Orbotech (ORBK)

(viii)    Share-based Compensation

In accordance with FAS 123(R), the Company accounts for employees’ awards classified as equity awards using the grant-date fair value method. The fair value of share-based payment transactions is recognized as an expense over the requisite service period, net of estimated forfeitures. The Company estimates forfeitures based on historical experience and anticipated future conditions.

Staff Accounting Bulletin No. 107 (“SAB 107”) requires share-based payment to be classified in the same expense line items as cash compensation. The Company has applied the classification requirements of SAB 107 in its adoption of FAS 123(R).

The Company elected to recognize compensation cost for awards with only service conditions that have a graded vesting schedule using the accelerated multiple-option approach.

The Company elected to adopt the modified prospective transition method, permitted by FAS 123(R). Under such transition method, FAS 123(R) has been implemented as from the first quarter of 2006 with no restatement of prior periods. The valuation provisions of FAS 123(R) apply to new awards and to awards modified, repurchased or cancelled after January 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite service had not been rendered that were outstanding as of January 1, 2006 are recognized over the remaining service period using the grant-date fair value of those awards as calculated for pro forma disclosure purposes under FAS No. 123, ‘Accounting for Stock-Based Compensation’.

As a result of adopting FAS 123(R), total expenses recorded during 2008 were $5.3 million ($3.5 million in respect of option grants and $1.8 million in respect of restricted shares awarded and RSUs assumed). The corresponding aggregate amounts in 2007 and 2006 were $4.5 million and $5.3 million, respectively. Compensation expense for equity awards in 2008 was allocated as follows: $0.5 million to cost of revenues: $1.4 million to research and development costs and $3.4 million to selling, general and administrative expenses. As a result of an election under Section 102 of the Israeli Income Tax Ordinance (New Version), 1961 (the “Tax Ordinance”), the Company generally will not be allowed to claim an expense in Israel for tax purposes. For further information see Item 6—Directors, Senior Management and Employees—Share Ownership—The 2000 Plan.

The unrecorded maximum compensation expense for equity awards outstanding at January 1, 2009 is estimated at approximately $10.7 million at that date (without taking into account forfeiture rates) and will be recorded in the consolidated financial statements for the following periods:

These amounts reflect the compensation cost of all outstanding awards, including those granted or assumed in 2008 (which consisted of options to purchase a total of 3,469,544 Ordinary Shares, 158,839 restricted shares and RSUs with respect to 1,542,693 Ordinary Shares), but do not reflect the compensation cost of any equity awards granted commencing January 1, 2009, which will be reflected in future consolidated financial statements over the applicable vesting period in accordance with FAS 123(R).

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Compensation expense relating to future equity awards will depend on a variety of factors including the level and type of future awards and their terms; valuation considerations such as expected option life, volatility of the market price of the Ordinary Shares and applicable risk-free interest rates; and future levels of forfeitures of such awards. The Company is not currently able to estimate the additional compensation expense from future grants but will examine carefully this expense and its relation to net income (loss) when making such grants.

For a discussion of modifications to the Company’s equity remuneration plans approved by shareholders in July 2005 prior to the adoption of FAS 123(R) and for a discussion of equity remuneration plans assumed by the Company in connection with the PDI Acquisition, see Item 6—Directors, Senior Management and Employees—Share Ownership.

(vii)    Share-based Compensation

Prior to January 1, 2006, the Company accounted for employees’ share-based payment under the intrinsic value model in accordance with APB Opinion No. 25, ‘Accounting for Stock Issued to Employees’ (“APB 25”), and related interpretations. In accordance with FAS 123, ‘Accounting for Stock-Based Compensation’ (“FAS 123”), as amended by FAS No. 148, ‘Accounting for Stock-Based Compensation—Transition and Disclosure’, the Company disclosed pro forma information, assuming the Company had accounted for employees’ share-based payments using the fair value-based method defined in FAS 123.

Effective January 1, 2006, the Company adopted FAS 123(R), which supersedes APB 25 and related interpretations and amends FAS No. 95, ‘Statement of Cash Flows’. FAS 123(R) requires that awards classified as equity awards be accounted for using the grant-date fair value method. The fair value of share-based payment transactions is recognized as expense over the requisite service period, net of estimated forfeitures. The Company estimates forfeitures based on historical experience and anticipated future conditions.

In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”). SAB 107 provides supplemental implementation guidance on FAS 123(R), including guidance on valuation methods, inventory

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capitalization of share-based compensation cost, income statement effects, disclosures and other issues. SAB 107 requires share-based payment to be classified in the same expense line items as cash compensation. The Company has applied the classification requirements of SAB 107 in its adoption of FAS 123(R).

The Company elected to recognize compensation cost for awards with only service conditions that have a graded vesting schedule using the accelerated multiple-option approach.

The Company elected to adopt the modified prospective transition method, permitted by FAS 123(R). Under such transition method, FAS 123(R) has been implemented as from the first quarter of 2006 with no restatement of prior periods. The valuation provisions of FAS 123(R) apply to new awards and to awards modified, repurchased or cancelled after January 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite service had not been rendered that were outstanding as of January 1, 2006 are recognized over the remaining service period using the grant-date fair value of those awards as calculated for pro forma disclosure purposes under FAS 123.

As a result of adopting FAS 123(R), income before taxes on income and net income in 2007 were each lower by $4.5 million ($3.4 million in respect of option grants and $1.1 million in respect of restricted share awards) than if the Company had continued to account for compensation for equity awards under APB 25. The corresponding aggregate amount in 2006 was $5.3 million. Compensation expense for equity awards in 2007 was allocated as follows: $0.4 million to cost of revenues: $1.1 million to research and development costs and $3.0 million to selling, general and administrative expenses. As a result of an election under Section 102 of the Israeli Income Tax Ordinance (New Version), 1961 (the “Tax Ordinance”), the Company generally will not be allowed to claim an expense for tax purposes. For further information see Item 6.E—Share Ownership—The 2000 Plan.

The unrecorded maximum compensation expense for equity awards outstanding at January 1, 2008 is estimated at approximately $7.9 million at that date (without taking into account forfeiture rates) and will be recorded in the consolidated financial statements for the following periods:

These amounts do not reflect the compensation cost of any awards granted commencing January 1, 2008, which will be reflected in future consolidated financial statements over the applicable vesting period in accordance with FAS 123(R).

Compensation expense relating to future equity awards will depend on a variety of factors including the level and type of future awards and their terms; valuation considerations such as expected option life, volatility of the market price of the Ordinary Shares and applicable interest rates; and future levels of forfeitures of such awards. The Company is not currently able to estimate the additional compensation expense from future grants but will examine carefully this expense and its relation to net income when making such grants.

For a discussion of modifications to the Company’s equity remuneration plans approved by shareholders in July 2005 prior to the adoption of FAS 123(R), see Item 6.E—Share Ownership.