WEIL, GOTSHAL & MANGES LLP
767 FIFTH AVENUE - NEW YORK, NY 10153
212-310-8000
(FAX) 212-310-8007
April 5, 2006
Securities and Exchange Commission
Division of Corporation Finance
100 F Street, N.E.
Washington, D.C. 20549-0305
Attention: Barbara C. Jacobs
Jay Ingram
Morgan Youngwood
Re: M-Systems Flash Disk Pioneers Ltd. (i) Registration Statement on Form
F-3 (File No. 333-129291) filed on October 28, 2005, (ii) Form 20-F for
the year ended December 31, 2004, filed on May 27, 2005, and (iii) Form
6-K filed on September 30, 2005 (File No. 001-11712)
Ladies and Gentlemen:
Further to our conversations with the Staff, on behalf of our
client, M-Systems Flash Disk Pioneers Ltd., an Israeli company ("M-Systems" or
the "Company"), please find enclosed the Company's analysis of Financial
Accounting Standard Board Interpretation No. 46R with respect to the Venture.
Should you wish to discuss the enclosed materials at any time
please do not hesitate to contact Jeffrey Nadler, Esq. (212-310-8387) of Weil,
Gotshal & Manges LLP or Clifford M. J. Felig, Adv., of Meitar Liquornik Geva &
Leshem Brandwein (011-972-3-610-3100).
Sincerely,
/s/ Jeffrey Nadler
Jeffrey Nadler
Enclosures
cc: Ronit Maor, M-Systems Flash Disk Pioneers Ltd.
Clifford M.J. Felig, Meitar Liquornik Geva & Leshem Brandwein
FIN 46(R) - ANALYSIS OF PRIMARY BENEFICIARY
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Pursuant to the Staff's request, M-Systems ("M-Systems" or the "Company") has
re-assessed, in consultation with Ernst & Young's National Office, its analysis
as to the determination of the primary beneficiary of the venture with Toshiba
(the "Venture") in accordance with paragraphs 16 and 17 of FIN 46(R).
INTRODUCTION
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As stated in previous responses to the Staff, the Company is a party in the
Venture with Toshiba that was designed to result in a 50/50 split of economics,
among other attributes. The assessment of which of the two parties is the
primary beneficiary in terms of the related party concept of FIN 46(R) requires
significant judgment. While a few aspects of the Venture appear to suggest that
Toshiba could be the potential primary beneficiary, we believe that the analysis
below supports a conclusion that the Company should be the primary beneficiary
of the Venture.
The principal difference between the Company's previous analysis of FIN 46(R)
and the analysis currently submitted to the Staff may be summarized as follows.
In its previous analysis of the primary beneficiary of the variable interest
entity ("VIE"), the Company focused principally on the party that has greater
exposure to the expected losses of the variable interest entity and the party
that enjoys greater benefits from the variable interest entity, as the Company
believed those factors to be the most influential in determining the primary
beneficiary. The Company's previous analysis provides support for a conclusion
that Toshiba is the primary beneficiary of the Venture. In light of the Staff's
comments and after further consideration of Paragraph 17, which provides that
the party with activities that are most closely associated with the variable
interest entity is the primary beneficiary, the Company placed greater emphasis
on this factor. After taking into consideration the similarities of the
Venture's activities to those of the Company and the significance and integral
nature of the Venture's operations to the Company's operations, this factor
provides support for a conclusion that the Company is the primary beneficiary of
the Venture.
Paragraph 16 of FIN 46(R) requires variable interests held by an enterprise's
related parties and de facto agents to be aggregated with the enterprise's
variable interests. Paragraph 16(d)(i) states that a party that has an agreement
that it can not sell, transfer, or encumber its interest in the entity without
the prior approval of the other enterprise creates a de facto agency
relationship. As the Venture agreement with Toshiba limits the parties' ability
to sell, transfer, or encumber their respective economic rights in the Venture
without the prior consent of the other party, a "de facto" agency exists and
therefore M-Systems and Toshiba are considered related parties. As the
combination of these interests absorbs 100% of the Venture's variable interests,
the determination of the primary beneficiary should be performed according to
the guidance of Paragraph 17 of FIN 46(R).
Pursuant to Paragraph 17 of FIN 46(R), the determination of which party within
the related party group is most closely associated with the variable interest
entity requires judgment and is to be based on an analysis of all relevant facts
and circumstances, including:
a. The existence of a principal-agency relationship between parties within
the related party group.
b. The relationship and significance of the activities of the variable
interest entity to the various parties within the related party group.
c. A party's exposure to the expected losses of the variable interest
entity.
d. The design of the variable interest entity.
ANALYSIS
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A) THE EXISTENCE OF A PRINCIPAL-AGENCY RELATIONSHIP BETWEEN PARTIES
WITHIN THE RELATED PARTY GROUP.
In this case, each party is acting both as principal and agent to
the other because both parties have to receive prior approval of
each other for the sale, transfer or encumbrance of their interests.
Therefore, in this case no party is effectively acting on behalf of
the other.
B) THE RELATIONSHIP AND SIGNIFICANCE OF THE ACTIVITIES OF THE VARIABLE
INTEREST ENTITY TO THE VARIOUS PARTIES WITHIN THE RELATED PARTY
GROUP.
We have conducted our determination of which party within the
related party group is more closely associated with the VIE
using the following factors:
o Did any member significantly influence the design or
redesign of the entity, or the determination of its
primary operations, products or services?
The design of the Venture, including pricing, profit
sharing and capacity allocation, and the determination
of its primary operations, were mutually agreed upon by
both parties. However, the Venture's day to day
operations, including its manufacturing processes, were
determined by M-Systems for the manufacturing of
DiskOnKey ("DOK"), which were essentially identical to
M-Systems' then current manufacturing operations.
o Does a member have an ability through its individual
variable interest(s) to directly or indirectly make
decisions that have a significant effect on the success
of the VIE's activities?
As previously stated, the parties intended for each to
benefit equally from the existence of the Venture. As
such, both parties jointly make all significant
decisions related to the Venture and no party can
independently through its individual variable interest
make any decision that would have a significant effect
on the success of the Venture.
o Are the operations of any member substantially similar
in nature to the activities of the VIE?
The activities of the Venture are essentially identical
to the operations of M-Systems' DOK manufacturing in
which it is engaged outside the Venture. The formation
of the Venture was, from the M-Systems' perspective, an
extension of its existing sourcing relationship with
Toshiba for its DOK products. The Venture was designed
operationally to continue the manufacture of DOK
products in the same manner as M-Systems' ordinary
course of operations prior to the formation of the
Venture. The Venture has no employees and the operations
and manufacturing method of the Venture are identical to
the one employed by M-Systems.
o Does the variable interest in the VIE represent a
substantial portion of the total assets of any member?
We believe that on balance the Venture itself is more
significant to the Company than to Toshiba given the
relative size of both companies.
o Are the products or services produced by the VIE
significant inputs to any member's operations?
The Venture's products are significant inputs to both
parties; however the source of this significance is
different for each of the partners. As most of
M-Systems' sales are derived from the sale of DOK
products, and because the Venture provides DOK products
to M-Systems at a generally lower relative cost for such
products as compared to its DOK products based on flash
components sourced from other flash suppliers, the
Venture's products are significant inputs for M-Systems.
Because Toshiba did not have independent DOK
manufacturing capabilities at the inception date of the
Venture nor did it have the IP required for this
manufacturing capability, the Venture's products were
significant inputs to Toshiba as without them Toshiba
had no DOK business.
o Are the majority of any member's products or services
sold to the VIE?
Neither of the parties sells to the Venture the majority
of its products or services. Toshiba is the sole
supplier of flash components to the Venture, which is a
necessary raw material for the production of DOK, and
has allocated a meaningful portion of its flash
manufacturing capacity to the Venture. M-Systems sources
controllers to the Venture, another raw material
required for the production of DOK, which M-Systems
purchases for its activities outside of the Venture and
in that capacity sources to the Venture as well.
o Are the products or services of any member significant
inputs to the VIE's operations?
Both parties provide the Venture with significant inputs
to its operations: Toshiba provides the Venture with
committed capacity of flash components and M-Systems
provides its IP and controllers. While Toshiba provides
a commodity-like product to the Venture available from
other sources, M-Systems provides a unique, proprietary,
patented technology which cannot be obtained from other
sources.
o Are employees of any member actively involved in
managing the operations of the VIE?
The day to day operations of the Venture are managed by
M-Systems' employees. All substantive decisions of the
Venture require the mutual agreement of both partners.
C) A PARTY'S EXPOSURE TO THE EXPECTED LOSSES OF THE VARIABLE INTEREST
ENTITY.
The Venture's profits and losses are split evenly between the
partners. However, the Company believes that Toshiba has a higher
exposure to losses because Toshiba extends more credit to the
Venture in its capacity as the principal supplier of raw materials
to the Venture, thus exposing it to more than 50% of the expected
losses of the Venture.
D) THE DESIGN OF THE VARIABLE INTEREST ENTITY.
As previously discussed, the design of the Venture, including
pricing, profit sharing and capacity allocation, was mutually agreed
upon by both parties.
We believe that the above analysis supports a conclusion that the Company is
more closely associated with the Venture. M-Systems has been engaged in the
business of selling DOK product - the business in which the Venture is engaged -
since before the Venture's formation and continues to be engaged in this
business independently of the Venture. Moreover, M-Systems owns the IP required
to manufacture DOK. While Toshiba provides a valuable input to the Venture in
the form of flash components, it is a commodity-like product that was sourced by
M-Systems prior to entering into the Venture. Indeed, one of the primary
purposes for forming the Venture was to enable M-Systems to obtain the lowest
price available for flash components. We believe that in applying the "most
closely associated" test, the fact (1) that at the Venture's formation M-Systems
owned the IP and Toshiba contributed a commodity-like product, (2) that
M-Systems' employees manage the day to day operations of the Venture, (3) that
the Venture's operations are integral to M-Systems' operations and (4) that
M-Systems has been, is currently, and expects to continue to be engaged in the
business in which the Venture is engaged, supports a conclusion that M-Systems
was most closely associated with the Venture at its formation. Accordingly, the
foregoing analysis supports a conclusion that M-Systems should be the primary
beneficiary of the Venture.
With respect to the period from when M-Systems should begin to consolidate the
Venture, the Venture began its operations in November 2003 and was first
reported in the Company's financial statements for the year ended December 31,
2003. FIN46(R) was issued in December 2003 and became effective by the end of
the first reporting period ending after March 15, 2004. FIN 46(R) provides
additional guidance for determining the party most closely associated with a
variable interest entity and provides the basis for supporting a conclusion that
the Company is the primary beneficiary of the Venture. Accordingly, based on the
analysis above, the Company believes that the Venture should be consolidated
only beginning with its fiscal quarter ended March 31, 2004.
Moreover, in assessing whether to consolidate the Venture for the period prior
to the first quarter of 2004, the Company conducted an analysis based on the
guidance of SAB 99 in order to determine the materiality of the impact of the
Venture on the Company's consolidated financial statements for 2003. Pursuant to
this analysis, the Company notes that all the Venture's sales in 2003 were made
to the Company and the Venture's operating expenses were negligible. The Company
held the products purchased from the Venture in inventory, and did not recognize
any revenues in 2003 from sales of these products. Therefore, consolidating the
Venture would have no effect on the Company's 2003 consolidated statement of
operations. Additionally, the Company notes that the only effect on its 2003
balance sheet of consolidating the Venture would be to increase both current
assets (cash and inventory) and current liabilities (trade payables) by similar
amounts, with only minimal effect on working capital, as detailed below.
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ITEM AS REPORTED IF CONSOLIDATED
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(in thousands)
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Current assets $ 102,476 $ 107,145
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Current liabilities $ 36,649 $ 40,618
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Working capital $ 65,827 $ 66,527
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The Company further reviewed the other considerations enumerated in SAB 99 in
assessing if a quantitatively small change in the Company's financial statements
due to consolidating the Venture would nonetheless be material, including
whether:
o any item relates to an amount that requires estimation,
o not consolidating the Venture would mask a change in earnings or
other trends,
o not consolidating the Venture would hide a failure to meet analysts'
consensus expectations for the Company,
o not consolidating the Venture would change a loss into income or
vice versa,
o the Venture concerns a segment of the Company's business that plays
a significant role in the Company's operations and profitability for
the period,
o not consolidating the Venture would affect the Company's compliance
with its regulatory requirements,
o not consolidating the Venture would affect the Company's compliance
with loan covenants or other contractual requirements
o not consolidating the Venture would have the effect of increasing
management's compensation, and
o not consolidating the Venture would involve concealment of an
unlawful transaction.
The Company concluded that none of these considerations would be implicated by
not consolidating the Venture in 2003.
Therefore, since the consolidation would have no effect on any line item in the
Company's consolidated statement of operations, and the principal effect on the
Company's balance sheet would be a minimal change to working capital, the
Company concluded that the effect of consolidating the Venture on its 2003
financial statements would be immaterial.
This analysis was reviewed by Ernst & Young's National Office in the United
States, who concurred with the analysis.
The Company is providing the Staff with a draft Form 20-F/A (including draft
restated financial statements) for the Staff's consideration.