructuring
      plan balance at September 28, 2008
              
              $
              801
              
              
              $
              194
              
              
              $
              995
 
 The
Company anticipates that the remaining restructuring plan reserve balance
related to severance and benefits will be paid out in cash by the end of fiscal
year 2008.
 
  -
15 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 7.
              Accumulated
      Other Comprehensive Income
 
 Accumulated
other comprehensive income, net of tax, presented in the accompanying balance
sheets consists of the accumulated unrealized gains and losses on
available-for-sale investments, including the Company’s investments in equity
securities, as well as currency translation adjustments relating to local
currency denominated subsidiaries and equity investees, and the accumulated
unrealized gains and losses related to derivative instruments accounted for
under hedge accounting (in thousands).
  September 28,2008
              
              
              December 30,
      2007Accumulated
      net unrealized gain (loss) on:Available-for-sale
      investments
              
              $
              (12,263
              )
              
              $
              4,242Foreign
      currency translation
              
              
              51,718
              
              
              
              23,818Hedging
      activities
              
              
              (1,240
              )
              
              
              4,415Total
      accumulated other comprehensive income
              
              $
              38,215
              
              
              $
              32,475
 
 Comprehensive
net income (loss) is presented below (in thousands):
  Three
      months ended
              
              
              Nine
      months endedSeptember 28,
      2008
              
              
              September 30,
      2007
              
              
              September 28,
      2008
              
              
              September 30,
      2007Net
      income (loss)
              
              $
              (155,194
              )
              
              $
              84,638
              
              
              $
              (205,191
              )
              
              $
              112,547Change
      in unrealized gain (loss) on available-for-sale
investments
              
              
              (12,262
              )
              
              
              8,792
              
              
              
              (16,505
              )
              
              
              10,771Foreign
      currency translation adjustments
              
              
              8,097
              
              
              
              17,754
              
              
              
              27,900
              
              
              
              4,072Change
      in unrealized gain (loss) on hedging activities
              
              
              15,469
              
              
              
              —
              
              
              
              (5,655
              )
              
              
              —Comprehensive
      net income (loss)
              
              $
              (143,890
              )
              
              $
              111,184
              
              
              $
              (199,451
              )
              
              $
              127,390
  -
16 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  8.
              Derivatives
      and Hedging Activities
 
 The
Company uses derivative instruments primarily to manage exposures to foreign
currency and equity security price risks.  The Company’s primary
objective in holding derivatives is to reduce the volatility of earnings and
cash flows associated with changes in foreign currency and equity security
prices.  The program is not designated for trading or speculative
purposes.  The Company’s derivatives expose the Company to
credit risk to the extent that the counterparties may be unable to meet the
terms of the agreement.  The Company seeks to mitigate such risk by
limiting its counterparties to major financial institutions and by spreading the
risk across several major financial institutions.  In addition, the
potential risk of loss with any one counterparty resulting from this type of
credit risk is monitored on an ongoing basis.
 
 In
accordance with Statement of Financial Accounting Standards No. 133 (“SFAS
133”), Accounting for
Derivative Instruments and Hedging Activities, the Company recognizes
derivative instruments as either assets or liabilities on the balance sheet at
fair value.  Changes in fair value (i.e. gains or losses) of the
derivatives are recorded as cost of product revenues or other income (expense),
or as accumulated other comprehensive income (“OCI”).
 
 In
March 2008, the FASB issued Statement of Financial Accounting Standards No. 161
(“SFAS 161”), Disclosures
about Derivative Instruments and Hedging Activities.  SFAS 161
amends and expands the disclosure requirements of SFAS 133, and requires qualitative
disclosures about objectives and strategies for using derivatives, quantitative
disclosures about fair value amounts of and gains and losses on derivative
instruments, and disclosures about credit-risk-related contingent features in
derivative agreements.  The Company adopted the reporting requirements
per SFAS 161 during the second quarter of fiscal year 2008.
 
 Cash Flow
Hedges. The Company uses a combination of forward contracts and options
designated as cash flow hedges to hedge a substantial portion of future
forecasted purchases in Japanese yen.  The gain or loss on the
effective portion of a cash flow hedge is initially reported as a component of
accumulated OCI and subsequently reclassified into cost of product revenues in
the same period or periods in which the cost of product revenues is recognized,
or reclassified into other income (expense) if the hedged transaction becomes
probable of not occurring.  Any gain or loss after a hedge is
de-designated because it is no longer probable of occurring or related to an
ineffective portion of a hedge, as well as any amount excluded from the
Company’s hedge effectiveness, is recognized as other income (expense)
immediately.  The net gains or losses relating to ineffectiveness were
not material in the three and nine months ended September 28,
2008.  As of September 28, 2008, the Company had forward
contracts and options in place that hedged future purchases of approximately
78.8 billion Japanese yen, or approximately $753 million based upon
the exchange rate as of September 28, 2008.  The forward and
option contracts cover future Japanese yen purchases expected to occur over the
next twelve months.
 
 The
Company has an outstanding cash flow hedge designated to mitigate equity risk
associated with certain available-for-sale investments in equity
securities.  The gain or loss on the cash flow hedge is reported as a
component of accumulated OCI and will be reclassified into other income
(expense) in the same period that the equity securities are sold.  The
securities had a fair value of $50.0 million and $60.4 million as of
September 28, 2008 and December 30, 2007, respectively.
 
 Other
Derivatives.  Other derivatives not designated as hedging
instruments under SFAS 133 consists primarily of forward contracts to minimize
the risk associated with the foreign exchange effects of revaluing monetary
assets and liabilities.  Monetary assets and liabilities denominated
in foreign currencies and the associated outstanding forward contracts are
marked-to-market at September 28, 2008 with realized
and  unrealized gains and losses included in other income
(expense).  As of September 28, 2008, the Company had foreign
currency forward contracts in place hedging exposures in European euros, new
Israel shekels, Japanese yen and new Taiwanese dollars.  Foreign
currency forward contracts were outstanding to buy and sell U.S. dollar
equivalent of approximately $115 million and $858 million in foreign
currencies, respectively, based upon the exchange rates at September 28,
2008.
 
 For
the three and nine months ended September 28, 2008, foreign currency
forward contracts resulted in  losses of $0.3 million
and $22.8 million, respectively, including forward-point
income.  For the three and nine months ended September 28, 2008,
the revaluation of the foreign currency exposures hedged by these forward
contracts resulted in gains of $5.2 million and $42.3 million,
respectively.  All of the above noted gains and losses are included in
the “Interest expense and other income (expense), net” in the Company's
Condensed Consolidated Statement of Operations.  As of and based upon the
exchange rates at September 28, 2008, the Company had total foreign
currency exchange contract lines available of $2.28 billion of which
$1.73 billion were utilized.
 
  -
17 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  The
amounts in the tables below include fair value adjustments related to our own
credit risk and counterparty credit risk.
 
 Fair Value of
Derivative Contracts.  Fair value of derivative contracts under
SFAS 133 were as follows (in thousands):
  Derivative Assets
      Reported
                  in Other Current
      Assets
              
              
              Long-term
      Investments
              
              
              Derivative Liabilities Reported in
      Other Current Accrued LiabilitiesSeptember 28,
      2008
              
              
              December 30,
      2007
              
              
              September 28,
      2008
              
              
              December 30,
      2007
              
              
              September 28,
      2008
              
              
              December 30,
      2007Foreign
      exchange contracts designated as cash flow hedges
              
              $
              13,007
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —Equity
      market risk contract designated as cash flow hedge
              
              
              —
              
              
              
              —
              
              
              
              14,209
              
              
              
              4,415
              
              
              
              —
              
              
              
              —Total derivatives designated as
      hedging instruments
              
              
              13,007
              
              
              
              —
              
              
              
              14,209
              
              
              
              4,415
              
              
              
              —
              
              
              
              —Foreign exchange contracts not
      designated
              
              
              4,240
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              8,707
              
              
              
              5,714Total
      derivatives
              
              $
              17,247
              
              
              $
              —
              
              
              $
              14,209
              
              
              $
              4,415
              
              
              $
              8,707
              
              
              $
              5,714
 
 Effect
of Designated Derivative Contracts on Accumulated Other Comprehensive
Income.The
following table represents only the balance of designated derivative contractsunder SFAS 133as of December 30, 2007 and
September 28, 2008, and the impact of designated derivative contracts on
OCI for the nine months ended September 28, 2008 (in
thousands):
  December 30,
      2007
              
              
              Amount
      of gain (loss) recognized in OCI (effective portion)
              
              
              Amount
      of gain (loss) reclassified from OCI to income (loss) (effective
      portion)
              
              
              September 28,
      2008Foreign exchange contracts
      designated as cash flow hedges
              
              $
              —
              
              
              $
              (13,719
              )
              
              $
              1,730
              
              
              $
              (15,449
              )Equity market risk contract
      designated as cash flow hedge
              
              
              4,415
              
              
              
              9,794
              
              
              
              —
              
              
              
              14,209
 
 Foreign exchange contracts designated as
cash flow hedges relate primarily to production and inventory and the associated
gains and losses are expected to be recorded in cost of sales when reclassed out
of OCI.  Gain and losses from the equity market risk contract are
expected to be recorded in other income (expense) when reclassed out of
OCI.
 
 The Company expects to realize the
accumulated OCI balance related to foreign exchange contracts within the next
twelve months and realize the accumulated OCI balance related to the equity
market risk contract in fiscal year 2011.
 
 Effect
of Designated Derivative Contracts on the Condensed Consolidated Statement of
Operations.Impact of designated
derivative contracts under SFAS 133 on results of operations was as follows (in
thousands):
  Three
      months ended
              
              
              Nine
      months endedSeptember 28,
      2008
              
              
              September 30,
      2007
              
              
              September 28,
      2008
              
              
              September 30,
      2007Foreign exchange contracts
      designated as cash flow hedges
              
              $
              940
              
              
              $
              —
              
              
              $
              (466
              )
              
              $
              —Net investment hedging
      relationships
              
              
              43
              
              
              
              —
              
              
              
              43
              
              
              
              —Equity market risk contract
      designated as cash flow hedge
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
 
 Effect
of Non-Designated Derivative Contracts on the Condensed Consolidated Statement
of Operations.Impact of non-designated
derivative contracts on results of operations was as follows (in
thousands):
  Three
      months ended
              
              
              Nine
      months endedSeptember 28,
      2008
              
              
              September 30,
      2007
              
              
              September 28,
      2008
              
              
              September 30,
      2007Gain (loss) on foreign exchange
      contracts recognized in other income (expense)
              
              $
              (330
              )
              
              $
              (9,522
              )
              
              $
              (22,846
              )
              
              $
              (5,248
              )
  -
18 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  9.
              Share-Based
      Compensation
 
 Share-Based
Plans.The
Company has a share-based compensation program that provides its Board of
Directors with broad discretion in creating equity incentives for employees,
officers, non-employee board members and non-employee service
providers.  This program includes incentive and non-statutory stock
option awards, stock appreciation right awards, restricted stock awards,
performance-based cash bonus awards for Section 16 executive officers and an
automatic grant program for non-employee board members pursuant to which such
individuals will receive option grants or other stock awards at designated
intervals over their period of board service.  These awards are
granted under various plans, all of which are stockholder
approved.  Stock option awards generally vest as follows: 25% of the
shares vest on the first anniversary of the vesting commencement date and the
remaining 75% vest proportionately each quarter over the next 12 quarters of
continued service.  Restricted stock awards generally vest in equal
annual installments over a 2 or 4-year period.  Initial grants under
the automatic grant program vest over a 4-year period and subsequent grants vest
over a 1-year period in accordance with the specific vesting provisions set
forth in that program.  Additionally, the Company has an Employee
Stock Purchase Plan (“ESPP”) that allows employees to purchase shares of common
stock at 85% of the fair market value at the subscription date or the date of
purchase, whichever is lower.
 
 Valuation
Assumptions.The fair value of the
Company’s stock options granted to employees, officers and non-employee board
members and ESPP shares granted to employees for the three and nine months ended
September 28, 2008 and September 30, 2007 was estimated using the
following weighted average assumptions:
  Three
      months ended
              
              Nine
      months endedSeptember 28,
      2008
              
              September 30,
      2007
              
              September 28,2008
              
              September 30,
      2007Option
      Plan SharesDividend
      yield
              None
              
              None
              
              None
              
              NoneExpected
      volatility
              0.54
              
              0.39
              
              0.52
              
              0.43Risk
      free interest rate
              2.83%
              
              4.33%
              
              2.52%
              
              4.54%Expected
      lives
              3.4
      years
              
              3.3
      years
              
              3.5
      years
              
              3.4
      yearsEstimated
      annual forfeiture rate
              8.31%
              
              7.59%
              
              8.31%
              
              7.59%Weighted
      average fair value at grant date
              $6.10
              
              $17.74
              
              $8.47
              
              $15.90Employee
      Stock Purchase Plan SharesDividend
      yield
              None
              
              None
              
              None
              
              NoneExpected
      volatility
              0.64
              
              0.41
              
              0.60
              
              0.43Risk
      free interest rate
              1.88%
              
              4.96%
              
              1.97%
              
              5.08%Expected
      lives
              1⁄2
      year
              
              1⁄2
      year
              
              1⁄2
      year
              
              1⁄2
      yearWeighted
      average fair value for grant period
              $4.77
              
              $14.52
              
              $6.00
              
              $12.75
 
 
  -
19 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  Share-Based
Compensation Plan Activities
 
 Stock Options and
SARs.  A summary of option and stock appreciation right (“SAR”)
activity under all of the Company’s share-based compensation plans as of
September 28, 2008 and changes during the nine months ended
September 28, 2008 is presented below (in thousands, except exercise price
and contractual term):
  Shares
              
              Weighted
      Average Exercise Price
              
              Weighted
      Average Remaining Contractual Term (Years)
              
              Aggregate
      Intrinsic ValueOptions
      and SARs outstanding at December 30, 2007
              25,557
              
              $
              35.59
              
              5.8
              
              $
              165,185Granted
              3,513
              
              
              21.52Exercised
              (809
              )
              
              8.15
              
              
              
              
              11,197Forfeited
              (1,607
              )
              
              43.21Expired
              (1,010
              )
              
              44.35Options
      and SARs outstanding at September 28, 2008
              25,644
              
              
              33.71
              
              5.2
              
              
              59,474Options
      and SARs vested and expected to vest after September 28, 2008, net of
      forfeitures
              24,273
              
              
              33.57
              
              5.2
              
              
              57,974Options
      and SARs exercisable at September 28, 2008
              15,781
              
              
              31.13
              
              4.8
              
              
              50,653
 
 At
September 28, 2008, the total compensation cost related to options granted
to employees under the Company’s share-based compensation plans but not yet
recognized was approximately $139.0 million, net of estimated
forfeitures.  The unamortized compensation expense will be amortized
on a straight-line basis and the weighted average period of this expense is
approximately 2.5 years.
 
 Restricted Stock
Units.  Restricted stock units (“RSUs”) are converted into
shares of the Company’s common stock upon vesting on a one-for-one
basis.  Typically, vesting of RSUs is subject to the employee’s
continuing service to the Company.  The cost of these awards is
determined using the fair value of the Company’s common stock on the date of the
grant, and compensation is recognized on a straight-line basis over the
requisite vesting period.
 
 A
summary of the changes in RSUs outstanding under the Company’s share-based
compensation plan during the nine months ended September 28, 2008 is
presented below (in thousands, except for grant date fair
value):
  Shares
              
              
              Weighted
      Average Grant Date Fair Value
              
              
              Aggregate
      Intrinsic ValueUnvested
      share units at December 30, 2007
              
              
              499
              
              
              $
              55.20
              
              
              $
              16,735Granted
              
              
              1,337
              
              
              
              18.79Vested
              
              
              (169
              )
              
              
              55.06
              
              
              
              4,121Forfeited
              
              
              (99
              )
              
              
              36.96Unvested
      share units at September 28, 2008
              
              
              1,568
              
              
              
              34.67
              
              
              
              33,807
 
 As
of September 28, 2008, the Company had approximately $29.9 million of
unrecognized compensation expense, net of estimated forfeitures, related to
RSUs.  The unamortized compensation expense will be recognized on a
straight-line basis and the weighted average estimated remaining life is
2.3 years.
 
 Employee Stock
Purchase Plan.  At September 28, 2008, there was
$3.7 million of unrecognized compensation cost related to ESPP that is
expected to be recognized over a period of approximately
4 months.
 
  -
20 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  Share-Based
Compensation Expense.  Share-based compensation expense for the
three and nine monthsendedSeptember 28,
2008andSeptember 30, 2007,ispresented below (in
thousands):
  Three
      months ended
              
              
              Nine
      months endedSeptember 28,
      2008
              
              
              September 30,
      2007
              
              
              September 28,
      2008
              
              
              September 30,
      2007Share-based
      compensation expense by caption:Cost
      of product sales
              
              $
              2,649
              
              
              $
              4,162
              
              
              $
              8,286
              
              
              $
              10,683Research
      and development
              
              
              10,544
              
              
              
              12,528
              
              
              
              28,693
              
              
              
              38,228Sales
      and marketing
              
              
              5,545
              
              
              
              7,956
              
              
              
              15,480
              
              
              
              25,240General
      and administrative
              
              
              6,813
              
              
              
              9,481
              
              
              
              21,426
              
              
              
              28,166Total
      share-based compensation expense
              
              $
              25,551
              
              
              $
              34,127
              
              
              $
              73,885
              
              
              $
              102,317Share-based
      compensation expense by type of award:Stock
      options and SARs
              
              $
              19,515
              
              
              $
              28,552
              
              
              $
              59,838
              
              
              $
              85,216Restricted
      stock
              
              
              4,324
              
              
              
              4,095
              
              
              
              9,740
              
              
              
              13,275ESPP
              
              
              1,712
              
              
              
              1,480
              
              
              
              4,307
              
              
              
              3,826Total
      share-based compensation expense
              
              $
              25,551
              
              
              $
              34,127
              
              
              $
              73,885
              
              
              $
              102,317
 
 Share-based
compensation expense of $2.6 million and $4.1 million related to
manufacturing personnel was capitalized into inventory as of September 28,
2008 and September 30, 2007, respectively.
  -
21 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 10.
              Net
      Income (Loss) Per Share
 
 The
following table sets forth the computation of basic and diluted net income
(loss) per share (in thousands, except per share amounts):
  Three
      months ended
              
              
              Nine
      months endedSeptember 28,
      2008
              
              
              September 30,
      2007
              
              
              September 28,
      2008
              
              
              September 30,
      2007Numerator
      for basic net income (loss) per share:Net
      income (loss), as reported
              
              $
              (155,194
              )
              
              $
              84,638
              
              
              $
              (205,191
              )
              
              $
              112,547Denominator
      for basic net income (loss) per share:Weighted
      average common shares outstanding
              
              
              225,682
              
              
              
              228,689
              
              
              
              225,030
              
              
              
              228,034Basic
      net income (loss) per share
              
              $
              (0.69
              )
              
              $
              0.37
              
              
              $
              (0.91
              )
              
              $
              0.49Numerator
      for diluted net income (loss) per share:Net
      income (loss), as reported
              
              $
              (155,194
              )
              
              $
              84,638
              
              
              $
              (205,191
              )
              
              $
              112,547Interest
      on the 1% Convertible Notes due 2035, net of tax
              
              
              —
              
              
              
              116
              
              
              
              —
              
              
              
              348Net
      income (loss) used in computing diluted net income per
    share
              
              $
              (155,194
              )
              
              $
              84,754
              
              
              $
              (205,191
              )
              
              $
              112,895Denominator
      for diluted net income (loss) per share:Weighted
      average common shares outstanding
              
              
              225,682
              
              
              
              228,689
              
              
              
              225,030
              
              
              
              228,034Effect
      of dilutive 1% Convertible Notes due 2035
              
              
              —
              
              
              
              2,012
              
              
              
              —
              
              
              
              2,012Effect
      of dilutive options and restricted stock
              
              
              —
              
              
              
              6,229
              
              
              
              —
              
              
              
              5,946Shares
      used in computing diluted net income (loss) per share
              
              
              225,682
              
              
              
              236,930
              
              
              
              225,030
              
              
              
              235,992Diluted
      net income (loss) per share
              
              $
              (0.69
              )
              
              $
              0.36
              
              
              $
              (0.91
              )
              
              $
              0.48Anti-dilutive
      shares excluded from net income (loss) per share
    calculation
              
              
              54,857
              
              
              
              39,840
              
              
              
              53,595
              
              
              
              39,777
 
 Basic
earnings per share exclude any dilutive effects of stock options, SARs, RSUs,
warrants and convertible securities.  For the three and nine months
ended September 30, 2007, diluted earnings per share include the dilutive
effects of stock options, SARs, RSUs, warrants and the 1% Convertible Notes due
2035.  Certain common stock issuable under stock options, SARs,
warrants and the 1% Senior Convertible Notes due 2013 were anti-dilutive for the
three and nine months ended September 28, 2008 and September 30,
2007.
 
  -
22 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  11.
              Commitments, Contingencies and
    Guarantees
 
 FlashVision.In June 2008, the
Company agreed to wind-down its 49.9% ownership interest in FlashVision Ltd.
(“FlashVision”), a business venture with Toshiba Corporation (“Toshiba”) which
owns 50.1%.  In this venture, the Company and Toshiba collaborated in
the development and manufacture of 200-millimeter NAND flash memory
products.  However, the Company and Toshiba have determined that
production of NAND flash memory products utilizing 200-millimeter wafers is no
longer cost effective relative to current and projected market prices for NAND
flash memory.
 
 As
part of the ongoing wind-down of FlashVision, Toshiba has agreed to purchase
certain assets of FlashVision and has retired the existing master lease
agreement between FlashVision and a consortium of financial institutions,
thereby releasing the Company from its contingent indemnification
obligation.  Due to the wind-down qualifying as a reconsideration
event under FASB Interpretation No. 46 (Revised) (“FIN 46(R)”), Consolidation of Variable Interest
Entities,the Company re-evaluated whether FlashVision is a variable
interest entity and concluded that FlashVision is no longer a variable interest
entity within the scope of FIN 46(R).  In the three and nine months
ended September 28, 2008, the Company received distributions of
$73.5 million and $102.5 million, respectively, relating to its
investment in FlashVision.  In the third quarter of fiscal year 2008,
the Company also took an impairment charge on its investment of
$10.4 million due to FlashVision’s difficulty in selling the remaining
excess capital equipment due to deteriorating market conditions for equipment
related to the production of 200-millimeter NAND flash memory
products.  At September 28, 2008, the Company had an investment
in FlashVision of $51.0 million denominated in Japanese yen, offset by
$27.9 million of cumulative translation adjustments recorded in OCI.
 
 Flash
Partners.  The Company has a
49.9% ownership interest in Flash Partners Ltd. (“Flash Partners”), a business
venture with Toshiba which owns 50.1%, formed in fiscal year 2004.  In
the venture, the Company and Toshiba have collaborated in the development and
manufacture of NAND flash memory products.  These NAND flash memory
products are manufactured by Toshiba at the 300-millimeter wafer fabrication
facility (“Fab 3”) located in Yokkaichi, Japan, using the semiconductor
manufacturing equipment owned or leased by Flash Partners.  Flash
Partners purchases wafers from Toshiba at cost and then resells those wafers to
the Company and Toshiba at cost plus a markup.  The Company accounts
for its 49.9% ownership position in Flash Partners under the equity method of
accounting.  The Company is committed to purchase its provided
three-month forecast of Flash Partner’s NAND wafer supply, which generally
equals 50% of the venture’s output.  The Company is not able to
estimate its total wafer purchase commitment obligation beyond its rolling
three-month purchase commitment because the price is determined by reference to
the future cost of producing the semiconductor wafers.  In addition,
the Company is committed to fund 49.9% of Flash Partners’ costs to the extent
that Flash Partners’ revenues from wafer sales to the Company and Toshiba are
insufficient to cover these costs.
 
 As
of September 28, 2008, the Company had notes receivable from Flash Partners
of 76.3 billion Japanese yen, or approximately $722 million based upon
the exchange rate at September 28, 2008 of 105.66 Japanese yen to one U.S.
dollar.  These notes are secured by the equipment purchased by Flash
Partners using the note proceeds.  The Company has additional
guarantee obligations to Flash Partners, see “Off-Balance Sheet
Liabilities.”
 
 Flash
Alliance.  The Company has a 49.9% ownership interest in Flash
Alliance Ltd. (“Flash Alliance”), a business venture with Toshiba which owns
50.1%, formed in fiscal year 2006.  In the venture, the Company and
Toshiba have collaborated in the development and manufacture of NAND flash
memory products.  These NAND flash memory products are manufactured by
Toshiba at its 300-millimeter wafer fabrication facility (“Fab 4”) located
in Yokkaichi, Japan, using the semiconductor manufacturing equipment owned or
leased by Flash Alliance.  Flash Alliance purchases wafers from
Toshiba at cost and then resells those wafers to the Company and Toshiba at cost
plus a markup.  The Company accounts for its 49.9% ownership position
in Flash Alliance under the equity method of accounting.  The Company
is committed to purchase its provided three-month forecast of Flash Alliance’s
NAND wafer supply, which generally equals 50% of the venture’s
output.  The Company is not able to estimate its total wafer purchase
commitment obligation beyond its rolling three-month purchase commitment because
the price is determined by reference to the future cost of producing the
semiconductor wafers.  In addition, the Company is committed to fund
49.9% of Flash Alliance’s costs to the extent that Flash Alliance’s revenues
from wafer sales to the Company and Toshiba are insufficient to cover these
costs.
 
  -
23 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  As
of September 28, 2008, the Company had notes receivable from Flash Alliance
of 10.0 billion Japanese yen, or approximately $95 million based upon
the exchange rate at September 28, 2008.  These notes are secured
by the equipment purchased by Flash Alliance using the note
proceeds.  The Company has additional guarantee obligations to Flash
Alliance, see “Off-Balance Sheet Liabilities.”
 
 As
a part of the Flash Partners and Flash Alliance (hereinafter referred to as
“Flash Ventures”) agreements, the Company is required to fund direct and common
research and development expenses related to the development of advanced NAND
flash memory technologies.  As of September 28, 2008 and
December 30, 2007, the Company had accrued liabilities related to these
expenses of $4.0 million and $8.0 million, respectively.
 
 The
Company has guarantee obligations to Flash Ventures, see “Off-Balance Sheet
Liabilities.”
 
 Toshiba
Foundry.The Company has the
ability to purchase additional capacity under a foundry arrangement with
Toshiba.
 
 Business Ventures
and Foundry Arrangement with Toshiba.  Purchase orders placed
under Flash Ventures and the foundry arrangement with Toshiba for up to three
months are binding and cannot be canceled.
 
 Other Silicon
Sources.The Company’s contracts
with its other sources of silicon wafers generally require the Company to
provide purchase order commitments based on nine-month rolling
forecasts.  The purchase orders placed under these arrangements
relating to the first three months of the nine-month forecast are generally
binding and cannot be canceled.  These outstanding purchase
commitments for other sources of silicon wafers are included as part of the
total “Noncancelable production purchase commitments” in the “Contractual
Obligations” table below.
 
 Subcontractors.In the normal course of
business, the Company’s subcontractors periodically procure production materials
based on the forecast the Company provides to them.  The Company’s
agreements with these subcontractors require that the
Company reimburse them for materials that are purchased on the Company’s
behalf in accordance with such forecast.  Accordingly, the Company may
be committed to certain costs over and above its open noncancelable purchase
orders with these subcontractors.  These commitments for production
materials to subcontractors are included as part of the total “Noncancelable
production purchase commitments” in the “Contractual Obligations” table
below.
 
  -
24 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  Off-Balance
Sheet Liabilities
 
 The
following table details the Company’s portion of the remaining guarantee
obligations under each of Flash Ventures’ master lease facilities in both
Japanese yen and U.S. dollar equivalent based upon the exchange rate at
September 28, 2008.
  Master
      Lease Agreements by Execution Date
                
                Lease
      Amounts
                
                Expiration(Yen
      in billions)
                
                
                (Dollars
      in thousands)Flash
      PartnersDecember 2004
                
                ¥
                13.1
                
                
                $
                123,972
                
                2010December 2005
                
                
                10.4
                
                
                
                98,264
                
                2011June
      2006
                
                
                10.8
                
                
                
                101,957
                
                2011September 2006
                
                
                33.4
                
                
                
                316,315
                
                2011March
      2007
                
                
                23.0
                
                
                
                217,722
                
                2012February
      2008
                
                
                11.2
                
                
                
                105,993
                
                2013¥
                101.9
                
                
                $
                964,223Flash
      AllianceNovember
      2007
                
                ¥
                43.7
                
                
                $
                413,522
                
                2013June
      2008
                
                
                49.1
                
                
                
                464,792
                
                2013¥
                92.8
                
                
                $
                878,314Total
      guarantee obligations
                
                ¥
                194.7
                
                
                $
                1,842,537
 
 The
following table details the breakdown of the Company’s remaining guarantee
obligations between the principal amortization and the purchase option exercise
price at the term of the master lease agreements, in annual installments, as of
September 28, 2008 in U.S. dollars based upon the exchange rate at
September 28, 2008.
   Annual
      Installments
                  
                  Payment
      of Principal Amortization
                  
                  
                  Purchase
      Option Exercise Price at Final Lease Terms
                  
                  
                  Guarantee
      Amount(In thousands)Year
      1
                  
                  $
                  428,255
                  
                  
                  $
                  —
                  
                  
                  $
                  428,255Year
      2
                  
                  
                  385,933
                  
                  
                  
                  34,955
                  
                  
                  
                  420,888Year
      3
                  
                  
                  290,495
                  
                  
                  
                  210,940
                  
                  
                  
                  501,435Year
      4
                  
                  
                  152,552
                  
                  
                  
                  123,508
                  
                  
                  
                  276,060Year
      5
                  
                  
                  54,532
                  
                  
                  
                  161,367
                  
                  
                  
                  215,899Total
      guarantee obligations
                  
                  $
                  1,311,767
                  
                  
                  $
                  530,770
                  
                  
                  $
                  1,842,537
 FlashVision.  FlashVision
had an equipment lease arrangement of approximately 15.0 billion Japanese
yen, or approximately $143 million based upon the exchange rate at May 30,
2008, of which 6.2 billion Japanese yen, or approximately $59 million
based upon the exchange rate at May 30, 2008, was retired by Toshiba on May 30,
2008 thereby releasing the Company of its indemnification agreement with
Toshiba.
 
  -
25 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  Flash
Partners.  Flash Partners sells and leases back from a
consortium of financial institutions (“lessors”) a portion of its tools and has
entered into six equipment master lease agreements totaling 300.0 billion
Japanese yen, or approximately $2.84 billion based upon the exchange rate
at September 28, 2008, of which 203.8 billion Japanese yen, or
approximately $1.93 billion based upon the exchange rate at
September 28, 2008, was outstanding at
September 28, 2008.  The Company and Toshiba have each
guaranteed 50%, on a several basis, of Flash Partners’ obligations under the
master lease agreements. In addition, these master lease agreements are secured
by the underlying equipment.  As of September 28, 2008, the
amount of the Company’s guarantee obligation of the Flash Partners master lease
agreements, which reflects future payments and any lease adjustments, was
101.9 billion Japanese yen, or approximately $964 million based upon
the exchange rate at September 28, 2008.  Certain lease
payments are due quarterly and certain lease payments are due semi-annually, and
are scheduled to be completed in stages through fiscal year 2013.  At
each lease payment date, Flash Partners has the option of purchasing the tools
from the lessors.  Flash Partners is obligated to insure the
equipment, maintain the equipment in accordance with the manufacturers’
recommendations and comply with other customary terms to protect the leased
assets.  The fair value of the Company’s guarantee obligation of Flash
Partners’ master lease agreements was not material at inception of each master
lease.
 
 The
master lease agreements contain customary covenants for Japanese lease
facilities.  In addition to containing customary events of default
related to Flash Partners that could result in an acceleration of Flash
Partners’ obligations, the master lease agreements contain an acceleration
clause for certain events of default related to the Company as guarantor,
including, among other things, the Company’s failure to maintain a minimum
shareholder equity of at least $1.51 billion, and its failure to maintain a
minimum corporate rating from one of two named independent ratings
services.
 
 On
July 23, 2008, one named independent rating service lowered its corporate rating
of the Company to B+, which caused Flash Partners to no longer be in compliance
with the rating covenant applicable in three of the six outstanding Flash
Partners master lease agreements.  On September 30, 2008, Flash
Partners amended the three master lease agreements to address this
non-compliance.  As amended, the three master lease agreements now
require the Company to maintain a minimum corporate rating of BB- or BB+, from
at least one of two named independent ratings services and minimum shareholder
equity of at least $1.51 billion.  The amendment also includes
nominal increases in debt spreads, which are not material to our future
results.  As of September 30, 2008, Flash Partners was in
compliance with all of its master lease covenants.
 
 On
October 23, 2008, one of the two named independent ratings services downgraded
the Company’s credit rating further below the minimum corporate rating
threshold, and while this specific downgrade did not trigger non-compliance
under Flash Partners’ master equipment lease agreements, there can be no
assurance that the other named independent ratings service will maintain its
credit rating of the Company above the required threshold.  If the
other named independent ratings service downgrades the Company’s credit rating
below the minimum corporate rating threshold, Flash Partners could
become non-compliant under its master equipment lease agreements and may be
required to negotiate a resolution to the non-compliance to avoid acceleration
of the obligations under such agreements.  Such resolution could
include, among other things, supplementary security to be supplied by the
Company, as guarantor, or increased interest rates or waiver fees, should the
lessors decide they need additional collateral or financial consideration under
the circumstances.  If a resolution is unsuccessful, the Company may
be required to pay a portion or the entire outstanding lease obligations covered
by its guarantee under such Flash Partners master lease agreements.
  Flash
Partners expects to secure additional equipment lease facilities over time, for
which the Company will be expected to provide guarantees.
  -
26 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  Flash
Alliance.  Flash Alliance sells and leases-back from a
consortium of financial institutions (“lessors”) a portion of its tools and has
entered into two equipment master lease agreements totaling 200.0 billion
Japanese yen, or approximately $1.89 billion based upon the exchange rate
at September 28, 2008, of which 185.6 billion Japanese yen, or
approximately $1.76 billion based upon the exchange rate at
September 28, 2008, was outstanding as of
September 28, 2008.  The Company and Toshiba have each
guaranteed 50%, on a several basis, of Flash Alliance’s obligation under the
master lease agreements.  In addition, these master lease agreements
are secured by the underlying equipment.  As of September 28,
2008, the amount of the Company’s guarantee obligation of the Flash Alliance
master lease agreements was 92.8 billion Japanese yen, or approximately
$878 million based upon the exchange rate at September 28,
2008.  Remaining master lease payments are due semi-annually and are
scheduled to be completed in fiscal year 2013.  At each lease payment
date, Flash Alliance has the option of purchasing the tools from the
lessors.  Flash Alliance is obligated to insure the equipment,
maintain the equipment in accordance with the manufacturers’ recommendations and
comply with other customary terms to protect the leased assets.  The
fair value of the Company’s guarantee obligation of Flash Alliance’s master
lease agreements was not material at inception of each master
lease.
 
 The
master lease agreements contain customary covenants for Japanese lease
facilities.  In addition to containing customary events of default
related to Flash Alliance that could result in an acceleration of Flash
Alliance’s obligations, the master lease agreements contain an acceleration
clause for certain events of default related to the Company as guarantor,
including, among other things, the Company’s failure to maintain a minimum
shareholder equity of at least $1.51 billion, and its failure to maintain a
minimum corporate rating of BB- or BB+, from at least one of two named
independent ratings services.  As of September 28, 2008, Flash
Alliance was in compliance with all of its master lease covenants.
 
 On
October 23, 2008, one of the two named independent ratings services downgraded
the Company’s credit rating further below the minimum corporate rating
threshold, and while this specific downgrade did not trigger non-compliance
under Flash Alliance’s master equipment lease agreements, there can be no
assurance that the other named independent ratings service will maintain its
credit rating of the Company above the threshold.  If the other named
independent ratings service downgrades the Company’s credit rating below the
minimum corporate rating threshold, Flash Alliance could become
non-compliant under their master equipment lease agreements and may be required
to negotiate a resolution to the non-compliance to avoid acceleration of the
obligations under such agreements.  Such resolution could include,
among other things, supplementary security to be supplied by the Company, as
guarantor, or increased interest rates or waiver fees, should the lessors decide
they need additional collateral or financial consideration under the
circumstances.  If a resolution is unsuccessful, the Company may be
required to pay a portion or the entire outstanding lease obligations covered by
its guarantee under such Flash Alliance master lease agreements.
  Flash
Alliance expects to secure additional equipment lease facilities over time, for
which the Company will be expected to provide guarantees.
 
  -
27 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  Guarantees
 
 Indemnification
Agreements.  The Company has agreed to indemnify suppliers and
customers for alleged patent infringement.  The scope of such
indemnity varies, but may, in some instances, include indemnification for
damages and expenses, including attorneys’ fees.  The Company may
periodically engage in litigation as a result of these indemnification
obligations.  The Company’s insurance policies exclude coverage for
third-party claims for patent infringement.  Although the liability is
not remote, the nature of the patent infringement indemnification obligations
prevents the Company from making a reasonable estimate of the maximum potential
amount it could be required to pay to its suppliers and
customers.  Historically, the Company has not made any significant
indemnification payments under any such agreements.  As of
September 28, 2008, no amount had been accrued in the accompanying
Condensed Consolidated Financial Statements with respect to these
indemnification guarantees.
 
 As
permitted under Delaware law and the Company’s certificate of incorporation and
bylaws, the Company has agreements, or has assumed agreements in connection with
its acquisitions, whereby it indemnifies certain of its officers, employees, and
each of its directors for certain events or occurrences while the officer,
employee or director is, or was, serving at the Company’s or the acquired
company’s request in such capacity.  The term of the indemnification
period is for the officer’s, employee’s or director’s lifetime.  The
maximum potential amount of future payments the Company could be required to
make under these indemnification agreements is generally unlimited; however, the
Company has a Director and Officer insurance policy that may reduce its exposure
and enable it to recover all or a portion of any future amounts
paid.  As a result of its insurance policy coverage, the Company
believes the estimated fair value of these indemnification agreements is
minimal.  The Company has no liabilities recorded for these agreements
as of September 28, 2008 or December 30, 2007, as these
liabilities are not reasonably estimable even though liabilities under these
agreements are not remote.
 
 The
Company and Toshiba have agreed to mutually contribute to, and indemnify each
other and Flash Ventures for environmental remediation costs or liability
resulting from Flash Ventures’ manufacturing operations in certain
circumstances.  In fiscal years 2004 and 2006, the Company and Toshiba
each engaged consultants to perform a review of the existing environmental
conditions at the site of the facilities at which Flash Ventures operations are
located to establish a baseline for evaluating future environmental
conditions.  The Company and Toshiba have also entered into a Patent
Indemnification Agreement under which in many cases the Company will share in
the expenses associated with the defense and cost of settlement associated with
such claims.  This agreement provides limited protection for the
Company against third-party claims that NAND flash memory products manufactured
and sold by Flash Ventures infringes third-party patents.  The Company
has not made any indemnification payments under any such agreements and as of
September 28, 2008, no amounts have been accrued in the accompanying
Condensed Consolidated Financial Statements with respect to these
indemnification guarantees.
 
  -
28 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  Contractual
Obligations and Off-Balance Sheet Arrangements
 
 The
following tables summarize the Company’s contractual cash obligations,
commitments and off-balance sheet arrangements at September 28, 2008, and
the effect such obligations are expected to have on its liquidity and cash flows
in future periods (in thousands).
 
 
 
 Contractual
Obligations.
 Total
              
              
              1
      Year or Less
                  (3
      months)
              
              2
      - 3 Years
                  (Fiscal
      2009
                  and
      2010)
              
              4
      –5 Years
                  (Fiscal
      2011
                  and
      2012)
              
              More
      than 5 Years (Beyond
                  Fiscal
      2012)Operating
      leases
              
              $
              36,258
              
              
              $
              2,298
              
              $
              17,067
              
              $
              8,728
              
              $
              8,165Flash
      Partners reimbursement for certain other costs including
      depreciation
              
              
              1,720,223
              (3)
              
              
              128,530
              
              
              1,015,395
              
              
              483,094
              
              
              93,204Flash
      Alliance fabrication capacity expansion and reimbursement for certain
      other costs including depreciation
              
              
              2,300,969
              (3)
              
              
              226,702
              
              
              1,220,206
              
              
              713,146
              
              
              140,915Toshiba
      research and development
              
              
              23,929
              (3)
              
              
              12,638
              
              
              11,291
              
              
              —
              
              
              —Capital
      equipment purchases commitments
              
              
              36,505
              
              
              
              28,830
              
              
              7,383
              
              
              292
              
              
              —Convertible
      notes principal and interest (1)
              
              
              1,304,108
              
              
              
              9,188
              
              
              24,500
              
              
              24,500
              
              
              1,245,920Operating
      expense commitments
              
              
              100,892
              
              
              
              64,304
              
              
              29,928
              
              
              6,660
              
              
              —Noncancelable
      production purchase commitments (2)
              
              
              464,395
              (3)
              
              
              464,395
              
              
              —
              
              
              —
              
              
              —Total
      contractual cash obligations
              
              $
              5,987,279
              
              
              $
              936,885
              
              $
              2,325,770
              
              $
              1,236,420
              
              $
              1,488,204
 
 
 Off-Balance
Sheet Arrangements.
 As
      of
                  September 28,
      2008Guarantee
      of Flash Partners equipment leases (4)
              
              $
              964,223Guarantee
      of Flash Alliance equipment leases (4)
              
              
              878,314
 _________________
 (1)
              In
      May 2006, the Company issued and sold $1.15 billion in aggregate
      principal amount of 1% Senior Convertible Notes due May
      15, 2013.  The Company will pay cash interest at an annual
      rate of 1%, payable semi-annually on May 15 and November 15 of each
      year until calendar year 2013.  In November 2006, through
      its acquisition of msystems Ltd. (“msystems”), the Company assumed
      msystems’ $75 million in aggregate principal amount of 1% Convertible
      Notes due March 15, 2035.  The Company will pay cash
      interest at an annual rate of 1%, payable semi-annually on March 15
      and September 15 of each year until calendar year
    2035.
 
 (2)
              Includes
      Toshiba foundries, Flash Ventures, related party vendors and other silicon
      source vendor purchase commitments.
 
 (3)
              Includes
      amounts denominated in Japanese yen, which are subject to fluctuation in
      exchange rates prior to payment and have been translated using the
      exchange rate at September 28,
2008.
 
 (4)
              The
      Company’s guarantee obligation, net of cumulative lease payments, is
      194.7 billion Japanese yen, or approximately $1.84 billion based
      upon the exchange rate at September 28,
  2008.
 
  -
29 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  The
Company has excluded $111.9 million of unrecognized tax benefits from the
contractual obligation table above due to the uncertainty with respect to the
timing of associated future cash flows at September 28, 2008. The Company
is unable to make reasonable reliable estimates of the period of cash settlement
with the respective taxing authorities.
 
 The
Company leases many of its office facilities and operating equipment for various
terms under long-term, noncancelable operating lease agreements.  The
leases expire at various dates from fiscal year 2008 through fiscal year
2016.  Future minimum lease payments at September 28, 2008 are
presented below (in thousands):
  Fiscal
      Year:2008
      (remaining three months)
              
              $
              2,5152009
              
              
              9,8382010
              
              
              8,6722011
              
              
              6,5542012
              
              
              4,8932013
      and thereafter
              
              
              8,16540,637Sublease
      income to be received in the future under noncancelable
      subleases
              
              
              (4,379
              )Net
      operating leases
              
              $
              36,258
  -
30 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 12.
              Related
      Parties and Strategic Investments
 
 Toshiba.  The Company and
Toshiba have collaborated in the development and manufacture of NAND flash
memory products.  These NAND flash memory products are manufactured by
Toshiba at Toshiba’s Yokkaichi, Japan operations using the semiconductor
manufacturing equipment owned or leased by Flash Ventures.  See also
Note 11, “Commitments, Contingencies and Guarantees.”  The Company
purchased NAND flash memory wafers from Flash Ventures and Toshiba, made
payments for shared research and development expenses, made loans to Flash
Ventures and made investments in Flash Ventures totaling approximately
$520.8 million, $1,524.9 million, $324.1 million and
$890.8 million in the three and nine months ended September 28, 2008
and September 30, 2007, respectively.  The purchases of NAND
flash memory wafers are ultimately reflected as a component of the Company’s
cost of product revenues.  During the three and nine months ended
September 28, 2008 and September 30, 2007, the Company had sales to
Toshiba of zero, $5.1 million, $9.6 million and $19.1 million,
respectively. At
September 28, 2008 and December 30, 2007, the Company had accounts
payable balances due to Toshiba of $1.2 million and $0.2 million,
respectively, and trade and other receivable balances from Toshiba of
$25.0 million and $4.2 million, respectively.  As of
September 28, 2008 and December 30, 2007, the Company had accrued
current liabilities due to Toshiba for shared research and development expenses
of $4.0 million and $8.0 million, respectively.
 
 Flash Ventures
with Toshiba.  The Company owns
49.9% of each Flash Venture entity and accounts for its ownership position under
the equity method of accounting.  The Company’s obligations with
respect to Flash Ventures’ master lease agreements, capacity expansion,
take-or-pay supply arrangements and research and development cost sharing are
described in Note 11, “Commitments, Contingencies and
Guarantees.”  Flash Ventures are variable interest entities as defined
under FIN 46(R), and
the Company is not the primary beneficiary of any of Flash Ventures' entities
because it absorbs less than a majority of the expected gains and losses of each
entity.  At September 28, 2008 and December 30, 2007, the
Company had accounts payable balances due to Flash Ventures of
$128.3 million and $131.3 million, respectively.  For
activity related to the wind-down of FlashVision, see Note 11, “Commitments,
Contingencies and Guarantees.”
 
 Tower
Semiconductor.As of
September 28, 2008, the Company owned 15.9 million Tower shares or
approximately 10.0% of the outstanding shares of Tower Semiconductor Ltd.
(“Tower”), one of its suppliers of wafers for its controller components and has
convertible debt, an equipment loan, and warrants to purchase Tower ordinary
shares.  In the first quarter of fiscal year 2008, the Company’s Chief
Executive Officer resigned as a member of the Tower Board of
Directors.  In the third quarter of fiscal year 2008, the Company
recognized an $11.7 million impairment charge as a result of the
other-than-temporary decline in its investment in Tower ordinary shares which
reduced the investment value to $9.2 million as of September 28,
2008.  Subsequent to the end of the third quarter of fiscal year 2008,
Tower’s stock price declined further, which may cause the Company to take
additional impairments in future periods.  In addition, the Company
holds a Tower convertible debenture with a market value of
$3.3 million.  As of September 28, 2008, the Company also
had an outstanding loan of $6.5 million to Tower for expansion of Tower’s
0.13 micron logic wafer capacity.  The loan to Tower is secured
by the equipment purchased.  The Company purchased controller wafers
and related non-recurring engineering of $4.1 million, $23.0 million,
$15.3 million and $53.8 million in the three and nine months ended
September 28, 2008 and September 30, 2007,
respectively.  The purchases of controller wafers are ultimately
reflected as a component of the Company’s cost of product
revenues.  At September 28, 2008 and December 30, 2007, the
Company had amounts payable to Tower of zero and $6.1 million,
respectively.
 
 Flextronics.On January 10, 2008,
Michael Marks, who serves on the Company’s Board of Directors, resigned from
Flextronics International, Ltd., (“Flextronics”), where he had held the position
of chairman of the Board of Directors.  The activity from
December 31, 2007 to January 10, 2008 between Flextronics and the Company
was immaterial.
 
  -
31 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 13.
              Litigation
 
 The
flash memory industry is characterized by significant litigation seeking to
enforce patent and other intellectual property rights.  The Company's
patent and other intellectual property rights are primarily responsible for
generating license and royalty revenue.  The Company seeks to protect
its intellectual property through patents, copyrights, trademarks, trade secret
laws, confidentiality agreements and other methods, and has been, and likely
will, continue to enforce such rights as appropriate through litigation and
related proceedings.  The Company expects that its competitors and
others who hold intellectual property rights related to its industry will
pursue similar strategies against it in litigation and related
proceedings.  From time-to-time, it has been and may continue to be
necessary to initiate or defend litigation against third
parties.  These and other parties could bring suit against the
Company.  In each case listed below where the Company is the
defendant, the Company intends to vigorously defend the action.  At
this time, the Company does not believe it is reasonably possible that losses
related to the litigation described below have occurred beyond the amounts, if
any, that have been accrued.
 
 On
October 31, 2001, the Company filed a complaint for patent infringement in the
United States District Court for the Northern District of California against
Memorex Products, Inc. (“Memorex”), Pretec Electronics Corporation (“Pretec”),
RITEK Corporation (“RITEK”), and Power Quotient International Co., Ltd
(“PQI”).  In the suit, captioned SanDisk Corp. v. Memorex Products,
Inc., et al., Civil Case No. CV 01 4063 VRW, the Company seeks damages and
injunctions against these companies from making, selling, importing or using
flash memory cards that infringe its U.S. Patent No. 5,602,987.  On
May 6, 2003, the District Court entered a stipulated consent judgment against
PQI.  The District Court granted summary judgment of non-infringement
in favor of defendants RITEK, Pretec and Memorex and entered judgment on May 17,
2004.  On June 2, 2004, the Company filed a notice of appeal of the
summary judgment rulings to the United States Court of Appeals for the Federal
Circuit.  On July 8, 2005, the Federal Circuit held in favor of the
Company, vacating the judgment of non-infringement and remanding the case back
to the District Court.  The District Court issued an order on claim
construction on February 22, 2007.  On June 29, 2007, defendant RITEK
entered into a settlement agreement and cross-license with the
Company.  In light of the agreement, the Company agreed to dismiss all
current patent infringement litigation against RITEK.  A stipulated
dismissal with prejudice between the Company and RITEK was entered on July 23,
2007.  On August 30, 2007, the Company entered into a settlement
agreement with Memorex regarding the accused products.  On
September 7, 2007, in light of the settlement between the Company and
Memorex, the Court entered a stipulation dismissing the Company’s claims against
Memorex.  On October 25, 2007, the Court Clerk entered a default
against Pretec.  On January 14, 2008, the Company filed a motion for
default judgment against Pretec.  The Court scheduled a hearing
regarding the Company’s motion for April 3, 2008.  In light of ongoing
settlement discussions with Pretec and its successor, PTI Global, the Court
issued an Order of Dismissal on July 1, 2008, with the provision that the order
could be vacated and a trial date would be reset if one of the parties certified
that consideration for the settlement was not delivered within ninety
days.  The Company has since signed patent cross-license agreements
with both PTI Global and Pretec.  Pursuant to the Court’s order, the
case is now dismissed.
 
  -
32 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  On
October 15, 2004, the Company filed a complaint for patent infringement and
declaratory judgment of non-infringement and patent invalidity against
STMicroelectronics N.V. and STMicroelectronics, Inc. (collectively, “ST”) in the
United States District Court for the Northern District of California, captioned
SanDisk Corporation v. STMicroelectronics, Inc., et al., Civil Case No. C 04
04379 JF.  The complaint alleges that ST’s products infringe one of
the Company’s U.S. patents, U.S. Patent No. 5,172,338 (the “’338 patent”), and
also alleges that several of ST’s patents are invalid and not
infringed.  On June 18, 2007, the Company filed an amended complaint,
removing several of the Company’s declaratory judgment claims.  A case
management conference was conducted on June 29, 2007.  At that
conference, the parties agreed that the remaining declaratory judgment claims
will be dismissed, pursuant to a settlement agreement in two matters being
litigated in the Eastern District of Texas (Civil Case No. 4:05CV44 and Civil
Case No. 4:05CV45, discussed below).  The parties also agreed that the
’338 patent and a second Company patent, presently at issue in Civil Case No.
C0505021 JF (discussed below), will be litigated together in this
case.  ST filed an answer and counterclaims on September 6,
2007.  ST’s counterclaims included assertions of antitrust
violations.  On October 19, 2007, the Company filed a motion to
dismiss ST’s antitrust counterclaims.  On December 20, 2007, the
Court entered a stipulated order staying all procedural deadlines until the
Court resolves the Company’s motion to dismiss.  On January 25, 2008,
the Court held a hearing on the Company’s motion.  At the hearing, the
Court converted the Company’s Motion to Dismiss into a Motion for Summary
Judgment.  On June 17, 2008, the Court issued a stipulated order
rescheduling the hearing on the Company’s Motion for Summary Judgment for
September 12, 2008.  On October 17, 2008, the Court issued an
order granting in part and denying in part the Company’s motion for summary
judgment on ST’s antitrust counterclaims.  The Court has not yet
established new procedural deadlines in this matter.
 
 On
October 14, 2005, STMicroelectronics, Inc. (“STMicro”) filed a complaint against
the Company and the Company’s CEO, Dr. Eli Harari, in the Superior Court of the
State of California for the County of Alameda, captioned STMicroelectronics,
Inc. v. Harari, Case No. HG 05237216 (the “Harari Matter”).  The
complaint alleges that STMicro, as the successor to Wafer Scale Integration,
Inc.’s (“WSI”) legal rights, has an ownership interest in several Company
patents that were issued from applications filed by Dr. Harari, a former WSI
employee.  The complaint seeks the assignment or co-ownership of
certain inventions and patents conceived of by Dr. Harari, including some of the
patents asserted by the Company in its litigations against STMicro, as well as
damages in an unspecified amount.  On November 15, 2005, Dr. Harari
and the Company removed the case to the U.S. District Court for the Northern
District of California, where it was assigned case number
C05-04691.  On December 13, 2005, STMicro filed a motion to
remand the case back to the Superior Court of Alameda County.  The
case was remanded to the Superior Court of Alameda County on July 18, 2006,
after briefing and oral argument on a motion by STMicro for reconsideration of
an earlier order denying STMicro’s request for remand.  Due to the
remand, the District Court did not rule upon a summary judgment motion
previously filed by the Company.  In the Superior Court of Alameda
County, the Company filed a Motion to Transfer Venue to Santa Clara County on
August 10, 2006, which was denied on September 12, 2006.  On
October 6, 2006, the Company filed a Petition for Writ of Mandate with the First
District Court of Appeal, which asked that the Superior Court’s
September 12, 2006 Order be vacated, and the case transferred to Santa
Clara County.  On October 20, 2006, the Court of Appeal requested
briefing on the Company’s petition for a writ of mandate and stayed the action
during the pendency of the writ proceedings.  On January 17, 2007, the
Court of Appeal issued an alternative writ directing the Superior Court to issue
a new order granting the Company’s venue transfer motion or to show cause why a
writ of mandate should not issue compelling such an order.  On January
23, 2007, the Superior Court of Alameda transferred the case to Santa Clara
County as a result of the writ proceeding at the Court of Appeal.  The
Company also filed a special motion to strike STMicro’s unfair competition
claim, which the Superior Court denied on September 11,
2006.  The Company appealed the denial of that motion, and the
proceedings at the Superior Court were stayed during the pendency of the
appeal.  On August 7, 2007, the First District Court of Appeal
affirmed the Superior Court’s decision, and the Supreme Court subsequently
denied the Company’s petition for review.  On February 7, 2008, the
Company and Dr. Harari moved for judgment on the pleadings on the ground that
the federal courts have exclusive jurisdiction over the claims in the
case.  The Superior Court denied this motion and litigation then
proceeded at the Superior Court until May 7, 2008, when the Company and Dr.
Harari again removed the case to the U.S. District Court for the Northern
District of California.  The District Court consolidated the case and
the previously-removed action under case number C05-04691.  STMicro
filed a motion to remand which was granted on August 26, 2008.  The
case was remanded to the Superior Court for the County of Santa Clara, Case No.
1-07-CV-080123, and trial has been set for September 8, 2009.
 
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  On
December 6, 2005, the Company filed a complaint for patent infringement in
the United States District Court for the Northern District of California against
ST (Case No. C0505021 JF).  In the suit, the Company seeks damages and
injunctions against ST from making, selling, importing or using flash memory
chips or products that infringe the Company’s U.S. Patent No. 5,991,517 (the
“’517 patent”).  As discussed above, the ’517 patent will be litigated
together with the ’338 patent in Civil Case No. C 04 04379JF.
 
 On
September 11, 2006, Mr. Rabbi, a shareholder of msystems filed a derivative
action and a motion to permit him to file the derivative action against four
directors of msystems and msystems, arguing that options were allegedly
allocated to officers and employees of msystems in violation of applicable
law.  Mr. Rabbi claimed that the aforementioned actions allegedly
caused damage to msystems.  On January 25, 2007, msystems filed a
motion to dismiss the motion to seek leave to file the derivative action and the
derivative action on the grounds, inter alia, that Mr. Rabbi ceased to be a
shareholder of msystems after the merger between msystems and the
Company.  On March 12, 2008, the court accepted msystems’ motion and
determined that the motion to seek leave to file the derivative action is
dismissed and consequently, the derivative action itself is dismissed. On May
15, 2008, Mr. Rabbi filed an appeal with the Supreme Court. The hearing in the
Supreme Court is set for March 19, 2009.
 
 On
February 16, 2007, Texas MP3 Technologies, Ltd. (“Texas MP3”) filed suit against
the Company, Samsung Electronics Co., Ltd., Samsung Electronics America, Inc.
and Apple Inc., Case No. 2:07-CV-52, in the Eastern District of Texas, Marshall
Division, alleging infringement of U.S. Patent 7,065,417 (the “’417
patent”).  On June 19, 2007, the Company filed an answer and
counterclaim:  (a) denying infringement; (b) seeking a declaratory
judgment that the ’417 patent is invalid, unenforceable and not infringed by the
Company.  On July 31, 2007, Texas MP3 filed an amended complaint
against the Company and the other parties named in the original complaint,
alleging infringement of the ’417 patent.  On August 1, 2007,
defendant Apple, Inc. filed a motion to stay the litigation pending completion
of an inter-partes reexamination of the ’417 patent by the U.S. Patent and
Trademark Office.  That motion was denied.  On August 10,
2007, the Company filed an answer to the amended complaint and a counterclaim:
(a) denying infringement; (b) seeking a declaratory judgment that the ’417
patent is invalid, unenforceable and not infringed by the Company.  A
status conference in the case was held on November 2, 2007.  A Markman
hearing has been scheduled for March 12, 2009 and jury selection for July 6,
2009.  Discovery is proceeding.
 
 On
or about May 11, 2007, the Company received written notice from Alcatel-Lucent,
S.A., (“Lucent”), alleging that the Company’s digital music players require a
license to U.S. Patent No. 5,341,457 (the “’457 patent”) and U.S. Patent No. RE
39,080 (the “’080 patent”).  On July 13, 2007, the Company filed a
complaint for a declaratory judgment of non-infringement and patent invalidity
against Lucent Technologies Inc. and Lucent in the United States District Court
for the Northern District of California, captioned SanDisk Corporation v. Lucent
Technologies Inc., et al., Civil Case No. C 07 03618.  The complaint
seeks a declaratory judgment that the Company does not infringe the two patents
asserted by Lucent against the Company’s digital music players.  The
complaint further seeks a judicial determination and declaration that Lucent’s
patents are invalid.  Defendants answered and defendant Lucent
asserted a counterclaim of infringement in connection with the ’080
patent.  Defendants also moved to dismiss the case without prejudice
and/or stay the case pending their appeal of a judgment involving the same
patents in suit entered by the United States District Court for the Southern
District of California.  The Company moved for summary judgment on its
claims for declaratory relief, and has moved to dismiss defendant Lucent’s
counterclaim for infringement of the ’080 patent as a matter of
law.  The Court granted Defendants’ motion to stay and dismissed all
other motions without prejudice.  A case management conference is
scheduled for November 21, 2008.
 
 On
August 10, 2007, Lonestar Invention, L.P. (“Lonestar”) filed suit against the
Company in the Eastern District of Texas, Civil Action No.
6:07-CV-00374-LED.  The complaint alleges that a memory controller
used in the Company’s flash memory devices infringes U.S. Patent No.
5,208,725.  Lonestar is seeking a permanent injunction, actual
damages, treble damages for willful infringement, and costs and attorney
fees.  The Company has answered Lonestar’s complaint, denying
Lonestar’s allegations.  The Court has scheduled a Markman hearing for
November 6, 2008, and set the case for trial on July 13, 2009.
 
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  On
September 11, 2007, the Company and the Company’s CEO, Dr. Eli Harari,
received grand jury subpoenas issued from the United States District Court for
the Northern District of California indicating a Department of Justice
investigation into possible antitrust violations in the NAND flash memory
industry.  The Company also received a notice from the Canadian
Competition Bureau (“Bureau”) that the Bureau has commenced an industry-wide
investigation with respect to alleged anti-competitive activity regarding the
conduct of companies engaged in the supply of NAND flash memory chips to Canada
and requesting that the Company preserve any records relevant to such
investigation.  The Company is cooperating in these
investigations.
 
 On
September 11, 2007, Premier International Associates LLC (“Premier”) filed
suit against the Company and 19 other named defendants, including Microsoft
Corporation, Verizon Communications Inc. and AT&T Inc., in the United States
District Court for the Eastern District of Texas (Marshall
Division).  The suit, Case No. 2-07-CV-396, alleges infringement of
Premier's U.S. Patents 6,243,725 (the “’725”) and 6,763,345 (the “’345”) by
certain of the Company’s portable digital music players, and seeks an injunction
and damages in an unspecified amount.  On December 10, 2007, an
amended complaint was filed.  On February 5, 2008, the Company filed
an answer to the amended complaint and counterclaims: (a) denying infringement;
(b) seeking a declaratory judgment that the ’725 and ’345 patents are invalid,
unenforceable and not infringed by the Company.  On February 5, 2008,
the Company (along with the other defendants in the action) filed a motion to
stay the litigation pending completion of reexaminations of the ’725 and ’345
patents by the U.S. Patent and Trademark Office.  This motion was
granted and on June 4, 2008, the action was stayed.
 
 On
October 24, 2007, the Company filed a complaint under Section 337 of the Tariff
Act of 1930 (as amended) (Inv. No. 337-TA-619) titled, “In the matter of flash
memory controllers, drives, memory cards, and media players and products
containing same” in the ITC (hereinafter, “the 619 Investigation”), naming the
following companies as respondents:  Phison Electronics Corp.
(“Phison”); Silicon Motion Technology Corporation, Silicon Motion, Inc. (located
in Taiwan), Silicon Motion, Inc. (located in California), and Silicon Motion
International, Inc. (collectively, “Silicon Motion”); USBest Technology, Inc.
(“USBest”); Skymedi Corporation (“Skymedi”); Chipsbrand Microelectronics (HK)
Co., Ltd., Chipsbank Technology (Shenzhen) Co., Ltd., and Chipsbank
Microelectronics Co., Ltd., (collectively, “Chipsbank”); Zotek Electronic Co.,
Ltd., dba Zodata Technology Ltd. (collectively, “Zotek”); Infotech Logistic LLC
(“Infotech”); Power Quotient International Co., Ltd., and PQI Corp.
(collectively, “PQI”); Power Quotient International (HK) Co., Ltd.; Syscom
Development Co. Ltd.; PNY Technologies, Inc. (“PNY”); Kingston Technology Co.,
Inc., Kingston Technology Corp., Payton Technology Corp., and MemoSun, Inc.
(collectively, “Kingston”); Buffalo, Inc., Melco Holdings, Inc., and Buffalo
Technology (USA), Inc. (collectively, “Buffalo”); Verbatim Corp. (“Verbatim”);
Transcend Information Inc. (located in Taiwan), Transcend Information Inc.
(located in California), and Transcend Information Maryland, Inc.,
(collectively, “Transcend”); Imation Corp., Imation Enterprises Corp., and
Memorex Products, Inc. (collectively, “Imation”); Add-On Computer Peripherals,
Inc. and Add-On Computer Peripherals, LLC (collectively, “Add-On Computer
Peripherals”); Add-On Technology Co.; A-Data Technology Co., Ltd., and A-Data
Technology (USA) Co., Ltd., (collectively, “A-DATA”); Apacer Technology Inc. and
Apacer Memory America, Inc. (collectively, “Apacer”); Acer, Inc. (“Acer”);
Behavior Tech Computer Corp. and Behavior Tech Computer (USA) Corp.
(collectively, “Behavior”); Emprex Technologies Corp.(“Emprex”); Corsair Memory,
Inc. (“Corsair”); Dane-Elec Memory S.A., and Dane-Elec Corp. USA, (collectively,
“Dane-Elec”); Deantusaiocht Dane-Elec TEO; EDGE Tech Corp. (“EDGE”); Interactive
Media Corp, (“Interactive”); Kaser Corporation (“Kaser”); LG Electronics, Inc.,
and LG Electronics U.S.A., Inc., (collectively, “LG”); TSR Silicon Resources
Inc. (“TSR”); and Welldone Co. (“Welldone”).  In the complaint, the
Company alleges that respondents’ flash memory products, such as USB flash
drives, compact flash cards, and flash media players, infringe the following:
U.S. Patent No. 5,719,808 (the “’808 patent”); U.S. Patent No. 6,763,424 (the
“’424 patent”); U.S. Patent No. 6,426,893 (the “’893 patent”); U.S. Patent No.
6,947,332 (the “’332 patent”); and U.S. Patent No. 7,137,011 (the “’011
patent”).  The Company seeks an order excluding the respondents’ flash
memory controllers, drives, memory cards, and media players, and products
containing them, from entry into the United States as well as a permanent cease
and desist order against the respondents.  On December 6, 2007,
the Commission instituted an investigation based on the Company’s
complaint.  The target date for completing the investigation was
originally set for March 12, 2009.  Since filing its complaint, the
Company has reached settlement agreements with Add-On Computer Peripherals,
EDGE, Infotech, Interactive, Kaser, PNY, TSR, and Welldone; and Buffalo agreed
to entry of a consent order.  The investigation has been terminated as
to these respondents in light of the settlement agreements and entry of the
consent order.  The investigation has also been terminated as to Acer
after Acer provided evidence that it has no corporate relationship with
Respondents who import products accused of infringement in the
investigation.  On May 20, 2008, the Commission issued Notice of its
decision not to review the ALJ’s Initial Determination
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  terminating
Acer from the investigation.  Respondents Add-On Technology Co.,
Behavior, Emprex, and Zotek have failed to respond to the Company’s complaint or
discovery requests and were ordered to show cause as to why they should not be
found in default no later than March 28, 2008.  These respondents
failed to show cause as of March 28, 2008.  On April 25, 2008, the
Administrative Law Judge (“ALJ”) issued an Initial Determination Granting
SanDisk’s Motion for an Entry of Default Against these Five
Respondents.  On May 14, 2008, the Commission issued Notice of its
decision not to review the ALJ’s Initial Determination finding these five
Respondents in default.  Most of the respondents that have not settled
with the Company have responded to the complaint.  Among other things,
these respondents deny infringement or that the Company has a domestic industry
in the asserted patents.  In responding to the complaint, these
respondents have also raised several affirmative defenses including, among
others, invalidity, unenforceability, express license, implied license, patent
exhaustion, waiver, acquiescence, latches, estoppel and unclean
hands.  On January 23, 2008, the ALJ issued an initial determination
extending the target date for conclusion of the investigation by three months to
June 12, 2009.  On February 2, 2008, the ALJ set the evidentiary
hearing for October 27, 2008, through November 7, 2008.  On March 12,
2008, the ALJ issued an order bifurcating and staying the investigation with
respect to the ’808 patent pending the outcome of the Harari Matter that
includes ownership allegations regarding the ’808 patent and
others.  On April 11, 2008, the Commission issued a Notice that it
intended to review the ALJ’s Initial Determination to bifurcate the ’808 patent
from the instant investigation.  On April 24, 2008, the Company filed
a motion to terminate the investigation as to the ’808 patent.  On May
6, 2008, the ALJ issued an Initial Determination granting the Company’s motion
to terminate the investigation as to the ’808 patent.  On May 30,
2008, the Commission determined not to review the ALJ’s Initial
Determination.  The Commission also vacated the ALJ’s earlier Order
bifurcating the investigation with respect to the ’808 patent and ordered that
briefing requested in the Commission’s Notice of April 11, 2008, was no longer
required.  On July 14, the Company filed an unopposed motion to
terminate the Investigation as to Respondent Payton Technology (“Payton”) after
Payton and its corporate affiliate, Kingston Technology Co., Inc. (“Kingston”),
represented in a sworn declaration that Payton does not import, sell for
importation, or sell within the U.S. any flash memory products that are at issue
in the ITC Investigation.  The ALJ issued an Initial Determination on
July 29, 2008, granting the motion. (Order No. 35). The Commission determined
not to review the Initial Determination on May 20, 2008.  Kingston
remains a named Respondent in the Investigation.  On May 6-7, the ALJ
held a Markman patent interpretation hearing regarding the ’893 patent, the ’332
patent, the ’424 patent and the ’011 patent.  The ALJ issued a Markman
ruling dated July 15, 2008.  Also on July 15, 2008, the ALJ issued an
Order changing the date for the pre-hearing conference from October 21, 2008 to
October 23, 2008.  On August 7, 2008, the Company filed a motion to
terminate the ’332 patent from the investigation.  The ALJ granted the
motion in an Initial Determination, dated August 27, 2008.  The
Commission declined to review the Initial Determination on September 15,
2008.  On September 4, 2008, Respondent Corsair filed a motion to
terminate based on a stipulated Consent Order.  The ALJ issued an ID
granting the motion on September 22, 2008.  On September 18,
2008, the Company filed a motion to terminate Silicon Motion Technology Corp.
and Silicon Motion International, Inc., but not the remaining Silicon Motion
respondents.  The ALJ issued an Initial Determination granting the
motion on October 2, 2008.  On September 23, 2008, the Company
filed a motion to terminate certain claims of the ’893 patent from the
investigation.  In particular, the Company sought to terminate all
asserted claims of the ’893 patent as to Respondents Phison Electronics Corp.,
Kingston Technology Co., Inc., Kingston Technology Corp., MemoSun, Inc. and
Skymedi Corp.  As to the remaining Respondents, the Company moved to
terminate claims 12‐14, 17,
30, 36, 37, 39, 41 and 58. The ALJ issued an Initial Determination granting that
motion on October 7, 2008.  On October 6, 2008, the Company filed a
motion to terminate A-Data Technology Co., Ltd., and
A-Data Technology (USA) Co., Ltd., based on a
stipulated Consent Order.  On October 14, 2008, the Company filed a
motion to terminate the ’893 patent based on certain settlement agreements and
consent orders.  The Company also terminated PQI from the
investigation as to the ’011 patent.  The ALJ has not yet ruled the
motion to terminate A-Data.  On October 23, 2008, the ALJ held a
pre-hearing conference regarding the upcoming hearing.  Beginning on
October 27, 2008, the ALJ held a hearing on the merits.  The hearing
concluded on November 5, 2008.  On October 29, 2008, the parties filed
a motion to terminate the investigation as to Verbatim in light of a settlement
agreement between the Company and certain Verbatim entities.
 
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TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  On
October 24, 2007, the Company filed a complaint for patent infringement in the
United States District Court for the Western District of Wisconsin against the
following defendants: Phison, Silicon Motion, Synergistic Sales, Inc.
(“Synergistic”), USBest, Skymedi, Chipsbank, Infotech, Zotek, PQI, PNY,
Kingston, Buffalo, Verbatim, Transcend, Imation, Add-On, A-DATA, Apacer,
Behavior, Corsair, Dane-Elec, EDGE, Interactive, LG, TSR and
Welldone.  In this action, Case No. 07-C-0607-C, the Company asserts
that the defendants infringe the ’808 patent, the ’424 patent, the ’893 patent,
the ’332 patent and the ’011 patent.  The Company seeks damages and
injunctive relief.  In light of the above mentioned settlement
agreements, the Company dismissed its claims against Add-On Computer
Peripherals, EDGE, Infotech, Interactive, PNY, TSR, and Welldone.  The
Company also voluntarily dismissed its claims against Acer and Synergistic
without prejudice.  On November 21, 2007, defendant Kingston filed a
motion to stay this action.  Several defendants joined in Kingston’s
motion.  On December 19, 2007, the Court issued an order staying
the case in its entirety until the 619 Investigation becomes
final.  On January 14, 2008, the Court issued an order clarifying that
the entire case is stayed for all parties.
 
 On
October 24, 2007, the Company filed a complaint for patent infringement in the
United States District Court for the Western District of Wisconsin against the
following defendants: Phison, Silicon Motion, Synergistic, USBest, Skymedi,
Zotek, Infotech, PQI, PNY, Kingston, Buffalo, Verbatim, Transcend, Imation,
A-DATA, Apacer, Behavior, and Dane-Elec.  In this action, Case No.
07-C-0605-C, the Company asserts that the defendants infringe U.S. Patent No.
6,149,316 (the “’316 patent”) and U.S. Patent No. 6,757,842 (the “’842
patent”).  The Company seeks damages and injunctive
relief.  In light of above mentioned settlement agreements, the
Company dismissed its claims against Infotech and PNY.  The Company
also voluntarily dismissed its claims against Acer and Synergistic without
prejudice.  On November 21, 2007, defendant Kingston filed a motion to
consolidate and stay this action.  Several defendants joined in
Kingston’s motion.  On December 17, 2007, the Company filed an
opposition to Kingston’s motion.  That same day, several defendants
filed another motion to stay this action.  On January 7, 2008, the
Company opposed the defendants’ second motion to stay.  On January 22,
2008, defendants Phison, Skymedi and Behavior filed motions to dismiss the
Company’s complaint for lack of personal jurisdiction.  That same day,
defendants Phison, Silicon Motion, USBest, Skymedi, PQI, Kingston, Buffalo,
Verbatim, Transcend, A-DATA, Apacer, and Dane-Elec answered the Company’s
complaint denying infringement and raising several affirmative
defenses.  These defenses included, among others, lack of personal
jurisdiction, improper venue, lack of standing, invalidity, unenforceability,
express license, implied license, patent exhaustion, waiver, latches, and
estoppel.  On January 24, 2008, Silicon Motion filed a motion to
dismiss the Company’s complaint for lack of personal jurisdiction.  On
January 25, 2008, Dane-Elec also filed a motion to dismiss the Company’s
complaint for lack of personal jurisdiction.  On January 28, 2008, the
Court issued an order staying the case in its entirety with respect to all
parties until the proceeding in the 619 Investigation become
final.  In its order, the Court also consolidated this action (Case
Nos. 07-C-0605-C) with the action discussed in the preceding paragraph
(07-C-0607-C).
 
 Between
August 31, 2007 and December 14, 2007, the Company (along with a number of
other manufacturers of flash memory products) was sued in the Northern District
of California, in eight purported class action complaints.  On
February 7, 2008, all of the civil complaints were consolidated into two
complaints, one on behalf of direct purchasers and one on behalf of indirect
purchasers, in the Northern District of California in a purported class action
captioned In re Flash Memory Antitrust Litigation, Civil Case No.
C07-0086.  Plaintiffs allege the Company and a number of other
manufacturers of flash memory products conspired to fix, raise, maintain, and
stabilize the price of NAND flash memory in violation of state and federal
laws.  The lawsuits purport to be on behalf of purchasers of flash
memory between January 1, 1999 through the present.  The lawsuits seek
an injunction, damages, restitution, fees, costs, and disgorgement of
profits.  On April 8, 2008, the Company, along with co-defendants,
filed motions to dismiss the direct purchaser and indirect purchaser
complaints.  Also on April 8, 2008, the Company, along with
co-defendants, filed a motion for a protective order to stay
discovery.  On April 22, 2008, direct and indirect purchaser
plaintiffs filed oppositions to the motions to dismiss.  The
Company’s, along with co-defendants’, reply to the oppositions was filed May 13,
2008.  The Court took the motions to dismiss and the motion for a
protective order under submission on June 3, 2008, and has yet to rule on the
motions.
 
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  On
November 11, 2007, Gil Mosek, a former employee of SanDisk IL Ltd. (“SDIL”),
filed a lawsuit against SDIL, Dov Moran and Amir Ban in the Tel-Aviv District
Court, claiming that he and Amir Ban, another former employee of SDIL, reached
an agreement, according to which a jointly-held company will be established
together with SDIL. According to Mr. Mosek, SDIL knew about the agreement,
approved it and breached it, while deciding not to establish the jointly-held
company. On January 1, 2008 SDIL filed a statement of defense. Simultaneously,
SDIL filed a request to dismiss the lawsuit, claiming that Mr. Mosek signed a
waiver in favor of SDIL, according to which he has no claim against SDIL. On
February 12, 2008, Mr. Mosek filed a request to allow him to present certain
documents, which contain confidential information of SDIL. On February 26, 2008,
SDIL opposed this request, claiming that SDIL’s documents are the sole property
of SDIL and Mr. Mosek has no right to hold and to use them. On March 6, 2008,
the court decided that Mr. Mosek has to pay a fee according to the estimated
amount of the claim. On April 3, 2008, Mr. Mosek filed a request to amend the
claim by setting the claim on an amount of NIS 3,000,000. On April 9, 2008, SDIL
filed its response to this request, according to which it has no objection to
the amendment, subject to the issuance of an order for costs. On April 10, 2008,
the court accepted Mr. Mosek’s request. According to the settlement agreement,
reached between the SDIL and Amir Ban in January 2008, Amir Ban shall indemnify
and hold SDIL harmless with regard to the claim filed by Mosek, as described in
this section above. The court set a date for a pre-trial hearing on
December 2, 2008.
 
 In
April 2006, the Company's subsidiary SanDisk IL Ltd. (“SDIL”) terminated its
supply and license agreement (the “Agreement”) with Samsung. As a result of this
termination, our subsidiary no longer was entitled to purchase products on
favorable pricing terms from Samsung, Samsung no longer had a life-of-patent
license to our subsidiary’s patents, and no further patent licensing payments
would be due. Samsung contested the termination and SDIL commenced an
arbitration proceeding seeking a declaration that its termination was
valid.  Samsung asserted various defenses and counterclaims in the
arbitration.  A hearing was held in December 2007, and the
arbitration panel issued an award on May 16, 2008 declaring that SDIL’s
termination of the agreement was valid and effective, and dismissing all
Samsung’s counterclaims (the “Award”).  On July 24, 2008, in an action
captioned Samsung Electronics Co., Ltd. v. SanDisk IL f/k/a M-Systems Ltd., No.
08 Civ. 6596 (AKH), Samsung filed a petition to vacate the Award in the District
Court for the Southern District of New York (“Samsung's
Petition”).  On September 18, 2008, in an action captioned
SanDisk IL, Ltd. f/k/a msystems Ltd., No. 08 Civ. 8069 (AKH), SDIL petitioned to
confirm the Award pursuant to the dispute resolution provisions of the Agreement
and Section 207 of the Federal Arbitration Act, 9 U.S.C. § 207.  On
September 22, 2008, Samsung withdrew its Petition for Vacatur and asked the
Court to immediately enter judgment against itself with respect to SDIL's
Petition to Confirm.  On September 24, 2008, the Court entered
judgment in favor of SDIL on SDIL's Petition to Confirm the Award.  On
October 7, 2008, SDIL filed a Motion for Attorneys' Fees and Expenses incurred
in connection with Samsung's withdrawn Petition to vacate the
Award.  On October 20, 2008, after Samsung offered to pay in full the
$176,000 in expenses claimed by SDIL, the motion for Attorneys’ Fees and
Expenses was denied by the District Court.
 
 On
September 14, 2008, Daniel Harkabi and Gidon Elazar, former employees and
founders of MDRM, Inc., filed a breach of contract action in the U.S. District
Court for the Southern District of New York seeking earn-out payments of
approximately $3.8M in connection with SanDisk’s acquisition of MDRM in
2004.  A mediation was held in June 2007, as required by the
acquisition agreement, but was unsuccessful.
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  On
September 17, 2008, a purported shareholder class action, captioned McBride
v. Federman, et al., Case No. 1-08-CV-122921, was filed in the Superior Court of
California in Santa Clara County.  The lawsuit was brought by a
purported shareholder of the Company and names as defendants the Company and its
directors, Irwin Federman, Steven J. Gomo, Dr. Eli Harari, Eddy W. Hartenstein,
Catherine P. Lego, Michael E. Marks, and Dr. James D. Meindl.  The
complaint alleges breach of fiduciary duty by the Company and its directors in
rejecting Samsung Electronics Co., Ltd.'s non-binding proposal to acquire all of
the outstanding common stock of the Company for $26.00 per share.  On
September 29, 2008, plaintiff served his first request for production of
documents on the Company.  On October 17, 2008, the Company and its
directors filed a demurrer seeking dismissal of the lawsuit, and plaintiff
served his first requests for production of documents on the Company's
directors.  The Plaintiff and the Company have entered into a
stipulation agreement providing for a dismissal of the claims without
prejudice.  The stipulation and proposed order have been submitted to the
Superior Court.
 
 On
October 1, 2008, NorthPeak Wireless LLC (“NorthPeak”) filed suit against the
Company and 30 other named defendants including Dell, Inc., Fujitsu Computer
Systems Corporation, Gateway, Inc., Hewlett-Packard Company and Toshiba America,
Inc., in the United States District Court for the Northern District of Alabama,
Northeastern Division.  The suit, Case No. CV-08-J-1813, alleges
infringement of U.S. Patents 4,977,577 and 5,978,058 by certain of the Company’s
discontinued wireless electronic products.
 
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  14.
              Condensed
      Consolidating Financial Statements
 
 As
part of the acquisition of msystems Ltd. (hereinafter referred to as “SanDisk IL
Ltd.,” “SDIL,” or “Other Guarantor Subsidiary”) in November 2006, the Company
entered into a supplemental indenture whereby the Company became an additional
obligor and guarantor of the assumed $75 million 1% Convertible Notes due
2035 issued by M-Systems Finance, Inc. (the “Subsidiary Issuer” or “mfinco”) and
guaranteed by SDIL.  The Company’s (the “Parent Company”) guarantee is
full and unconditional, and joint and several with SDIL.  Both SDIL
and mfinco are wholly-owned subsidiaries of the Company.  The
following Condensed Consolidating Financial Statements present separate
information for mfinco as the subsidiary issuer, the Company and SDIL as
guarantors and the Company’s other combined non-guarantor subsidiaries, and
should be read in conjunction with the Condensed Consolidated Financial
Statements of the Company.
 
 These
Condensed Consolidating Financial Statements have been prepared using the equity
method of accounting.  Earnings of subsidiaries are reflected in the
Company’s investment in subsidiaries account.  The elimination entries
eliminate investments in subsidiaries, related stockholders’ equity and other
intercompany balances and transactions.  Amounts of operating and
financing cash flows related to combined non-guarantor subsidiaries and
consolidating adjustments for the nine months ended September 30, 2007 have
been revised to properly reflect certain reclassifications.  The
reclassifications did not have any effect on the net change in cash and cash
equivalents for the Combined Non-guarantor Subsidiaries, the Consolidating
Adjustments or the Total Company columns of the Condensed Consolidating
Statements of Cash Flows for the nine months ended September 30,
2007.
 
  -
40 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 Condensed
      Consolidating Statements of Operations
                For
      the three months ended September 28, 2008Parent
                  Company
      (1)
              
              
              Subsidiary
      Issuer (1)
              
              
              Other
      Guarantor Subsidiary (1)
              
              
              Combined
      Non-Guarantor
                  Subsidiaries
      (2)
              
              
              Consolidating
      Adjustments
              
              
              Total
                  Company(Inthousands)Total
    revenues
              
              $
              440,715
              
              
              $
              —
              
              
              $
              45,157
              
              
              $
              1,467,703
              
              
              $
              (1,132,078
              )
              
              $
              821,497Total cost of
      revenues
              
              
              570,792
              
              
              
              —
              
              
              
              26,758
              
              
              
              1,308,615
              
              
              
              (1,078,751
              )
              
              
              827,414Grossprofit
    (loss)
              
              
              (130,077
              )
              
              
              —
              
              
              
              18,399
              
              
              
              159,088
              
              
              
              (53,327
              )
              
              
              (5,917
              )Total operating
      expenses
              
              
              180,529
              
              
              
              —
              
              
              
              30,611
              
              
              
              85,828
              
              
              
              (52,692
              )
              
              
              244,276Operating income
      (loss)
              
              
              (310,606
              )
              
              
              —
              
              
              
              (12,212
              )
              
              
              73,260
              
              
              
              (635
              )
              
              
              (250,193
              )Total other income
      (expense)
              
              
              (10,040
              )
              
              
              (1
              )
              
              
              (1,475
              )
              
              
              11,474
              
              
              
              (408
              )
              
              
              (450
              )Income (loss) before
      taxes
              
              
              (320,646
              )
              
              
              (1
              )
              
              
              (13,687
              )
              
              
              84,734
              
              
              
              (1,043
              )
              
              
              (250,643
              )Provisionfor(benefitfrom) income
    taxes
              
              
              (93,637
              )
              
              
              —
              
              
              
              (105
              )
              
              
              (2,453
              )
              
              
              746
              
              
              
              (95,449
              )Equity in net income (loss) of
      consolidated subsidiaries
              
              
              78,264
              
              
              
              —
              
              
              
              2,466
              
              
              
              10,134
              
              
              
              (90,864
              )
              
              
              —Net income
      (loss)
              
              $
              (148,745
              )
              
              $
              (1
              )
              
              $
              (11,116
              )
              
              $
              97,321
              
              
              $
              (92,653
              )
              
              $
              (155,194
              )
  
 Condensed Consolidating Statements of
      Operations
                For thenine monthsendedSeptember 28,
      2008Parent
                  Company
      (1)
              
              
              Subsidiary
      Issuer (1)
              
              
              Other
      Guarantor Subsidiary (1)
              
              
              Combined
      Non-Guarantor Subsidiaries (2)
              
              
              Consolidating
      Adjustments
              
              
              Total
                  Company(In
    thousands)Total
    revenues
              
              $
              1,336,167
              
              
              $
              —
              
              
              $
              191,761
              
              
              $
              3,675,373
              
              
              $
              (2,715,826
              )
              
              $
              2,487,475Total cost of
      revenues
              
              
              1,042,047
              
              
              
              —
              
              
              
              120,441
              
              
              
              3,462,683
              
              
              
              (2,541,431
              )
              
              
              2,083,740Grossprofit
    (loss)
              
              
              294,120
              
              
              
              —
              
              
              
              71,320
              
              
              
              212,690
              
              
              
              (174,395
              )
              
              
              403,735Total operating
      expenses
              
              
              515,588
              
              
              
              —
              
              
              
              108,060
              
              
              
              298,357
              
              
              
              (174,757
              )
              
              
              750,248Operating income
      (loss)
              
              
              (224,468
              )
              
              
              —
              
              
              
              (36,740
              )
              
              
              (85,667
              )
              
              
              362
              
              
              
              (346,513
              )Total other income
      (expense)
              
              
              12,215
              
              
              
              (1
              )
              
              
              3,702
              
              
              
              31,495
              
              
              
              (1,437
              )
              
              
              45,974Income (loss) before
      taxes
              
              
              (212,253
              )
              
              
              (1
              )
              
              
              (33,038
              )
              
              
              (54,172
              )
              
              
              (1,075
              )
              
              
              (300,539
              )Provisionfor(benefitfrom) income
    taxes
              
              
              (105,220
              )
              
              
              —
              
              
              
              (487
              )
              
              
              10,919
              
              
              
              (560
              )
              
              
              (95,348
              )Equity in net income (loss) of
      consolidated subsidiaries
              
              
              (75,259
              )
              
              
              —
              
              
              
              (3,668
              )
              
              
              26,031
              
              
              
              52,896Net income
      (loss)
              
              $
              (182,292
              )
              
              $
              (1
              )
              
              $
              (36,219
              )
              
              $
              (39,060
              )
              
              $
              52,381
              
              
              $
              (205,191
              )
 _________________
 (1)
              This
      represents legal entity results which exclude any subsidiaries required to
      be consolidated under GAAP.
 (2)
              This
      represents all other legal
subsidiaries.
 
 
  -
41 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 Condensed
      Consolidating Statements of Operations
                For
      the three months ended September 30, 2007Parent
                  Company
      (1)
              
              
              Subsidiary
      Issuer (1)
              
              
              Other
      Guarantor Subsidiary (1)
              
              
              Combined
      Non-Guarantor Subsidiaries (2)
              
              
              Consolidating
      Adjustments
              
              
              Total
                  Company(Inthousands)Total  revenues
              
              $
              540,479
              
              
              $
              —
              
              
              $
              63,929
              
              
              $
              1,442,818
              
              
              $
              (1,009,803
              )
              
              $
              1,037,423Total cost of
      revenues
              
              
              298,311
              
              
              
              —
              
              
              
              71,364
              
              
              
              1,294,954
              
              
              
              (969,526
              )
              
              
              695,103Grossprofit
    (loss)
              
              
              242,168
              
              
              
              —
              
              
              
              (7,435
              )
              
              
              147,864
              
              
              
              (40,277
              )
              
              
              342,320Total operating
      expenses
              
              
              137,832
              
              
              
              —
              
              
              
              40,515
              
              
              
              95,767
              
              
              
              (40,945
              )
              
              
              233,169Operating income
      (loss)
              
              
              104,336
              
              
              
              —
              
              
              
              (47,950
              )
              
              
              52,097
              
              
              
              668
              
              
              
              109,151Total other income
      (expense)
              
              
              32,729
              
              
              
              6
              
              
              
              (4,137
              )
              
              
              (1,021
              )
              
              
              1,623
              
              
              
              29,200Income (loss) before
      taxes
              
              
              137,065
              
              
              
              6
              
              
              
              (52,087
              )
              
              
              51,076
              
              
              
              2,291
              
              
              
              138,351Provision (benefit) for income
      taxes
              
              
              45,385
              
              
              
              —
              
              
              
              (2,485
              )
              
              
              10,824
              
              
              
              (11
              )
              
              
              53,713Equity in net income (loss) of
      consolidated subsidiaries
              
              
              43,185
              
              
              
              —
              
              
              
              (10,490
              )
              
              
              (6,185
              )
              
              
              (26,510
              )
              
              
              —Net income
      (loss)
              
              $
              134,865
              
              
              $
              6
              
              
              $
              (60,092
              )
              
              $
              34,067
              
              
              $
              (24,208
              )
              
              $
              84,638
  
 Condensed
      Consolidating Statements of Operations
                For
      the nine months ended September 30, 2007Parent
                  Company
      (1)
              
              
              Subsidiary
      Issuer (1)
              
              
              Other
      Guarantor Subsidiary (1)
              
              
              Combined
      Non-Guarantor Subsidiaries (2)
              
              
              Consolidating
      Adjustments
              
              
              Total
                  Company(Inthousands)Total  revenues
              
              $
              1,492,326
              
              
              $
              —
              
              
              $
              217,871
              
              
              $
              3,416,831
              
              
              $
              (2,476,487
              )
              
              $
              2,650,541Total cost of
      revenues
              
              
              832,172
              
              
              
              —
              
              
              
              230,089
              
              
              
              3,207,764
              
              
              
              (2,380,453
              )
              
              
              1,889,572Grossprofit
    (loss)
              
              
              660,154
              
              
              
              —
              
              
              
              (12,218
              )
              
              
              209,067
              
              
              
              (96,034
              )
              
              
              760,969Total operating
      expenses
              
              
              398,475
              
              
              
              —
              
              
              
              106,820
              
              
              
              247,013
              
              
              
              (94,557
              )
              
              
              657,751Operating income
      (loss)
              
              
              261,679
              
              
              
              —
              
              
              
              (119,038
              )
              
              
              (37,946
              )
              
              
              (1,477
              )
              
              
              103,218Total other income
      (expense)
              
              
              92,346
              
              
              
              (1
              )
              
              
              21,976
              
              
              
              (14,729
              )
              
              
              4,423
              
              
              
              104,015Income (loss) before
      taxes
              
              
              354,025
              
              
              
              (1
              )
              
              
              (97,062
              )
              
              
              (52,675
              )
              
              
              2,946
              
              
              
              207,233Provision(benefit)for income
      taxes
              
              
              76,863
              
              
              
              —
              
              
              
              1,578
              
              
              
              11,043
              
              
              
              (9
              )
              
              
              89,475Minority
      interest
              
              
              —
              
              
              
              —
              
              
              
              5,211
              
              
              
              —
              
              
              
              —
              
              
              
              5,211Equity in net income (loss) of
      consolidated subsidiaries
              
              
              (38,705
              )
              
              
              —
              
              
              
              (1,349
              )
              
              
              (13,555
              )
              
              
              53,609
              
              
              
              —Net income
      (loss)
              
              $
              238,457
              
              
              $
              (1
              )
              
              $
              (105,200
              )
              
              $
              (77,273
              )
              
              $
              56,564
              
              
              $
              112,547
 _________________
 (1)
              This
      represents legal entity results which exclude any subsidiaries required to
      be consolidated under GAAP.
 (2)
              This
      represents all other legal
subsidiaries.
 
 
  -
42 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 Condensed
      Consolidating Balance Sheets
                As
      of September 28, 2008Parent
      Company (1)
              
              
              Subsidiary
      Issuer (1)
              
              
              Other
      Guarantor Subsidiary (1)
              
              
              Combined
      Non-Guarantor Subsidiaries (2)
              
              
              Consolidating
      Adjustments
              
              
              Total
      Company(Inthousands)ASSETSCurrent
    Assets:Cash and cash
      equivalents
              
              $
              478,868
              
              
              $
              66
              
              
              $
              54,366
              
              
              $
              187,808
              
              
              $
              (1
              )
              
              $
              721,107Short-term
      investments
              
              
              740,058
              
              
              
              —
              
              
              
              51,014
              
              
              
              62,040
              
              
              
              (1
              )
              
              
              853,111Accounts receivable,
      net
              
              
              (4,256
              )
              
              
              —
              
              
              
              3,037
              
              
              
              127,785
              
              
              
              (8,003
              )
              
              
              118,563Inventory
              
              
              133,622
              
              
              
              —
              
              
              
              2,689
              
              
              
              580,656
              
              
              
              (4,561
              )
              
              
              712,406Other current
      assets
              
              
              1,483,009
              
              
              
              —
              
              
              
              227,711
              
              
              
              1,174,407
              
              
              
              (2,388,893
              )
              
              
              496,234Total current
      assets
              
              
              2,831,301
              
              
              
              66
              
              
              
              338,817
              
              
              
              2,132,696
              
              
              
              (2,401,459
              )
              
              
              2,901,421Property and equipment,
      net
              
              
              215,805
              
              
              
              —
              
              
              
              33,775
              
              
              
              159,701
              
              
              
              —
              
              
              
              409,281Other non-current
      assets
              
              
              2,563,455
              
              
              
              71,577
              
              
              
              882,011
              
              
              
              1,823,739
              
              
              
              (1,638,449
              )
              
              
              3,702,333Total
assets
              
              $
              5,610,561
              
              
              $
              71,643
              
              
              $
              1,254,603
              
              
              $
              4,116,136
              
              
              $
              (4,039,908
              )
              
              $
              7,013,035LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent
      Liabilities:Accounts
      payable
              
              $
              91,700
              
              
              $
              —
              
              
              $
              3,687
              
              
              $
              276,676
              
              
              $
              (452
              )
              
              $
              371,611Other current accrued
      liabilities
              
              
              843,407
              
              
              
              32
              
              
              
              30,938
              
              
              
              1,804,451
              
              
              
              (2,298,142
              )
              
              
              380,686Total current
      liabilities
              
              
              935,107
              
              
              
              32
              
              
              
              34,625
              
              
              
              2,081,127
              
              
              
              (2,298,594
              )
              
              
              752,297Convertible long-term
      debt
              
              
              1,150,000
              
              
              
              75,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,225,000Non-current liabilities and
      deferred taxes
              
              
              113,204
              
              
              
              —
              
              
              
              14,010
              
              
              
              64,733
              
              
              
              (7,603
              )
              
              
              184,344Total
      liabilities
              
              
              2,198,311
              
              
              
              75,032
              
              
              
              48,635
              
              
              
              2,145,860
              
              
              
              (2,306,197
              )
              
              
              2,161,641Minority
      interest
              
              
              —
              
              
              
              —
              
              
              
              151
              
              
              
              —
              
              
              
              —
              
              
              
              151Total stockholders'
      equity
              
              
              3,412,250
              
              
              
              (3,389
              )
              
              
              1,205,817
              
              
              
              1,970,276
              
              
              
              (1,733,711
              )
              
              
              4,851,243Total liabilities and
      stockholders' equity
              
              $
              5,610,561
              
              
              $
              71,643
              
              
              $
              1,254,603
              
              
              $
              4,116,136
              
              
              $
              (4,039,908
              )
              
              $
              7,013,035
 _________________
 (1)
              This
      represents legal entity results which exclude any subsidiaries required to
      be consolidated under GAAP.
 (2)
              This
      represents all other legal
subsidiaries.
 
  -
43 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 Condensed
      Consolidating Balance Sheets
                As
      of December 30, 2007Parent
      Company (1)
              
              
              Subsidiary
      Issuer (1)
              
              
              Other
      Guarantor Subsidiary (1)
              
              
              Combined
      Non-Guarantor Subsidiaries (2)
              
              
              Consolidating
      Adjustments
              
              
              Total
      Company(In thousands)ASSETSCurrent
    Assets:Cash and cash
      equivalents
              
              $
              389,337
              
              
              $
              215
              
              
              $
              90,639
              
              
              $
              353,558
              
              
              $
              —
              
              
              $
              833,749Short-term
      investments
              
              
              1,001,641
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,001,641Accounts receivable,
      net
              
              
              215,049
              
              
              
              —
              
              
              
              32,497
              
              
              
              223,624
              
              
              
              (8,187
              )
              
              
              462,983Inventory
              
              
              104,626
              
              
              
              —
              
              
              
              30,238
              
              
              
              423,850
              
              
              
              (3,637
              )
              
              
              555,077Other current
      assets
              
              
              759,872
              
              
              
              —
              
              
              
              221,932
              
              
              
              823,387
              
              
              
              (1,358,984
              )
              
              
              446,207Total current
      assets
              
              
              2,470,525
              
              
              
              215
              
              
              
              375,306
              
              
              
              1,824,419
              
              
              
              (1,370,808
              )
              
              
              3,299,657Property and equipment,
      net
              
              
              222,038
              
              
              
              —
              
              
              
              34,975
              
              
              
              165,882
              
              
              
              —
              
              
              
              422,895Other non-current
      assets
              
              
              2,684,232
              
              
              
              71,998
              
              
              
              925,424
              
              
              
              1,350,985
              
              
              
              (1,520,372
              )
              
              
              3,512,267Total
assets
              
              $
              5,376,795
              
              
              $
              72,213
              
              
              $
              1,335,705
              
              
              $
              3,341,286
              
              
              $
              (2,891,180
              )
              
              $
              7,234,819LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent
      Liabilities:Accounts
      payable
              
              $
              48,386
              
              
              $
              —
              
              
              $
              34,462
              
              
              $
              362,138
              
              
              $
              (832
              )
              
              $
              444,154Other current accrued
      liabilities
              
              
              587,129
              
              
              
              601
              
              
              
              66,353
              
              
              
              1,253,114
              
              
              
              (1,437,468
              )
              
              
              469,729Total current
      liabilities
              
              
              635,515
              
              
              
              601
              
              
              
              100,815
              
              
              
              1,615,252
              
              
              
              (1,438,300
              )
              
              
              913,883Convertible long-term
      debt
              
              
              1,150,000
              
              
              
              75,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,225,000Non-current
      liabilities
              
              
              67,895
              
              
              
              —
              
              
              
              11,428
              
              
              
              60,839
              
              
              
              (4,910
              )
              
              
              135,252Total
      liabilities
              
              
              1,853,410
              
              
              
              75,601
              
              
              
              112,243
              
              
              
              1,676,091
              
              
              
              (1,443,210
              )
              
              
              2,274,135Minority
      interest
              
              
              —
              
              
              
              —
              
              
              
              1,067
              
              
              
              —
              
              
              
              —
              
              
              
              1,067Total stockholders'
      equity
              
              
              3,523,385
              
              
              
              (3,388
              )
              
              
              1,222,395
              
              
              
              1,665,195
              
              
              
              (1,447,970
              )
              
              
              4,959,617Total liabilities and
      stockholders' equity
              
              $
              5,376,795
              
              
              $
              72,213
              
              
              $
              1,335,705
              
              
              $
              3,341,286
              
              
              $
              (2,891,180
              )
              
              $
              7,234,819
 _________________
 (1)
              This
      represents legal entity results which exclude any subsidiaries required to
      be consolidated under GAAP.
 (2)
              This
      represents all other legal
subsidiaries.
 
  -
44 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 Condensed Consolidating Statements
      of Cash Flows
                For thenine months endedSeptember 28,
      2008Parent
      Company (1)
              
              
              Subsidiary
      Issuer (1)
              
              
              Other
      Guarantor Subsidiary (1)
              
              
              Combined
      Non-Guarantor Subsidiaries (2)
              
              
              Consolidating
      Adjustments
              
              
              Total
      Company(Inthousands)Net cash provided by (used in)
      operating activities
              
              $
              (60,953
              )
              
              $
              (149
              )
              
              $
              (33,779
              )
              
              $
              117,006
              
              
              $
              (1
              )
              
              $
              22,124Net cash provided by (used in)
      investing activities
              
              
              125,736
              
              
              
              —
              
              
              
              (2,494
              )
              
              
              (265,860
              )
              
              
              —
              
              
              
              (142,618
              )Net cash provided by (used in)
      financing activities
              
              
              21,395
              
              
              
              —
              
              
              
              —
              
              
              
              (9,785
              )
              
              
              —
              
              
              
              11,610Effect of changes in foreign
      currency exchange rates on cash
              
              
              3,353
              
              
              
              —
              
              
              
              —
              
              
              
              (7,111
              )
              
              
              —
              
              
              
              (3,758
              )Net increase (decrease) in cash
      and cash equivalents
              
              
              89,531
              
              
              
              (149
              )
              
              
              (36,273
              )
              
              
              (165,750
              )
              
              
              (1
              )
              
              
              (112,642
              )Cash and cash equivalents at
      beginning of period
              
              
              389,337
              
              
              
              215
              
              
              
              90,639
              
              
              
              353,558
              
              
              
              —
              
              
              
              833,749Cash and cash equivalents at end
      of period
              
              $
              478,868
              
              
              $
              66
              
              
              $
              54,366
              
              
              $
              187,808
              
              
              $
              (1
              )
              
              $
              721,107
  
 Condensed Consolidating Statements
      of Cash Flows
                For thenine monthsendedSeptember 30, 2007Parent
      Company (1)
              
              
              Subsidiary
      Issuer (1)
              
              
              Other Guarantor
      Subsidiary (1)
              
              
              Combined
      Non-Guarantor Subsidiaries (2)
              
              
              Consolidating
      Adjustments
              
              
              Total
      Company(Inthousands)Net cash provided by operating
      activities
              
              $
              345,616
              
              
              $
              174
              
              
              $
              88,175
              
              
              $
              72,799
              
              
              $
              (3,049
              )
              
              $
              503,715Net cash provided by (used in)
      investing activities
              
              
              (1,023,282
              )
              
              
              —
              
              
              
              28,698
              
              
              
              (134,016
              )
              
              
              —
              
              
              
              (1,128,600
              )Net cashprovided by (used in)financing
      activities
              
              
              23,410
              
              
              
              —
              
              
              
              (9,880
              )
              
              
              —
              
              
              
              —
              
              
              
              13,530Effect of changes in foreign
      currency exchange rates on cash
              
              
              1,192
              
              
              
              —
              
              
              
              383
              
              
              
              —
              
              
              
              —
              
              
              
              1,575Net increase (decrease) in cash
      and cash equivalents
              
              
              (653,064
              )
              
              
              174
              
              
              
              107,376
              
              
              
              (61,217
              )
              
              
              (3,049
              )
              
              
              (609,780
              )Cash and cash equivalents at
      beginning of period
              
              
              1,165,473
              
              
              
              48
              
              
              
              71,839
              
              
              
              340,291
              
              
              
              3,049
              
              
              
              1,580,700Cash and cash equivalents at end
      of period
              
              $
              512,409
              
              
              $
              222
              
              
              $
              179,215
              
              
              $
              279,074
              
              
              $
              —
              
              
              $
              970,920
 _________________
 (1)
              This
      represents legal entity results which exclude any subsidiaries required to
      be consolidated under GAAP.
 (2)
              This
      represents all other legal
subsidiaries
  -
45 -
 Table of Contents
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
  
 15.
              Subsequent
      Event
 
 On
October 20, 2008, the Company entered into a non-binding memorandum of
understanding (“MOU”) with Toshiba to sell to Toshiba approximately 30% of the
current combined manufacturing capacity of Flash Partners and Flash Alliance.
The Company expects to receive repayment on outstanding Flash Partners and Flash
Alliance Notes Receivable and reduce equipment lease obligations by a total of
approximately $1.0 billion through this transaction.  The total value
of approximately $1.0 billion is expected to be comprised of approximately
50% reduction of Notes Receivable and 50% reduction of future lease
obligations.  The Company and Toshiba will continue to be equal
partners for the approximately 70% remaining current capacity of Flash Partners
and Flash Alliance.  The Company will have the option to purchase a part of
the sold 30% capacity from Toshiba on a foundry basis and will have the option
to continue to invest up to 50% in future Flash Alliance expansions and
technology transitions in Flash Partners and Flash Alliance.  The Company
and Toshiba will continue their existing joint technology development in
advanced NAND and 3-dimensional read/write memory.  The Company is
currently negotiating a definitive agreement and expects this transaction to be
completed in the first quarter of fiscal year 2009.
 -
46 -
 Table of Contents
 Item
      2.
              Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
 
 Statements
in this report, which are not historical facts, are forward-looking statements
within the meaning of the federal securities laws.  These statements
may contain words such as “expects,” “anticipates,” “intends,” “plans,”
“believes,” “seeks,” “estimates” or other wording indicating future results or
expectations.  Forward-looking statements are subject to significant
risks and uncertainties.  Our actual results may differ materially
from the results discussed in these forward-looking
statements.  Factors that could cause our actual results to differ
materially include, but are not limited to, those discussed under “Risk Factors”
and elsewhere in this report.  Our business, financial condition or
results of operations could be materially adversely affected by any of these
factors.  We undertake no obligation to revise or update any
forward-looking statements to reflect any event or circumstance that arises
after the date of this report, except as required by law.  References
in this report to “SanDisk®,” “we,”
“our,” and “us” refer collectively to SanDisk Corporation, a Delaware
corporation, and its subsidiaries.
 
 Overview
 
 We
are the inventor of and worldwide leader in NAND-based flash storage
cards.  Our mission is to provide simple, reliable and affordable
storage for consumer use in portable devices.  We sell SanDisk branded
products for consumer electronics through broad global retail and original
equipment manufacturer, or OEM, distribution channels.
 
 We
design, develop and manufacture products and solutions in a variety of form
factors using our flash memory, controller and firmware
technologies.  We source the vast majority of our flash memory supply
through our significant venture relationships with Toshiba Corporation, or
Toshiba, which provide us with leading edge low-cost memory
wafers.  Our cards are used in a wide range of consumer electronics
devices such as mobile phones, digital cameras, gaming devices and laptop
computers.  We also produce Universal Serial Bus, or USB, drives, MP3
players and other flash storage products that are embedded in a variety of
systems for the enterprise, industrial, military and other markets.
 
 Our
results are primarily driven by worldwide demand for flash storage devices,
which in turn depends on end-user demand for electronic products.  We
believe the market for flash storage is generally price
elastic.  Accordingly, we expect that as we reduce the price of our
flash devices, consumers will demand an increasing number of gigabytes and/or
units of memory and that over time, new markets will emerge.  In order
to profitably capitalize on price elasticity of demand in the market for flash
storage products, we must reduce our cost per gigabyte at a rate similar to the
change in selling price per gigabyte to the consumer and the average capacity of
our products must grow enough to offset price declines.  We seek to
achieve these cost reductions through technology improvements primarily by
increasing the amount of memory stored in a given area of silicon.
 
 We
adopted Statement of Financial Accounting Standards No. 157, or SFAS 157, Fair Value Measurements, as
of the beginning of fiscal year 2008.  In February 2008, the Financial
Accounting Standards Board, or FASB, issued FASB Staff Position No. FAS 157-2,
Effective Date of FASB
Statement No. 157, which provides a one year deferral of the effective
date of SFAS 157 for non-financial assets and non-financial liabilities, except
those that are recognized or disclosed in the financial statements at fair value
at least annually. Therefore, we have only adopted the provisions of SFAS 157
with respect to our financial assets and liabilities.  SFAS 157
defines fair value, establishes a framework for measuring fair value under
generally accepted accounting principles and enhances disclosures about fair
value measurements.  Fair value is defined under SFAS 157 as the
exchange price that would be received for an asset or paid to transfer a
liability (an exit price) in the principal or most advantageous market for the
asset or liability in an orderly transaction between market participants on the
measurement date. Valuation techniques used to measure fair value under SFAS 157
must maximize the use of observable inputs and minimize the use of unobservable
inputs.  The adoption of this statement did not have a material impact
on our consolidated results of operations and financial
condition.  See Note 2, “Fair Value Measurements,” in the Notes to the
Condensed Consolidated Financial Statements of this Form 10-Q.
 
 We
adopted Statement of Financial Accounting Standards No. 159, or SFAS 159,
Establishing the Fair Value
Option for Financial Assets and Liabilities, which permits entities to
elect, at specified election dates, to measure eligible financial instruments at
fair value.  As of September 28, 2008, we did not elect the fair
value option for any financial assets and liabilities that were not previously
measured at fair value.  See Note 2, “Fair Value Measurements,”
in the Notes to the Condensed Consolidated Financial Statements of this Form
10-Q.
 
  -
47 -
 Table of Contents
  Results
of Operations.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              %
      of
                  Revenues
              
              
              September 30,
                  2007
              
              
              %
      of
                  Revenues
              
              
              September 28,
                  2008
              
              
              %
      of
                  Revenues
              
              
              September 30,
                  2007
              
              
              %
      of
                  Revenues(In millions,
      except percentages)Product
      revenues
              
              $
              689.6
              
              
              
              83.9
              %
              
              $
              918.8
              
              
              
              88.6
              %
              
              $
              2,101.1
              
              
              
              84.5
              %
              
              $
              2,328.1
              
              
              
              87.8
              %License
      and royalty revenues
              
              
              131.9
              
              
              
              16.1
              %
              
              
              118.6
              
              
              
              11.4
              %
              
              
              386.4
              
              
              
              15.5
              %
              
              
              322.4
              
              
              
              12.2
              %Total
      revenues
              
              
              821.5
              
              
              
              100.0
              %
              
              
              1,037.4
              
              
              
              100.0
              %
              
              
              2,487.5
              
              
              
              100.0
              %
              
              
              2,650.5
              
              
              
              100.0
              %Cost
      of product revenues
              
              
              812.8
              
              
              
              98.9
              %
              
              
              680.5
              
              
              
              65.6
              %
              
              
              2,040.0
              
              
              
              82.0
              %
              
              
              1,839.3
              
              
              
              69.4
              %Amortization
      of acquisition-related intangible assets
              
              
              14.6
              
              
              
              1.8
              %
              
              
              14.6
              
              
              
              1.4
              %
              
              
              43.8
              
              
              
              1.8
              %
              
              
              50.2
              
              
              
              1.9
              %Total
      cost of product revenues
              
              
              827.4
              
              
              
              100.7
              %
              
              
              695.1
              
              
              
              67.0
              %
              
              
              2,083.8
              
              
              
              83.8
              %
              
              
              1,889.5
              
              
              
              71.3
              %Gross
      profit (loss)
              
              
              (5.9
              )
              
              
              (0.7
              %)
              
              
              342.3
              
              
              
              33.0
              %
              
              
              403.7
              
              
              
              16.2
              %
              
              
              761.0
              
              
              
              28.7
              %Operating
      expensesResearch
      and development
              
              
              104.6
              
              
              
              12.7
              %
              
              
              110.5
              
              
              
              10.7
              %
              
              
              328.1
              
              
              
              13.2
              %
              
              
              307.4
              
              
              
              11.6
              %Sales
      and marketing
              
              
              87.8
              
              
              
              10.7
              %
              
              
              72.5
              
              
              
              7.0
              %
              
              
              245.6
              
              
              
              9.9
              %
              
              
              189.2
              
              
              
              7.1
              %General
      and administrative
              
              
              47.1
              
              
              
              5.7
              %
              
              
              45.6
              
              
              
              4.4
              %
              
              
              158.6
              
              
              
              6.4
              %
              
              
              133.8
              
              
              
              5.1
              %Amortization
      of acquisition-related intangible assets
              
              
              4.8
              
              
              
              0.6
              %
              
              
              4.6
              
              
              
              0.4
              %
              
              
              13.8
              
              
              
              0.5
              %
              
              
              20.7
              
              
              
              0.8
              %Restructuring
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              4.1
              
              
              
              0.1
              %
              
              
              6.7
              
              
              
              0.2
              %Total
      operating expenses
              
              
              244.3
              
              
              
              29.7
              %
              
              
              233.2
              
              
              
              22.5
              %
              
              
              750.2
              
              
              
              30.1
              %
              
              
              657.8
              
              
              
              24.8
              %Operating
      income (loss)
              
              
              (250.2
              )
              
              
              (30.4
              %)
              
              
              109.1
              
              
              
              10.5
              %
              
              
              (346.5
              )
              
              
              (13.9
              %)
              
              
              103.2
              
              
              
              3.9
              %Other
      income (expense)
              
              
              (0.4
              )
              
              
              (0.1
              %)
              
              
              29.2
              
              
              
              2.8
              %
              
              
              46.0
              
              
              
              1.8
              %
              
              
              104.0
              
              
              
              3.9
              %Income
      (loss) before taxes
              
              
              (250.6
              )
              
              
              (30.5
              %)
              
              
              138.3
              
              
              
              13.3
              %
              
              
              (300.5
              )
              
              
              (12.1
              %)
              
              
              207.2
              
              
              
              7.8
              %Provisionfor(benefitfrom) income
    taxes
              
              
              (95.4
              )
              
              
              (11.6
              %)
              
              
              53.7
              
              
              
              5.1
              %
              
              
              (95.3
              )
              
              
              (3.8
              %)
              
              
              89.5
              
              
              
              3.4
              %Minority
      interest
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              5.2
              
              
              
              0.1
              %Net
      income (loss)
              
              $
              (155.2
              )
              
              
              (18.9
              %)
              
              $
              84.6
              
              
              
              8.2
              %
              
              $
              (205.2
              )
              
              
              (8.3
              %)
              
              $
              112.5
              
              
              
              4.3
              %
 
  -
48 -
 Table of Contents
  Product
Revenues.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change
              
              
              September 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change(In millions,
      except percentages)Retail
              
              $
              433.1
              
              
              $
              607.7
              
              
              
              (28.7
              )%
              
              $
              1,272.8
              
              
              $
              1,436.0
              
              
              
              (11.4
              %)OEM
              
              
              256.5
              
              
              
              311.1
              
              
              
              (17.6
              %)
              
              
              828.3
              
              
              
              892.1
              
              
              
              (7.2
              %)Product
      revenues
              
              $
              689.6
              
              
              $
              918.8
              
              
              
              (25.0
              %)
              
              $
              2,101.1
              
              
              $
              2,328.1
              
              
              
              (9.8
              %)
 
 The
decrease in our product revenues for the three months ended September 28,
2008 as compared to the three months ended September 30, 2007 resulted from
a 63% reduction in average selling price per gigabyte, partially offset by a
105% increase in the number of gigabytes sold.  The decrease in our
product revenues for the nine months ended September 28, 2008 as compared
to the nine months ended September 30, 2007 resulted from a 59% reduction
in average selling price per gigabyte, partially offset by a 127% increase in
the number of gigabytes sold.  Price declines in fiscal year 2008 have
been steep due to industry-wide supply and demand imbalance.
 
 The
decline in retail product revenues for the three and nine months ended
September 28, 2008 versus the comparable periods in fiscal year 2007 was
due to minimal growth in unit demand more than offset by aggressive price
declines.
 
 Original
equipment manufacturer, or OEM, product revenues for the three months ended
September 28, 2008 decreased versus the comparable period in fiscal year
2007 primarily due to price declines more than offsetting unit
growth.  OEM product revenues for the nine months ended
September 28, 2008 were lower than the comparable period in fiscal year
2007 due to price declines more than offsetting unit growth and the
discontinuation of our TwinSys LLC operations on March 31, 2007, which
contributed $53.0 million of product revenues in the first quarter of
fiscal year 2007 prior to ceasing operations.
 
 Our
ten largest customers represented approximately 49% and 47% of our total
revenues in the three and nine months ended September 28, 2008,
respectively, compared to 44% and 47% in the three and nine months ended
September 30, 2007.  In the three and nine months ended
September 28, 2008, revenue from Samsung Electronics Co. Ltd., or Samsung,
which included both license and royalty revenues and product revenues, accounted
for 13% of our total revenues in each period, respectively.  No other
customer exceeded 10% of our total revenues during those periods.  No
customer exceeded 10% of our total revenues in the three months ended
September 30, 2007.  Customers who exceeded 10% of our total
revenues in the nine months ended September 30, 2007 were Sony Ericsson
Mobile Communications AB, or Sony Ericsson, and Samsung, each of which were 10%
of our total revenues.
 
  -
49 -
 Table of Contents
  Geographical
Product Revenues.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              %
      of Product Revenues
              
              
              September 30,
                  2007
              
              
              %
      of Product Revenues
              
              
              Percent
                  Change
              
              
              September 28,
                  2008
              
              
              %
      of Product Revenues
              
              
              September 30,
                  2007
              
              
              %
      of Product Revenues
              
              
              Percent
                  Change(In millions,
      except percentages)United
      States
              
              $
              235.5
              
              
              
              34.1
              %
              
              $
              278.2
              
              
              
              30.3
              %
              
              
              (15.4
              %)
              
              $
              706.4
              
              
              
              33.6
              %
              
              $
              745.0
              
              
              
              32.0
              %
              
              
              (5.2
              %)Japan
              
              
              44.8
              
              
              
              6.5
              %
              
              
              62.3
              
              
              
              6.8
              %
              
              
              (28.2
              %)
              
              
              146.4
              
              
              
              7.0
              %
              
              
              215.7
              
              
              
              9.3
              %
              
              
              (32.1
              %)Europe
      and Middle East
              
              
              170.1
              
              
              
              24.7
              %
              
              
              281.0
              
              
              
              30.6
              %
              
              
              (39.5
              %)
              
              
              539.7
              
              
              
              25.7
              %
              
              
              610.1
              
              
              
              26.2
              %
              
              
              (11.5
              %)Asia-Pacific
              
              
              220.0
              
              
              
              31.9
              %
              
              
              273.3
              
              
              
              29.7
              %
              
              
              (19.5
              %)
              
              
              658.7
              
              
              
              31.3
              %
              
              
              654.7
              
              
              
              28.1
              %
              
              
              0.6
              %Other
      foreign countries
              
              
              19.2
              
              
              
              2.8
              %
              
              
              24.0
              
              
              
              2.6
              %
              
              
              (19.8
              %)
              
              
              49.9
              
              
              
              2.4
              %
              
              
              102.6
              
              
              
              4.4
              %
              
              
              (51.4
              %)Product
      revenues
              
              $
              689.6
              
              
              
              100.0
              %
              
              $
              918.8
              
              
              
              100.0
              %
              
              
              (25.0
              %)
              
              $
              2,101.1
              
              
              
              100.0
              %
              
              $
              2,328.1
              
              
              
              100.0
              %
              
              
              (9.8
              %)
 
 Product
revenues declined in all regions for the three months ended September 28,
2008 versus the comparable period in fiscal year 2007 due to aggressive industry
price declines as well as unit sales declines in Europe and
Japan.  Regional declines in product revenues for the nine months
ended September 28, 2008 were due primarily to aggressive industry price
declines partially offset by unit sales growth in all regions except
Japan.  The decline in Japan was primarily due to the termination of
the TwinSys LLC venture on March 31, 2007, which contributed
$53.0 million of product revenues in the nine months ended
September 30, 2007.
 
 License
and Royalty Revenues.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change
              
              
              September 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change(In millions,
      except percentages)License
      and royalty revenues
              
              $
              131.9
              
              
              $
              118.6
              
              
              
              11.2
              %
              
              $
              386.4
              
              
              $
              322.4
              
              
              
              19.9
              %
 
 The
increase in our license and royalty revenues for the three and nine months ended
September 28, 2008 over the comparable periods of fiscal year 2007 was due
to higher NAND-based royalties and the addition of new licensees.
 
 Gross
Profit (Loss) and Margin.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change
              
              
              September 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change(In millions,
      except percentages)Product
      gross profit (loss)
              
              $
              (137.9
              )
              
              $
              223.7
              
              
              
              (161.6
              %)
              
              $
              17.4
              
              
              $
              438.6
              
              
              
              (96.0
              %)Product
      gross margin (as a percent of product revenues)
              
              
              (20.0
              %)
              
              
              24.4
              %
              
              
              
              
              
              
              0.8
              %
              
              
              18.8
              %Total
      gross margin (as a percent of total revenues)
              
              
              (0.7
              %)
              
              
              33.0
              %
              
              
              
              
              
              
              16.2
              %
              
              
              28.7
              %
 
 Product
gross margin for the three months ended September 28, 2008 was negative and
lower than the comparable period of fiscal year 2007 due primarily to aggressive
industry price declines resulting in the sale of products below cost and related
lower-of-cost or market and excess inventory charges of $109.0 million for
both inventory on-hand and in the channel.
 
 Product
gross margin for the nine months ended September 28, 2008 was lower than
the comparable period of fiscal year 2007 due primarily to aggressive price
declines resulting in the sale of products below cost in the third quarter of
fiscal year 2008, lower-of-cost or market and excess inventory charges for both
inventory on-hand and in the channel, and decline of the U.S. dollar to Japanese
yen exchange rate.
 
 In
the three and nine months ended September 28, 2008 and September 30,
2007, we sold approximately $16.3 million, $27.1 million,
$9.3 million and $10.2 million, respectively, of inventory that had
been fully written-off or reserved.
 
  -
50 -
 Table of Contents
  Research
and Development.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change
              
              
              September 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change(In millions,
      except percentages)Research
      and development
              
              $
              104.6
              
              
              $
              110.5
              
              
              
              (5.4
              %)
              
              $
              328.1
              
              
              $
              307.4
              
              
              
              6.8
              %Percent
      of revenue
              
              
              12.7
              %
              
              
              10.7
              %
              
              
              
              
              
              
              13.2
              %
              
              
              11.6
              %
 
 Our
reduction in research and development expense for the three months ended
September 28, 2008 versus the comparable period in fiscal year 2007 was due
primarily to lower Flash Alliance start-up costs of
$7.9 million.
 
 Our
research and development expense growth for the nine months ended
September 28, 2008 versus the comparable period in fiscal year 2007
included increased employee-related costs of $8.9 million and increased
engineering consulting, material and equipment costs of $14.5 million and
$9.3 million of increases in other engineering costs, partially offset by
lower Flash Alliance start-up costs of $11.9 million.
 
 Sales
and Marketing.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change
              
              
              September 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change(In millions,
      except percentages)Sales
      and marketing
              
              $
              87.8
              
              
              $
              72.5
              
              
              
              21.3
              %
              
              $
              245.6
              
              
              $
              189.2
              
              
              
              29.9
              %Percent
      of revenue
              
              
              10.7
              %
              
              
              7.0
              %
              
              
              
              
              
              
              9.9
              %
              
              
              7.1
              %
 
 Our
sales and marketing expense growth for the three months ended September 28,
2008 over the comparable period in fiscal year 2007 was primarily due to
increased branding and merchandising costs of $15.9 million.
 
 Our
sales and marketing expense growth for the nine months ended September 28,
2008 over the comparable period in fiscal year 2007 was primarily due to
increased branding and merchandising costs of $48.1 million and increased
employee-related costs of $5.2 million.
 
 General
and Administrative.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change
              
              
              September 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change(In millions,
      except percentages)General
      and administrative
              
              $
              47.1
              
              
              $
              45.6
              
              
              
              3.3
              %
              
              $
              158.6
              
              
              $
              133.8
              
              
              
              18.6
              %Percent
      of revenue
              
              
              5.7
              %
              
              
              4.4
              %
              
              
              
              
              
              
              6.4
              %
              
              
              5.1
              %
 
 Our
general and administrative expense growth for the three months ended
September 28, 2008 over the comparable period in fiscal year 2007 was
primarily related to increased legal and outside advisor costs of
$6.4 million, partially offset by lower employee-related costs of
$2.2 million and lower bad debt expense of $2.2 million.
 
 Our
general and administrative expense growth for the nine months ended
September 28, 2008 over the comparable period in fiscal year 2007 was
primarily related to increased legal and outside advisor costs of
$23.7 million and bad debt expense of $3.2 million, offset by lower
employee-related costs of $2.1 million.
 
  -
51 -
 Table of Contents
  Amortization
of Acquisition-Related Intangible Assets.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change
              
              
              September 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change(In millions,
      except percentages)Amortization
      of acquisition-related intangible assets
              
              $
              4.8
              
              
              $
              4.6
              
              
              
              3.6
              %
              
              $
              13.8
              
              
              $
              20.7
              
              
              
              (33.5
              %)Percent
      of revenue
              
              
              0.6
              %
              
              
              0.4
              %
              
              
              
              
              
              
              0.5
              %
              
              
              0.8
              %
 
 Amortization
of acquisition-related intangible assets was lower in the three and nine months
ended September 28, 2008 compared to the three and nine months ended
September 30, 2007, due to intangibles that were fully amortized in fiscal
year 2007.  Our expense from the amortization of acquisition-related
intangible assets was primarily related to our acquisitions of Matrix
Semiconductor, Inc. in January 2006 and msystems Ltd. in November
2006.
 
 Net
acquisition-related intangible assets at September 28, 2008 were
$243.3 million.  If we are required to evaluate our goodwill
under a Step 2 analysis as defined by Statement of Financial Accounting Standard
No. 142, or SFAS 142, Goodwill
and Other Intangible Assets, we will also be required to evaluate our
intangible assets for impairment under Statement of Financial Accounting
Standards No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets.Any potential
impairment of intangible assets would increase expenses in a current period and
decrease expenses in subsequent periods.  See Note 4, “Goodwill and
Other Intangible Assets,” in the Notes to the Condensed Consolidated Financial
Statements of this Form 10-Q.
 
 Restructuring.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change
              
              
              September 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change(In millions,
      except percentages)Restructuring
              
              $
              —
              
              
              $
              —
              
              
              
              —
              
              
              $
              4.1
              
              
              $
              6.7
              
              
              
              (39.2
              %)Percent
      of revenue
              
              
              
              
              
              
              —
              
              
              
              
              
              
              
              0.1
              %
              
              
              0.2
              %
 
 During
the second quarter of fiscal year 2008, we implemented a restructuring plan in
order to reduce our cost structure, which included reductions of our workforce
in all functions of the organization worldwide.
 
 As
a result of our second quarter of fiscal year 2008 restructuring plan, we expect
to reduce our annual spending by approximately $15.2 million, of which
approximately 26%, 17%, 41% and 16% will be reflected as a reduction in
operations, research and development expense, sales and marketing expense, and
general and administrative expense, respectively.
 
 Other
Income.
 Three
      months ended
              
              
              Nine
      months endedSeptember 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change
              
              
              September 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change(In millions,
      except percentages)Interest
      income
              
              $
              26.0
              
              
              $
              31.8
              
              
              
              (18.3
              %)
              
              $
              75.0
              
              
              $
              104.0
              
              
              
              (27.9
              %)Interest
      expense and other income (expense), net
              
              
              (26.4
              )
              
              
              (2.6
              )
              
              
              (970.7
              %)
              
              
              (29.0
              )
              
              
              —
              
              
              
              N/ATotal
      other income (loss)
              
              $
              (0.4
              )
              
              $
              29.2
              
              
              
              (101.5
              %)
              
              $
              46.0
              
              
              $
              104.0
              
              
              
              (55.8
              %)
 
 The
decrease in other income for the three and nine months ended September 28,
2008 compared to the three and nine months ended September 30, 2007 was
primarily due to impairment of our equity investment in Tower Semiconductor,
Ltd., or Tower, of ($11.7) million, impairment of our investment in
FlashVision Ltd., or FlashVision, of ($10.4) million and lower interest
income from reduced interest rates and lower cash and investment
balances.
 
  -
52 -
 Table of Contents
  Provision
for (Benefit from) Income Taxes.
 Three
      months ended
                
                
                Nine
      months endedSeptember 28,
                    2008
                
                
                September 30,
                    2007
                
                
                Percent
                    Change
                
                
                September 28,
                    2008
                
                
                September 30,
                    2007
                
                
                Percent
                    Change(In millions,
      except percentages)Provision
      for (benefit from) income taxes
                
                $
                (95.4
                )
                
                $
                53.7
                
                
                
                (277.7
                %)
                
                $
                (95.3
                )
                
                $
                89.5
                
                
                
                (206.6
                %)Effective
      tax rate
                
                
                38.1
                %
                
                
                38.8
                %
                
                
                
                
                
                
                31.7
                %
                
                
                43.2
                %
  
 The
decrease in our effective tax rate for the three and nine months ended
September 28, 2008 compared to the three and nine months ended
September 30, 2007 was primarily due to the impact of the jurisdictional
changes in earnings and losses and the tax impact of certain items not directly
related to earnings.
 
 The
balance of unrecognized tax benefits as of September 28, 2008 decreased
$4.0 million from June 29, 2008 and increased $22.7 million from
December 30, 2007.  Approximately $10.1 million of the
$22.7 million increase in unrecognized tax benefits in the nine months
ended September 28, 2008 may favorably impact the effective tax rate in
future periods.  We recognized interest and/or penalties of
$2.0 million and $5.5 million in the three and nine months ended
September 28, 2008, respectively, in income tax expense.  We are
currently under audit by tax authorities but do not expect that the outcome of
these examinations will have a material effect on our financial position,
results of operations or liquidity.
 
  -
53 -
 Table of Contents
  Liquidity
and Capital Resources.
 
 Our
cash flows were as follows:
 Nine
      months endedSeptember 28,
                  2008
              
              
              September 30,
                  2007
              
              
              Percent
                  Change(In millions,
      except percentages)Net
      cash provided by operating activities
              
              $
              22.1
              
              
              $
              503.7
              
              
              
              (95.6
              %)Net
      cash used in investing activities
              
              
              (142.6
              )
              
              
              (1,128.6
              )
              
              
              87.4
              %Net
      cash provided by financing activities
              
              
              11.6
              
              
              
              13.5
              
              
              
              (14.2
              %)Effect
      of changes in foreign currency exchange rates on cash
              
              
              (3.7
              )
              
              
              1.6
              
              
              
              (338.6
              %)Net
      decrease in cash and cash equivalents
              
              $
              (112.6
              )
              
              $
              (609.8
              )
              
              
              81.5
              %
 
 Operating
Activities.Cash provided by operating activities is generated
by net income (loss) adjusted for certain non-cash items and changes in assets
and liabilities.  Cash provided by operations was $22.1 million
for the first nine months of fiscal year 2008 as compared to cash provided by
operations of $503.7 million for the first nine months of fiscal year
2007.  The decline in cash provided by operations in the first nine
months of fiscal year 2008 compared to the first nine months of fiscal year
2007, resulted primarily from our net loss of $205.2 million and an
increase in inventory of $157.3 million.  The increase in
inventory was related primarily to the capacity and production expansion at
Flash Alliance increasing at a faster rate than the growth in demand for our
products.  Cash flow from accounts receivable in fiscal year 2008 was
positively impacted by increased collection efforts but was negatively impacted
by reduced product revenue levels as compared with the prior year
period.  Within operating activities for the first nine months of
fiscal year 2008, there was an increased usage in cash used by other
liabilities, primarily related to a reduction in taxes payable due to the
current year net loss compared with prior year net income and lower deferred
income on shipments to distributors and retailers related to lower revenue
levels.
 
 Investing
Activities.  Cash used in investing activities for the first
nine months of fiscal year 2008 was $142.6 million as compared to
$1,128.6 million in the first nine months of fiscal year
2007.  The decrease in cash used in investing was primarily related to
reduced purchases of short and long-term investments due to our higher liquidity
requirements and the return of $102.5 million on our investment in
FlashVision and $39.7 million from the sale of 200-millimeter fab equipment
that we owned directly as compared to the return of $37.5 million from
FlashVision in the nine months ended fiscal year 2007.  Usage of cash
for investments in and loans to Flash Partners and Flash Alliance was
$227.2 million in the first nine months of fiscal year 2008 compared to
$447.6 million in the first nine months of fiscal year 2007.
 
 Financing
Activities.  Net cash provided by financing activities for the
first nine months of fiscal year 2008 of $11.6 million as compared to cash
provided by financing activities of $13.5 million in the first nine months
of fiscal year 2007 was primarily related to lower cash proceeds from employee
stock programs and repayment of debt financing in fiscal year 2008 partially
offset by the termination of the share repurchase programs which used cash in
fiscal year 2007.
 
 Short-Term
Liquidity.  At September 28, 2008, we had cash, cash
equivalents and short-term investments of $1.57 billion and our working
capital balance was $2.15 billion.  We currently expect to loan
to and make investments of approximately $0.2 billion in the flash ventures
with Toshiba for fab expansion and to spend approximately $0.2 billion for
property and equipment during the next twelve months.
 
 Long-Term
Requirements.  Depending on the demand for our products, we may
decide to make additional investments, which could be substantial, in wafer
fabrication foundry capacity and assembly and test manufacturing equipment to
support our business in the future.  We may also make equity
investments in other companies or engage in merger or acquisition
transactions.  We may raise additional financing, which could be
difficult to obtain, and which if not obtained in satisfactory amounts may
prevent us from funding the ventures with Toshiba, increasing our wafer supply,
developing or enhancing our products, taking advantage of future opportunities,
engaging in investments in or acquisitions of companies, growing our business,
responding to competitive pressures or unanticipated industry changes, or making
payments under or repurchasing our notes, any of which could harm our
business.
 
  -
54 -
 Table of Contents
  Financing
Arrangements. At September 28,
2008, we had $1.23 billion of aggregate principal amount in convertible
notes outstanding, consisting of $1.15 billion in aggregate principal
amount of our 1% Senior Convertible Notes due 2013 and $75.0 million in
aggregate principal amount of our 1% Convertible Notes due 2035.
 
 Concurrent
with the issuance of the 1% Senior Convertible Notes due 2013, we sold warrants
to acquire shares of our common stock at an exercise price of $95.03 per
share.  As of September 28, 2008, the warrants had an expected
life of approximately 5.4 years and expire in August 2013.  At
expiration, we may, at our option, elect to settle the warrants on a net share
basis.  As of September 28, 2008, the warrants had not been
exercised and remain outstanding.  In addition, counterparties agreed
to sell to us up to approximately 14.0 million shares of our common stock,
which is the number of shares initially issuable upon conversion of the 1%
Senior Convertible Notes due 2013 in full, at a conversion price of $82.36 per
share.  The convertible bond hedge transaction will be settled in net
shares and will terminate upon the earlier of the maturity date of the 1% Senior
Convertible Notes due 2013 or the first day that none of the 1% Senior
Convertible Notes due 2013 remain outstanding due to conversion or
otherwise.  Settlement of the convertible bond hedge in net shares on
the expiration date would result in us receiving net shares equivalent to the
number of shares issuable by us upon conversion of the 1% Senior Convertible
Notes due 2013.  As of September 28, 2008, we had not purchased
any shares under this convertible bond hedge agreement.
 
 Flash Partners
and Flash Alliance Ventures with Toshiba.  We are a 49.9%
percent owner in both Flash Partners and Flash Alliance, or hereinafter referred
to as Flash Ventures, our business ventures with Toshiba to develop and
manufacture NAND flash memory products.  These NAND flash memory
products are manufactured by Toshiba at Toshiba’s Yokkaichi, Japan operations
using the semiconductor manufacturing equipment owned or leased by Flash
Ventures.  This equipment is funded or will be funded by investments
in or loans to the Flash Ventures from us and Toshiba as well as through
operating leases received by Flash Ventures from third-party banks and
guaranteed by us and Toshiba.  Flash Ventures purchase wafers from
Toshiba at cost and then resells those wafers to us and Toshiba at cost plus a
markup.  We are contractually obligated to purchase half of Flash
Ventures’ NAND wafer supply.  We are not able to estimate our total
wafer purchase obligations beyond our rolling three month purchase commitment
because the price is determined by reference to the future cost to produce the
wafers.  See Note 12, “Related Parties and Strategic Investments,” of
the Notes to the Condensed Consolidated Financial Statements of this Form
10-Q.
 
 The
cost of the wafers we purchase from Flash Ventures is recorded in inventory and
ultimately cost of sales.  Flash Ventures are variable interest
entities, and we are not the primary beneficiary of these ventures because we
are entitled to less than a majority of expected gains and losses with respect
to each venture.  Accordingly, we account for our investments under
the equity method and do not consolidate.
 
 Under
Flash Ventures’ agreements, we agreed to share in Toshiba’s costs associated
with NAND product development and its common semiconductor research and
development activities.  As of September 28, 2008, we had accrued
liabilities related to those common research and development expenses of
$4.0 million.  Our common research and development obligation
related to Flash Ventures is variable but capped at fixed quarterly amounts
through fiscal year 2008.  In addition to general NAND product
development and common semiconductor research performed by Toshiba, both parties
perform direct research and development activities specific to Flash Ventures,
and our contribution is based on a variable computation.  We and
Toshiba each pay the cost of our own design teams and 50% of the wafer
processing and similar costs associated with this direct design and development
of flash memory.
 
 For
semiconductor fixed assets that are leased by Flash Ventures, we and/or Toshiba
jointly guaranteed on an unsecured and several basis, 50% of the outstanding
Flash Ventures’ lease obligations under master lease agreements entered into
from December 2004 through September 2008.  These master
lease obligations are denominated in Japanese yen and are
noncancelable.  Our total master lease obligation guarantee, net of
lease payments as of September 28, 2008, was 194.7 billion Japanese
yen, or approximately $1.84 billion based upon the exchange rate at
September 28, 2008.
 
  -
55 -
 Table of Contents
  Flash
Ventures’ master equipment lease agreements contain customary covenants and
events of default related to them which could result in an acceleration of their
obligations if there is non-compliance.  In addition, the master lease
agreements contain an acceleration clause for certain events of default related
to us as guarantor.  For example, events of default related to us as a
guarantor include our failure to maintain minimum shareholder equity of at least
$1.51 billion, or our failure to maintain a minimum corporate rating of BB-
or BB+ from at least one of two named independent ratings
services.  On October 23, 2008, one of the two named independent
ratings services downgraded our credit rating further below the minimum
corporate rating threshold, and while this specific downgrade did not trigger
non-compliance under Flash Ventures’ master equipment lease agreements, there
can be no assurance that the other named independent ratings service will
maintain our credit rating above the threshold.  If the other named
independent ratings service downgrades our credit rating below the
minimum corporate rating threshold, Flash Ventures could become
non-compliant under their master equipment lease agreements and may be required
to negotiate a resolution to the non-compliance to avoid acceleration of the
obligations under such agreements.  Such resolution could include,
among other things, supplementary security to be supplied by us, as guarantor,
or increased interest rates or waiver fees, should the lessors decide they need
additional collateral or financial consideration under the
circumstances.  If a resolution is unsuccessful, we may be required to
pay some or all of the entire outstanding lease obligations covered by our
guarantee under such Flash Venture master lease agreements.
 
 From
time-to-time, we and Toshiba mutually approve increases in the wafer supply
capacity of Flash Ventures that may contractually obligate us to increase
capital funding.  As of September 28, 2008, Flash Partners’ Fab 3
had reached full capacity of approximately 150,000 wafers per month; however, we
expect to continue to invest in Flash Partners in order to convert to the next
technology node.  The capacity of Flash Alliance’s Fab 4 at full
expansion is expected to be approximately 210,000 wafers per month, and the
timeframe to reach full capacity is to be mutually agreed upon by both
parties.  During the remainder of fiscal year 2008, we expect to
invest approximately $0.4 billion in Flash Ventures, which we expect will
be funded through additional investments, loans, lease guarantees and working
capital contributions to Flash Ventures.
 
 On
October 20, 2008, we entered into a non-binding memorandum of understanding
(“MOU”) with Toshiba to sell to Toshiba approximately 30% of the current
combined manufacturing capacity of Flash Partners and Flash Alliance. We expect
to receive repayment on outstanding Flash Partners and Flash Alliance Notes
Receivable and reduce equipment lease obligations by a total of approximately
$1.0 billion through this transaction.  The total value of
approximately $1.0 billion is expected to be comprised of approximately 50%
reduction of Notes Receivable and 50% reduction of future lease
obligations.  We and Toshiba will continue to be equal partners for
the approximately 70% remaining current capacity of Flash Partners and Flash
Alliance.  We will have the option to purchase a part of the sold 30%
capacity from Toshiba on a foundry basis and will have the option to continue to
invest up to 50% in future Flash Alliance expansions and technology transitions
in Flash Partners and Flash Alliance.  We and Toshiba will continue
our existing joint technology development in advanced NAND and 3-dimensional
read/write memory.  We are currently negotiating a definitive
agreement and expect this transaction to be completed in the first quarter of
fiscal year 2009.  However, there can be no assurance we will be successful
in completing this transaction.
 
 FlashVision
Venture with Toshiba.In the second quarter of fiscal year
2008, we and Toshiba determined that production of NAND flash memory products
utilizing 200-millimeter wafers was no longer cost effective relative to market
prices for NAND flash memory and decided to wind-down the FlashVision
venture.  As part of the ongoing wind-down of FlashVision, Toshiba
purchased certain assets of FlashVision.  The existing master
equipment lease agreement between FlashVision and a consortium of financial
institutions has been retired, thereby releasing us from our contingent
indemnification obligation with Toshiba.  Due to the wind-down
qualifying as a reconsideration event under Financial Accounting Standards
Board, or FASB, Interpretation No. 46 (Revised), or FIN 46(R), Consolidation of Variable Interest
Entities,we re-evaluated and concluded that FlashVision is no longer a
variable interest entity within the scope of FIN 46(R).  In the three
and nine months ended September 28, 2008, we received distributions of
$73.5 million and $102.5 million, respectively, relating to our
investment in FlashVision.  In the third quarter of fiscal year 2008,
we took an impairment on our investment of $10.4 million due to
FlashVision’s difficulty in selling the remaining excess capital equipment due
to deteriorating market conditions for equipment related to the production of
200-millimeter NAND flash memory products.  At September 28,
2008, we had a net investment in FlashVision of $51.0 million denominated
in Japanese yen, offset by $27.9 million of cumulative translation
adjustments recorded in OCI.
 
  -
56 -
 Table of Contents
  Contractual
Obligations and Off-Balance Sheet Arrangements
 
 Our
contractual obligations and off-balance sheet arrangements at September 28,
2008, and the effect those obligations and arrangements are expected to have on
our liquidity and cash flow over the next five years is presented in textual and
tabular format in Note 11, “Commitments, Contingencies and Guarantees,” in the
Notes to the Condensed Consolidated Financial Statements of this Form
10-Q.
 
 Critical
Accounting Policies
 
 Our
discussion and analysis of our financial condition and results of operations is
based upon our Condensed Consolidated Financial Statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States.  The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent
liabilities.  On an ongoing basis, we evaluate our estimates,
including among others, those related to customer programs and incentives,
product returns, bad debts, inventories, investments, income taxes, warranty
obligations, share-based compensation, contingencies and
litigation.  We base our estimates on historical experience and on
other assumptions that we believe are reasonable under the circumstances, the
results of which form the basis for our judgments about the carrying values of
assets and liabilities when those values are not readily apparent from other
sources.  Estimates have historically approximated actual
results.  However, future results will differ from these estimates
under different assumptions and conditions.
 
 During
the three months ended September 28, 2008, we implemented the following new
critical accounting policy:
 
 Goodwill.  Goodwill
from our acquisitions was recorded in accordance with FASB Statement No. 141,
Business
Combinations.  In accordance with FASB Statement No. 142, or
SFAS 142, Goodwill and Other
Intangible Assets, we perform our annual impairment analysis on the first
day of the fourth quarter of each year, or more often if there are indicators of
impairment present. The provisions of SFAS 142 require that a two-step
impairment test be performed on goodwill.  In the first step (Step 1),
we compare our fair value to our carrying value.  If the fair value exceeds
the carrying value of the net assets, goodwill is considered not impaired and we
are not required to perform further testing.  If the carrying value of the
net assets exceeds the fair value, then we must perform the second step (Step 2)
of the impairment test in order to determine the implied fair value of goodwill.
 If the carrying value of goodwill exceeds its implied fair value, then we
would record an impairment loss equal to the difference.
 
 To
determine the fair value used in Step 1, we use our market capitalization based
upon our quoted closing stock price per NASDAQ, including an estimated control
premium that an investor would be willing to pay for a controlling interest in
us.  The control premium requires the use of judgment and is based
primarily on comparable industry and deal-size transactions, related synergies
and other benefits.  If we are required to perform a Step 2 analysis,
determining the fair value of our off-balance sheet intangibles used in Step 2
requires us to make judgments and involves the use of significant estimates and
assumptions.  These estimates and assumptions include revenue growth rates
and operating margins used to calculate projected future cash flows,
risk-adjusted discount rates based on our weighted average cost of capital,
future economic and market conditions and determination of appropriate market
comparables.  Our estimates of market segment growth, our market segment
share and costs are based on historical data, various internal estimates and
certain external sources, and are based on assumptions that are consistent with
the plans and estimates we are using to manage the underlying business.
 Our business consists of both established and emerging technologies and
our forecasts for emerging technologies are based upon internal estimates and
external sources rather than historical information.  If future forecasts
are revised, they may indicate or require future impairment charges.  We
base our fair value estimates on assumptions we believe to be reasonable but
that are unpredictable and inherently uncertain.  Actual future results may
differ from those estimates.
 
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  Recent
Accounting Pronouncements
 
 SFAS No.
160.In December 2007, the FASB issued Statement of
Financial Accounting Standards No. 160, or SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No.
51.  SFAS 160 changes the accounting for noncontrolling
(minority) interests in consolidated financial statements, including the
requirements to classify noncontrolling interests as a component of consolidated
stockholders’ equity, to identify earnings attributable to noncontrolling
interests reported as part of consolidated earnings, and to measure gain or loss
on the deconsolidated subsidiary based upon the fair value of the noncontrolling
equity investment.  Additionally, SFAS 160 revises the accounting for
both increases and decreases in a parent’s controlling ownership
interest.  SFAS 160 is effective for fiscal years beginning after
December 15, 2008, with early adoption prohibited.  We are
assessing the impact of SFAS 160 to our consolidated results of operations and
financial position.
 
 SFAS No. 141
(revised).  In December 2007, the FASB issued Statement of
Financial Accounting Standards No. 141 (revised), or SFAS 141(R), Business
Combinations.  SFAS 141(R) changes the accounting for business
combinations by requiring that an acquiring entity measure and recognize
identifiable assets acquired and liabilities assumed at the acquisition date
fair value with limited exceptions.  The changes include the treatment
of acquisition-related transaction costs, the valuation of any noncontrolling
interest at acquisition date fair value, the recording of acquired contingent
liabilities at acquisition date fair value and the subsequent re-measurement of
such liabilities after the acquisition date, the recognition of capitalized
in-process research and development, the accounting for acquisition-related
restructuring cost accruals subsequent to the acquisition date, and the
recognition of changes in the acquirer’s income tax valuation
allowance.  In addition, any changes to the recognition or measurement
of uncertain tax positions related to pre-acquisition periods will be recorded
through income tax expense, whereas the current accounting treatment requires
any adjustment to be recognized through the purchase price.  SFAS
141(R) is effective for fiscal years beginning after December 15, 2008,
with early adoption prohibited.  The adoption of SFAS 141(R) is
expected to change our accounting treatment prospectively for all business
combinations consummated after the effective date.
 
 FSP No. APB
14-1.In May 2008, the FASB issued FASB Staff Position No. APB
14-1, or FSP APB 14-1, Accounting for Convertible Debt
Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash
Settlement).  FSP APB 14-1 requires the issuer to separately
account for the liability and equity components of the instrument in a manner
that reflects the issuer’s economic interest cost.  Further, FSP APB
14-1 requires bifurcation of a component of the debt, classification of that
component to equity, and then accretion of the resulting discount on the debt to
result in the “economic interest cost” being reflected in the statement of
operations.  FSP APB 14-1 is effective for fiscal years beginning
after December 15, 2008, will not permit early application, and will
require retrospective application to all periods presented.  We
estimate that we would be required to report an additional before tax, non-cash
interest expense of approximately $400 million over the life of the 1%
Senior Convertible Notes due 2013, including approximately $50 million to
$55 million in fiscal year 2008.
 
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 Item
      3.
              Quantitative and Qualitative Disclosures About Market
      Risk
 
 Foreign Currency
Risk.A substantial majority of our revenue, expense, and
capital purchasing activities are transacted in U.S.
dollars.  However, we do enter into transactions in other currencies,
primarily European euros, new Israel shekels, Japanese yen and new Taiwanese
dollars.  The most significant of these transactions is our purchases
of NAND flash memory from Flash Ventures, which is denominated in Japanese
yen.  In addition, we have significant monetary assets and liabilities
that are denominated in non-U.S. currencies, including our notes receivable from
Flash Ventures.  From December 2007 to September 2008, the
Japanese yen has appreciated 6.4% relative to the U.S.
dollar.  Significant strengthening or weakening of the U.S. dollar
relative to these foreign currencies, especially the Japanese yen, could cause
variability in our operating results, financial condition and cash
flows.
 
 To
protect against reductions in value and the volatility of future cash flows
caused by changes in foreign currency exchange rates, we have established
balance sheet and anticipated transaction risk management
programs.  Currency forward contracts and currency options are
generally utilized in these hedging programs.  Our hedging program
reduces, but does not eliminate the impact of currency exchange rate movements
(see Part II, Item 1A, “Risk Factors”).  If we were to experience a
10% change in currency exchange rates, the impact on assets and liabilities
denominated in currencies other than the U.S. dollar, after taking into account
hedges and offsetting positions, would result in income (loss) before taxes of
approximately $25.2 million at September 28, 2008.  There
would also be impact on future revenues and purchases denominated in currencies
other than the U.S. dollar, the most significant of which is our Japanese
yen-based wafer purchases from Flash Ventures.  The Company’s
derivatives expose it to credit risk to the extent that the counterparties may
be unable to meet the terms of the agreement.  The Company seeks to
mitigate such risk by limiting its counterparties to major financial
institutions and by spreading the risk across several major financial
institutions.  However, under current market conditions, failure of
one or more of these financial institutions is possible and could result in
incurred losses.
 
 Interest Rate
Risk.Our exposure to market risk for changes in interest
rates relates primarily to our investment portfolio.  The primary
objective of our investment activities is to preserve principal while maximizing
yields without significantly increasing risk.  This is accomplished by
investing in widely diversified marketable securities, consisting primarily of
investment grade securities.  In addition, our Flash Ventures have
outstanding operating leases, for which the interest rate is tied to the Tokyo
Interbank Offer Rate, or TIBOR.  To the extent that there are material
adverse changes to TIBOR, our inventory purchase costs from Flash Ventures could
increase.
 
 Item
      4.
              Controls and
Procedures
 
 Evaluation of
Disclosure Controls and Procedures.  Under the supervision and
with the participation of our management, including our principal executive
officer and principal financial officer, we conducted an evaluation of the
effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the
period covered by this report (the “Evaluation Date”).  Based upon the
evaluation, our principal executive officer and principal financial officer
concluded as of the Evaluation Date that our disclosure controls and procedures
were effective to ensure that information required to be disclosed by us in
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms.
 
 There
were no changes in our internal control over financial reporting (as defined in
Exchange Act Rule 13a-15(f)) during the three and nine months ended
September 28, 2008 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.
 
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  PART
II.  OTHER INFORMATION
 Item
      1.
              Legal
Proceedings
 
 For
a discussion of legal proceedings, see Note 13,
“Litigation,” in the Notes to the Condensed Consolidated Condensed Financial
Statements of this Form 10-Q.
 
 Item
      1A.
              Risk
Factors
 The
following description of the risk factors associated with our business includes
any material changes to and supersedes the description of the risk factors
associated with our business previously disclosed in Part 1, Item 1A of our
Annual Report on Form 10-K for the fiscal year ended December 30,
2007.
 
 Our operating
resultsmayfluctuate
significantly, whichmayadversely affect our
financial condition and our stock price.  Our quarterly and
annual operating results have fluctuated significantly in the past and we expect
that they will continue to fluctuate in the future.  Our results of
operations are subject to fluctuations and other risks, including, among
others:
 
 ·
              competitive
      pricing pressures and industry or our excess supply, resulting in
      significantly lower average selling prices and lower or negative product
      gross margins;
  ·
              significant
      reduction in demand due to a prolonged and severe global economic
      downturn, or other conditions;
  ·
              reduction
      in price elasticity of demand related to pricing changes for our markets
      and products;
  ·
              our
      license and royalty revenues may decline significantly in the future as
      our existing license agreements and key patents expire or if licensees
      fail to perform on a portion or all of their contractual obligations,
      which may also lead to increased patent litigation
  costs;
  ·
              reduced
      sales to our customers due to continued declines in consumer confidence or
      worldwide economic weakness;
  ·
              inability
      to match our captive memory output to overall market demand for our
      products, which could result in write-downs for excess inventory, lower of
      cost or market reserves, fixed costs associated with our investments,
      restructuring of our joint ventures with Toshiba, or other
      actions;
  ·
              inability
      to complete definitive agreements with Toshiba in a timely manner, or at
      all, to restructure our flash memory joint ventures related to our MOU
      with Toshiba dated October 20,
2008;
  ·
              inability
      to reduce operating expenses to reflect the current environment while
      continuing to invest in future technologies and
  products;
  ·
              expansion
      of supply from existing competitors and ourselves creating excess market
      supply, causing our average selling prices to decline faster than our
      costs;
  ·
              inability
      to develop or unexpected difficulties or delays in developing or
      manufacturing with acceptable yields, X3, X4, 3D Read/Write, or other
      advanced, alternative technologies or difficulty in bringing advanced
      technologies into volume production at cost competitive
      levels;
  ·
              increased
      memory component and other costs as a result of currency exchange rate
      fluctuations to the U.S. dollar, particularly with respect to the Japanese
      yen;
  ·
              increased
      purchases of non-captive flash memory, including due to our plan to
      restructure and slow the growth of captive capacity, which typically costs
      more than captive flash memory and may be of less consistent
      quality;
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  ·
              unpredictable
      or changing demand for our products, particularly demand for certain types
      or capacities of our products or demand for our products in certain
      markets or geographies;
  ·
              difficulty
      in forecasting and managing inventory levels, particularly due to
      noncancelable contractual obligations to purchase materials such as custom
      non-memory materials, and the need to build finished product in advance of
      customer purchase orders;
  ·
              timing,
      volume and cost of wafer production from Flash Ventures as impacted by fab
      start-up delays and costs, technology transitions, yields or production
      interruptions;
  ·
              disruption
      in the manufacturing operations of suppliers, including suppliers of
      sole-sourced components;
  ·
              potential
      delays in the emergence of new markets and products for NAND flash memory
      and acceptance of our products in these
markets;
  ·
              timing
      of sell-through by our distributors and retail
  customers;
  ·
              errors
      or defects in our products caused by, among other things, errors or
      defects in the memory or controller components, including memory and
      non-memory components we procure from third-party
    suppliers;
  ·
              write-downs
      or impairments of our investments in fabrication capacity, equity
      investments and other assets;
  ·
              impairment
      of goodwill and/or intangible assets related to our
      acquisitions;
  ·
              insufficient
      assembly and test capacity from our contract manufacturers or our Shanghai
      facility; and
  ·
              other
      factors described under “Risk Factors” and elsewhere in this
      report.
  
 Competitive pricing
pressuresand industry orourexcess supply have
resulted inloweraverage selling
pricesand negative product
gross marginswhich may
continue.  The NAND flash memory industry is currently
experiencing a downturn, resulting in supply exceeding demand, leading to
significant declines in average selling prices.  For example, our
average selling price per gigabyte for product revenues declined 63% in the
third quarter of fiscal year 2008 compared to the same period in fiscal year
2007.  Price declines may be influenced by, among other factors,
supply exceeding demand, macroeconomic factors, technology transitions,
conversion of industry DRAM capacity to NAND and new technologies or other
strategic actions by us or our competitors to gain market share.  In
the third quarter of fiscal year 2008, we experienced negative product gross
margins.  We are expecting a continuation of aggressive industry
pricing.  If our technology transitions take longer or are more costly
than anticipated to complete, or our cost reductions continue to fail to keep
pace with the rate of price declines, our gross margins and operating results
will continue to be negatively impacted, leading to quarterly or annual net
losses.  Over our history, price decreases have generally been more
than offset by increased unit demand and demand for products with increased
storage capacity.  However, in the recent past, price declines have
outpaced growth in unit demand and demand for higher capacities for some
products resulting in reduced revenue growth or revenue
declines.  There can be no assurance that current and future price
reductions will result in sufficient demand for increased product capacity or
unit sales, which could harm our margins and revenue.
 
 We have incurred
negative product gross margins and net losses, which may continue to reduce our
cash flows and harm our financial condition. In the third quarter
of fiscal year 2008, we had negative product gross margins due to sustained
aggressive industry price declines as well as higher inventory charges primarily
due to lower of cost or market write downs.  As a result, we incurred a net
loss of $155.2 million in the third quarter of fiscal year 2008.  We
expect product gross margins to continue to be negative in the fourth quarter of
fiscal year 2008 and likely into the first half of fiscal year
2009.  Our ability to return to or sustain profitability on a
quarterly or annual basis in the future depends in part on industry and our
supply/demand balance, our ability to develop new products, the rate of growth
of our target markets, the competitive position of our products, the continued
acceptance of our products by our customers, and our ability to manage expenses.
 If we fail to return to profitability, the continued operating losses will
reduce our cash flows and negatively harm our business and financial condition.
 If we are unable to generate sufficient cash, we may have to reduce,
curtail or terminate certain business activities.
 
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  Sales to a small
number of customers represent a significant portion of our revenues, and if we
were to lose one of our major licensees or customers or experience any material
reduction in orders from any of our customers, our revenues and operating
results would suffer.  Our ten largest
customers represented approximately 49% and 47% of our total revenues in the
three and nine months ended September 28, 2008, respectively, compared to
44% and 47% in the three and nine months ended September 30,
2007.  In the three and nine months ended September 28, 2008,
revenue from Samsung Electronics Co. Ltd., or Samsung, which included both
license and royalty revenues and product revenues, accounted for 13% of our
total revenues in each period, respectively.  No other customer
exceeded 10% of our total revenues during those periods.  No customer
exceeded 10% of our total revenues in the three months ended September 30,
2007.  Customers who exceeded 10% of our total revenues in the nine
months ended September 30, 2007 were Sony Ericsson Mobile Communications
AB, or Sony Ericsson, and Samsung, each of which were 10% of our total
revenues.  The composition of our major customer base has changed over
time, and we expect this pattern to continue as our markets and strategies
evolve.  If we were to lose one of our major customers or licensees,
or experience any material reduction in orders from any of our customers or in
sales of licensed products by our licensees, our revenues and operating results
would suffer.  Additionally, our license and royalty revenues may
decline significantly in the future as our existing license agreements and key
patents expire or if licensees fail to perform on a portion or all of their
contractual obligations.  Our sales are generally made from standard
purchase orders rather than long-term contracts.  Accordingly, our
customers may generally terminate or reduce their purchases from us at any time
without notice or penalty.  In addition, the composition of our major
customer base changes from year-to-year as we enter new markets, making our
revenues from these major customers less predictable from
year-to-year.
 
 Our business depends
significantly upon sales through retailers and distributors, and if our
retailers and distributors are not successful, we could experiencereduced
sales,substantial product returnsor increased price
protection, any ofwhich would
negatively impact our business, financial condition and results of
operations.A
significant portion of our sales are made through retailers, either directly or
through distributors.  Sales through these channels typically include
rights to return unsold inventory and protection against price declines, as well
as participation in various cooperative marketing programs.  As a
result, we do not recognize revenue until after the product has been sold
through to the end user, in the case of sales to retailers, or to our
distributors’ customers, in the case of sales to distributors.  Price
protection against declines in our selling prices has the effect of reducing our
deferred revenues and eventually, our revenues.  If our retailers and
distributors are not successful, due to weak consumer retail demand caused by
the current worldwide economic downturn, decline in consumer confidence, or
other factors, we could continue to experience reduced sales as well as
substantial product returns or price protection claims, which would harm our
business, financial condition and results of operations.  Except in
limited circumstances, we do not have exclusive relationships with our retailers
or distributors, and therefore, must rely on them to effectively sell our
products over those of our competitors.  Certain of our retail and
distributor partners are experiencing financial difficulty and prolonged negativeeconomic conditions could
cause liquidity issues for our retail and distributor customers and
channels.  Changes in the credit worthiness, access to available
credit or the failure of any of our significant retail or distribution partners
would harm our revenue and our ability to collect on outstanding receivable
balances.  Additionally, to the degree that the recent turmoil in the
credit markets makes it more difficult for some customers to obtain financing,
those customers’ ability to pay could be adversely impacted, which in turn could
have a material adverse impact on our business, operating results, and financial
condition.
 
 We may be unable to
license intellectual property to or from third parties as needed, which could
expose us to liability for damages, increase our costs or limit or prohibit us
from selling products.  If we incorporate third-party
technology into our products or if we are found to infringe others’ intellectual
property, we could be required to license intellectual property from a third
party.  We may also need to license some of our intellectual property
to others in order to enable us to obtain important cross-licenses to
third-party patents.  We cannot be certain that licenses will be
offered when we need them, that the terms offered will be acceptable, or that
these licenses will help our business.  If we do obtain licenses from
third parties, we may be required to pay license fees or royalty
payments.  In addition, if we are unable to obtain a license that is
necessary to manufacture our products, we could be required to suspend the
manufacture of products or stop our product suppliers from using processes that
may infringe the rights of third parties.  We may not be successful in
redesigning our products, or the necessary licenses may not be available under
reasonable terms.
 
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  We may be unable to
renew existing licenses, which could reduce ourlicense androyalty
revenues.Our
license and royalty revenues currently comprise the majority of our operating
margin and cash provided by operating activities.  If our existing
licensees do not renew their licenses upon expiration and we are not successful
in signing new licensees in the future, our license revenue, profitability, and
cash provided by operating activities would be harmed.  Our current
license agreement with Samsung expires in August 2009, and to the extent
that we are unable to renew this agreement under similar terms or at all, our
financial results would be adversely impacted by the reduced license and royalty
revenue and the significant patent litigation costs to enforce our patents
against and renew our license agreement with Samsung.
 
 We may be
unableto complete definitive agreements related to our MOU with Toshiba dated October
20, 2008 in a timely manner, or at all.On October 20, 2008,
we entered into a non-binding MOU with Toshiba to sell approximately 30% of the
current combined manufacturing capacity of Flash Partners and Flash Alliance in
order to reduce excess inventory and our future production
commitments.  See Note 15, “Subsequent Event,” in the Notes to the
Condensed Consolidated Financial Statements of this Form
10-Q.  However, if we fail to complete the binding definitive
agreements with Toshiba on a timely basis, or at all, we may continue to
experience significant excess inventory and production commitments and we would
not receive the expected cash and reduction in lease
obligations.  Failure to reduce our excess inventory and production
commitments and the loss of liquidity that the definitive agreements related to
the MOU are expected to provide, could result in a material adverse effect on
our business, financial condition and results of operations.
 
 Our financial
performance depends significantly on worldwide economic conditions and the
related impact on levels of consumer spending, whichhasrecently
deteriorated significantly in many countries and regions, including theUnited
States,
and may remain depressed for the foreseeable future.Demand for our
products is adversely affected by negative macroeconomic factors affecting
consumer spending.  The severe tightening of consumer credit, low
level of consumer liquidity, and extreme volatility in credit and equity markets
have resulted in weakening of consumer confidence and decreased consumer
spending.  These and other economic factors have reduced demand for
our products and harmed our business, financial condition and results of
operations, and to the extent such economic conditions continue, they could
cause further harm to our business, financial condition and results of
operations.
 
 Our revenues depend
in part on the success of products soldby our OEM
customers.  A significant portion of our sales are to OEMs,
which either bundle or embed our flash memory products with their products, such
as mobile phones, global positioning system, or GPS, devices and
computers.  Our sales to these customers are dependent upon the OEMs
choosing our products over those of our competitors and on the OEMs’ ability to
create, introduce, market and sell their products successfully in their
markets.  Should our OEM customers be unsuccessful in selling their
current or future products that include our products, or should they decide to
discontinue using our products, our results of operation and financial condition
could be harmed.
 
 The continued growth
of our business depends onthedevelopment and
performance of new markets and products for NAND flash.Our
growth is dependent on development of new markets, new applications and new
products for NAND flash memory.  Historically, the digital camera
market provided the majority of our revenues, but it is now a more mature market
representing a declining percentage of our total revenues, and the mobile
handset market has emerged as the largest segment of our
revenues.  Other markets for flash memory include digital audio and
video players, universal serial bus, or USB, drives and solid state
drives.  We cannot assure you that the use of flash memory in mobile
handsets or other existing markets and products will develop and grow fast
enough, or that new markets will adopt NAND flash technologies in general or our
products in particular, to enable us to grow.  In addition, there can
be no assurance that the increase in average product capacity and unit demand in
response to price reductions will again generate revenue growth for us as it has
in the past.
 
 Our
growth is also dependent on continued geographic expansion and we may face
difficulties entering or maintaining sales in international
markets.  In recent periods prior to the third quarter, our sales have
grown faster internationally than in the United States.  Some
international markets are subject to a higher degree of commodity pricing than
in the United States, subjecting us to increased risk of pricing and margin
pressure.
 
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  Our strategy of
investing in captive manufacturing sources could harm us if our competitors are
able to produce products at lower costs or if industry supply exceeds
demand.  We secure captive sources of NAND through our
significant investments in manufacturing capacity.  We believe that by
investing in captive sources of NAND, we are able to develop and obtain supply
at the lowest cost and access supply during periods of high
demand.  Our significant investments in manufacturing capacity may
require us to obtain and guarantee capital equipment leases and use available
cash, which could be used for other corporate purposes.  To the extent
we secure manufacturing capacity and supply that is in excess of demand, or our
cost is not competitive with other NAND suppliers, we may not achieve an
adequate return on our significant investments and our revenues, gross margins
and related market share may be negatively impacted.  We may also
incur increased inventory or impairment charges related to our captive
manufacturing investments and may not be able to exit those investments without
significant cost to us.  For example, in the third quarter of fiscal
year 2008, we took an impairment on our FlashVision investment of
$10.4 million due to FlashVision’s difficulty in selling its excess capital
equipment due to deteriorating market conditions and we recorded inventory
related charges of $109.0 million for inventory expected to sell below
cost, excess inventory and inventory commitments.  In addition, if we
finance manufacturing investments with debt, our return may not be sufficient to
finance the related debt payments or we may need to raise additional funding,
which could be difficult to obtain or may only be available at rates and other
terms that are unfavorable.
 
 We continually seek
to develop new applications, products, technologies and standards, which may not
be widely adopted by consumers or, if adopted, may reduce demand for our older
products; and our competitors seek to develop new standards which could reduce
demand for our products.We continually devote significant
resources to the development of new applications, products and standards and the
enhancement of existing products and standards with higher memory capacities and
other enhanced features.  Any new applications, products,
technologies, standards or enhancements we develop may not be commercially
successful.  The success of new product introductions is dependent on
a number of factors, including market acceptance, our ability to manage risks
associated with new products and production ramp issues.  New
applications, such as the adoption of flash-based solid state drives, or SSDs,
that are designed to replace hard disk drives in devices such as computers and
servers, can take several years to develop.  We cannot guarantee that
manufacturers will adopt SSDs or that this market will grow as we
anticipate.  For the SSD market to become sizeable, the cost of flash
memory must decline significantly so that the cost to consumers is competitive
with the cost of hard disk drives.  We believe this will require us to
implement multi-level cell, or MLC, technology into our SSDs, which will require
us to develop new controllers.  There can be no assurance that our
MLC-based SSDs will be able to meet the specifications required to gain customer
qualification and acceptance or will be delivered to the market on a timely
basis as compared with our competitors.  Other new products, such as
slotMediaTM, our
pre-recorded flash memory cards, may not gain market acceptance, and we may not
be successful in penetrating the new markets that we target.  For
example, our Sansa®ConnectTM product,
a Wi-Fi® enabled
MP3 player, did not achieve market acceptance or our expected sales
volume.
 
 New
applications may require significant up-front investment with no assurance of
long-term commercial success or profitability.  As we introduce new
standards or technologies, it can take time for these new standards or
technologies to be adopted, for consumers to accept and transition to these new
standards or technologies and for significant sales to be generated, if at
all.
 
 Competitors
or other market participants could seek to develop new standards for flash
memory products that, if accepted by device manufacturers or consumers, could
reduce demand for our products.  For example, certain handset
manufacturers and flash memory chip producers are currently advocating the
development of a new standard, referred to as Universal Flash Storage, or UFS,
for flash memory cards used in mobile phones.  Intel Corporation, or
Intel, and Micron Technology, Inc., or Micron, have also developed a new
specification for a NAND flash interface, called Open NAND Flash Interface, or
ONFI, which would be used primarily in computing devices.  Broad
acceptance of new standards, technologies or products may reduce demand for some
of our products.  If this decreased demand is not offset by increased
demand for new form factors or products that we offer, our results of operations
would be harmed.
 
 Alternative
storage solutions such as high bandwidth wireless or internet-based storage
could reduce the need for physical flash storage within electronic
devices.  These alternative technologies could negatively impact the
overall market for flash-based products, which could seriously harm our results
of operations.
 
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  Consumer
devices that use NAND flash memory do so in either a removable card or an
embedded format.  We offer NAND flash memory products in both
categories; however, our market share is strongest for removable flash memory
products.  If designers and manufacturers of consumer devices,
including mobile phones, increase their usage of embedded flash memory, we may
not be able to sustain our market share.  In addition, if NAND flash
memory is used in an embedded format, we would have less opportunity to
influence the capacity of the NAND flash products and we would not have the
opportunity for additional after-market retail sales related to these consumer
devices or mobile phones.  Any loss of market share or reduction in
the average capacity of our product sales or any loss in our retail after-market
opportunity could harm our operating results and business
condition.
 
 We
are developing new generations of MLC technology, including 3-bits per cell, or
X3, and 4-bits per cell, or X4.  We believe the successful
introduction of X3 and X4 technology may be required in order to achieve the
level of future cost reductions necessary for the further adoption of flash
memory in consumer applications and to reduce our costs to the level necessary
to achieve and maintain profitability.  The performance, reliability,
yields and time-to-market of X3 and X4 technologies are uncertain, and there can
be no assurance of the commercial success of these technologies.
 
 In
addition, we are investing in future alternative technologies, such as our
three-dimensional semiconductor memory, which currently is limited to one-time
programmable applications.  We are investing significant resources to
develop this technology for multiple read-write applications; however, there can
be no assurance that we will be successful in developing these alternative
technologies or that we will be able to achieve the yields, quality or capacity
required for this technology to be cost competitive with new or other
alternative memory technologies.
 
 We face competition
from numerous manufacturers and marketers of products using flash memory, as
well as from manufacturers of new and alternative technologies, and if we cannot
compete effectively, our results of operations and financial condition will
suffer.  Our competitors include many large companies that may
have greater advanced wafer manufacturing capacity and substantially greater
financial, technical, marketing and other resources than we do, which allows
them to produce flash memory chips in high volumes at low costs and to sell
these flash memory chips themselves or to our flash card competitors at a low
cost.  Some of our competitors may sell their flash memory chips at or
below their true manufacturing costs to gain market share and to cover their
fixed costs.  Such practices occurred in the DRAM industry during
periods of excess supply and resulted in substantial losses in the DRAM
industry.  Our primary semiconductor competitors include Hynix
Semiconductor Inc., or Hynix, IM Flash Technologies, or IM Flash, Micron,
Numonyx B.V., Samsung and Toshiba.  We, along with Hynix, IM Flash,
Samsung and Toshiba, are increasing NAND output and are expected to continue to
produce significant NAND output in the future.  In addition, current
and future competitors produce or could produce alternative flash or other
memory technologies that compete against our NAND flash memory technology or our
alternative technologies, which may reduce demand or accelerate price declines
for NAND.  Furthermore, the future rate of scaling of the NAND flash
technology design that we employ may slow down significantly, which would slow
down cost reductions that are fundamental to the adoption of flash memory
technology in new applications.  If the scaling of NAND slows down or
alternative technologies prove to be more economical, our business would be
harmed, and our investments in captive fabrication facilities could be
impaired.
 
 We
also compete with flash memory card manufacturers and resellers.These
companies purchase or have a captive supply of flash memory components and
assemble memory cards.  Our primary competitors currently include,
among others, A-Data Technology Co., Ltd., Buffalo Technology, Inc., Chips and
More GmbH, Dane-Elec Memory, Elecom Co., Ltd., Emtec Magnetics, a subsidiary of
the Dexxon Group, FUJIFILM Corporation, Hagiwara Sys-Con Co., Ltd., Hama
Corporation, Inc., Imation Corporation, or Imation, and its division Memorex
Products, Inc., or Memorex, I/O Data Device, Inc., Kingmax Digital Inc.,
Kingston Technology Company, or Kingston, Eastman Kodak Company, Matsushita
Electric Industrial Co., Ltd. which owns the Panasonic brands, Micron and its
subsidiary Lexar Media, Inc., or Lexar, Netac Technology Co., Ltd., Olympus
Corporation, PNY Technologies, Inc., or PNY, RITEK Corporation, Samsung, Sony
Corporation, or Sony, Toshiba, Tradebrands International, Transcend Information,
Inc., or Transcend, and Verbatim Corporation, or Verbatim.
 
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  Some
of our competitors have substantially greater resources than we do, have well
recognized brand names or have the ability to operate their business on lower
margins than we do.  The success of our competitors may adversely
affect our future revenues or margins and may result in the loss of our key
customers.  For example, Toshiba and other manufacturers have
increased their market share of flash memory cards for mobile phones, including
the microSDTM card,
which have been a significant driver of our growth.  In the digital
audio market, we face competition from well established companies such as Apple,
Inc., ARCHOS Technology, Creative Technologies, Ltd., Microsoft Corporation, or
Microsoft, Samsung and Sony.  In the USB flash drive market, we face
competition from a large number of competitors, including Imation, Kingston,
Koninklijke Philips Electronics N.V., Lexar, Memorex, PNY, Sony, Trek 2000
International Ltd. and Verbatim.  In the market for SSDs, we may face
competition from large NAND flash producers such as Hynix, Intel, Micron,
Samsung and Toshiba, as well as from hard drive manufacturers, such as Hitachi,
Ltd., Seagate Technology, and others, who have established relationships with
computer manufacturers.  We may also face competition from third-party
SSD solutions providers such as Kingston, STEC Inc., and Transcend.
 
 Furthermore,
many companies are pursuing new or alternative technologies or alternative forms
of NAND, such as phase-change technology, charge-trap flash and
millipedes/probes, which may compete with flash memory.  For example,
our competitors are developing new technologies such as charge-trap flash and
three-dimensional technology which if successful and if we are unable to scale
our technology on an equivalent basis, could provide an advantage to these
competitors.
 
 These
new or alternative technologies may enable products that are smaller, have a
higher capacity, lower cost, lower power consumption or have other
advantages. If we
cannot compete effectively, our results of operations and financial condition
will suffer.
 
 We
believe that our ability to compete successfully depends on a number of factors,
including:
 
 ·
              price,
      quality and on-time delivery to our
customers;
  ·
              product
      performance, availability and
differentiation;
  ·
              success
      in developing new applications and new market
  segments;
  ·
              sufficient
      availability of supply, the absence of which could lead to loss of market
      share;
  ·
              efficiency
      of production;
  ·
              timing
      of new product announcements or introductions by us, our customers and our
      competitors;
  ·
              the
      ability of our competitors to incorporate standards or develop formats
      which we do not offer;
  ·
              the
      number and nature of our competitors in a given
  market;
  ·
              successful
      protection of intellectual property rights;
and
  ·
              general
      market and economic conditions.
  
 There
can be no assurance that we will be able to compete successfully in the
future.
 
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  The semiconductor
industry is subject to significant downturns that have harmed our business,
financial condition and results of operations in the past and may do so in the
future.  The semiconductor industry is highly cyclical and is
characterized by constant and rapid technological change, rapid product
obsolescence, price declines, evolving standards, short product life cycles and
wide fluctuations in product supply and demand.  The industry has
experienced significant downturns, often in connection with, or in anticipation
of, maturing product cycles of both semiconductor companies’ and their
customers’ products and declines in general economic conditions.  The
flash memory industry is currently experiencing significant excess supply,
reduced demand, high inventory levels, and accelerated declines in selling
prices.  If the oversupply of NAND flash products continues, we may be
forced to hold excessive inventory, sell our inventory below cost, and record
inventory write-downs, all of which would place additional pressure on our
results of operation and our cash position.  We are currently
experiencing these conditions in our business and may experience such downturns
in the future.
 
 Our business and the
markets we address are subject to significant fluctuations in supply and demand
and our commitments to our flash ventures with Toshiba may result in periods of
significant excess inventory.The start of production at Fab 4
at the end of fiscal year 2007 and the continuing ramp of production has
increased our captive supply and resulted in excess inventory in the first nine
months of fiscal year 2008.  Our obligation to purchase 50% of the
supply from Flash Ventures could continue to harm our business and results of
operations if our committed supply exceeds demand for our
products.  The adverse effects could include, among other things,
significant decreases in our product prices, and significant excess, obsolete or
lower of cost or market inventory write-downs, such as those we experienced in
the third quarter of fiscal year 2008, which would harm our gross margins and
could result in the impairment of our investments in Flash
Ventures.
 
 We depend onour
Flash Ventures and third partiesfor silicon supply
and any disruption or shortage in our supply from these sources will reduce our
revenues, earnings and gross margins.  All of our flash memory
products require silicon supply for the memory and controller
components.  The substantial majority of our flash memory is currently
supplied by Flash Ventures and to a much lesser extent by third-party silicon
suppliers.  Any disruption or shortage in supply of flash memory from
our captive or non-captive sources would harm our operating
results.  The risks of supply disruption are magnified at Toshiba’s
Yokkaichi, Japan operations, where Flash Ventures are operated and Toshiba’s
foundry capacity is located.  Earthquakes and power outages have
resulted in production line stoppages and loss of wafers in Yokkaichi and
similar stoppages and losses may occur in the future.  For example, in
the first quarter of fiscal year 2006, a brief power outage occurred at Fab 3,
which resulted in a loss of wafers and significant costs associated with
bringing the fab back on line.  In addition, the Yokkaichi location is
often subject to earthquakes, which could result in production stoppage, a loss
of wafers and the incurrence of significant costs.  Moreover,
Toshiba’s employees that produce Flash Ventures’ products are covered by
collective bargaining agreements and any strike or other job action by those
employees could interrupt our wafer supply for Flash
Ventures.  Furthermore, in July 2008, we announced that we have
decided to slow our captive supply growth, including delaying Fab 4 expansion
and any investment in Fab 5.  If we fail to make timely investments in
future capacity additions or our non-captive sources fail to supply wafers in
the amounts and at the times we expect, we may not have sufficient supply to
meet demand and our operating results could be harmed.
 
 Currently,
our controller wafers are manufactured by Semiconductor Manufacturing
International Corporation, Taiwan Semiconductor Manufacturing Corporation, Tower
Semiconductor Ltd., or Tower, and United Microelectronics
Corporation.  The Tower fabrication facility, from which we source
controller wafers, is continuing to face financial challenges and is located in
Israel, an area of political and military turmoil.  Any disruption in
the manufacturing operations of Tower or one of our other controller wafer
vendors would result in delivery delays, adversely affect our ability to make
timely shipments of our products and harm our operating results until we could
qualify an alternate source of supply for our controller wafers, which could
take several quarters to complete.  In times of significant growth in
global demand for flash memory, demand from our customers may outstrip the
supply of flash memory and controllers available to us from our current
sources.  If our silicon vendors are unable to satisfy our
requirements on competitive terms or at all, we may lose potential sales and our
business, financial condition and operating results may suffer.  Any
disruption or delay in supply from our silicon sources could significantly harm
our business, financial condition and results of operations.
 
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  If actual
manufacturing yields are lower than our expectations, this may result in
increased costs and product shortages.  The fabrication of our
products requires wafers to be produced in a highly controlled and ultra clean
environment.  Semiconductor manufacturing yields and product
reliability are a function of both design technology and manufacturing process
technology and production delays may be caused by equipment malfunctions,
fabrication facility accidents or human errors.  Yield problems may
not be identified or improved until an actual product is made and can be
tested.  As a result, yield problems may not be identified until the
wafers are well into the production process.  We have from
time-to-time experienced yields that have adversely affected our business and
results of operations.  We have experienced adverse yields on more
than one occasion when we have transitioned to new generations of
products.  If actual yields are low, we will experience higher costs
and reduced product supply, which could harm our business, financial condition
and results of operations.  For example, if the production ramp and/or
yield of 56-nanometer or 43-nanometer X3 technology wafers and 43-nanometer or
32-nanometer 2-bits per cell, or X2, technology wafers do not increase as
expected in fiscal years 2008 and 2009, our cost competitiveness would be
harmed, we may not have adequate supply or the right product mix to meet demand,
and our business, financial condition and results of operations will be
harmed.
 
 We depend on our
third-party subcontractors and our business could be harmed if our
subcontractors do not perform as planned.We rely on
third-party subcontractors for much of our wafer testing, IC assembly, packaged
testing, product assembly, product testing and order
fulfillment.  From time-to-time, our subcontractors have experienced
difficulty meeting our requirements.  If we are unable to increase the
capacity of our current subcontractors or qualify and engage additional
subcontractors, we may not be able to meet demand for our
products.  We do not have long-term contracts with our existing
subcontractors nor do we expect to have long-term contracts with any new
subcontract suppliers.  We do not have exclusive relationships with
any of our subcontractors, and therefore, cannot guarantee that they will devote
sufficient resources to manufacturing our products.  We are not able
to directly control product delivery schedules.  Furthermore, we
manufacture on a turnkey basis with some of our subcontract
suppliers.  In these arrangements, we do not have visibility and
control of their inventories of purchased parts necessary to build our products
or of the progress of our products through their assembly line.  Any
significant problems that occur at our subcontractors, or their failure to
perform at the level we expect, could lead to product shortages or quality
assurance problems, either of which would have adverse effects on our operating
results.
 
 We have a captive
assembly and test manufacturing facility inChina.Our
reliance on our captive assembly and test manufacturing facility near Shanghai,
China has increased significantly during fiscal year 2008 as we utilize this
factory to satisfy an increasing proportion of our assembly and test
requirements, and also to produce products with leading-edge technologies such
as multi-stack die packages.  Any delays or interruptions in the
production ramp or targeted yields or any quality issues at our captive facility
could harm our results of operations and financial condition.
 
 In transitioning to
new processes, products and silicon sources, we face production and market
acceptance risks that may cause significant product delays, cost overruns or
performance issues that could harm our business.Successive generations
of our products have incorporated semiconductors with greater memory capacity
per chip.  The transition to new generations of products, such as
products containing 32-nanometer X2 technology or 43-nanometer X3 technology, is
highly complex and requires new controllers, new test procedures and
modifications of numerous aspects of manufacturing, as well as extensive
qualification of the new products by both us and our OEM
customers.  There can be no assurance that these transitions or other
future technology transitions will occur on schedule or at the yields or costs
that we anticipate.  If Flash Partners or Flash Alliance encounters
difficulties in transitioning to new technologies, our cost per gigabyte may not
remain competitive with the costs achieved by other flash memory producers,
which would harm our gross margins and financial results.  Any
material delay in a development or qualification schedule could delay deliveries
and adversely impact our operating results.  We periodically have
experienced significant delays in the development and volume production ramp-up
of our products.  Similar delays could occur in the future and could
harm our business, financial condition and results of operations.
 
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  Our products may
contain errors or defects, which could result in the rejection of our products,
product recalls, damage to our reputation, lost revenues, diverted development
resources and increased service costs and warranty claims and
litigation.  Our products are complex, must meet stringent user
requirements, may contain errors or defects and the majority of our products are
warrantied for one to five years.  Errors or defects in our products
may be caused by, among other things, errors or defects in the memory or
controller components, including components we procure from non-captive
sources.  In addition, the substantial majority of our flash memory is
supplied by Flash Ventures, and if the wafers contain errors or defects, our
overall supply could be adversely affected.  These factors could
result in the rejection of our products, damage to our reputation, lost
revenues, diverted development resources, increased customer service and support
costs and warranty claims and litigation.  We record an allowance for
warranty and similar costs in connection with sales of our products, but actual
warranty and similar costs may be significantly higher than our recorded
estimate and result in an adverse effect on our results of operations and
financial condition.
 
 Our
new products have from time-to-time been introduced with design and production
errors at a rate higher than the error rate in our established
products.  We must estimate warranty and similar costs for new
products without historical information and actual costs may significantly
exceed our recorded estimates.  Warranty and similar costs may be even
more difficult to estimate as we increase our use of non-captive
supply.  Underestimation of our warranty and similar costs would have
an adverse effect on our results of operations and financial
condition.
 
 Ourremaininginvestment ofapproximately
$51.0million in our
FlashVision venture may not be recoverable.In the second quarter
of fiscal year 2008, we determined that the production of NAND flash memory
products utilizing 200-millimeter wafers is no longer cost effective for our
products and signed an agreement with Toshiba to wind-down our FlashVision
venture.  As of the end of May 2008, the operations of FlashVision were
discontinued and a plan was put in place to sell or otherwise dispose of all the
tools owned or leased by FlashVision.  In the third quarter of fiscal year
2008, we took an impairment on our investment of $10.4 million due to
FlashVision’s difficulty in selling its excess capital equipment due to
deteriorating market conditions.  As of September 28, 2008, we had an
investment in FlashVision of $51.0 million denominated in Japanese yen,
offset by $27.9 million of cumulative translation adjustments recorded in
OCI.
 
 Seasonality in our
business may result in our inability to accurately forecast our product purchase
requirements.Sales of our products in the consumer electronics market
are subject to seasonality.  For example, sales have typically
increased significantly in the fourth quarter of each fiscal year, sometimes
followed by significant declines in the first quarter of the following fiscal
year.  This seasonality makes it more difficult for us to forecast our
business, especially in the current global economic environment and its
corresponding decline in consumer confidence, which may impact typical seasonal
trends.  If our forecasts are inaccurate, we may lose market share or
procure excess inventory or inappropriately increase or decrease our operating
expenses, any of which could harm our business, financial condition and results
of operations.  This seasonality also may lead to higher volatility in
our stock price, the need for significant working capital investments in
receivables and inventory and our need to build inventory levels in advance of
our most active selling seasons.
 
 From time-to-time,
we overestimate our requirements and build excess inventory, or underestimate
our requirements and have a shortage of supply, either of which harm our
financial results.The majority of our products are sold into
consumer markets, which are difficult to accurately forecast.  Also, a
substantial majority of our quarterly sales are from orders received and
fulfilled in that quarter.  Additionally, we depend upon timely
reporting from our retail and distributor customers as to their inventory levels
and sales of our products in order to forecast demand for our
products.  We have in the past significantly over-forecasted or
under-forecasted actual demand for our products.  The failure to
accurately forecast demand for our products will result in lost sales or excess
inventory, both of which will have an adverse effect on our business, financial
condition and results of operations.  In addition, at times inventory
may increase in anticipation of increased demand or as captive wafer capacity
ramps.  If demand does not materialize, we may be forced to write-down
excess inventory or write-down inventory to the lower of cost or market, as was
the case in the third quarter of fiscal year 2008, which may harm our financial
condition and results of operations.
 
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  During
periods of excess supply in the market for our flash memory products, we may
lose market share to competitors who aggressively lower their
prices.  In order to remain competitive, we may be forced to sell
inventory below cost.  If we lose market share due to price
competition or we must write-down inventory, our results of operations and
financial condition could be harmed.  Conversely, under conditions of
tight flash memory supply, we may be unable to adequately increase our
production volumes or secure sufficient supply in order to maintain our market
share.  If we are unable to maintain market share, our results of
operations and financial condition could be harmed.
 
 Our
ability to respond to changes in market conditions from our forecast is limited
by our purchasing arrangements with our silicon sources.  Some of
these arrangements provide that the first three months of our rolling six-month
projected supply requirements are fixed and we may make only limited percentage
changes in the second three months of the period covered by our supply
requirement projections.
 
 We
have some non-silicon components which have long lead times requiring us to
place orders several months in advance of our anticipated demand.  The
extended period of time to secure these long lead time parts increases our risk
that forecasts will vary substantially from actual demand, which could lead to
excess inventory or loss of sales.
 
 We are sole-sourced
for a number of our critical components and the absence of a back-up supplier
exposes our supply chain to unanticipated disruptions.  We rely
on our vendors, some of which are a sole source of supply, for many of our
critical components, such as certain controllers for our CompactFlash® and USB
products.  We do not have long-term supply agreements with most of
these vendors.  Our business, financial condition and operating
results could be significantly harmed by delays or reductions in shipments if we
are unable to obtain sufficient quantities of these components or develop
alternative sources of supply.
 
 Our global
operations and operations at Flash Ventures and third-party subcontractors are
subject to risks for which we may not be adequately
insured.Our global operations are subject to many risks
including errors and omissions, infrastructure disruptions, such as large-scale
outages or interruptions of service from utilities or telecommunications
providers, supply chain interruptions, third-party liabilities and fires or
natural disasters.  No assurance can be given that we will not incur
losses beyond the limits of, or outside the scope of, coverage of our insurance
policies.  From time-to-time, various types of insurance have not been
available on commercially acceptable terms or, in some cases, have been
unavailable.  We cannot assure you that in the future we will be able to
maintain existing insurance coverage or that premiums will not increase
substantially.  We maintain limited insurance coverage and in some cases no
coverage for natural disasters and sudden and accidental environmental damages
as these types of insurance are sometimes not available or available only at a
prohibitive cost.  Accordingly, we may be subject to an uninsured or
under-insured loss in such situations.  We depend upon Toshiba to
obtain and maintain sufficient property, business interruption and other
insurance for Flash Ventures.  If Toshiba fails to do so, we could suffer
significant unreimbursable losses, and such failure could also cause Flash
Ventures to breach various financing covenants.  In addition, we
insure against property loss and business interruption resulting from the risks
incurred at our third-party subcontractors; however, we have limited control as
to how those sub-contractors run their operations and manage their risks, and as
a result, we may not be adequately insured.
 
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  We are exposed to
foreign currency exchange rate fluctuations that could negatively impact our
business, results of operations and financial condition.  A
significant portion of our business is conducted in currencies other than the
U.S. dollar which exposes us to adverse movements in foreign currency exchange
rates.  These exposures may change over time as our business and
business practices evolve, and they could have a material adverse impact on our
financial results and cash flows.  Our most significant exposure is
related to our purchases of NAND flash memory from Flash Ventures, which are
denominated in Japanese yen.  In the first nine months of fiscal year
2008, the Japanese yen has appreciated relative to the U.S. dollar and this has
increased our costs of NAND flash wafers, negatively impacting our gross margins
and results of operations.  In addition, our investments in Flash
Ventures are denominated in Japanese yen and adverse changes in the exchange
rate could increase the cost to us of future funding.  We also have
foreign currency exposures related to certain non-dollar-denominated revenue and
operating expenses in Europe and Asia.  Additionally, we have
exposures to emerging market currencies, which can have extreme currency
volatility.  An increase in the value of the U.S. dollar could
increase the real cost to our customers of our products in those markets outside
the United States where we sell in dollars, and a weakened dollar could increase
the cost of local operating expenses and procurement of raw materials to the
extent that we must purchase components in foreign currencies.  We
also have significant monetary assets and liabilities that are denominated in
non-functional currencies.
 
 We
enter into foreign exchange forward and options contracts to reduce the
short-term impact of foreign currency fluctuations on certain foreign currency
receivables, and payables. In addition, we currently hedge certain anticipated
foreign currency cash flows.  We generally have not hedged our future
investments and distributions denominated in Japanese yen related to our Flash
Ventures.
 
 Our
attempts to hedge against currency risks may not be successful, resulting in an
adverse impact on our net income.  In addition, if we do not
successfully manage our hedging program in accordance with current accounting
guidelines, we may be subject to adverse accounting treatment of our hedging
program, which could harm our results of operations and financial
condition.  There can be no assurance that this hedging program will
be economically beneficial to us.  Further, the availability of
foreign exchange credit lines from financial institutions is based upon
available credit.  Continued Company operating losses, third party
credit rating downgrades of the Company or continued instability in the
worldwide financial markets could impact our ability to effectively manage our
foreign currency exchange rate fluctuation risk, which could negatively impact
our business, results of operations and financial
condition.
 
 Our goodwill and
other intangible assets could become impaired, which may require us to take
significant non-cash charges against earnings.Under current
accounting guidelines, we must assess, at least annually and potentially more
frequently, whether the value of our goodwill and other intangible assets has
been impaired.  Certain events or changes in circumstances could
require us to test the carrying value of our goodwill and other intangible
assets during the interim.  Our stock price has been trading below our
net book value per share and if our stock price remains below net book value per
share, or other negative business factors exist, we may be required to perform
an interim goodwill impairment analysis, which could require an impairment of
goodwill as well as require us to perform an analysis and potentially impair our
other intangibles.  Any impairment of goodwill or other intangible
assets as a result of an impairment analysis would result in a one-time non-cash
charge against earnings which could materially adversely affect our reported
results of operations and our stock price in future periods.  If our
goodwill and intangibles impairment analyses determine that an impairment is
necessary, we could be required to take a charge of up to $1.1 billion,
comprised of up to approximately $844 million of goodwill and up to
approximately $243 million of intangible assets as of September 28,
2008.
 
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  We may be unable to
protect our intellectual property rights, which would harm our business,
financial condition and results of operations.We rely on a
combination of patents, trademarks, copyright and trade secret laws,
confidentiality procedures and licensing arrangements to protect our
intellectual property rights.  In the past, we have been involved in
significant and expensive disputes regarding our intellectual property rights
and those of others, including claims that we may be infringing third-parties’
patents, trademarks and other intellectual property rights.  We expect
that we may be involved in similar disputes in the future.
 
 We
cannot assure you that:
 
 ·
              any
      of our existing patents will not be
invalidated;
  ·
              patents
      will be issued for any of our pending
  applications;
  ·
              any
      claims allowed from existing or pending patents will have sufficient scope
      or strength;
  ·
              our
      patents will be issued in the primary countries where our products are
      sold in order to protect our rights and potential commercial advantage;
      or
  ·
              any
      of our products or technologies do not infringe on the patents of other
      companies.
  
 In
addition, our competitors may be able to design their products around our
patents and other proprietary rights.  We also have patent
cross-license agreements with several of our leading
competitors.  Under these agreements, we have enabled competitors to
manufacture and sell products that incorporate technology covered by our
patents.  While we obtain license and royalty revenue or other
consideration for these licenses, if we continue to license our patents to our
competitors, competition may increase and may harm our business, financial
condition and results of operations.
 
 There
are both flash memory producers and flash memory card manufacturers who we
believe may require a license from us.  Enforcement of our rights
often requires litigation.  If we bring a patent infringement action
and are not successful, our competitors would be able to use similar technology
to compete with us.  Moreover, the defendant in such an action may
successfully countersue us for infringement of their patents or assert a
counterclaim that our patents are invalid or unenforceable.  If we do
not prevail in the defense of patent infringement claims, we could be required
to pay substantial damages, cease the manufacture, use and sale of infringing
products, expend significant resources to develop non-infringing technology,
discontinue the use of specific processes, or obtain licenses to the infringing
technology.
 
 On
October 24, 2007, we initiated two patent infringement actions in the United
States District Court for the Western District of Wisconsin and one action in
the United States International Trade Commission against 25 companies that
manufacture, sell and import USB flash drives, CompactFlash cards, multimedia
cards, MP3/media players and/or other removable flash storage
products.  There can be no assurance that we will be successful in
these litigations, that the validity of the asserted patents will be preserved
or that we will not face counterclaims of the nature described
above.
 
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  We are currently and
may in the future be involved in litigation, including litigation regarding our
intellectual property rights or those of third parties, which may be costly, may
divert the efforts of our key personnel and could result in adverse court
rulings, which could materially harm our business.  We are
involved in a number of lawsuits, including among others, several cases
involving our patents and the patents of third parties.  We are the
plaintiff in some of these actions and the defendant in other of these
actions.  Some of the actions seek injunctions against the sale of our
products and/or substantial monetary damages, which if granted or awarded, could
have a material adverse effect on our business, financial condition and results
of operations.
 
 We
and other companies have been sued in the United States District Court of the
Northern District of California in purported consumer class actions alleging a
conspiracy to fix, raise, maintain or stabilize the pricing of flash memory, and
concealment thereof, in violation of state and federal laws.  The
lawsuits purport to be on behalf of classes of purchasers of flash
memory.  The lawsuits seek restitution, injunction and damages,
including treble damages, in an unspecified amount.
 
 In
addition, in September 2007, we and Dr. Eli Harari, our founder, chairman
and chief executive officer, received grand jury subpoenas issued from the
United States District Court for the Northern District of California indicating
a Department of Justice investigation into possible antitrust violations in the
NAND flash memory industry.  We also received a notice from the
Canadian Competition Bureau that the Bureau has commenced an industry-wide
investigation with respect to alleged anti-competitive activity regarding the
conduct of companies engaged in the supply of NAND flash memory chips to Canada
and requesting that we preserve any records relevant to such
investigation.  We intend to cooperate in these
investigations.  We are unable to predict the outcome of these
lawsuits and investigations.  The cost of discovery and defense in
these actions as well as the final resolution of these alleged violations of
antitrust laws could result in significant liability and expense and may harm
our business, financial condition and results of operations.  For
additional information concerning these proceedings, see Part II, Item 1, “Legal
Proceedings.”
 
 Litigation
is subject to inherent risks and uncertainties that may cause actual results to
differ materially from our expectations.  Factors that could cause
litigation results to differ include, but are not limited to, the discovery of
previously unknown facts, changes in the law or in the interpretation of laws,
and uncertainties associated with the judicial decision-making
process.  If we receive an adverse judgment in any litigation, we
could be required to pay substantial damages and/or cease the manufacture, use
and sale of products.  Litigation, including intellectual property
litigation, can be complex, can extend for a protracted period of time, and can
be very expensive.  Litigation initiated by us could also result in
counter-claims against us, which could increase the costs associated with the
litigation and result in our payment of damages or other judgments against
us.  In addition, litigation may divert the efforts and attention of
some of our key personnel.
 
 We
have been, and expect to continue to be, subject to claims and legal proceedings
regarding alleged infringement by us of the patents, trademarks and other
intellectual property rights of third parties.  From time-to-time we
have sued, and may in the future sue, third parties in order to protect our
intellectual property rights.  Parties that we have sued and that we
may sue for patent infringement may countersue us for infringing their
patents.  If we are held to infringe the intellectual property of
others, we may need to spend significant resources to develop non-infringing
technology or obtain licenses from third parties, but we may not be able to
develop such technology or acquire such licenses on terms acceptable to us or at
all.  We may also be required to pay significant damages and/or
discontinue the use of certain manufacturing or design processes.  In
addition, we or our suppliers could be enjoined from selling some or all of our
respective products in one or more geographic locations.  If we or our
suppliers are enjoined from selling any of our respective products or if we are
required to develop new technologies or pay significant monetary damages or are
required to make substantial royalty payments, our business would be
harmed.
 
 We
may be obligated to indemnify our current or former directors or employees, or
former directors or employees of companies that we have acquired, in connection
with litigation or regulatory or Department of Justice
investigations.  These liabilities could be substantial and may
include, among other things, the costs of defending lawsuits against these
individuals; the cost of defending any shareholder derivative suits; the cost of
governmental, law enforcement or regulatory investigations; civil or criminal
fines and penalties; legal and other expenses; and expenses associated with the
remedial measures, if any, which may be imposed.
 
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  We
continually evaluate and explore strategic opportunities as they arise,
including business combinations, strategic partnerships, collaborations, capital
investments and the purchase, licensing or sale of assets.  Potential
continuing uncertainty surrounding these activities may result in legal
proceedings and claims against us, including class and derivative lawsuits on
behalf of our shareholders.  We may be required to expend significant
resources, including management time, to defend these actions and could be
subject to damages or settlement costs related to these actions.
 
 Moreover,
from time-to-time we agree to indemnify certain of our suppliers and customers
for alleged patent infringement.  The scope of such indemnity varies
but generally includes indemnification for direct and consequential damages and
expenses, including attorneys’ fees.  We may from time-to-time be
engaged in litigation as a result of these indemnification
obligations.  Third-party claims for patent infringement are excluded
from coverage under our insurance policies.  A future obligation to
indemnify our customers or suppliers may have a material adverse effect on our
business, financial condition and results of operations.  For
additional information concerning legal proceedings, see Part II, Item 1, “Legal
Proceedings.”
 
 Because of our
international business and operations, we must comply with numerous
international laws and regulations, and we are vulnerable to political
instability and other risks related to international
operations.  Currently, a large portion of our revenues is
derived from our international operations, and all of our products are produced
overseas in China, Israel, Japan, South Korea and Taiwan.  We are,
therefore, affected by the political, economic, labor, environmental, public
health and military conditions in these countries.
 
 For
example, China does not currently have a comprehensive and highly developed
legal system, particularly with respect to the protection of intellectual
property rights.  This results, among other things, in the prevalence
of counterfeit goods in China.  The enforcement of existing and future
laws and contracts remains uncertain, and the implementation and interpretation
of such laws may be inconsistent.  Such inconsistency could lead to
piracy and degradation of our intellectual property
protection.  Although we engage in efforts to prevent counterfeit
products from entering the market, those efforts may not be
successful.  Our results of operations and financial condition could
be harmed by the sale of counterfeit products.
 
 Our
international business activities could also be limited or disrupted by any of
the following factors:
 
 ·
              the
      need to comply with foreign government
  regulation;
  ·
              changes
      in diplomatic and trade
relationships;
  ·
              reduced
      sales to our customers or interruption to our manufacturing processes in
      the Pacific Rim that may arise from regional issues in
    Asia;
  ·
              imposition
      of regulatory requirements, tariffs, import and export restrictions and
      other barriers and restrictions;
  ·
              changes
      in, or the particular application of, government
    regulations;
  ·
              duties
      and/or fees related to customs entries for our products, which are all
      manufactured offshore;
  ·
              longer
      payment cycles and greater difficulty in accounts receivable
      collection;
  ·
              adverse
      tax rules and regulations;
  ·
              weak
      protection of our intellectual property
rights;
  ·
              delays
      in product shipments due to local customs restrictions;
  and
  ·
              delays
      in research and development that may arise from political unrest at our
      development centers in Israel.
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  Tower
Semiconductor’s financial situation is challenging.  Tower
supplies a significant portion of our controller wafers and is currently a sole
source of supply for some of our controllers.  Tower’s ability to
continue to supply sufficient controller wafers on a cost-effective basis may be
dependent upon Tower having sufficient funds to operate in the short-term and
raising the funds required to complete its capacity expansion.  If
Tower fails to comply with the financial ratios and covenants contained in the
amended credit facility agreement with its banks, fails to attract additional
customers, fails to operate its fab facilities in a cost-effective manner, fails
to secure additional financing, fails to meet the conditions to receive approved
government grants and tax benefits, or fails to obtain the approval of the
Israeli Investment Center for a new expansion program, Tower’s continued
operations could be at risk.  If this occurs, we will be forced to
source our controllers from another supplier and our business, financial
condition and results of operations may be harmed.  Specifically, our
ability to supply a number of products would be disrupted until we were able to
transition manufacturing and qualify a new foundry with respect to controllers
that are currently sole sourced at Tower, which could take three or more
quarters to complete.
 
 As
of September 28, 2008, we had recognized cumulative losses of approximately
$67.2 million as a result of the other-than-temporary decline in the value
of our investment in Tower ordinary shares, $12.2 million as a result of
the impairment in value on our prepaid wafer credits, $2.5 million of
losses on an equipment loan to Tower, $0.2 million of losses on a
convertible loan to Tower, and $1.3 million of losses on our warrant to
purchase Tower ordinary shares.  We are subject to certain legal
restrictions on the transfer of our approximately 15.9 million Tower
ordinary shares.  It is possible that we will record further
write-downs of our investments and loans to Tower, which was carried on our
Condensed Consolidated Balance Sheet at $16.5 million at September 28,
2008, which would harm our results of operations and financial
condition.
 
 Our stock price has
been, and may continue to be, volatile, which could result in investors losing
all or part of their investments.The market price of our
stock has fluctuated significantly in the past and may continue to fluctuate in
the future.  We believe that such fluctuations will continue as a
result of many factors, including future announcements concerning us, our
competitors or our principal customers regarding financial results or
expectations, technological innovations, industry supply or demand dynamics, new
product introductions, governmental regulations, the commencement or results of
litigation or changes in earnings estimates by analysts.  In addition,
in recent years the stock market has experienced significant price and volume
fluctuations and the market prices of the securities of high technology and
semiconductor companies have been especially volatile, often for reasons outside
the control of the particular companies.  These fluctuations as well
as general economic, political and market conditions may have an adverse affect
on the market price of our common stock as well as the price of our outstanding
convertible notes and could impact the likelihood of those notes being converted
into our common stock, which would cause further dilution to our
stockholders.
 
 We may engage in
business combinations that are dilutive to existing stockholders, result in
unanticipated accounting charges or otherwise adversely affect our results of
operations, and result in difficulties in assimilating and integrating the
operations, personnel, technologies, products and information systems of
acquired companies or businesses.  We continually evaluate and
explore strategic opportunities as they arise, including business combinations,
strategic partnerships, collaborations, capital investments and the purchase,
licensing or sale of assets.  If we issue equity securities in
connection with an acquisition, the issuance may be dilutive to our existing
stockholders.  Alternatively, acquisitions made entirely or partially
for cash would reduce our cash reserves.
 
 Acquisitions
may require significant capital infusions, typically entail many risks and could
result in difficulties in assimilating and integrating the operations,
personnel, technologies, products and information systems of acquired
companies.  We may experience delays in the timing and successful
integration of acquired technologies and product development through volume
production, unanticipated costs and expenditures, changing relationships with
customers, suppliers and strategic partners, or contractual, intellectual
property or employment issues.  In addition, key personnel of an
acquired company may decide not to work for us.  The acquisition of
another company or its products and technologies may also result in our entering
into a geographic or business market in which we have little or no prior
experience.  These challenges could disrupt our ongoing business,
distract our management and employees, harm our reputation, subject us to an
increased risk of intellectual property and other litigation and increase our
expenses.  These challenges are magnified as the size of the
acquisition increases, and we cannot assure you that we will realize the
intended benefits of any acquisition.  Acquisitions may require large
one-time charges and can result in increased debt or contingent liabilities,
adverse tax consequences, substantial depreciation or deferred compensation
charges, the amortization of identifiable purchased intangible assets or
impairment of goodwill, any of which could have a material adverse effect on our
business, financial condition or results of operations.
 
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  Mergers
and acquisitions of high-technology companies are inherently risky and subject
to many factors outside of our control, and no assurance can be given that our
previous or future acquisitions will be successful and will not materially
adversely affect our business, operating results, or financial
condition.  Failure to manage and successfully integrate acquisitions
could materially harm our business and operating results.  Even when
an acquired company has already developed and marketed products, there can be no
assurance that such products will be successful after the closing, will not
cannibalize sales of our existing products, that product enhancements will be
made in a timely fashion or that pre-acquisition due diligence will have
identified all possible issues that might arise with respect to such
company.  Failed business combinations, or the efforts to create a
business combination, can also result in litigation.
 
 Our success depends
on our key personnel, including our executive officers, the loss of whom could
disrupt our business.  Our success greatly depends on the
continued contributions of our senior management and other key research and
development, sales, marketing and operations personnel, including Dr. Eli
Harari, our founder, chairman and chief executive officer.  We do not
have employment agreements with any of our executive officers and they are free
to terminate their employment with us at any time.  Our success will
also depend on our ability to recruit additional highly skilled
personnel.  Historically, a significant portion of our employee
compensation has been dependent on equity compensation, which is directly tied
to our stock price.  Currently, the equity incentives for virtually
all our employees are underwater, and as a result, our equity compensation has
little or no retention value.  In addition, the Company plans to
reduce or eliminate annual cash bonuses for the current fiscal year and is
engaged in planning further restructuring.  These reductions or any
further reduction in these compensation elements may make it more difficult to
hire or retain key personnel.
 
 We may incur
additional restructuring charges or not realize the expected benefits of new
initiatives to reduce costs across our operations. In 2008, we
pursued and will be pursuing a number of initiatives to reduce costs across our
operations.  These initiatives included workforce reductions in certain
areas as we realigned our business.  For example, in the first nine
months of fiscal year 2008, we recorded charges of $4.1 million for
employee severance and related costs and we expect to record additional employee
severance and related costs for terminated employees in the fourth quarter of
fiscal year 2008.  We may not realize the expected benefits of these
initiatives.  In addition, we continue to focus on reducing our overhead
costs to meet or exceed industry benchmarks.  As a result of these
initiatives, we expect to incur restructuring or other charges and we may
experience disruptions in our operations and loss of key personnel.
 
 Terrorist attacks,
war, threats of war and government responses thereto may negatively impact our
operations, revenues, costs and stock price.Terrorist attacks, U.S.
military responses to these attacks, war, threats of war and any corresponding
decline in consumer confidence could have a negative impact on consumer retail
demand, which is the largest channel for our products.  Any of these
events may disrupt our operations or those of our customers and suppliers and
may affect the availability of materials needed to manufacture our products or
the means to transport those materials to manufacturing facilities and finished
products to customers.  Any of these events could also increase
volatility in the United States and world financial markets, which could harm
our stock price and may limit the capital resources available to us and our
customers or suppliers, or adversely affect consumer confidence.  We
have substantial operations in Israel including a development center in Northern
Israel, near the border with Lebanon, areas that have recently experienced
significant violence and political unrest.  Tower, which supplies a
significant portion of our controller wafers, is also located in
Israel.  Continued turmoil and unrest in Israel or the Middle East
could cause delays in the development or production of our
products.  This could harm our business and results of
operations.
 
 Natural disasters or
epidemics in the countries in which we or our suppliers or subcontractors
operate could negatively impact our operations.  Our
operations, including those of our suppliers and subcontractors, are
concentrated in Milpitas, California; Yokkaichi, Japan; Hsinchu and Taichung,
Taiwan; and Dongguan, Shanghai and Shenzen, China.  In the past, these
areas have been affected by natural disasters such as earthquakes, tsunamis,
floods and typhoons, and some areas have been affected by epidemics, such as
avian flu.  If a natural disaster or epidemic were to occur in one or
more of these areas, our operations could be significantly impaired and our
business may be harmed.  This is magnified by the fact that we do not
have insurance for most natural disasters, including
earthquakes.  This could harm our business and results of
operations.
 
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  To manage our
growthor business complexity, we may need to
improve our systems, controls, processes and procedures.  We have
experienced and may continue to experience rapid growthor changes in
business requirements, which could place
a significant strain on our managerial, financial and operations resources and
personnel.Our business and number of employees have increased
significantly over the last several years.  We must continually
enhance our operational, accounting and financial systems to accommodate the
growth, changing practices, and increasing complexity of our
business.  For example, we have recently decided to replace our
enterprise resource planning, or ERP, system.  This project requires
significant investment, the re-engineering of many processes used to run our
business, and the attention of many employees and managers who would otherwise
be focused on other aspects of our business.  The design and
implementation of the new ERP system could also take longer than anticipated and
put further strain on our ability to run our business on the older, existing ERP
system.  Any design flaws or delays in the new ERP system or any
distraction of our workforce from competing business requirements could harm our
business or results of operations.  We must also continue to enhance
our controls and procedures and workforce training.  If we do not
manage or adapt our systems, processes and procedures to our changing or growing
business and organization, our business and results of operations could be
harmed.
 
 Under certain
conditions, a portion or the entire outstandingleaseobligations related
to Flash Ventures’ master equipment lease agreementscould be
accelerated, which if triggered could harm our business, negatively impact our
results from operations, cash flows, and liquidity. Flash Ventures’ master
equipment lease agreements contain customary covenants and events of default
related to them which could result in an acceleration of their obligations if
there is non-compliance.  In addition, the master lease agreements
contain an acceleration clause for certain events of default related to us as
guarantor.  For example, events of default related to us as a
guarantor include our failure to maintain minimum shareholder equity of at least
$1.51 billion, or our failure to maintain a minimum corporate rating of BB-
or BB+ from at least one of two named independent ratings
services.  On October 23, 2008, one of the two named independent
ratings services downgraded our credit rating further below the minimum
corporate rating threshold, and while this specific downgrade did not trigger
non-compliance under Flash Ventures’ master equipment lease agreements, there
can be no assurance that the other named independent ratings service will
maintain our credit rating above the threshold.  If the other named
independent ratings service downgrades our credit rating below the
minimum corporate rating threshold, Flash Ventures could become
non-compliant under their master equipment lease agreements and may be required
to negotiate a resolution to the non-compliance to avoid acceleration of the
obligations under such agreements.  Such resolution could include,
among other things, supplementary security to be supplied by us, as guarantor,
or increased interest rates or waiver fees, should the lessors decide they need
additional collateral or financial consideration under the
circumstances.  If a resolution is unsuccessful, we may be required to
pay a portion or the entire outstanding lease obligations covered by our
guarantee under such Flash Venture master lease agreements.
 
 We may need to raise
additional financing, which could be difficult to obtain,and which if not
obtained in satisfactory amounts may prevent us from fundingtheflash ventures with
Toshiba orventures withother
third parties, increasing our wafer supply, developing or enhancing our
products, taking advantage of future opportunities, growing our business or
responding to competitive pressures or unanticipated industry changes, any of
which could harm our business.We currently believe that we
have sufficient cash resources to fund our operations as well as our anticipated
investments in ventures with third parties for at least the next twelve months;
however, we may in the future raise additional funds, including funds to meet
our obligations with respect to Flash Ventures, and we cannot be certain that we
will be able to obtain additional financing on favorable terms, if at
all.  The current worldwide financing environment is extremely
challenging, which could make it more difficult for us to raise funds on
reasonable terms or at all.  From time-to-time, we may decide to raise
additional funds through public or private debt, equity or lease
financings.  If we issue additional equity securities, our
stockholders will experience dilution and the new equity securities may have
rights, preferences or privileges senior to those of existing holders of common
stock.  If we raise funds through debt or lease financing, we will
have to pay interest and may be subject to restrictive covenants, which could
harm our business.  In the coming year, we expect Flash Ventures to
add to their outstanding equipment leases which will require us to increase the
value of the lease guarantees we provide.  The amount of our equipment
lease guarantees is included in financial ratios that the rating agencies use to
assess our credit rating.  If our credit rating is downgraded or
access to credit in Japanese financial markets is reduced, future operating
leases may not be available to us on acceptable terms or at all.  If
we cannot raise funds on acceptable terms, if and when needed, we may not be
able to develop or enhance our technology or products, fulfill our obligations
to Flash Ventures, take advantage of future opportunities, grow our business or
respond to competitive pressures or unanticipated industry changes, any of which
could have a negative impact on our business.
 
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  Anti-takeover
provisions in our charter documents, stockholder rights plan and inDelawarelaw could
discourage or delay a change in control and, as a result, negatively impact our
stockholders.  We have taken a number of actions that could
have the effect of discouraging a takeover attempt.  For example, we
have a stockholders’ rights plan that would cause substantial dilution to a
stockholder, and substantially increase the cost paid by a stockholder, who
attempts to acquire us on terms not approved by our board of
directors.  This could discourage an acquisition of us.  In
addition, our certificate of incorporation grants our board of directors the
authority to fix the rights, preferences and privileges of and issue up to
4,000,000 shares of preferred stock without stockholder action (2,000,000 of
which have already been reserved under our stockholder rights
plan).  Issuing preferred stock could have the effect of making it
more difficult and less attractive for a third party to acquire a majority of
our outstanding voting stock.  Preferred stock may also have other
rights, including economic rights senior to our common stock that could have a
material adverse effect on the market value of our common stock.  In
addition, we are subject to the anti-takeover provisions of Section 203 of the
Delaware General Corporation Law.  This section provides that a
corporation may not engage in any business combination with any interested
stockholder during the three-year period following the time that a stockholder
became an interested stockholder.  This provision could have the
effect of delaying or discouraging a change of control of SanDisk.
 
 Unanticipated
changes in our tax provisions or exposure to additional income tax liabilities
could affect our profitability.  We are subject to income tax
in the United States and numerous foreign jurisdictions.  Our tax
liabilities are affected by the amounts we charge for inventory, services,
licenses, funding and other items in intercompany transactions.  We
are subject to ongoing tax audits in various jurisdictions.  Tax
authorities may disagree with our intercompany charges or other matters and
assess additional taxes.  We regularly assess the likely outcomes of
these audits in order to determine the appropriateness of our tax
provision.  However, there can be no assurance that we will accurately
predict the outcomes of these audits, and the actual outcomes of these audits
could have a material impact on our net income or financial
condition.  In addition, our effective tax rate in the future could be
adversely affected by changes in the mix of earnings in countries with differing
statutory tax rates, changes in the valuation of deferred tax assets and
liabilities, changes in tax laws, and the discovery of new information in the
course of our tax return preparation process.  In particular, the
carrying value of deferred tax assets, which are predominantly in the United
States, is dependent on our ability to generate future taxable income in the
United States.  Any of these changes could affect our
profitability.
 
 We may be subject to
risks associated with environmental regulations.  Production
and marketing of products in certain states and countries may subject us to
environmental and other regulations including, in some instances, the
responsibility for environmentally safe disposal or recycling.  Such
laws and regulations have recently been passed in several jurisdictions in which
we operate, including Japan and certain states within the United
States.  Although we do not anticipate any material adverse effects in
the future based on the nature of our operations and the focus of such laws,
there is no assurance such existing laws or future laws will not have a material
adverse effect on our financial condition, liquidity or results of
operations.
 
 In the event we are
unable to satisfy regulatory requirements relating to internal controls, or if
our internal controls over financial reporting are not effective, our business
could suffer.  In connection with our certification process
under Section 404 of Sarbanes-Oxley, we have identified in the past and will
from time-to-time identify deficiencies in our internal control over financial
reporting.  We cannot assure you that individually or in the aggregate
these deficiencies would not be deemed to be a material weakness.  A
material weakness or deficiency in internal control over financial reporting
could materially impact our reported financial results and the market price of
our stock could significantly decline.  Additionally, adverse
publicity related to the disclosure of a material weakness or deficiency in
internal controls could have a negative impact on our reputation, business and
stock price.  Any internal control or procedure, no matter how well
designed and operated, can only provide reasonable assurance of achieving
desired control objectives and cannot prevent intentional misconduct or
fraud.
 
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  Our debt service
obligations may adversely affect our cash flow.While the 1%
Senior Convertible Notes due 2013 and the 1% Convertible Notes due 2035 are
outstanding, we are obligated to pay to the holders thereof approximately
$12.3 million per year in interest.  If we issue other debt
securities in the future, our debt service obligations will
increase.  If we are unable to generate sufficient cash to meet these
obligations and must instead use our existing cash or investments, we may have
to reduce, curtail or terminate other business activities.  We intend
to fulfill our debt service obligations from cash generated by our operations,
if any, and from our existing cash and investments.  Our indebtedness
could have significant negative consequences.
 
 For
example, it could:
 
 ·
              increase
      our vulnerability to general adverse economic and industry
      conditions;
  ·
              limit
      our ability to obtain additional
financing;
  ·
              require
      the dedication of a substantial portion of any cash flow from operations
      to the payment of principal of, and interest on, our indebtedness, thereby
      reducing the availability of such cash flow to fund our growth strategy,
      working capital, capital expenditures and other general corporate
      purposes;
  ·
              limit
      our flexibility in planning for, or reacting to, changes in our business
      and our industry; and
  ·
              place
      us at a competitive disadvantage relative to our competitors with less
      debt.
  
 The accounting
method for convertible debt securities with net share settlement, such as our 1%
Senior Convertible Notes due 2013is
scheduledto change.
In
May 2008, the FASB issued FASB Staff Position No. APB 14-1, or FSP APB 14-1,
Accounting for Convertible
Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial
Cash Settlement).  The FSP APB 14-1 requires the issuer to
separately account for the liability and equity components of the instrument in
a manner that reflects the issuer’s economic interest cost.  Further,
the FSP APB 14-1 requires bifurcation of a component of the debt, classification
of that component to equity, and then accretion of the resulting discount on the
debt to result in the “economic interest cost” being reflected in the statement
of operations.  The FSP APB 14-1 is effective for fiscal years
beginning after December 15, 2008, does not permit early application, and
requires retrospective application to all periods presented.  Our
estimate based upon the current interpretations by the FASB, is that we will be
required to report an additional before tax, non-cash interest expense of
approximately $400 million over the life of the 1% Senior Convertible Notes
due 2013, including approximately $50 million to $55 million in fiscal
year 2008.
 
 We have significant
financial obligations related to our flash ventures with Toshiba, which could
impact our ability to comply with our obligations under our 1% Senior
Convertible Notes due 2013 and our 1% Convertible Notes due
2035.  We have entered into agreements to guarantee or provide
financial support with respect to lease and certain other obligations of Flash
Ventures in which we have a 49.9% ownership interest.  In addition, we
may enter into future agreements to increase manufacturing capacity, including
the expansion of Fab 4.  As of September 28, 2008, we had
guarantee obligations for Flash Venture master lease agreements of approximately
$1.84 billion.  As of September 28, 2008, we had unfunded
commitments of approximately $0.95 billion to fund our various obligations
under the Flash Partners and Flash Alliance ventures with
Toshiba.  Due to these and our other commitments, we may not have
sufficient funds to make payments under or repurchase the notes.
 
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  The settlement of
the 1% Senior Convertible Notes due 2013or the 1%
Convertible Notes due 2035may have adverse
consequences.  The 1% Senior Convertible Notes due 2013 are
subject to net share settlement, which means that we will satisfy our conversion
obligation to holders by paying cash in settlement of the lesser of the
principal amount and the conversion value of the 1% Senior Convertible Notes due
2013 and by delivering shares of our common stock in settlement of any and all
conversion obligations in excess of the daily conversion values.  The
holders of the 1% Convertible Notes due 2035 have a put option in March 2010 and
various dates thereafter under which they can demand cash repayment of the
principal amount of $75 million.
 
 Our
failure to convert the 1% Senior Convertible Notes due 2013 into cash or a
combination of cash and common stock upon exercise of a holder’s conversion
right in accordance with the provisions of the indenture would constitute a
default under the indenture.  Similarly, our failure to settle the 1%
Convertible Notes due 2035 if we were forced to repurchase the Notes in March
2010 or thereafter would constitute a default under the indenture.  We
may not have the financial resources or be able to arrange for financing to pay
such principal amount in connection with the surrender of the 1% Senior
Convertible Notes due 2013 or the 1% Convertible Notes due
2035.  While we currently only have debt related to the 1% Senior
Convertible Notes due 2013 and the 1% Convertible Notes due 2035 and we do not
have other agreements that would restrict our ability to pay the principal
amount of any convertible notes in cash, we may enter into such an agreement in
the future, which may limit or prohibit our ability to make any such
payment.  In addition, a default under the indenture could lead to a
default under existing and future agreements governing our
indebtedness.  If, due to a default, the repayment of related
indebtedness were to be accelerated after any applicable notice or grace
periods, we may not have sufficient funds to repay such indebtedness and amounts
owing in respect of the conversion, maturity, or put of any convertible
notes.
 
 The convertible note
hedge transactions and the warrant option transactions may affect the value of
the notes and our common stock.We have entered into
convertible note hedge transactions with Morgan Stanley & Co. International
Limited and Goldman, Sachs & Co., or the dealers.  These
transactions are expected to reduce the potential dilution upon conversion of
the 1% Senior Convertible Notes due 2013.  We used approximately
$67.3 million of the net proceeds of funds received from the 1% Senior
Convertible Notes due 2013 to pay the net cost of the convertible note hedge in
excess of the warrant transactions.  These transactions were accounted
for as an adjustment to our stockholders’ equity.  In connection with
hedging these transactions, the dealers or their affiliates:
 
 ·
              have
      entered into various over-the-counter cash-settled derivative transactions
      with respect to our common stock, concurrently with, and shortly after,
      the pricing of the notes; and
 ·
              may
      enter into, or may unwind, various over-the-counter derivatives and/or
      purchase or sell our common stock in secondary market transactions
      following the pricing of the notes, including during any observation
      period related to a conversion of
notes.
 
 The
dealers or their affiliates are likely to modify their hedge positions from
time-to-time prior to conversion or maturity of the notes by purchasing and
selling shares of our common stock, our securities or other instruments they may
wish to use in connection with such hedging.  In particular, such
hedging modification may occur during any observation period for a conversion of
the 1% Senior Convertible Notes due 2013, which may have a negative effect on
the value of the consideration received in relation to the conversion of those
notes.  In addition, we intend to exercise options we hold under the
convertible note hedge transactions whenever notes are converted.  To
unwind their hedge positions with respect to those exercised options, the
dealers or their affiliates expect to sell shares of our common stock in
secondary market transactions or unwind various over-the-counter derivative
transactions with respect to our common stock during the observation period, if
any, for the converted notes.
 
 The
effect, if any, of any of these transactions and activities on the market price
of our common stock or the 1% Senior Convertible Notes due 2013 will depend in
part on market conditions and cannot be ascertained at this time, but any of
these activities could adversely affect the value of our common stock and the
value of the 1% Senior Convertible Notes due 2013 and, as a result, the amount
of cash and the number of shares of common stock, if any, holders will receive
upon the conversion of the notes.
 
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 Table of Contents
  Item
      2.
              Unregistered Sales of Equity Securities and Use of
      Proceeds
 
 None.
 
 Item
      3.
              Defaults upon Senior
  Securities
 
 None.
 
 Item
      4.
              Submission of Matters to a Vote of Security
      Holders
 
 None.
 
 Item
      5.
              Other
Information
 
 None.
 
 Item
      6.
              Exhibits
 
 The
information required by this item is set forth on the exhibit index which
follows the signature page of this report.
 
 
 
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 Table of Contents
  SIGNATURES
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this Report to be signed on its behalf by the undersigned, thereunto
duly authorized.
 
 SANDISK
CORPORATION
 (Registrant)
 
 Dated:
      November 7, 2008
              By:
      /s/ Judy BrunerJudy
      Bruner
                Executive
      Vice President, Administration and
                Chief
      Financial Officer
                (On
      behalf of the Registrant and as Principal
                Financial
      and Accounting Officer)
 
 
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 Table of Contents
  EXHIBIT INDEX
 Exhibit
                Number
              Exhibit
      Title2.1
              Agreement
      and Plan of Merger and Reorganization, dated as of October 20, 2005, by
      and among the Registrant, Mike Acquisition Company LLC, Matrix
      Semiconductor, Inc. and Bruce Dunlevie as the stockholder representative
      for the stockholders of Matrix Semiconductor, Inc.(1)2.2
              Agreement
      and Plan of Merger, dated as of July 30, 2006, by and among the
      Registrant, Project Desert, Ltd. and msystems
      Ltd.(2)3.1
              Restated
      Certificate of Incorporation of the Registrant.(3)3.2
              Certificate
      of Amendment of the Restated Certificate of Incorporation of the
      Registrant dated December 9, 1999.(4)3.3
              Certificate
      of Amendment of the Restated Certificate of Incorporation of the
      Registrant dated May 11, 2000.(5)3.4
              Certificate
      of Amendment to the Amended and Restated Certificate of Incorporation of
      the Registrant dated May 26, 2006.(6)3.5
              Amended andRestated Bylaws of the Registrant,
      as amended to date.(7)3.6
              Certificate
      of Designations for the Series A Junior Participating Preferred
      Stock, as filed with the Delaware Secretary of State on October 14,
      1997.(8)3.7
              Amendment
      to Certificate of Designations for the Series A Junior Participating
      Preferred Stock, as filed with the Delaware Secretary of State on
      September 24, 2003.(9)4.1
              Reference
      is made to Exhibits 3.1, 3.2, 3.3, and 3.4.(3), (4), (5),
      (6)4.2
              Rights
      Agreement, dated as of September 15, 2003, between the Registrant and
      Computershare Trust Company, Inc.(9)4.3
              Amendment
      No. 1 to Rights Agreement, dated as of November 6, 2006, by and between
      the Registrant and Computershare Trust Company,
Inc.(10)31.1
              Certification of Chief Executive Officer Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.(*)31.2
              Certification of Chief Financial Officer Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.(*)32.1
              Certification of Chief Executive Officer Pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.(**)32.2
              Certification of Chief Financial Officer Pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.(**) * Filed
herewith.
 **
Furnished herewith.
 
 (1)           Previously
filed as an Exhibit to the Registrant’s Current Report on Form 8-K filed with
the SEC on January 20, 2006.
 (2)           Previously
filed as an Exhibit to the Registrant’s Current Report on Form 8-K/A filed with
the SEC on August 1, 2006.
 (3)           Previously
filed as an Exhibit to the Registrant’s Registration Statement on Form S-1 (No.
33-96298).
 (4)           Previously
filed as an Exhibit to the Registrant’s Form 10-Q for the quarter ended
June 30, 2000.
 (5)           Previously
filed as an Exhibit to the Registrant’s Registration Statement on Form S-3 (No.
333-85686).
 (6)           Previously
filed as an Exhibit to the Registrant’s Current Report on Form 8-K filed with
the SEC on June 1, 2006.
 (7)           Previously
filed as an Exhibit to the Registrant’s Current Report on Form 8-K filed with
the SEC on July 27, 2007.
 (8)           Previously
filed as an Exhibit to the Registrant’s Current Report on Form 8-K/A dated
April 18, 1997.
 (9)           Previously
filed as an Exhibit to the Registrant’s Registration Statement on Form 8-A dated
September 25, 2003.
 (10)           Previously
filed as an Exhibit to the Registrant’s Registration Statement on Form 8-A/A
dated November 8, 2006.
 
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