Exhibit 99.1
MSYSTEMS LTD. AND ITS SUBSIDIARIES
INTERIM CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 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 - 17
- - - - - - - - - - - - - - -
msystems Ltd. AND ITS SUBSIDIARIES
INTERIM CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31, SEPTEMBER 30,
2005 2006
---------------- -----------------
UNAUDITED
-----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 71,507 $ 39,732
Short-term bank deposits 1,202 1,480
Short-term held-to-maturity securities 26,177 80,465
Trade receivables (net of allowance for doubtful accounts of $ 424 as of
December 31, 2005, and $ 446 as of September 30, 2006) 131,857 129,750
Related party trade receivables 1,476 1,061
Deferred taxes - 1,632
Inventories (Note 3) 76,326 117,871
Other receivables and prepaid expenses 15,153 12,193
---------------- -----------------
Total current assets 323,698 384,184
----- ---------------- -----------------
LONG-TERM INVESTMENTS AND RECEIVABLES:
Severance pay fund 4,821 6,412
Investment in and advances to equity method investee - 699
Long-term held-to-maturity securities 87,448 38,983
Available-for-sale equity securities 5,036 5,944
Long-term receivables 886 1,143
---------------- -----------------
Total long-term investments and receivables 98,191 53,181
----- ---------------- -----------------
DEFERRED PURCHASE CREDITS, NET 71,544 85,583
---------------- -----------------
PROPERTY AND EQUIPMENT, NET 29,462 41,871
---------------- -----------------
MINORITY INTEREST IN SUBSIDIARY 2,167 -
---------------- -----------------
DEFERRED TAXES - 3,387
---------------- -----------------
INTANGIBLE ASSETS AND DEBT ISSUANCE COSTS, NET 12,677 11,746
---------------- -----------------
GOODWILL 28,518 30,192
---------------- -----------------
Total assets $ 566,257 $ 610,144
----- ================ =================
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, SEPTEMBER 30,
2005 2006
---------------- -----------------
UNAUDITED
-----------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 121,792 $ 93,719
Excess of losses over investment in equity method investee 1,171 -
Deferred revenues 2,280 3,214
Other payables and accrued expenses 29,175 37,623
---------------- -----------------
Total current liabilities 154,418 134,556
----- ---------------- -----------------
LONG-TERM LIABILITIES:
Convertible Senior Notes 71,380 71,457
Severance pay obligations 6,133 8,372
Deferred tax liabilities 3,699 6,548
Other long-term liabilities 488 870
---------------- -----------------
Total long-term liabilities 81,700 87,247
----- ---------------- -----------------
MINORITY INTEREST IN SUBSIDIARY - 14,933
---------------- -----------------
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 September 30, 2006; Issued and outstanding -
36,864,457 shares at December 31, 2005 and 38,305,971 shares at September
30, 2006 10 10
Additional paid-in capital 325,801 350,318
Deferred stock compensation (1,334) -
Accumulated other comprehensive income 3,815 6,656
Retained earnings 1,847 16,424
---------------- -----------------
Total shareholders' equity 330,139 373,408
----- ---------------- -----------------
Total liabilities and shareholders' equity $ 566,257 $ 610,144
----- ================ =================
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
NINE MONTHS
ENDED SEPTEMBER 30,
------------------------------------
2005 2006
------------------ ---------------
UNAUDITED
------------------------------------
Revenues $ 392,540 $ 645,679
------------------ ---------------
Costs and expenses:
Costs of goods sold (1) 288,717 515,586
Non recurring credit received from supplier - (19,426)
Research and development, net (1) 28,084 38,206
Selling and marketing (1) 25,250 40,748
General and administrative (1) 9,405 24,045
------------------ ---------------
Total costs and expenses 351,456 599,159
----- ------------------ ---------------
Operating income 41,084 46,520
Financial income, net 6,923 3,479
Other income, net - 1,184
------------------ ---------------
Income before taxes on income 48,007 51,183
Taxes on income - 641
------------------ ---------------
Income after taxes on income 48,007 50,542
Equity in losses of an affiliate (2,294) (4,013)
Minority interest in earnings of a subsidiary (21,264) (31,952)
------------------ ---------------
Net income $ 24,449 $ 14,577
================== ===============
Basic earnings per share $ 0.68 $ 0.38
================== ===============
Diluted earnings per share $ 0.62 $ 0.36
================== ===============
Weighted average number of shares used in computing basic earnings per share 36,011,603 37,907,373
================== ===============
Weighted average number of shares used in computing diluted earnings per share 40,380,426 42,194,638
================== ===============
(1) Stock-based compensation expense is included in the following line items:
Cost of goods sold $ 143 $ 720
Research and development 715 3,072
Selling and marketing 937 2,973
General and administrative 500 2,891
------------------ ---------------
Total $ 2,295 $ 9,656
------ ================== ===============
The accompanying notes are an integral part of the interim consolidated
financial statements.
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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 EARNINGS INCOME 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 *) - 13,782 - - - 13,782
Reversal of valuation allowance relating to
operating loss carryforwards resulting
from exercise of stock options 2,413 2,413
Stock based compensation expense - 9,656 - - - 9,656
Other comprehensive income (loss):
Reclassification to income statement of
realized loss on cash flow hedge - - - 114 - $ 114 114
Unrealized loss on available- for-sale
securities and reclassification adjustment
to income statement of realized gain, net
of tax - - - (725) - (725) (725)
Foreign currency translation adjustments - - - 3,452 - 3,452 3,452
Net income - - - - 14,577 14,577 14,577
------- ---------- ------------ ------------- -------- ------------- -------------
Total comprehensive income $ 17,418
- ----- =============
Balance as of September 30, 2006 $ 10 $ 350,318 $ - $ 6,656 $ 16,424 $ 373,408
======= ========== ============ ============= ======== =============
*) 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
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
2005 2006
---------------- ---------------
UNAUDITED
---------------------------------
Cash flows from operating activities:
Net income $ 24,449 $ 14,577
Adjustments required to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 3,167 6,644
Amortization of deferred purchase credit - 12,339
Gain from initial purchasers' option related to Convertible Senior Notes (1,450) -
Minority interest in earnings of a subsidiary 21,264 31,952
Stock-based compensation expense 2,295 9,656
Equity in losses of an affiliate 2,294 4,013
Accrued interest on short-term bank deposits (18) (28)
Interest accrued and amortization of premium and discount on held-to-maturity
marketable securities 354 139
Amortization of discount on Convertible Senior Notes and deferred charges 53 77
Loss (gain) from sale of available-for-sale marketable securities 127 (1,184)
Accrued severance pay, net 444 648
Long-term lease deposits, net 26 (123)
Deferred income taxes, net - (1,777)
Decrease (increase) in trade receivables, net (9,353) 2,612
Decrease (increase) in related party trade receivables (1,161) 415
Decrease (increase) in inventories 6,558 (41,441)
Decrease in other receivables and prepaid expenses 654 3,381
Increase (decrease) in trade payables 36,249 (19,097)
Increase in deferred revenues 889 934
Increase in other payables and accrued expenses 3,719 8,228
---------------- ---------------
Net cash provided by operating activities 90,560 32,070
---------------- ---------------
Cash flows from investing activities:
Investment in held-to-maturity marketable securities (244,944) (47,862)
Investment in available-for-sale marketable securities (36,823) -
Purchase of property and equipment (6,941) (17,314)
Purchase of intangible assets - (50)
Loans to employees, net (100) 2
Proceeds from maturities of held-to-maturity marketable securities 145,931 41,900
Proceeds from sale of available-for-sale marketable securities - 1,260
Short-term bank deposits, net 40,518 (250)
Purchase of equipment pursuant to PSA with Hynix - (35,439)
Investment in loans and shares of equity method investee (1,426) (5,882)
---------------- ---------------
Net cash used in investing activities $ (103,785) $ (63,635)
================ ===============
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
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------------
2005 2006
---------------- --------------
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 (26,000) (14,852)
Payment of issuance costs for Convertible Senior Notes - (250)
Proceeds from exercise of share options, net 6,230 14,025
Proceeds from issuance of shares related to employee stock purchase plan 626 -
Issuance costs of Convertible Senior Notes (947) -
Proceeds of long-term loan - 366
---------------- --------------
Net cash provided by (used in) financing activities 52,659 (711)
---------------- --------------
Effect of foreign currency exchange differences on cash and cash equivalents - 501
---------------- --------------
Increase (decrease) in cash and cash equivalents 39,434 (31,775)
Cash and cash equivalents at the beginning of the period 56,511 71,507
---------------- --------------
Cash and cash equivalents at the end of the period $ 95,945 $ 39,732
================ ==============
Non-cash investing and financing activities:
Accrued issuance costs for Convertible Senior Notes $ 250 $ -
================ ==============
Purchase of equipment under the PSA with Hynix $ - $ 270
================ ==============
Accrued expenses related to issuance of share capital $ - $ 243
================ ==============
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, EXCEPT SHARE AND PER SHARE DATA
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 nine months ended September 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. 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.
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.
On November 8, 2006 the shareholders of msystems have voted to
approve the acquisition of msystems by SanDisk. More than 99%
of the shares represented at the meeting voted in favor of the
transaction.
On November 16, 2006, the District Court of Tel Aviv in Israel
gave its final approval for SanDisk to complete its
acquisition of the Company, following the Company's
shareholder approval of the transaction on November 8, 2006.
c. 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
- 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.)
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 nine months ended September 30, 2006,
the Company amortized an amount of approximately $ 12,436 of
the deferred purchase credits (including an amount of $ 212
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, which have already been sold as
of September 30, 2006.
d. 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.
e. Non recurring credit received from supplier:
During the nine month period ended September 30, 2006, the
Company's joint venture with Toshiba (the "Venture") received
a non recurring credit from Toshiba as price adjustments for
flash components purchased during previous years in the amount
of $ 20,000 of which $ 19,426 was recognized as a reduction of
cost and expenses in the nine months ended September 30, 2006.
f. As mentioned in Note 1f to the Company's annual consolidated
financial statements, the Company restated its financial
statements as of December 31, 2004 and 2005 and for each of
the three years period ended December 31, 2005 for the
previous stock option grants for which the stock price on the
corrected measurement date was higher than such price on the
previously determined measurement dates. As a result, the
Company also recorded an accrual for certain employee tax
exposures. During the nine months ended September 30, 2006,
the Company recorded additional accrual of $2.6 million
g. Seasonal effect:
The Company experiences stronger demand for its mDrive
products in the second half of the fiscal year due to
end-of-year holiday purchases.
- 9 -
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
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,. 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"). Under the intrinsic value method
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 nine months ended
September 30, 2005, the Company recognized stock-based
compensation expense related to employee stock options in the
amount of $2,295.
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 nine months period
ended September 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 from 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.
- 10 -
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.)
As a result of adopting SFAS 123(R) on January 1, 2006, the
Company's income before income taxes and net income for the
nine months ended September 30, 2006, is $ 8,872 lower than if
it had continued to account for stock-based compensation under
APB 25. Basic and diluted net earnings per share for the nine
months ended September 30, 2006, are $ 0.23 and $ 0.21 per
share lower, respectively, than if the Company had continued
to account for share-based compensation under APB 25.
In May 2006 the Company granted Stock Appreciation Right
("SAR") units under the terms of the Company's 2003 Stock
Option and Restricted Stock Incentive Plan. SAR unit - is a
right granted to an employee to obtain such number of ordinary
shares of the Company which aggregate value (up to a maximum
of $80 per unit) on date of exercise will equal the difference
between the exercise price determined on the date of grant to
the market value on the date of exercise. The fair value of
the SAR units is calculated based on the Binomial valuation
method.
The Company estimates the fair value of stock options granted
using the Black-Scholes-Merton option-pricing model and the
Binomial model for the May 2006 grants. 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 September 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.
The fair value of the Company's stock options granted to
employees and directors for the nine months ended September
30, 2006 and 2005 was estimated using the following weighted
average assumptions:
NINE MONTHS ENDED
SEPTEMBER 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
- 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.)
A summary of option activity under the Company's Stock Option
and Restricted Stock Incentive Plan as of September 30, 2006
and changes during the nine months ended September 30, 2006
are as follows:
WEIGHTED-
WEIGHTED- AVERAGE
AVERAGE REMAINING AGGREGATE
NUMBER OF EXERCISE CONTRACTUAL INTRINSIC
OPTIONS PRICE TERM (IN YEARS) VALUE
------------- -------------- ----------------- --------------
UNAUDITED
-----------------------------------------------------------------
Outstanding at December 31, 2005 5,806,965 $ 14.77
Granted 1,282,850 $ 32.56
Exercised (1,441,514) $ 9.73
Forfeited (366,467) $ 20.92
-------------
Outstanding at September 30, 2006 5,281,834 $ 20.04 7.89 $ 106,719
============= ============== ================= ==============
Exercisable at September 30, 2006 1,236,203 $ 8.6 5.75 $ 39,112
============= ============== ================= ==============
Vested and expected to vest 4,270,368 $ 24.78 7.74 89,817
============= ============== ================= ==============
The weighted-average grant-date fair value of options granted
during the nine months ended September 30, 2006 was $ 9.83.
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
third 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 September 30, 2006. This
amount changes based on the fair market value of the Company's
stock. Total intrinsic value of options exercised for the nine
months ended September 30, 2006 was $ 34,397. As of September
30, 2006, there was $ 18,414 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 3.26 years.
- 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 pro-forma table below reflects the Company's stock based
compensation expense, net income and basic and diluted
earnings per share for the nine months ended September 30,
2005, had the Company applied the fair value recognition
provisions of SFAS 123, as follows:
NINE MONTHS ENDED
SEPTEMBER 30, 2005
--------------------
UNAUDITED
--------------------
Net income as reported $ 24,449
Add: stock-based compensation expense recognized under APB 25 2,295
Deduct: stock-based compensation expense determined under fair value method
for all awards (8,752)
--------------------
Pro forma net income $ 17,992
====================
Basic earnings per share, as reported $ 0.68
====================
Diluted earnings per share, as reported $ 0.62
====================
Pro forma basic earnings per share $ 0.50
====================
Pro forma diluted earnings per share $ 0.45
====================
Weighted average number of shares used in computing pro forma basic earnings
per share 36,011,603
====================
Weighted average number of shares used in computing pro forma diluted earnings
per share 40,041,253
====================
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 nine months period ended September 30, 2005 under
SFAS 123 and the stock based compensation expense recognized
during the current nine months ended September 30, 2006 under
SFAS 123(R) are not directly comparable.
- 13 -
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
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 is still evaluating the potential impact
of FIN 48 on the Company's financial position and results of
operations.
NOTE 3:- INVENTORIES
DECEMBER 31, 2005 SEPTEMBER 30, 2006
----------------- ------------------
UNAUDITED
------------------
Raw materials $ 33,248 $ 44,856
Work in progress 2,386 3,398
Finished goods 40,692 69,617
----------------- ------------------
$ 76,326 $ 117,871
================= ==================
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 $ 11,721
at September 30, 2006.
- 14 -
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 4:- EARNINGS PER SHARE
The following table sets forth the computation of historical basic
and diluted earnings per share:
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2005 2006
------------------------------
UNAUDITED
------------------------------
Numerator:
Numerator for basic earnings per share - income available to
Ordinary shareholders $ 24,449 $ 14,577
Effect of dilutive securities:
Interest expenses on Convertible Senior Notes 464 666
------------- -------------
Net income used for the computation of diluted earnings per share $ 24,913 $ 15,243
============= =============
Denominator:
Denominator for basic earnings per share -
Weighted average number of shares outstanding during the period 36,011,603 37,907,373
Effect of dilutive securities:
Employee stock options and stock purchase plan 2,533,889 1,651,987
Convertible Senior Notes 1,834,934 2,635,278
------------- -------------
Denominator for diluted earnings per share 40,380,426 42,194,638
============= =============
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 hearing in respect of the legal costs is set to
be heard November 20, 2006. The Company provided an accrual in
prior periods and subsequently updated the amount accrued for
this litigation based on current estimates provided by the
Company's external legal counsel.
- 15 -
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 5:- LITIGATION (CONT.)
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 breached an undertaking to him to establish a
jointly-held company with him, which would be the owner of
intellectual property rights over certain technologies
developed by the plaintiff 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 plaintiff filed his response to the
statement of defense on October 9, 2006. The Court has set
dates for preliminary proceedings of disclosure. The Company
believes it has strong defenses against the plaintiffs claim,
and accordingly has good chances to dismiss the claim. At this
stage, the Company and its legal advisors are unable to
estimate the financial impact, if any, of this claim. However,
if the Company does not prevail, its financial position and
results of operation may be adversely affected.
c. On September 11, 2006, Mr. Rabbi, a shareholder of the
Company, filed a derivative action and a motion to permit him
to file the derivative action against 4 directors of the
Company and the Company, arguing that options were allegedly
allocated to officers and employees of the Company in
violation of applicable law. Mr. Rabbi claimed that the
aforementioned actions allegedly caused damages to the
Company. On October 17, 2006, the Company filed a motion to
change its title in the motion to permit the filing of the
derivative action from "Formal Respondent" to a "Respondent,"
and Mr. Rabbi has consented to this motion. The Company
received an extension of time to file its response to the
motion until December 25, 2006. At this stage, the Company and
its legal advisors are unable to estimate the financial
impact, if any, of this claim.
d. 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 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 plaintiffs, the Company
and SanDisk have entered into a stipulation which has been
approved by the Court providing that, among other things, the
four actions be consolidated and no defendant served need
respond to the existing complaints and that any defendant
served will have 30 days from the service of a consolidated,
amended complaint to file a responsive pleading or motion with
respect to the complaint. The Company also has received
certain discovery requests which the Company has served
objections to. On October 27, 2006, the plaintiffs filed and
served their consolidated amended shareholder class action and
derivative complaint, which is substantially similar to the
previously filed complaints. The company currently has until
November 27, 2006, to answer, move against or otherwise
respond to the new complaint.
- 16 -
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 5:- LITIGATION (CONT.)
At this stage, the Company and its legal advisors are unable to
estimate the financial impact, if any, of this claim.
NOTE 6:- INCOME TAX
The provision for income taxes is comprised as follows:
NINE MONTHS
ENDED SEPTEMBER 30,
---------------------------------
2005 2006
-------------- --------------
UNAUDITED
---------------------------------
Domestic taxes:
Current $ - $ 1,357
Deferred - (724)
-------------- --------------
- 633
-------------- --------------
Foreign taxes:
Current - 1,012
Deferred - (1,004)
-------------- --------------
- 8
-------------- --------------
Taxes on income $ - $ 641
============== ==============
Deferred income taxes reflect the net tax effects of operating loss
carryforwards and temporary differences between the carrying amounts
of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes. Significant components of the
Company's deferred tax assets and liabilities are as follows (in
thousands):
- 17 -
msystems Ltd. AND ITS SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31, SEPTEMBER 30,
2005 2006
------------------- -------------------
UNAUDITED
-------------------
DEFERRED TAX ASSETS:
Net operating loss carryforward of subsidiaries $ 5,606 $ 4,706
Temporary differences relating to stock compensation 677 -
Temporary differences relating to reserves, allowances and
research and development costs 382 1,155
------------------- -------------------
Total deferred tax asset before valuation allowance 6,665 5,861
Valuation allowance for deferred tax assets (6,497) -
------------------- -------------------
Total deferred tax assets 168 5,861
------------------- -------------------
DEFERRED TAX LIABILITIES:
Temporary differences relating to exchange differences on loan
to foreign subsidiary - (1,996)
Temporary differences relating to available-for-sale equity
securities - (1,753)
Temporary differences relating to intangible assets (3,867) (3,641)
------------------- -------------------
Total deferred tax liabilities (3,867) (7,390)
------------------- -------------------
TOTAL NET DEFERRED LIABILITIES $ (3,699) $ (1,529)
=================== ===================
In the nine months period ended September 30, 2006, the Company's US
subsidiary concluded to fully reverse its valuation allowance on
deferred taxes expected to be reversed in 2007 and thereafter in the
amount of approximately $ 4,900. Out of the aforementioned amount
approximately $2,400 were in respect of loss carryforwards resulting
from exercise of stock options and therefore recorded in APIC, while
the remaining $2,500 were recorded in the income statement.
- - - - - - - - - - - - - - - - - - - - - -
- 18 -