Good day, everyone and welcome to the SanDisk Third Quarter 2006 Earnings Release Conference Call. Today's call is being recorded. At this time I would like the turn the call over to Ms. Lori Barker Padon, Director of Investor Relations. Please go ahead, ma'am.

Thank you, good afternoon and welcome to the teleconference for SanDisk Corporation for the third quarter of 2006. I am Lori Barker Padon, SanDisk's Director of Investor Relations. Today with me is Eli Harari, Chairman and Chief Executive Officer of SanDisk, Sanjay Mehrotra, President and Chief Operating Officer and Judy Bruner, Executive Vice President of Administration and CFO. The agenda for today’s teleconference is as follows. Eli will start with remarks about SanDisk and trends in our markets. Judy will follow-up with our third quarter financial results and future guidance, and we will conclude the teleconference with your questions. Any non-GAAP financial measures discussed during this call as defined by the SEC in Regulation G will be reconciled to the most directly comparable GAAP financial measure. That reconciliation is now available after the completion of this call and audio replay of this conference call, a copy of today's prepared comments and quarterly metrics will be made available on SanDisk's Investor Relations website at SanDisk.com. By now all of you have seen our press release and the associated Form 8-K filed this afternoon. I would like to remind everyone that today's comments including our Question and Answer Session will include forward-looking statements within the meaning of section 27A of the securities act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended that are based on our current expectations. Forward-looking statements in this teleconference are generally identified by words such as believes, anticipates, expects, intends, may, will and other similar expressions. In addition, any statement that refers expectations, projections or other characterizations of future events or circumstances are forward-looking statements. There are significant risks and uncertainties that could cause our actual results to differ materially from those expressed in these forward-looking statements. These risks and…

Thank you Eli and good afternoon everyone. Our total revenue for Q3 was a record $751 million just above the previous record revenue achieved in the seasonally strong fourth quarter of 2005. License and royalty revenue of $78 million grew 31% year-over-year and product revenue of $673 million was up 27% year-over-year. Our ASP per megabyte declined 25% sequentially more than we had forecasted due primarily to heavier promotions implemented in response to the competitive pricing environment during the quarter. Megabytes sold increased 40% sequentially more than the 20% to 25% sequential growth we had originally forecasted and compared to 23% sequential growth in the Q3 of last year. Retail revenue was 66% of product revenue in Q3, average capacity for retail products increased 16% sequentially to 882 megabytes and total retail megabytes sold increased 33% sequentially. Within the retail business, the highest sequential growth in megabytes sold and in revenue came from our USB and MP3 products. Looking at the retail business on a year-over-year basis, the strongest growth in megabytes sold and revenue came from our microSD cards for the mobile phone market and our MP3 players. Within the OEM channel, average capacity increased 27% sequentially and megabytes sold increased 59% sequentially. The highest sequential revenue growth came from our iNAND products for the mobile phone market and our 3D memory products for the gaming market. On a year-over-year basis revenue growth was strongest for microSD and Memory Stick PRO Duo cards both for the mobile phone market. On a geographic basis our product revenue mix in Q3 was 46% Americas, 36% Europe, and 18% Asia and Japan, a mix similar to the previous quarter. Q3 non-GAAP product gross margin excluding stock compensation was 32.7% compared to 32.8% in Q2. On a GAAP basis, the Q3 product gross…

[Operator Instructions]. We'll take our first question from Daniel Gelbtuch with CIBC.

Congratulations on a very solid quarter. With respect to pro forma operating or guess non-GAAP operating expenses, wanted to do a little housekeeping. It looks like you had about 22 million change that was pro forma out. I was wondering how you split that between R&D and SG&A?

Sure, Daniel. There was actually about 25 million of stock compensation expense in the P&L, and let me give you a breakdown of that. There is 2.6 million in cost of sales. There is 10.3 million in R&D, 4.6 million in sales and marketing, and 7.7 million in G&A. And then the other GAAP to non-GAAP item is a line item that you see for amortization of intangible assets.

Okay. Thank you on that. And then with regard you made mention of two to four X declines in NAND pricing to get the laptop market or to get the PC markets going with NAND. I was wondering, is there a dollar amount per gigabyte that you would say is a specific point to get there, obviously 2 to 4X is a very wide range.

Daniel, I think that we've fully expect that solid state disk in other hybrid Flash devices following Flash will start showing up in the market in 2007, certainly with early adoptions, but at the current price of, like – about $0.02 per megabyte, 32 gigabyte drive even at the OEM level is still way too expensive except for early adopters. So, however, this market, it is not just a one- -- a kind of a step function. We continuously expect to see technology allowing us to bring the costs down, and that will allow this market to become the Flash solution to become more attractive. I would expect that by 2008 if you look at just historic cost and price reductions that we've seen over the last five years, extrapolate that on the next two years, 2008 this will become a more significant market and by 2009, 2010, I think it will become a very, very large market, at least that's what some marketing organizations are projecting, and I personally agree with them, but it won't happen except through -- I mean Flash really has got to come down in price.

Okay. Thank you very much.

We'll take our next question from Jim Covello with Goldman Sachs.

Good afternoon guys thanks so much. Just a couple of questions on the supply demand. I guess first, do you have any thoughts about some of the third parties that have come out and suggest that there could be some pretty significant excess capacity next year? I think the numbers that maybe an I-supply or someone like that saying maybe 160% demand bit growth, 200% supply bit growth. What are your thoughts on that as it stands today?

You know, this market is proving to be quite adaptive in fact to the demand side, and we've seen Samsung just announced two days ago in the quarterly results that they're going to -- they're projecting a 120% megabyte increase for them next year, and that is -- and 140% increase in supply industry wide. We think that the demand next year from the new markets and existing markets will be higher than that and frankly, 120% is for additional supplies from Samsung appears relatively low, I think it would be surprised that low. The adaptive part of the market is as you know, NAND with the 60% price decline over the last year or so has become less profitable substantially so than DRAM. DRAM pricing has been going up, and it is no question that DRAM wafer today generates substantially more growth margin dollars to the DRAM manufacturers that also in NAND Flash particularly if they are behind the technology curve in NAND Flash or have not yet adopted MLC to be profitable in NAND you really have to be in 200 millimeters today and you have to be on leading edge technology with MLC and high volume production. So, I think that the sub corrective nature of this business is if the prices will drop too fast, people will not add new capacity, and that will reduce the price decline. In general, and I have said that many times in the past, pricing for NAND in the annual 40% to 45%, maybe 50% price decline very healthy for the creation of new markets and I would say certainly in the 40% range sustainable from the point of view of technology migrations. 60% is not sustainable long-term. You cannot have 60% price reductions every year. Let's say we've had 52% last year, I think this year is more like between 55% and 60%. I think that next year I would not be surprised if the demand supply is better because of reduced supply and increased demand. I am actually modestly optimistic about next year.

Can I ask -- just one quick follow-up on the reduced supply relative to this year. I mean isn’t Samsung's CapEx plans, that's going to impact the latter part of 2007, but we head into 2007 with some pretty significant excess or at least not anywhere near as tight as we were last year, and I guess the question is what do you make of the fact that this time last year with the new products for the seasonal period we were in a significantly tighter supply demand situation and that kind of carried through the first part of this year that we are right now, and thanks very much.

Yeah. It’s a very complex multi-faceted situation, for example, the adoption rate of MLC by everyone of supply has a lot of bearing on the eventual total supply. You know, some of the new players that were supposed to be, pretty significant attributive to capacity in 2006 and certainly in 2007 are having a lot more difficult time competing this market. You just so, what, last week Saifun announced that Qimonda is backing out of this NROM, and that's because of both the pricing situation that makes it less attracted active for them to enter and the technology difficulties that they would be having very similar to what AGN had two years ago for in essence. So, it’s very, very difficult. I have characterized NAND and particularly NAND MLC as a bullet train, and if you're not operating at the leading edge, if you're not sitting in the -- you know, driving the train up front, you're going to be -- you may make decisions to not invest -- you would think a lot harder before you invest in major new NAND capacity.

Thank you.

We'll take our next question from Satya Chillara with Pacific Growth Equities.

Hi. Good afternoon, guys. Judy, this is a question for you in terms of royalty. Can you walk us through how there seems to be some upside, where is this upside coming from, is this mainly from MLC or is this more of a quad royalty uptick that you're having?

The increase -- I presume you're referring to the increase in royalty revenue from Q3 to our Q4 forecast. Does that right?

No, from Q3 to Q4 and also Q4 to Q3, please. Basically you guided, what, 67, right, and you did $78 million in Q3, and so there is some upside. So I am just trying to understand where the upside is coming from?

So actually we had guided back in July, I believe, to a decrease in royalty revenue of 10 to $12 million from the first quarter which I believe would have worked out to something like 70 to $72 million in royalties, and we achieved $78 million.

Right.

So there was something like 6 to $8 million of upside, and you know, let me remind that you when we give this guidance we do not have any precise reporting from our licensees on these numbers, so these are estimates that we're putting together based upon various forecasts data and various public statements that we've heard these licensees say, so I am not going to take you through the specific details, but as you know, the royalty revenue -- the royalty rate is applied to revenue of our licensees, so if our licensees either sell more bits or price differently than we were forecasting, or have a different mix as you referred to of SLC versus MLC, all those factor into the number.

I would like to say, make another point on the royalties which actually is today relatively small factor, but nonetheless, I think is one that is perhaps you guys are not really maybe focused on, and that is that as SD particularly miniSD and microSD – microSD particularly, as that market grows in volume, you know, SD has -- microSD essentially has not become the (indiscernible) for handsets, and we fully expect volume in microSD cards to take off very, very significantly over the next several years, and we do expect that our co-ownership of the SD, miniSD and microSD card standards through 3C, Toshiba and SanDisk to begin to reflect some increased contribution from royalties that we expect to be collecting from those cards. As I said today it’s still relatively small number, but when you're looking at the kind of projections for handsets that have card slots, that overtime could grow and become a nice contributor.

Actually I will add on one point to that to the question you asked, Satya. There was a bit of upside in the Q2 royalty revenue on the card side but it primarily came from royalties on chips.

On chips. Okay. On the royalty subject, sounds like Samsung is increasing dramatically from 40% to 75% in Q4. What are your thoughts, and it’s all that royalty will start coming into Q1. Is that right, Judy? The MLC contribution from Samsung?

As we've said in the past, there is a higher royalty rate that we derive on sales of MLC, NAND versus SLC NAND, and so, yes, that bodes well for 2007, but keep in mind that we've seen a fair amount of variation in the past between the projected MLC mix from our licensees and the actual MLC mix that has occurred.

Okay. Great. One question for Eli. Eli, on the cell phone which is in 2007 with the number of models you're talking about and so on, what are the metrics that make you a little more optimistic the retail versus OEM last two quarters you talked about retail uptick being 15% of the entire mix. Any other metrics you can talk about how are they shaking out at this point for Q3 and Q4?

Yes. Let me give you, Satya, one metric that I saw today that really is really very encouraging, and that is the number -- this is a market that I will get the number. The name of the marketing -- they're projecting the number of cell phones sold in the fourth quarter, this quarter, that music enabled will be 90 million actual handsets that are music enabled, and let me remind you they're enabled through Flash memory. Because if you don't have 5 megabyte minimum, you don't really have music, and the number from next year that they're projecting is that fully 51% of all handsets, that is 550 million handsets will be music enabled, enabled either through embedded Flash which something like the iNAND or the mDOC from M-Systems or through mobile cards, so even this quarter 90 million units compared to, -- 8.7 million iPods sold in the third quarter. This is a 10 X large number, and this is why we're so excited about that. And as far as your question about retail and OEM, it’s still early for retail, but it is growing, and I expect it will become a substantial portion eventually I would say within the next eighteen months or so could well become the dominant part of the sales. It sure feels like I could tell you like the heady days of the digital camera market when that really started moving from just a bundle to very strong retail after-market sales, and I would say that for the fourth quarter we are scrambling -- we're really scrambling to meet the demand particularly for microSD, mostly for backend assembly and test capacity, mostly assembly capacity.

Okay, Great.

So the signs are very positive for -- in that regard for Q4 and for next year.

Great. Thank you.

We'll take our next question from Paul Coster with J.P. Morgan.

Yeah, good afternoon. I have a couple of quick questions. Eli, as you look at the downward sloping cost curve for the NAND industry in aggregate, how smooth is it now and if there are going to be any sort of step function reductions, when will they takes place and for what reasons?

Good question, Paul. The industry -- these price reductions that we saw over this past several quarters clearly have been faster than anybody would expect including myself, ourselves, and are beginning to -- I believe are not sustainable as I said before until frankly the next major cost reduction has got to come with the next generation technology, and that technology applied at MLC which we've said is around middle of next year, so to the extent that there is aggressive price reductions in the first half of the year, they will -- it become more difficult to bring the cost down until the next generation comes in. We've said that we are -- we expect to start production of the 56 nanometer in the first quarter next year, but the full positive impact will start showing up until the significantly lower cost hopefully that is we don't know the yield of costs in the third quarter of next year. We think that our cost structure is as good as anybody out there. Samsung has said that they planned to introduce the 51 nanometer technology I think in the second quarter next year. So unless you are operating at that node it’s going to be very difficult for other competitors to drive pricing down from where they are today, but as we know, sometimes prices are not driven by cost but rather by other considerations.

Okay, my second question really relates to the channel fill that's happening at the moment. Sounds like you're going from approximately 200,000 outlets to considerably more over the next year or so. As that channel fills out, what kind of product is going into it?

Maybe Sanjay can comment. Sanjay just came back from India. We have a major effort in new geographies -- go ahead.

Basically our retail sales organization is very much focused on increasing the store fronts globally and yes we are around 200,000 now and over longer term over the next three to four years time frame we expect to increase that dramatically toward our goal of about 400,000 stores or so, and basically through the detailed handheld and through all those stores we plan to sell our full lineup of products, the mobile cards, the imaging cards as well as USB flashlight and the complete line of products.

Can you say anything about the margin of that product lineup? Is it going to align with the corporate average or will it be lower?

You know, we certainly expect the margin to align with corporate targets that we have for the gross margins even as we expand in other regions. We are very much focused on cost reductions and cost reductions achieved through technology transitions as well as manufacturing efficiencies, so we would expect the overall gross margin alignment to remain similar to what we have experienced in the past.

Okay. Thank you.

We'll take our next question from Daniel Amir with WR Hambrecht.

Thanks a lot and congratulations on a good quarter.

Thank you.

A couple questions. First of all, can you comment a bit on two things related to handset, first the number of units shipped? You made your comment on past couple of quarters of microSD units, and second can you maybe give your best estimate kind of what the attach rate right now between a phone and a card and where it’s going into in '07?

In terms of the number of cards shipped into the mobile, about 16 million units cards shipped into the mobile space, and in terms of the attached rate, at this point especially it include both the OEM and the retail, the attach rate I believe is somewhere in the range of about 20%, but you would look at having this attach rate go higher.

This is both bundled and unbundled?

Yes, bundled and unbundled. The majority is still bundled, and the first question was what format, the majority now is microSD, the second largest format is the Memory Stick Pro Duo for the Sony Erickson, we point out that Sony Erickson is 10% -- our 10% customer in the third quarter.

Okay. Thanks. One other question, can you give a litigation update? You commented that you have some expense related to the ITC hearings, where is that standing, what's kind of the time schedule there?

We have a scheduled court date in the month of December of this year at the ITC, and this is with regard to the suits that we've brought against STMicro.

And the expense?

You know, we haven't given the specific amount of expense. But it will cost some increase in G&A in the fourth quarter, and it’s included within the 30 to 35. I actually talked about the expense increase in order of size, so the biggest increase in expenses in the fourth quarter will come from sales and marketing expenses related to the holiday selling season, next biggest increase will come from 56 nanometer development, and then there will be some increase in expense in G&A primarily related to legal.

Thanks a lot.

And we'll take our next question from Gurinder Kalra with Bear Stearns.

My first question on cost reductions, what is the sweet spot for your current cost reduction in terms of 12 inch RAM and the 70 nanometer transition? Is it Q4 or do you think you will see significant cost reduction from Q4 into Q1 also?

You know, we are continue to go ramp Fab 3 at the more or less the linear pace. We expect to reach by the middle of next year I think we said 110,000 wafers a month, and the yields have reached very high level. We're very pleased with the yield, so there is not a lot of upside on the yield side. There is some upside on volume. The volume will increase -- will continue to increase substantially absorbing the fixed costs of those fab.

Let me just add to that, Gurinder. Keep in mind that we just completed the transition to 70 nanometer in Q3 from a production perspective, and so from a revenue perspective it takes one to two quarters before that production is actually built into products, shipped, and recognized as revenue, so there will be clearly some benefit of the 70 nanometer transition that will be impacting Q4 revenue, and we've taken that into account in the guidance that we gave for the 33% to 35% gross margin.

And my second question in terms of seasonality, is your seasonality changing a bit given that the OEM business now is such a big portion of your revenues, I mean normal seasonality obviously strongest in Q4, second strongest in Q2. Is seasonality changing between how you use Q1, Q2 and Q3 given the OEM proportion of your revenues?

I would say perhaps it moderates it a little bit. But if you think about, the sale of mobile phones and cards for mobile phones are actually do very well in the holiday selling season as well, so and in fact the handset manufacturers, you know, are very focused on taking delivery of the cards on a bundled basis on adjust-in-time basis as well, so there is definitely for example strong demand that we're seeing now in the fourth quarter for cards for mobile phones.

But the OEM business and the handset business, do you think that could make the seasonality in Q1 less pronounced given the linear effect?

I think you'll still see very traditional seasonality from the fourth quarter to the first quarter in our business.

Thanks.

Thank you. If I could ask the next caller to limit their questions to one or two, please.

Let me just -- the source for that number of cellphones, 19 million in Q4, and 550 million next year is strategy related and that is their latest report.

And we'll take our next question from Alex Gauna with UBS. Steven Chen – UBS: This is Steven Chen calling behalf of Alex. My question is in regards to handsets form factor cards. Just would you give us more color on the competition that you're seeing in that space for OEM bundled products from other branded cards and also what kind much ESP pressures do you see in that space given that you're probably dealing more directly with wireless service providers rather than a retail source?

As I said before, the dominant phone factor has now become microSD both in terms of handset models that supported but also it is almost a wholesale adoption now of microSD. There is motorola ofcourse started that with the thin phones that were enabled by the microSD, but now, you know, Nokia has basically endorsed it wholeheartedly. There is not a single handset guide that is not -- just about any handset guide that has plans for a mobile card slot either goes to microSD or to Sony Erickson equivalent which is M2, MMC -- Memory Stick Duo micro which we're developing together with Sony. The clear, if your SD is basically falling out, MMC is falling out, MMC micro is falling out, compared to 49% for microSD, MMC micro is 1% of the new handsets. It is just -- now, as far as the new players, you know, we've standardized microSD through the SD association, and we do see other suppliers coming into the market. We expect to see competition that's the name of the game, but frankly at this stage, with the very rapid growth I believe everybody is scrambling to go on if you will the back end assembly capacity that's out there. We saw it coming a lot earlier and we are in better shape I think that most other people, but we, too, are scrambling.

The second piece of your question relative to pricing, the price movement within our OEM channel was very similar to the price movement within the retail channel in this quarter. And typically over time that's going to be the case. You're not going to have big divergence of price movement between those two channels over time. Steven Chen – UBS: Okay. And lastly, when would you expect to see some royalty revenues that is derived from your microSD from TransFlash?

We're seeing that as I said, but the numbers are still relatively small, and of course these are royalty says that are shared between ourselves and Matsushita and Toshiba. Steven Chen – UBS: And last question I have this for Judy, Judy could you provide us your CapEx spending for Q3 and if you could also an estimate for Q4?

Okay, so you can actually see the CapEx spending for Q3 on the cash flow statement that's attached to our press release, and you can see it was about $34 million of non-fab related CapEx spending for the third quarter. Are you asking about fab or non-fab? Steven Chen – UBS: For everything.

Okay. For the third quarter is about 34 million for non-fab and as I mentioned in my prepared remarks, we made very little in the way of fab cash investment in the third quarter. We invested 4 million in Flash alliance for fab 4. Dialing forward to the fourth quarter, on the fab side we expect about $200 million of investment in fab 3, but we expected to come primarily from guarantee of operating leases as I have said a couple of times in the past, as long as we can get attractive operating leases at very low rates, we are prioritizing that type of funding for the fab. And then in terms of non-fab related CapEx I would expect at the beginning of the year I gave a forecast of about 200 million for the year, and I would say we're at about 125 million so far year-to-date and I think Q4 we'll see higher CapEx spending than we did in Q3. I think we will begin to -- we may not reach the 200 million, but we'll get a good way towards that number in the fourth quarter.

And we'll take our next question from Christian Garo (ph) with Robert Baird.

Your long-term model for captive, non-captive mix is 70/30%. Given that your guidance for the non-captive mix to be less than 10% of -- less than 10% in Q4 which is seasonally the strongest quarter, what could we expect in the first half of next year and specifically could we run of risk of you getting to a 100% captive model and then potentially some other capacity, and I guess the leading question to that is how long are the supply contracts and system has to abide to? Eli Harari : M-System.

You know, let me start. First, let me say we still believe over the long-term the right strategic model for our business is a 70/30 mix, 70% captive, 30% non-captive, and it is too early at this point for us to give any specific guidance for 2007 or the first half of 2007, but as you described, we will have the M-systems business combining with our business fairly soon now, so I think that significantly decreases the type of risk you were suggesting from over supply. Of course M-systems has some clearly has some commitments to current suppliers, and that will put some limitation on our ability to utilize our growing non-captive supply in that business, but we fully intend to work to be able to utilize some of our captive supply within the M-systems business as fast as we can. That's one of the key synergies that we expect to gain out of this transaction over the coming quarters. That's part of what we expect will lead to the deal being accretive by the end of year one as well as revenue synergies that we expect to gain.

Great.

And we'll take our next question from Craig Ellis with Citigroup.

Thank you. Just starting with a clarification. You mentioned competitive pricing. Could you just provide some context around when in the quarter you started to see things being more competitive than you thought they would be when you gave your initial guidance and was that in a particular product line or particular geography?

I think my saying was fairly competitive throughout the course of the quarter. So these promotion that we implemented to really match and maintain our position was pretty much throughout the course of the quarter.

Okay.

When you ask that, as we saw the quarter unfold, demand was in line with our expectations if not somewhat stronger than our expectations in the summer months. It really was -- there was a bigger gap than we like to see between our pricing and the competitive pricing and so that's what caused us to make a move to implement higher pricing actions primarily in the form of promotions than we had anticipated when we gave guidance in July.

That was across all products, all retail products, Judy.

For the most part, yes.

Okay. And then prospectively, you recently had the announcement with Best Buy and Circuit City, how should we think about MP3 market share as we look towards the fourth quarter into next year and how we think about the potential for other similar such agreements that broaden out your partnership profile on the MP3 side of the business?

I will say New York when we launched supported Best Buy and launching that program. They're very, very serious about the digital music store. We've been working roughly to optimize the something 200 to be seamless. The fourth quarter we're going to have a number of models that span entire price range and we are launching pretty aggressively MP3 players in Europe and the Pac Rim. So fourth quarter we're looking as you know the MP3 market is very, very much centered on the fourth quarter and we are pretty optimistic. We expect to do well, certainly looks very good.

And due to time constraints, we have time for one final question. It comes from Eric Gomberg with Thomas Weisel Partners.

Great. Thanks for taking my question. I was hoping you could update us on technology developments where you stand in the migration to smaller geometries and higher capacities in the one-time programmable as well as where things might be in 3 bit per cell or X 4 or making 3D rewritable.

Okay on 3D we are -- we plan to move by about a middle of next year I would say third quarter next year in production to the next technology node which is still lagging going from .13 micron to 80-nanometer, but it is a very important step to get their costs down. 3 bit and 4 bit per cell, 4 bit is of course X 4 and emphasis has been working on for the last four years or so will have to see how we can do, what comes support we can throw in to accelerate that, but both the 3 bit and 4 bit although quite challenging, we think overall that we have a good shot at commercializing but it probably will not make substantial impact on our cost structure or output until late 2007 at the earliest.

Okay.

So I think we really have to close here although we are really having enjoying ourselves, so in closing first of all I would like to congratulate us all for Wall Street hitting the 12,000 mark today. It is really great. I wish and you your family a happy holiday season. Also, I want to say that I will be planning a vacation in January, so I won't be here. I will be in the Southern Hampshire and Sanjay will join Jude to discuss Q4 results. But these are good exciting times for all of us and thank you very much.

Ladies and Gentlemen this concludes the today SanDisk Corporation Conference Call. Thank you for participating and you may now disconnect your phone lines.