UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-7422
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STANDARD MICROSYSTEMS CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 11-2234952
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
80 Arkay Drive, Hauppauge, New York 11788
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 631-435-6000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes _X_ No ____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of November 30, 2004, there were 18,655,000 shares of the registrant's common
stock outstanding.
Standard Microsystems Corporation
Form 10-Q
For the Quarter Ended November 30, 2004
Table of Contents
Part I Financial Information
Item 1 Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of November 30, 2004 and
February 29, 2004
Condensed Consolidated Statements of Operations for the Three and Nine
Month Periods Ended November 30, 2004 and 2003
Condensed Consolidated Statements of Cash Flows for the Nine Month
Periods Ended November 30, 2004 and 2003
Notes to Condensed Consolidated Financial Statements
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3 Quantitative and Qualitative Disclosures About Market Risk
Item 4 Controls and Procedures
Part II Other Information
Item 1 Legal Proceedings
Item 6 Exhibits and Reports on Form 8-K
Signature
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STANDARD MICROSYSTEMS CORPORATION
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(In thousands)
November 30, February 29,
2004 2004
---- ----
Assets
Current assets:
Cash and cash equivalents $ 119,767 $ 135,161
Short-term investments 61,113 23,136
Accounts receivable, net 16,782 21,946
Inventories 38,009 23,162
Deferred income taxes 14,648 15,064
Other current assets 8,840 8,549
- ----------------------------------------------------------------------------
Total current assets 259,159 227,018
- ----------------------------------------------------------------------------
Property, plant and equipment, net 22,767 23,430
Long-term investments - 15,600
Goodwill 29,435 29,595
Intangible assets, net 3,849 4,697
Deferred income taxes 5,971 6,493
Other assets 3,707 3,192
- ----------------------------------------------------------------------------
$ 324,888 $ 310,025
============================================================================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 19,783 $ 14,679
Deferred income on shipments to
distributors 6,808 7,972
Accrued expenses, income taxes and other
liabilities 14,367 13,168
- ----------------------------------------------------------------------------
Total current liabilities 40,958 35,819
- ----------------------------------------------------------------------------
Other liabilities 11,967 12,104
Shareholders' equity:
Preferred stock - -
Common stock 2,050 2,019
Additional paid-in capital 187,239 181,830
Retained earnings 103,430 99,010
Treasury stock, at cost (23,799) (23,454)
Deferred stock-based compensation (2,163) (1,962)
Accumulated other comprehensive income 5,206 4,659
- ----------------------------------------------------------------------------
Total shareholders' equity 271,963 262,102
- ----------------------------------------------------------------------------
$ 324,888 $ 310,025
============================================================================
See Notes to Condensed Consolidated Financial Statements.
STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except per share data)
Three Months Ended Nine Months Ended
November 30, November 30,
--------------------------------- ------------------------------------
2004 2003 2004 2003
---- ---- ---- ----
Sales and revenues:
Product sales $ 48,026 $ 52,282 $ 145,611 $ 142,751
Intellectual property revenues 2,729 20,467 8,354 21,008
- -----------------------------------------------------------------------------------------------------------------------------------
50,755 72,749 153,965 163,759
Cost of goods sold 27,483 30,350 80,128 79,192
- -----------------------------------------------------------------------------------------------------------------------------------
Gross profit 23,272 42,399 73,837 84,567
Operating expenses (income):
Research and development 10,390 10,244 32,472 28,625
Selling, general and administrative 12,989 11,570 36,693 31,048
Amortization of intangible assets 265 317 848 994
Gain on real estate transaction - - - (1,444)
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) from operations (372) 20,268 3,824 25,344
Interest income 704 617 1,726 1,451
Other expense, net (20) (145) (58) (890)
- -----------------------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes
and minority interest 312 20,740 5,492 25,905
Provision for (benefit from) income taxes (301) 5,910 1,072 7,590
Minority interest in net income of subsidiary - 43 - 139
- -----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 613 14,787 4,420 18,176
Loss from discontinued operations (net of income tax
benefits of $2 and $108) - (3) - (193)
- -----------------------------------------------------------------------------------------------------------------------------------
Net income $ 613 $ 14,784 $ 4,420 $ 17,983
===================================================================================================================================
Basic net income per share:
Income from continuing operations $ 0.03 $ 0.84 $ 0.24 $ 1.06
Loss from discontinued operations - - - (0.01)
- -----------------------------------------------------------------------------------------------------------------------------------
Basic net income per share $ 0.03 $ 0.84 $ 0.24 $ 1.05
===================================================================================================================================
Diluted net income per share:
Income from continuing operations $ 0.03 $ 0.77 $ 0.23 $ 1.00
Loss from discontinued operations - - - (0.01)
- -----------------------------------------------------------------------------------------------------------------------------------
Diluted net income per share $ 0.03 $ 0.77 $ 0.23 $ 0.99
===================================================================================================================================
Weighted average common shares outstanding:
Basic 18,395 17,577 18,321 17,120
Diluted 19,035 19,242 19,375 18,143
See Notes to Condensed Consolidated Financial Statements.
STANDARD MICROSYSTEMS CORPORATION
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
Nine Months Ended November 30,
-----------------------------------
2004 2003
--------------- --------------
Cash flows from operating activities:
Cash received from customers and
licensees $ 158,732 $ 164,609
Cash paid to suppliers and employees (156,309) (131,263)
Interest received 1,486 1,361
Interest paid (108) (51)
Income taxes refunded (paid) 6,703 (363)
- -------------------------------------------------------------------------------
Net cash provided by operating activities 10,504 34,293
- -------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (7,335) (7,563)
Sales of property, plant and equipment 1,677 7,121
Sales of long-term investments 4,000 2,114
Purchases of short-term investments (46,030) (36,675)
Sales of short-term investments 19,653 22,795
Other 24 139
- -------------------------------------------------------------------------------
Net cash used for investing activities (28,011) (12,069)
- -------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock 3,618 13,698
Purchases of treasury stock (344) -
Repayments of obligations under capital
leases and notes payable (1,575) (1,249)
- -------------------------------------------------------------------------------
Net cash provided by financing activities 1,699 12,449
- -------------------------------------------------------------------------------
Effect of foreign exchange rate changes on
cash and cash equivalents 414 789
Cash used for discontinued operation - (301)
- -------------------------------------------------------------------------------
Net increase (decrease) in cash and
cash equivalents (15,394) 35,161
Cash and cash equivalents at beginning
of period 135,161 90,025
- -------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 119,767 $ 125,186
===============================================================================
Reconciliation of income from continuing operations
to net cash provided by operating activities:
Income from continuing operations $ 4,420 $ 18,176
Adjustments to reconcile income from
continuing operations to net cash
provided by operating activities:
Depreciation and amortization 8,586 7,329
Stock-based compensation 1,545 813
Tax benefits from employee stock plans 759 5,615
Gains from sales of investments and
property, net (9) (686)
Other adjustments, net (23) (197)
Changes in operating assets and
liabilities:
Accounts receivable (4,576) 1,512
Inventories (14,713) (3,444)
Accounts payable, deferred income,
accrued expenses and other liabilities 8,873 3,891
Current and deferred income taxes 7,018 1,136
Other changes, net (1,376) 148
- -------------------------------------------------------------------------------
Net cash provided by operating activities $ 10,504 $ 34,293
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
STANDARD MICROSYSTEMS CORPORATION
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial information of
Standard Microsystems Corporation and subsidiaries, referred to herein as
"SMSC" or "the Company," has been prepared in accordance with generally
accepted accounting principles and the rules and regulations of the
Securities and Exchange Commission, and reflects all adjustments,
consisting only of normal recurring adjustments, which in management's
opinion are necessary to state fairly the Company's financial position,
results of operations and cash flows for all periods presented.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the
financial statements, as well as the reported amounts of sales and revenues
and expenses during the reporting period. Actual results may differ from
those estimates, and such differences may be material to the financial
statements. These condensed consolidated financial statements should be
read in conjunction with the audited consolidated financial statements for
the year ended February 29, 2004 included in the Company's annual report on
Form 10-K, as filed on May 14, 2004 with the Securities and Exchange
Commission (SEC). The results of operations for the three and nine-month
periods ended November 30, 2004 are not necessarily indicative of the
results to be expected for any future periods.
2. Stock-Based Compensation
The Company has in effect several stock-based compensation plans under
which incentive stock options, non-qualified stock options and restricted
stock awards are granted to employees and directors. All stock options are
granted with exercise prices equal to the fair value of the underlying
shares on the date of grant. The Company accounts for stock option grants
in accordance with Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees" and accordingly recognizes no
compensation expense for the stock option grants. Additional pro forma
disclosures as required under Statement of Financial Accounting Standards
(SFAS) No. 123, "Accounting for Stock-Based Compensation," as amended by
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure," are detailed below.
For purposes of pro forma disclosures, the estimated fair market value of
the Company's options is amortized as an expense over the options' vesting
periods. The fair value of each option grant, as defined by SFAS No. 123,
is estimated on the date of grant using the Black-Scholes option-pricing
model. The Black-Scholes model, as well as other currently accepted option
valuation models, was developed to estimate the fair value of freely
tradable, fully transferable options without vesting restrictions, that
significantly differ from the Company's stock option awards. Because the
Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate,
in the opinion of management, the existing models do not necessarily
provide a reliable single measure of the fair value of employee stock
options.
Had compensation expense been recorded under the provisions of SFAS No.
123, the Company's net income (loss) and net income (loss) per share would
have been the pro forma amounts indicated below (in thousands, except per
share data):
Three Months Ended Nine Months Ended
November 30, November 30,
-----------------------------------------------------
2004 2003 2004 2003
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Net income - as reported $ 613 $ 14,784 $ 4,420 $ 17,983
Stock-based compensation expense included in net income,
net of taxes - as reported 724 232 1,055 691
Stock-based compensation expense determined using the
fair value method for all awards, net of taxes (1,877) 2,916 (6,398) (1,775)
-------------------------------------------------------------------------------------------------------------------
Net income (loss) - pro forma $ (540) $ 17,932 $ (923) $ 16,899
===================================================================================================================
Basic net income per share - as reported $ 0.03 $ 0.84 $ 0.24 $ 1.05
===================================================================================================================
Diluted net income per share - as reported $ 0.03 $ 0.77 $ 0.23 $ 0.99
===================================================================================================================
Basic net income (loss) per share - pro forma $ (0.03) $ 1.02 $ (0.05) $ 0.99
===================================================================================================================
Diluted net income (loss) per share - pro forma $ (0.03) $ 1.02 $ (0.05) $ 0.99
===================================================================================================================
3. Balance Sheet Data
Inventories are valued at the lower of first-in, first-out cost or market
and consist of the following (in thousands):
Nov. 30, 2004 Feb. 29, 2004
-----------------------------------------------------------------------
Raw materials $ 963 $ 910
Work in process 21,756 13,202
Finished goods 15,290 9,050
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$ 38,009 $ 23,162
=======================================================================
Property, plant and equipment consist of the following (in thousands):
Nov. 30, 2004 Feb. 29, 2004
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Land $ 578 $ 1,570
Buildings and improvements 13,143 20,842
Machinery and equipment 91,053 90,195
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104,774 112,607
Less: accumulated depreciation 82,007 89,177
-----------------------------------------------------------------------
$ 22,767 $ 23,430
=======================================================================
4. Net Income Per Share
Basic net income per share is calculated using the weighted-average number
of common shares outstanding during the period. Diluted net income per
share is calculated using the weighted-average number of common shares
outstanding during the period, plus the dilutive effect of unvested
restricted stock awards and shares issuable through stock options.
The shares used in calculating basic and diluted net income per share for
the Condensed Consolidated Statements of Operations included within this
report are reconciled as follows (in thousands):
Three Months Ended Nine Months Ended
November 30, November 30,
2004 2003 2004 2003
-------------------------------------------
Average shares outstanding
for basic net income per
share 18,395 17,577 18,321 17,120
Dilutive effect of stock
options and unvested
restricted stock awards 640 1,665 1,054 1,023
-------------------------------------------------------------------------
Average shares outstanding for
diluted net income per share 19,035 19,242 19,375 18,143
=========================================================================
Options covering 1.8 million and 0.3 million shares for the three-month
periods ended November 30, 2004 and 2003, respectively, and 1.0 million and
1.6 million shares for the nine-month periods ended November 30, 2004 and
2003, respectively, were excluded from the computation of average shares
outstanding for diluted net income per share because their effect was
antidilutive.
5. Comprehensive Income
The Company's other comprehensive income consists of foreign currency
translation adjustments from those subsidiaries not using the U.S. dollar
as their functional currency, and unrealized gains and losses on equity
investments classified as available-for-sale. The components of the
Company's comprehensive income for the three and nine-month periods ended
November 30, 2004 and 2003 were as follows (in thousands):
Three Months Ended Nine Months Ended
November 30, November 30,
2004 2003 2004 2003
--------------------------------------------
Net income $ 613 $ 14,784 $ 4,420 $ 17,983
Other comprehensive income:
Change in foreign currency
translation adjustment 568 995 558 1,211
Change in unrealized gain
(loss) on marketable
equity securities, net of
taxes 8 12 (11) 47
Reclassification adjustment for
loss on marketable equity
security included in net
income, net of taxes - - - 665
-------------------------------------------------------------------------
Total comprehensive income $ 1,189 $ 15,791 $ 4,967 $ 19,906
=========================================================================
During the nine-month period ended November 30, 2003, the Company sold its
remaining equity investment in Chartered Semiconductor Manufacturing, Ltd.
This investment was classified as available-for-sale, and temporary changes
in its market value, net of income taxes, were included within the
Company's other comprehensive income, and were presented cumulatively as an
unrealized gain or loss, net of income taxes, within Accumulated other
comprehensive income on the Company's Consolidated Balance Sheets. The
amount presented as a reclassification adjustment in the preceding table
represents the amount previously reported within Other comprehensive income
as an unrealized loss on this investment, net of income taxes, through
February 28, 2003.
6. Agreements with Intel Corporation
In 1987, the Company and Intel Corporation (Intel) entered into an
agreement providing for, among other things, a broad, worldwide,
non-exclusive patent cross-license, covering manufacturing processes and
products, thereby providing each company access to the other's current and
future patent portfolios.
In September 2003, the Company and Intel announced that they had enhanced
their intellectual property and business relationship. The companies agreed
to collaborate on certain future Input/Output (I/O) and sensor products,
and Intel agreed to use the Company's devices on certain current and future
generations of Intel products. In addition, the Company agreed to limit its
rights, under its 1987 patent cross-license with Intel, to manufacture and
sell Northbridge products and Intel Architecture Microprocessors on behalf
of third parties. The companies also terminated an Investor Rights
Agreement between them, which had been entered into in connection with
Intel's 1997 acquisition of 1,543,000 shares of the Company's common stock.
Under this agreement, Intel had certain information, corporate governance
and other rights with respect to the activities of the Company.
In respect of this relationship, Intel agreed to pay to the Company an
aggregate amount of $75 million, of which $20 million and $2.5 million was
recognized as Intellectual property revenue, and paid, in the third and
fourth quarters of fiscal 2004, respectively, and $2.5 million was
recognized as Intellectual property revenue, and paid, in each of the
first, second and third quarters of fiscal 2005, respectively. Of the
remaining amount, $2.5 million is payable during the balance of fiscal
2005, $10.25 million is payable in fiscal 2006, $11.25 million is payable
in fiscal 2007, $12.0 million is payable in fiscal 2008 and $9.0 million is
payable in fiscal 2009. Such amounts are payable in quarterly installments
each year, and are subject to possible reduction, in a manner and to an
extent to be agreed by the parties, based upon the companies' collaboration
and sales, facilitated by Intel, of certain future new products of the
Company.
7. Business Restructuring
In December 2001, the Company announced a restructuring plan for its exit
from the PC chipset business.
The Company's reserve related to this restructuring declined from $1.0
million at February 29, 2004 to $0.6 million at November 30, 2004,
reflecting payments against previously reserved non-cancelable lease
obligations, which will continue through their respective lease terms
through August 2008.
8. Discontinued Operations
The Company had been involved in an arbitration proceeding with Accton
Technology Corporation (Accton) and SMC Networks, Inc. (Networks), relating
to claims associated with the October 1997 purchase of a majority interest
in Networks by Accton from SMSC. This divestiture was accounted for as a
discontinued operation, and accordingly, costs associated with this action,
net of income taxes, were reported within Loss from discontinued operations
on the Consolidated Statements of Operations. These costs were negligible
for the three-month period ended November 30, 2003, and totaled $0.2
million for the nine-month period ended November 30, 2003, after applicable
income tax benefits. This action was settled during the fourth quarter of
fiscal 2004.
9. Goodwill and Intangible Assets
The Company's June 2002 acquisition of Tucson, Arizona-based Gain
Technology Corporation included the acquisition of $7.1 million of
finite-lived intangible assets and $29.4 million of goodwill, after
adjustments. In accordance with the provisions of SFAS No. 142, this
goodwill is not amortized, but is tested for impairment in value annually,
as well as when an event or circumstance occurs indicating a possible
impairment in its value.
All finite-lived intangible assets are being amortized on a straight-line
basis over their estimated useful lives. Existing technologies were
assigned an estimated useful life of six years. Customer contracts were
assigned useful lives of between one and ten years (with a weighted average
life of approximately seven years), and non-compete agreements were
assigned useful lives of two years. The weighted average useful life of all
intangible assets is approximately six years.
As of November 30, 2004 and February 29, 2004, the Company's finite-lived
intangible assets consisted of the following (in thousands):
November 30, 2004 February 29, 2004
--------------------------------------------------------------------------
Accumulated Accumulated
Cost Amortization Cost Amortization
--------------------------------------------------------------------------
Existing technologies $ 6,179 $ 2,575 $ 6,179 $ 1,802
Customer contracts 326 81 326 57
Non-compete agreements - - 410 359
--------------------------------------------------------------------------
$ 6,505 $ 2,656 $ 6,915 $ 2,218
==========================================================================
Estimated future intangible asset amortization expense for the remainder of
fiscal 2005 and thereafter is as follows (in thousands):
Period Amount
-------------------------------------------------
Remainder of fiscal 2005 $ 266
Fiscal 2006 1,063
Fiscal 2007 1,063
Fiscal 2008 1,062
Fiscal 2009 290
Fiscal 2010 and thereafter 105
=================================================
10. Real Estate Transactions
During the quarter ended November 30, 2004, the Company sold its remaining
parcel of unused real estate in Hauppauge, New York, for net proceeds of
$1.7 million, after transaction costs. This property had a carrying value
of approximately $0.4 million. The contract of sale requires the Company to
complete the remediation of certain soil contamination of uncertain origin
identified at this property, at its expense, the completion of which is
subject to regulatory approval. The completion date and cost of this
remediation project are not yet determined, but based upon existing
information, management expects to complete the project within twelve
months at a cost no greater than $0.5 million.
In a real estate sale, if a seller retains involvement with a property
after it is sold in any way that results in retention of substantial risks
or rewards of ownership, an "absence-of-continuing-involvement" criterion,
which is required for the seller's recognition of a gain, has not been
achieved. As a result of the arrangement described above, the
"absence-of-continuing-involvement" criterion in this transaction has not
yet been satisfied and accordingly no gain has been reflected within the
Company's Consolidated Statement of Operations. The $1.3 million excess of
the net proceeds from the sale over the carrying value of the property is
included within Accrued expenses, income taxes and other liabilities on the
Company's November 30, 2004 Condensed Consolidated Balance Sheet. Any gain
on this transaction, net of costs incurred in the remediation project, will
be recorded upon satisfaction of the "absence-of-continuing-involvement"
criterion.
During the quarter ended May 31, 2003, the Company sold certain portions of
its Hauppauge, New York real estate holdings, for aggregate proceeds of
$7.0 million, net of transaction costs. These transactions resulted in an
aggregate gain of $1.7 million, $1.4 million of which related to property
in which the Company has no continued interest and was recognized within
the Company's fiscal 2004 first quarter operating results, and $0.3 million
of which related to property that the Company has leased back from the
purchaser and was therefore deferred. This deferred gain is being
recognized within the Company's operating results as a reduction in rent
expense on a straight-line basis over a 30-month period beginning in June
2003, consistent with the term of the lease. As of November 30, 2004, the
Company's remaining rent obligation over the term of this lease is
approximately $0.3 million.
11. Retirement Plans
The Company maintains an unfunded Supplemental Executive Retirement Plan to
provide senior management with retirement, disability and death benefits.
The Company's subsidiary, SMSC Japan, also maintains an unfunded retirement
plan, which provides its employees and directors with separation benefits,
consistent with customary practices in Japan. Benefits under these defined
benefit plans are based upon various service and compensation factors. The
following table sets forth the components of the consolidated net periodic
pension expense for the three and nine-month periods ended November 30,
2004 and 2003, respectively (in thousands):
Three Months Ended Nine Months Ended
November 30, November 30,
---------------------------------------
2004 2003 2004 2003
--------------------------------------------------------------------------
Service cost - benefits earned $ 71 $ 65 $ 214 $ 196
Interest cost on projected benefit
obligations 107 102 320 305
Net amortization and deferral 72 68 217 204
--------------------------------------------------------------------------
Net periodic pension expense $ 250 $ 235 $ 751 $ 705
==========================================================================
Additionally, the Company is the beneficiary of life insurance policies
that have been purchased as a method of partially financing benefits under
the Supplemental Executive Retirement Plan.
12. Litigation
In June 2003, SMSC was named as a defendant in a patent infringement
lawsuit filed by Analog Devices, Inc. (ADI) in the United States District
Court for the District of Massachusetts (Analog Devices, Inc. v. Standard
Microsystems Corporation, Case Number 03 CIV 11216). The Complaint, as
amended, alleges that some of the Company's products infringe one or more
of three of ADI's patents, and seeks injunctive relief and unspecified
damages. In September 2003, the Company filed an Answer in the lawsuit,
denying ADI's allegations and raising affirmative defenses and
counterclaims. The Company is vigorously defending the lawsuit and
collecting evidence to support its defenses to infringement and its
allegations of patent invalidity and unenforceability. A trial date in the
first quarter of calendar 2005 is expected to be scheduled. Although it is
premature to assess the outcome of the litigation, the Company believes
that the allegations against it are without merit.
13. Common Stock Repurchase Program
The Company maintains a common stock repurchase program, as approved by its
Board of Directors, which authorizes the Company to repurchase up to three
million shares of its common stock on the open market or in private
transactions. Under this program, the Company repurchased approximately
22,000 shares of its common stock at a cost of $0.3 million during the
second quarter of fiscal 2005. No shares were repurchased during the third
quarter of fiscal 2005. The Company currently holds repurchased shares as
treasury stock. As of November 30, 2004, the Company has repurchased a
total of approximately 1.8 million shares of its common stock, at a cost of
$23.8 million, under this program.
14. Stock Appreciation Rights Plan
In September 2004, the Company's Board of Directors approved a Stock
Appreciation Rights (SAR) Plan (the Plan), the purpose of which is to
attract, retain, reward and motivate employees and consultants to promote
the Company's best interests and to share in its future success. The Plan
authorizes the Board's Compensation Committee to grant up to two million
SAR awards to eligible officers, employees and consultants. Each award,
when granted, provides the participant with the right to receive payment in
cash, upon exercise, for the appreciation in market value of a share of
SMSC common stock over the award's exercise price. The exercise price of a
SAR is equal to the closing market price of SMSC stock on the date of
grant. SAR awards generally vest over four or five-year periods, and expire
no later than ten years from the date of grant. The Company recognizes
compensation expense for the appreciation of a SAR award's market value
over its exercise price over the term of the award.
During the quarter ended November 30, 2004, the Company awarded
approximately 1.5 million SARs, which will vest ratably over four and
five-year periods on the anniversary date of the awards. All of these SAR
awards were granted on the same date and carry an exercise price of $17.10.
The Company recorded $0.9 million of compensation expense for these awards
during the quarter ended November 30, 2004.
15. Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 151, "Inventory Costs, An Amendment of ARB No. 43, Chapter 4."
SFAS No. 151 clarifies that abnormal inventory costs such as costs of idle
facilities, excess freight and handling costs, and wasted materials
(spoilage) are required to be recognized as current period charges. The
provisions of SFAS No. 151 are effective for fiscal years beginning after
June 15, 2005. The Company is currently evaluating the provisions of SFAS
No. 151 and does not expect that its adoption will have a material impact
on its consolidated financial position, results of operations and cash
flows.
In December 2004, the FASB issued SFAS No. 123R (Revised 2004),
"Share-Based Payment". The scope of SFAS No. 123R includes a wide range of
share-based compensation arrangements including share options, restricted
share plans, performance-based awards, share appreciation rights, and
employee stock purchase plans. SFAS No. 123R replaces SFAS No. 123,
"Accounting for Stock-Based Compensation," and supersedes APB Opinion No.
25, "Accounting for Stock Issued to Employees." SFAS No. 123, as originally
issued in 1995, established as preferable a fair-value-based method of
accounting for share-based payment transactions with employees. However,
that statement permitted the option of continuing to apply the guidance in
APB Opinion 25, provided that the footnotes to the consolidated financial
statements disclosed pro forma net income and net income per share, as if
the preferable fair-value-based method had been applied. SFAS No. 123R
requires that compensation costs relating to share-based payment
transactions be recognized in the consolidated financial statements.
Compensation costs will be measured based on the fair value of the equity
or liability instruments issued. SFAS No. 123R is effective as of the first
interim or annual reporting period that begins after June 15, 2005. The
Company is currently evaluating the impact of SFAS No. 123R and believes
that the adoption of this statement could have a material impact on its
consolidated financial position, results of operations and cash flows.
In December 2004, the FASB issued Statement No. 153, "Exchanges of
Nonmonetary Assets", an amendment of APB Opinion No. 29. SFAS No. 153
addresses the measurement of exchanges of nonmonetary assets and redefines
the scope of transactions that should be measured based on the fair value
of the assets exchanged. SFAS No. 153 is effective for nonmonetary asset
exchanges in fiscal periods beginning after June 15, 2005. The Company does
not believe adoption of SFAS No. 153 will have a material effect on its
consolidated financial position, results of operations or cash flows.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's
Condensed Consolidated Financial Statements and notes thereto contained in
this report.
Portions of this report may contain forward-looking statements about
expected future events and financial and operating results that involve
risks and uncertainties. These include the timely development and market
acceptance of new products; the impact of competitive products and pricing;
the effect of changing economic conditions in domestic and international
markets; changes in customer order patterns and creditworthiness; loss of
key customers, order cancellations or reduced bookings; and excess or
obsolete inventory and variations in inventory valuation, among others.
Words such as "believe," "expect," "anticipate" and similar expressions
identify forward-looking statements. Such statements are qualified in their
entirety by the inherent risks and uncertainties surrounding future
expectations and may not reflect the potential impact of any future
acquisitions, mergers or divestitures.
SMSC competes in the semiconductor industry, which has historically been
characterized by intense competition, rapid technological change, cyclical
market patterns, price erosion and periods of mismatched supply and demand.
In addition, sales of many of the Company's products depend largely on
sales of personal computers (PCs) and peripheral devices, and reductions in
the rate of growth of the PC, consumer electronics and embedded markets
could adversely affect its operating results. SMSC conducts business
outside the United States and is subject to tariff and import regulations
and currency fluctuations, which may have an effect on its business. All
forward-looking statements speak only as of the date hereof and are based
upon the information available to SMSC at this time. Such information is
subject to change, and the Company may not inform, or be required to
inform, investors of such changes. These and other risks and uncertainties,
including potential liability resulting from pending or future litigation,
are detailed from time to time in the Company's reports filed with the SEC.
Investors are advised to read the Company's Annual Report on Form 10-K and
quarterly reports on Form 10-Q filed with the SEC, particularly those
sections entitled "Other Factors That May Affect Future Operating Results,"
for a more complete discussion of these and other risks and uncertainties.
Recently enacted and proposed changes in the laws and regulations affecting
public companies, including the provisions of the Sarbanes-Oxley Act of
2002, have increased the Company's expenses as it evaluates the
implications of these new rules and devotes resources to respond to the new
requirements. The Sarbanes-Oxley Act mandates, among other things, that
companies adopt new corporate governance measures and imposes comprehensive
reporting and disclosure requirements, sets stricter independence and
financial expertise standards for audit committee members and imposes
increased civil and criminal penalties for companies, their officers and
their directors for securities law violations. In particular, the Company
is incurring additional administrative expenses and investing substantial
management time to implement Section 404 of the Sarbanes-Oxley Act, which
requires management to report on, and independent auditors to attest to,
internal controls over financial reporting. The Company currently is in the
process of documenting its internal controls and testing their
effectiveness. While management currently anticipates implementing the
requirements relating to internal controls and other aspects of Section 404
in a timely manner, the evaluation and attestation process is new and
neither the Company nor its auditors have significant experience with it
and have no precedent available by which to measure compliance adequacy. If
the Company is unable to implement the requirements of Section 404 in a
timely manner or with adequate compliance, it could be required to disclose
deficiencies and take other actions which could result in the use of
significant financial and managerial resources and could also be subject to
sanctions or investigation by regulatory authorities, including the SEC or
The Nasdaq National Market. Any such action could adversely affect the
Company's financial results and the market price of its common stock.
In addition, The Nasdaq National Market, on which the Company's common
stock is listed, has also adopted comprehensive rules and regulations
relating to corporate governance. These laws, rules and regulations have
increased, and may continue to increase, the scope, complexity and cost of
the Company's corporate governance, reporting and disclosure practices. As
a result, the Company's board members, Chief Executive Officer, Chief
Financial Officer and other corporate officers could face increased risks
of personal liability in connection with the performance of their duties.
As a result, the Company may have difficultly attracting and retaining
qualified board members and officers, which would adversely affect its
business. Further, these developments could affect the Company's ability to
secure desired levels of directors' and officers' liability insurance,
requiring the Company to accept reduced insurance coverage or incur
substantially higher costs to obtain coverage.
Overview
========
Description of Business
SMSC provides semiconductor systems solutions for high-speed communication
and computing applications. Through the integration of its digital,
mixed-signal and analog design capabilities and software expertise, SMSC
delivers complete solutions that monitor and manage computing systems and
connect peripherals to computers and to one another.
The Company addresses computing, communications and consumer electronics
markets through world-leading positions in Input/Output and non-PCI
Ethernet products, innovations in USB2.0 and other high-speed serial
solutions, and integrated networking products employed in a broad range of
applications.
SMSC is a fabless semiconductor supplier, whose products are manufactured
by world-class third-party semiconductor foundries and assemblers. To
ensure the highest product quality, the Company conducts a significant
portion of its final testing requirements in the Company's own
state-of-the-art testing operation.
The Company is based in Hauppauge, New York with operations in North
America, Taiwan, Japan, Korea, China, Singapore and Europe. SMSC operates
engineering design centers in New York, Arizona and Texas.
New Brand Identity and Corporate Image
On April 26, 2004, SMSC was honored to open the Nasdaq stock market and
concurrently unveiled a new global brand identity, including a new logo,
tagline - "Success by Design," and website design at its www.smsc.com
homepage. Through its communication initiatives, the Company has placed a
renewed emphasis on building awareness of its market leadership position
and capabilities to serve its customers. The "Success by Design" tagline
underscores the Company's mission of being an essential ingredient that
fuels its customers' success. This tagline highlights SMSC's culture, which
is deliberate in the manner in which it seeks to ensure success for its
customers and stakeholders.
Critical Accounting Policies and Estimates
==========================================
This discussion and analysis of the Company's financial condition and
results of operations is based upon the unaudited condensed consolidated
financial statements included in this report, which have been prepared in
accordance with accounting principles for interim financial statements
generally accepted in the United States. The preparation of financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the
reported amount of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amount of sales and revenues and expenses during the reporting
period.
The Company believes that the critical accounting policies and estimates
listed below are important to the portrayal of the Company's financial
condition and operating results, and require critical management judgments
and estimates about matters that are inherently uncertain. Although
management believes that its judgments and estimates are appropriate and
reasonable, actual future results may differ from these estimates, and to
the extent that such differences are material, future reported operating
results may be affected.
o Revenue recognition
o Inventory valuation
o Determination of the allowance for doubtful accounts receivable
o Valuation of long-lived assets
o Accounting for deferred income tax assets
o Legal contingencies
Further information regarding these policies appears within the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in the Company's annual report on Form 10-K for the
fiscal year ended February 29, 2004 filed with the SEC on May 14, 2004.
During the three-month period ended November 30, 2004, there were no
significant changes to any critical accounting policies or to the related
estimates and judgments involved in applying these policies.
Results of Operations
=====================
Sales and Revenues
Sales and revenues for the three months ended November 30, 2004 were $50.7
million, consisting of $48.0 million of product sales and $2.7 million of
intellectual property revenues, compared to sales and revenues of $72.7
million for the prior-year's corresponding quarter, consisting of $52.3
million of product sales and $20.4 million of intellectual property
revenues. Sales and revenues for the nine months ended November 30, 2004
were $154.0 million, consisting of $145.6 million of product sales and $8.4
million of intellectual property revenues, compared to sales and revenues
of $163.8 million, consisting of $142.8 million of product sales and $21.0
million of intellectual property revenues, for the year earlier period.
The Company's product sales for the three months ended November 30, 2004
were lower than management's expectations, due to an accounts receivable
collectibility issue with one of the Company's Taiwan-based distributors.
Specifically, the Company determined that this customer, whose credit
history with the Company had consistently been excellent, was experiencing
financial distress and a lack of liquidity.
Since the Company recognizes product sales and related cost of goods sold
on shipments to distributors only upon the distributors' resale of the
products to end customers, a portion of the accounts receivable from a
distributor at any time are for products still in the distributor's
inventory, for which the Company has not yet recognized product sales.
These deferred product sales and related cost of goods sold are reported
net as Deferred income on shipments to distributors on the Company's
Consolidated Balance Sheet. Generally accepted accounting principles
preclude the recognition of revenue when collectibility is not reasonably
assured. The Company concluded that this standard had not been met with
respect to shipments to this distributor that remained uncollected at
November 30, 2004. Therefore, $4.2 million of product sales, representing
products resold by the distributor during the third fiscal quarter but
unpaid for by the distributor at November 30, 2004, were not recognized.
The original SMSC inventory cost of those products resold by the
distributor, but as yet unpaid for, as well as the inventory cost of unsold
inventory held by the distributor, was $4.6 million at November 30, 2004.
That amount is included within Other current assets on the Condensed
Consolidated Balance Sheet at that date. The Company's current expectation
is that this amount will be recovered.
The Company is not currently extending any credit to this distributor and
has arranged alternate channels for delivery of products to its end
customers. No credit will be extended to this distributor in the future
unless the Company determines that the distributor's financial condition
has improved to a point warranting consideration of credit terms.
As any payments are received from this distributor, or if collectibility
otherwise becomes reasonably assured, product sales of up to $7.2 million
from prior shipments to this distributor could be recorded in the fourth
quarter of fiscal 2005 or beyond. This includes the $4.2 million of product
sales that were not recognized in the third quarter, as discussed above,
and approximately $3.0 million of additional product sales derived from
sales of the distributor's unsold November 30, 2004 inventory. As of the
date of this filing, $1.0 million of the $7.2 million has been paid to the
Company and will be recognized as product sales in the fourth quarter of
fiscal 2005. Any additional collections will also be recognized as product
sales, in the period in which the collection occurs, or when collectibility
from this distributor becomes reasonably assured, if earlier.
The decline in product sales in the current fiscal year's third quarter,
compared to the prior year's third quarter, reflects the impact of the
above-referenced $4.2 million of product sales not recognized in this
year's third quarter. When used in this paragraph, the term "demand" will
refer to the Company's current period product sales inclusive of the
unrecognized product sales. As such, demand for the Company's products in
the third quarter of fiscal 2005 was $52.2 million, approximately level
with $52.3 million in the prior year's third quarter. Sequentially, demand
for the Company's products increased from $47.3 million in the second
quarter of fiscal 2005 to $52.2 million in the third quarter of fiscal
2005, an increase of 10%. Sequential growth was achieved in demand for both
PC I/O and non-PC I/O products, on the strength of both new design-wins and
the typical trend experienced during the holiday buying season.
Compared to the prior year's third quarter, in which non-PC I/O products
contributed 35% of total product sales, the Company has experienced strong
growth in its non-PC I/O products, which contributed 44% of product sales
for the three months ended November 30, 2004. Non-PC I/O products include
networking, connectivity and other products. During the nine months ended
November 30, 2004, non-PC I/O products contributed 42% of total product
sales, compared to 32% for the year earlier period. These mix changes
reflect the impact of new non-PC I/O design-wins, broader product
offerings, and the Company's ongoing focus on aggressively identifying and
pursuing market opportunities in its non-PC I/O product lines, and is
consistent with the Company's diversification goals.
Product sales to customers outside of North America accounted for
approximately 84% and 85% of the Company's product sales for the three and
nine-month periods ended November 30, 2004, respectively, the largest
portion of which was to the Asia and Pacific Rim region. The comparable
percentages for the three and nine-month periods in the prior fiscal year
were 95% and 93%, respectively. The Company expects that international
shipments, particularly to the Asia and Pacific Rim region, will continue
to represent a significant portion of its product sales.
Intellectual property revenues for the three and nine-month periods ended
November 30, 2004 were $2.7 million and $8.4 million, respectively,
compared to $20.5 million and $21.0 million, respectively, for the
corresponding prior-year periods. As more fully described within Note 6 to
the Condensed Consolidated Financial Statements, intellectual property
revenues for both the current and prior fiscal years include payments from
Intel Corporation pursuant to the terms of a September 2003 business
agreement. Revenues for the current fiscal year include payments under this
agreement of $2.5 million in each of the year's three fiscal quarters, and
in the prior fiscal year include the agreement's initial payment of $20
million in the quarter ended November 30, 2003.
Gross Profit
Gross profit for the quarter ended November 30, 2004 was $23.3 million, or
45.9% of sales and revenues, compared to $42.4 million, or 58.3% of sales
and revenues, for the three months ended November 30, 2003. Excluding
intellectual property revenues, gross profit from product sales was $20.5
million, or 42.8% of product sales, for the quarter ended November 30,
2004, compared to $21.9 million, or 41.9% of product sales, for quarter
ended November 30, 2003.
For the nine-month period ended November 30, 2004, gross profit was $73.8
million, or 48.0% of sales and revenues, compared to $84.6 million, or
51.6% of sales and revenues, for the nine-month period ended November 30,
2003. Excluding intellectual property revenues, gross profit from product
sales was $65.5 million, or 45.0% of product sales, for the current year
nine-month period, compared to $63.6 million, or 44.5% of product sales,
for the prior year nine-month period.
During fiscal 2005, the Company has experienced a change in its product
mix, with more of its product sales being derived from non-PC I/O products,
as compared to the year-earlier periods. While in the past, non-PC I/O
products traditionally produced higher gross profit margins than PC I/O
products, the Company has introduced new USB2.0 products into a very
competitive market that currently generate lower gross profit margins than
other non-PC I/O products. Accordingly, while gross profit as a percentage
of product sales has increased modestly for both the current three and
nine-month periods, as compared to the corresponding prior-year periods,
the Company is not currently realizing the overall increased gross profit
percentage at the level that would otherwise be expected from a higher
product sales mix of non-PC I/O products. The Company is working on
increasing its margins through design changes, enhanced product features,
and cost saving initiatives, as it continues expanding its new product
offerings in these competitive markets.
Research and Development Expenses
Research and development (R&D) expenses consist primarily of salaries and
related costs of employees engaged in research, design and development
activities, costs related to engineering design tools and computer
hardware, subcontracting costs and prototyping costs. The Company intends
to continue its efforts to develop innovative new products and technologies
and believes that an ongoing commitment to R&D is essential in order to
maintain product leadership and compete effectively. Therefore, the Company
expects to continue to make significant R&D investments in the future.
R&D expenses were $10.4 million, or approximately 20% of sales and
revenues, for the three months ended November 30, 2004, compared to $10.2
million, or approximately 14% of sales and revenues, for the three months
ended November 30, 2003. The increase in the current year's three-month
period, compared to the prior year's three-month period, includes $0.6
million of higher depreciation expenses associated with investments in
advanced semiconductor design tools, partially offset by lower costs in
several other categories. The increase in R&D expenses as a percentage of
sales and revenues in the current three-month period, compared to the prior
year's three-month period, results primarily from the higher intellectual
property revenue in the prior year period.
For the nine months ended November 30, 2004, R&D expenses were $32.5
million, or approximately 21% of sales and revenues, compared to $28.6
million, or approximately 17% of sales and revenues, for the nine months
ended November 30, 2003. The increase in the current year's nine-month
period, compared to the prior year's nine-month period, includes $1.7
million of higher compensation and benefit costs driven by engineering
staff additions, $1.7 million of higher depreciation expense associated
with investments in advanced semiconductor design tools, $0.6 million of
higher device prototype costs and $0.2 million of stock-based compensation
expense associated with the Company's SAR Plan. The largest portion of the
increase in R&D expenses as a percentage of sales and revenues in the
current nine-month period, compared to the prior year's nine-month period,
results from the higher intellectual property revenue in the prior-year
period.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $13.0 million, or
approximately 26% of sales and revenues, for the quarter ended November 30,
2004, compared to $11.6 million, or approximately 16% of sales and
revenues, for the quarter ended November 30, 2003. The increase in the
current year's three-month period, compared to the prior year's three-month
period, includes $0.9 million of higher legal fees associated with
litigation, $0.4 million of expenses associated with projects to achieve
compliance with provisions of the Sarbanes-Oxley Act of 2002, and $0.6
million of stock-based compensation expense associated with the Company's
SAR Plan, partially offset by the impact of $0.8 million of special
incentives paid in the prior year's third quarter. The increase in expenses
as a percentage of sales and revenues in the current three-month period,
compared to the prior year's three-month period, results primarily from the
higher intellectual property revenue in the prior year period.
For the current nine-month period, selling, general and administrative
expenses were $36.7 million, or approximately 24% of sales and revenues,
compared to $31.0 million, or approximately 19% of sales and revenues, in
the prior year nine-month period. The increase in the current year's
nine-month period, compared to the prior year's nine-month period, includes
$1.9 million of higher legal fees associated with litigation, $1.9 million
of higher expenses associated with expanded worldwide resources in sales
and marketing, $0.5 million of higher publicity and advertising expenses,
$0.8 million of expenses associated with projects to achieve compliance
with provisions of the Sarbanes-Oxley Act of 2002, and $0.6 million of
stock-based compensation expense associated with the Company's SAR Plan,
partially offset by the impact of $0.8 million of special incentives paid
in the prior year period.
Amortization of Intangible Assets
For the three and nine-month periods ended November 30, 2004, the Company
recorded amortization expenses of $0.3 million and $0.8 million,
respectively, for intangible assets associated with the June 2002
acquisition of Gain. Comparable amortization expense was $0.3 million and
$1.0 million for the three and nine-month periods ended November 30, 2003.
Real Estate Transactions
During the quarter ended November 30, 2004, the Company sold its remaining
parcel of unused real estate in Hauppauge, New York, for net proceeds of
$1.7 million, after transaction costs. This property had a carrying value
of approximately $0.4 million. The contract of sale requires the Company to
complete the remediation of certain soil contamination of uncertain origin
identified at this property, at its expense, the completion of which is
subject to regulatory approval. The completion date and cost of this
remediation project are not yet determined, but based upon existing
information, management expects to complete the project within twelve
months at a cost no greater than $0.5 million.
In a real estate sale, if a seller retains involvement with a property
after it is sold in any way that results in retention of substantial risks
or rewards of ownership, an "absence-of-continuing-involvement" criterion,
which is required for the seller's recognition of a gain, has not been
achieved. As a result of the arrangement described above, the
"absence-of-continuing-involvement" criterion in this transaction has not
yet been satisfied and accordingly no gain has been reflected within the
Company's Consolidated Statement of Operations. The $1.3 million excess of
the net proceeds from the sale over the carrying value of the property is
included within Accrued expenses, income taxes and other liabilities on the
Company's November 30, 2004 Condensed Consolidated Balance Sheet. Any gain
on this transaction, net of costs incurred in the remediation project, will
be recorded upon satisfaction of the "absence-of-continuing-involvement"
criterion.
During the quarter ended May 31, 2003, the Company sold certain portions of
its Hauppauge, New York real estate holdings, for aggregate proceeds of
$7.0 million, net of transaction costs. These transactions resulted in an
aggregate gain of $1.7 million, $1.4 million of which related to property
in which the Company has no continued interest and was recognized within
the Company's fiscal 2004 first quarter operating results, and $0.3 million
of which related to property that the Company has leased back from the
purchaser and was therefore deferred. This deferred gain is being
recognized within the Company's operating results as a reduction in rent
expense on a straight-line basis over a 30-month period beginning in June
2003, consistent with the term of the lease. As of November 30, 2004, the
Company's remaining rent obligation over the term of this lease is
approximately $0.3 million.
Other Income and Expense
During the quarter ended May 31, 2003, the Company sold its remaining
equity investment in Chartered Semiconductor Manufacturing, Ltd., realizing
losses of $0.7 million, which are included within Other expense, net, for
the nine-month period ended November 30, 2003.
Provision For Income Taxes
The Company's effective income tax rate primarily reflects statutory
Federal and state income tax rates, adjusted for the impact of tax-exempt
interest income and anticipated income tax credits.
The Company's $1.1 million provision for income taxes for the nine-month
period ended November 30, 2004 reflects an expected fiscal 2005 effective
tax rate of 24.5%, as well as a $0.3 million tax benefit related to prior
fiscal years, primarily due to better than expected settlements of open tax
audits. The 24.5% effective tax rate for fiscal 2005 is lower than the
26.5% effective rate which was expected as of August 31, 2004, reflecting a
higher proportionate impact of income tax credits and tax-exempt interest
income against a reduced pre-tax income projection. The $0.3 million income
tax benefit recorded for the three months ended November 30, 2004 reflects
the cumulative impact of this lower expected effective income tax rate as
well as the $0.3 million tax benefit related to prior fiscal years.
The $7.6 million provision for income taxes for the nine-month period ended
November 30, 2003 resulted in an effective income tax rate of 29.3% for
that period. This provision for income taxes included the tax effects of
certain special transactions, including real estate and equity investment
sales, and $20 million of special intellectual property revenues, income
taxes on all of which are recorded when they occur, at the Company's
incremental income tax rate of approximately 36.0%. The prior year's
provision for income taxes also reflected a $0.8 million income tax benefit
related to prior fiscal years, primarily due to better than expected
settlements of open tax audits.
Discontinued Operations
The Company had been involved in an arbitration proceeding with Accton
Technology Corporation (Accton) and SMC Networks, Inc. (Networks), relating
to claims associated with the October 1997 purchase of a majority interest
in Networks by Accton from SMSC. The divestiture was accounted for as a
discontinued operation, and accordingly, costs associated with this action,
net of income taxes, were reported within Loss from discontinued operations
on the Consolidated Statements of Operations. These costs were negligible
for the quarter ended November 30, 2003, and totaled $0.2 million for the
nine-month period ended November 30, 2003, after applicable income tax
benefits. This action was settled during the fourth quarter of fiscal 2004.
Liquidity and Capital Resources
===============================
The Company currently finances its operations through a combination of
existing resources and cash generated by operations.
The Company's cash, cash equivalents and liquid investments (including
marketable securities with maturities in excess of one year) were $180.9
million at November 30, 2004, compared to $173.9 million at February 29,
2004, an increase of $7.0 million. The Company's operating activities
provided $10.5 million of cash during the first nine months of fiscal 2005,
compared to $34.3 million for the first nine months of fiscal 2004. The
higher net cash provided from operating activities in the first nine months
of fiscal 2004, compared to the fiscal 2005 nine-month period, reflects
$12.5 million of higher intellectual property revenue payments from Intel
Corporation in the prior year period and the impact of an increase in
inventories during the current period, partially offset by $6.7 million of
income tax refunds, net of income taxes paid, in the current period.
The Company's inventories were $38.0 million at November 30, 2004, an
increase of $14.8 million compared to $23.2 million at February 29, 2004.
This increase resulted from the replenishment of depleted buffer stocks, as
well as accelerated purchases of high-volume parts in response to apparent
shortages in the supply chain earlier in fiscal 2005. The Company currently
estimates that its inventories will be below $35 million by the end of the
fiscal year and should return to normal turnover levels by the end of the
first quarter of fiscal 2006.
Accounts receivable declined from $21.9 million at February 29, 2004 to
$16.8 million at November 30, 2004, a decrease of $5.1 million. The
majority of this decline reflects the impact of an accounts receivable
collectibility issue with one customer, as discussed in detail within the
"Sales and Revenues" portion of this analysis. Partially offsetting the
impact of the collectibility issue has been the impact of a reduction in
unclaimed pricing credits by distributors during fiscal 2005. SMSC accrues
a liability for distributor pricing credits when the distributor ships the
Company's products and earns such credits, but the issuance of the actual
credit memo to the distributor is dependent upon the distributor's
submission of an appropriate claim to SMSC. Delays in distributors' claims
for these credits typically results in lower than expected accounts
receivable balances, since the delays result in full collections for
certain invoices against which the distributor is actually entitled to, but
has not yet claimed, a pricing credit. It has been the Company's experience
that all such pricing credits are claimed, although the timing of the
claims varies by distributor. Pricing credits are recorded as a reduction
of product sales when accrued.
Other than the collectibility issue with one customer as discussed earlier,
the remainder of the Company's accounts receivable portfolio is almost
entirely current.
Capital expenditures for the nine-month period ended November 30, 2004 were
$7.3 million, and were predominantly for production test equipment,
investments in intellectual property used in product design activities and
facility improvements. Capital expenditures for the nine-month period ended
November 30, 2003 were $8.6 million, including $4.3 million in advanced
design tools that were financed on a short-term basis by the supplier with
payment terms which extended through fiscal 2004. As of November 30, 2003,
the $1.1 million remaining obligation under this arrangement was reported
within Accounts payable.
The Company anticipates that capital expenditures in fiscal 2006 will
exceed those expected to be incurred during fiscal 2005, due in part to the
Company's plan to begin construction of an addition to its primary facility
in Hauppauge, New York, during the fourth quarter of fiscal 2005. The
current plan is to expand the facility from its current 80,000 square feet
to approximately 200,000 square feet, allowing consolidation of the
Company's Hauppauge operations into a single facility during fiscal 2007.
The Company currently expects that the cost of this expansion will be
between $15 million and $20 million. There were no material commitments for
capital expenditures as of November 30, 2004.
Proceeds from the issuance of common stock of $13.7 million reported in the
prior year's nine-month period represents proceeds from common stock issued
under the Company's stock option plans, compared to $3.6 million of such
proceeds during the current year's nine-month period. The prior year
period's activity was driven by increases in the market price of the
Company's common stock during that period.
During the quarter ended August 31, 2004, the Company filed claims for $7.3
million of Federal income tax refunds which resulted from the carry back of
several capital losses realized during fiscal 2004 against capital gains
reported in previous fiscal years. Refunds of $6.9 million were received
against these claims during the second quarter, and receipt of the
remaining $0.4 million refund is dependent upon completion of the related
I.R.S. audit.
For federal income tax purposes, the Company has $7.2 million of net
operating loss carryforwards that are available to offset ordinary taxable
income generated in fiscal 2005 and beyond.
The Company has considered in the past, and will continue to consider,
various possible transactions to secure necessary foundry manufacturing
capacity, including equity investments in, prepayments to, or deposits with
foundries, in exchange for guaranteed capacity or other arrangements which
address the Company's manufacturing requirements. The Company may also
consider utilizing cash to acquire or invest in complementary businesses or
products or to obtain the right to use complementary technologies. From
time to time, in the ordinary course of business, the Company may evaluate
potential acquisitions of or investment in such businesses, products or
technologies owned by third parties.
The Company expects that its cash, cash equivalents, short-term
investments, cash flows from operations and its borrowing capacity will be
sufficient to finance the Company's operating and capital requirements for
at least the next twelve months and for the foreseeable future thereafter.
Recent Accounting Pronouncements
--------------------------------
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, An
Amendment of ARB No. 43, Chapter 4." SFAS No. 151 clarifies that abnormal
inventory costs such as costs of idle facilities, excess freight and
handling costs, and wasted materials (spoilage) are required to be
recognized as current period charges. The provisions of SFAS No. 151 are
effective for fiscal years beginning after June 15, 2005. The Company is
currently evaluating the provisions of SFAS No. 151 and does not expect
that its adoption will have a material impact on its consolidated financial
position, results of operations and cash flows.
In December 2004, the FASB issued SFAS No. 123R (Revised 2004),
"Share-Based Payment". The scope of SFAS No. 123R includes a wide range of
share-based compensation arrangements including share options, restricted
share plans, performance-based awards, share appreciation rights, and
employee stock purchase plans. SFAS No. 123R replaces SFAS No. 123,
"Accounting for Stock-Based Compensation," and supersedes APB Opinion No.
25, "Accounting for Stock Issued to Employees." SFAS No. 123, as originally
issued in 1995, established as preferable a fair-value-based method of
accounting for share-based payment transactions with employees. However,
that statement permitted the option of continuing to apply the guidance in
APB Opinion 25, provided that the footnotes to the consolidated financial
statements disclosed pro forma net income and net income per share, as if
the preferable fair-value-based method had been applied. SFAS No. 123R
requires that compensation costs relating to share-based payment
transactions be recognized in the consolidated financial statements.
Compensation costs will be measured based on the fair value of the equity
or liability instruments issued. SFAS No. 123R is effective as of the first
interim or annual reporting period that begins after June 15, 2005. The
Company is currently evaluating the impact of SFAS No. 123R, and believes
that the adoption of this statement could have a material impact on its
consolidated financial position, results of operations and cash flows.
In December 2004, the FASB issued Statement No. 153, "Exchanges of
Nonmonetary Assets", an amendment of APB Opinion No. 29. SFAS No. 153
addresses the measurement of exchanges of nonmonetary assets and redefines
the scope of transactions that should be measured based on the fair value
of the assets exchanged. SFAS No. 153 is effective for nonmonetary asset
exchanges in fiscal periods beginning after June 15, 2005. The Company does
not believe adoption of SFAS No. 153 will have a material effect on its
consolidated financial position, results of operations or cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Financial Market Risks
======================
Interest Rate Risk - The Company's exposure to interest rate risk relates
primarily to its investment portfolio. The primary objective of SMSC's
investment portfolio management is to invest available cash while
preserving principal and meeting liquidity needs. In accordance with the
Company's investment policy, investments are placed with high
credit-quality issuers and the amount of credit exposure to any one issuer
is limited.
As of November 30, 2004, the Company's $61.1 million of short-term
investments consisted primarily of investments in corporate, government and
municipal obligations with maturities of between three and twelve months.
If market interest rates were to increase immediately and uniformly by 10
percent from levels at November 30, 2004, the Company estimates that the
fair value of these short-term and long-term investments would decline by
an immaterial amount. The Company generally expects to hold these
investments until maturity and, therefore, would not expect operating
results or cash flows to be affected to any significant degree by a sudden
change in market interest rates.
Equity Price Risk - The Company has no material investments in equity
securities of other companies on its Consolidated Balance Sheet as of
November 30, 2004.
Foreign Currency Risk - The Company has international sales and
expenditures and is, therefore, subject to certain foreign currency rate
exposure. The Company conducts a significant amount of its business in Asia
and the Pacific Rim region. In order to reduce the risk from fluctuation in
foreign exchange rates, most of the Company's product sales and all of its
arrangements with its foundry, test and assembly vendors are denominated in
U.S. dollars. Most transactions in the Japanese market made by the
Company's subsidiary, SMSC Japan, are denominated in Japanese yen. SMSC
Japan purchases a significant amount of its products for resale from SMSC
in U.S. dollars, and from time to time has entered into forward exchange
contracts to hedge against currency fluctuations associated with these
product purchases. No such contracts were executed during either fiscal
2004 or the first nine months of fiscal 2005, and there are no obligations
under any such contracts as of November 30, 2004.
The Company has never received a cash dividend (repatriation of cash) from
SMSC Japan.
Other Factors That May Affect Future Operating Results
======================================================
As a supplier of semiconductors, the Company competes in a challenging
business environment, which is characterized by intense competition, rapid
technological changes and cyclical business patterns. Except for the
historical information contained herein, the matters discussed in this
report are forward-looking statements. The Company faces a variety of risks
and uncertainties in conducting its business, some of which are out of its
control, and any of which, were they to occur, could impair the Company's
operating performance. For a more detailed discussion of risk factors,
please refer to the Company's annual report on Form 10-K for the fiscal
year ended February 29, 2004 filed with the Securities and Exchange
Commission on May 14, 2004.
ITEM 4. CONTROLS AND PROCEDURES
The Company has carried out an evaluation under the supervision and with
the participation of the Company's management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures.
There are inherent limitations to the effectiveness of any system of
disclosure controls and procedures, including the possibility of human
error and the circumvention or overriding of the controls and procedures.
Accordingly, even effective disclosure controls and procedures can only
provide reasonable assurance of achieving their control objectives. Based
upon the Company's evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that, as of November 30, 2004, the
disclosure controls and procedures are effective to provide reasonable
assurance that information required to be disclosed in the reports the
Company files under the Exchange Act is recorded, processed, summarized,
and reported as and when required.
There has been no change in the Company's internal control over financial
reporting during the Company's fiscal quarter covered by this report that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
In June 2003, SMSC was named as a defendant in a patent infringement
lawsuit filed by Analog Devices, Inc. (ADI) in the United States District
Court for the District of Massachusetts (Analog Devices, Inc. v. Standard
Microsystems Corporation, Case Number 03 CIV 11216). The Complaint, as
amended, alleges that some of the Company's products infringe one or more
of three of ADI's patents, and seeks injunctive relief and unspecified
damages. In September 2003, the Company filed an Answer in the lawsuit,
denying ADI's allegations and raising affirmative defenses and
counterclaims. The Company is vigorously defending the lawsuit and
collecting evidence to support its defenses to infringement and its
allegations of patent invalidity and unenforceability. A trial date in the
first quarter of calendar 2005 is expected to be scheduled. Although it is
premature to assess the outcome of the litigation, the Company believes
that the allegations against it are without merit.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 - Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
(17 CFR 240.13a-14(a)), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 - Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
(17 CFR 240.13a-14(a)), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 - Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
On September 22, 2004, SMSC filed a report on Form 8-K pursuant to which it
furnished a press release announcing the Company's operating results for
the second quarter of fiscal 2005.
On October 1, 2004, SMSC filed a report on Form 8-K pursuant to which it
announced the adoption of the Standard Microsystems Corporation 2004
Employee Stock Appreciation Rights Plan, which was approved by the
Company's Board of Directors on September 28, 2004.
SIGNATURE
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.
STANDARD MICROSYSTEMS CORPORATION
DATE: January 10, 2005 By: /s/ Andrew M. Caggia
-------------------------
(Signature)
Andrew M. Caggia
Senior Vice President - Finance
(duly authorized officer) and
Chief Financial Officer
(principal financial officer)