EXHIBIT 99.1
msystems Ltd. AND ITS SUBSIDIARIES
INTERIM CONSOLIDATED FINANCIAL STATEMENTS
AS OF JUNE 30, 2006
U.S. DOLLARS IN THOUSANDS
UNAUDITED
INDEX
PAGE
INTERIM CONSOLIDATED BALANCE SHEETS 2 - 3
INTERIM CONSOLIDATED STATEMENTS OF INCOME 4
INTERIM STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY 5
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS 6 - 7
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS 8 - 18
- --------------------------------------------------------------------------------
- - - - - - - - - - - - - - -
msystems Ltd. AND ITS SUBSIDIARIES
INTERIM CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31, JUNE 30,
2005 2006
-------- --------
UNAUDITED
---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 71,507 $ 58,282
Short-term bank deposits 1,202 1,318
Short-term held-to-maturity securities 26,177 68,160
Trade receivables (net of allowance for doubtful
accounts of $ 424 as of December 31, 2005, and
$ 617 as of June 30, 2006) 131,857 106,052
Related party trade receivables 1,476 750
Inventories (Note 3) 76,326 84,110
Other receivables and prepaid expenses 15,153 12,608
-------- --------
Total current assets 323,698 331,280
-------- --------
LONG-TERM INVESTMENTS AND RECEIVABLES:
Severance pay fund 4,821 5,579
Investment in equity method investee -- 615
Long-term held-to-maturity securities 87,448 51,284
Available-for-sale equity securities 5,036 4,254
Long-term receivables 886 1,040
-------- --------
Total long-term investments and receivables 98,191 62,772
-------- --------
DEFERRED PURCHASE CREDIT, NET 71,544 89,658
-------- --------
PROPERTY AND EQUIPMENT, NET 29,462 35,723
-------- --------
MINORITY INTEREST IN SUBSIDIARY 2,167 --
-------- --------
INTANGIBLE ASSETS AND DEBT ISSUANCE COSTS, NET 12,677 12,158
-------- --------
GOODWILL 28,518 29,872
-------- --------
Total assets $566,257 $561,463
======== ========
The accompanying notes are an integral part of the interim consolidated
financial statements.
-2-
msystems Ltd. AND ITS SUBSIDIARIES
INTERIM CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
DECEMBER 31, JUNE 30,
2005 2006
--------- ---------
UNAUDITED
---------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 121,792 $ 80,768
Excess of losses over investment in equity method investee 1,171 --
Deferred revenues 2,280 6,567
Other payables and accrued expenses 29,175 32,039
--------- ---------
Total current liabilities 154,418 119,374
--------- ---------
LONG-TERM LIABILITIES:
Convertible Senior Notes 71,380 71,431
Accrued severance pay 6,133 7,458
Deferred tax liabilities 3,699 5,667
Other long-term liabilities 488 866
--------- ---------
Total long-term liabilities 81,700 85,422
--------- ---------
MINORITY INTEREST IN SUBSIDIARY -- 590
--------- ---------
COMMITMENTS AND CONTINGENT LIABILITIES
SHAREHOLDERS' EQUITY:
Share capital:
Ordinary shares of NIS 0.001 par value: Authorized -
100,000,000 shares at December 31, 2005 and
June 30, 2006; Issued and outstanding - 36,864,457
shares at December 31, 2005 and 38,077,581
shares at June 30, 2006 10 10
Additional paid-in capital 325,801 341,208
Deferred stock compensation (1,334) --
Accumulated other comprehensive income 3,815 4,228
Retained earnings 1,847 10,631
--------- ---------
Total shareholders' equity 330,139 356,077
--------- ---------
Total liabilities and shareholders' equity $ 566,257 $ 561,463
========= =========
The accompanying notes are an integral part of the interim consolidated
financial statements.
-3-
msystems Ltd. AND ITS SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
SIX MONTHS
ENDED JUNE 30,
----------------------------
2005 2006
------------ ------------
AS RESTATED (*)
----------------------------
UNAUDITED
----------------------------
Revenues $ 238,630 $ 428,603
------------ ------------
Costs and expenses:
Costs of goods sold (1) 172,847 335,159
Research and development, net (1) 17,449 24,286
Selling and marketing (1) 17,064 27,587
General and administrative (1) 6,500 14,172
------------ ------------
Total costs and expenses 213,860 401,204
------------ ------------
Operating income 24,770 27,399
Financial income, net 4,550 2,878
Other income, net -- 1,184
------------ ------------
Income before taxes on income 29,320 31,461
Taxes on income -- 2,526
------------ ------------
Income after taxes on income 29,320 28,935
Equity in losses of an affiliate (1,619) (2,542)
Minority interest in earnings of a subsidiary (16,060) (17,609)
------------ ------------
Net income $ 11,641 $ 8,784
============ ============
Basic earnings per share $ 0.32 $ 0.23
============ ============
Diluted earnings per share $ 0.30 $ 0.22
============ ============
Weighted average number of shares used in computing basic earnings per share 35,894,351 37,776,767
============ ============
Weighted average number of shares used in computing diluted earnings per share 39,774,865 41,905,177
============ ============
(1) Stock-based compensation expense is included in the following line items:
Cost of goods sold $ 94 $ 391
Research and development 470 1,547
Selling and marketing 617 1,669
General and administrative 328 1,724
------------ ------------
Total $ 1,509 $ 5,331
============ ============
(*) See Note 1d.
The accompanying notes are an integral part of the interim consolidated
financial statements.
-4-
msystems Ltd. AND ITS SUBSIDIARIES
INTERIM STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
ACCUMULATED
ADDITIONAL DEFERRED OTHER TOTAL TOTAL
SHARE PAID-IN STOCK COMPREHENSIVE RETAINED COMPREHENSIVE SHAREHOLDERS'
CAPITAL CAPITAL COMPENSATION INCOME(LOSS) EARNINGS INCOME(LOSS) EQUITY
--------- --------- --------- --------- --------- --------- ---------
Balance as of January 1, 2006 $ 10 $ 325,801 $ (1,334) $ 3,815 $ 1,847 $ 330,139
Reversal of deferred stock compensation
due to adoption of FAS 123(R) (1,334) 1,334 -- -- --
Exercise of share options, net *) 11,410 -- -- -- 11,410
Stock based compensation expense -- 5,331 -- -- -- 5,331
Other comprehensive income (loss):
Reclassification to income statement of
realized loss on cash flow hedge -- -- -- 186 -- $ 186 186
Unrealized loss on available- for-sale
securities and reclassification
adjustment to income statement of
realized gain -- -- -- (1,943) -- (1,943) (1,943)
Foreign currency translation adjustments -- -- -- 2,170 -- 2,170 2,170
Net income -- -- -- -- 8,784 8,784 8,784
--------- --------- --------- --------- --------- --------- ---------
Total comprehensive income $ 9,197
=========
Balance as of June 30, 2006 $ 10 $ 341,208 $ -- $ 4,228 $ 10,631 $ 356,077
========= ========= ========= ========= ========= =========
*) Represents an amount lower than $ 1.
The accompanying notes are an integral part of the interim consolidated
financial statements.
-5-
msystems Ltd. AND ITS SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
SIX MONTHS ENDED
JUNE 30,
----------------------
2005 2006
--------- ---------
AS RESTATED (1)
----------------------
UNAUDITED
----------------------
Cash flows from operating activities:
Net income $ 11,641 $ 8,784
Adjustments required to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 2,160 4,234
Amortization of deferred purchase credit -- 8,292
Gain from initial purchasers' option related to Convertible Senior Notes (1,450) --
Minority interest in earnings of a subsidiary 16,060 17,609
Stock-based compensation expense 1,509 5,331
Equity in losses of an affiliate 1,619 2,542
Accrued interest on short-term bank deposits (12) (16)
Interest accrued and amortization of premium and discount on held-to-maturity
marketable securities 200 131
Amortization of discount on Convertible Senior Notes and deferred charges 38 71
Gain from sale of available-for-sale marketable securities -- (1,184)
Accrued severance pay, net 437 567
Long-term lease deposits, net (125) (107)
Deferred income taxes, net -- 563
Decrease (increase) in trade receivables, net (10,598) 26,238
Decrease in related party trade receivables -- 726
Decrease (increase) in inventories 4,263 (7,712)
Decrease in other receivables and prepaid expenses 221 2,774
Increase (decrease) in trade payables 30,154 (32,005)
Increase in deferred revenues 5,947 4,287
Increase (decrease) in other payables and accrued expenses (1,222) 2,637
--------- ---------
Net cash provided by operating activities 60,842 43,762
--------- ---------
Cash flows from investing activities:
Investment in held-to-maturity marketable securities (210,618) (19,550)
Purchase of property and equipment (4,555) (9,267)
Purchase of intangible assets -- (50)
Loans to employees, net 55 62
Proceeds from maturities of held-to-maturity marketable securities 77,525 13,600
Proceeds from sale of available-for-sale marketable securities -- 1,260
Short-term bank deposits, net 40,518 (100)
Purchase of equipment pursuant to PSA with Hynix -- (35,439)
Investment in equity method investee (500) (4,328)
--------- ---------
Net cash used in investing activities (97,575) (53,812)
========= =========
(1) See Note 1d.
The accompanying notes are an integral part of the interim consolidated
financial statements.
-6-
msystems Ltd. AND ITS SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
SIX MONTHS ENDED
JUNE 30
--------------------
2005 2006
-------- --------
AS RESTATED (1)
--------------------
UNAUDITED
--------------------
Cash flows from financing activities:
Proceeds from issuance of Convertible Senior Notes 71,300 --
Proceeds from issuance of initial purchasers option on Convertible Senior Notes 1,450 --
Cash distribution to minority shareholders of a subsidiary (17,500) (14,852)
Proceeds from exercise of share options, net 3,578 11,544
Proceeds from issuance of shares related to employee stock purchase plan 626 --
Issuance costs of Convertible Senior Notes (724) --
Receipt of long-term loan -- 362
-------- --------
Net cash provided by (used in) financing activities 58,730 (2,946)
-------- --------
Effect of foreign currency exchange differences on cash and cash equivalents -- (229)
-------- --------
Increase (decrease) in cash and cash equivalents 21,997 (13,225)
Cash and cash equivalents at the beginning of the period 56,511 71,507
-------- --------
Cash and cash equivalents at the end of the period $ 78,508 $ 58,282
======== ========
Non-cash investing and financing activities:
Accrued issuance costs for Convertible Senior Notes $ 386 $ --
======== ========
Purchase of equipment under the PSA with Hynix $ -- $ 270
======== ========
Accrued expenses related to issuance of share capital $ -- $ 134
======== ========
(1) See Note 1d.
The accompanying notes are an integral part of the interim consolidated
financial statements.
-7-
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 1:- GENERAL
a. Interim unaudited financial statements:
The accompanying unaudited interim consolidated financial
statements have been prepared in accordance with generally
accepted accounting principles in the United States
relating to interim financial information. Accordingly,
they do not include all the information and footnotes
required by generally accepted accounting principles for
complete financial statements. In the opinion of
management, these financial statements include all
adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation of the
consolidated balance sheets, operating results and cash
flows for the periods presented. Operating results for the
six months ended June 30, 2006, are not necessarily
indicative of the results of operations that may be
expected for the year ended December 31, 2006.
These consolidated financial statements should be read in
conjunction with the Company's annual audited consolidated
financial statements and accompanying notes as of December
31, 2005, included in the Company's annual report for the
year ended December 31, 2005, filed on Form 20-F on July
17, 2006 ("the annual consolidated financial statements").
b. Product Supply Agreement with Hynix:
As discussed in Note 1d to the Company's annual
consolidated financial statements, in August 2005, the
Company entered into a Product Supply Agreement ("PSA")
with Hynix whereby the Company is committed to purchase
equipment for a total amount of approximately $ 100,000,
which is to be placed at Hynix's manufacturing facility in
return for which the Company is to receive guaranteed
capacity and favorable pricing on purchases from Hynix.
Over the term of the PSA (six years), the Company will
receive credit on the products purchased from Hynix of up
to the $ 100,000 invested in the equipment.
The Company completed the purchase of the equipment under
the PSA and Hynix has initiated the supply of products to
the Company under the abovementioned terms during the first
quarter of 2006.
The Company has recognized the amount invested in the
equipment as deferred purchase credit, which will be
amortized over the term of the PSA as an additional cost to
the products purchased from Hynix. The amount will be
amortized on a straight-line method over the PSA term,
subject to certain conditions. During the six months ended
June 30, 2006, the Company amortized an amount of
approximately $ 8,292 of the deferred purchase credit
(including an amount of $ 142 out of other comprehensive
loss resulting from a cash flow hedge on the purchase of a
portion of the equipment) and recorded such amortization as
an increase to the cost of the products purchased from
Hynix and which have already been sold as of June 30, 2006.
-8-
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 1:- GENERAL (CONT.)
c. During April 2006, the Company terminated its strategic
agreement with Samsung, which was effective until December
31, 2007. As a result of this termination, the Company will
no longer be entitled to committed manufacturing capacity
and favorable pricing terms from Samsung under the
agreement or to receive license fees from Samsung. Samsung
will no longer hold a license to the Company's patents,
effective from the termination date. Consequently, the
Company will likely need to source flash components from
alternate sources and may encounter difficulties in
sourcing additional flash components, or be required to
source flash components from alternate sources at higher
relative prices. The Company has received a letter from
Samsung according to which Samsung disputes the termination
of the agreement.
d. As discussed in Note 1f to the Company's consolidated
financial statements for the year ended December 31, 2004,
filed on Form 20-F on April 20, 2006, in connection with a
review of the company's 2004 annual report by the staff of
the U.S. Securities and Exchange Commission, the Company
reconsidered the manner in which FIN 46R applies to the
venture, which the Company and Toshiba established, under a
set of agreements (the "Venture") and concluded that the
Company is the primary beneficiary of the Venture and,
therefore, it is required to consolidate the Venture in its
financial statements. The Company has restated its
financial statements as of December 31, 2004 and for the
year then ended to reflect the effect of the consolidation
of the Venture. The impact of the restatement on the
Company's previously issued financial statements is set
forth in the 2004 Annual Report.
As discussed in Note 1f. to the Company's annual
consolidated financial statements, the Company has restated
its financial statements as of December 31, 2004 and 2005
and for each of the three years in the period ended
December 31, 2005, to reflect the effect of stock-based
compensation expense which was not properly accounted for
in previously issued financial statements. The impact of
the restatement on the Company's previously issued
financial statements is set forth in the annual
consolidated financial statements.
The effect of the two restatements on the Company's interim
consolidated financial statements for the six-months ended
June 30, 2005, is summarized below:
-9-
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 1:- GENERAL (CONT.)
Consolidated statement of income for the six months ended
June 30, 2005:
ADJUSTMENT
ADJUSTMENT FOR STOCK
FOR BASED
AS PREVIOUSLY CONSOLIDATION COMPENSATION
REPORTED OF VENTURE EXPENSE AS RESTATED
--------------- --------------- --------------- -------------
UNAUDITED
-----------------------------------------------------------
Revenues $ 201,611 $ 37,019 $ -- $ 238,630
Costs and expenses:
Costs of goods sold 151,888 20,865 94 172,847
Research and development, net 16,979 -- 470 17,449
Selling and marketing 15,856 -- 1,208 17,064
General and administrative 6,006 166 328 6,500
Total costs and expenses 190,729 21,031 2,100 213,860
Operating income 10,882 15,988 (2,100) 24,770
Financial income, net 4,478 72 -- 4,550
Income before taxes on income 15,360 16,060 (2,100) 29,320
Income after taxes on income 15,360 16,060 (2,100) 29,320
Minority interest in earnings of a
subsidiary -- (16,060) -- (16,060)
Net income 13,741 -- (2,100) 11,641
Basic net earnings per share 0.38 -- (0.06) 0.32
Diluted net earnings per share 0.35 -- (0.05) 0.30
Weighted average number of shares
used in computing diluted net
earnings per share 40,089,242 -- (314,377) 39,774,865
Consolidated statement of cash flows for the six months ended June 30, 2005:
SIX MONTHS ENDED
JUNE 30, 2005
--------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -------------
UNAUDITED
--------------------
Cash flows from operating activities:
Net income $ 13,741 $ 11,641
Undistributed equity in earnings of a venture 3,675 --
Minority interest in earnings of a subsidiary -- 16,060
Stock based compensation expense -- 1,509
Increase in trade receivables (11,790) (10,598)
Decrease in inventories 4,828 4,263
Increase in trade payables 21,103 30,154
Increase in related party trade payables 7,413 --
Decrease in other payables and accrued expenses (1,813) (1,222)
Net cash provided by operating activities 41,082 60,842
Cash flows from financing activities:
Cash distribution to minority shareholders of a subsidiary -- (17,500)
Net cash provided by financing activities 76,230 58,730
Increase in cash and cash equivalents 21,694 21,997
Cash and cash equivalents at the beginning of the period 50,187 56,511
Cash and cash equivalents at the end of the period 71,881 78,508
-10-
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 1:- GENERAL (CONT.)
e. Seasonal effect:
In 2005, the Company experienced stronger demand for its
mDOC products in the second half of the fiscal year, and
for its mDrive products in the fourth quarter, in each case
due to end-of-year holiday purchases.
f. Reclassification:
Certain amounts from prior years referring to excess of
losses over investment in equity method investee and
related equity in losses of such investee have been
reclassified to conform to current period presentation.
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
a. The significant accounting policies followed in the
preparation of these financial statements are identical to
those applied in the preparation of the latest annual
financial statements except as detailed in c below.
b. Use of estimates:
The preparation of financial statements in conformity with
generally accepted accounting principles requires
management to make estimates and assumptions that affect
the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those
estimates.
c. On January 1, 2006, the Company adopted Statement of
Financial Accounting Standards No. 123 (revised 2004),
"Share-Based Payment" ("SFAS 123(R)") which requires the
measurement and recognition of compensation expense based
on estimated fair values for all share-based payment awards
made to employees and directors. SFAS 123(R) supersedes
Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"), under which the
Company previously accounted for its share based awards
granted to employees and directors, for periods beginning
in fiscal 2006. In March 2005, the Securities and Exchange
Commission issued Staff Accounting Bulletin No. 107 ("SAB
107") relating to SFAS 123(R). The Company has applied the
provisions of SAB 107 in its adoption of SFAS 123(R).
SFAS 123(R) requires companies to estimate the fair value
of equity-based payment awards on the date of grant using
an option-pricing model. The value of the portion of the
award that is ultimately expected to vest is recognized as
an expense over the requisite service periods in the
Company's consolidated income statement. Prior to the
adoption of SFAS 123(R), the Company accounted for
equity-based awards to employees and directors using the
intrinsic value method in accordance with APB 25 as allowed
under Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123").
-11-
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The Company adopted SFAS 123(R) using the modified
prospective transition method, which requires the
application of the accounting standard starting from
January 1, 2006, the first day of the Company's fiscal year
2006. Under that transition method, compensation cost
recognized in the six months period ended June 30, 2006,
includes: (a) compensation cost for all share-based
payments granted prior to, but not yet vested as of January
1, 2006, based on the grant date fair value estimated in
accordance with the original provisions of Statement 123,
and (b) compensation cost for all share-based payments
granted subsequent to January 1, 2006, based on the
grant-date fair value estimated in accordance with the
provisions of Statement 123(R). Results for prior periods
have not been restated.
The Company recognizes compensation expenses for the value
of its awards, which have graded vesting, based on the
accelerated attribution method over the requisite service
period of each of the awards, net of estimated forfeitures.
Estimated forfeitures are based on actual historical
pre-vesting forfeitures.
As a result of adopting SFAS 123(R) on January 1, 2006, the
Company's income before income taxes and net income for the
six months ended June 30, 2006, is $ 4,808 lower than if it
had continued to account for stock-based compensation under
APB 25. Basic and diluted net earnings per share for the
six months ended June 30, 2006, are $ 0.12 and $ 0.11 per
share lower, respectively, than if the Company had
continued to account for share-based compensation under APB
25.
Prior to January 1, 2006, the Company applied the intrinsic
value method of accounting for stock options as prescribed
by APB 25, whereby compensation expense is equal to the
excess, if any, of the quoted market price of the stock
over the exercise price at the grant date of the award.
During the six months ended June 30, 2005, the Company
recognized stock-bases compensation expense related to
employee stock options in the amount of $1,509.
The Company estimates the fair value of stock options
granted using the Black-Scholes-Merton option-pricing
model. The option-pricing model requires a number of
assumptions, of which the most significant are, expected
stock price volatility, and the expected option term.
Expected volatility was calculated based upon actual
historical stock price movements over the most recent
periods ending June 30, 2006, equal to the expected option
term. The expected option term represents the period that
the Company's stock options are expected to be outstanding
and was determined based on historical experience of
similar options, giving consideration to the contractual
terms of the stock options. The Company has historically
not paid dividends and has no foreseeable plans to issue
dividends. The risk-free interest rate is based on the
yield from U.S. Treasury zero-coupon bonds with an
equivalent term.
-12-
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The fair value of the Company's stock options granted to
employees and directors for the six months ended June 30,
2006 and 2005 was estimated using the following weighted
average assumptions:
SIX MONTHS ENDED JUNE 30,
-------------------
2005 2006
------ ------
UNAUDITED
-------------------
Risk free interest rate 3.80% 4.90%
Dividend yields 0% 0%
Volatility 0.56 0.63
Expected term (in years) 3.25 4.82
A summary of option activity under the Company's Stock
Option and Restricted Stock Incentive Plan as of June 30,
2006 and changes during the six months ended June 30, 2006
are as follows:
WEIGHTED-
WEIGHTED- AVERAGE
AVERAGE REMAINING AGGREGATE
NUMBER OF EXERCISE CONTRACTUAL (IN INTRINSIC
OPTIONS PRICE TERM YEARS) VALUE
--------- -------------- ------------- --------------
UNAUDITED
--------------------------------------------------------
Outstanding at December 31, 2005 5,806,965 $ 14.77
Granted 195,000 $ 27.86
Exercised (1,207,174) $ 9.52
Forfeited (240,145) $ 18.4
----------
Outstanding at June 30, 2006 4,554,646 $ 16.53 7.69 $ 60,889
========== ========== ========== ==========
Exercisable at June 30, 2006 1,314,013 $ 8.79 6.0 $ 27,378
========== ========== ========== ==========
Vested and expected to vest 3,744,113 $ 15.87 7.54 52,511
========== ========== ========== ==========
The weighted-average grant-date fair value of options
granted during the six months ended June 30, 2006 was $
15.78. The aggregate intrinsic value in the table above
represents the total pre-tax intrinsic value (the
difference between the Company's closing stock price on the
last trading day of the second quarter of fiscal 2006 and
the exercise price, multiplied by the number of
in-the-money options) that would have been received by the
option holders had all option holders exercised their
options on June 30, 2006. This amount changes based on the
fair market value of the Company's stock. Total intrinsic
value of options exercised for the six months ended June
30, 2006 was $ 27,831. As of June 30, 2006, there was $
13,210 of total unrecognized compensation cost related to
non-vested share-based compensation arrangements granted
under the Company's stock option plans. That cost is
expected to be recognized over a weighted-average period of
2.8 years. Total fair value of options vested for the six
months ended June 30, 2006 was $ 11,372.
-13-
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The pro-forma table below reflects the Company's stock
based compensation expense, net income and basic and
diluted earnings per share for the six months ended June
30, 2005, had the Company applied the fair value
recognition provisions of SFAS 123, as follows:
SIX MONTHS ENDED
JUNE 30, 2005
-----------------
UNAUDITED
-----------------
AS RESTATED (1)
------------
Net income as reported $ 11,641
Add: stock-based compensation expense recognized
under APB 25 1,509
Deduct: stock-based compensation expense
determined under fair value method for
all awards (5,812)
------------
Pro forma net income $ 7,338
============
Basic earnings per share, as reported $ 0.32
============
Diluted earnings per share, as reported $ 0.30
============
Pro forma basic earnings per share $ 0.20
============
Pro forma diluted earnings per share $ 0.19
============
Weighted average number of shares used in computing
pro forma basic earnings per share 35,894,351
============
Weighted average number of shares used in computing
pro forma diluted earnings per share 39,507,721
============
(1) See Note 1d.
For purpose of pro-forma disclosures stock based
compensation is amortized over the vesting period using the
accelerated attribution method.
Pro-forma compensation expense under SFAS 123, among other
computational differences, does not consider potential
pre-vesting forfeitures. Because of these differences, the
pro-forma stock based compensation expense presented above
for the prior six months period ended June 30, 2005 under
SFAS 123 and the stock based compensation expense
recognized during the current six months ended June 30,
2006 under SFAS 123(R) are not directly comparable.
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msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
d. Recently issued accounting pronouncements:
In July 2006, the FASB issued FASB Interpretation No. 48
"Accounting for Uncertainty in Income Taxes an
Interpretation of FASB Statement No. 109" ("FIN 48"). FIN
48 clarifies the accounting for income taxes by prescribing
the minimum recognition threshold a tax position is
required to meet before being recognized in the financial
statements. FIN 48 utilizes a two-step approach for
evaluating tax positions. Recognition (step one) occurs
when an enterprise concludes that a tax position, based
solely on its technical merits, is more-likely-than-not to
be sustained upon examination. Measurement (step two) is
only addressed if step one has been satisfied (i.e., the
position is more-likely-than-not to be sustained). Under
step two, the tax benefit is measured as the largest amount
of benefit, determined on a cumulative probability basis
that is more-likely-than-not to be realized upon ultimate
settlement.
FIN 48 applies to all tax positions related to income taxes
subject to the Financial Accounting Standard Board
Statement No. 109, "Accounting for income taxes" ("FAS
109"). This includes tax positions considered to be
"routine" as well as those with a high degree of
uncertainty.
FIN 48 has expanded disclosure requirements, which include
a tabular roll forward of the beginning and ending
aggregate unrecognized tax benefits as well as specific
detail related to tax uncertainties for which it is
reasonably possible the amount of unrecognized tax benefit
will significantly increase or decrease within twelve
months. These disclosures are required at each annual
reporting period unless a significant change occurs in an
interim period.
FIN 48 is effective for fiscal years beginning after
December 15, 2006. The cumulative effect of applying FIN 48
will be reported as an adjustment to the opening balance of
retained earnings. The Company does not expect that the
adoption of FIN 48 will have a significant impact on the
Company's financial position and results of operations.
NOTE 3:- INVENTORIES
DECEMBER 31, JUNE 30,
2005 2006
------------ ------------
UNAUDITED
------------
Raw materials $ 33,248 $ 36,310
Work in progress 2,386 1,594
Finished goods 40,692 46,206
------------ ------------
------------ ------------
$ 76,326 $ 84,110
============ ============
Finished goods include products already delivered to customers for
which revenues were not recognized in accordance with the
Company's revenue recognition policy and to a lesser extent,
inventory on consignment to the Company's customers, in the
aggregate amount of $ 21,910 at December 31, 2005 and $ 17,987 at
June 30, 2006.
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msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 4:- EARNINGS PER SHARE
The following table sets forth the computation of historical basic
and diluted earnings per share:
-------------------------
SIX MONTHS
ENDED JUNE 30,
-------------------------
2005 2006
----------- -----------
AS RESTATED (1)
-------------------------
UNAUDITED
-------------------------
Numerator:
Numerator for basic earnings per share - income
available to Ordinary shareholders $ 11,641 $ 8,784
Effect of dilutive securities:
Interest expenses on Convertible Senior Notes, net
of tax 249 443
----------- -----------
Net income used for the computation of diluted $ 11,890 $ 9,227
earnings per share
=========== ===========
Denominator:
Denominator for basic earnings per share -
weighted average number of shares outstanding during
the period 35,894,351 37,776,767
Effect of dilutive securities:
Employee stock options and stock purchase plan 2,445,752 1,493,132
Convertible Senior Notes 1,434,762 2,635,278
----------- -----------
Denominator for diluted earnings per share 39,774,865 41,905,177
=========== ===========
(1) See Note 1d.
NOTE 5:- LITIGATION
a. The Company and a number of its distributors are in
litigation in Singapore with a Singaporean company ("the
Plaintiff") with respect to, inter-alia, alleged
infringement of a patent. On May 12, 2005, the High Court
of Singapore ("the Court") ruled in favor of the Plaintiff.
On November 11, 2005, the Court of Appeals of Singapore
confirmed the Court's ruling and dismissed the Company's
appeal. The matter is currently before the Court to
determine the amount of damages, both for legal costs and
compensatory damages, which are to be awarded to the
Plaintiff. The Company provided an accrual in prior periods
for this litigation based on current estimates provided by
the Company's external legal counsel.
b. On May 7, 2006, a former employee of the Company ("the
plaintiff") filed a lawsuit against the Company in the Tel
Aviv District Court claiming, among other things, that the
Company
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msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 5:- LITIGATION (CONT.)
breached a contractual promise to establish with him a
jointly-held company, which would be the owner of certain
intellectual property rights, in the development in which
he claims to have participated during his employment with
the Company. The plaintiff has previously filed a similar
lawsuit against the Company in Labor Court, which was
dismissed due to lack of jurisdiction. The Company filed a
statement of defense on July 16, 2006. The Company believes
it has meritorious defenses to the claim and it intends to
contest the plaintiff's claim vigorously. At this stage,
the Company and its legal advisors are unable to estimate
the financial impact, if any, of this action. However, if
the Company does not prevail, its financial position and
results of operation may be adversely affected.
NOTE 6:- SUBSEQUENT EVENTS
a. On July 30, 2006, the Company entered into an Agreement and
Plan of Merger with SanDisk Corporation ("SanDisk") and
Project Desert Ltd., a wholly-owned subsidiary of SanDisk
("MergerSub") pursuant to which, and subject to the terms
and the conditions set forth in the agreement, (A)
MergerSub would merge with and into the Company and, as a
result, the Company would become a wholly-owned subsidiary
of SanDisk and (B) at the effective time of the merger,
each Ordinary share of the Company outstanding will be
converted into the right to receive 0.76368 of a share of
SanDisk Common stock.
Consummation of the proposed merger is subject to closing
conditions, including (among others) receipt of a vote in
favor of the merger from the requisite percentage of the
Company's security holders, Israeli court approval
requisite regulatory approvals and expiration of requisite
waiting periods under antitrust laws.
Each party has certain rights to terminate the merger
agreement. If the merger agreement is terminated under
certain circumstances (including if it is terminated by the
Company in order to accept a superior acquisition
proposal), the Company has agreed that it will pay SanDisk
a termination fee of $ 74,000. If the merger agreement is
terminated under certain circumstances as a result of not
receiving antitrust approvals, SanDisk has agreed that the
Company will have the option of requiring SanDisk to make
an investment in the Company by purchasing from the Company
a number of msystems Ltd. Ordinary shares equal to up to
9.9% of the number of Ordinary shares outstanding on the
date of termination of the merger agreement, at a per share
purchase price equal to the greater of (A) $ 38.15 and (B)
the average closing price of the Company's Ordinary shares
for the five consecutive trading days ending on the date of
such termination.
b. Four lawsuits were filed by purported shareholders of the
Company in the Superior Court of the State of California
(County of Santa Clara), naming as defendants each of the
directors of the Company, including one director who also
serves as its President, and Chief Executive Officer, and
naming its then Chief Financial Officer (currently the
Chief Operating Officer) and SanDisk as defendants, and
naming the Company as a nominal defendant. The allegations
in the lawsuits are virtually identical and assert
purported class action and derivative claims. The alleged
derivative claims assert, among other things, breach of
fiduciary duties, abuse of control, constructive fraud,
corporate waste, unjust enrichment and gross mismanagement
with respect to past stock option grants. The alleged class
action claims allege, among other things, breach of
fiduciary duties by the Company's directors relating to the
proposed merger transaction with SanDisk. The class action
claims also
-17-
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 6:- SUBSEQUENT EVENTS (CONT.)
include a claim against SanDisk for aiding and abetting the
Company's directors' alleged breach of fiduciary duties
relating to the proposed merger. The complaints seek, among
other things, equitable relief, including enjoining the
proposed merger, and compensatory and punitive damages.
The Company's time to respond to the complaints has been
extended until at least September 17, 2006. The Company
also has received certain discovery requests relating to
the proposed merger. The complaints seek, among other
things, equitable relief, including enjoining the proposed
merger, and compensatory and punitive damages. The Company
cannot at this time predict the outcome or estimate the
financial consequences of these actions.
In addition, the Company has received letters from an
Israeli shareholder demanding that the Company file a claim
against certain individuals to recover damages claimed by
the shareholder to have been suffered by the Company with
respect to prior option grants alleged to have been made in
violation of applicable laws. On September 6, 2006, the
Company sent its reply denying all claims.
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