-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ltl60R+R8403bx9ctUVNjRy8Uoy1Fi/sPhTIY9TaCwEKtJbtz7thAhXwqP31GSNk NYXE/ZC5I8qdXMukb30LVA== 0000909518-06-000893.txt : 20060922 0000909518-06-000893.hdr.sgml : 20060922 20060922102538 ACCESSION NUMBER: 0000909518-06-000893 CONFORMED SUBMISSION TYPE: 6-K/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20060911 FILED AS OF DATE: 20060922 DATE AS OF CHANGE: 20060922 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MSYSTEMS LTD CENTRAL INDEX KEY: 0000895361 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER STORAGE DEVICES [3572] IRS NUMBER: 000000000 STATE OF INCORPORATION: L3 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 6-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-11712 FILM NUMBER: 061103487 BUSINESS ADDRESS: STREET 1: M-SYSTEMS BUILDING STREET 2: 7 ATIR YEDA STREET CITY: KFAR-SABA STATE: L3 ZIP: 44425 BUSINESS PHONE: 00 972 9 7645000 MAIL ADDRESS: STREET 1: M-SYSTEMS BUILDING STREET 2: 7 ATIR YEDA STREET CITY: KFAR-SABA STATE: L3 ZIP: 44425 FORMER COMPANY: FORMER CONFORMED NAME: M-SYSTEMS FLASH DISK PIONEERS LTD DATE OF NAME CHANGE: 20021210 FORMER COMPANY: FORMER CONFORMED NAME: M SYSTEMS FLASH DISK PIONEERS LTD DATE OF NAME CHANGE: 19990611 6-K/A 1 mm9-2106_6ka.txt AMEND 9-11-06 FORM 6-K/A SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 REPORT OF FOREIGN PRIVATE ISSUER PURSUANT TO RULE 13A-16 OR 15D-16 OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE 22nd OF SEPTEMBER, 2006 msystems Ltd. ------------- (Translation of registrant's name in English) 7 ATIR YEDA ST. KFAR SABA 44425, ISRAEL ----------------------- (Address of principal executive offices) Indicate by check mark whether registrant files or will file annual reports under cover Form 20-F or Form 40-F: Form 20-F X Form 40-F ----------- --------- Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1): ____ Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7): ____ Indicate by check mark whether registrant by furnishing the information contained in this Form is also thereby furnishing the information to the commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934: Yes No X ----------- --------- If "Yes" is marked, indicate below the file number assigned to the registrant in connection with rule 12g3-2(b): 82-___________________. THIS FORM 6-K (INCLUDING THE EXHIBITS ATTACHED HERETO) IS INCORPORATED BY REFERENCE INTO OUR REGISTRATION STATEMENT ON FORM F-3 (REGISTRATION NO. 333-126774) FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. EXPLANATORY NOTE This Amendment on Form 6-K/A is being furnished by us as an amendment to our Report on Form 6-K furnished with the Securities and Exchange Commission on September 11, 2006, to replace in its entirety Exhibit 99.1 attached to such Report and substitute therefor the attached Exhibit 99.1A which contains our unaudited interim consolidated financial statements as of and for the six months ended June 30, 2006 (which were inadvertently not attached to such Report). Exhibit 99.1 which was inadvertently attached to the Report on Form 6-K filed on September 11, 2006 is not incorporated by reference into any of our Registration Statements, notwithstanding any statement to the contrary set forth in such Report. For convenience, Exhibit 99.2, which was attached to our Report on Form 6-K filed on September 11, 2006, is also attached to this Amendment. CONTENTS The following documents, which are attached hereto, relating to the Registrant are incorporated by reference herein: 99.1A Unaudited interim consolidated financial statements of msystems Ltd. as of and for the six months ended June 30, 2006. 99.2 Management's Discussion and Analysis of Financial Condition and Results of Operations. 2 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. msystems Ltd. -------------------------------------- (Registrant) Date: September 22, 2006 By: /s/ Ronen Faier ---------------------- ---------------------------------- Ronen Faier Interim Chief Financial Officer 3 EX-99 2 mm9-1106_6ke991.txt 99.1 - INT. CONS. FINANCIALS 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. -14- 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. -15- 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 -16- 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. - - - - - - - - - - - - - - - - - - - - - - EX-99 3 mm9-1106_6ke992.txt 99.2 MD&A EXHIBIT 99.2 OPERATING AND FINANCIAL REVIEW AND PROSPECTS YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION WITH OUR INTERIM CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS CURRENT REPORT ON FORM 6-K. THIS "OPERATING AND FINANCIAL REVIEW AND PROSPECTS" SECTION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS. OVERVIEW We design, develop and market innovative flash data storage solutions for digital consumer electronics markets. We primarily target two digital consumer electronics markets: the USB flash drive market with our mDrive products and the mobile handset market with our mDOC products. We also sell flash data storage products targeted at the embedded systems market, including our mModule and mSSD products. BELOW ARE SOME OF THE HIGHLIGHTS AND TRENDS AFFECTING OUR BUSINESS SINCE THE BEGINNING OF 2005: REVENUE GROWTH - Because the markets that our products address grew rapidly, our revenues have grown significantly over the past few years. Our revenues in 2005 grew by 47.6% in comparison to 2004 and our revenues in the six-month period ended June 30, 2006, grew by 79.6% in comparison to the same period in 2005. In particular, our sales to the USB flash drive market grew by 42.3%, from $172.2 million in the six month period ended June 30, 2005, to $245.0 million in the six month period ended June 30, 2006, and our sales to the mobile handset and portable devices market grew by 223.5% from $42.0 million in the six month period ended June 30, 2005, to $135.9 million in the six month period ended June 30, 2006. Our revenue growth since the beginning of 2005 was attributable in large part to significant growth in unit sales of both our mDrive and mDOC products, as both the USB flash drive and mobile handset markets experienced strong end-user demand. Although the average selling prices per megabyte for our products have declined in recent years, the average selling prices per unit of our mDrive and mDOC products decreased at a lower rate, because consumers purchased products with higher density storage. This revenue growth has placed a strain on our operational, logistical and managerial resources. To support our revenue growth, we have expanded our work force from approximately 689 employees at June 30, 2005, to approximately 822 employees at December 31, 2005, and approximately 843 employees at June 30, 2006. SEASONALITY. In 2005, we experienced stronger demand for our mDOC products in the second half of the fiscal year, and for our mDrive products in the fourth quarter of the fiscal year, in each case due to end-of-year holiday purchases. MERGER AGREEMENT. On July 30, 2006, we 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 conditions set forth in the agreement, (i) MergerSub will merge with and into our company and our company will become a wholly-owned subsidiary of SanDisk and, (ii) at the effective time of the merger, each of our outstanding ordinary shares 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 the requisite vote of our shareholders in favor of the merger, Israeli court approval and 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 us in order to accept a superior acquisition proposal), we have agreed to pay SanDisk a termination fee of $74.0 million. If the merger agreement is terminated under certain circumstances as a result of not receiving antitrust approvals, we will have the option of requiring SanDisk to purchase from us 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 price per share equal to the greater of (i) $38.15 and (ii) the average closing price of our ordinary shares on the Nasdaq Stock Market for the five consecutive trading days ending on the date of such termination. RESTATEMENT OF CONSOLIDATED FINANCIAL INFORMATION. 1. CONSOLIDATION OF THE VENTURE In 2003, we and Toshiba entered into a venture (the "Venture"), which is designed, among other things, to enable us and Toshiba to benefit from a portion of each party's respective sales of USB flash drives. The Venture is jointly owned and equally controlled by us and Toshiba. We previously accounted for our investment in the Venture from its inception under the equity method. On December 24, 2003, the Financial Accounting Standard Board ("FASB") issued FASB Interpretation No. 46R, "Accounting for Variable Interest Entities" ("FIN 46R"), which is applicable for financial statements issued for reporting periods ending after March 15, 2004. We considered the provisions of FIN 46R in our fiscal 2004 financial statements and made the determination that the Venture was a variable interest entity under FIN 46R. At that time, we also determined that we were not the primary beneficiary of the Venture under FIN 46R and, therefore, we did not consolidate the Venture's results in our financial statements. .. In connection with a review of our 2004 annual report on Form 20-F by the staff of the U.S. Securities and Exchange Commission, we reconsidered the manner in which FIN 46R applies to the Venture and concluded that we are the primary beneficiary of the Venture and, therefore, we are required to consolidate the Venture in our financial statements. We have restated our financial statements to consolidate the Venture from the beginning of 2004. Since we previously accounted for the Venture using the equity method, consolidation of the Venture does not affect our previously reported net income, shareholders' equity or earnings per share. 2. STOCK- BASED COMPENSATION On June 1, 2006, we announced the commencement, at our own initiative, of an internal review of prior stock option grants. Our Board of Directors subsequently appointed a special committee (the "Special Committee") to conduct this review. A description of the internal review, including the findings of the Special Committee, is set forth in our annual report on Form 20-F for the year ended December 31, 2005, filed with the Securities and Exchange Commission on July 17, 2006, (the "Annual Report"). Based on the Special Committee's findings, we concluded that for accounting purposes the actual measurement dates of certain past stock option grants differed from the previously determined measurement dates for these grants. Because the closing market prices of our ordinary shares as of the corrected measurement dates were generally higher than the relevant option exercise prices, we determined that we should have recognized non-cash stock-based compensation expense and related tax adjustments which were not previously accounted for in our previously issued financial statements. Accordingly, as disclosed in the Annual Report, we have restated our consolidated financial statements as of December 31, 2004 and 2005, and for each of the years in the three-year period ended December 31, 2005, and certain financial information as of December 31, 2003 and as of and for the years ended December 31, 1999, 2000, 2001 and 2002. We have also revised previously issued financial information as of and for the quarter ended March 31, 2006. Consequently, we have rested our previously issued financial statements for the six months ended June 30, 2005. The effect of these two restatement adjustments on our net income for the six-month period ended June 30, 2005, is a reduction of $2.1 million in our net income previously reported for such period. The cumulative effect of these two restatement adjustments on our retained earning as of January 1, 2006 is a reduction of $18.8 million. -2- The effects of these two restatement adjustments on the Company's interim consolidated financial statements for the six-month period ended June 30, 2005 are summarized below:
- ------------------------------------------------------------------------------------------------------------------ ADJUSTMENT ADJUSTMENT FOR STOCK AS FOR -BASED PREVIOUSLY CONSOLIDATION COMPENSATION REPORTED OF VENTURE EXPENSE AS RESTATED - ------------------------------------------------------------------------------------------------------------------ UNAUDITED - ------------------------------------------------------------------------------------------------------------------ Revenues $ 201,611 $ 37,019 $ - $ 238,630 Costs and expense: 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 earnings per share 0.38 - ( 0.06) 0.32 Diluted earnings per share 0.35 - ( 0.05) 0.30 Weighted average number of shares used in 40,089,242 (314,377) 39,774,865 computing diluted earnings per share - - ------------------------------------------------------------------------------------------------------------------
TERMINATION OF SAMSUNG AGREEMENT - We recently terminated our strategic agreement with Samsung, which term was until December 31, 2007. As a result of this termination, we 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 our patents, effective from the termination date. Consequently, we will likely need to purchase flash components from alternate sources and may encounter difficulties in purchasing additional flash components, or be required to purchase 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. -3- RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage of revenues represented by certain items reflected in our consolidated statements of operations. - ----------------------------------------------- -------------------------------- SIX MONTHS ENDED JUNE 30, - ----------------------------------------------- -------------- ----------------- 2006 2005*) - ----------------------------------------------- -------------- ------------- Revenues 100.0% 100.0% Costs and expenses: Cost of goods sold 78.2% 72.4% Research and development, net 5.7% 7.3% Selling and marketing 6.4% 7.2% General and administrative 3.3% 2.7% - ----------------------------------------------- -------------- ------------- Total costs and expenses 93.6% 89.6% - ----------------------------------------------- -------------- ------------- Operating income 6.4% 10.4% Financial income, net 0.7% 1.9% Other income, net 0.3% - - ----------------------------------------------- -------------- ------------- Income before taxes on income 7.4% 12.3% - ----------------------------------------------- -------------- ------------- Taxes on income 0.6% - - ----------------------------------------------- -------------- ------------- Income after taxes on income 6.8% 12.3% Equity losses of an affiliate 0.6% 0.7% Minority interest in earnings of subsidiaries 4.2% 6.7% - ----------------------------------------------- -------------- ------------- Net income 2.0% 4.9% =============================================== ============== ============= *) As restated - ----------------------------------------------- -------------- ------------- The following table sets forth, for the periods indicated, our revenues by end markets (in thousands): - ----------------------------------------------- -------------------------------- SIX MONTHS ENDED JUNE 30, - ----------------------------------------------- -------------- ----------------- 2006 2005 - ----------------------------------------------- ---------- ------------- Revenues USB flash drive market 245,040 172,178 Mobile handset and portable devices market 135,857 41,996 Embedded systems market 46,166 23,808 Other 1,540 648 - ------------------------------------------------ ----------- ------------ Total. 428,603 238,630 - ------------------------------------------------ ----------- ------------ SIX MONTHS ENDED JUNE 30, 2006, COMPARED TO SIX MONTHS ENDED JUNE 30, 2005 REVENUES - Revenues for the six months ended June 30, 2006, increased by $190.0 million, or 79.6%, to $428.6 million from $238.6 million for the six months ended June 30, 2005. Revenues derived from the USB flash drive market increased by $72.9 million, or 42.3%, to $245.0 million, revenues derived from the mobile handset and portable devices market increased by $93.9 million, or 223.5%, to $135.9 million and revenues derived from the embedded systems market increased by $22.4 million, or 93.9%, to $46.2 million. COST OF GOODS SOLD - Our cost of goods sold for the six months ended June 30, 2006, increased by $162.3 million to $335.2 million, an increase of 93.9% from cost of goods sold of $172.8 million for the six months ended June 30, 2005. Our costs of goods sold as a percentage of total revenues increased from 72.4% for the six months ended June 30, 2005, to 78.2% for the six months ended June 30, 2006, due to (i) pricing pressures resulting from increasing competition and (ii) a decrease in the gross margins of the Venture. -4- RESEARCH AND DEVELOPMENT EXPENSES, NET - Our gross research and development expenses for the six months ended June 30, 2006, increased by $6.9 million to $24.5 million, an increase of 39.0% from gross research and development expenses of $17.6 million for the six months ended June 30, 2005. Our net research and development expenses for the six months ended June 30, 2006, increased by $6.9 million to $24.3 million, an increase of 39.2% from net research and development expenses of $17.4 for the six months ended June 30, 2005. The increase in our gross research and development expenses is attributable to an increase in our investment in the development of new products and technologies, and the enhancement of existing products. As a percentage of revenues, our net research and development expenses decreased to 5.7% for the six months ended June 30, 2006, from 7.3% for the six months ended June 30, 2005. During the six months ended June 30, 2006, we recognized $152,000 and $63,000 of research and development grants from Magneton and Britech, respectively, compared to $0 and $172,000 of research and development grants we recognized during the six months ended June 30, 2005. SELLING AND MARKETING EXPENSES - Selling and marketing expenses for the six months ended June 30, 2006, increased by $10.5 million, or 61.7%, to $27.6 million from $17.1 million for the six months ended June 30, 2005. Our selling and marketing expenses are only partially affected by an increase in our product sales, due to the fact that the direct expenses related to actual sales are limited. The increase in our sales and marketing expenses was attributable mainly to (i) an increase of our marketing activities in the USB flash drive market and (ii) increases in sales and marketing personnel in order to support our substantial revenue growth. As a percentage of revenues, our selling and marketing expenses decreased to 6.4% for the six months ended June 30, 2006, from 7.2% for the six months ended June 30, 2005. GENERAL AND ADMINISTRATIVE EXPENSES - General and administrative expenses for the six months ended June 30, 2006 increased by $7.7 million, or 118.0%, to $14.2 million from $6.5 million for the six months ended June 30, 2005. This increase was attributable mainly to expanding our operations in order to support our substantial growth, principally increases in personnel, legal and accounting expenses as well as expenses attributable to the internal review of prior stock option grants described above and to the previously contemplated securities offering. As a percentage of revenues, our general and administrative expenses remained unchanged. FINANCIAL INCOME, NET - Financial income, net for the six months ended June 30, 2006, decreased by $1.7 million to $2.9 million from $4.6 million for the six months ended June 30, 2005. The decrease was attributable to the lower aggregate amount of our cash, cash equivalents, bank deposits and marketable securities held by us during the six months ended June 30, 2006, compared to the six months ended June 30, 2005. OTHER INCOME - In 2006, we realized a gain from the sale of a portion of our shares of a Taiwanese company, in the amount of $1.2 million. EQUITY IN LOSSES OF AN AFFILIATE - Equity in losses of an affiliate represents our share in the losses incurred by U3 LLC, a partnership established by us and Sandisk to develop a unified standard for the development of software applications for USB flash drives, which commenced operations at the beginning of 2005. The equity in losses of an affiliate for the period ended June 30, 2006, increased by $ 0.9 million to $2.5 million from $1.6 million for the six months ended June 30, 2005. The increase was attributable to the increased marketing activity of the U3 standard. MINORITY INTEREST - Minority interest in earnings of consolidated subsidiary was $17.6 million in the six months ended June 30, 2006, compared to $16.1 million in the six months ended June 30, 2005. Minority interest in the earnings of our consolidated subsidiary represents the proportional share of Toshiba in the earnings of the Venture, a variable interest entity consolidated in accordance with FIN 46R. INCOME TAXES - Income taxes for the six months ended June 30, 2006, amounted to $2.5 million, which consisted of $2.2 million of current income taxes and $0.3 million of deferred tax income. Income taxes in 2006 are mainly attributable to our wholly-owned Spanish subsidiary, Microelectronica Espanola S.A.U. ("MEE"), which we acquired in November 2005, which is subject to a 35% tax rate, to recent changes in Israeli tax law which apply a 31% tax rate to financial income, to the sale of available for sales equity securities, and to our wholly-owned Taiwanese subsidiary, which is subject to 25% tax rate. -5- Due to our utilization of net operating loss carryforwards and to our not being liable for taxes with respect to the share of the Venture's earnings attributable to Toshiba, as well as various tax reduction programs established by the Israeli government to encourage investment in Israel, we did not incur any income tax expenses in Israel in 2005. NET INCOME - For the six months ended June 30, 2006, we recognized net income of $8.8 million, representing 2.0% of total revenues, compared to a net income of $11.6 million for the six months ended June 30, 2005, representing 4.9% of total revenues. The decrease of net income as a percentage of the total revenues was attributable principally to lower margins realized on revenues, higher general and administrative expenses and higher taxes during the six months ended June 30, 2006. LIQUIDITY AND CAPITAL RESOURCES Through June 30, 2006, we funded our operations primarily from cash from operations and previous issuances and sales of ordinary shares and convertible senior notes. Our cash flow from operating activity for the six months ended June 30, 2006, amounted to $43.8 million. In March 2005 we completed an offering of convertible senior notes which provided net proceeds of $72.8 million. We believe that our cash, cash equivalents, bank deposits, marketable securities and cash generated from operations will be sufficient to fund our anticipated working capital needs for the next twelve months. As of June 30, 2006, our cash, cash equivalents, bank deposits and marketable securities were $179.0 million ($51.3 million of this amount being comprised of long-term marketable securities) compared to $186.3 million as of December 31, 2005. The decrease results mainly from the purchase of equipment placed at Hynix. We had indebtedness of $71.4 million as of June 30, 2006, attributable exclusively to the convertible senior notes issued by us in March 2005. Our trade receivables decreased to $106.1 million at June 30, 2006, from $131.9 million at December 31, 2005, which reflects decrease in our sales from $222.4 million in the quarter ended December 31, 2005 to $209.5 million in the quarter ended June 30, 2006. Our inventories increased from $76.3 million at December 31, 2005, to $84.1 million at June 30, 2006. The main reason for the increase is build up of inventory for the mobile handset market. OPERATING ACTIVITIES Net cash provided by operating activities for the six months ended June 30, 2006, was $43.8 million as compared to $60.8 million of net cash provided by operating activities for the six months ended June 30, 2005. The decrease in cash provided by operating activities was primarily attributable to the decrease in our accounts payable. INVESTING ACTIVITIES Net cash used in investing activities for the six months ended June 30, 2006, was $53.8 million as compared to $97.6 million of net cash used in investing activities for the six months ended June 30, 2005. The decrease was primarily attributable to lower investments in marketable securities, which was partially offset by the investment in equipment under the purchase agreement with Hynix. For the six months ended June 30, 2006, the aggregate amount of capital expenditures was $9.3 million. These expenditures were principally for the construction of our second facility in Kfar-Saba and for the purchases of computer hardware and software. In addition, during the six months ended June 30, 2006, we purchased $ 35.4 million of equipment which we placed in Hynix's facilities under the terms of our agreement with Hynix. -6- FINANCING ACTIVITIES Net cash used in financing activities during the six months ended June 30, 2006, was $2.9 million as compared to net cash provided by financing activities of $58.7 million during the six months ended June 30, 2005. The significantly higher amount of net cash provided by financing activities during the six months ended June 30, 2005, was primarily attributable to our issuance in 2005 of convertible senior notes, which provided net proceeds of $72.8. We expect to use cash in the near future to fund working capital and increased selling and marketing and research and development expenses. We currently have no commitments or plans for the acquisition of any business, product line or technology, or for any material expenditures or investments. Under our merger agreement with SanDisk, we are required to obtain SanDisk's prior written consent for, among other things, the acquisition of any business, joint venture, strategic partnership or similar alliance as well as for certain capital expenditures. -7- -----END PRIVACY-ENHANCED MESSAGE-----