News Column

SANDISK CORP - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

February 21, 2014

Overview Fiscal years ended December 29, December 30, January 1, 2013 % of Revenue 2012 % of Revenue 2012 % of Revenue (In millions, except percentages) Revenue $ 6,170.0 100.0 % $ 5,052.5 100.0 % $5,662.1 100.0 % Cost of revenue 3,253.0 52.7 % 3,326.7 65.8 % 3,183.3 56.2 % Amortization of acquisition-related intangible assets 49.5 0.8 % 42.6 0.9 % 39.7 0.7 % Total cost of revenue 3,302.5 53.5 % 3,369.3 66.7 % 3,223.0 56.9 % Gross profit 2,867.5 46.5 % 1,683.2 33.3 % 2,439.1 43.1 % Operating expenses Research and development 742.3 12.0 % 602.7 11.9 % 547.4 9.7 % Sales and marketing 276.3 4.5 % 224.1 4.4 % 199.4 3.5 % General and administrative 192.3 3.1 % 150.4 3.0 % 157.8 2.8 % Amortization of acquisition-related intangible assets 11.2 0.2 % 9.0 0.2 % 4.4 0.1 % Impairment of acquisition-related intangible assets 83.2 1.4 % 0.9 - % - - % Total operating expenses 1,305.3 21.2 % 987.1 19.5 % 909.0 16.1 % Operating income 1,562.2 25.3 %



696.1 13.8 % 1,530.1 27.0 % Other income (expense), net (46.1 ) (0.7 %)

(69.2 ) (1.4 %) (53.3 ) (0.9 %) Income before income taxes 1,516.1 24.6 %



626.9 12.4 % 1,476.8 26.1 % Provision for income taxes

473.4 7.7 % 209.5 4.1 % 489.8 8.7 % Net income $ 1,042.7 16.9 % $ 417.4 8.3 % $ 987.0 17.4 % General We are a global leader in NAND flash storage solutions. We sell our products globally to commercial and retail customers. We design, develop and manufacture data storage solutions in a variety of form factors using flash memory, controller, firmware and software technologies. Our solutions include SSDs, embedded products, removable cards, USB drives, wireless media drives, digital media players, and wafers and components. Our SSD products are used in both client computing platforms and enterprise data centers and provide high-speed, high-capacity storage solutions that can be used in lieu of hard disk drives. Our embedded flash products are used in mobile phones, tablets, computing platforms, imaging devices, and many other products. Our removable cards are used in a wide range of consumer electronics devices such as mobile phones, tablets, digital cameras, gaming devices and PCs. We have a deep understanding of the technology used in the design, manufacture and operation of NAND flash and have invented many of the key NAND flash technologies and solutions. We strive to continuously reduce the cost of NAND flash in order to continue to grow our markets, supply a diverse set of customers and channels, and enable us to profitably grow our business. A key component of our ability to reduce the cost of NAND flash is our ability to continue to transition our NAND flash manufacturing technology to smaller geometries. We currently expect to be able to continue to scale our current NAND flash architecture (2D NAND) to the 1Y要anometer node, which is currently in progress, and at least one more technology node (1Z要anometer), which is expected to ramp in late 2014 and throughout 2015. Beyond the 1Z要anometer node, there is no certainty that further technology scaling can be achieved cost-effectively with the 2D NAND flash architecture. We are investing in our 3D NAND architecture, which we refer to as BiCS, and we expect to begin to ramp BiCS in fiscal year 2016. We are also investing in 3D ReRAM technology which we believe may be a future alternative to NAND. We expect 2D NAND, 3D NAND and potential future technologies, including 3D ReRAM, to co-exist for an extended period of time. 35



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Through our investments in our ventures with Toshiba and our in-house assembly and test facility, we have invested heavily in a vertically integrated business model. We purchase substantially all of our NAND flash supply requirements through Flash Ventures, our significant flash venture relationships with Toshiba, which produce and provide us with leading-edge, high-quality, low-cost NAND flash wafers. While substantially all of our flash memory supply is purchased from the Flash Ventures, from time-to-time, we also purchase flash memory from other NAND flash manufacturers. While we do not unilaterally control the operations of Flash Ventures, we believe that our vertically integrated business model helps us to reduce the costs of producing our products, increases our ability to control the quality of our products and speeds delivery to our customers. Our vertically integrated manufacturing operations are concentrated in two locations, with Flash Ventures located in Yokkaichi, Japan, and our in-house assembly and test operations located in Shanghai, China. We also utilize third-party contract manufacturers in China, Malaysia and Taiwan. Most of our products are made by combining NAND flash memory with a controller and firmware. We use controllers which we have designed in-house as well as controllers purchased from third-parties. Our controllers that are designed in-house are manufactured at third-party foundries. The vast majority of our products use firmware that is developed in-house. Beginning in the first quarter of fiscal year 2013, we report only revenue, which includes product revenue and license and royalty revenue. In addition, during the first quarter of fiscal year 2013, we have recast our sales channels to be Retail and Commercial. Retail channel sales are made directly to retail customers and indirectly through distributors to retail customers. Commercial channel sales are made directly and through distributors to OEMs, system integrators and value-added resellers who bundle, embed or integrate our data storage solutions. Our Commercial revenue also includes license and royalty revenue related to IP. We have adjusted all prior year comparative amounts and explanations within Management's Discussion and Analysis of Financial Condition and Results of Operations to reflect these changes in classification to be consistent for all periods presented.



Industry and Company Trends

We operate in an industry characterized by rapid technology transitions and evolving end-user markets for NAND flash. Historically, flash memory cards for imaging devices and USB drives provided the majority of our revenue. With the emergence of smartphones, tablets and other mobile devices, which we refer to as mobile products, our sales of embedded and removable NAND flash solutions for the mobile market grew to represent the largest percentage of our revenue, and we continue to see growth in smartphone and tablet adoption as well as in the average capacity of our embedded and removable products used in these mobile products. We believe these trends will lead to continued revenue growth for our mobile products; however, we believe that demand for NAND flash in the mobile market will grow at a slower rate than in the past. Over the past two years, we have seen significant growth in our client SSD and enterprise SSD solutions, and we believe that over the next several years, the largest growth areas for NAND flash will be SSD solutions in the client computing and enterprise data center markets. We expect the retail market for NAND flash in imaging products and USB drives to be approximately constant or declining over the next several years. We continue to focus on adapting our business to the changing end-markets for NAND flash and aligning our resources accordingly. We currently expect that industry bit-supply growth for fiscal year 2014 will be approximately 40%, similar to the estimated supply growth rate in fiscal year 2013 and significantly lower than in fiscal year 2012. We expect that our captive bit-supply growth for fiscal year 2014 will be between 25% and 35%, compared to 18% in fiscal year 2013 and 86% in fiscal year 2012. In fiscal year 2014, we expect our business to experience a modest decline in our blended average selling price per gigabyte compared to no change in fiscal year 2013. Our revenue for fiscal year 2014 will be influenced primarily by our captive bit-supply growth, industry pricing trends and the mix of our product sales. We expect our fiscal year 2014 cost reduction per gigabyte to be less than the 20% generated in fiscal year 2013, likely in the range of 15% to 20%. Our primary cost reduction in fiscal year 2014 will come from the 1Y要anometer technology transition and expected positive impact of the Japanese yen to U.S. dollar exchange rate for Japanese yen denominated wafer purchases, offset by a continued product mix shift toward products which carry higher non-flash memory content. As part of our efforts to continuously reduce the cost of NAND flash, we are currently focused on transitioning our products to 19要anometer and 1Y要anometer technologies and we plan to transition to 1Z要anometer technology beginning in late 2014 and throughout the 2015 timeframe. Our 1Y要anometer and subsequent technology nodes have increased manufacturing equipment requirements, which reduce the cost reduction benefits obtainable through these technologies compared with previous technology node transitions. We continue to develop our 3D NAND architecture, and we continue to target pilot production for our 3D NAND in 2015 and volume ramp of our 3D NAND products in 2016. Some of our competitors have announced the launch of 3D NAND technologies with volume production beginning in 2014. At this time, 36



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these technologies are still emerging and it is unclear how these new technologies will compare to our 3D NAND technology and what implications other 3D NAND approaches may have for our industry or our business in terms of cost leadership, technology leadership, supply increases and product specifications. We believe that continued 2D NAND scaling is the most efficient method of reducing NAND costs in the near term and addressing the broadest range of market opportunities and therefore continue to focus on scaling 2D NAND flash at least through the 1Y要anometer and 1Z要anometer technology nodes, while we work on alternative technologies, primarily 3D NAND and 3D ReRAM in parallel. We believe that both 3D NAND and 3D ReRAM technologies may be viable alternatives to 2D NAND flash memory, when 2D NAND flash memory can no longer cost-effectively scale at a sufficient rate, or at all. However, even when 2D NAND flash memory can no longer be further scaled, we expect 2D NAND flash technology and potential alternative technologies to coexist for an extended period of time.



Fiscal Year 2013 Developments and Transactions

Convertible Notes. In the second quarter of fiscal year 2013, we settled our 1% Convertible Senior Notes due 2013, or the 1% Notes due 2013, in cash for $928.1 million principal plus $4.6 million of accrued interest. In addition, the associated convertible bond hedge transaction was terminated, with no shares purchased and the associated warrants that expired unexercised. In October 2013, we issued and sold $1.5 billion in aggregate principal amount of 0.5% Convertible Senior Notes due October 15, 2020, or the 0.5% Notes due 2020. The 0.5% Notes due 2020 were issued at par and pay interest at a rate of 0.5% per annum. The 0.5% Notes due 2020 may be converted into our common stock, under certain circumstances, based on an initial conversion rate of 10.8470 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $92.19 per share). The conversion price will be subject to adjustment in some events, but will not be adjusted for accrued interest. The net proceeds to us from the offering of the 0.5% Notes due 2020 were $1.48 billion. Concurrently with the issuance of the 0.5% Notes due 2020, we purchased a convertible bond hedge for $332 million and sold warrants for proceeds of $218 million. The separate convertible bond hedge and warrant transactions are structured to reduce the potential future economic dilution associated with the conversion of the 0.5% Notes due 2020. We used approximately $150 million of the net proceeds of the 0.5% Notes due 2020 to repurchase 2.2 million shares of our common stock. We currently intend to use the remainder of the net proceeds of the offering for general corporate purposes, including (1) the repurchase, from time-to-time, of shares of our common stock pursuant to our existing stock repurchase program; (2) to fund potential strategic investments or acquisitions of products, technologies or complementary businesses or to obtain the right to license or use additional technologies; (3) the repayment at maturity or repurchase, from time-to-time, of a portion of our currently outstanding indebtedness; and (4) other general corporate purposes, including capital expenditures related to manufacturing and technology. We currently have no commitments or agreements for any specific acquisitions, investments or licenses. Acquisitions. In August 2013, we completed the acquisition of SMART Storage, a developer of enterprise SSDs. This acquisition represents an opportunity for us to further enhance our storage product portfolio. We acquired all of the outstanding shares of SMART Storage through an all-cash transaction. The total purchase price was $305 million. Acquisition-related costs of approximately $3 million were expensed during fiscal year 2013. Dividend Declarations. In each of the third and fourth quarters of fiscal year 2013, we paid a cash dividend of $0.225 per common share. On January 21, 2014, our Board of Directors declared a dividend of $0.225 per share for holders of record as of February 3, 2014, which is to be paid on February 24, 2014. Share Repurchase Program. During the third quarter of fiscal year 2013, our Board of Directors increased the share repurchase program authorization by $2.50 billion, to an aggregate amount of $3.75 billion, for share repurchases. In the third quarter of fiscal year 2013, we entered into an ASR agreement with a financial institution to purchase $1.0 billion of our common stock. In exchange for an up-front payment totaling $1.0 billion, the financial institution committed to deliver shares during the ASR's purchase period, which will end no later than April 8, 2014. The total number of shares ultimately delivered, and therefore the average price paid per share, will be determined at the end of the applicable purchase period based on the volume weighted average price of our common stock during that period. During the third quarter of fiscal year 2013, 14.5 million shares were initially delivered to us by the financial institution. This does not represent the final number of shares to be delivered under the ASR. Depending on the average price of our common stock while the ASR is outstanding, upon the maturity of the ASR, the financial institution may be required to deliver additional shares to us or we may be required to deliver shares to the financial institution. We currently expect the purchase period for the ASR program to remain open until April 8, 37



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2014. The up-front payment of $1.0 billion was accounted for as a reduction to stockholders' equity in our Consolidated Balance Sheet.

Impairments. In the third quarter of fiscal year 2013, we recorded impairment charges of $47 million related to amortizable intangible assets and $36 million related to an in-process research and development intangible asset, both related to the acquisition of Pliant. These impairment charges are primarily the result of our decision to integrate more of the SMART Storage architecture and technology into our future enterprise product roadmap and from the delay in the launch of our next-generation SSD platform built on the Pliant technology.



Critical Accounting Policies & Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles, or GAAP. Use of Estimates. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue 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, allowance for doubtful accounts, valuation of inventories, valuation and impairments of marketable securities and investments, valuation and impairments of goodwill and long-lived assets, income taxes, warranty obligations, restructurings, contingencies, share-based compensation, IP claims and litigation. We base our estimates on historical experience and on other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for our judgments about the carrying values of assets and liabilities when those values are not readily apparent from other sources. Estimates have historically approximated actual results. However, future results will differ from these estimates under different assumptions and conditions. Revenue Recognition, Sales Returns and Allowances and Sales Incentive Programs. We recognize revenue when the earnings process is complete, as evidenced by an agreement with the customer, transfer of title and acceptance, if applicable, pricing is fixed or determinable and collectability is reasonably assured. Revenue is generally recognized at the time of shipment or transfer of title for customers not eligible for price protection and/or a right of return. Sales made to distributors and retailers are generally under agreements allowing price protection and/or right of return and, therefore, the sales and related costs of these transactions are deferred until the distributors or retailers sell the merchandise to their end customer, or the rights of return expire. At December 29, 2013 and December 30, 2012, deferred income from sales to distributors and retailers was $254 million and $205 million, respectively. Estimated sales returns are recorded as a reduction to revenue and deferred revenue and were not material for any period presented in our Consolidated Financial Statements. Sales of standalone software products were not material for any period presented. We record estimated reductions to revenue or to deferred revenue for customer and distributor incentive programs and offerings, including price protection, promotions, co-op advertising, and other volume-based incentives and expected returns. All sales incentive programs are recorded as an offset to revenue or deferred revenue. In calculating the value of sales incentive programs, actual and estimated activity is used based upon reported weekly sell-through data from our customers and historical activity. The resolution of these claims is generally within twelve months and could materially impact revenue or deferred revenue. In addition, actual returns and rebates in any future period could differ from our estimates, which could impact the revenue we report. Inventories and Inventory Valuation. Inventories are stated at the lower of cost (first-in, first-out) or market. Market value is based upon an estimated average selling price reduced by estimated costs of disposal. The determination of market value involves numerous judgments including estimating average selling prices based upon recent sales, industry trends, existing customer orders, current contract prices, industry analysis of supply and demand and seasonal factors. Should actual market conditions differ from our estimates, our future results of operations could be materially affected. The valuation of inventory also requires us to estimate obsolete or excess inventory. The determination of obsolete or excess inventory requires us to estimate the future demand for our products within appropriate time horizons, generally six to twelve months. The estimated future demand is compared to inventory levels to determine the amount, if any, of obsolete and excess inventory. The demand forecast includes our estimates of market growth and our market share, various internal estimates and data from certain external sources, and is based on assumptions that are consistent with the plans and estimates we are using to manage our underlying business and short-term manufacturing plans. To the extent our demand forecast for specific products is less than the combination of our product on-hand and our noncancelable orders from suppliers, we could be required to record additional inventory reserves, which would have a negative impact on our gross margin. 38



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Deferred Tax Assets. We must make certain estimates in determining income tax expense for financial statement purposes. These estimates occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. From time-to-time, we must evaluate the expected realization of our deferred tax assets and determine whether a valuation allowance needs to be established or released. In determining the need for and amount of our valuation allowance, we assess the likelihood that we will be able to recover our deferred tax assets using historical levels of income, estimates of future income and tax planning strategies. Our estimates of future income include our internal projections and various internal estimates and certain external sources which we believe to be reasonable but that are unpredictable and inherently uncertain. We also consider the jurisdictional mix of income and loss, changes in tax regulations in the period the changes are enacted and the type of deferred tax assets and liabilities. In assessing whether a valuation allowance needs to be established or released, we use judgment in considering the cumulative effect of negative and positive evidence and the weight given to the potential effect of the evidence. Recent historical income or loss and future projected operational results have the most influence on our determinations of whether a deferred tax valuation allowance is required or not. Our estimates for tax uncertainties require substantial judgment based upon the period of occurrence, complexity of the matter, available federal tax case law, interpretation of foreign laws and regulations and other estimates. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining whether the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. If we determine that a tax position will more likely than not be sustained on audit, the second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given with respect to the final outcome of these matters. To the extent that the final outcome of these matters is different than the amounts recorded, such differences generally will impact our provision for income taxes in the period in which such a determination is made. Valuation of Long-Lived Assets, Intangible Assets and Goodwill. We perform tests for impairment of long-lived assets whenever events or circumstances suggest that long-lived assets may not be recoverable. An impairment is only deemed to have occurred if the sum of the forecasted undiscounted future cash flows related to the assets are less than the carrying value of the asset we are testing for impairment. If the forecasted undiscounted cash flows are less than the carrying value, then we must determine the fair value of the long-lived asset or group of long-lived assets and recognize an impairment loss if the carrying amount of the long-lived asset or group of long-lived assets exceeds its fair value which is based primarily upon forecasted discounted cash flows. These forecasted discounted cash flows include estimates and assumptions related to revenue growth rates and operating margins, 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 growth and our market 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. We perform our annual impairment analysis of goodwill and indefinite-lived intangible assets (such as in-process research and development) on the first day of the fourth quarter of each fiscal year, or more often if there are indicators of impairment. We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. As of December 29, 2013, we had one reporting unit. We may first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is "more likely than not" that the fair value of the reporting unit is less than its carrying amount and whether the two-step impairment test on goodwill is required. If, based upon qualitative factors, it is "more likely than not" that the fair value of a reporting unit is greater than its carrying amount, we will not be required to proceed to a two-step impairment test on goodwill. However, we also have the option to proceed directly to a two-step impairment test on goodwill. In the first step, or Step 1, of the two-step impairment test, we compare the fair value of each reporting unit to its 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, or Step 2, of the two-step 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. The fair value of each reporting unit is estimated using a discounted cash flow methodology. This analysis requires 39



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significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. We evaluate the reasonableness of the fair value calculations of our reporting units by reconciling the total of the fair values of all of our reporting units to our total market capitalization, taking into account an appropriate control premium. The determination of a control premium requires the use of judgment and is based primarily on comparable industry and deal-size transactions, related synergies and other benefits. When we are required to perform a Step 2 analysis, determining the fair value of our net assets and our off-balance sheet intangibles used in Step 2 requires us to make judgments and involves the use of significant estimates and assumptions. For both goodwill and indefinite-lived intangible assets, we have the option to first assess qualitative factors to determine whether events and circumstances indicate that it is more likely than not that the goodwill or an indefinite-lived intangible asset is impaired and determine whether further action is needed. Fair Value of Investments in Debt Instruments. There are three levels of inputs that may be used to measure fair value (see Note 2, "Investments and Fair Value Measurements" in the Notes to Consolidated Financial Statements included in Item 8 of this report). Each level of input has different levels of subjectivity and difficulty involved in determining fair value. Level 1 securities represent quoted prices in active markets, and therefore do not require significant management judgment. Our Level 2 securities are primarily valued using quoted market prices for similar instruments and nonbinding market prices that are corroborated by observable market data. We use inputs such as actual trade data, benchmark yields, broker/dealer quotes, and other similar data, which are obtained from independent pricing vendors, quoted market prices, or other sources to determine the ultimate fair value of our assets and liabilities. The inputs and fair value are reviewed for reasonableness, may be further validated by comparison to publicly available information, compared to multiple independent valuation sources and could be adjusted based on market indices or other information. In the current market environment, the assessment of fair value can be difficult and subjective. However, given the relative reliability of the inputs we use to value our investment portfolio and because substantially all of our valuation inputs are obtained using quoted market prices for similar or identical assets, we do not believe estimates and assumptions materially impacted our valuation of our cash equivalents and short and long-term marketable securities. We currently do not have any investments that use Level 3 inputs. 40



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Table of Contents Results of Operations Revenue by Channel. FY 2013 FY 2012 FY 2011 Percent of Percent of Percent of Revenue Total Revenue Total Revenue Total (In millions, except percentages) Commercial $ 3,907.3 63.3 % $ 3,205.5 63.4 % $ 3,833.0 67.7 % Retail 2,262.7 36.7 % 1,847.0 36.6 % 1,829.1 32.3 % Total revenue $ 6,170.0 100.0 % $ 5,052.5 100.0 % $ 5,662.1 100.0 % The increase in our fiscal year 2013 revenue, compared to fiscal year 2012, reflected a 22% increase in the number of gigabytes sold with no change in the average selling price per gigabyte. The increase in Commercial revenue is primarily related to increased sales of client and enterprise SSD products and embedded memory products for mobile devices, partially offset by decreased sales of cards for mobile devices due to continued OEM debundling and our allocation of less supply to private label channels. The increase in Retail revenue is primarily related to increased sales of cards for mobile devices, USB drives and SSDs. While sales of cards for mobile devices through the Commercial channel are down on a year-over-year basis, increased sales in aftermarket retail mobile cards have partially offset the Commercial channel declines. The decrease in our fiscal year 2012 revenue, compared to fiscal year 2011, reflected a 45% reduction in average selling price per gigabyte, partially offset by a 62% increase in the number of gigabytes sold. A primary factor in the decrease in revenue was a steep rate of price decline in the year ended December 30, 2012 largely due to oversupply in the NAND industry in the first half of fiscal year 2012. The increase in number of gigabytes sold was driven by an 11% increase in memory units sold with an increase in average capacity of 47%. The decrease in revenue in fiscal year 2012, over fiscal year 2011, was due primarily to lower Commercial sales of cards and embedded products for mobile devices, and lower sales of wafers and components, partially offset by increased sales of client and enterprise SSD products. Our sales of mobile cards were lower due to a reduced rate of card bundling and bundling of lower capacity cards by mobile commercial customers, and in the first half of fiscal year 2012, our sales of mobile embedded products were lower as our next generation of those products were in various stages of development and qualification. Our Retail revenue for fiscal year 2012, compared to fiscal year 2011, remained relatively flat compared to the prior year. Geographical Revenue. FY 2013 FY 2012 FY 2011 Percent of Percent of Percent of Revenue Total Revenue Total Revenue Total (In millions, except percentages) United States $ 877.8 14.2 % $ 714.3 14.2 % $ 853.8 15.1 % Asia-Pacific 4,209.8 68.3 % 3,467.7 68.6 % 3,896.5 68.8 % Europe, Middle East and Africa 780.1 12.6 % 642.5 12.7 % 688.5 12.2 % Other foreign countries 302.3 4.9 % 228.0 4.5 % 223.3 3.9 % Total revenue $ 6,170.0 100.0 % $ 5,052.5 100.0 % $ 5,662.1 100.0 % Revenue in the U.S. increased in fiscal year 2013, compared to fiscal year 2012, due primarily to increased sales of client and enterprise SSD products, retail cards for mobile devices and USB drives. Revenue in Asia-Pacific increased in fiscal year 2013, compared to fiscal year 2012, due primarily to increased sales of client and enterprise SSD products and embedded products for mobile devices, partially offset by lower OEM sales of cards for mobile and gaming devices, and lower sales of wafers and components. Revenue in the Europe, Middle East and Africa, or EMEA, increased in fiscal year 2013, compared to fiscal year 2012, due primarily to increased sales of client and enterprise SSD products, retail cards for mobile devices and USB drives. Revenue in other foreign countries increased in fiscal year 2013, compared to fiscal year 2012, due primarily to higher sales of USB drives and cards for mobile devices. 41



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Revenue in Asia-Pacific decreased in fiscal year 2012, compared to fiscal year 2011, due primarily to decreased OEM sales of cards and embedded products for mobile devices, partially offset by higher retail sales of mobile cards, USB drives and SSDs. The decrease in revenue for the U.S. in fiscal year 2012, compared to fiscal year 2011, was due primarily to lower retail sales of cards for mobile and imaging devices, and lower OEM sales of cards and embedded products for mobile devices, partially offset by increased sales of client and enterprise SSD products. Revenue in EMEA, decreased slightly in fiscal year 2012, compared to fiscal year 2011, due primarily to decreased OEM sales of cards and embedded products for mobile devices and lower retail sales of cards for the imaging market, partially offset by increased sales of retail mobile cards, USB drives and client SSD products. Gross Profit and Margin. FY 2013 Percent Change FY 2012 Percent Change FY 2011 (In millions, except percentages) Gross profit $ 2,867.5 70 % $ 1,683.2 (31 %) $ 2,439.1 Gross margin 46.5 % 33.3 % 43.1 % Gross margin increased in fiscal year 2013, compared to fiscal year 2012, due primarily to a favorable industry supply and demand environment coupled with a higher product mix of enterprise SSD products and high-performance retail products. These factors led to no year-over-year change in our average selling price per gigabyte, while our cost per gigabyte declined by 20%. Cost declines in fiscal year 2013, compared to fiscal year 2012, were derived primarily from our increased mix of 19要anometer wafers, lower depreciation costs for fab equipment, and weakening of the Japanese yen relative to the U.S. dollar, partially offset by increased non-flash memory costs and decreased usage of X3負echnology memory, both due to the increased mix of SSD and embedded products. Gross margin decreased in fiscal year 2012, compared to fiscal year 2011, due primarily to declines in average selling price per gigabyte of 45% exceeding cost reduction per gigabyte of 36%. The degree to which price decline exceeded cost decline was primarily due to oversupply in the NAND industry in the first half of fiscal year 2012. Costs per gigabyte improved over the prior year primarily due to wafer production transitioning from 24要anometer to 19要anometer and lower usage of non-captive memory. This cost reduction includes higher inventory-related charges in fiscal year 2012, offset by a reduction in fab start-up costs that occurred in fiscal year 2011 and did not recur in fiscal year 2012.



Research and Development.

FY 2013 Percent Change FY 2012



Percent Change FY 2011

(In millions, except



percentages)

Research and development $ 742.3 23 % $ 602.7 10 % $ 547.4 Percent of revenue 12.0 % 11.9 % 9.7 % The increase in our research and development expense for fiscal year 2013, compared to fiscal year 2012, was due primarily to higher employee-related costs of $119 million, which includes an increase in incentive compensation of $59 million due to improved financial and operational performance, and increases in salary and benefits of $49 million and share-based compensation of $11 million due to increased head count. In addition, fiscal year 2013 expenses included an increase of $25 million for technology acquisition, prototype expenditures and non-recurring engineering costs. The increase in research and development expense for fiscal year 2012, compared to fiscal year 2011, was due primarily to a net compensation expense increase of $27 million driven by higher headcount, partially offset by lower incentive compensation. In addition, we incurred higher third-party engineering costs of $14 million and technology license and equipment expense of $13 million. 42



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Sales and Marketing.

FY 2013 Percent Change FY 2012 Percent



Change FY 2011

(In millions, except percentages) Sales and marketing $ 276.3 23 % $ 224.1 12 % $ 199.4 Percent of revenue 4.5 % 4.4 % 3.5 % The increase in our sales and marketing expense for fiscal year 2013, compared to fiscal year 2012, was due primarily to higher employee-related costs of $47 million, which includes an increase in incentive compensation of $22 million, an increase in salary and benefits of $20 million and an increase in share-based compensation of $5 million. The increase in incentive compensation expense was due to improved financial and operational performance and the increase in salary and benefit costs was due primarily to increased headcount. In addition, branding, merchandising and other expenses increased by $5 million. The increase in our sales and marketing expense for fiscal 2013, compared to fiscal year 2011, was due primarily to a net compensation expense increase of $14 million driven by higher headcount, partially offset by lower incentive compensation. In addition, we incurred higher marketing and promotional costs of $11 million.



General and Administrative.

FY 2013 Percent Change FY



2012 Percent Change FY 2011

(In millions, except percentages) General and administrative $ 192.3 28 % $ 150.4 (5 %) $ 157.8 Percent of revenue 3.1 % 3.0 % 2.8 % The increase in our general and administrative expense for fiscal year 2013, compared to fiscal year 2012, was due primarily to higher employee-related costs of $20 million, which includes increases in incentive compensation expense of $14 million due to improved financial and operational performance, and salary and benefits of $6 million, higher charitable expense of $10 million and outside service expenses of $5 million. Expenses in fiscal year 2012 were reduced by insurance recoveries of $5 million that did not recur in fiscal year 2013.



Our fiscal year 2012 general and administrative expense decreased from fiscal year 2011 primarily due to insurance recoveries of $5 million.

Amortization of Acquisition-related Intangible Assets.

FY 2013 Percent Change FY



2012 Percent Change FY 2011

(In millions, except percentages) Amortization of acquisition-related intangible assets $ 11.2 24 % $ 9.0 105 % $ 4.4 Percent of revenue 0.2 % 0.2 % 0.1 % Amortization of acquisition-related intangible assets in fiscal year 2013, compared to fiscal year 2012, reflected higher amortization of intangible assets from our SMART Storage acquisition which was completed in the third quarter of fiscal year 2013, partially offset by lower amortization of intangible assets from our Pliant acquisition, which were impaired in fiscal year 2013. Amortization of acquisition-related intangible assets in fiscal year 2012, compared to fiscal year 2011, was higher due to increased amortization of intangible assets from the acquisitions of FlashSoft Corporation, or FlashSoft, and Schooner Information Technology, Inc., or Schooner, as well as a full year of amortization related to the acquisition of Pliant, offset by a reduction in the amortization of intangible assets from a prior acquisition, which became fully amortized during the first quarter of fiscal year 2012. Amortization of acquisition-related intangible assets associated with these acquisitions will continue to be amortized through fiscal year 2016. 43



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Impairment of Acquisition-related Intangible Assets.

Percent Percent FY 2013 Change FY 2012 Change FY 2011 (In millions, except percentages) Impairment of acquisition-related intangible assets $ 83.2 ** $ 0.9 ** $ - Percent of revenue 1.4 % - % - % ** Amount not meaningful



Impairment of acquisition-related intangible assets in fiscal year 2013, compared to fiscal year 2012, reflected an impairment of in-process research and development, or IPR&D, and amortizable intangible assets from our Pliant acquisition.

Other Income (Expense), net.

FY 2013 Percent Change FY 2012 Percent Change FY 2011 (In millions, except percentages) Interest income $ 48.8 (17 %) $ 59.0 (2 %) $ 60.4 Interest expense (91.5 ) 24 % (119.7 ) 3 % (123.3 ) Other income (expense), net (3.4 ) ** (8.5 ) ** 9.6



Total other income (expense), net $ (46.1 ) ** $ (69.2 ) **

$ (53.3 ) ** Amount not meaningful "Total other income (expense), net" for the fiscal year 2013 reflected a lower net expense, compared to fiscal year 2012, due primarily to lower interest expense as a result of lower average convertible debt balances, lower interest income due to lower average interest income yield on our cash and investments, a non-recurring charge incurred by Flash Ventures of $9 million and losses on non-designated foreign exchange contracts included in "Other income (expense)" in fiscal year 2012 that did not recur in fiscal year 2013. Our fiscal year 2012 "Total other income (expense), net" was a higher net expense compared to fiscal year 2011 primarily due to non-recurring charges and losses reflected in "Other income (expense), net." "Other income (expense), net" for fiscal year 2012 primarily included a non-recurring charge incurred by Flash Ventures of $9 million. "Other income (expense), net" for fiscal year 2011 primarily included a net gain on sale of equity securities of $19 million, offset by the expense of $11 million incurred from the change in fair value of the liability component of the repurchased portion of the 1% Notes due 2013. Provision for Income Taxes. FY 2013 Percent Change FY 2012 Percent Change FY 2011 (In millions, except percentages) Provision for income taxes $ 473.4 126 % $ 209.5 (57 %) $ 489.8 Effective tax rate 31.2 % 33.4 % 33.2 % Our fiscal year 2013, 2012 and 2011 provisions for income taxes differ from the U.S. statutory tax rate primarily due to the tax impact of earnings from foreign operations, state taxes, non-deductibility of certain share-based compensation, and tax-exempt interest income. In addition, fiscal year 2013 and 2011 included a benefit from federal research and development credits. Earnings and taxes resulting from foreign operations are largely attributable to our Irish, Chinese, Israeli and Japanese entities. We are subject to U.S. federal income tax as well as income taxes in multiple state and foreign jurisdictions. In February 2012, the IRS completed its field audit of our federal income tax returns for the fiscal years 2005 through 2008 and issued the Revenue Agent's Report. The most significant proposed adjustments are comprised of related party transactions between our U.S. parent entity and our foreign subsidiaries. We are contesting these adjustments through the IRS Appeals Office and cannot predict when a resolution will be reached. 44



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We strongly believe that the IRS's position regarding the intercompany transactions is inconsistent with applicable tax laws, judicial precedent and existing Treasury regulations, and that our previously reported income tax provisions for the years in question are appropriate. We believe that an adequate provision has been made for the adjustments from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner that is not consistent with our expectations, we could be required to adjust our provision for income tax in the period such resolution occurs. The IRS recently initiated an examination of our federal income tax returns for fiscal years 2009 through 2011. We do not expect a resolution of this audit to be reached during the next twelve months. In addition, we are currently under audit by various state and international tax authorities. While we believe that we have an adequate provision for the years under audit, there is still a possibility that an adverse outcome from these matters could have a material effect on our financial position, results of operations or liquidity. The American Taxpayer Relief Act of 2012 enacted on January 2, 2013 retroactively extended the federal research and development tax credit and exemption of certain intercompany transactions from federal taxation through December 31, 2013. As a result, our income tax provision for fiscal year 2013 includes a tax benefit that reduced our effective annual fiscal year 2013 tax rate. The financial statement benefit related to the retroactive 2012 federal research and development tax credit was $8 million. Non-GAAP Financial Measures Reconciliation of Net Income. Fiscal years ended December 29, December 30, January 1, 2013 2012 2012 (In millions except per share amounts) Net income $ 1,042.7$ 417.4$ 987.0 Share-based compensation 99.8 78.4 63.1 Amortization of acquisition-related intangible assets 60.7 51.5 44.2 Impairment of acquisition-related intangible assets 83.2 0.9 - Convertible debt interest 67.6 90.0 111.4 Income tax adjustments (87.0 ) (55.8 ) (67.7 ) Non-GAAP net income $ 1,267.0$ 582.4$ 1,138.0 Diluted net income per share: $ 4.34 $ 1.70$ 4.04 Share-based compensation 0.42 0.32 0.26 Amortization of acquisition-related intangible assets 0.26 0.21 0.18 Impairment of acquisition-related intangible assets 0.35 - - Convertible debt interest 0.29 0.37 0.45 Income tax adjustments (0.35 ) (0.22 ) (0.28 ) Non-GAAP diluted net income per share $ 5.31 $



2.38 $ 4.65

Reconciliation of Diluted Shares.

Fiscal years ended December 29, December 30, January 1, 2013 2012 2012 (In thousands) GAAP diluted shares 240,236 245,253 244,553 Adjustment for share-based compensation 271 (54 )



15

Offsetting shares from bond hedge (2,088 ) - - Non-GAAP diluted shares 238,419 245,199 244,568 45



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We believe these non-GAAP measures provide investors the ability to better assess and understand operating performance, especially when comparing results with previous periods or forecasting performance for future periods, primarily because management typically monitors the business excluding these items. We also use these non-GAAP measures to establish operational goals and for measuring performance for compensation purposes. However, analysis of results on a non-GAAP basis should be used as a complement to, and in conjunction with, and not as a replacement for, data presented in accordance with GAAP. We believe that the presentation of non-GAAP measures, including non-GAAP net income and non-GAAP diluted net income per share, provides important supplemental information to management and investors about financial and business trends relating to our operating results. We believe that the use of these non-GAAP financial measures also provides consistency and comparability with our past financial reports. We have historically used these non-GAAP measures when evaluating operating performance because we believe that the inclusion or exclusion of the items described below provides an additional measure of our core operating results and facilitates comparisons of our core operating performance against prior periods and our business model objectives. We have chosen to provide this information to investors to enable them to perform additional analyses of past, present and future operating performance and as a supplemental means to evaluate our ongoing core operations. Externally, we believe that these non-GAAP measures continue to be useful to investors in their assessment of our operating performance and their valuation of our company. Internally, these non-GAAP measures are significant measures used by us for purposes of: evaluating our core operating performance; establishing internal budgets; setting and determining variable compensation levels; calculating return on investment for development programs and growth initiatives; comparing performance with internal forecasts and targeted business models; strategic planning; and benchmarking performance externally against our competitors.



We exclude the following items from our non-GAAP measures:

Share-based Compensation Expense. These expenses consist primarily of

expenses for share-based compensation, such as stock options, restricted

stock units and our employee stock purchase plan. Although share-based

compensation is an important aspect of the compensation of our employees,

we exclude share-based compensation expenses from our non-GAAP measures

primarily because they are non-cash expenses. Further, share-based compensation expenses are based on valuations with many underlying assumptions not in our control that vary over time and may include modifications that may not occur on a predictable cycle, neither of which is necessarily indicative of our ongoing business performance. In addition, the share-based compensation expenses recorded are often



unrelated to the actual compensation an employee realizes. We believe that

it is useful to exclude share-based compensation expense for investors to

better understand the long-term performance of our core operations and to

facilitate comparison of our results to our prior periods and to our peer companies.



Amortization and Impairment of Acquisition-related Intangible Assets. We

incur amortization, and, occasionally, impair intangible assets in

connection with acquisitions. Since we do not acquire businesses on a

predictable cycle, we exclude these items in order to provide investors

and others with a consistent basis for comparison across accounting periods.



Convertible Debt Interest. We incur non-cash economic interest expense

relating to the implied value of the equity conversion component of our

convertible debt. The value of the equity conversion component is treated

as a debt discount and amortized to interest expense over the life of the

notes using the effective interest rate method. We also incur interest

expense equal to the change in fair value of the liability component of the convertible debt when we repurchase a portion of the convertible debt. We exclude these non-cash interest expenses that do not represent cash interest payments made to our note holders.



Income Tax Adjustments. This amount is used to present each of the amounts

described above on an after-tax basis, considering jurisdictional tax rates, consistent with the presentation of non-GAAP net income. 46



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Diluted Share Adjustments. As share-based compensation is excluded from our presentation of non-GAAP net income, the impact of share-based



compensation on diluted share calculations is also excluded from non-GAAP

diluted shares. Concurrent with the issuance of our convertible debt, we

entered into convertible bond hedge transactions in which counterparties

agreed to sell us a number of shares of our common stock which will be

equal to the number of shares issuable upon conversion of the convertible

debt. As a result, our convertible bond hedges, when exercised, will

deliver shares to offset the issuance of dilutive shares from our

convertible debt. Because the bond hedges will ultimately offset the

shares issued at maturity of our convertible debt, we include the impact

of the bond hedges in our non-GAAP dilutive shares in any period where the

associated convertible debt is dilutive. The impact of the convertible

bond hedges is excluded from GAAP dilutive shares.

From time-to-time in the future, there may be other items that we may exclude if we believe that doing so is consistent with the goal of providing useful information to investors and management.

Limitations of Relying on Non-GAAP Financial Measures. We have incurred and will incur in the future, many of the costs that we exclude from the non-GAAP measures, including share-based compensation expense, impairment of goodwill and acquisition-related intangible assets, amortization of acquisition-related intangible assets and other acquisition-related costs, non-cash economic interest expense associated with our convertible debt and income tax adjustments. These measures should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for, or superior to, GAAP results. These non-GAAP measures may be different than the non-GAAP measures used by other companies. 47



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Liquidity and Capital Resources

Cash Flows. Our cash flows were as follows:

FY 2013 FY 2012



FY 2011

(In millions)



Net cash provided by operating activities $ 1,863.7$ 529.9

$ 1,053.7 Net cash used in investing activities (922.9 ) (574.4 ) (667.0 ) Net cash used in financing activities (956.4 ) (125.1 ) (47.1 ) Effect of changes in foreign currency exchange rates on cash 6.4 (2.4 ) (1.3 ) Net increase (decrease) in cash and cash equivalents $ (9.2 )$ (172.0 )$ 338.3 Operating Activities. Cash provided by operating activities is generated by net income adjusted for certain non-cash items and changes in assets and liabilities. The increase in cash provided by operations in fiscal year 2013, compared to fiscal year 2012, resulted primarily from higher net income. Cash flow from accounts receivable was a lower usage of cash compared with the prior year due to collections of outstanding receivables, partially offset by higher sales in the current year compared to the prior year. Cash flow from inventory increased compared to the prior year due primarily to utilization of fiscal year 2012 inventory balances in fiscal year 2013. Cash flow from other assets increased compared to the prior year due primarily to utilization of income tax receivables. Cash flow related to accounts payable increased due primarily to the timing of payments to vendors. Cash flow related to accounts payable to related parties was a higher usage of cash primarily due to the timing of payments to Flash Ventures as compared to the prior year. Cash flow from other liabilities was a source of cash compared to a usage of cash in the prior year due primarily to higher accrued incentive compensation and higher tax liabilities in fiscal year 2013, both as a result of higher fiscal year 2013 profitability, as well as higher other accrued liabilities in fiscal year 2013. The decrease in cash provided by operations in fiscal year 2012, compared to fiscal year 2011, resulted primarily from lower net income. Cash flow from accounts receivable was a lower usage of cash compared with the prior year due to lower sales in fiscal year 2012 compared to the prior year. Cash flow from inventory was a lower usage of cash compared to the prior year due to inventory increasing at a slower rate compared to the prior year. Cash flow from other assets was a lower usage of cash compared to the prior year primarily due to a prior year prepayment of building-related costs for Flash Forward. Cash flow related to accounts payable to related parties decreased primarily due to the timing of payments to Flash Ventures as compared to the prior year. Cash flow from other liabilities was a usage of cash compared to an inflow of cash in the prior year primarily due to higher tax payments in fiscal year 2012 related to fiscal year 2011 higher profitability. Investing Activities. Net cash used in investing activities for fiscal year 2013 was primarily related to acquisition of property and equipment of $213 million, net purchases of short and long-term marketable securities of $472 million and the acquisition of SMART Storage, net of cash acquired of $304 million, partially offset by net proceeds from Flash Ventures of $75 million. Net cash used in investing activities for fiscal year 2012 was primarily related to acquisition of property and equipment of $488 million, net purchases of short and long-term marketable securities of $331 million and acquisitions of FlashSoft and Schooner, net of cash acquired of $70 million, partially offset by net proceeds from Flash Ventures of $319 million. Financing Activities. Net cash used in financing activities for fiscal year 2013 was primarily related to stock repurchases of $1.59 billion, repayment of our 1% Notes due 2013 of $928 million, and dividends paid of $101 million, offset by net cash received of $1.48 billion from the issuance of our 0.5% Notes due 2020, and related transactions including the purchase of a convertible bond hedge for $332 million and proceeds from the sale of warrants of $218 million. Net cash used in financing activities for fiscal year 2012 was primarily related to stock repurchases of $230 million, partially offset by cash received from employee stock programs of $86 million. Liquid Assets. At December 29, 2013, we had cash, cash equivalents and short-term marketable securities of $2.91 billion. We had $3.18 billion of long-term marketable securities, which we believe are also liquid assets, but are classified as long-term marketable securities due to the remaining maturity of each marketable security being greater than one year. 48



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Short-Term Liquidity. As of December 29, 2013, our working capital balance was $3.42 billion. During fiscal year 2014, we expect our total capital investment to be $1.5 billion to $1.7 billion, including our net capital investments in Flash Ventures and our investment in non-fab property and equipment. We expect these fiscal year 2014 investments to be funded approximately half by our cash and half by the Flash Ventures' working capital and equipment leases. Depending on the forecasted demand for our products, we may decide to make additional investments, which could be substantial, in wafer fabrication capacity and assembly and test manufacturing equipment. We may also engage in merger or acquisition transactions, make equity investments in other companies or purchase or license technologies. These activities may require us to raise additional financing, which could be difficult to obtain, and which if not obtained in satisfactory amounts, could prevent us from funding Flash Ventures, increasing our wafer supply, developing or enhancing our products, taking advantage of future opportunities, engaging in acquisitions of or investments in companies, growing our business, or responding to competitive pressures or unanticipated industry changes, any of which could harm our business.



On January 21, 2014, our Board of Directors declared a dividend of $0.225 per share for holders of record as of February 3, 2014. We expect to pay approximately $52 million to these holders of record on February 24, 2014.

Our short-term liquidity is impacted in part by our ability to maintain compliance with covenants in the outstanding Flash Ventures master lease agreements. The Flash Ventures master lease agreements contain customary covenants for Japanese lease facilities as well as an acceleration clause for certain events of default related to us as guarantor, including, among other things, our failure to maintain shareholder equity of at least $1.51 billion. As of December 29, 2013, Flash Ventures was in compliance with all of its master lease covenants, including the shareholder equity covenant with our stockholders' equity at $6.97 billion as of December 29, 2013. If our shareholders' equity falls below $1.51 billion or other events of default occur, Flash Ventures would become non-compliant with certain covenants under certain master equipment lease agreements and would be required to negotiate a resolution to the non-compliance to avoid acceleration of the obligations under such agreements, which at December 29, 2013 was 51.6 billion Japanese yen, or approximately $492 million based upon the exchange rate at December 29, 2013. As of December 29, 2013, the amount of cash and cash equivalents and short and long-term marketable securities held by foreign subsidiaries was $858 million, and a portion of this amount could be subject to U.S. income taxes if repatriated to the U.S. We provide for U.S. income taxes on the earnings of foreign subsidiaries unless the earnings are considered indefinitely invested outside of the U.S. As of December 29, 2013, no provision had been made for U.S. income taxes or foreign withholding taxes on $752 million of undistributed earnings of foreign subsidiaries since we intend to indefinitely reinvest these earnings outside the U.S. We determined that the calculation of the amount of unrecognized deferred tax liability related to these cumulative unremitted earnings was not practicable. If these earnings were distributed to the U.S., we would be subject to additional U.S. income taxes and foreign withholding taxes reduced by available foreign tax credits. Our Board of Directors has authorized up to $3.75 billion for stock repurchases, of which $1.93 billion remain available for stock repurchases as of December 29, 2013. As of December 29, 2013, we had cumulatively repurchased on the open market 15.9 million shares for $823 million, of which 10.2 million shares for $589 million were repurchased in fiscal year 2013. In addition to shares repurchased on the open market, we entered into an ASR program with a financial institution to purchase $1.0 billion of our common stock. In exchange for an up-front payment totaling $1.0 billion, the financial institution committed to deliver shares during the ASR's purchase period, which will end no later than April 8, 2014. The total number of shares ultimately delivered, and therefore the average price paid per share, will be determined at the end of the purchase period based on the volume weighted average price of our common stock during the period. The financial institution initially delivered 14.5 million shares in the third quarter of fiscal year 2013. This does not represent the final number of shares to be delivered under the ASR. Depending on the average price of our common stock while the ASR is outstanding, upon the maturity of the ASR, the financial institution may be required to deliver additional shares to us or we may be required to deliver shares to the financial institution. We currently expect the purchase period for the ASR program to remain open until April 8, 2014. Long-Term Requirements. Depending on the forecasted demand for our products, we may decide to make additional investments, which could be substantial, in wafer fabrication capacity and assembly and test manufacturing equipment. We may also engage in merger or acquisition transactions; make equity investments in other companies; or purchase or license technologies. These activities may require us to raise additional financing, which could be difficult to obtain, and which if not obtained in satisfactory amounts, could prevent us from funding Flash Ventures, 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, any of which could harm our business. 49



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Financing Arrangements. At December 29, 2013, we had $1.0 billion aggregate principal amount of our 1.5% Notes due 2017 and $1.5 billion aggregate principal amount of our 0.5% Notes due 2020 outstanding. See Note 6, "Financing Arrangements," in the Notes to Consolidated Financial Statements of this Form 10-K included in Item 8 of this report. 1.5% Notes due 2017. Concurrent with the issuance of the 1.5% Notes due 2017, we sold warrants to acquire initially up to approximately 19.1 million shares of our common stock at an exercise price of $73.3250 per share. The 1.5% Notes due 2017 contains provisions whereby the number of shares to be acquired under the warrants and the strike price are adjusted if we pay a cash dividend or make a distribution to all or substantially all holders of our common stock. After adjusting for the dividends paid through December 29, 2013, holders of the warrants may acquire up to approximately 19.2 million shares of our common stock at a strike price of $72.8005 per share. The warrants mature on 40 different dates from November 13, 2017 through January 10, 2018, and are exercisable at the maturity date. At each maturity date, we may, at our option, elect to settle the warrants on a net share basis. As of December 29, 2013, the warrants had not been exercised and remain outstanding. In addition, concurrent with the issuance of the 1.5% Notes due 2017, we entered into a convertible bond hedge transaction in which counterparties initially agreed to sell to us up to approximately 19.1 million shares of our common stock, which is the number of shares initially issuable upon conversion of the 1.5% Notes due 2017 in full, at a conversion price of $52.37 per share. The 1.5% Notes due 2017 contains provisions where the number of shares to be sold under the convertible bond hedge transaction and the conversion price will be adjusted if we pay a cash dividend or make a distribution to all or substantially all holders of our common stock. After adjusting for the dividends paid through December 29, 2013, the counterparties may acquire up to approximately 19.2 million shares of our common stock, which is the number of shares issuable upon conversion of the 1.5% Notes due 2017 in full, at a price of $52.00 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 1.5% Notes due 2017 or the first day none of the 1.5% Notes due 2017 remain outstanding due to conversion or otherwise. Settlement of the convertible bond hedge in net shares, based on the number of shares issuable upon conversion of the 1.5% Notes due 2017, on the expiration date would result in us receiving net shares equivalent to the number of shares issuable by us upon conversion of the 1.5% Notes due 2017. As of December 29, 2013, we had not purchased any shares under this convertible bond hedge agreement. 0.5% Notes due 2020. Concurrent with the issuance of the 0.5% Notes due 2020, we sold warrants to acquire initially up to approximately 16.3 million shares of our common stock at an exercise price of $122.9220 per share. The 0.5% Notes due 2020 contains provisions whereby the number of shares to be acquired under the warrants and the strike price are adjusted if we pay a cash dividend greater than a regular quarterly cash dividend of $0.225 per share or make a distribution to all or substantially all holders of our common stock. As of December 29, 2013, no adjustment has been made to the number of shares to be acquired under the warrants or the strike price. The warrants mature on 40 different dates from January 13, 2021 through March 11, 2021, and are exercisable at the maturity date. At each maturity date, we may, at our option, elect to settle the warrants on a net share basis. As of December 29, 2013, the warrants had not been exercised and remain outstanding. In addition, concurrent with the issuance of the 0.5% Notes due 2020, we entered into a convertible bond hedge transaction in which counterparties initially agreed to sell to us up to approximately 16.3 million shares of our common stock, which is the number of shares initially issuable upon conversion of the 0.5% Notes due 2020 in full, at a conversion price of $92.19 per share. The 0.5% Notes due 2020 contains provisions where the number of shares to be sold under the convertible bond hedge transaction and the conversion price will be adjusted if we pay a cash dividend greater than a regular quarterly cash dividend of $0.225 per share or make a distribution to all or substantially all holders of our common stock. As of December 29, 2013, no adjustment has been made to the number of shares to be sold under the convertible bond hedge transaction or the conversion price. The convertible bond hedge transaction will be settled in net shares and will terminate upon the earlier of the maturity date of the 0.5% Notes due 2020 or the first day none of the 0.5% Notes due 2020 remain outstanding due to conversion or otherwise. Settlement of the convertible bond hedge in net shares, based on the number of shares issuable upon conversion of the 0.5% Notes due 2020, on the expiration date would result in us receiving net shares equivalent to the number of shares issuable by us upon conversion of the 0.5% Notes due 2020. As of December 29, 2013, we had not purchased any shares under this convertible bond hedge agreement. 50



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Ventures with Toshiba. We are a 49.9% owner in each of the 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 the 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. The Flash Ventures purchase wafers from Toshiba at cost and then resell those wafers to us and Toshiba at cost plus a markup. We are contractually obligated to purchase half of the Flash Ventures' NAND wafer supply or pay for 50% of the fixed costs of the Flash Ventures. 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 semiconductor wafers. See Note 13, "Related Parties and Strategic Investments," in the Notes to Consolidated Financial Statements of this Form 10-K. From time-to-time, we and Toshiba mutually approve the purchase of equipment for Flash Ventures in order to convert to new process technologies or add wafer capacity. Flash Partners Ltd., or Flash Partners, and Flash Alliance Ltd., or Flash Alliance, have been previously equipped to full wafer capacity. Flash Forward Ltd, or Flash Forward, occupies Fab 5 which is being built in two phases. As of December 29, 2013, over half of the Phase 1 building has been equipped with wafer capacity or equipment required to enable technology transition of the Flash Ventures' wafer capacity. Construction of the Phase 2 shell of the Fab 5 wafer fabrication facility is underway with expected completion in mid-2014. Our current plans are to use the Phase 2 shell primarily for technology transition of the existing Flash Ventures wafer capacity to 1Y要anometer and 1Z要anometer technology nodes and the addition of a 3D NAND pilot line. The last new Flash Ventures wafer capacity was added in January 2012 in Phase 1 of Fab 5. We regularly seek to enhance wafer output through productivity improvements. These improvements increased our wafer capacity by less than 10% in fiscal year 2013. In fiscal year 2014, we currently expect productivity improvements and possible new wafer capacity investments to result in up to a 5% increase in our current wafer capacity. We and Toshiba each retain some flexibility as to the extent and timing of each party's respective fab capacity ramps. To date, we have invested in 50% of the Flash Forward equipment and the output has been in accordance with each party's proportionate level of equipment funding. The cost of the wafers we purchase from Flash Ventures is recorded in inventory and ultimately cost of revenue. Flash Ventures are variable interest entities; however, we are not the primary beneficiary of these ventures because we do not have a controlling financial interest in each venture. Accordingly, we account for our investments under the equity method and do not consolidate. For semiconductor manufacturing equipment that is leased by Flash Ventures, we and Toshiba jointly guarantee, on an unsecured and several basis, 50% of the outstanding Flash Ventures' lease obligations under original master lease agreements entered into by Flash Ventures. These master lease obligations are denominated in Japanese yen and are noncancelable. Our total master lease obligation guarantees as of December 29, 2013 were 51.6 billion Japanese yen, or approximately $492 million based upon the exchange rate at December 29, 2013. In the first quarter of fiscal year 2011, we made a $62 million prepayment for Flash Forward building-related costs. As of December 29, 2013, approximately $5 million of this prepayment remains, which was classified as other current assets.



Contractual Obligations and Off-Balance Sheet Arrangements

Our contractual obligations and off-balance sheet arrangements at December 29, 2013 and the effect those contractual obligations are expected to have on our liquidity and cash flow over the next five years are presented in textual and tabular format in Note 12, "Commitments, Contingencies and Guarantees," in the Notes to Consolidated Financial Statements of this Form 10-K included in Item 8 of this report. 51



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Impact of Currency Exchange Rates

Exchange rate fluctuations could have a material adverse effect on our business, financial condition and results of operations. Our most significant foreign currency exposure is to the Japanese yen in which we purchase substantially all of our NAND flash wafers and incur R&D expenditures. In addition, we also have significant costs denominated in the Chinese renminbi and the Israeli new shekel, and we have revenue denominated in the European euro, the British pound, the Japanese yen, the Chinese renminbi and the Canadian dollar. We do not enter into derivatives for speculative or trading purposes. We use foreign currency forward and cross currency swap contracts to mitigate transaction gains and losses generated by certain monetary assets and liabilities denominated in currencies other than the U.S. dollar. From time-to-time, we use foreign currency forward contracts to partially hedge our future Japanese yen requirements for NAND flash wafers and R&D expenses. Our derivative instruments are recorded at fair value in assets or liabilities with final gains or losses recorded in other income (expense) or as a component of accumulated other comprehensive income, or AOCI, and subsequently reclassified into cost of revenue in the same period or periods in which the cost of revenue is recognized or into R&D expense as the R&D expenses are incurred. These foreign currency exchange exposures may change over time as our business and business practices evolve, and they could harm our financial results and cash flows. See Note 3, "Derivatives and Hedging Activities," in the Notes to Consolidated Financial Statements of this Form 10-K included in Item 8 of this report. Because we purchase substantially all of our flash memory wafers from Flash Ventures, our flash memory costs, which represent the largest portion of our cost of revenue, are based upon wafer purchases denominated in Japanese yen. However, our cost of revenue in any given quarter generally reflects wafer purchases that were made in the previous quarter, and is impacted by hedging decisions we may make from time to time, including entering into forward contracts or other instruments to hedge our future Japanese yen purchase rate. Based on wafer purchases made in the fourth quarter of fiscal year 2013 and forward contracts entered into for early 2014, changes in the Japanese yen to U.S. dollar exchange rate after December 2013 are not expected to have a material impact on our cost of revenue in the first quarter of fiscal year 2014. We expect the average rate of the Japanese yen to the U.S. dollar for the wafer portion of our cost of revenue to be approximately 99 Japanese yen to the U.S. dollar for the first quarter of fiscal year 2014, in comparison to a rate of approximately 97 Japanese yen to the U.S. dollar in our fourth quarter of fiscal year 2013. Our wafer purchases are denominated in Japanese yen and generally comprise 50 percent or more of our cost of revenue. As of December 29, 2013, approximately one負hird of our expected Japanese yen denominated wafer purchases for fiscal year 2014 had been hedged at an average rate of approximately 99 Japanese yen to the U.S. dollar. See Item 7A, "Quantitative and Qualitative Disclosure About Market Risk - Foreign Currency Risk" for more information about our foreign currency forward and cross currency swap contracts.



For a discussion of foreign operating risks and foreign currency risks, see Item 1A, "Risk Factors."

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